2023-24774
[Federal Register Volume 88, Number 223 (Tuesday, November 21, 2023)]
[Proposed Rules]
[Pages 81236-81292]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-24774]
[[Page 81235]]
Vol. 88
Tuesday,
No. 223
November 21, 2023
Part III
Commodity Futures Trading Commission
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17 CFR Parts 1, 22, and 30
Investment of Customer Funds by Futures Commission Merchants and
Derivatives Clearing Organizations; Proposed Rule
Federal Register / Vol. 88 , No. 223 / Tuesday, November 21, 2023 /
Proposed Rules
[[Page 81236]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 22, and 30
RIN 3038-AF24
Investment of Customer Funds by Futures Commission Merchants and
Derivatives Clearing Organizations
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing to amend its regulations governing the types of
investments that futures commission merchants (``FCMs'') and
derivatives clearing organizations may make with funds held for the
benefit of customers trading futures, foreign futures, and cleared swap
transactions. The Commission is also specifying market risk capital
charges that an FCM would be required to take on the revised permitted
investments in computing the firm's adjusted net capital. The proposed
amendments would also amend regulations that require each FCM to report
to the Commission and to the firm's designated self-regulatory
organization the name, location, and amount of customer funds held by
each depository, including any investments of customer funds held by
the depository. Lastly, the Commission is proposing to revise its
regulations to eliminate the requirement that a depository holding
customer funds must provide the Commission with read-only electronic
access to such accounts for the FCM to treat the funds held in the
accounts as customer segregated fund accounts.
DATES: Comments must be received on or before January 17, 2024.
ADDRESSES: You may submit comments, identified by RIN 3038-AF24, 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
Center, 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 (``FOIA''), 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.\1\
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\1\ 17 CFR 145.9. Commission Regulations referred to herein are
found at 17 CFR Chapter I, and are accessible on the Commission's
website: https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm.
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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 rulemaking 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: Amanda L. Olear, Director, (202) 418-
5213, [email protected]; Thomas J. Smith, Deputy Director, 202-418-5495,
[email protected]; Warren Gorlick, Associate Director, 202-418-5195,
[email protected]; Liliya Bozhanova, Special Counsel, 202-418-6232,
[email protected]; Joo Hong, Risk Analyst, (202) 418-6221,
[email protected], Market Participants Division, or Lihong McPhail,
Research Economist, (202) 418-5722, [email protected], Office of the
Chief Economist, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581; Scott Sloan, Special
Counsel, 312-596-0708, [email protected], Division of Clearing and Risk,
Commodity Futures Trading Commission, 77 West Jackson Boulevard, Suite
800, Chicago, Illinois 60604.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Background and Statutory Authority
1. Segregation of Customer Funds by Futures Commission Merchants
and Derivatives Clearing Organizations
2. Authority for Futures Commission Merchants and Derivatives
Clearing Organizations To Invest Customer Funds
II. Requests for Amendments to the List of Permitted Investments
III. Proposal
A. Investment of Customer Funds
1. Interests in Money Market Funds
2. Foreign Sovereign Debt
3. Interests in U.S. Treasury Exchange-Traded Funds
4. Investments in Commercial Paper and Corporate Notes or Bonds
5. Investments in Permitted Investments With Adjustable Rates of
Interest
6. Investments in Certificates of Deposit Issued by Banks
B. Asset-Based and Issuer-Based Concentration Limits for
Permitted Investments
C. Futures Commission Merchant Capital Charges on Permitted
Investments
D. Segregation Investment Detail Report
E. Read-Only Electronic Access to Customer Funds Accounts
Maintained by Futures Commission Merchants
F. Proposed Conforming Amendments
IV. Section 4(c) of the Act
V. Administrative Compliance
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost-Benefit Considerations
a. Foreign Sovereign Debt, Interests in Exchange-Traded Funds,
and Associated Capital Charges
b. Government Money Market Funds, Commercial Paper and Corporate
Notes or Bonds, and Certificates of Deposit Issued by Banks
c. SOFR as a Permitted Benchmark
d. Revision of the Read-Only Access Provisions
D. Antitrust Laws
I. Introduction
A. Background and Statutory Authority
1. Segregation of Customer Funds by Futures Commission Merchants and
Derivatives Clearing Organizations
A primary objective of the Commodity Exchange Act (``Act'') \2\ and
Commission regulations is the establishment of a framework to safeguard
funds of customers engaging in CFTC-regulated derivative transactions.
A core component of the framework is the requirement for a futures
commission merchant (``FCM'') or a derivatives clearing organization
(``DCO'') to treat customer funds as belonging to the customers and not
as the property of the FCM or DCO, and for the FCM or DCO to segregate
customer funds from its own funds by holding the funds in specially
designated customer accounts maintained at banks, trust companies,
FCMs, or DCOs, as applicable. The segregation of customer funds from an
FCM's or DCO's own funds is intended to ensure that customer funds are
used
[[Page 81237]]
only to support customer trading and transactions, and to facilitate
the return of the funds to customers in the event of the insolvency of
the FCM or DCO.
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\2\ 7 U.S.C. 1 et seq.
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Customer funds are classified into one of three distinct regulatory
frameworks that are based on the derivatives markets on which the
customers are transacting. Specifically, customer funds are classified
as either: (i) ``futures customer funds;'' (ii) ``Cleared Swaps
Customer Collateral;'' or (iii) ``30.7 customer funds.'' \3\ The term
``futures customer funds'' is defined by Regulation 1.3 to mean, in
relevant part, all money, securities, and property received by an FCM
or a DCO from, for, or on behalf of ``futures customers'' \4\ to
margin, guarantee, or secure futures and options on futures
transactions traded on a CFTC-designated contract market, and all money
accruing to futures customers as a result of trading futures and
options on futures. Section 4d(a)(2) of the Act requires an FCM to
treat and deal with futures customer funds received to margin,
guarantee, or secure trades or contracts of any futures customer, or
accruing to a futures customer as the result of such trades or
contracts, as belonging to the futures customer.\5\ Section 4d(a)(2)
further provides that an FCM may not commingle futures customer funds
of a futures customer with the FCM's own funds, provided, however, that
the FCM may commingle the futures customer funds of two or more futures
customers and deposit the funds with any bank, trust company, DCO, or
other FCM.\6\
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\3\ See generally, 17 CFR 1.20 (segregation framework for
futures customer funds); 17 CFR 22.2 and 22.3 (segregation framework
for Cleared Swaps Customer Collateral); and 17 CFR 30.7 (segregation
framework for 30.7 customer funds).
\4\ The term ``futures customer'' is defined by Regulation 1.3
to mean, in relevant part, any person who uses an FCM as an agent in
connection with trading in any contract for the purchase or sale of
a commodity for future delivery or any option on such contract. 17
CFR 1.3.
\5\ 7 U.S.C. 6d(a)(2).
\6\ Id.
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Section 4d(b) of the Act addresses the duties imposed on DCOs and
other depositories receiving futures customer funds from FCMs pursuant
to Section 4d(a)(2) of the Act.\7\ Section 4d(b) provides that it is
unlawful for any person, including a DCO, that has received futures
customer funds to hold, dispose of, or use the funds as belonging to
the depositing FCM or any person other than the futures customers of
the FCM.\8\ The Commission adopted Regulations 1.20 through 1.30, and
Regulations 1.32 and 1.49, to implement the segregation requirements
for futures customer funds mandated by Sections 4d(a)(2) and 4d(b) of
the Act.\9\
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\7\ 7 U.S.C. 6d(b).
\8\ Id.
\9\ 17 CFR 1.20 through 17 CFR 1.30, 17 CFR 1.32, and 17 CFR
1.49.
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The term ``Cleared Swaps Customer Collateral'' is defined by
Regulations 1.3 and 22.1 \10\ to mean, in relevant part, all money,
securities, or other property received by an FCM or a DCO from, for, or
on behalf of, a ``Cleared Swaps Customer'' to margin, guarantee, or
secure ``Cleared Swap'' positions.\11\ Section 4d(f)(2)(A) of the Act
requires an FCM to treat Cleared Swaps Customer Collateral received
from a Cleared Swaps Customer, or accruing to a Cleared Swaps Customer
as a result of Cleared Swap positions, as belonging to the Cleared
Swaps Customer.\12\ Section 4d(f)(2)(B) of the Act provides that an FCM
may not commingle Cleared Swaps Customer Collateral of a Cleared Swaps
Customer with the FCM's own funds,\13\ provided, however, that the FCM
may commingle Cleared Swaps Customer Collateral of two or more Cleared
Swap Customers and deposit the funds in any bank, trust company, DCO,
or other FCM.\14\ Section 4d(f)(6) of the Act provides that it is
unlawful for any person, including a DCO and any depository
institution, that has received Cleared Swaps Customer Collateral to
hold, dispose of, or use the Cleared Swaps Customer Collateral as
belonging to the depositing FCM or any person other than the Cleared
Swaps Customer of the FCM.\15\ The Commission adopted Regulations 22.2
through 22.13, and Regulations 22.15 through 22.17, to implement the
segregation requirements for Cleared Swaps Customer Collateral mandated
by Section 4d(f) of the Act.\16\
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\10\ 17 CFR 22.1.
\11\ The term ``Cleared Swaps Customer'' is defined by
Regulation 22.1 to mean, in relevant part, any customer entering
into a Cleared Swap. The term ``Cleared Swap'' is defined to mean
any swap that is, directly or indirectly, submitted to and cleared
by a DCO registered with the Commission. See 7 U.S.C. 1a(7) and 17
CFR 22.1.
\12\ 7 U.S.C. 6d(f)(2)(A).
\13\ 7 U.S.C. 6d(f)(2)(B).
\14\ 7 U.S.C. 6d(f)(3)(A)(i).
\15\ 7 U.S.C. 6d(f)(6).
\16\ 17 CFR 22.2 through 17 CFR 22.13, 17 CFR 22.15 through 17
CFR 22.17.
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The term ``30.7 customer funds'' is defined by Regulation 30.1 to
mean any money, securities, or other property received by an FCM from,
for, or on behalf of a U.S. person or foreign-domiciled person (a
``30.7 customer'') \17\ to margin, guarantee, or secure futures or
options on futures positions executed on foreign boards of trade
(``foreign futures'').\18\ Section 4(b)(2)(A) of the Act authorizes the
Commission to adopt regulations imposing requirements on FCMs regarding
the safeguarding of 30.7 customer funds deposited by 30.7 customers for
trading on foreign boards of trade.\19\ The Commission adopted
Regulation 30.7 pursuant to Section 4(b)(2)(A) of the Act.\20\
Regulation 30.7(e)(2) requires an FCM to segregate 30.7 customer funds
from the FCM's own funds, and Regulation 30.7(b) provides that an FCM
may hold 30.7 customer funds with designated depositories, including
banks, trust companies, DCOs, foreign brokers, and clearing
organizations of foreign boards of trade.\21\
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\17\ The term ``30.7 customer'' is defined by Regulation 30.1 to
mean any person located in the U.S., its territories or possessions,
as well as any foreign-domiciled person, who trades in foreign
futures or foreign options. 17 CFR 30.1.
\18\ 17 CFR 30.1.
\19\ 7 U.S.C. 6(b)(2)(A).
\20\ 17 CFR 30.7.
\21\ 17 CFR 30.7(b) and 17 CFR 30.7(e)(2).
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Throughout this release, the terms ``futures customer funds,''
``Cleared Swaps Customer Collateral,'' and ``30.7 customer funds'' are
collectively referred to as ``Customer Funds,'' unless otherwise
stated.
2. Authority for Futures Commission Merchants and Derivatives Clearing
Organizations To Invest Customer Funds
Section 4d(a)(2) of the Act authorizes FCMs to invest futures
customer funds in: (i) obligations of the U.S.; (ii) obligations fully
guaranteed as to principal and interest by the U.S.; and (iii) general
obligations of any State or of any political subdivision of a
State.\22\ Regulation 1.25 was initially adopted to implement Section
4d(a)(2), and authorized FCMs and DCOs to invest futures customer funds
in the instruments set forth in Section 4d(a)(2) of the Act (the
``Permitted Investments'').\23\
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\22\ 7 U.S.C. 6d(a)(2).
\23\ See Title 17--Commodity and Securities Exchanges, 33 FR
14454 (Sept. 26, 1968), amending Regulation 1.25 and providing that
FCMs and clearing organizations may invest customer funds in
obligations of the U.S., in general obligations of any State or of
any political subdivision of any State, or in obligations fully
guaranteed as to principal and interest by the U.S.
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The Commission, in 2000, expanded the Permitted Investments beyond
the investments specifically stated in Section 4d(a)(2) of the Act to
include certificates of deposit, commercial paper, corporate notes,
foreign sovereign debt, and interests in money market funds.\24\ In
addition, the Commission
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authorized an FCM or a DCO to buy the Permitted Investments under
agreements to resell the securities (``reverse repurchase agreements'')
and to sell the Permitted Investments under agreements to repurchase
the securities (``repurchase agreements'').\25\ To minimize credit
risk, market risk, and liquidity risk, the Commission also imposed
conditions that Permitted Investments were required to meet, including
a restriction on the dollar-weighted average of the time-to-maturity of
securities held in the segregated portfolio, asset-based and issuer-
based concentration limits, and prohibitions on certain investments
containing embedded derivatives.\26\ More generally, Regulation 1.25
requires all Permitted Investments to be ``consistent with the
objectives of preserving principal and maintaining liquidity.'' \27\
The 2000 Permitted Investments Amendment was adopted under the
authority of Section 4(c) of the Act.\28\ In adopting the amendment,
the Commission stated that the expanded list of Permitted Investments
would enhance the yield available to FCMs, DCOs, and their customers
without compromising the safety of futures customer funds.\29\
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\24\ See Rules Relating to Intermediaries of Commodity Interest
Transactions, 65 FR 77993 (Dec. 13, 2000) (publishing final rules);
and Investment of Customer Funds, 65 FR 82270 (Dec. 28, 2000)
(making technical corrections and accelerating the effective date of
the final rules from February 12, 2001 to December 28, 2000)
(collectively, the ``2000 Permitted Investments Amendment'').
\25\ Id. Reverse repurchase agreements and repurchase agreements
are collectively referred to as ``Repurchase Transactions'' in the
Proposal.
\26\ 17 CFR 1.25(b).
\27\ Id.
\28\ Section 4(c)(1) of the Act empowers the Commission to
``promote responsible economic or financial innovation and fair
competition'' by exempting any transaction or class of transactions
(including any person or class of persons offering, entering into,
rendering advice or rendering other services with respect to, the
agreement, contract, or transaction), from any of the provisions of
the Act, subject to certain exceptions. The Commission may grant
such an exemption by rule, regulation, or order, after notice and
opportunity for hearing, and may do so on application of any person
or on its own initiative. See 7 U.S.C. 6(c). A further discussion of
Section 4(c)(1) of the Act is set forth in Section IV of this
Federal Register release.
\29\ See 2000 Permitted Investments Amendment at 78007.
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Following the 2000 Permitted Investments Amendment, the list of
Permitted Investments has undergone several revisions.\30\ In its
current form, Regulation 1.25 lists seven categories of investments
that qualify as Permitted Investments: (i) obligations of the U.S. and
obligations fully guaranteed as to principal and interest by the U.S.
(``U.S. government securities''); (ii) general obligations of any State
or political subdivision of a State (``municipal securities''); (iii)
obligations of any U.S. government corporation or enterprise sponsored
by the U.S. (``U.S. agency obligations''); (iv) certificates of deposit
issued by a bank; (v) commercial paper fully guaranteed by the U.S.
under the Temporary Liquidity Guarantee Program (``TLGP'') as
administered by the Federal Deposit Insurance Corporation (``FDIC'')
(``commercial paper''); (vi) corporate notes and bonds fully guaranteed
as to principal and interest by the U.S. under the TLGP (``corporate
notes and bonds''); and (vii) interests in money market mutual
funds.\31\ In addition, Regulation 1.25(a)(2) permits FCMs and DCOs to
buy and sell the Permitted Investments under Repurchase
Transactions.\32\
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\30\ See Investment of Customer Funds and Record of Investments,
70 FR 28190 (May 17, 2005) (``2005 Permitted Investments
Amendment''), and Investment of Customer Funds and Funds Held in an
Account for Foreign Futures and Foreign Options Transactions, 76 FR
78776 (Dec. 19, 2011) (``2011 Permitted Investments Amendment'').
\31\ 17 CFR 1.25(a)(1).
\32\ 17 CFR 1.25(a)(2).
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Section 4(b)(2)(A) of the Act grants the Commission the plenary
authority to adopt rules and regulations regarding an FCM's
safeguarding of 30.7 customer funds.\33\ Prior to 2011, an FCM was not
subject to restrictions on the investments that it could enter into
with 30.7 customer funds.\34\ In 2011, the Commission extended the
requirements of Regulation 1.25 to an FCM's investment of 30.7 customer
funds for trading foreign futures positions. Specifically, the
Commission amended Regulation 30.7 to provide that to the extent an FCM
invested 30.7 customer funds, it must invest such funds subject to, and
in compliance with, the terms and conditions of Regulation 1.25.\35\
The Commission exercised its plenary authority under Section 4(b) of
the Act to adopt Regulation 30.7.
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\33\ 7 U.S.C. 6(b)(2)(A).
\34\ 2011 Permitted Investments Amendment at 78777, providing
that because Congress did not expressly apply the investment
limitations set forth in Section 4d of the Act to 30.7 customer
funds, the Commission historically has not subjected such funds to
the investment limitations applicable to futures customer funds.
\35\ See 17 CFR 30.7. The Commission stated that it was
appropriate to align the investment standards of Regulation 30.7
with those of Regulation 1.25 as many of the same prudential
concerns arise with respect to both futures customer funds and 30.7
customer funds. See 2011 Permitted Investment Amendment at 78791.
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The Commission also extended the requirements of Regulation 1.25 to
FCMs and DCOs investing Cleared Swaps Customer Collateral.\36\
Regulations 22.2 and 22.3 were adopted in 2012 under the authority of
Section 4d(f)(4) of the Act,\37\ which provides that Cleared Swaps
Customer Collateral may be invested by an FCM or a DCO in: (i)
obligations of the U.S.; (ii) general obligations of any State or of
any political subdivision of a State; (iii) obligations fully
guaranteed as to principal and interest by the U.S.; and, (iv) any
other investment that the Commission may by rule or regulation
prescribe.\38\ Section 4d(f)(4) of the Act further provides that the
investments must be made in accordance with the rules and regulations,
and subject to any conditions, as the Commission prescribes.\39\
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\36\ See 17 CFR 22.2(e)(1) and 17 CFR 22.3(d).
\37\ 7 U.S.C. 6d(f).
\38\ See Protection of Cleared Swaps Customer Contracts and
Collateral; Conforming Amendments to the Commodity Amendments to the
Commodity Broker Bankruptcy Provisions, 77 FR 6336 (Feb. 7, 2012).
\39\ See 7 U.S.C. 6d(f)(4).
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In addition to setting forth the Permitted Investments that FCMs
and DCOs may enter into with Customer Funds, Regulation 1.25 also
includes several conditions on the investment of Customer Funds.
Regulation 1.25(b)(3) contains both asset-based and issuer-based
concentration limits applicable to Permitted Investments. The asset-
based concentration limit restricts the total amount of Customer Funds
that an FCM or a DCO may invest in a particular Permitted Investment to
a defined percentage of the total funds held in segregation by the FCM
or DCO.\40\ The issuer-based concentration limit caps the total amount
of Customer Funds that may be invested in instruments offered by, or
managed by, a particular issuer to a defined percentage of the total
funds held in segregation by the FCM or DCO.\41\
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\40\ 17 CFR 1.25(b)(3)(i).
\41\ 17 CFR 1.25(b)(3)(ii).
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Consistent with the objective of limiting customer risk, Commission
regulations also provide that FCMs and DCOs are financially responsible
for any losses resulting from Permitted Investments, and are explicitly
prohibited from allocating investment losses to customers or clearing
FCMs, respectively.\42\
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\42\ Regulation 1.29 provides that FCMs or DCOs, as applicable,
shall bear sole responsibility for any losses resulting from the
investment of futures customer funds, and further provides that no
investment losses shall be borne or otherwise allocated to FCM
customers or to FCMs clearing customer accounts at DCOs. 17 CFR
1.29(b).
Regulation 22.2(e)(1) provides that an FCM shall bear sole
responsibility for any losses resulting from the investment of
Cleared Swaps Customer Collateral and may not allocate investment
losses to Cleared Swaps Customers of the FCM. 17 CFR 22(e)(1).
Regulation 30.7(i) provides that an FCM shall bear sole
financial responsibility for any losses resulting from the
investment of 30.7 customer funds, and further provides that no
investment losses may be allocated to the 30.7 customers of the FCM.
17 CFR 30.7(i).
In addition, Regulation 22.3(d) provides that DCOs may invest
Cleared Swaps Customer Collateral in Permitted Investments set forth
in Regulation 1.25. The regulation, however, does not provide that a
DCO is responsible for investment losses. The Commission is
proposing to amend Regulation 22.3(d) to explicitly provide that a
DCO shall bear sole responsibility for any losses resulting from the
investment of Cleared Swaps Customer Collateral, and may not
allocate such losses to Cleared Swaps Customers. See Section III.C.
below. 17 CFR 22.3(d).
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[[Page 81239]]
The Commission has previously noted the importance of conducting
periodic reassessments of Regulation 1.25 ``and, as necessary, revising
regulatory policies to strengthen safeguards designed to minimize risk
while retaining an appropriate degree of investment flexibility and
opportunities for capital efficiency for DCOs and FCMs investing
customer segregated funds.'' \43\ In furtherance of these objectives
and in consideration of the requests for amendments to Regulation 1.25
discussed in Section II below, the Commission is proposing to amend the
list of Permitted Investments in Regulation 1.25 to: (i) add two new
asset classes (i.e., specified foreign sovereign debt instruments and
certain exchange-traded funds (``ETFs'')), subject to certain
conditions, (ii) limit the scope of money market funds (``MMFs'') whose
interests qualify as Permitted Investments, and (iii) remove corporate
notes, corporate bonds, and commercial paper. In connection with the
proposed amendments to the list of Permitted Investments, the
Commission is further proposing changes to the counterparty and
depository requirements of Regulation 1.25(d)(2) and (7) and revisions
to the concentration limits for Permitted Investments set forth in
Regulation 1.25(b)(3), and is specifying the capital charges that would
apply to the proposed new categories of Permitted Investments.
Additionally, the Commission is proposing an amendment to Regulation
22.3(d) to clarify that DCOs are financially responsible for any losses
resulting from investments of Cleared Swap Customer Collateral in
Permitted Investments, consistent with Regulation 1.29, which addresses
financial responsibility for losses resulting from investment of
futures customer funds. The proposed amendment reflects the
Commission's original intent to permit investments of Cleared Swaps
Customer Collateral within the parameters applicable to investments of
futures customer funds.\44\ The Commission is also proposing to replace
the London Interbank Offered Rate (``LIBOR'') with the Secured
Overnight Financing Rate (``SOFR'') as a permitted benchmark for
variable and floating interest rates for securities that qualify as
Permitted Investments. Each of the proposed amendments is discussed
below.
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\43\ 2011 Permitted Investments Amendment at 78777.
\44\ See Enhancing Protections Afforded Customers and Customer
Funds Held by Futures Commission Merchants and Derivatives Clearing
Organizations, 78 FR 68506 (Nov. 14, 2013) (``2013 Protections of
Customer Funds'') at 68556.
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II. Requests for Amendments to the List of Permitted Investments
The Futures Industry Association (``FIA) and CME Group Inc.
(``CME'') (collectively, the ``Petitioners'') submitted a joint
petition requesting the Commission to issue an order under Section 4(c)
of the Act, or to take such other action as the Commission deems
appropriate, to expand investments that FCMs and DCOs may enter into
with Customer Funds.\45\ The Petitioners request that the Commission
take action to permit FCMs and DCOs to invest Customer Funds in the
foreign sovereign debt of Canada, France, Germany, Japan, and the
United Kingdom (``Specified Foreign Sovereign Debt''), subject to the
condition that the investment in the foreign sovereign debt is limited
to balances owed by FCMs and DCOs to customers and FCM clearing firms,
respectively, denominated in the applicable currency of Canada, France,
Germany, Japan, or the United Kingdom.\46\ The Petitioners further
request that the Commission exempt FCMs and DCOs from the provisions of
Regulation 1.25(d)(2) to authorize FCMs and DCOs to enter into
Repurchase Transactions involving Specified Foreign Sovereign Debt with
foreign banks and foreign securities brokers or dealers and to hold
Specified Foreign Sovereign Debt in safekeeping accounts at foreign
banks.\47\
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\45\ Petition for Order under Section 4(c) of the Commodity
Exchange Act, dated May 24, 2023 (the ``Joint Petition''). On
September 22, 2023, the Petitioners submitted updated data in
support of the Joint Petition and corrected an inadvertent
transposition of data items in the Joint Petition. Supplement to
Petition for Order under Section 4(c) of the Commodity Exchange Act
(``Supplement to Joint Petition''). The Joint Petition and the
Supplement to Joint Petition are available on the Commission's
website, https://www.cftc.gov/media/9531/FIA_CMEPetition_Regulation125_052423/download and https://www.cftc.gov/media/9536/FIALetterSupplementing_Regulation125_092223/download.
\46\ Joint Petition at p. 4.
\47\ Joint Petition at p. 5.
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In support of the request, the Petitioners note that the Commission
issued an order in 2018 pursuant to Section 4(c) of the Act providing a
limited exemption to Section 4d of the Act and Regulation 1.25 to
permit DCOs to invest futures customer funds and Cleared Swaps Customer
Collateral in the foreign sovereign debt of France and Germany.\48\ The
exemption for DCOs to invest in French and German sovereign debt is
subject to conditions, including that: (i) investment in French or
German sovereign debt is limited to investments made with euro-
denominated balances owed to the futures customers and Cleared Swaps
Customers of FCM clearing members; (ii) the dollar-weighted average of
the remaining time-to-maturity of a DCO's portfolio of investments in
each of French and German sovereign debt may not exceed 60 days; and
(iii) a DCO may not make a direct investment in any sovereign debt
instrument of France or Germany that has a remaining time-to-maturity
in excess of 180 calendar days.\49\ The 2018 Order also provides that
if the two-year credit default spread of the French or German sovereign
debt exceeds 45 basis points (``BPS''), the DCO may not make any new
direct investments in the relevant sovereign debt using futures
customer funds or Cleared Swaps Customer Collateral, and must
discontinue investing futures customer funds and Cleared Swaps Customer
Collateral in the relevant debt through Repurchase Transactions as soon
as practicable under the circumstances.\50\
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\48\ Order Granting Exemption from Certain Provisions of the
Commodity Exchange Act Regarding Investment of Customer Funds and
from Certain Related Commission Regulations, 83 FR 35241 (Jul. 25,
2018) (``2018 Order''). The 2018 Order provides an exemption only to
DCOs. FCMs are not subject to the 2018 Order, and currently may not
invest Customer Funds in any foreign sovereign debt.
\49\ Conditions (3)(a), 3(c), and 3(d) of the 2018 Order at
35245.
\50\ Condition (3)(b) of the 2018 Order at 35245.
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The 2018 Order also grants an exemption from Regulation 1.25(d)(2)
to permit DCOs to enter into Repurchase Transactions involving French
or German sovereign debt with foreign banks and foreign securities
brokers or dealers as counterparties.\51\ A DCO may
[[Page 81240]]
enter into Repurchase Transactions with a foreign bank or foreign
securities broker or dealer provided that the such firm qualifies as a
permitted depository under Regulation 1.49(d)(3) and is located in a
money center country or in another jurisdiction that has adopted the
euro as its currency.\52\ The 2018 Order further grants an exemption
from the requirement in Regulation 1.25(d)(7) that securities
transferred to an FCM or a DCO under reverse repurchase agreements must
be held in safekeeping accounts with certain U.S.-domiciled banks, a
Federal Reserve Bank, a DCO, or the Depository Trust Company,\53\ to
permit DCOs to hold French or German sovereign debt received under
reverse repurchase agreements in a safekeeping account with foreign
banks that qualify as depositories for Customer Funds under Regulation
1.49(d)(3).
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\51\ As noted above, Regulation 1.25(d)(2) provides that an FCM
or a DCO may enter into Repurchase Transactions only with the
following counterparties: (i) a bank as defined in Section 3(a)(6)
of the Securities Exchange Act of 1934; (ii) a domestic branch of a
foreign bank insured by the FDIC; (iii) an SEC-registered securities
broker or dealer; or (iv) an SEC-registered government securities
broker or dealer. Section 3(a)(6) of the Securities Exchange Act of
1934 defines the term ``bank'' to mean: (i) a banking institution
organized under the laws of the U.S. or a Federal savings
association; (ii) a member bank of the Federal Reserve System; (iii)
any other banking institution or savings association doing business
under the laws of any State or the U.S., a substantial portion of
the business of which consists of receiving deposits or exercising
fiduciary powers similar to those permitted to national banks under
the authority of the Comptroller of the Currency, and which is
supervised and examined by a State or Federal authority having
supervision over banks or savings associations; and (iv) a receiver,
conservator, or other liquidating agent of any institution or firm
included in clauses (i), (ii), or (iii) above (``Section 3(a)(6)
bank''). 15 U.S.C. 78 et seq. Foreign-domiciled banks and foreign
securities brokers or dealers are not authorized counterparties for
Repurchase Transactions under Regulation 1.25(d)(2).
\52\ Regulation 1.49(d)(3) provides that a foreign depository
must be a bank or trust company that has in excess of $1 billion in
regulatory capital, a registered FCM, or a DCO in order to be a
qualified counterparty to Repurchase Transactions.
\53\ Specifically, Regulation 1.25(d)(7) provides that
securities transferred to an FCM or a DCO under a reverse repurchase
agreement must be held in a safekeeping account only with the
following depositories: (i) a Section 3(a)(6) bank; (ii) a domestic
branch of a foreign bank insured by the FDIC; (iii) a Federal
Reserve Bank; (iv) a DCO; or (v) the Depository Trust Company. A
foreign-domiciled bank is currently not an authorized depository for
securities transferred to an FCM or a DCO under Regulation
1.25(d)(7).
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The Petitioners further request that FCMs and DCOs be permitted to
invest Customer Funds in certain ETFs that invest primarily in short-
term U.S. Treasury securities (``U.S. Treasury ETFs'').\54\ In support
of their request, the Petitioners state that U.S. Treasury ETFs have
characteristics that may be consistent with those of other Permitted
Investments and may provide FCMs and DCOs with an opportunity to
diversify further their investments of customer funds.\55\
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\54\ Joint Petition at pp. 8-9.
\55\ Id.
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The Commission also received a petition from Invesco Capital
Management LLC (``Invesco''), which serves as a sponsor of various
ETFs, advocating for the addition of U.S. Treasury ETF securities to
the list of Permitted Investments.\56\ Invesco states that U.S.
Treasury ETFs will provide FCMs and DCOs with additional investment
choices for customer funds, promote operational efficiencies and offer
potentially better investment returns for FCMs, DCOs, and their
customers, and facilitate financial market innovation.\57\ Invesco
further states that permitting investments of U.S. Treasury ETFs would
be consistent with, and promote, the public interest goals enumerated
in the Act.\58\ Invesco further notes that U.S. Treasury ETFs invest in
a sub-set of the same high-quality liquid instruments that are
Permitted Investments under Regulation 1.25 (i.e., U.S. government
securities), and as such, the ETFs offer an indirect, possibly simpler,
and more cost-efficient way for FCMs and DCOs to invest Customer Funds
in U.S. Treasury securities and obligations fully guaranteed as to
principal and interest by the U.S. as the ETFs eliminate the need for
FCMs and DCOs to administer investments in individual U.S. government
securities.\59\
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\56\ Letter from Anna Paglia, Chief Executive Officer, Invesco
Capital Management LLC, dated September 28, 2023 (``Invesco
Petition''). See https://www.cftc.gov/media/9541/Invesco_CFTCPetition_Regulation125_092823/download. Invesco is a
registered with the Commission as a commodity pool operator and
commodity trading advisor, and is registered with the Securities and
Exchange Commission (``SEC'') as an investment adviser.
\57\ Invesco Petition at p. 1.
\58\ Id.
\59\ See Invesco Petition at p. 2.
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Finally, the Petitioners also request that the Commission amend its
regulations consistent with CFTC Staff Letter 21-02 and CFTC Staff
Letter 22-21,\60\ to permit FCMs and DCOs to invest Customer Funds in
qualifying Permitted Investments that have adjustable rates of interest
that correlate closely to SOFR.\61\
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\60\ CFTC Staff Letter 21-02--CFTC Regulation 1.25--Investment
of Customer Funds--Time-Limited No-Action Position for Investments
in Securities with an Adjustable Rate of Interest Benchmarked to the
Secured Overnight Financing Rate, issued January 4, 2021 (``Staff
Letter 21-02''); CFTC Staff Letter 22-21--CFTC Regulation 1.25--
Investment of Customer Funds in Securities with an Adjustable Rate
of Interest Benchmarked to the Secured Overnight Financing Rate--
Extension of Time-Limited No-Action Position Concerning Investments
by Futures Commission Merchants and No-Action Position Concerning
Investments by Derivatives Clearing Organizations, issued December
23, 2022 (``Staff Letter 22-21'').
\61\ See Joint Petition at p. 4.
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III. Proposal
As part of its periodic assessment of Regulation 1.25 and in
consideration of the information set forth in the Joint Petition and
the Invesco Petition, the Commission is proposing to amend the list of
Permitted Investments, subject to certain terms and conditions, as
discussed in detail below. In connection with the proposed amendments
to the list of Permitted Investments, the Commission is further
proposing changes to the counterparty and depository requirements of
Regulation 1.25(d)(2) and (7), and revisions to the concentration
limits for Permitted Investments set forth in Regulation 1.25(b)(3).
Separately, the Commission is specifying capital charges that FCMs
would apply to the revised list of Permitted Investments as proposed,
and is proposing a clarifying amendment to Regulation 22.3(d) to
specify that DCOs bear the financial responsibility for losses
resulting from Permitted Investments. The Commission is also proposing
to replace LIBOR with SOFR as a permitted benchmark for the interest
rate of adjustable rate securities that qualify as Permitted
Investments. Lastly, the Commission is proposing to revise its
regulations to eliminate the requirement that a depository holding
customer funds must provide the Commission with read-only electronic
access to such accounts for the FCM to treat the accounts as customer
segregated fund accounts. Collectively, the proposed revisions and
amendments are referred to as the ``Proposal.''
A. Investment of Customer Funds
1. Interests in Money Market Funds
Regulation 1.25(a)(1)(vii) currently provides that FCMs and DCOs
may invest Customer Funds in interests in MMFs, subject to specified
terms and conditions.\62\ To qualify as a Permitted Investment, a MMF
must: (i) be an investment company that is registered with the SEC
under the Investment Company Act of 1940 \63\ and hold itself out to
investors as a MMF in accordance with SEC Rule 2a-7; \64\ (ii) be
sponsored by a federally-regulated financial institution, a Section
3(a)(6) bank,\65\ an investment adviser registered under the Investment
Advisers Act of 1940,\66\ or a domestic branch of a foreign bank
insured by the FDIC; and (iii) compute the net asset value (``NAV'') of
the fund by 9 a.m. of the business day following each business day and
make the NAV available to MMF shareholders by that time.\67\
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\62\ 17 CFR 1.25(a)(vii).
\63\ 15 U.S.C. 80a-1--80a-64.
\64\ 17 CFR 270.2a-7.
\65\ For a definition of Section 3(a)(6) bank, see supra note
51.
\66\ 15 U.S.C. 80b-1--80b-21.
\67\ 17 CFR 1.25(c).
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The Commission is proposing to amend Regulation 1.25(a)(1)(vii) to
limit the scope of MMFs whose interests qualify as Permitted
Investments to ``government money market funds,'' as defined in SEC
Rule 2a-7, in response to two sets of amendments that the SEC adopted
to its rules governing MMFs
[[Page 81241]]
discussed below.\68\ A Government MMF is defined in SEC Rule 2a-7 as a
fund that invests 99.5 percent or more of its total assets in cash,
``government securities,'' and/or Repurchase Transactions that are
collateralized fully by cash or ``government securities.'' \69\ A
``government security'' is defined as ``any security issued or
guaranteed as to principal or interest by the United States, or by a
person controlled or supervised by and acting as instrumentality of the
Government of the United States pursuant to authority granted by the
Congress of the United States; or any certificate of deposit of any of
the foregoing.'' \70\ Therefore, a ``government security'' encompasses
``U.S. government securities'' and ``U.S. agency obligations'' as
defined under Regulation 1.25(a)(1)(i) and (iii), respectively.\71\
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\68\ SEC Rule 2a-7 addresses MMFs that primarily invest in
securities issued or guaranteed by the U.S. government (``government
money market funds'' or ``Government MMFs''), MMFs that primarily
invest in short-term corporate debt securities (``Prime MMFs''), and
other types of MMFs that are not relevant to this Proposal, such as
tax-exempt funds. 17 CFR 270.2a-7.
\69\ 17 CFR 270.2a-7(a)(14).
\70\ 15 U.S.C. 80a-2(a)(16).
\71\ Regulation 1.25(a)(1)(i) and (iii) defines ``U.S.
government securities'' as obligations of the U.S. and obligations
fully guaranteed as to principal and interest by the U.S. and ``U.S.
agency obligations'' as obligations of any U.S. government
corporation or enterprise sponsored by the U.S. government,
respectively.
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As noted above, the Commission is proposing to amend Regulation
1.25 to limit the scope of MMFs that qualify as Permitted Investments
in response to SEC revisions to its MMF rules. In that regard, in 2014,
the SEC amended Rule 2a-7 to permit an MMF to impose liquidity fees on
participant redemptions or to temporarily suspend participant
redemptions if the MMF's investment portfolio triggered certain
liquidity thresholds.\72\ The 2014 SEC MMF Final Rule was adopted to
mitigate the adverse effects on fund liquidity resulting from increased
participant redemptions during times of financial stress.\73\
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\72\ Money Market Fund Reform; Amendments to Form PF, 79 FR
47736 (Aug. 14, 2014) (``2014 SEC MMF Final Rule''). See 17 CFR
270.2a-7(c)(2).
\73\ 2014 SEC MMF Final Rule at 47747.
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The 2014 SEC MMF Final Rule provides that a MMF that invests less
than 30 percent of its total assets in instruments defined as ``weekly
liquid assets'' \74\ may impose a liquidity fee of up to two percent of
the value of any shares redeemed, or may temporarily suspend
participants' redemptions for up to 10 business days in a 90-day
period, if the MMF's board of directors determines that imposing the
liquidity fee or suspending redemptions is in the best interest of the
MMF.\75\ In addition, if a MMF invests less than 10 percent of its
total assets in weekly liquid assets, the MMF must impose a liquidity
fee of at least one percent, and not more than two percent, on the
value of any shares redeemed, unless the MMF's board of directors
determines that the fee is not in the best interest of the MMF.\76\ The
SEC Redemption Provisions are directly applicable to Prime MMFs, and
Government MMFs may voluntarily elect to impose such provisions
(``Electing Government MMFs'').\77\
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\74\ The term ``weekly liquid assets'' is generally defined as:
(i) cash; (ii) direct obligations of the U.S. Government; (iii) U.S.
Agency securities that are issued at a discount to the principal
amount to be repaid at maturity and have a remaining time to
maturity of 60 days or less; (iv) securities that mature, or are
subject to a demand feature that is exercisable and payable, within
5 business days; or (v) amounts receivable and due unconditionally
within 5 business days on pending sales of portfolio securities. 17
CFR 270-2a-7(c)(a)(28).
\75\ 17 CFR 270.2a-7(c)(2)(i).
\76\ 17 CFR 270.2a-7(c)(2)(ii). (The liquidity fees and
suspension of redemptions provisions of SEC Rule 2a-7(c)(2) are
referred to as the ``SEC Redemption Provisions'' in this document.)
\77\ 17 CFR 270.2a-7(c)(2)(iii).
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Commission staff subsequently received inquiries from market
participants concerning the permissibility of investing Customer Funds
in MMF interests under Regulation 1.25 in light of the SEC Redemption
Provisions. The Commission's Division of Swap Dealer and Intermediary
Oversight (``DSIO''), currently known as the Market Participants
Division (``MPD'') issued CFTC Staff Letter 16-68 \78\ and the
Commission's Division of Clearing and Risk (``DCR'') issued CFTC Staff
Letter 16-69 \79\ addressing the SEC Redemption Provisions and the
investment of Customer Funds in MMFs by FCMs and DCOs, respectively.
Staff Letter 16-68 \80\ expressed DSIO staff's view that the SEC
Redemption Provisions conflict with paragraphs (b)(1) \81\ and
(c)(5)(i) \82\ of Regulation 1.25, as the Redemption Provisions have
the effect of potentially reducing the liquidity of Prime MMFs and
Electing Government MMFs. Therefore, in connection with the no-action
position taken in the staff letter, DSIO indicated that FCMs may no
longer invest Customer Funds in such MMFs.\83\
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\78\ CFTC Letter No. 16-68, No-Action Relief with Respect to
CFTC Regulation 1.25 Regarding Money Market Funds (Aug. 8, 2016)
(``Staff Letter 16-68''). CFTC Staff Letters are available at the
Commission's website, www.cftc.gov.
As noted above, Staff Letter 16-68 was issued by DSIO, which was
subsequently renamed MPD. For purposes of clarity, the Commission
notes that the formal division name change is not reflected in the
proposed amendments to existing Commission regulations and
appendices discussed in this Proposal, as the Commission plans to
address the name change in a separate Commission rulemaking. The new
division name, however, appears in the newly introduced proposed
appendices H and I to Part 1 and Appendix G to Part 30, as these
appendices do not currently exist in Commission's regulations and
would not be addressed in the above-referenced separate rulemaking.
\79\ CFTC Letter No. 16-69, Staff Interpretation Regarding CFTC
Part 39 In Light Of Revised SEC Rule 2a-7 (Aug. 8, 2016) (``Staff
Letter 16-69'').
\80\ See also CFTC Staff Advisory No. 16-75, Practical
Application of No-Action Letter No. 16-68 Regarding the Investments
in Money Market Mutual Funds (Oct. 18, 2016) (``Staff Letter 16-
75'') (discussing the practical applicability and effect of Staff
Letter 16-68).
\81\ 17 CFR 1.25(b)(1) (providing that investments of customer
funds must be highly liquid such that the investments must have the
ability to be liquidated and converted into cash within one business
day without material discount in value).
\82\ 17 CFR 1.25(c)(5)(i) (providing that to qualify as a
Permitted Investment an MMF must be legally obligated to pay a fund
investor (including an FCM) by the close of business on the day
following a redemption request).
\83\ Staff Letter 16-68 at p. 2.
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Staff Letter 16-69 set forth DCR staff's interpretation that
Regulations 39.15(c) and (e) \84\ prohibit a DCO from holding funds
belonging to clearing members or their customers in Prime MMFs or
Electing Government MMFs. DCR staff stated that the SEC Redemption
Provisions were not consistent with Regulation 39.15(c), which requires
a DCO to hold funds and assets belonging to clearing members and their
customers in a manner that minimizes the risk of loss or of delay in
the access by the DCO to such funds and assets. DCR staff further
stated that the SEC Redemption Provisions were inconsistent with
Regulation 39.15(e), which limits a DCO to investing funds and assets
belonging to clearing members and their customer in instruments with
minimal credit, market, and liquidity risk. Therefore, FCMs and DCOs
have not invested customer funds in Prime MMFs or Electing Government
MMFs since the issuance of the aforementioned Staff Letters in 2016.
---------------------------------------------------------------------------
\84\ 17 CFR 39.15(c) and (e).
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The SEC has recently adopted additional amendments to its MMF
rules, including amendments revising the SEC Redemption Provisions
discussed above.\85\ The SEC MMF Reforms are intended to address issues
observed by the SEC with MMFs in connection with the economic shock
from the onset of the COVID-19 pandemic. Specifically, the SEC stated
in March 2020, that concerns about the impact of COVID-19 pandemic led
[[Page 81242]]
investors to reallocate their assets into cash and short-term
government securities. Certain Prime MMFs, in particular, experienced
significant outflows, contributing to stress on short-term funding
markets that resulted in government intervention to enhance the
liquidity of such markets.\86\ The events of March 2020 led the SEC to
re-evaluate certain aspects of the regulatory framework applicable to
MMFs. In considering the potential factors that caused the increased
redemption activity in March 2020, the SEC noted that, among other
concerns, fears about the potential imposition of redemption gates and
liquidity fees based on observed declines in some funds' weekly liquid
assets appear to have incentivized investors to redeem from certain
MMFs.\87\ Further, according to the SEC, the presence of a liquidity
threshold for consideration of fees and gates appears to have affected
fund managers' behavior, encouraging the sale of long-term portfolio
assets to maintain weekly liquid assets above the 30 percent threshold.
The SEC also cited to evidence suggesting that investors are
particularly sensitive to the potential imposition of redemption gates,
which fully inhibit the redeemability of MMF shares for the duration of
the gate.\88\ In the SEC's view, generally supported by commenters'
feedback, the gates and liquidity fees associated with predictable
weekly liquid asset triggers proved counterproductive in stemming heavy
redemptions from certain MMFs.\89\ As such, the SEC concluded that MMFs
needed better functioning tools for managing through stress while
mitigating harm to shareholders.\90\
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\85\ Money Market Fund Reforms; Form PF Reporting Requirements
for Large Liquidity Fund Advisers, Technical Amendments to Form N-
CSR and Form N-1A, 88 FR 51404 (Aug. 3, 2023) (``SEC MMF Reforms'').
The SEC MMF Reforms have an effective date of October 2, 2023.
\86\ As noted in the SEC MMF Reforms' adopting release, to
support the short-term funding markets, on March 18, 2020, the
Federal Reserve, with the approval of the Department of the
Treasury, established the Money Market Mutual Fund Liquidity
Facility. The facility provided loans to financial institutions on
advantageous terms to purchase securities from MMFs that were
raising liquidity. See SEC MMF Reforms at 51408.
\87\ SEC MMF Reforms at 51407.
\88\ Id. at 51409.
\89\ Id.
\90\ Id. at 51408.
