Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations, 68505-68657 [2013-26665]

Download as PDF Vol. 78 Thursday, No. 220 November 14, 2013 Part II Commodity Futures Trading Commission TKELleY on DSK3SPTVN1PROD with RULES2 17 CFR Parts 1, 3, 22, et al. Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations; Final Rule VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 PO 00000 Frm 00001 Fmt 4717 Sfmt 4717 E:\FR\FM\14NOR2.SGM 14NOR2 68506 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations COMMODITY FUTURES TRADING COMMISSION 17 CFR Parts 1, 3, 22, 30, and 140 RIN 3038–AD88 Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations Commodity Futures Trading Commission. ACTION: Final rule. AGENCY: The Commodity Futures Trading Commission (‘‘Commission’’ or ‘‘CFTC’’) is adopting new regulations and amending existing regulations to require enhanced customer protections, risk management programs, internal monitoring and controls, capital and liquidity standards, customer disclosures, and auditing and examination programs for futures commission merchants (‘‘FCMs’’). The regulations also address certain related issues concerning derivatives clearing organizations (‘‘DCOs’’) and chief compliance officers (‘‘CCOs’’). The final rules will afford greater assurances to market participants that: Customer segregated funds, secured amount funds, and cleared swaps funds are protected; customers are provided with appropriate notice of the risks of futures trading and of the FCMs with which they may choose to do business; FCMs are monitoring and managing risks in a robust manner; the capital and liquidity of FCMs are strengthened to safeguard their continued operations; and the auditing and examination programs of the Commission and the self-regulatory organizations (‘‘SROs’’) are monitoring the activities of FCMs in a prudent and thorough manner. DATES: Effective date: January 13, 2014. Compliance date: The applicable compliance dates are discussed in the section of the release titled ‘‘III. Compliance Dates.’’ FOR FURTHER INFORMATION CONTACT: Division of Swap Dealer and Intermediary Oversight: Gary Barnett, Director, 202–418–5977, gbarnett@ cftc.gov; Thomas Smith, Deputy Director, 202–418–5495, tsmith@ cftc.gov;mailto: Jennifer Bauer, Special Counsel, 202–418–5472, jbauer@ cftc.gov; Joshua Beale, AttorneyAdvisor, 202–418–5446, jbeale@ cftc.gov, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581; Kevin Piccoli, Deputy Director, 646– 746–9834, kpiccoli@cftc.gov, 140 Broadway, 19th Floor, New York, NY 10005; or Mark Bretscher, Special TKELleY on DSK3SPTVN1PROD with RULES2 SUMMARY: VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 Counsel, 312–596–0529, mbretscher@ cftc.gov, 525 W. Monroe Street, Suite 1100, Chicago, IL. 60661. Division of Clearing and Risk: Ananda Radhakrishnan, Director, 202–418– 5188, aradhakrishnan@cftc.gov; Robert B. Wasserman, Chief Counsel, 202–418– 5092, rwasserman@cftc.gov; Phyllis P. Dietz, Deputy Director, 202–418–5449, pdietz@cftc.gov; M. Laura Astrada, Associate Chief Counsel, 202–418–7622, lastrada@cftc.gov, Eileen Donovan, Associate Director, 202–418–5096, edonovan@cftc.gov; Kirsten V. K. Robbins, Special Counsel, 202–418– 5313, krobbins@cftc.gov; or Shawn R. Durrani, Attorney-Advisor, 202–418– 5048, sdurrani@cftc.gov, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581. Office of the Chief Economist: Stephen Kane, Research Economist, skane@cftc.gov, 202–418–5911, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581. SUPPLEMENTARY INFORMATION: Table of Contents I. Background A. General Statutory and Current Regulatory Structure B. Self-Regulatory Structure C. Futures Commission Merchant Insolvencies and Failures of Risk Management D. Recent Commission Rulemakings and Other Initiatives Relating to Customer Protection E. The Proposed Amendments II. Comments on the Notice of Proposed Rulemaking A. § 1.10: Financial Reports of Futures Commission Merchants and Introducing Brokers 1. Amendments of the Segregation and Secured Amount Schedules With Respect to the Reporting of Residual Interest 2. New Cleared Swaps Segregation Schedules 3. Amendments to Form 1–FR–FCM 4. FCM Certified Annual Report Deadline 5. Leverage Ratio Calculation 6. Procedural Filing Requirements B. § 1.11: Risk Management Program for Futures Commission Merchants 1. Applicability 2. Definitions 3. Approval of Policies and Procedures and Submission to the Commission 4. Organizational Requirements of the Risk Management Program a. Separation of Risk Management Unit From Business Unit 5. Components of the Risk Management Program 6. Annual Review, Distribution of Policies and Procedures and Recordkeeping 7. CCO or CEO Certification C. § 1.12: Maintenance of Minimum Financial Requirements by Futures Commission Merchants and Introducing Brokers PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 1. Timing of Notices 2. Undercapitalized FCMs and IBs 3. Insufficient Segregation of Funds of Cleared Swaps Customers 4. Investment of Customer Funds in Contravention of Regulation 1.25 5. Notice of Residual Interest Falling Below Targeted Level or Undermargined Amounts 6. Events Causing Material Adverse Financial Impact or Material Change in Operations 7. Notice of Correspondence From Other Regulatory Authorities 8. Filing Process and Content 9. Public Disclosure of Early Warning Notices D. § 1.15: Risk Assessment Reporting Requirement for Futures Commission Merchants E. § 1.16: Qualifications and Reports of Accountants 1. Mandatory PCAOB Registration Requirement 2. PCAOB Inspection Requirement 3. Remediation of PCAOB Inspection Findings by the Public Accountant 4. Auditing Standards 5. Review of Public Accountant’s Qualifications by the FCM’s Governing Body 6. Electronic Filing of Certified Annual Reports F. § 1.17: Minimum Financial Requirements for Futures Commission Merchants and Introducing Brokers 1. FCM Cessation of Business and Transfer of Customer Accounts if Unable To Demonstrate Adequate Liquidity 2. Reducing Time Period for FCMs To Incur a Capital Charge for Undermargined Accounts to One Day after Margin Calls Are Issued 3. Permit an FCM that is not a BD To Develop Policies and Procedures To Determine Creditworthiness 4. Revisions to Definitions in Regulation 1.17(b) G. § 1.20: Futures Customer Funds To Be Segregated and Separately Accounted for 1. Identification of Customer Funds and Due Diligence 2. Permitted Depositories 3. Limitation on the Holding of Futures Customer Funds Outside of the United States 4. Acknowledgment Letters a. Background b. Technical Changes to the Template Letters c. Federal Reserve Banks as Depositories d. Foreign Depositories e. Release of Funds Upon Commission Instruction f. Read-Only Access and Information Requests g. Requirement To File New Acknowledgment Letters h. Standard of Liability i. Liens j. Examination of Accounts 5. Prohibition Against Commingling Customer Funds 6. Limitations on the Use of Customer Funds 7. Segregation Requirements for DCOs E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations 8. Immediate Availability of Bank and Trust Company Deposits 9. Segregated Funds Computation Requirement 10. Segregation Regimes H. § 1.22: Use of Futures Customer Funds I. § 1.23: Interest of Futures Commission Merchant in Segregated Futures Customer Funds; Additions and Withdrawals J. § 1.25: Investment of Customer Funds 1. General Comments Regarding the Investment of Customer Funds 2. Reverse Repurchase Agreement Counterparty Concentration Limits K. § 1.26: Deposit of Instruments Purchased With Futures Customer Funds L. § 1.29: Increment or Interest Resulting From Investment of Customer Funds 1. FCM’s Responsibility for Losses Incurred on the Investment of Customer Funds 2. FCM’s Obligation in Event of Bank Default M. § 1.30: Loans by Futures Commission Merchants: Treatment of Proceeds N. § 1.32: (§ 22.2(g) for Cleared Swaps Customers and § 30.7(l) for Foreign Futures and Foreign Options Customers): Segregated Account: Daily Computation and Record O. § 1.52: Self-Regulatory Organization Adoption and Surveillance of Minimum Financial Requirements 1. Swap Execution Facilities Excluded From the Scope of Regulation 1.52 2. Revisions to the Current SRO Supervisory Program 3. Auditing Standards Utilized in the SRO Supervisory Program 4. ‘‘Examinations Expert’’ Reports P. § 1.55: Public disclosures by Futures Commission Merchants 1. Amendments to the Risk Disclosure Statement a. Firm Specific Disclosure Document i. General Requirements ii. Specific Disclosure Information Required (by rule paragraph) 2. Public Availability of FCM Financial Information Q. Part 22—Cleared Swaps R. Amendments to § 1.3: Definitions; and § 30.7: Treatment of Foreign Futures or Foreign Options Secured Amount 1. Elimination of the ‘‘Alternative Method’’ for Calculating the Secured Amount 2. Funds Held in Non-U.S. Depositories 3. Commingling of Positions in Foreign Futures and Foreign Options Accounts 4. Further Harmonization With Treatment of Customer Segregated Funds 5. Harmonization With Other Commission Proposals S. § 3.3: Chief Compliance Officer Annual Report III. Compliance Dates A. Financial Reports of FCMs: § 1.10 B. Risk Management Program for FCMs: § 1.11 C. Qualifications and Reports of Accountants: § 1.16 D. Minimum Financial Requirements for FCMs E. Written Acknowledgment Letters: §§ 1.20, 1.26, and 30.7 F. Undermargined Amounts: §§ 1.22(c), 30.7(a) VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 G. SRO Minimum Financial Surveillance: § 1.52 H. Public Disclosures by FCMs: § 1.55 IV. Cost Benefit Considerations V. Related Matters A. Regulatory Flexibility Act B. Paperwork Reduction Act Appendix 1—Table of Comment Letters Appendix 2—CFTC Form 1–FR–FCM I. Background A. General Statutory and Current Regulatory Structure The protection of customers—and the safeguarding of money, securities or other property deposited by customers with an FCM—is a fundamental component of the Commission’s disclosure and financial responsibility framework. Section 4d(a)(2) 1 of the Commodity Exchange Act (‘‘the Act’’ or ‘‘the CEA’’) 2 requires each FCM to segregate from its own assets all money, securities, and other property deposited by futures customers to margin, secure, or guarantee futures contracts and options on futures contracts traded on designated contract markets.3 Section 4d(a)(2) further requires an FCM to treat and deal with futures customer funds as belonging to the futures customer, and prohibits an FCM from using the funds deposited by a futures customer to margin or extend credit to any person other than the futures customer that deposited the funds. Section 4d(f) of the Act, which was added by section 724(a) of the DoddFrank Wall Street Reform and Consumer Protection Act (‘‘Dodd-Frank Act’’),4 requires each FCM to segregate from its own assets all money, securities, and other property deposited by Cleared Swaps Customers to margin Cleared Swaps.5 Section 4d(f) also provides that 17 U.S.C. 6d(a)(2). U.S.C. 1 et seq. 3 The term ‘‘futures customer’’ is defined in § 1.3(iiii) of the Commission’s regulations to include any person who uses an FCM as an agent in connection with trading in any contract for the purchase or sale of a commodity for future delivery or an option on such contract (excluding any proprietary accounts under § 1.3(y)). The Commission adopted the definition of the term ‘‘futures customer’’ on October 16, 2012 as part of the final rulemaking that amended existing Commission regulations to incorporate swaps. The Federal Register release adopting the final rules can be accessed at https://www.cftc.gov/ucm/groups/ public/@newsroom/documents/file/federal register101612.pdf. Commission regulations can be found at 17 CFR Ch. 1. 4 See Dodd-Frank 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/DoddFrankAct/index.htm. 5 The term ‘‘Cleared Swap’’ is defined in section 1a(7) of the Act as any swap that is, directly or indirectly, submitted to and cleared by a DCO registered with the Commission. The term ‘‘Cleared Swaps Customer’’ is defined in § 22.1 as any person entering into a Cleared Swap, but excludes: (1) Any 27 PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 68507 an FCM shall treat and deal with all money, securities, and property of any swaps customer received to margin, guarantee, or secure a swap cleared by or through a DCO (including money, securities, or property accruing to the swaps customer as the result of such a swap) as belonging to the swaps customer. Section 4d(f) further provides that an FCM shall separately account for and not commingle with its own funds any money, securities, and property of a swaps customer, and shall not use such swaps customer’s funds to margin, secure, or guarantee any trades or contracts of any swaps customer or person other than the person for whom the same are held. The Commission adopted §§ 1.20 through 1.30, and § 1.32, to implement section 4d(a)(2) of the Act, and adopted part 22 to implement section 4d(f) of the Act. The purpose of these regulations is to safeguard funds deposited by futures customers and Cleared Swaps Customers, respectively. Regulation 1.20 requires each FCM and DCO to separately account for and to segregate from its own proprietary funds all money, securities, or other property deposited by futures customers for trading on designated contract markets. In addition, all futures customer funds must be separately accounted for, and may not be commingled with the money, securities or property of an FCM or of any other person, or be used to secure or guarantee the trades, contracts or commodity options, or to secure or extend the credit, of any person other than the one for whom the same are held. Regulation 1.20 also provides that an FCM or DCO may deposit futures customer funds only with a bank or trust company, and for FCMs only, a DCO or another FCM. The funds must be deposited under an account name that clearly identifies the funds as belonging to the futures customers of the FCM or DCO and further shows that the funds are segregated as required by section 4d(a)(2) of the Act and Commission regulations. FCMs and DCOs also are required to obtain a written acknowledgment from a depository stating that the depository was informed that the funds deposited are customer funds being held in accordance with the Act. FCMs and DCOs also are restricted in their use of futures customer funds. Regulation 1.22 prohibits an FCM from using, or permitting the use of, the owner or holder of a Cleared Swaps Proprietary Account with respect to the Cleared Swaps in such account; and (2) A clearing member of a DCO with respect to Cleared Swaps cleared on that DCO. E:\FR\FM\14NOR2.SGM 14NOR2 68508 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 futures customer funds of one futures customer to purchase, margin, or settle the trades, contracts, or commodity options of, or to secure or extend the credit of, any person other than such futures customer. In addition, § 1.22 provides that futures customer funds may not be used to carry trades or positions of the same futures customer other than in commodities or commodity options traded through the facilities of a contract market. Under § 1.20, an FCM or DCO may, however, for convenience, commingle and hold funds deposited as margin by multiple futures customers in the same account or accounts with one of the recognized depositories. An FCM or DCO also may invest futures customer funds in certain permitted investments under § 1.25. Part 22 of the Commission’s regulations, which governs Cleared Swaps, implements section 4d(f) of the Act and parallels many of the provisions in part 1 that address the manner in which, and the responsibilities imposed upon, an FCM may hold funds for futures customers trading on designated contract markets.6 For example, § 22.2 requires an FCM to treat and to deal with funds deposited by Cleared Swaps Customers as belonging to such Cleared Swaps Customers and to hold such funds separately from the FCM’s own funds. Regulation 22.4 provides that an FCM may deposit Cleared Swaps Customer Collateral with a bank, trust company, DCO, or another registered FCM.7 Regulation 22.6 requires that the account holding the Cleared Swaps Customers Collateral must clearly identify the account as an account for Cleared Swaps Customers of the FCM engaging in Cleared Swaps and that the funds maintained in the account are subject to the segregation provisions of section 4d(f) of the Act and Commission regulations. Regulation 22.2(d) also prohibits an FCM from using the Cleared Swaps Customer Collateral of one Cleared Swaps Customer to purchase, margin, or settle the Cleared Swaps or any other trade or contract, or to secure or extend credit, of any person other than such Cleared Swaps Customer. Further, 6 The Commission approved the part 22 regulations on January 11, 2012, with an effective date of April 9, 2012. Compliance with the part 22 regulations was required by November 8, 2012. See Protection of Cleared Swaps Customer Contracts and Collateral; Conforming Amendments to the Commodity Broker Bankruptcy Provisions, 77 FR 6336 (Feb. 7, 2012). 7 The term ‘‘Cleared Swaps Customer Collateral’’ is defined in § 22.2 to mean all money, securities, or other property (including accruals) received by an FCM or DCO from, for, or on behalf of a Cleared Swaps Customer to margin, guarantee, or secure a Cleared Swap. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 § 22.2(c) permits an FCM to commingle the Cleared Swaps Customer Collateral of multiple Cleared Swaps Customers into one or more accounts, and § 22.2(e)(1) permits an FCM to invest Cleared Swaps Customer Collateral in accordance with § 1.25. In addition to holding funds for futures customers transacting on designated contract markets and for Cleared Swaps Customers engaging in Cleared Swaps, FCMs also hold funds for persons trading futures contracts listed on foreign boards of trade. Section 4(b) of the Act provides that the Commission may adopt rules and regulations proscribing fraud and requiring minimum financial standards, the disclosure of risk, the filing of reports, the keeping of books and records, the safeguarding of the funds deposited by persons for trading on foreign markets, and registration with the Commission by any person located in the United States (‘‘U.S.’’) who engages in the offer or sale of any contract of sale of a commodity for future delivery that is made subject to the rules of a board of trade located outside of the U.S. Pursuant to the statutory authority of section 4(b), the Commission adopted part 30 of its regulations to address foreign futures and foreign option transactions. The segregation provisions for funds deposited by foreign futures or foreign options customers to margin foreign futures or foreign options transactions under part 30, however, are significantly different from the requirements set forth in § 1.20 for futures customers trading on designated contract markets and part 22 for Cleared Swaps Customers engaging in Cleared Swaps.8 Regulation 30.7 provides that an FCM may deposit the funds belonging to foreign futures or foreign options customers in an account or accounts maintained at a bank or trust company located in the U.S.; a bank or trust company located outside of the U.S. that has in excess of $1 billion of regulatory capital; an FCM registered with the Commission; a DCO; a member of a foreign board of trade; a foreign clearing organization; or a depository selected by the member of a foreign board of trade or foreign clearing organization. The account with the depository must be titled to clearly specify that the account holds funds 8 The term ‘‘foreign futures or foreign options customer’’ is defined in § 30.1 to mean any person located in the U.S., its territories or possessions who trades in foreign futures or foreign options, with the exception of accounts that are proprietary accounts under § 1.3. The term ‘‘foreign futures or foreign option’’ is defined in § 30.1 to generally mean any futures and/or options transactions executed on a foreign board of trade. PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 belonging to the foreign futures or foreign options customers of the FCM that are trading on foreign futures markets. An FCM also is permitted to invest the funds deposited by foreign futures or foreign option customers in accordance with § 1.25. However, unlike § 1.20 and part 22, which require an FCM to hold a sufficient amount of funds in segregation to meet the total account equities of all of the FCM’s futures customers and Cleared Swaps Customers ‘‘at all times’’ (i.e., the ‘‘Net Liquidating Equity Method’’), § 30.7 requires an FCM to maintain in separate accounts an amount of funds only sufficient to cover the margin required on open foreign futures contracts, plus or minus any unrealized gains or losses on such open positions, plus any funds representing premiums payable or received on foreign options (including any additional funds necessary to secure such options, plus or minus any unrealized gains or losses on such options) (i.e., the ‘‘Alternative Method’’). Thus, under the part 30 Alternative Method an FCM is not required to maintain a sufficient amount of funds in such separate accounts to pay the full account balances of all of its foreign futures or foreign options customers at all times. In addition to the segregation requirements of sections 4d(a)(2) and 4d(f) of the Act, and the secured amount requirements in part 30 of the Commission’s regulations, FCMs also are subject to minimum net capital and financial reporting requirements that are intended to ensure that such firms meet their financial obligations in a regulated marketplace, including their financial obligations to customers and DCOs. Each FCM is required to maintain a minimum level of ‘‘adjusted net capital,’’ which is generally defined under § 1.17 as the firm’s net equity as computed under generally accepted accounting principles, less all of the firm’s liabilities (except for certain qualifying subordinated debt) and further excluding all assets that are not liquid or readily marketable. Regulation 1.17(c)(5) further requires an FCM to impose capital charges (i.e., deductions) on certain of its liquid assets to protect against possible market risks in such assets. FCMs also are subject to financial recordkeeping and reporting requirements. FCMs that carry customer accounts are required under § 1.32 to prepare a schedule each business day demonstrating their compliance with the segregation and secured amount requirements. Regulation 1.32 requires the calculation to be performed by noon E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 each business day, reflecting the account balances and open positions as of the close of business on the previous business day. Each FCM also is required by § 1.10 to file with the Commission and with its designated self-regulatory organization (‘‘DSRO’’) monthly unaudited financial statements and an annual audited financial report.9 Regulation 1.12 requires an FCM to file a notice with the Commission and with the firm’s DSRO whenever, among other things, the firm: (1) Fails to maintain compliance with the Commission’s capital requirements; (2) fails to hold sufficient funds in segregated or secured amount accounts to meet its regulatory requirements; (3) fails to maintain current books and records; or (4) experiences a significant reduction in capital from the previous month-end. The purpose of the regulatory notices is to alert the Commission and the firm’s DSRO as early as possible to potential financial issues at the firm that may adversely impact the ability of the FCM to comply with its obligations to safeguard customer funds, or to meet its financial obligations to other FCMs or DCOs. The statutory mandate to segregate customer funds—to treat them as belonging to the customer and not use the funds inappropriately—takes on greater meaning in light of the devastating events experienced over the last two years. Those events, which are discussed in greater detail below, demonstrate that the risks of misfeasance and malfeasance, and the risks of an FCM failing to maintain sufficient excess funds in segregation: (i) Put customer funds at risk; and (ii) are exacerbated by stresses on the business of the FCM. Many of those risks can be mitigated significantly by better risk management systems and controls, along with an increase in risk-oriented oversight and examination of the FCMs. Determining what is a ‘‘sufficient’’ amount of excess funds in segregation for any particular FCM requires a full understanding of the business of that FCM, including a proper analysis of the factors that affect the actual amount of segregated funds held by the FCM relative to the minimum amount of segregated funds it is required to hold. Further, appropriate care must be taken to avoid withdrawing such excess funds 9 The term ‘‘self-regulatory organization’’ is defined by § 1.3 to mean a contract market, a swap execution facility, or a registered futures association. A DSRO is the SRO that is appointed to be primarily responsible for conducting ongoing financial surveillance of an FCM that is a member of two or more SROs under a joint audit agreement submitted to and approved by the Commission under § 1.52. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 at times of great stress to cover needs unrelated to the purposes for which excess segregated and secured funds are maintained. In times of stress, excess funds may look like an easy liquidity source to help cover other risks of the business; yet withdrawing such excess funds makes the funds unavailable when they may be most needed. The recent market events illustrate both the need to: (i) Require that care be taken about monitoring excess segregated and secured funds, and the conditions under and the extent to which such funds may be withdrawn; and (ii) place appropriate risk management controls around the other risks of the business to help relieve (A) the likelihood of an exigent event or, (B) if such an event occurs, the likelihood of a failure to prepare for such an event, which in either case could create pressures that result in an inappropriate withdrawal of customer funds. Although the Commission’s existing regulations provide an essential foundation to fostering a wellfunctioning marketplace, wherein customers are protected and institutional risks are minimized, recent events have demonstrated that additional measures are necessary to effectuate the fundamental purposes of the statutory provisions discussed above. Further, concurrently with the enhanced responsibilities for FCMs that were proposed by the Commission, the oversight and examination systems must be enhanced to mitigate risks and effectuate the statutory purposes. B. Self-Regulatory Structure The Commission’s oversight structure provides that SROs are the frontline regulators of FCMs, introducing brokers (‘‘IBs’’), commodity pool operators, and commodity trading advisors. In 2000, Congress affirmed the Commission’s reliance on SROs by amending section 3 of the Act to state: ‘‘It is the purpose of this Act to serve the public interests through a system of effective selfregulation of trading facilities, clearing systems, market participants and market professionals under the oversight of the Commission.’’ As part of its oversight responsibility, an SRO is required to conduct periodic examinations of member FCMs’ compliance with Commission and SRO financial and related reporting requirements, including the FCMs’ holding of customer funds in segregated and secured accounts. The Commission oversees the SROs by examining them for the performance of their duties. The Commission recently has moved to conducting continuous reviews of the SROs’ FCM examination program that PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 68509 includes a process whereby the Commission selects a small sample of the SRO’s FCM work papers to review. In addition, the Commission also conducts limited-scope reviews of FCMs in ‘‘for cause’’ situations that are sometimes referred to as ‘‘audits,’’ but they are not full-scale audits as accountants commonly use that term. In addition, because there are multiple SROs who share the same member FCMs, to avoid subjecting FCMs to duplicative examinations from SROs, the Commission has a permissive system that allows the SROs to agree how to allocate FCMs amongst them. An SRO who is allocated certain FCMs for such examination is referred to as the DSRO of those FCMs. Under Commission regulations, FCMs must have their annual financial statements audited by an independent certified public accountant following generally accepted auditing standards as adopted in the U.S. (‘‘U.S. GAAS’’). As part of this certified annual report, the independent accountant also must conduct appropriate reviews and tests to identify any material inadequacies in systems and controls that could violate the Commission’s capital, segregation or secured amount requirements. Any such inadequacies are required to be reported to the FCM’s DSRO and to the Commission. C. Futures Commission Merchant Insolvencies and Failures of Risk Management The recent insolvencies of two FCMs demonstrate the need for revisions to the Commission’s customer protection regime. On October 31, 2011, MF Global, Inc. (‘‘MFGI’’), which was dually-registered as an FCM with the Commission and as a securities brokerdealer (‘‘BD’’) with the U.S. Securities and Exchange Commission (‘‘SEC’’), was placed into a liquidation proceeding under the Securities Investor Protection Act by the Securities Investor Protection Corporation (‘‘SIPC’’). The trustee appointed to oversee the liquidation of MFGI reported a potential $900 million shortfall of funds necessary to repay the account balances due to customers trading futures on designated contract markets, and an approximately $700 million shortfall in funds immediately available to repay the account balances of customers trading on foreign futures markets.10 The shortfall in customer segregated accounts was attributed by the MFGI Trustee to significant transfers of funds 10 See Report of the Trustee’s Investigation and Recommendations, In re MF Global Inc., No. 11– 2790 (MG) SIPA (Bankr. S.D.N.Y. June 4, 2012). E:\FR\FM\14NOR2.SGM 14NOR2 68510 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 out of the customer accounts that were used by MFGI for various purposes other than to meet obligations to or on behalf of customers. In addition, the Commission filed a civil injunctive complaint in federal district court on July 10, 2012, against Peregrine Financial Group, Inc. (‘‘PFGI’’), a registered FCM and its Chief Executive Officer (‘‘CEO’’) and sole owner, Russell R. Wasendorf, Sr., alleging that PFGI and Wasendorf, Sr. committed fraud by misappropriating customer funds, violated customer fund segregation laws, and made false statements regarding the amount of funds in customer segregated accounts in financial statements filed with the Commission. The complaint states that in July 2012 during an NFA examination PFGI falsely represented that it held in excess of $220 million of customer funds when in fact it held approximately $5.1 million.11 Recent incidents also have demonstrated the value of establishing robust risk management systems within FCMs and enhanced early warning systems to detect and address financial and regulatory issues. In particular, problems that arise through an FCM’s non-futures-related business can have a direct and significant impact on the FCM’s financial condition, raising questions as to whether the FCM will be able to protect customer funds 12 and maintain the minimum financial requirements mandated by the Act and Commission regulations.13 These recent incidents highlighted weaknesses in the customer protection regime prescribed in the Commission’s regulations and through the selfregulatory system. In particular, questions have arisen on the requirements surrounding the holding and investment of customer funds, including the ability of FCMs to withdraw funds from futures customer 11 Complaint, U.S. Commodity Futures Trading Commission v. Peregrine Financial Group, Inc., and Russell R. Wasendorf, Sr., No. 12–cv–5383 (N.D. Ill. July 10, 2012). A copy of the Commission’s complaint has been posted to the Commission’s Web site. 12 The Commission notes that the definition of ‘‘customer funds’’ in § 1.3(gg) includes funds held for customers trading on designated contract markets and customers engaging in cleared swap transactions. However, as used in this notice, unless otherwise specified, the term ‘‘customer funds’’ also includes funds held for customers trading on foreign markets pursuant to part 30 of the Commission’s regulations. 13 See, e.g., Edward Krudy, Jed Horowitz and John McCrank, ‘‘Knight’s Future in Balance After Trading Disaster,’’ Reuters (Aug. 3, 2012), available at https://in.reuters.com/article/2012/08/03/ knightcapital-loss-idINL2E8J27QE20120803 (noting that a software issue caused the firm to incur a $440 million trading loss, which represented much of the firm’s capital). