2023-28767
[Federal Register Volume 89, Number 2 (Wednesday, January 3, 2024)]
[Proposed Rules]
[Pages 286-307]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-28767]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 39
RIN 3038-AF39
Protection of Clearing Member Funds Held by Derivatives Clearing
Organizations
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (CFTC or Commission)
is proposing regulations to ensure clearing member funds and assets
receive the proper treatment in the event the derivatives clearing
organization (DCO) enters bankruptcy by requiring, among other things,
that clearing member funds be segregated from the DCO's own funds and
held in a depository that acknowledges in writing that the funds belong
to clearing members, not the DCO. In addition, the Commission is
proposing to permit DCOs to hold customer and clearing member funds at
foreign central banks subject to certain requirements. Finally, the
Commission is proposing to require DCOs to conduct a daily calculation
and reconciliation of the amount of funds owed to customers and
clearing members and the amount actually held for customers and
clearing members.
DATES: Comments must be received by February 16, 2024.
ADDRESSES: You may submit comments, identified by RIN 3038-AF39, by any
of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above. Please submit your comments using only one of these
methods. Submissions through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be
[[Page 287]]
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 (2022), and are accessible on the
Commission's website at 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: Eileen A. Donovan, Deputy Director,
202-418-5096, [email protected], Division of Clearing and Risk,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street NW, Washington, DC 20581; Theodore Z. Polley, Associate
Director, 312-596-0551, [email protected]; or 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:
I. Background
A. Proprietary Funds
Section 4d of the Commodity Exchange Act (CEA) and part 1 of the
Commission's regulations establish a comprehensive regime to safeguard
the funds belonging to customers of a futures commission merchant
(FCM).\2\ Commission regulations define a ``customer'' as any person
who uses an FCM, introducing broker, commodity trading advisor, or
commodity pool operator as an agent in connection with trading in any
commodity interest, and therefore, this customer protection regime does
not apply to the funds of any person who clears trades directly through
a DCO, who is a ``clearing member.'' \3\ At the most general level, the
customer protection regime requires FCMs to segregate customer funds
from their own funds, deposit customer funds under an account name that
clearly identifies them as customer funds,\4\ and obtain a written
acknowledgment from each depository that holds customer funds.\5\ These
acknowledgment letters, which must adhere to specific templates
contained in the Commission's regulations, require a depository to
acknowledge, among other things, that the accounts opened by the FCM
hold funds that belong to the FCM's customers. The customer protection
regime also establishes accounting and reporting requirements
applicable to customer funds,\6\ and limits both the types of
investments that can be made with customer funds \7\ and the type of
depositories that can hold customer funds.\8\
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\2\ 7 U.S.C. 6d; 17 CFR 1.20-1.39. See also 17 CFR 22.1-22.17,
and 30.7 (establishing similar regimes for cleared swaps customer
collateral and foreign futures customer funds).
\3\ 17 CFR 1.3.
\4\ 17 CFR 1.20(a).
\5\ 17 CFR 1.20, 22.5, and 30.7 (requiring an acknowledgment
letter for futures customer funds, cleared swaps customer
collateral, and foreign futures customer funds, respectively).
\6\ 17 CFR 1.32, 1.33.
\7\ 17 CFR 1.25.
\8\ 17 CFR 1.49.
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Many of the customer protection requirements that apply to FCMs
also apply to DCOs that receive customer funds from their FCM clearing
members. DCOs must segregate the customer funds of their FCM clearing
members from their own funds,\9\ deposit customer funds under an
account name that identifies the funds as customer funds,\10\ obtain
acknowledgment letters from depositories,\11\ limit the investment of
customer funds to instruments listed in Sec. 1.25,\12\ and limit
depositories for customer funds to those listed in Sec. Sec. 1.20 and
1.49.\13\ These protections, however, do not extend to clearing members
of DCOs. Only section 5b(c)(2)(F) of the CEA (Core Principle F) and
Sec. 39.15 apply to the treatment of clearing members' funds and
assets held by a DCO in relation to cleared contracts (proprietary
funds).\14\ These provisions require DCOs to establish standards and
procedures that are designed to protect and ensure the safety of
proprietary funds and require DCOs to hold proprietary funds in a
manner that will minimize the risk of loss or delay in access by the
DCO to the proprietary funds.\15\ These provisions further require any
investment of proprietary funds to be in instruments with minimal
credit, market, and liquidity risks.\16\
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\9\ 17 CFR 1.20(g)(1); 17 CFR 39.15 (b); 17 CFR 22.3(b)(1).
\10\ 17 CFR 1.20(g)(1).
\11\ 17 CFR 1.20(g)(4); 17 CFR 22.5.
\12\ 17 CFR 39.15(e).
\13\ 17 CFR 1.20(g)(2), (3); 17 CFR 22.3(b) (cross-referencing
17 CFR 22.4).
\14\ This definition of proprietary funds is only for
explanatory purposes in the background section. As discussed further
below, the Commission is proposing a definition of ``proprietary
funds'' that is referred to throughout the remainder of this
proposed rulemaking.
\15\ 7 U.S.C. 7a-1(c)(2)(F); 17 CFR 39.15.
\16\ Id.
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Section 8a(5) of the CEA grants the Commission authority to adopt
rules it determines are reasonably necessary to effectuate, among other
things, the DCO core principles.\17\ The Commission's initial focus in
implementing Core Principle F was on the custody and safeguarding of
customer funds, consistent with section 4d of the CEA. This approach
was largely responsive to the historical prevailing model in which all
or nearly all clearing members of a DCO are FCMs. However, the
Commission has since granted registration to a number of DCOs that
clear directly for market participants without the intermediation of
FCMs, including, in most cases, market participants who are natural
persons (i.e., individuals).\18\ Additionally, many DCOs that use the
traditional FCM clearing model have at least some non-FCM clearing
members. The Commission therefore is proposing safeguards for
proprietary funds to provide protections for clearing members
comparable to those applicable to customers.\19\ The Commission has
preliminarily determined that each of these additional safeguards is
reasonably necessary to effectuate DCO Core Principle F.\20\
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\17\ 7 U.S.C. 12a(5).
\18\ Currently, CBOE Clear Digital, LLC; CX Clearinghouse, L.P.;
LedgerX, LLC; and North American Derivatives Exchange Inc. allow
individuals to be direct clearing members. Further, ICE NGX Canada
Inc. clears physically delivered energy contracts directly for
clearing members with a net worth exceeding CAD $5,000,000 or assets
exceeding CAD $25,000,000.
\19\ The U.S. Bankruptcy Code requires a bankruptcy trustee to
distribute clearing members' cash and other assets held by a debtor
DCO ratably among all clearing members. 11 U.S.C. 766(i)(2); 11
U.S.C. 761(9)(D), (10), (16). Therefore, the Commission cannot
effectively create multiple account classes for the clearing members
of a DCO--e.g., one for FCM proprietary funds and one for non-FCM
proprietary funds--because the different account classes would not
be recognized by a bankruptcy court.
\20\ CEA section 5b(c)(2)(F), 7 U.S.C. 7a-1(c)(2)(F).
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Specifically, the Commission is proposing to require a DCO to hold
proprietary funds separately from the DCO's own funds, in accounts that
are named to clearly identify the funds as belonging to clearing
members. The
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Commission is further proposing to prohibit a DCO or any depository
from using proprietary funds in any way other than as belonging to the
clearing member.
Additionally, the proposed rules include requirements for a DCO to
review, on a daily basis, the amount of funds owed to each clearing
member with respect to each of its accounts, both customer (including,
as relevant, futures and cleared swaps) and proprietary, and to
reconcile those figures to the amount of funds held in aggregate in
each such type of account across all of the DCO's depositories.
The Commission is also proposing to require a DCO to obtain a
letter from the depository for each account holding proprietary funds
(proprietary funds letter) acknowledging, among other things, that the
funds belong to clearing members and cannot be used by the DCO for any
other purpose. The proposed proprietary funds letter is based on the
template acknowledgment letter that a DCO is required to use in
connection with customer funds.\21\
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\21\ See 17 CFR 1.20 App. B.
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In addition to preventing the misuse of proprietary funds, the
proposed requirements would help ensure that proprietary funds are
appropriately protected in the event of a DCO bankruptcy. The U.S.
Bankruptcy Code establishes that in the event of a DCO bankruptcy,
member property, which includes funds held for clearing members'
proprietary accounts,\22\ is repaid to clearing members pro rata based
on their claims for such funds, and ahead of most other claims against
the DCO's estate.\23\ Further, part 190 of the Commission's regulations
establishes how clearing members' claims against the DCO's estate
should be determined and how payments should be allocated among
clearing members.\24\ By requiring proprietary funds to be held
separately from the DCO's funds and easily identified in a proprietary
funds letter, the proposed rules will enable a bankruptcy court or
trustee to more clearly identify these funds as member property.
Further, the proposed rules will require the DCO to verify, on a
regular basis, that it is holding the proper amount of proprietary
funds, thus ensuring that these funds would be available for
distribution in the event of a DCO bankruptcy.
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\22\ See 11 U.S.C. 761(16) (defining ``member property'' as
cash, a security, or other property, or proceeds of such cash,
security, or property, held by a DCO for a clearing member's
proprietary account).
\23\ See 11 U.S.C. 766(i) (providing that member property is
distributed ratably to clearing members on the basis and to the
extent of their allowed net equity claims based on their proprietary
accounts, and in priority to all other claims, except claims related
to the administration of member property).
\24\ See 17 CFR 190.00-190.19.
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B. Central Bank Depositories
The Commission is also proposing requirements specific to obtaining
written acknowledgments from central banks holding customer or
proprietary funds.\25\ When the Commission adopted the template
acknowledgment letter for depositories holding customer funds in 2013,
it did not require use of the template letter by Federal Reserve Banks,
due to the ``unique role'' of the U.S. central bank.\26\ The Commission
also recognized that there may be valid reasons why some foreign
depositories would require modifications to the letter and stated that,
in such circumstances, the Commission would consider ``alternative
approaches'' on a case-by-case basis.\27\
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\25\ ``Central bank'' is the term used to describe the authority
responsible for policies that affect a country's supply of money and
credit. See, e.g., https://www.clevelandfed.org/publications/economic-commentary/2007/ec-20071201-a-brief-history-of-central-banks.
\26\ Enhancing Protections Afforded Customers and Customer Funds
Held by Futures Commission Merchants and Derivatives Clearing
Organizations, 78 FR 68506, 68535 (Nov. 14, 2013).
\27\ Id. at 68536.
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Since then, the Commission's Division of Clearing and Risk (DCR)
has issued several no-action letters in which the Division confirmed
that it would not recommend that the Commission take enforcement action
against a DCO for making certain modifications to the template
acknowledgment letter in connection with customer accounts maintained
at a foreign central bank.\28\ To encourage the use of central bank
accounts, which can provide a superior alternative to holding funds at
a commercial bank from the perspective of credit and liquidity risk,
the Commission is proposing to allow a DCO to hold customer and
proprietary funds at certain central banks without obtaining the
template acknowledgment letter for customer funds or the proposed
proprietary funds letter. Instead, a DCO would need to obtain only a
written acknowledgment that the central bank was informed that the
funds deposited with the bank are customer or proprietary funds (as
applicable) held in accordance with section 4d or 5b of the CEA, and
that the central bank agrees to respond to requests from specified
Commission staff for information about the account, including the
account balance (modified written acknowledgments). These proposed
requirements are based on the requirements the Commission adopted in
2013 with regard to written acknowledgments from Federal Reserve
Banks.\29\
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\28\ See, e.g., CFTC Letter No. 14-124 (Oct. 8, 2014) (related
to customer accounts held at the Bank of England); CFTC Letter No.
16-05 (Feb. 1, 2016) (related to customer accounts held at the
Deutsche Bundesbank).
\29\ Enhancing Protections Afforded Customers and Customer
Funds, 78 FR at 68628. In 2016, the Commission issued an order under
section 4(c) of the CEA conditionally exempting Federal Reserve
Banks from section 4d of the CEA (Order Exempting the Federal
Reserve Banks from Sections 4d and 22 of the Commodity Exchange Act,
81 FR 53467 (Aug. 12, 2016)). The conditions of the order require
Federal Reserve Banks to keep customer funds segregated and respond
to information requests from the Commission, making a separate
written acknowledgment from a Federal Reserve Bank unnecessary. The
Commission therefore repealed the 2013 provision (then Sec.
1.20(g)(4)(ii)) concerning written acknowledgments from Federal
Reserve Banks and adopted current Sec. 1.20(g)(4)(i), which
excludes Federal Reserve Banks from the written acknowledgment
requirement.
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The Commission is proposing to allow use of the modified written
acknowledgment only by a DCO that holds customer or proprietary funds
at the central bank of a ``money center country'' as defined in Sec.
1.49--Canada, France, Germany, Italy, Japan, and the United Kingdom--to
limit risks to customer and proprietary funds. Along with the United
States, these countries comprise the Group of Seven (G7).
Representatives from the G7 countries meet several times each year to
coordinate their cooperation on issues of economic policy, and the
United States and its financial regulatory agencies have a history of
successful cooperation with the respective financial regulatory
agencies of these countries. When the definition of ``money center
country'' was first proposed in connection with the adoption of Sec.
1.49, a commenter suggested that the definition include ``other
locations with stable currencies and other indicia that customer funds
will be relatively secure.'' \30\ The Commission rejected this proposal
as difficult to apply and noted that it would require the Commission to
expend significant resources to conduct a broad evaluation of, among
other things, a country's banking, monetary, and economic policies and
systems.\31\ The Commission believes that limiting the proposed change
to central banks of money center countries appropriately considers
security for customer and proprietary funds, flexibility for DCOs, and
creating a system that is workable in practice.
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\30\ See Denomination of Customer Funds and Location of
Depositories, 68 FR at 5546-5547 (Mar. 6, 2003).
\31\ Id.
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Further, the Commission is not proposing to require a DCO to obtain
an
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acknowledgment letter from a Federal Reserve Bank holding proprietary
funds. This is consistent with Sec. 1.20(g)(4), which states that a
DCO does not need a written acknowledgment to hold customer funds held
at a Federal Reserve Bank. Federal Reserve Banks have previously
expressed an inability to agree to all of the terms in the template
acknowledgment letter.\32\ Because Federal Reserve Banks are the source
of liquidity for U.S. dollar deposits, a DCO would face lower credit
and liquidity risk with a deposit at a Federal Reserve Bank than it
would with a deposit at a commercial bank. In the context of customer
funds, the Commission determined that it would not require a written
acknowledgment from Federal Reserve Banks in order to facilitate use of
these accounts and help obtain these benefits that ultimately serve
market participants and the integrity of the financial markets.\33\ The
Commission believes that the same rationale applies with respect to
proprietary funds. Further, the Commission has required DCOs with
access to accounts and services at a Federal Reserve Bank to use such
accounts and services where practical,\34\ and as a policy matter seeks
to facilitate use of those accounts.
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\32\ Enhancing Protections Afforded Customers and Customer
Funds, 78 FR at 68535.
\33\ Denomination of Customer Funds and Location of
Depositories, 68 FR at 53468 (Mar. 6, 2003).
\34\ 17 CFR 39.33(d)(5).
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II. Definitions--Sec. 39.2
The Commission is proposing to add in Sec. 39.2 a definition for
``money center country'' that is identical to the definition currently
in Sec. 1.49. Under the proposed definition, ``money center country''
means Canada, France, Germany, Italy, Japan, and the United Kingdom.
The Commission is also proposing a definition for ``proprietary
funds.'' The definition uses language similar to that included in the
current definitions of ``futures customer funds'' in Sec. 1.3 \35\ and
``cleared swaps customer collateral'' in Sec. 22.1.\36\ The proposed
definition includes all money, securities, and property held in a
proprietary account \37\ on behalf of clearing members used to margin,
guarantee, or secure futures, foreign futures and swaps contracts, as
well as option premiums and other funds held in relation to options
contracts. The proposed definition also includes clearing member
contributions to a guaranty fund to mutualize the losses resulting from
a default by a clearing member.\38\
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\35\ 17 CFR 1.3.
\36\ 17 CFR 22.1.
\37\ See 17 CFR 1.3 (defining ``proprietary account'' as a
commodity futures, commodity options, or swaps trading account, for
the clearing member itself, or for certain owners and affiliates of
the clearing member).
\38\ These guaranty fund contributions include those received
pursuant to an assessment for additional guaranty fund contributions
when permitted by a DCO's rules.
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For the avoidance of doubt, a proprietary account may be the
``house'' account of a clearing member that is an FCM, where the
clearing member may also maintain a futures customer and/or cleared
swaps customer account. The term also would include the account of a
direct clearing member (that may or may not be a natural person) that
does not intermediate transactions for anyone else.
III. Treatment of Funds--Sec. 39.15
A. Holding Customer Funds at Central Banks--Sec. 39.15(b)(3)
The Commission is proposing to amend Sec. 39.15(b) to allow a DCO
to hold customer funds at the central bank of a money center country.
