CFTC Final Rule on Customer Protections
AT
OCTOBER 30TH’S COMMODITY FUTURES TRADING COMMISSION (CFTC) meeting, regulators
approved Final Rules Enhancing Protections Afforded Customers and Customer
Funds Held by Futures Commission Merchants and Derivatives Clearing
Organizations, by vote of 3-1.
The Final Rule includes:
o FCM Risk Management
Program Rules
o Enhanced Record
Keeping and Disclosure Rules
o The Treatment of
Customer Segregated Funds and Foreign Futures or Foreign Options Secured
Amounts
o Reorientation of
Regulatory Framework for Self-Regulatory Organizations, the Joint Audit
Committee, and Accountants
o Inclusion of Standard
Depository Acknowledgment Letters
·
The Final Rule allows for a 5 year phase-in period for
the residual interest requirements to be completed by the next settlement
cycle, with no requirements in the first year and a T+1 at 6:00 p.m. the next
trading day requirement after the first year.
·
Commissioner O’Malia voted against the Final Rule.
·
Commissioner O’Malia offered an amendment, which was not
approved by vote of 1-3, which he explained would: 1) not predetermine a policy
outcome by requiring the commission to study the feasibility and costs and
technology solutions before it moves beyond a T1 at 6 p.m. settlement date; 2)
not bind a future commission; and 3) not bias the study to be conducted.
Opening
Remarks
In
his opening remarks, Chairman Gary Gensler stated that segregation of
customer funds is “the core foundation” of the commodity futures and swaps
markets and must be maintained at all times. He noted that the rules
being discussed benefited from significant public input including comment
letters, roundtables, committee meetings, and coordinated efforts with other
regulators.
Gensler
said he supported the rules for six reasons: 1) futures commission merchants
(FCMs) and clearing members will have to enhance their supervision of and
accounting for customer funds; 2) enhancements around outside accounting and
auditing; 3) significant changes and protections with regard to the movement of
funds; 4) aligning the protections of foreign futures accounts with domestic
ones; 5) new transparency to regulators and the public; and 6) provisions on
capital and residual interest of FCMs.
Gensler
concluded that the five year phase-in period will help smooth the
implementation of these rules and noted that the rules require that a study be
conducted to assess the impacts of the regulations.
Commissioner
Bart Chilton
stated that the Commodity Exchange Act (CEA) sometimes leaves “lots of latitude
for attitude” but that the language on protection customer’s funds at all times
does not. He said that the rules presented “gets us to where we need to
be” and will protect farmers, ranchers and end-users from another MF Global or
Peregrine Financial situation where customer funds were lost. He added
that FCMs will no longer be able to use customer money as a comingled “slush
fund” to cover one customer’s margin shortfall with funds from another
customer.
Chilton
noted that the Commission can use “exemptive relief, given unforeseen
circumstances” if something is “technologically impractical” and that since the
phase-in period is over five years, Congress would be able to “change the law
if they want.”
Commissioner
Scott O’Malia
stated that “customer protection must be the cornerstone of the Commission’s
oversight” and that measures to improve the “efficiency and transparency of the
markets are critically important.”
O’Malia’s
main concern with the rules was the “radical interpretation of the long
standing residual interest deadline” as it decreases the time for margin calls
to arrive at the FCMs from three days to one. He said that this change could
lead to significant increases in prefunding of margins by “perhaps nearly
double based on some reports” and could lead to small agri-business hedgers
considering alternative tools or being forced out of the market.
Commissioner
Mark Wetjen
stated that it is “vital that the Commission unceasingly look to update and
improve the protections we have in order to better serve the public.” He
said that customers would benefit under the new rules from: 1) enhancements to
FCM risk management programs; 2) modernized reporting programs; and 3)
streamlined measures to insulate customers from “fellow customer risk.”
Wetjen explained the final rule represents a compromise “intended to usher in
improvements in margin collection practices over time” and will incentivize
FCMs to address circumstances where customers are under-margined.
Wetjen
noted that “for one year, there will be no change to current practice” with
respect to the treatment of residual interest due to the phase-in process and
that 30 months after the rules are published the Commission staff is obligated
to conduct “a study determining the feasibility, costs, and benefits” of moving
the residual interest deadline to the completion of the first settlement cycle
after the trade day. He added that this study will be published for
public comment and a roundtable will be held to discuss its finding.