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 segregated accounts and part 30 secured accounts. Additionally, the incidents have underscored the need for additional safeguards—such as robust risk management systems, strengthened early-warning systems surrounding margin and capital requirements, and enhanced public disclosures—to promote the protection of customer funds and to minimize the systemic risk posed by certain actions of market participants. Further questions have arisen on the system of audits and examinations of FCMs, and whether the system functions adequately to monitor FCMs’ activities, verify segregated funds and secured amount balances, and detect fraud. D. Recent Commission Rulemakings and Other Initiatives Relating to Customer Protection Since late 2011, the Commission has promulgated rules directly impacting the protection of customer funds. The Commission also has studied the current regulatory framework surrounding customer protection, particularly in light of the recent incidents outlined above, in order to identify potential enhancements to the systems and Commission regulations protecting customer funds. The Commission’s efforts have been informed, in part, by efforts undertaken by industry participants. The proposed rule amendments were informed by the efforts detailed below. In December 2011, the Commission adopted final rule amendments revising the types of investments that an FCM or DCO can make with customer funds under § 1.25, for the purpose of affording greater protection for such funds.14 Among other changes to §§ 1.25 and 30.7, the final rule amendments removed from the list of permitted investments: (1) Corporate debt obligations not guaranteed by the U.S. Government; (2) foreign sovereign debt; and (3) in-house and affiliate transactions. In adopting the amendments to § 1.25, the Commission was mindful that customer segregated funds must be invested by FCMs and DCOs 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. The amendments are consistent with the general prudential standard contained in § 1.25, 14 See Investment of Customer Funds and Funds Held in an Account for Foreign Futures and Foreign Options Transactions, 76 FR 78776 (Dec. 19, 2011). PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 which provides that all permitted investments must be ‘‘consistent with the objectives of preserving principal and maintaining liquidity.’’ The Commission also approved final regulations that require DCOs to collect initial customer margin from FCMs on a gross basis.15 Under the final regulations, FCMs are no longer permitted to offset one customer’s margin requirement against another customer’s margin requirements and deposit only the net margin collateral with the DCO. As a result of the rule change, a greater portion of customer initial margin is posted by FCMs to the DCOs. The Commission also approved regulations that impose requirements on FCMs and DCOs regarding the treatment of Cleared Swaps and Cleared Swaps Customer Collateral.16 Under the traditional futures model, DCOs hold an FCM’s futures customers’ funds on an omnibus basis in a futures customer account. In the event of a double default, which is a situation where a futures customer defaults on its obligation to its clearing FCM and the loss is so great that the clearing FCM defaults on its obligation to the DCO, the DCO is permitted to use the funds held in the futures customers’ omnibus account to cover the loss of the defaulting futures customer before applying its own capital or the guaranty fund contributions of non-defaulting FCM members. The Commission approved an alternative model for Cleared Swaps. Under the ‘‘LSOC’’ (legal segregation with operational comingling) model, DCOs may hold Cleared Swaps Customer Collateral on an omnibus basis in a Cleared Swaps Customer Account.17 However, unlike with the futures model, following a double default the DCO would only be permitted to access the collateral of the defaulting Cleared Swaps Customers; it would not be permitted to use the collateral of non-defaulting Cleared Swaps Customers to cover a defaulting Cleared Swaps Customer’s losses. Pursuant to section 724(c) of the Dodd-Frank Act, the final rule on segregation for uncleared swaps, approved by the Commission on October 30, 2013, implements the 15 See Commission Regulation 39.12(g)(8)(i) and Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 69334 (Nov. 8, 2011). 16 See 77 FR 6336 (Feb. 7, 2012). 17 The term ‘‘Cleared Swaps Customer Account’’ is defined in § 22.1 and generally refers to an account that an FCM or a DCO maintains at a permitted depository for the Cleared Swaps (and related collateral) of Cleared Swaps Customers. E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations requirements of section 4s(l) of the CEA that Swap Dealers (‘‘SDs’’) and Major Swap Participants (‘‘MSPs’’) notify their counterparties that such counterparties have a right to require that any initial margin which they post to guarantee uncleared swaps be segregated at an independent custodian. Where the counterparty elects segregation for its initial margin, the account must be held at a custodian that is independent of both the counterparty and the SD or MSP. The Commission also included customer protection enhancements in a final rulemaking for designated contract markets issued in June 2012. These enhancements codify into regulations staff guidance on minimum requirements for SROs regarding their financial surveillance of FCMs.18 The regulations require a DCM to have arrangements and resources for effective rule enforcement and trade and financial surveillance programs, including the authority to collect information and examine books and records of members and market participants. The regulations also establish minimum financial standards for both member FCMs and IBs and nonintermediated market participants. The Commission expressly noted in the preamble of the Federal Register release that ‘‘a DCM’s duty to set financial standards for its FCM members involves setting capital requirements, conducting surveillance of the potential future exposure of each FCM as compared to its capital, and taking appropriate action in light of the results of such surveillance.’’ 19 Further, the rules mandate that DCMs adopt rules for the protection of customer funds, including the segregation of customer and proprietary funds, the custody of customer funds, the investment standards for customer funds, intermediary default procedures and related recordkeeping. In addition to the rulemaking efforts outlined above, the Commission sought additional information through a series of roundtables and other meetings. On February 29 and March 1, 2012, the Commission solicited comments and held public roundtables to solicit input on customer protection issues from a broad cross-section of the futures industry, including market participants, FCMs, DCOs, SROs, securities regulators, foreign clearing organizations, and academics.20 The 18 See Core Principles and Other Requirements for Designated Contract Markets, 77 FR 36612 (June 19, 2012). 19 Id. at 36646. 20 Further information on the public roundtable, including video recordings and transcripts of the VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 roundtable focused on issues relating to the advisability and practicality of modifying the segregation models for customer funds; alternative models for the custody of customer collateral; enhancing FCM controls over the disbursement of customer funds; increasing transparency surrounding an FCM’s holding and investment of customer funds; and lessons learned from recent commodity brokerage bankruptcy proceedings. The Commission also hosted a public meeting of the Technology Advisory Committee (‘‘TAC’’) on July 26, 2012.21 Panelists and TAC members discussed potential technological solutions directed at enhancing the protection of customer funds by identifying and exploring technological issues and possible solutions relating to the ability of the Commission, SROs and customers to verify the location and status of funds held in customer segregated accounts. Commission staff hosted an additional roundtable on August 9, 2012, to discuss SRO requirements for examinations of FCMs and Commission oversight of SRO examination programs. The roundtable also focused on the role of the independent public accountant in the FCM examination process, and proposals addressing various alternatives to the current system for segregating customer funds. The Commission also considered industry initiatives to enhance customer protections. On February 29, 2012, the Futures Industry Association (‘‘FIA’’) initiated steps to educate customers on the extent of the protections provided under the current regulatory structure. FIA issued a list of Frequently Asked Questions (‘‘FAQ’’) prepared by members of the FIA Law and Compliance Division addressing the basics of segregation, collateral management and investments, capital requirements and other issues for FCMs and joint FCM/BDs, and clearinghouse guaranty funds.22 The FAQ is intended to provide existing and potential customers with a better understanding of the risks of engaging in futures trading and a clear explanation of the extent of the protections provided to discussions, have been posted to the Commission’s Web site. See https://www.cftc.gov/PressRoom/ Events/opaevent_cftcstaff022912 (relating to Feb. 29, 2012); https://www.cftc.gov/PressRoom/Events/ opaevent_cftcstaff030112 (relating to Mar. 1, 2012). 21 Additional information, including documents submitted by meeting participants, has been posted to the Commission’s Web site. See https:// www.cftc.gov/PressRoom/Events/opaevent_ tac072612. 22 The FIA’s release addressing FAQs on the protection of customer funds is accessible on the FIA’s Web site at https://www.futuresindustry.org/ downloads/PCF-FAQs.PDF. PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 68511 customers and their funds under the Act and Commission regulations. FIA also issued a series of initial recommendations for the protection of customer funds.23 The recommendations were prepared by the Financial Management Committee, whose members include representatives of FIA member firms, DCOs and depository institutions. The initial recommendations address enhanced disclosure on the protection of customer funds, reporting on segregated funds balances by FCMs, FCM internal controls surrounding the holding and disbursement of customer funds, and revisions to part 30 regulations to make the protections comparable to those provided for customers trading on designated contract markets. On July 13, 2012, the Commission approved new FCM financial requirements proposed by the National Futures Association (‘‘NFA’’).24 The NFA Financial Requirements Section 16 and its related Interpretive Notice entitled ‘‘NFA Financial Requirements Section 16: FCM Financial Practices and Excess Segregated Funds/Secured Amount Disbursements’’ (collectively referred to as ‘‘the Segregated Funds Provisions’’) were developed in consultation with Commission staff. NFA’s Segregated Funds Provisions require each FCM to: (1) Maintain written policies and procedures governing the deposit of the FCM’s proprietary funds (i.e., excess or residual funds) in customer segregated accounts and part 30 secured accounts; (2) maintain a targeted amount of excess funds in segregate accounts and part 30 secured accounts; (3) file on a daily basis the FCM’s segregation and part 30 secured amount computations with NFA; (4) obtain the approval of senior management prior to a withdrawal that is not for the benefit of customers whenever the withdrawal equals 25 percent or more of the excess segregated or part 30 secured amount funds; (5) file a notice with NFA of any withdrawal that is not for the benefit of customers whenever the withdrawal equals 25 percent or more of the excess segregated or part 30 secured amount funds; (6) file detailed information regarding the depositories holding customer funds and the investments made with customer funds as of the 15th day (or 23 The FIA’s initial recommendations are accessible on the FIA’s Web site at https:// www.futuresindustry.org/downloads/Initial_ Recommendations_for_Customer_Funds_ Protection.pdf. 24 For more information relating to the new FCM financial requirements, see https:// www.nfa.futures.org/news/ newsNotice.asp?ArticleID=4072. E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68512 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations the next business day if the 15th is not a business day) and the last business day of each month; and (7) file additional monthly net capital and leverage information with NFA. Significantly, NFA’s Segregated Funds Provisions also require FCMs to compute their part 30 secured amount requirement and compute their targeted excess part 30 secured funds using the same Net Liquidating Equity Method that is required by the Act and Commission regulations for computing the segregation requirements for customers trading on U.S. contract markets under section 4d of the Act. FCMs are not permitted under the NFA rules to use the Alternative Method to compute the part 30 secured amount requirement. The failure of an FCM to maintain its targeted amount of excess part 30 funds computed using the Net Liquidating Equity Method may result in NFA initiating a Membership Responsibility Action against the firm. In addition, in setting the target amount of excess funds, the FCM’s management must perform a due diligence inquiry and consider various factors relating, as applicable, to the nature of the FCM’s business, including the type and general creditworthiness of the FCM’s customers, the trading activity of the customers, the types and volatility of the markets and products traded by the FCM’s customers, and the FCM’s own liquidity and capital needs. The FCM’s Board of Directors (or similar governing body), CEO or Chief Financial Officer (‘‘CFO’’) must approve in writing the FCM’s targeted residual amount, any changes thereto, and any material changes in the FCM’s written policies and procedures. The NFA and CME Group Inc. (‘‘CME’’) also adopted rules requiring FCMs to instruct each depository holding futures customer funds to report such balances on a daily basis to the NFA or CME, respectively.25 Initially, the NFA and CME retained the services of a third-party vendor which received account balance information directly from certain banks, custodians of securities, and money market funds, and passed such information on to the NFA and CME. The CME, however, took over the role of the third-party vendor effective October 29, 2013 and receives account information directly from all depositories holding futures customer funds. The CME also provides NFA with daily account balance information for the FCMs that NFA is the DSRO. The 25 See NFA Financial Requirements Rules, Section 4. Financial Requirements and Treatment of Customer Property, and CME Rule 971, Segregation, Secured, and Cleared Swaps Customer Account Requirements. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 same process applies to the FCM’s customer secured account(s) held for customers trading on foreign futures exchanges, and for the FCM’s Cleared Swaps Customers engaging in Cleared Swaps. In addition, NFA and CME expanded their oversight of FCMs under the amended rules, by developing programs that compare the daily balances reported by the depositories with the balances reported by the FCMs in their daily segregation reports. An immediate alert is generated for any material discrepancies. E. The Proposed Amendments The incidents outlined above, coupled with the information generated through the recent efforts undertaken by the Commission and industry participants, demonstrate the need for new rules and amendments to existing rules. In particular, an examination of FCM business operations—including the non-futures business of FCMs—and the currently regulatory framework, evince a need for enhanced customer protections, risk management programs, disclosure requirements, and auditing and examination programs. To address these needs, the Commission issued a Notice of Proposed Rulemaking (‘‘NPRM’’) on November 14, 2012 (‘‘the Proposal’’) containing a series of amendments to enhance customer protections.26 The Proposal addressed six main issues. First, recognizing problems surrounding the treatment of customer segregated funds and foreign futures or foreign options secured amounts, the Commission proposed to amend several components of parts 1, 22, and 30 of the Commission’s regulations to provide greater certainty to market participants that the customer funds entrusted to FCMs will be protected. Second, to address shortcomings in the risk management of FCMs, the Commission proposed a new § 1.11 that establishes robust risk management programs. Third, the Commission determined that the current regulatory framework should be re-oriented to implement a more riskbased, forward-looking perspective, affording the Commission and SROs with read-only access to accounts holding customer funds and additional information on depositories and the customer assets held in such depositories. Fourth, given the difficulties that can arise in an FCM’s business, and the direct and significant impact on the FCM’s regulatory capital that can result from such difficulties, the Commission proposed to amend 26 77 PO 00000 FR 67866 (Nov. 14, 2012). Frm 00008 Fmt 4701 Sfmt 4700 § 1.17(a)(4) to ensure that an FCM’s capital and liquidity are sufficient to safeguard the continuation of operations at the FCM. Fifth, to effect the change in orientation needed in FCM examinations programs, as well as to assure quality control over program contents, administration and oversight, the Commission proposed to amend § 1.52, which, among other things, addresses the formation of Joint Audit Committees and the implementation of Joint Audit Programs. And sixth, recognizing the need to increase the information provided to customers concerning the risks of futures trading and the FCMs with which they may choose to conduct business, the Commission proposed amendments to § 1.55 that enhance the disclosures provided by FCMs. II. Comments on the Notice of Proposed Rulemaking The Proposal, aimed at: (1) Amending and enhancing its current customer protection regime; (2) imposing risk management requirements on FCMs; (3) requiring additional ‘‘early warning’’ notices from FCMs regarding material changes in their operations or financial condition; (4) imposing additional liquidity requirements for FCMs; (5) revising the examination process of FCMs by both the SROs and public accountants; and (6) requiring additional disclosures to customers concerning the risks of futures trading and the FCMs that hold customer funds. The Commission extended the initial 60-day comment period for approximately 30 additional days at the request of various commenters and in order to provide interested parties with an additional opportunity to comment on the proposal.27 The comment period closed on February 15, 2013. During the comment period the Commission held two public roundtables to solicit input on issues related to the proposal from a crosssection of the futures industry, including market participants, FCMs, DCOs, SROs, securities regulators, foreign clearing organizations, and academics. The Commission received more than 120 written submissions on the proposing release from a range of commenters.28 Commission staff also met with representatives from at least eight of the commenters and other 27 78 FR 4093 (Jan. 18, 2013). written submissions from the public are available in the comment file on www.cftc.gov. They include, but are not limited to, those listed in the table in Appendix 1 to this release. In citing to the comments received during the discussion of the comments in this Section, the Commission used the abbreviations set forth in the table in Appendix 1. 28 The E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 members of the public. Commenters represented a broad spectrum of industry participants, trade organizations, law firms, accounting firms and self-regulatory organizations. The majority of commenters supported the overall principles proposed by the Commission although many raised concerns or offered suggestions regarding certain proposal specifics. The Commission also held a meeting of the Agricultural Advisory Committee on July 25, 2013, and included in the agenda a discussion of the Proposal. The transcript of the Agricultural Advisory Committee meeting is included in the comment file to the Proposal, and the Commission has considered those comments in finalizing the regulations. The Commission has carefully considered the comments received and is adopting the Proposal herein subject to various amendments that address certain concerns raised or suggestions made by commenters. Each section of the final rules, including any relevant revisions to the corresponding section of the Proposal, is discussed in greater detail in the following sections. A. § 1.10: Financial Reports of Futures Commission Merchants and Introducing Brokers Regulation 1.10 requires each FCM to file with the Commission and with the firm’s DSRO an unaudited financial report each month. The financial report must be prepared using Form 1–FR– FCM. An FCM that is dually-registered as a BD, however, may file a Financial and Operational Combined Uniform Single Report under the Securities Exchange Act of 1934 (‘‘FOCUS Report’’) in lieu of the Form 1–FR–FCM. Each FCM also is required to file with the Commission and with its DSRO an annual financial report certified by an independent public accountant. The unaudited monthly and certified annual financial reports are required to contain basic financial statements, including a statement of financial condition, a statement of income (loss), and a statement of changes in ownership equity. The financial reports also are required to include additional schedules designed to address specific regulatory objectives to demonstrate that the FCM is in compliance with minimum capital and customer funds segregation requirements. These additional schedules include a statement of changes in liabilities subordinated to claims of general creditors, a statement of the computation of the minimum capital requirements (‘‘Capital Computation Schedule’’), a statement of segregation requirements and funds in segregation VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 for customers trading on U.S. commodity exchanges (‘‘Segregation Schedule’’), and a statement of secured amounts and funds held in separate accounts for foreign futures and foreign options customers (‘‘Secured Amount Schedule’’). In addition, the certified annual report must contain a reconciliation of material differences between the Capital Computation Schedule, the Segregation Schedule, and the Secured Amount Schedule contained in the certified annual report and the unaudited monthly report for the FCM’s year-end month. 1. Amendments to the Segregation and Secured Amount Schedules With Respect to the Reporting of Residual Interest The Segregation Schedule and the Secured Amount Schedule generally indicate, respectively, (1) The total amount of funds held by the FCM in segregated or secured accounts; (2) the total amount of funds that the FCM must hold in segregated or secured accounts to meet its regulatory obligations to futures customers and foreign futures or foreign options customers; and (3) whether the firm holds excess segregated or secured funds in the segregated or secured accounts as of the reporting date. FCMs also deposit proprietary funds into customer segregated and secured accounts to protect against becoming undersegregated or undersecured by failing to hold a sufficient amount of funds in such accounts to meet the regulatory requirements. This cushion of proprietary funds is referred to as the FCM’s ‘‘residual interest’’ in the customer segregated and secured accounts. The Commission proposed to amend § 1.10 to require each FCM to also disclose in the Segregation Schedule and in the Secured Amount Schedule its targeted amount of ‘‘residual interest’’ that the FCM seeks to maintain in customer segregated accounts and secured accounts as computed under § 1.11.29 As more fully discussed in section II.B. below, new § 1.11(e)(3)(i)(D) requires the senior management of each FCM that carries customer funds to perform appropriate due diligence in setting the amount of 29 The Commission also proposed to revise the title of the ‘‘Secured Amount Schedule’’ by adding the term ‘‘30.7 Customer’’ to specify that the secured amount will include both U.S.-domiciled and foreign-domiciled customers consistent with the proposed amendments to part 30 of the Commission Regulations discussed in Section II.R. below. No comments were received regarding the revisions to the title of the ‘‘Secured Amount Schedule,’’ and the Commission is adopting the revisions as proposed. PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 68513 the residual interest. Such due diligence must consider the nature of the FCM’s business including the type and general creditworthiness of its customer base, the types of markets and products traded by the firm’s customers, the proprietary trading activities of the FCM, the volatility and liquidity of the markets and products traded by the customers and by the FCM, the FCM’s own liquidity and capital needs, historical trends in customer segregation and secured account funds balances, and historical trends in customer debits and margin deficits (i.e., undermargined amounts).30 The FCM also is required to maintain policies and procedures establishing the targeted amount of residual interest that the FCM seeks to maintain as its residual interest in the segregated and secured accounts. The FCM’s due diligence and policies and procedures must be designed to reasonably ensure that the FCM maintains the targeted residual interest amount and remains in compliance with its segregation requirements at all times.31 The disclosure of the targeted amount of the FCM’s residual interest in segregated or secured accounts will allow the Commission and the FCM’s DSRO to determine whether the FCM actually maintains funds in segregated and secured accounts in amounts sufficient to cover the respective targeted residual interest amounts. If a firm does not maintain sufficient funds to cover the targeted residual interest amounts, the Commission and/or DSRO will take appropriate steps to assess whether the FCM is experiencing financial issues that may indicate potential threats to the overall safety of customer funds. The disclosure of the amounts of the FCM’s targeted residual interest also will enhance the Commission’s and DSROs’ surveillance of FCMs by providing information that will allow for the assessment of the size of the targeted residual interest relative to both the total funds held in segregation or secured accounts and to 30 The NPRM explained that a margin deficit occurs when the value of the customer funds for a customer’s account is less than the total amount of collateral required by DCOs for that account’s contracts. As explained further in the discussion in sections II.G.9., II.Q., and II.R., the term ‘‘undermargined amount,’’ as defined in §§ 1.22(c)(1), 22.2(f)(6)(i), and 30.7(f)(1)(ii)(A), is used in place of the term ‘‘margin deficit’’ in the final rule. 31 The NFA adopted a similar amendment to its rules, mandating that FCMs maintain written policies and procedures identifying a target amount that the FCM will seek to maintain as its residual interest in customer segregated and secured accounts. See NFA Notice I–12–14 (July 18, 2012), available at https://www.nfa.futures.org/news/ newsNotice.asp?ArticleID=4072. E:\FR\FM\14NOR2.SGM 14NOR2 68514 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 the size of the targeted residual interest maintained by other comparable FCMs. This information will assist the Commission and DSROs in the overall risk assessment of the FCMs, including the assessment of the potential risk that a firm may become undersegregated or undersecured. This additional information will further enhance the Commission’s and DSROs’ overall ability to protect customer funds. The Commission also proposed to amend the Segregation Schedule and the Secured Amount Schedule to require each FCM filing such schedules to disclose the sum of the outstanding margin deficits (i.e., undermargined amounts) as of the reporting date. The purpose of this disclosure was to demonstrate that the FCM’s residual interest in the segregated and secured account exceeded the respective customer margin deficits (i.e., undermargined amounts) as proposed in §§ 1.22 and 1.23. The Commission has considered the proposal and has determined not to amend the Segregation Schedule and Secured Amount Schedule to require the disclosure of the undermargined amounts. As further discussed in sections II.G.9. and II.R. below, the Commission is revising the proposed amendments to § 1.22 that would have required an FCM to maintain at all times a residual interest in segregated or secured accounts in excess of its undermargined amounts. The final regulations being adopted in § 1.22, § 22.2, and § 30.7 will require computations as of different points in time than that of the computations reflected on the Segregation Schedule and the Secured Amount Schedule, which are prepared as of the close of business each day. The reporting of the undermargined amount information on the Segregation and Secured Amount Schedules would not be accurate as the firm’s customers may not be undermargined, or may be less undermargined, at the time the undermargined amount calculations are required to be performed due, for example, to customers meeting margin calls.32 32 The Commission notes, however, that it will receive notice under § 1.12 from an FCM if the firm maintains residual interest in the segregated or secured amount accounts that is less than the sum of the firm’s undermargined amount at the point in time the FCM is required to maintain such undermargined amounts under § 1.22, § 22.2, and § 30.7. The notice provision will alert the Commission and the FCM’s DSRO to the fact that the undermargined amounts exceed the firm’s residual interest in the accounts, and the Commission and DSRO can monitor the firm’s actions to restore its residual interest to a level that is above the undermargined amounts, or take other actions as appropriate. See section II.C. below. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 The Commission has considered the comments and is adopting the amendments to § 1.10 as proposed, with the above revisions to the Segregation Schedule and the Secured Amount Schedule. 