The proposed amendment would supplement the list of permissible
depositories in Sec. 1.49 and Sec. Sec. 22.4 and 22.9. Currently,
Sec. 1.49 and Sec. 22.9 limit foreign depositories for customer funds
to a bank or trust company that has in excess of $1 billion of
regulatory capital, an FCM, or a DCO. Foreign central banks, as
independent government entities, are not structured to meet regulatory
capital requirements and are therefore excluded from holding customer
funds under Sec. 1.49.
The Commission believes a DCO holding customer funds at a central
bank can be a superior alternative to holding commercial bank deposits
because it limits the DCO's credit and liquidity risks. The Commission
is therefore proposing new Sec. 39.15(b)(3) to permit a DCO to hold
customer funds at the central bank of a money center country if the DCO
obtains a modified written acknowledgment, rather than the template
acknowledgment letter required by Sec. Sec. 1.20 and 22.5, to which
some central banks have objected.\39\ The proposed rule would require
the central bank of a money center country only to acknowledge that it
was informed that the funds deposited with the bank are customer funds
held in accordance with section 4d of the CEA and to agree to respond
to requests from the Commission for information about the account,
including the account balance. The Commission believes the proposed
rule would facilitate the holding of customer funds at the central
banks of money center countries while ensuring appropriate customer
protections.
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\39\ See, e.g., CFTC Letter No. 14-124 (Oct. 8, 2014); CFTC
Letter No. 16-05 (Feb. 1, 2016) (regarding modifications to the
template acknowledgment letter to enable certain central banks to
hold customer funds).
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The Commission believes that central banks are often the safest
place to deposit customer funds and has provided exemptions from Sec.
1.49 to permit customer funds to be held at foreign central banks in
money center countries.\40\ The proposed rule would codify those
exemptions and permit DCOs to hold customer funds with the central bank
of a money center country. As previously discussed, the Commission is
proposing to limit the permissible central bank depositories to those
of money center countries after considering security for customer
funds, flexibility for DCOs, and the need to create a system that is
workable in practice.
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\40\ See, e.g., CFTC Letter No. 14-124 (Oct. 8, 2014); CFTC
Letter No. 16-05 (Feb. 1, 2016) (granting exemptive relief from
Sec. 1.49 to permit certain central banks to act as a depository
for customer funds).
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B. Permitted Investments--Sec. 39.15(e)
The Commission is proposing to amend Sec. 39.15(e) to permit a DCO
to invest proprietary funds only as permitted for investment of
customer funds under Sec. 1.25. The proposed regulation specifies that
the DCO would bear any losses from investments, as is the case with
customer funds.\41\ The list of investments in Sec. 1.25 is a
conservative list, and the Commission believes it is appropriate for
all types of clearing members. Currently, permissible investments under
Sec. 1.25 include, among other investments, general obligations of the
U.S. government, general obligations of any U.S. state or municipality,
certificates of deposit, and interests in money market funds.\42\
Further, Sec. 1.25 specifies a number of terms and conditions with
which permitted investments must comply, including limits on the
features that an investment can contain, concentration limits, and time
to maturity limits.\43\ Regulation Sec. 1.25 also includes specific
requirements for investments in money market funds and repurchase
agreements.\44\ By limiting investments of proprietary funds to
investments that meet the requirements
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of Sec. 1.25,\45\ the proposed rule will ensure that any investment of
proprietary funds will have minimal credit, market, and liquidity risk
as required by Core Principle F.\46\
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\41\ 17 CFR 1.29(b).
\42\ 17 CFR 1.25(a); see also Investment of Customer Funds by
[FCMs] and [DCOs], 88 FR 81236 (Nov. 21, 2023) (proposing, among
other changes, to add certain foreign sovereign debt and certain
U.S. Treasury exchange traded funds, both subject to limitations, to
the list of permitted investments and to limit the types of money
market funds that are permitted investments).
\43\ 17 CFR 1.25(b).
\44\ 17 CFR 1.25(c), (d).
\45\ Proposed Sec. 39.15(e) cross-references Sec. 1.25, which
provides that an FCM or DCO may invest ``customer money'' in certain
instruments. The regulatory text of Sec. 1.25, however, does not
refer to ``proprietary funds.'' The Commission recently approved
proposed amendments to Sec. 1.25. Based on comments received on
those proposed amendments, if appropriate, the Commission may
consider further amending Sec. 1.25 either in the final rule or as
a re-proposed rule to ensure that the regulatory text provides
clarity on the application of Sec. 1.25 to a DCO's investment of
``proprietary funds,'' as permitted under Sec. 39.15(e).
\46\ 7 U.S.C. 7a-1(c)(2)(F); 17 CFR 39.15(e).
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C. Additional Protections for Proprietary Funds--Sec. 39.15(f)
The Commission is proposing new Sec. 39.15(f) to establish
additional protections for proprietary funds.
1. Segregation of Proprietary Funds--Sec. 39.15(f)(1)
Proposed Sec. 39.15(f)(1) is based on Sec. 1.20(a) and would
require a DCO to account for proprietary funds separately from its own
funds, and to hold proprietary funds in accounts that are named to
clearly identify the funds being held as belonging to clearing members.
The Commission believes this would prevent misuse of proprietary funds
by a DCO, and would help a bankruptcy trustee or judge to easily
identify the funds that should be treated as member property in the
unlikely event of a DCO bankruptcy. The proposed rule also would
require the DCO to, at all times, maintain in the accounts holding
proprietary funds enough resources to cover the total value of
proprietary funds owed to its clearing members. The proposed rule would
prevent a DCO from rehypothecating or otherwise using proprietary funds
for its own benefit, thus ensuring that the funds are available when
needed by clearing members or the DCO for permitted uses.
2. Written Acknowledgment from Depositories--Sec. 39.15(f)(2)
The Commission is proposing to require a DCO to obtain from any
depository holding proprietary funds a written acknowledgment that the
funds belong to the DCO's clearing members and cannot be used by the
DCO for any other purpose. The Commission is proposing a template
proprietary funds letter that DCOs would be required to use, which
would be contained in proposed appendix D to part 39. The proposed
template proprietary funds letter is substantively the same as the
current template acknowledgment letter for DCO accounts holding futures
customer funds required by Sec. 1.20, and requires a depository to
acknowledge, among other things, that the accounts referenced in the
letter hold funds that belong to the DCO's clearing members, that the
funds should be accounted for separately from those belonging to the
DCO, and that the funds cannot be used to cover the DCO's obligations
to the depository.\47\ Further, the template proprietary funds letter
would require the depository to respond to a request from the director
of DCR, or any successor division, or the director's designees, for
information about the account, including the account balance. Proposed
Sec. 39.15(f)(2) also includes the same procedural requirements as
those in Sec. 1.20. Specifically, it would require a DCO to file a
proprietary funds letter with the Commission within three days of
opening an account, to update a letter when certain information it
contains changes, and to maintain a copy of the letter in accordance
with Sec. 1.31.
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\47\ See 17 CFR 1.20 App. B.
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The Commission believes that requiring a proprietary funds letter
would ensure that a depository holding proprietary funds would know
that the funds belong to the DCO's clearing members and cannot be used
by the DCO for any other purpose, which will help prevent the misuse of
funds by the DCO or an employee of the DCO. Further, having a letter
for each proprietary funds account would help a bankruptcy court or
trustee easily identify those funds that constitute member property in
the event of a DCO bankruptcy.
The Commission is proposing to exclude accounts at Federal Reserve
Banks from the requirement to obtain a proprietary funds letter. This
is consistent with Sec. 1.20(g)(4), which states that a DCO does not
need a written acknowledgment to hold customer funds at a Federal
Reserve Bank. As discussed above, the Commission believes that Federal
Reserve Banks would be unable to sign the template proprietary funds
letter, and wants to promote the use of Federal Reserve Bank accounts
by DCOs when possible.
The Commission is also proposing a simpler written acknowledgment
requirement for accounts held at the central bank of a money center
country. Although a DCO holding proprietary funds at the central bank
of a money center country would have to comply with the same procedural
requirements applicable to other depositories, it would not have to use
the template proprietary funds letter. The DCO would only have to
obtain a written acknowledgment stating that: (1) the central bank was
informed that the funds deposited with the bank are proprietary funds
held in accordance with section 5b(c)(2)(F) of the CEA and Commission
regulations; and (2) the bank agrees to respond to requests from the
Commission for information about the account, including the account
balance. As was the case with the acknowledgment letter used for
accounts holding customer funds, the Commission believes many central
banks would have issues with the proposed template proprietary funds
letter. The Commission believes the proposed rule would allow DCOs to
gain the benefits of holding funds at central banks while adequately
safeguarding those funds and ensuring that the Commission has the
information it needs to conduct oversight of DCOs.
3. Commingling of Proprietary Funds--Sec. 39.15(f)(3)
Proposed Sec. 39.15(f)(3) is based on Sec. 1.20(e) and (g)
applicable to customer funds, and would permit a DCO to commingle
proprietary funds from multiple clearing members in a single account at
a depository, but would not permit a DCO to commingle proprietary funds
with the DCO's own funds or customer funds. Having a clear separation
between proprietary funds and a DCO's own funds will make it more
difficult for funds to be misused, and will provide additional clarity
in the event of a DCO bankruptcy regarding the funds that should be
treated as member property rather than part of the debtor's estate.
Further, the ability to commingle proprietary funds from multiple
clearing members in one account allows DCOs to limit operational risks
by simplifying their banking processes and procedures.
4. Use of Proprietary Funds--Sec. 39.15(f)(4)
Proposed Sec. 39.15(f)(4) is based on Sec. 1.20(f) and would
require a DCO and any depository holding proprietary funds to treat all
proprietary funds as belonging to the clearing members of the DCO. The
Commission believes the proposed rule will help ensure that proprietary
funds are not rehypothecated or otherwise used by a DCO and are readily
available if needed either by the clearing member directly, or for a
permitted clearing member use by the DCO. However, the Commission does
not intend for this requirement to interfere with or alter DCOs' risk
management programs. Proposed Sec. 39.15(f)(4)(i)(A) therefore would
clarify that the proprietary funds of a
[[Page 291]]
clearing member could be used to satisfy obligations of that clearing
member's customers, to the extent that use is permitted by the DCO's
rules and the DCO's agreement(s) with the clearing member. In addition,
proposed Sec. 39.15(f)(4)(i)(B) further would clarify that a DCO use
contributions of non-defaulting clearing members to a guaranty fund to
cover losses stemming from a default, to the extent that use is
permitted by the DCO's rules and its agreement(s) with its clearing
members. Nothing in the proposed rule would prevent a DCO from holding
guaranty fund contributions in a separate proprietary funds account
from proprietary funds held as initial margin.
Moreover, proposed Sec. 39.15(f)(4)(ii) would provide that a
depository receiving proprietary funds from a DCO for deposit in a
segregated account may not hold, dispose of, or use such funds as
belonging to any person other than the clearing members of the
depositing DCO. Unlike the DCO, which is responsible for separately
considering the proprietary funds owed to each individual clearing
member, a depository is only responsible for considering the
proprietary funds it has received as belonging to the clearing members
as a group.
D. Daily Reconciliation--Sec. 39.15(g)
The Commission is proposing new Sec. 39.15(g), which would require
a DCO to conduct a daily reconciliation for each type of segregated
account (futures customer funds, cleared swaps customer collateral, and
proprietary funds) it holds for its clearing members. This proposal is
based on the requirement applicable to FCMs in Sec. 1.32. Under
proposed Sec. 39.15(g), by noon of each business day, the DCO would
have to perform these reconciliations on balances held as of the close
of the previous business day. The proposed requirement is intended to
verify, each business day, that the DCO maintains sufficient funds in
each relevant account type to cover its aggregate obligations to
clearing members. The Commission believes that the required daily
calculation and reconciliation and independent review requirements in
the proposed rule would help a DCO to identify quickly any misuse or
loss of proprietary or customer funds.
Proposed Sec. 39.15(g)(1), (2), and (3) would require a DCO to
calculate the amount of, respectively, futures customer funds, cleared
swaps customer collateral, and proprietary funds owed to each clearing
member. These provisions would further require the DCO to reconcile the
total amount, aggregated across all clearing members, of each of
futures customer funds, cleared swaps customer collateral, and
proprietary funds, with the amount of each respective type of funds
held in separate accounts across all depositories. This reconciliation
is intended to confirm, each business day, that the DCO maintains, in
each type of account, an adequate value of segregated funds to meet its
obligations to clearing members.
Requirements for the method of conducting these calculations are
contained in proposed Sec. 39.15(g)(4). Proposed Sec. 39.15(g)(4)(i)
would require segregation of duties, consistent with generally accepted
auditing standards.\48\ Each of the DCO's calculations and
reconciliations would need to be approved by a person who did not
prepare the initial calculation or the related reconciliation, and who
does not report to the person who prepared them.
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\48\ See Statement on Auditing Standards 145, Appendix C, ] 21
(``Segregation of duties is intended to reduce the opportunities to
allow any person to be in a position to both perpetrate and conceal
errors or fraud in the normal course of the person's duties''). See
also 17 CFR 1.11(e)(3)(i)(G) (requiring each FCM's Risk Management
Program to include procedures requiring the appropriate separation
of duties among individuals responsible for compliance with the Act
and Commission regulations relating to the protection and financial
reporting of segregated funds.)
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Proposed Sec. 39.15(g)(4)(ii)(A) would address the valuation of
securities in the required calculations of amounts owed and held.
Securities would have to be valued at their current market value, with
haircuts applied in accordance with existing Sec. 39.11(d)(1).
Proposed Sec. 39.15(g)(4)(ii)(B) would address mismatches in
currencies in the same account type by permitting a deficit in one
currency to be offset by a surplus in another currency, with conversion
based on publicly available exchange rates, and with surpluses subject
to haircuts reasonably determined by the DCO, applied consistently.\49\
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\49\ For example, one would expect that the haircuts the DCO
applies to currency mismatches with respect to its obligations to
clearing members here would be no smaller than the haircuts the DCO
applies to currency mismatches with respect to collateral posted by
a clearing member.
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Proposed Sec. 39.15(g)(4)(ii)(C) would address situations in which
customer funds of one type are commingled in a different type of
customer account (e.g., futures customer funds in a cleared swaps
customer account). In these instances, the proposed rule would require
DCOs to treat all funds in a futures customer account as futures
customer funds and all funds in a cleared swaps customer account as
cleared swaps customer collateral, both in terms of funds owed and
funds held, for purposes of the calculation and reconciliation required
by proposed Sec. 39.15(g).
Proposed Sec. 39.15(g)(4)(iii) would address the process by which
a DCO would calculate the amounts owed to clearing members for each
account type by requiring the DCO to apply, for each account type, the
approach set forth for FCMs in Sec. 1.20(i). This would include
calculating the net liquidating equity for each clearing member (in
each account type), taking into account the market value of funds it
receives from the clearing member, gains and losses on futures
contracts, options, and swaps (applying this approach to cleared
swaps), fees lawfully accruing in the normal course of business (which,
in the case of a DCO, would include transaction fees), and authorized
distributions or transfers of collateral. In aggregating amounts owed,
the DCO would not reduce the sum of credit balances owed to clearing
members with debit balances owed by other clearing members.\50\
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\50\ See 17 CFR 1.20(i)(4).
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Finally, proposed Sec. 39.15(g)(5) would require the DCO to
immediately report to the Commission any discrepancy in any of the
relevant calculations or any one or more of the reconciliations that
reveals that the DCO did not, at the close of the previous business
day, maintain in separate segregated accounts money, securities, and
property in an amount sufficient in the aggregate to cover the total
value of funds owed to all clearing members.
E. Exclusions for Foreign Derivatives Clearing Organizations--Sec.
39.15(h)
The Commission is not, at this time,\51\ proposing to apply the new
member property protections in proposed Sec. 39.15(e)(3) (permitted
investment of proprietary funds), (f) (proprietary funds), and (g)(3)
(daily reconciliation of proprietary funds) to certain DCOs organized
outside the United States (foreign DCOs). Specifically, proposed Sec.
39.15(h) would provide that proposed Sec. 39.15(e)(3), (f) and (g)(3)
do not apply to a foreign DCO that would, in the event of its
insolvency, be subject to a foreign proceeding, as defined in the U.S.
Bankruptcy Code, in the jurisdiction in which it is organized.\52\
[[Page 292]]
Member property held at most foreign DCOs would not be protected under
part 190 in the event the DCO enters bankruptcy,\53\ and the Commission
wants to avoid potential conflicts with requirements concerning
protection of member property under the applicable law in a foreign
DCO's home jurisdiction.\54\
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\51\ The Commission may, in light of ongoing and future
developments with respect to clearing models at such DCOs, including
with respect to the participation of U.S. market participants
(particularly such market participants who are natural persons)
reconsider these decisions (both with respect to part 39 and to part
190) in a future rulemaking.