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Accordingly, in an effort to improve the resilience of MMFs and
address the issue of preemptive investor redemption behavior,
particularly in times of stress, the SEC adopted changes to the fee and
gate provisions in SEC Rule 2a-7. The SEC MMF Reforms, among other
things, amend the SEC Redemption Provisions by removing a Prime MMF's
ability to temporarily suspend participant redemptions and by removing
an Electing Government MMF's ability to voluntarily retain authority to
suspend participant redemptions. The SEC MMF Reforms will also require
Prime MMFs to impose a liquidity fee when the fund experiences net
redemptions that exceed 5 percent of the fund's net assets, and will
permit Prime MMFs to impose a discretionary liquidity fee if the fund's
board of directors determines that a fee is in the best interest of the
fund.\91\ Government MMFs will not be required to implement the
mandatory liquidity fee but, consistent with the current SEC Redemption
Provisions, may choose to rely on the ability to impose discretionary
liquidity fees.\92\ Such fees, however, are no longer tied to the
weekly liquid asset threshold.\93\
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\91\ 17 CFR 270.2a-7(c)(2)(i) and (ii) (as amended by the SEC
MMF Reforms). In describing the different types of MMFs, the SEC
distinguishes between Prime MMFs, Government MMFs, and tax-exempt
(or municipal) MMFs. See SEC MMF Reforms at 51406. Tax-exempt MMFs
primarily hold obligations of state and local governments and their
instrumentalities, and pay interest that is generally exempt from
Federal income tax for individual taxpayers. Within the category of
Prime and tax-exempt MMFs, the SEC also treats retail and
institutional funds separately. The new mandatory liquidity fee
framework will apply to institutional Prime and institutional tax-
exempt MMFs. Tax-exempt MMFs are not specifically discussed in this
Proposal, though the Commission notes that these funds would be
subject to the same restrictions as those proposed with respect to
Prime MMFs. Retail MMFs are held only by natural persons, and as
such, are not discussed in this Proposal either.
\92\ 17 CFR 270.2a-7(c)(2)(i)(B) (as amended by the SEC MMF
Reforms).
\93\ 17 CFR 270.2a-7(c)(2)(i) (as amended by the SEC MMF
Reforms).
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The SEC's liquidity fee mechanism is designated to address
shareholder dilution and the potential for first-mover advantage by
allocating liquidity costs to redeeming investors. Although the
mechanism may contribute to decreasing outflows from certain MMFs, the
Commission preliminarily believes that the potential imposition of a
fee will nonetheless have the effect of reducing the liquidity of such
funds and will reduce the principal of an FCM's or DCO's investment in
MMF shares. Therefore, consistent with the positions taken in Staff
Letter 16-68 and Staff Letter 16-69, the Commission is preliminarily of
the view that FCMs and DCOs should be allowed to invest Customer Funds
only in MMFs that will not be subject to a liquidity fee (i.e.,
Government MMFs that do not elect to apply a discretionary liquidity
fee). Thus, the proposed amendments would remove Prime MMFs and
Electing Government MMFs, as participants in such funds may be subject
to liquidity fees in certain circumstances. Therefore, the Commission
is proposing amendments to Regulation 1.25(a)(1)(vii) that would limit
the scope of MMFs whose interests qualify as Permitted Investments to
Government MMFs that are not Electing Government MMFs (``Permitted
Government MMFs'').\94\ To qualify as a Permitted Government MMF, at
least 99.5 percent of the fund's investment portfolio must be comprised
of cash, government securities (i.e., U.S. Treasury securities,
securities fully-guaranteed as to principal and interest by the U.S.
Government, and U.S. agency obligations), and/or Repurchase
Transactions that are fully collateralized by government securities as
set forth in SEC Rule 2a-7. The Commission preliminarily believes that
the proposed amendment would ensure that FCMs and DCOs invest Customer
Funds in instruments that are consistent with the objectives of
Regulation 1.25 of preserving principal and maintaining liquidity of
the investments.
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\94\ See proposed paragraph (a)(1)(iv) of Regulation 1.25. As
discussed in Section III.A, the Commission is proposing to renumber
paragraph (a)(1) of Regulation 1.25 to reflect proposed revisions to
the list of Permitted Investments. The proposed revisions would
result in the renumbering of current paragraph (a)(1)(vii) to
paragraph (a)(1)(v) of Regulation 1.25.
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The Commission also notes that the proposed amendments to remove
from the scope of Permitted Investments the interests in MMFs whose
redemptions may be subject to a liquidity fee would prohibit an FCM
from depositing proprietary interests in such MMFs into Customer Funds
accounts. Regulations 1.23(a)(1), 22.2(e)(3)(i), and 30.7(g)(1) permit
FCMs to deposit proprietary cash and unencumbered securities into the
accounts of futures customers, Cleared Swaps Customers, and 30.7
customers, respectively, to help ensure that at all times the accounts
maintain sufficient funds to cover the amounts due to all customers and
prevent the accounts from becoming undersegregated.\95\ The securities
deposited by FCMs, however, must be Permitted Investments as set forth
in Regulation 1.25.\96\ Therefore, with respect to MMFs, FCMs would
only be permitted to deposit proprietary interest in Permitted
Government MMFs in the accounts of futures customers, Cleared Swaps
Customers, and 30.7 customers under the Proposal.
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\95\ 17 CFR 1.23(a)(1), 22.2(e)(3)(i), and 30.7(g)(1).
\96\ Id.
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To eliminate MMFs whose redemptions may be subject to a liquidity
fee from the scope of Permitted Investments under Regulation 1.25, the
Commission proposes to revise Regulation 1.25(a)(1)(vii), which would
be redesignated Regulation 1.25(a)(1)(v) to accommodate other
amendments to Regulation 1.25(a) discussed in this Proposal, by
replacing the term ``money
[[Page 81243]]
market mutual fund'' with the term ``government money market funds as
defined in Sec. 270.2a-7 of this title, provided that the funds do not
elect to be subject to liquidity fees in accordance with Sec. 270.2a-7
of this title (government money market fund).'' The Commission also
proposes to make further conforming changes throughout Regulation 1.25
and the Appendix to Regulation 1.25 by replacing all references to
``money market mutual fund'' with ``government money market fund.'' In
addition, the Appendix to Regulation 1.25 would be redesignated as
Appendix E to Part 1 to address a change in the rules of the Office of
the Federal Register regarding the structure of regulatory text to be
codified in the Code of Federal Regulations.
Request for comment: The Commission seeks comment on all aspects of
the Proposal to limit the scope of MMFs whose interests qualify as
Permitted Investments to certain Government MMFs to address changes to
SEC rules governing MMFs as described above, including:
1. Other than concentration limits that are discussed further
below, should any other safeguards be considered for Government MMFs
whose interests qualify as Permitted Investments under the Proposal to
ensure that the credit, liquidity, and market risk of those investments
is maintained at an acceptable level, particularly in light of the
history of runs in the Prime MMF markets and the potential for
contagion?
2. Regulation 1.25(b)(5)(ii) currently provides that an FCM or a
DCO may invest Customer Funds in a fund affiliated with that FCM or
DCO. Should the Commission revise Regulation 1.25(b)(5)(ii) to prohibit
an FCM or a DCO from investing Customer Funds in affiliated funds? Are
there other Commission or SEC rules that mitigate any potential
conflicts of interest that may arise from an FCM or a DCO investing
Customer Funds in affiliated funds?
2. Foreign Sovereign Debt
Regulation 1.25(a)(1) currently permits FCMs and DCOs to invest in
the sovereign debt of the U.S. only. Regulation 1.25 previously
permitted FCMs and DCOs to invest Customer Funds in the foreign
sovereign debt of any country, provided that the investments were
limited to balances owed by FCMs or DCOs to customers denominated in
the currency of the applicable foreign sovereign debt.\97\ The
Commission subsequently eliminated all foreign sovereign debt as a
Permitted Investment in 2011, citing an interest in both simplifying
the regulation and safeguarding Customer Funds in light of economic
crises experienced by a number of foreign sovereigns.\98\ The
Commission, however, also stated that it recognized that the safety of
sovereign debt issuances of one country may vary greatly from the
sovereign debt issuances of another country, and that investment in
certain sovereign debt may be consistent with Regulation 1.25's
objective of preserving principal and maintaining liquidity of
investments.\99\ The Commission further stated that it was amenable to
considering requests for Section 4(c) exemptions to permit FCMs and
DCOs to invest Customer Funds in foreign sovereign debt. Specifically,
the Commission stated that it would consider permitting Customer Funds
to be invested in the foreign sovereign debt of a country to the extent
that: (i) FCMs or DCOs held balances in segregated accounts owed to
customers denominated in that country's currency; and (ii) the foreign
sovereign debt serves to preserve principal and maintain liquidity of
Customer Funds as required for all other investments of Customer Funds
under Regulation 1.25.\100\
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\97\ Regulation 1.25(a)(1) (2005).
\98\ 2011 Permitted Investments Amendment at 78781.
\99\ Id. at 78782.
\100\ Id.
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As discussed in Section II above, the Commission subsequently
issued the 2018 Order pursuant to Section 4(c) of the Act granting DCOs
a limited exemption from the provisions of Regulation 1.25(a) to
authorize the investment of euro-denominated futures customer funds and
Cleared Swaps Customer Collateral in euro-denominated sovereign debt
issued by France or Germany subject to specified terms and
conditions.\101\ The 2018 Order also provides an exemption from
Regulation 1.25(d) to permit DCOs to enter into Repurchase Transactions
involving French or German sovereign debt with: (i) the European
Central Bank; (ii) the Deutsche Bundesbank; (iii) the Banque de France;
(iv) a foreign bank located in a country that has adopted the euro as
its currency and maintains in excess of $1 billion in regulatory
capital; and (v) a foreign dealer located in a country that has adopted
the euro as its currency and is subject to regulation by a national
financial regulator.\102\ The 2018 Order also permits DCOs to hold
German or French foreign sovereign debt purchased under reverse
repurchase agreements with depositories located in a country that has
adopted the euro as its currency and that maintain in excess of $1
billion in regulatory capital, provided that the DCOs separately
account for the securities purchased as futures customer funds or
Cleared Swaps Customer Collateral, as applicable.\103\
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\101\ 2018 Order at 35244-35245. The 2018 Order does not address
30.7 customer funds.
\102\ Condition 3(e) of the 2018 Order at 35245.
\103\ Condition 3(f) of the 2018 Order at 35245.
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The 2018 Order also contains certain conditions regarding the
investment of futures customer funds or Cleared Swaps Customer
Collateral in French or German sovereign debt. Specifically, the 2018
Order provides that the dollar-weighted average time-to-maturity of a
DCO's portfolio of investments in either French or German sovereign
debt may not exceed 60 days.\104\ In addition, the 2018 Order provides
that a DCO may not make a direct investment in any French or German
debt instrument with a remaining time-to-maturity of greater than 180
calendar days.\105\
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\104\ Condition 3(c) of the 2018 Order at 35245.
\105\ Condition 3(d) of the 2018 Order at 35245.
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For the reasons stated below, the Commission is proposing to amend
Regulation 1.25 to add Specified Foreign Sovereign Debt to the list of
Permitted Investments. The proposed addition of Specified Foreign
Sovereign Debt would be subject to certain conditions that are
consistent with the criteria specified in the 2011 Permitted
Investments Amendment \106\ and the conditions specified in the 2018
Order discussed above. The proposed conditions are also consistent with
the general objectives set forth in Regulation 1.25 of preserving
principal and maintaining liquidity of Permitted Investments.\107\
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\106\ See 2011 Permitted Investments Amendment at 78782 (stating
that the Commission would consider permitting foreign sovereign debt
investments to the extent that: (i) the petitioner has balances in
segregated accounts owed to customers or clearing member FCMs in
that country's currency; and (ii) the sovereign debt serves to
preserve principal and maintain liquidity of customer funds as
required for all other investments of customer funds under
Regulation 1.25).
\107\ 17 CFR 1.25(b).
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The proposed amendments would expand the exemptive relief provided
in the 2018 Order by adding the debt of Canada, Japan, and the United
Kingdom, in addition to that of France and Germany, to the list of
Permitted Investments under Regulation 1.25, and by allowing FCMs, in
addition to DCOs, to invest in the foreign sovereign debt.\108\ FCMs
collectively held an aggregate of a U.S. dollar equivalent of $51
billion of Customer Funds denominated in Canadian dollars
[[Page 81244]]
(``CAD''), euros (``EUR''), Japanese yen (``JPY''), and Great British
pounds (``GBP'') on August 15, 2023. The $51 billion represented
approximately 10 percent of the total $490 billion of Customer Funds
held by FCMs in segregated accounts on August 15, 2023.\109\
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\108\ Proposed Regulation 1.25(a)(1)(vi).
\109\ The $490 billion represents the U.S. dollar equivalent of
the total value of margin assets held by FCMs for futures customers,
Cleared Swaps Customers, and 30.7 customers as reported to CME as of
August 15, 2023. The breakdown by currency was as follows: CAD 14
billion; EUR 18 billion; GBP 3 billion; and JPY 16 billion. Some of
these funds may have been posted by the FCMs to DCOs as margin
collateral.
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Having considered the Joint Petition and analyzing the instruments'
characteristics, the Commission believes that including Specified
Foreign Sovereign Debt as a Permitted Investment would be consistent
with the overall objectives set forth in Regulation 1.25 of preserving
principal and maintaining liquidity of Customer Funds. The Joint
Petition states that the Specified Foreign Sovereign Debt has credit
and liquidity characteristics that are comparable to the credit and
liquidity characteristics of U.S. Treasury securities. Specifically,
the Joint Petition states that the credit default swaps of Canada,
France, Germany, Japan, and the United Kingdom have relatively narrow
spreads similar to the credit default spread of the United States.\110\
With respect to liquidity, the Joint Petition states that there were
substantial amounts of outstanding marketable Canadian, French, German,
Japanese, and United Kingdom debt and provided data on the amount of
outstanding debt in instruments with time-to-maturity of two years or
less issued by each relevant jurisdiction.\111\
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\110\ See Joint Petition at pp. 6-7.
\111\ See Appendix A to Joint Petition and Supplement to Joint
Petition at p. 1 (indicating that the outstanding debt in
instruments with time-to-maturity of two years or less issued by
Canada, France, Germany, Japan, and the United Kingdom, based on
information available on Bloomberg as of July 11, 2023, was equal to
the USD equivalence of $447 billion, $594 billion, $557 billion,
$2.6 trillion, and $534 billion, respectively). See also Bank of
International Settlements' Debt Securities Statistics (including
data as of the end of 2021), available here: https://www.bis.org/statistics/secstats.htm?m=2615 and 2021 Survey on Liquidity in
Government Bond Secondary Markets, Organization for Economic Co-
operation and Development, available here: https://www.oecd-ilibrary.org/sites/b2d85ea7-en/1/4/2/index.html?itemId=/content/publication/b2d85ea7-en&_csp_=e3b7b0a57d02c41c597306342c85c8b6&itemIGO=oecd&itemContentType=book (confirming that Specified Foreign Sovereign Debt instruments
presented good liquidity characteristics in 2021).
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The Commission also analyzed the volatility of the Specified
Foreign Sovereign Debt and observed, based on the available data, that
the price risk of the relevant foreign sovereign debt is comparable to
that of U.S. Treasury securities. Specifically, using one-year
sovereign debt instruments yield data for the period September 21, 2018
to September 20, 2023, the Commission notes that the standard deviation
of daily yield change for one-year U.S. Treasury bills was 9 BPS,
whereas the same measure for Canadian, French, German, Japanese, and
United Kingdom one-year debt instruments ranged from 1 to 7 BPS.\112\
The Commission also notes that holding high-quality foreign sovereign
debt may pose less risk to Customer Funds than the credit risk of
commercial banks through unsecured bank demand deposit accounts.\113\
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\112\ The Commission reviewed yield data available through
Bloomberg, a proprietary financial data provider, for 1-year
sovereign debt instruments issued by Canada, France, Germany, Japan,
the United Kingdom, and the U.S.
\113\ The Commission discussed the preferability from a risk
management perspective of investing foreign currency in high quality
foreign sovereign debt relative to the credit risk posed by
unsecured demand deposit accounts at commercial banks in issuing the
2018 Order permitting DCOs to invest futures customer funds and
Cleared Swaps Customer Collateral in French and German sovereign
debt. See 2018 Order at 35245-35246.
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Furthermore, the Commission believes that the proposed amendments
would provide FCMs and DCOs with an investment option to manage the
potential foreign exchange risk that may arise in their administration
and investment of Customer Funds. Specifically, the Commission notes
that absent the ability to invest Customer Funds in identically-
denominated sovereign debt securities, an FCM or a DCO seeking to
invest customer foreign currency deposits would need to convert the
currencies to a U.S. dollar-denominated asset, which would introduce
potential foreign currency fluctuation risk to the FCMs and DCOs.\114\
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\114\ To reach this conclusion, the Commission considered, among
other factors, the daily volatility of exchange rates of the
relevant currency pairs. Specifically, based on data from the
Federal Reserve Bank of St. Louis' FRED database, the Commission
notes that for the period from September 2018 to September 2023, the
standard deviation of the daily percentage change of exchange rate
between the relevant currency pairs was 0.45 percent for the CAD/USD
pair, 0.46 percent for the EUR/USD pair, 0.61 percent for the GBP/
USD pair, and 0.55 percent for the JPY/USD pair, indicating a
currency fluctuation that is an additional risk factor with respect
to the return on investment of customer foreign currency deposits in
U.S. dollar-denominated assets. The Commission also recognized
foreign currency fluctuation risk in the 2000 Permitted Investments
Amendment, which added foreign sovereign debt to the list of
Permitted Investments for the first time. See 2000 Permitted
Investments Amendment at 78003.
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Based on these considerations, the Commission proposes to expand
the list of Permitted Investments to include Specified Foreign
Sovereign Debt. To ensure that investments in Specified Foreign
Sovereign Debt remain consistent with Regulation 1.25's general
objectives of preserving principal and maintaining liquidity, and with
the criteria specified in the 2011 Permitted Investments Amendment for
adding foreign sovereign debt as a Permitted Investment, the Commission
is proposing to permit the investment of Customer Funds in such debt
subject to specified conditions, which are discussed below.
First, under the Proposal, an FCM or a DCO would be permitted to
invest in the foreign sovereign debt of only Canada, France, Germany,
Japan, and the United Kingdom.\115\ The five jurisdictions are among
the seven largest economies in the International Monetary Fund's
classification of advanced economies.\116\ Each country is also a
member of the Group of 7 (``G7''), which represents the world's largest
industrial democracies, and qualifies as a ``money center country'' as
the term is defined in Regulation 1.49(a)(1).\117\ Additionally, the
currencies of the five jurisdictions represent a material portion of
the total amount of non-U.S. dollar-denominated obligations that FCMs
owe to customers, and amount to approximately 10 percent of the total
Customer Funds held by FCMs and DCOs.\118\
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\115\ Proposed Regulation 1.25(a)(1)(vii).
\116\ See Statistical Appendix to the World Economic Outlook,
April 2023, International Monetary Fund, available here: https://www.imf.org/en/Publications/WEO/Issues/2023/04/11/world-economic-outlook-april-2023.
\117\ 17 CFR 1.49(a). In the absence of customer instructions to
the contrary, Regulation 1.49(c) limits permissible locations of
depositories of Customer Funds to the U.S., the country of origin of
the currency, and a ``money center country.'' The concept of ``money
center country'' is defined to mean Canada, France, Italy, Germany,
Japan, and the United Kingdom, and is intended to correspond,
together with the U.S., to the list of G7 countries. See
Denomination of Customer Funds and Location of Depositories, 68 FR
5551 (Feb. 4, 2003) at 5546.
\118\ Based on data contained in the Segregation Investment
Detail Reports filed by FCMs with the Commission as of August 15,
2023. The reports contain detailed listings of the Permitted
Investments held by each FCM. See 17 CFR 1.32(f), 17 CFR 22.2(g)(5),
and 17 CFR 30.7(l)(5).
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Second, an FCM or a DCO would be permitted to invest in the
Specified Foreign Sovereign Debt of a country only to the extent that
the FCM or a DCO has balances in accounts owed to customers denominated
in the country's currency.\119\ Prior to the 2011 Permitted Investments
Amendment, when Regulation 1.25 permitted the investment of Customer
Funds in foreign sovereign debt, the regulation
[[Page 81245]]
included a similar restriction.\120\ As noted above, the Commission
explained that an FCM or a DCO seeking to invest deposits of foreign
currencies, absent the ability to invest in identically-denominated
sovereign debt securities, would need to convert the foreign currencies
to a U.S. dollar-denominated asset, which would increase the FCM's or
DCO's exposure to foreign currency fluctuation risk.\121\ The
Commission believes the restriction is appropriate as it balances the
need to ensure the safety of Customer Funds with the Commission's
desire to provide a degree of investment flexibility to FCMs and
DCOs.\122\
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\119\ Proposed Regulation 1.25(a)(1)(vii)(A) and (B).
\120\ See 2000 Permitted Investments Amendment at 65 FR 78010,
which provided in paragraph (a)(1)(vii) of Regulation 1.25 that an
FCM or a DCO could invest in debt of a foreign sovereign subject to
certain conditions, including that the FCM or DCO had balances owed
to customers denominated in that country's currency.
\121\ Id. at 78003.
\122\ As discussed supra, prior to 2011, the Commission
permitted an FCM or a DCO to invest Customer Funds in foreign
sovereign debt subject to the condition that the FCM or DCO held
balances owed to customers denominated in the currency of the
foreign country. In the wake of the 2008 financial crisis, the
Commission eliminated foreign sovereign debt from the list of
permitted investments noting at the time that ``in many cases, the
potential volatility of foreign sovereign debt in the current
economic environment and the varying degrees of financial stability
of different issuers make foreign sovereign debt inappropriate for
hedging foreign currency risk.'' 2011 Permitted Investments
Amendment at 78781. Yet it recognized that ``the safety of sovereign
debt issuances of one country may vary greatly from those of
another, and that investment in certain sovereign debt might be
consistent with the objectives of preserving principal and
maintaining liquidity, as required by Regulation 1.25.'' Id. at
78782. For the reasons discussed above, the Commission is proposing
to reinstate certain foreign sovereign debt consistent with the
Commission's expressed statement in the 2011 Permitted Investments
Amendment that it would consider permitting such investments
provided that the investments: (i) are limited to balances owed to
customers denominated in the currency of the applicable foreign
sovereign, and (ii) serve to preserve the principal and maintain the
liquidity of Customer Funds. See id. at 78782. The Proposal is also
consistent with the Commission's approach in the 2018 Order of
permitting DCOs to invest in the sovereign debt of France and
Germany to the extent such foreign sovereign debt satisfies specific
criteria demonstrating consistency with the credit, liquidity, and
volatility of short-term U.S. Treasury securities.
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Third, the Commission is proposing to permit FCMs and DCOs to
invest in Specified Foreign Sovereign Debt provided that the two-year
credit default spread of the issuing sovereign is 45 BPS or less.\123\
This condition is consistent with the 45 BPS two-year credit default
spread limit specified by the Commission in the 2018 Order permitting
DCOs to invest futures customer funds and Cleared Swaps Customer
Collateral in French and German sovereign debt.\124\ The Commission set
the cap of 45 BPS in the 2018 Order based on a historical analysis of
the two-year credit default spread of the U.S. (``U.S. Spread'').\125\
Forty-five BPS was, at the time, approximately two standard deviations
above the mean U.S. Spread over the preceding eight years.\126\
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\123\ Proposed Regulation 1.25(f)(3).
\124\ Condition 3(b) of the 2018 Order at 35245.
\125\ See 2018 Order at 35243.
\126\ In 2018, the Commission reviewed the daily U.S. Spread
from July 3, 2009 to July 3, 2017. Over that time period, the U.S.
Spread had a mean of approximately 26.5 BPS and a standard deviation
of approximately 9.72 BPS. Forty-five BPS were approximately two
standard deviations above the 26.5 mean.
---------------------------------------------------------------------------
The Commission observed that over that eight-year period of July 3,
2009 to July 3, 2017, the U.S. Spread was 45 BPS or less approximately
95 percent of the time and exceeded 45 BPS approximately 5 percent of
the time. During the same period, the two-year German spread exceeded
45 BPS approximately 6 percent of the time and the two-year French
spread exceeded 45 BPS approximately 25 percent of the time, with all
exceedances occurring between July 2009 and September 2012, in the
aftermath of the 2008 financial crisis and the European sovereign debt
crisis.\127\
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\127\ See 2018 Order at 35243.
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During the more recent period of September 21, 2018 to September
20, 2023, the U.S. Spread had a mean of approximately 16.4 BPS,\128\
which was lower than the mean spread of 26.5 BPS for the July 3, 2009
to July 3, 2017 period. In that same time period, the two-year credit
default swap spread of the sovereigns issuing the Specified Foreign
Sovereign Debt did not exceed 45 BPS. Based on these more recent U.S.
Spread and Foreign Sovereign Debt data, the Commission preliminarily
believes that the cap of 45 BPS established in the 2018 Order continues
to be set at an appropriate level.\129\
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\128\ Based on an assessment conducted by CFTC staff on
September 20, 2023.
\129\ Using the daily U.S. Spread data from July 3, 2009 to July
3, 2017 and assuming the two-year credit default spread follows a
normal distribution, the Commission estimated that there was less
than 2.5 percent likelihood that the U.S. credit default spread
would exceed 45 BPS over a two-year period. In addition, the
Commission's estimate, based on the daily U.S. Spread data from
September 21, 2018 to September 20, 2023, indicates that there is
less than 1 percent likelihood, under both normal and empirical
distributions, that the two-year credit default swap spread of the
sovereigns issuing Specified Foreign Sovereign Debt would exceed 45
BPS. Therefore, the Commission preliminarily believes that 45 BPS
represents an appropriate threshold for countries whose debt may
qualify as a Permitted Investment under Regulation 1.25.
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Under the Proposal, if the credit default spread of a subject
country were to exceed the 45 BPS cap, FCMs and DCOs would not be
permitted to make new investments in the country's Specified Foreign
Sovereign Debt.\130\ In addition, if the credit default spread exceeded
the 45 BPS cap, FCMs and DCOs would be required to discontinue
investing Customer Funds in that sovereign's debt through Repurchase
Transactions as soon as practicable under the circumstances.\131\ The
FCMs or DCOs would not, however, be required to immediately divest
their current investments in Specified Foreign Sovereign Debt, given
the risks associated with selling assets into a potentially volatile
market or having to immediately locate depositories for funds that had
been invested in a Repurchase Transaction with limited notice. The
prohibition on new investments would reduce the exposure to Customer
Funds by avoiding the risk of default on the Specified Foreign
Sovereign Debt. In situations where the 45 BPS cap is exceeded, the
Commission preliminarily believes that it would be more appropriate for
FCMs and DCOs to hold Customer Funds denominated in foreign currency in
cash or invest the foreign currency in U.S. dollar-denominated
Permitted Investments instead of Specified Foreign Sovereign Debt. In
addition, the length to maturity condition discussed immediately below
would mitigate price risks to the Customer Funds that might arise from
a country's two-year credit default spread exceeding the 45 BPS limit.
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\130\ Proposed Regulation 1.25(f)(3)(i).
\131\ Proposed Regulation 1.25(f)(3)(ii).
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Fourth, the Commission is proposing to limit the time-to-maturity
of investments in Specified Foreign Sovereign Debt. Specifically, under
the Proposal, an FCM or a DCO would be required to ensure that the
dollar-weighted average time-to-maturity of its portfolio of
investments in the Specified Foreign Sovereign Debt, as the average is
computed under Rule 2a-7 under the Investment Company Act of 1940
(``SEC Rule 2a-7'') \132\ on a country-by-country basis, does not
exceed 60 calendar days.\133\ Consistent with the position taken in the
2018 Order,\134\ if the portfolio includes Specified Foreign Sovereign
Debt instruments that have been acquired under a reverse repurchase
agreement, the FCM or DCO would be permitted to use the maturity
[[Page 81246]]
of the reverse repurchase agreement to compute the dollar-weighted
average time-to-maturity of the portfolio.\135\ This approach takes
into account the expected resale of the instruments, which would be
scheduled to occur within one business day or on demand as required by
Regulation 1.25(d)(6).\136\ Conversely, if the FCM or DCO sells
Specified Foreign Sovereign Debt instruments under a repurchase
agreement, the FCM or DCO would be required to include the instruments
in the calculation of the dollar-weighted average based on the
remaining time-to-maturity of each instrument sold, to account for the
expected repurchase of such instruments.\137\ In addition, an FCM or a
DCO would not be permitted to make direct investments in any Specified
Foreign Sovereign Debt instrument that had a remaining maturity greater
than 180 calendar days.\138\
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\132\ 17 CFR 270.2a-7.
\133\ Proposed Regulation 1.25(f)(1). Under the Proposal, the
dollar-weighted average of the time-to-maturity would be computed
pursuant to SEC Rule 2a-7 (17 CFR 270.2a-7), consistent with the
general time-to-maturity provision in Regulation 1.25(b)(4)(i).
\134\ 2018 Order at 35244.
\135\ Consistent with SEC Rule 2a-7(i)(6), the reverse
repurchase agreement would be deemed to have a maturity equal to the
period remaining until the date on which the resale of the
underlying instruments is scheduled to occur, or, where the
agreement is subject to demand, the notice period applicable to a
demand for the resale of the instruments. See proposed Regulation
1.25(f)(1).
\136\ 17 CFR 1.25(d)(6).
\137\ Proposed Regulation 1.25(f)(1).
\138\ Proposed Regulation 1.25(f)(2).
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Arguing that these restrictions, which are analogous to the
restrictions in the 2018 Order, would be too limiting, the Petitioners
requested that the Commission revise the regulations to provide a six-
month dollar-weighted average time-to-maturity for the portfolio of
foreign sovereign debt, and a maximum two-year remaining time-to-
maturity for each foreign sovereign debt instrument.\139\ The
Commission, however, notes that the proposed restrictions are intended
to ensure that an FCM's or DCO's portfolio of Specified Foreign
Sovereign Debt is comprised of sovereign debt instruments that mature
within a relatively short period of time. The short time-to-maturity
requirement is expected to assist FCMs and DCOs in managing and
mitigating potential market and/or credit risk by providing FCMs and
DCOs with the option of holding the debt instruments to maturity during
periods of market stress and price volatility rather than selling the
debt instruments at potentially significant discounts. This option may
be particularly valuable in periods of significant interest rate
movements, which could exacerbate market risk in sovereign debt
markets. In that regard, the Commission preliminarily views the
relatively short time-to-maturity as an essential risk-managing feature
in the context of investments in Specified Foreign Sovereign Debt and
preliminarily believes that the 60-day dollar-weighted average time-to-
maturity restriction and the 180-day remaining maturity restriction are
more appropriate than the six months and two years respective limits
requested in the Joint Petition.
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\139\ Joint Petition at pp. 5-6 (asserting that the new issuance
supply of the Specified Foreign Sovereign Debt meeting the
restrictions is limited and would be thinly traded/quoted).
---------------------------------------------------------------------------
The Commission also believes that the proposed time-to-maturity
requirements would not be as limiting as asserted in the Joint Petition
given that the new issuance supply of the Specified Foreign Sovereign
Debt meeting the proposed restrictions appears adequate to satisfy the
demand for the investment of Customer Funds in the relevant
instruments.\140\ In addition, the use of the maturity of reverse
repurchase agreements in the calculation of the dollar-weighted average
of the portfolio of investments in Specified Foreign Sovereign Debt
would reduce the average time-to-maturity of the portfolio as a whole.
As noted in the request for comment below, the Commission is explicitly
seeking comment on its preliminary analysis.
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\140\ Data made available by the Bank of Canada, l'Agence France
Tr[eacute]sor (the French Finance Agency), the Bundesrepublik
Deutschland Finanzagentur (the German Finance Agency), the Japan
Ministry of Finance, and the United Kingdom Debt Management Office
indicate that the five jurisdictions issue a sizable amount of debt
securities with time-to-maturity of less than 180 days on a frequent
basis. Specifically, in July 2023, Canada auctioned approximately
USD 22 billion, France auctioned approximately USD 18 billion,
Germany auctioned approximately USD 10 billion, Japan auctioned
approximately USD 15 billion, and the United Kingdom auctioned
approximately USD 34 billion in debt instruments with time-to-
maturity of six months or less (see Canadian Treasury bills auction
results at https://www.bankofcanada.ca/markets/government-securities-auctions/calls-for-tenders-and-results/regular-treasury-bills/; French BTF auction history at https://www.aft.gouv.fr/en/dernieres-adjudications); German Bubills issuance results at https://www.deutsche-finanzagentur.de/en/federal-securities/issuances/issuance-results (refer to reopening of 12-month Bubills with
residual maturities between three and six months); Japanese T-bills
auction results at https://www.mof.go.jp/english/policy/jgbs/auction/past_auction_results/index.html; and United Kingdom Treasury
Bill tender results at https://www.dmo.gov.uk/data/treasury-bills/tender-results/).
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The Commission is also proposing to amend Regulation 1.25(b)(4)(i),
which provides that except for investments in MMFs, the dollar-weighted
average time-to-maturity of an FCM's or a DCO's portfolio of Permitted
Investments, as computed under SEC Rule 2a-7, may not exceed 24 months.
The proposed amendment would revise Regulation 1.25(b)(4)(i) to exclude
Specified Foreign Sovereign Debt from the calculation of the dollar-
weighted average time-to-maturity of the portfolio.\141\ The Commission
is proposing this amendment as Specified Foreign Sovereign Debt would
be subject to its own dollar-weighted average time-to-maturity limit of
60 calendar days, which is substantially shorter than the two-year
dollar-weighted average time-to-maturity requirement for the overall
portfolio required by Regulation 1.25(b)(4)(i).
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\141\ Proposed revised Regulation 1.25(b)(4)(i).
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To allow Regulation 1.25(a)(2) to effectively incorporate Specified
Foreign Sovereign Debt as a Permitted Investment that FCMs and DCOs
would be able to buy or sell pursuant to Repurchase Transactions, the
Commission also proposes to expand the permissible counterparties and
depositories under Regulation 1.25(d)(2) and (7) to include certain
foreign entities. Regulation 1.25(d)(2) limits counterparties with
which an FCM or a DCO may enter into a Repurchase Transaction to a
Section 3(a)(6) \142\ bank, a domestic branch of a foreign bank insured
by the FDIC, a securities broker or dealer, or a government securities
dealer registered with the SEC or which has filed a notice pursuant to
Section 15C(a) of the Government Securities Act of 1986.\143\
Regulation 1.25(d)(7) further requires an FCM and a DCO to hold the
securities transferred to the FCM or DCO under a reverse repurchase
agreement, in a safekeeping account held with a bank as referred to in
Regulation 1.25(d)(2), a Federal Reserve Bank, a DCO, or the Depository
Trust Company.
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\142\ For a definition of Section 3(a)(6) bank, see supra note
51.
\143\ Public Law 99-571, 100 Stat. 3208 (Oct. 28, 1986).
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As a practical matter, absent amendment to these counterparty and
depository provisions, an FCMs' and DCOs' ability to buy and sell
Specified Foreign Sovereign Debt pursuant to Repurchase Transactions
would be restricted given that participants in the foreign sovereign
debt Repurchase Transactions market are predominantly non-U.S.
entities. The Commission therefore proposes to add foreign banks and
foreign brokers or dealers meeting certain requirements, as well as the
European Central Bank and the central banks of Canada, France, Germany,
Japan, and the United Kingdom, to the list of permitted
counterparties.\144\ To be deemed a permitted counterparty, a foreign
bank would have to qualify as a depository under Regulation 1.49(d)(3)
[[Page 81247]]
by holding regulatory capital in excess of $1 billion, and would also
have to be located in a money center country as defined in Regulation
1.49(a)(1) (i.e., Canada, France, Italy, Germany, Japan, and the United
Kingdom) or in another jurisdiction that has adopted the currency of
the permitted foreign sovereign debt. Similarly, a foreign broker or
dealer would have to be located in a money center country and be
regulated by a foreign financial regulator. The proposed provisions are
designed to ensure that the counterparties would be regulated entities
comparable to those counterparties already permitted under Regulation
1.25(d)(2), and are consistent with the counterparty conditions set
forth in the 2018 Order.\145\
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\144\ Proposed Regulation 1.25(d)(2).
\145\ See 2018 Order, Condition (e) at 35245.
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With respect to permitted depositories, the Commission proposes to
permit Specified Foreign Sovereign Debt instruments transferred to an
FCM or a DCO under a reverse repurchase agreement to be held with a
foreign bank that qualifies as a permitted depository under Regulation
1.49.\146\ The proposed provision is designed to ensure that any
additional depositories would be comparable to those already permitted
under Regulation 1.25(d)(7), and subject to the conditions for
depositories in the 2018 Order.\147\ The Commission notes that
mandating the safekeeping of foreign securities purchased through
reverse repurchase agreements with a U.S. custodian as required under
the current regulation may be inefficient or impractical.
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\146\ Proposed Regulation 1.25(d)(7).
\147\ See 2018 Order, Condition (f) at 35245.
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Request for Comment. The Commission seeks comment on all aspects of
the Proposal relating to the expansion of the list of Permitted
Investments to include Specified Foreign Sovereign Debt, including:
3. Under the Proposal, the list of Permitted Investments set forth
in Regulation 1.25(a) would be expanded to include sovereign debt
issued by Canada, France, Germany, Japan, and the United Kingdom,
subject to specified conditions. Although these Specified Foreign
Sovereign Debt instruments present credit and liquidity characteristics
that are similar to those of currently Permitted Investments, such debt
may also be less liquid than U.S. government securities. Do investments
in Specified Foreign Sovereign Debt raise any liquidity issues or
concerns? If so, please explain your responses and provide data if
possible.
4. The Proposal would prohibit investments of Customer Funds in
Specified Foreign Sovereign Debt if the two-year credit default swap
spread of the issuing sovereign exceeds 45 BPS. Should the Commission
consider a higher or lower credit default spread limit? If so, please
specify the appropriate credit default spread and explain why it is
necessary and appropriate. Should the investment prohibition be
contingent on the breach of the 45 BPS threshold occurring a certain
number of times within a specified time period or for a particular
duration within a specified time period? Should there be a ``cooling-
off'' period before the Specified Foreign Sovereign Debt may be used
again as a Permitted Investment under Regulation 1.25? For instance,
should the Specified Foreign Sovereign Debt be subject to a requirement
that the CDS spread be below 45 BPS for a minimum period of time (e.g.,
3 months) before it could be reinstated as an eligible Permitted
Investment?
5. The Proposal would limit the time-to-maturity of investments in
Specified Foreign Sovereign Debt to a 60-day maximum dollar-weighted
average time-to-maturity of the portfolio of investments and a 180-day
maximum remaining time-to-maturity of individual direct investments.
The Petitioners requested that the limits be set at six months and two
years, respectively. Should the Commission consider extending the time-
to-maturity limits as requested? If yes, please provide analysis and
appropriate market data supporting the extension.
3. Interests in U.S. Treasury Exchange-Traded Funds
ETFs are collective investment vehicles that issue redeemable
securities that are also traded at the market price on national
securities exchanges.\148\ The Commission proposes to add interests in
ETFs to the list of Permitted Investments under Regulation 1.25,
subject to specified proposed conditions discussed below.
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\148\ Invesco Petition at p. 5. See also, Exchange-Traded Funds,
84 FR 57162 (Oct. 24, 2019) (``SEC ETFs Release'') at 57164.
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The SEC adopted Rule 6c-11 \149\ under the Investment Company Act
of 1940 in 2019, creating a regulatory framework that allows ETFs
meeting certain requirements to operate as investment companies under
the Investment Company Act of 1940 without having to obtain an
exemptive order from the SEC as previously required.\150\ Like other
investment companies, an ETF pools the assets of multiple investors and
invests those assets according to a set investment objective and
principal investment strategies.\151\ Each share of an ETF represents
an undivided fractional interest in the underlying assets of the
ETF.\152\ Similar to indexed mutual funds, many ETFs are designed to
passively track a particular market index, investing in all or a
representative sample of the instruments included in the index and
aiming to achieve the same return as the tracked index.\153\ Other ETFs
are actively managed, with portfolio managers buying and selling stocks
in accordance with an investment strategy rather than passively
tracking an index.\154\
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\149\ 17 CFR 270.6c-11 (``SEC Rule 6c-11'').
\150\ See generally SEC ETFs Release.
\151\ Invesco Petition at p. 5. See also, SEC ETFs Release at
57164.
\152\ Id.
\153\ See ``Exchange-Traded Funds,'' publication by FINRA,
available at: https://www.finra.org/investors/learn-to-invest/types-investments/investment-funds/exchange-traded-fund.
\154\ Id.
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As an open-end management company,\155\ similar to a mutual
fund,\156\ an ETF continuously offers its shares for sale. Unlike
mutual funds, however, ETFs do not sell shares to, or redeem shares
from, investors directly. Instead, ETFs issue (and redeem) shares to
(and from) ``authorized participants''--market intermediaries that have
a contractual arrangement with the ETF (or its distributor) and are
members or participants of a clearing agency registered with the SEC--
in blocks called ``creation units.'' \157\ Authorized participants play
a key role for ETF shares as they are the only investors that are
allowed to transact directly with the ETF.\158\ Authorized participants
must: (i) be an SEC-registered broker or dealer or other securities
market participant (such as a bank or other financial institution that
is not required to register as a broker or dealer to engage in
securities transactions); (ii) be a full participating member of the
National Securities Clearing Corporation and the Depository Trust
Company; and (iii) have entered
[[Page 81248]]
into an authorized participant agreement with the ETF (and potentially
other parties, such as the ETF's sponsor, distributor or transfer
agent).\159\
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\155\ Some ETFs may also be structured as unit-investment
trusts. See e.g., SPDR[supreg] S&P 500[supreg] ETF Trust and
SPDR[supreg] Dow Jones Industrial Average ETF Trust. The regulatory
framework set forth by SEC Rule 6c-11, however, applies only to ETFs
that are organized as open-end management investment companies. See
17 CFR 270.6c-11.
\156\ A ``mutual fund'' is a type of open-end management
company, meaning that investors can purchase and redeem shares in
the fund on a daily basis based on the NAV of their shares. Mutual
funds pool the money of many investors to purchase a range of
securities to meet specified investment objectives.
\157\ See 17 CFR 270.6c-11 (defining ``exchange-traded fund'').
\158\ Invesco Petition at p. 5.
\159\ Id.
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An authorized participant may act as a principal for its own
account or as an agent for others when purchasing or redeeming creation
units.\160\ Purchases and redemptions of ETF shares by an authorized
participant are referred to as ``primary market transactions'' and
occur at the next-calculated NAV. As noted above, ETF shares can also
be purchased and sold in the secondary market at market prices that may
reflect a discount or premium to the ETF's NAV.
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\160\ See SEC ETFs Release at 57164; see also David Abner, The
ETF Handbook: How to Value and Trade Exchange-Traded Funds, 2nd ed.
(2016).
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As part of its periodic reassessment of the list of Permitted
Investments of Customer Funds and in consideration of industry input
provided by the Joint Petition and the Invesco Petition, the Commission
is proposing to include shares in U.S. Treasury ETFs to the list of
Permitted Investments under Regulation 1.25. More specifically, in
assessing the potential expansion of the list of Permitted Investments,
the Commission has considered statements emphasizing the liquidity of
U.S. Treasury ETF shares and the diversification opportunity that such
ETFs provide for Customer Funds. In particular, as discussed in other
parts of the Proposal, the Petitioners note that U.S. Treasury ETFs
have characteristics that may be consistent with those of Permitted
Investments and may provide FCMs and DCOs with an opportunity to
further diversify their investments of Customer Funds.\161\ Similarly,
the Invesco Petition focused on the fact that U.S. Treasury ETFs invest
in a sub-set of the same high-quality liquid instruments that are
Permitted Investments under Regulation 1.25 (i.e., U.S. government
securities).\162\ The Invesco Petition also notes that ETFs, as
registered investment companies whose shares are registered under the
Securities Act and Exchange Act, must comply with a number of SEC
financial reporting requirements and liquidity risk management program
requirements.\163\ Finally, the Invesco Petition asserts that the
design and characteristics such as price and investment transparency,
and intra-day trading and liquidity, are additional features that help
make interests in U.S. Treasury ETFs a safe and efficient vehicle for
investment of Customer Funds.\164\
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\161\ See Joint Petition at pp. 8-9.
\162\ Invesco Petition at p. 2.
\163\ Id. at pp. 6-7. Financial requirements include: (i) annual
shareholder report, including audited financial statements (17 CFR
270.30e-1); (ii) semi-annual shareholder report, including unaudited
financial statements (17 CFR 270.30e-1); (iii) monthly portfolio
statistics and holdings filed quarterly (17 CFR 270.30b1-9); (iv)
annual census report containing financial-related information (17
CFR 270.30a-1); and (v) periodic reports with respect to portfolio
liquidity and derivatives use (17 CFR 270.30b1-10). With respect to
liquidity risk management, SEC regulations require open-ended
management investment companies, including ETFs, to adopt and
implement a liquidity risk management program that is reasonably
designed to assess and manage liquidity risk, which is defined to
mean the risk that the fund could not meet redemption requests to
redeem shares issued by the fund without significant dilution of
remaining investors' interests in the fund (17 CFR 270.22e-4).
\164\ Invesco Petition at p. 2.
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Further, the Commission has taken into consideration the limited
range of investments that meet the requirements of Regulation 1.25. In
that regard, the Commission notes that as a result of various
regulatory reforms, discussed in this Federal Register release, several
asset classes included in Regulation 1.25 no longer qualify as
Permitted Investments. In particular, as discussed in Section III.A.2.
above, the range of MMFs whose securities qualify as Permitted
Investments has contracted, as only interests in Permitted Government
MMFs currently meet the eligibility criteria of Regulation 1.25. In
addition, as discussed in Section III.A.4. below, commercial paper and
corporate notes and bonds no longer qualify as Permitted Investments
with the expiration of the TLGP.
Also, due to certain regulatory reforms, there has been an
increased demand for high quality collateral, including for assets that
currently qualify as Permitted Investments under Regulation 1.25. For
example, in the aftermath of the 2008 financial crisis, Congress
enacted the Dodd-Frank Wall Street Reform and Consumer Protection
Act,\165\ which set forth a regulatory framework for swaps, requiring,
among other things, the clearing of certain swaps or the margining of
certain uncleared swaps. As a result, market participants dealing in
swaps may be required to post to clearinghouses, or post and collect
with swap counterparties, specified forms of liquid collateral, driving
increased demand for assets that currently qualify as Permitted
Investments.
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\165\ The Dodd-Frank Wall Street Reform and Consumer Protection
Act of 2010 (Pub. L. 111-203, H.R. 4173).
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The Commission believes expanding the range of available Permitted
Investments to include interests in ETFs that meet specified
conditions, as discussed below, would provide FCMs and DCOs with
greater flexibility and opportunities for capital efficiency in the
investment of Customer Funds, without unacceptably increasing risk to
customers. Consistent with the existing regulations limiting customer
risk associated with the investment of Customer Funds by FCMs and DCOs,
under the terms of the Proposal, FCMs and DCOs would be financially
responsible for bearing any loss on an investment of Customer Funds in
an ETF in the same manner as FCMs and DCOs are financially responsible
for losses incurred from the investment of Customer Funds in Permitted
Investments.\166\
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\166\ See Regulation 1.29(b) (providing that an FCM or a DCO, as
applicable, shall bear sole responsibility for any losses resulting
from the investment of futures customer funds in Permitted
Investments) and Regulations 22.2(e)(1) and 30.7(i) (providing that
an FCM shall bear sole responsibility for any losses resulting from
the investment of Cleared Swaps Customer Collateral and 30.7 funds,
respectively, in Permitted Investments). As further discussed in
Section III.C. below, the Commission is also proposing an amendment
to Regulation 22.3(d) to clarify that DCOs are financially
responsible for investments of Cleared Swaps Customer Collateral in
Permitted Investments.