2. New Cleared Swaps Segregation Schedules The Commission proposed to amend § 1.10(d) and to revise the Form 1–FR– FCM to adopt a new ‘‘Statement of Cleared Swap Customer Segregation Requirements and Funds in Cleared Swap Customer Accounts Under Section 4d(f) of the Act’’ (‘‘Cleared Swaps Segregation Schedule’’).33 The Commission proposed the Cleared Swaps Segregation Schedule to further implement section 724(a) of the DoddFrank Act. Section 724(a) of the DoddFrank Act amended section 4d of the Act by adding a new paragraph (f) to require an FCM to separately account for and segregate from its own assets Cleared Swaps Customers Collateral deposited by Cleared Swaps Customers. Section 4d(f) of the Act also requires FCMs to treat and deal with all the Cleared Swaps Customer Collateral deposited by a Cleared Swaps Customer as belonging to such customer, and prohibits an FCM from, with certain exceptions, using the Cleared Swaps Customer Collateral to margin, secure or guarantee the Cleared Swaps of any person other than the Cleared Swaps Customer who deposited the Cleared Swaps Customer Collateral. FCMs currently prepare a schedule comparable to the Cleared Swaps Segregation Schedule for Cleared Swaps under applicable contract market or NFA rules, and the Commission’s proposal would codify existing practices. The Commission received one comment on the proposed Cleared Swaps Segregation Schedule. The Students at the SUNY Buffalo Law School supported the development of the Cleared Swaps Segregation 33 The Commission previously proposed a Cleared Swaps Segregation Schedule as part of its proposed regulations to adopt capital requirements for swap dealers and major swap participants. See Capital Requirements of Swap Dealers and Major Swap Participants, 76 FR 27802 (May 12, 2011). The Commission re-proposed the schedule as part of the Proposal in light of the Commission’s decision to revise the schedule by requiring FCMs to separately disclose their targeted residual interest in Cleared Swaps Customer Accounts and the sum of margin deficits (i.e., undermargined amounts) for such accounts. The Commission also has adopted new regulations requiring FCMs to hold in segregated accounts funds received from customers engaging in Cleared Swaps to margin, secure or guarantee their Cleared Swaps in accordance with section 4d(f) of the Act. See 77 FR 6336 (Feb. 7, 2012). PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 Schedule.34 The Commission has considered the comment and has determined to adopt the Cleared Swaps Segregation Schedule as proposed.35 In addition, § 1.10 currently provides that the Commission will treat the monthly Form 1–FR–FCM reports, and monthly FOCUS Reports filed in lieu of the Forms 1–FR–FCM, as exempt from mandatory public disclosure for purposes of the Freedom of Information Act and the Government in the Sunshine Act.36 Regulation 1.10(g)(2) provides, however, that the following information in Forms 1–FR–FCM, and the same or equivalent information in FOCUS Reports filed in lieu of Forms 1–FR–FCM, are publicly available: The amount of the FCM’s adjusted net capital; the amount of the FCM’s minimum net capital requirement under § 1.17; and the amount of its adjusted net capital in excess of its minimum net capital requirement. In addition, § 1.10(g)(2) further provides that the FCM’s Statement of Financial Condition in the certified annual financial report and the Segregation Schedule and Secured Amount Schedule are public documents. The Commission proposed to amend § 1.10(g)(2)(ii) to add the Cleared Swaps Segregation Schedule to the list of documents that are publicly available. The only comment that the Commission received regarding making the Cleared Swaps Segregation Schedule public was received from students at the SUNY Buffalo Law School. The students at the SUNY Buffalo Law School supported the development and implementation of the Cleared Swaps Segregation Schedule as a regulatory tool for the Commission to receive additional information and to provide greater protection to customer funds.37 The students, however, also stated that the public disclosure of the Cleared Swaps Segregation Schedule and other financial information could 34 SUNY Buffalo Comment Letter at 7 (Mar. 19, 2013). 35 The Commission will revise the Cleared Swaps Segregation Schedule consistent with the revisions to the Segregation Schedule and Secured Amount Schedule discussed in section II.A.1. to remove the requirement for the firm to disclose the amount of the margin deficits as of the close of business on the previous business day. In addition, § 1.10(h) provides that a dually-registered FCM/BD may file a FOCUS Report in lieu of the Form 1–FR–FCM provided that all information that is required to be included in the Form 1–FR–FCM is included in the FOCUS Report. Currently, dual-registrant FCM/BDs include a Segregation Schedule and a Secured Amount Schedule in the FOCUS Report filings as supplemental schedules. Dual-registrant FCM/BDs that have Cleared Swaps Customers will also have to include a Cleared Swaps Segregation Schedule to their Focus Report filings. 36 5 U.S.C. 552. 37 SUNY Buffalo Comment Letter at 8 (Mar. 19, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 cause public panic in certain situations.38 They cited MFGI and Bear Stearns as examples of how public panic can rapidly accelerate a company’s collapse by exacerbating the effects of financial injuries that might otherwise be manageable.39 The Commission notes that the monthly Segregation Schedules and Secured Amount Schedules have been available to the public for many years and provide important information that allows customers to monitor the financial condition of FCMs. As noted in the Proposal, the Commission believes that making the Cleared Swaps Segregation Schedule publicly available will benefit customers and potential customers by providing greater transparency on the status of the Cleared Swaps Customer Collateral held by FCMs. This disclosure allows customers and other members of the public to review an FCM’s compliance with its regulatory obligations to safeguard customer funds. The disclosure of the Cleared Swaps Segregation Schedule also will provide a certain amount of detail as to how the FCM holds Cleared Swaps Customer Collateral, which customers and potential customers will be able to assess as part of their risk management process. The disclosure of the status of an FCM’s compliance with its obligation to segregate customer funds, coupled with the additional firm risk disclosures that the Commission proposed in § 1.55 (and is adopting in relevant part herein as discussed in detail in section II.P. below), will provide customers with greater transparency regarding the risks of entrusting their funds and engaging in transactions with particular FCMs. The Commission believes that these benefits to customers outweigh any potential adverse market impact which, in any event, has not been shown to be an issue based on the Commission’s experience in making FCMs’ Segregation Schedules and Secured Amount Schedules publicly available. The Commission has, therefore, determined to adopt the amendments to § 1.10(g)(2) as proposed. 3. Amendments to Form 1–FR–FCM The Commission proposed to amend several statements in the Form 1–FR–FCM. The Commission proposed to amend the Statement of Financial Condition by adding a new line item 1.D. Line 1 currently separately details: (1) The amount of funds that the FCM holds in segregated accounts for customers trading on designated contract markets (Line 1.A.); (2) the amount of funds held in segregation for dealer options (Line 1.B.); and (3) the amount of funds held in secured accounts for foreign futures and foreign option customers (Line 1.C.). Proposed line item 1.D. would set forth the amount of funds held by the FCM in segregated accounts for Cleared Swaps Customers. This amendment is necessary due to the adoption of the part 22 regulations, which requires the segregation of Cleared Swaps Customer Collateral and the proposed adoption of the Cleared Swaps Segregation Schedule as part of the Form 1–FR–FCM.40 The Commission also proposed to amend the Statement of Financial Condition by adding a new line item 22.F., which would require the separate disclosure of the FCM’s liability to Cleared Swaps Customers. The proposed amendments to disclosure the total amount of funds held by the FCM for Cleared Swaps Customers, and the FCM’s total obligation to Cleared Swaps Customers, is consistent with the reporting required on the Form 1–FR–FCM for customers trading on designated contract markets. The Commission also proposed to revise line item 27.J. of the Statement of Financial Condition to require an FCM to disclose separately its obligation to retail forex customers. Currently, an FCM’s obligation to retail forex customers is included with other miscellaneous liabilities and reported under current line item 27.J. ‘‘Other.’’ The separate reporting of an FCM’s retail forex obligation will provide greater transparency on the Statement of Financial Condition regarding the firm’s obligations to its retail counterparties in off-exchange foreign currency transactions, and is appropriate given the Commission’s direct jurisdiction over such activities when conducted by an FCM under section 2(c) of the Act.41 NFA filed the only comment addressing the proposed amendments to the Statement of Financial Condition. NFA noted its full support of the proposed amendments to line item 27.J of the Statement of Financial Condition contained in Form 1–FR–FCM, and further requested that the Commission consider amending the asset section of the Statement of Financial Condition of Form 1–FR–FCM to require an FCM or Retail Foreign Exchange Dealer (‘‘RFED’’) to report the total funds on deposit to cover its obligations to retail forex customers as required by Commission Regulation 5.8.42 NFA stated that this revision would result in more accurate reporting and is consistent with the reporting for customer segregated funds.43 The Commission has considered the comment and has determined to adopt the amendments as proposed. The Commission also is revising the Statement of Financial Condition in the Form 1–FR–FCM in response to the NFA’s comment to include a new line item to require FCMs and RFEDs to separately disclose the assets held in qualifying accounts in excess of the firms’ obligations to retail forex customers as required by Commission Regulation 5.8. Regulation 5.8 requires each FCM and RFED offering or engaging in retail forex transactions to hold, at all times, assets of the type permissible in § 1.25 in an amount that exceeds the FCM’s or RFED’s total obligation to its retail forex customers at qualifying institutions set forth in the Regulation. The requirement of Regulation 5.8 is to ensure the RFED or FCM holds liquid assets in relation to the amount of liability to retail forex customers.44 However, such retail forex customer funds are not held in ‘‘segregated accounts’’ in manner comparable to section 4d of the Act, which are provided with explicit protections in the event of the bankruptcy of the FCM. The Commission is revising the Statement of Financial Condition of the Form 1–FR– FCM to require each FCM or RFED to report on line 19.B. the aggregate amount of funds held in qualifying accounts to meet its total obligation to retail forex customers as required by § 5.8. Such disclosure will provide greater transparency as to the firm’s compliance with Commission regulations. 4. FCM Certified Annual Report Deadline The Commission proposed to amend § 1.10(b)(1)(ii) to require an FCM to submit its certified annual report to the Commission and to the firm’s DSRO within 60 days of its year-end date. Currently, an FCM is required to submit the annual certified financial statements within 90 days of its year-end date, except for FCMs that also are registered with the SEC as BDs, which are require to submit the certified annual report within 60 days of the year-end date under both Commission and SEC regulations. Therefore, the proposal would impact only FCMs that are not 42 NFA 38 Id. at 8–9. 40 See 77 FR 6336 (Feb. 7, 2012). 41 7 U.S.C. 2(c). 39 Id. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 68515 Comment Letter at 9 (Feb. 15, 2013). 43 Id. 44 See E:\FR\FM\14NOR2.SGM 75 FR 3282, 3290 (Jan. 20, 2010). 14NOR2 68516 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations dually-registered as BDs and would align the filing deadlines for both FCMs and dual registrant FCMs/BDs. The Commission received one comment on the proposal. NFA supported the proposal noting that the amendment will provide both the Commission and DSROs with more timely information for monitoring the financial condition of an FCM.45 The Commission considered the comment received and is adopting the amendments to § 1.10(b)(1)(ii) as proposed. The Commission also is cognizant of the fact that public accountants are currently engaged in the audit of FCMs for the year ending December 31, 2013 and possible for other year-end dates in 2014. Accordingly, in order to ensure that the amendments do not impede examinations that are currently in process, the Commission is establishing a compliance date for FCM annual audits for years ending June 1, 2014 or later. This compliance date also will align the revised reporting deadline with the auditing amendments to the auditing standards that public accountants use in the audit of FCMs and discussed in section II.E. below. Compliance dates are discussed further in section III below. TKELleY on DSK3SPTVN1PROD with RULES2 5. Leverage Ratio Calculation The Commission proposed to add a new requirement in § 1.10(b)(5) to require each FCM to file with the Commission on a monthly basis its balance sheet leverage ratio. Proposed § 1.10(b)(5) defined the term ‘‘leverage’’ as an FCM’s total balance sheet assets, less any instruments guaranteed by the U.S. Government and held as an asset or to collateralize an asset (e.g., a reverse repurchase agreement) divided by the FCM’s total capital (i.e., the sum of the FCM’s stockholders’ equity and subordinated debt). FCMs currently file the same leverage information with NFA on a monthly basis using the same definition of the term ‘‘leverage.’’ The leverage ratio would provide information regarding the amount of assets supported by the FCM’s capital base, and would allow the Commission to enhance its oversight of FCMs that are highly leveraged relative to their peers or based upon the Commission’s understanding of the firm’s business model. The Commission received three comments with respect to this proposal. Commenters were concerned that the leverage metrics proposed might not 45 NFA Comment Letter at 9 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 provide meaningful information and/or that the Commission’s leverage definition was not consistent with those of other regulatory authorities. NFA noted that while the leverage definition proposed by the Commission is the same definition as that set forth in NFA Financial Requirement Section 16, it may not be the most appropriate measure.46 NFA noted that it has been studying an alternative calculation method and encouraged the Commission to defer codifying a single definition until it has the opportunity to examine NFA’s calculation results.47 NFA also suggested the Commission consider adopting a requirement that FCMs report a leverage ratio as defined by a registered futures association rather than including a specific definition in the Commission’s regulations.48 FIA indicated that it supported the proposed amendment, but stated that it is essential that the definition of the term ‘‘leverage’’ be consistent among regulatory authorities with supervision over FCMs and encouraged the Commission to coordinate with the SEC and the relevant SROs to ensure consistent treatment across the industry.49 RJ O’Brien objected to the proposal on the grounds that the definition of ‘‘leverage’’ in the proposal ‘‘penalizes’’ FCMs that are not dually-registered as BDs.50 RJ O’Brien stated that an FCMonly entity’s balance sheet is primarily composed of funds deposited by customers for trading commodity interests, and that the leverage ratio computed under the proposed regulation does not properly reflect the risk of the firm’s business.51 RJ O’Brien recommended that the Commission work with NFA to develop a more meaningful metric and further recommended that the Commission not permit or require public disclosure of FCM leverage ratios under the current methodology because RJ O’Brien believes it could provide the public with misleading information.52 The Commission has considered the comments and has determined to adopt a final regulation requiring FCMs to submit to the Commission monthly balance sheet leverage information. As noted above, such information will enhance the Commission’s ability to conduct financial surveillance of FCMs. The final regulation, however, will 46 NFA Comment Letter at 7–8 (Feb. 15, 2013). 47 Id. at 7. 48 Id. at 8. 49 FIA Comment Letter at 12 (Feb. 15, 2013). 50 RJ O’Brien Comment Letter at 8–9 (Feb. 15, 2013) 51 Id. 52 Id. PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 define the term ‘‘leverage’’ by referencing to the rules of a registered futures association as suggested by NFA. This revision to the final regulation will align the Commission’s definition of leverage with the current NFA definition of leverage.53 As stated above, in proposing the requirement for FCMs to report their monthly leverage ratios, the Commission intended for FCMs to file the same leverage information that they currently file with the NFA. In this regard, the Commission proposed a definition of leverage that is identical to the current NFA definition contained in its Financial Requirement Section 16. Such an approach will enhance the consistency in how the Commission and the SROs impose leverage reporting requirements on FCMs and in how leverage is monitored by the regulators. Furthermore, in response to RJ O’Brien’s comment, the Commission intends to work with NFA and other regulators going forward on any revisions to the definition of ‘‘leverage’’ to maintain as consistent a definition as practicable. 6. Procedural Filing Requirements The Commission proposed to amend § 1.10(c)(2)(i) to require FCMs to electronically file with the Commission their monthly unaudited Forms 1–FR– FCM or FOCUS Reports and their certified annual financial reports. FCMs currently file their monthly unaudited financial statements with the Commission electronically using the WinJammer Online Filing System (‘‘WinJammer’’) and the proposed amendments merely codify current practices.54 FCM annual financial reports are filed in paper form with the Commission. Under the Commission’s proposal, an FCM would use the WinJammer system to electronically file its certified financial report as a ‘‘PDF’’ document. No comments were received on the proposed amendments to § 1.10(c)(2)(i). The Commission is adopting the amendments as proposed. The Commission also is adopting a proposed technical amendment to § 1.10(c)(1) on which no comments were received. Regulation 1.10(c)(1) provides that any report or information required to be provided to the Commission by an IB or FCM will be considered filed 53 NFA is currently the only registered futures association. 54 WinJammer is a web-based application developed and maintained jointly by the Chicago Mercantile Exchange and the NFA. The WinJammer system is provided at no cost to FCMs. FCMs currently use WinJammer to transmit Forms 1–FR– FCM, FOCUS Reports, and other financial information and regulatory notices to the Commission and to the SROs. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations when received by the Commission Regional office with jurisdiction over the state in which the FCM has its principal place of business. The amendments to § 1.10(c)(1) sets forth the jurisdiction of each of the Commission’s three Regional offices under § 140.02, and is intended to ensure that FCM’s financial reports are filed expeditiously with the correct Commission Regional office. TKELleY on DSK3SPTVN1PROD with RULES2 B. § 1.11: Risk Management Program for Futures Commission Merchants The Commission proposed new § 1.11 to require each FCM that carries customer accounts to establish a ‘‘Risk Management Program,’’ as defined in § 1.11(c), designed to monitor and manage the risks associated with the FCM’s activities as an FCM. Under the Commission’s proposal, the Risk Management Program must: (1) consist of written policies and procedures that have been approved by the ‘‘governing body’’ (defined below) of the FCM and furnished to the Commission; and (2) establish a risk management unit that is independent from an FCM’s ‘‘business unit’’ (defined below) to administer the Risk Management Program. NFA, FIA, ICI, CFA, Chris Barnard, and Paul/Weiss generally supported proposed § 1.11.55 Advantage stated ‘‘that most aspects of proposed § 1.11 are appropriate and unlikely to be burdensome as FCMs typically have most (if not all) of these requirements in place.’’ 56 Several other commenters raised issues with specific components of the proposed regulation, which are discussed in the sections below. The Commission has considered the comments received and is adopting § 1.11 as proposed, with the following observations and clarifications. 1. Applicability Proposed paragraph (a) of § 1.11 provides that the regulation would only apply to FCMs that accept money, securities, or property (or extend credit in lieu thereof) to margin, guarantee, or secure any trades or contracts that result from soliciting or accepting orders for the purchase or sale of any commodity interest. FCMs that do not accept or hold customer funds to margin, guarantee or secure commodity interests are generally not operating as FCMs, and are not subject to § 1.11. To clarify, the Commission notes that it would 55 NFA Comment Letter at 10 (Feb. 15, 2013); FIA Comment Letter at 52 (Feb. 15, 2013); ICI Comment Letter at 7 (Jan. 14, 2013); CFA Comment Letter at 4 (Feb. 13, 2013); Chris Barnard Comment Letter at 2 (Dec. 18, 2012); Paul/Weiss Comment Letter at 2 (Feb. 15, 2013). 56 Advantage Comment Letter at 2 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 expect registered FCMs that do not accept customer funds to establish a Risk Management Program that complies with § 1.11 and file such program with the Commission and with the FCMs’ DSROs prior to changing their business model to begin accepting customer funds. The Commission also requested comment on whether different risk management requirements for FCMs should be based upon some measurable criteria, such as size of the firm, and whether different elements of § 1.11 should apply to smaller FCMs versus larger FCMs. Advantage stated that a one-size fits all approach is less than optimal, and that the Commission could establish minimum risk management standards for specific business lines/ customer type, and then require that FCMs engaging in those lines of business/clearing that type of customer have those programs in place.57 The Commission has considered the comment and has determined that § 1.11 provides sufficient flexibility for FCMs to establish a risk management program that is appropriate to its business operations. To develop specific requirements for different business activities would not be appropriate in that each FCM may operate in a different manner. The Commission believes that each FCM can develop its own program to meet its business activities using the general framework established by § 1.11. The Commission received no additional comments on proposed § 1.11(a) and is adopting the provision as proposed. 2. Definitions The Commission proposed definitions of the terms ‘‘customer,’’ ‘‘business unit,’’ ‘‘governing body,’’ ‘‘segregated funds,’’ and ‘‘senior management’’ in paragraph (b) of § 1.11. These definitions are designed to ensure that there is accountability at the highest levels for the FCM’s key internal controls and processes regarding the FCM’s responsibility to meet its obligations as a futures market participant, including acting as an intermediary for customer transactions, and its obligation to safeguard customer funds. The term ‘‘business unit’’ was proposed to include generally any department, division, group or personnel of an FCM or any affiliate involved in soliciting orders and handling customer money, including segregation functions, and personnel exercising direct supervisory authority 57 Advantage PO 00000 Frm 00013 Comment Letter at 2 (Feb. 15, 2013). Fmt 4701 Sfmt 4700 68517 over the performance of such activities. The definition was intended to delineate clearly the separation of the risk management unit required by the regulation from the other personnel of an FCM from whom the risk management must be independent. The term ‘‘customer’’ was proposed broadly to include futures customers (as defined in § 1.3) trading futures contracts, or options on futures contracts listed on designated contract markets, 30.7 customers (as proposed to be defined in § 30.1) trading futures contracts or options on futures contracts listed on foreign contract markets, and Cleared Swaps Customers (as defined in § 22.1) engaging in Cleared Swaps. The term ‘‘governing body’’ was proposed to be defined as the sole proprietor, if the FCM is a sole proprietorship; a general partner, if the FCM is a partnership; the board of directors, if the FCM is a corporation; and the chief executive officer, chief financial officer, the manager, the managing member, or those members vested with the management authority if the FCM is a limited liability company or limited liability partnership. The term ‘‘senior management’’ was proposed to mean any officer or officers specifically granted the authority and responsibility to fulfill the requirements of senior management under proposed § 1.11 by the governing body. The term ‘‘segregated funds’’ was proposed to mean money, securities, or other property held by an FCM in separate accounts pursuant to § 1.20 for futures customers, pursuant to § 22.2 for Cleared Swaps Customers, and pursuant to § 30.7 for 30.7 customers. The proposed definition of ‘‘segregated funds’’ makes clear that the requirements of § 1.11 apply to all customer funds that may be held by an FCM. The Act and Commission regulations currently require FCMs to hold each type of segregated funds in separate accounts and to segregate such segregated funds from the FCM’s own funds and to segregate each class of segregated funds from each other type, except if otherwise permitted by Commission rule, regulation or order.58 The Commission did not receive any comments regarding the proposed definitions in § 1.11(b) and is adopting the amendments as proposed. 3. Approval of Policies and Procedures and Submission to the Commission The Commission proposed § 1.11(c) to require each FCM to establish, maintain, and enforce a system of risk management policies and procedures 58 See E:\FR\FM\14NOR2.SGM 7 U.S.C. 6d(a)(2) and 7 U.S.C. 6d(f). 14NOR2 68518 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations The Commission proposed § 1.11(d), requiring an FCM to establish a risk management unit that is independent from the FCM’s business unit to administer the Risk Management Program. As part of the Risk Management Program, each FCM must establish and maintain a risk management unit with sufficient authority, qualified personnel, and financial, operational, and other resources to carry out the Risk Management Program. The risk management unit is required to report directly to senior management. Several commenters opposed the separation of the risk management unit from the business unit. RCG stated that requiring FCMs to separate the risk management function from the ‘‘business unit’’ is unnecessary, counterproductive, and will likely result in increased risk to the FCM and its customers.61 RCG argued that the proposed requirement removes a valuable, mature talent pool from participating in risk management, and the proposal is counterproductive in that it has the potential of blocking the flow of historical and financial information about a customer from the business side of the FCM to the risk management side of the FCM, information that is crucial to evaluating risk.62 Phillip Futures Inc. stated that the proposed separation of the business unit from the risk management unit will lead to a decrease in the timeliness of decision making as decisions will have to be filtered through new supervisory employees that the proposal will ultimately create, which will hinder each FCM’s ability to assess risk.63 Phillip Futures Inc. stated that so long as internal controls, senior leadership, and training programs of a firm are created with the proper checks and balances which ensure proper supervision of activities conducted by the business unit and the risk management unit, the respective units need not be independent from each other.64 Phillip Futures Inc. also asserted that the separation of duties required by the regulation would require it to hire multiple employees who would have limited job responsibilities.65 CHS Hedging stated that it would not be realistic or cost effective for smaller FCMs to establish an entirely separate risk management unit, and argued that if supervisory risk management personnel report to senior management separately from the business side to avoid a conflict of interest, a standalone unit should not be required.66 RJ O’Brien also argued that requiring FCMs to create a separate risk management unit is not operationally or financially practical for all FCMs, particularly small to midsized FCMs, and needlessly increases the costs of compliance for most firms without producing significant benefits.67 RJ O’Brien stated that supervisors at many small to mid-sized FCMs have the knowledge and expertise that can be essential to maintaining a strong risk 59 Because § 1.11 applies to all FCMs that accept money, securities, or property (or extend credit in lieu thereof) from customers, it necessarily applies to any risks generated by the FCMs customers’ trading activities. See, e.g., In re FCStone LLC, CFTC Docket 13–24, (May 29, 2013), where a customer’s trading activities and the FCM’s inadequate risk management practices caused the firm to lose over $127,000,000. 60 See Franklin Comment Letter at 2 (Feb. 15, 2013); AIMA Comment Letter at 1 and 4 (Feb. 15, 2013); TIAA–CREF Comment Letter at 3 (Feb. 15, 2013). 61 RCG Comment Letter at 5 (Feb. 12, 2013). See also Phillip Futures Inc. Comment Letter at 2 (Feb. 14, 2013). 62 RCG Comment Letter at 5 (Feb. 12, 2013). See also Phillip Futures Inc. Comment Letter at 2 (Feb. 14, 2013). 63 Phillip Futures Inc. Comment Letter at 2 (Feb. 14, 2013). 64 Id. 65 Id. 66 CHS Hedging Comment Letter at 3 (Feb. 15, 2013). 67 RJ O’Brien Comment Letter at 9 (Feb. 15, 2013). designed to monitor and manage the risks associated with the activities of the FCM as an FCM.59 The policies and procedures are collectively referred to as the FCM’s Risk Management Program. Under proposed § 1.11, the FCM’s governing body is required to approve in writing the FCM’s Risk Management Program and any material changes to the Risk Management Program. The FCM also is required to provide a copy of the Risk Management Program to the Commission and to the FCM’s DSRO upon application for registration or upon request by the Commission or by the FCM’s DSRO. The filing of the Risk Management Program is intended to allow the Commission and the FCM’s DSRO to monitor the status of risk management practices among FCMs. Several commenters expressed general support for the requirement that an FCM implement a risk management program.60 The Commission received no other comments on proposed § 1.11(c) and is adopting the amendments as proposed. 4. Organizational Requirements of the Risk Management Program TKELleY on DSK3SPTVN1PROD with RULES2 a. Separation of Risk Management Unit from Business Unit VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 management program at their firm, however, such supervisors also may have a role in the business unit activities.68 They proposed that the Commission revise the proposed regulation such that supervisors of business unit personnel are permitted to be part of the risk management unit provided that such supervisors are not compensated in connection with soliciting or accepting orders for the purchase or sale of any commodity interest.69 The Commission notes that, as stated above, only employees involved in soliciting orders and handling customer money (including the segregation functions), and employees directly supervising such activities would fall within the definition of ‘‘business unit’’ under § 1.11(b)(1). Therefore, the Commission does not agree with the assertion that a large pool of employees will be barred from participating in the risk management unit. Further, the Commission observes that the independence of the risk management unit required by proposed § 1.11 does not require FCMs to establish information partitions between the risk management unit and members of the business unit, and disagrees with commenters that such independence requirement would block the flow of historical and financial information about a customer from the business side of the FCM to the risk management side of the FCM. In any event, the Commission believes that the freedom from conflicts of interests that the independence of the risk management unit provides is critically important to the protection of customer funds in the custody of the FCM. The FIA commented that in adopting the rules governing risk management programs for SDs and MSPs, the Commission clarified the interpretation of certain provisions, and asked that the Commission confirm that such clarifications apply equally to the provisions of § 1.11.70 In general, the FIA requested the Commission to confirm, subject to certain exceptions or requirements, that the requirements of § 1.11: (1) Do not prescribe rigid organization structures; (2) do not require an FCM’s risk management unit to be a formal division in the FCM’s organizational structure, provided that the FCM will be able to identify all personnel responsible for required risk management activities 68 Id. 69 Id. 70 See E:\FR\FM\14NOR2.SGM 77 FR 20128 (April 3, 2012). 