\52\ The U.S. Bankruptcy Code defines ``foreign proceeding'' as
a collective judicial or administrative proceeding in a foreign
country, including an interim proceeding, under a law relating to
insolvency or adjustment of debt in which proceeding the assets and
affairs of the debtor are subject to control or supervision by a
foreign court, for the purpose of reorganization or liquidation. 11
U.S.C. 101(23). Further, the U.S. Bankruptcy Code defines ``foreign
court'' as a judicial or other authority competent to control or
supervise a foreign proceeding (emphasis added). 11 U.S.C. 1502(3).
Because the definition includes non-judicial authorities, a
resolution proceeding where the assets and affairs of a foreign DCO
are controlled by a resolution authority would constitute a foreign
proceeding under 11 U.S.C. 101(23), and thus a DCO that is subject
to such a resolution proceeding would fall within the exclusion of
such paragraphs. (See, e.g., In re Tradex Swiss AG, 384 B.R. 34, 42
(Bankr. D.Mass. 2008) (Swiss Federal Banking Commission ``is an
administrative agency'' and qualifies as a foreign court under
1502(3)), In re ENNIA Caribe Holding N.V., 594 B.R. 631, 639-40 & n.
11(Bankr. S.D.N.Y. 2018) (where the Central Bank of Cura[ccedil]ao
and St. Maarten, as a regulator, controls the affairs of the foreign
debtor, an insurance company, it constitutes a foreign court under
11 U.S.C. 1502(3)).
\53\ See 17 CFR 190.11(b).
\54\ As the Commission noted in revising its part 190 bankruptcy
regulations in 2020, in the context of certain DCOs organized
outside the United States, the Commission has traditionally focused
its efforts on the protection of the customers of FCM members of
such foreign DCOs. Bankruptcy Regulations, 86 FR 19324, 19366 (April
13, 2021). In promulgating those regulations, the Commission
attempted to avoid conflicts with insolvency proceedings in the
jurisdiction where a foreign DCO is organized. Id. Thus, pursuant to
17 CFR 190.11(b), the Commission's part 190 bankruptcy regulations
are limited to protecting contracts cleared on behalf of FCM
customers at such foreign DCOs and the property margining or
securing such contracts. The foreign DCOs to which this limitation
applies are those DCOs organized outside the United States that are
subject to a foreign proceeding, as defined in 11 U.S.C. 101(23), in
the jurisdiction in which it is organized.
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IV. Reporting--Sec. 39.19
The Commission is proposing new Sec. 39.19(c)(4)(xxvi) to include,
together with the other event-specific reporting requirements
applicable to DCOs, the requirement in proposed Sec. 39.15(g)(5) that
a DCO report any discrepancies in the amount of proprietary or customer
funds it holds. The Commission believes that including all reporting
requirements applicable to DCOs in Sec. 39.19 may assist DCOs in
tracking their reporting obligations.
V. Request for Comment
The Commission is requesting comments on all aspects of its
proposal. Additionally, the Commission specifically requests comment on
the following:
Would classification of guaranty fund contributions as proprietary
funds inhibit DCOs' current guaranty fund programs? The Commission has
proposed to specifically include guaranty fund deposits in the
definition of proprietary funds, and does not intend for the inclusion
to prevent DCOs from continuing to use guaranty funds as one of their
default resources.
Should the Commission require DCOs to report to the Commission the
daily calculations and reconciliations required by proposed Sec.
39.15(g)?
Anti-money laundering (AML) and know-your-client (KYC) programs are
required for many entities registered with the Commission, including
intermediaries such as FCMs. In the context of intermediated DCOs, FCMs
perform this critical role of assisting U.S. government agencies in
detecting and preventing money laundering. However, in the context of
non-intermediated DCOs, in the absence of an FCM, DCOs may be exploited
by actors seeking to engage in illegal and illicit activities. How
might the Commission ensure AML and KYC compliance for DCOs that offer
direct clearing services (a market structure that would not include
FCMs or other intermediaries that are typically directed to create Bank
Secrecy Act compliance programs)? Should DCOs offering direct-to-
customer services to non-eligible contract participants or retail
customers be required to comply with AML and KYC requirements?
Should the Commission require any additional written
acknowledgments (to those contained in proposed Sec. 39.15(b)(3) or
Sec. 39.15(f)(2)(vi) as applicable) from central banks of money center
countries in order for a DCO to use them to hold futures customer
funds, cleared swaps customer collateral, or proprietary funds?
VI. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) requires that agencies
consider whether the regulations they propose will have a significant
economic impact on a substantial number of small entities and, if so,
provide a regulatory flexibility analysis on the impact.\55\ The
amendments proposed by the Commission will affect only DCOs. The
Commission has previously established certain definitions of ``small
entities'' to be used by the Commission in evaluating the impact of its
regulations on small entities in accordance with the RFA.\56\ The
Commission has previously determined that DCOs are not small entities
for the purpose of the RFA.\57\ Accordingly, the Chairman, on behalf of
the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that the
proposed regulations will not have a significant economic impact on a
substantial number of small entities.
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\55\ 5 U.S.C. 601 et seq.
\56\ Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618 (Apr. 30, 1982).
\57\ See A New Regulatory Framework for Clearing Organizations
66 FR 45604, 45609 (Aug. 29, 2001).
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B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (PRA) \58\ imposes certain
requirements on federal agencies, including the Commission, in
connection with 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).\59\ 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.\60\ 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.\61\
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\58\ 44 U.S.C. 3501 et seq.
\59\ See 44 U.S.C. 3507(a)(3); 5 CFR 1320.5(a)(3).
\60\ See 44 U.S.C. 3501.
\61\ See 44 U.S.C. 3502(3).
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This proposal, if adopted, would result in a collection of
information within the meaning of the PRA, as discussed below. This
proposed rulemaking contains collections of information for which the
Commission has previously received a control number from OMB. The title
for this existing collection of information is OMB control number 3038-
0076, Requirements for Derivatives Clearing Organizations (``OMB
Collection 3038-0076'').
[[Page 293]]
The Commission therefore is submitting this proposal to the OMB for
its review in accordance with the PRA.\62\ Responses to this collection
of information would be mandatory. The Commission will protect any
proprietary information according to the Freedom of Information Act and
part 145 of the Commission's regulations.\63\ In addition, section
8(a)(1) of the CEA strictly prohibits the Commission, unless
specifically authorized by the CEA, from making public any data and
information that would separately disclose the business transactions or
market positions of any person and trade secrets or names of
customers.\64\ Finally, the Commission is also required to protect
certain information contained in a government system of records
according to the Privacy Act of 1974.\65\
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\62\ See 44 U.S.C. 3507(d) 5 CFR 1320.11.
\63\ See 5 U.S.C. 552; see also 17 CFR part 145 (Commission
Records and Information).
\64\ 7 U.S.C. 12(a)(1).
\65\ 5 U.S.C. 552a.
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1. OMB Collection 3038-0076--Requirements for Derivatives Clearing
Organizations
The Commission is proposing a new reporting requirement in Sec.
39.15(f)(2) to require DCOs based in the United States to obtain a
template proprietary funds letter from each depository that holds
proprietary funds and to file that letter with the Commission. The
template letter and filing requirements are substantially the same as
the requirement in Sec. 1.20(d) for FCMs to file an acknowledgment
letter signed by each depository holding customer funds. In OMB control
number 3038-0024, ``Regulations and Forms Pertaining to Financial
Integrity of the Market Place; Margin Requirements for SDs/MSPs,'' \66\
the Commission estimated that each FCM would file three acknowledgment
letters a year and that filing each letter would take two hours to
complete. Because the proposed letter and requirements for DCOs are the
same as those for FCMs, the Commission believes that the estimates for
FCMs filing acknowledgment letters are appropriate for DCOs filing
proprietary funds letters. Therefore, the Commission believes that the
proposed requirement will require each DCO based in the United States
to expend six hours per year to comply, resulting in a total burden of
60 hours for DCOs.
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\66\ For the previously approved estimates for this collection,
see ICR Reference No. 202207-3038-001 (conclusion date Aug. 23,
2022, available at https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=202207-3038-001).
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The aggregate burden estimate for proprietary funds template letter
reporting in Collection 3038-0076 is as follows:
Estimated number of respondents: 10.
Estimated annual reports per respondent: 3.
Estimated total annual responses: 30.
Estimated average burden hours per response: 2.
Estimated annual burden hours per respondent: 6.
Estimated total annual reporting burden for all respondents: 60.
Finally, the Commission is proposing Sec. 39.15(g) to require DCOs
to report in accordance with Sec. 39.19(c)(4) any discrepancies in the
results of the required daily calculations and reconciliations. This is
a new reporting requirement and thus the Commission is revising its
estimate of the burden associated with event-specific reporting under
Sec. 39.19(c)(4) in Collection 3038-0076. A discrepancy in one of the
required calculations or reconciliations would mean that the DCO is not
holding or accounting for the correct amount of either customer or
proprietary funds, i.e., that it is not meeting regulatory
requirements. The Commission does not anticipate DCOs will need to file
this report often, and ideally not at all, such that even one report
per year would exceed expectations. Nonetheless, to avoid under-
estimating the burden of the proposed regulation, the Commission
estimates that DCOs will file the required report once per year. The
Commission believes that each report will take approximately 30 minutes
to complete. The requirement is for DCOs to file immediately upon
learning of the discrepancy, which will necessarily limit the amount of
time available to prepare a report. The current burden estimate in
Collection 3038-0076 for event specific reporting under Sec. 39.19(c)
is 14 reports a year per respondent. Therefore, the Commission amending
Collection 3038-0076 and s estimating that 13 covered DCOs will
complete an estimated 15 reports per year per respondent, resulting in
a total burden of seven-and-a-half hours for event-specific reporting.
The aggregate burden estimate for event-specific reporting under
Sec. 39.19(c)(4), as amended by the proposal, is updated as follows:
Estimated number of respondents: 13.
Estimated annual reports per respondent: 15.
Estimated total annual responses: 195.
Estimated average hours per response: 0.5.
Estimated annual burden hours per respondent: 7.5.
Estimated total annual burden hours for all respondents: 97.5.
The Commission's existing recordkeeping rule will require DCOs to
maintain records of the information generated though compliance with
the proposed rules.\67\ Specifically, DCOs will need to maintain
records related to the calculations and reconciliations required under
proposed Sec. 39.15(g) and the proprietary funds letters required
under proposed Sec. 39.15(f)(2). The Commission, however, believes
that the impact of the proposed regulations on the recordkeeping burden
in Collection 3038-0076 will be negligible. DCOs are already required
to maintain all information required to be created, generated, or
reported under part 39.\68\ DCOs regularly maintain records of items
created through their compliance with the Commission's regulations, and
the proposed rules will not raise unique recordkeeping challenges or
burdens. Therefore, the Commission is retaining its existing
recordkeeping burden estimates for Collection 3038-0076.
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\67\ See 17 CFR 39.20.
\68\ Id.
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2. Request for Comment
The Commission invites the public and other Federal agencies to
comment on any aspect of the proposed information collection
requirements discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the
Commission will consider public comments on this proposed collection of
information in:
(1) Evaluating whether the proposed collection of information is
necessary for the proper performance of the functions of the
Commission, including whether the information will have a practical
use;
(2) Evaluating the accuracy of the estimated burden of the proposed
collection of information, including the degree to which the
methodology and the assumptions that the Commission employed were
valid;
(3) Enhancing the quality, utility, and clarity of the information
proposed to be collected; and
(4) Minimizing the burden of the proposed information collection
requirements on registered entities, including through the use of
appropriate automated, electronic, mechanical, or other technological
information collection techniques, e.g., permitting electronic
submission of responses.
The Commission specifically invites public comment on the accuracy
of its estimates that the proposed regulations will not impose a new
recordkeeping burden and its determination to retain
[[Page 294]]
its existing burden estimates for recordkeeping for Collection 3038-
0076.
Copies of the submission from the Commission to OMB are available
from the CFTC Clearance Officer, 1155 21st Street NW, Washington, DC
20581, (202) 418-5714 or from https://RegInfo.gov. Organizations and
individuals desiring to submit comments on the proposed information
collection requirements should send those comments to:
The Office of Information and Regulatory Affairs, Office
of Management and Budget, Room 10235, New Executive Office Building,
Washington, DC 20503, Attn: Desk Officer of the Commodity Futures
Trading Commission;
(202) 395-6566 (fax); or
[email protected] (email).
Please provide the Commission with a copy of submitted comments so
that all comments can be summarized and addressed in the final
rulemaking, and please refer to the ADDRESSES section of this
rulemaking for instructions on submitting comments to the Commission.
OMB is required to make a decision concerning the proposed information
collection requirements between 30 and 60 days after publication of
this release in the Federal Register. Therefore, a comment to OMB is
best assured of receiving full consideration if OMB receives it within
30 calendar days of publication of this release. Nothing in the
foregoing affects the deadline enumerated above for public comment to
the Commission on the proposed rules.
C. Cost-Benefit Considerations
1. Introduction
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders.\69\ 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) factors (collectively referred to herein as
Section 15(a) factors).
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\69\ 7 U.S.C. 19(a).
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The Commission recognizes that the proposed amendments impose
costs. The Commission has endeavored to assess the anticipated costs
and benefits of the proposed amendments in quantitative terms,
including PRA-related costs, where feasible. In situations where the
Commission is unable to quantify the costs and benefits, the Commission
identifies and considers the costs and benefits of the applicable
proposed amendments in qualitative terms. The lack of data and
information to estimate those costs is attributable in part to the
nature of the proposed amendments. Additionally, any initial and
recurring compliance costs for any particular DCO will depend on the
size, existing infrastructure, level of clearing activity, practices,
and cost structure of the DCO.
The Commission generally requests comment on all aspects of its
cost-benefit considerations, including the identification and
assessment of any costs and benefits not discussed herein; data and any
other information to assist or otherwise inform the Commission's
ability to quantify or qualitatively describe the costs and benefits of
the proposed amendments; and substantiating data, statistics, and any
other information to support positions posited by commenters with
respect to the Commission's discussion. The Commission welcomes comment
on such costs, particularly from existing DCOs that can provide
quantitative cost data based on their respective experiences.
Commenters may also suggest other alternatives to the proposed
approach.
The Commission notes that this consideration is based on its
understanding that the derivatives market regulated by the Commission
functions internationally with: (1) transactions that involve entities
organized in the United States occurring across different international
jurisdictions; (2) some entities organized outside of the United States
that are prospective Commission registrants; and (3) some entities that
typically operate both within and outside the United States and that
follow substantially similar business practices wherever located. Where
the Commission does not specifically refer to matters of location, the
discussion of costs and benefits below refers to the effects of the
proposed regulations on all relevant derivatives activity, whether
based on their actual occurrence in the United States or on their
connection with, or effect on U.S. commerce.\70\
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\70\ See, e.g. 7 U.S.C. 2(i).
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2. Baseline
The Commission identifies and considers the benefits and costs of
the proposed amendments relative to the baseline of the status quo. In
particular, the baseline for the Commission's consideration of the
costs and benefits of this proposed rulemaking is the existing
statutory and regulatory framework applicable to DCOs, including: (1)
the DCO core principles set forth in section 5b(c)(2) of the CEA; (2)
the requirements associated with holding clearing member funds for
positions in futures, foreign futures, and swaps under Sec. 39.15; (3)
the current DCO reporting requirements under Sec. 39.19; and (4) the
requirements for obtaining an acknowledgment letter from a foreign
central bank holding customer funds, but not member funds.
3. Proposed Amendments to Sec. 39.15(b)
a. Summary of Changes
The Commission is proposing new Sec. 39.15(b)(3), which would
allow the central banks of money center countries to serve as
depositories for customer funds. The proposed regulation would further
allow a DCO holding customer funds at the central bank of a money
center country to obtain a modified written acknowledgment that is
shorter and less detailed than the template acknowledgment letter in
Sec. Sec. 1.20 and 22.4.
b. Benefits
The Commission believes that central banks are often the best
option for deposit of customer funds. By using a central bank, DCOs can
minimize the credit and liquidity risks they face when holding foreign
currency cash deposits. Many foreign central banks do not fit into any
of the categories of permissible depositories in Sec. 1.49, and some
central banks have expressed unwillingness to sign the template
acknowledgment letter. By permitting DCOs to deposit customer funds at
the central banks of money center countries and requiring an
abbreviated written acknowledgment suitable for the central bank
context, the Commission believes that DCOs will be able to avail
themselves of the risk management benefits of holding funds at a
central bank.
c. Costs
The Commission does not believe the proposed rule will impose costs
on DCOs. The proposed rule does not require DCOs to hold customer funds
at any particular central bank and merely enables DCOs to hold funds at
certain central banks.