Wetjen
explained that after the five year phase-in period, the residual interest
requirement “will move up to the first clearing settlement cycle of the day,
typically first thing in the morning,” if the Commission does not decide to
change this based on the findings of the study.
Additional
Final Rules
Chairman
Gensler noted that the Commission unanimously finalized two other rule sets
before the open meeting: 1) Segregation for Uncleared Swaps; Treatment of
Securities in a Portfolio Margining Account in a Commodity Broker Bankruptcy;
and 2) Ownership and Control Reports, Forms 102/102S, 40/40S, and 71.
On
Segregation for Uncleared Swaps, Gensler stated that the rule relates to a customer’s
choice to segregate their collateral and funds or “initial margins standing
behind swaps” that are uncleared.
On
Ownership and Control Reports, Gensler said that the Commission “finally [has]
in our rulebook” that ownership and control reports must be filed
electronically and will give the CFTC “a greater window” into these reports. He
explained that the Commission will now be able to view high frequency trading
activities, even if these parties end “flat or without a position” at the end
of a trading day.
Staff
Presentation
Thomas
Smith,
Division of Swap Dealer and Intermediary Oversight, noted that staff
recommendations have been influenced by the over 120 written submissions they
received, roundtables, and the actions already taken by self regulatory
organizations (SROs).
Smith
explained that the final rules will enhance customer protections by 1)
strengthening the requirements on how FCMs and DCOs hold customer funds and
record obligations to customers in their books and records; 2) imposing risk
management requirements on how FCMs that hold customer funds; 3) revising the
SRO and public accounting examination process over FCMs, requiring FCMs to
provide additional discourses to customers and market participants; and 4)
requiring FCMs to provide the Commission with additional information to assist
with the identification of potential risk to the financial soundness of the
FCM.
On
providing greater protection to customer funds, Smith said the final regulations
explicitly require the FCM to segregate the requirement under Regulation 1.20
using the net liquidating equity method and further provide that the FCM must
hold sufficient funds in segregation at all times to meet the net liquidating
equity requirement for all of its futures customers.
Next,
Smith said the final rules: 1) eliminate the alternative method of computing
the amount of funds an FCM is required to hold in secured accounts for Part 30
customers; 2) requires an FCM to hold sufficient
funds in secured accounts to meet the total net liquidating equities of each of
its customers trading on foreign markets; 3) prohibits an FCM from holding
customers non-foreign futures positions in secured accounts; 4) restrict the
amount of Part 30 customer funds that an FCM may hold in depositories located
outside of the United States to the amount of margin required by foreign
carrying brokers or clearing organizations plus 20 percent cushion; and 5)
require an FCM to establish a targeted amount of residual interest and restore
balance to the target amount with proprietary funds prior to the close of the
next business day.
Further, Smith explained that an FCM is also prohibited from
withdrawing funds from segregated or secured accounts where such withdrawals
are not for the benefit of the customers unless the FCM verifies that the it
holds excess funds in the customer’s segregated or secured accounts and would
require a FCM’s management to actively monitor withdrawals from segregated or
secured accounts preapprove any withdrawal that exceeds 25 percent of the FCM’s
excess segregated or secured funds.
On the risk management program, Smith said it must take into
account market credit liquidity, foreign liquidity, operational settlements,
technological, and other applicable risks and provide a description of risk
tolerance limits. These limits must be reviewed and approved quarterly by
senior management and annually by the FCM governing body, he added. Smith also
said the FCM must be able to demonstrate upon a request of the Commission with
“verifiable evidence” that the FCM has access to sufficient liquidity “to
continue to operate as a going concern.”
On the SRO and public accountant process, Smith said that the
final regulations require that accountants be certified with the Public Company
Accounting Oversight Board and be in good standing. He added that SROs are
required to establish and operate supervisory programs what include written
policies and procedures for assessing member FCMs and file a copy of this program
with the Commission.
Under Regulation 1.55, Smith explained, FCMs must: 1) provide
customers with additional firm-specific disclosures intended to provide
customers including general information of each person that is defined as a
principal of the firm; 2) the types of businesses the FCM engages in; 3) the
material risk of entrusting funds to the FCM; and 4) provide financial
information on the website for examiners and prospective.
