Investment of Customer Funds and Funds Held in an Account for Foreign Futures and Foreign Options Transactions, 67642-67657 [2010-27657]

Agencies

• Commodity Futures Trading Commission

[Federal Register Volume 75, Number 212 (Wednesday, November 3, 2010)]
[Proposed Rules]
[Pages 67642-67657]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-27657]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1 and 30

RIN 3038-AC15


Investment of Customer Funds and Funds Held in an Account for 
Foreign Futures and Foreign Options Transactions

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rule.

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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC) 
is proposing to amend its regulations regarding the investment of 
customer segregated funds and funds held in an account subject to 
Commission Regulation 30.7 (30.7 funds). Certain amendments reflect the 
implementation of new statutory provisions enacted under Title IX of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act. The 
proposed rules address: Certain changes to the list of permitted 
investments, a clarification of the liquidity requirement, the removal 
of rating requirements, an expansion of concentration limits including 
asset-based, issuer-based, and counterparty concentration restrictions. 
It also addresses revisions to the acknowledgment letter requirement 
for investment in a money market mutual fund (MMMF), revisions to the 
list of exceptions to the next-day redemption requirement for MMMFs, 
the application of customer segregated funds investment limitations to 
30.7 funds, the removal of ratings requirements for depositories of 
30.7 funds, and the elimination of the option to designate a depository 
for 30.7 funds.

DATES: Comments must be received on or before December 3, 2010.

ADDRESSES: You may submit comments, identified by RIN number, by any of 
the following methods:
     Agency Web site, via its Comments Online process: https://comments.cftc.gov. Follow the instructions for submitting comments 
through the Web site.
     Mail: David A. Stawick, Secretary of the Commission, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, NW., Washington, DC 20581.
     Hand Delivery/Courier: Same as mail above.
     Federal eRulemaking Portal: https://www.regulations.gov. 
Follow the instructions for submitting comments.
    All comments must be submitted in English, or if not, accompanied 
by an English translation. Comments will be posted as received to 
https://www.cftc.gov. You should submit only information that you wish 
to make available publicly. If you wish the Commission to consider 
information that may be exempt from disclosure under the Freedom of 
Information Act, a petition for confidential treatment of the exempt 
information may be submitted according to the established procedures in 
CFTC Regulation 145.9.\1\
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    \1\ Commission regulations referred to herein are found at 17 
CFR Ch. 1.

FOR FURTHER INFORMATION CONTACT: Phyllis P. Dietz, Associate Director, 
202-418-5449, pdietz@cftc.gov, or Jon DeBord, Attorney-Advisor, 202-
418-5478, jdebord@cftc.gov, or Division of Clearing and Intermediary 
Oversight, Commodity Futures Trading Commission, Three Lafayette 
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Centre, 1151 21st Street, NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background
    A. Regulation 1.25
    B. Regulation 30.7
    C. Advance Notice of Proposed Rulemaking
    D. The Dodd-Frank Act
II. Discussion of the Proposed Rules
    A. Permitted Investments
    1. Government Sponsored Enterprise Securities
    2. Commercial Paper and Corporate Notes or Bonds
    3. Foreign Sovereign Debt
    4. In-House Transactions
    B. General Terms and Conditions
    1. Marketability
    2. Ratings
    3. Restrictions on Instrument Features
    4. Concentration Limits
    (a) Asset-Based Concentration Limits
    (b) Issuer-Based Concentration Limits
    (c) Counterparty Concentration Limits
    C. Money Market Mutual Funds
    1. Acknowledgment Letters
    2. Next-Day Redemption Requirement
    D. Repurchase and Reverse Repurchase Agreements
    E. Regulation 30.7
    1. Harmonization
    2. Ratings
    3. Designation as a Depository for 30.7 Funds
III. Related Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act
    C. Costs and Benefits of the Proposed Rules
Text of Rules

I. Background

A. Regulation 1.25

    Under Section 4d(a)(2) of the Commodity Exchange Act (Act),\2\ the 
investment of customer segregated funds is limited to obligations of 
the United States and obligations fully guaranteed as to principal and 
interest by the United States (U.S. government securities), and general 
obligations of any State or of any political subdivision thereof 
(municipal securities). Pursuant to authority under Section 4(c) of the 
Act,\3\ the Commission substantially expanded the list of permitted 
investments by amending Commission Regulation 1.25 \4\ in December 2000 
to permit investments in general obligations issued by any enterprise 
sponsored by the United States (government sponsored enterprise 
securities or GSE securities), bank certificates of deposit (CDs), 
commercial paper, corporate notes,\5\ general obligations of a 
sovereign nation, and interests in MMMFs.\6\ In connection

[[Page 67643]]

with that expansion, the Commission included several provisions 
intended to control exposure to credit, liquidity, and market risks 
associated with the additional investments, e.g., requirements that the 
investments satisfy specified rating standards and concentration 
limits, and be readily marketable and subject to prompt liquidation.\7\
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    \2\ 7 U.S.C. 6d(a)(2).
    \3\ 7 U.S.C. 6(c).
    \4\ 17 CFR 1.25.
    \5\ This category of permitted investment was later amended to 
read ``corporate notes or bonds.'' See 70 FR 28190, 28197 (May 17, 
2005).
    \6\ See 65 FR 77993 (Dec. 13, 2000) (publishing final rules); 
and 65 FR 82270 (Dec. 28, 2000) (making technical corrections and 
accelerating effective date of final rules from February 12, 2001 to 
December 28, 2000).
    \7\ Id.
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    The Commission further modified Regulation 1.25 in 2004 and 2005. 
In February 2004, the Commission adopted amendments regarding 
repurchase agreements using customer-deposited securities and time-to-
maturity requirements for securities deposited in connection with 
certain collateral management programs of derivatives clearing 
organizations (DCOs).\8\ In May 2005, the Commission adopted amendments 
related to standards for investing in instruments with embedded 
derivatives, requirements for adjustable rate securities, concentration 
limits on reverse repurchase agreements, transactions by futures 
commission merchants (FCMs) that are also registered as securities 
brokers or dealers (in-house transactions), rating standards and 
registration requirements for MMMFs, an auditability standard for 
investment records, and certain technical changes.\9\
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    \8\ 69 FR 6140 (Feb. 10, 2004).
    \9\ 70 FR 28190.
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    The Commission has been, and continues to be, mindful that 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 in order to avoid 
systemic risk. Toward these ends, Regulation 1.25 establishes a general 
prudential standard by requiring that all permitted investments be 
``consistent with the objectives of preserving principal and 
maintaining liquidity.'' \10\
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    \10\ 17 CFR 1.25(b).
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    In 2007, the Commission's Division of Clearing and Intermediary 
Oversight (Division) launched a review of the nature and extent of 
investments of customer segregated funds and 30.7 funds (2007 Review) 
in order to further its understanding of investment strategies and 
practices and to assess whether any changes to the Commission's 
regulations would be appropriate. As part of this review, all 
registered DCOs and FCMs carrying customer accounts provided responses 
to a series of questions. As the Division was conducting follow-up 
interviews with respondents, the market events of September 2008 
occurred and changed the financial landscape such that much of the data 
previously gathered no longer reflected current market conditions. 
However, much of that data remains useful as an indication of how 
Regulation 1.25 was implemented in a more stable financial environment, 
and recent events in the economy have underscored the importance of 
conducting periodic reassessments and, as necessary, revising 
regulatory policies to strengthen safeguards designed to minimize risk.