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The Commission also believes that the proposed addition of
interests in ETFs as Permitted Investments under Regulation 1.25(a)
would foster innovation and promote competition in the ETF market and
the financial services industry more generally, as the Proposal would
permit the flow of Customer Funds into a new type of financial
instrument that previously had been prohibited and, as discussed below,
would offer the possibility for market participants to purchase a type
of collateral that is already a Permitted Investment without having to
purchase the securities directly or through a MMF.
As noted above, industry representatives and other market
participants have also expressed interest in U.S. Treasury ETFs as
Permitted Investments.\167\ Both the Petitioners and Invesco highlight
the similarity in characteristics between U.S. Treasury ETF securities
and other instruments that qualify as Permitted Investments under
Regulation 1.25.\168\ Invesco further notes that ETFs investing in U.S.
Treasury securities offer an indirect, yet simpler and more cost-
efficient way, for FCMs to invest Customer Funds in such instruments,
eliminating the need to identify, invest in, and administer
[[Page 81249]]
investments in individual U.S. Treasury securities.\169\
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\167\ They generally refer to short-term U.S. Treasury ETFs that
invest at least 80 percent of their assets in U.S. Treasury
securities with a remaining term to final maturity of 12 months or
less.
\168\ See Joint Petition at pp. 8-9 and Invesco Petition at pp.
9-10.
\169\ Invesco Petition at p. 11. Invesco states that an ETF
would allow FCMs and DCOs to gain exposure to short-term U.S.
Treasury securities without buying and selling Treasury securities
on a periodic basis, such as each quarter, eliminating the costs
associated with trading Treasury securities.
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The Commission also notes that CME accepts shares of short-term
U.S. Treasury ETFs as performance bond from clearing members to margin
customer and house trades.\170\ The Commission believes that this
represents an important consideration in determining whether to add
interests of U.S. Treasury ETFs to the list of Permitted Investments
given that interests in U.S. Treasury ETFs that qualify as a Permitted
Investment under the Proposal could ultimately be accepted by DCOs,
such as CME, as performance bond, and pledged by FCMs as margin
collateral.
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\170\ CME Advisory Notice, Modifications to Schedule of
Acceptable Performance Bond--Addition of Short-Term U.S. Treasury
ETFs (Aug. 2, 2022) (``2022 CME Advisory Notice''), available at
https://www.cmegroup.com/notices/clearing/2022/08/Chadv22-293.pdf
(providing that acceptable ETFs must track a U.S. Treasury index and
must have a minimum 80 percent investment in U.S. Treasury
securities with a time to maturity of 1 year or less).
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To ensure consistency with the requirements applicable to other
Permitted Investments and the general objectives of Regulation 1.25 of
preserving principal and maintaining liquidity of Permitted
Investments, the Commission is proposing to impose the conditions
discussed below on ETFs for their interests to qualify as a Permitted
Investment. The Commission preliminarily believes that to the extent
ETFs meet the proposed conditions, the ETFs would be comparable to
Permitted Government MMFs whose interests currently qualify as
Permitted Investments under Regulation 1.25(a).\171\ The Commission
also notes that by allowing FCMs and DCOs to invest Customer Funds in
ETFs that meet the specified proposed conditions, it would provide FCMs
and DCOs with a means for investing indirectly in Permitted
Investments--U.S. Treasury securities, while allowing FCMs and DCOs to
dispense with the expense and resources required to manage individual
investments in such instruments.
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\171\ The Commission notes that SEC Rule 2a-7, which applies to
MMFs, restricts the types of investments in which MMFs can invest
their assets, limits the terms of the investments, and imposes
liquidity requirements with respect to the investments, among other
things. See 17 CFR 270.2a-7(d)(2) (providing that MMFs must limit
their portfolio investments to U.S. dollar-dominated securities that
at the time of acquisition are eligible securities), 17 CFR 270.2a-
7(d)(1) (limiting the terms of maturity of MMFs' investments), and
17 CFR 270.2a-7(d)(4) (providing that MMFs must hold securities that
are sufficiently liquid to meet reasonably foreseeable shareholder
redemptions and setting forth other liquidity requirements).
Although SEC Rule 2a-7 does not apply to ETFs, as described below,
this Proposal would admit as a Permitted Investment only ETFs
providing investors with substantial protections that are
comparable, though not identical, to those afforded to MMF
investors.
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One rationale for adding ETFs investing primarily in short-term
U.S. Treasury securities to the list of Permitted Investments is the
similarity of the ETFs to MMFs whose interests qualify as Permitted
Investments under Regulation 1.25(a). As such, the Commission
preliminarily believes that it is appropriate to propose to impose all
pertinent requirements applicable to MMFs under Regulation 1.25 to such
ETFs, subject to certain modification to address the unique
characteristics of the ETFs. Therefore, under the terms of the
Proposal, an ETF would be required to satisfy specified requirements,
as discussed below, to be a qualified ETF (``Qualified ETF'') whose
interests qualify as a Permitted Investment.
Consistent with Regulation 1.25(c), which sets forth provisions for
MMFs whose interests qualify as Permitted Investments, a Qualified ETF
would be required to be an investment company that is registered under
the Investment Company Act of 1940 with the SEC and that holds itself
out to investors as an ETF under SEC Rule 6c-11.\172\ The ETF would
also be required to be sponsored by a federally regulated financial
institution, a Section 3(a)(6) bank,\173\ an investment adviser
registered under the Investment Advisers Act of 1940, or a domestic
branch of a foreign bank insured by the FDIC.\174\
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\172\ Proposed Regulation 1.25(c)(1).
\173\ For a definition of Section 3(a)(6) bank, see supra note
51.
\174\ Proposed Regulation 1.25(c)(2), as applying to Qualified
ETFs per proposed revised introductory text of paragraph (c) of
Regulation 1.25.
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In addition, the Commission is proposing to limit Qualified ETFs to
funds that are passively managed and seek to replicate the performance
of a published short-term U.S. Treasury security index.\175\ For
purposes of the Proposal, short-term U.S. Treasury securities are
bonds, notes, and bills with a remaining maturity of 12 months or less,
issued by, or unconditionally guaranteed as to the timely payment of
principal and interest by, the U.S. Department of the Treasury.\176\
Consistent with this condition, the Commission is further proposing to
require that the eligible U.S. Treasury securities represent at least
95 percent of the ETF's investment portfolio. In that regard, the
Commission notes that pursuant to SEC requirements,\177\ certain
registered investment companies, including ETFs, must adopt a policy to
invest at least 80 percent of the value of their assets in accordance
with the investment focus suggested by the fund's name.\178\
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\175\ Proposed revised Regulation 1.25(a)(1)(vi).
\176\ Id.
\177\ SEC Rule 35d-1 under the Investment Company Act of 1940
(indicating that a fund name suggesting that the fund focuses its
investments in a particular type of investments or in investments in
a particular industry would be a materially deceptive and misleading
name unless the fund has adopted a policy to invest, under normal
circumstances, at least 80 percent of the value of its assets in the
particular type of investments or in investments in the particular
industry suggested by the fund's name). 17 CFR 270.35d-1.
\178\ Proposed Regulation 1.25(c)(8)(ii).
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The Commission, however, preliminarily believes that a stricter
standard is necessary to help ensure that FCMs and DCOs invest Customer
Funds in accordance with Regulation 1.25's general objectives of
preserving principal and maintaining liquidity. The Commission's
preliminary analysis indicates that short-term U.S. Treasury ETFs
generally invest at least 95 percent of their assets in securities
comprising the U.S. Treasury securities index whose performance the
funds seek to replicate. As such, the Commission preliminarily believes
that mandating that a Qualified ETF invest a minimum of 95 percent of
its assets in eligible U.S. Treasury securities would not be overly
restrictive. \179\ To ensure compliance with the proposed condition,
FCMs and DCOs would be required to monitor the Qualified ETF's
portfolio. If the portion of the ETF's assets invested in eligible U.S.
Treasury securities falls below 95 percent of the fund's total assets,
the FCM or DCO would not be permitted to make additional investments of
Customer Funds in the ETF. The FCM or DCO would also be expected to
take reasonable actions to divest interests in the fund, while managing
Customer Funds in a manner consistent with Regulation 1.25's general
objectives of preserving principal and maintaining liquidity. Depending
on the market conditions, such actions may include taking steps to
progressively reduce the
[[Page 81250]]
amount of Customer Funds invested in ETFs instead of immediately
divesting the investments in a potentially volatile market.
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\179\ The Commission considered proposing to require that
Qualified ETFs invest at least 99.5 percent of their assets in
eligible U.S. Treasury securities to reflect an analogous condition
in SEC Rule 2a-7 requiring that government MMFs invest at least 99.5
percent of their assets in government securities. The Commission,
however, preliminarily believes that such threshold would be more
restrictive in the context of Qualified ETFs, given that an eligible
U.S. Treasury security would be defined as a bond, note, or bill
with a remaining maturity of 12 months or less, issued or
unconditionally guaranteed by the U.S. Department of the Treasury,
whereas a government security is broadly defined in SEC Rule 2a-7
(by reference to 15 U.S.C. 80a-2(a)(16)) to include U.S. government
securities and U.S. agency obligations.
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The Commission preliminarily believes that limiting the investments
of Qualified ETFs as proposed would increase the safety and resilience
of the ETFs \180\ and allow the funds to more closely match the risk
profile of Permitted Investments, including Permitted Government MMFs.
Also, Qualified ETFs that maintain portfolios primarily comprised of
high-quality and liquid investments are better able to redeem interests
without placing excessive downward pressure on the NAVs.
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\180\ The Commission notes that a preliminary analysis of ETFs
investing primarily in short-term U.S. Treasury securities indicates
that the funds have a risk profile and volatility characteristics
that are comparable to that of the underlying U.S. Treasury security
investments. Specifically, using data available on Bloomberg, the
Commission notes that for the period June 2020-September 2023, the
Invesco Collateral Treasury ETF, as well as four other short-term
U.S. Treasury ETFs that CME accepts as performance bond--
SPDR[supreg] Bloomberg 1-3 Month T-Bill ETF, Goldman Sachs Access
Treasury 0-1 Year ETF, iShares 0-3 Month Treasury Bond ETF, and
iShares Short Treasury Bond ETF--had a standard deviation for a two-
day period of risk of approximately 6 BPS, whereas the one-year U.S.
Treasury securities had a standard deviation of 8 BPS for the same
period.
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In addition, the agreement pursuant to which an FCM or a DCO
acquires and holds its interest in the Qualified ETF would be
prohibited from containing provisions that would prevent the pledging
of the Qualified ETF's shares.\181\ FCMs and DCOs would be required to
maintain confirmations relating to their purchase of interests in a
Qualified ETF in their records in accordance with Regulation 1.31 and
note the ownership of the interests (by book-entry or otherwise) in the
FCMs' and DCOs' custody account in accordance with Regulation
1.26.\182\ FCMs and DCOs would be required to obtain the acknowledgment
letter required by Regulation 1.26 from an entity that has substantial
control over the ETF interests purchased with Customer Funds and that
has the knowledge and authority to facilitate redemption and payment or
transfer of the Customer Funds. Such entity may be the sponsor of the
Qualified ETF or a depository acting as custodian for the ETF
interests.
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\181\ Paragraph (c)(6) of Regulation 1.25 as applying to
Qualified ETFs per proposed revised introductory text of paragraph
(c) of Regulation 1.25.
\182\ Paragraph (c)(3) of Regulation 1.25 as applying to
Qualified ETFs per proposed revised introductory text of paragraph
(c) of Regulation 1.25.
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Also, the NAV for the Qualified ETF would be required to be
computed by 9 a.m. of the business day following each business day and
made available to FCMs or DCOs, as applicable, by that time.\183\ The
Commission notes that this proposed requirement is intended to allow
for the valuation of the Qualified ETF's investment portfolio to be
available by 9 a.m. the business day following an investment in the
ETF, so that the valuation is available in time for FCMs to perform
their daily segregation calculations, which are required to be
completed by noon each business day, reflecting balances as of the
close of business on the previous business day.\184\
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\183\ Paragraph (c)(4) of Regulation 1.25 as applying to
Qualified ETFs per proposed revised introductory text of paragraph
(c) of Regulation 1.25.
\184\ 2000 Permitted Investments Amendment at 78003.
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Further, the Qualified ETF would be required to be legally
obligated to redeem its interests and make payment in satisfaction of
the interests by the business day following a redemption request.\185\
FCMs or DCOs, as applicable, would be required to retain documentation
demonstrating compliance with this requirement.\186\ Regulation
1.25(c)(5)(ii) currently provides an exception to the next-day
redemption obligation for MMFs for defined extraordinary circumstances,
such as the non-routine closures of the Fedwire or applicable Federal
Reserve Banks, and any period during which the SEC by order restricts
redemptions for the protection of security holders in the fund.
Regulation 1.25(c)(5)(ii) was adopted by the Commission to be
consistent with Section 22(e) of the Investment Company Act of 1940
\187\ and SEC Rule 22e-3,\188\ which provides exceptions to MMFs for
next-day redemptions.\189\ The Commission is not proposing to adopt
next-day redemption exceptions for Qualified ETFs as no comparable
provisions are provided under the rules of the SEC, and in recognition
that the redemption process for ETFs involves the exchange of ETF share
for cash by authorized participants. As noted below, the Commission is
seeking comment on the potential existence of extraordinary
circumstances that may warrant an exception to the proposed next-day
redemption requirement.
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\185\ Paragraph (c)(5)(i) of Regulation 1.25 as applying to
Qualified ETFs per proposed revised introductory text of paragraph
(c) of Regulation 1.25.
\186\ Id.
\187\ 15 U.S.C. 80a-22(e).
\188\ 17 CFR 270.22e-3.
\189\ Regulation 1.25(c)(5)(ii) was originally adopted in 2005.
See 2005 Permitted Investments Amendment at 28196. It codified a
2001 letter issued by the Commission's Division of Trading and
Markets in response to an industry inquiry, stating that the
division would raise no issue in connection with MMFs that provide
for certain exceptions to the next-day redemption requirement. Id.
As specified in the 2001 letter, the circumstances in which the
next-day redemption could be excused overlapped to a certain extent
with those contained in Section 22(e) of the Investment Company Act
of 1940. See CFTC Staff Letter No. 01-31, [2000-2002 Transfer
Binder] Comm. Fut. L. Rep. (CCH)] 28,521 (Apr. 2, 2001). In 2011,
the Commission revised Regulation 1.25(c)(5)(ii) to more closely
align the language of that regulation with Section 22(e) and to
expressly incorporate SEC Rule 22e-3. See 2011 Permitted Investments
Amendment at 78789.
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The Commission preliminarily believes that limiting, as discussed
above, Qualified ETFs to funds that track the performance of a
published short-term U.S. Treasury security index would contribute to
facilitating redemptions of Qualified ETFs' shares to be completed
within one business day consistent with Regulations 1.25(c)(5)(i) and
1.25(b)(1).\190\
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\190\ See 17 CFR 1.25(c)(5) (providing that MMFs must be legally
obligated to redeem their interests and to make payment in
satisfaction of the interests by the business day following a
redemption request) and 17 CFR 1.25(b)(1) (providing that Permitted
Investments must be ``highly liquid'' such that the investments have
the ability to be converted into cash within one business day
without material discount in value).
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As previously discussed, ETFs issue and redeem their shares with
authorized participants in primary market transactions in blocks of
shares or ``creation units'' at the NAV per share. Redemptions may be
in cash or in kind. Authorized participants and the general public can
also purchase and sell ETF shares in the secondary market at the market
price per share. The Commission preliminarily believes that FCMs and
DCOs are likely to purchase and redeem the shares of a Qualified ETF
through primary market transactions intermediated by authorized
participants rather than purchasing and selling the ETF shares in the
secondary market, because the price of the shares in the secondary
market may differ from the NAV, and the sale of the shares in the
secondary market may delay the liquidation of the instruments.
The Commission notes that an FCM's or a DCO's purchase or
redemption of Qualified ETF shares through intermediated transactions
with authorized participants raises two concerns. First, if an FCM or a
DCO invests Customer Funds in shares of a Qualified ETF by purchasing
the shares through an authorized participant, the FCM or DCO would need
to take Customer Funds out of the segregated account maintained in
compliance with Section 4d of the Act and/or Part 30 of the
Commission's regulations to
[[Page 81251]]
purchase the ETF shares.\191\ As a result, customer segregated accounts
may not be fully funded, thus potentially violating Commission
regulations that require FCMs to maintain, at all times, in the
segregated account, money, securities and property in an amount that is
at least sufficient in the aggregate to cover their total obligations
to all customers.\192\ Also, the transfer of Customer Funds to the
authorized participant may be in contravention of Commission
regulations that provide that Customer Funds may only be deposited with
a bank or trust company, a DCO, or another FCM.\193\ Second, if an FCM
or a DCO uses an unaffiliated authorized participant to redeem its
Qualified ETF shares, the redemption of the ETF shares may be
protracted, preventing the redemption and liquidation of the shares to
occur within one business day, as required by Regulation 1.25.
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\191\ See 7 U.S.C. 6d (setting forth segregation requirements
for FCMs' futures customer funds); see also 17 CFR 1.20(a)
(providing that FCMs must separately account for futures customer
funds and segregate such funds as belonging to their futures
customers) and 17 CFR 1.20(g) (providing that DCOs must separately
account for and segregate futures customer funds as belonging to
futures customers); 17 CFR 22.2 (providing that FCMs must segregate
Cleared Customer Collateral) and 17 CFR 22.3 (requiring that DCOs
segregate Cleared Customer Collateral); and 17 CFR 30.7(b)
(providing that FCMs must deposit 30.7 funds under an account name
that clearly identifies the funds as belonging to 30.7 customers).
\192\ 17 CFR 1.20(a), 17 CFR 22.2(f), and 17 CFR 30.7(a).
\193\ 17 CFR 1.20(b), 17 CFR 22.2(b) and 17 CFR 30.7(b). With
respect to 30.7 customer funds, Regulation 30.7(b) also permits
funds to be deposited with the clearing organization of any foreign
board of trade, a member of any foreign board of trade, or such
member's or clearing organization's designated depositories. 17 CFR
30.7(b).
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To address these two concerns, the Commission proposes to require
an FCM or a DCO that invests Customer Funds in the shares of a
Qualified ETF to be an authorized participant of the ETF.\194\ The
Commission believes that this approach would permit Customer Funds to
be maintained in a segregated account in accordance with Section 4d or
Part 30, as applicable, with a permitted depository (i.e., a bank,
trust company, DCO, or another FCM), given that the Customer Funds
would not need to be transferred to an authorized participant
unaffiliated with the FCM or DCO. In addition, because an FCM or a DCO
acting as an authorized participant would be able to redeem the shares
without relying on a separate authorized participant, the Commission
believes that the FCM or DCO would be able to better manage completing
the redemption and liquidation of the Qualified ETFs shares within one
business day, as required by Regulation 1.25.
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\194\ Proposed paragraph (c)(8) of Regulation 1.25.
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The Commission, however, understands that FCMs and DCOs may have
access to other means of purchasing or liquidating interest in ETFs.
For instance, an FCM or a DCO may be able to acquire interests in an
ETF on a delivery-versus-payment basis through a securities broker or
dealer at price equal to the next calculated NAV amount per share or
another agreed-upon price that approximates the last calculated NAV.
Similarly, an FCM or a DCO may be able to sell Qualified ETF shares to
a broker or dealer willing to buy them at a price corresponding to the
NAV amount per share and later redeem them from the fund. To be able to
assess the feasibility of such arrangements and the potential
associated risks, the Commission requests additional information on the
availability and functioning of alternative mechanisms of purchasing
and liquidating Qualified ETF interests in a manner compliant with
Regulation 1.25 and compliant with the segregation requirements for
Customer Funds.
The Commission is also proposing that Qualified ETFs be required to
redeem their shares in cash.\195\ The Commission understands that ETFs
typically redeem interests in kind, although they may also redeem in
cash or both in kind and in cash. The Commission also notes that CME,
in announcing its acceptance of short-term U.S. Treasury ETFs as
performance bond, stated that it would accept short-term U.S. Treasury
ETFs that redeem their shares in cash or in kind.\196\ As discussed
above, the Commission is requiring that Qualified ETFs redeem their
shares within one business day following the submission of the
redemption request, consistent with the time limit for redemptions
applicable to MMFs under Regulation 1.25(c)(5). In addition, under
Regulation 1.25(c)(1), the shares of Qualified ETFs, as a Permitted
Investment, would be required to be convertible into cash within one
business day without material discount in value. As such, given these
time limits for the redemption and liquidation of Qualified ETF shares,
the Commission is proposing to require Qualified ETFs to redeem their
shares in cash because in-cash redemptions may allow for a more
expeditious liquidation of the shares than in-kind redemptions.
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\195\ Proposed Regulation 1.25(c)(8)(i).
\196\ 2022 CME Advisory Notice at 1.
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In this regard, the Commission notes that in-kind redemptions may
introduce a time lag between the redemption of the ETF shares and the
ultimate liquidation of the shares, as the assets received in in-kind
redemptions would need to be sold or otherwise converted into cash to
complete the liquidation of the ETF shares, hindering the ability to
liquidate the ETF shares within one business day, as required by
Regulation 1.25(b)(1). As such, the Commission is proposing to require
that Qualified ETFs redeem their shares only in cash. The Commission,
however, is requesting information on the availability and functioning
of potential mechanisms or arrangements that may allow FCMs and DCOs to
liquidate a Qualified ETF's shares in a manner compliant with
Regulation 1.25 and the segregation requirements if the fund's
interests were redeemed in kind.
The Commission is also proposing to require, as a condition for
qualification as a Permitted Investment, that Qualified ETFs be
acceptable by a DCO as performance bond from clearing members to margin
customer trades.\197\ Although qualification as acceptable collateral
by a DCO is not determinative of qualification as a Permitted
Investment, the Commission preliminarily believes that limiting
Qualified ETFs to funds that have met a DCO's criteria of eligibility
as performance bond represents an additional safeguard. In addition, as
noted above, the possibility that ETF shares could be pledged by an FCM
as margin collateral is an important consideration for the Commission
in determining whether to add the interests of ETFs to the list of
Permitted Investments.
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\197\ Proposed Regulation 1.25(c)(8)(iii).
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In order to add the interests of Qualified ETFs to the list of
Permitted Investments under Regulation 1.25, the Commission is
proposing to add paragraph (vi) to Regulation 1.25(a)(1), as
redesignated to accommodate other amendments to the list of Permitted
Investments pursuant to this Proposal. Paragraph (vi) would identify
interests in U.S. Treasury exchange-traded funds as a Permitted
Investment. The Commission also proposes further conforming changes
throughout Regulation 1.25. Section III.A.2. above provides for the
replacement of ``money market mutual fund'' or ``money market mutual
funds'' with ``government money market fund'' or ``government money
market funds'' throughout Regulation 1.25. The Commission proposes,
unless otherwise discussed below, to insert next to the term
[[Page 81252]]
``government money market fund'' or ``government money market funds,''
the term ``U.S. Treasury exchange-traded fund'' or ``U.S. Treasury
exchange-traded funds,'' as appropriate, preceded by an appropriate
conjunction (i.e., ``or'' or ``and''), as necessary.
To incorporate the condition that a Qualified ETF must be an
investment company that is registered under the Investment Company Act
of 1940 with the SEC and holds itself out to investors as an ETF under
SEC Rule 6c-11, the Commission proposes to revise Regulation 1.25(c)(1)
to provide that, ``The fund must be an investment company that is
registered under the Investment Company Act of 1940 with the Securities
and Exchange Commission and that holds itself out to investors as a
government money market fund, in accordance with 270.2a-7 of this
title, or an exchange-traded fund, in accordance with 270.6c-11 of this
title.''
Moreover, to incorporate the requirement that an FCM or a DCO
investing in a Qualified ETF must be an authorized participant, the
Commission proposes to revise Regulation 1.25(c) to add paragraph (8),
which would provide, ``Interests in U.S. Treasury exchange-traded funds
will qualify as a Permitted Investment under Regulation 1.25(a) if the
interests are redeemable in cash by a futures commission merchant or
derivatives clearing organization in its capacity as an authorized
participant pursuant to an authorized participant agreement, as defined
in Sec. 270.6c-11, at a price based on the net asset value in
accordance with the Investment Company Act of 1940 and regulations
thereunder, and on a delivery versus payment basis.''
To account for the possibility that, as part of their investment
strategy and within the limits of applicable SEC rules, Qualified ETFs
may engage in derivatives transactions, the Commission is also
proposing to amend Regulation 1.25(b)(2)(i) to indicate that the
prohibition of investments containing embedded derivatives would not
apply to Qualified ETFs.
Finally, the Commission is proposing to amend Regulation
1.25(b)(4)(i), which provides that except for investments in MMFs, the
dollar-weighted average time-to-maturity of an FCM's or a DCO's
portfolio of Permitted Investments, as computed under SEC Rule 2a-7,
may not exceed 24 months. The proposed amendment would revise
Regulation 1.25(b)(4)(i) to exclude Qualified ETFs from the calculation
of the dollar-weighted average time-to-maturity of the portfolio of
Permitted Investments.\198\ The Commission is proposing this amendment
as interests in Qualified ETFs do not have maturity dates, as the
Qualified ETF manages the rolling of maturing U.S. Treasury securities
into new investments.
---------------------------------------------------------------------------
\198\ Proposed revised Regulation 1.25(b)(4)(i).
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Request for Comment: The Commission seeks comment on all aspects of
the Proposal relating to the expansion of the list of Permitted
Investments to include interests in ETFs subject to the specified
conditions discussed above, including:
6. For the interests of ETFs to be deemed a Permitted Investment,
the ETFs would have to satisfy requirements similar to the requirements
that apply to Government MMFs whose interests qualify as Permitted
Investments. Is it appropriate to apply the regulatory framework that
applies to Government MMFs to ETFs for determining whether an ETF would
be deemed a Qualified ETF and interests in the ETF be deemed a
Permitted Investment? To the extent some aspects of the regulatory
framework applicable to MMFs is not appropriate for ETFs, please
specify and explain why.
7. The Proposal to add interests in Qualified ETFs to the list of
Permitted Investments provides that only the interests of ETFs that are
passively managed and seek to replicate the performance of a published
short-term U.S. Treasury security index by investing in a limited set
of instruments would qualify as Permitted Investments. The Commission
notes that the types of investments in which Qualified ETFs and
Permitted Government MMFs would be permitted to invest under the
Proposal would differ in that Qualified ETFs' investments would be
determined by its investment strategy seeking to replicate the
performance of a public short-term U.S. Treasury index and a
requirement that the Qualified ETFs invest 95 percent or more of their
assets in U.S. Treasury securities that are components of the index,
whereas government MMFs would be required to invest 99.5 percent or
more of their assets in cash, government securities (defined in 15
U.S.C. 80a-2(a)(16) to broadly include U.S. Treasury securities and
U.S. agency securities), and/or Repurchase Transactions that must be
collateralized fully, consistent with the definition of government
money market funds under SEC Rule 2a-7. Should the Commission further
limit the types of underlying instruments in which a Qualified ETF
would be permitted to invest? If so, what criteria should be applied to
determine the appropriate limitations? Should the Commission permit
Qualified ETFs to invest a lower or higher percentage of their assets
in short-term U.S. Treasury securities that are components of the index
than the proposed 95 percent? If so, what percentage should the
Commission consider and why? Also, should the Commission reconcile the
types of investments in which Qualified ETFs and Permitted Government
MMFs would be permitted to invest by allowing Qualified ETFs to invest
in the same investments as Permitted Government MMFs?
8. Under the Proposal, Qualified ETFs would not be precluded from
undertaking Repurchase Transactions. Does an ETF engaging in Repurchase
Transactions with fund assets have the potential to adversely impact an
authorized participant's ability to redeem interest in the fund in
exchange for cash? Does an ETF engaging in Repurchase Transactions
present other issues that would delay the ability of an authorized
participant to redeem interest in the fund in cash? Could the potential
delay prevent completing redemptions and liquidation of the ETF shares
within one business day, as required by Regulation 1.25? Should
Qualified ETFs be prohibited from undertaking Repurchase Transactions
given the possible risk of delay in redemptions?
9. The Proposal would require that FCMs or DCOs that invest
Customer Funds in interests of Qualified ETFs be authorized
participants in order to address concerns that during purchase or
redemption of ETF shares, Customer Funds might be moved to an account
not held by an appropriate depository of customer segregated funds
(i.e., a bank, trust company, DCO or FCM) without a contemporaneous
deposit of ETF shares or cash in customer segregated accounts,
resulting in the FCM or DCO being undersegregated. Are there
alternative approaches other than requiring FCMs or DCOs to be
authorized participants that could address or mitigate the Commission's
concerns? Can DCOs be authorized participants of Qualified ETFs? If
not, are there alternatives that would permit DCOs to invest Customer
Funds in Qualified ETFs consistent with the requirements of Regulation
1.25 and the Commission's segregation requirements?
10. The Commission understands that interests in short-term U.S.
Treasury ETFs may be redeemed in cash or in kind. The Commission is
proposing to require that the shares of a Qualified ETF be redeemable
only in cash given the concern that in-kind redemptions may not permit
the liquidation of the
[[Page 81253]]
ETF shares within one business day, as required by Regulation
1.25(b)(1). If the Commission were to allow shares of Qualified ETFs to
be redeemable in kind, would the Qualified ETF's interests have the
ability to be liquidated within one business day as required by
Regulation 1.25(b)(1)? What mechanisms or arrangements exist that may
allow FCMs and DCOs to convert Qualified ETF shares into cash within
one business day without material discount in value if redemptions
occur in kind? Are there any potential risks associated with such
mechanisms and arrangements that the Commission should consider? Is
there an alternative approach to address the Commission's concerns that
would permit the use of in-kind redemptions and also provide FCMs and
DCOs with access to cash for the redemptions within one business day?
Does the proposed requirement that the Qualified ETF invest 95 percent
or more of its total assets in short-term U.S. Treasury securities help
ensure that FCMs and DCOs will be able to liquidate securities received
from an in-kind redemption within one business day? Does the proposed
requirement that an FCM or a DCO must be an authorized participant help
ensure that the FCM or DCO has the internal operational capability and
resources to liquidate in-kind redemptions in a manner and time-frame
compliant with Regulation 1.25 requirements?
11. As noted, the Commission is proposing to require that interests
in Qualified ETFs be redeemable in cash within one business day. Are
there any extraordinary circumstances, similar to the events listed in
Regulation 1.25(c)(5)(ii) with respect to MMFs, that may justify an
exception to the proposed next-day redemption requirement? If so,
please specify what redemption exceptions are necessary, and explain
why the exceptions are necessary. Also address potential impacts to
customers if Qualified ETFs do not redeem within one business if
exceptions were provided.
12. Does the Proposal to add Qualified ETFs to the list of
Permitted Investments under Regulation 1.25, along with the continued
inclusion of MMFs, have the potential to reduce the availability of
funds from the banking system in a manner that would raise any
financial stability concerns? Could the use of Repurchase Transactions
by MMFs and ETFs exacerbate any financial stability issues that may
exist?
13. The Proposal would require that a Qualified ETF must be a
passively managed fund that seeks to replicate the performance of a
published short-term U.S. Treasury security index composed of bonds,
notes, and bills with a remaining maturity of 12 months or less, issued
by, or unconditionally guaranteed as to the timely payment of principal
and interest by, the U.S. Department of the Treasury. Should the
Commission impose conditions or requirements that a publisher of an ETF
index must meet or satisfy in order for the ETF to be a Qualified ETF?
If so, what conditions or requirements should the Commission impose,
and why?
14. Regulation 1.25(b)(5)(ii) currently provides that an FCM or a
DCO may invest Customer Funds in a fund affiliated with that FCM or
DCO. Should the Commission revise Regulation 1.25(b)(5)(ii) to prohibit
an FCM or a DCO from investing Customer Funds in affiliated funds? Are
there other Commission or SEC rules that mitigate any potential
conflicts of interest that may arise from an FCM or a DCO investing
Customer Funds in affiliated funds?
4. Investments in Commercial Paper and Corporate Notes or Bonds
The Commission originally approved commercial paper and corporate
notes as Permitted Investments for FCMs and DCOs in 2000.\199\ The
Commission subsequently revised the list of Permitted Investments in
2005 to include corporate bonds.\200\
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\199\ See 2000 Permitted Investments Amendment at 78010.
\200\ See 2005 Permitted Investments Amendment at 28200.
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In 2007, the Commission's Division of Clearing and Intermediary
Oversight conducted a review of the use of Permitted Investments by
FCMs and DCOs.\201\ The review indicated that commercial paper and
corporate notes and bonds were not widely used by FCMs and DCOs. In
2011, in an effort to simplify Regulation 1.25 by eliminating rarely-
used instruments and in consideration of the Commission's concerns that
corporate debt securities posed credit, liquidity and market risks, the
Commission revised Regulation 1.25 to provide that an FCM or a DCO may
invest Customer Funds in commercial paper and corporate notes and
corporate bonds only if the debt instruments were guaranteed by the
TLGP.\202\
---------------------------------------------------------------------------
\201\ 2011 Permitted Investments Amendment at 78776.
\202\ Id. at 78779.
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The TLGP expired in 2012, and, therefore, commercial paper,
corporate notes, and corporate bonds are no longer Permitted
Investments under the terms of Regulation 1.25.\203\ Accordingly, the
Commission is proposing to remove commercial paper, corporate notes,
and corporate bonds from the list of Permitted Investments.
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\203\ Temporary Liquidity Guarantee Program, available at
https://www.fdic.gov/Regulations/resources/tlgp/index.html (``Under
the [Debt Guarantee Program], the FDIC guaranteed in full, through
maturity or June 30, 2012, whichever came first, the senior
unsecured debt issued by a participating entity between October 14,
2008, and June 30, 2009. In 2009, the issuance period was extended
through October 31, 2009. The FDIC's guarantee on each debt
instrument was also extended in 2009 to the earlier of the stated
maturity date of the debt or December 31, 2012.'').
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5. Investments in Permitted Investments With Adjustable Rates of
Interest
Regulation 1.25(b)(2)(iv)(A) provides that Permitted Investments
may contain variable or floating rates of interest provided, among
other things, that: (i) the interest payments on variable rate
securities correlate closely, and on an unleveraged basis, to a
benchmark of either the Federal Funds target or effective rate, the
prime rate, the three-month Treasury Bill rate, the one-month or three-
month LIBOR, or the interest rate of any fixed rate instrument that is
a listed Permitted Investment under Regulation 1.25(a); \204\ and (ii)
the interest rate, in any period, on floating rate securities is
determined solely by reference, on an unleveraged basis, to a benchmark
of either the Federal Funds target or effective rate, the prime rate,
the three-month Treasury Bill rate, the one-month or three-month
LIBOR,\205\ or the interest rate of any fixed rate instrument that is a
listed Permitted Investment under Regulation 1.25(a).\206\
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\204\ 17 CFR 1.25(b)(2)(iv)(A)(1).
\205\ For simplicity, subsequent references to ``one-month or
three-month LIBOR rate'' will be referred to as LIBOR unless
otherwise required by the context of the discussion.
\206\ 17 CFR 1.25(b)(2)(iv)(A)(2).
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LIBOR has been used extensively as a reference rate in various
commercial and financial contracts, including corporate and municipal
bonds, commercial loans, floating rate mortgages, asset-backed
securities, consumer loans, and interest rate swaps and other
derivatives.\207\ The U.K. Financial Conduct Authority, however,
announced on March 5, 2021 that LIBOR would cease to be published and
would effectively be discontinued.\208\
[[Page 81254]]
This announcement had been anticipated given the loss of confidence in
LIBOR as a reliable benchmark following a number of enforcement actions
concerning attempts to manipulate the benchmark.\209\
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\207\ Staff Statement on LIBOR Transition, SEC Division of
Corporation Finance, Division of Investment Management, Division of
Trading and Markets, and Office of the Chief Accountant (July 12,
2019), available at https://www.sec.gov/news/public-statement/libor-transition.
\208\ See CFTC Staff Letter No. 21-26, Revised No-Action
Positions to Facilitate an Orderly Transition of Swaps from Inter-
Bank Offered Rates to Alternative Benchmarks (Dec. 20, 2021)
(``Staff Letter 21-26''), (More specifically, the U.K. Financial
Conduct Authority, which regulates ICE Benchmark Administration
Limited, the administrator of ICE LIBOR, confirmed that LIBOR would
either cease to be provided by any administrator or would no longer
be representative for the 1-week and 2-month USD LIBOR settings,
immediately after December 31, 2021, and for all other USD LIBOR
settings immediately after June 30, 2023). As noted supra, CFTC
Staff Letters are available at the Commission's website,
www.cftc.gov.
\209\ See e.g., In re Barclays PLC, CFTC Docket No. 12-25 (June
27 2012); In re UBS AG, CFTC Docket No. 13-09 (Dec. 19, 2012).
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The Federal Reserve Bank of New York convened the Alternative
Reference Rate Committee (``ARRC'') in 2014 to identify best practices
for U.S. alternative reference rates and best practices for contract
robustness, to develop an adoption plan, and to create an
implementation plan with metrics of success and a timeline.\210\ In
June 2017, the ARRC identified SOFR, a broad Treasury repurchase
agreements financing rate, as the preferred alternative benchmark to
USD LIBOR for certain new USD derivatives and financial contracts.\211\
SOFR is a broad measure of the cost of borrowing cash overnight
collateralized by U.S. Treasury securities in the Repurchase
Transaction market used by financial institutions, governments, and
corporations.\212\ SOFR is calculated as a volume-weighted median of
transaction-level triparty repo data collected from the Bank of New
York Mellon as well as data on bilateral U.S. Treasury Repurchase
Transactions cleared through the Fixed Income Clearing
Corporation.\213\ The Federal Reserve Bank of New York, in cooperation
with the U.S. Office of Financial Research, publishes SOFR by 8:00 a.m.
each business day.\214\
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\210\ Staff Letter 21-26 at p. 3.
\211\ ARRC, ``The ARRC Selects a Broad Repo Rate as its
Preferred Alternative Reference Rate,'' June 22, 2017, available at
https://www.newyorkfed.org/medialibrary/microsites/arrc/files/2017/ARRC-press-release-Jun-22-2017.pdf.
\212\ See Secured Overnight Financing Rate Data, published by
the Federal Reserve Bank of New York (``FRBNY'') and available at
https://apps.newyorkfed.org/markets/autorates/sof.
\213\ Id.
\214\ See Additional Information about the Treasury Repo
Reference Rates, published by the FRBNY and available at https://www.newyorkfed.org/markets/treasury-repo-reference-rates-information.
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In response to the anticipated termination of the publication of
LIBOR and the increasing acceptance and use of SOFR as a benchmark
interest rate, MPD issued Staff Letter 21-02 on January 4, 2021.\215\
Staff Letter 21-02 provides that MPD would not recommend enforcement
action to the Commission if an FCM invested Customer Funds in Permitted
Investments that contain adjustable rates of interest benchmarked to
SOFR. Staff Letter 21-02 was a time-limited no-action position that was
to expire on December 31, 2022. MPD and DCR, however, subsequently
issued a joint letter, Staff Letter 22-21, extending the effective date
of the no-action position to December 31, 2024, and expanding the scope
of the no-action position to include Permitted Investments made by
DCOs.\216\
---------------------------------------------------------------------------
\215\ See supra note 60.
\216\ See id.
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Given the discontinuation of the publishing of LIBOR and the
increasing use of SOFR, the Commission is proposing to amend Regulation
1.25(b)(2)(iv)(A) by replacing LIBOR with SOFR as a permitted benchmark
for Permitted Investments that contain an adjustable rate of interest.
To give effect to this revision, paragraphs (b)(2)(iv)(A)(1) and (2) of
Regulation 1.25 would be amended to replace the phrase ``one-month or
three-month LIBOR rate'' with the phrase ``SOFR rate.'' These proposed
amendments would be consistent with the Commission's intent of
providing FCMs and DCOs with a certain degree of flexibility in
selecting Permitted Investments with adjustable rates of interest,
while also recognizing changes in the market.\217\ The Commission
preliminarily believes that the replacement of LIBOR with SOFR advances
the objective of Regulation 1.25 of preserving principal and
maintaining liquidity by requiring the use of reliable benchmarks in
the qualification as Permitted Investments.
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\217\ See 2005 Permitted Investments Amendment at 28192, where
the Commission stated that it is appropriate to afford latitude in
establishing benchmarks for Permitted Investments to enable FCMs and
DCOs to more readily respond to changes in the market.
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Request for Comment: The Commission seeks comment on all aspects of
the Proposal to eliminate LIBOR as a permitted benchmark, including:
15. The ARRC has identified SOFR as a preferred alternative
reference interest rate to LIBOR. Should the Commission consider other
additional interest rates beyond SOFR as permitted benchmarks for
adjustable rate securities under Regulation 1.25? If so, please explain
why such interest rates would be appropriate benchmarks.
16. The Commission is proposing to amend Regulation 1.25(b)(2)(iv)
to permit SOFR as a benchmark for interest payments on variable rate
securities or floating rate securities that are otherwise Permitted
Investments under Regulation 1.25. Should the Commission reference a
particular SOFR rate to provide greater certainty and clarity as to the
acceptable benchmark? For instance, should the reference be to the
overnight SOFR rate published by the Federal Reserve Bank of New York,
to a CME Term SOFR Rate, or to another published SOFR rate? Please
explain your answer.
6. Investments in Certificates of Deposit Issued by Banks
Regulation 1.25(a)(1)(iv) permits FCMs and DCOs to invest Customer
Funds in certificates of deposit (``CDs'') issued by a Section 3(a)(6)
bank or a domestic branch of a foreign bank that carries deposits
insured by the FDIC (``bank CDs''). To qualify as a Permitted
Investment under Regulation 1.25, a bank CD must be redeemable at the
issuing bank within one business day, with any penalty for early
withdrawal limited to accrued interest earned according to the written
terms of the CD agreement.\218\
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\218\ Regulation 1.25(b)(2)(v); 17 CFR 1.25(b)(2)(v).
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The Commission's experience has been, however, that FCMs and DCOs
do not select bank CDs as an investment option. In addition to the
Commission's general experience in overseeing DCOs and FCMs, Commission
staff also reviewed Segregation Investment Detail Reports (``SIDR
Reports'') filed by FCMs for the period September 15, 2022 through
February 15, 2023 and noted no FCMs reporting investment of Customer
Funds in bank CDs.\219\
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\219\ Regulations 1.32(f), 22.2(g)(5), and 30.7(l)(5) require
each FCM to submit a SIDR Report to the Commission and the FCM's
designated self-regulatory organization (``DSRO'') listing the names
of all banks, trust companies, FCMs, DCOs, and any other
depositories or custodians holding futures customer funds, Cleared
Swaps Customer Collateral, or 30.7 customer funds, respectively.
FCMs are required to submit the SIDR Report as of the 15th day of
each month (or the next business day if the 15th day of the month is
not a business day) and the last business day of the month. 17 CFR
1.32(f), 17 CFR 22.2(g)(5), and 17 CFR 30.7(l)(5). Proposed
amendments to the SIDR Report to reflect the proposed revisions to
the list of Permitted Investments discussed in this Proposal are
discussed in Section III.D. below.
With respect to an FCM, a DSRO is the self-regulatory
organization that has been delegated the responsibility under a
formal plan approved by the Commission pursuant to Regulation 1.52
to monitor and examine the FCM for compliance with Commission and
self-regulatory organization minimum financial and related financial
reporting requirements. 17 CFR 1.52.
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The Commission believes that bank CDs are consistent with the
overall objective of Regulation 1.25 that all Permitted Investments
must preserve principal and maintain liquidity of the Customer Funds.
In this regard, and as noted above, Regulation 1.25(b)(2)(v) provides
that in order to qualify as a
[[Page 81255]]
Permitted Investment, a CD must be redeemable at the issuing bank
within one business day, with any penalty for early withdrawal limited
to any accrued interest earned according to its written terms.\220\
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\220\ 17 CFR 1.25(b)(2)(v).
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Request for Comment: Notwithstanding that bank CDs currently
qualify as Permitted Investments, the Commission is seeking comment on
whether Regulation 1.25 should be amended to remove bank CDs from the
list of Permitted Investments. As noted above, the Commission's
experience and the staff's review of the SIDR reports indicate that
FCMs and DCOs generally have not invested Customer Funds in bank CDs.
Specifically, the Commission seeks comment on the following issues:
17. Notwithstanding the Commission's experience and staff's review
of the SIDR Reports discussed above, do FCMs and/or DCOs invest
Customer Funds in bank CDs? If so, would the elimination of bank CDs as
a Permitted Investment have a material adverse impact on FCMs' and
DCOs' ability to invest Customer Funds pursuant to the proposed
revisions to Regulation 1.25?
18. Are there provisions contained in current Regulation 1.25 or
other regulations of the Commission that hinder or prevent FCMs or DCOs
from investing Customer Funds in bank CDs? If so, please identify which
provisions of Regulation 1.25 are at issue and explain why.
19. Are there legal or operational issues associated with bank CDs
that hinder or prevent FCMs or DCOs from investing Customer Funds in
such instruments? If so, please identify the legal or operational
issues, and explain how such issues hinder or prevent the investment in
bank CDs.
20. Would FCMs or DCOs elect to invest Customer Funds in bank CDs
with the current rising interest rate environment? Are there other
factors that may lead FCMs or DCOs to increase their use of bank CDs as
Permitted Investments?
21. What factors should the Commission consider before removing
bank CDs from the list of Permitted Investments?
Based on comments received and the Commission's further
consideration of this issue, the Commission may determine to revise the
Permitted Investments by removing bank CDs in the final rulemaking. If
the Commission were to remove bank CDs from the list of Permitted
Investments, the Commission would delete paragraph (a)(1)(iv) of
Regulation 1.25 and redesignate the paragraphs of Regulation 1.25(a)(1)
as appropriate to reflect the revised list of Permitted Investments. In
addition, the Commission would delete paragraph (b)(2)(v) of Regulation
1.25, which sets forth restrictions on the features of permitted bank
CDs, and revise and/or delete, as appropriate in light of other
amendments, paragraphs (b)(3)(i)(C) and (b)(3)(ii)(B) of Regulation
1.25, which set forth asset-based and issuer-based concentration limits
for certain instruments currently included in the list of Permitted
Investments, to reflect the elimination of bank CDs from that list. The
Commission would also make conforming amendments to Regulations
1.32(f), 22.2(g)(5), and 30.7(l)(5), which define the content of the
SIDR Reports described in Section III.D. below, to reflect the removal
of bank CDs from the list of Permitted Investments in Regulation 1.25.
Specifically, the Commission would delete the requirement for an FCM to
report the balances invested in bank CDs in the SIDR Report.
B. Asset-Based and Issuer-Based Concentration Limits for Permitted
Investments
Regulation 1.25 establishes asset-based and issuer-based
concentration limits for an FCM's and a DCO's investment of Customer
Funds in Permitted Investments.\221\ The asset-based and issuer-based
concentration limits are set at the same levels for investments of
futures customer funds, Cleared Swaps Customer Collateral, and 30.7
customer funds.\222\ An FCM or a DCO is also required to calculate the
asset-based and issuer-based concentration limits separately for
futures customer funds, Cleared Swaps Customer Collateral, and 30.7
customer funds based on the total amount of funds held by the FCM or
DCO in each respective segregation classification.\223\
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\221\ 17 CFR 1.25(b)(3).