He also noted that under Regulation 1.10 each FCM must provide a
calculation of its leverage ratio to the Commission on a monthly basis.
Phyllis Dietz, Division of Clearing and Risk, explained
the final regulations governing acknowledgment letters that FCMs and
derivatives clearing organizations (DCOs) must obtain from depositories holding
customer funds. She said that the purpose of the letters is to “put the
depository on notice” that funds held in customer accounts “must be treated in
accordance with the applicable segregation requirements.”
She said the regulations require the use of a template letter and
that there are a total of six which are to be used by FCMs and two to be used
by DCOs. Dietz explained that the letters include provisions that enhance
the Commission’s ability to identify and respond to potential problems in the
treatment of customer funds by FCMs, DCOs or the depositories themselves and
provide that the depository has the right to recover funds advanced in the form
of cash transfers, repurchase agreements, or other similar liquidity
arrangements the depository makes.
Robert Wasserman, Division of Clearing and Risk,
stated that the statuary requirement in the CEA, prohibits using one customer’s
margin surplus to cover another customer’s margin deficit as well as “carrying
the trades” of other customers.
Wasserman then explained that under the final regulations require 1) a
calculation of each customer’s under margin amount based on a comparison of
collateral required for the customer’s positions versus the customer’s net
liquidating equity; 2) each FCM to calculate based on the information available
to the FCM at the end of close of each business day “the under-margin amount
calculated on the clear margin” required for the next day’s settlements; and 3)
the FCM to maintain by the residual interest deadline the residual interest in
segregated funds reduced to take into account payments received from under
margin customers before that deadline.
He noted that starting one year after publication; the deadline
would be 6:00 p.m. on T+1 basis and, absent contrary action by the Commission,
the residual interest deadline moves on December 31, 2018, to the time of
settlement.
Commissioner Questions
Chairman Gensler asked the staff if the three different types of
accounts; domestic futures, foreign futures, and cleared swaps accounts would
all be covered by the various aspects of the new regulations. Staff agreed that
the new regulations do cover all of these types of accounts with a couple of
exceptions.
Notably on the residual interest deadline, staff said that foreign
futures accounts are not subject to the same requirements as domestic accounts
for, due to differences in the statute and practicality concerns when dealing
with jurisdictions in different time zones and that the cleared swaps accounts
are already subject to this deadline as it was implemented “right as the system
was being built.”
Also staff noted that the “under-margined capital charge” does not
apply to Part 22 accounts as this provision is part of the proposed amendments
to the swap dealer capital rules which are still outstanding.
When Gensler asked the staff if these rules would protect against
another MF Global or Peregrine Financial situation staff replied
affirmatively and that “these rules will make it very, very difficult” for
something like that to happen again, due to better internal controls, and focus
on risk management.
Next, Chilton asked why customers should care about the residual
interest provision. Staff replied that customers should care because in the
event of an insolvency, if a customer’s funds are being used to cover a
different customers margin deficit, they may not get that money back.
Chilton then asked what the staff has done in the rule to ensure
that the regulations are not overly costly for small FCMs. Staff replied
that costs will be mitigated by the rules imposing a “point in time”
requirement” rather than a continuous one and that the lengthy phase-in period
can allow for technological changes to be developed to reduce operational
costs.
Chilton then stated that “theoretically there could be competition
between FCMs” and provide their customers more time to make payments by running
as close to the deadline as possible to make the ultimate payment up the DCO.
Gensler then asked if customers using CFTC account structures to
do portfolio margining and using securities in their account would still be
receive the protection of segregation, to which the staff replied yes.
O’Malia expressed concern with a lack of specifics in the
requirements of SROs to conduct surveillance of FCMs and questioned their
ability to “address all areas of risk.” Staff replied that there are many
good templates that SROs can use to follow traditional enterprise management
practices and said “the more granular they can make it, the better they can
manage business risk.” O’Malia followed up saying he was happy to hear
“that as long as they do those types of things, they will be in compliance.”
O’Malia then asked what the cost will be to FCMs of these
regulations. Staff cited their report which states that the aggregate annual
cost for all FCMs is approximately $487 million and that after the five year
delay period, the cost for the top ten FCMs is about $78 million.
