Introduction

The Commodity Futures Trading Commission’s (Commission or CFTC) governing statute, the Commodity Exchange Act (CEA), enumerates several key aims. Protecting customers from the misuse of customer assets is one of the central goals of derivatives market regulations. Protecting customers begins with carefully evaluating, reviewing, monitoring, and enforcing the regulations that govern intermediaries in our markets.

The Commission has established a comprehensive customer protection framework that applies to futures commission merchants (FCM). This framework requires certain entities that hold customer assets to register with the Commission as an FCM. Under our rules, FCMs must comply with strict segregation and risk disclosure requirements and establish know-your-customer (KYC) and anti-money laundering (AML) programs.

Consequently, any Commission rule or regulation that permits entities exempt from registration as an FCM to hold customer assets must be based on a careful evaluation and consideration of the protections afforded to such customers. Our consideration is particularly critical, if not heightened, in the absence of FCM registration.

Additionally, the Commission must ensure that U.S. customers are not afforded less protection when trading outside the United States. Trading in foreign markets exposes U.S. customers—institutional or retail—to a number of important risks because clearing intermediaries may hold U.S. customers’ cash and securities outside the United States.

The mechanics of trading in foreign markets involve posting customer cash and securities to a clearing firm or exchange organized pursuant to the laws of, and physically located in, a foreign jurisdiction. A bankruptcy or insolvency proceeding related to the foreign clearing firm will be subject to applicable foreign laws. These laws will govern the application of any customer protections and the repatriation of customer assets to U.S. residents. As a result, U.S. customers may not receive the specific protections they would be afforded as customers of a Commission-registered FCM under the U.S. bankruptcy code and Part 190 of the Commission’s regulations.

Part 48 of the Commission’s regulations sets forth the conditions under which a foreign board of trade (FBOT) may provide persons located in the United States with direct access to the FBOT’s trading system to trade foreign futures and options. CFTC Regulation 48.4 establishes the registration eligibility for FBOTs and identifies the entities to which an FBOT may permit direct access once it is registered.

The Commission seeks to amend Part 48 to permit an FBOT registered with the Commission to provide direct access to introducing brokers (IBs) located in the United States and registered with the Commission to submit orders to trade foreign futures and options on behalf of customers located in the United States (Proposed Rule).[1] Under the Proposed Rule, the foreign futures and options must be cleared by a registered FCM or a foreign clearing firm that is exempt from FCM registration (exempt clearing firm) and located in a foreign jurisdiction that the Commission has determined to have a comparable regulatory framework to the CFTC’s regulatory scheme pursuant to CFTC Regulation 30.10.

While our regulations permit exempt clearing firms, the Commission must maintain a robust process for evaluating exemption requests. These criteria, pursuant to CFTC Regulation 30.10, ensure that only countries with comparable regulatory requirements—including with respect to segregation, risk disclosures, and KYC and AML programs—are granted an exemption from Commission regulations. The need for strong customer protection safeguards is heightened when firms organized and located outside the United States. solicit U.S. customers to engage in derivatives activities outside the United States.

The Proposed Rule must therefore include critical customer protection and market integrity guardrails. The Commission must ensure that U.S. customers allowed to have direct access to FBOTs through CFTC-registered IBs receive customer protections equivalent to the protections available when engaging with U.S-registered FCMs.

Wherever the Commission permits firms to follow foreign regulatory requirements instead of Commission requirements, the Commission must undertake a thorough process to ensure that those foreign requirements are, among other things, no less protective for customers than Commission requirements.

Over the course of my tenure as a Commissioner, I have consistently supported the Commission’s efforts to advance the protection of customer funds. I support the Proposed Rule, which includes important protections for U.S. customers, and look forward to comments confirming or offering guidance on how the Commission may ensure that the Proposed Rule advances equivalent protections for U.S. customers clearing through an exempt clearing firms, including with respect to segregation requirements, risk disclosures, and KYC and AML programs.