B. Regulation 30.7

    Regulation 30.7 \11\ governs an FCM's treatment of customer money, 
securities, and property associated with positions in foreign futures 
and foreign options. Regulation 30.7 was issued pursuant to the 
Commission's plenary authority under Section 4(b) of the Act.\12\ 
Because Congress did not expressly apply the limitations of Section 4d 
of the Act to 30.7 funds, the Commission historically has not subjected 
those funds to the investment limitations applicable to customer 
segregated funds.
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    \11\ 17 CFR 30.7.
    \12\ 7 U.S.C. 6(b).
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    The investment guidelines for 30.7 funds are general in nature.\13\ 
Although Regulation 1.25 investments offer a safe harbor, the 
Commission does not currently limit investments of 30.7 funds to 
permitted investments under Regulation 1.25. Appropriate depositories 
for 30.7 funds currently include certain financial institutions in the 
United States, financial institutions in a foreign jurisdiction meeting 
certain capital and credit rating requirements, and any institution not 
otherwise meeting the foregoing criteria, but which is designated as a 
depository upon the request of a customer and the approval of the 
Commission.
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    \13\ See Commission Form 1-FR-FCM Instructions at 12-9 (Mar. 
2010) (``In investing funds required to be maintained in separate 
section 30.7 account(s), FCMs are bound by their fiduciary 
obligations to customers and the requirement that the secured amount 
required to be set aside be at all times liquid and sufficient to 
cover all obligations to such customers. Regulation 1.25 investments 
would be appropriate, as would investments in any other readily 
marketable securities.'').
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C. Advance Notice of Proposed Rulemaking

    In May 2009, the Commission issued an advance notice of proposed 
rulemaking (ANPR) \14\ to solicit public comment prior to proposing 
amendments to Regulations 1.25 and 30.7. The Commission stated that it 
was considering significantly revising the scope and character of 
permitted investments for customer segregated funds and 30.7 funds. In 
this regard, the Commission sought comments, information, research, and 
data regarding regulatory requirements that might better safeguard 
customer segregated funds. It also sought comments, information, 
research, and data regarding the impact of applying the requirements of 
Regulation 1.25 to investments of 30.7 funds.
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    \14\ 74 FR 23962 (May 22, 2009).
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    The Commission received twelve comment letters in response to the 
ANPR, and it has considered those comments in formulating its 
proposal.\15\ Eleven of the 12 letters supported maintaining the 
current list of permitted investments and/or specifically ensuring that 
MMMFs remain a permitted investment. Five of the letters were dedicated 
solely to the topic of MMMFs, providing detailed discussions of their 
usefulness to FCMs. Several letters addressed issues regarding ratings, 
liquidity, concentration, and portfolio weighted average time to 
maturity. The alignment of Regulation 30.7 with Regulation 1.25 was 
viewed as non-controversial.
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    \15\ The Commission received comment letters from CME Group Inc. 
(CME), Crane Data LLC (Crane), The Dreyfus Corporation (Dreyfus), 
FCStone Group Inc. (FCStone), Federated Investors, Inc. (Federated), 
Futures Industry Association (FIA), Investment Company Institute 
(ICI), MF Global Inc. (MF Global), National Futures Association 
(NFA), Newedge USA, LLC (Newedge), and Treasury Strategies, Inc. 
(TSI). Two letters were received from Federated: A July 10, 2009 
letter (Federated letter I) and an August 24, 2009 letter.
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    The FIA's comment letter expressed its view that ``all of the 
permitted investments described in Rule 1.25(a) are compatible with the 
Commission's objectives of preserving principal and maintaining 
liquidity.'' This opinion was echoed by MF Global, Newedge and FC 
Stone. CME asserted that only ``a small subset of the complete list of 
Regulation 1.25 permitted investments are actually used by the 
industry. * * *'' NFA also wrote that investments in instruments other 
than U.S. government securities and MMMFs are ``negligible'' and 
recommended that the Commission eliminate asset classes not ``utilized 
to any material extent.''

D. The Dodd-Frank Act

    On July 21, 2010, President Obama signed the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (Dodd-Frank Act).\16\ Title IX of 
the

[[Page 67644]]

Dodd-Frank Act \17\ was promulgated in order to increase investor 
protection, promote transparency and improve disclosure.
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    \16\ See Dodd-Frank Wall Street Reform and Consumer Protection 
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the 
Dodd-Frank Act may be accessed at https://www.cftc.gov./
LawRegulation/OTCDERIVATIVES/index.htm.
    \17\ Pursuant to Section 901 of the Dodd-Frank Act, Title IX may 
be cited as the ``Investor Protection and Securities Reform Act of 
2010.''
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    Section 939A of the Dodd-Frank Act obligates federal agencies to 
review their respective regulations and make appropriate amendments in 
order to decrease reliance on credit ratings. The Dodd-Frank Act 
requires the Commission to conduct this review within one year after 
the date of enactment.\18\ The Commission is proposing amendments to 
Regulations 1.25 and 30.7 that include removal of provisions setting 
forth credit rating requirements. Separate rulemakings proposed today 
address the elimination of credit ratings from Regulations 1.49 and 
4.24 and the removal of Appendix A to Part 40 (which contains a 
reference to credit ratings).
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    \18\ See Section 939A(a) of the Dodd-Frank Act.
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    The Commission is now proposing amendments to Regulations 1.25 and 
30.7 and requests comment on all aspects of the proposed rules, as well 
as comment on the specific provisions and issues highlighted in the 
discussion below. In addition, commenters are welcome to offer their 
views regarding any other related matters that are raised by the 
proposed amendments.