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations even if such personnel fulfill other functions; and (3) Allow FCMs to establish dual reporting lines for risk management personnel performing functions in addition to their risk management duties, provided that § 1.11 would not permit a member of the risk management unit to report to any officer in the business unit for any non-risk management activity.71 The FIA further commented that the ‘‘policies and procedures’’ approach provides an adequate amount of flexibility that will allow the FCMs to rely upon any existing compliance or risk management capabilities to meet the requirements of the rule.72 The Commission generally agrees with the FIA in that, while the requirements of § 1.11 represent prudent risk management practices, they do not prescribe rigid organizational structures. The Commission also believes that the ‘‘policies and procedures’’ approach provides an adequate amount of flexibility that will allow FCMs to rely upon any existing compliance or risk management capabilities to meet the requirements of the final rule. The Commission further believes that nothing in § 1.11 would prevent FCMs from relying upon existing compliance and risk management programs to a significant degree. As the Commission confirmed in its final rulemaking discussing § 23.600(b) regarding the risk management program for SDs and MSPs, the Commission also confirms that § 1.11(d) does not require a registrant’s risk management unit to be a formal division in the registrant’s organizational structure, provided that the FCM will be able to identify all personnel responsible for required risk management activities as its ‘‘risk management unit’’ even if such personnel fulfill other functions in addition to their risk management activities; and permits FCMs to establish dual reporting lines for risk management personnel performing functions in addition to their risk management duties, but this rule would not permit a member of the risk management unit to report to any officer in the business unit for any non-risk management activity.73 Such dual reporting invites conflicts of interest and would violate § 1.11’s risk management unit independence requirement. The Commission notes that the formal independence of the risk management unit from the business unit does not Comment Letter at 54–55 (Feb. 15, 2013). at 52. 73 77 FR 20128 (April 3, 2012). relieve an FCM from the duty to resolve other conflicts of interest that may have an adverse effect on the effectiveness of the FCM’s risk management program. An FCM’s CCO is required under § 3.3(d)(2) to resolve any conflicts of interest that may arise, in consultation with the FCM’s board of directors or its senior officer. Thus, the Commission would expect an FCM to recognize and eliminate or appropriately mitigate any conflict of interest between the FCM’s business interests and its duty to establish and maintain an effective risk management program. Having considered the comments regarding § 1.11(d), the Commission is adopting the provision as proposed. 5. Components of the Risk Management Program The Commission’s proposed § 1.11(e) provides for a non-exclusive list of the elements that must be a part of the Risk Management Program of an FCM. Those elements include: (1) Identifying risks (including risks posed by affiliates, all lines of business of the FCM, and all other trading activity of the FCM) and setting of risk tolerance limits; (2) providing periodic risk exposure reports to senior management and the governing body; (3) operational risk controls; (4) capital controls; and (5) establishing a risk management program that takes into account risks associated with the safekeeping and segregation of customer funds. Proposed § 1.11(e)(1)(ii) requires the Risk Management Program to take into account risks posed by affiliates, all lines of business of the FCM, and all other trading activity engaged in by the FCM. The FIA asked the Commission to confirm its position that, to the extent that many FCMs are part of a larger holding company structure that may include affiliates that are engaged in a wide array of business activities, the Commission understands that, in some instances, the top level company in the holding company structure, which has the benefit of an organization-wide view, is in the best position to evaluate the risks that an affiliate of an FCM may pose to the FCM.74 Therefore, to the extent an FCM is part of a holding company within an integrated risk management program, the FCM may address affiliate risks and comply with § 1.11 through its participation in a consolidated entity risk management program provided that such program does in fact assess the risks posed to the FCM by its affiliated entities.75 71 FIA 72 Id. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 74 FIA Comment Letter at 55 (Feb. 15, 2013). The Commission recognizes that some FCMs will be part of a larger holding company structure that may include affiliates that are engaged in a wide array of business activities. The Commission understands with respect to these entities, that in some instances, the top level company in the holding company structure is in the best position to evaluate the risks that an affiliate of an FCM may pose to the enterprise, as it has the benefit of an organization-wide view and because an affiliate’s business may be wholly unrelated to an FCM’s activities. Therefore, to the extent an FCM is part of a holding company with an integrated risk management program, the Commission would allow an FCM to address affiliate risks and comply with § 1.11(e)(1)(ii) through its participation in a consolidated entity risk management program. In regard to customer funds, the Commission notes that FCMs are required by the Act and Commission regulations to segregate and safeguard funds deposited by customers for trading commodity interests. Recent events have emphasized that it is essential that FCMs maintain adequate systems of internal controls, involving the participation and review of the firm’s senior management, in order to properly safeguard customer funds. Accordingly, § 1.11(e)(3)(i) requires that the risk management policies and procedures of an FCM related to the risks associated with safekeeping and segregation of customer funds must include: (1) The evaluation and monitoring of depositories; 76 (2) account opening procedures that ensure the FCM obtains the acknowledgment required under § 1.20 from the depository and that the account is properly titled as belonging to the customers of the FCM; 77 (3) establishing 76 The evaluation process must include documented criteria that any depository will be assessed against in order to qualify to hold funds belonging to customers. The criteria must address a depository’s capitalization, creditworthiness, operational reliability, and access to liquidity. The criteria must also address risks associated with concentration of customer funds in any depository or group of depositories, the availability of deposit insurance, and the regulation and supervision of depositories. The evaluation criteria is intended to ensure that the FCM adopts an evaluation process which reviews potential depositories against substantive criteria relevant to the safe custody of customer funds and that the FCM’s process for evaluating and selecting depositories can be reviewed by regulators and auditors. The FCM also must maintain a documented process addressing the ongoing monitoring of selected depositories, including a thorough due diligence review of each depository at least annually. 77 As required by § 1.20, such account opening documentation is necessary to ensure that the 75 Id. PO 00000 Frm 00015 68519 Continued Fmt 4701 Sfmt 4700 E:\FR\FM\14NOR2.SGM 14NOR2 68520 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 and maintaining an adequate targeted amount of excess funds in customer accounts reasonably designed to ensure the FCM is at all times in compliance with the segregation requirements for customer funds under the Act and Commission regulations, as discussed further below; (4) controls ensuring that the withdrawal of cash, securities, or other property from accounts holding customer funds not for the benefit of customers are in compliance with the Act and Commission regulations; 78 (5) procedures for assessing the appropriateness of investing customer funds in accordance with § 1.25; 79 (6) the valuation, marketability, and liquidity of customer funds and permitted investments made with customer funds; (7) the appropriate separation of duties of personnel responsible for compliance with the Act and Commission regulations relating to the protection and financial reporting of customer funds; 80 (8) procedures for the timely recording of transactions in the firm’s books and records; and (9) annual training of personnel responsible for compliance with the Act and Commission regulations relating to the protection and financial reporting of customer funds. Regarding the requirement that FCMs establish and maintain an adequate targeted amount of excess funds in customer accounts, the Commission notes that FCMs currently deposit proprietary funds into both customer segregated accounts and part 30 secured accounts as a buffer to minimize the possibility of the firm being in violation of its segregated and secured fund obligations at any time. Under the final rule, the senior management of the FCM must perform appropriate due diligence in setting the amount of this buffer and must consider the nature of the FCM’s business including the type and general creditworthiness of its customer base, the types of markets and products depositories are aware of their obligations regarding the accounts and the statutory and regulatory protections afforded the funds held in the accounts due to their status as segregated funds. 78 The controls must include the conditions for pre-approval and the notice to the Commission for such withdrawals required by § 1.23, § 22.17, or § 30.7, discussed below. 79 The FCM’s assessment must take into consideration the market, credit, counterparty, operational, and liquidity risks associated with the investments. 80 The policies and procedures must provide for the separation of duties among personnel that are responsible for customer trading activities, and approving and overseeing cash receipts and disbursements (including investment and treasury operations). The policies and procedures must further require that any movement of funds to affiliated companies or parties be approved and documented. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 traded by the firm’s customers, the proprietary trading activities of the FCM, the volatility and liquidity of the markets and products traded by the customers and the FCM, the FCM’s own liquidity and capital needs, and historical trends in customer segregation and secured account funds balances, customer debits, and margin deficits (i.e., undermargined amounts). The FCM also must reassess the adequacy of the targeted residual interest quarterly. The Commission believes that each FCM must set the amount of excess segregated and secured funds required utilizing a quantitative and qualitative analysis that reasonably ensures compliance at all times with segregated and secured fund obligations. Such analysis must take into account the various factors that could affect segregated and secured balances, and must be sufficiently described in writing to allow the DSRO of the FCM and the Commission to duplicate the calculations and test the assumptions. The analysis must provide a reasonable level of assurance that the excess is at an appropriate level for the FCM.81 A failure to adopt or maintain appropriate risk management policies and procedures or to implement, monitor and enforce controls required by § 1.11 may result in a referral to the Commission’s Division of Enforcement for appropriate action. Proposed § 1.11(e)(3)(i)(G) requires the appropriate separation of duties among individuals responsible for compliance with the Act and Commission regulations relating to the protection and financial reporting of segregated funds, including the separation of duties among personnel that are responsible for advising customers on trading activities, approving or overseeing cash receipts and disbursements (including investment operations), and recording and reporting financial transactions. Phillip Futures Inc. stated that such a separation of duties would require it to hire multiple employees that would have limited job responsibilities, and suggested that as long as internal controls are adequate and supervisory personnel are properly registered with 81 Separate from requiring the establishment of a target for residual interest, the Commission is further requiring, as discussed in more detail under sections II.G.9., II.H., and II.I. for §§ 1.20, 1.22, and 1.23, respectively, that residual interest exceed the sum of outstanding undermargined amounts to provide a mechanism for ensuring compliance with the prohibition of the funds of one customer being used to margin or guarantee the positions of another customer under the Act and existing regulations. PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 the Commission and NFA, the separation of duties is not necessary.82 Regulation 1.11(e)(3)(i)(I) requires that the written policies and procedures include procedures for the reporting of suspected breaches of the policies and procedures to the CCO, without fear of retaliation, and the consequences of failing to comply with the segregation requirements of the Act and regulations. Chris Barnard recommended that the procedures for reporting breaches should allow and stress the complete anonymity of the reporting party (whistleblower).83 The Commission takes note of Mr. Barnard’s comments related to whistleblowers as sound practices. The Commission notes, however, that such additional requirements were not proposed and, in any event, are outside the scope of this rulemaking.84 Also, to ensure the effectiveness of a Risk Management Program, § 1.11(e)(4) requires that the Risk Management Program include a supervisory system that is reasonably designed to ensure that the risk management policies and procedures are diligently followed. The Commission has considered the comments received on the proposal and, for the reasons stated above, is adopting § 1.11(e) as proposed. 6. Annual Review, Distribution of Policies and Procedures and Recordkeeping The Commission’s proposal also includes: (1) § 1.11(f) which requires an annual review and testing of the adequacy of each FCM’s Risk Management Program by internal audit staff or a qualified external, third party service; (2) § 1.11(g) which requires the timely distribution of written risk management policies and procedures to relevant supervisory personnel; and (3) § 1.11(h) which discusses recordkeeping and availability of records. The Commission received no comments on paragraphs (f), (g), and (h) of § 1.11 and is adopting the paragraphs as proposed. 7. CCO or CEO Certification Regulation 3.3 requires the CCO or CEO of an FCM to provide an annual report to the Commission that must review each applicable requirement under the Act and Commission regulations, and with respect to each 82 Phillip Futures Inc. Comment Letter at 2 (Feb. 14, 2013). 83 Chris Barnard Comment Letter at 2 (Dec. 18, 2012). 84 The Commission further notes that it maintains a whistleblower program that provides for the anonymous reporting of violations of the Act and Commission regulations. See part 165 of the Commission’s regulations. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 applicable requirement, identify the policies and procedures that are reasonably designed to ensure compliance with the requirement, and provide an assessment of the effectiveness of the policies and procedures.85 The annual report also must include a certification by the CCO or CEO that, to the best of his or her knowledge and reasonable belief, and under penalty of law, the information contained in the annual report is accurate and complete. The Commission requested comment on whether the standard for the CCO’s or CEO’s certification in the annual report (i.e., based on the CCO’s or CEO’s knowledge and reasonable belief) required under § 3.3 is adequate for a certification of the FCM’s compliance with policies and procedures for the safeguarding of customer funds. Specifically, the Commission requested comment on whether § 1.11 should contain a separate CCO or CEO certification requirement that would impose a higher duty of strict liability or some other higher obligation on a CCO or CEO. The Commission received three comments in this regard. NFA and FIA believed that the ‘‘knowledge and reasonable belief’’ standard in § 3.3 remains appropriate for a CCO’s/CEO’s certification regarding an FCM’s customer funds safeguards.86 That is, the CCO or CEO should not be liable for matters that are beyond the CCO’s/ CEO’s knowledge and reasonable belief. Further, NFA stated that the Commission should reconsider whether the CCO’s/CEO’s annual report should contain a separate certification (with the ‘‘knowledge and reasonable belief language’’) executed by the FCM’s CEO or CFO regarding the adequacy of the FCM’s customer funds safeguards.87 Newedge opposed the imposition of a strict liability standard on a CCO/CEO for the annual certifications because the CCO/CEO is relying on internal representations from other FCM employees that are far more expert regarding these matters.88 Newedge stated that such a standard would make 85 Such report is mandated by § 3.3 of the Commission’s regulations; See Swap Dealer and Major Swap Participant Recordkeeping, Reporting, and Duties Rules; Futures Commission Merchant and Introducing Broker Conflicts of Interest Rules; and Chief Compliance Officer Rules for Swap Dealers, Major Swap Participants, and Futures Commission Merchants, 77 FR 20128, Apr. 3, 2012 (promulgating final rules concerning the CCOs of FCMs, swap dealers, and major swap participants); see also § 4d(d) of the Act, 7 U.S.C. 6d(d). 86 FIA Comment Letter at 11 (Feb. 15, 2013); NFA Comment Letter at 10 (Feb. 15, 2013). 87 NFA Comment Letter at 10 (Feb. 15, 2013). 88 Newedge Comment Letter at 3 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 it difficult to recruit qualified persons to serve as a CCO/CEO.89 In response to these comments, the Commission is not requiring a separate CCO/CEO certification requirement imposing a higher duty of strict liability or other standard for the segregation of customer funds. The Commission also is not imposing a separate certification by the FCM’s CEO or CFO at this time. Commission staff will monitor the role of the CCO/CEO as the regulation is implemented and propose to the Commission any amendments to the CCO’s/CEO’s standard for certifying compliance as deemed appropriate based upon staff’s experiences. C. § 1.12: Maintenance of Minimum Financial Requirements by Futures Commission Merchants and Introducing Brokers The regulatory notices required under § 1.12 are intended to provide the Commission and SROs with prompt notice of potential adverse conditions at FCMs that may indicate a possible threat to the financial condition of the firm or to the safety of customer funds held by the FCM. Regulation 1.12 currently obligates FCMs to provide notice to the Commission and to the respective DSROs if certain specified reportable events occur. Reportable events include: Failing to maintain the minimum level of required regulatory capital (§ 1.12 (a)); failing to maintain current books and records (§ 1.12(c)); and failing to comply with the requirements to properly segregate customer funds (§ 1.12(h)). As discussed further below, the Commission proposed to amend § 1.12 to include several additional reportable events and to revise the process for submitting reportable events to the Commission and DSROs. 1. Timing of Notices The proposed new reportable events, discussed individually below, will require immediate notice to the Commission and the firm’s DSRO upon the occurrence of the relevant event. FIA commented that while it is not opposed to a requirement for FCMs to provide prompt notice of a reportable event, it questioned the need for ‘‘immediate’’ notice as proposed by the Commission.90 FIA recommended that if the Commission determined to adopt the proposed early warning notices that it allow 24 hours if the event is financial in nature and 48 hours for businessrelated events in order to afford FCMs time to determine the cause of the event and take an appropriate corrective action.91 The purpose of the ‘‘early warning’’ notice system established under § 1.12 is to provide the Commission and an FCM’s DSRO with adequate and prompt notice of a reportable event in order to allow Commission staff to assess the situation and to consult with the registrant and the SROs to determine if further action is necessary in order to protect customer funds or to determine if the FCM can continue to meet its obligations to the marketplace and clearing process. The filing of a notice is often the first step where the Commission staff is alerted to a potential issue at a firm. The Commission also initiates a dialogue with the firm and the firm’s DSRO, as necessary, upon receipt of a § 1.12 notice. Given the critical role that notices play in the Commission’s and DSRO’s surveillance of FCMs, the Commission believes that immediate notice is necessary when a reportable event is financial in nature (e.g., the FCM is not in compliance with the Commission’s capital or segregation requirements). In such situations, the firm should file immediate notice with the Commission. If a firm needs additional time to assess the cause of the reportable event, or if additional time is needed to document what steps the FCM will take to remedy the situation causing the reportable event, it may file an amendment to its initial notice with the Commission. In addition, in a situation where the registrant is reporting that it is undercapitalized or undersegregated, the Commission and DSRO will have initiated an ongoing dialogue whereby the Commission and the DSRO will be in frequent communication with the registrant and will receive updated information as the registrant becomes aware of the facts. Reportable events that are not related to an FCM’s ability to meet its financial obligations or not directly related to the protection of customer funds may not be subject to the same sense of immediacy and the Commission is revising its proposed regulations accordingly. The revisions to the proposed amendments are discussed in the appropriate sections below with the comments received on the proposed new notice provisions. 2. Undercapitalized FCMs and IBs Regulation 1.12(a) requires an FCM or IB that fails to maintain the minimum level of adjusted net capital required by § 1.17 to provide immediate notice to 89 Id. 90 FIA PO 00000 Comment Letter at 37–38 (Feb. 15, 2013). Frm 00017 Fmt 4701 Sfmt 4700 68521 91 Id. E:\FR\FM\14NOR2.SGM 14NOR2 68522 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations the Commission and to the entity’s DSRO. The notice must include additional information to adequately reflect the FCM’s or IB’s current capital condition as of any date that the entity is undercapitalized. The Commission proposed to amend § 1.12(a) to clarify that if the FCM or IB cannot compute or document its actual capital at the time it knows that it is undercapitalized, it must still provide the written notice required by § 1.12(a) immediately and may not delay filing the notice until it has adequate information to compute its actual level of adjusted net capital. NFA commented in support of the Commission’s proposal noting that in situations where an FCM is in potential distress, it may be even more important for the Commission and the firm’s DSRO to become immediately aware of the situation so that the Commission and DSRO staff can assist in determining the firm’s current, accurate financial condition.92 The Commission agrees that it is imperative that an FCM or IB provide immediate notice if the firm is undercapitalized and, accordingly is adopting the amendment as proposed. TKELleY on DSK3SPTVN1PROD with RULES2 3. Insufficient Segregation of Funds of Cleared Swaps Customers Regulation 1.12(h) currently requires an FCM that fails to hold sufficient funds in segregated accounts to meet its obligations to futures customers, or that fails to hold sufficient funds in separate accounts for foreign futures or foreign options customers, to provide immediate notice to the Commission and to the FCM’s DSRO. The Commission proposed to amend paragraph (h) to include an explicit requirement that an FCM provide immediate notice to the Commission and to its DSRO if the FCM fails to hold sufficient funds in segregated accounts for Cleared Swaps Customers to meet its obligation to such customers.93 The amendment will ensure immediate notification of a failure to hold sufficient funds in segregation for Cleared Swaps Customers so that the Commission and the firm’s DSRO can promptly assess the financial condition of an FCM and determine if there are threats to the safety of the Cleared Swaps Customers Collateral held by the FCM. The amendment also harmonizes 92 NFA Comment Letter at 10 (Feb. 15, 2013). November 13, 2012, the compliance date for certain Commission part 22 regulations, FCMs are required under § 22.2 to hold a sufficient amount of funds in Cleared Swaps Customer Accounts to meet the Net Liquidating Equity of each Cleared Swaps Customer. 77 FR 6336 (Feb. 7, 2012). 93 Commencing VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 the notice requirements whenever an FCM fails to hold in proper segregated or secured accounts sufficient funds to meet its total obligations to futures customers, 30.7 customers, and Cleared Swaps Customers. The Commission did not receive any comments on proposed § 1.12(h). The Commission is adopting the amendments to paragraph (h) as proposed. 4. Investment of Customer Funds in Contravention of Regulation 1.25 The Commission also proposed to amend § 1.12 by adding new paragraph (i) to require an FCM to provide immediate notice whenever it discovers or is informed that it has invested funds held for customers in investments that are not permitted investments under § 1.25, or if the FCM holds permitted investments in a manner that is not in compliance with the provisions of § 1.25, such as the investment concentration limitations contained in § 1.25(b)(3). The proposal applies to funds held for futures customers, 30.7 customers, and Cleared Swaps Customers. The Commission received no comments on the proposed amendments to § 1.12(i). The Commission is adopting paragraph (i) as proposed. 5. Notice of Residual Interest Falling Below Targeted Level or Undermargined Amounts The Commission proposed to amend § 1.12 to provide a new paragraph (j) to require an FCM to provide immediate notice to the Commission and to the firm’s DSRO if the FCM does not hold an amount of funds in segregated accounts for futures customers or for Cleared Swaps Customers, or if the FCM does not hold sufficient funds in secured accounts for 30.7 customers, sufficient to meet the firm’s targeted residual interest in one or more of these accounts as computed under proposed § 1.11, which is being adopted herein, or if its residual interest in one or more of these accounts is less than the sum of outstanding margin deficits (i.e., undermargined amounts) for such accounts. Regulation 1.11, as adopted herein, also requires each FCM that carries customer funds to calculate an appropriate amount of excess funds (i.e., proprietary funds) to hold in segregated or secured accounts to mitigate the possibility of the FCM being undersegregated or undersecured due to a withdrawal of proprietary funds from a segregated or secured account. FIA questioned the necessity of the proposed provision noting that under the proposed amendments to § 1.32 each PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 FCM holding customer funds is required to file a report with the Commission on a daily basis that will disclose if the FCM’s residual interest has fallen below the FCM’s targeted amount or if the residual amount is less than the sum of the customers’ margin deficits.94 FIA also noted that under current regulations an FCM’s residual interest will frequently fall below its targeted amount and that if the Commission adopts its proposed amendments to §§ 1.20, 22.2 and 30.7 to require an FCM to use proprietary funds to cover margin deficits, withdrawals in excess of 25 percent of the firm’s residual interest will likely be a daily event requiring daily notices to be filed with the Commission and with the FCM’s DSRO.95 One of the primary objectives of the proposed amendments to § 1.12 is to ensure that the Commission and DSROs receive notice of potential financial or operational issues at an FCM, or of rule violations by an FCM, in as timely a manner as possible such that the Commission and the FCM’s DSRO will be in a position to assess the issues and the potential impact on the FCM’s ability to meet its regulatory obligations and its ability to safeguard customer funds. While the proposed amendments to § 1.32 do require each FCM holding customer funds to file on a daily basis a Segregation Schedule, Secured Amount Schedule, and Cleared Swaps Segregation Schedule (as appropriate) that includes information concerning the amount of the firm’s actual and targeted residual interests, the notice required by § 1.12(j) requires the firm to include a discussion of the cause of the event, and what steps the firm will take to increase the residual interest. The notice will assist the Commission and the DSROs in determining what, if any, additional steps may be necessary in order to mitigate potential market disruptions if the FCM cannot meet its regulatory obligations, and will enhance the overall safety of customer funds. In addition, the Commission believes that the filing of a notice by an FCM will focus greater attention by management at the firm on the fact that the firm’s 94 FIA Comment Letter at 38 (Feb. 15, 2013). The Commission is proposing to require each FCM to file with the Commission and with the firm’s DSRO a daily: (1) Segregation Schedule (§ 1.32); (2) Secured Amount Schedule (§ 30.7); and, (3) Cleared Swaps Segregation Schedule (§ 22.2)). The Commission proposed to include information disclosing the FCM’s targeted residual interest and whether the amount of the actual residual interest exceeds the targeted residual interest and the total amount of the FCM’s margin deficiencies in the Segregation Schedule, Secured Amount Schedule, and the Cleared Swaps Segregation Schedule. 95 Id. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 actual residual interest is below its targeted residual interest, which should result in further reflection by management on the adequacy of the target amount and/or any changes in operations that may be appropriate, including increasing the firm’s residual interest or using other sources of liquidity. The Commission also notes that an FCM’s obligation under § 1.12(j) to file a notice when the firm’s residual interest is less than the sum of the undermargined amounts in its customer accounts is determined at the point in time that the firm is required to maintain as residual interest the undermargined amounts under § 1.22, § 22.2, and § 30.7. In addition, the Commission further notes that the obligation to file a notice under § 1.12(j) when the firm’s residual interest is less than the sum of the undermargined amounts in its customer accounts commences as of the respective compliance dates for § 1.22, § 22.2, and § 30.7 established by the Commission and discussed further in section III below. The Commission has considered the comments and has determined to adopt new paragraph 1.12(j) as proposed and as clarified above. 