Part 48 History

Since as early as 1996, FBOTs relied on staff no-action letters to provide trading direct access to persons located in the United States. Section 738 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) amends Section 4(b) of the CEA, empowering the Commission to “adopt rules and regulations requiring registration with the Commission for [an FBOT] that provides the members of the [FBOT] or other participants located in the United States with direct access to the electronic trading and order matching system.”[2] To have direct access, a U.S.-registered IB must be given “an explicit grant of authority” by the FBOT “to enter trades directly into the [FBOT’s] trade matching system.”[3]

In 2011, the Commission adopted Part 48 pursuant to this statutory mandate, requiring an FBOT to register with the Commission in order to provide its members or other participants located in the United States with direct access for electronic trading and execution.[4]

Under Part 48, registered FBOTs may permit direct access by specified participants located in the United States for the purpose of executing customer orders, but the Commission imposed very important conditions on certain specific trading intermediaries—Commission-registered CPOs and CTAs submitting orders on behalf of a United States pool or customer. Those CPOs and CTAs are also required to submit such orders for clearing to a Commission-registered FCM or a clearing broker exempt from FCM registration under CFTC regulation 30.10 that “guarantees, without limitation, all such trades.”[5] As an intermediary between the U.S.-located customer and the foreign exchange, the FCM or foreign clearing broker is liable for all trades executed on the FBOT.

Proposed Rule

The Proposed Rule would be the first change to Part 48 since 2011, amending CFTC Regulation 48.4(b) to add IBs located in the United States and registered with the Commission to the list of trading intermediaries to whom FBOTs may grant direct access for the execution of U.S. customer orders. The customer base of IBs is diverse and includes both institutional customers, retail customers, and end-users. IBs engage in soliciting U.S. customers to purchase a wide range of derivatives, including futures contracts, but do not collect margin against those orders (or extend credit in lieu of margin).[6]

Currently, FBOTs may provide direct access to IBs located outside the United States but not to IBs located in the United States. Under the Proposed Rule, FBOTs would be able to provide registered IBs located in the United States with direct access to execute customer trades, provided that, like CTAs and CPOs, they submit such orders for clearing to a Commission-registered FCM or a firm exempt from FCM registration under CFTC Regulation 30.10 that guarantees all trades.

Commission Customer Protections

The condition requiring that IBs submit their foreign futures and options to a Commission-registered FCM or exempt clearing firm is meant to safeguard customer margin; but the Commission must be deeply thoughtful in its assessment of whether a foreign jurisdiction offers comparable customer protection guardrails. Protecting the assets of customers is one of the Commission’s core missions.

Adopted in 1987, Part 30 of the CFTC’s regulations are intended to “add to the Commission’s existing customer protection regulatory scheme coverage of foreign futures and options transactions undertaken by U.S. domiciliaries.”[7]

Pursuant to CFTC Regulation 30.4, an intermediary that accepts the funds of U.S. residents must register as an FCM, provide risk disclosures and comply with the customer protection framework for U.S. customers established in CFTC Regulation 30.7.[8] Notably, a Commission-registered FCM is required to maintain in a separate account sufficient customer funds (referred to as secured amounts) to cover its liabilities to foreign futures and options customers, among other requirements.[9] Separately, the Bank Secrecy Act and related regulations require FCMs and IBs to “establish [AML] programs, report suspicious activity, verify the identity of customers and apply enhanced due diligence to certain types of accounts involving foreign persons.”[10]

By contrast, pursuant to CFTC Regulation 30.10, an exempt clearing firm may hold the funds of U.S. customers outside the United States without registering as an FCM, if it is located in a jurisdiction that the Commission has determined has a comparable regulatory framework to the U.S. scheme. The Commission may grant, and has granted, exemptions from Part 30 pursuant to the exemptive procedures set forth in CFTC Regulation 30.10, a framework that has been in place at least since the 1980s. Customers of exempt clearing firms should benefit from the customer protection, risk disclosure, KYC, and AML requirements available to customers of Commission-registered FCMs.

In making its comparability determination, the Commission considers certain threshold elements of a comparability framework, including minimum financial requirements for entities that accept customer funds; protection of customer funds from misapplication; and sales practice standards, which includes disclosure of the risks of futures and options transactions, particularly the risk of foreign transactions traded outside the jurisdiction of U.S. law.[11] In evaluating the treatment of customer funds, the Commission will also “consider protections accorded customer funds in a bankruptcy under applicable law, as well as protection from fraud.”[12] The Commission may also take into account other factors. This analysis is essential to ensuring the integrity of our markets, the protection of our customers, and the mitigation of systemic risk.

Protecting U.S. Customers in Foreign Jurisdictions

In adopting the Proposed Rule’s requirement that foreign futures and options transactions be cleared through either an FCM or a clearing firm exempt from FCM registration, the Commission’s goal is to ensure that U.S. customers are not afforded less protection when trading offshore and clearing through an exempt clearing firm. This is accomplished through the application of robust comparability standards when the Commission provides exemptions pursuant to CFTC Regulation 30.10.