II. Discussion of the Proposed Rules

A. Permitted Investments

    In proposing amendments to Regulation 1.25, the Commission seeks to 
simplify the regulation and impose requirements that can better ensure 
the preservation of principal and maintenance of liquidity. The 
Commission has endeavored to tailor its proposal to achieve these goals 
while retaining an appropriate degree of investment flexibility and 
opportunities for attaining capital efficiency for DCOs and FCMs 
investing customer segregated funds.
    The Commission seeks to simplify Regulation 1.25 by narrowing the 
scope of investment choices in order to eliminate the potential use of 
instruments that may pose an unacceptable level of risk. In their July 
2009 comment letters, both NFA and CME suggested contracting the scope 
of permitted investments by eliminating asset classes used negligibly 
as investment vehicles.
    The Commission seeks to increase the safety of Regulation 1.25 
investments by promoting diversification. For example, issuer-specific 
concentration limits control how much exposure an FCM or DCO has to the 
credit risk of any one investment. The Commission believes that greater 
diversification can be achieved through instituting two additional 
types of concentration limits. First, asset-based concentration limits, 
suggested by the FIA, MF Global and Newedge in their comment letters, 
reduce market risk by limiting how much of any one class of instrument 
an FCM or DCO can have in its portfolio at any one time. Second, 
repurchase agreement counterparty concentration limits serve to cap an 
FCM or DCO's exposure to the credit risk of a counterparty.
    Below, the Commission details its proposal to remove government 
sponsored enterprise (GSE) securities that are not backed by the full 
faith and credit of the United States, corporate debt obligations not 
guaranteed by the United States, general obligations of a sovereign 
nation (foreign sovereign debt), and in-house transactions from the 
list of permitted investments. These proposed changes reflect the 
position of the Commission that the safety of a particular instrument 
or transaction must be viewed through the lens of its likely 
performance during a period of market volatility and financial 
instability.
1. Government Sponsored Enterprise Securities
    The Commission proposes to amend paragraph (a)(1)(iii) to expressly 
add U.S. government corporation obligations \19\ to GSE securities 
(together, U.S. agency obligations) and to add the requirement that the 
U.S. agency obligations must be fully guaranteed as to principal and 
interest by the United States. GSEs are chartered by Congress but are 
privately owned and operated. Securities issued by GSEs do not have an 
explicit federal guarantee although they are considered by some to have 
an ``implicit'' guarantee due to their federal affiliation.\20\ 
Obligations of U.S. government corporations, such as the Government 
National Mortgage Association (known as Ginnie Mae), are explicitly 
backed by the full faith and credit of the United States. Although the 
Commission is not aware of any GSE securities that have an explicit 
federal guarantee, it believes that GSE securities should remain on the 
list of permitted investments in the event this status changes in the 
future.
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    \19\ See 31 U.S.C. 9101 (defining ``government corporation'').
    \20\ Frank J. Fabozzi with Steven V. Mann, The Handbook of Fixed 
Income Securities, 242-245 (McGraw Hill 7th ed. 2005).
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    The failure of two GSEs during the financial crisis has moved the 
Commission to view the securities of such GSEs as inappropriate for 
investments of customer funds. In 2008, the Federal National Mortgage 
Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation 
(Freddie Mac) failed due to problems in the subprime mortgage market. 
While Fannie Mae and Freddie Mac were bailed out in 2008, the U.S. 
government had no obligation to do so and investors cannot rely on 
another bailout should a GSE fail in the future.
    In consideration of the above, the Commission proposes to amend 
paragraph (a)(1)(iii) of Regulation 1.25 by permitting investments in 
only those U.S. agency obligations that are fully guaranteed as to 
principal and interest by the United States.\21\ The Commission 
requests comment on whether GSE securities should remain as permitted 
investments under Regulation 1.25, either subject to a Federal 
guarantee requirement or not.
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    \21\ Although U.S. Government corporation obligations backed by 
the full faith and credit of the United States could also be 
categorized as U.S. Government securities under Regulation 
1.25(a)(1)(i), the Commission is distinguishing them from other 
government securities, such as Treasury securities, because they 
cannot be expected to have the same liquidity even if they satisfy 
the ``highly liquid'' requirement under proposed. Regulation 
1.25(b)(1). See also discussion of concentration limits in Section 
II.B.4. of this notice.
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2. Commercial Paper and Corporate Notes or Bonds
    In order to simplify the regulation by eliminating rarely-used 
instruments, and in light of the credit, liquidity, and market risks 
posed by corporate debt securities, the Commission proposes to limit 
investments in ``commercial paper'' \22\ and ``corporate notes or 
bonds'' \23\ to commercial paper and corporate notes or bonds that are 
federally guaranteed as to principal and interest under the Temporary 
Liquidity Guarantee Program (TLGP) and meet certain other prudential 
standards.\24\
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    \22\ Regulation 1.25(a)(1)(v).
    \23\ Regulation 1.25(a)(1)(vi).
    \24\ Commercial paper would remain available as a direct 
investment for MMMFs and corporate notes or bonds would remain 
available as indirect investments for MMMFs by means of a repurchase 
agreement. Additionally, it should be noted that two commenters 
suggested expanding the list of permitted investments to include 
commercial paper and corporate notes or bonds guaranteed by foreign 
sovereign governments. However, as the Commission has determined 
that foreign sovereign debt is itself unsuitable as a permitted 
investment, going forward (explained in more detail below), it 
follows that corporate debt guaranteed by a foreign sovereign 
government would also not be permissible.

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[[Page 67645]]

