The CFTC has a sacrosanct responsibility to safeguard customer funds held by brokers and clearinghouses. For our markets to work well, customers must have confidence that their funds will be safe. Safe from a broker or clearinghouse who misuses customer money for their own purposes or decides on their own to use customer funds to make risky bets chasing their own profits.

The Importance of Customer Confidence and Public Confidence for Markets to Work Well

History has shown that a loss of customer confidence in the safety of their funds often has immediate negative consequences on markets. Vulnerability to runs, increased customer redemption requests, significant market volatility, and rapid and steep drop in prices, can signal a loss of confidence. And given how interconnected our markets are, this can happen very fast, and can cause contagion. We saw an example earlier this year with Silicon Valley Bank.

Promoting public and customer confidence in our markets is one of the CFTC’s most important regulatory responsibilities. There is a disconnect between regular people and what goes on on Wall Street and in Washington. That’s a message from the late CFTC Commissioner Bart Chilton at the open meeting the last time the CFTC took up this same regulation in 2011.[1] He was speaking with the backdrop of MF Global’s bankruptcy weeks before, where there were concerns of misuse of customer funds. Commissioner Chilton said that we cannot get disconnected, and sometimes it’s just a matter of explaining what we’re doing. He said that we have to do the best we can to explain to people what our job is, what our responsibilities are, and that the first responsibility is to protect customer funds.

Well put, and I agree. Today we meet with the backdrop of the conviction on all counts of the founder of FTX, counts that included misuse of customer funds.[2] It’s not the same as MF Global. Regular people may not realize that those missing FTX customer funds were in an entity not regulated by the CFTC. But we have to stay connected to regular people who might be concerned about the safety of their funds in our markets. We have to explain how we are part of the solution to safeguard customer funds. This is particularly important because we have seen a rise of retail customers in our markets associated with trading in cryptocurrency and event contracts—retail customers who may not have the same ability as an institutional customer to withstand losses or delays if a broker or clearinghouse goes bankrupt.

We have to send a message and show through our actions that the CFTC is doing all that we can to protect customer funds.

Protecting Customer Funds by Limiting What They Can be Invested In

One way the CFTC protects customer funds is by limiting what they can be invested in. In section 4(d) of the Commodity Exchange Act, Congress limited investments of customer funds to U.S. government and other municipal securities, and obligations fully guaranteed by the U.S.

The CFTC can make an exemption to section 4(d) to allow other investment types if they meet certain carefully designed factors established by Congress in section 4(c). From 2000 to 2005, the CFTC used this exemptive authority to considerably loosen Regulation 1.25 to allow brokers (FCMs) and clearinghouses (DCOs) to invest customer funds in all kinds of investments.

Then there was the financial crisis, the Dodd Frank Act, and the MF Global scandal. In 2011, the CFTC under Chairman Gary Gensler, eliminated exemptions for certain investments that could pose an unacceptable level of risk to customer funds.[3] One investment type eliminated in a 5-0 vote in 2011 was foreign sovereign debt. That investment type is before us again today at the request of the same groups (CME and FIA) who opposed the CFTC’s elimination of foreign sovereign debt as a permitted investment in 2011. While the Commission subsequently made a limited exception for clearinghouses in the debt of France and Germany in 2018, at that time, it declined to apply that exception to brokers as requested by FIA.

We need to be very cautious about revisiting post-crisis CFTC reforms, particularly reforms that only came after substantial public engagement and careful CFTC deliberation. In good economic times like we are in today, we have to keep the lessons learned from the past in mind, while we look to the future. One of those lessons learned is that things can change quickly when it comes to risk.

We have to always keep sacrosanct our responsibility to protect customer funds and avoid systemic risk. Holding customer funds is not intended to be a way for brokers and clearinghouses to maximize profits through investments that could prove risky. Customer funds must only be invested in a way that minimizes exposure to credit, liquidity, and market risk, not just now, but in the future. This would preserve customer funds, and enable investments to be quickly converted to cash at a predictable value, which is necessary to avoid systemic risk. This has to be one of our top priorities.

That’s why I support prohibiting investments of customer funds in: (1) commercial paper; (2) corporate notes and bonds; (3) bank certificates of deposit; (4) adjustable rate securities that reference LIBOR; and (5) money market funds that are not government money market funds or that charge a liquidity fee for customer redemptions. I also support the concentration limits on money market funds to protect customer funds from potential risk of loss from a cyber-attack.

Proposed Expansion of How Brokers and Clearinghouses Can Invest Customer Funds

The proposal before us would also make two exemptions under section 4(d),[4] allowing investments of customer funds in: (1) ETFs that invest in primarily short-term U.S. Treasury securities; and (2) sovereign debt of five G7 countries (Canada, France, Germany, Japan, and the United Kingdom) and expanding the list of counterparties to foreign banks, brokers and dealers, and central banks.

Section 4(c)(2) sets a high bar for exemptions. The CFTC is required to show:

1. It is in the public interest;
2. It is consistent with the purposes of the Act;
3. The agreements, contracts or transactions have to be between appropriate persons; and
4. The exemption cannot have a material adverse effect on the ability of the Commission or any contract market to discharge its regulatory responsibilities.

I would have liked to see more independent CFTC analysis of these factors in this proposal.

Public Interest Factor: I am concerned about the proposal’s discussion of the public interest factor:

The expanded selection of Permitted Investments is expected to also permit FCMs and DCOs to remain competitive globally and domestically and maintain safeguards against systemic risk. A wider range of alternatives to invest futures customer funds may provide more profitable investment options, allowing FCMs and DCOs to generate more income for themselves and their customers. This, in turn, may motivate FCMS and DCOs to increase their presence in the futures markets and other relevant markets, thus increasing competition. Increased revenue to FCMs and DCOs from the investment of Customer Funds also may benefit customers in the form of lower commission charges of direct interest payments on funds on deposit with the FCM or DCO, which may lead to greater market participation by customers and increased market liquidity. In light of the foregoing, the Commission believes that the adoption of the proposed amendments would promote responsible economic and financial innovation and fair competition, and would be consistent with the objective of Regulation 1.25 and with the “public interest.”