\222\ The asset-based and issuer-based concentration limits for
futures customer funds are set forth in Regulation 1.25(b)(3). 17
CFR 1.25(b)(3). With respect to 30.7 customer funds, Regulation
30.7(h)(1) provides that an FCM may invest 30.7 customer funds
subject to, and in compliance with the terms and conditions of
Regulation 1.25, which includes the asset-based and issuer-based
concentration limits. 17 CFR 30.7(h)(1). With respect to Cleared
Swaps Customer Collateral, Regulations 22.2(e)(1) and 22.3(d)
provide that an FCM or a DCO, respectively, may invest Cleared Swaps
Customer Collateral in accordance with Regulation 1.25, which
includes the asset-based and issuer-based concentration limits. 17
CFR 22.2(e)(1) and 17 CFR 22.3(d).
\223\ See 2011 Permitted Investments Amendment at 78787, where
the Commission stated that concentration limits are to be calculated
on a fund-by-fund basis (i.e., based on separate segregation
classifications).
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An FCM or a DCO is currently permitted to directly invest futures
customer funds, Cleared Swaps Customer Collateral, and 30.7 customer
funds in each of the Permitted Investments up to the following asset-
based limits: (i) U.S. government securities--100 percent; (ii) U.S.
agency obligations--50 percent; (iii) for each investment asset class
of bank CDs, commercial paper, and corporate notes and bonds--25
percent; and (iv) municipal securities--10 percent.\224\
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\224\ Regulation 1.25(b)(3)(i)(A)-(D); 17 CFR 1.25(b)(3)(i)(A)-
(D). U.S. government securities refers to general obligations of the
U.S. and obligations fully guaranteed as to principal and interest
by the U.S. See 17 CFR 1.25(a)(1)(i).
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With respect to MMFs, an FCM or a DCO may invest up to 100 percent
of the total futures customer funds, Cleared Swaps Customer Collateral,
and 30.7 customer funds that it holds in MMFs that invest only in U.S.
government securities, provided that the size of the funds' portfolio
is at least $1 billion and the funds' management company has at least
$25 billion of assets under management.\225\ If a fund has less than $1
billion of assets under management, or if the manager of the fund has
less than $25 billion of assets under management, the FCM or DCO may
invest up to 10 percent of its total futures customer funds, Cleared
Swaps Customer Collateral, and 30.7 customer funds in the fund.\226\
For Prime MMFs, an FCM or a DCO may invest up to 50 percent of the
total futures customer funds, Cleared Swaps Customer Collateral, and
30.7 customer funds in such MMFs; however, the asset-based
concentration is limited to 10 percent if a fund has less than $1
billion in assets under management or if the fund's manager has less
than $25 billion of assets under management.\227\
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\225\ 17 CFR 1.25(b)(3)(i)(E).
\226\ 17 CFR 1.25(b)(3)(i)(G).
\227\ 17 CFR 1.25(b)(3)(i)(F) and (G).
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With respect to issuer-based concentration limits, an FCM or a DCO
is permitted to invest up to 100 percent of the total futures customer
funds, Cleared Swaps Customer Collateral, and 30.7 customer funds that
it holds in U.S. government securities.\228\ An FCM or a DCO also may
invest futures customer funds, Cleared Swaps Customer Collateral, and
30.7 customer funds directly in qualifying Permitted Investments, other
than U.S. government securities, subject to the following issuer-based
concentration limits: (i) obligations of any single issuer of U.S.
agency obligations--25 percent;
[[Page 81256]]
(ii) obligations of any single issuer of municipal securities, bank
CDs, commercial paper, or corporate notes or bonds--5 percent.\229\
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\228\ See 17 CFR 1.25(b)(3)(ii), which excludes U.S. government
securities from the issuer-based concentration limits. See also,
2011 Permitted Investments Amendment at 78788.
\229\ 17 CFR 1.25(b)(3)(ii)(A) and (B).
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With respect to MMFs, an FCM or a DCO may invest up to 100 percent
of the total futures customer funds, Cleared Swaps Customer Collateral,
and 30.7 customer funds in a single MMF that invests only in U.S.
government securities.\230\ With respect to MMFs that maintain
investment portfolios that hold instruments other than U.S. government
securities, an FCM or a DCO is subject to the following issuer-based
concentration limits: (i) interest in any single MMF family may not
exceed 25 percent of customer funds held; and (ii) interest in any
individual MMF may not exceed 10 percent of customer funds held.\231\
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\230\ See 17 CFR 1.25(b)(3)(ii) which excludes MMFs that invest
only in U.S. government securities from the issuer-based
concentration limits.
\231\ 17 CFR 1.25(b)(3)(ii)(C) and (D).
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The Commission is proposing to amend the asset-based and issuer-
based concentration limits in Regulation 1.25(b)(3) to reflect the
proposed revisions to the list of Permitted Investments discussed in
this Proposal and to adjust the limits based on the Commission's
experience administering Regulation 1.25. In that regard, as discussed
in Section III.A.2. above, the Commission is proposing to limit the
scope of MMFs whose interests qualify as Permitted Investments to
Permitted Government MMFs. A Permitted Government MMF would be defined
by reference to SEC Rule 2a-7 as an MMF that invests at least 99.5
percent or more of its total assets in cash, government securities,
and/or Repurchase Transactions that are collateralized fully.\232\ The
Commission notes that the scope of underlying instruments in which a
Permitted Government MMF would be allowed to invest is broader than
that of the MMFs currently excluded from the concentration limits of
Regulation 1.25(c) (i.e., MMFs investing solely in U.S. government
securities). To account for the potential increase in risk associated
with such broader scope and in the interest of imposing a simple and
consistent approach to concentration limits, the Commission is
proposing to establish a single concentration limit of 50 percent for
all Permitted Government MMFs of a certain size, without distinguishing
between funds investing solely in U.S. government securities and those
whose portfolio may also include U.S. agencies securities and/or other
instruments within the limits of SEC Rule 2a-7.
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\232\ See supra notes 120 and 121.
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More precisely, under the Proposal, an FCM's or a DCO's investment
of Customer Funds in interests in Permitted Government MMFs with at
least $1 billion in assets and whose management company manages at
least $25 billion in assets would be limited to no more than 50 percent
of the total Customer Funds computed separately for each of the
segregated funds classifications of futures customer funds, Cleared
Swaps Customer Collateral, and 30.7 customer funds.\233\ The proposed
asset-based concentration limits are consistent with the concentration
limits applicable to U.S. agency obligations, which along with U.S.
Treasury securities, are a permitted underlying instrument for
Permitted Government MMFs.\234\
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\233\ Proposed revised Regulation 1.25(c)(3)(i)(E).
\234\ 17 CFR 1.25(b)(3)(i)(B).
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More generally, the Commission is proposing these asset-based
concentration limits for Permitted Government MMFs to ensure that
Customer Funds are invested in a manner that limits risks arising from
a high concentration in any particular Permitted Investment asset
class. In particular, based on its experience administering the CFTC's
customer protection rules, the Commission preliminarily believes that
it is not prudent to allow FCMs and DCOs to invest up to 100 percent of
segregated Customer Funds in any category of MMFs. For the reasons
discussed below in connection with the proposed issuer-based
concentration limits, the Commission is of the view that holding U.S.
government securities through an MMF gives rise to risks that are
different from those associated with holding U.S. government securities
directly, including operational and cybersecurity risks. As such, the
Commission preliminarily believes that even large MMFs that invest
solely in U.S. government securities should be subject to a
concentration limit. The Commission is also proposing to maintain the
current 10 percent asset-based concentration limit on investments in
MMFs that hold less than $1 billion in assets or have a management
company with less than $25 billion in assets under management.\235\ For
purposes of clarity, the Commission is proposing to delete the
conjunction ``and'' in that provision to indicate that the fund size
threshold and the management company size threshold are to be construed
as alternative prongs triggering the 10 percent limit.
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\235\ Proposed Regulation 1.25(c)(3)(i)(F).
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In addition, to mitigate the potential risks arising from
concentration in any particular fund or family of funds, the Commission
is proposing issuer-based concentration limits for investments in
Permitted Government MMFs. Specifically, the Commission is proposing to
limit investments of Customer Funds in any single family of Permitted
Government MMFs to 25 percent and investments of Customer Funds in any
single issuer of Permitted Government MMFs to 5 percent of the total
assets held in each of the segregated classifications of futures
customer funds, Cleared Swaps Customer Collateral, and 30.7 customer
funds.\236\
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\236\ Proposed Regulations 1.25(c)(3)(ii)(C) and (D),
respectively.
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In adopting the 2011 Permitted Investment Amendment, the Commission
decided not to introduce concentration limits for MMFs of a certain
size investing solely in U.S. government securities. This determination
was made in consideration of comments received from the public,
including in particular a comment asserting that if FCMs and DCOs are
permitted to invest all customer segregated funds in U.S. government
securities directly, an FCM or a DCO should be able to make the same
investment indirectly via an MMF.\237\ Based on its experience
administrating CFTC's customer protection rules and in consideration of
certain recent marketplace events, however, the Commission
preliminarily believes that introducing concentration limits for
Permitted Government MMFs is warranted. In particular, the Commission
is concerned that MMFs, like any institution relying on electronic
communications, are susceptible to cyber-attacks and operational
incidents that may adversely impact their normal operating
capabilities, including delaying or otherwise preventing them from
processing redemption requests of FCMs and DCOs in a timely
manner.\238\ FCMs and DCOs may need to redeem
[[Page 81257]]
their interest in Permitted Government MMFs to provide customers with
cash that is needed to meet, for example, margin calls at other FCMs or
DCOs, or variation or initial margin requirements for uncleared swap
transactions, or to cover cash market losses or purchases. More
generally, the concentration of Customer Funds in any single MMF
creates vulnerabilities that may affect FCMs' and DCOs' ability to meet
their regulatory obligations, including providing customers with prompt
access to their funds.\239\
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\237\ 2011 Permitted Investments Amendment at 78787.
\238\ The cyber-attack against ION Cleared Derivatives, a third-
party provider of cleared derivatives order management, order
execution, trading, and trade processing, demonstrated that an
incident affecting a single entity may disrupt the operations of
other market participants and have ripple effects across the
industry. The incident impacted certain FCMs' operations, including
by preventing such FCMs from submitting timely and accurate
positions data to the CFTC. See CFTC Statement on ION and the Impact
on the Derivatives Markets, available here: https://www.cftc.gov/PressRoom/SpeechesTestimony/cftcstatement020223.
\239\ For instance, as discussed in the 2011 Permitted
Investments Amendment, the Reserve Primary Fund's ``breaking the
buck,'' in September 2008, called attention to the risk to principal
and potential lack of sufficient liquidity of Prime MMF investments.
See 2011 Permitted Investments Amendment at 78785. In connection
with the events affecting the Reserve Primary Fund, staff of the
CFTC's Division of Clearing and Intermediary Oversight, intervened
and issued guidance indicating that FCMs holding shares of the fund,
either as a proprietary investment or as an investment of customer
segregated funds, could include these investments in the
calculations required for purposes of compliance with capital,
segregation, and secured amount reporting requirements (with the
condition that the NAV be reduced appropriately) even though the
fund had suspended redemptions. See CFTC Staff Letter No. 08-17,
available here: https://www.cftc.gov/csl/08-17/download.
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Although cyber-attacks and other operational incidents may impact
transactions in any Permitted Investment, including U.S. government
securities, the Commission believes that the potential risk of Customer
Funds becoming unavailable is elevated when access to such funds
depends on the operations of a third party such as an MMF. For
instance, to the extent a fund experiences an operational issue, such
incident may result in a redemption suspension for all participants in
the fund. Thus, by imposing issuer-based concentration limits, the
Commission intends to facilitate the preservation of principal and
maintenance of liquidity of Customer Funds through sound
diversification standards and to mitigate the potential risk of access
to a large portion of Customer Funds becoming unavailable due to
cybersecurity or operational incidents, among other events. Given the
large number of SEC-registered Government MMFs available on the market
and likely to meet the Permitted Investments' eligibility criteria, the
Commission preliminarily believes that diversifying an FCM's or DCO's
portfolio of MMF investments would not be burdensome.\240\
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\240\ As of August 17, 2023, there are 183 government MMFs
registered with the SEC (of which 49 are ``Treasury-only'' MMFs).
See U.S. Securities and Exchange Commission, Money Market Funds
Statistics, available here: https://www.sec.gov/divisions/investment/mmf-statistics. The government MMFs currently registered
with the SEC generally do not elect to apply liquidity fees and/or
redemption gates.
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In addition, as part of the proposed amendments to the
concentration limits in Regulation 1.25,\241\ the Commission is
proposing to revise the asset-based and issuer-based concentration
limits set forth in paragraphs (b)(3)(i)(F) and (b)(3)(ii)(C) and (D),
respectively, to reflect the removal of Prime MMFs from the list of
Permitted Investments.
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\241\ See discussion in Section III.A.2 above.
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As discussed in Section III.A.3 above, the Commission is also
proposing to permit FCMs and DCOs to invest Customer Funds in Qualified
ETFs.\242\ The Commission is proposing to impose conditions on
Qualified ETFs that are similar to the conditions that are imposed on
Permitted Government MMFs whose interests qualify as Permitted
Investments.\243\ Among other things, similar to Government MMFs, which
can invest in a limited set of instruments, including government
securities and cash, Qualified ETFs would be required to limit their
investments to instruments that are consistent with their investment
strategy of seeking to replicate the performance of a public short-term
U.S. Treasury security index.\244\ For purposes of the Proposal, short-
term U.S. Treasury securities are bonds, notes, and bills with a
remaining maturity of 12 months or less, issued by, or unconditionally
guaranteed as to the timely payment of principal and interest by, the
U.S. Department of the Treasury. Consistent with this condition, the
Commission is also proposing to require that the eligible U.S. Treasury
securities represent at least 95 percent of the ETF's investment
portfolio. Given the similarity of the terms that would apply to
Permitted Government MMFs and Qualified ETFs under the Proposal, and
the comparable credit, market, and liquidity risk associated with these
types of funds comprising instruments generally recognized as safe and
highly liquid, the Commission preliminarily believes that it is
appropriate for Qualified ETFs to have the same asset-based and issuer-
based concentration limits as those proposed for Permitted Government
MMFs. Specifically, under the Proposal, an FCM's or a DCO's investment
of Customer Funds in Qualified ETFs with at least $1 billion in assets
and whose management company manages at least $25 billion in assets
would be limited to an asset-based concentration limit of 50 percent of
total funds held in each of the segregated classifications of futures
customer funds, Cleared Swaps Customer Collateral, and 30.7 customer
funds.\245\ The current 10 percent asset-based concentration limit for
investments in MMFs that hold less than $1 billion in assets or whose
management company manages less than $25 billion in assets under
management would also be extended to Qualified ETFs. In addition, for
the reasons described supra in connection with Permitted Government
MMFs, the Commission is proposing to limit investments of Customer
Funds in any single family of Qualified ETFs to 25 percent and
investments of Customer Funds in any single issuer of Qualified ETFs to
5 percent of the total assets held in each of the segregated
classifications of futures customer funds, Cleared Swaps Customer
Collateral, and 30.7 customer funds.\246\ Given that there may be at
least five U.S. Treasury ETFs that could potentially qualify as
Permitted Investments, the Commission preliminarily believes that the
proposed issuer-based concentration limits would not be overly
restrictive.\247\
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\242\ Proposed Regulation 1.25(a)(1)(vi).
\243\ See Section III.A.3. above.
\244\ Proposed Regulation 1.25(a)(1)(vi).
\245\ Proposed Regulation 1.25(b)(3)(i)(E).
\246\ Proposed Regulations 1.25(b)(3)(ii)(C) and (D).
\247\ See 2022 CME Advisory Notice, supra note 170 (announcing
that CME has added five Short-Term U.S. Treasury ETFs to the list of
accepted margin collateral). The five ETFs would meet the proposed
condition of being accepted as performance bond by a DCO. For
purposes of clarity, the Commission notes, however, that should the
Commission proceed with adding Qualified ETFs to the list of
Permitted Investments, FCMs and DCOs would need to assess ETFs'
eligibility in light of all applicable conditions.
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The Commission is also proposing revisions to the asset-based and
issuer-based concentration limits to remove commercial paper, and
corporate notes and bonds from the limits.\248\ As noted in Section
III.A.4. above, the Commission is proposing to remove commercial paper
and corporate notes and bonds from the list of Permitted Investments
due to the termination of the TLGP by the FDIC in 2012, which resulted
in such investments no longer qualifying as Permitted Investments. In
addition, as discussed in Section III.A.6. above, the Commission is
requesting public comment on the elimination of bank CDs as a Permitted
Investment due to the apparent lack of interest by FCMs and DCOs in
such instruments. Therefore, if bank CDs are removed from the list of
Permitted Investments in a final rulemaking after considering
[[Page 81258]]
comments, specifying asset-based and issuer-based concentration limits
on investments in commercial paper, corporate notes and bonds, and bank
CDs would no longer be necessary and would be removed from Regulation
1.25.
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\248\ See proposed Regulation 1.25(b)(3)(i)(C) removing
commercial paper and corporate notes and bonds from the 25 percent
asset-based concentration limit and proposed Regulation
1.25(b)(3)(ii)(B) removing commercial paper and corporate notes and
bonds from the 5 percent issuer-based concentration limit.
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Finally, as noted in Section III.A.1., the Commission is proposing
to expand the types of investments that would qualify as Permitted
Investments to include Specified Foreign Sovereign Debt. The
Commission, however, is not proposing to impose asset-based or issuer-
based concentration limits on FCM or DCO investments in Specified
Foreign Sovereign Debt.
Not imposing concentration limits on the Specified Foreign
Sovereign Debt would be consistent with the current exclusion of U.S.
government securities from the asset-based and issuer-based
concentration limits. As discussed in Section III.A.1. above, the
relative strength of the economies and limited default risk of Canada,
France, Germany, Japan, and the United Kingdom are demonstrated by such
countries being ranked among the seven largest economies in the
International Monetary Fund's classification of advanced
economies,\249\ and by the countries being members of the G7, which
represents the world's largest industrial democracies. In addition, as
discussed in Section III.A.1. above, the Commission has preliminarily
determined that the two-year debt instruments that would qualify as
Specified Foreign Sovereign Debt have credit, liquidity, and volatility
characteristics that are consistent with two-year U.S. Treasury
securities. Furthermore, the proposed condition in Regulation
1.25(a)(1)(vii) that permits an FCM or a DCO to invest Customer Funds
in Specified Foreign Sovereign Debt only to the extent that the DCO or
FCM has balances owed to customers denominated in the currency of the
applicable country is expected to effectively limit the amount of
Customer Funds that an FCM or a DCO may invest in the Specified Foreign
Sovereign debt.\250\ The proposed condition that an FCM or a DCO must
stop making direct investments, or engaging in reverse repurchase
agreements, involving the Specified Foreign Sovereign Debt of a country
whose credit default spread on two-year debt instruments exceeds 45 BPS
would be expected to further preserve the principal of customers'
foreign currency deposits held by FCMs and DCOs.\251\ Lastly, not
imposing asset-based or issuer-based concentration limits on an FCM's
or a DCO's investments in Specified Foreign Sovereign Debt is
consistent with the Commission's 2018 Order, which did not impose
concentration limits on a DCO's investment of futures customer funds or
Cleared Swaps Customer Collateral in the sovereign debt of France or
Germany. Accordingly, based on the above, the Commission preliminarily
believes that asset-based and issuer-based concentration limits are not
necessary for investments in Specified Foreign Sovereign Debt.
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\249\ See Statistical Appendix to the World Economic Outlook,
April 2023, International Monetary Fund, available here: https://www.imf.org/en/Publications/WEO/Issues/2023/04/11/world-economic-outlook-april-2023.
\250\ Proposed Regulation 1.25(a)(1)(vii).
\251\ Proposed Regulation 1.25(f)(3).
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The Commission also notes that the concentration limits in
Regulation 1.25 are minimum requirements. Pursuant to Regulation 1.11,
an FCM is required to monitor and manage market, credit, liquidity,
foreign currency, legal, operational, settlement, segregation, capital,
and any other applicable risks associated with its activity, as part of
the FCM's risk management program.\252\ If, based on its independent
risk assessment, an FCM determines that stricter concentration limits
with respect to Permitted Investments of Customer Funds are
appropriate, the FCM is required to implement such stricter limits, in
accordance with Regulation 1.11. Similarly, Regulation 39.13(g)(10)
requires a DCO to limit the assets it accepts as initial margin to
those that have minimal credit, market, and liquidity risks, while
Regulation 39.13(g)(13) requires the DCO to apply appropriate
limitations or charges on the concentration of assets posted as initial
margin, as necessary, in order to ensure its ability to liquidate such
assets quickly with minimal adverse price effects.
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\252\ 17 CFR 1.11.
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In addition, if as a result of market events or extraneous
circumstances, such as a change in an MMF's size, the FCM or DCO
inadvertently breaches the concentration thresholds, the FCM or DCO
would be expected to undertake prompt actions to restore compliance
with the concentration limits, while managing the investments of
Customer Funds in a manner consistent with the general objectives of
preserving principal and maintaining liquidity. Depending on the market
conditions, such actions may include taking steps to progressively
reduce the amount of Customer Funds invested in a particular asset
class instead of immediately divesting the investments in a potentially
volatile market.
[[Page 81259]]
The foregoing discussion of concentration limits can be summarized
as follows:
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Current concentration limits Proposed concentration limits
Instrument Size --------------------------------------------------------------------------------------------
Asset-based Issuer-based Asset-based Issuer-based
--------------------------------------------------------------------------------------------------------------------------------------------------------
U.S. government securities......... N/A................... No limit.............. No limit............. No limit............. No limit.
Municipal Securities............... N/A................... 10%................... 5%................... 10%.................. 5%.
U.S. agency obligations............ N/A................... 50%................... 25%.................. 50%.................. 25%.
Bank CDs........................... N/A................... 25%................... 5%................... 25%.................. 5%.
Government MMFs investing solely in >$1B assets and/or No limit.............. No limit............. 50%.................. 25% per family 5% per
U.S. government securities (i.e., management company ...................... ..................... ..................... fund.
securities issued or fully with >25B in assets. 10%................... 10% (de facto limit 10%..................
guaranteed by the U.S. government). <$1B assets and/or based on asset-based
management company limit).
with <$25B in assets.
Government MMFs as defined in SEC >$1B assets and/or 50%................... 25% per family 10% 50%
Rule 2a-7 (including MMFs whose management company ...................... per fund. .....................
portfolio includes U.S. agency with >25B in assets. 10%................... 10%..................
obligations and other instruments). <$1B assets and/or
management company
with <$25B in assets.
Qualified ETFs..................... >$1B assets and/or N/A................... N/A.................. 50%.................. 25% per family 5% per
management company fund.
with >25B in assets.
<$1B assets and/or N/A................... N/A.................. 10%
management company
with <$25B in assets.
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Request for Comment: The Commission requests comment on all aspects
of its Proposal relating to concentration limits, including the
proposed asset-based and issuer-based concentration limits for
Permitted Government MMFs and Qualified ETFs. The Commission requests
specific comment with respect to the following:
22. Should the Commission adopt different asset-based and issuer-
based concentration limits for Permitted Government MMFs and/or
Qualified ETFs than the limits proposed? Are the proposed limits
sufficiently conservative to ensure that Customer Funds are adequately
protected and liquid?
23. Should the Commission revise any of the asset-based
concentration limits that are not proposed to be revised as part of
this Proposal? For instance, FCMs and DCOs are permitted to invest up
to 50 percent of their Customer Funds in U.S. agency obligations and up
to 10 percent in municipal securities. Should the Commission consider
revising these or other asset-based concentration limits? If so, how
should the asset-based concentration limits be revised? Please explain,
and provide data if possible.
24. Should the Commission revise any of the issuer-based
concentration limits that are not proposed to be revised as part of
this Proposal? For instance, FCMs and DCOs are permitted in invest up
to 25 percent of their Customer Funds in obligations of a single issuer
of U.S. agency obligations and up to 5 percent in obligations of any
single issuer of municipal securities. Should the Commission consider
revising these or other issuer-based concentration limits? If so, how
should the issuer-based concentration limits be revised? Please
explain, and provide data to support your comment, if possible.
25. Should the Commission impose asset-based and/or issuer-based
concentration limits on Specified Foreign Sovereign Debt? If so, please
explain why such concentration limits are necessary. Please provide
data to support your comment, if possible.
26. Given the similarities between Permitted Government MMFs and
Qualified ETFs discussed above, the Commission is proposing to apply
the same asset-based and issuer-based concentration limits to both
asset classes. Is there any reason to distinguish between Permitted
Government MMFs and Qualified ETFs with respect to the application of
concentration limits? If so, please explain.
C. Futures Commission Merchant Capital Charges on Permitted Investments
Although FCMs and DCOs may invest Customer Funds in Permitted
Investments, as discussed supra, Commission regulations provide that
FCMs and DCOs are also financially responsible for any losses resulting
from such investments, and are explicitly prohibited from allocating
investment losses to customers or clearing FCMs, respectively.
Specifically, Regulation 1.29 provides that FCMs or DCOs, as
applicable, shall bear sole responsibility for any losses resulting
from the investment of futures customer funds, and further provides
that no investment losses shall be borne or otherwise allocated to FCM
customers or to FCMs clearing customer accounts at DCOs.\253\ In
addition, Regulation 22.2(e)(1) \254\ provides that an FCM shall bear
sole responsibility for any losses resulting from the investment of
Cleared Swaps Customer Collateral and may not allocate investment
losses to Cleared Swaps Customers of the FCM and Regulation 30.7(i)
provides that an FCM shall bear sole financial responsibility for any
losses resulting from the investment of 30.7 customer funds, and
further provides that no investment losses may be allocated to the 30.7
customers of the FCM.\255\ Additionally, the Commission is proposing an
amendment to Regulation 22.3(d) to clarify that DCOs are financially
responsible for any losses resulting from investments of Cleared Swap
Customer Collateral in Permitted Investments, consistent with
Regulation 1.29, which addresses financial responsibility for losses
resulting from investment of futures customer funds, and the
Commission's original intent to permit investments of Cleared Swaps
Customer Collateral within the parameters applicable to investments of
futures customer funds.\256\
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\253\ 17 CFR 1.29(b).
\254\ 17 CFR 22(e)(1).
\255\ 17 CFR 30.7(i).
\256\ See supra note 42.
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To reserve liquidity for potential losses resulting from
investments of Customer Funds, Regulation 1.17(c)(5)(v) requires an FCM
to take capital charges in computing the firm's regulatory
capital.\257\ The capital
[[Page 81260]]
charges are designed to reflect potential market risk associated with
the FCM's holding of Permitted Investments, and to ensure that the firm
has sufficient liquid financial resources to cover potential investment
losses. Regulation 1.17(c)(5)(v) further provides that an FCM must
apply the capital charges set forth in Rule 15c3-1 under the Securities
Exchange Act (``SEC Rule 15c3-1'') \258\ and Appendix A to SEC Rule
15c3-1 \259\ to the Permitted Investments.
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\257\ 17 CFR 1.17(c)(5). Although capital charges do not apply
to DCOs, a DCO is required under Regulation 39.11(a)(2) to maintain
financial resources sufficient to enable it to cover its operating
costs for a period of at least one year, calculated on a rolling
basis. Investment losses would be included in the DCO's operating
costs.
\258\ 17 CFR 240.15c3-1.
\259\ 17 CFR 240.15c3-1a.
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As discussed in Section III.A.1. above, the Commission is proposing
to revise the Permitted Investments to include Specified Foreign
Sovereign Debt (i.e., the sovereign debt of Canada, France, Germany,
Japan, and the United Kingdom). Under the Proposal, each Specified
Foreign Sovereign Debt instrument must have a remaining time-to-
maturity of 180 calendar days or less. Given the proposed remaining
time-to-maturity limit of 180 calendar days for each Specified Foreign
Sovereign Debt instrument, an FCM investing Customer Funds in
qualifying sovereign debt of Canada would have no capital charge for
instruments with a remaining time to maturity of less than 3 months and
a capital charge of 0.5 percent of the market value for instruments
with a remaining time to maturity of 3 to 6 months under SEC Rule 15c3-
1.\260\ The capital charge for the sovereign debt of France, Germany,
Japan, and the United Kingdom, is determined under SEC rules by
reference to nonconvertible debt securities with a fixed interest rate,
fixed maturity date, and minimal credit risk. Such nonconvertible debt
securities that have a remaining time to maturity of one year or less
are subject to a capital charge of 2 percent of the market value of the
security under SEC Rule 15c3-1(c)(2)(F)(1).\261\
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\260\ SEC Rule 15c3-1(c)(2)(vi)(C) provides that the capital
charges on the sovereign debt of Canada is the same as the capital
charges set forth in SEC Rule 15c3-1(c)(2)(vi)(A) for debt
obligations of the U.S., debt obligations fully guaranteed as to
principal and interest by the U.S., or debt obligations of U.S.
agencies. SEC Rule 15c3-1(c)(2)(vi)(A) provides that a broker or
dealer must take a 0.5 percent capital charge on U.S. Treasury and
U.S. agency debt instruments that have a remaining time to maturity
of between 3 months and 6 months, and no capital charge on U.S.
Treasury and U.S. agency debt instruments having a remaining time to
maturity of less than 3 months.
\261\ SEC Rule 15c3-1(c)(2)(F)(1) specifies the capital charges
for nonconvertible debt securities with a fixed interest rate, fixed
maturity date, and minimal credit risk, which includes the sovereign
debt of France, Germany, Japan, and the United Kingdom. The capital
charge for the sovereign debt of these countries that have a
remaining time-to-maturity of no more than one year is 2 percent of
the market value of debt instrument.
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With respect to Qualified ETFs, neither SEC Rule 15c3-1 nor
Appendix A to SEC Rule 15c3-1 explicitly addresses capital charges for
ETFs primarily comprised of U.S. Treasury securities. SEC Rule 15c3-
1(c)(2)(vi)(D)(1) does specify a 2 percent capital charge for a broker-
dealer's net position in redeemable securities of a Prime MMF or a
Permitted Government MMF.
SEC staff, however, has provided guidance to registered securities
brokers or dealers stating that staff would not recommend an
enforcement action to its Commission if a broker or dealer applied a
capital charge of 2 percent of the market value of ETFs shares held in
the size of a creation units.\262\ The SEC staff's guidance was
applicable to a U.S. Treasury ETF that: (i) is an open-ended management
company registered with the SEC under the Investment Company Act of
1940 that issues securities redeemable at the net asset value; and (ii)
invests solely in cash and government securities that are eligible
securities under paragraph (a)(11) of Rule 2a-7, limited to U.S.
Treasury floating and fixed rate bills, notes, and bonds with a
remaining term to final maturity of 12 months or less, government money
market funds as defined in Rule 2a-7, and/or Repurchase Transactions
with a remaining term to final maturity of 12 months or less
collateralized by U.S. Treasury securities or other government
securities with a remaining term to final maturity of 12 months or
less. The SEC staff position was subject to the following conditions:
(i) the broker or dealer is not aware of any substantial operational
problem that the U.S. Treasury ETF may be experiencing; (ii) the U.S.
Treasury ETF shares can be redeemed by a broker or dealer through an
authorized participant, the redemption of the U.S. Treasury ETF's
shares can be settled in exchange for a basket of the ETF's underlying
securities and/or cash by T+1, and the U.S. Treasury ETF has committed
in its registration statement to permit shareholders, except in
extraordinary circumstances, to settle transactions within that
timeframe; and (iii) the U.S. Treasury ETF's shares are listed for
trading on a national securities exchange and trades of such shares are
settled in accordance with the standard cycle prescribed by SEC Rule
15c6-1 \263\ under the Securities Exchange Act of 1934.
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\262\ See Letter titled Net Capital Treatment of Certain U.S.
Treasury Exchange-Traded Funds, issued by the Division of Trading
and Markets to Ms. Kris Dailey, Vice President, Risk Oversight &
Operational Regulations, Financial Industry Regulatory Authority,
June 2, 2022 (``SEC ETF Letter''). The SEC ETF Letter is available
at the SEC's website: https://www.sec.gov/divisions/marketreg/mr-noaction/2022/finra-060222-15c3-1.pdf.
\263\ 17 CFR 240.15c6-1.
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Based on the SEC's guidance regarding the capital charges for U.S.
Treasury ETFs, the Commission is specifying that FCMs would be required
to apply a capital charge equal to 2 percent of the fair market value
of the shares of a Qualified ETF that invests in the instruments
specified in the SEC ETF Letter.
Request for Comment:
27. The Commission requests comment on the proposed capital charges
for Specified Foreign Sovereign Debt and Qualified ETFs.
28. The Proposal would apply a 2 percent capital charge on the
value of Qualified ETF shares that invests solely in cash and
government securities that are eligible securities under paragraph
(a)(11) of SEC Rule 2a-7, limited to U.S. Treasury floating and fixed
rate bills, notes, and bonds with a remaining term to final maturity of
12 months or less, government money market funds as defined in SEC Rule
2a-7, and/or Repurchase Transactions with a remaining term to final
maturity of 12 months or less collateralized by U.S. Treasury
securities or other government securities with a remaining term to
final maturity of 12 months or less. Does the limitation on the
investments that the Qualified ETF may hold in order to apply the 2
percent capital charge raise any issues for FCMs investing in Qualified
ETFs? Would Qualified ETFs hold investments not covered by the SEC ETF
Letter? If so, what different investments could a Qualified ETF hold?
How would such additional investments impact the capital charge that
should be applied to Qualified ETFs?
D. Segregation Investment Detail Report
Regulations 1.32(f), 22.2(g)(5), and 30.7(l)(5) require each FCM to
submit a SIDR Report to the Commission and the FCM's DSRO listing the
names of all banks, trust companies, FCMs, DCOs, and other depositories
or custodians holding futures customer funds, Cleared Swaps Customer
Collateral, or 30.7 customer funds. The FCM is further required to
identify in the SIDR Report the amount of futures customer funds,
Cleared Swaps Customer Collateral, or 30.7 customer funds invested in
each of the following categories of Permitted Investments: (i) U.S.
Treasury securities;
[[Page 81261]]
(ii) municipal securities; (iii) government sponsored enterprise
securities (i.e., U.S. agency obligations); (iv) bank CDs; (v)
commercial paper; (vi) corporate notes or bonds; and (vii) interests in
MMFs. The SIDR Report is required to be filed twice each month with the
Commission and the firm's DSRO, with balances reported as of the
fifteenth day of each month, or the first business day thereafter if
the fifteenth day of the month is not a business day, and as of the
last business day of each month.
The Commission is proposing to amend Regulations 1.32(f),
22.2(g)(5), and 30.7(l)(5), which define the content of the SIDR
Report, by deleting the requirement for an FCM to report the balances
invested in commercial paper and corporate notes and bonds as such
investments would no longer be Permitted Investments under the
Proposal, for the reasons articulated supra.\264\
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\264\ As discussed in Section III.A.6. above, the Commission
notes that no FCMs or DCOs currently invest Customer Funds in bank
CDs and has requested public comment regarding the elimination of
bank CDs from the list of Permitted Investments. If the Commission
were to eliminate bank CDs in the final rulemaking, the Commission
would also amend Regulations 1.32(f), 22.2(g)(5), and 30.7(l)(5) to
remove references to bank CDs.
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The Commission is also proposing to amend Regulations 1.32(f),
22.2(g)(5), and 30.7(l)(5) to require each FCM to report the total
amount of futures customer funds, Cleared Swaps Customer Collateral,
and 30.7 customer funds invested in Specified Foreign Sovereign Debt of
each country that is included within the Specified Foreign Sovereign
Debt (i.e., individual reporting for Canada, France, Germany, Japan,
and the United Kingdom). The Commission is also proposing to amend
Regulations 1.32(f), 22.2(g)(5), and 30.7(l)(5) to require an FCM to
include in the SIDR Report the total amount of futures customer funds,
Cleared Swaps Customer Collateral, and 30.7 customer funds invested in
Qualified ETFs as such investments would be Permitted Investments under
the Proposal. In addition, the Commission is proposing to amend the
above regulations by revising the requirement to report balances
invested in interests in MMFs to reflect that such investments are
limited to interests in Government MMFs consistent with the Proposal.
Request for Comment:
29. The Commission requests comment on the proposed amendments to
Regulations 1.32(f), 22.2(g)(5), and 30.7(l)(5) and the proposed
revisions to the SIDR Reports, including whether additional revisions
would be necessary.
E. Read-Only Electronic Access to Customer Funds Accounts Maintained by
Futures Commission Merchants
Commission regulations require depositories holding Customer Funds
for FCMs to provide the Commission with direct, read-only electronic
access to the Customer Fund accounts (``Read-only Access Provisions'').
The Read-only Access Provisions are set forth in Regulation 1.20,
Appendix A to Regulation 1.20, and Appendix A to Regulation 1.26, for
futures customer funds; Regulation 22.5 for Cleared Swaps Customer
Collateral; and, Regulation 30.7 and appendices E and F to Part 30 of
the Commission's regulations for 30.7 customer funds.
The Commission adopted the Read-only Access Provisions in 2013 as
part of a regulatory reform seeking to enhance the CFTC's customer
protection regime.\265\ In particular, the Commission sought to
strengthen the customer fund protections in response to the failure of
two FCMs that violated customer fund segregation laws, which resulted
in shortfalls in Customer Funds balances.\266\ The Commission noted
that the FCM failures raised questions concerning the adequate
functioning and capacity of the oversight system to monitor FCM
activities, verify Customer Funds balances, and detect fraud.\267\
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\265\ See generally 2013 Protections of Customer Funds Release.
\266\ Id. at 68509.
\267\ Id. at 68510.
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By adopting the Read-only Access Provisions, the Commission sought
to establish, among other measures, a mechanism that would enable
Commission staff to review and identify discrepancies between an FCM's
daily segregation reports \268\ and customer fund balances on deposit
at various depositories.\269\ To that effect, the Commission amended
Regulations 1.20 and 30.7 to include provisions requiring FCMs to
deposit Customer Funds only with depositories that agree to provide the
Commission with direct, read-only electronic access to allow Commission
staff to review account balance information and transactions.
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\268\ Regulations 1.32 (for futures customer funds), 22.2(g)
(for Cleared Swaps Customer Collateral) and 30.7(l) (for 30.7
customer funds) require an FCM to prepare, among other records, a
daily record as of the close of each business detailing the total
amount of funds on deposit in customer segregated accounts and the
total amount of funds owed to customers. The purpose of the daily
record is for the FCM to demonstrate compliance with its obligation
to hold a sufficient amount of funds in segregated accounts to pay
the full account balance of each customer.
\269\ See 2013 Protections of Customer Funds Release at 68537
and 68580.
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The Commission also adopted template acknowledgment letters set
forth in Appendix A to Regulation 1.20 and Appendix E to Part 30 of the
Commission's regulations to require, among other things,\270\ that the
depository acknowledge and agree, pursuant to authorization granted by
the FCM, to provide the appropriate Commission staff with ``the
technological connectivity, which may include provision of hardware,
software, and related technology and protocol support, to facilitate
direct, read-only electronic access to transaction and account balance
information.'' \271\ The template acknowledgment letters set forth in
Appendix A to Regulation 1.26 and Appendix F to Part 30 contain similar
provisions with respect to MMF accounts in which FCMs hold customer
segregated funds.\272\
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\270\ These appendices are intended to be used by depositories
that accept Customer Funds from FCMs to acknowledge that the funds
belong to the FCM customer and cannot be used to offset obligations
of the FCM.
\271\ 17 CFR Appendix A to 1.20, 17 CFR Appendix E to Part 30.
\272\ 17 CFR Appendix A to 1.26, 17 CFR Appendix F to Part 30.
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In adopting the Read-only Access Provisions, the Commission noted
that it did not anticipate that staff would access FCM accounts on a
regular basis to monitor account activity, but, rather, that staff
would make use of the Read-only Access Provision only when necessary to
obtain account balances and other information that staff could not
obtain via the CME and NFA automated daily segregation confirmation
system or otherwise directly from the depositories.\273\ Specifically,
the Commission explained that CME and NFA had adopted rules requiring
FCMs to instruct each depository holding Customer Funds to report
balances on a daily basis to CME or NFA, respectively.\274\
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\273\ 2013 Protections of Customer Funds Release at 68537 and
68592 (noting in footnote 662 that the Commission generally expected
that it would seek to obtain account information from the CME and
NFA automated daily segregation confirmation system and/or from
depositories directly prior to requesting a depository to activate
electronic access).
\274\ Id., at 68512. CME Rule 971.C. provides that in order for
an FCM clearing member's account held at a depository to qualify as
a segregated account for Customer Funds, the FCM clearing member
must provide CME with access to account information, in a form and
manner prescribed by CME, and the depository must allow the FCM
clearing member to provide CME with access to the account
information, in a form and manner prescribed by CME. NFA Financial
Requirements Section 4, paragraph (b), provides that each member FCM
must instruct each depository, as required by NFA, holding
segregated Customer Funds to report balances in the FCM's customer
segregated accounts to NFA or a third party designated by NFA in the
form and manner prescribed by NFA. CME and NFA Rules are available
at the following websites: https://www.CMEGroup.com, and https://www.NFA.Futures.Org.
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[[Page 81262]]
In practice, CME and NFA receive account information from all
depositories holding Customer Funds on a daily basis pursuant to CME
Rule 971.C. and NFA Financial Requirements Section 4, respectively.
Furthermore, CME and NFA have developed programs that compare the daily
balances reported by each of the depositories with balances reported by
the FCMs in their daily segregation reports that are filed with CME
and/or NFA.\275\ Under these programs, an alert is generated for
discrepancies that exceed defined thresholds. In the event of such
alerts, CME/NFA staff conduct appropriate analysis and follow-up
actions, which may involve communications with an FCM to clarify or
remedy the situation, and document the outcome.
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\275\ At the time the Commission issued the 2013 Protections of
Customer Funds Release, CME and NFA had just recently launched the
programs. See 2013 Protections of Customer Funds Release at 68512.
The verification programs have been further developed in the years
that followed. FCMs report on the daily segregation records total
funds held in segregation with banks, clearing organizations, and
net equities with other FCMs in addition to other balances.
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The Commission's experience with overseeing the administration of
the CME and NFA daily segregation confirmation and verification
processes for several years has afforded sufficient assurances that the
system provides adequate access to relevant information and is capable
of detecting discrepancies in account balances in a timely manner.
Moreover, the establishment of an efficient method for obtaining and
verifying FCM balances of Customer Funds at each depository supports
the Commission's initial expectation that the direct, read-only
electronic access would not be the Commission's principal tool for
obtaining account information at depositories.\276\ The Commission also
is retaining the current requirement that FCMs deposit Customer Funds
only with depositories that agree that accounts may be examined by
Commission or DRSO staff at any reasonable time, and that further agree
to reply promptly and directly to any request from Commission or DSRO
staff for confirmation of account balances or provision of any other
information regarding or related to an account, in order to ensure that
staff have timely access information concerning Customer Funds from
depositories.\277\
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\276\ See 2013 Protections of Customer Funds Release at 68537
(noting that the Commission anticipated that the combination of
receipt of daily account balances reported by depositories to CME
and NFA, and the Commission's ability to confirm account balances
and transactions directly with depositories via direct
communications would diminish the need to rely upon direct
electronic access to account information at depositories).
\277\ See Regulations 1.20(d)(5) and (6), 1.26(b), 22.5(a) and
(b), and 30.7(d)(5) and (6). 17 CFR 1.20(d), 1.26(b), 22.5, and
30.7(d). For example, Regulation 1.20(d)(5) provides that an FCM
must deposit futures customer funds only with a depository that
agrees that accounts may be examined at any reasonable time by
specified Commission or DSRO staff. Regulation 1.20(d)(6) provides
that an FCM must deposit futures customer funds only with a
depository that agrees to reply promptly and directly to any request
from specified Commission staff or DSRO staff for confirmation of
account balances or provision of any other information regarding or
related to the FCM's account. Regulation 1.20(d)(5) and (6) further
provide that the written acknowledgment required from the depository
must contain the FCM's authorization to the depository to reply
promptly and directly to the Commission or DSRO without further
notice to or consent from the FCM. Regulation 22.5 provides that an
FCM must obtain a written acknowledgment letter in accordance with
Regulation 1.20 and Regulation 1.26 from each depository holding
Cleared Swaps Customer Collateral, except an acknowledgment letter
is not required of a DCO that has adopted rules providing for the
segregation of Cleared Swaps Customer Collateral.
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In addition, in implementing the Read-only Access Provisions, the
Commission has encountered various practical challenges. Specifically,
given the number of depositories with which FCMs establish
relationships and the total number of accounts that FCMs maintain with
various depository institutions, the Commission must obtain and keep a
current log of credentials to access the depository accounts, and in
some instances, must obtain and store physical devices required as part
of a multi-factor authentication process, for thousands of different
depository accounts.\278\ Frequently, Commission staff must be trained
to navigate the various account access systems and work regularly with
depositories' technology staff to ensure that the systems' security
features do not prevent the Commission's access to the accounts.\279\
Furthermore, due to lack of appropriate infrastructure, some foreign
depository institutions are unable to provide direct electronic access
to the customer segregated accounts, offering instead to send end-of-
day accounts statements by email. These operational challenges put an
undue burden on the Commission's resources, particularly considering
that the Commission contemplated that the use of real-time access would
be limited, and prevent Commission staff from using the Read-only
Access Provisions as intended.\280\
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\278\ Based on information provided by CME, as of March 7, 2023,
FCM registrants maintained over 3,600 active accounts with
approximately 200 banks, other registered FCMs, foreign broker-
dealers, foreign exchanges, and DCOs.
\279\ In this regard, depositories often require Commission
staff to revise user-ids and passwords on a regular basis otherwise
the access is interrupted and must be reset by the depositories.
Some depositories also require the use of additional security
devices beyond user-IDs and passwords, including key fobs or other
forms of multi-factor authentication.
\280\ Commission staff has not had a regulatory need to attempt
to use read-only access for any FCM's depository accounts in the
approximately 10 years since the Regulation was implemented.
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Thus, in light of the practical challenges of maintaining direct
read-only access to depository accounts and the availability of
efficient alternative methods for verifying customer segregated account
balances, the Commission is proposing to eliminate the Read-only Access
Provisions in Regulations 1.20 and 30.7, and Appendix A to Regulation
1.20, Appendix A to Regulation 1.26, and appendices E and F to Part 30
of the Commission's regulations.\281\
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\281\ If adopted, the proposed amendments would extend to
Regulation 22.5, which requires FCMs to obtain an acknowledgment
letter from depositories before depositing Cleared Swaps Customer
Collateral with a depository, in accordance with Regulations 1.20
and 1.26. 17 CFR 22.5(a). Regulation 22.5(b) further requires FCMs
to adhere to all requirements specified in Regulation 1.20 and 1.26
regarding retaining, permitting access to filing, or amending the
written acknowledgment letters. 17 CFR 22.5.