Next, O’Malia expressed concern about the cyber security
implications of having the CFTC be granted access to customer accounts
electronically to monitor activity and also asked if there are legal issues
prohibiting this type of access. Staff replied that they would not have
direct access upfront to this data but would work with depository institution
if they needed to gain access. They added that there should not be legal issues
as there is a contractual agreement between the depository and the customer
that allows third party access.
Wetjen asked who would bear the costs of the shift in residual
interest deadline practices. Staff replied that the costs will go to the FCMs
and the customers who aren’t able to pay as quickly. They further explained
that FCMs would have to collect margin deficits upfront or use their own money.
Wetjen also asked if every customer shares in a “pro rata
distribution” in the event of an FCM bankruptcy, to which staff replied “absolutely.”
O’Malia Amendment (Not Approved, Vote of 1-3)
Commissioner O’Malia offered an amendment to the final rules which
he explained would not mandate that in five years time that customers would
need to meet their margin obligation by the end of the settlement cycle.
He next explained that the amendment would, like the final rule: 1) continue to
make progress to accelerate the progress of margin and customers from three
days to a one-day settlement date of 6:00 p.m.; 2) be phased in over one year
after enactment just like the draft rule; 3) require a study to determine the
feasibility of changing the collection days.
Further, O’Malia also said his amendment: will not predetermine a
policy outcome; will not bind a future Commission; and does not bias the study.
He said that moving beyond the residual deadline of T+1 to 7:00 –
9:00 a.m. in the settlement cycle may result in higher prefunding levels and
may cause small market participants to be blocked from the market. O’Malia also
said it is possible that some smaller FCMs may stop operating as FCMs as a
result of these costs.
Gensler said he could not support the amendment and believed the
final rule represented an appropriate balance and represented the “best read of
the law.” He noted that a future Commission could propose something else after
the study if they felt it was necessary.
When asked for his opinion Ananda Radhakrishnan, Division of
Clearing and Risk, stated that “any rule that goes past time of settlement is
not comporting with the law” and that “the rule we passed for swaps comports
with the law.”
Wetjen also said he could not support the amendment and that the
Commission is “making a judgment” that is “on balance” and that the final rule
is preferable to the amendment put forth by Commissioner O’Malia.
The Commission voted 1-3, with O’Malia supporting, and the
amendment was not approved.
The Final Rule on Customer Protections was passed by vote of 3-1,
with O’Malia voting “nay.”
Closing Comments
In closing remarks, Gensler noted that the Commission will have
another open meeting on November 5, 2013 to discuss Proposals on Position
limits.
O’Malia then brought up the Volcker Rule saying that the
regulators and Obama Administration have been signaling that it will be
completed by the end of the year, but he has yet to see “a single sheet of
paper” on the rule.
Chairman Gensler stated that the CFTC will likely hold a public
commission meeting in the second or third week of December on the Volcker Rule
but said he will not be able to share any documents with the Commissioners at
this point in time as it is “still very much moving between the SEC, FDIC, Fed,
OCC, and Treasury.”
For more information on this meeting, please click here.
Opening Statements:
Statement of Support of Chairman Gary Gensler- Ownership and
Control (“OCR”)
Statement of Support of Chairman Gary Gensler – Customer Protection
Opening Statement of Commissioner Bart Chilton – “The Law”
Opening Statement of Commissioner Scott O’Malia – Customer
Protection
Statement of Commissioner Scott O’Malia – Customer Protection Residual
Interest Amendment
Opening Statement of Commissioner Mark Wetjen
Additional Documents:
Fact Sheet: Final Rules Enhancing Protections Afforded Customers
and Customer Funds Held by Futures Commission Merchants and Derivatives
Clearing Organizations
Questions and Answers: Final Rules Enhancing Protections Afforded Customers
and Customer Funds Held by Futures Commission Merchants and Derivatives
Clearing
Fact Sheet: Final Rule on Segregation for Uncleared Swaps;
Treatment of Securities in a Portfolio Margining Account in a Commodity Broker
Bankruptcy
Questions & Answers: Segregation for Uncleared Swaps; Treatment of
Securities in a Portfolio Margining Account in a Commodity Broker Bankruptcy
Fact
Sheet: Final Rule on Ownership and Control Reports, Forms 102/102S, 40/40S, and
71
Questions & Answers: Final Rule on Ownership and Control Reports, Forms
102/102S, 40/40S, and 71
,Blog Tags:,Blog Categories:,Blog TrackBack:,Blog Pingback:No,Hearing Summaries Issues:Derivatives,Hearing Summaries Agency:CFTC,Publish Year:2013
AT
OCTOBER 30TH’S COMMODITY FUTURES TRADING COMMISSION (CFTC) meeting, regulators
approved Final Rules Enhancing Protections Afforded Customers and Customer
Funds Held by Futures Commission Merchants and Derivatives Clearing
Organizations, by vote of 3-1.