[[Page 295]]
d. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(b)(3)
in light of the specific considerations identified in section 15(a) of
the CEA. The Commission believes the proposed rule would protect market
participants by allowing their funds to be more easily held at foreign
central banks. Central banks expose depositors to minimal credit and
liquidity risks and are safe depositories for assets belonging to
market participants. Similarly, the proposed rules may improve DCOs'
risk management because of the low credit and liquidity risks
associated with holding funds at a central bank. The Commission has
considered the other Section 15(a) factors and believes that they are
not implicated by the proposed amendments to Sec. 39.15(b)(3).
4. Proposed Amendments to Sec. 39.15(e)
a. Summary of Changes
The Commission is proposing rules that would limit the investments
DCOs can make with proprietary funds to those that are permissible for
customer funds under Sec. 1.25. The proposed rule also states that
DCOs would be responsible for investment losses.
b. Benefits
The proposed rule would limit investments of proprietary funds to
the safe investments listed in Sec. 1.25. This is the same list of
investments that can be made with customer funds. The Commission
believes this proposal would appropriately protect clearing members
from risk of loss by ensuring that any investment is in instruments
with minimal credit, market, and liquidity risks.
c. Costs
The proposed rule may impose some costs on DCOs. Some DCOs may have
to stop investing proprietary funds in certain instruments that are
currently permitted and may incur some operational costs in revising
the investments that are offered to clearing members for their
proprietary funds. Further, to the extent the permitted investments
earn less yield than what a DCO currently invests in, the regulation
would impose costs in the form of lost investment revenue for the DCO
and clearing member. The total cost of this regulation will depend on a
number of factors including the number of clearing members of the DCO
and what, if any, investments the DCO currently makes with proprietary
funds.
a. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(e) in
light of the specific considerations identified in section 15(a) of the
CEA. The proposed rule would benefit clearing member market
participants by ensuring their funds are invested in instruments that
minimize the risk of loss. While DCOs currently determine what
investments to make with clearing member funds, the proposed rule
establishes a list of investments that the Commission believes is
appropriately conservative for all clearing members. The Commission has
considered the other Section 15(a) factors and believes that they are
not implicated by the proposed amendments to Sec. 39.15(e).
5. Proposed Amendments to Sec. 39.15(f)(1)
a. Summary of Changes
The Commission is proposing new Sec. 39.15(f)(1), which would
require DCOs to segregate proprietary funds from their own funds, hold
the funds in accounts clearly labeled as holding proprietary funds, and
hold at all times an amount sufficient in the aggregate to cover the
total value of proprietary funds held for all clearing members.
b. Benefits
The proposed rule would benefit clearing members by helping to
ensure that proprietary funds on deposit will not be misused. Holding
proprietary funds in an account that is exclusively for proprietary
funds and clearly named as being for proprietary funds would make it
difficult for a DCO or any employee to use the funds for an improper
purpose without being detected. Further, the requirement that accounts
hold funds adequate to cover the total value of proprietary funds held
for all clearing members at all times would prevent a DCO from
rehypothecating or otherwise using proprietary funds for its own
benefit, thus ensuring that the funds are available when needed by
clearing members or the DCO for permitted uses. The proposed rule would
also ensure funds are readily identifiable in the event of a DCO
bankruptcy, which would facilitate those funds receiving the
appropriate preferential treatment.
c. Costs
The proposed rule might add some costs for DCOs if they need to
establish new accounts for proprietary funds. DCOs would need to
establish new procedures for regularly confirming that the accounts
hold funds adequate to cover the total value of proprietary funds of
all clearing members. However, as a mitigating factor, the Commission
believes that most, if not all, DCOs currently hold proprietary funds
separately from their own, and that most DCOs do not rehypothecate or
otherwise use funds for their own purposes. In such cases, if there are
any costs, they would be related to staff time involved with renaming
current accounts holding proprietary funds. The exact costs will depend
on a number of factors including how many accounts a DCO maintains for
proprietary funds.
d. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(f)(1)
in light of the specific considerations identified in section 15(a) of
the CEA. The Commission believes the proposed rule would benefit market
participants by helping to ensure their funds are not misused and by
helping to make sure the funds receive the proper, preferential
treatment in the event of a DCO bankruptcy. The Commission also
believes that requiring DCOs to hold the total amount of proprietary
funds at all times would promote sound risk management because it would
ensure that the funds are available to the DCO in the event of a
clearing member default. The Commission has considered the other
section 15(a) factors and believes that they are not implicated by the
proposed amendments to Sec. 39.15(f)(1).
6. Proposed Amendments to Sec. 39.15(f)(2)
a. Summary of Changes
The proposed rule would require DCOs to obtain a proprietary funds
letter in the form prescribed in the proposed appendix from each
depository holding proprietary funds. The proposed letter is based on
the template acknowledgment letter for DCOs required by Sec. 1.20, and
requires depositories to acknowledge, among other things, that the
funds belong to clearing members and cannot be used by the DCO for any
other purpose. The proposed rule would also require a DCO to file the
letters with the Commission and update the letters when certain
information changes. The proposed rule would exclude Federal Reserve
Banks from the requirement to obtain a proprietary funds letter from a
depository holding proprietary funds. Further, the proposed rule would
require a simpler written
[[Page 296]]
acknowledgment from the central bank of a money center country that is
holding proprietary funds than that required of other depositories.
b. Benefits
The proposed rule would benefit clearing members by ensuring that
all depositories holding proprietary funds would know that the funds
belong to clearing members and cannot be used by the DCO for any other
purpose, which would help prevent the misuse of funds by the DCO or an
employee of the DCO. Further, having a proprietary funds letter for
each proprietary funds account would help a bankruptcy court or trustee
easily identify that the funds are member property in the event of a
DCO bankruptcy.
c. Costs
The proposed rule would impose costs on DCOs. DCOs would be
required to work with depositories to obtain proprietary funds letters
for existing accounts and to file the letters with the Commission.
Further, DCOs would need procedures for obtaining a letter for any new
account and for updating letters as information changes going forward.
The Commission is attempting to limit the costs of obtaining
proprietary funds letters by proposing to use a template that is
substantively the same as the template letter required for customer
funds and is thus already in use by many DCOs and their depositories.
The costs each DCO would incur would depend, in large part, on the
number of depositories the DCO uses to hold proprietary funds. The
Commission has estimated that the PRA costs for this rule will be $100
per burden hour. Based on the burden estimate discussed above of six
hours annually per DCO, the Commission estimates that each DCO will
spend $600 in PRA costs under this proposed rule.
d. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(f)(2)
in light of the specific considerations identified in section 15(a) of
the CEA. The Commission believes the proposed rule would benefit market
participants by ensuring that all depositories holding proprietary
funds know that the funds belong to clearing members and cannot be used
by the DCO for any other purpose, thus helping to prevent the misuse of
funds. Having a proprietary funds letter for each proprietary funds
account would help easily identify which funds are member property in
the event of a DCO bankruptcy. Finally, the helping to prevent the
misuse of proprietary funds would promote sound risk management by
making it more likely that the funds are available if needed to cover a
clearing member default. The Commission has considered the other
section 15(a) factors and believes that they are not implicated by the
proposed amendments to Sec. 39.15(f)(2).
7. Proposed Amendments to Sec. 39.15(f)(3)
a. Summary of Changes
Proposed Sec. 39.15(f)(3) would permit DCOs to commingle
proprietary funds belonging to multiple clearing members in the same
custodial account. The rule would prohibit a DCO from commingling
proprietary funds with the DCO's own funds or with FCM customer funds.
b. Benefits
The Commission believes that permitting DCOs to commingle
proprietary funds from multiple clearing members in one account would
allow DCOs to minimize operational risk by simplifying their banking
processes and procedures. Further, the proposed rule would ensure that
proprietary funds are held separately from the DCO's funds at the
depository, making it harder for a DCO or an employee of the DCO to
misuse the funds without detection.
c. Costs
The Commission does not believe permitting the commingling of
multiple clearing members' funds in one account would impose new costs
on DCOs. Currently, many DCOs hold clearing member funds in a
commingled account, and the proposed rule would only permit, not
require, clearing member funds to be commingled. However, the
Commission recognizes that a DCO that currently commingles clearing
member funds with other funds would need to segregate such funds and
establish a separate account for such funds, thereby incurring new
costs. But because the prohibition on commingling a DCO's funds with
its clearing members' funds codifies sound participant protection and
risk management principles that most, if not all, DCOs already apply,
the Commission does not believe that it would impose significant new
costs on existing DCOs. Additionally, DCOs are currently prohibited by
the requirements of section 4d of the Act and the regulations
thereunder from commingling customer funds with the funds of clearing
members. The proposed rule would therefore not impose new costs with
regard to holding clearing member funds and customer funds separately.
d. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(f)(3)
in light of the specific considerations identified in section 15(a) of
the CEA. The Commission believes that prohibiting a DCO from
commingling its own funds with proprietary funds would benefit market
participants by ensuring a clear delineation between the DCO's funds
and proprietary funds. This delineation would make it more difficult to
misuse proprietary funds and would make proprietary funds readily
identifiable in the event of a DCO bankruptcy. Further, the Commission
believes that the proposed rule would promote sound risk management
because ensuring that clearing members' funds are held separately from
the DCO's would make it more difficult for the funds to be misused
without detection and would therefore make it more likely that the
funds are available if needed to cover a clearing member default. The
Commission has considered the other section 15(a) factors and believes
that they are not implicated by the proposed amendments to Sec.
39.12(f)(3).
8. Proposed Amendments to Sec. 39.15(f)(4)
a. Summary of Changes
The proposed rule would prohibit a DCO or any of its depositories
from using proprietary funds for any reason other than as belonging to
the DCO's clearing members. The rule would specifically provide that an
FCM's funds may be used to cover its customers' losses and as part of a
DCO's mutualized guaranty fund.
b. Benefits
By eliminating any uses for proprietary funds other than on behalf
of clearing members, the proposed rule would help ensure that the funds
are readily available if needed either by the clearing member directly,
or for a permitted use by the DCO. The clarifications providing that an
FCM's funds may be used by a DCO to cover the FCM's customers' losses,
or as part of a clearing member-funded, mutualized guaranty fund,
ensures that the rule would not hamper DCOs' existing risk management
programs.
c. Costs
Because the proposed rule would codify sound participant protection
and risk management principles, the Commission does not believe that it
[[Page 297]]
would impose significant costs on DCOs. The Commission does not believe
DCOs are currently using clearing member funds in a manner that is
inconsistent with this regulation. Further, the proposed rule would not
require a guaranty fund or any specific type of FCM guarantee of its
customers' performance, but instead would merely permit what is
currently common risk management practice among DCOs.
d. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(f)(4)
in light of the specific considerations identified in section 15(a) of
the CEA. The proposed rule would benefit market participants by helping
to ensure that their funds are protected and available for their use.
Additionally, the proposed rule would promote sound risk management by
helping to ensure that clearing member funds are readily available for
permitted risk management uses by a DCO, such as in the event of a
customer shortfall or clearing member default. The Commission has
considered the other section 15(a) factors and believes that they are
not implicated by the proposed amendments to Sec. 39.12(f)(3).
9. Proposed Amendments to Sec. Sec. 39.15(g) and 39.19(c)(4)(xxvi)
a. Summary of Changes
Proposed Sec. 39.15(g) would require DCOs to, on a daily basis,
calculate the amount of futures customer funds, cleared swaps customer
collateral, and proprietary funds owed to each clearing member,
separately for each account class and on a currency by currency basis.
The proposed rule further would require DCOs to reconcile, separately
for each account class, the amount of funds owed to all clearing
members with the amount of funds held in depository accounts for that
class of funds. Each calculation and reconciliation would have to be
approved by a person who did not prepare the initial calculation or
reconciliation. The calculation and reconciliation would have to be
performed as of the close of each business day and completed by noon on
the following business day. The proposed rule also would require
securities to be valued at their current market value, subject to the
DCO's haircuts, and calculations of the amount owed to be made in a
manner consistent with the requirements of Sec. 1.20(i). Finally, both
proposed Sec. Sec. 39.15(g)(5) and 39.19(c)(4)(xxvi) would require
DCOs to immediately report any discrepancy in the calculation or
reconciliation to the Commission.
b. Benefits
By requiring a DCO to verify on a daily basis the amount of futures
customer funds, cleared swaps customer collateral, and proprietary
funds it is holding, for each clearing member and across all clearing
members, the proposed rule would facilitate the prompt discovery of any
missing futures customer funds, cleared swaps customer collateral, or
proprietary funds. Additionally, by requiring the daily calculation and
reconciliation to be approved by an independent employee, the proposed
rule would help prevent a single bad actor at a DCO from misusing
futures customer funds, cleared swaps customer collateral, or
proprietary funds, and from concealing that misuse. The requirement to
report any discrepancies to the Commission would help ensure that the
Commission is immediately made aware of potentially missing funds, and
that it can work with the DCO to resolve the matter.
c. Costs
The Commission understands that the daily calculation and
reconciliation would impose costs on DCOs. DCOs would need to develop
procedures that comply with the timing, valuation, and calculation
requirements in the proposed rule, to calculate the amount of funds
owed to each clearing member for each account class and to reconcile
the amount of funds owed to all clearing members with the amount of
funds held at depositories for each account class. Further, at least
two DCO employees would have to be involved in the process of
performing and approving the calculations and reconciliations each day.
DCOs would also need to include the new reporting requirement in their
process and procedures for event-specific reporting to the Commission.
The Commission has sought to minimize the costs of the proposed
regulation by only requiring reporting to the Commission of
discrepancies rather than the filing of daily reports. The exact costs
would depend on the account class(es) in which a DCO holds funds, and
the number of clearing members and customer accounts at issue. The
Commission has estimated that the PRA costs for event specific
reporting are $79 per hour. Based on the burden estimate discussed
above of .5 hours annually per DCO, the Commission estimates that each
DCO will spend $39.50 in PRA costs under this rule.
d. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(f)(5)
in light of the specific considerations identified in section 15(a) of
the CEA. The proposed rule would benefit market participants by
enabling any loss or theft of funds to be discovered by the DCO and
reported to the Commission quickly. The Commission further believes
that the proposed rule would promote sound risk management by helping
to ensure that the funds are available if needed by the DCO to cover a
clearing member or customer default. The Commission has considered the
other section 15(a) factors and believes that they are not implicated
by the proposed amendments.
10. Proposed Amendment to Sec. 39.15(h)
a. Summary of Changes
The proposed rule would exempt foreign DCOs from the requirements
of proposed Sec. 39.15(e)(3), (f), and (g)(3) because in the event of
an insolvency, the clearing member funds held by a foreign DCO would
not be subject to U.S. bankruptcy law.\71\
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\71\ See 17 CFR 190.11(b).
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b. Benefits
The Commission has determined to seek to avoid conflicts with
insolvency proceedings in the jurisdiction where a foreign DCO is
organized. The Commission believes that certainty surrounding which
insolvency law would apply would benefit the clearing members of
foreign DCOs.
c. Costs
The Commission does not believe the rule would impose costs on
foreign DCOs. The proposed rule is preserving the baseline, that funds
belonging to a foreign DCO's clearing members will be treated in
accordance with the insolvency law of the foreign DCO's home
jurisdiction.
d. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(h) in
light of the specific considerations identified in section 15(a) of the
CEA. The proposed rule would benefit market participants by providing
certainty regarding which insolvency law would apply to their funds in
the event a foreign DCO enters an insolvency proceeding. The Commission
has considered the other section 15(a) factors and believes that
[[Page 298]]
they are not implicated by the proposed amendments.
D. Antitrust Considerations
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the CEA, in issuing any order or adopting any Commission
rule or regulation.\72\
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\72\ 7 U.S.C. 19(b).
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The Commission believes that the public interest to be protected by
the antitrust laws is the promotion of competition. The Commission
requests comment on whether the proposed amendments implicate any other
specific public interest to be protected by the antitrust laws. The
Commission has considered the proposed rulemaking to determine whether
it is anticompetitive and has identified no anticompetitive effects.
The Commission requests comment on whether the proposed rulemaking is
anticompetitive and, if it is, what the anticompetitive effects are.
Because the Commission has determined that the proposed rule
amendments are not anticompetitive and have no anticompetitive effects,
the Commission has not identified any less anticompetitive means of
achieving the purposes of the CEA. The Commission requests comment on
whether there are less anticompetitive means of achieving the relevant
purposes of the CEA that would otherwise be served by adopting the
proposed rule amendments.
List of Subjects in 17 CFR Part 39
Reporting, Treatment of funds.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR part 39 as follows:
PART 39--DERIVATIVES CLEARING ORGANIZATIONS
0
1. The authority citation for part 39 continues to read as follows:
Authority: 7 U.S.C. 2, 6(c), 7a-1, and 12a(5); 12 U.S.C. 5464;
15 U.S.C. 8325; Section 752 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111-203, title VII, sec. 752, July
21, 2010, 124 Stat. 1749.
