Introduction

The Commodity Futures Trading Commission (Commission or CFTC) has adopted several key regulations that establish guardrails to protect against the misuse or misapplication of customer funds. The Commodity Exchange Act (CEA) and Commission regulations establish critical protections for customers to help prevent them from losing money as a result of losses caused by their futures commission merchant (FCM) or their fellow customers at the FCM. These include Sections 4 and 4d of the CEA and Parts 1, 22, and 30 of the Commission regulations, which require an FCM to segregate its own funds from those of its customers and prohibit an FCM from using one customer’s funds to cover the losses of another.

A foundational principle of the Commission’s customer protection regime is a prohibition against the use of one customer’s funds to cover the liabilities of another customer. It is difficult to overstate the importance of regulations that prevent this kind of misuse, particularly when customer funds are commingled in a single omnibus account.

The Commission must not weaken regulations intended to reinforce these protections. Determining whether a regulation might result in weakening these protections requires careful qualitative and quantitative assessment and evaluation of (un)anticipated risks and thoughtful reinforcement of robust risk management requirements.

The Commission is amending an existing customer protection provision under CFTC Regulation 39.13(g)(8)(iii). This regulation establishes a margin adequacy requirement by prohibiting the withdrawal of funds by a customer of a clearing FCM if such withdrawal would result in the account being undermargined. The purpose of Commission Regulation 39.13(g)(8)(iii) is to mitigate the risk that a clearing member, using an omnibus margin account, fails to hold sufficient funds from one customer to cover that customer’s initial margin requirements and effectively covers the customer’s margin shortfall using another customer’s funds.

The proposed amendment would codify the requirements of CFTC Regulation 39.13(g)(8)(iii) in Part 1 of the Commission's regulations governing FCMs, thus extending the requirements to non-clearing FCMs as well, but would permit an FCM to treat the separate accounts of a single customer, or beneficial owner, as accounts of separate entities, subject to certain risk-mitigation conditions (Proposed Rule).[1] This amendment thus allows disbursements on a separate account basis such that a customer may withdraw funds from one account even if its other account is undermargined, so long as the customer is in compliance with the relevant risk-management conditions.

It is indisputable that the Proposed Rule introduces risks that do not exist under CFTC Regulation 39.13(g)(8)(iii). Permitting a customer to withdraw “excess” margin from one account when it has insufficient margin in another account could exacerbate the customer’s overall margin deficiency and any shortfall in the FCM’s customer account, amplify default risk, and increase fellow-customer risk. Prior to finalizing this rule, it is imperative that the Commission understand the potential risks that may arise by permitting disbursements on a separate account basis.

Customer asset protections are essential to the individuals and institutional businesses whose assets are held by an intermediary and therefore may be at risk. As I have stated previously,

creating and enforcing effective, well-tailored rules governing the custody, investment, and preservation of customer funds must be among the Commission’s highest priorities. Without these rules and rigorous enforcement, our markets would lack the foundation of trust upon which every transaction is built.[2]

I am supportive of careful, well-tailored, workable, and practical regulations that do not undermine or weaken customer protection. I strongly believe that the Commission would have benefited from a formal report detailing relevant risk management concerns that may arise as a result of introducing the Proposed Rule. Among other issues outlined below, the Commission would benefit from receiving data and analysis that details the potential risk management consequences attendant to adopting the Proposed Rule as well as any related measures that may mitigate risk management concerns.

Before adopting a final rule, the Commission, through supporting data and analyses, must assure itself that the Proposed Rule accomplishes the customer protection and risk management goals of regulation 39.13(g)(8)(iii).

Call for Supporting Risk Management Data and Analyses

The Commission is amending CFTC Regulation 39.13(g)(8)(iii) to permit disbursements on a separate accounts basis, subject to certain risk-mitigating conditions.

As I have said before, permitting disbursements on a separate accounts basis is inconsistent with the plain language of CFTC Regulation 39.13(g)(8)(iii), which was adopted by the Commission following the 2008-2009 financial crisis pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), and introduces new or additional risks. I am, however, supportive of solutions that are grounded in data and analyses demonstrating that an amendment to CFTC Regulation 39.13(g)(8)(iii) achieves the same goals and objectives underpinning this regulation.