The Final Rule includes:
o FCM Risk Management
Program Rules
o Enhanced Record
Keeping and Disclosure Rules
o The Treatment of
Customer Segregated Funds and Foreign Futures or Foreign Options Secured
Amounts
o Reorientation of
Regulatory Framework for Self-Regulatory Organizations, the Joint Audit
Committee, and Accountants
o Inclusion of Standard
Depository Acknowledgment Letters
·
The Final Rule allows for a 5 year phase-in period for
the residual interest requirements to be completed by the next settlement
cycle, with no requirements in the first year and a T+1 at 6:00 p.m. the next
trading day requirement after the first year.
·
Commissioner O’Malia voted against the Final Rule.
·
Commissioner O’Malia offered an amendment, which was not
approved by vote of 1-3, which he explained would: 1) not predetermine a policy
outcome by requiring the commission to study the feasibility and costs and
technology solutions before it moves beyond a T1 at 6 p.m. settlement date; 2)
not bind a future commission; and 3) not bias the study to be conducted.
Opening
Remarks
In
his opening remarks, Chairman Gary Gensler stated that segregation of
customer funds is “the core foundation” of the commodity futures and swaps
markets and must be maintained at all times. He noted that the rules
being discussed benefited from significant public input including comment
letters, roundtables, committee meetings, and coordinated efforts with other
regulators.
Gensler
said he supported the rules for six reasons: 1) futures commission merchants
(FCMs) and clearing members will have to enhance their supervision of and
accounting for customer funds; 2) enhancements around outside accounting and
auditing; 3) significant changes and protections with regard to the movement of
funds; 4) aligning the protections of foreign futures accounts with domestic
ones; 5) new transparency to regulators and the public; and 6) provisions on
capital and residual interest of FCMs.
Gensler
concluded that the five year phase-in period will help smooth the
implementation of these rules and noted that the rules require that a study be
conducted to assess the impacts of the regulations.
Commissioner
Bart Chilton
stated that the Commodity Exchange Act (CEA) sometimes leaves “lots of latitude
for attitude” but that the language on protection customer’s funds at all times
does not. He said that the rules presented “gets us to where we need to
be” and will protect farmers, ranchers and end-users from another MF Global or
Peregrine Financial situation where customer funds were lost. He added
that FCMs will no longer be able to use customer money as a comingled “slush
fund” to cover one customer’s margin shortfall with funds from another
customer.
Chilton
noted that the Commission can use “exemptive relief, given unforeseen
circumstances” if something is “technologically impractical” and that since the
phase-in period is over five years, Congress would be able to “change the law
if they want.”
Commissioner
Scott O’Malia
stated that “customer protection must be the cornerstone of the Commission’s
oversight” and that measures to improve the “efficiency and transparency of the
markets are critically important.”
O’Malia’s
main concern with the rules was the “radical interpretation of the long
standing residual interest deadline” as it decreases the time for margin calls
to arrive at the FCMs from three days to one. He said that this change could
lead to significant increases in prefunding of margins by “perhaps nearly
double based on some reports” and could lead to small agri-business hedgers
considering alternative tools or being forced out of the market.
Commissioner
Mark Wetjen
stated that it is “vital that the Commission unceasingly look to update and
improve the protections we have in order to better serve the public.” He
said that customers would benefit under the new rules from: 1) enhancements to
FCM risk management programs; 2) modernized reporting programs; and 3)
streamlined measures to insulate customers from “fellow customer risk.”
Wetjen explained the final rule represents a compromise “intended to usher in
improvements in margin collection practices over time” and will incentivize
FCMs to address circumstances where customers are under-margined.
Wetjen
noted that “for one year, there will be no change to current practice” with
respect to the treatment of residual interest due to the phase-in process and
that 30 months after the rules are published the Commission staff is obligated
to conduct “a study determining the feasibility, costs, and benefits” of moving
the residual interest deadline to the completion of the first settlement cycle
after the trade day. He added that this study will be published for
public comment and a roundtable will be held to discuss its finding.