Separately, the Commission is proposing to redesignate
appendices A and B to Regulation 1.20 as appendices C and D to Part
1, and appendices A and B to Regulation 1.26 as appendices F and G
to Part 1, to address a change in the rules of the Office of the
Federal Register regarding the structure of regulatory text to be
codified in the Code of Federal Regulations.
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The Commission notes that under the Proposal, FCMs would not need
to obtain new acknowledgment letters for existing accounts at
depositories holding Customer Funds. Should the Commission proceed with
the proposed amendments after notice and comment, the revised
acknowledgment letters would have to be obtained for accounts opened
following the effective date of the revisions or in the event the FCM
is required to obtain a new acknowledgment letter for reasons unrelated
to the elimination of the Read-only Access Provisions. For the
avoidance of doubt, the Commission confirms that even if an FCM had not
obtained revised acknowledgment letters for accounts existing prior to
the effective date of the proposed revisions, but keeps instead such
letters in the currently applicable template form, the depositories
would not be required to provide direct, read-only access to accounts
holding Customer Funds.
Request for Comment: The Commission seeks comment on all
[[Page 81263]]
aspects of the Proposal relating to the elimination of the Read-only
Access Provisions, including:
30. The existing Read-only Access Provisions currently afford the
Commission with direct access to depository accounts holding Customer
Funds. Given the challenges depositories and Commission staff are
encountering in implementing and administrating the provisions and the
availability of alternative means of obtaining transaction and account
balance information, what practical implications should the Commission
consider prior to deciding whether to eliminate the requirement for
depositories to provide Commission's staff with direct, read-only
electronic access?
F. Proposed Conforming Amendments
Regulation 1.26 requires each FCM or DCO that invests futures
customer funds in financial instruments that are Permitted Investments,
including qualifying MMFs, to separately account for such instruments
and to segregate the instruments from its own funds. The FCM or DCO
also must obtain and retain in its files a written acknowledgment from
the depository holding the instruments stating that the depository was
informed that the instruments belong to futures customers and are being
held in accordance with the provisions of the Act and Commission
regulations. Regulation 1.26 also specifies how direct investments in
MMFs must be held and sets forth the template acknowledgement letter to
be used with respect to direct investments in MMFs.\282\
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\282\ For purposes of clarification, an FCM or a DCO that holds
shares of an MMF in a custodial account at a depository (not
directly with the MMF or its affiliate) is required to execute the
template acknowledgement letter set forth in Appendix A or B of
Regulation 1.20 (to be redesignated Appendix C and Appendix D to
Part 1), as applicable. 17 CFR 1.20.
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To account for the proposed change in the scope of MMFs that
qualify as Permitted Investments and the proposed addition of Qualified
ETFs to the list of Permitted Investments, the Commission proposes
revisions to paragraphs (a) and (b) of Regulation 1.26 to replace the
term ``money market mutual fund'' with ``government money market fund
and U.S. Treasury exchange-traded fund'' or ``government money market
fund or U.S. Treasury exchange-traded fund,'' as appropriate. To
address the adoption of appendices H and I, as discussed below,
paragraph (b) of Regulation 1.26 would be further revised to replace
the reference to ``appendix A or B to this section'' with ``appendix F,
G, H or I to this part.'' \283\
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\283\ Regulation 1.26 currently refers to ``appendix A or B to
this section.'' As noted supra, Appendix A and Appendix B to
Regulation 1.26 would be redesignated Appendix F and Appendix G to
Part 1 to address a change in the rules of the Office of the Federal
Register regarding the structure of regulatory text to be codified
in the Code of Federal Regulations.
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The Commission also proposes to amend Appendices A and B to
Regulation 1.26 (to be redesignated appendices F and G to Part 1) to
replace the term ``Money Market Mutual Fund'' with ``Government Money
Market Fund.''
To account for the proposed addition of Qualified ETFs to the list
of Permitted investments, the Commission also proposes to adopt new
appendices H and I to Part 1. The appendices would set forth template
acknowledgment letters for Qualified ETFs and would be modeled on
appendices A and B to Regulation 1.26 (to be redesignated appendices F
and G to Part 1), which currently address money market mutual funds.
Appendices H and I to Part 1 would mostly replicate appendices A and B
to Regulation 1.26, except that the term ``money market mutual fund''
would be replaced with ``U.S. Treasury exchange-traded fund;''
condition (1) will read ``To qualify as a Permitted Investment,
interests in U.S. Treasury exchange-traded funds must be redeemable in
cash by a futures commission merchant or derivatives clearing
organization in its capacity as an authorized participant pursuant to
an authorized participant agreement, as defined in Sec. 270.6c-11 of
this title, at a price based on the net asset value in accordance with
the Investment Company Act of 1940 and regulations thereunder, and on a
delivery versus payment basis;'' and references relating to money
market mutual funds would be eliminated.
In addition, Regulation 30.7(d) requires that FCMs obtain written
acknowledgment letters from each depository with which they maintain
30.7 customer funds. Appendices E and F to Part 30 of the Commission's
regulations set forth the template acknowledgment letters. The
Commission is proposing conforming changes to Regulation 30.7(d)(2) to
replace the term ``money market mutual fund'' with ``government money
market fund and U.S. Treasury exchange-traded fund'' or ``government
money market fund or U.S. Treasury exchange-traded fund,'' as
appropriate. The Commission is also proposing changes to Appendix F to
Part 30, to replace the term ``money market mutual fund'' with
``government money market fund.'' In addition, the Commission is also
proposing to revise Regulation 30.7(d)(2) to add ``or Appendix G to
this part, respectively'' after ``Appendix F to this part'' to address
the adoption of new Appendix G to Part 30, which would set forth a
template acknowledgment letter modeled on proposed Appendix C to
Regulation 1.26 but addressing 30.7 customer funds.
Request for Comment: The Commission seeks comment on all aspects of
the Proposal relating to the conforming amendments. The Commission also
invites comments on any other aspect of the Proposal. The Commission
also specifically requests comment on the following question:
31. Are there any risks associated with the Proposal that the
Commission has not considered? What measures could the Commission take
to mitigate such risks?
IV. Section 4(c) of the Act
With respect to investment of futures customer funds, the proposed
amendments to Regulation 1.25 would be promulgated under Section
4d(a)(2) of the Act.\284\ Section 4d(a)(2) provides that customer money
may be invested in U.S. government securities and municipal securities.
It further provides that such investments must be made in accordance
with such rules and regulations and subject to such conditions as the
Commission may prescribe.
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\284\ 7 U.S.C. 6(c).
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Pursuant to its authority under Section 4(c) of the Act, the
Commission proposes to expand the range of instruments in which FCMs
and DCOs may invest futures customer funds beyond those listed in
Section 4d(a)(2) of the Act to enhance the yield available to FCMs,
DCOs and their customers, without compromising the safety of futures
customer funds.
Section 4(c)(1) of the Act empowers the Commission to ``promote
responsible economic or financial innovation and fair competition'' by
exempting any transaction or class of transactions (including any
person or class of persons offering, entering into, rendering advice or
rendering other services with respect to, the agreement, contract, or
transaction), from any of the provisions of the Act, subject to certain
exceptions.\285\ The Commission's authority under Section 4(c) extends
to transactions covered by Section 4d(a)(2) and to FCMs and DCOs that
offer, enter into, render advice, or render other services with respect
to such
[[Page 81264]]
transactions. In enacting Section 4(c), Congress noted that its goal
``is to give the Commission a means of providing certainty and
stability to existing and emerging markets so that financial innovation
and market development can proceed in an effective and competitive
manner.'' \286\ The Commission may grant such an exemption by rule,
regulation, or order, after notice and opportunity for hearing, and may
do so on application of any person or on its own initiative.
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\285\ 7 U.S.C. 6(c)(1).
\286\ House Conf. Report No. 102-978, 1992 U.S.C.C.A.N. 3179,
3213.
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Section 4(c)(2) of the Act provides that the Commission may grant
exemptions under Section 4(c)(1) only when it determines that the
requirements for which an exemption is being provided should not be
applied to the agreements, contracts, or transactions at issue; that
the exemption is consistent with the public interest and the purposes
of the Act; that the agreements, contracts, or transactions will be
entered into solely between appropriate persons; and that the exemption
will not have a material adverse effect on the ability of the
Commission or any contract market to discharge its regulatory or self-
regulatory responsibilities under the Act. The Proposal would provide
FCMs and DCOs with a limited exemption from the restrictions in Section
4d(a) and (b) of the CEA pertaining to the safeguarding and investment
of Customer Funds. As such, the Commission's preliminary analysis below
focuses on how the proposed expansion of the list of Permitted
Investments meets the conditions in Section 4(c)(2)(A) as they apply to
an exemption with respect to an FCM or a DCO. More specifically, the
discussion below describes how the proposed expansion is, in the
Commission's view, consistent with the public interest and the purposes
of the CEA.\287\ In that regard, the Commission notes that when Section
4(c) was enacted, the Conference Report accompanying the Futures
Trading Practices Act of 1992 \288\ stated that the ``public interest''
in this context would ``include the national public interests noted in
the Act, the prevention of fraud and the preservation of the financial
integrity of the markets, as well as the promotion of responsible
economic or financial innovation and fair competition.'' \289\
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\287\ The analysis does not include a discussion of Section
4(c)(2)(B)'s conditions because the exemption in this instance does
not implicate or affect a futures agreement, contract, or
transaction.
\288\ Public Law 102-546, 106 Stat. 3590 (1992).
\289\ H.R. Conf. Rep. No. 102-978 (1992). The Conference Report
also states that the reference in Section 4(c) to the ``purposes of
the Act'' is intended to ``underscore [the Conferees'] expectation
that the Commission will assess the impact of a proposed exemption
on the maintenance of the integrity and soundness of markets and
market participants.'' Id.
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To qualify as Permitted Investments, the instruments subject to
this Proposal would need to meet strict conditions to ensure that
investments of futures customer funds in these instruments are
consistent with the objective of preserving principal and maintaining
liquidity, as provided by Regulation 1.25. The Commission's preliminary
analysis, presented above, indicates that the instruments proposed
herein to be included as Permitted Investments meeting the specified
proposed conditions present credit and volatility characteristics that
are comparable to instruments that already qualify as Permitted
Investments. As such, the Commission is of the view that the proposed
expansion of the list of Permitted Investments would provide FCMs and
DCOs with an opportunity to diversify their investments of Customer
Funds, mitigating the risks that can arise from concentrating Customer
Funds in a smaller set of Permitted Investments, without compromising
the safety of such investments.
The expanded selection of Permitted Investments is expected to also
permit FCMs and DCOs to remain competitive globally and domestically
and maintain safeguards against systemic risk. A wider range of
alternatives to invest futures customer funds may provide more
profitable investment options, allowing FCMs and DCOs to generate more
income for themselves and their customers. This, in turn, may motivate
FCMs and DCOs to increase their presence in the futures market and
other relevant markets, thus increasing competition. Increased revenue
to FCMs and DCOs from the investment of Customer Funds also may benefit
customers in the form of lower commission charges or direct interest
payments on funds on deposit with the FCM or DCO, which may lead to
greater market participation by customers and increased market
liquidity. In light of the foregoing, the Commission believes that the
adoption of the proposed amendments would promote responsible economic
and financial innovation and fair competition, and would be consistent
with the objective of Regulation 1.25 and with the ``public interest,''
as that term is used in Section 4(c) of the Act. Specifically,
permitting FCMs and DCOs to invest Customer Funds in Specified Foreign
Sovereign Debt to the extent they hold balances owed to customers
denominated in the applicable currency reduces potential currency risk
to DCOs, FCMs, and customers that would result from investing such
foreign currencies in U.S.-dollar denominated assets. In addition,
permitting investments in Qualified ETFs, subject to the proposed
conditions, including that the ETF is passively managed with the
investment objective of replicating the performance of a published
short-term U.S. Treasury security index composed of U.S. Treasury
bonds, notes, and bills with a remaining maturity of 12 months or less,
provides an opportunity for greater diversification of the types of
investment options that FCMs and DCO may use to manage the risk of
holding Customer Funds. Proposed Qualified ETFs also provide potential
benefits to FCMs, particularly smaller FCMs, that don't have the
internal operations and resources to effectively manage direct
investments in other Permitted Investments, such as U.S. government
securities, U.S. agency obligations, and municipal securities. Both
Specified Foreign Sovereign Debt and Qualified ETFs have the potential
to reduce costs to FCMs, DCOs, and customers while remaining consistent
with the requirement in Regulation 1.25 for the preservation of
principal and liquidity of Permitted Investments. The Commission
solicits public comment on whether the Proposal satisfies the
requirements for exemption under Section 4(c) of the Act.
The Commission notes that with respect to investments of Cleared
Swaps Customer Collateral and 30.7 customer funds, the Commission would
be acting pursuant to its plenary authority under Sections 4d(f) \290\
and 4(b) \291\ of the Act, respectively, and would not need to apply
Section 4(c) to effectuate the proposed amendments.
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\290\ 7 U.S.C. 6d(f)(4) (providing that Cleared Swaps Customer
Collateral may be invested in certain specified investments and ``in
any other investment that the Commission may by rule or Regulation
prescribe, and such investments shall be made in accordance with
such rules and Regulations and subject to such conditions as the
Commission may prescribe.'')
\291\ 7 U.S.C. 6(b)(2)(A) (providing that the Commission may
adopt rules and Regulations requiring, among other things, the
safeguarding of customer's funds, by any person located in the U.S.
who engages in foreign futures trading).
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V. Administrative Compliance
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires Federal 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 respecting the
[[Page 81265]]
impact.\292\ Whenever an agency publishes a general notice of proposed
rulemaking for any rule, pursuant to the notice-and-comment provisions
of the Administrative Procedure Act,\293\ a regulatory flexibility
analysis or certification typically is required.\294\ The Commission
has previously determined that registered FCMs and DCOs are not small
entities for purposes of the RFA.\295\ Accordingly, the Chairman, on
behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b)
that the Proposal will not have a significant economic impact on a
substantial number of small entities.
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\292\ 5 U.S.C. 601 et seq.
\293\ 5 U.S.C. 553. The Administrative Procedure Act is found at
5 U.S.C. 500 et seq.
\294\ See 5 U.S.C. 601(2), 603, 604, and 605.
\295\ See 47 FR 18618, 18619 (Apr. 30, 1982) and 66 FR 45604,
45609 (Aug. 29, 2001).
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B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \296\ imposes certain
requirements on Federal agencies in connection with their conducting or
sponsoring any collection of information as defined by the PRA. Under
the PRA, an agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a currently valid control number from the Office of Management and
Budget (``OMB'').\297\ The PRA is intended, in part, to minimize the
paperwork burden created for individuals, businesses, and other persons
as a result of the collection of information by federal agencies, and
to ensure the greatest possible benefit and utility of information
created, collected, maintained, used, shared, and disseminated by or
for the Federal Government.\298\ The PRA applies to all information,
regardless of form or format, whenever the Federal Government is
obtaining, causing to be obtained, or soliciting information, and
includes required disclosure to third parties or the public, of facts
or opinions, when the information collection calls for answers to
identical questions posed to, or identical reporting or recordkeeping
requirements imposed on, ten or more persons.\299\
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\296\ 44 U.S.C. 3501 et seq.
\297\ See 44 U.S.C. 3507(a)(3); 5 CFR 1320.5(a)(3).
\298\ See 44 U.S.C. 3501.
\299\ See 44 U.S.C. 3502(3).
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The regulation to be amended under this proposal contains a
collection of information for which the Commission has previously
received control numbers from OMB. The titles for this collection of
information are OMB Control No. 3038-0024, Regulations and Forms
Pertaining to Financial Integrity of the Market Place; Margin
Requirements for SDs/MSPs and OMB Control No. 3038-0091, Disclosure and
Retention of Certain Information Relating to Cleared Swaps Customer
Collateral.\300\
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\300\ For the previously approved PRA estimates under OMB
Control No. 3038-0024, see ICR Reference No. 202101-3038-001, at
https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=202207-3038-001. For previously approved PRA estimated under OMB Control No.
3038-0091, see ICR Reference No. 202009-3038-007, at https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=202009-3038-007.
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As discussed in Section III.D. above, among other reporting items,
FCMs are required to report in the SIDR Reports the amount of futures
customer funds, Cleared Swaps Customer Collateral, and 30.7 customer
funds invested in each of the current categories of Permitted
Investments. The Commission is proposing to amend Regulations 1.32(f),
22.2(g)(5), and 30.7(l)(5), which define the content of the SIDR
Report, by deleting the requirement for an FCM to report the balances
invested in commercial paper and corporate notes and bonds as such
investments would no longer be Permitted Investments under the
Proposal; to require each FCM to report the total amount of futures
customer funds, Cleared Swaps Customer Collateral, and 30.7 customer
funds invested in Specified Foreign Sovereign Debt of each country that
is included within the Specified Foreign Sovereign Debt; and to require
an FCM to include in the SIDR Report the total amount of futures
customer funds, Cleared Swaps Customer Collateral, and 30.7 customer
funds invested in Qualified ETFs as such investments would be Permitted
Investments under the Proposal. As such, the proposed changes to the
content of the SIDR Reports would reflect the proposed revisions to the
list of Permitted Investments discussed in Section III.A. of the
Proposal. The Commission does not expect these proposed changes to
result in an increase in the number of burden hours required for the
completion of the reports. Accordingly, the Commission is retaining its
existing burden estimates associated with this collection of
information.\301\
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\301\ The Commission has previously estimated that compliance
with the requirements under Regulations 1.32(f) and 1.32(g) to file
SIDR reports requires 59 covered FCMs to expend 2,832 burden hours
annually. The Commission has estimated that each FCM will file 24
reports per year requiring approximately 48 burden hours per
respondent. This yields a total of 2,832 burden hours annually (59
FCM respondents x 48 burden hours annually = 2,832 hours).
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In addition, the Commission is proposing to revise Regulation 1.26,
which requires each FCM or DCO investing futures customer funds in MMFs
that are Permitted Investments to obtain and retain in its files a
written acknowledgment from the depository holding the funds stating
that the depository was informed that the funds belong to customers and
are being held in accordance with the provisions of the Act and
Commission regulations. Regulation 1.26 also specifies the form of the
written acknowledgment letter that each FCM or DCO must obtain from an
MMF, in the event futures customer funds are held directly with the
MMF. Regulations 22.5 and 30.7(d) set forth similar requirements with
respect to Cleared Swaps Customer Collateral and 30.7 customer funds.
The proposed amendments to Regulation 1.26 would require FCMs and DCOs
segregating Customer Funds in a Permitted Government MMF or Qualified
ETF account to obtain and maintain in their files an acknowledgment
letter from the fund in which Customer Funds are held and to file such
acknowledgment letter electronically with the Commission. The
Commission is proposing an analogous amendment to Regulation 30.7(d)(2)
with respect to investments of 30.7 customer funds by FCMs.\302\ The
Commission notes that the proposed revisions to Regulations 1.26 and
30.7(d) would reduce the scope of MMFs from which FCMs and DCOs, as
applicable, would be required to obtain an acknowledgment letter by
limiting the requirement to Permitted Government MMFs, a smaller set of
MMFs. The proposed revisions to Regulations 1.26 and 30.7(d) would also
impose a new requirement on FCMs and DCOs, as applicable, to obtain an
acknowledgment letter from Qualified ETFs. The requirement would also
apply under Regulation 22.5, which cross-references Regulation 1.26. To
the extent that the new collection requirement would apply only to FCMs
and DCOs that are APs and invest in Qualified ETFs in such capacity,
the Commission estimates that the proposed requirement would affect no
more than 15 registrants (i.e., approximately 10 FCMs and five DCOs).
Using the Commission's prior estimates of the number of burden hours
necessary to comply with the requirement to obtain an acknowledgment
letter pursuant to Regulations 1.26 and 30.7(d) (i.e., 0.75 burden
hours per response), the Commission estimates that the new requirement
would result in 0.75 annual burden hours per registrant per category
[[Page 81266]]
of Customer Funds, as applicable, assuming that a registrant would
obtain one acknowledgement letter per year from a Qualified ETF with
which it holds Customer Funds.\303\
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\302\ The Commission notes that an amendment to Regulation 22.5
would not be necessary as this regulation cross-references
Regulation 1.26.
\303\ The Commission has previously estimated that an FCM or a
DCO, as applicable, spends 0.75 hours per acknowledgement letter
required under Regulation 1.26 or Regulation 30.7(d). See ICR
Reference No. 202101-3038-001, at https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=202207-3038-001. The Commission therefore
estimates that to obtain an acknowledgement letter from Qualified
ETFs, 15 registrants would have to extend 30 burden hours annually.
Specifically, the Commission estimates that FCMs would have to spend
a total of 22.5 hours (10 FCMs x 1 report x 0.75 burden hours x 3
categories of Customer Funds = 22.5 hours) and DCOs would have to
spend a total of 7.5 hours (5 DCOs x 1 report x 0.75 burden hours x
2 categories of Customer Funds = 7.5 hours). The Commission notes
that investments by DCOs are only relevant with respect to futures
customer funds and Cleared Swaps Customer Collateral.
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The Commission also notes that, in connection with the proposed
revisions related to the elimination of the Read-only Access
Provisions, an FCM would need to obtain the revised acknowledgment
letter only for accounts opened following the effective date of the
proposed revisions or if the FCM is required to obtain a new
acknowledgment letter for reasons unrelated to the elimination of the
Read-only Access Provisions. The opening of a new depository account
triggers a requirement to obtain an acknowledgment letter in all
circumstances, regardless of the proposed revisions related to the
elimination of the Read-only Access Provisions. For these reasons, the
Commission is retaining its existing estimate of the burden that
covered FCMs and DCOs incur to obtain, maintain, and electronically
file the acknowledgment letters with the Commission, as currently
provided in the approved collection of information.\304\
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\304\ The Commission has estimated that 36 covered FCMs incur an
estimated 216 burden hours annually to file required acknowledgment
letters pursuant to Regulation 1.20(d). The Commission has estimated
that each respondent will file 3 reports per year requiring an
estimated 2 burden hours per report, for a total of 6 burden hours
per respondent. This yields a total of 216 burden hours annually (36
respondents x 6 burden hours annually = 216 burden hours). Under
Regulation 1.26, the Commission has estimated that 74 covered
respondents incur an estimated 111 burden hours annually to obtain
and maintain required acknowledgement forms (74 respondents x 1.5
hours annually = 111 burden hours). Under Regulation 30.7, the
Commission has estimated that 42 covered respondents incur an
estimated 252 burden hours annually (42 respondents x 6 burden hours
annually = 252 burden hours) and under Regulation 22.5, the
Commission has estimated that 78 covered respondents incur an
estimated 390 burden hours annually (78 respondents x 5 burden hours
annually = 390 burden hours) to obtain and maintain the required
acknowledgment letters.
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The Commission welcomes public comment on all aspects of its
analysis of the PRA requirements. In particular, the Commission invites
comment on its estimates of additional burden hours in connection with
the proposed requirement for FCMs and DCOs that invest Customer Funds
in Qualified ETFs to obtain an acknowledgment letter from such ETFs.
C. Cost-Benefit Considerations
Section 15(a) of the Act requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the Act.\305\ Section 15(a) further specifies that the costs and
benefits shall be evaluated in light of the following five broad areas
of market and public concern: (1) protection of market participants and
the public; (2) efficiency, competitiveness and financial integrity of
futures markets; (3) price discovery; (4) sound risk management
practices; and (5) other public interest considerations. The Commission
considers the costs and benefits resulting from its discretionary
determinations with respect to the Section 15(a) considerations, and
seeks comments from interested persons regarding the nature and extent
of such costs and benefits.
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\305\ 7 U.S.C. 19(a).
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As described in more detail above, the Commission is proposing to
revise the list of Permitted Investments in Regulation 1.25(a) to: (i)
add the foreign sovereign debt of certain jurisdictions and interests
in certain ETFs that invest primarily in short-term U.S. Treasury
securities; (ii) limit the scope of MMFs whose interests qualify as
Permitted Investments to certain Government MMFs; and (iii) eliminate
commercial paper, corporate notes or bonds. The Commission is further
specifying the capital charges that FCMs would be required to take on
investments of Customer Funds in foreign sovereign debt and ETFs. The
Commission is also proposing to replace LIBOR with SOFR as a permitted
benchmark under Regulation 1.25(b)(2)(iv)(A)(1) and (2), as well as to
adopt certain conforming changes consistent with the proposed
amendments, and is requesting public comment on the possible removal of
bank CDs from the list of Permitted Investments. Finally, the
Commission is proposing to revise relevant provisions in Parts 1 and 30
of the Commission's regulations to eliminate the requirement for
depositories to provide read-only electronic access to accounts
maintained by FCMs that hold Customer Funds.
The baseline for consideration of the benefits and costs associated
with the Proposal are the benefits and costs that FCMs, DCOs, and the
public would realize if the Commission does not proceed with the
proposed amendments, or in other words, the status quo.
The Commission notes that the consideration of costs and benefits
below is based on the understanding that the markets function
internationally, with many transactions involving U.S. firms taking
place across international boundaries; with some Commission registrants
being organized outside of the United States; with leading industry
members typically conducting operations both within and outside the
United States; and with industry members commonly following
substantially similar business practices wherever located. Where the
Commission does not specifically refer to matters of location, the
below discussion of costs and benefits refers to the effects of these
proposed amendments on all activity subject to the proposed amended
regulations, whether by virtue of the activity's physical location in
the United States or by virtue of the activity's connection with
activities in, or effect on, U.S. commerce under Section 2(i) of the
Act.\306\
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\306\ 7 U.S.C. 2(i).
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The Commission recognizes that the Proposal may result in some
additional, incremental costs for FCMs and DCOs. However, the
Commission lacks the data necessary to reasonably quantify all of the
costs and benefits considered below. Additionally, any initial and
recurring compliance costs for any particular FCM or DCO will depend on
its size, existing infrastructure, practices, and cost structures. The
Commission welcomes comments on any such incremental costs, especially
by DCOs and FCMs, who may be better able to provide quantitative costs
data or estimates, based on their respective experiences relating to
Commission's regulations governing the investment of Customer Funds and
related requirements.
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 and DCOs resulting
from the proposed amendments 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
[[Page 81267]]
difficulties, for this NPRM, the Commission offers the following
qualitative discussion of its costs and benefits.
a. Foreign Sovereign Debt, Interests in Exchange-Traded Funds, and
Associated Capital Charges
The Proposal would expand the list of Permitted Investments to add
two new categories of instruments. Specifically, the Proposal would
add: (i) the sovereign debt of Canada, France, Germany, Japan, and the
United Kingdom, and (ii) interests in certain ETFs that invest in
primarily short-term U.S. Treasury securities, to the list of Permitted
Investments in which FCMs and DCOs may invest customer segregated funds
pursuant to Regulation 1.25. The Proposal would also require an FCM to
apply capital charges on any investments of Customer Funds in the
Specified Foreign Sovereign Debt and Qualified ETFs to account for
potential market risk associated with such investments. The Proposal
would further expand the universe of permitted counterparties and
depositories that can be used to buy and sell permitted foreign
sovereign debt pursuant to Repurchase Transactions to include certain
non-U.S. entities.
1. Benefits
The Commission preliminarily believes that expanding the list of
Permitted Investments to include Specified Foreign Sovereign Debt and
interests in Qualified ETFs would provide FCMs and DCOs with a wider
range of alternatives to invest Customer Funds, and as a result, FCMs
and DCOs might have more investment options, some of which might be
more profitable than the existing Permitted Investments, such that FCMs
and DCOs may be able to generate more income for themselves and their
customers. This may motivate FCMs or DCOs to increase their presence in
the futures market and other relevant markets, thereby increasing
competition, which might lead to a reduction in charges to customers
and an increase trading activity and liquidity.
Also, the ability to use Specified Foreign Sovereign Debt as a
Permitted Investment would facilitate FCMs' and DCOs' management of
foreign currencies that customers deposit to margin their trades and
enable FCMs and DCOs to avoid certain risks and practical challenges in
the handling of foreign currencies. For example, providing FCMs and
DCOs with the opportunity to invest customer foreign currencies in
identically-denominated assets would help manage the foreign currency
risk that FCMs and DCOs face if they seek to invest foreign currencies
in the currently permitted, U.S. dollar-denominated investments. In
addition, in their Joint Petition, the Petitioners asserted that as a
matter of risk management policy, or due to regulatory requirements,
many clearing organizations located outside of the United States impose
strict cut-off times for cash withdrawal by clearing members, while
allowing later cut-off times for withdrawal of other types of
collateral.\307\ Also, for reasons such as capital requirements and
balance sheet management, banks may not accept foreign currencies at
all or may place limits on the accepted amount. Banks may also charge
higher rates for holding foreign currencies. As such, FCM customers
depositing foreign currencies might potentially absorb those costs. The
Petitioners also argued that it may be preferable to hold foreign
currencies in the form of high-quality sovereign debt than keeping the
funds in unsecured bank demand deposit accounts that might expose the
funds to the credit risk of commercial banks.
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\307\ Joint Petition at p. 3 (citing, as an example of
regulatory requirements, Article 45 of the regulatory technical
standards on requirements for central counterparties (Commission
Delegated Regulation (EU) No. 153/2013) (``CCP RTS''), which
supplements provisions in the EU Market Infrastructure Regulation
(Regulation (EU) No 648/2012) (``EMIR'') governing the investment
policies of EU central counterparties. Per Article 45(2) of the CCP
RTS, not less than 95 percent of cash deposited other than with a
central bank and maintained overnight must be deposited through
arrangements that ensure its collateralization with highly liquid
financial instruments).
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Similarly, for reasons related to balance sheet management,
custodian institutions may impose higher fees for accepting cash
deposits denominated in USD or limit the amounts of USD cash that they
are willing to safeguard.
Expanding the list of Permitted Investments to instruments that
meet the overall required standards of preserving principal and
maintaining liquidity, while also providing the potential for greater
diversification or higher returns for FCMs, DCOs and customers, would
give FCMs and DCOs more flexibility in the management of Customer
Funds. This might be particularly important given the narrower range of
assets that currently qualify as Permitted Investments under Regulation
1.25.
In addition, Qualified ETFs, in particular, may offer an
opportunity to invest in U.S. Treasury securities, which qualify as a
Permitted Investment, without devoting the resources required to
purchase, monitor, and roll over such securities when they mature.
The Commission also preliminarily believes that requiring an FCM to
apply capital charges on investments of Customer Funds in Specified
Foreign Sovereign Debt and Qualified ETFs helps ensure that the FCM
maintains a sufficient level of readily available liquid funds that
would be available to transfer into the FCM's futures accounts, Cleared
Swaps Customer Accounts, and/or 30.7 accounts to cover decreases in
value of the investments to help ensure continue compliance with
Customer Funds segregation requirements.\308\ Requiring an FCM to
maintain regulatory capital to cover potential decreases in the value
of the Permitted Investments benefits the FCM by helping to ensure that
such firms have sufficient, liquid financial resources to meet 100
percent of their obligations to futures customers, Cleared Swaps
Customers, and 30.7 customers at all times as required by Regulations
1.20, 22.2, and 30.7. Capital charges on Permitted Investments also
benefit FCM customers as the charges help ensure an FCM maintains
capital in an amount sufficient to cover investment losses and to
prevent such losses from being passed on to customers in violation of
Regulations 1.29(b), 22.2(e)(1), and 30.7(i).
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\308\ The terms ``futures account,'' ``Cleared Swap Customer
Account,'' and ``30.7 account'' are defined in Regulations 1.3,
22.1, and 30.1, respectively. 17 CFR 1.3, 17 CFR 22.1, and 17 CFR
30.1.
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In addition, the Commission also notes that the proposed amendment
to Regulation 22.3(d), seeking to clarify that DCOs are responsible for
losses resulting from their investments of Customer Funds, would
provide legal certainty with respect to the Commission's customer
protection regulations.
2. Costs
Although the Proposal would increase the range of permissible
investments in which DCOs and FCMs may invest customers funds,
facilitating their management of investments and capital, the Proposal
may result in customer segregated funds being invested in instruments
that may be less liquid and have increased exposure to credit and
market risks than those currently permitted under Regulation 1.25. Such
risks could result in an increased exposure for FCMs and DCOs, who
pursuant to Regulations 1.29(b), 22.2(e)(1), 22.3(d), and 30.7(i), as
applicable, are responsible for losses resulting from investments of
Customer Funds. A heightened risk exposure may also indirectly impact
customers if the
[[Page 81268]]
losses compromise the FCM's or DCO's ability to return Customer Funds.
To account for these potential risks and ensure that the proposed
Permitted Investments are consistent with the general objectives of
Regulation 1.25 of preserving principal and maintaining liquidity, the
Commission is proposing several conditions for foreign sovereign debt
and interests in U.S. Treasury ETFs to qualify as Permitted
Investments. Specifically, for the Specified Foreign Sovereign Debt,
the proposed conditions include a cap of 45 BPS on the two-year credit
default spread of the issuing sovereign, a 60-day limit on the dollar-
weighted average of the time to maturity of the FCM's or DCO's
portfolio of investments in each type of Specified Foreign Sovereign
Debt, and a 180-day limit on the time-to-maturity of any individual
Specified Foreign Sovereign Debt instrument. For interests in Qualified
ETFs to be deemed Permitted Investments, the Commission proposes to
require, among other conditions, that the ETF is passively managed and
seeks to replicate the performance of a published short-term U.S.
Treasury security index. For purposes of the Proposal, short-term U.S.
Treasury securities are bonds, notes, and bills with a remaining
maturity of 12 months or less, issued by, or unconditionally guaranteed
as to the timely payment of principal and interest by, the U.S.
Department of the Treasury. Under the Proposal, the eligible U.S.
Treasury securities must represent at least 95 percent of the Qualified
ETF's investment portfolio. In addition, to be able invest in a
Qualified ETF, an FCM or a DCO would have to qualify as an authorized
participant such that it would be able to redeem interests in the ETF
directly from the fund. Moreover, as discussed above, the Proposal
would require FCMs to take capital charges based on the current market
value of the Specified Foreign Sovereign Debt and Qualified ETFs to
address potential market risk of such investments. The capital charges
are intended to ensure that an FCM has sufficient financial resources
in the form of cash and other readily marketable collateral to
adequately cover potential market risk of the investments, consistent
with the FCM's obligation to bear any losses resulting from such
investments.
Requiring an FCM to apply capital charges in connection with the
proposed new categories of Permitted Investments would result in costs
associated with reserving capital. The FCM may not be able to use the
amounts reserved as capital to maximize the profit of its business
operations, thus potentially reducing its income. The Commission notes,
however, that capital requirements are an essential risk-management
feature of the FCM's regulatory regime and the amounts reserved as
capital would be necessary and expected costs associated with operating
a business as an FCM.
In addition, the Commission preliminarily believes that the
proposed clarifying amendment to Regulation 22.3(d) would not result in
increased costs for DCOs. The proposed amendment seeks to expressly
state a regulatory obligation that is consistent with the Commission's
original intent to permit DCOs to invest Cleared Swaps Customer
Collateral within the parameters applicable to investments of futures
customer funds.\309\ As such, the Commission preliminarily believes
that DCOs already reserve financial resources to account for their
responsibility for such investments.
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\309\ See supra note 42.
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Finally, as discussed above, the Commission has slightly adjusted
its existing burden estimates associated with the approved collection
of information. As such, the Commission preliminarily believes that
FCMs and DCOs would not incur material costs relating to the collection
of information as a result of this Proposal.
3. Section 15(a) Considerations
In light of the foregoing, the Commission has evaluated the costs
and benefits of the Proposal pursuant to the five considerations
identified in Section 15(a) of the Act as follows:
(a) Protection of Market Participants and the Public
The Proposal would expand the list of permitted instruments set
forth in Regulation 1.25(a) to include instruments that may be less
liquid and may be more exposed to credit and market risks than some of
the currently Permitted Investments under Regulation 1.25, resulting in
Customer Funds being invested in potentially illiquid and risky
instruments. To address these potential risks with respect to Specified
Foreign Sovereign Debt and Qualified ETFs, the Proposal would include
strict conditions for the relevant instruments to qualify as Permitted
Investments, and would require FCMs to reserve regulatory capital to
cover potential decreases in the market value of the Specified Foreign
Sovereign Debt and Qualified ETFs and not pass such losses on to
customers. The Commission's preliminary analysis indicates that
instruments meeting the specified conditions present credit and
volatility characteristics that are comparable to those of instruments
that already qualify as Permitted Investments.\310\ As such, the
Commission believes that the current level of protection provided to
Customer Funds would be maintained under the terms of the proposal.
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\310\ See supra note 77 (using one-year sovereign debt
instruments yield data to demonstrate that the price risk of the
Specified Foreign Sovereign Debt instruments is comparable to that
of U.S. government securities), Section III.A.1 and note 94 (using
credit default swap data to demonstrate that the Specified Foreign
Sovereign Debt instruments have a risk profile comparable to that of
U.S. government securities) and note 180 (using yield data to
demonstrate that five ETFs currently available on the market, which
invest in short-term U.S. Treasury securities, are at least as
stable as one-year U.S. Treasury securities).
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(b) Efficiency, Competitiveness, and Financial Integrity of Markets
Having a greater selection of Permitted Investments may provide
FCMs or DCOs with the ability to generate more income from their
investment of Customer Funds. This may motivate FCMs or DCOs to
increase their presence in the futures and other relevant markets
increasing competition, which might lead to lower charges for
customers. The increase in revenue may also increase earnings to
customers as DCOs and FCMs often pay a return on customer deposited
funds, and FCMs may otherwise share some or all of the income to
customers.
The increased range of Permitted Investments is expected to provide
investment flexibility to FCMs and DCOs and an opportunity to realize
cost savings. More specifically, by being able to invest in Specified
Foreign Sovereign Debt, FCMs and DCOs may be able to avoid practical
challenges, such as having to meet clearing organizations' strict cut-
off times for cash withdrawal, or the additional fees for holding
foreign currencies, imposed by some institutions. In addition,
investing in Specified Foreign Sovereign Debt could be a safer
alternative than holding cash at a commercial bank. It may also help
avoid the foreign currency risk to which FCMs and DCOs may be exposed
absent the ability to invest customer foreign currencies in
identically-denominated assets.
In addition, Qualified ETFs may provide a simpler and cost-
efficient way of investing in U.S. Treasury securities, saving the
resources that would otherwise be required to roll over such securities
at their maturity.
(c) Price Discovery
The Proposal would increase the selection of Permitted Investments
and may lead FCMs and DCO to generate more income from their
investments of
[[Page 81269]]
Customer Funds. This might lead to a reduction in charges for
customers, or provide customers with additional revenue, and
potentially motivate customers to increase their trading in the futures
market and other relevant markets, which might increase liquidity in
those markets and enhance price discovery.
(d) Sound Risk Management
Increasing the range of Permitted Investments would provide FCMs
and DCOs with a broader selection of investment options to invest
Customer Funds, enabling FCMs and DCOs to have more diversified
portfolios and reduce the potential concentration in a few instruments.
Providing safe alternative investment options may be particularly
beneficial for FCMs and DCOs in light of the limited range of
instruments that meet the eligibility criteria of Regulation 1.25 and
the competing demand for high quality forms of collateral driven by the
regulatory reforms implementing the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010.
By making available Specified Foreign Sovereign Debt as a Permitted
Investment, the Commission would provide FCMs and DCOs with an
opportunity to better manage risks associated with holding foreign
currencies deposited by customers. As noted above, the Commission
recognizes that investing customer segregated funds in Specified
Foreign Sovereign Debt provides an alternative to taking on the
exposure of holding cash at a commercial bank. The Commission notes
also that absent the ability to invest Customer Funds in identically-
denominated sovereign debt securities, an FCM or a DCO seeking to
invest customer foreign currency deposits would need to convert the
currencies to a U.S. dollar-denominated asset, which would increase the
potential foreign currency risk. In addition, by limiting the
investment of foreign currency to foreign sovereign debt that meets
certain requirements, the Proposal is expected to further promote sound
risk management. Lastly, requiring an FCM to reserve capital to cover
potential decreases in the value of the Specified Foreign Sovereign
Debt and Qualified ETFs would help ensure that an FCM has the financial
resources to meet its regulatory obligations of bearing 100 percent of
the losses on the investment of Customer Funds.
(e) Other Public Interest Considerations
Although the four factors mentioned above are considered to be the
primary cost-benefit considerations, other public interest
considerations may also be relevant. For instance, in addition to the
potential benefits that may accrue to FCMs, DCOs, and customers,
benefits associated with the addition of Qualified ETFs to the list of
Permitted Investments may also accrue to the general public, as
allowing FCMs and DCOs to invest Customer Funds in such instruments may
contribute to a more vibrant and robust market for ETFs. In addition,
the expansion of Permitted Investments to include Specified Foreign
Sovereign Debt may ease access to futures and cleared swaps markets for
entities domiciled in non-U.S. jurisdictions that can now more easily
transaction in foreign currency with potentially lower costs and risk.
This may provide additional hedging opportunities for entities and
enhance market liquidity.
b. Government Money Market Funds, Commercial Paper and Corporate Notes
or Bonds, and Certificates of Deposit Issued by Banks
The Proposal would limit the scope of MMFs whose interests qualify
as Permitted Investments to certain Government MMFs as defined by SEC
Rule 2a-7, revise the asset-based concentration limits applicable to
such funds, and add issuer-based concentration limits. The Proposal
would also remove from the list of Permitted Investments commercial
paper and corporate notes or bonds guaranteed as to principal and
interest by the United States under the TLGP. The Proposal would also
request public comment as to whether bank CDs should be removed from
the list of Permitted Investments due to a lack of use by FCMs and
DCOs.
1. Benefits
The Proposal would remove interests in certain MMFs, including
Prime MMFs and Electing Government MMFs, from the list of Permitted
Investments set forth in Regulation 1.25, limiting the scope of MMFs
whose interests qualify as Permitted Investments to Permitted
Government MMFs, as further discussed above. The Commission believes
that interests in Prime MMFs and Electing Government MMFs are
unsuitable as Permitted Investments under Regulation 1.25 because such
MMFs are subject to the SEC MMF Reforms pursuant to which liquidity
fees to stem redemptions may be imposed, which could hinder the
liquidity of the MMFs and adversely impact customers' access to their
funds, which may be needed to meet margin calls on open positions or
cash market transaction. The Proposal would therefore prevent
investments of Customer Funds in MMFs that might pose unacceptable
levels of liquidity risk.
The Proposal would impose asset-based concentration limits
according to the size of the Permitted Government MMFs and their
management companies. A 50 percent concentration limits would apply to
Government MMFs with at least $1 billion in assets and with management
companies with more than $25 billion in assets under management. The
current 10 percent concentration limit for MMFs with less than $1
billion in assets and/or which have a management company managing less
than $25 billion in assets would be maintained. These concentration
limits recognize that larger Government MMFs may be a safer investment
alternative given that they may be better positioned to withstand times
of significant financial stress and to manage high levels of
redemptions. As such, the concentration limits, as proposed, ensure
that FCMs' and DCOs' investments in Permitted Government MMFs account
for the level of liquidity, market, and credit risk posed by a fund in
light of its capital base, portfolio of holdings, and capacity to
handle market stress.
The proposed concentration limits would promote investments of
Customer Funds in Permitted Government MMFs of different sizes subject
to different concentration limits, leading to diversification in FCMs'
and DCO's portfolios, while encouraging investments in safer larger
Government MMFs. The proposed concentration limits might also reduce
the potential concentration in certain Permitted Government MMFs,
fostering competition across the funds, which might lead to better
terms and reduced costs for FCMs and DCOs. In addition, the Commission
is proposing issuer-based limits with the goal of mitigating potential
risks associated with concentrating investments of Customer Funds in
any single fund or family of Government MMFs such as the risk that
access to Customer Funds may become restricted due to a cybersecurity
or an operational incident affecting the fund. Specifically, the
Commission is proposing to limit investments of Customer Funds in any
single family of Government MMFs to 25 percent and investments of
Customer Funds in any single issuer of Government MMFs to 5 percent of
the total assets held in each of the segregated classifications of
futures customer funds, Cleared Swaps Customer Collateral, and 30.7
customer funds. In establishing these concentration limits, the
Commission acknowledges that there are no precise
[[Page 81270]]
limits that can guarantee absolute protection against market
volatility. The Commission's preliminary assessment indicates, however,
that these proposed limits represent a practical approach that
effectively balances the need to support the viability of FCMs' and
DCOs' business model while safeguarding the principal and liquidity of
the Customer Funds.
The Proposal would also eliminate commercial paper and corporate
notes or bonds guaranteed under the TLGP as Permitted Investments given
that the TLGP expired in 2012. This proposed rule amendment will
streamline the CFTC rules, facilitating their implementation and
administration, and is consistent with the Commission's earlier
determination that commercial paper and corporate notes or bonds are
rarely used and pose unacceptable levels of credit, liquidity, and
market risk.\311\ The Proposal is also requesting public comment on
whether to remove bank CDs from the list of Permitted Investments, in
light of the Commission's experience that FCMs and DCOs do not invest
Customer Funds in these instruments.\312\
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\311\ Investment of Customer Funds and Funds Held in an Account
for Foreign Futures and Foreign Options Transactions, 75 FR 67642,
67644 (Nov. 3, 2010).
\312\ In addition to the Commission's general experience in
overseeing DCOs and FCMs, Commission staff also reviewed how FCMs
invested customer funds as reported in the SIDR Report for the
period September 15, 2022 to February 15, 2023 and noted that no
FCMs reported investing customer funds in bank CDs.
---------------------------------------------------------------------------
2. Costs
As the Proposal would limit the scope of MMFs whose interests
qualify as Permitted Investments to Permitted Government MMFs, the
Proposal may lead to less diversification in the investment of Customer
Funds by FCMs and DCOs. FCMs' and DCOs' portfolios may be concentrated
in the Permitted Government MMFs, increasing exposure to risks
associated with the funds, which might heighten the risk of loss of
Customer Funds. Also, given that fewer MMFs would be available as
Permitted Investments, FCMs and DCOs would have less flexibility in
investing Customer Funds. FCMs and DCOs might thus generate less income
and may pass on additional operational costs to customers by increasing
their fees.
The Commission notes, however, that the potential risk of
concentration of investments in Permitted Government MMFs would be
mitigated by the proposed asset-based and issuer-based concentration
limits, which are designed to promote diversification among different
categories of Permitted Investments and among different individual
Permitted Government MMFs.
To meet the proposed concentration limits, FCMs and DCOs may be
required to liquidate Government MMFs held in their portfolios and
might incur losses. The Commission notes that the risk of loss is
likely to be mitigated given that the Government MMFs in which FCMs and
DCOs have been permitted to invest Customer Funds since the issuance of
Staff Letter 16-68 and Staff Letter 16-69 are presumably highly
liquid.\313\
---------------------------------------------------------------------------
\313\ See 17 CFR 1.25(b)(1).
---------------------------------------------------------------------------
In the Commission's view, the elimination of commercial paper and
corporate notes or bonds guaranteed under the TLGP would not result in
any costs as the instruments have not been available as Permitted
Investments since the 2012 when the TLGP expired. Similarly, the
Commission believes that were it to remove banks CDs at a later time,
there would be no immediate potential cost because in the Commission's
experience FCMs and DCOs do not currently invest Customer Funds in this
type of instrument. Eliminating this investment option, however, may
lead to potential long-term costs if this option becomes valuable.