0
2. Amend Sec. 39.2 by adding definitions of the terms ``Money center
country'' and ``Proprietary funds'' in alphabetical order to read as
follows:
Sec. 39.2 Definitions.
* * * * *
Money center country means Canada, France, Germany, Italy, Japan,
and the United Kingdom.
* * * * *
Proprietary funds means all money, securities, and property
received by a derivatives clearing organization from, for, or on behalf
of, a clearing member and held in a proprietary account, as defined in
Sec. 1.3 of this chapter:
(1) To margin, guarantee, or secure contracts for future delivery
on or subject to the rules of a contract market, derivatives clearing
organization, or foreign board of trade or a cleared swap contract, and
all money accruing to a clearing member as the result of such
contracts;
(2) In connection with a commodity option transaction on or subject
to the rules of a contract market, derivatives clearing organization,
or foreign board of trade:
(i) To be used as a premium for the purchase of a commodity option
transaction for a clearing member;
(ii) As a premium payable to a clearing member;
(iii) To guarantee or secure performance of a commodity option by a
clearing member; or
(iv) Representing accruals (including, for purchasers of a
commodity option for which the full premium has been paid, the market
value of such commodity option) to a clearing member;
(3) That constitutes, if a cleared swap is in the form or nature of
an option, the settlement value of the option; or
(4) As a contribution to a guaranty fund to mutualize the losses
resulting from a default by a clearing member by covering the losses in
accordance with the derivatives clearing organization's rules and its
agreement(s) with its clearing members.
* * * * *
0
3. Amend Sec. 39.15 by adding paragraph (b)(3), revising paragraph
(e), and adding paragraphs (f), (g), and (h) to read as follows:
Sec. 39.15 Treatment of funds.
* * * * *
(b) * * *
(3) Central banks. Notwithstanding anything to the contrary in
Sec. Sec. 1.20, 1.49, 22.4, 22.5, or 22.9 of this chapter, a
derivatives clearing organization may hold futures customer funds or
cleared swaps customer collateral at the central bank of a money center
country if it obtains from the central bank a written acknowledgment
that:
(i) The central bank was informed that the customer funds deposited
therein are those of customers who trade commodities, options, swaps,
and other products and are being held in accordance with the provisions
of section 4d of the Act and applicable Commission regulations
thereunder; and
(ii) The central bank agrees to reply promptly and directly to any
request from the director of the Division of Clearing and Risk or the
director of the Market Participants Division, or any successor
divisions, or such directors' designees, for confirmation of account
balances or provision of any other information regarding or related to
an account.
* * * * *
(e) Permitted investments. (1) Funds and assets belonging to
clearing members and their customers that are invested by a derivatives
clearing organization shall be held in instruments with minimal credit,
market, and liquidity risks.
(2) Any investment of customer funds or assets by a derivatives
clearing organization shall comply with Sec. 1.25 of this chapter.
(3) A derivatives clearing organization may invest proprietary
funds only in a manner that would be permitted for customer funds under
Sec. 1.25 of this chapter. The derivatives clearing organization shall
bear sole responsibility for any losses resulting from the investment
of proprietary funds.
(f) Proprietary funds--(1) Segregation. A derivatives clearing
organization must separately account for and segregate all proprietary
funds as belonging to its clearing members. A derivatives clearing
organization shall deposit proprietary funds under an account name that
clearly identifies the funds as belonging to clearing members and shows
that the funds are segregated as required by this part. A derivatives
clearing organization must at all times maintain in the separate
segregated account or accounts money, securities and property in an
amount sufficient in the aggregate to cover the total value of
proprietary funds owed to all clearing members.
(2) Written acknowledgment from depositories. (i) A derivatives
clearing organization must obtain a written acknowledgment from each
depository prior to or contemporaneously with the opening of an account
for proprietary funds by the derivatives clearing organization with the
depositories; provided, however, a derivatives clearing organization is
not required to obtain a written acknowledgment from a Federal Reserve
Bank with which it has opened an account for proprietary funds.
[[Page 299]]
(ii) The written acknowledgment must be in the form as set out in
Appendix D to this part, except as provided in paragraph (f)(2)(vi) of
this section.
(iii) A derivatives clearing organization shall promptly file a
copy of the written acknowledgment with the Commission in the format
and manner specified by the Commission no later than three business
days after the opening of the account or the execution of a new written
acknowledgment for an existing account, as applicable.
(iv) A derivatives clearing organization shall obtain a new written
acknowledgment within 120 days of any changes in the following:
(A) The name or business address of the derivatives clearing
organization;
(B) The name or business address of the depository receiving
proprietary funds; or
(C) The account number(s) under which proprietary funds are held.
(v) A derivatives clearing organization shall maintain each written
acknowledgment readily accessible in its files in accordance with Sec.
1.31 of this chapter, for as long as the account remains open, and
thereafter for the period provided in Sec. 1.31 of this chapter.
(vi) Notwithstanding paragraph (f)(2)(ii) of this section, a
derivatives clearing organization may deposit proprietary funds with
the central bank of a money center country if it obtains from the
central bank a written acknowledgment that:
(A) The central bank was informed that the proprietary funds
deposited therein are those of clearing members who trade commodities,
options, swaps, and other products and are being held in accordance
with the provisions of section 5b(c)(2)(F) of the Act and Commission
regulations thereunder; and
(B) The central bank agrees to reply promptly and directly to any
request from the director of the Division of Clearing and Risk, or any
successor division, or the director's designees, for confirmation of
account balances or provision of any other information regarding or
related to an account.
(3) Commingling. (i) A derivatives clearing organization may for
convenience commingle the proprietary funds that it receives from, or
on behalf of, clearing members in a single account or multiple accounts
with one or more depositories.
(ii) A derivatives clearing organization shall not commingle
proprietary funds with the money, securities or property of the
derivatives clearing organization, or a customer account of a clearing
member of the derivatives clearing organization, or use proprietary
funds to secure or guarantee the obligation of, or extend credit to,
the derivatives clearing organization.
(4) Limitation on use of proprietary funds. (i) A derivatives
clearing organization shall not hold, use or dispose of proprietary
funds except as belonging to the clearing member that deposited the
proprietary funds. The use of proprietary funds as belonging to
clearing members may include, but is not limited to:
(A) A derivatives clearing organization may use the proprietary
funds belonging to a clearing member to guarantee or cover deficits in
a customer account of that clearing member in accordance with the
derivatives clearing organization's rules and its agreement(s) with the
clearing member; and
(B) A derivatives clearing organization may use non-defaulting
clearing members' money, securities, or property that is being held as
a guaranty fund to mutualize the losses resulting from a default by a
clearing member to cover such losses in accordance with the derivatives
clearing organization's rules and its agreement(s) with its clearing
members.
(ii) No person, including any derivatives clearing organization or
any depository, that has received proprietary funds for deposit in a
segregated account, as provided in this section, may hold, dispose of,
or use any the funds as belonging to any person other than the clearing
members of the derivatives clearing organization which deposited the
funds.
(g) Daily reconciliation--(1) Futures customer funds. By noon of
each business day, a derivatives clearing organization that has
received futures customer funds from its clearing members shall, as of
the close of the previous business day:
(i) Calculate the amount of futures customer funds owed to each
clearing member, on a currency by currency basis; and
(ii) Reconcile the total amount of futures customer funds owed, on
a currency by currency basis, aggregated across all clearing members,
with the amount of futures customer funds held in separate accounts
across all depositories.
(2) Cleared swaps customer funds. By noon of each business day, a
derivatives clearing organization that has received cleared swaps
customer collateral from its clearing members shall, as of the close of
the previous business day:
(i) Calculate the amount of cleared swaps customer collateral owed
to each clearing member, on a currency by currency basis; and
(ii) Reconcile the total amount of cleared swaps customer
collateral owed, aggregated across all clearing members, with the
amount of cleared swaps customer collateral held in separate accounts
across all depositories.
(3) Proprietary funds. By noon of each business day, a derivatives
clearing organization that has received proprietary funds from its
clearing members shall, as of the close of the previous business day:
(i) Calculate the amount of proprietary funds owed to each clearing
member, on a currency by currency basis; and
(ii) Reconcile the total amount of proprietary funds owed,
aggregated across all clearing members, with the amount of proprietary
funds held in separate accounts across all depositories.
(4) Calculations. (i) Each calculation and reconciliation required
by this paragraph (g) must be approved by a person who did not prepare
the calculation or reconciliation and who does not report to the person
that prepared the calculation or reconciliation.
(ii) In performing the calculations required by this paragraph (g):
(A) Securities shall be valued at their current market value, with
haircuts applied in accordance with Sec. 39.11(d); and
(B) A reconciliation deficit in a particular account type in one
currency may be offset by a surplus in that same account type in
another currency, based on publicly available exchange rates, with the
surplus subject to haircuts reasonably determined by the derivatives
clearing organization, consistently applied.
(C) Where customer funds, including funds received to margin,
guarantee, or secure futures, options, foreign futures, foreign
options, or swaps, are, pursuant to an order of the Commission or a DCO
rule filed pursuant to paragraph (b)(2)of this section, received for
the purpose of holding such funds in a futures account, they shall be
treated as futures customer funds, both for purposes of funds owed and
funds held. Where such funds are received for the purpose of holding
such funds in a cleared swaps customer account, they shall be treated
as cleared swaps customer collateral, both for purposes of funds owed
and funds held.
(iii) Calculations of amounts owed in this paragraph (g) shall be
made consistent with the requirements of Sec. 1.20(i) of this chapter,
as applied to the accounts of a derivatives clearing organization with
respect to its members' futures customer, cleared swaps customer, and
proprietary accounts.
[[Page 300]]
(5) A derivatives clearing organization shall immediately report to
the Commission, pursuant to Sec. 39.19, any discrepancies in the
calculation of the amount of funds held for each clearing member and
any one or more of the reconciliations that reveals that the
derivatives clearing organization did not, at the close of the previous
business day, maintain in separate segregated accounts money,
securities and property in an amount sufficient in the aggregate to
cover the total value of funds owed to all clearing members.
(h) Exclusions for foreign derivatives clearing organizations--
Paragraphs (e)(3), (f) and (g)(3) of this section do not apply to a
derivatives clearing organization organized outside the United States
that would, in the event of its insolvency, be subject to a foreign
proceeding, as defined in 11 U.S.C. 101(23), in the jurisdiction in
which it is organized.
0
4. In Sec. 39.19, add paragraph (c)(4)(xxvi) to read as follows:
Sec. 39.19 Reporting.
* * * * *
(c) * * *
(4) * * *
(xxvi) Discrepancy in customer or proprietary funds. A derivatives
clearing organization shall immediately report to the Commission any
discrepancies in the calculation of the amount of funds held for each
clearing member and any one or more of the reconciliations required
pursuant to Sec. 39.15(g) that reveals that the derivatives clearing
organization did not, at the close of the previous business day,
maintain in separate segregated accounts money, securities and property
in an amount sufficient in the aggregate to cover the total value of
funds owed to all clearing members.
* * * * *
0
5. Add appendix D to part 39 to read as follows:
Appendix D to Part 39--Derivatives Clearing Organization Acknowledgment
Letter for CFTC Regulation Sec. 39.15 Proprietary Funds Account
[Date]
[Name and Address of Bank or Trust Company]
We refer to the Segregated Account(s) which [Name of Derivatives
Clearing Organization] (``we'' or ``our'') have opened or will open
with [Name of Bank or Trust Company] (``you'' or ``your'') entitled:
[Name of Derivatives Clearing Organization] Proprietary Funds
Account, CFTC Regulation Sec. 39.15 Proprietary Funds Account under
Section 5b(c)(2)(F) 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 the ``Funds'') of
clearing members who trade commodities, options, swaps, and other
products, as required by Commodity Futures Trading Commission
(``CFTC'') Regulations, including Regulation Sec. 39.15, 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 39 of the CFTC's regulations, as amended; and
that the Funds constitute member property as defined by 11 U.S.C.
761(16) and CFTC Regulation Sec. 190.01.
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.
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 any successor
divisions, or such director's 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 any successor divisions, or such director's
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 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 account maintained by us with you for the purpose of holding
our own funds. 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 proprietary 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
[[Page 301]]
the parties in connection with the Account(s), this letter agreement
shall govern with respect to matters specific to section 5b(c)(2)(F)
of the Act and CFTC Regulation Sec. 39.15, 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). 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 Bank or Trust Company]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
DATE:
Issued in Washington, DC, on December 26, 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 Protection of Clearing Member Funds Held by Derivatives
Clearing Organizations--Commission Voting Summary, Chairman's
Statement, and Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Behnam and Commissioner Johnson voted in
the affirmative. Commissioner Pham concurred. Commissioners Goldsmith
Romero and Mersinger voted in the negative.
Appendix 2--Statement of Support of Chairman Rostin Behnam
I support the issuance and publication of the proposed rule on
the protection of clearing member funds held by derivatives clearing
organizations (DCOs). The Commission has longstanding regulations
that provide comprehensive protections for funds belonging to
customers of a Futures Commission Merchant (FCM).\1\ Similar
protections, however, do not exist for funds belonging to clearing
members of a DCO, whether they are individual market participants or
FCMs themselves. The proposed rule would implement a regime for the
protection of clearing member funds largely analogous to the current
regime applicable to FCM customer funds. Specifically, the proposed
rule would ensure that clearing member funds and assets receive
proper treatment if a DCO enters bankruptcy by requiring segregation
of clearing member funds from the DCO's own funds \2\ and that the
funds be held in a depository that acknowledges in writing that the
funds belong to clearing members,\3\ not the DCO. The proposed rule
would require new regulations regarding the commingling of clearing
member or proprietary funds; \4\ limitations on the use of these
funds; \5\ and limit investments of the funds to the investments
permitted for customer funds under Regulation Sec. 1.25.\6\ In
addition, the proposed rule would permit DCOs to hold customer and
clearing member funds at foreign central banks subject to certain
requirements. Finally, the proposed rule would require DCOs to
conduct a daily calculation and reconciliation of the amount of
funds owed to customers and clearing members and the amount actually
held for customers and clearing members.\7\
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\1\ See 7 U.S.C. 6d; 17 CFR 1.20 through 1.39. See also 17 CFR
22.1 through 22.17, and 30.7 (establishing similar regimes for
cleared swaps customer collateral and foreign futures customer
funds, respectively). DCOs that receive customer funds from their
FCM clearing members must also apply many of these customer
protection requirements.
\2\ See also 17 CFR 1.20(a) (requiring FCMs to segregate
customer funds from their own funds); 17 CFR 1.20(g)(1), 17 CFR
39.15 (b), 17 CFR 22.3(b)(1) (requiring DCOs to segregate the
customer funds of their FCM clearing members from their own funds).
\3\ See also 17 CFR 1.20, 22.5, and 30.7 (requiring an FCM to
obtain an acknowledgment letter for futures customer funds, cleared
swaps customer collateral, and foreign futures customer funds,
respectively); 17 CFR 1.20(g)(4), 17 CFR 22.5 (requiring a DCO to
obtain an acknowledgment letter from depositories).
\4\ See also 17 CFR 1.20(e) and (g).
\5\ See also 17 CFR 1.20(f).
\6\ 17 CFR 1.25.
\7\ See also 17 CFR 1.32, 1.33.
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Commission regulations addressing the custody and safeguarding
of customer funds have historically responded to the characteristics
of the prevailing model in which all, or nearly all, clearing
members of a DCO were FCMs acting as intermediaries. However, as
noted in the proposed rule, the Commission has granted registration
to a number of DCOs that clear directly for market participants
without the intermediation of FCMs.\8\ Additionally, many DCOs that
use the traditional FCM clearing model have at least some non-FCM
clearing members. The growth and evolution of the non-intermediated
clearing model necessitates ensuring that our regulations establish
a regime for the safeguarding and protection of clearing member
funds that addresses the issues and risks presented.
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\8\ Currently, CBOE Clear Digital, LLC; CX Clearinghouse, L.P.;
LedgerX, LLC; and North American Derivatives Exchange Inc. allow
individuals to be direct clearing members. See In the Matter of the
Application of CBOE Clear Digital, LLC For Registration as a
Derivatives Clearing Organization (June 5, 2023), available at
https://www.cftc.gov/IndustryOversight/IndustryFilings/ClearingOrganizations/39855; In the Matter of the Application of CX
Clearinghouse, L.P. For Registration as a Derivatives Clearing
Organization (Aug. 3, 2018), available at https://www.cftc.gov/IndustryOversight/IndustryFilings/ClearingOrganizations/16767; In
the Matter of the Application of LedgerX, LLC For Registration as a
Derivatives Clearing Organization (Sept. 2, 2020), available at
https://www.cftc.gov/IndustryOversight/IndustryFilings/ClearingOrganizations/30998; In the Matter of the Application of the
North American Derivatives Exchange for Registration as a
Derivatives Clearing Organization (Jan. 17, 2014), available at
https://www.cftc.gov/IndustryOversight/IndustryFilings/ClearingOrganizations/38.