It would be helpful, in the context of evaluating the Proposed Rule, to have a sufficiently robust analysis of the sufficiency and adequacy of the risk-mitigating measures that have been in place since 2019.

The Commission should conduct a study to assess any additional risks and the scope and magnitude of such risks. Alongside a formal report offering a data-driven analysis, commentators should include comprehensive analyses and evidence indicating that the adoption of the Proposed Rule does not increase risks to our markets, or, if there are increased risks, that the risk-mitigation measures adopted by the Commission are effective. We also welcome feedback on other measures to ensure that FCMs maintain robust risk-management practices.

Margin Adequacy Requirement

In order to register, and maintain registration, as a derivatives clearing organization (DCO), a clearinghouse must demonstrate the ability, and continue, to comply with the core principles for DCOs set forth in Section 5b of the CEA. The core principles were added to the CEA by the Commodity Futures Modernization Act of 2000 (CFMA). In implementing the CFMA, the Commission did not adopt implementing rules and regulations, but instead promulgated guidance for DCOs on compliance with the core principles.

Section 725(c) of the Dodd-Frank Act amended Section 5b(c)(2) of the CEA to expressly confirm that the Commission may adopt implementing rules and regulations pursuant to its rulemaking authority under Section 8a(5) of the CEA.

The Commission adopted CFTC Regulation 39.13(g)(8)(iii) in 2011. The adoption was part of a broader rulemaking to implement certain provisions of the Dodd-Frank Act governing the activities of DCOs, including Core Principle D—risk management—requiring each DCO to ensure that its risk management framework is sufficient to manage the risks associated with discharging the responsibilities of a DCO through the use of appropriate tools and procedures. CFTC regulations require DCOs to collect initial margin from their customers on a gross basis, even if customer collateral is held in an omnibus account.

Under CFTC Regulation 39.13(g)(8)(iii), a DCO must require “its clearing members to ensure that their customers do not withdraw funds from their accounts with such clearing members unless the net liquidating value plus the margin deposits remaining in a customer's account after such withdrawal are sufficient to meet the customer initial margin requirements with respect to all products and swap portfolios held in such customer's account which are cleared by the derivatives clearing organization.”[3]

The purpose of this regulation is to mitigate the risk that a clearing member, using an omnibus margin account, fails to hold sufficient funds from one customer to cover such customer’s initial margin requirements and effectively covers such customer’s margin shortfall using another customer’s funds.

In the Preamble to the Proposed Rule, the Commission recognizes,

[i]n light of the use of omnibus margin accounts, where the funds of multiple customers are held together, this safeguard is necessary to “avoid the misuse of customer funds” by mitigating the likelihood that the clearing member will effectively cover one customer’s margin shortfall using another customer’s funds.[4]

An omnibus account structure creates a potential dilution of the pool of funds available to U.S. customers in the event of a bankruptcy of the FCM to the extent the FCM’s customer account is undermargined. In a bankruptcy proceeding, customer property is distributed pro rata and so all customers share in any shortfall in the customer account of a particular class.

Concerns with Separate Accounts

In 2019, the Joint Audit Committee (JAC) issued a regulatory alert providing an interpretation of the requirements of CFTC Regulation 39.13(g)(8)(iii).[5] Under the JAC’s interpretation, separate accounts of the same customer were to be combined for the purpose of determining the amount of margin funds available for disbursement from any of the accounts.

This interpretation was inconsistent with the prevailing practices, including as documented under customer agreements, among FCMs, and FCM customers with respect to the treatment of separate accounts.

FCMs would establish separate accounts for customers for commercial purposes. For example, “such accounts are: (i) separately contracted for with different asset management firms; (ii) established as a separate investment portfolio within the same asset management firm; (iii) established by a commercial entity for the purpose of a commodity or margin financing arrangement and secured by the lender as a secondary security interest; or (iv) necessary to separately account for or settle obligations of separate branches established pursuant to separate legal/country jurisdictions.”[6] Although separate accounts may be owned by the same customer or beneficial owner, FCMs did not combine those accounts for margin purposes.