    Information obtained during the 2007 Review indicated that 
commercial paper and corporate notes or bonds were not widely used by 
FCMs or DCOs.\25\ Consistent with this, the NFA states in its comment 
letter that most firms invest about 33 percent of their customer funds 
in government securities, 10 percent in MMMFs, and the balance 
maintained in bank accounts or on deposit with a carrying broker.
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    \25\ The 2007 Review indicated that out of 87 FCM respondents, 
only nine held commercial paper and seven held corporate notes/bonds 
as direct investments during the November 30, 2006-December 1, 2007 
period. Further, 26 FCM respondents engaged in reverse repurchase 
agreements as of December 1, 2007 and none received commercial paper 
or corporate notes or bonds in those transactions.
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    In the fall of 2008, the Federal Deposit Insurance Corporation 
(FDIC) created the TLGP, which guarantees principal and interest on 
certain types of corporate debt. Although the TLGP debt securities are 
backed by the full faith and credit of the U.S. Government and 
therefore pose minimal credit risk to the buyer for the period during 
which the guarantee is effective, initially there was concern as to 
whether the securities were readily marketable and sufficiently liquid 
so that the holders of such securities would be able to liquidate them 
quickly and easily without having to incur a substantial discount.
    In February 2010, having evaluated the growing market for TLGP debt 
securities, the Division issued an interpretative letter concluding 
that TLGP debt securities are sufficiently liquid, and might therefore 
qualify as permitted investments under Regulation 1.25 if they meet the 
following criteria in addition to satisfying the pre-existing 
requirements imposed by Regulation 1.25: (1) The size of the issuance 
is greater than $1 billion; (2) the debt security is denominated in 
U.S. dollars; and (3) the debt security is guaranteed for its entire 
term.\26\
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    \26\ Letter from Ananda Radhakrishnan, Director, Division of 
Clearing and Intermediary Oversight, CFTC, to Debra Kokal, Chairman 
of the Joint Audit Committee (Jan. 15, 2010) (TLGP Letter).
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    Although the TLGP expires in 2012, the Commission believes it is 
useful to include commercial paper and corporate notes or bonds that 
are fully guaranteed as to principal and interest by the United States 
as permitted investments because this would permit continuing 
investment in TLGP debt securities, even though the Commission has 
proposed to otherwise eliminate commercial paper and corporate notes or 
bonds. Therefore, the Commission proposes to limit the commercial paper 
and corporate notes or bonds that can qualify as permitted investments 
to only those guaranteed as to principal and interest under the TLGP 
and that meet the criteria set forth in the Division's interpretation. 
As a result of this limitation, paragraph (b)(3)(iv), which relates to 
adjustable rate securities, is no longer necessary.\27\ The Commission 
proposes to delete current paragraph (b)(3)(iv) and replace it with 
language codifying the criteria for federally backed commercial paper 
and corporate notes or bonds. Accordingly, the Commission proposes to 
delete paragraph (b)(3)(i)(B) and amend paragraph (b)(3)(iii) to remove 
references to paragraph (b)(3)(iv). The Commission requests comment on 
the proscription of commercial paper and corporate notes or bonds that 
are not federally guaranteed under the TLGP, the liquidity of TLGP 
debt, and whether the removal of the requirements for adjustable rate 
securities will have any unintended or detrimental effects on 
Regulation 1.25 investments.
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    \27\ The original purpose of this paragraph was to set 
parameters for adjustable rate securities issued by corporations 
and, to a lesser extent, GSEs. As proposed, Regulation 1.25 would 
only permit corporate and GSE securities that had explicit U.S. 
Government guarantees. Therefore, the mechanics of an adjustable 
rate component for these instruments would no longer require 
oversight for Regulation 1.25 purposes.
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3. Foreign Sovereign Debt
    The Commission proposes to remove foreign sovereign debt as a 
permitted investment in the interests of both simplifying the 
regulation and safeguarding customer funds. The 2007 Review revealed 
negligible investment in foreign sovereign debt \28\ and that fact, in 
combination with recent events undermining confidence in the solvency 
of a number of foreign countries, supports the Commission's proposed 
action. Removal of foreign sovereign debt from the list of permitted 
investments is not expected to significantly impact FCM and DCO 
investment strategies for customer funds. The Commission notes that, 
aside from general appeals to maintain the current list of permitted 
investments, only one commenter specifically addressed foreign 
sovereign debt.\29\
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    \28\ The 2007 Review indicated that out of 87 FCM respondents, 
only three held an investment in foreign sovereign debt at any time 
during that year. It should also be noted that only one FCM invested 
in such debt under Regulation 30.7.
    \29\ FIA, in its comment letter, recommended expanding 
investment in foreign sovereign debt beyond the current rule, which 
limits an FCM's investment in foreign sovereign debt to the amount 
of its liabilities to its clients in that foreign country's currency 
(FIA letter at 5). As the Commission is prepared to remove foreign 
sovereign debt entirely, a more detailed analysis of this 
recommendation is unnecessary.
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    Currently, an FCM or DCO can invest customer funds in foreign 
sovereign debt subject to two limitations: (1) The debt must be rated 
in the highest category by at least one nationally recognized 
statistical rating organization (NRSRO) and (2) the FCM or DCO may 
invest in such debt only to the extent it has balances in segregated 
accounts owed to its customers or its clearing member FCMs, 
respectively, denominated in that country's currency. The purpose of 
permitting investments in foreign sovereign debt is to facilitate 
investments of customer funds in the form of foreign currency without 
the need to convert that foreign currency to a U.S. dollar denominated 
asset, which would increase the FCM or DCO's exposure to currency risk. 
An investment in the sovereign debt of the same country that issues the 
foreign currency would limit the FCM or DCO's exposure to sovereign 
risk, i.e., the risk of the sovereign's default.
    Both the lack of investment in foreign sovereign debt and the 
recent global financial volatility have caused the Commission to 
reevaluate this provision. First, as noted above, it appears that 
foreign sovereign debt is rarely used as an investment tool by FCMs. 
Second, the financial crisis has highlighted the fact that certain 
countries' debt can exceed an acceptable level of risk.
    In consideration of the above, the Commission proposes to remove 
foreign sovereign debt as a permitted investment under Regulation 1.25 
and renumber paragraph (a)(1) accordingly. The Commission requests 
comment on whether foreign sovereign debt should remain, to any extent, 
as a permitted investment and, if so, what requirements or limitations 
might be imposed in order to minimize sovereign risk.
4. In-House Transactions
    The Commission proposes to eliminate in-house transactions 
permitted under paragraph (a)(3) and subject to the requirements of 
paragraph (e) of Regulation 1.25. This proposal is consistent with the 
Commission's proposed prohibition on an FCM or DCO entering into a 
repurchase or reverse repurchase agreement with a counterparty that is 
an affiliate of the FCM or DCO.\30\
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    \30\ See discussion infra at Section II.D, regarding proposed 
Regulation 1.25(d)(3).
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    In 2005, two commenters recommended that the Commission permit FCMs 
that are dually registered as securities brokers or dealers to engage