6. Events Causing Material Adverse Financial Impact or Material Change in Operations The Commission proposed new paragraphs (k) and (l) to § 1.12. Proposed paragraphs (k) and (l) will require an FCM to provide notice to the Commission and to the firm’s DSRO in the event of a material adverse impact in the financial condition of the firm or a material change in the firm’s operations. Proposed paragraph (k) will require an FCM to provide immediate notice if the FCM, its parent, or a material affiliate, experiences a material adverse impact to its creditworthiness or its ability to fund its obligations. Indications of a material adverse impact of an FCM’s creditworthiness may include a bank or other financing entity withdrawing credit facilities, a credit rating downgrade, or the FCM being placed on ‘‘credit watch’’ by a credit rating agency. Proposed paragraph (l) will require an FCM to provide immediate notice of material changes in the operations of the firm, including: A change in senior management; the establishment or termination of a material line of business; a material change in the FCM’s clearing arrangements; or a material change in the FCM’s credit arrangements. Paragraph (l) is intended to provide the Commission with notice VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 of material events, such as the departure of the FCM’s CCO, CFO, or CEO. Two comments were received on the proposal. FIA stated that the proposed amendments do not provide an FCM sufficient guidance on the circumstances that would require notice and requested that the Commission define more precisely the events that would require notice.96 RJ O’Brien similarly stated its concern that the term ‘‘creditworthiness’’ as used in proposed Regulation 1.12(k) is ambiguous and subjective and requires a clearer definition to afford FCMs the ability to reasonably ascertain their reporting duties and obligations.97 FIA also recommended that the Commission coordinate with the SEC and the banking regulators to establish a uniform standard identifying ‘‘material adverse’’ changes or impacts.98 Finally, FIA noted that it does not believe that a change in senior management at an FCM should require an early warning notice of any kind because such notice is already provided to NFA in the ordinary course.99 The Commission has considered the comments and has determined to adopt the amendments to § 1.12(k) and (l) as proposed, with the revision that the notices required by § 1.12(l) must be filed promptly, but not later than 24 hours after the event, instead of immediately. By adopting this revision, the Commission acknowledges that immediate notice is not necessary in all situations. An FCM should report § 1.12(l) notices in a punctual or prompt manner, but may do so without the expediency required by an immediate notice provision that is required, for example, when a firm is undercapitalized or undersegregated, which may indicate that immediate Commission or DSRO action is required to assess the financial condition of the FCM or the safety of customer funds. This revision provides the appropriate balance between the receipt of timely notices and the ability of the FCM to document an explanation of the events that trigger the notice. As noted above, the Commission proposed additional notice provisions under § 1.12 in order to ensure that the Commission and DSROs receive timely information regarding certain events that should be assessed by the Commission and the DSROs as part of the overall oversight and risk assessment of FCMs. Regulation 1.12(k) 96 Id. 97 RJ O’Brien Comment Letter at 10 (Feb. 15, 2013). 98 FIA Comment Letter at 38 (Feb. 15, 2013). 99 Id. PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 68523 will require an FCM to provide notice if the FCM or its parent or material affiliate experiences a material adverse impact to its creditworthiness or its ability to fund its obligations. Regulation 1.12(l) will require an FCM to provide notice if there is a material change in the firm’s operations, senior management, clearing arrangements, or a material line of business.100 The purpose of paragraphs (k) and (l) is to provide the Commission and the relevant DSRO with an opportunity to initiate a dialogue with the firm regarding any potential adverse impact that such a material change may have on the ability of the FCM to meet its obligations as a market intermediary and on the protection of the customer funds held by the FCM. The Commission is cognizant of the commenters’ desire for more precise guidance on when notices must be filed under § 1.12(k) and (l). However, FCMs represent a broad range of entities, with diverse business models. In this regard, some FCMs are small operations with a minimum level of capital, and others are highly capitalized entities with more sophisticated operations. Some FCMs focus on retail and/or agricultural clients, and others focus exclusively on institutional clients. Some FCMs are standalone entities that do not engage in proprietary or securities trading, and others are dually-registered with the SEC as BDs and engage in a significant amount of securities transactions for both their proprietary and customer accounts. With FCMs covering such a broad and diverse spectrum of business organizations and models, the Commission does not believe that it would be appropriate to define by regulation the scenarios that are material to an FCM and would automatically require the filing of a regulatory notice. Instead, the regulation has been developed to allow each FCM to assess whether any particular or unique event is material to the specific firm. In making this determination, each FCM should assess the potential impact that an event may have on the FCM. This would include whether new lines of business would result in a significant increase in the firm’s capital requirement or otherwise result in a significant additional financial or operational risk to the FCM’s existing business, or whether the change in credit terms will significantly impact 100 Regulation 1.12(k) and (l) both require an FCM to report a material change in the firm’s creditworthiness or its ability to fund its obligations. Accordingly, the Commission is removing the reference to the FCM’s credit arrangements in § 1.12(l). E:\FR\FM\14NOR2.SGM 14NOR2 68524 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 the liquidity resources available to the FCM. The Commission also considered the comment that FCMs should not be required to report to the Commission changes in senior management as such information is reported to NFA. The Commission does not agree with this comment. As previously noted, the § 1.12 notice provisions are intended to provide the Commission and DSROs with prompt notice of material events at FCMs that will allow the Commission and DSROs to monitor the impact of such material events on FCMs and to factor such events into the risk assessment of the firm as part of their respective surveillance programs. The resignation or appointment of a new chief executive officer or chief risk officer at an FCM is a material change at an FCM and is information that should be reported to enhance the Commission’s and DSRO’s understanding of the firm’s operations and the assessment of risk at the FCM. 7. Notice of Correspondence From Other Regulatory Authorities The Commission proposed to add a new paragraph (m) to § 1.12 to require an FCM that receives a notice, examination report, or any other correspondence from a DSRO, the SEC, or a securities self-regulatory organization to immediately file a copy of such notice, examination report, or correspondence with the Commission. The Commission stated in proposing § 1.12(m) that the receipt of such notices, examination reports, or correspondence is necessary for the Commission to conduct appropriate oversight of FCMs. The Commission received several comments that expressed a general concern that the language of the proposal is overbroad.101 FIA noted that FCMs receive regular, and often routine, correspondence from their DSROs and that the amount of correspondence is multiplied for FCMs that are also registered as BDs and receive similar correspondence from their securities SROs and the SEC.102 NFA agreed with the Commission that notices of material regulatory actions would provide the Commission and the DSROs with important information to carry out their oversight responsibilities, but also encouraged the Commission to reconsider the breadth of the proposal.103 NFA noted that with 101 FIA Comment Letter at 39 (Feb. 15, 2013); TD Ameritrade Comment Letter at 3 (Feb. 15, 2013); RCG Comment Letter at 7 (Feb. 12, 2013); CHS Hedging Comment Letter at 3 (Feb. 15, 2013). 102 FIA Comment Letter at 39 (Feb. 15, 2013). 103 NFA Comment Letter at 10 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 respect to futures examinations reports, it already files such reports with the Commission’s Division of Swap Dealer and Intermediary Oversight.104 NFA also requested that the Commission clarify that FCMs would not have to file notices of public regulatory actions taken by futures SROs against an FCM because NFA already provides the complaint associated with these actions to the Commission and makes the action available on NFA’s BASIC system.105 TD Ameritrade recommended that the Commission limit notification to items that pertain to financial responsibility rules.106 The Commission notes that it was not its intention to require an FCM to file with the Commission routine or nonmaterial correspondence from regulators or SROs. Regulation 1.12 in general is intended to provide the Commission with information regarding an FCM’s interaction with its other regulators regarding the regulators’ examinations and other material communications with FCMs. The Commission would use such information to enhance its understanding of the firm and its compliance with regulatory requirements to assess the operations of the firm and learn of events that may present a potential adverse impact on the firm, including its ability to properly operate in a regulated environment or otherwise safeguard customer funds. The Commission is revising final § 1.12(m) to require an FCM to file notice with the Commission: (1) if the FCM is informed by the SEC or a SRO that it is the subject of a formal investigation; (2) if the FCM is provided with an examination report issued by the SEC or a SRO, and the FCM is required to file a copy of such examination report with the Commission; and (3) if the FCM receives notice of any correspondence from the SEC or a securities SRO that raises issues with the adequacy of the FCM’s capital position, liquidity to meet its obligations or otherwise operate its business, or internal controls. The Commission believes that the revised regulation will provide the Commission with information necessary for the effective oversight of FCMs and will minimize the notices that dualregistrant FCMs/BDs will have to file with the Commission. 8. Filing Process and Content The Commission proposed to amend the process that an FCM uses to file the 104 Id. at 11. 105 Id. 106 TD Ameritrade Comment Letter at 3 (Feb. 15, 2013). PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 notices required by § 1.12. Currently, § 1.12 requires an FCM to provide the Commission and DSROs with telephonic and facsimile notice in some situations, and to provide written notice by mail in other situations. An FCM also is permitted, but not required, to file notices and written reports with the Commission and with its DSRO using an electronic filing system in accordance with instructions issued by, or approved by, the Commission. The Commission proposed to amend § 1.12(n) to require that all notices and reports filed by an FCM with the Commission or with the FCM’s DSRO must be in writing and submitted using an electronic filing system.107 Each FCM currently uses WinJammer to file regulatory notices with the Commission and with the firm’s DSRO. The proposed regulation further provides that if the FCM cannot file a notice due to the electronic system being inoperable, or for any other reason, it must contact the Commission’s Regional office with jurisdiction over the firm and make arrangements for the filing of the regulatory notices with the Commission via electronic mail at a specially designated email address established by the Commission; fcmnotices@cftc.gov. The Commission also proposed to amend § 1.12(n) to require that each notice filed by an FCM, IB, or SRO under § 1.12 include a discussion of what caused the reportable event, and what steps have been, or are being taken, to address the reportable event. Additional amendments to § 1.12(b), (d), (e), (f) and (g) were proposed that were necessary and technical in nature, and primarily revise internal cross-references to the filing requirements in § 1.12(n). The Commission received one comment on the proposed amendments to Regulation 1.12(n), specifically with respect to the requirement that notices under the regulation include a discussion of what caused the reportable event and what steps have been or will be taken to address the event.108 CHS Hedging stated its concern that requiring such a discussion in the notice is at odds with the requirement that notices be filed immediately.109 The Commission has determined to adopt the amendments to § 1.12(n) and the technical and related amendments 107 The Commission’s proposed amendment to require the electronic filing of reports applies to both registered FCMs and applicants for registration as FCMs. Applicants for FCM registration currently file regulatory notices with NFA using WinJammer. 108 CHS Hedging Comment Letter at 3 (Feb. 15, 2013). 109 Id. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations in § 1.12(b), (d), (e), (f) and (g) as proposed. In the Commission’s experience, in many cases an FCM has sufficient information to provide a notice of reportable event and the remedial steps that can be taken to mitigate future issues upon learning of the reportable event or very shortly thereafter. The Commission does not believe that the requirement to provide such information is at odds with the need to provide the information immediately. In the event that an FCM does not possess complete information on what caused the event, or the steps that have been taken or are being taken to address the event, it may revise its notice at a later date when it has more complete or accurate information. It is essential, however, that the Commission receives timely notice of early warning events, and compliance with the relevant notice time period should be an FCM’s first priority. Accordingly, as noted in the Proposal, even if such information is not immediately readily available, the reporting entity may not delay the reporting of a reportable event. TKELleY on DSK3SPTVN1PROD with RULES2 9. Public Disclosure of Early Warning Notices The Commission requested comment as to whether reportable events should be made public by the Commission, SROs, or FCMs and what the benefits and/or negative impact from public disclosure of such events would be. The Commission received several comments regarding the public disclosure of reportable events. Several commenters, including FHLB, the ICI, ACLI, BlackRock, and SIFMA believed that the Commission should mandate public disclosure of such information.110 Two commenters, FIA and NFA, believed that such events should not be made public.111 NFA did not believe any of the filings should be public, but emphasized that those events that are not subject to a formal public action particularly should not be subject to public disclosure.112 FIA was concerned that without context, public disclosure of the notices would be subject to misinterpretation and could create an adverse market event.113 The Commission has considered the comments and has determined that regulatory notices filed under § 1.12 should not be made publicly available. 110 FHLB Comment Letter at 10 (Feb. 15, 2013); ICI Comment Letter at 7–8 (Jan. 14, 2013); ACLI Comment Letter at 4 (Feb. 15, 2013); BlackRock Letter at 3 (Feb. 15, 2013); and SIFMA Comment Letter at 2 (Feb. 21, 2013). 111 NFA Comment Letter at 11 (Feb. 15, 2013); FIA Comment Letter at 38 (Feb. 15, 2013). 112 NFA Comment Letter at 11 (Feb. 15, 2013). 113 FIA Comment Letter at 38 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 The notices required under § 1.12 provide a mechanism whereby Commission and SRO staff are alerted to potential issues at an FCM. In order to fully assess the potential impact of a reportable event, Commission and SRO staff generally must contact the firm to obtain additional information, including up to date information on how the firm is addressing the matter that caused the reportable event to develop. If reportable events were disclosed to the public, they may not provide complete or current information. For example, an FCM may be required to file immediate notice that it was undersegregated at a point in time, but the notice may not contain information that the FCM has taken corrective action and is no longer in violation of the segregation requirements. The Commission also recognizes that many of the § 1.12 notices are required to be filed as a result of one-off processing errors or timing differences that trigger a reportable event but are immediately rectified by the FCM and do not indicate a failure of the FCM’s control system nor the firm’s ability to effectively operate as an FCM. In addition, under § 1.12 FCMs that are dually registered BDs with the SEC are required to file with the Commission copies of certain regulatory notices that they are required to file with the SEC. The SEC, however, does not make such notices public. The Commission believes it is important to ensure consistency such that information that a firm must file with the SEC and that is otherwise not publicly disclosed is not made public by the Commission as a result of the firm also being required to file a notice with the Commission under § 1.12. D. § 1.15: Risk Assessment Reporting Requirement for Futures Commission Merchants Regulation 1.15 currently requires each FCM subject to the risk assessment reporting requirements to file certain financial reports with the Commission within 120 days of the firm’s year end. The risk assessment filings include FCM organizational charts; financial, operational, and risk management policies, procedures, and systems maintained by the FCM; and, fiscal yearend consolidated and consolidating financial information for the FCM and its highest level material affiliate. The Commission proposed to amend § 1.15 to require the financial information to be filed in electronic format. The Commission received no comments on the proposed amendments to § 1.15. The Commission is adopting the amendments as proposed. The PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 68525 Commission also has revised the final regulation to provide that the risk assessment filings should be filed via transmission using a form of user authentication assigned in accordance with procedures established by or approved by the Commission, and otherwise in accordance with instructions issued by or approved by the Commission. The Commission will provide direction regarding how FCMs should file the risk assessment reports in a secure manner with the Commission prior to the effective date of the regulation. E. § 1.16: Qualifications and Reports of Accountants Regulation 1.16 addresses the minimum requirements a public accountant must meet in order to be recognized by the Commission as qualified to conduct an examination for the purpose of expressing an opinion on the financial statements of an FCM. Regulation 1.16(b) currently provides that the Commission will recognize a person as qualified if such person is duly registered and in good standing as a public accountant under the laws of the place of the accountant’s principal office or principal residence. The Commission proposed several amendments to enhance the qualifications that a public accountant must meet in order to conduct an examination of an FCM. Specifically, the Commission proposed to require that the public accountant must: (1) Be registered with the Public Company Accounting Oversight Board (‘‘PCAOB’’); (2) have undergone an examination by the PCAOB; and, (3) have remediated to the satisfaction of the PCAOB any deficiencies identified during the examination within three years of the PCAOB issuing its report. The Commission also sought to enhance the quality of the public accountant’s examination of an FCM by proposing to require that the examination be conducted in accordance with U.S. GAAS after full consideration of the auditing standards issued by the PCAOB. The Commission further sought to ensure that the FCM’s governing body took an active role in the assessment and appointment of the public accountant by imposing an obligation on the governing body to evaluate, among other things, the accountant’s experience auditing FCMs; the adequacy of the accountant’s knowledge of the Act and Commission regulations; the depth of the accountant’s staff; and, the independence of the accountant. Additionally, the Commission proposed technical amendments to E:\FR\FM\14NOR2.SGM 14NOR2 68526 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations § 1.16. The Commission proposed to amend § 1.16(f)(1)(i)(C) to require each FCM to submit its certified annual report to the Commission in an electronic format. The Commission also proposed to amend § 1.16(c)(2) to remove the requirement that the accountant manually sign the accountant’s report, which would facilitate the electronic filing of the FCM’s certified annual report with the Commission. The proposed amendments to § 1.16, including a discussion of the comments received, are discussed below. TKELleY on DSK3SPTVN1PROD with RULES2 1. Mandatory PCAOB Registration Requirement Regulation 1.16(b)(1) would continue to require a public accountant to be registered and in good standing under the laws of the place of the accountant’s principal office or principal residence in order to be qualified to conduct examinations of FCMs. The Commission proposed to enhance the qualifications of public accountants by further requiring the public accountant to be registered with the PCAOB. The PCAOB is a nonprofit corporation established by Congress under the Sarbanes-Oxley Act of 2002 (‘‘SOX’’) to oversee the audits of public companies and BDs of securities registered with the SEC in order to protect investors and the public interest by promoting informative, accurate, and independent audit reports.114 The SEC has oversight authority over the PCAOB, including the approval of the PCAOB’s rules, auditing and other standards, and budget.115 The Commission received several comments on the proposed amendments to Regulation 1.16, which are discussed below. The commenters, however, did not oppose the proposed PCAOB registration requirement. In addition, the Commission does not anticipate that the PCAOB registration requirement will present a significant issue to FCMs or public accountants. In this regard, only one public accountant that currently conducts examinations of FCMs is not registered with the PCAOB. PCAOB-registered public accountants conducted the examinations of 103 of the 104 registered FCMs based upon a review of the most current annual reports submitted by FCMs to the Commission. Accordingly, after considering the comments, the Commission is adopting the PCAOB registration requirement as proposed. 114 Public Law 107–204, 116 Stat. 745 (July 30, 2002). See also section 101 of SOX. 115 Sections 107 and 109 of SOX. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 2. PCAOB Inspection Requirement The Commission proposed to amend § 1.16(b)(1) to require that a public accountant must have undergone a PCAOB examination in order to be qualified to conduct examinations of FCMs. Section 104 of SOX requires the PCAOB to conduct an annual inspection of each registered public accountant that regularly provides audit reports for more than 100 public issuers each year.116 Section 104 further requires public accountants that provide audit reports for 100 or fewer issuers to be inspected by the PCAOB no less frequently than once every three years.117 In addition, the Dodd-Frank Act amended SOX and vested the PCAOB with new oversight authority over the audits of BDs registered with the SEC.118 The PCAOB was provided with the authority, subject to SEC approval, to determine the scope and frequency of the inspection of public accountants of BDs. The SEC also approved a PCAOB temporary rule implementing an inspection program for BDs.119 Several commenters raised issues with, or objected to, the proposal. Ernst & Young requested clarification that the term ‘‘examination’’ in proposed § 1.16(b)(1) referred to the ‘‘inspections’’ that are required under section 104 of SOX.120 The Commission confirms that the term ‘‘examination’’ in proposed § 1.16 was intended to refer to the ‘‘inspections’’ required under section 104 of the SOX, and has revised the regulation accordingly. Several commenters stated that the proposed inspection requirement would disqualify public accountants that were registered with the PCAOB, but had not yet undergone an inspection.121 These commenters stated that the proposal would disqualify accounting firms that recently registered with the PCAOB, but due to the triennial inspections schedule may not be subject to a PCAOB 116 Section 104(b)(1)(A) of SOX. 104(b)(1)(B) of SOX. 118 Section 982 of the Dodd-Frank Act. 119 See Public Company Oversight Board; Order Approving Proposed Temporary Rule for an Interim Program of Inspection Related to Audits of Brokers and Dealers, 76 FR 52996 (Aug. 24, 2011). 120 Section 104 of SOX requires the PCAOB to conduct a continuing program of inspections to assess the degree of compliance of each registered public accounting firm and associated persons of that firm with the provisions of the SOX, the rules of the PCAOB, the rules of the SEC, or professional standards, in connection with its performance of audits, issuance of audit reports, and related matters involving public issuers. 121 Center for Audit Quality Comment Letter at 2 (Jan. 14, 2013); Deloitte Comment Letter at 2 (Jan. 14, 2013); Ernst & Young Comment Letter at 2 (Jan. 14, 2013). 117 Section PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 inspection for almost three years.122 Commenters also noted that certain PCAOB registered accounting firms may audit non-issuer BDs and may be subject to inspection under the PCAOB’s temporary or permanent inspection program, but may not have been selected yet for inspection by the PCAOB.123 The AICPA stated that, while any public accounting firm can register with the PCAOB, by law only accountants that audit public issuers or audit certain non-issuer BDs may be inspected by the PCAOB.124 KPMG also stated that the requirement that accounting firms auditing an FCM must have undergone an inspection makes the rules governing the audits of FCMs more restrictive than the SEC rules governing the audits of BDs.125 KPMG suggests that the Commission align the standards required of auditors of FCMs and BDs.126 The AICPA also stated that the Commission should permit a practice monitoring program (such as the AICPA peer review program) that evaluates and opines on an accounting firm’s system of quality control relevant to the firm’s non-issuer accounting and auditing practice as an alternative to the PCAOB inspection requirement.127 The AICPA also stated that a robust process, such as the AICPA’s peer review program, whereby a team of certified public accountants conducts a comprehensive evaluation of a public accountant’s system of quality control and whose work is subject to the oversight and approval by a separate group of certified public accountants should be required rather than having one certified public accountant review another.128 The NFA also supported a temporary alternative to the PCAOB inspection requirement in order to ensure that public accountants that are unable to obtain a PCAOB inspection within the time period required by the Commission will not automatically be prohibited from conducting FCM examinations.129 NFA recommended that the Commission specifically designate the AICPA’s peer review program as the only peer review program that will be acceptable to alleviate any uncertainty as to whether a certified public 122 Id. 123 Center for Audit Quality Comment Letter at 2 (Jan. 14, 2013); Deloitte Comment Letter at 2 (Jan 14, 2013). 124 AICPA Comment Letter at 2 (Feb. 11, 2013). 125 KPMG Comment Letter at 2 (Jan. 11, 2013). 126 Id. 127 AICPA Comment Letter at 3 (Feb 11, 2013). 128 Id. 129 NFA Comment Letter at 11 (Feb. 15, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations accountant is ‘‘qualified’’ to conduct the peer review.130 As noted in the proposal, FCMs are sophisticated financial market participants that are entrusted with more than $182 billion of customers’ funds.131 FCMs intermediate futures customers activities and guarantee customers’ financial performance to DCOs, other FCMs, and foreign brokers. In addition, FCMs are anticipated to hold significant amounts of Cleared Swaps Customer Collateral deposited to margin, secure or guarantee Cleared Swaps as more provisions of the DoddFrank Act are implemented. FCMs also may conduct proprietary futures and securities transactions, and handle business for securities customers in addition to futures customers. The sophistication of the futures markets and the Commission’s regulations, coupled with the critical role played by FCMs in the futures market (and in the case of many of the largest FCMs, the securities markets) necessitates the engagement of competent and experienced accountants to conduct the examinations of FCMs. The Commission believes that registration with the PCAOB and being subject to the PCAOB inspection program will help to ensure that accounting firms engaged to conduct audits of FCMs remain competent and qualified. The PCAOB inspection program involves the review of the accounting firm’s compliance with PCAOB issued audit, quality control, independence and ethics standards. In addition, the purpose of the PCAOB registration and inspection requirement in the final rule is not to ensure that the accounting firm’s audits of FCMs are subject to inspection by the PCAOB. The Commission acknowledges that the PCAOB’s primary jurisdiction and inspections are directed toward the audits of public issuers and BDs. However, the Commission’s objective is to reasonably ensure the quality and competence of the public accountants engaged in the audits of FCMs. The Commission believes that such quality and competence may be assessed by the PCAOB inspecting the accounting firms’ audit process for issuers and BDs, and is not dependent solely upon the inspection of the accounting firms’ audits of FCMs. The Commission further believes that its proposed PCAOB inspection requirement is consistent with the SEC’s audit requirements for BDs. Any auditor 130 Id. 131 The customer funds information is based upon the 1–FR–FCM reports and FOCUS Reports filed by FCMs for the month ending April 30, 2013. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 of an SEC-registered BD must register with the PCAOB and will be subject to the PCAOB inspection program. Moreover, the Commission believes that the imposition of a PCAOB inspection requirement provides several benefits over a peer review program. The PCAOB is an entity that was created by Congress and charged with improving audit quality, reducing the risks of audit failures in the U.S. public securities markets and promoting public trust. As previously noted, the PCAOB is subject to oversight by the SEC, which approves the PCAOB’s rules, auditing and other standards, and budget. A peer review program, while providing many benefits in the oversight of the accounting profession, is overseen by the accounting industry and is not subject to oversight by a federal regulator, which the Commission believes is a key advantage of the PCAOB in the furtherance of the protection of customer funds. The Commission also does not anticipate a significant impact on existing FCMs from the imposition of the PCAOB inspection requirement on public accountants. As noted above, 103 of the 104 FCMs currently are subject to examination by public accountants that are registered with the PCAOB. In addition, only six of the PCAOBregistered public accountants that conduct examinations of fourteen FCMs have not been subject to a PCAOB inspection at this time. However, all six of these firms have indicated in their PCAOB filings that they conduct audits of BDs and, therefore, will be subject at a future date to the PCAOB inspection program for the inspection of accountants that conduct audits of BDs. The Commission, based upon the analysis above and further consideration of the comments, has determined to adopt the regulation as proposed. The Commission recognizes, however, that the audits of many FCMs with a yearend date of December 31, 2013 or later have already been initiated. Accordingly, the Commission has determined that the PCAOB registration requirement will apply for audit reports issued for the year ending June 1, 2014 or later so as not to unnecessarily interrupt the examinations that currently are in progress. The Commission also is adopting a December 31, 2015 compliance date for a PCAOB inspection. The deferred compliance date will provide public accountants with additional time to register with, and to be inspected by, the PCAOB. The compliance dates are discussed further in section III below. PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 68527 3. Remediation of PCAOB Inspection Findings by the Public Accountant The Commission proposed in § 1.16(b)(1) that any deficiencies noted during a PCAOB inspection must be successfully remediated to the satisfaction of the PCAOB within three years. KPMG, the Center for Audit Quality, Deloitte, the AICPA, and PWC generally argued that it is not clear how the requirement that any deficiencies noted during the PCAOB exam must have been remediated to the satisfaction of the PCAOB would work or what it means.132 The commenters also noted that the Commission’s proposed requirement that the public accountant remediate any deficiencies noted in a PCAOB inspection report is more stringent than the SEC’s requirements for auditors of BDs and public issuers. KPMG also asked who would make a determination of remediation as there is no procedure for the PCAOB to communicate such determinations to the public accountant or the public.133 PWC also stated that reliance on the PCAOB inspection results was misplaced and that the PCAOB inspection comments are issued in the context of a constructive dialogue to encourage Certified Public Account (‘‘CPA’’) firms to improve their practices and procedures.134 PWC further noted that disciplinary sanctions such as revocation of the firm’s right to audit a public company or BD can only be made in the context of an adjudicative process in which the firm is afforded procedural rights.135 Lastly, PWC asserted that the Commission’s proposal would disqualify a firm without providing any of the procedural rights or safeguards established by SOX.136 The Commission has considered the comments and recognizes that the PCAOB inspection process does not involve a formal process for communicating that a public accountant has adequately remediated deficiencies identified during the PCAOB’s last inspection. In addition, the Commission understands that the PCAOB may not always issue a report at the conclusion of an inspection, or that the report may contain both public and non-public sections. In light of these comments, the Commission has determined to revise 132 KPMG Comment Letter at 2–3 (Jan. 11, 2013); Center for Audit Quality Comment Letter at 2–3 (Jan. 14, 2013); Deloitte Comment Letter at 2–3 (Jan. 14, 2013); AICPA Comment Letter at 2 (Feb. 11, 2013); PWC Comment Letter at 2 (Jan. 15, 2013). 