3. Section 15(a) Considerations
In light of the foregoing, the Commission has evaluated the costs
and benefits of the Proposal pursuant to the five considerations
identified in Section 15(a) of the Act as follows:
(a) Protection of Market Participants and the Public
The Proposal would remove from the list of Permitted Investments
interests in MMFs whose redemptions may be subject to liquidity fees,
including Prime MMFs and Electing Government MMFs. In the Commission's
view, the imposition of a liquidity fee is in conflict with provisions
in Regulation 1.25 that are designed to reduce Customer Funds' exposure
to liquidity risk and to preserve the principal of investments
purchased with Customer Funds. As a result, by preventing investments
in instruments that pose unacceptable levels of liquidity risk, the
Proposal would provide greater protection to customer segregated funds
and promote the efficient and safe investment of Customer Funds by FCMs
and DCOs.
The Proposal would limit the scope of MMFs whose interests qualify
as Permitted Investments to Government MMFs as defined by SEC Rule 2a-
7. The Commission notes that these types of funds are less susceptible
to runs and have seen inflows during periods of market
instability.\314\ As such, the Proposal, by limiting the scope of
eligible MMFs to Government MMFs, would reduce the potential that funds
in which Customer Funds are invested may be impacted by run risk and
other associated risks. However, given that there would be fewer MMFs
available as Permitted Investments, FCMs' and DCOs' investments may be
concentrated in fewer MMFs and the investments may be more susceptible
to risk associated with the fewer available funds.
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\314\ See SEC MMF Reforms at 51417 (noting that investors
typically view government MMFs, in contrast to Prime MMFs, as a
relatively safe investment during times of market turmoil). See also
Money Market Fund Reforms, 87 FR 7248 (Feb. 8, 2022) (``SEC MMF
Reforms Proposing Release'') at 7250 (recounting that during the
2008 financial crisis there was a run primarily on institutional
Prime MMFs after an MMF ``broke the buck'' and suspended
redemptions, which motivated many fund sponsors to step in and
provide financial support to their funds. The events led to general
turbulence in the financial markets and contributed to severe
dislocations in short-term credit markets.
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The proposed asset-based concentration limits for Government MMFs
would ascribe limits according to the size of the funds, with larger
funds being subject to a 50 percent limit and smaller funds to a 10
percent limit. These limits recognize that larger funds have capital
bases better capable of handling a high volume of redemptions in times
of stress. Accordingly, the concentration limits would promote
investments in larger funds, which represent a safer investment
alternative, while providing for diversification by permitting
investments in smaller Government MMFs subject to concentration limits
to ensure the safety of Customer Funds. In addition, the proposed
issuer-based concentration limits would promote diversification among
different individual Government MMFs, thus mitigating the potential
risks associated with concentrating investments of Customer Funds with
a single fund or family of funds.
The implementation of the proposed concentration limits may require
FCMs and DCOs to liquidate their fund holdings, which could lead to
losses. The Commission believe that the potential for losses would be
mitigated because since the issuance in 2016 of Staff Letter 16-68 and
Staff Letter 16-69, FCMs and DCOs have been allowed to invest only in
Government MMFs meeting the liquidity standards of Regulation 1.25.
By removing commercial paper and corporate notes or bonds
guaranteed under the TLGP from the list of
[[Page 81271]]
Permitted Investments under Regulation 1.25, the Proposal would
eliminate instruments that are no longer available given the expiration
of the TLGP in 2012. This would streamline the CFTC rules and
facilitate their implementation, removing a potential source of
confusion and allowing FCMs and DCOs to focus their efforts on more
immediate regulatory concerns. If the Commission were to proceed with
the removal of bank CDs, a type of instruments that is not used by FCMs
and DCOs as an investment of Customer Funds, the elimination would
similarly contribute to the effort of streamlining Commission's
regulations.
(b) Efficiency, Competitiveness, and Financial Integrity of Markets
By eliminating interests in Prime MMFs and Electing Government MMFs
from the list of Permitted Investments, the Proposal would prevent
investments of Customer Funds in instruments that might be less liquid
in light of the SEC MMF Reforms, thus advancing the objectives of
Regulation 1.25 of preserving principal and maintaining liquidity.
As discussed earlier, the elimination of commercial paper and
corporate notes or bonds guaranteed under the TLGP would remove
instruments that are either no longer available given the expiration of
the program or not used as an investment of Customer Funds, allowing
FCMs and DCOs to more efficiently allocate their resources and address
more immediate regulatory concerns.
(c) Price Discovery
The Proposal, by reducing the selection of Permitted Investments,
would lead to fewer investment options available to FCMs and DCOs. As
such, FCMs and DCOs might generate less income from their investment of
Customer Funds and might pass onto customers the costs of operations by
increasing fees. Facing increased costs, customers might cut back on
their trading, reducing liquidity, which might hinder price discovery.
(d) Sound Risk Management
By eliminating from the list of Permitted Investments interests in
Prime MMFs and Electing Government MMFs, the Proposal would prevent
investments of customers funds in certain MMFs, which might be
susceptible to increased liquidity risk in light the SEC MMF Reforms,
thus promoting sound risk management. Also, the concentration limits
that would apply to the Permitted Government MMFs would foster adequate
diversification in FCMs' and DCOs' portfolios by encouraging
investments of Customer Funds in larger funds expected to have the
capacity to withstand significant market stress and increasing
redemptions, while making available smaller funds subject to specified
concentration limits.
(e) Other Public Interest Considerations
The Commission believes that the relevant cost-benefit
considerations are captured in the four factors above.
c. SOFR as a Permitted Benchmark
In March 2021, the U.K. Financial Conduct Authority announced that
LIBOR would be effectively discontinued.\315\ The Commission is
therefore proposing to replace LIBOR with SOFR as a permitted benchmark
for variable and floating rate securities that qualify as Permitted
Investments under Regulation 1.25.
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\315\ Staff Letter 21-26 at p. 1.
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1. Benefits
Under Regulation 1.25(b)(2)(iv)(A), variable and floating
securities qualify as Permitted Investments if, among other things, the
interest payments on the securities correlate to specified benchmarks,
including LIBOR.\316\ As discussed in more detail above, a number of
enforcement actions concerning attempts to manipulate the LIBOR
benchmark led to a loss of confidence in the reliability and robustness
of LIBOR and to the benchmark's discontinuation. The Commission
therefore proposes to remove LIBOR as a permitted benchmark and replace
it with SOFR. The Commission believes that the unreliability of LIBOR
could undermine the value of variable and floating rate securities that
reference the benchmark. Accordingly, the replacement of LIBOR with
SOFR, which has been identified as a preferred benchmark alternative by
the ARRC,\317\ would ensure that Customer Funds are invested in
securities that reference a reliable and robust benchmark providing
greater protection to Customer Funds.
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\316\ 17 CFR 1.25(b)(2)(iv)(A).
\317\ See Staff Letter 21-26 at p. 3.
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2. Costs
The Commission notes that given the widespread use of LIBOR as a
benchmark, FCMs and DCOs that invest Customer Funds in variable and
fixed rate securities might incur costs as a result of the transition
to SOFR. To the extent that FCMs and DCOs already invest in variable
and fixed rate securities benchmarked to LIBOR, they would need to
amend the terms of their agreements to incorporate the new benchmark.
FCMs and DCOs may also need to adjust their systems and processes to
implement and recognize SOFR as a benchmark. However, the Commission
believes that transitioning to a more reliable benchmark offsets these
associated costs by enhancing security for Customer Funds and removing
a potential source of risk to the financial system overall.
3. Section 15(a) Considerations
In light of the foregoing, the Commission has evaluated the costs
and benefits of the Proposal pursuant to the five considerations
identified in Section 15(a) of the Act as follows:
(a) Protection of Market Participants and the Public
As previously discussed, LIBOR is no longer deemed a reliable and
robust benchmark. As such, it could negatively impact the value of
variable and floating rate securities that reference the benchmark. By
eliminating LIBOR as a permitted benchmark, the Proposal would prevent
investments of Customer Funds in securities referencing an unreliable
benchmark and would promote the use of a safer benchmark alternative.
(b) Efficiency, Competitiveness, and Financial Integrity of Markets
By formalizing the use of SOFR as a permitted benchmark for
Permitted Investments in which Customer Funds may be invested, the
Proposal would promote the transition to SOFR and facilitate the
phasing out of LIBOR, a widely used benchmark that is now deemed to be
unreliable, removing a potential source of risk to the financial
system.\318\
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\318\ The replacement of LIBOR as a benchmark for Permitted
Investments represents another step in the Commission's efforts to
facilitate the transition away from LIBOR, as illustrated by a
recent amendment to the clearing requirements. See Clearing
Requirement Determination Under Section 2(h) of the Commodity
Exchange Act for Interest Rate Swaps to Account for the Transition
from LIBOR and Other IBORs to Alternative Reference Rates, 87 FR
52182 (Aug. 24, 2022) (replacing the requirement to clear interest
rate swaps referencing LIBOR and certain other interbank offered
rates with the requirement to clear interest rate swaps referencing
overnight, nearly risk-free reference rates).
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In addition, SOFR is an essential benchmark that helps ensure the
stability and integrity of financial markets. As such, formalizing the
use of SOFR as a permitted benchmark for permitted investments may
enhance the financial integrity of markets.
[[Page 81272]]
(c) Price Discovery
The proposed amendment to replace LIBOR with SOFR as a permitted
benchmark would have no negative impact on price discovery. Permitting
SOFR as a benchmark for Customer Funds investments would benefit FCMs
and DCOs and their customers. This might increase liquidity in the
futures markets and enhance the process of price discovery.
(d) Sound Risk Management
By eliminating LIBOR as a permitted benchmark and replacing it with
SOFR, the Proposal would ensure that to the extent FCMs and DCOs select
variable and floating rate securities as Permitted Investments to
invest Customer Funds, these instruments would reference benchmarks
that are, in the Commission's view, sound and reliable, thus fostering
sound risk management.
(e) Other Public Interest Considerations
The Commission believes that the relevant cost-benefit
considerations are captured in the four factors above.
d. Revision of the Read-Only Access Provisions
The Proposal would eliminate the Read-only Access Provisions in
parts 1 and 30 of the Commission's regulations,\319\ which require
depositories to provide the Commission with direct, read-only
electronic access to accounts maintained by FCMs that hold Customer
Funds.
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\319\ More specifically, the relevant provisions appear in
Regulation 1.20, Appendix A to Regulation 1.20, Appendix A to
Regulation 1.26, Regulation 30.7 and appendices E and F to Part 30
of CFTC's Regulations. If adopted, the proposed amendments would
extend to Regulation 22.5, which requires FCMs and DCOs, before
depositing Cleared Swaps Customer Collateral with a depository, to
obtain an acknowledgment letter from each depository in accordance
with Regulations 1.20 and 1.26. 17 CFR 22.5(a). Regulation 22.5
further requires FCMs and DCOs to adhere to all requirements
specified in Regulation 1.20 and 1.26 regarding retaining,
permitting access to filing, or amending the written acknowledgment
letters. 17 CFR 22.5(a).
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1. Benefits
Eliminating the Read-only Access Provisions would streamline the
CFTC rules, facilitating their implementation and administration, and
is consistent with the Commission's anticipation that the existence of
alternative methods for obtaining and verifying account balance
information would diminish the need to rely on the direct read-only
access to accounts. More specifically, by relying on the CME's and
NFA's daily segregation confirmation and verification process, the
Commission would be able to allocate resources to focus on more
immediate regulatory concerns within its jurisdictional purview. In
that regard, the Commission notes, as discussed above, that it has
encountered numerous practical challenges in the administration of
direct access to depository accounts, which unduly burden the
Commission's resources, particularly considering that the Commission
contemplated that the use of real-time access would be limited, and
prevent Commission staff from using the Read-only Access Provisions as
intended.
In addition, eliminating the requirement to provide the Commission
with direct, read-only access to accounts maintained by FCMs, would
reduce costs for depositories, which may motivate these institutions to
more readily take FCM Customer Funds on deposit. The Proposal may thus
foster competition in the futures market and ultimately reduce costs
for FCMs and their customers.
Furthermore, the deletion of the Read-only Access Provisions would
eliminate the need for the Commission to keep a log of access
credentials and physical authentication devices, thereby reducing the
potential cybersecurity risk associated with the maintenance of such
credentials and devices.
2. Costs
Withdrawing the requirement that depositories provide the
Commission with direct, read-only electronic access to depository
accounts holding Customer Funds would deprive the Commission from
ongoing, instantaneous access to the accounts for purposes of
identifying potential discrepancies between the account balance
information reported by the FCMs and the account balance information
available directly from the depositories.
The Commission believes, however, that more efficient means for
identifying discrepancies in the account balance information exist,
namely by obtaining account balance and transaction information through
the CME's and NFA's automated daily segregation confirmation system or
by requesting the information directly from the depositories.
3. Section 15(a) Considerations
In light of the foregoing, the Commission has evaluated the costs
and benefits of the Proposal pursuant to the five considerations
identified in Section 15(a) of the Act as follows:
(a) Protection of Market Participants and the Public
As previously noted, if the Commission is no longer required to
administer the direct, read-only access to depository accounts, the
Commission would eliminate the potential cybersecurity risk associated
with the maintenance of access credentials and authentication devices,
thus limiting risk for market participants and the public.
The Commission further notes that the CME's and NFA's automated
daily segregation confirmation system provides an efficient and
effective method for verifying customer accounts balances, which, in
conjunction with the Commission's right to request information from the
depositories, would ensure an adequate degree of protection for market
participants and the public.
(b) Efficiency, Competitiveness, and Financial Integrity of Markets
By eliminating the Read-only Access Provisions, the Commission
would dispense with a method for verifying account balance information
that imposes technological challenges in its implementation and
administration, allowing for Commission staff to direct its efforts to
more effective alternative means for verifying the information.
In addition, as noted, the elimination of the requirement to
provide the Commission with direct, read-only access to accounts
maintained by FCMs would reduce costs for depositories, which may
motivate them to more readily take FCM Customer Funds on deposit,
potentially fostering competition in the futures market and ultimately
reducing costs for FCMs.
(c) Price Discovery
The Proposal, by eliminating the requirement for depositories to
provide the Commission with read-only access to accounts maintained by
FCMs, may reduce operational costs for depositories, which may
ultimately lead to cost reductions that benefit both depositories and
FCMs. The FCMs may, in turn, pass those benefits to customers via
reduced charges.
(d) Sound Risk Management
As previously noted, CME and NFA have developed a sophisticated
system--the automated daily segregation confirmation system--which
provides DSROs and the Commission with an efficient tool for detection
of potential discrepancies between FCMs' reports and the balances on
deposit at various depositories. If the Commission proceeds with the
proposed amendment to delete the Read-only Access Provisions, the
Commission would continue to rely on CME's and NFA's automated system
for
[[Page 81273]]
oversight purposes. As such, the Commission believes that the proposed
amendment would not be detrimental to sound risk management practices.
Furthermore, as noted above, the deletion of the Read-only Access
Provisions would eliminate a potential cybersecurity risk associated
with the maintenance by the Commission of periodically updated access
credentials and physical authentication devices, thus promoting sound
risk management.
(e) Other Public Interest Considerations
The Commission believes that the relevant cost-benefit
considerations are captured in the four factors above.
Request for Comments on Cost-Benefit Considerations
The Commission invites public comment on its cost-benefit
considerations, including the Section 15(a) factors described above.
Commenters are also invited to submit any data or other information
they may have quantifying or qualifying the costs and benefits of the
proposed amendments. In particular, the Commission seeks specific
comment on the following:
1. Has the Commission accurately identified all the benefits of
this Proposal? Are there other benefits to the Commission, market
participants, and/or the public that may result from the adoption of
this Proposal that the Commission should consider? Please provide
specific examples and explanations of any such benefits.
2. Has the Commission accurately identified all the costs of this
Proposal? Are there additional costs to the Commission, market
participants and/or the public that may result from the adoption of
this Proposal that the Commission should consider? Please provide
specific examples and explanations of any such costs.
3. Are the regulatory safeguards that are included in the Proposal
adequate to address the potential risks that may arise from the
Proposal? Are there other regulatory safeguards that the Commission
should consider?
4. Does this Proposal impact the Section 15(a) factors in any way
that is not described above? Please provide specific examples and
explanations of any such impact.
D. Antitrust Laws
Section 15(b) of the Act 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 this Act, in issuing any order or adopting any Commission
rule or regulation (including any exemption under Section 4(c) or
4c(b)), or in requiring or approving any bylaw, rule or regulation of a
contract market or registered futures association established pursuant
to Section 17 of this Act.'' \320\
---------------------------------------------------------------------------
\320\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------
The Commission believes that the public interest to be protected by
the antitrust laws is generally to protect competition. The Commission
requests comment on whether the Proposal implicates any other specific
public interest to be protected by the antitrust laws.
The Commission has considered the Proposal to determine whether it
is anticompetitive, and has preliminarily identified no anticompetitive
effects. The Commission requests comment on whether the Proposal is
anticompetitive and, if it is, what the anticompetitive effects are.
Because the Commission has preliminarily determined that the
Proposal is not anticompetitive and has no anticompetitive
effects,\321\ the Commission has not identified any less competitive
means of achieving the purposes of the Act. The Commission requests
comment on whether there are less anticompetitive means of achieving
the relevant purposes of the Act that would otherwise be served by
adopting the proposed amendments.
---------------------------------------------------------------------------
\321\ In this regard, the Commission has considered whether the
proposed concentration limits might have an anti-competitive effect.
The Commission is preliminarily of the view that, on balance,
issuer-based concentration limits enhance competition by preventing
any one MMF or ETF from having too great market power, and thereby
fostering competition. Although the asset-based concentration limits
might theoretically have an anti-competitive impact, the limits are
set at a relatively high level and therefore the Commission
preliminarily believes that they are unlikely to have a significant
market impact. The Commission invites comments on this analysis.
---------------------------------------------------------------------------
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.
For the reasons stated 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).
Sec. 1.20 [Amended]
0
2. Amend Sec. 1.20 by:
0
a. Revising in paragraph (d)(2), the cross-reference to ``appendix A to
this part'' to read ``Appendix C to this part'';
0
b. Removing and reserving paragraph (d)(3);
0
c. Revising in paragraph (g)(4)(ii), the cross-reference to ``appendix
B to this part'' to read ``Appendix D to this part'';
0
d. Redesignating Appendix A to Sec. 1.20 as Appendix C to Part 1; and
0
e. Redesignating Appendix B to Sec. 1.20 as Appendix D to Part 1.
0
3. Amend Sec. 1.25 by:
0
a. Republishing paragraph (a) heading and the introductory text of
paragraph (a)(1);
0
b. Removing paragraphs (a)(1)(v) and (vi);
0
c. Redesignating paragraph (a)(1)(vii) as paragraph (a)(1)(v);
0
d. Revising newly redesignated paragraph (a)(1)(v);
0
e. Adding new paragraphs (a)(1)(vi) and (a)(1)(vii);
0
f. Republishing the introductory text of paragraph (b) and the
paragraph (b)(2) heading;
0
g. Revising paragraph (b)(2)(i) introductory text;
0
h. Republishing paragraph (b)(2)(iv)(A);
0
i. Revising paragraphs (b)(2)(iv)(A)(1) and (2);
0
j. Removing paragraph (b)(2)(vi);
0
k. Republishing paragraph (b)(3) heading;
0
l. Revising paragraphs (b)(3)(i)(C) and (E);
0
m. Removing paragraph (b)(3)(i)(F);
0
n. Redesignating paragraph (b)(3)(i)(G) as (b)(3)(i)(F);
0
o. Revising newly redesignated paragraph (b)(3)(i)(F), paragraphs
(b)(3)(ii)(B) through (E) and (b)(4)(i), paragraph (c) introductory
text, paragraph (c)(1), and paragraph (c)(5)(ii) introductory text;
0
p. Revising in paragraph (c)(7), the cross-reference to ``The appendix
to this section'' to read ``Appendix E to this part'';
0
q. Adding paragraph (c)(8);
0
r. Republishing the introductory text of paragraph (d);
0
s. Revising paragraphs (d)(2) and (d)(7);
[[Page 81274]]
0
t. Adding paragraph (f); and
0
u. Redesignating the Appendix to Sec. 1.25 as Appendix E to Part 1.
The republications, revisions, and additions read as follows:
Sec. 1.25 Investment of customer funds.
(a) Permitted investments. (1) Subject to the terms and conditions
set forth in this section, a futures commission merchant or a
derivatives clearing organization may invest customer money in the
following instruments (permitted investments):
* * * * *
(v) Interests in government money market funds as defined in Sec.
270.2a-7 of this title, provided that the government money market funds
do not choose to rely on the ability to impose discretionary liquidity
fees consistent with the requirements of Sec. 270.2a-7(c)(2)(i) of
this title (government money market fund);
(vi) Interests in exchange-traded funds, as defined in Sec.
270.6c-11 of this title, which seek to replicate the performance of a
published short-term U.S. Treasury security index composed of bonds,
notes, and bills with a remaining maturity of 12 months or less, issued
by, or unconditionally guaranteed as to the timely payment of principal
and interest by, the U.S. Department of the Treasury (U.S. Treasury
exchange-traded fund); and
(vii) General obligations of Canada, France, Germany, Japan, and
the United Kingdom (permitted foreign sovereign debt), subject to the
following:
(A) A futures commission merchant may invest in the permitted
foreign sovereign debt of a country to the extent it has balances in
segregated accounts owed to its customers denominated in that country's
currency; and
(B) A derivatives clearing organization may invest in the permitted
foreign sovereign debt of a country to the extent it has balances in
segregated accounts owed to its clearing members that are futures
commission merchants denominated in that country's currency.
* * * * *
(b) General terms and conditions. A futures commission merchant or
a derivatives clearing organization is required to manage the permitted
investments consistent with the objectives of preserving principal and
maintaining liquidity and according to the following specific
requirements:
* * * * *
(2) Restrictions on instrument features. (i) With the exception of
government money market funds and U.S. Treasury exchange-traded funds,
no permitted investment may contain an embedded derivative of any kind,
except as follows:
* * * * *
(iv)(A) Adjustable rate securities are permitted, subject to the
following requirements:
(1) The interest payments on variable rate securities must
correlate closely and on an unleveraged basis to a benchmark of either
the Federal Funds target or effective rate, the prime rate, the three-
month Treasury Bill rate, the Secured Overnight Financing Rate, or the
interest rate of any fixed rate instrument that is a permitted
investment listed in paragraph (a)(1) of this section;
(2) The interest payment, in any period, on floating rate
securities must be determined solely by reference, on an unleveraged
basis, to a benchmark of either the Federal Funds target or effective
rate, the prime rate, the three-month Treasury Bill rate, the Secured
Overnight Financing Rate, or the interest rate of any fixed rate
instrument that is a permitted investment listed in paragraph (a)(1) of
this section;
* * * * *
(3) Concentration--
(i) * * *
(C) Investments in certificates of deposit may not exceed 25
percent of the total assets held in segregation by the futures
commission merchant or derivatives clearing organization.
* * * * *
(E) Investments in government money market funds or U.S. Treasury
exchange-traded funds with $1 billion or more in assets and whose
management company manages $25 billion or more in assets may not exceed
50 percent of the total assets held in segregation by the futures
commission merchant or derivatives clearing organization.
(F) Investments in government money market funds or U.S. Treasury
exchange-traded funds with less than $1 billion in assets or which have
a management company managing less than $25 billion in assets, may not
exceed 10 percent of the total assets held in segregation by the
futures commission merchant or derivatives clearing organization.
(ii) * * *
(B) Securities of any single issuer of municipal securities or
certificates of deposit held by a futures commission merchant or
derivatives clearing organization may not exceed 5 percent of the total
assets held in segregation by the futures commission merchant or
derivatives clearing organization.
(C) Interests in any single family of government money market funds
or U.S. Treasury exchange-traded funds may not exceed 25 percent of the
total assets held in segregation by the futures commission merchant or
derivatives clearing organization.
(D) Interests in any individual government money market fund or
U.S. Treasury exchange-traded fund may not exceed 5 percent of the
total assets held in segregation by the futures commission merchant or
derivatives clearing organization.
(E) For purposes of determining compliance with the issuer-based
concentration limits set forth in this section, securities issued by
entities that are affiliated, as defined in paragraph (b)(5) of this
section, shall be aggregated and deemed the securities of a single
issuer. An interest in a permitted government money market fund or U.S.
Treasury exchange-traded fund is not deemed to be a security issued by
its sponsoring entity.
* * * * *
(4) Time-to-maturity. (i) Except for investments in government
money market funds, U.S. Treasury exchange-traded funds, and permitted
foreign sovereign debt subject to the requirements of paragraph (f) of
this section, the dollar-weighted average of the time-to-maturity of
the portfolio, as that average is computed pursuant to Sec. 270.2a-7
of this title, may not exceed 24 months.
* * * * *
(c) Government money market funds and U.S. Treasury exchange-traded
funds. The following provisions will apply to the investment of
customer funds in government money market funds or U.S. Treasury
exchange-traded funds (the fund).
(1) The fund must be an investment company that is registered under
the Investment Company Act of 1940 with the Securities and Exchange
Commission and that holds itself out to investors as a government money
market fund, in accordance with Sec. 270.2a-7 of this title, or an
exchange-traded fund, in accordance with Sec. 270.6c-11 of this title.
* * * * *
(5) * * *
(ii) Exception. A government money market fund may provide for the
postponement of redemption and payment due to any of the following
circumstances:
* * * * *
(8) Interests in U.S. Treasury exchange-traded funds will qualify
as permitted investments under paragraph (a) of this section if:
(i) The interests are redeemable in cash by a futures commission
merchant
[[Page 81275]]
or a derivatives clearing organization in its capacity of an authorized
participant pursuant to an authorized participant agreement, as defined
in Sec. 270.6c-11 of this title, at a price based on the net asset
value in accordance with the Investment Company Act of 1940 and
regulations thereunder, and on a delivery versus payment basis;
(ii) The U.S. Treasury exchange-traded fund invests at least 95
percent of its assets in securities comprising the short-term U.S.
Treasury index whose performance the fund seeks to replicate; and
(iii) The interests are acceptable as performance bond by a
derivatives clearing organization.
(d) Repurchase and reverse repurchase agreements. A futures
commission merchant or derivatives clearing organization may buy and
sell the permitted investments listed in paragraphs (a)(1)(i) through
(vii) of this section pursuant to agreements for resale or repurchase
of the securities (agreements for repurchase or resell), provided the
agreements to repurchase or resell conform to the following
requirements:
* * * * *
(2) Permitted counterparties are limited to a bank as defined in
section 3(a)(6) of the Securities Exchange Act of 1934, a domestic
branch of a foreign bank insured by the Federal Deposit Insurance
Corporation, a securities broker or dealer, a government securities
dealer registered with the Securities and Exchange Commission or which
has filed notice pursuant to section 15C(a) of the Government
Securities Act of 1986. In addition, with respect to agreements to
repurchase or resell permitted foreign sovereign debt, the following
entities are also permitted counterparties: a foreign bank that
qualifies as a depository under Sec. 1.49(d)(3) and that is located in
a money center country as the term is defined in Sec. 1.49(a)(1) or in
another jurisdiction that has adopted the currency in which the
permitted foreign sovereign debt is denominated as its currency; a
securities broker or dealer located in a money center country as the
term is defined in Sec. 1.49(a)(1) and that is regulated by a national
financial regulator; and the Bank of Canada, the Bank of England, the
Banque de France, the Central Bank of Japan, the Deutsche Bundesbank,
or the European Central Bank.
* * * * *
(7) Securities transferred to the futures commission merchant or
derivatives clearing organization under the agreement are held in a
safekeeping account with a bank as referred to in paragraph (d)(2) of
this section, a Federal Reserve Bank, a derivatives clearing
organization, or the Depository Trust Company in an account that
complies with the requirements of Sec. 1.26. Securities transferred to
the futures commission merchant or derivatives clearing organization
under an agreement related to permitted foreign sovereign debt may also
be held in a safekeeping account that complies with the requirements of
Sec. 1.26 at a foreign bank that meets the location and qualification
requirements in Sec. 1.49(c) and (d).
* * * * *
(f) Permitted foreign sovereign debt. The following provisions will
apply to investments of customer funds in permitted foreign sovereign
debt.
(1) The dollar-weighted average of the remaining time-to-maturity
of the portfolio of investments in permitted foreign sovereign debt, as
that average is computed pursuant to Sec. 270.2a-7 of this title on a
country-by-country basis, may not exceed 60 calendar days. Permitted
foreign sovereign debt instruments acquired under an agreement to
resell shall be deemed to have a maturity equal to the period remaining
until the date on which the resale of the underlying instruments is
scheduled to occur, or, where the agreement is subject to demand, the
notice period applicable to a demand for the resale of the securities.
Permitted foreign sovereign debt instruments sold under an agreement to
repurchase shall be included in the calculation of the dollar-weighted
average based on the remaining time-to-maturity of each instrument
sold.
(2) A futures commission merchant or a derivatives clearing
organization may not invest customer funds in any permitted foreign
sovereign debt that has a remaining maturity greater than 180 calendar
days.
(3) If the two-year credit default spread of an issuing sovereign
of permitted foreign sovereign debt is greater than 45 basis points:
(i) The futures commission merchant or derivatives clearing
organization shall not make any new investments in that sovereign's
debt using customer funds.
(ii) The futures commission merchant or derivatives clearing
organization must discontinue investing customer funds in that
sovereign's debt through agreements to resell as soon as practicable
under the circumstances.
Sec. 1.26 [Amended]
0
4. Amend Sec. 1.26 by:
0
a. Redesignating Appendix A to Sec. 1.26 as Appendix F to Part 1 and
Appendix B to Sec. 1.26 as Appendix G to Part 1; and
0
b. In the table below, for each paragraph indicated in the left column,
removing the words indicated in the middle column from wherever they
appear in the paragraph, and adding the words indicated in the right
column:
----------------------------------------------------------------------------------------------------------------
Paragraph Remove Add
----------------------------------------------------------------------------------------------------------------
(a)................................ ``money market mutual ``government money market funds and U.S.
funds''. Treasury exchange-traded funds.''
(b)................................ ``the money market mutual ``the government money market fund or U.S.
fund''. Treasury exchange-traded fund.''
(b)................................ ``appendix A or B to this ``Appendix F, G, H or I to this part.''
section''.
(b)................................ ``appendix A or B to Sec. ``appendix C or D to this part.''
1.20''.
----------------------------------------------------------------------------------------------------------------
0
5. Revise newly redesignated Appendix C to part 1 to read as follows:
Appendix C to Part 1--Futures Commission Merchant Acknowledgment Letter
for CFTC Regulation 1.20 Customer Segregated Account
[Date]
[Name and Address of Bank, Trust Company, Derivatives Clearing
Organization or Futures Commission Merchant]
We refer to the Segregated Account(s) which [Name of Futures
Commission Merchant] (``we'' or ``our'') have opened or will open
with [Name of Bank, Trust Company, Derivatives Clearing Organization
or Futures Commission Merchant] (``you'' or ``your'') entitled:
[Name of Futures Commission Merchant] [if applicable, add ``FCM
Customer Omnibus Account''] CFTC Regulation Sec. 1.20 Customer
Segregated Account under Sections 4d(a) and 4d(b) of the Commodity
Exchange Act [and, if applicable, ``, Abbreviated as [short title
reflected in the depository's electronic system]'']
Account Number(s): [ ]
(collectively, the ``Account(s)'').
You acknowledge that we have opened or will open the above-
referenced Account(s) for the purpose of depositing, as applicable,
money, securities and other property
[[Page 81276]]
(collectively the ``Funds'') of customers who trade commodities,
options, swaps, and other products, as required by Commodity Futures
Trading Commission (``CFTC'') Regulations, including Regulation
Sec. 1.20, as amended; that the Funds held by you, hereafter
deposited in the Account(s) or accruing to the credit of the
Account(s), will be separately accounted for and segregated on your
books from our own funds and from any other funds or accounts held
by us in accordance with the provisions of the Commodity Exchange
Act, as amended (the ``Act''), and part 1 of the CFTC's regulations,
as amended; and that the Funds must otherwise be treated in
accordance with the provisions of Section 4d of the Act and CFTC
regulations thereunder.
Furthermore, you acknowledge and agree that such Funds may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, and they may not be used by us to secure or
obtain credit from you. You further acknowledge and agree that the
Funds in the Account(s) shall not be subject to any right of offset
or lien for or on account of any indebtedness, obligations or
liabilities we may now or in the future have owing to you. This
prohibition does not affect your right to recover funds advanced in
the form of cash transfers, lines of credit, repurchase agreements
or other similar liquidity arrangements you make in lieu of
liquidating non-cash assets held in the Account(s) or in lieu of
converting cash held in the Account(s) to cash in a different
currency.
In addition, you agree that the Account(s) may be examined at
any reasonable time by the director of the Division of Swap Dealer
and Intermediary Oversight of the CFTC or the director of the
Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent or employee of our designated self-regulatory organization
(``DSRO''), [Name of DSRO], and this letter constitutes the
authorization and direction of the undersigned on our behalf to
permit any such examination to take place without further notice to
or consent from us.
You agree to reply promptly and directly to any request for
confirmation of account balances or provision of any other
information regarding or related to the Account(s) from the director
of the Division of Swap Dealer and Intermediary Oversight of the
CFTC or the director of the Division of Clearing and Risk of the
CFTC, or any successor divisions, or such directors' designees, or
an appropriate officer, agent, or employee of [Name of DSRO], acting
in its capacity as our DSRO, and this letter constitutes the
authorization and direction of the undersigned on our behalf to
release the requested information without further notice to or
consent from us.
The parties agree that all actions on your part to respond to
the above information request will be made in accordance with, and
subject to, such usual and customary authorization verification and
authentication policies and procedures as may be employed by you to
verify the authority of, and authenticate the identity of, the
individual making any such information request, in order to provide
for the secure transmission and delivery of the requested
information to the appropriate recipient(s). We will not hold you
responsible for acting pursuant to any information request from the
director of the Division of Swap Dealer and Intermediary Oversight
of the CFTC or the director of the Division of Clearing and Risk of
the CFTC, or any successor divisions, or such directors' designees,
or an appropriate officer, agent, or employee of [Name of DSRO],
acting in its capacity as our DSRO, upon which you have relied after
having taken measures in accordance with your applicable policies
and procedures to assure that such request was provided to you by an
individual authorized to make such a request.
In the event that we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Funds
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of offset or lien on assets that are not Funds
maintained in the Account(s), or to impose such charges against us
or any proprietary account maintained by us with you. Further, it is
understood that amounts represented by checks, drafts or other items
shall not be considered to be part of the Account(s) until finally
collected. Accordingly, checks, drafts and other items credited to
the Account(s) and subsequently dishonored or otherwise returned to
you or reversed, for any reason, and any claims relating thereto,
including but not limited to claims of alteration or forgery, may be
charged back to the Account(s), and we shall be responsible to you
as a general endorser of all such items whether or not actually so
endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that, in the ordinary course of your business as a
depository, you have no notice of or actual knowledge of a potential
violation by us of any provision of the Act or the CFTC regulations
that relates to the segregation of customer funds; and you shall not
in any manner not expressly agreed to herein be responsible to us
for ensuring compliance by us with such provisions of the Act and
CFTC regulations; however, the aforementioned presumption does not
affect any obligation you may otherwise have under the Act or CFTC
regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any action or omission to act
pursuant to any such order, judgment, decree or levy, to us or to
any other person, firm, association or corporation even if
thereafter any such order, decree, judgment or levy shall be
reversed, modified, set aside or vacated.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns and, for the avoidance of
doubt, regardless of a change in the name of either party. This
letter agreement supersedes and replaces any prior agreement between
the parties in connection with the Account(s), including but not
limited to any prior acknowledgment letter agreement, to the extent
that such prior agreement is inconsistent with the terms hereof. In
the event of any conflict between this letter agreement and any
other agreement between the parties in connection with the
Account(s), this letter agreement shall govern with respect to
matters specific to Section 4d of the Act and the CFTC's regulations
thereunder, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning to us the
enclosed copy of this letter agreement, and that you further agree
to provide a copy of this fully executed letter agreement directly
to the CFTC (via electronic means in a format and manner determined
by the CFTC) and to [Name of DSRO], acting in its capacity as our
DSRO. We hereby authorize and direct you to provide such copies
without further notice to or consent from us, no later than three
business days after opening the Account(s) or revising this letter
agreement, as applicable.
[Name of Futures Commission Merchant]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Bank, Trust Company, Derivatives Clearing Organization or
Futures Commission Merchant]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
DATE:
0
6. Revise the heading of newly redesignated Appendix E to part 1 to
read as follows:
Appendix E to Part 1--Government Money Market Fund Prospectus
Provisions Acceptable for Compliance With Sec. 1.25(c)(5)
* * * * *
0
7. Revise newly redesignated Appendix F to part 1 to read as follows:
Appendix F to Part 1--Futures Commission Merchant Acknowledgment Letter
for CFTC Regulation Sec. 1.26 Customer Segregated Government Money
Market Fund Account
[Date]
[Name and Address of Government Money Market Fund]
We propose to invest funds held by [Name of Futures Commission
Merchant] (``we'' or
[[Page 81277]]
``our'') on behalf of our customers in shares of [Name of Government
Money Market Fund] (``you'' or ``your'') under account(s) entitled
(or shares issued to):
[Name of Futures Commission Merchant] [if applicable, add ``FCM
Customer Omnibus Account''] CFTC Regulation Sec. 1.26 Customer
Segregated Government Money Market Fund Account under Sections 4d(a)
and 4d(b) of the Commodity Exchange Act [and, if applicable, ``,
Abbreviated as [short title reflected in the depository's electronic
system]'']
Account Number(s): [ ]
(collectively, the ``Account(s)'').
You acknowledge that we are holding these funds, including any
shares issued and amounts accruing in connection therewith
(collectively, the ``Shares''), for the benefit of customers who
trade commodities, options, swaps and other products (``Commodity
Customers''), as required by Commodity Futures Trading Commission
(``CFTC'') Regulation Sec. 1.26, as amended; that the Shares held
by you, hereafter deposited in the Account(s) or accruing to the
credit of the Account(s), will be separately accounted for and
segregated on your books from our own funds and from any other funds
or accounts held by us in accordance with the provisions of the
Commodity Exchange Act, as amended (the ``Act''), and part 1 of the
CFTC's regulations, as amended; and that the Shares must otherwise
be treated in accordance with the provisions of Section 4d of the
Act and CFTC regulations thereunder.
Furthermore, you acknowledge and agree that such Shares may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, and they may not be used by us to secure or
obtain credit from you. You further acknowledge and agree that the
Shares in the Account(s) shall not be subject to any right of offset
or lien for or on account of any indebtedness, obligations or
liabilities we may now or in the future have owing to you.
In addition, you agree that the Account(s) may be examined at
any reasonable time by the director of the Division of Swap Dealer
and Intermediary Oversight of the CFTC or the director of the
Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent or employee of our designated self-regulatory organization
(``DSRO''), [Name of DSRO], and this letter constitutes the
authorization and direction of the undersigned on our behalf to
permit any such examination to take place without further notice to
or consent from us.
You agree to reply promptly and directly to any request for
confirmation of account balances or provision of any other account
information regarding or related to the Account(s) from the director
of the Division of Swap Dealer and Intermediary Oversight of the
CFTC or the director of the Division of Clearing and Risk of the
CFTC, or any successor divisions, or such directors' designees, or
an appropriate officer, agent, or employee of [Name of DSRO], acting
in its capacity as our DSRO, and this letter constitutes the
authorization and direction of the undersigned on our behalf to
release the requested information without further notice to or
consent from us.
The parties agree that all actions on your part to respond to
the above information request will be made in accordance with, and
subject to, such usual and customary authorization verification and
authentication policies and procedures as may be employed by you to
verify the authority of, and authenticate the identity of, the
individual making any such information request, in order to provide
for the secure transmission and delivery of the requested
information to the appropriate recipient(s).
We will not hold you responsible for acting pursuant to any
information request from the director of the Division of Swap Dealer
and Intermediary Oversight of the CFTC or the director of the
Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent, or employee of [Name of DSRO], acting in its capacity as our
DSRO, upon which you have relied after having taken measures in
accordance with your applicable policies and procedures to assure
that such request was provided to you by an individual authorized to
make such a request.
In the event we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Shares
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of offset or lien on assets that are not Shares
maintained in the Account(s), or to impose such charges against us
or any proprietary account maintained by us with you. Further, it is
understood that amounts represented by checks, drafts or other items
shall not be considered to be part of the Account(s) until finally
collected. Accordingly, checks, drafts and other items credited to
the Account(s) and subsequently dishonored or otherwise returned to
you or reversed, for any reason and any claims relating thereto,
including but not limited to claims of alteration or forgery, may be
charged back to the Account(s), and we shall be responsible to you
as a general endorser of all such items whether or not actually so
endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that, in the ordinary course of your business as a
depository, you have no notice of or actual knowledge of a potential
violation by us of any provision of the Act or the CFTC regulations
that relates to the segregation of customer funds; and you shall not
in any manner not expressly agreed to herein be responsible to us
for ensuring compliance by us with such provisions of the Act and
CFTC regulations; however, the aforementioned presumption does not
affect any obligation you may otherwise have under the Act or CFTC
regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any action or omission to act
pursuant to such order, judgment, decree or levy, to us or to any
other person, firm, association or corporation even if thereafter
any such order, decree, judgment or levy shall be reversed,
modified, set aside or vacated.
We are permitted to invest customers' funds in government money
market funds pursuant to CFTC Regulation Sec. 1.25. That rule sets
forth the following conditions, among others, with respect to any
investment in a government money market fund:
(1) The net asset value of the fund must be computed by 9:00
a.m. of the business day following each business day and be made
available to us by that time;
(2) The fund must be legally obligated to redeem an interest in
the fund and make payment in satisfaction thereof by the close of
the business day following the day on which we make a redemption
request except as otherwise specified in CFTC Regulation Sec.
1.25(c)(5)(ii); and,
(3) The agreement under which we invest customers' funds must
not contain any provision that would prevent us from pledging or
transferring fund shares.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns, and for the avoidance of
doubt, regardless of a change in the name of either party. This
letter agreement supersedes and replaces any prior agreement between
the parties in connection with the Account(s), including but not
limited to any prior acknowledgment letter agreement, to the extent
that such prior agreement is inconsistent with the terms hereof. In
the event of any conflict between this letter agreement and any
other agreement between the parties in connection with the
Account(s), this letter agreement shall govern with respect to
matters specific to Section 4d of the Act and the CFTC's regulations
thereunder, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning to us the
enclosed copy of this letter agreement, and that you further agree
to provide a copy of this fully executed letter agreement directly
to the CFTC (via electronic means in a format and manner determined
by the CFTC) and to [Name of DSRO], acting in its capacity as our
DSRO, in accordance with CFTC Regulation Sec. 1.20. We hereby
authorize and direct you to provide such copies without further
notice to or consent from us, no later than three business days
after opening the Account(s) or revising this letter agreement, as
applicable.
[Name of Futures Commission Merchant]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Government Money Market Fund]
By:
[[Page 81278]]
Print Name:
Title:
Contact Information: [Insert phone number and email address]
Date:
0
8. Revise newly redesignated Appendix G to part 1 to read as follows:
Appendix G to Part 1--Derivatives Clearing Organization Acknowledgment
Letter for CFTC Regulation Sec. 1.26 Customer Segregated Government
Money Market Fund Account
[Date]
[Name and Address of Government Money Market Fund]
We propose to invest funds held by [Name of Derivatives Clearing
Organization] (``we'' or ``our'') on behalf of customers in shares
of [Name of Government Money Market Fund] (``you'' or ``your'')
under account(s) entitled (or shares issued to):
[Name of Derivatives Clearing Organization] Futures Customer
Omnibus Account, CFTC Regulation Sec. 1.26 Customer Segregated
Government Money Market Fund Account under Sections 4d(a) and 4d(b)
of the Commodity Exchange Act [and, if applicable, ``, Abbreviated
as [short title reflected in the depository's electronic system]'']
Account Number(s): [ ]
(collectively, the ``Account(s)'').
You acknowledge that we are holding these funds, including any
shares issued and amounts accruing in connection therewith
(collectively, the ``Shares''), for the benefit of customers who
trade commodities, options, swaps and other products, as required by
Commodity Futures Trading Commission (``CFTC'') Regulation Sec.
1.26, as amended; that the Shares held by you, hereafter deposited
in the Account(s) or accruing to the credit of the Account(s), will
be separately accounted for and segregated on your books from our
own funds and from any other funds or accounts held by us in
accordance with the provisions of the Commodity Exchange Act, as
amended (the ``Act''), and part 1 of the CFTC's regulations, as
amended; and that the Shares must otherwise be treated in accordance
with the provisions of Section 4d of the Act and CFTC regulations
thereunder.
Furthermore, you acknowledge and agree that such Shares may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, and they may not be used by us to secure or
obtain credit from you. You further acknowledge and agree that the
Shares in the Account(s) shall not be subject to any right of offset
or lien for or on account of any indebtedness, obligations or
liabilities we may now or in the future have owing to you.
You agree to reply promptly and directly to any request for
confirmation of account balances or provision of any other
information regarding or related to the Account(s) from the director
of the Division of Clearing and Risk of the CFTC or the director of
the Division of Swap Dealer and Intermediary Oversight of the CFTC,
or any successor divisions, or such directors' designees, and this
letter constitutes the authorization and direction of the
undersigned on our behalf to release the requested information
without further notice to or consent from us.
The parties agree that all actions on your part to respond to
the above information requests will be made in accordance with, and
subject to, such usual and customary authorization verification and
authentication policies and procedures as may be employed by you to
verify the authority of, and authenticate the identity of, the
individual making any such information request, in order to provide
for the secure transmission and delivery of the requested
information to the appropriate recipient(s).
We will not hold you responsible for acting pursuant to any
information request from the director of the Division of Clearing
and Risk of the CFTC or the director of the Division of Swap Dealer
and Intermediary Oversight of the CFTC, or any successor divisions,
or such directors' designees, upon which you have relied after
having taken measures in accordance with your applicable policies
and procedures to assure that such request was provided to you by an
individual authorized to make such a request.
In the event that we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Shares
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of offset or lien on assets that are not Shares
maintained in the Account(s), or to impose such charges against us
or any proprietary account maintained by us with you. Further, it is
understood that amounts represented by checks, drafts or other items
shall not be considered to be part of the Account(s) until finally
collected. Accordingly, checks, drafts and other items credited to
the Account(s) and subsequently dishonored or otherwise returned to
you or reversed, for any reason, and any claims relating thereto,
including but not limited to claims of alteration or forgery, may be
charged back to the Account(s), and we shall be responsible to you
as a general endorser of all such items whether or not actually so
endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that, in the ordinary course of your business as a
depository, you have no notice of or actual knowledge of a potential
violation by us of any provision of the Act or the CFTC regulations
that relates to the segregation of customer funds; and you shall not
in any manner not expressly agreed to herein be responsible to us
for ensuring compliance by us with such provisions of the Act and
CFTC regulations; however, the aforementioned presumption does not
affect any obligation you may otherwise have under the Act or CFTC
regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any action or omission to act
pursuant to any such order, judgment, decree or levy, to us or to
any other person, firm, association or corporation even if
thereafter any such order, decree, judgment or levy shall be
reversed, modified, set aside or vacated.
