I support the Notice of Proposed Rulemaking on Investment of Customer Funds by Futures Commission Merchants and Derivatives Clearing Organizations (Proposed Amendments to Regulation 1.25 or NPRM) because, importantly, it provides regulatory clarity by codifying outstanding no-action relief, and promotes good government by providing a timely response to a petition from market participants.  I would like to thank Tom Smith, Warren Gorlick, Liliya Bozhanova, and Jeff Burns for their work on the NPRM.

Regulatory clarity has a number of key aspects: transparency, simplicity, and significantly, unambiguity.  In turn, regulatory clarity promotes compliance, market integrity, and confidence.  As regulators, in everything we do, we must remember that regulatory clarity enables businesses to effectively comply with our regulations, thereby reducing the likelihood of non-compliance issues.  It’s why I have made regulatory clarity a guiding principle of my commissionership.

Good government has a number of key aspects that overlap with those of regulatory clarity: transparency and simplicity, for instance.  However, responsiveness is an aspect unique to good government.  In serving the public, we must be mindful that we are here to be responsive to the concerns and needs of our constituents—in our case, market participants.  Good government, in turn, promotes economic growth and progress. It’s why I have made good government something I am always striving to encourage as Commissioner.

Background

Regulation 1.25 is the primary CFTC rule setting forth safeguards for the investment of customer funds held by futures commission merchants (FCMs) and derivatives clearing organizations (DCOs).  As the Commission has said in the past, customer segregated funds must be invested in a manner that minimizes their exposure to credit, liquidity, and market risks, both to preserve their availability to customers and DCOs and to enable investments to be quickly converted to cash at a predictable value to avoid systemic risk.[1]  These safeguards are vital in maintaining confidence in our markets.

The requirement for a FCM or DCO to treat customer funds as belonging to the customers, and for the FCM or DCO to segregate customer funds from its own funds, is a critical component of this framework.  The Commodity Exchange Act (CEA) and CFTC regulations provide three regulatory frameworks based on the market in which customers are transacting: (i) futures customer funds; (ii) cleared swaps customer collateral; or (iii) 30.7 customer funds.[2]

CEA section 4d(a)(2) covers futures customer funds, setting forth the framework for requiring FCMs to treat futures customer funds as belonging to the futures customer.[3] CEA section 4d(b) addresses the duties imposed on DCOs and other depositories receiving futures customer funds from FCMs pursuant to section 4d(a)(2).[4]  Regulations 1.20 through 1.30, and Regulations 1.32 and 1.49 implement sections 4d(a)(2) and 4d(b).[5]

CEA section 4d(f)(2)(A) covers cleared swaps customer collateral, setting forth a framework for requiring FCMs to treat cleared swaps customer collateral as belonging to the cleared swaps customer.[6]  Regulations 22.2 through 22.13, and Regulations 22.15 through 22.17, implement CEA section 4d(f).[7]  And CEA section 4(b)(2)(A) covers 30.7 customer funds, setting forth a framework for requiring FCMs to safeguard 30.7 customer funds deposited by 30.7 customers for trading on foreign boards of trade (FBOTs).[8] Regulation 30.7 implements CEA section 4(b)(2)(A).[9]

A cornerstone of these frameworks is the ability of FCMs and DCOs to invest customer funds.  CEA section 4d(a)(2) authorizes FCMs to invest futures customer funds in: (i) obligations of the U.S.; (ii) obligations fully guaranteed as to principal and interest by the U.S.; and (iii) general obligations of any State or of any political subdivision of a State.[10]  Regulation 1.25 was initially adopted to implement section 4d(a)(2), and authorized FCMs and DCOs to invest futures customer funds in the instruments set forth in Section 4d(a)(2) of the Act (the Permitted Investments).[11]

Over time, the Commission has changed the Permitted Investments: in 2000, for instance, expanding the list to include certificates of deposit, commercial paper, corporate notes, foreign sovereign debt, and interests in money market funds. Currently, Regulation 1.25 lists seven categories of investments that qualify as Permitted Investments.[12]  In addition, the Commission extended Regulation 1.25 to apply to an FCM’s investment of 30.7 customer funds for trading foreign futures positions, and to FCMs and DCOs investing cleared swaps customer collateral.[13]

When looking at Regulation 1.25, the Commission always has to balance the need to safeguard customer funds, against retaining an appropriate degree of flexibility for FCMs and DCOs to invest funds and attain capital efficiency.  I believe the Proposed Amendments to Regulation 1.25 continue to strike the right balance, though I encourage commenters to comment on that facet.

How the Commission Does, and Should Continue to, Promote Regulatory Clarity and Good Government

I would like to highlight two aspects of the Proposed Amendments to Regulation 1.25 that provide examples of regulatory clarity and good government.

The NPRM endeavors to promote regulatory clarity by codifying outstanding CFTC staff no-action relief, proposing to replace LIBOR with SOFR as a permitted benchmark for adjustable rate securities.