Wetjen
explained that after the five year phase-in period, the residual interest
requirement “will move up to the first clearing settlement cycle of the day,
typically first thing in the morning,” if the Commission does not decide to
change this based on the findings of the study.
Additional
Final Rules
Chairman
Gensler noted that the Commission unanimously finalized two other rule sets
before the open meeting: 1) Segregation for Uncleared Swaps; Treatment of
Securities in a Portfolio Margining Account in a Commodity Broker Bankruptcy;
and 2) Ownership and Control Reports, Forms 102/102S, 40/40S, and 71.
On
Segregation for Uncleared Swaps, Gensler stated that the rule relates to a customer’s
choice to segregate their collateral and funds or “initial margins standing
behind swaps” that are uncleared.
On
Ownership and Control Reports, Gensler said that the Commission “finally [has]
in our rulebook” that ownership and control reports must be filed
electronically and will give the CFTC “a greater window” into these reports. He
explained that the Commission will now be able to view high frequency trading
activities, even if these parties end “flat or without a position” at the end
of a trading day.
Staff
Presentation
Thomas
Smith,
Division of Swap Dealer and Intermediary Oversight, noted that staff
recommendations have been influenced by the over 120 written submissions they
received, roundtables, and the actions already taken by self regulatory
organizations (SROs).
Smith
explained that the final rules will enhance customer protections by 1)
strengthening the requirements on how FCMs and DCOs hold customer funds and
record obligations to customers in their books and records; 2) imposing risk
management requirements on how FCMs that hold customer funds; 3) revising the
SRO and public accounting examination process over FCMs, requiring FCMs to
provide additional discourses to customers and market participants; and 4)
requiring FCMs to provide the Commission with additional information to assist
with the identification of potential risk to the financial soundness of the
FCM.
On
providing greater protection to customer funds, Smith said the final regulations
explicitly require the FCM to segregate the requirement under Regulation 1.20
using the net liquidating equity method and further provide that the FCM must
hold sufficient funds in segregation at all times to meet the net liquidating
equity requirement for all of its futures customers.
Next,
Smith said the final rules: 1) eliminate the alternative method of computing
the amount of funds an FCM is required to hold in secured accounts for Part 30
customers; 2) requires an FCM to hold sufficient
funds in secured accounts to meet the total net liquidating equities of each of
its customers trading on foreign markets; 3) prohibits an FCM from holding
customers non-foreign futures positions in secured accounts; 4) restrict the
amount of Part 30 customer funds that an FCM may hold in depositories located
outside of the United States to the amount of margin required by foreign
carrying brokers or clearing organizations plus 20 percent cushion; and 5)
require an FCM to establish a targeted amount of residual interest and restore
balance to the target amount with proprietary funds prior to the close of the
next business day.
Further, Smith explained that an FCM is also prohibited from
withdrawing funds from segregated or secured accounts where such withdrawals
are not for the benefit of the customers unless the FCM verifies that the it
holds excess funds in the customer’s segregated or secured accounts and would
require a FCM’s management to actively monitor withdrawals from segregated or
secured accounts preapprove any withdrawal that exceeds 25 percent of the FCM’s
excess segregated or secured funds.
On the risk management program, Smith said it must take into
account market credit liquidity, foreign liquidity, operational settlements,
technological, and other applicable risks and provide a description of risk
tolerance limits. These limits must be reviewed and approved quarterly by
senior management and annually by the FCM governing body, he added. Smith also
said the FCM must be able to demonstrate upon a request of the Commission with
“verifiable evidence” that the FCM has access to sufficient liquidity “to
continue to operate as a going concern.”
On the SRO and public accountant process, Smith said that the
final regulations require that accountants be certified with the Public Company
Accounting Oversight Board and be in good standing. He added that SROs are
required to establish and operate supervisory programs what include written
policies and procedures for assessing member FCMs and file a copy of this program
with the Commission.
Under Regulation 1.55, Smith explained, FCMs must: 1) provide
customers with additional firm-specific disclosures intended to provide
customers including general information of each person that is defined as a
principal of the firm; 2) the types of businesses the FCM engages in; 3) the
material risk of entrusting funds to the FCM; and 4) provide financial
information on the website for examiners and prospective.