We are permitted to invest customers' funds in government money
market funds pursuant to CFTC Regulation Sec. 1.25. That rule sets
forth the following conditions, among others, with respect to any
investment in a government money market fund:
(1) The net asset value of the fund must be computed by 9:00
a.m. of the business day following each business day and be made
available to us by that time;
(2) The fund must be legally obligated to redeem an interest in
the fund and make payment in satisfaction thereof by the close of
the business day following the day on which we make a redemption
request except as otherwise specified in CFTC Regulation Sec.
1.25(c)(5)(ii); and,
(3) The agreement under which we invest customers' funds must
not contain any provision that would prevent us from pledging or
transferring fund shares.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns and, for the avoidance of
doubt, regardless of a change in the name of either party. This
letter agreement supersedes and replaces any prior agreement between
the parties in connection with the Account(s), including but not
limited to any prior acknowledgment letter agreement, to the extent
that such prior agreement is inconsistent with the terms hereof. In
the event of any conflict between this letter agreement and any
other agreement between the parties in connection with the
Account(s), this letter agreement shall govern with respect to
matters specific to Section 4d of the Act and the CFTC's regulations
thereunder, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning to us the
enclosed copy of this letter agreement, and that you further agree
to provide a copy of this fully executed letter agreement directly
to the CFTC (via electronic means in a format and manner determined
by the CFTC) in accordance with CFTC Regulation Sec. 1.20. We
hereby authorize and direct you to provide such copy without further
notice to or consent from us, no later than three business days
after opening the Account(s) or revising this letter agreement, as
applicable.
[Name of Derivatives Clearing Organization]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Government Money Market Fund]
By:
Print Name:
[[Page 81279]]
Title:
Contact Information: [Insert phone number and email address]
DATE:
0
9. Add Appendix H to part 1 to read as follows:
Appendix H to Part 1--Futures Commission Merchant Acknowledgment Letter
for CFTC Regulation Sec. 1.26 Customer Segregated U.S. Treasury
Exchange-Traded Fund Account
[Date]
[Name and Address of U.S. Treasury Exchange-Traded Fund]
We propose to invest funds held by [Name of Futures Commission
Merchant] (``we'' or ``our'') on behalf of our customers in shares
of [Name of U.S. Treasury Exchange-Traded Fund] (``you'' or
``your'') under account(s) entitled (or shares issued to):
[Name of Futures Commission Merchant] [if applicable, add ``FCM
Customer Omnibus Account''] CFTC Regulation Sec. 1.26 Customer
Segregated U.S. Treasury Exchange-Traded Fund Account under Sections
4d(a) and 4d(b) of the Commodity Exchange Act [and, if applicable,
``, Abbreviated as [short title reflected in the depository's
electronic system]'']
Account Number(s): [ ]
(collectively, the ``Account(s)'').
You acknowledge that we are holding these funds, including any
shares issued and amounts accruing in connection therewith
(collectively, the ``Shares''), for the benefit of customers who
trade commodities, options, swaps and other products (``Commodity
Customers''), as required by Commodity Futures Trading Commission
(``CFTC'') Regulation Sec. 1.26, as amended; that the Shares held
by you, hereafter deposited in the Account(s) or accruing to the
credit of the Account(s), will be separately accounted for and
segregated on your books from our own funds and from any other funds
or accounts held by us in accordance with the provisions of the
Commodity Exchange Act, as amended (the ``Act''), and part 1 of the
CFTC's regulations, as amended; and that the Shares must otherwise
be treated in accordance with the provisions of Section 4d of the
Act and CFTC regulations thereunder.
Furthermore, you acknowledge and agree that such Shares may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, and they may not be used by us to secure or
obtain credit from you. You further acknowledge and agree that the
Shares in the Account(s) shall not be subject to any right of offset
or lien for or on account of any indebtedness, obligations or
liabilities we may now or in the future have owing to you.
In addition, you agree that the Account(s) may be examined at
any reasonable time by the Director of the Market Participants
Division of the CFTC or the Director of the Division of Clearing and
Risk of the CFTC, or any successor divisions, or such Directors'
designees, or an appropriate officer, agent or employee of our
designated self-regulatory organization (``DSRO''), [Name of DSRO],
and this letter constitutes the authorization and direction of the
undersigned on our behalf to permit any such examination to take
place without further notice to or consent from us.
You agree to reply promptly and directly to any request for
confirmation of account balances or provision of any other account
information regarding or related to the Account(s) from the Director
of the Market Participants Division of the CFTC or the Director of
the Division of Clearing and Risk of the CFTC, or any successor
divisions, or such Directors' designees, or an appropriate officer,
agent, or employee of [Name of DSRO], acting in its capacity as our
DSRO, and this letter constitutes the authorization and direction of
the undersigned on our behalf to release the requested information
without further notice to or consent from us.
The parties agree that all actions on your part to respond to
the above information request will be made in accordance with, and
subject to, such usual and customary authorization verification and
authentication policies and procedures as may be employed by you to
verify the authority of, and authenticate the identity of, the
individual making any such information request, in order to provide
for the secure transmission and delivery of the requested
information to the appropriate recipient(s).
We will not hold you responsible for acting pursuant to any
information request from the Director of the Market Participants
Division of the CFTC or the Director of the Division of Clearing and
Risk of the CFTC, or any successor divisions, or such Directors'
designees, or an appropriate officer, agent, or employee of [Name of
DSRO], acting in its capacity as our DSRO, upon which you have
relied after having taken measures in accordance with your
applicable policies and procedures to assure that such request was
provided to you by an individual authorized to make such a request.
In the event we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Shares
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of offset or lien on assets that are not Shares
maintained in the Account(s), or to impose such charges against us
or any proprietary account maintained by us with you. Further, it is
understood that amounts represented by checks, drafts or other items
shall not be considered to be part of the Account(s) until finally
collected. Accordingly, checks, drafts and other items credited to
the Account(s) and subsequently dishonored or otherwise returned to
you or reversed, for any reason and any claims relating thereto,
including but not limited to claims of alteration or forgery, may be
charged back to the Account(s), and we shall be responsible to you
as a general endorser of all such items whether or not actually so
endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that, in the ordinary course of your business as a
depository, you have no notice of or actual knowledge of a potential
violation by us of any provision of the Act or the CFTC regulations
that relates to the segregation of customer funds; and you shall not
in any manner not expressly agreed to herein be responsible to us
for ensuring compliance by us with such provisions of the Act and
CFTC regulations; however, the aforementioned presumption does not
affect any obligation you may otherwise have under the Act or CFTC
regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any action or omission to act
pursuant to such order, judgment, decree or levy, to us or to any
other person, firm, association or corporation even if thereafter
any such order, decree, judgment or levy shall be reversed,
modified, set aside or vacated.
We are permitted to invest customers' funds in U.S. Treasury
exchange-traded funds pursuant to CFTC Regulation Sec. 1.25. That
rule sets forth the following conditions, among others, with respect
to any investment in a U.S. Treasury exchange-traded fund:
(1) To qualify as a permitted investment, interests in U.S.
Treasury exchange-traded must be redeemable in cash by a futures
commission merchant or derivatives clearing organization in its
capacity as an authorized participant pursuant to an authorized
participant agreement, as defined in Sec. 270.6c-11 of Title 17 of
the Code of Federal Regulations, at a price based on the net asset
value in accordance with the Investment Company Act of 1940 and
regulations thereunder, and on a delivery versus payment basis;
(2) The fund must be legally obligated to redeem an interest in
the fund and make payment in satisfaction thereof by the close of
the business day following the day on which we make a redemption
request; and,
(3) The agreement under which we invest customers' funds must
not contain any provision that would prevent us from pledging or
transferring fund shares.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns, and for the avoidance of
doubt, regardless of a change in the name of either party. This
letter agreement supersedes and replaces any prior agreement between
the parties in connection with the Account(s), including but not
limited to any prior acknowledgment letter agreement, to the extent
that such prior agreement is inconsistent with the terms hereof. In
the event of any conflict between this letter agreement and any
other agreement between the parties in connection with the
Account(s), this letter agreement shall govern with respect to
matters specific to Section 4d of the Act and the CFTC's regulations
thereunder, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws
[[Page 81280]]
of [Insert governing law] without regard to the principles of choice
of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning to us the
enclosed copy of this letter agreement, and that you further agree
to provide a copy of this fully executed letter agreement directly
to the CFTC (via electronic means in a format and manner determined
by the CFTC) and to [Name of DSRO], acting in its capacity as our
DSRO, in accordance with CFTC Regulation Sec. 1.20. We hereby
authorize and direct you to provide such copies without further
notice to or consent from us, no later than three business days
after opening the Account(s) or revising this letter agreement, as
applicable.
[Name of Futures Commission Merchant]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of U.S. Treasury Exchange-Traded Fund]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
Date:
0
10. Add Appendix I to part 1 to read as follows:
Appendix I to Part 1--Derivatives Clearing Organization Acknowledgment
Letter for CFTC Regulation Sec. 1.26 Customer Segregated U.S. Treasury
Exchange-Traded Fund Account
[Date]
[Name and Address of U.S. Treasury Exchange-Traded Fund]
We propose to invest funds held by [Name of Derivatives Clearing
Organization] (``we'' or ``our'') on behalf of customers in shares
of [Name of U.S. Treasury Exchange-Traded Fund] (``you'' or
``your'') under account(s) entitled (or shares issued to):
[Name of Derivatives Clearing Organization] Futures Customer
Omnibus Account, CFTC Regulation Sec. 1.26 Customer Segregated U.S.
Treasury Exchange-Traded Fund Account under Sections 4d(a) and 4d(b)
of the Commodity Exchange Act [and, if applicable, ``, Abbreviated
as [short title reflected in the depository's electronic system]'']
Account Number(s): [ ]
(collectively, the ``Account(s)'').
You acknowledge that we are holding these funds, including any
shares issued and amounts accruing in connection therewith
(collectively, the ``Shares''), for the benefit of customers who
trade commodities, options, swaps and other products, as required by
Commodity Futures Trading Commission (``CFTC'') Regulation Sec.
1.26, as amended; that the Shares held by you, hereafter deposited
in the Account(s) or accruing to the credit of the Account(s), will
be separately accounted for and segregated on your books from our
own funds and from any other funds or accounts held by us in
accordance with the provisions of the Commodity Exchange Act, as
amended (the ``Act''), and part 1 of the CFTC's regulations, as
amended; and that the Shares must otherwise be treated in accordance
with the provisions of Section 4d of the Act and CFTC regulations
thereunder.
Furthermore, you acknowledge and agree that such Shares may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, and they may not be used by us to secure or
obtain credit from you. You further acknowledge and agree that the
Shares in the Account(s) shall not be subject to any right of offset
or lien for or on account of any indebtedness, obligations or
liabilities we may now or in the future have owing to you.
You agree to reply promptly and directly to any request for
confirmation of account balances or provision of any other
information regarding or related to the Account(s) from the Director
of the Division of Clearing and Risk of the CFTC or the Director of
the Market Participants Division of the CFTC, or any successor
divisions, or such Directors' designees, and this letter constitutes
the authorization and direction of the undersigned on our behalf to
release the requested information without further notice to or
consent from us.
The parties agree that all actions on your part to respond to
the above information requests will be made in accordance with, and
subject to, such usual and customary authorization verification and
authentication policies and procedures as may be employed by you to
verify the authority of, and authenticate the identity of, the
individual making any such information request, in order to provide
for the secure transmission and delivery of the requested
information to the appropriate recipient(s).
We will not hold you responsible for acting pursuant to any
information request from the Director of the Division of Clearing
and Risk of the CFTC or the Director of the Market Participants
Division of the CFTC, or any successor divisions, or such Directors'
designees, upon which you have relied after having taken measures in
accordance with your applicable policies and procedures to assure
that such request was provided to you by an individual authorized to
make such a request.
In the event that we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Shares
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of offset or lien on assets that are not Shares
maintained in the Account(s), or to impose such charges against us
or any proprietary account maintained by us with you. Further, it is
understood that amounts represented by checks, drafts or other items
shall not be considered to be part of the Account(s) until finally
collected. Accordingly, checks, drafts and other items credited to
the Account(s) and subsequently dishonored or otherwise returned to
you or reversed, for any reason, and any claims relating thereto,
including but not limited to claims of alteration or forgery, may be
charged back to the Account(s), and we shall be responsible to you
as a general endorser of all such items whether or not actually so
endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that, in the ordinary course of your business as a
depository, you have no notice of or actual knowledge of a potential
violation by us of any provision of the Act or the CFTC regulations
that relates to the segregation of customer funds; and you shall not
in any manner not expressly agreed to herein be responsible to us
for ensuring compliance by us with such provisions of the Act and
CFTC regulations; however, the aforementioned presumption does not
affect any obligation you may otherwise have under the Act or CFTC
regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any action or omission to act
pursuant to any such order, judgment, decree or levy, to us or to
any other person, firm, association or corporation even if
thereafter any such order, decree, judgment or levy shall be
reversed, modified, set aside or vacated.
We are permitted to invest customers' funds in U.S. Treasury
exchange-traded funds pursuant to CFTC Regulation Sec. 1.25. That
rule sets forth the following conditions, among others, with respect
to any investment in a U.S. Treasury exchange-traded fund:
(1) To qualify as a permitted investment, interests in U.S.
Treasury exchange-traded must be redeemable in cash by a futures
commission merchant or derivatives clearing organization in its
capacity as an authorized participant pursuant to an authorized
participant agreement, as defined in Sec. 270.6c-11 of Title 17 of
the Code of Federal Regulations, at a price based on the net asset
value in accordance with the Investment Company Act of 1940 and
regulations thereunder, and on a delivery versus payment basis;
(2) The fund must be legally obligated to redeem an interest in
the fund and make payment in satisfaction thereof by the close of
the business day following the day on which we make a redemption
request; and,
(3) The agreement under which we invest customers' funds must
not contain any provision that would prevent us from pledging or
transferring fund shares.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns and, for the avoidance of
doubt, regardless of a change in the name of either party. This
letter agreement supersedes and replaces any prior agreement between
the parties in connection with the Account(s), including but not
limited to any prior acknowledgment letter agreement, to the extent
that such prior agreement is inconsistent with the terms hereof. In
the
[[Page 81281]]
event of any conflict between this letter agreement and any other
agreement between the parties in connection with the Account(s),
this letter agreement shall govern with respect to matters specific
to Section 4d of the Act and the CFTC's regulations thereunder, as
amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning to us the
enclosed copy of this letter agreement, and that you further agree
to provide a copy of this fully executed letter agreement directly
to the CFTC (via electronic means in a format and manner determined
by the CFTC) in accordance with CFTC Regulation Sec. 1.20. We
hereby authorize and direct you to provide such copy without further
notice to or consent from us, no later than three business days
after opening the Account(s) or revising this letter agreement, as
applicable.
[Name of Derivatives Clearing Organization]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of U.S. Treasury Exchange-Traded Fund]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
DATE:
0
11. In Sec. 1.32, revise paragraphs (f)(3)(v), (vi), and (vii) to read
as follows:
Sec. 1.32 Reporting of segregated account computation and details
regarding the holding of futures customer funds.
* * * * *
(f) * * *
(3) * * *
(v) Permitted foreign sovereign debt by country:
(A) Canada;
(B) France;
(C) Germany;
(D) Japan;
(E) United Kingdom;
(vi) Interests in U.S. Treasury exchange-traded funds; and
(vii) Interests in government money market funds.
* * * * *
PART 22--CLEARED SWAPS
0
12. 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
13. In Sec. 22.2, revise paragraphs (g)(5)(iii)(E), (F), and (G) to
read as follows:
Sec. 22.2 Futures Commission Merchants: Treatment of Cleared Swaps
and Associated Cleared Swaps Customer Collateral.
* * * * *
(g) * * *
(5) * * *
(iii) * * *
(E) Permitted foreign sovereign debt by country:
(1) Canada;
(2) France;
(3) Germany;
(4) Japan;
(5) United Kingdom;
(F) Interests in U.S. Treasury exchange-traded funds; and
(G) Interests in government money market funds.
* * * * *
0
14. In Sec. 22.3, revise paragraph (d) to read as follows:
Sec. 22.3 Derivatives clearing organizations: Treatment of cleared
swaps customer collateral.
* * * * *
(d) Exceptions; Permitted investments. Notwithstanding the
foregoing and Sec. 22.15, a derivatives clearing organization may
invest the money, securities, or other property constituting Cleared
Swaps Customer Collateral in accordance with Sec. 1.25 of this
chapter. A derivative clearing organization shall bear sole
responsibility for any losses resulting from the investment of Cleared
Swaps Customer Collateral in instruments described in Sec. 1.25 of
this chapter. No investment losses shall be borne or otherwise
allocated to a futures commission merchant.
PART 30--FOREIGN FUTURES AND FOREIGN OPTIONS TRANSACTIONS
0
15. 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
16. In Sec. 30.7, revise paragraphs (d)(2) and (3) and (l)(5)(iii)(E)
through (G) to read as follows:
Sec. 30.7 Treatment of foreign futures or foreign options secured
amount.
* * * * *
(d) * * *
(2) The written acknowledgment must be in the form as set out in
Appendix E to this part; Provided, however, that if the futures
commission merchant invests funds set aside as the foreign futures or
foreign options secured amount in government money market funds or U.S.
Treasury exchange-traded funds as a permitted investment under
paragraph (h) of this section and in accordance with the terms and
conditions of Sec. 1.25(c) of this chapter, the written acknowledgment
with respect to such investment must be in the form as set out in
Appendix F to this part or in Appendix G to this part, respectively.
(3)(i) A futures commission merchant shall deposit 30.7 customer
funds only with a depository that agrees to provide the director of the
Division of Swap Dealer and Intermediary Oversight, or any successor
division, or such director's designees, with account balance
information for 30.7 customer accounts.
(ii) The written acknowledgment must contain the futures commission
merchant's authorization to the depository to provide account balance
information to the director of the Division of Swap Dealer and
Intermediary Oversight, or any successor division, or such director's
designees, without further notice to or consent from the futures
commission merchant.
* * * * *
(l) * * *
(5) * * *
(iii) * * *
(E) Permitted foreign sovereign debt by country:
(1) Canada;
(2) France;
(3) Germany;
(4) Japan;
(5) United Kingdom;
(F) Interests in U.S. Treasury exchange-traded funds; and
(G) Interests in government money market funds.
* * * * *
0
17. Revise Appendix E to part 30 to read as follows:
Appendix E to Part 30--Acknowledgment Letter for CFTC Regulation Sec.
30.7 Customer Secured Account
[Date]
[Name and Address of Depository]
We refer to the Secured Amount Account(s) which [Name of Futures
Commission Merchant] (``we'' or ``our'') have opened or will open
with [Name of Depository] (``you'' or ``your'') entitled:
[Name of Futures Commission Merchant] [if applicable, add ``FCM
Customer Omnibus Account''] CFTC Regulation Sec. 30.7 Customer
Secured Account under Section 4(b) of the Commodity Exchange Act
[and, if applicable, ``, Abbreviated as [short title reflected in
the depository's electronic system]'']
Account Number(s): [ ]
(collectively, the ``Account(s)'').
You acknowledge that we have opened or will open the above-
referenced Account(s) for the purpose of depositing, as applicable,
money, securities and other property (collectively ``Funds'') of
customers who
[[Page 81282]]
trade foreign futures and/or foreign options (as such terms are
defined in U.S. Commodity Futures Trading Commission (``CFTC'')
Regulation Sec. 30.1, as amended); that the Funds held by you,
hereafter deposited in the Account(s) or accruing to the credit of
the Account(s), will be kept separate and apart and separately
accounted for on your books from our own funds and from any other
funds or accounts held by us, in accordance with the provisions of
the Commodity Exchange Act, as amended (the ``Act''), and part 30 of
the CFTC's regulations, as amended; that the Funds may not be
commingled with our own funds in any proprietary account we maintain
with you; and that the Funds must otherwise be treated in accordance
with the provisions of Section 4(b) of the Act and CFTC Regulation
Sec. 30.7.
Furthermore, you acknowledge and agree that such Funds may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, and they may not be used by us to secure or
obtain credit from you. You further acknowledge and agree that the
Funds in the Account(s) shall not be subject to any right of offset
or lien for or on account of any indebtedness, obligations or
liabilities we may now or in the future have owing to you. This
prohibition does not affect your right to recover funds advanced in
the form of cash transfers, lines of credit, repurchase agreements
or other similar liquidity arrangements you make in lieu of
liquidating non-cash assets held in the Account(s) or in lieu of
converting cash held in the Account(s) to cash in a different
currency.
In addition, you agree that the Account(s) may be examined at
any reasonable time by the director of the Division of Swap Dealer
and Intermediary Oversight of the CFTC or the director of the
Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent or employee of our designated self-regulatory organization
(``DSRO''), [Name of DSRO], and this letter constitutes the
authorization and direction of the undersigned on our behalf to
permit any such examination to take place without further notice or
consent from us.
You agree to reply promptly and directly to any request for
confirmation of account balances or provision of any other
information regarding or related to the Account(s) from the director
of the Division of Swap Dealer and Intermediary Oversight of the
CFTC or the director of the Division of Clearing and Risk of the
CFTC, or any successor divisions, or such directors' designees, or
an appropriate officer, agent, or employee of [Name of DSRO], acting
in its capacity as our DSRO, and this letter constitutes the
authorization and direction of the undersigned on our behalf to
release the requested information without further notice to or
consent from us.
The parties agree that all actions on your part to respond to
the above information request will be made in accordance with, and
subject to, such usual and customary authorization verification and
authentication policies and procedures as may be employed by you to
verify the authority of, and authenticate the identity of, the
individual making any such information request, in order to provide
for the secure transmission and delivery of the requested
information to the appropriate recipient(s).
We will not hold you responsible for acting pursuant to any
information request from the director of the Division of Swap Dealer
and Intermediary Oversight of the CFTC or the director of the
Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent, or employee of [Name of DSRO], acting in its capacity as our
DSRO, upon which you have relied after having taken measures in
accordance with your applicable policies and procedures to assure
that such request was provided to you by an individual authorized to
make such a request.
In the event we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Funds
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of offset or lien on assets that are not Sec.
30.7 customer funds maintained in the Account(s), or to impose such
charges against us or any proprietary account maintained by us with
you. Further, it is understood that amounts represented by checks,
drafts or other items shall not be considered to be part of the
Account(s) until finally collected. Accordingly, checks, drafts and
other items credited to the Account(s) and subsequently dishonored
or otherwise returned to you or reversed, for any reason, and any
claims relating thereto, including but not limited to claims of
alteration or forgery, may be charged back to the Account(s), and we
shall be responsible to you as a general endorser of all such items
whether or not actually so endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that, in the ordinary course of your business as a
depository, you have no notice of or actual knowledge of a potential
violation by us of any provision of the Act or part 30 of the CFTC
regulations that relates to the holding of customer funds; and you
shall not in any manner not expressly agreed to herein be
responsible to us for ensuring compliance by us with such provisions
of the Act and CFTC regulations; however, the aforementioned
presumption does not affect any obligation you may otherwise have
under the Act or CFTC regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any action or omission to act
pursuant to any such order, judgment, decree or levy, to us or to
any other person, firm, association or corporation even if
thereafter any such order, decree, judgment or levy shall be
reversed, modified, set aside or vacated.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns and, for the avoidance of
doubt, regardless of a change in the name of either party. This
letter agreement supersedes and replaces any prior agreement between
the parties in connection with the Account(s), including but not
limited to any prior acknowledgment letter agreement, to the extent
that such prior agreement is inconsistent with the terms hereof. In
the event of any conflict between this letter agreement and any
other agreement between the parties in connection with the
Account(s), this letter agreement shall govern with respect to
matters specific to Section 4(b) of the Act and the CFTC's
regulations thereunder, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning to us the
enclosed copy of this letter agreement, and that you further agree
to provide a copy of this fully executed letter agreement directly
to the CFTC (via electronic means in a format and manner determined
by the CFTC) and to [Name of DSRO], acting in its capacity as our
DSRO. We hereby authorize and direct you to provide such copies
without further notice to or consent from us, no later than three
business days after opening the Account(s) or revising this letter
agreement, as applicable.
[Name of Futures Commission Merchant]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Depository]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
DATE:
0
18. Revise Appendix F to part 30 to read as follows:
Appendix F to Part 30--Acknowledgment Letter for CFTC Regulation Sec.
30.7 Customer Secured Government Money Market Fund Account
[Date]
[Name and Address of Government Money Market Fund]
We propose to invest funds held by [Name of Futures Commission
Merchant] (``we'' or ``our'') on behalf of our customers in shares
of [Name of Government Money Market Fund] (``you'' or ``your'')
under account(s) entitled (or shares issued to):
[Name of Futures Commission Merchant] [if applicable, add ``FCM
Customer Omnibus Account''] CFTC Regulation Sec. 30.7 Customer
Secured Government Money Market Fund Account under Section 4(b) of
the Commodity Exchange Act [and, if applicable,
[[Page 81283]]
``, Abbreviated as [short title reflected in the depository's
electronic system]'']
Account Number(s): [ ]
(collectively, the ``Account(s)'').
You acknowledge that we are holding these funds, including any
shares issued and amounts accruing in connection therewith
(collectively, the ``Shares''), for the benefit of customers who
trade foreign futures and/or foreign options (as such terms are
defined in U.S. Commodity Futures Trading Commission (``CFTC'')
Regulation Sec. 30.1, as amended); that the Shares held by you,
hereafter deposited in the Account(s) or accruing to the credit of
the Account(s), will be kept separate and apart and separately
accounted for on your books from our own funds and from any other
funds or accounts held by us in accordance with the provisions of
the Commodity Exchange Act, as amended (the ``Act''), and part 30 of
the CFTC's regulations, as amended; and that the Shares must
otherwise be treated in accordance with the provisions of Section
4(b) of the Act and CFTC Regulations Sec. Sec. 1.25 and 30.7.
Furthermore, you acknowledge and agree that such Shares may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, and they may not be used by us to secure or
obtain credit from you. You further acknowledge and agree that the
Shares in the Account(s) shall not be subject to any right of offset
or lien for or on account of any indebtedness, obligations or
liabilities we may now or in the future have owing to you.
In addition, you agree that the Account(s) may be examined at
any reasonable time by the director of the Division of Swap Dealer
and Intermediary Oversight of the CFTC or the director of the
Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent or employee of our designated self-regulatory organization
(``DSRO''), [Name of DSRO], and this letter constitutes the
authorization and direction of the undersigned on our behalf to
permit any such examination to take place without further notice to
or consent from us.
You agree to reply promptly and directly to any request for
confirmation of account balances or provision of any other
information regarding or related to the Account(s) from the director
of the Division of Swap Dealer and Intermediary Oversight of the
CFTC or the director of the Division of Clearing and Risk of the
CFTC, or any successor divisions, or such directors' designees, or
an appropriate officer, agent, or employee of [Name of DSRO], acting
in its capacity as our DSRO, and this letter constitutes the
authorization and direction of the undersigned on our behalf to
release the requested information, without further notice to or
consent from us.
The parties agree that all actions on your part to respond to
the above information request will be made in accordance with, and
subject to, such reasonable and customary authorization verification
and authentication policies and procedures as may be employed by you
to verify the authority of, and authenticate the identity of, the
individual making any such information request, in order to provide
for the secure transmission and delivery of the requested
information to the appropriate recipient(s).
We will not hold you responsible for acting pursuant to any
information request from the director of the Division of Swap Dealer
and Intermediary Oversight of the CFTC or the director of the
Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent, or employee of [Name of DSRO], acting in its capacity as our
DSRO, upon which you have relied after having taken measures in
accordance with your applicable policies and procedures to assure
that such request was provided to you by an individual authorized to
make such a request.
In the event we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Shares
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of offset or lien on assets that are not Shares
maintained in the Account(s), or to impose such charges against us
or any proprietary account maintained by us with you. Further, it is
understood that amounts represented by checks, drafts or other items
shall not be considered to be part of the Account(s) until finally
collected. Accordingly, checks, drafts and other items credited to
the Account(s) and subsequently dishonored or otherwise returned to
you or reversed, for any reason and any claims relating thereto,
including but not limited to claims of alteration or forgery, may be
charged back to the Account(s), and we shall be responsible to you
as a general endorser of all such items whether or not actually so
endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that, in the ordinary course of your business as a
depository, you have no notice of or actual knowledge of a potential
violation by us of any provision of the Act or part 30 of the CFTC
regulations that relates to the holding of customer funds; and you
shall not in any manner not expressly agreed to herein be
responsible to us for ensuring compliance by us with such provisions
of the Act and CFTC regulations; however, the aforementioned
presumption does not affect any obligation you may otherwise have
under the Act or CFTC regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any action or omission to act
pursuant to any such order, judgment, decree or levy, to us or to
any other person, firm, association or corporation even if
thereafter any such order, decree, judgment or levy shall be
reversed, modified, set aside or vacated.
We are permitted to invest customers' funds in government money
market funds pursuant to CFTC Regulation Sec. 1.25. That rule sets
forth the following conditions, among others, with respect to any
investment in a government money market fund:
(1) The net asset value of the fund must be computed by 9:00
a.m. of the business day following each business day and be made
available to us by that time;
(2) The fund must be legally obligated to redeem an interest in
the fund and make payment in satisfaction thereof by the close of
the business day following the day on which we make a redemption
request except as otherwise specified in CFTC Regulation Sec.
1.25(c)(5)(ii); and,
(3) The agreement under which we invest customers' funds must
not contain any provision that would prevent us from pledging or
transferring fund shares.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns and, for the avoidance of
doubt, regardless of a change in the name of either party. This
letter agreement supersedes and replaces any prior agreement between
the parties in connection with the Account(s), including but not
limited to any prior acknowledgment letter agreement, to the extent
that such prior agreement is inconsistent with the terms hereof. In
the event of any conflict between this letter agreement and any
other agreement between the parties in connection with the
Account(s), this letter agreement shall govern with respect to
matters specific to Section 4(b) of the Act and the CFTC's
regulations thereunder, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning to us the
enclosed copy of this letter agreement, and that you further agree
to provide a copy of this fully executed letter agreement directly
to the CFTC (via electronic means in a format and manner determined
by the CFTC) and to [Name of DSRO], acting in its capacity as our
DSRO. We hereby authorize and direct you to provide such copies
without further notice to or consent from us, no later than three
business days after opening the Account(s) or revising this letter
agreement, as applicable.
[Name of Futures Commission Merchant]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Government Money Market Fund]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
DATE:
0
19. Add Appendix G to part 30 to read as follows:
[[Page 81284]]
Appendix G to Part 30--Acknowledgment Letter for CFTC Regulation Sec.
30.7 Customer Secured U.S. Treasury Exchange-Traded Fund Account
[Date]
[Name and Address of U.S. Treasury Exchange-Traded Fund]
We propose to invest funds held by [Name of Futures Commission
Merchant] (``we'' or ``our'') on behalf of our customers in shares
of [Name of U.S. Treasury Exchange-Traded Fund] (``you'' or
``your'') under account(s) entitled (or shares issued to):
[Name of Futures Commission Merchant] [if applicable, add ``FCM
Customer Omnibus Account''] CFTC Regulation Sec. 30.7 Customer
Secured U.S. Treasury Exchange-Traded Fund Account under Section
4(b) of the Commodity Exchange Act [and, if applicable, ``,
Abbreviated as [short title reflected in the depository's electronic
system]'']
Account Number(s): [ ]
(collectively, the ``Account(s)'').
You acknowledge that we are holding these funds, including any
shares issued and amounts accruing in connection therewith
(collectively, the ``Shares''), for the benefit of customers who
trade foreign futures and/or foreign options (as such terms are
defined in U.S. Commodity Futures Trading Commission (``CFTC'')
Regulation Sec. 30.1, as amended); that the Shares held by you,
hereafter deposited in the Account(s) or accruing to the credit of
the Account(s), will be separately accounted for and segregated on
your books from our own funds and from any other funds or accounts
held by us in accordance with the provisions of the Commodity
Exchange Act, as amended (the ``Act''), and part 30 of the CFTC's
regulations, as amended; and that the Shares must otherwise be
treated in accordance with the provisions of Section 4(b) of the Act
and CFTC Regulations Sec. Sec. 1.25 and 30.7.
Furthermore, you acknowledge and agree that such Shares may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, and they may not be used by us to secure or
obtain credit from you. You further acknowledge and agree that the
Shares in the Account(s) shall not be subject to any right of offset
or lien for or on account of any indebtedness, obligations or
liabilities we may now or in the future have owing to you.
In addition, you agree that the Account(s) may be examined at
any reasonable time by the Director of the Market Participants
Division of the CFTC or the Director of the Division of Clearing and
Risk of the CFTC, or any successor divisions, or such Directors'
designees, or an appropriate officer, agent or employee of our
designated self-regulatory organization (``DSRO''), [Name of DSRO],
and this letter constitutes the authorization and direction of the
undersigned on our behalf to permit any such examination to take
place without further notice to or consent from us.
You agree to reply promptly and directly to any request for
confirmation of account balances or provision of any other account
information regarding or related to the Account(s) from the Director
of the Market Participants Division of the CFTC or the Director of
the Division of Clearing and Risk of the CFTC, or any successor
divisions, or such Directors' designees, or an appropriate officer,
agent, or employee of [Name of DSRO], acting in its capacity as our
DSRO, and this letter constitutes the authorization and direction of
the undersigned on our behalf to release the requested information
without further notice to or consent from us.
The parties agree that all actions on your part to respond to
the above information requests will be made in accordance with, and
subject to, such usual and customary authorization verification and
authentication policies and procedures as may be employed by you to
verify the authority of, and authenticate the identity of, the
individual making any such information request, in order to provide
for the secure transmission and delivery of the requested
information to the appropriate recipient(s).
We will not hold you responsible for acting pursuant to any
information request from the Director of the Market Participants
Division of the CFTC or the Director of the Division of Clearing and
Risk of the CFTC, or any successor divisions, or such Directors'
designees, or an appropriate officer, agent, or employee of [Name of
DSRO], acting in its capacity as our DSRO, upon which you have
relied after having taken measures in accordance with your
applicable policies and procedures to assure that such request was
provided to you by an individual authorized to make such a request.
In the event we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Shares
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of offset or lien on assets that are not Shares
maintained in the Account(s), or to impose such charges against us
or any proprietary account maintained by us with you. Further, it is
understood that amounts represented by checks, drafts or other items
shall not be considered to be part of the Account(s) until finally
collected. Accordingly, checks, drafts and other items credited to
the Account(s) and subsequently dishonored or otherwise returned to
you or reversed, for any reason and any claims relating thereto,
including but not limited to claims of alteration or forgery, may be
charged back to the Account(s), and we shall be responsible to you
as a general endorser of all such items whether or not actually so
endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that, in the ordinary course of your business as a
depository, you have no notice of or actual knowledge of a potential
violation by us of any provision of the Act or the CFTC regulations
that relates to the segregation of customer funds; and you shall not
in any manner not expressly agreed to herein be responsible to us
for ensuring compliance by us with such provisions of the Act and
CFTC regulations; however, the aforementioned presumption does not
affect any obligation you may otherwise have under the Act or CFTC
regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any action or omission to act
pursuant to such order, judgment, decree or levy, to us or to any
other person, firm, association or corporation even if thereafter
any such order, decree, judgment or levy shall be reversed,
modified, set aside or vacated.
We are permitted to invest customers' funds in U.S. Treasury
exchange-traded funds pursuant to CFTC Regulation Sec. 1.25. That
rule sets forth the following conditions, among others, with respect
to any investment in a U.S. Treasury exchange-traded fund:
(1) To qualify as a permitted investment, interests in U.S.
Treasury exchange-traded must be redeemable in cash by a futures
commission merchant or derivatives clearing organization in its
capacity as an authorized participant pursuant to an authorized
participant agreement, as defined in Sec. 270.6c-11 of Title 17 of
the Code of Federal Regulations, at a price based on the net asset
value in accordance with the Investment Company Act of 1940 and
regulations thereunder, and on a delivery versus payment basis;
(2) The fund must be legally obligated to redeem an interest in
the fund and make payment in satisfaction thereof by the close of
the business day following the day on which we make a redemption
request; and,
(3) The agreement under which we invest customers' funds must
not contain any provision that would prevent us from pledging or
transferring fund shares.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns, and for the avoidance of
doubt, regardless of a change in the name of either party. This
letter agreement supersedes and replaces any prior agreement between
the parties in connection with the Account(s), including but not
limited to any prior acknowledgment letter agreement, to the extent
that such prior agreement is inconsistent with the terms hereof. In
the event of any conflict between this letter agreement and any
other agreement between the parties in connection with the
Account(s), this letter agreement shall govern with respect to
matters specific to Section 4(b) of the Act and the CFTC's
regulations thereunder, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning to us the
enclosed copy of this letter agreement, and that you further agree
to provide a copy of this fully executed letter agreement directly
to the CFTC (via electronic means in a format
[[Page 81285]]
and manner determined by the CFTC) and to [Name of DSRO], acting in
its capacity as our DSRO. We hereby authorize and direct you to
provide such copies without further notice to or consent from us, no
later than three business days after opening the Account(s) or
revising this letter agreement, as applicable.
[Name of Futures Commission Merchant]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of U.S. Treasury Exchange-Traded Fund]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
Date:
Issued in Washington, DC, on November 3, 2023, by the
Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Investment of Customer Funds by Futures Commission
Merchants and Derivatives Clearing Organizations--Commission Voting
Summary, Chairman's Statement, and Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Behnam and Commissioners Johnson,
Goldsmith Romero, Mersinger, and Pham voted in the affirmative. No
Commissioner voted in the negative.
Appendix 2--Statement of Support of Chairman Rostin Behnam
A fundamental tenet of the Commission's customer protection
framework is the safeguarding and investment of customer funds
deposited by customers with futures commission merchants (``FCMs'')
and derivatives clearing organizations (``DCOs'') to margin futures,
foreign futures, and cleared swaps transactions. This proposal to
revise the Commission's regulations for the safeguarding and
investment of customer funds by FCMs and DCOs in Commission
regulations Sec. Sec. 1.20, 1.25, 1.26, 1.32, 22.2, 22.3, and 30.7
along with the relevant appendices does not change this foundational
principle. This proposal embodies a prudent, periodic reassessment
of these requirements to ensure that this framework remains
appropriately calibrated to preserve principal and maintain
liquidity. Therefore, I support the Commission issuing this proposal
for public comment.
Modernizing the List of Permitted Investments of Customer Funds
Regulation Sec. 1.25 currently permits FCMs and DCOs to invest
customer funds in, among other things, U.S. government securities,
municipal securities, and U.S. agency obligations. The Commission's
proposal would expand the list of permitted investments to add the
foreign sovereign debt of Canada, France, Germany, Japan, and the
United Kingdom, and add interests in certain short-term U.S.
Treasury exchange-traded funds. These investments would be subject
to various restrictions based on credit default spreads, time-to-
maturity, concentration limits, and liquidity conditions that limit
FCMs and DCOs to investing customer funds in safe investments. The
Commission's proposal to add these instruments follows a detailed
staff analysis of these instruments' liquidity, volatility, and
credit characteristics. To the extent the proposal refines
regulations in response to a decade of market developments
including, but not limited to, the LIBOR transition to SOFR, changes
to the broader U.S regulatory framework, and lessons learned from
the implementation of the electronic access requirement, the
amendments exemplify good government.
FCM and DCO Permitted Investments Parity
FCMs and DCOs operate in tandem as the backbone of our cleared
markets. Given that the number of FCMs that offer customer clearing
has significantly decreased in the past decade, alignment of the
types of investments permitted for FCMs and DCOs is an essential
component to maintaining market continuity and resiliency for
customer clearing. The proposal would permit FCMs and DCOs to invest
customer funds in the same narrowly-tailored set of foreign
sovereign debt to the extent that FCMs and DCOs hold balances owed
to customers in the currency of the issuing sovereign and subject to
certain eligibility, credit, and time-to-maturity conditions. This
addition to the list of permitted investments would not only
minimize FCMs' exposure to foreign currency risk fluctuations, but
also incorporate the exact same conditions currently in place for
CFTC registered DCOs to uneventfully invest customer funds in French
and German sovereign debt--conditions that have been in place for
the past five years. Simply put, a level playing field across agency
registrants.
Stay Strong
The proposal would not undermine or weaken any of the safeguards
that the Commission has had in place since 2011. In fact, the
Commission recognized in the 2011 final rule release ``that the
safety of sovereign debt issuances of one country may vary greatly
from those of another, and that investment in certain sovereign debt
may be consistent with the objectives of preserving principal and
maintaining liquidity, as required by Regulation 1.25.'' \1\ The
Commission not only anticipated, but ``invite[d] FCMs and DCOs that
seek to invest customer funds in foreign sovereign debt to petition
the Commission pursuant to Section 4(c).'' \2\ This proposal
incorporates the section 4(c) order and its conditions that the
Commission provided to DCOs in 2018.
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\1\ Investment of Customer Funds and Funds Held in an Account
for Foreign Futures and Foreign Options Transactions Final Rule, 76
FR 78776, 78782 (Dec. 19, 2011).
\2\ Id.
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Welcome Public Comment
I look forward to hearing the public's comments for further
guidance on how to strengthen Regulation Sec. 1.25 and the related
regulations, while also making the derivatives markets more
resilient and less concentrated.
I want to thank Abigail Knauff, and staff in the Market
Participants Division, Division of Clearing and Risk, Office of the
General Counsel, and the Office of the Chief Economist for all of
their work on the proposal.
Appendix 3--Statement of Commissioner Kristin N. Johnson
Preserving Trust and Preventing the Erosion of Customer Protection
Regulation
Introduction
The Commodity Exchange Act (CEA) tasks the Commodity Futures
Trading Commission (CFTC or Commission) with developing, adopting,
and implementing rules that effectively protect customer funds or
property held by market participants that serve as custodians.
Preserving the value of customer funds and property held by a third-
party is a central, critical, and foundational role of the CFTC.
Retail participation in our markets is growing. The regulation
advanced today is only part of our broader framework to preserve
customer assets.
As we examine the matter before us today, I strongly advocate
for the Commission to carefully consider (among other issues
outlined below) and implement:
appropriate parallel rules to protect retail customer
assets, funds, and property across our markets;
a regulatory metric that acknowledges the challenges of
relying on credit default swap (CDS) spreads calculated by an
increasingly concentrated market to inform our understanding of the
likelihood of foreign sovereign debt default risk; and
forthcoming rules governing the clearing of U.S.
treasuries.
Preserving Customer Assets Is Our Mission
Successful preservation of customer assets directly impacts
transaction costs and, in periods marked by significant losses of
customer funds, may impact market integrity.
For decades, the CFTC and other market and prudential regulators
have introduced and enforced important rules governing the
preservation of customer funds and property. Notwithstanding
prudential and market regulators' best efforts, markets and
customers have experienced remarkable losses. We have witnessed
customer losses in heavily regulated markets as well as markets
where there are regulatory gaps and regulators may have limited
visibility.
FTX and Billions in Missing Customer Funds
Last year, we witnessed a series of bankruptcies in the $1
trillion cryptocurrency markets. Several of the failed firms were
among the largest global retail customer trading platforms in the
digital asset marketplace.
A year ago today, media accounts began reporting that FTX
Trading or FTX.com
[[Page 81286]]
(FTX) could not account for more than $10 billion in customer
funds.\1\ Yesterday, in a federal courtroom in the Southern District
of New York, jurors found Sam Bankman-Fried, former chief executive
officer (CEO) of FTX, guilty of misappropriating and embezzling
billions of dollars in customer funds deposited with and held in the
custody by FTX in connection with crypto-trading transactions at
FTX.
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\1\ FTX Demonstrates Need for More Oversight: CFTC's Johnson
(Bloomberg TV Nov. 9, 2022), https://www.bloomberg.com/news/videos/2022-11-09/ftx-demonstrates-need-for-more-oversight-cftc-s-johnson.
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An ounce of prevention is worth a pound of cure. When customers
entrust their resources and assets to registered participants in our
markets, regulation offers the first-best method of preserving
customers funds or property. Consequently, 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.
Commission Regulation Sec. 1.25
A recent report indicates that futures commission merchants
(FCMs) may hold approximately $500 billion of customer funds in
segregated accounts--a number that is the equivalent of the gross
domestic product of certain medium-sized countries.
Today, the Commission seeks to refine a foundational rule
governing the investment of funds by FCMs and derivatives clearing
organizations (DCOs) in our markets. FCMs and DCOs, alongside
several other registered futures and swaps market participants, are
entrusted with customer funds.
I commend the Market Participants Division (Division) for its
willingness to incorporate comments from my office in the Proposed
Rule.\2\ I applaud the effort of the proposed amendments to
Regulation Sec. 1.25 and related matters (Proposed Rule) advanced
today, which seeks to introduce greater protections for customer
funds, yet, regrettably I find that the Commission has missed an
important opportunity.
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\2\ I thank the Division for carefully considering and agreeing
to include a question in the Proposed Rule evaluating Regulation
Sec. 1.25(b)(5)(ii), which currently provides that an FCM or a DCO
may invest customer funds in a fund affiliated with that FCM or DCO,
and they have introduced several questions in the Proposed Rule.
Additionally, at my request, the Commission is exploring whether we
should provide greater certainty and clarity as to the acceptable
benchmark in light of the various types of Secured Overnight
Financing Rates (SOFR) that are available, the permissible
investments that are likely to have a floating interest rate
calculated on SOFR, and the recommendations of the Alternative
Reference Rates Committee.
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Over the term of my service as a Commissioner, I have
continuously advocated for enhanced protection of customer funds.
While I support the adoption of the Proposed Rule, I find that the
Commission has missed an opportunity to effectively address gaps in
a parallel market that has had exponential growth in recent years
due, in part, to the introduction of cryptocurrency or digital
assets.
Understanding and Applying Our Regulatory Authority
Before reaching the impact of the Proposed Rule, it is important
to consider the scope of the Commission's authority to act to refine
existing rules governing the investment of customer funds as well as
a broader intervention that addresses evolving market structures.
The Commission is proposing to amend Regulation Sec. 1.25
pursuant to its public interest exemptive authority under section
4(c) of the CEA. The Commission may exercise this power to provide
certain exemptions from the requirements of the CEA and regulations
promulgated thereunder, if the Commission determines that such an
exemption would be consistent with the public interest.\3\
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\3\ 7 U.S.C. 6(c).
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The Commission may grant a public interest exemption by engaging
in the rulemaking process for the Proposed Rule. In a formal
rulemaking process, we benefit from careful review and development
of the proposed rule text and the heightened discourse and public
exchanges that are characteristic of the notice and comment period.
As a financial market regulator, the Commission must continuously
engage in careful and deliberative analyses to ensure the adoption
and implementation of robust regulatory processes. Our efforts to
achieve these goals ensure the continued stability and integrity of
our derivatives markets.