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Lastly, I am pleased that the proposed rule would, in effect,
codify the no-action and exemptive relief previously given to four
DCOs \9\ by permitting DCOs to hold customer funds at foreign
central banks and use a modified acknowledgment letter. The proposed
rule would also extend these amended provisions to clearing member
funds. Permitting DCOs to hold customer and clearing member funds at
a central bank allows them to take advantage of the credit and
liquidity risk management benefits that central bank accounts
provide. This is sound policy and risk management.
---------------------------------------------------------------------------
\9\ See CFTC Letter No. 16-59 (June 21, 2016), available at
https://www.cftc.gov/csl/16-59/download (granting an exemption to
the Chicago Mercantile Exchange, Inc (CME) from the requirements of
Regulation Sec. 1.49(d)(3) to permit CME to hold customer funds at
the Bank of Canada and permitting the use of a modified
acknowledgment letter for customer accounts maintained by the CME.
at the Bank of Canada); CFTC Letter No. 16-05 (Feb. 1, 2016),
available at https://www.cftc.gov/csl/16-05/download (granting an
exemption to Eurex Clearing AG (Eurex) from the requirements of
Regulation Sec. 1.49(d)(3) to permit Eurex to hold customer funds
at Deutsche Bundesbank and permitting the use of a modified
acknowledgment letter for customer accounts maintained by Eurex at
Deutsche Bundesbank); and CFTC Letters No. 14-123 (Oct. 8, 2014),
available at https://www.cftc.gov/csl/14-123/download and 14-124
(Oct. 8, 2014), available at https://www.cftc.gov/csl/14-124/download (granting an exemption to ICE Clear Europe Limited and LCH
Ltd, respectively, from the requirements of Regulation Sec.
1.49(d)(3) to permit ICE Clear Europe Limited and LCH Ltd to hold
customer funds at the Bank of England and permitting the use of a
modified acknowledgment letter for customer accounts maintained by
ICE Clear Europe Limited and LCH Ltd, respectively, at the Bank of
England).
---------------------------------------------------------------------------
I look forward to hearing the public's comments on the proposed
rule. The 60-day comment period will begin upon the Commission's
publication of the proposed rule on its website.
Appendix 3--Statement of Commissioner Kristin N. Johnson
Trust is the core issue that motivates today's notice of
proposed rulemaking (Proposed Rule) regarding the protection of
clearing member funds held by derivatives clearing organizations
(DCOs) advanced by the Division of Clearing and Risk.
On March 30, 2022, I commenced service as a Commissioner of the
Commodity Futures Trading Commission (Commission or CFTC). In a
hearing before the Senate Agriculture, Nutrition, and Forestry
Committee a few weeks earlier, I committed to promote the
[[Page 302]]
integrity and stability of our markets and protect customers,
particularly vulnerable and marginalized individual retail customers
who participate in our markets. This commitment is among the most
compelling reasons for my public service.
Over the last few decades, the Commission has adopted and
refined protections for customers of intermediaries in our markets,
namely by imposing rigorous obligations on intermediaries to
segregate the funds of their customers, designating specific
authorized depositories, and outlining permitted investments of
customer funds.
Over the course of my tenure as a Commissioner, in numerous
public speeches, statements, and interviews, I have called on the
Commission to advance parallel customer protections for direct
participants of non-intermediated clearinghouses registered with the
Commission as DCOs.\1\
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\1\ Kristin N. Johnson, Commissioner, CFTC, Statement on
Preserving Trust and Preventing the Erosion of Customer Protection
Regulation (Nov. 3, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnstatement110323; Kristin N. Johnson,
Commissioner, CFTC, Keynote Address at the World Federation of
Exchanges Annual Meeting: Creating Rules of the Road for
(Dis)Intermediated and (De)Centralized Markets (Sept. 21, 2023),
https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson5;
Kristin N. Johnson, Commissioner, CFTC, Keynote Address at Salzburg
Global Finance Forum: Future-Proofing Financial Markets Regulation
(June 29, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson4; Kristin N. Johnson, Commissioner, CFTC, Statement
Calling for the CFTC to Initiate A Rulemaking Process for CFTC-
Registered DCOs Engaged in Crypto or Digital Asset Clearing
Activities (May 30, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement053023; Kristin N. Johnson,
Commissioner, CFTC, Keynote Address at Digital Assets @Duke
Conference, Duke's Pratt School of Engineering and Duke Financial
Economics Center: Mitigating Crypto-Crises: Applying Lessons Learned
in Governance, Risk Management, and Compliance (Jan. 26, 2023),
https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson2;
Kristin N. Johnson, Commissioner, CFTC, Statement in Support of
Notice of Proposed Amendments to Reporting and Information
Requirements for Derivatives Clearing Organizations (Nov. 10, 2022),
https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement111022b.
---------------------------------------------------------------------------
Today's Proposed Rule takes the first steps to close this gap. I
support this Proposed Rule that advances the protection of clearing
member proprietary funds held by a DCO. Specifically, the Proposed
Rule:
Requires a DCO to segregate clearing member proprietary
funds from the DCO's own funds, hold such funds in an account
labeled as proprietary funds, and obtain a written acknowledgment
letter from a depository;
Requires a DCO to treat clearing member proprietary
funds as belonging to the clearing member while permitting the DCO
to use clearing member proprietary funds as part of the DCO's
default waterfall, consistent with the DCO's rules and agreement
with its clearing members;
Permits the DCO to commingle proprietary funds of
multiple clearing members in a single omnibus account for
convenience while prohibiting the commingling of proprietary funds
with the DCO's own funds or futures commission merchant (FCM)
customer funds;
Permits the DCO to invest clearing member proprietary
funds in highly liquid financial instruments pursuant to CFTC
Regulation Sec. 1.25 and requires DCOs to be responsible for
investment losses; and
Requires the daily reconciliation of balances of FCM
customers and clearing members and segregated funds and the
reporting of any discrepancies.
In my capacity as a Commissioner at the CFTC, I have strongly
advocated for the development of these important regulatory
protections that parallel existing protections in intermediated
market structures. This Proposed Rule reflects the tremendous
efforts of coordination among the Division of Clearing and Risk, the
office of the Chairman, my office, and my fellow Commissioners'
offices and their staff. Our collective engagement reflects years of
dialogue with market participants, CFTC staff, other market and
prudential regulators and engagement with the U.S. Department of the
Treasury, members of Congress, academics, and public interest
advocates.
This Proposed Rule offers a transformational reform that brings
to markets in which clients may interact directly with a DCO
foundational protections currently established in CFTC regulations
and enforced in markets that rely on intermediaries.\2\
---------------------------------------------------------------------------
\2\ Although the focus of my statement is on direct participants
in the context of non-intermediated clearing models, the Proposed
Rule has broader implications. It applies to the proprietary funds
of FCMs in the context of an intermediated model as well.
---------------------------------------------------------------------------
In a direct clearing model (non-intermediated market structure),
clearing members are not customers of intermediaries,\3\ and
therefore, do not qualify for the regulatory protections available
under part 1 of the Commission's regulations, including the
requirement to separately account for and segregate customer funds
as belonging to customers, deposit customer funds in specific
locations, obtain written acknowledgment letters from depositories,
and use customer funds as belonging to such customers.\4\ The
Proposed Rule reflects the historic development and evolution of
markets and refers to the assets or funds on deposit from a customer
of an intermediary as ``customer funds.'' The Proposed Rule adopts
the term ``clearing member'' to describe those directly interacting
with the clearinghouse and ``proprietary funds'' to describe
clearing members' assets or funds on deposit.
---------------------------------------------------------------------------
\3\ The term ``customer'' is generally reserved for the
individuals or businesses that rely on an intermediary such as an
FCM to facilitate a transaction. Where a DCO offers direct services,
the individuals or businesses engaged with the clearinghouse are
generally described as ``members.''
\4\ 17 CFR 1.20.
---------------------------------------------------------------------------
The Commission acts to ensure parallel protections in the market
for every asset class, adopting and seeking to implement the
existing, well-tested, and effective regulatory framework under
certain provisions of part 1 of the CFTC's regulation to the
preservation of clearing member proprietary funds. This may be
increasingly important as the Commission anticipates market
participants' introduction of novel financial products.
In adopting the Proposed Rule, the Commission seeks to ensure
that clearing member proprietary funds are easily identified and
receive the proper treatment in the event the DCO enters an
insolvency or bankruptcy proceeding.
Today, the Commission takes a first step to ensure that there
are parallel protections for both the ``customers'' of
intermediaries, and the ``clearing members'' of DCOs who may include
(in a direct clearing model) individual retail market participants.
Regulatory Gap for Direct Participants in Non-Intermediated Clearing
Models
Section 4d of the Commodity Exchange Act (CEA) and parts 1, 22
and 30 of the Commission's regulations establish a comprehensive
regime to safeguard the funds belonging to customers of FCMs in the
context of intermediated DCOs.
The customer protection regime requires FCMs to segregate
customer funds from their own funds, deposit customer funds under an
account name that clearly identifies them as customer funds, and
obtain a written acknowledgment from each depository that holds
customer funds. The customer protection regime does not apply to the
funds of a person that clears trades directly through a DCO and is a
``clearing member'' because such market participants do not meet the
legal and regulatory definitions of the term ``customer.''
Therefore, direct participants that are not ``customers'' of
intermediaries may not benefit from the Commission's well-
established customer protection regime.
The Commission seeks to offer parallel customer protections to
direct participants in non-intermediated DCOs--clearing members--to
preserve the value of their proprietary funds, mitigate the risk of
loss, and improve the availability of those funds for return to the
clearing member should the DCO fail. Section 5b(c)(2)(F) of the CEA
(Core Principle F) and CFTC Regulation Sec. 39.15 apply to the
treatment of clearing members' funds and assets held by a DCO.
CFTC regulations require DCOs to establish standards and
procedures designed to protect and ensure the safety of proprietary
funds and require DCOs to hold proprietary funds in a manner that
will minimize the risk of loss or delay in access by the DCO to the
proprietary funds. Section 8a(5) of the CEA grants the Commission
authority to adopt rules it determines are reasonably necessary to
effectuate the DCO core principles.\5\ The safeguards in this
Proposed Rule are indeed reasonably necessary to effectuate DCO Core
Principle F.\6\
---------------------------------------------------------------------------
\5\ 7 U.S.C. 12a(5).
\6\ 7 U.S.C. 7a-1(c)(2)(F).
---------------------------------------------------------------------------
In light of the lack of parallel protections for ``clearing
members'' who directly interface with DCOs, there is a significant
gap in the Commission's ability to ensure the protection and
preservation of funds or assets of direct participants. This
Proposed Rule closes the gap.
[[Page 303]]
The Collapse of the FTX Complex
The bankruptcy of FTX illustrates the magnitude of the losses
that customers may experience in the absence of regulation that
prohibits commingling of client assets or imposes obligations to
segregate client assets for the benefit of customers.
In November 2022, FTX Trading Ltd. d/b/a/FTX.com (FTX), Alameda
Research LLC (Alameda) and approximately one hundred and thirty FTX-
affiliated entities filed for bankruptcy in the United States.
Contemporaneous with the bankruptcy filing, the Department of
Justice (DOJ), Commission, and other federal regulators began to
investigate claims that FTX employed omnibus accounts that
commingled customer funds with the FTX enterprise resources,
allegedly misappropriating more than $10 billion in client
assets.\7\
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\7\ 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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The CFTC has alleged that Mr. Bankman-Fried and FTX solicited
customers on the premise that the FTX platform could be trusted.\8\
The CFTC's complaint alleges that despite these statements, FTX
permitted Alameda to access customer deposits and commingle customer
assets with Alameda's proprietary assets, which were used for
Alameda's and its executives' own business operations, personal
purchases, acquisitions of other businesses, and risky investments.
---------------------------------------------------------------------------
\8\ See Commodity Futures Trading Commission v. Samuel Bankman-
Fried, FTX Trading Ltd d/b/a FTX.com, and Alameda Research LLC
(S.D.N.Y. 2022) (Compl.).
---------------------------------------------------------------------------
While soliciting customers to trust in the integrity of its
business, FTX is alleged to have siphoned off billions in customer
deposits.
The Benefits and Limits of Alternatives to Regulation: LedgerX
LedgerX, a non-intermediated clearinghouse registered with the
Commission as a DCO and owned by parent company FTX, illustrates the
importance of the protections advanced in the proposed rulemaking.
On October 25, 2021, FTX.US acquired LedgerX through a Delaware
company doing business as West Realm Shires Services Inc. (West
Realm Shires). When parent company FTX filed a petition seeking
bankruptcy protection on November 11, 2022, the bankruptcy court
declared LedgerX a non-debtor entity. LedgerX was one of the few
assets within the network of FTX-affiliated companies that remained
solvent.
In 2017, years before the acquisition by West Realm Shires,
LedgerX submitted an application with the Commission seeking
authorization to register as a DCO offering fully-collateralized
(crypto) derivatives contracts. The Commission's order, amended in
September 2020, imposed a number of important conditions, including
a condition requiring LedgerX to ``at all times maintain funds of
its clearing members separate and distinct from its own funds.'' \9\
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\9\ Press Release No. 8230-20, CFTC, 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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When FTX filed for bankruptcy protection, the conditions in the
LedgerX order and Commission staff's enforcement of compliance with
the conditions contributed significantly to the preservation of
LedgerX's customer property.\10\ The LedgerX order serves as an
important precedent for the framework the Commission must consider
when adopting parallel protections for DCO direct clients,
particularly retail clients, in the non-intermediated context.
---------------------------------------------------------------------------
\10\ LedgerX's ``customers'' are clearing members as described
above and would not otherwise qualify for protections under parts 1
and 22 of the Commission's regulations.
---------------------------------------------------------------------------
In 2022, LedgerX applied to amend its order of registration as a
DCO to allow it to modify its existing non-intermediated model to
clear margined products for retail participants while continuing
with a non-intermediated model.
In May 2022, the Commission held a convening to examine the
implications of a derivatives clearing market structure that offers
direct-to-client services. The convening outlined important issues
addressed in this Proposed Rule.
The Rise of Non-Intermediated DCOs
DCOs play an increasingly important role in the financial
markets, though DCOs have been central to facilitating access to the
derivatives market since the founding of our nation and the futures
market. The Dodd-Frank Act introduced a framework for the regulation
of swaps that imposed central clearing and trade execution
requirements, registration and comprehensive regulation of swap
dealers, and recordkeeping and real-time reporting requirements.
The clearing market structure has evolved from a traditional
clearing model, where an FCM served as an intermediary in
transactions between a customer and a DCO, to a direct clearing
model, where the transactions are between the customer and the DCO
directly.\11\ As I have previously stated:
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\11\ Currently, CBOE Clear Digital, LLC, CX Clearinghouse, L.P.;
LedgerX, LLC, and North American Derivatives Exchange Inc. allow
individuals to be direct clearing members. Additionally, ICE NGX
Canada Inc. clears physically delivered energy contracts directly
for clearing members with a net worth exceeding CAD $5,000,000 or
assets exceeding CAD $25,000,000.
---------------------------------------------------------------------------
FCMs solicit and accept orders for derivatives transactions on
behalf of customers and receive customer funds to margin, guarantee,
or secure derivatives transactions. FCMs are subject to significant
regulatory requirements, including customer protection safeguards,
safety and soundness capital requirements, risk management,
conflicts of interest requirements, and anti-money laundering and
know-your-customer programs.\12\
---------------------------------------------------------------------------
\12\ Kristin N. Johnson, Commissioner, CFTC, Keynote Address at
the World Federation of Exchanges Annual Meeting: Creating Rules of
the Road for (Dis)Intermediated and (De)Centralized Markets (Sept.
21, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson5.
---------------------------------------------------------------------------
At the core, in a traditional, intermediated model, customer
protection rules apply to FCMs and require FCMs to segregate
customer funds, including when such funds are held at a DCO, among
other safekeeping measures.
In newly emerging disintermediated market structures, the
absence of an intermediary creates a gap in the application of the
CFTC's customer protection rules because key customer protections
are triggered by the presence of a ``customer,'' as defined by the
CFTC, and an FCM that facilitates the clearing of a customer's
derivatives transactions at the DCO.\13\
---------------------------------------------------------------------------
\13\ See supra note 1.
---------------------------------------------------------------------------
The Proposed Rule achieves parallel protections by applying key
aspects of the customer protection regime to proprietary funds of
clearing members and imposing parallel asset protection requirements
on DCOs--both in intermediated and non-intermediated clearing
models.
In addition, the Proposed Rule contains important requests for
comments, soliciting feedback and engagement from the industry on a
number of potential future actions.
Future Rulemaking: Anti-Money Laundering Requirements for DCOs
Anti-money laundering (AML) regulations ensure that all
transactions in our markets are subject to identification
verification standards and prevent illicit activity in our markets.