He also noted that under Regulation 1.10 each FCM must provide a
calculation of its leverage ratio to the Commission on a monthly basis.
Phyllis Dietz, Division of Clearing and Risk, explained
the final regulations governing acknowledgment letters that FCMs and
derivatives clearing organizations (DCOs) must obtain from depositories holding
customer funds. She said that the purpose of the letters is to “put the
depository on notice” that funds held in customer accounts “must be treated in
accordance with the applicable segregation requirements.”
She said the regulations require the use of a template letter and
that there are a total of six which are to be used by FCMs and two to be used
by DCOs. Dietz explained that the letters include provisions that enhance
the Commission’s ability to identify and respond to potential problems in the
treatment of customer funds by FCMs, DCOs or the depositories themselves and
provide that the depository has the right to recover funds advanced in the form
of cash transfers, repurchase agreements, or other similar liquidity
arrangements the depository makes.
Robert Wasserman, Division of Clearing and Risk,
stated that the statuary requirement in the CEA, prohibits using one customer’s
margin surplus to cover another customer’s margin deficit as well as “carrying
the trades” of other customers.
Wasserman then explained that under the final regulations require 1) a
calculation of each customer’s under margin amount based on a comparison of
collateral required for the customer’s positions versus the customer’s net
liquidating equity; 2) each FCM to calculate based on the information available
to the FCM at the end of close of each business day “the under-margin amount
calculated on the clear margin” required for the next day’s settlements; and 3)
the FCM to maintain by the residual interest deadline the residual interest in
segregated funds reduced to take into account payments received from under
margin customers before that deadline.
He noted that starting one year after publication; the deadline
would be 6:00 p.m. on T+1 basis and, absent contrary action by the Commission,
the residual interest deadline moves on December 31, 2018, to the time of
settlement.
Commissioner Questions
Chairman Gensler asked the staff if the three different types of
accounts; domestic futures, foreign futures, and cleared swaps accounts would
all be covered by the various aspects of the new regulations. Staff agreed that
the new regulations do cover all of these types of accounts with a couple of
exceptions.
Notably on the residual interest deadline, staff said that foreign
futures accounts are not subject to the same requirements as domestic accounts
for, due to differences in the statute and practicality concerns when dealing
with jurisdictions in different time zones and that the cleared swaps accounts
are already subject to this deadline as it was implemented “right as the system
was being built.”
Also staff noted that the “under-margined capital charge” does not
apply to Part 22 accounts as this provision is part of the proposed amendments
to the swap dealer capital rules which are still outstanding.
When Gensler asked the staff if these rules would protect against
another MF Global or Peregrine Financial situation staff replied
affirmatively and that “these rules will make it very, very difficult” for
something like that to happen again, due to better internal controls, and focus
on risk management.
Next, Chilton asked why customers should care about the residual
interest provision. Staff replied that customers should care because in the
event of an insolvency, if a customer’s funds are being used to cover a
different customers margin deficit, they may not get that money back.
Chilton then asked what the staff has done in the rule to ensure
that the regulations are not overly costly for small FCMs. Staff replied
that costs will be mitigated by the rules imposing a “point in time”
requirement” rather than a continuous one and that the lengthy phase-in period
can allow for technological changes to be developed to reduce operational
costs.
Chilton then stated that “theoretically there could be competition
between FCMs” and provide their customers more time to make payments by running
as close to the deadline as possible to make the ultimate payment up the DCO.
Gensler then asked if customers using CFTC account structures to
do portfolio margining and using securities in their account would still be
receive the protection of segregation, to which the staff replied yes.
O’Malia expressed concern with a lack of specifics in the
requirements of SROs to conduct surveillance of FCMs and questioned their
ability to “address all areas of risk.” Staff replied that there are many
good templates that SROs can use to follow traditional enterprise management
practices and said “the more granular they can make it, the better they can
manage business risk.” O’Malia followed up saying he was happy to hear
“that as long as they do those types of things, they will be in compliance.”
O’Malia then asked what the cost will be to FCMs of these
regulations. Staff cited their report which states that the aggregate annual
cost for all FCMs is approximately $487 million and that after the five year
delay period, the cost for the top ten FCMs is about $78 million.