[[Page 67646]]

in in-house transactions.\31\ At the time, the Commission concluded 
that in-house transactions would allow FCMs to realize ``greater 
capital efficiency'' and further reasoned that ``the substitution of 
one permitted investment for another in an in-house transaction [would] 
not present an unacceptable level of risk to the customer segregated 
account.'' \32\ The Commission therefore amended Regulation 1.25 to 
allow an FCM/broker-dealer to enter into transactions that are the 
economic equivalent of a repurchase or reverse repurchase agreement, 
subject to certain requirements.\33\ More specifically, an FCM may 
exchange customer money for permitted investments held in its capacity 
as a broker-dealer, it may exchange customer securities for permitted 
investments held in its capacity as a broker-dealer, and it may 
exchange customer securities for cash held in its capacity as a broker-
dealer.\34\
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    \31\ See 70 FR at 28193 (FIA and Lehman Brothers supporting in-
house transactions).
    \32\ 70 FR 5577, 5581 (Feb. 3, 2005).
    \33\ See Regulation 1.25(a)(3) and (e).
    \34\ Regulation 1.25(a)(3)(i)-(iii).
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    Recent market events have, however, increased concerns about the 
concentration of credit risk within the FCM/broker-dealer corporate 
entity in connection with in-house transactions. Therefore, consistent 
with the Commission's proposal to prohibit FCMs from entering into 
repurchase and reverse repurchase agreements with affiliates, the 
Commission is proposing to eliminate in-house transactions as permitted 
investments for customer funds under paragraph (a)(3) of Regulation 
1.25 and rescind paragraph (e), which sets forth the requirements for 
in-house transactions. Accordingly, paragraph (f) will be redesignated 
as new paragraph (e).
    The Commission requests comment on the impact of this proposal on 
the business practices of FCMs and DCOs. Specifically, the Commission 
requests that commenters present scenarios in which a repurchase or 
reverse repurchase agreement with a third party could not be 
satisfactorily substituted for an in-house transaction.
    The Commission requests comment on any other aspect of the proposed 
changes to paragraph (a) of Regulation 1.25. In particular, the 
Commission solicits comment on whether MMMFs should be eliminated as a 
permitted investment.\35\ In discussing whether MMMF investments 
satisfy the overall objective of preserving principal and maintaining 
liquidity, the Commission specifically requests comment on whether 
changes in the settlement mechanisms for the tri-party repo market 
might impact a MMMF's ability to meet the requirements of Regulation 
1.25.\36\
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    \35\ MMMFs are discussed in greater detail infra, in Sections 
II.B.4 and II.C of this notice.
    \36\ An industry task force recently concluded an extensive 
review of the tri-party repo market to identify ways in which it 
could be improved. See Payments Risk Committee, Task Force on Tri-
Party Repo Infrastructure, https://www.newyorkfed.org/tripartyrepo/task_force_report.html (May 17, 2010). In contrast to current 
practice, under which funds from maturing repos are available early 
in the day, modifications to the settlement arrangements for tri-
party repo transactions may result in payments occurring later in 
the day. To the extent that MMMFs invest in tri-party repos, this 
change could impact their ability to pay out large amounts of cash 
early in the day.
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B. General Terms and Conditions

    FCMs and DCOs may invest customer funds only in enumerated 
permitted investments ``consistent with the objectives of preserving 
principal and maintaining liquidity * * *.'' \37\ In furtherance of 
this general standard, paragraph (b) of Regulation 1.25 establishes 
various specific requirements designed to minimize credit, market, and 
liquidity risk. Among them are a requirement that the investment be 
``readily marketable,'' that it meet specified rating requirements, and 
that it not exceed specified issuer concentration limits. The 
Commission is proposing to amend these standards to facilitate the 
preservation of principal and maintenance of liquidity by establishing 
clear, prudential standards that further investment quality and 
portfolio diversification. The Commission notes that an investment that 
meets the technical requirements of Regulation 1.25 but does not meet 
the overarching prudential standard cannot qualify as a permitted 
investment.
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    \37\ Regulation 1.25(b).
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1. Marketability
    Regulation 1.25(b)(1) states that ``[e]xcept for interests in money 
market mutual funds, investments must be `readily marketable' as 
defined in Sec.  240.15c3-1 of this title.'' \38\ The Commission 
proposes to remove the ``readily marketable'' requirement from 
paragraph (b)(1) and substitute in its place a ``highly liquid'' 
standard.\39\ The Commission did not receive any comment letters 
specifically discussing the meaning and application of the ``readily 
marketable'' requirement.\40\
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    \38\ See 17 CFR 240.15c3-1(c)(11)(i) (SEC regulation defining 
``ready market'').
    \39\ Related to this proposed new standard, the provision in 
paragraph (a)(2)(ii)(A) that requires securities subject to 
repurchase agreements to be `` `readily marketable' as defined in 
Sec.  240.15c-1 of this title'' also would be amended to provide 
that securities subject to repurchase agreements must be `` `highly 
liquid' as defined in paragraph (b)(2) of this section.''
    \40\ FIA, MF Global and Newedge mentioned marketability in their 
letters but no significant changes were recommended.
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    The term ``ready market'' is borrowed from the Securities and 
Exchange Commission (SEC) capital rules and is interpreted by the 
SEC.\41\ That standard is used in setting appropriate haircuts for the 
purpose of calculating capital. Although its inclusion in Regulation 
1.25 was intended to be a proxy for the concept of liquidity, it is not 
a concept that is otherwise easily applied as a prudential standard in 
determining the appropriateness of a debt instrument for investment of 
customer funds.
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    \41\ The term ``ready market'' is defined, in relevant part, to 
``include a recognized established securities market in which there 
exists independent bona fide offers to buy and sell so that a price 
reasonably related to the last sales price or current bona fide 
competitive bid and offer quotations can be determined for a 
particular security almost instantaneously and where payment will be 
received in settlement of a sale at such price within a relatively 
short time conforming to trade custom.'' 17 CFR 240.15c3-
1(c)(11)(i).
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    It is the Commission's view that the ``readily marketable'' 
language should be eliminated as it creates an overlapping and 
confusing standard when applied in the context of the express objective 
of ``maintaining liquidity.'' While ``liquidity'' and ``ready market'' 
appear to be interchangeable concepts, they have distinctly different 
origins and uses: The objective of ``maintaining liquidity'' is to 
ensure that investments can be promptly liquidated in order to meet a 
margin call, pay variation settlement, or return funds to the customer 
upon demand. As noted above, the SEC's ``ready market'' standard is 
intended for a different purpose and is easier to apply to exchange 
traded equity securities than debt securities.
    Although Regulation 1.25 requires that investments be consistent 
with the objective of maintaining liquidity, the Commission has not 
articulated an explanation or a definition of the concept of 
``liquidity.'' The Commission therefore proposes to define ``highly 
liquid'' functionally, as having the ability to be converted into cash 
within one business day, without a material discount in value. This 
approach focuses on outcome rather than process, and the Commission 
believes it will be easier to apply to debt securities than the current 
``readily marketable'' standard.
    An alternative to using a materiality standard in the definition of 
highly liquid is to employ a more formulaic and measurable approach. An 
example of a calculable standard would be one that provides that an 
instrument is