The Commission has been guided by “Congress’ intent that foreign futures and options products sold in the U.S. be subject to regulatory safeguards comparable to those applicable to domestic transactions.”[13] The legal and regulatory framework of the foreign jurisdiction must be found to be comparable to the U.S. framework, but the foreign jurisdiction’s segregation, risk disclosure, KYC, and AML requirements merit particular attention.

As I noted in a recent statement regarding a proposed comparability determination for the UK’s capital adequacy and financial reporting requirements, “mutual understanding and respect for partner regulators in other countries advances the Commission’s goal of setting a global standard for sound derivatives regulation, enhances market stability, and is also deeply rigorous, reflecting the Commission’s commitment to safe swaps markets.”[14]

The Commission included several important questions as requests for comments to assist in evaluating whether certain elements of the foreign jurisdiction’s laws adequately protect our markets and customers. I want to highlight a few questions below.

(1) Are there other issues the Commission should address in order to ensure that FBOTs providing direct access to IBs under proposed § 48.4(b)(4) does not harm U.S. markets or increase risk to the U.S. economy?

(2) Are there relevant considerations relating to the clearing and guarantee of IB trades that differ from that of CPO and CTA trades?

(3) Should the Commission instead require all U.S. customer trades entered by an IB via direct access on a registered FBOT to be guaranteed by a registered FCM (but not extend the condition to firms exempt from FCM registration under § 30.10 to carry such trades)? Would permitting firms exempt from FCM registration under § 30.10 to carry U.S. customer trades entered by an IB via direct access on a registered FBOT raise any issues with anti-money laundering (AML) requirements under the Bank Secrecy Act and Commission regulations?

I invite comments regarding comparable protections for U.S. customers clearing through an exempt clearing firms pursuant to CFTC Regulation 30.10, including with respect to segregation requirements, risk disclosures, and KYC and AML programs. These comments may inform the development of the Proposed Rule.

The Commission is required to engage in a rigorous comparability assessment of the foreign jurisdiction’s legal and regulatory scheme. Among other concerns, the analysis must ensure that permitting U.S. customers to access foreign markets through IBs does not engender systemic risks that may undermine the integrity of U.S. or global derivatives markets or otherwise amplify risks to the U.S. or global economy. Exempt clearing firms must protect the positions and collateral of U.S. customers under the relevant laws of their jurisdiction in a manner parallel to the protections afforded customer positions and collateral under U.S. regulations governing the protection of assets of U.S. customers using on a Commission-registered FCM as a clearing intermediary.

Risk disclosure requirements reduce information asymmetries, improve transparency, and enable U.S. customers to make informed decisions about the appropriateness of entering into a foreign futures and options transaction. Commission-registered FCMs that clear foreign futures and options transactions for U.S. IB customers are required to provide disclosures to alert U.S. customers to the risks of trading in foreign markets and the application of foreign laws. It is imperative that U.S. customers that clear through an exempt clearing firm are similarly apprised.

The Preamble to the Proposed Rule notes that an exempt clearing firm should be subject to a comparable regulatory program that includes, among other elements, minimum sales practice standards, including “disclosure of the risks of futures and options transactions and, in particular, the risk of transactions undertaken outside the jurisdiction of domestic law.”[15] The Commission must be certain.

Protecting our markets from fraud, illicit trading, and money laundering or terrorism financing promotes market integrity within our financial system. Commission-registered FCMs that clear foreign futures and options transactions for U.S. IB customers are subject to KYC and AML requirements under the Bank Secrecy Act and Commission regulations. The Commission must be confident that allowing foreign clearing firms exempt from FCM registration under CFTC Regulation 30.10 are allowed to carry U.S. customer trades entered by an IB via direct access on a registered FBOT would not raise any issues with KYC and AML requirements. Careful consideration must be given to the existence of similar requirements in the country in which the exempt clearing firm is located.

I look forward to the comments to the Proposed Rule. I am particularly interested in commenters’ perspective on whether the Proposed Rule will engender risks or consequences that the Proposed Rule fails to examine or consider. Among other risks, it is imperative that the Commission understand the diverse risks to U.S. retail customers.

Conclusion

I support the issuance of the Proposed Rule, which seeks to advance the CEA’s goals of protecting U.S. markets, market participants, and both institutional and retail customers.

I commend the careful work of the staff of the Division of Market Oversight, including Alexandros Stamoulis, Roger Smith, Maura Dundon, and David Reiffen, on the Proposed Rule.