It is imperative that the Commission continue to engage with the
U.S. Department of Treasury to ensure that AML regulations apply to
all applicable market structures involving activities that create
obligations to comply with AML regulations.
The Proposed Rule includes a request for comment that asks how
might the Commission ensure AML and KYC compliance for DCOs that
offer direct clearing services (a market structure that would not
include FCMs or other intermediaries that are typically directed to
create Bank Secrecy Act compliance programs)? Should DCOs offering
direct-to-customer services to non-eligible contract participants or
retail customers be required to comply with AML and KYC
requirements?
Following consultation with the U.S. Department of Treasury, the
Commission may need to engage in a formal rulemaking that imposes
AML requirements on DCOs.\14\
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\14\ I note that the Commission has negotiated the inclusion of
AML requirements in the registration order for several DCOs,
including CBOE Clear Digital, LLC and LedgerX LLC. I commend DCOs
that have implemented these conditions.
---------------------------------------------------------------------------
Technical Clarifications in CFTC Regulation 1.25
The Proposed Rule allows DCOs to invest proprietary funds in
permitted investments pursuant to CFTC Regulation Sec. 1.25. The
drafting cross-refers to CFTC Regulation Sec. 1.25, but the
Commission is currently engaged in a proposed rulemaking that amends
CFTC Regulation Sec. 1.25. My supporting statements to amendments
to CFTC Regulation Sec. 1.25 note that it is imperative that the
Commission consider an equivalent application of CFTC Regulation
[[Page 304]]
Sec. 1.25 in the context of a DCO's investment of the member
property of retail customers.\15\
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\15\ Kristin N. Johnson, Commissioner, CFTC, Statement on
Preserving Trust and Preventing the Erosion of Customer Protection
Regulation (Nov. 3, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnstatement110323.
---------------------------------------------------------------------------
Comments to the Proposed Rule should indicate how best to ensure
equivalence.\16\
---------------------------------------------------------------------------
\16\ In footnote 45 in the Proposed Rule, the Commission notes:
Proposed Sec. 39.15(e) cross-references Sec. 1.25, which provides
that an FCM or DCO may invest ``customer money'' in certain
instruments. The regulatory text of Sec. 1.25, however, does not
refer to ``proprietary funds.'' The Commission recently approved
proposed amendments to Sec. 1.25. Based on comments received on
those proposed amendments, if appropriate, the Commission may
consider further amending Sec. 1.25 either in the final rule or as
a re-proposed rule to ensure that the regulatory text provides
clarity on the application of Sec. 1.25 to a DCO's investment of
``proprietary funds,'' as permitted under Sec. 39.15(e).
---------------------------------------------------------------------------
Periodic Reporting of Daily Reconciliations
The Proposed Rule requires a DCO to notify the CFTC of
discrepancies in its daily calculations. The Commission exercises
direct oversight with respect to DCOs, meaning DCOs are not
supervised by self-regulatory organizations (SRO) or designated
self-regulatory organizations (DSRO). The Commission performs the
examination functions. DCOs may benefit from a similar oversight as
FCMs, which involves a regular reporting of reconciliation and not
just the reporting of discrepancies.\17\ DCOs are subject to robust
Commission regulations, examinations, and oversight. It will be
important to receive comments from all stakeholders regarding the
reporting of DCO reconciliations.
---------------------------------------------------------------------------
\17\ See supra note 15.
---------------------------------------------------------------------------
Conclusion
It is my hope that this Proposed Rule will move forward so that
we can begin to introduce greater protections for clearing members,
including retail customers. I thank the Division of Clearing and
Risk--Clark Hutchinson, Eileen Donovan, Theodore Polley, and Scott
Sloan--for their tremendous efforts in advancing this very
important, significant, and transformative Proposed Rule.
Appendix 4--Dissenting Statement of Commissioner Christy Goldsmith
Romero
This week, the Commission in a split vote, on which I dissented,
approved the first proposed rule related to FTX's bespoke direct-to-
retail market structure. That structure removed the intermediary
(known as a futures commission merchant or FCM) where the CFTC's
customer protection and anti-money laundering regimes sit. I believe
that before my tenure, the Commission made a mistake in approving
two clearinghouses (LedgerX owned by FTX before FTX's bankruptcy,
and Nadex, which is now Crypto.com) for this direct-to-retail market
structure before analyzing and addressing the risks of a lack of AML
requirements, customer protections, and other checks and balances.
After FTX's bankruptcy, the CFTC is now trying to remedy the
consequences of its mistake, one of which is that retail
participants do not have customer protections under this model
because they lose their status as ``customers,'' instead becoming
``clearing members.'' In the open meeting, the CFTC staff said that
the proposed rule was an attempt to provide parallel protections to
those individuals who we would normally consider to be
``customers,'' but who now are ``members.'' But it fails to provide
parallel protections to retail participants. The proposed rule
attempts to port over to this direct-to-retail model one protection
(segregation of funds, which I support) without the other
protections, or checks and balances present in an intermediated
model with an FCM.
I do not know if it is even possible for the CFTC to give
parallel protections to retail participants under a direct-to-retail
model, because the Commodity Exchange Act and Commission rules
contemplate the presence of an FCM. Additionally, anti-money
laundering controls sit with the FCM, and clearinghouses have no AML
requirements. AML is a critical guardrail for national security and
customer protection. The Financial Stability Oversight Council's
(FSOC) 2023 Annual Report says, ``Crypto-assets remain susceptible
to misuse by terrorist organizations and other sanctioned
individuals' efforts to move funds in support of illicit
activities.'' \1\
---------------------------------------------------------------------------
\1\ See Financial Stability Oversight Council, Annual Report
2023, https://home.treasury.gov/system/files/261/FSOC2023AnnualReport.pdf, (December 14, 2023).
---------------------------------------------------------------------------
I do not believe that the rule, which was rushed in three weeks
at the end of the year, is sufficient to remedy that earlier
mistake. The rule would benefit from more time than three weeks.\2\
We should step back and assess the impact of changing the tried and
true market structure by removing the FCM. Without addressing a
number of serious issues, the rule may give a false sense of
security about the safety of a direct-to-retail model, while hiding
the threats. The CFTC staff in the open meeting said that there are
a number of applications pending for this model and they expect
more. Without an assessment, we may just move risk around the
system, while creating an illusion of safety.
---------------------------------------------------------------------------
\2\ Commissioners received it late Wednesday, the day before
Thanksgiving, three weeks before the meeting, with no prior
engagement with Commissioners on the content of the rule. Because,
it raised serious questions, I asked that it be pulled from the
meeting and that Commissioners would have more time. My request was
denied with no reason given.
---------------------------------------------------------------------------
Such an assessment would implement a recommendation from the
FSOC. In its October 2022 Report on Digital Asset Financial
Stability Risks and Regulation, the FSOC recommended that member
agencies (including the CFTC) ``assess the impact of vertical
integration (i.e., direct access to markets by retail customers) on
conflicts of interest and market volatility, and whether vertically
integrated market structures can or should be accommodated under
existing laws and regulations.'' The CFTC has not conducted this
analysis, leaving the CFTC out of step with FSOC's recommendation.
I invite the public to watch this week's CFTC public meeting,
which showed that there are serious issues that the CFTC should
assess and address before accommodating this crypto industry
model.\3\ The first is whether the CFTC can impose AML requirements
on clearinghouses to prevent retail funds from being commingled with
funds belonging to terrorists, cyber criminals and drug cartels--a
question on which the CFTC is in the middle of its analysis.\4\ This
rule also does not require disclosures to inform retail participants
that they are giving up customer protections and bankruptcy customer
priority, instead taking the status of ``clearing members,'' similar
to the roles and duties that normally falls to an FCM such as a
large bank.\5\ The rule also would not limit clearinghouses to
depositing these ``member'' funds in only banks or trusts, as FCMs
are required, which would allow the clearinghouse to deposit funds
with an unregulated affiliate.\6\
---------------------------------------------------------------------------
\3\ See CFTC to Hold and Open Commission Meeting on December 13,
https://www.youtube.com/watch?v=zANNkH5STzk, (December 13, 2023) at
2:12:00.
\4\ See Id. at 3:07:40-3:08:40; 3:16:52-3:17:40.
\5\ See Id. at 2:37:45-2:39:10.
\6\ See Id. at 2:44:20-2:44:55.
---------------------------------------------------------------------------
Instead of learning the lessons of FTX, I worry that rushing to
approve this proposal leaves the Commission out of step with other
federal financial regulators that are asking whether a direct-to-
retail model can or should be accommodated under current law, and
assessing its implications. I also worry that this proposed rule
will form the basis for the CFTC to approve more crypto companies
for this direct-to-retail model under the false impression that this
model is safe. I am concerned about rushing this rule through at the
end of the year in three weeks' time, when these are critical post-
FTX issues. I must dissent.
The CFTC's Laws and Regulations Protect Customers and Guard Against
Illicit Finance Through a Market Structure That Has Stood the Test of
Time
Clearinghouses play an important public interest role--they are
critical market infrastructure intended to foster financial
stability, trust, and confidence in U.S. markets. Dodd-Frank Act
reforms increased central clearing, thereby increasing financial
stability. Those reforms also concentrated risk in clearinghouses.
With that concentrated risk, it is critical that the Commission
maintain vigilance in its oversight over clearinghouses to identify
and monitor risk and promote financial stability. This is most
important for the CFTC's monitoring of systemic risk.
FCMs also play an important role. First, they stand as a shock
absorber, providing additional financial support to the
clearinghouse to safeguard the financial system. Second, because
they are customer-facing, they are responsible for providing
customer protections. The customer protection regime under the
Commodity Exchange Act and CFTC rules are found in
[[Page 305]]
requirements for FCMs. In its October 2022 report, the FSOC
discussed: \7\
---------------------------------------------------------------------------
\7\ See Financial Stability Oversight Council, Report on Digital
Asset Financial Stability Risks and Regulation, https://home.treasury.gov/news/press-releases/jy0986, (October 3, 2022).
---------------------------------------------------------------------------
The current framework of markets regulation is generally
structured around the requirement or presumption that markets are
accessed by retail customers through intermediaries such as broker-
dealers or future commission merchants (FCMs). Those intermediaries
perform many important functions, such as processing transactions,
acting as agent and obtaining best execution for customers,
extending credit, managing custody of customer assets, ensuring
compliance with federal regulations, and guaranteeing performance of
contracts. As a result of the special role these intermediaries play
in traditional market structures, they are subject to unique
regulations often focused on customer protections, such as
regulations around conflicts of interest, suitability, best
execution, segregation of funds, disclosures, and fitness standards
for employees.
Upending this traditional market structure, without analysis,
can have unintended consequences.
There Are No Customers or Customer Protections in a Direct-to-Retail
Model
The CFTC does not require disclosures to retail participants
about the consequences of participating in this model. In the
direct-to-retail model, customers lose their status as
``customers,'' thereby losing all of the customer protections in the
CFTC's regulatory framework, and instead take the status of
``clearing members,'' raising a host of issues. It is unlikely that
retail customers know and understand that they gave up all of their
customer protections. It is also unlikely that retail customers know
and understand that in the event of a bankruptcy, they lose their
``customer'' priority in a distribution. It is also a question
whether these retail customers would have to take on the FCM's shock
absorbing role.
When FTX's application for authority to issue margined crypto
products \8\ was pending before us, on May 25, 2022, the CFTC held a
roundtable on the disintermediated model. We heard then and later
received comments from many stakeholders expressing serious concerns
over this model.
---------------------------------------------------------------------------
\8\ The CFTC conditioned LedgerX's registration on the trades
being fully collateralized. FTX applied to eliminate this condition
to issue margined products directly to customers. I was not in favor
of FTX's application, and signaled that weeks before FTX's failure.
See CFTC Commissioner Christy Goldsmith Romero, Financial Stability
Risks of Crypto Assets: Remarks before the International Swaps and
Derivatives Association's Crypto Forum 2022, https://www.cftc.gov/PressRoom/SpeechesTestimony/oparomero3, (Oct. 26, 2022).
---------------------------------------------------------------------------
The FSOC also expressed concerns over direct-to-retail models,
warning in its October 2022 report:
Financial stability implications may arise from vertically
integrated platforms' approaches to managing risk . . . Direct
exposure by retail investors to rapid liquidations of this kind also
raises investor and consumer protection issues. Platforms dealing
directly with retail investors would need to ensure the provision of
adequate disclosures, responsibilities otherwise taken on by
intermediaries. The vertically integrated model presents conflict of
interest. . . .\9\
---------------------------------------------------------------------------
\9\ See Financial Stability Oversight Council, Report on Digital
Asset Financial Stability Risks and Regulation, https://home.treasury.gov/news/press-releases/jy0986, (October 3, 2022).
---------------------------------------------------------------------------
The CFTC has not conducted the assessment that FSOC recommended
more than one year ago. It is an open question of whether the CFTC
should accommodate these direct-to-retail models given how much is
lost, including the loss of the CFTC's customer protection regime
and AML regime.
This Rushed Proposed Rule Does Not Replace Customer Protections, AML,
and Other Checks and Balances, Lost by Removing the FCM
The CFTC has had a year to learn the lessons from FTX's
application and assess direct-to-retail models as FSOC recommended.
I am strongly in favor of strengthening customer protections,
particularly for retail, including banning commingling of customer
funds,\10\ but this proposal is not about ``customer'' funds. In a
direct-to-retail model, legally, there are no customers. I am not in
favor of retail losing their status as customers and losing customer
protections.\11\ The proposed rule would be the first post-FTX rule
on this model, but it was rushed and as a result, lacks sufficient
analysis.
---------------------------------------------------------------------------
\10\ See CFTC Commissioner Christy Goldsmith Romero, Crypto's
Crisis of Trust: Lessons Learned from the FTX's Collapse, https://www.cftc.gov/PressRoom/SpeechesTestimony/oparomero5#_ftnref10, (Jan
18, 2023) (I warned in the aftermath of FTX's collapse about how
commingling presents ``a significant threat to customers that can
leave customers in a musical chairs dilemma.'')
\11\ All participants, retail or institutional, are considered
clearinghouse members. This is not some technical, legalistic
distinction. Our laws will treat those retail participants the same
as the largest financial institution.
---------------------------------------------------------------------------
The question raised by the FSOC of whether we should accommodate
this market structure from crypto is a critical one to answer. The
deliberations at last week's open meeting confirmed that it may not
be possible to give retail participants the same protections in a
disintermediated model as in the intermediated model. And just last
week, the FSOC Annual Report again warned about the vulnerabilities
arising from collapsing regulatory functions into a single entity,
including ``conflicts of interest, inappropriate use of clients'
funds, and market manipulation.'' \12\
---------------------------------------------------------------------------
\12\ See Financial Stability Oversight Council, Annual Report
2023, https://home.treasury.gov/system/files/261/FSOC2023AnnualReport.pdf, (December 14, 2023).
---------------------------------------------------------------------------
This rule would not resolve the FSOC's concerns. It does not
contain the assessment needed as to risk and what regulatory
requirements would be required in a direct-to-retail model to meet a
``same risk, same regulatory outcome approach'' that makes up for
the checks and balances lost from removing the FCM. That would
require establishing the basic foundation of customer protections
and guardrails (including against illicit finance). Without that
analysis, this proposal puts the CFTC out of step with other federal
financial regulators.
The Direct to Retail Model Raises Many Questions the CFTC Has Not
Adequately Considered
My concerns about a direct-to-retail model include:
1. Losing status of ``customer'': Regular people lose their
protections as ``customer'' under the law in the direct-to-retail
model. Instead, they are treated as clearinghouse ``members,'' a
role that traditionally has been reserved for FCMs, which include
the largest financial institutions. The regular person trading in
bitcoin futures or event contracts is not the same as J.P. Morgan or
Wells Fargo. Clearing members have obligations to the clearinghouse
to stave off clearinghouse failure. This presumably would also be
the case for retail acting as members. I have serious concerns about
whether retail participants understand what they are giving up and
that this is the role they are taking on. The CFTC should consider
requiring plain English disclosures delivered in a manner that
actually informs people of their rights and risks, as opposed to a
click-wrap agreement or lengthy legal document.
2. No AML/CTF/KYC: Because the Commodity Exchange Act envisions
the presence of an FCM that has significant responsibilities,
including anti-money laundering/Know Your Customer requirements,
clearinghouses do not have currently have any obligation to
implement Anti-Money Laundering, Countering Terrorist Financing or
Know Your Customer safeguards, opening up our market to illicit
finance. The Commission staff are still analyzing what safeguards
the CFTC can require.
3. No requirements to deposit funds in a regulated entity: FCMs
are required to hold customer funds at a bank, trust or a CFTC-
regulated entity. That requirement is absent for member funds and is
not added in this rule, allowing clearinghouses to place the funds
anywhere, even an affiliate. That means that FTX's registered
clearinghouse LedgerX could have deposited retail ``member'' funds
with Alameda, the trading firm involved in the loss of billions of
customer funds.