Next, O’Malia expressed concern about the cyber security
implications of having the CFTC be granted access to customer accounts
electronically to monitor activity and also asked if there are legal issues
prohibiting this type of access. Staff replied that they would not have
direct access upfront to this data but would work with depository institution
if they needed to gain access. They added that there should not be legal issues
as there is a contractual agreement between the depository and the customer
that allows third party access.
Wetjen asked who would bear the costs of the shift in residual
interest deadline practices. Staff replied that the costs will go to the FCMs
and the customers who aren’t able to pay as quickly. They further explained
that FCMs would have to collect margin deficits upfront or use their own money.
Wetjen also asked if every customer shares in a “pro rata
distribution” in the event of an FCM bankruptcy, to which staff replied “absolutely.”
O’Malia Amendment (Not Approved, Vote of 1-3)
Commissioner O’Malia offered an amendment to the final rules which
he explained would not mandate that in five years time that customers would
need to meet their margin obligation by the end of the settlement cycle.
He next explained that the amendment would, like the final rule: 1) continue to
make progress to accelerate the progress of margin and customers from three
days to a one-day settlement date of 6:00 p.m.; 2) be phased in over one year
after enactment just like the draft rule; 3) require a study to determine the
feasibility of changing the collection days.
Further, O’Malia also said his amendment: will not predetermine a
policy outcome; will not bind a future Commission; and does not bias the study.
He said that moving beyond the residual deadline of T+1 to 7:00 –
9:00 a.m. in the settlement cycle may result in higher prefunding levels and
may cause small market participants to be blocked from the market. O’Malia also
said it is possible that some smaller FCMs may stop operating as FCMs as a
result of these costs.
Gensler said he could not support the amendment and believed the
final rule represented an appropriate balance and represented the “best read of
the law.” He noted that a future Commission could propose something else after
the study if they felt it was necessary.
When asked for his opinion Ananda Radhakrishnan, Division of
Clearing and Risk, stated that “any rule that goes past time of settlement is
not comporting with the law” and that “the rule we passed for swaps comports
with the law.”
Wetjen also said he could not support the amendment and that the
Commission is “making a judgment” that is “on balance” and that the final rule
is preferable to the amendment put forth by Commissioner O’Malia.
The Commission voted 1-3, with O’Malia supporting, and the
amendment was not approved.
The Final Rule on Customer Protections was passed by vote of 3-1,
with O’Malia voting “nay.”
Closing Comments
In closing remarks, Gensler noted that the Commission will have
another open meeting on November 5, 2013 to discuss Proposals on Position
limits.
O’Malia then brought up the Volcker Rule saying that the
regulators and Obama Administration have been signaling that it will be
completed by the end of the year, but he has yet to see “a single sheet of
paper” on the rule.
Chairman Gensler stated that the CFTC will likely hold a public
commission meeting in the second or third week of December on the Volcker Rule
but said he will not be able to share any documents with the Commissioners at
this point in time as it is “still very much moving between the SEC, FDIC, Fed,
OCC, and Treasury.”
For more information on this meeting, please click here.
Opening Statements:
Statement of Support of Chairman Gary Gensler- Ownership and
Control (“OCR”)
Statement of Support of Chairman Gary Gensler – Customer Protection
Opening Statement of Commissioner Bart Chilton – “The Law”
Opening Statement of Commissioner Scott O’Malia – Customer
Protection
Statement of Commissioner Scott O’Malia – Customer Protection Residual
Interest Amendment
Opening Statement of Commissioner Mark Wetjen
Additional Documents:
Fact Sheet: Final Rules Enhancing Protections Afforded Customers
and Customer Funds Held by Futures Commission Merchants and Derivatives
Clearing Organizations
Questions and Answers: Final Rules Enhancing Protections Afforded Customers
and Customer Funds Held by Futures Commission Merchants and Derivatives
Clearing
Fact Sheet: Final Rule on Segregation for Uncleared Swaps;
Treatment of Securities in a Portfolio Margining Account in a Commodity Broker
Bankruptcy
Questions & Answers: Segregation for Uncleared Swaps; Treatment of
Securities in a Portfolio Margining Account in a Commodity Broker Bankruptcy
Fact
Sheet: Final Rule on Ownership and Control Reports, Forms 102/102S, 40/40S, and
71
Questions & Answers: Final Rule on Ownership and Control Reports, Forms
102/102S, 40/40S, and 71