133 KPMG Comment Letter at 2 (Jan. 11, 2013). 134 See PWC Comment Letter at 2 (Jan. 15, 2013). 135 Id. 136 Id. E:\FR\FM\14NOR2.SGM 14NOR2 68528 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 the final regulation by removing the requirement that a public accountant must remediate any deficiencies identified during a PCAOB inspection to the satisfaction of the PCAOB within three years of the inspection. The Commission is further revising § 1.16(b)(1) to provide that a public accountant that, as a result of the PCAOB disciplinary process, is subject to a sanction that would permanently or temporarily bar the public accountant from engaging in the examination of a public issuer or BD may not conduct the examination of an FCM. The Commission notes that the PCAOB has the authority to initiate a disciplinary action against a firm and its associated persons for failing to adequately address inspection findings or for other transgressions. The Commission also is revising § 1.16(b)(4) to require the governing body of the FCM to review and consider the PCAOB’s inspection reports of the public accountant as part of the governing body’s assessment of the qualifications of the public accountant to perform an audit of the FCM. The governing body is in a position to request information from the public accountant regarding the PCAOB inspections and general oversight of the public accountant and should use such information in assessing the competency of the accountant to conduct an examination of the FCM. An FCM’s governing body should be concerned if the PCAOB inspection reports indicate that the public accountant has significant deficiencies and should take such information into consideration in assessing the qualifications of the public accountant. 4. Auditing Standards The Commission proposed to amend § 1.16(c)(2) to require that the public accountant’s report of its examination of an FCM must state whether the examination was done in accordance with generally accepted auditing standards promulgated by the Auditing Standards Board of the AICPA (i.e., U.S. GAAS), after giving full consideration to the auditing standards issued by the PCAOB. Commenters raised issues with the proposal noting that there is no existing reporting framework that requires the application of one set of auditing standards and the consideration of another set of auditing standards.137 Deloitte noted that public accountants may be specifically engaged 137 Ernst & Young Comment Letter at 3 (Jan. 14, 2013); Deloitte Comment Letter at 1 (Jan. 14, 2013); PWC Comment Letter at 3 (Jan. 15, 2013); AICPA Comment Letter at 2 (Feb. 11, 2013); and KPMG Comment Letter at 3 (Jan. 11, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 to conduct an audit of an entity under both PCAOB auditing standards and U.S. GAAS, but that there is no reporting framework for an audit under one set of auditing standards, after giving ‘‘full consideration’’ to a separate set of auditing standards.138 The Commission has reviewed the comments and has determined to revise the final regulation to provide that the accountant’s report must state whether the examination of the FCM was conducted in accordance with the auditing standards issued by the PCAOB. The Commission acknowledges the fact that there is no reporting framework for public accountants to report on one set of auditing standards after giving full consideration to another set of auditing standards. Also, the Commission recognizes that the SEC has recently adopted final regulations to its Rule 17a–5 to require public accountants to use PCAOB standards in the examination of the financial statements of BDs.139 Therefore, the Commission’s amendments to § 1.16(c)(2) to require public accountants to use PCAOB standards in conducting the examination of the financial statements of an FCM is consistent with the SEC’s revisions to its Rule 17a–5. The Commission also is setting a compliance date for public accountants to use PCAOB auditing standards for all FCM examinations with a year-end date of June 1, 2014 or later. The extended compliance date allows FCMs currently subject to an examination by a public accountant to complete the examination cycle without having the public accountant adjust the examination for the new PCAOB standards requirement. The June 1, 2014 compliance date also is consistent with the SEC’s compliance date for revisions to Rule 17a-5 and, therefore, will allow FCMs that are dually-registered as FCMs/BDs to be subject to uniform CFTC and SEC requirements.140 Compliance dates are discussed further in section III below. 5. Review of Public Accountant’s Qualifications by the FCM’s Governing Body The Commission proposed to amend § 1.16(b) by adding new paragraph (4) which would require the FCM’s governing body to ensure that a public accountant engaged to conduct an examination of the FCM is duly qualified to perform the audit. The proposed new paragraph further 138 Deloitte 139 Broker Comment Letter at 1 (Jan. 14, 2013). Dealer Reports, 78 FR 51910 (Aug. 21, 2013). 140 Id. PO 00000 Frm 00024 provided that the evaluation should include, among other things, the public accountant’s experience in auditing FCMs, the public accountant’s knowledge of the Act and Commission regulations, the depth of the public accountant’s staff, and the public accountant’s size and geographical location. The proposed requirements are intended to ensure that the FCM’s governing body takes an active role in the assessment and appointment of the public accountant. PWC requested clarification of the Commission’s expectations for the criteria that would be expected to be used by the FCM’s governing body for determining qualification. PWC stated that such clarification may be helpful so that a consistent framework for determining the qualifications is used across the industry and FCM governing bodies.141 The Commission has considered the comments and has determined to adopt the amendments as proposed. FCMs represent a diverse group of entities and business models. Some FCMs focus primarily on institutional clients and engage in securities transactions as their primary business. Other FCMs focus on retail customers and engage in no proprietary or securities transactions. With such a wide range of business models, the Commission believes that it is not practical to provide a uniform set of criteria that each governing body of each FCM should use to assess the qualifications of a public accountant. In fact, such a standard list would go against the Commission’s objective of ensuring that the governing body is actively reviewing the qualifications of the public accountant relative to the FCM’s particular business model. The requirement is not intended to exclude regional or smaller public accountants from being qualified to conduct examinations, provided that the governing body is satisfied that the public accountant has the appropriate skill, knowledge, and other resources to effectively conduct an examination, and is otherwise in compliance with the qualification requirements in § 1.16. The Commission also is revising final § 1.16(b)(4) in response to the comments received on proposed § 1.16(b)(1) that would have required that a public accountant remediate any findings issued by the PCAOB in its inspection report within 3 years of the issuance of the inspection report. As stated above, commenters noted that there is no formal mechanism to assess whether a public accountant has remediated any inspection findings to the satisfaction of 141 PWC Fmt 4701 Sfmt 4700 E:\FR\FM\14NOR2.SGM Comment Letter at 3 (Jan. 15, 2013). 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations the PCAOB. Accordingly, the Commission is revising § 1.16(b)(4) to provide that the governing body of the FCM should review the inspection report of the public accountant and discuss inspection findings as appropriate with the public accountant. Such reviews and discussions will provide additional information to the governing body that will allow it to better assess the qualifications of the public accountant to conduct an audit of the FCM. 6. Electronic Filing of Certified Annual Reports The Commission proposed to amend § 1.16(f)(1)(i)(C) to require each FCM to submit its certified annual report to the Commission in an electronic format. The Commission also proposed to amend § 1.16(c)(2) to remove the requirement that the accountant manually sign the account’s report, which will facilitate the electronic filing of the FCM’s certified annual report with the Commission. The Commission received no comments on the above amendments and is adopting the amendments as proposed. F. § 1.17: Minimum Financial Requirements for Futures Commission Merchants and Introducing Brokers TKELleY on DSK3SPTVN1PROD with RULES2 1. FCM Cessation of Business and Transfer of Customer Accounts if Unable To Demonstrate Adequate Liquidity Section 4f(b) of the Act provides that no person may be registered as an FCM unless it meets the minimum financial requirements that the Commission has established as necessary to ensure that the FCM meets its obligations as a registrant at all times, which would include its obligations to customers and to market participants, including DCOs. The Commission’s minimum capital requirements for FCMs are set forth in § 1.17 which, among other things, currently provides that an FCM must cease operating as an FCM and transfer its customers’ positions to another FCM if the FCM is not in compliance or is not able to demonstrate its compliance with the minimum capital requirements. The proposed amendments to § 1.17 authorize the Commission to request certification in writing from an FCM that it has sufficient liquidity to continue operating as a going concern. If an FCM is not able to immediately provide the written certification, or is not able to demonstrate adequate access to liquidity with verifiable evidence, the FCM must transfer all customer accounts and immediately cease doing business as an FCM. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 The FIA stated that it agreed with the regulatory purpose underlying this proposed amendment, but stated that the Commission should not adopt the rule before it clearly articulates the objective standards by which it will determine that an FCM has ‘‘sufficient liquidity.’’ 142 Similarly, FCStone requested clarity with respect to the exigent circumstances that would give the Commission authority to require an FCM to cease operating.143 The Commission understands the concerns of commenters regarding the process by which the Commission, or the Director of the Division of Swap Dealer and Intermediary Oversight acting pursuant to delegated authority under § 140.91(6), could require immediate cessation of business as an FCM and the transfer of customer accounts; however, that same authority currently exists should a firm fail to meet its minimum capital requirement. The Commission believes the ability to certify, and if requested, demonstrate with verifiable evidence, access to sufficient liquidity to operate as a going concern to meet immediate financial obligations is a minimum financial requirement necessary to ensure an FCM will continue to meet its obligations as a registrant as set forth under section 4f(b) of the Act. Further, the Commission notes that the ‘‘going concern’’ standard is well defined in accounting literature and practice, and generally means an ability to continue operating in the near term. The proposed liquidity provision is intended to cover circumstances that require immediate attention and would provide the Commission with a means of addressing exigent circumstances by requiring an FCM to produce a written analysis showing the sources and uses of funds over a short period of time not to exceed one week. The purpose of the provision is to address situations where an FCM may currently be in compliance with minimum financial requirements, but lacks liquidity to meet pending, non-discretionary obligations such that the firm’s ability to continue operating in the near term is in serious jeopardy. In such a situation, it is expected that the Commission and the FCM’s DSRO and applicable DCOs would be in frequent communication with the firm to review the FCM’s options and plans to continue operating as a going concern and to assess what actions were necessary to ensure the firm continues to meet its obligations as a market intermediary and to protect customer funds. If an FCM’s management cannot 142 FIA Comment Letter at 8 (Feb. 15, 2013). Comment Letter at 4 (Feb. 15, 2013). 143 FCStone PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 68529 in good faith certify that the FCM has sufficient liquidity to permit it to operate throughout the following week, then the FCM has failed to meet its minimum financial requirements necessary to ensure that the firm will continue to meet its obligations as a registrant and the Commission would have to determine how to minimize the impact of a potential FCM insolvency or default. The Commission has considered the comments and has determined to adopt the amendments as proposed. 2. Reducing Time Period for FCMs To Incur a Capital Charge for Undermargined Accounts to One Day After Margin Calls Are Issued Regulation 1.17 requires an FCM to incur a charge to capital for customer and noncustomer accounts that are undermargined beyond a specified period of time.144 Regulation 1.17(c)(5)(viii) currently requires an FCM to reduce its capital (i.e., take a capital charge) if a customer account is undermargined for three business days after the margin call is issued.145 Regulation 1.17(c)(5)(ix) requires an FCM to take a capital charge for noncustomer and omnibus accounts that are undermargined for two business days after the margin call is issued. The Commission proposed to amend § 1.17(c)(5)(viii) and (ix) to require an FCM to take capital charges for undermargined customer, noncustomer, and omnibus accounts that are undermargined for more than one business day after a margin call is issued. Thus, for example, under the proposal, if an account carried by an FCM became undermargined on Monday, the operation of the regulation assumes that the FCM would issue a margin call on Tuesday, and the FCM would have to incur a capital charge at the close of business on Wednesday if the margin call was still outstanding. Vanguard commented that it supported the Commission’s proposal, stating that the accelerated timetable makes sense given modern trading and asset transfer timing.146 Vanguard further stated that each customer must stand up for its trades and promptly post margin, and it further stated that it believes the overall market may be weakened to the extent an FCM is 144 Noncustomers are defined in § 1.17(b)(4) as accounts carried by the FCM that are not customer accounts or proprietary accounts. Noncustomer accounts are generally accounts carried by an FCM for affiliates and certain employees of the FCM. 145 For purposes of these Commission regulations, a margin call is presumed to be issued by the FCM the day after an account becomes undermargined. 146 Vanguard Comment Letter at 7 (Feb. 22, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 68530 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations extending significant amounts of credit over an extended period to cover a customer’s margin deficit.147 MFA objected to the proposal noting that, while in the ordinary course of business, few margin calls remain outstanding for more than two business days, the proposal does recognize the practical reasons why a margin call may be outstanding more than 2 business days after the call issued.148 MFA cited disputes between an FCM and its customer as to the appropriate level of margin, and good faith errors that may cause a delay beyond 2 days for a margin call to be met.149 MFA also stated that an increase in costs resulting from the regulation will ultimately be passed on the customers. The NCBA stated that the proposal may require market participants to use wire transfers in lieu of checks, which will increase the costs and impose a significant financial burden to the cattle industry.150 The NCBA also stated that the proposal will cause customers to prefund their accounts for anticipated margin requirements, which will reduce customers’ capital and impede their other business operations.151 The NCBA further noted that the proposal is not related to the MFGI and PFGI failures, which were not caused by customers failing to meet margin calls.152 JSA stated that an effective increase in a capital charge for undermargined customer accounts could cause an increase in requirements for customers to prefund their accounts, which would be punitive in a highly competitive environment that already places midsized FCMs and FCMs that are not affiliated with a banking institution at a disadvantage to larger, more highly capitalized firms, or FCMs that are affiliated with banking institutions.153 JSA also stated that if smaller FCMs are forced out of the market, larger FCMs or FCMs affiliated with banks may not be willing to service customers that are farmers, ranchers, retail, or introduced brokerage accounts, for which they have historically shown little interest.154 FIA stated that while institutional and many commercial market participants generally meet margin calls by means of wire transfers, the proposal, creates Comment Letter at 7 (Feb. 15, 2013). 149 Id. TKELleY on DSK3SPTVN1PROD with RULES2 155 FIA Comment Letter at 26 (Feb. 15, 2013). 156 Id. 147 Id. 148 MFA operational problems because it does not consider delays arising from accounts located in other time zones that cannot settle same day, or ACH settlements, or the requirement to settle or convert certain non-U.S. dollar currencies.155 FIA also stated that a substantial number of customers that do not have the resources of large institutional customers (in particular members of the agricultural community) depend on financing from banks to fund margin requirements, which may require more than one day to obtain.156 RJ O’Brien stated that it recognized that the collection of margin is a critical component of an FCM’s risk management program, however, it objected to the proposed amendment.157 RJ O’Brien stated that as the largest independent FCM serving a client base that includes a great number of farmers and ranchers, it is well aware that many customers that use the markets to hedge commercial risk still meet margin calls by check or ACH because of the impracticality and costliness of wire transfers in their circumstances.158 RJ O’Brien stated that in many cases, the costs of a wire transfer would exceed the transaction costs paid by the client to its FCMs, and additionally, that some customers in the farming and ranching community finance their margin calls, which can require additional time to arrange for delivery of margin call funds due to routine banking procedures.159 RJ O’Brien also stated that if the proposal is adopted, FCMs that service non-institutional clients will struggle to remain competitive and the proposal may result in fewer clearing FCMs and greater systemic risk to the marketplace.160 RJ O’Brien further stated that many of the larger FCM/BDs likely have little interest in servicing smaller rancher and farmer clients, as was evidenced in the wake of MFGI’s failure, and that a loss of such smaller FCMs will result in fewer options available to these ranchers, farmers and other commercial market participants that wish to hedge their commercial risks.161 TD Ameritrade stated that it did not support the proposed amendments to 150 NCBA Comment Letter at 2 (Feb. 15, 2013). 151 Id. 152 Id. See also JSA Comment Letter at 2 (Feb. 15, 2013) and ICA Comment Letter at 1–2 (Feb. 15, 2013). 153 JSA Comment Letter at 2 (Feb. 15, 2013). See also Frontier Futures Comment Letter at 2–3 (Feb. 14, 2013). 154 Id. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 157 RJ O’Brien Comment Letter at 3–4 (Feb. 15, 2013). 158 Id. See also RCG Comment Letter at 5 (Feb. 12, 2013). RCG also recommended that the Commission implement a pilot program that requires FCMs to provide the Commission with daily undermargined reports. The Commission does not believe that a pilot program is necessary for gathering additional information. 159 Id. 160 Id. 161 Id. PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 § 1.17(c)(5)(viii) and (ix) as it would impose financial hardships on customers that the Proposal was intended to protect.162 TD Ameritrade stated that a large number of retail customers do not currently use wire transfers to meet a margin requirement in one business day.163 TD Ameritrade also noted that non-U.S. customer accounts are faced with time zone differences and inherent delays in meeting margin calls.164 Other commenters expressed the general concern that the proposal will harm the customers it is meant to protect by requiring more capital to be kept in customer accounts, possibly forcing users to hold funds at FCMs well in excess of their margin requirements, or resulting in certain segments of the market to forego the futures markets to hedge their commercial operations.165 Those commenters argued that such prefunding could add significant financial burdens to trading as customers find themselves having to provide excess funds to their brokers which could increase their risk with regard to the magnitude of funds potentially at risk in the event of future FCM insolvencies.166 The commenters general expressed significant concerns that reducing margin calls to one day will harm many customers as: (1) Many small businesses, farmers, cattle producers and feedlot operators routinely pay by check and forcing them to use wire transfers increases their cost of doing business; (2) clients who make margin calls by ACH payments instead of wire transfers because ACH is cheaper, would no longer be able to do so because there is a one-day lag in availability of funds; and (3) foreign customers would not be able to make margin calls due to time zone differences, the time required to convert certain non-USD currencies, and for 162 TD Ameritrade Comment Letter at 3–4 (Feb. 15, 2013). 163 Id. 164 Id. 165 NPPC Comment Letter at 2 (Feb. 14, 2013); RCG Comment Letter at 4–5 (Feb. 12, 2013); NGFA Comment Letter at 3 (Feb. 15, 2013); NEFI/PMAA Comment Letter at 3 (Jan. 14, 2013); AIM Comment Letter at 15 (Jan. 24, 2013); Amarillo Comment Letter at 1 (Feb. 14, 2013); NCFC Comment Letter at 1 (Feb. 15,2013); NFA Comment Letter at 12–13 (Feb. 15, 2013); FCStone Comment Letter at 3 (Feb. 15, 2013); Advantage Comment Letter at 1–2 (Feb. 15, 2013); AFBF Comment Letter at 2 (Feb. 15, 2013); CCC Comment Letter at 2 (Feb. 15, 2013); Steve Jones Comment Letter at 1 (Feb. 14, 2013); ICA Comment letter at 1–2 (Feb. 15, 2013);TCFA Comment Letter at 1–2 (Feb. 15, 2013); CME Comment Letter at 5 (Feb. 15, 2013). AIM resubmitted the comment letters of Premier Metal Services, NEFI/PMAA, and the ISRI and indicated its support for the recommendations therein (Jan. 14, 2013). 166 Id. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations whom banking holidays fall on different days.167 The CCC stated that the proposed amendment to the capital rule places an undue burden on the FCMs, which will likely result in FCMs demanding that customers prefund trades to prevent market calls and potential capital charges.168 The CCC also stated that the proposal could result in forced liquidations of customer positions to ensure that the FCM does not incur a capital charge.169 FIA and RJ O’Brien provided alternatives to the Commission’s proposal. Both FIA and RJ O’Brien offered that an FCM be required to take a capital charge for any customer margin deficit exceeding $500,000 that is outstanding for more than one business day.170 FIA further suggested that if the customer’s margin deficit is $500,000 or less, the FCM should take a capital charge if the margin call is outstanding two business days or more after the margin call is issued.171 RJ O’Brien’s comment letter does not address the timing of the capital charge for accounts with a margin deficit of $500,000 or less. NFA, FIA, MFA and AIMA stated that if the Commission adopts the amendments regarding residual interest as proposed, then the Commission should consider whether a capital charge for undermargined accounts remains necessary at all because the FCM will have already accounted for an undermargined account by maintaining a residual interest sufficient at all times to exceed the sum of all margin deficits; hence the capital charges related to an undermargined account appear to impose an additional financial burden without any necessary financial protection.172 RJ O’Brien also stated that the Commission should provide at least a one-year period of time for any changes to the timeframe for taking a capital charge for undermargined accounts to be effective.173 RJ O’Brien stated that FCMs will need to educate and develop systems to assist their clients in meeting margin calls in an expedited timeframe.174 Lastly, RJ O’Brien stated that the Commission should require 167 Id. 168 CCC Comment Letter at 2–3 (Feb. 15, 2013). TKELleY on DSK3SPTVN1PROD with RULES2 169 Id. 170 FIA Comment Letter at 27 (Feb. 27, 2013); RJ O’Brien Comment Letter at 4 (Feb. 15, 2013). 171 FIA Comment Letter at 27 (Feb. 15, 2013). 172 NFA Comment Letter at 13 (Feb. 15, 2013); FIA Comment Letter at 26 (Feb. 15, 2013); MFA Comment Letter at 6–7 (Feb. 15, 2013); and AIMA Comment Letter at 3 (Feb. 15, 2013). 173 RJ O’Brien Comment Letter at 4 (Feb. 15, 2013). 174 Id. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 futures exchanges to increase their margin requirements to 135% of maintenance margin to reduce the number and frequency of margin calls.175 With respect to the reduction of the timeframe in § 1.17(c)(5)(viii) for an FCM to incur a capital charge for undermargined customer accounts, the Commission has considered the comments and has determined to adopt the amendments as proposed. The timely collection of margin is a critical component of an FCM’s risk management program and is intended to ensure that an FCM holds sufficient funds deposited by customers to meet their potential obligations to a DCO. As guarantor of the financial performance of the customer accounts that it carries, the FCM is financially responsible if the owner of an account cannot meet its margin obligations to the FCM and ultimately to a DCO. The timeframe for meeting margin calls currently provided in § 1.17(c)(5)(viii) was established in the 1970s when the use of checks and the mail system were more prevalent for depositing margin with an FCM. However, in today’s markets, with the increasing use of technology, 24-hour-aday trading, and the use of wire transfers to meet margin obligations, the Commission believes that the timeframe for taking a capital charge should be reduced both to give an incentive to FCMs to exercise prudent risk management and to strengthen the financial protections of FCMs, and to enhance the safety of the clearing systems and other customers by requiring FCMs to reserve capital for undermargined customer accounts that fail to meet a margin call on a timely basis. Several commenters have stated that the proposal would harm customers by increasing costs to customers or by exposing more of the customers’ funds to the FCM.176 The Commission notes that the final regulation provides for at least two full days from the point in time that a customer’s account is undermargined to the time the FCM is required to incur a capital charge for the undermargined account. Under the regulation, if a customer’s account becomes undermargined at some point before close of business on Monday, the FCM will have until the close of business on Wednesday before it is required to take a capital charge. Customers are responsible for 175 Id. 176 See, e.g., NCBA Comment Letter at 2 (Feb. 15, 2013); NGFA Comment Letter at 3–4 (Feb. 15, 2013). PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 68531 monitoring the activity in their account and should have information that would allow them to determine that their trading account is undermargined prior to the close of business on Monday. The alternative proposed by FIA and RJ O’Brien is premised on their belief that the regulation would not provide an adequate amount of time for a customer to meet a margin call before the FCM would have to take a capital charge for an undermargined account. As noted above, the Commission believes that the regulation, which provides at least two full business days for a customer to fund its undermargined account, does provide an adequate period of time for margin calls to be met. In situations involving customers located in foreign jurisdictions and the associated issues of time zone differences and differences in banking holidays, the Commission believes that the FCM should include such factors in its risk management program and operating procedures with such customers in an effort to ensure compliance with the regulations. The Commission believes that the time period provided in § 1.17(c)(5)(viii) is adequate in most situations for a customer to receive and fund a margin call. The intent of margin is to ensure that a customer maintains a sufficient amount of funds in its account to cover 99 percent of the observed market moves of its portfolio of positions over a specified period of time. Customers that maintain fully margined accounts are exposed to greater risk to the safety of their funds if other customer accounts carried by the FCM are undermargined. In order to provide greater protection to the customers that are fully margined or maintain excess margin on deposit, and to provide greater assurance that the FCM can continue to meet its financial obligations to DCOs, the Commission believes that the FCM should maintain a sufficient amount of capital to cover the potential shortfall in undermargined customers’ accounts. The Commission also has considered the comments on the proposed amendments to § 1.17(c)(5)(ix), which reduce the timeframe for an FCM to incur a capital charge on an undermargined noncustomer or omnibus account from two days after the call was issued to one day after the call was issued. The Commission notes that the majority of the comments addressed the undermargined charge on customer accounts, but considered the comments generally in reviewing the proposed amendments to § 1.17(c)(5)(ix). The Commission has considered the proposal and is adopting the amendments to § 1.17(c)(5)(ix) as E:\FR\FM\14NOR2.SGM 14NOR2 68532 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 proposed. As noted above, § 1.17(c)(5)(ix) applies to noncustomers and omnibus accounts carried by an FCM. Many of the concerns raised by the comments regarding the ability to fund a margin call under § 1.17(c)(5)(viii) do not apply to accounts held by an affiliate or an omnibus accounts. Such accounts should pay margin calls promptly and by wire transfer to reduce the potential exposure to the FCM resulting from undermargined accounts. The Commission also believes that the amendments to § 1.17(c)(5)(viii) and (ix) are appropriate even if the Commission amends its regulations to require an FCM to maintain residual interest in segregated accounts in excess of the undermargined amount of customer accounts. The purpose of the capital rule is to ensure that an FCM maintains sufficient liquid assets to meet its obligations as a going concern. Proprietary funds held in segregated accounts that exceed the total obligation to customers are included in an FCM’s capital computation. However, in situations where the FCM’s residual interest in segregated accounts is covering an undermargined customer account, a capital charge is appropriate because the FCM’s residual interest is necessary to cover potential market losses on the undermargined accounts. 