4. No checks and balances: FCMs who interface with customers
have regulatory requirements for customer protections, and have
incentives to monitor the clearinghouse to make sure it is not
misusing customer funds. This role sits empty in a direct-to-retail
model.
5. No customer bankruptcy priority: In the case of the
clearinghouse bankruptcy under this model, the bankruptcy code would
not consider retail participants to be ``customers,'' and they would
not receive the customer priority in any distribution.
More Time Is Needed To Analyze New AML Requirements for Clearinghouses
I want to call special attention to the proposal's lack of anti-
money laundering (AML) and know your customer (KYC) requirements for
clearinghouses. Without
[[Page 306]]
these protections, retail funds may be at serious risk of seizure if
they are commingled with funds of terrorist organizations, drug
cartels, or other illicit actors. It is well known that
cryptocurrency transactions are used to finance cybercrime,
terrorism, sanctions avoidance, and the drug trade.\13\ News reports
suggest that Hamas used cryptocurrency to receive significant
funding preceding its October 7th attacks.\14\
---------------------------------------------------------------------------
\13\ See Attorney General, U.S. Department of Justice, The Role
of Law Enforcement in Detecting, Investigating, and Prosecuting
Criminal Activity Related to Digital Assets, https://www.justice.gov/d9/2022-12/The%20Report%20of%20the%20Attorney%20General%20Pursuant%20to%20Section.pdf, (Sept. 6, 2022).
\14\ Wall Street Journal, ``Hamas Needed a New Way to Get Money
From Iran. It Turned to Crypto,'' https://www.wsj.com/world/middle-east/hamas-needed-a-new-way-to-get-money-from-iran-it-turned-to-crypto-739619aa?mg=prod/com-wsj, (Nov. 12, 2023). The CFTC has
brought enforcement actions against two spot crypto exchanges,
BitMEX and Binance, for failing to follow AML controls. Our action
against Binance found that instead of implementing those controls,
Binance turned a blind eye and even advised users to circumvent the
superficial controls it claimed to have.
---------------------------------------------------------------------------
FCMs have regulatory responsibilities to implement AML and KYC
procedures, to perform standardized diligence, to verify customer
identify and to assess whether customers may be known or suspected
terrorists or sanctioned individuals. That AML/CTF/KYC
responsibility puts them at the front lines of combating illicit
finance. The legal requirement also means the CFTC and the National
Futures Association can examine how FCMs are implementing required
anti-money laundering controls. That makes it more likely we will
identify material weaknesses before an FCM becomes a conduit for
illicit funds. Reporting requirements also may make it easier for
law enforcement to identify suspicious patterns and investigate
them.
The proposed rule would not impose any AML responsibilities for
clearinghouses. Under the proposal, retail participants could have
their funds commingled with those deposited by terrorist or
cybercriminals, including state-sponsored cybercrime gangs. In a
seizure, the FBI, other law enforcement or Treasury would seize all
of the funds. I would consider that a very serious risk to member
funds, one that the proposal does not address.
At the open meeting, when I asked whether the CFTC could impose
AML requirements on clearinghouses, the CFTC's General Counsel said
that they had not completed their analysis, but had not foreclosed
the possibility that the CFTC has authority to impose AML
requirements on clearinghouses and that ``it has some promise.''
\15\ The proposed rule contained no analysis of this issue. That was
one of the reasons why I asked that this proposed rule be pulled off
of the meeting, so that the CFTC could continue to work on that
analysis and include AML requirements. My request was denied. At the
open meeting, the Office of the General Counsel said that while the
analysis was ongoing, ``it was decided on a policy basis that we
save that for another day.'' \16\ That was not a policy decision
made by a majority of the Commission as that was never before us.
---------------------------------------------------------------------------
\15\ CFTC to Hold and Open Commission Meeting on December 13,
https://www.youtube.com/watch?v=zANNkH5STzk, (December 13, 2023) at
3:16:20-3:17:50.
\16\ Id.
---------------------------------------------------------------------------
More Analysis Is Needed To Determine Whether Other Customer Protections
and Other Checks and Balances Can Be Provided to Clearinghouses in the
Direct-to-Retail Model
This proposal would impose some safeguards for member funds held
at a disintermediated clearinghouse by banning commingling and
imposing certain limits on how funds can be used.\17\ But it is
narrowly targeted, and serious gaps remain, leaving the proposed
requirements far from the same regulatory outcome as the traditional
model.
---------------------------------------------------------------------------
\17\ It would require direct clearing customer funds to be held
in a separate account from the clearinghouse's funds, in an account
identifying them as belonging to the customers. Those funds could
only be used on behalf of the customer, not on behalf of the company
or its affiliates. The funds would need to be accounted for daily,
and reconciled with the total amount the clearinghouse owes its
customers. It would also limit what clearinghouses can invest those
funds in, with the same limits that apply to brokers today under
Commission Regulation Sec. 1.25. These protections are largely in
line with the representations made by FTX about LedgerX's rules in
its application.
---------------------------------------------------------------------------
Location of Deposits
FCMs and clearinghouses in the traditional model are only
permitted to deposit customer funds with regulated entities--a bank
or trust, a clearinghouse, or another FCM--giving the CFTC
visibility into customer funds, and layering customer protections.
This proposal would not have the same limitation because these would
not be ``customer'' funds. This proposed rule could benefit from
adding in the same requirement. Otherwise, member funds could be
deposited with an unregulated entity, including an unregulated
affiliate with conflicts of interest, that introduces more risk,
leaving the CFTC blind to risk.\18\ At the meeting, the Commission
heard from staff that they were concerned about whether the current
requirement for where FCM's can deposit funds provided sufficient
protections for customers.\19\ The proposal does not have any
analysis of these concerns, likely because it was rushed.
---------------------------------------------------------------------------
\18\ See Commissioner Christy Goldsmith Romero, Crypto's Crisis
of Trust: Lessons Learned from the FTX's Collapse, https://www.cftc.gov/PressRoom/SpeechesTestimony/oparomero5#_ftnref10, (Jan
18, 2023).
\19\ CFTC to Hold and Open Commission Meeting on December 13,
https://www.youtube.com/watch?v=zANNkH5STzk, (December 13, 2023) at
2:42:40-2:46:08.
---------------------------------------------------------------------------
Oversight From Checks and Balances
The proposal also does not replicate another important guardrail
of traditional market structure: checks and balances. Separate
clearinghouses and brokers (FCMs) create natural bumper guards not
present in the direct-to-retail model. However, the proposed rule
contains no analysis of the impacts of moving forward with this non-
traditional model. Instead, at the open meeting, comments were made
to the effect about how certain companies have determined that they
prefer this market structure, and the staff expect there to be more
applications for this model. It is concerning to me that this rushed
rule may be used to facilitate expanding the use of this model,
which is not responsible without further assessment as FSOC
recommended.
Bankruptcy Priority for Customers
The failures of FTX and Celsius show bankruptcy priority is a
serious issue, especially in the retail space. Retail participants
do not have the same ability as institutions to withstand losses or
delay. Existing bankruptcy law assumes a traditional market
structure.\20\ Customers take priority over FCMs in
distributions.\21\ Retail participants in a disintermediated
clearing model may not realize that they are losing bankruptcy
priority as customers because the CFTC requires no disclosures. This
loss of priority is not discussed in the proposal. We should
consider requiring clear disclosures.
---------------------------------------------------------------------------
\20\ Called ``customer funds other than member property.'' See
CFTC, Bankruptcy Regulations, 86 FR 19324 at 19365 (April 13, 2021).
\21\ Id. at 19378. There are also rules allocating customer
property among account classes.
---------------------------------------------------------------------------
Conclusion
It is not responsible to rush our first post-FTX rule on direct-
to-retail models in three weeks at the end of the year, without
conducting the necessary assessment of the impact of this model as
FSOC recommended more than one year ago. I asked for this proposed
rule to be pulled off this open meeting. I am concerned about the
lack of that assessment, including but not limited to specific
analysis of: (1) whether the CFTC should require disclosures to
inform retail participants that they are losing their customer
status in this direct-to-retail model, disclosures that describes
their rights and risks; (2) whether it is possible to take a same
risk, same regulatory outcome approach on issues such as where funds
can be deposited and other concerns raised in comments to the FTX
application about these models; and (3) whether the CFTC can require
clearinghouses to conduct AML/CTF/KYC. Although there are some
existing retail participants currently in this model, at the open
meeting, the staff said that they were already ensuring that the two
crypto direct-to-retail clearing houses were taking steps aligned
with the proposed rule.
Thirteen months after the collapse of FTX, I am glad that we are
starting to address the direct-to-retail model as I have serious
concerns about it, and remain concerned about any expansion of that
model. However, the risks to retail, financial stability, market
integrity and our national security, are too great to rush this in
three weeks without analysis as FSOC recommended. Therefore, I must
dissent.
Appendix 5--Concurring Statement of Commissioner Caroline D. Pham
I concur on the Notice of Proposed Rulemaking on Protection of
Clearing
[[Page 307]]
Member Funds Held by Derivatives Clearing Organizations (DCOs)
(Proposed Amendments to Clearing Member Funds Requirements or
Proposal) because it seeks to protect the proprietary funds of
futures commission merchants (FCMs), and I understand that it
essentially codifies the existing good practices most of the CFTC's
registered DCOs already follow. However, with respect to retail
participants, I believe that the Commission should consider whether
there should be a new registration category for direct clearing
retail DCOs. I also renew my call for an Office of the Retail
Advocate. Both of these steps would better ensure customer
protection in our regulated markets.
I would like to thank Scott Sloan, Tad Polley, Eileen Donovan,
and Clark Hutchison in the Division of Clearing and Risk for their
work on the Proposal. I appreciate the time staff took to answer my
questions.
Existing Protections for Both House Accounts and Customer Funds Have
Worked Well for Decades Without Issues
First, to be clear, the Commission already has extensive rules
in place for protecting FCM customer funds.\1\ Arguably, it is one
thing the CFTC is best-known for. For these FCM customers, FCMs must
segregate customer funds from their own funds, deposit customer
funds under an account name that clearly identifies them as customer
funds, and obtain a written acknowledgment from each depository that
holds customer funds.\2\ This customer protection regime also
establishes accounting and reporting requirements applicable to
customer funds, and limits both the types of investments that can be
made with customer funds and the type of depositories that can hold
customer funds.\3\
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\1\ Commodity Exchange Act (CEA) section 4d, 7 U.S.C. 6d, and
Regulations Sec. Sec. 1.20 through 1.39, 17 CFR 1.20 through 1.39
(futures customer funds), 22.1-22.17, 17 CFR 22.1 through 22.17
(cleared swaps customer collateral) and 30.7, 17 CFR 30.7 (foreign
futures) establish a comprehensive customer protection regime to
safeguard the funds belonging to customers of FCMs.
\2\ See 17 CFR 1.20, 22.5, and 30.7. The acknowledgment letters
must adhere to specific templates in the Commission's regulations,
and require a depository to acknowledge, among other things, that
the accounts opened by the FCM hold funds that belong to the FCM's
customers.
\3\ See 17 CFR 1.32, 1.33, 1.25, and 1.49.
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With respect to clearing member proprietary funds or house
accounts,\4\ consistent with our system of self-regulation set forth
in the Commodity Exchange Act, DCOs have to establish standards and
procedures designed to protect and ensure the safety of proprietary
funds, and hold them in a manner that will minimize the risk of loss
or delay in access by the DCO to the funds.\5\ DCOs also have to
invest clearing member proprietary funds in instruments with minimal
credit, market, and liquidity risks.\6\
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\4\ Regulation Sec. 1.3, 17 CFR 1.3, defines a ``customer'' as
``any person who uses [an FCM], introducing broker, [CTA or CPO] as
an agent in connection with trading in any commodity interest.''
DCOs have to apply many of the customer protection requirements that
apply to FCMs to the customer funds DCOs receive from FCM clearing
members. DCOs must segregate the customer funds of their FCM
clearing members from their own funds, deposit customer funds under
an account name that identifies the funds as customer funds, obtain
acknowledgment letters from depositories, limit the investment of
customer funds to instruments listed in Regulation Sec. 1.25, and
limit depositories for customer funds to those listed in Regulations
Sec. Sec. 1.20 and 1.49. See 17 CFR 1.20(g)(1), 39.15 (b),
22.3(b)(1), 1.20(g)(1) and (g)(4), and 22.5. However, these
protections do not apply to DCO clearing members (i.e., those that
are not FCMs).
\5\ See CEA section 5b(c)(2)(F), 7 U.S.C. 7a-1(c)(2)(F) (Core
Principle F), and 17 CFR 39.15.
\6\ Id.
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Today, the Commission is proposing new regulations for the
protection of clearing member funds, based largely on the customer
segregation requirements for FCMs and DCOs in Regulation Sec.
1.20.\7\ The Proposal explains that new safeguards are needed for
the direct participants at DCOs because (1) the Commission has
registered a number of DCOs that clear directly for market
participants without the involvement of FCMs (i.e., these DCOs are
only clearing for individuals), and (2) many DCOs that use the
traditional FCM clearing model have at least some non-FCM clearing
members.
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\7\ For instance, the Commission is proposing to require a DCO
to hold proprietary funds separately from the DCO's own funds, in
accounts that are named to clearly identify the funds as belonging
to clearing members, to prohibit a DCO or any depository from using
proprietary funds in any way other than as belonging to the clearing
member, to have DCOs review, on a daily basis, the amount of funds
owed to each clearing member with respect to each of its accounts,
both customer (including, as relevant, futures and cleared swaps)
and proprietary, and to reconcile those figures to the amount of
funds held in aggregate in each such type of account across all of
the DCO's depositories, and, to have DCOs obtain proprietary funds
acknowledgment letters.
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While I appreciate the intent of today's Proposal, with respect
to DCOs that have FCMs as clearing members, I believe we must be
careful in changing a regulatory framework that has served our
markets without any real issues for decades. I believe that the
Commission must have had a good reason when it originally
distinguished between house accounts and customer funds. There have
been a lot of spectres raised today that have nothing to do with our
actual regulated markets. Speaking from a practical perspective, I
worry that ``if it ain't broke, don't fix it.'' For example, we
should recognize that DCOs might have operational reasons for the
accounts distinction in our current rules. I encourage the public to
comment on whether the Proposal is workable for DCOs in that regard.
There Should Be a New Registration Category for Direct Clearing Retail
DCOs and an Office of the Retail Advocate To Ensure Customer Protection
I share the concerns where DCOs clear directly for retail
participants without FCMs. I would go further and state that I am
concerned that the Proposal's targeted approach may miss larger
issues. When a DCO faces direct retail participants that our rules
categorize as clearing members, we effectively allow a model that
eliminates intermediaries and the protections that they provide for
customers. Intermediaries perform critical functions, and that is
why markets all over the world require registered brokers and
stringent protections for customers.
If the Commission anticipates this type of DCO clearing model to
proliferate, we should step back and consider all issues that these
direct clearing retail DCOs raise.\8\ These types of concerns around
retail participants are why I have proposed that the Commission
needs an Office of the Retail Advocate.\9\ I continue to believe
that having an Office of the Retail Advocate is a tried-and-true way
to advance customer protection, and may be especially effective in
the area raised by today's Proposal.
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\8\ The Commission provided exemptions from the current
regulations for these DCOs in 2020. See Derivatives Clearing
Organization General Provisions and Core Principles, 85 FR 4800
(Jan. 27, 2020). However, I am suggesting a more holistic assessment
of these DCOs and their clearing members.
\9\ Keynote Address by Commissioner Caroline D. Pham at CordaCon
2022 (Sept. 27, 2022), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/opapham5.
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For example, perhaps there should be a distinct registration
category and requirements for direct clearing retail DCOs because
they raise singular issues, risks, and concerns--foremost, who
provides retail customer protection when there are no brokers or
intermediaries.
Frankly, I dislike a model where DCOs have clearing members that
are retail. To achieve the same market structure outcome, I think it
is better that a DCO has an affiliated FCM that only provides
services for its retail participants on an affiliated DCM and DCO
and would provide customer protections required under our rules.
This would, therefore, not disrupt our existing regulatory framework
and the current scope and application of the Bank Secrecy Act.\10\
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\10\ 31 U.S.C. 5311 et seq.
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Conclusion
I believe the Commission should further study the direct
clearing model for retail participants, together with the increase
in retail binary option contracts. I hope that my proposal for an
Office of the Retail Advocate comes to fruition, and that this is
one of the first issues that we tackle.
Again, I thank staff for the hard work on the Proposal. I look
forward to the public's comments on the Proposed Amendments to
Clearing Member Funds Requirements. Thank you.
[FR Doc. 2023-28767 Filed 1-2-24; 8:45 am]
BILLING CODE 6351-01-P