[[Page 67647]]

highly liquid if there is a reasonable basis to conclude that, under 
stable financial conditions, the instrument has the ability to be 
converted into cash within one business day, without greater than a 1 
percent haircut off of its book value.
    The Commission proposes to amend paragraph (b)(1) to eliminate the 
marketability standard and in its place establish a requirement that 
permitted investments be highly liquid. The Commission requests comment 
on whether the proposed definition of ``highly liquid'' accurately 
reflects the industry's understanding of that term, and whether the 
term ``material'' might be replaced with a more precise or, perhaps, 
even calculable standard. The Commission welcomes comment on the ease 
or difficulty in applying the proposed or alternative ``highly liquid'' 
standards.
2. Ratings
    The Commission proposes to remove all rating requirements from 
Regulation 1.25. This proposal is mandated by Section 939A of the Dodd-
Frank Act. Further, the proposal reflects the Commission's views that 
ratings are not sufficiently reliable as currently administered, that 
there is reduced need for a measure of credit risk given the proposed 
elimination of certain permitted investments, and that FCMs and DCOs 
should bear greater responsibility for understanding and evaluating 
their investments.\42\
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    \42\ The Commission received three letters regarding rating 
requirements, but none focused on the question of whether or not to 
retain ratings.
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    The original purpose of imposing rating requirements was to 
mitigate credit risk associated with permitted investments which 
included commercial paper and corporate notes. Recent events in the 
financial markets, however, revealed significant weaknesses in the 
ratings industry.
    Eliminating or restricting rating requirements has been considered 
by Congress and regulators with some frequency during the past two 
years. This has been motivated, at least in part, by public sentiment 
that credit rating agencies did not accurately rate debt in the months 
and years leading up to the financial crisis, worsening the financial 
crisis and increasing investors' losses. The SEC, in September 2009, 
adopted rule amendments that removed references to NRSROs from a 
variety of SEC rules and forms promulgated under the Securities 
Exchange Act of 1934 and from certain rules promulgated under the 
Investment Company Act of 1940 (Investment Company Act).\43\ In 
November 2009, the SEC adopted rules imposing enhanced disclosure and 
conflict of interest requirements for NRSROs.\44\ The SEC also has 
opened comment periods on other proposed amendments, including one that 
would remove references to NRSROs from its net capital rule.\45\
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    \43\ See 74 FR 52358 (Oct. 9, 2009) (publishing final rules and 
proposing additional rule amendments).
    \44\ See 74 FR 63832 (Dec. 4, 2009) (publishing final rules and 
proposing additional rule amendments).
    \45\ 74 FR at 52377-78 (proposing removal of certain references 
to NRSROs in the SEC's net capital rules for broker-dealers).
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    The Dodd-Frank Act contains several measures that focus both on 
decreasing reliance on NRSROs and improving the performance of NRSROs 
when they must be relied upon. Section 939 of the Dodd-Frank Act 
mandates the removal of certain references to NRSROs in several 
statutes,\46\ and Section 939A requires all Federal agencies to review 
references to NRSROs in their regulations, to remove reliance on credit 
ratings and, if appropriate, to replace such reliance with other 
standards of credit-worthiness.
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    \46\ Sections 7(b)(1)(E)(i), 28(d) and 28(e) of the Federal 
Deposit Insurance Act (12 U.S.C. 1811 et seq.), Section 1319 of the 
Federal Housing Enterprises Financial Safety and Soundness Act of 
1992 (12 U.S.C. 4519), Section 6(a)(5)(A)(iv)(I) of the Investment 
Company Act of 1940 (15 U.S.C. 80a-6(a)(5)(A)(iv)(I)), Section 5136A 
of title LXII of the Revised Statutes of the United States (12 
U.S.C. 24a), and Section 3(a) of the Securities Exchange Act of 1934 
(15 U.S.C. 78a(3)(a)).
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    The Commission, therefore, intends to remove credit rating 
requirements from Regulation 1.25.\47\ Alternative standards of credit-
worthiness are not being proposed. Evidence that rating agencies have 
not reliably gauged the safety of debt instruments in the past and the 
fact that other Regulation 1.25 proposed amendments published in this 
notice obviate much of the need for credit ratings, have helped to 
shape the Commission's decision.
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    \47\ See infra Section II.E.2 regarding the corresponding change 
in Regulation 30.7.
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    While some might argue that imperfect information is better than 
none at all, several factors outweigh the possible risks associated 
with removing rating requirements. First, eliminating commercial paper 
and corporate notes or bonds as permitted investments would take away a 
large class of potentially risky investments for which ratings would be 
relevant. Second, the issuer concentration limits and proposed asset-
based concentration limits should reduce the likelihood that one 
problem investment would destabilize an entire investment portfolio. 
Finally, removing rating requirements would not absolve FCMs and DCOs 
from investing in safe, highly liquid investments; rather it would 
shift to FCMs and DCOs more of the responsibility to diligently 
research their investments.
    In light of the above analysis, the Commission proposes to 
eliminate paragraph (b)(2) of Regulation 1.25 and renumber the 
subsequent provisions of paragraph (b) accordingly.
3. Restrictions on Instrument Features
    Currently, both non-negotiable and negotiable CDs are permitted 
under Regulation 1.25. Paragraph (b)(3)(v) details the required 
redemption features of both types of CDs.
    Non-negotiable CDs represent a direct obligation of the issuing 
bank to the purchaser. The CD is wholly owned by the purchaser until 
early redemption or the final maturity of the CD. To be permitted under 
Regulation 1.25, the terms of the CD must allow the purchaser to redeem 
the CD at the issuing bank within one business day, with any penalty 
for early withdrawal limited to any accrued interest earned. Therefore, 
other than in the event of a bank default, an investor is assured of 
the return of its principal.
    Negotiable CDs are considerably different than non-negotiable CDs 
in that they are typically purchased by a broker on behalf of a large 
number of investors. The large size of the purchase by the broker 
results in a more favorable interest rate for the purchasers, who 
essentially own shares of the negotiable CD. Unlike a non-negotiable 
CD, the purchaser of a negotiable CD cannot redeem its interest from 
the issuing bank. Rather, an investor seeking redemption prior to a 
CD's maturity date must liquidate the CD in the secondary market. 
Depending on the negotiated CD terms (interest rate and duration) and 
the current economic conditions, the market for a given CD can be 
illiquid and can result in the inability to redeem within one business 
day and/or a significant loss of principal.
    Therefore, the Commission proposes to amend paragraph (b)(3)(v) by 
restricting CDs to only those instruments which can be redeemed at the 
issuing bank within one business day, with any penalty for early 
withdrawal limited to accrued interest earned according to its written 
terms.\48\
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    \48\ While it proposes to eliminate negotiable CDs as an 
interest bearing vehicle for purposes of Regulation 1.25, the 
Commission notes that Section 627 of the Dodd-Frank Act removes the 
prohibition on payments of interest on demand deposits. Demand 
deposits which meet Regulation 1.25 standards of liquidity may, 
therefore, be a source of interest income to DCOs and FCMs.