In response to the JAC’s interpretation, several industry trade associations requested that the Commission provide time limited no-action relief with respect to the treatment of separate accounts by FCMs.[7] Specifically, they requested that the Commission interpret Commission Regulation 39.13(g)(8)(iii) to permit separate accounts of the same customer to “be treated as separate legal entities” therefore not combined when determining an account’s margin funds available for disbursement.”[8]

The separate account treatment permits margin to be withdrawn from one account of a customer while another account of that same customer faces a margin call, it creates the risk that a customer will withdraw funds from the account in surplus and then later default on the margin call, leaving the FCM with fewer resources to cover the resulting losses.

Separate Account Treatment

In 2019, the Commission issued a time-limited, temporary no-action letter that permitted disbursements on a separate account basis, subject to certain conditions that mitigate the risk of default and strengthen an FCM’s risk-management of customers granted separate account treatment. The Commission aimed to achieve the customer protection and risk management goals of CFTC Regulation 39.13(g)(8)(iii).

In 2023, the Commission approved a proposed rule to codify, in Part 39 governing DCOs, the staff no-action position regarding the treatment of separate accounts of a single customer by an FCM that is a clearing member of a DCO. In April 2023, the Commission published in the Federal Register a notice of proposed rulemaking that would codify the no-action letter.

Following comments to the proposed rule supporting direct application of separate account treatment to FCMs (both clearing and non-clearing), the Commission proposes to withdraw the original proposal in favor of the Proposed Rule.[9]

The Proposed Rule codifies (with important changes, including the establishment of a margin adequacy requirement applicable to clearing and non-clearing FCMs and increased specificity in the one-day margin requirement) the existing no-action position under which FCMs are permitted to treat different accounts of the same beneficial owner as separate accounts for purposes of permitting margin withdrawals.

Sufficiency of Risk-Mitigation Conditions

The Proposed Rule permits separate account treatment subject to risk-management standards. The customer protections built into this Proposed Rule help to mitigate the risk that it creates, particularly by requiring customers receiving separate account treatment to meet margin calls the same day they are made (referred to as the one-day margin requirement), and requiring separate account treatment to cease when the customer or the FCM is no longer operating in the ordinary course of business. In many ways, the enhanced requirements for FCMs to maintain internal controls and policies and procedures designed to ensure compliance with the Proposed Rule strengthen the risk-management compliance practices of FCMs.

One-day margin requirement. Under the one-day margin requirement, a separate account customer must meet any margin call by the close of the Fedwire Funds Service on the same day.[10] This requirement is subject to enumerated exemptions, including for payments in certain foreign currencies where the mechanics of international payment systems would make compliance with the one-day margin requirement impractical.[11]

Ordinary course of business. Under the Proposed Rule, separate account treatment for a customer would cease if the customer or its FCM ceased operating in the ordinary course of business—the day-to-day operation of the FCM’s relationship with its customer.[12] These events include a failure to meet the one-day margin call as well as an event of default, financial distress, other distress, insolvency, bankruptcy, or an inability to perform financial obligations. These events are standard across all FCMs that elect separate account treatment.[13]

These two requirements work together to mitigate the risk of default by a customer that benefits from separate account treatment. The ordinary course of business standard works to prevent an insolvent or soon-to-be insolvent beneficial owner from continuing to receive separate account treatment. And the one-day margin requirement creates a cap on the amount of time during which an insolvent or soon-to-be insolvent beneficial owner could take funds out of one account while failing to meet a margin call for another account.

Conclusion

As I have previously noted,

[s]ince the earliest days of federal prudential and market regulation in our nation, thought leaders have advocated for regulation that preserves customer assets held by others. In his book published in 1914—Other People’s Money—former Supreme Court Justice Louis Brandeis advocated for similar reforms that safeguard the assets of financial markets customers.[14]

Under the CEA, the Commission is directed to “protect all market participants from … misuses of customer assets.”[15] For these reasons articulated above, I concur with the Proposed Rule.

The final rule addressing these issues, however, must be supported by data and analyses indicating the potential risks arising from the Proposed Rule and how such risks will be managed. I look forward to comments on this Proposed Rule, particularly comments that demonstrate the sufficiency or adequacy of the risk-mitigation conditions in the Proposed Rule.

I would like to thank the staff of the Division of Clearing and Risk for their thoughtful work on this rule and for their willingness to incorporate feedback from my office into the proposed amendments published today.