Regulation 1.25(b)(2)(iv)(A) provides that permitted investments may contain variable or floating rates of interest provided, among other things, that: (i) the interest payments on variable rate securities correlate closely, and on an unleveraged basis, to a benchmark of either the Federal Funds target or effective rate, the prime rate, the three-month Treasury Bill rate, the one-month or three-month LIBOR, or the interest rate of any fixed rate instrument that is a listed permitted investment under Regulation 1.25(a);[14] and (ii) the interest rate, in any period, on floating rate securities is determined solely by reference, on an unleveraged basis, to a benchmark of either the Federal Funds target or effective rate, the prime rate, the three-month Treasury Bill rate, the one-month or three-month LIBOR, or the interest rate of any fixed rate instrument that is a listed permitted investment under Regulation 1.25(a).[15]

As we all know, it was announced in March 2021 that LIBOR would cease to be published and would effectively be discontinued.[16]  In response to the Alternative Reference Rate Committee (ARRC) identifying SOFR as the preferred alternative benchmark to USD LIBOR for certain new USD derivatives and financial contracts,[17] CFTC staff issued Staff Letter 21-02 in January 2021,[18] permitting FCMs to invest customer funds in permitted investments that contain adjustable rates of interest benchmarked to SOFR.  A later CFTC Staff letter 22-21 extended the effective date of the no-action position to December 31, 2024, and expanded the scope of the no-action position to include permitted investments made by DCOs.[19]

Given the discontinuation of LIBOR and the increasing use of SOFR, the Commission is proposing to amend Regulation 1.25(b)(2)(iv)(A) by replacing LIBOR with SOFR as a permitted benchmark for permitted investments that contain an adjustable rate of interest.  To give effect to this revision, paragraphs (b)(2)(iv)(A)(1) and (2) of Regulation 1.25 would be amended to replace the phrase “one-month or three-month LIBOR rate” with the phrase “SOFR rate.”

This is important to me for three reasons.  First, I have been vocal that the Commission must not get stuck in a never-ending loop of extending staff no-action relief.[20]  To be sure, no-action relief has its place in our regulatory framework.[21]  But the Commission should seek to find pragmatic solutions to fixing unworkable rules.

Second, I appreciate the Commission is taking action in advance of the relief expiration date of December 2024.  Firms expend considerable resources to come into compliance with our requirements.  To the extent our requirements are changing (e.g., staff no-action relief is expiring), waiting on the part of the Commission only unnecessarily increases the risks and costs to firms for implementation.

And third, I am pleased the NPRM does not propose to impose any additional conditions beyond the relief contained in CFTC staff letter 22-21.  Conditions may have their place, but the Commission needs to avoid a “kitchen sink” approach when adding them.

All of this comes together to provide an example of what regulatory clarity needs to entail.  Extraneous changes, unworkable conditions, and waiting too long to act all inhibit regulatory clarity by introducing ambiguity, unnecessary burdens, and wasted time.

The NPRM also endeavors to promote good government by providing a timely, thorough response to a petition submitted by market participants.

The Futures Industry Association (FIA) and CME Group Inc. (CME) submitted a joint petition requesting the Commission to expand investments that FCMs and DCOs may enter into with Customer Funds.[22]  The Petitioners requested that the Commission permit FCMs and DCOs to invest Customer Funds in the foreign sovereign debt of Canada, France, Germany, Japan, and the United Kingdom, subject to the condition that the investment in the foreign sovereign debt is limited to balances owed by FCMs and DCOs to customers and FCM clearing firms, respectively, denominated in the applicable currency of Canada, France, Germany, Japan, or the United Kingdom.[23]  The Petitioners further request that the Commission exempt FCMs and DCOs from the provisions of Regulation 1.25(d)(2) to authorize FCMs and DCOs to enter into Repurchase Transactions involving Specified Foreign Sovereign Debt with foreign banks and foreign securities brokers or dealers and to hold Specified Foreign Sovereign Debt in safekeeping accounts at foreign banks.[24]

The Petitioners further request that FCMs and DCOs be permitted to invest Customer Funds in certain ETFs that invest primarily in short-term U.S.  Treasury securities (U.S. Treasury ETFs),[25] because U.S.  Treasury ETFs have characteristics that may be consistent with those of other Permitted Investments and may provide FCMs and DCOs with an opportunity to diversify further their investments of customer funds.[26]

This is important to me for two reasons. First, the Commission is providing a timely response to the petition.  Not only does every market participant deserve a response to a request to the Commission, but they deserve a response in a reasonable amount of time. Second, the NPRM does not propose additional conditions beyond what was requested in the Joint Petition.  Instead, and admirably, the Commission requests comment where it is unsure about conditions, after a careful and thorough analysis of its proposed actions.

In conclusion, I am pleased to support the NPRM because multiple aspects set an example for how the Commission can promote regulatory clarity and good government in all areas of its regulation and oversight.  Thank you again to the staff for their hard work, and I look forward to the comments on the Proposed Amendments to Regulation 1.25.