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[[Page 67648]]

4. Concentration Limits
    Paragraph (b)(4) of Regulation 1.25 currently sets forth issuer-
based concentration limits for direct investments, securities subject 
to repurchase or reverse repurchase agreements, and in-house 
transactions. The Commission proposes to adopt asset-based 
concentration limits for direct investments and a counterparty 
concentration limit for reverse repurchase agreements in addition to 
amending its issuer-based concentration limits and rescinding 
concentration limits applied to in-house transactions.\49\
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    \49\ The Commission is aware that other diversification methods 
exist or could be devised (such as the diversification requirements 
for MMMF investments in CME's IEF2 collateral management program) 
and believes that such methods can coexist with the proposed 
concentration limits.
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    (a) Asset-based concentration limits. Asset-based concentration 
limits would dictate the amount of funds an FCM or DCO could hold in 
any one class of investments, expressed as a percentage of total assets 
held in segregation. In their comment letters, the FIA, MF Global and 
Newedge specifically suggested the incorporation of asset-based 
concentration limits. The Commission agrees that such limits could 
increase the safety of customer funds by promoting diversification.
    Specifically, the Commission proposes the following asset-based 
limits in light of its evaluation of credit, liquidity, and market 
risk:
     No concentration limit (100 percent) for U.S. government 
securities;
     A 50 percent concentration limit for U.S. agency 
obligations fully guaranteed as to principal and interest by the United 
States;
     A 25 percent concentration limit for TLGP guaranteed 
commercial paper and corporate notes or bonds;
     A 25 percent concentration limit for non-negotiable CDs;
     A 10 percent concentration limit for municipal securities; 
and
     A 10 percent concentration limit for interests in MMMFs.
    Asset-based concentration limits are consistent with the 
Commission's historical view that not all permitted investments have 
identical risk profiles.\50\ In its efforts to increase the safety of 
permitted investments on a portfolio basis, the Commission has decided 
to assign to each permitted investment an asset-based concentration 
limit that correlates to its level of risk and liquidity relative to 
other permitted investments.\51\
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    \50\ See 70 FR at 5581 (discussing the relative risk profiles of 
permitted investments in the context of repurchase agreements).
    \51\ The Commission notes that paragraphs (b)(4)(ii)-(iii) of 
Regulation 1.25 would apply to both asset-based and issuer-based 
concentration limits. Therefore, for the purpose of calculating 
asset-based concentration limits, instruments purchased by an FCM or 
DCO as a result of a reverse repurchase agreement under paragraph 
(b)(4)(iii) would be combined with instruments held by the FCM or 
DCO as direct investments.
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    U.S. government securities are backed by the full faith and credit 
of the U.S. government, are highly liquid, and are the safest of the 
permitted investments. As such, the Commission proposes a 100 percent 
concentration limit, allowing an FCM or DCO to invest all of its 
segregated funds in U.S. government securities.\52\
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    \52\ FIA, MF Global and Newedge each assigned a 100 percent 
concentration limit to U.S. government securities. See FIA letter at 
3, MF Global letter at 2, and Newedge letter at 5.
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    U.S. agency obligations, as proposed, must be fully guaranteed as 
to principal and interest by the United States. The Commission views 
these as sufficiently safe but potentially not as liquid as a Treasury 
security. Because of this concern, and in the interest of promoting 
diversification, the Commission proposes a 50 percent concentration 
limit.\53\
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    \53\ FIA, MF Global and Newedge each assigned a 75 percent 
concentration limit to GSE securities. See FIA letter at 3, MF 
Global letter at 2, and Newedge letter at 5.
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    The Commission categorizes TLGP debt securities as corporate 
securities,\54\ which are riskier than U.S. government securities. 
While TLGP debt securities have an explicit FDIC guarantee, which 
provides confidence for TLGP debt investors that they will receive the 
full amount of principal and interest in the event of an issuer 
default, the timing of such a payment is uncertain. Additionally, while 
TLGP debt securities that meet the Commission's requirements have a 
liquid secondary market, that might not always be the case. The 
Commission therefore proposes to apply a 25 percent concentration limit 
for TLGP debt securities as well.
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    \54\ See TLGP Letter.
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    CDs are safe for relatively small amounts, but the risk increases 
for larger sums. The rise in bank failures since 2008 is a cause for 
concern with regard to CDs because they are FDIC insured to a maximum 
of only $250,000. As a result, the Commission proposes to apply a 25 
percent concentration limit to CDs.
    In evaluating possible asset-based concentration limits for TLGP 
debt securities and CDs, the Commission determined that the same 
concentration limit should apply to both, even though the risk profiles 
of the asset classes are different. The Commission recognizes that TLGP 
debt securities pose no risk to principal, unlike bank CDs which are 
subject to the possible default of the issuing bank. However, a CD 
which must be redeemable within one business day under Regulation 
1.25(b)(3)(v) could prove to be more liquid than TLGP debt securities 
during a time of market stress. The Commission requests comment on 
whether there should be differentiation between asset-based 
concentration limits for TLGP debt securities and CDs and, if so, what 
those different concentration limits should be.
    Municipal securities are backed by the state or local government 
that issues them, and they have traditionally been viewed as a safe 
investment. However, municipal securities have been volatile and, in 
some cases, increasingly illiquid over the past two years. Therefore, 
the Commission proposes to apply a 10 percent concentration limit to 
municipal securities.\55\
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    \55\ FIA, MF Global and Newedge each assigned a 25 percent 
concentration limit to all assets that were not U.S. government 
securities, GSE securities or MMMFs. See FIA letter at 3, MF Global 
letter at 2, and Newedge letter at 5.
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    MMMFs have been widely used as an investment for customer 
segregated funds.\56\ As discussed in the next section, their portfolio 
diversification, administrative ease, and heightened prudential 
standards recently imposed by the SEC, continue to make MMMFs an 
attractive investment option. However, their volatility during the 2008 
financial crisis, which culminated in one fund ``breaking the buck'' 
and many more funds requiring infusions of capital, underscores the 
fact that investments in MMMFs are not without risk.\57\ To mitigate 
these risks, the Commission proposes to assign a 10 percent 
concentration limit for MMMFs.\58\ The Commission believes that this 
concentration limit is commensurate with the risks posed by MMMFs. The 
Commission solicits comment regarding whether 10 percent is an 
appropriate asset-based concentration limit for MMMFs. The Commission 
welcomes opinions on what alternative asset-based concentration limit 
might be appropriate for MMMFs and, if such