3. Permit an FCM That Is Not a BD To Develop Policies and Procedures To Determine Creditworthiness The Commissions proposed to amend § 1.17(c)(v) to permit an FCM that is not a BD to develop a framework to establish, maintain and enforce written policies and procedures for determining creditworthiness of commercial paper, convertible debt, and nonconvertible debt instruments that are readily marketable. In recommending the proposal, the Commission noted that the SEC proposed to permit a BD to establish written policies and procedures to assess the credit risk of commercial paper, convertible debt, and nonconvertible debt instruments that are readily marketable.177 Under both the Commission’s proposal and the SEC’s proposal, an FCM or BD would assess the security’s credit risk using the following factors, to the extent appropriate: • Credit spreads (i.e., whether it is possible to demonstrate that a position in commercial paper, nonconvertible 177 The SEC has proposed rule amendments to implement the Dodd-Frank Act requirement to remove references to credit ratings in its regulations and substitute a standard for creditworthiness deemed appropriate. See 76 FR 26550 (May 6, 2011). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 debt, and preferred stock is subject to a minimal amount of credit risk based on the spread between the security’s yield and the yield of Treasury or other securities, or based on credit default swap spreads that reference the security); • Securities-related research (i.e., whether providers of securities-related research believe the issuer of the security will be able to meet its financial commitments, generally, or specifically, with respect to securities held by the FCM or BD); • Internal or external credit risk assessments (i.e., whether credit assessments developed internally by the FCM or BD or externally by a credit rating agency, irrespective of its status as an NRSRO, express a view as to the credit risk associated with a particular security); • Default statistics (i.e., whether providers of credit information relating to securities express a view that specific securities have a probability of default consistent with other securities with a minimal amount of credit risk); • Inclusion on an index (i.e., whether a security, or issuer of the security, is included as a component of a recognized index of instruments that are subject to a minimal amount of credit risk); • Priorities and enhancements (i.e., the extent to which a security is covered by credit enhancements, such as overcollateralization and reserve accounts, or has priority under applicable bankruptcy or creditors’ rights provisions); • Price, yield and/or volume (i.e., whether the price and yield of a security or a credit default swap that references the security are consistent with other securities that the FCM or BD has determined are subject to a minimal amount of credit risk and whether the price resulted from active trading); and • Asset class-specific factors (e.g., in the case of structured finance products, the quality of the underlying assets). An FCM that maintains written policies and procedures and determines that the credit risk of a security is minimal is permitted under the proposal to apply the lesser haircut requirement currently specified in the SEC capital rule for commercial paper (i.e., between zero and 1⁄2 of 1 percent), nonconvertible debt (i.e., between 2 percent and 9 percent), and preferred stock (i.e., 10 percent). The CFA does not believe it is appropriate for FCMs to use internal models to determine minimum required capital.178 The CFA believes that capital models should be established by the relevant regulatory agencies for use by FCMs or BDs.179 It has serious concerns that internal models used for calculating minimum capital requirements are prone to failure in a crisis.180 The CFA states that the regulatory agency should provide an objective and clear minimum risk-based capital baseline.181 As noted above, the SEC has proposed amendments to its net capital rule to allow BDs to take a lower net capital charge on certain securities based on the BDs’ own determinations that certain securities have minimal credit risk, pursuant to the BDs having protocols for assessing the credit risk and maintaining appropriate documentations. If the SEC approves the proposal, the SEC capital charges would apply to an FCM that is duallyregistered as an FCM/BD. In the absence of the Commission adopting a similar provision, certificates of deposit, bankers acceptances, commercial paper and nonconvertible debt securities held by standalone FCMs that have very low credit and market risk securities would be subject to the minimum default securities haircut of 15 percent. The Commission proposed that standalone FCMs be permitted the same flexibility as FCM/BDs with respect to taking a lower capital charges for certain securities that may be determined to have minimal credit risk. The Commission also notes that based upon a review of Forms 1–FR–FCM filed with the Commission, standalone FCMs generally have limited investments in the types of securities that would be subject to the internal models, and such haircuts are not material to most standalone FCM’s adjusted net capital. The Commission has considered the proposal and is adopting the amendments as proposed. 4. Revisions to Definitions in Regulation 1.17(b) The Commission proposed technical amendments to certain definitions in § 1.17(b)(2) and (7) to reflect proposed changes the term ‘‘30.7 customer’’ and to remove surplus language due to other revisions to the regulations. No comments were received on these proposed changes and the Commission is adopting the proposal as final. Regulation 1.17(a) requires each FCM, in computing its minimum capital requirement, to include 8 percent of the risk margin required on futures and over the counter derivative instruments that the FCM carries in customer and non179 Id. 180 Id. 178 CFA PO 00000 Comment Letter at 4–5 (Feb. 13, 2013). Frm 00028 Fmt 4701 Sfmt 4700 181 Id. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations customer accounts. Regulation 1.17(b)(9) defines the term ‘‘over the counter derivative instruments’’ as those instruments set forth in 12 U.S.C. 4421. Section 740 of the Dodd-Frank Act, however, repealed 12 U.S.C. 4421. The Commission, however, has not revised its capital requirements and continues to require FCMs to include over the counter derivative instruments that it carries in customer and noncustomer accounts in their minimum capital computations. The Commission interprets § 1.17(b)(9) to require an FCM to include the types of derivative transactions or instruments that were previously set forth in 12 U.S.C. 4421 in its computation of its minimum capital requirement. The Commission also has directed staff to develop a rulemaking to amend Regulation 1.17(b)(9) to account for the repeal of 12 U.S.C. 4421. TKELleY on DSK3SPTVN1PROD with RULES2 G. § 1.20: Futures Customer Funds To Be Segregated and Separately Accounted for Regulation 1.20 imposes obligations on FCMs, DCOs, and other depositories regarding the holding, and accounting for, customer funds. The Commission proposed to reorganize the structure of § 1.20 by providing additional subparagraphs to the existing specific requirements, and by applying headings to the regulation to assist in the reading and understanding of the regulation. The Commission also proposed new provisions discussed below to enhance the protection of customer funds. 1. Identification of Customer Funds and Due Diligence The Commission proposed to amend § 1.20(a) to more clearly define the requirements regarding how FCMs must hold customer funds. Proposed paragraph (a) of § 1.20 requires an FCM to separately account for all futures customer funds and to segregate futures customer funds from its own funds. The proposed amendments further provide that an FCM shall deposit customer funds with a depository under an account name that clearly identifies the funds as futures customer funds and shows that the funds are segregated as required by the Act and Commission regulations. Proposed paragraph (a) also provides that an FCM must perform due diligence of each depository holding customer segregated funds (including depositories affiliated with the FCM), as required by new § 1.11, and to update its due diligence on at least an annual basis. Proposed paragraph (a) also provides that an FCM must maintain at all times in the separate account or accounts funds in an amount at least sufficient in VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 the aggregate to cover its total obligations to all futures customers. Proposed paragraph (a) further provides that an FCM computes its ‘‘total obligations’’ to futures customers as the aggregate amount of funds necessary to cover the Net Liquidating Equities of all futures customers as set forth in paragraph § 1.20(i). The Commission stated in the Proposal that it is not sufficient for an FCM to be in compliance with its segregation requirement at the end of a business day, but fail to hold sufficient funds in segregation to meet the Net Liquidating Equities of each of its customers on an intra-day basis. This provision explicitly clarifies the Commission’s long-standing interpretation of existing statutory and regulatory requirements on how FCMs must hold customer funds. Section 4d(a)(2) of the Act requires an FCM to treat and deal with all money, securities, and property received by the FCM to margin, guarantee, or secure the trades or contracts of any customer of the FCM, or accruing to such customer as the result of such trades or contracts, as belonging to such customer. Section 4d(a)(2) further provides that funds belonging to a customer must be separately accounted for by the FCM and may not be commingled with the funds of the FCM or be used to margin or guarantee the trades or contracts, or extend the credit, of any customer or person other than the customer for whom the FCM holds the funds. The separate treatment of customer funds is further set forth in § 1.22 which provides that no FCM shall use, or permit the use of, the funds of one customer to purchase, margin, or settle the trades, contracts, or commodity options of, or to secure or extend the credit of, any person other than such customer. Therefore, the current statutory and regulatory regime requires an FCM to maintain at all times a sufficient amount of funds in segregation to cover the full amount of the firm’s obligations to its customers (i.e., the aggregate Net Liquidating Equity of each customer) to prevent the FCM from using the funds of one customer to margin or guarantee the commodity interests of other customers, or to extend credit to other customers. In its letter, the FIA stated that ‘‘[t]he Commission has stated, and [FIA] agrees, that FCMs are required to comply with the segregation provisions of the Act at all times.’’ 182 FIA further 182 FIA Comment Letter at 2 (Jun 20, 2013). In addition, FIA expressed its agreement with the existing requirement for an FCM to maintain sufficient funds in segregation at all times to cover its total obligation to its customers. PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 68533 cited to a Commission 1998 rulemaking where the Commission stated the segregation rules require compliance at all times.183 If an FCM is not in compliance with its obligation to maintain a sufficient amount of funds in segregation to meet the Net Liquidating Equities of all of its customer on an intra-day basis, the FCM would be using the funds of one customer to margin positions of another customer, or to cover the losses of another customer in violation of section 4d of the Act and Commission regulations. The Commission did not receive any comments on revised paragraph (a) and is adopting the amendments as proposed. 2. Permitted Depositories Proposed paragraph (b) of § 1.20 lists the permitted depositories for futures customer funds as any bank, trust company, DCO, or another FCM, subject to compliance with the FCM’s risk management policies and procedures required in new § 1.11. The Commission did not propose changes to the list of permitted depositories for FCMs. The Commission did not receive any comments on paragraph (b) and is adopting the amendments as proposed. 3. Limitation on the Holding of Futures Customer Funds Outside of the United States Proposed paragraph (c) of § 1.20 provides that an FCM may hold futures customer funds in depositories outside of the U.S. only in accordance with the current provisions of § 1.49. The Commission received no comments on paragraph (c) and is adopting the amendments as proposed. 4. Acknowledgment Letters a. Background Proposed paragraph (d) of § 1.20 would require an FCM to obtain a written acknowledgment from each bank, trust company, DCO, or FCM with which the FCM opens an account to hold futures customer funds, with the exception of a DCO that has Commission-approved rules providing for the segregation of such funds. Similarly, proposed § 1.20(g)(4) would require a DCO to obtain a written acknowledgment from each depository prior to or contemporaneously with the opening of a futures customer funds account. Paragraphs (d) and (g) further enumerate requirements for acknowledgment letters, expanding upon the requirements set forth in current § 1.20. Proposed § 1.26, which would require an FCM or DCO that 183 Id. E:\FR\FM\14NOR2.SGM (citing 63 FR 2188, 2190 (Jan. 14, 1998)). 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68534 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations invests customer funds in instruments described in § 1.25 to obtain an acknowledgment letter from the depository holding such instruments,184 and proposed § 30.7(c)(2), which would require an FCM to obtain an acknowledgment letter from each depository with which it opens an account to hold funds on behalf of its foreign futures and foreign options customers, are consistent with proposed § 1.20(a) and (g)(4). The Commission proposed to repeal and replace § 30.7(c)(2), but retain the requirement to obtain an acknowledgment letter in proposed § 30.7(d). The Commission has proposed amendments to the acknowledgment letter requirements in §§ 1.20, 1.26, and 30.7 in three separate notices of proposed rulemaking, the first being published on February 20, 2009 (the ‘‘Original Proposal’’).185 The Original Proposal set out specific representations that would have been required to be included in all acknowledgment letters in order to reaffirm and to clarify the obligations that depositories incur when accepting customer funds. In light of the comments on the Original Proposal, in 2010 the Commission re-proposed the amendments with several changes made in response to comments (the ‘‘First Revised Proposal’’).186 As part of the First Revised Proposal, the Commission proposed the required use of standard template acknowledgment letters, which were included as Appendix A to each of §§ 1.20 and 1.26, and Appendix E to part 30 of the Commission’s regulations (referred to herein as the ‘‘Template Letters’’). The Commission received nine comment letters on the First Revised Proposal. In general, the commenters were supportive of the First Revised Proposal and, in particular, were very supportive of requiring the use of Template Letters. It was noted by certain commenters that use of a standard letter would simplify the process of obtaining an acknowledgment letter. In addition, commenters were in agreement that uniformity of acknowledgment letters would provide consistency and greater legal certainty across the commodities and banking industries. The Commission proposed further refinements to the acknowledgment letter requirements in 2012 to address 184 Section 22.5 applies the written acknowledgment requirements of §§ 1.20 and 1.26 to FCMs and DCOs in connection with depositing Cleared Swaps Customer Collateral in an account at a permitted depository. 185 74 FR 7838 (Feb. 20, 2009). 186 75 FR 47738 (Aug. 9, 2010). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 several issues that had arisen in the context of the MFGI and PFGI failures and their adverse impact on customers of those FCMs (‘‘Second Revised Proposal’’).187 In the Second Revised Proposal, the Commission also addressed comments it had received in response to the First Revised Proposal and incorporated related changes to the Template Letters. The Commission received 15 comment letters related to the Template Letters in response to the Second Revised Proposal.188 Again, the commenters were generally supportive of the Commission’s proposal and, in particular, were supportive of the mandatory use of Template Letters. The Depository Bank Group commented that the Template Letters will help ‘‘facilitate a more efficient process for the establishment and maintenance of customer segregated accounts’’ and clarify the rights and responsibilities of depositories.189 Eurex noted that it appreciated the ‘‘potential convenience’’ and increased certainty and transparency afforded by the Template Letters.190 CME supported the Commission’s efforts to ‘‘strengthen and standardize’’ the Template Letters.191 While many of the comments were supportive of the Template Letters, FCStone expressed the view that ‘‘prescriptive rules’’ could drive participants out of the futures industry.192 MGEX commented that the required use of a Template Letter appeared to be a ‘‘dramatic shift’’ from the current requirements and questioned whether depositories would be willing to sign the Template Letter due to the ‘‘access and timing information requirements.’’ 193 RCG stated that early indications were that many depositories ‘‘with extensive experience servicing FCMs’’ are unwilling to sign the Template Letter and expressed concern that if such depositories refuse to sign, customer funds will become concentrated with depositories ‘‘less experienced in carrying FCM accounts.’’ 194 Regulation 1.20 in its current form already requires FCMs and DCOs to obtain acknowledgment letters, and the 187 77 FR 67866 (Nov. 14, 2012). were submitted by Schwartz & Ballen, FIA, LCH.Clearnet, MGEX, the Federal Reserve Banks, NYPC, CME, the Depository Bank Group, Eurex, RJ O’Brien, RCG, NFA, FCStone, ICI, and Katten-FIA. 189 Depository Bank Group Comment Letter at 2 (Feb. 15, 2013). 190 Eurex Comment Letter at 1 (Aug. 1, 2013). 191 CME Comment Letter at 7 (Feb. 15, 2013). 192 FCStone Comment Letter at 5 (Feb. 15, 2013). 193 MGEX Comment Letter at 3 (Feb. 18, 2013). 194 RCG Comment Letter at 7 (Feb. 12, 2013). 188 Letters PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 Commission believes that use of a standardized Template Letter will reduce negotiation costs, create efficiencies for Commission registrants as well as non-registrant depositories, provide greater legal certainty as to the rights and obligations of parties under the Act and CFTC regulations, and facilitate consistent treatment of customer funds across FCMs, DCOs, and depositories. In addition, the use of a standardized letter is the approach that has been proposed by the Financial Conduct Authority (‘‘FCA’’) in the United Kingdom (‘‘U.K.’’).195 The Commission has taken into consideration the comments and recommendations provided by FCMs, DCOs, and depositories, and it believes the final rules and Template Letters largely address the concerns they have expressed. The Commission’s response to comments on the major issues raised by commenters is discussed by subject matter, below. b. Technical Changes to the Template Letters Proposed paragraphs (d)(2) and (g)(4)(ii) of § 1.20 would require FCMs and DCOs, respectively, to use the Template Letter set forth in Appendix A to § 1.20 when opening a customer segregated account with a depository. In response to the comments, and in recognition of the different functions FCMs and DCOs perform in relation to customer funds, the Commission has determined to finalize different versions of the Template Letters for FCMs and DCOs. The Template Letter specific to FCMs is being adopted as Appendix A to § 1.20, and the Template Letter for DCOs is being adopted as Appendix B to § 1.20. Paragraph (g)(4)(ii) has been revised to require DCOs to use the Template Letter in Appendix B. Another change concerns the full account name as it appears in the Template Letter. Proposed § 1.20(a) and (g)(1) provides in part that customer funds shall be deposited ‘‘under an account name that clearly identifies them as futures customer funds and shows that such funds are segregated as required by sections 4d(a) and 4d(b) of the Act and [part 1 of the Commission’s regulations].’’ Schwartz & Ballen noted that operational constraints limit the number of characters available for account names, and requested additional flexibility with regard to account titles ‘‘so long as the accounts are clearly identified as custodial 195 See Financial Conduct Authority, ‘‘Review of the client assets regime for investment business,’’ Consultation Paper CP13/5 (July 2013). E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations accounts held for the benefit of the FCM’s customers.’’ 196 The Commission has modified the Template Letters to accommodate a depository’s account titling conventions. The Commission will permit a depository to abbreviate the account name when the full name as set forth in the Template Letter is too long for a depository’s operational system to include all characters, provided that (i) the Template Letter includes both the full and abbreviated account name(s) and (ii) the abbreviated account name clearly identifies the account as a Commission-regulated segregated/ secured account that holds customer funds (e.g., ‘‘segregated’’ may be shortened to ‘‘seg;’’ ‘‘customer’’ may be shortened to ‘‘cust;’’ ‘‘account’’ to ‘‘acct;’’ etc.). FIA recommended several modifications to the Template Letters, including the addition of a clause to address banking practices used to provide third-party access to account information. As a result, the Commission has added the following language to the FCM Template Letter (and similar language to the other Template Letters): ‘‘The parties agree that all actions on your part to respond to the above information and access requests will be made in accordance with, and subject to, such usual and customary authorization verification and authentication policies and procedures as may be employed by you to verify the authority of, and authenticate the identity of, the individual making any such information or access request, in order to provide for the secure transmission and delivery of the requested information or access to the appropriate recipient(s).’’ In addition, the proposed Template Letters, as well as proposed §§ 1.20(d)(4) and (g)(4)(iv) and 30.7(d)(4), would require the depository to agree to provide a copy of the executed acknowledgment letter to the Commission at a specific email address. The email address has been deleted from the Template Letters, and the depository is now required to provide a copy to the Commission via electronic means in a format and manner determined by the Commission. The rule text has been revised accordingly (and § 1.20(g)(4)(iv) has been renumbered as § 1.20(g)(4)(iii)). Finally, the Commission has made minor technical revisions to the Template Letters in the form of grammatical and stylistic changes to 196 Schwartz & Ballen Comment Letter at 8 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 clarify meaning and provide consistency among the letters. c. Federal Reserve Banks as Depositories Pursuant to § 806(a) of the DoddFrank Act, the Board of Governors of the Federal Reserve System (the ‘‘Board’’) may authorize a Federal Reserve Bank to establish and maintain an account for systemically important DCOs (‘‘SIDCOs’’) that have been designated by the Financial Stability Oversight Council (‘‘FSOC’’) as systemically important financial market utilities (‘‘Designated FMUs’’).197 In their comment letter, the Federal Reserve Banks stated: ‘‘Absent clarification, the [Federal] Reserve Banks must assume that we would be treated as depository institutions under the proposed rules if we were to hold Designated FMU customer funds.’’ The Federal Reserve Banks commented that they do not believe that they can accept all of the terms of the Template Letters given the ‘‘unique nature of the [Federal] Reserve Banks and of Designated FMUs.’’ 198 The Federal Reserve Banks raised specific concerns with two terms of the Template Letters: (1) The provision authorizing the Commission to order the immediate release of customer funds; and (2) the provision that allows a depository to presume legality for any withdrawal of customer funds, provided the depository has no knowledge of, or could not reasonably know of, any violation of the law. The Federal Reserve Banks suggested that under ‘‘exceptional circumstances, such as a prospective insolvency of the SIDCO that threatens customer funds,’’ a Commission-authorized withdrawal would need to be considered in the context of a larger coordinated effort, which would include FSOC.199 The Federal Reserve Banks further asserted that, due to their dual roles as both supervisory bodies and providers of financial services, coupled with the Board prohibition on sharing supervisory information with personnel performing financial services, the standard of liability leaves them in the ‘‘untenable position of not being able to rely on the presumption of legality.’’ 200 The Commission is adopting, as proposed, § 1.20(g)(2), which confirms that the Federal Reserve Banks are depositories for purposes of section 4d of the Act and Commission regulations thereunder. Accordingly, a Federal 197 Section 806(a) of the Dodd-Frank Act; see also Federal Reserve Banks Comment Letter at 1 (Feb. 22, 2013). 198 Federal Reserve Banks Comment Letter at 2 (Feb. 22, 2013). 199 Id. at 1. 200 Id. at 2. PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 68535 Reserve Bank would be required to execute a written acknowledgment when it accepts customer funds from a SIDCO or other DCO for which it holds customer funds. However, the Commission recognizes the unique role of the Federal Reserve Bank and is therefore modifying proposed § 1.20(g)(4)(ii) to provide an exception for Federal Reserve Banks from the requirement that depositories accepting customer funds from DCOs execute the Template Letter in Appendix B to § 1.20. Rather, a Federal Reserve Bank will be required only to execute a written acknowledgment that: (1) It was informed that the customer funds deposited therein are those of customers who trade commodities, options, swaps, and other products and are being held in accordance with the provisions of section 4d of the Act and Commission regulations thereunder; and (2) it agrees to reply promptly and directly to any request from the director of the Division of Clearing and Risk or the director of the Division of Swap Dealer and Intermediary Oversight, or any successor divisions, or such directors’ designees, for confirmation of account balances or provision of any other information regarding or related to an account. The Commission is modifying proposed § 1.20(g)(2) from ‘‘A [DCO] may deposit futures customer funds with a bank or trust company, which shall include a Federal Reserve Bank with respect to deposits of a systemically important [DCO]’’ to ‘‘A [DCO] may deposit futures customer funds with a bank or trust company, which may include a Federal Reserve Bank with respect to deposits of a [DCO] that is designated by the Financial Stability Oversight Council to be systemically important.’’ Changing the phrase ‘‘which shall include a Federal Reserve Bank’’ to ‘‘which may include a Federal Reserve Bank,’’ avoids possible ambiguity as to whether the DCO is required to deposit futures customer funds with a Federal Reserve Bank. By revising the description of the DCO, the Commission has effectively captured any DCO, such as one that is also registered with the SEC as a clearing agency and has been designated to be systemically important in that capacity, which could hold customer funds at a Federal Reserve Bank.201 201 For example, The Options Clearing Corporation is a registered DCO that has been designated as ‘‘systemically important’’ but is not a SIDCO as defined in § 39.2 of the Commission’s regulations. A Federal Reserve Bank would be required to segregate customer funds and provide an acknowledgment letter under § 1.20 with respect E:\FR\FM\14NOR2.SGM Continued 14NOR2 68536 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 d. Foreign Depositories In its comment letter, Eurex questioned whether foreign depositories could fully comply with the proposed regulations and execute the Template Letters, noting the probability of ‘‘strong resistance’’ by foreign depositories to providing the Commission with readonly electronic access to account information.202 Eurex pointed to the ‘‘detailed nature of the representations’’ in the Template Letters and further expressed its belief that foreign depositories would not be permitted to legally execute the Template Letters.203 Eurex recommended that the Commission consider alternative methods for achieving the goal of the Template Letters, such as authorizing Commission staff to ‘‘accept alternate language’’ from foreign depositories.204 FIA commented that it had not discussed the Template Letters with foreign depositories and thus did not know whether the Template Letters would ‘‘cause concern’’ under a foreign jurisdiction’s laws.205 The Commission appreciates these perspectives related to foreign depositories, but notes that the comments are of a general nature and do not provide any specific examples to support the commenters’ assertions. The Commission did not receive a comment letter from any foreign depository holding customer funds. As noted above, the FCA recently proposed the use of template acknowledgment letters for purposes of satisfying FCA acknowledgment letter requirements. The proposed letters are similar in many respects to the Template Letters the Commission is adopting herein, and FCA regulations would require both U.K. and non-U.K. depositories to execute the template acknowledgment letters. The Commission recognizes that there may be valid reasons why some foreign depositories would require modifications to the Template Letters. In such circumstances, the Commission would consider alternative approaches, including no-action relief, on a case-bycase basis. e. Release of Funds Upon Commission Instruction As proposed, the Template Letters would require a depository to release funds immediately upon instruction to any customer account subject to section 4d of the Act and opened by The Options Clearing Corporation in its capacity as a DCO. 202 Eurex Comment Letter at 1 (Aug. 1, 2013). 203 Id. at 2. 204 Id. 205 FIA Comment Letter at 40 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 from the director of the Division of Clearing and Risk, the director of the Division of Swap Dealer and Intermediary Oversight, or any successor divisions, or such directors’ designees. The purpose of this provision was to enable the Commission to expeditiously carry out measures to protect customer funds in exceptional circumstances, such as the imminent bankruptcy of an FCM. Commenters expressed concerns about this requirement, citing liability that might arise from a depository acting or failing to act ‘‘immediately,’’ 206 and the need for the depository to implement proper security and authorization procedures in connection with acting upon instructions from the Commission rather than the account holder.207 With respect to DCOs in particular, NYPC pointed out that a DCO normally holds customer funds in a segregated account without further subdivision by customer or clearing member and, as a result, a DCO would effectuate a transfer of customer funds from a defaulting clearing member to a non-defaulting clearing member by book entry on the DCO’s books and records.208 NYPC noted that no transfer of funds may be required if the DCO holds the funds at the same depository. The Depository Bank Group commented that the term ‘‘immediately’’ may subject a depository to potential claims by FCMs, DCOs or the Commission in the event of a delay in the transfer of customer funds, even if such delay is the result of reasonable actions or events beyond the control of the depository.209 As previously noted, the Federal Reserve Banks commented that during such ‘‘exceptional circumstances’’ in which instructions to transfer funds from a SIDCO’s account would likely be made, the FSOC would be involved.210 The Depository Bank Group, FIA, and Schwartz & Ballen all commented that the proposal is ‘‘inconsistent’’ with a depository’s security policies and procedures.211 CME requested that the Commission clarify the exceptional circumstances that would give rise to the Commission’s request for an immediate release of customer funds and the Bank Group Comment Letter at 10. at 11; Schwartz & Ballen Comment Letter at 2 (Feb. 15, 2013); Katten-FIA Comment Letter at 2 (Aug. 2, 2013). 