We should be very careful about drawing the dangerous conclusion that increased profits is a sufficient justification to satisfy the public interest factor. This conclusion could justify granting every requested exemption, which is surely not what Congress had in mind or the message that we should send. It is important to remember that broker and clearinghouse profit is not the goal for the CFTC, the Commodity Exchange Act or the public. Chasing profits could lead to risky investments, potentially putting customer funds at risk.

We should not draw an unsupported conclusion that if brokers and clearinghouses make more profit, that the benefits will flow to customers, as opposed to being kept for those companies or their shareholders. There was also no independent supportive analysis that additional profits would increase competition or innovation. I would also have liked to see analysis on the avoidance of systemic risk, not just a conclusory, unsupported statement that this change will permit brokers and clearinghouses to “maintain safeguards against systemic risk.”

An independent CFTC analysis of whether a Commission action is in the public interest is the important responsibility given to us by Congress. The proposal discusses without supporting data or analysis that the proposal could reduce foreign currency risk and result in diversification of investments. However, those were the same considerations that were not persuasive to the Commission in 2011. I encourage public interest groups and customers of brokers and clearinghouses to let the CFTC know if they think these exemptions are in the public interest. Should we go forward in the future with a final rule, I would expect to see an independent and supported CFTC analysis.

I would encourage the CFTC to engage in more data analysis, as well as more roundtables and requests for comment, before proposing rules or exemptions that revise post-crisis reforms. We may also be able to use public interest analysis conducted by other federal agencies. I would also encourage greater engagement with public interest groups before proposing changes to rules, just as we engage with industry.

Consistent with the Purposes of the Act: The purposes of the Act are to deter and prevent price manipulation or other disruptions to market integrity; to ensure the financial integrity of all transactions and the avoidance of systemic risk; to protect all market participants from fraudulent or other abusive sales practices and misuses of customer assets; and to promote responsible innovation and fair competition among boards of trade, other markets and market participants.[5]

The proposal contains a thorough and independent CFTC analysis of conditions necessary to protect against the misuse of customer assets. But the proposal’s discussion of fair competition, responsible innovation, and systemic risk is conclusory, without supporting analysis. I encourage commenters and the public to let us know if these exemptions are consistent with the purposes of the Act.

Appropriate Persons Factor: I did not see discussion of this important factor. The proposal would expand counterparties for foreign sovereign debt, including foreign brokers and dealers, with certain conditions. I would have liked to see an analysis of how this factor is met. We should not assume that it is met, that no analysis is needed or that Commissioners do not have views on meeting this test. I look forward to commenters’ views on this. Should we go forward in the future with a final rule, I would expect to see an independent supported CFTC analysis of this factor.

Discharge of Regulatory Responsibilities Factor: The CFTC’s regulatory responsibility in Regulation 1.25 is to preserve principal and maintain liquidity. I commend the staff for the depth and comprehension of this analysis, and appreciate the thorough calibration of conditions to address future risk with sovereign debt. I agree that investments in certain sovereign debt might be consistent with preserving principal and maintaining liquidity. This analysis found that government ETFs and sovereign debt in these countries appear to be similar to existing permitted investments. Commenters will tell us whether we have conducted the correct analysis.

While I am supporting putting this out for public comment, I also believe that we should be very cautious in overturning post-crisis reforms. In 2011, the CFTC considered all of the same concerns raised before us today, but decided unanimously to ban investments in sovereign debt. The Commission in 2011 said that although it appreciated the risk of foreign currency exposure, not all sovereign debt, in all situations, is sufficiently safe. The Commission said then that global and regional crises illustrated that circumstances may quickly change, leaving a broker or clearinghouse unable to timely liquidate the investment, and potentially only after a significant mark-down.

At that time, the CFTC said it would consider exemption requests. The staff explained that when considering such a request, they would ask the petitioner why they need the exemption and to explain why it is in the public interest, and analyze liquidity. The record shows only one request in 12 years. In 2018, after notice and receiving only supporting comments, the Commission approved a limited exemption for clearinghouses to invest customer funds in the sovereign debt of France and Germany, finding comparable credit, liquidity and volatility characteristics to U.S. Government securities.

In the proposal before us, the staff’s analysis reflects that the debt of these countries is similar to current permitted investments, but may be less liquid than U.S. government securities. The proposal asks whether these investments would raise any liquidity or other concerns. I am interested in commenters’ views on this and on whether the expansion of counterparties will expose customers to unacceptable levels of risk.

Given that we know that circumstances can change very quickly, I often say that we should expect the unexpected. One alternative would be to leave in place the current process of considering any exemptive request, rather than change the rule, particularly if there are concerns over liquidity or counterparties. This should not be unduly burdensome given there was only one request in 12 years. The Commission could consider the conditions at that time, the reason for the request, the public interest, and liquidity. The flexibility to conduct this type of analysis at the specific time of the request, and after notice and comment, would be more targeted to avoid systemic risk. And should circumstances change quickly, an exemptive order could be much easier and faster to revisit than a rule. I look forward to commenters’ views on this alternative compared to rewriting the rule.

Finally, I would urge CFTC staff to look for other safeguards for customer funds in other Commission rules. Additional safeguards would allow us to fulfill our sacrosanct responsibility to protect customer funds, and promote public confidence.