[[Page 67649]]

asset-based concentration limit is higher than 10 percent, what 
corresponding issuer-based concentration limit should be adopted.
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    \56\ The 2007 Review indicated that out of 87 FCM respondents, 
46 had invested customer funds in MMMFs at some point during the 
November 30, 2006-December 1, 2007 period.
    \57\ See 75 FR 10060, 10078 n.234 (Mar. 4, 2010).
    \58\ FIA recommended a 100 percent concentration limit, Newedge 
recommended a 50 percent concentration limit, and MF Global 
recommended a 25 percent concentration limit for MMMFs. See FIA 
letter at 3, Newedge letter at 5, and MF Global letter at 2.
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    (b) Issuer-based concentration limits. The Commission has 
considered the current concentration limits and proposes to amend its 
issuer-based limits for direct investments to include a 2 percent limit 
for an MMMF family of funds, expressed as a percentage of total assets 
held in segregation. Currently, there is no concentration limit applied 
to MMMFs and the Commission believes that it is prudent to require FCMs 
and DCOs to diversify their MMMF portfolios. The 25 percent issuer-
based limitation for GSEs (now U.S. agency obligations) and the 5 
percent issuer-based limitation for municipal securities, commercial 
paper, corporate notes or bonds, and CDs will remain in place.
    (c) Counterparty concentration limits. Finally, the Commission 
proposes a counterparty concentration limit of 5 percent of total 
assets held in segregation for securities subject to reverse repurchase 
agreements. Under Regulation 1.25(b)(4)(iii), concentration limits for 
reverse repurchase agreements are derived from the concentration limits 
that would have been assigned to the underlying securities had the FCM 
or DCO made a direct investment. Therefore, under current rules, an FCM 
or DCO could have 100 percent of its segregated funds subject to one 
reverse repurchase agreement. The obvious concern in such a scenario is 
the credit risk of the counterparty. This credit risk, while 
concentrated, is significantly mitigated by the fact that in exchange 
for cash, the FCM or DCO is holding Regulation 1.25-permissible 
securities of equivalent or greater value. However, a default by the 
counterparty would put pressure on the FCM or DCO to convert such 
securities into cash immediately and would exacerbate the market risk 
to the FCM or DCO, given that a decrease in the value of the security 
or an increase in interest rates could result in the FCM or DCO 
realizing a loss. Even though the market risk would be mitigated by 
asset-based and issuer-based concentration limits, a situation of this 
type could seriously jeopardize an FCM or DCO's overall ability to 
preserve principal and maintain liquidity with respect to customer 
funds.
    In accordance with the above discussion, the Commission proposes to 
amend paragraph (b)(4) to add a new paragraph (i) setting forth asset-
based concentration limits for direct investments; amend and renumber 
as new paragraph (ii) issuer-based concentration limits for direct 
investments; amend and renumber as new paragraph (iii) concentration 
limits for reverse repurchase agreements; delete the existing paragraph 
(iv) due to the Commission's proposed elimination of in-house 
transactions; renumber as a new paragraph (iv) the provision regarding 
treatment of customer-owned securities; and add a new paragraph (v) 
setting forth counterparty concentration limits for reverse repurchase 
agreements.
    The Commission requests comment on any and all aspects of the 
proposed concentration limits, including whether asset-based 
concentration limits are an effective means for facilitating investment 
portfolio diversification and whether there are other methods that 
should be considered. In addition, the Commission requests comment on 
whether the proposed concentration levels are appropriate for the 
categories of investments to which they are assigned and whether there 
should be different standards for FCMs and DCOs.

C. Money Market Mutual Funds

    The continued use of MMMFs was the sole focus of five comment 
letters,\59\ a substantial focus of one,\60\ and referenced positively 
by an additional four.\61\ Taken together, the letters conveyed a 
consensus that MMMFs are both safe and administratively efficient. In 
their respective comment letters, Federated noted that MMMFs are 
subject to the overlapping regulatory regimes overseen by the SEC, and 
ICI highlighted the quality, liquidity and diversity of an MMMF's 
holdings. Further, TSI noted that out of 700-800 MMMFs, only one failed 
during the September 2008 financial turmoil, a crisis which Dreyfus 
likened to a ``1,000 year flood.''
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    \59\ See Crane letter, Dreyfus letter, Federated letter I, ICI 
letter, and TSI letter.
    \60\ See CME letter at 5-6.
    \61\ See FCStone letter at 2, MF Global letter at 2, Newedge 
letter at 5, and NFA letter at 1.
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    While the Commission appreciates the benefits of MMMFs, it also is 
cognizant of their risks. Reserve Primary Fund, the September 2008 
failure referenced by TSI, was an MMMF that satisfied the enumerated 
requirements of Regulation 1.25 and at one point was a $63 billion 
fund. The Reserve Primary Fund's breaking the buck called attention to 
the risk to principal and potential lack of sufficient liquidity of any 
MMMF investment. In the wake of the Reserve Primary Fund problem, the 
Commission has been forced to consider the possibility that any number 
of MMMFs that meet the technical requirements of Regulation 1.25(c) 
might not meet the Regulation 1.25 objective of preserving principal 
and maintaining liquidity, particularly during volatile market 
conditions.\62\ Lending credence to such concerns, the SEC has 
estimated that, in order to avoid breaking the buck, nearly 20 percent 
of all MMMFs received financial support from their money managers or 
affiliates from mid-2007 through the end of 2008.\63\
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    \62\ See 75 FR at 10078 n.234 (SEC final rulemaking adopting 
amendments to regulations governing MMMFs, describing the September 
2008 run on MMMFs: ``On September 17, 2008, approximately 25% of 
prime institutional money market funds experienced outflows greater 
than 5% of total assets; on September 18, 2008, approximately 30% of 
prime institutional money market funds experienced outflows greater 
than 5%; and on September 19, 2008, approximately 22% of prime 
institutional money market funds experienced outflows greater than 
5%'').
    \63\ See 74 FR 32688