However, as noted in the legislative history of section 4(c) of
the CEA, the Commission must be vigilant to ensure that the exercise
of its exemptive power does not ``prompt a wide-scale deregulation
of markets falling within the ambit of the [CEA].'' \4\
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\4\ H.R. Rep. No. 102-978, at 3213 (1992) (Conf. Rep.).
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Origins of the Commission's 4(c) Authority
Section 4(c) of the CEA was adopted in the context of the
evolution of the derivatives market from traditional agricultural
derivatives to financial derivatives. In the 1980s, market
participants developed a new OTC derivatives or swaps market
featuring instruments that shared characteristics with existing
futures contracts and had similar economic purposes. While some
questioned the CFTC's jurisdiction over the novel swap agreements,
the Commission's jurisdiction over futures contracts was clearly
established. Congress has long concluded that the CFTC has
jurisdiction over contracts that are ``in the character of'' futures
contracts.\5\
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\5\ 7 U.S.C. 2(a).
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In 1992, in response to regulatory uncertainty, Congress adopted
section 4(c) of the CEA--codified in the Futures Trading Practices
Act (1992 Act). Rather than resolving the appropriate classification
for OTC swap agreements, Congress deferred to the Commission to
exempt exchange-traded and OTC derivatives instruments from the CEA
where such exemptions are consistent with the public interest.
Congress granted the CFTC this exemptive authority to ensure
``certainty and stability'' for ``existing and emerging markets''
and to enable ``financial innovation and market development'' and
competition.\6\
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\6\ H.R. Conf. Rep. No. 102-978, at 3213.
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Roughly a year later, consistent with the authority granted by
Congress in the 1992 Act, the CFTC adopted an exemptive regulation
(1993 Exemptive Regulation).\7\ Relying on section 4(c)(3)(K) of the
CEA, the Commission limited the market participants permitted to
trade in these products to ``eligible swap participants,'' a group
that includes sophisticated individuals with assets over $10
million.\8\ To further enhance customer protection, the CFTC
mandated that an eligible swap participant could only trade
unregulated swaps on its own behalf or on behalf of another eligible
swap participant.\9\
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\7\ Exemption for Certain Swap Agreements, 58 FR 5587 (Jan. 22,
1993). The 1993 Exemptive Regulation for swaps was a revision to the
exemption the CFTC had previously issued in 1989 in a Statement of
Policy.
\8\ Id. at 5589-5590.
\9\ Id.
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Seven years later as the swaps market grew exponentially,
Congress enacted the Commodity Futures Modernization Act and
addressed the product classification issue head-on. By law, Congress
exempted financial OTC derivatives from the scope of the CEA,
subject to certain conditions that generally excluded small
businesses and individual investors from participating in the
unregulated swaps market.
The deregulation of the swaps market directly and markedly
contributed to the global financial crisis, which caused significant
stress and contagion in global financial markets. Certain of the
proposed amendments will weaken many of the regulations adopted
pursuant to the Dodd-Frank Act, and it is imperative that we not
make the same mistake as the Commission amends its customer
protection regime.
Explanation of the Customer Protection Framework
Pursuant to its authority under section 4(c) of the CEA, the
Commission proposes to expand the range of instruments in which FCMs
and DCOs may invest customer funds beyond those specifically
enumerated in the CEA under section 4d. The stated benefit is to
enhance the yield available to FCMs, DCOs and their customers,
without compromising the safety of customer funds.
The Commission has established a comprehensive customer
protection regime, designed to ensure that customer funds are
segregated from the proprietary funds of FCMs and DCOs, used only to
support customer positions, and available for return to customers in
the event of the insolvency of the FCM or DCO. Customer funds are
classified into one of three account classes based on the specific
type of customer position. The categories are futures customer
funds, cleared swaps collateral, or 30.7 customer funds in respect
of domestic futures, cleared swaps, and foreign futures,
respectively--all of which are referred to as customer funds.
[[Page 81287]]
The CEA and Commission Regulation Sec. 1.25 are foundational
provisions that set the framework and scope for FCMs' and DCOs'
investment of customer funds and are fundamentally interconnected
with the requirements to segregate customer funds.\10\ Section 4d of
the CEA permits FCMs to invest futures customer funds in a
prescribed list of instruments--obligations of U.S. government,
obligations fully guaranteed as to principal and interest by the
U.S., and general obligations of any State or any political
subdivision.\11\ The regulation permits FCMs and DCOs to invest
customer funds in each account class in a limited set of permitted
investments consistent with the prudential objectives of preserving
customer funds and mitigating credit risk, market risk, and
liquidity risk. The CEA and Regulation Sec. 1.25 reinforce the
long-held view of the Commission that customer funds, entrusted to
an FCM or a DCO, must be invested in a manner that preserves the
availability to customers of FCMs and DCOs.
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\10\ Kristin N. Johnson, Commissioner, CFTC, Statement on
Extension of Staff No-Action Letter Regarding Investments in
Securities with Adjustable Rate of Interest Benchmarked to SOFR
(Dec. 23, 2022), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement122322.
\11\ Section 4(b)(2)(A) of the CEA grants the Commission the
plenary authority to adopt rules and regulations regarding an FCM's
safeguarding of 30.7 customer funds. In 2011, the Commission
extended the requirements of Regulation Sec. 1.25 to an FCM's
investment of 30.7 customer funds for trading foreign futures
positions. Section 4d(f)(4) of the CEA prescribes a list of
instruments that cleared swaps customer collateral may be invested
in and further provides that the investments must be made in
accordance with the rules and regulations, and subject to any
conditions, as the Commission prescribes. In 2012, the Commission
extended the requirements of Regulation Sec. 1.25 to an FCM's
investment of cleared swaps customer collateral.
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However, the investment of customer funds may threaten the
preservation of such funds, and I have diligently and consistently
called for Commission regulation to protect the funds of retail
clients that might not fall within the definition of ``customer
funds.'' Some DCOs do not have an intermediated market structure. As
a result, the protections that exist for customers of FCMs in the
context of an intermediated DCO are not extended to direct clients
of a DCO in the context of a non-intermediated market structure.
Overview of the Proposed Amendments
Since the Commission first authorized FCMs and DCOs to invest
futures customer funds in these limited permitted instruments in
1968, the Commission has engaged in a series of critical expansions
and subsequent restrictions of the provisions of Commission
Regulation Sec. 1.25.\12\ This evolution is largely in response to
failures of large FCMs and major financial crises and economic
stresses.
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\12\ Title 17--Commodity and Securities Exchanges, 33 FR 14454
(Sept. 26, 1968).
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In its current form, Commission Regulation Sec. 1.25 applies to
all three account classes and lists seven categories of investments
that qualify as permitted investments--obligations of the U.S. and
obligations fully guaranteed as to principal and interest by the
U.S.; general obligations of any State or political subdivision of a
State; obligations of any U.S. government corporation or enterprise
sponsored by the U.S.; certificates of deposit issued by a bank;
commercial paper fully guaranteed by the U.S. under the Temporary
Liquidity Guarantee Program (TLGP) as administered by the Federal
Deposit Insurance Corporation; corporate notes and bonds fully
guaranteed as to principal and interest by the U.S. under the TLGP;
and interests in money market mutual funds (MMFs).\13\
---------------------------------------------------------------------------
\13\ 17 CFR 1.25(a)(1).
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The Commission's authority to introduce and enforce regulations
that ensure the preservation of customers' assets, particularly in
instances where FCMs and DCOs may experience liquidity crises, is
foundational to protecting market participants from fraudulent and
other abusive conduct and the misuse of customer assets. Effectively
exercising this authority is equally central to the Commission's
role in supporting sound risk management practices and ensuring the
stability of the broader financial system.
In the Proposed Rule, the Commission proposes to take several
significant actions: add specified foreign sovereign debt to the
list of permitted investments; add short-term U.S. treasury
exchange-traded funds (ETF) to the list of permitted investments;
limit the scope of MMF whose interest qualify as permitted
investments; eliminate commercial paper and corporate notes and
bonds as permitted investments; request comment on the potential
elimination of certificates of deposit issued by banks; replace the
London Interbank Offered Rate (LIBOR) with SOFR as a permitted
benchmark for adjustable rate securities; revise concentration
limits for certain permitted investments; establish capital charges
for specified foreign sovereign debt and qualified ETFs; propose to
eliminate the read-only, access provisions; and clarify that DCOs
are financially responsible for any losses resulting from
investments of cleared swap customer collateral in permitted
investments.
I appreciate the importance of the Commission's engagement in
the continual reassessment of Regulation Sec. 1.25 and related
matters and revising regulatory requirements as and when
appropriate. In this case, the proposed amendments are in response
to specific petitions by market participants; but the Commission
must ensure that its regulations are robust and responsive to our
evolving market structure.
Regulatory Gap for Non-Intermediated DCOs
The Proposed Rule does not consider the prudential principles of
Regulation Sec. 1.25 in the context of a non-intermediated clearing
model where the DCO offers direct client access to its clearing
services, without the FCM as an intermediary. The derivatives market
structure is significantly evolving, and it is imperative that the
Commission's regulations evolve in parallel.
Formal Rules Governing Custody for Retail Investors Across Our
Markets
In 2022, the Commission received a request from LedgerX, which
was withdrawn last year when LedgerX's parent company, FTX, filed
for bankruptcy protection. The request aimed to amend its order of
registration as a non-intermediated DCO to clear margined products
for retail participants.
Five years earlier, LedgerX solicited and the Commission granted
an order permitting the firm to offer fully-collateralized
derivatives contracts as a DCO. The Commission's order, amended in
September 2020, imposed a number of important conditions, including
requiring LedgerX to ``at all times maintain funds of its clearing
members separate and distinct from its own funds.'' \14\ The
conditions were necessary and important for the preservation of
customer property.
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\14\ See Press Release No. 8230-20, CFTC Approves LedgerX, LLC
to Clear Fully-Collateralized Futures and Options on Futures (Sept.
2, 2020), https://www.cftc.gov/PressRoom/PressReleases/8230-20.
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Our current regulations do not reach the issues addressed by the
conditions in the LedgerX order. The Commission should consider
regulation that closes this gap and ensures parallel retail customer
protection for trading through intermediaries and non-intermediated
DCOs.
LedgerX's obligation to comply with the Commission's conditions
contributed to the preservation of customer property after FTX
acquired LedgerX. When FTX, filed for bankruptcy, LedgerX remained
solvent, a non-debtor. The LedgerX order serves as an important
precedent for the framework the Commission should consider when
adopting parallel protections for direct clients, particularly
retail clients, in the non-intermediated context.
It is imperative that the Commission consider an equivalent
application of Regulation Sec. 1.25 in the context of a non-
intermediated DCO's investment of the property of retail
customers.\15\
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\15\ Kristin N. Johnson, Commissioner, CFTC, Keynote Speech at
the Salzburg Global Finance Forum (June 29, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson4; Kristin N.
Johnson, Commissioner, CFTC, Keynote Address at the World Federation
of Exchanges Annual Meeting (Sept. 21, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson5.
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Earlier Evidence of the Need To Enhance Customer Protections Rules
Long before crypto markets, however, we witnessed significant
FCM bankruptcies under then-existing rules that failed to prevent
losses to customers. Refco collapsed in 2005; Sentinel Management
Group shuttered its doors in 2007; MF Global failed in 2012; and
Peregrine Financial Group filed for bankruptcy protection in 2012.
The substantial amount of customer funds entrusted to FCMs and the
long history of FCM failures underscore the critical relationships
between FCMs and customers as well as the FCM's role,
responsibility, and accountability in serving as a custodian of
customer funds.
Elimination of Read-Only, Electronic Access to Customer Accounts
As historic and current events demonstrate, the Commission's
customer protection framework, though exceptionally
[[Page 81288]]
consequential and significant, does not guarantee against losses of
customer funds. Following several infamous bankruptcies, the
Commission tightened existing regulations including to improve
oversight of FCM activities and verify customer funds. The
Commission is reevaluating certain aspects of those regulations,
which is important. But we should be careful not to forget the
unprecedented events that led to the implementation of more
stringent oversight of FCMs and necessitate the extension of strict
oversight to non-intermediated DCOs.
The Failure of MF Global and Peregrine
MF Global, a prominent FCM and broker-dealer, is an example of a
firm that unraveled during the financial crisis. Jon Corzine, a
former investment banking executive and former Governor and Senator
of New Jersey, adopted a proprietary trading strategy involving the
investment in the sovereign debt (bonds) of certain European nations
through repurchase-to-maturity transactions. MF Global structured a
portfolio of ``repurchase to maturity'' bonds, bonds that paid large
coupon rates. Later the bonds were posted as ``collateral for short-
term borrowing'' and purportedly delayed any risk to the firm's
balance sheet until maturity.
A steep decline in sovereign debt markets triggered demands for
increased margin, and MF Global had insufficient liquidity to
maintain positions. In an attempt to stave off a ``run on the bank''
by customer withdrawals, creditors' demands, efforts to unwind repo
counterparty positions, and attempts to liquidate proprietary
positions at fire sale prices, MF Global made the unacceptable and
catastrophic decision to misappropriate customer funds in violation
of the Commission's customer segregation requirements.\16\
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\16\ Investing customer funds in foreign sovereign debt is
distinguishable from the investments of MF Global made for its own
account, and the issue with MF Global is that funds were transferred
out of the segregated account and used for other purposes. But MF
Global highlights the need for strong enforcement of segregation
requirements in times of unusual market conditions, such as a run.
See Rena S. Miller, Cong. Rsch. Serv., R42091, The MF Global
Bankruptcy, Missing Customer Funds, and Proposals for Reform (2013),
https://sgp.fas.org/crs/misc/R42091.pdf.
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The failure of futures trading firm Peregrine also created a
need for stronger customer protection tools. Russell Wasendorf Sr.
was the founder and former CEO of Peregrine, and he was sentenced to
50 years in prison because he siphoned off more than $215 million
from customers of Peregrine. The National Futures Association (NFA),
the self-regulatory organization (SRO) and Peregrine's auditor, was
heavily criticized for failing to catch the shortfall in customer
funds.
After the collapse of MF Global and Peregrine Financial Group,
the Commission supplemented the protections embedded in Commission
regulations to enhance customer protections and transparency at the
FCM level.\17\
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\17\ Kristin N. Johnson, Commissioner, CFTC, Keynote Address at
Digital Assets @Duke Conference, Duke's Pratt School of Engineering
and Duke Financial Economics Center (Jan. 26, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson2.
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Dated Efforts To Enhance Customer Protection
In November 2013, the Commission adopted a rule that afforded
greater assurances to market participants that customer funds are
protected.\18\ The Commission required depositories holding customer
funds for FCMs to provide the Commission with direct, read-only
electronic access to customer fund accounts while acknowledging that
the Commission did not intend to access FCM accounts on a regular
basis but would use that information when necessary to obtain
account balance and other information that staff could not obtain
via the designated auditors, either CME Group Inc. (CME) or NFA.
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\18\ Enhancing Protections Afforded Customers and Customer Funds
Held by Futures Commission Merchants and Derivatives Clearing
Organizations, 78 FR 68506 (Nov. 14, 2013).
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The Division notes that the Commission and depositories are
experiencing significant operational and resource-intensive
challenges in implementing and administering the provision and the
CME and NFA have provided alternative means of obtaining transaction
and account balance information.
Although the Commission is proposing to remove the ``direct
access'' requirement, the Commission should be confident that the
private sector auditing features that exist at the relevant
designated self-regulatory organization (DSRO) are considered in the
context of non-intermediated DCOs where there is an absence of an
FCM.
Whether it is a traditional market structure or new market
structure, the Commission needs to be comfortable that liabilities
to customers will be satisfied. I also expect that the Commission
and relevant DSRO would impose on non-intermediated market
infrastructures the same segregation investment reporting
obligations imposed on traditional infrastructures. There is a
continuous need to revisit whether measures to protect customer
funds are adequate.
Consideration of Other Important Factors
Although I support the Proposed Rule, a few discrete aspects of
the Proposed Rule merit additional discussion.
Inclusion of Foreign Sovereign Debt as Permitted
Investments
The Commission plans to use the CDS spread to determine whether
certain permitted foreign sovereign debt should qualify as
``permitted investments.'' The Commission needs to carefully
consider the conditions that apply to each permitted foreign
sovereign debt by establishing strong guardrails so that history
does not repeat itself.
On August 15, 2023, FCMs held the U.S. dollar equivalent of $51
billion of customer funds denominated in Canadian, European,
Japanese, and UK currencies. Given the significant non-U.S. dollar
customer transactions intermediated by FCMs, the Commission's
proposal expands the list of permissible investments to add the debt
of countries that represent the largest economies, are members of
the Group of 7, and a money center country--Canada, France, Germany,
Japan, and the UK.
De-Regulatory Decisions and the Recent Financial Crisis
The recent global financial crisis is a cautionary tale. A
series of deregulatory decisions created significant vulnerabilities
in financial markets. More specifically, an exemption from
regulation for bespoke OTC swaps trading in bilateral markets
obscured excessive risk-taking and undermined the integrity of
global markets. According to the U.S. Government Accountability
Office, the 2007-2009 financial crisis, which threatened the
stability of the U.S. financial system and the health of the U.S.
economy, may have led to $10 trillion in losses, including large
declines in employment and household wealth, reduced tax revenues
from lower economic activity, and lost output (value of goods and
services).\19\
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\19\ U.S. Gov't Accountability Off., GAO-13-180, Financial
Regulatory Reform: Financial Crisis Losses and Potential Impacts of
the Dodd-Frank Act (2013), https://www.gao.gov/assets/files.gao.gov/assets/gao-13-180.pdf.
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Traditionally, customer funds have been invested in U.S.
treasury securities. The Commission amended Regulation Sec. 1.25 in
2000 to expand the list of investments to include all foreign
sovereign debt, subject to a ratings requirement.\20\ Following the
2007-2009 global financial crisis, in December 2011, the Commission
unanimously approved a final rule amending Regulation Sec. 1.25 to
eliminate all foreign sovereign debt as permitted investments in
light of the economic crisis but remained open to the possibility of
reintroducing specific foreign debt.\21\ The Commission tightened
the definition of permissible investments.
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\20\ See Rules Relating to Intermediaries of Commodity Interest
Transactions, 65 FR 77993 (Dec. 13, 2000); Investment of Customer
Funds, 65 FR 82270 (Dec. 28, 2000) (making technical corrections and
accelerating the effective date of the final rules from February 12,
2001 to December 28, 2000).
\21\ Investment of Customer Funds and Funds Held in an Account
for Foreign Futures and Foreign Options Transactions, 76 FR 78776
(Dec. 19, 2011).
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History has demonstrated that certain sovereign debt instruments
may be risky. The financial crisis was closely intertwined with the
sovereign debt crisis, which is characterized by the economic
collapse in--and a deterioration in the credit quality of--Iceland,
Portugal, Italy, Ireland, Greece, and Spain. It is helpful that
sovereign debt from those countries are not proposed to be permitted
investments.
The Commission should reintroduce foreign sovereign debt as a
permitted investment with caution and sufficient guardrails. The
Commission is using the CDS spread of the sovereign issuer as a
proxy for default risk, such that the relevant sovereign is
disqualified if the issuer's two-year credit default spread exceeds
45 basis points. The CDS spread is the spread on protection pursuant
to a CDS against the default of the issuer of a debt instrument, and
an increase in the spread reflects a market perception that the
creditworthiness of the issuer has
[[Page 81289]]
deteriorated, implying an increased risk of non-payment on the debt
investment.
We must not forget that the CDS market came under heavy scrutiny
during the financial crisis. Warren Buffett infamously called CDS
``financial weapons of mass destruction.'' Since the adoption of the
Dodd-Frank Act, there has been significant contraction in a number
of important segments of the CDS market.
Given the nature of this specific market-based metric, I
encourage market participants, in responding to the request for
comment, to consider whether the use of the CDS spread, which is
dependent on a functioning CDS market, is (and the circumstances
under which it would be) an appropriate indicator of whether a
foreign sovereign debt is ``consistent with the objectives of
preserving principal and maintaining liquidity and according to the
following specific requirements.'' \22\
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\22\ 17 CFR 1.25(b).
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Interaction With Proposed U.S. Treasury Clearing Requirement
Financial markets are closely interconnected and correlated.
Consequently, we need a comprehensive and holistic approach to U.S.
treasury obligations. The Securities and Exchange Commission (SEC)
has announced a proposed rule that seeks to address the clearing of
certain repurchase or reverse repurchase agreements involving U.S.
treasury securities.
Our registrants, FCMs and DCOs, may buy and sell permitted
investments, including U.S. treasury obligations, pursuant to
repurchase and reverse repurchase transactions with permitted
counterparties, subject to certain conditions.
Upon the finalization of the SEC proposed rule, the Commission
may need to revisit Regulation Sec. 1.25 accordingly.
Conclusion
For the reasons above, I support the adoption of the Proposed
Rule. I look forward to the thoughtful contributions of market
participants.
Appendix 4--Statement of Commissioner Christy Goldsmith Romero
The CFTC's Sacrosanct Responsibility To Safeguard Customer Funds To
Protect Customers and Avoid Systemic Risk
Proposed Changes to Regulations Governing the Investment of Customer
Funds
The CFTC has a sacrosanct responsibility to safeguard customer
funds held by brokers and clearinghouses. For our markets to work
well, customers must have confidence that their funds will be safe.
Safe from a broker or clearinghouse who misuses customer money for
their own purposes or decides on their own to use customer funds to
make risky bets chasing their own profits.
The Importance of Customer Confidence and Public Confidence for Markets
to Work Well
History has shown that a loss of customer confidence in the
safety of their funds often has immediate negative consequences on
markets. Vulnerability to runs, increased customer redemption
requests, significant market volatility, and rapid and steep drop in
prices, can signal a loss of confidence. And given how
interconnected our markets are, this can happen very fast, and can
cause contagion. We saw an example earlier this year with Silicon
Valley Bank.
Promoting public and customer confidence in our markets is one
of the CFTC's most important regulatory responsibilities. There is a
disconnect between regular people and what goes on on Wall Street
and in Washington. That's a message from the late CFTC Commissioner
Bart Chilton at the open meeting the last time the CFTC took up this
same regulation in 2011.\1\ He was speaking with the backdrop of MF
Global's bankruptcy weeks before, where there were concerns of
misuse of customer funds. Commissioner Chilton said that we cannot
get disconnected, and sometimes it's just a matter of explaining
what we're doing. He said that we have to do the best we can to
explain to people what our job is, what our responsibilities are,
and that the first responsibility is to protect customer funds.
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\1\ See CFTC, Transcript of December 5, 2011 Open Commission
Meeting, https://www.cftc.gov/sites/default/files/idc/groups/public/@swaps/documents/dfsubmission/dfsubmission12_120511-trans.pdf.
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Well put, and I agree. Today we meet with the backdrop of the
conviction on all counts of the founder of FTX, counts that included
misuse of customer funds.\2\ It's not the same as MF Global. Regular
people may not realize that those missing FTX customer funds were in
an entity not regulated by the CFTC. But we have to stay connected
to regular people who might be concerned about the safety of their
funds in our markets. We have to explain how we are part of the
solution to safeguard customer funds. This is particularly important
because we have seen a rise of retail customers in our markets
associated with trading in cryptocurrency and event contracts--
retail customers who may not have the same ability as an
institutional customer to withstand losses or delays if a broker or
clearinghouse goes bankrupt.
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\2\ See United States Attorney Southern District of New York,
Statement Of U.S. Attorney Damian Williams On The Conviction Of
Samuel Bankman-Fried, https://www.justice.gov/usao-sdny/pr/statement-us-attorney-damian-williams-conviction-samuel-bankman-fried (Nov. 2, 2023).
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We have to send a message and show through our actions that the
CFTC is doing all that we can to protect customer funds.
Protecting Customer Funds by Limiting What They Can Be Invested In
One way the CFTC protects customer funds is by limiting what
they can be invested in. In section 4(d) of the Commodity Exchange
Act, Congress limited investments of customer funds to U.S.
government and other municipal securities, and obligations fully
guaranteed by the U.S.
The CFTC can make an exemption to section 4(d) to allow other
investment types if they meet certain carefully designed factors
established by Congress in section 4(c). From 2000 to 2005, the CFTC
used this exemptive authority to considerably loosen Regulation
Sec. 1.25 to allow brokers (FCMs) and clearinghouses (DCOs) to
invest customer funds in all kinds of investments.
Then there was the financial crisis, the Dodd Frank Act, and the
MF Global scandal. In 2011, the CFTC under Chairman Gary Gensler,
eliminated exemptions for certain investments that could pose an
unacceptable level of risk to customer funds.\3\ One investment type
eliminated in a 5-0 vote in 2011 was foreign sovereign debt. That
investment type is before us again today at the request of the same
groups (CME and FIA) who opposed the CFTC's elimination of foreign
sovereign debt as a permitted investment in 2011. While the
Commission subsequently made a limited exception for clearinghouses
in the debt of France and Germany in 2018, at that time, it declined
to apply that exception to brokers as requested by FIA.
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\3\ See 76 FR 78776 (Dec. 19, 2011) (``In issuing these final
rules, the Commission is narrowing the scope of investment choices
in order to eliminate the potential use of portfolios of instruments
that pose an unacceptable level of risk to customer funds.'').
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We need to be very cautious about revisiting post-crisis CFTC
reforms, particularly reforms that only came after substantial
public engagement and careful CFTC deliberation. In good economic
times like we are in today, we have to keep the lessons learned from
the past in mind, while we look to the future. One of those lessons
learned is that things can change quickly when it comes to risk.
We have to always keep sacrosanct our responsibility to protect
customer funds and avoid systemic risk. Holding customer funds is
not intended to be a way for brokers and clearinghouses to maximize
profits through investments that could prove risky. Customer funds
must only be invested in a way that minimizes exposure to credit,
liquidity, and market risk, not just now, but in the future. This
would preserve customer funds, and enable investments to be quickly
converted to cash at a predictable value, which is necessary to
avoid systemic risk. This has to be one of our top priorities.
That's why I support prohibiting investments of customer funds
in: (1) commercial paper; (2) corporate notes and bonds; (3) bank
certificates of deposit; (4) adjustable rate securities that
reference LIBOR; and (5) money market funds that are not government
money market funds or that charge a liquidity fee for customer
redemptions. I also support the concentration limits on money market
funds to protect customer funds from potential risk of loss from a
cyber-attack.
Proposed Expansion of How Brokers and Clearinghouses Can Invest
Customer Funds
The proposal before us would also make two exemptions under
section 4(d),\4\ allowing investments of customer funds in: (1) ETFs
that invest in primarily short-term U.S. Treasury securities; and
(2) sovereign debt of
[[Page 81290]]
five G7 countries (Canada, France, Germany, Japan, and the United
Kingdom) and expanding the list of counterparties to foreign banks,
brokers and dealers, and central banks.
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\4\ In addition to Regulation Sec. 1.25, the proposal also
applies to Regulation Sec. 30.7 that governs a broker's treatment
of customer funds associated with positions in foreign futures and
options. Additionally, the proposal applies to customer swaps funds
(cleared swaps customer collateral) held by brokers and
clearinghouses. See generally 17 CFR part 22 (implementing section
4d(f) of the Commodity Exchange Act).
---------------------------------------------------------------------------
Section 4(c)(2) sets a high bar for exemptions. The CFTC is
required to show:
1. It is in the public interest;
2. It is consistent with the purposes of the Act;
3. The agreements, contracts or transactions have to be between
appropriate persons; and
4. The exemption cannot have a material adverse effect on the
ability of the Commission or any contract market to discharge its
regulatory responsibilities.
I would have liked to see more independent CFTC analysis of
these factors in this proposal.
Public Interest Factor: I am concerned about the proposal's
discussion of the public interest factor:
The expanded selection of Permitted Investments is expected to
also permit FCMs and DCOs to remain competitive globally and
domestically and maintain safeguards against systemic risk. A wider
range of alternatives to invest futures customer funds may provide
more profitable investment options, allowing FCMs and DCOs to
generate more income for themselves and their customers. This, in
turn, may motivate FCMS and DCOs to increase their presence in the
futures markets and other relevant markets, thus increasing
competition. Increased revenue to FCMs and DCOs from the investment
of Customer Funds also may benefit customers in the form of lower
commission charges of direct interest payments on funds on deposit
with the FCM or DCO, which may lead to greater market participation
by customers and increased market liquidity. In light of the
foregoing, the Commission believes that the adoption of the proposed
amendments would promote responsible economic and financial
innovation and fair competition, and would be consistent with the
objective of Regulation 1.25 and with the ``public interest.''
We should be very careful about drawing the dangerous conclusion
that increased profits is a sufficient justification to satisfy the
public interest factor. This conclusion could justify granting every
requested exemption, which is surely not what Congress had in mind
or the message that we should send. It is important to remember that
broker and clearinghouse profit is not the goal for the CFTC, the
Commodity Exchange Act or the public. Chasing profits could lead to
risky investments, potentially putting customer funds at risk.
We should not draw an unsupported conclusion that if brokers and
clearinghouses make more profit, that the benefits will flow to
customers, as opposed to being kept for those companies or their
shareholders. There was also no independent supportive analysis that
additional profits would increase competition or innovation. I would
also have liked to see analysis on the avoidance of systemic risk,
not just a conclusory, unsupported statement that this change will
permit brokers and clearinghouses to ``maintain safeguards against
systemic risk.''
An independent CFTC analysis of whether a Commission action is
in the public interest is the important responsibility given to us
by Congress. The proposal discusses without supporting data or
analysis that the proposal could reduce foreign currency risk and
result in diversification of investments. However, those were the
same considerations that were not persuasive to the Commission in
2011. I encourage public interest groups and customers of brokers
and clearinghouses to let the CFTC know if they think these
exemptions are in the public interest. Should we go forward in the
future with a final rule, I would expect to see an independent and
supported CFTC analysis.
I would encourage the CFTC to engage in more data analysis, as
well as more roundtables and requests for comment, before proposing
rules or exemptions that revise post-crisis reforms. We may also be
able to use public interest analysis conducted by other federal
agencies. I would also encourage greater engagement with public
interest groups before proposing changes to rules, just as we engage
with industry.
Consistent with the Purposes of the Act: The purposes of the Act
are to deter and prevent price manipulation or other disruptions to
market integrity; to ensure the financial integrity of all
transactions and the avoidance of systemic risk; to protect all
market participants from fraudulent or other abusive sales practices
and misuses of customer assets; and to promote responsible
innovation and fair competition among boards of trade, other markets
and market participants.\5\
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\5\ 7 U.S.C. 5(b).
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The proposal contains a thorough and independent CFTC analysis
of conditions necessary to protect against the misuse of customer
assets. But the proposal's discussion of fair competition,
responsible innovation, and systemic risk is conclusory, without
supporting analysis. I encourage commenters and the public to let us
know if these exemptions are consistent with the purposes of the
Act.
Appropriate Persons Factor: I did not see discussion of this
important factor. The proposal would expand counterparties for
foreign sovereign debt, including foreign brokers and dealers, with
certain conditions. I would have liked to see an analysis of how
this factor is met. We should not assume that it is met, that no
analysis is needed or that Commissioners do not have views on
meeting this test. I look forward to commenters' views on this.
Should we go forward in the future with a final rule, I would expect
to see an independent supported CFTC analysis of this factor.
Discharge of Regulatory Responsibilities Factor: The CFTC's
regulatory responsibility in Regulation Sec. 1.25 is to preserve
principal and maintain liquidity. I commend the staff for the depth
and comprehension of this analysis, and appreciate the thorough
calibration of conditions to address future risk with sovereign
debt. I agree that investments in certain sovereign debt might be
consistent with preserving principal and maintaining liquidity. This
analysis found that government ETFs and sovereign debt in these
countries appear to be similar to existing permitted investments.
Commenters will tell us whether we have conducted the correct
analysis.
While I am supporting putting this out for public comment, I
also believe that we should be very cautious in overturning post-
crisis reforms. In 2011, the CFTC considered all of the same
concerns raised before us today, but decided unanimously to ban
investments in sovereign debt. The Commission in 2011 said that
although it appreciated the risk of foreign currency exposure, not
all sovereign debt, in all situations, is sufficiently safe. The
Commission said then that global and regional crises illustrated
that circumstances may quickly change, leaving a broker or
clearinghouse unable to timely liquidate the investment, and
potentially only after a significant mark-down.
At that time, the CFTC said it would consider exemption
requests. The staff explained that when considering such a request,
they would ask the petitioner why they need the exemption and to
explain why it is in the public interest, and analyze liquidity. The
record shows only one request in 12 years. In 2018, after notice and
receiving only supporting comments, the Commission approved a
limited exemption for clearinghouses to invest customer funds in the
sovereign debt of France and Germany, finding comparable credit,
liquidity and volatility characteristics to U.S. Government
securities.
In the proposal before us, the staff's analysis reflects that
the debt of these countries is similar to current permitted
investments, but may be less liquid than U.S. government securities.
The proposal asks whether these investments would raise any
liquidity or other concerns. I am interested in commenters' views on
this and on whether the expansion of counterparties will expose
customers to unacceptable levels of risk.
Given that we know that circumstances can change very quickly, I
often say that we should expect the unexpected. One alternative
would be to leave in place the current process of considering any
exemptive request, rather than change the rule, particularly if
there are concerns over liquidity or counterparties. This should not
be unduly burdensome given there was only one request in 12 years.
The Commission could consider the conditions at that time, the
reason for the request, the public interest, and liquidity. The
flexibility to conduct this type of analysis at the specific time of
the request, and after notice and comment, would be more targeted to
avoid systemic risk. And should circumstances change quickly, an
exemptive order could be much easier and faster to revisit than a
rule. I look forward to commenters' views on this alternative
compared to rewriting the rule.
Finally, I would urge CFTC staff to look for other safeguards
for customer funds in other Commission rules. Additional safeguards
would allow us to fulfill our sacrosanct responsibility to protect
customer funds, and promote public confidence.
Appendix 5--Statement of Support of Commissioner Caroline D. Pham
I support the Notice of Proposed Rulemaking on Investment of
Customer
[[Page 81291]]
Funds by Futures Commission Merchants and Derivatives Clearing
Organizations (Proposed Amendments to Regulation Sec. 1.25 or NPRM)
because, importantly, it provides regulatory clarity by codifying
outstanding no-action relief, and promotes good government by
providing a timely response to a petition from market participants.
I would like to thank Tom Smith, Warren Gorlick, Liliya Bozhanova,
and Jeff Burns for their work on the NPRM.
Regulatory clarity has a number of key aspects: transparency,
simplicity, and significantly, unambiguity. In turn, regulatory
clarity promotes compliance, market integrity, and confidence. As
regulators, in everything we do, we must remember that regulatory
clarity enables businesses to effectively comply with our
regulations, thereby reducing the likelihood of non-compliance
issues. It's why I have made regulatory clarity a guiding principle
of my commissionership.
Good government has a number of key aspects that overlap with
those of regulatory clarity: transparency and simplicity, for
instance. However, responsiveness is an aspect unique to good
government. In serving the public, we must be mindful that we are
here to be responsive to the concerns and needs of our
constituents--in our case, market participants. Good government, in
turn, promotes economic growth and progress. It's why I have made
good government something I am always striving to encourage as
Commissioner.
Background
Regulation Sec. 1.25 is the primary CFTC rule setting forth
safeguards for the investment of customer funds held by futures
commission merchants (FCMs) and derivatives clearing organizations
(DCOs). As the Commission has said in the past, customer segregated
funds must be invested in a manner that minimizes their exposure to
credit, liquidity, and market risks, both to preserve their
availability to customers and DCOs and to enable investments to be
quickly converted to cash at a predictable value to avoid systemic
risk.\1\ These safeguards are vital in maintaining confidence in our
markets.
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\1\ Investment of Customer Funds and Funds Held in an Account
for Foreign Futures and Foreign Options Transactions, 76 FR 78776
(Dec. 19, 2011).
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The requirement for a FCM or DCO to treat customer funds as
belonging to the customers, and for the FCM or DCO to segregate
customer funds from its own funds, is a critical component of this
framework. The Commodity Exchange Act (CEA) and CFTC regulations
provide three regulatory frameworks based on the market in which
customers are transacting: (i) futures customer funds; (ii) cleared
swaps customer collateral; or (iii) 30.7 customer funds.\2\
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\2\ See, 17 CFR 1.20 (segregation framework for futures customer
funds); 17 CFR 22.2 and 22.3 (segregation framework for cleared
swaps customer collateral); and 17 CFR 30.7 (segregation framework
for 30.7 customer funds).
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CEA section 4d(a)(2) covers futures customer funds, setting
forth the framework for requiring FCMs to treat futures customer
funds as belonging to the futures customer.\3\ CEA section 4d(b)
addresses the duties imposed on DCOs and other depositories
receiving futures customer funds from FCMs pursuant to section
4d(a)(2).\4\ Regulations Sec. Sec. 1.20 through 1.30, and
Regulations Sec. Sec. 1.32 and 1.49 implement sections 4d(a)(2) and
4d(b).\5\
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\3\ 7 U.S.C. 6d(a)(2).
\4\ 7 U.S.C. 6d(b).
\5\ 17 CFR 1.20 through 17 CFR 1.30, 17 CFR 1.32, and 17 CFR
1.49.
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CEA section 4d(f)(2)(A) covers cleared swaps customer
collateral, setting forth a framework for requiring FCMs to treat
cleared swaps customer collateral as belonging to the cleared swaps
customer.\6\ Regulations Sec. Sec. 22.2 through 22.13, and
Regulations Sec. Sec. 22.15 through 22.17, implement CEA section
4d(f).\7\ And CEA section 4(b)(2)(A) covers 30.7 customer funds,
setting forth a framework for requiring FCMs to safeguard 30.7
customer funds deposited by 30.7 customers for trading on foreign
boards of trade (FBOTs).\8\ Regulation Sec. 30.7 implements CEA
section 4(b)(2)(A).\9\
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\6\ 7 U.S.C. 6d(f)(2)(A).
\7\ 17 CFR 22.2 through 17 CFR 22.13, 17 CFR 22.15 through 17
CFR 22.17.
\8\ 7 U.S.C. 6(b)(2)(A).
\9\ 17 CFR 30.7.
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A cornerstone of these frameworks is the ability of FCMs and
DCOs to invest customer funds. CEA section 4d(a)(2) authorizes FCMs
to invest futures customer funds in: (i) obligations of the U.S.;
(ii) obligations fully guaranteed as to principal and interest by
the U.S.; and (iii) general obligations of any State or of any
political subdivision of a State.\10\ Regulation Sec. 1.25 was
initially adopted to implement section 4d(a)(2), and authorized FCMs
and DCOs to invest futures customer funds in the instruments set
forth in section 4d(a)(2) of the Act (the Permitted
Investments).\11\
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\10\ 7 U.S.C. 6d(a)(2).
\11\ See Title 17--Commodity and Securities Exchanges, 33 FR
14454 (Sept. 26, 1968).
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Over time, the Commission has changed the Permitted Investments:
in 2000, for instance, expanding the list to include certificates of
deposit, commercial paper, corporate notes, foreign sovereign debt,
and interests in money market funds. Currently, Regulation Sec.
1.25 lists seven categories of investments that qualify as Permitted
Investments.\12\ In addition, the Commission extended Regulation
Sec. 1.25 to apply to an FCM's investment of 30.7 customer funds
for trading foreign futures positions, and to FCMs and DCOs
investing cleared swaps customer collateral.\13\
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\12\ 17 CFR 1.25(a)(1).
\13\ See 17 CFR 22.2(e)(1) and 17 CFR 22.3(d).
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When looking at Regulation Sec. 1.25, the Commission always has
to balance the need to safeguard customer funds, against retaining
an appropriate degree of flexibility for FCMs and DCOs to invest
funds and attain capital efficiency. I believe the Proposed
Amendments to Regulation Sec. 1.25 continue to strike the right
balance, though I encourage commenters to comment on that facet.
How the Commission Does, and Should Continue to, Promote Regulatory
Clarity and Good Government
I would like to highlight two aspects of the Proposed Amendments
to Regulation Sec. 1.25 that provide examples of regulatory clarity
and good government.
The NPRM endeavors to promote regulatory clarity by codifying
outstanding CFTC staff no-action relief, proposing to replace LIBOR
with SOFR as a permitted benchmark for adjustable rate securities.
Regulation Sec. 1.25(b)(2)(iv)(A) provides that permitted
investments may contain variable or floating rates of interest
provided, among other things, that: (i) the interest payments on
variable rate securities correlate closely, and on an unleveraged
basis, to a benchmark of either the Federal Funds target or
effective rate, the prime rate, the three-month Treasury Bill rate,
the one-month or three-month LIBOR, or the interest rate of any
fixed rate instrument that is a listed permitted investment under
Regulation Sec. 1.25(a); \14\ and (ii) the interest rate, in any
period, on floating rate securities is determined solely by
reference, on an unleveraged basis, to a benchmark of either the
Federal Funds target or effective rate, the prime rate, the three-
month Treasury Bill rate, the one-month or three-month LIBOR, or the
interest rate of any fixed rate instrument that is a listed
permitted investment under Regulation Sec. 1.25(a).\15\
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\14\ 17 CFR 1.25(b)(2)(iv)(A)(1).
\15\ 17 CFR 1.25(b)(2)(iv)(A)(2).
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As we all know, it was announced in March 2021 that LIBOR would
cease to be published and would effectively be discontinued.\16\ In
response to the Alternative Reference Rate Committee (ARRC)
identifying SOFR as the preferred alternative benchmark to USD LIBOR
for certain new USD derivatives and financial contracts,\17\ CFTC
staff issued Staff Letter 21-02 in January 2021,\18\ permitting FCMs
to invest customer funds in permitted investments that contain
adjustable rates of interest benchmarked to SOFR. A later CFTC Staff
letter 22-21 extended the effective date of the no-action position
to December 31, 2024, and expanded the scope of the no-action
position to include permitted investments made by DCOs.\19\
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\16\ See CFTC Staff Letter No. 21-26, Revised No-Action
Positions to Facilitate an Orderly Transition of Swaps from Inter-
Bank Offered Rates to Alternative Benchmarks (Dec. 20, 2021).
\17\ ARRC, ``The ARRC Selects a Broad Repo Rate as its Preferred
Alternative Reference Rate,'' June 22, 2017, available at https://www.newyorkfed.org/medialibrary/microsites/arrc/files/2017/ARRC-press-release-Jun-22-2017.pdf.
\18\ See CFTC Staff Letter No. 22-21, CFTC Regulation 1.25--
Investment of Customer Funds in Securities with an Adjustable Rate
of Interest Benchmarked to [SOFR]--Extension of Time-Limited No-
Action Position Concerning Investments by [FCMs] and No-Action
Position Concerning Investments by [DCOs], Dec. 23, 2022.
\19\ See id.
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Given the discontinuation of LIBOR and the increasing use of
SOFR, the Commission is proposing to amend Regulation Sec.
1.25(b)(2)(iv)(A) by replacing LIBOR with SOFR as a permitted
benchmark for
[[Page 81292]]
permitted investments that contain an adjustable rate of interest.
To give effect to this revision, paragraphs (b)(2)(iv)(A)(1) and (2)
of Regulation Sec. 1.25 would be amended to replace the phrase
``one-month or three-month LIBOR rate'' with the phrase ``SOFR
rate.''
This is important to me for three reasons. First, I have been
vocal that the Commission must not get stuck in a never-loop of
extending staff no-action relief.\20\ To be sure, no-action relief
has its place in our regulatory framework.\21\ But the Commission
should seek to find pragmatic solutions to fixing unworkable rules.
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\20\ See Statement of Commissioner Caroline D. Pham on
Conditional Order of SEF Registration (July 20, 2022).
\21\ See e.g., Statement of Commissioner Caroline D. Pham on
Staff Letter Regarding ADM Investor Services, Inc. (June 16, 2023).
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Second, I appreciate the Commission is taking action in advance
of the relief expiration date of December 2024. Firms expend
considerable resources to come into compliance with our
requirements. To the extent our requirements are changing (e.g.,
staff no-action relief is expiring), waiting on the part of the
Commission only unnecessarily increases the risks and costs to firms
for implementation.
And third, I am pleased the NPRM does not propose to impose any
additional conditions beyond the relief contained in CFTC staff
letter 22-21. Conditions may have their place, but the Commission
needs to avoid a ``kitchen sink'' approach when applying them.
All of this comes together to provide an example of what
regulatory clarity needs to entail. Extraneous changes, unworkable
conditions, and waiting too long to act all inhibit regulatory
clarity by introducing ambiguity, unnecessary burdens, and wasted
time.
The NPRM also endeavors to promote good government by providing
a timely, thorough response to a petition submitted by market
participants.
The Futures Industry Association (FIA) and CME Group Inc. (CME)
submitted a joint petition requesting the Commission to expand
investments that FCMs and DCOs may enter into with Customer
Funds.\22\ The Petitioners requested that the Commission permit FCMs
and DCOs to invest Customer Funds in the foreign sovereign debt of
Canada, France, Germany, Japan, and the United Kingdom, subject to
the condition that the investment in the foreign sovereign debt is
limited to balances owed by FCMs and DCOs to customers and FCM
clearing firms, respectively, denominated in the applicable currency
of Canada, France, Germany, Japan, or the United Kingdom.\23\ The
Petitioners further request that the Commission exempt FCMs and DCOs
from the provisions of Regulation Sec. 1.25(d)(2) to authorize FCMs
and DCOs to enter into Repurchase Transactions involving Specified
Foreign Sovereign Debt with foreign banks and foreign securities
brokers or dealers and to hold Specified Foreign Sovereign Debt in
safekeeping accounts at foreign banks.\24\
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\22\ Petition for Order under Section 4(c) of the Commodity
Exchange Act, dated May 24, 2023 (the Joint Petition). The Joint
Petition and a Supplement are available on the Commission's website.
\23\ Joint Petition at p. 4.
\24\ Joint Petition at p. 5.
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The Petitioners further request that FCMs and DCOs be permitted
to invest Customer Funds in certain ETFs that invest primarily in
short-term U.S. Treasury securities (U.S. Treasury ETFs),\25\
because U.S. Treasury ETFs have characteristics that may be
consistent with those of other Permitted Investments and may provide
FCMs and DCOs with an opportunity to diversify further their
investments of customer funds.\26\
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\25\ Joint Petition at pp. 8-9.
\26\ Id.
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This is important to me for two reasons. First, the Commission
is providing a timely response to the petition. Not only does every
market participant deserve a response to a request to the
Commission, but they deserve a response in a reasonable amount of
time. Second, the NPRM does not propose additional conditions beyond
what was requested in the Joint Petition. Instead, and admirably,
the Commission requests comment where it is unsure about conditions,
after a careful and thorough analysis of its proposed actions.
In conclusion, I am pleased to support the NPRM because multiple
aspects set an example for how the Commission can promote regulatory
clarity and good government in all areas of its regulation and
oversight. Thank you again to the staff for their hard work, and I
look forward to the comments on the Proposed Amendments to
Regulation Sec. 1.25.
[FR Doc. 2023-24774 Filed 11-20-23; 8:45 am]
BILLING CODE 6351-01-P