208 NYPC Comment Letter at 2 (Feb. 15, 2013). 209 Depository Bank Group Comment Letter at 10 (Feb. 15, 2013). 210 Federal Reserve Banks Comment Letter at 1 (Feb. 22, 2013). 211 Id. at 11; Katten-FIA Comment Letter at 2 (Aug. 2, 2013); and Schwartz & Ballen Comment Letter at 5 (Feb. 15, 2013). impact such an instruction could have on the timely payment of obligations to a DCO.212 After considering the concerns raised by the commenters, the Commission has determined not to require depositories to agree to release or transfer customer funds upon its instruction. The Commission notes that in exceptional circumstances such as the imminent bankruptcy of an FCM, Commission staff would be in regular communication with the FCM, its DSRO, DCOs, and depositories in an effort to protect customer funds. f. Read-Only Access and Information Requests Proposed paragraphs (d)(3) and (g)(4)(iii) of § 1.20, proposed § 30.7(d)(3), and the proposed Template Letters, including the Template Letters for § 1.26 investments in money market mutual funds, would require depositories to provide the Commission with 24-hour, read-only electronic access to accounts holding customer funds. The Commission received eight comment letters on this requirement. As a preliminary matter, FIA noted that significant time for development would be necessary to implement such a requirement.213 Schwartz & Ballen observed that the read-only access approach conflicts with bank procedures used to provide account information to third parties, which typically involve allowing the customer to grant access to a third party, rather than the bank doing so.214 The Depository Bank Group and FIA also pointed out that Commission staff would be required to comply with the depository’s security policies and procedures.215 The Depository Bank Group recommended that the Template Letters expressly authorize the depository to provide access to the Commission and suggested language that could be incorporated into the Template Letters.216 RJ O’Brien agreed with the Depository Bank Group’s position on read-only access.217 FCStone noted that time differences and geographic locations may make it difficult for foreign commodity brokers to satisfy the 24-hour-a-day requirement and respond promptly to requests made 206 Depository 207 Id. PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 212 CME Comment Letter at 7 (Feb. 15, 2013). Comment Letter at 40 (Feb. 15, 2013). 214 Schwartz & Ballen Comment Letter at 4 (Feb. 15, 2013). 215 Depository Bank Group Comment Letter at 13 (Feb. 15, 2013); Katten-FIA Comment Letter at 2 (Aug. 2, 2013). 216 Depository Bank Group Comment Letter at 13 (Feb. 15, 2013). 217 RJ O’Brien Comment Letter at 11 (Feb. 15, 2013). 213 FIA E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations by the Commission.218 The Depository Bank Group commented that often a bank denies access during routine maintenance to technology systems, and asked that the Commission remove the ‘‘24-hour’’ requirement.219 NYPC commented that, because DCOs hold customer funds on behalf of all their clearing members in omnibus accounts that are not further subdivided by each customer, the account information to which the Commission would have access at a DCO’s depository ‘‘would not provide the level of detail that would permit reconciliation between either the DCO’s FCM clearing members or those clearing members’ underlying customers.’’ 220 In addition, Schwartz & Ballen contended that the requirement would not achieve the Commission’s goal of quickly identifying discrepancies between FCMreported balances and balances at a depository because the depository typically posts all credits and debits after the close of business.221 LCH.Clearnet recommended that the Commission consider ‘‘alternative approaches’’ for routine access to account balance information at depositories holding customer funds. For central banks, LCH.Clearnet suggested that the Commission should accept confirmation of balance information directly from the central bank in a form acceptable to the central bank, but it did not explain why central banks should be treated differently than other depositories. For other depositories, LCH.Clearnet believes the Commission should consider ‘‘following the lead of the [NFA].’’ 222 NFA pointed out that its board of directors had adopted a financial requirements rule in August 2012.223 NFA explained that instead of adopting a read-only access provision of its own in this rule, it instead chose to use, in conjunction with CME, an automated daily segregation confirmation system to monitor customer segregated and secured amount accounts and their balances.224 NFA requested that the Commission rescind its proposed readonly access requirement.225 With the goal of achieving the highest degree of customer protection, the Commission has determined to adopt, 218 FCStone Comment Letter at 5 (Feb. 15, 2013). Bank Group Comment Letter at 13 (Feb. 15, 2013). 220 NYPC Comment Letter at 2 (Feb. 15, 2013). 221 Schwartz & Ballen Comment Letter at 4 (Feb. 15, 2013). 222 LCH.Clearnet Comment Letter at 3 (Jan. 25, 2013). 223 NFA Comment Letter at 6 (Feb. 15, 2013). 224 Id. 225 Id. at 7. TKELleY on DSK3SPTVN1PROD with RULES2 219 Depository VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 with certain modifications, the requirement that a depository agree to provide the Commission with read-only access to accounts maintained by an FCM. Regulations 1.20(d)(3) and 30.7(d)(3) require the depository to agree to provide the Commission with ‘‘the technological connectivity, which may include provision of hardware, software, and related technology and protocol support, to facilitate direct, read-only electronic access to transaction and account balance information.’’ In the Template Letters, the parties further acknowledge and agree that the connectivity has either been provided (in the case of a new letter that covers existing accounts) or will be provided promptly following the opening of the account(s) (with respect to new accounts). However, the Commission is not requiring read-only electronic access for an FCM’s DSRO, as proposed. The Commission was advised by the DSROs that they intend to rely on the NFA and CME automated daily segregation confirmation system. The Commission does not anticipate that its staff would access FCM accounts on a regular basis to monitor account activity; rather, staff would make use of the read-only access only when necessary to obtain account balances and other information that staff could not obtain via the NFA and CME automated daily segregation confirmation system, or otherwise directly from the depositories, as discussed below. In this regard, the CME and NFA will provide the Commission on a daily basis with the account balances reported to them by each depository holding customer funds, under the CME and NFA’s daily confirmation process. In addition, as discussed in section N below, each FCM that completes a daily Segregation Schedule, Secured Amount Schedule, and/or Cleared Swaps Segregation Schedule will be required to file such schedules with the Commission on a daily basis. The Commission anticipates that the combination of receipt of daily account balances reported by depositories and the Commission’s ability to confirm account balances and transactions directly with depositories will diminish the need to rely upon direct electronic access to account information at depositories. With respect to depositories holding customer funds in accounts maintained by a DCO, the Commission has decided not to adopt the electronic access requirement. Given that DCOs hold omnibus customer accounts that are not subdivided by clearing member or individual customer, read-only access to a DCO’s customer account would not PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 68537 provide the kind of information that would identify inaccuracies in FCM reporting. Accordingly, proposed § 1.20(g)(4)(iii), which would require a DCO to deposit futures customer funds only with a depository that provides read-only access to the Commission, is not being adopted, and the remaining subparagraphs of § 1.20(g)(4) are renumbered accordingly. The Commission also is adopting §§ 1.20(d)(6), 1.20(g)(4)(iv), and 30.7(d)(6), which require an FCM or DCO to deposit customer funds only with a depository that agrees to reply promptly and directly to any request from the director of the Division of Swap Dealer and Intermediary Oversight, the director of the Division of Clearing and Risk, or any successor divisions, or such directors’ designees,226 (or, in the case of an FCM, an appropriate officer, agent or employee of the FCM’s DSRO), for confirmation of account balances or provision of any other information regarding or related to an account, without further notice to or consent from the FCM or DCO.227 For DCOs, the Commission believes that this ability, in addition to the daily reporting of various accounts by customer origin pursuant to § 39.19(c)(1), will enable it to verify DCO account balances with a depository as necessary. 226 Proposed §§ 1.20(d)(5) and (g)(4)(v) and 30.7(d)(5) would require the depository to reply promptly and directly to ‘‘the Commission’s’’ requests, and the authority to make such requests was delegated to the director of the Division of Swap Dealer and Intermediary Oversight and the director of the Division of Clearing and Risk under proposed § 140.91(a)(7) and (11). The proposed Template Letters would require the depository to agree ‘‘to respond promptly and directly to requests for confirmation of account balances and other account information from an appropriate officer, agent, or employee of the CFTC’’ and ‘‘immediately upon instruction by the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC or the director of the Division of Clearing and Risk of the CFTC, or any successor divisions, or such directors’ designees . . . provide any and all information regarding or related to the Funds or the Accounts as shall be specified in such instruction and as directed in such instruction.’’ The Commission is revising the rule text and the Template Letters so that all such requests will come from the director of the Division of Swap Dealer and Intermediary Oversight or the director of the Division of Clearing and Risk, or any successor divisions, or such directors’ designees. 227 To assist a depository in verifying authority and authenticating identity in connection with a request for information or electronic access, the Commission intends to post on its Web site an upto-date list of names (including title and contact information) of the directors of the Division of Swap Dealer and Intermediary Oversight and the Division of Clearing and Risk, or any successor divisions, and the directors’ designees, if any, for the relevant purpose. E:\FR\FM\14NOR2.SGM 14NOR2 68538 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 g. Requirement To File New Acknowledgment Letters Proposed paragraphs (d)(7) and (g)(4)(vii) of § 1.20 and proposed § 30.7(d)(7) would require FCMs and DCOs to file amended acknowledgment letters with the Commission upon a change to a depository’s name or other information specified in the regulation. The Commission received three comments on this requirement. Schwartz & Ballen recommended that the Commission remove this requirement from the Template Letters and instead include ‘‘binding effect’’ language to ensure that the counterparties remain subject to the terms of the acknowledgment letter even if a party’s name has changed.228 LCH.Clearnet recommended a sixmonth timeframe after the publication of these rules by which DCOs and FCMs must obtain acknowledgment letters.229 NYPC commented that the proposed requirements impose ‘‘an onerous periodic validation process with depositories’’ and, given this, it suggested that depositories provide written notice to a DCO of a name or address change no later than 30 days after any such change in order to permit a DCO to execute a new Template Letter.230 The Commission believes that acknowledgment letters should be as current and up-to-date as possible in order to maintain the clear legal status of the customer account, which will better protect customers in the event of an FCM failure. Accordingly, the Commission is adopting (renumbered) §§ 1.20(d)(8) and (g)(4)(vi) and 30.7(d)(8) as proposed, except that instead of providing for an ‘‘amended’’ letter, the regulation requires that a ‘‘new’’ letter be executed. The purpose of this technical change is to avoid problems in locating the accounts covered by a single letter that has been amended multiple times to reflect various changes. The Commission expects that a depository would notify account holders of a name change as a matter of practice and does not believe that it is too burdensome to expect a DCO or FCM to be aware of such changes. Any new acknowledgment letter reflecting a change enumerated in the regulation must be executed within 120 days of such changes, and then filed with the Commission within three business days of executing the new letter. 228 Schwartz & Ballen Comment Letter at 7 (Feb. 15, 2013). 229 LCH.Clearnet Comment Letter at 4 (Jan. 25, 2013). 230 NYPC Comment Letter at 4 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 The Commission also is adopting (renumbered) §§ 1.20(d)(7) and (g)(4)(v) and 30.7(d)(7), which require an FCM or DCO to submit a copy of the acknowledgment letter to the Commission within three business days of the opening of an account or obtaining a new acknowledgment letter for an existing account; and §§ 1.20(d)(4) and (g)(4)(iii) and 30.7(d)(4), which require an FCM or DCO to deposit customer funds only with a depository that agrees to provide a copy of the acknowledgment letter to the Commission (and, in the case of an FCM, the FCM’s DSRO) within the same time frame.231 The Commission is, however, giving FCMs, DCOs, and depositories 180 days from the effective date of the final rules to replace existing acknowledgment letters with new ones that conform to the Template Letters. As an additional matter, the Commission advises that it expects an FCM or DCO to follow customary authorization verification and signature authentication policies and procedures to ensure that an acknowledgment letter is executed by an individual authorized to bind the depository to the terms of the letter, and that the signature that appears on the letter is authentic. For example, an FCM or DCO may request from the depository a list of authorized signatories, a duly executed power of attorney, or other such documentation. h. Standard of Liability The proposed Template Letters would provide that a depository ‘‘may conclusively presume that any withdrawal from the Account(s) and the balances maintained therein are in conformity with the Act and CFTC regulations without any further inquiry, provided that [the depository has] no notice of or actual knowledge of, or could not reasonably know of, a violation of the Act or other provision of law by [the FCM or DCO]; and [the depository] shall not in any manner not expressly agreed to [in the letter] be responsible for ensuring compliance by [the FCM or DCO] with the provisions of the Act and CFTC regulations.’’ The Depository Bank Group commented that this ‘‘standard of liability’’ provision would impose a burden beyond that currently expected of depository institutions.232 In this regard, the Depository Bank Group asserted that the phrase ‘‘violation of the Act or other provision of law’’ 231 The acknowledgment letter must be executed upon the opening of the account, regardless of when customer funds are deposited in the account. 232 Depository Bank Group Comment Letter at 3 (Feb. 15, 2013). See also RJ O’Brien Comment Letter at 11 (Feb. 15, 2013). PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 encompasses much more than section 4d of the Act and would effectively require that the depository monitor and ensure the FCM’s or DCO’s compliance with all other laws, even those unrelated to the deposit of customer funds.233 The Depository Bank Group further contended that the proposed standard, ‘‘could not reasonably know of a violation’’ would likely be read to require depositories to ‘‘perform some undefined level of diligence’’ which would be highly problematic.234 The Depository Bank Group also stated that this requirement would likely delay transfers or withdrawals, and result in depositories passing on related costs to FCMs and DCOs and, in turn, to their clients, although the Depository Bank Group did not quantify the costs.235 FIA similarly expressed concern that the requirement could cause delays and increased costs, again, without providing specific details and quantifying costs.236 Schwartz & Ballen asserted that banks have no ability to determine what uses an FCM is making of funds it withdraws from the account.237 As noted above, the Federal Reserve Banks, which may act as depositories for Designated FMUs, commented that the ‘‘actual knowledge’’ standard, which typically imputes knowledge to a legal person as a whole, is not feasible for them because of the Board policy to not share supervisory information with Federal Reserve Bank personnel performing financial services. In response to concerns expressed by commenters, the Commission clarifies that it does not intend to use the Template Letters as means to expand the scope of a depository’s liability to FCM or DCO account holders, or to alter the responsibility that an FCM or DCO bears for its own compliance with the customer funds segregation requirements under the Act and Commission regulations. The use of standardized acknowledgment letters is intended to promote a uniform understanding among FCMs, DCOs, and depositories as to their obligations under the Act and Commission regulations with respect to the proper treatment of customer funds. In light of the public comments, the Commission is revising the language in the Template 233 Depository Bank Group Comment Letter at 5 (Feb. 15, 2013). See also Katten-FIA Comment Letter at 2 (Aug. 2, 2013); Schwartz & Ballen Comment Letter at 6 (Feb. 15, 2013); and CME Comment Letter at 7 (Feb. 15, 2013). 234 Depository Bank Group Comment Letter at 3 (Feb. 15, 2013). 235 Id. at 5. 236 FIA Comment Letter at 40 (Feb. 15, 2013). 237 Schwartz & Ballen Comment Letter at 6 (Feb. 15, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations Letters to more precisely articulate the intended scope of the depository’s responsibility. The provision, as adopted, reads as follows: ‘‘You [the depository] may conclusively presume that any withdrawal from the Account(s) and the balances maintained therein are in conformity with the Act and CFTC regulations without any further inquiry, provided that, in the ordinary course of your business as a depository, you have no notice of or actual knowledge of a potential violation by us of any provision of the Act or CFTC regulations that relates to the segregation of customer funds; and you shall not in any manner not expressly agreed to [in the letter] be responsible to us [the FCM or DCO] for ensuring compliance by us with the provisions of the Act and CFTC regulations; however, the aforementioned presumption does not affect any obligation you may otherwise have under the Act or CFTC regulations.’’ Changes from the proposed language are discussed below. The Depository Bank Group recommended inserting the phrase ‘‘in the ordinary course of your business as a depository,’’ and the Commission has accepted this recommendation to clarify the context in which the presumption of the FCM’s or DCO’s compliance is effective. As proposed, the presumption would be effective so long as the depository has ‘‘no notice of or actual knowledge of, or could not reasonably know of, a violation.’’ Given the concerns expressed by commenters as to the implications of the ‘‘reasonably know’’ standard, the Commission has determined to eliminate that clause in the final Template Letters. In considering the various circumstances in which the conclusive presumptions would no longer be effective, the Commission has determined that the proposed reference to notice or actual knowledge of a ‘‘violation,’’ does not adequately capture all of the relevant circumstances. This is because the depository might receive information that calls into question the conduct of the FCM or DCO account holder, but it might not be apparent whether or not the activity rises to the level of being an actual violation of the law. Indeed, some actions will not be deemed to be ‘‘violations’’ until a judicial decision is rendered. As a result, the Commission has revised the language to refer to a ‘‘potential violation’’ so as not to inadvertently exclude circumstances which would warrant further inquiry by a depository. The Commission agrees that the broad reference to ‘‘the Act and CFTC regulations’’ should be narrowed with VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 respect to the description of the potential violation. Therefore, the Commission is adopting the Depository Bank Group’s suggestions that the reference to the violation specify that it is limited to ‘‘any provision of the Act or the CFTC regulations that relates to the segregation of customer funds.’’ The Commission has made a similar change in the 30.7 Template Letters, referring to ‘‘any provision of the Act or Part 30 of the CFTC regulations that relates to the holding of customer funds.’’ This more precisely identifies the legal requirements that are the subject of the parties’ obligations and the acknowledgment letter as a whole. As an additional matter, the Commission has added to the standard of liability provision the following proviso: ‘‘however, the aforementioned presumption does not affect any obligation you may otherwise have under the Act or CFTC regulations.’’ This statement affirms the depository’s understanding that its statutory and regulatory obligations with respect to the customer funds on deposit are not limited by the presumption upon which it relies in its dealings with FCM or DCO account holders. The Commission notes that a depository’s obligation to comply with the segregation requirements under section 4d of the Act is explicitly imposed upon depositories by section 4d(b) of the Act,238 and legal precedent has established a standard of liability to which the Commission holds depositories and which is not dependent upon affirmation in the Template Letters. The Commission reaffirms its long-held position that the depository will be held liable for the improper transfers of customer funds by an FCM or DCO if it knew or should have known that the transfer was improper.239 The Commission recognizes that a depository’s treatment of customer funds may be limited in particular circumstances on the basis of what it knows or reasonably should know of a 238 Section 4d(b) of the Act explicitly provides that it is unlawful for any clearing agency of a contract market and any depository that has received customer funds to hold, dispose of, or use any such funds as belonging to the depositing FCM or any person other than the customers of such FCM. See also section 4d(f)(6) of the Act (applying the same requirement to Cleared Swaps Customer Collateral). 239 See, e.g., CFTC Interpretative Ltr. No. 79–1, [1977–1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶20,835 (May 29, 1979) at page 2. As long ago as 1979, the Commission found that ‘‘if a bank, with prior notice, permits or acquiesces in the withdraw [sic] or use of customers’ funds by a futures commission merchant for an unlawful purpose, the bank would violate or be aiding and abetting a violation of the Act.’’ PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 68539 violation of the Act that would preclude it from obtaining rights to such funds superior to those of one or more customers of the defaulting FCM.240 Such a violation could occur, for example, in circumstances in which the depository received particular margin funds with actual knowledge, or in circumstances in which it is reasonable to conclude that the depository should have known, that the depositing FCM or DCO has breached its duty under section 4d. The depository’s participation in such use of customer funds could subject it to liability for violating section 4d or aiding and abetting a violation of the Act under section 13(a) of the Act (7 U.S.C. 13c).241 The Commission emphasizes that while the depository has no affirmative obligation to police or monitor an FCM or DCO account holder’s compliance with the Act or Commission regulations, the depository cannot ignore signs of wrongdoing. Should a depository know or suspect that funds held in a customer account have been improperly withdrawn or otherwise improperly used in violation of section 4d of the Act or the Commission’s regulations related to segregation of customer funds, the Commission expects the depository to immediately report its concern to the Division of Swap Dealer and Intermediary Oversight, the Division of Clearing and Risk, the Division of Enforcement, or the Commission’s Whistleblower Office.242 i. Liens The proposed Template Letters would include the following language: ‘‘Furthermore, [the depository] 240 See CFTC Interpretative Ltr. No. 86–9, [1986– 1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶23,015 (April 21, 1986) (limiting a bank’s treatment of customer margin funds ‘‘in particular circumstances by reason of what it knows or reasonably should know of a violation of the Act or other provision of law that would preclude it from obtaining rights to such funds superior to those of one or more customers of the defaulting FCM.’’). 241 Id. See also CFTC Interpretative Statement. No. 85–3 [1984–1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶22,703 (Aug. 12, 1985). A DCO’s rights with respect to the use of customer margin funds may be limited in particular circumstances by reason of the clearing organization’s knowledge of or participation in a violation of the Act or other provision of law that precludes it from obtaining rights to such funds superior to those of one or more customers of the defaulting clearing member. The letter provides that a DCO could be subject to aiding and abetting liability under section 13(a) of the Act if the DCO knowingly participates in a violation of the Act. 242 See CFTC Interpretative Ltr. No. 79–1 (stating ‘‘if a bank subsequently becomes aware of an unauthorized withdrawal or use of customers’ funds by an FCM, we would expect the bank to notify the Commission immediately’’). E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68540 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations acknowledge[s] and agree[s] that such Funds may not be used by [the depository] or by [the FCM or DCO] to secure or guarantee any obligations that [the FCM or DCO] might owe to [the depository], nor may they be used by [the FCM or DCO] to secure credit from [the depository]. [The depository] further acknowledge[s] and agree[s] that the Funds in the Account(s) shall not be subject to any right of offset or lien for or on account of any indebtedness, obligations or liabilities [the FCM or DCO] may now or in the future have owing to [the depository]. This prohibition does not affect [the depository’s] right to recover funds advanced in the form of cash transfers [the depository] make[s] in lieu of liquidating non-cash assets held in the Account(s) for purposes of variation settlement or posting initial (original) margin.’’ This language is consistent with section 4d(b) of the Act, which states: ‘‘It shall be unlawful for any person, including but not limited to . . . any depository, that has received any money, securities, or property for deposit in a separate account as provided in [section 4d(a)(2) of the Act], to hold, dispose of, or use any such money, securities, or property as belonging to the depositing [FCM] or any person other than the customers of such [FCM].’’ Schwartz & Ballen asserted that because many FCMs hold only cash assets in the accounts, the language in the letter should be expanded to permit banks to recover funds they advance that result in overdrafts in the accounts.243 Schwartz & Ballen further stated that the failure to permit banks to recover such advances whether or not there are non-cash assets in the account will likely lead to banks incurring losses.244 FCStone elaborated on this issue, explaining that a customer receives a margin call through an account statement, which is transmitted overnight, and the customer wires funds the following day.245 The DCO, however, automatically drafts the funds from the FCM’s account at 9:00 a.m. on the basis of a depository’s intraday daylight overdraft.246 Without granting a depository a lien on customer funds, FCStone stated that an FCM would be required to ‘‘front’’ all funds for customers until the customer has wired funds to the FCM.247 FCStone contended that a change of this sort 243 Schwartz & Ballen Comment Letter at 6–7 (Feb. 15, 2013). 244 Id. 245 FCStone Comment Letter at 4. 246 Id. 247 Id. at 5. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 could ‘‘threaten the continued operations of small to mid-sized FCMs not affiliated with banks’’ and cause a substantial liquidity strain.248 The Depository Bank Group additionally warned that a depository may not be willing to provide intraday advances to the customer segregated account without the right to take a lien on the account or the right to set off between multiple customer segregated accounts and would, therefore, not be in a position to provide liquidity.249 As a result, an FCM or DCO would likely need to maintain a buffer of its own funds in the segregated customer accounts to fully pre-fund transactions related to such accounts.250 The Depository Bank Group contended that the impact on small- to mid-sized FCMs would be that of a lesser ability to enter into ‘‘everyday transactions’’ for the customer segregated account, which could result in exclusion from the industry.251 The Depository Bank Group cited as support a comment letter that staff of the Federal Reserve Bank of Chicago submitted in 2010.252 The Commission recognizes that a depository may not want to provide unsecured overdraft coverage. However, a depository taking a lien on a customer account to facilitate intraday payments presents a serious problem if an FCM’s customer does not satisfy a margin call and the FCM, in turn, cannot cover the call and becomes insolvent before the depository can be repaid. The Commission interprets the requirements of section 4d of the Act to prohibit a lien on customer funds to satisfy an intraday extension of credit to an FCM to meet margin requirements at a DCO. As an alternative to taking a lien on the customer account, the depository could take a lien on a proprietary account held by the FCM at the depository, or the FCM could add its own funds to the segregated account or collect more margin from its customers in order to provide a more substantial financial cushion. It is not the Commission’s intention to disadvantage mid-size and smaller FCMs in applying this standard across all FCMs, regardless of size. The Commission notes that no commenter has proffered information or data that would indicate intraday advances are a commonplace, routine occurrence. Indeed, it may be cause for 248 Id. 249 Depository Bank Group Comment Letter at 7 (Feb. 15, 2013). 250 Id. 251 Id. 252 Comment letter from David A. Marshall, Federal Reserve Bank of Chicago, dated September 8, 2010. PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 concern if a large number of FCMs cannot meet intraday margin calls for customer accounts on a regular basis. Without expressing a view of the Commission’s position concerning section 4d of the Act, FIA recommended expanding the circumstances in which a depository could impose a lien with respect to customer funds.253 FIA recommended revising the language to read: ‘‘You further acknowledge and agree that the Funds in the Account(s) shall not be subject to any right of offset or lien for or on account of any indebtedness, obligations or liabilities we may now or in the future have owing to you except to recover from the Account(s) (or from any other CFTC Regulation 1.20 Customer Segregated Account(s) we have with you), Funds you may advance from time to time to facilitate transactions by or on behalf of, or on account of, or otherwise for the benefit of, the Account(s) or our customers whose Funds are held in the Account(s).’’ 254 The Commission confirms that a depository can possess a lien across multiple accounts of the same FCM as long as the accounts are of the same account class (i.e., 4d(a) cash and custodial accounts). However, the Commission believes FIA’s suggested modification is overbroad and has the potential to be interpreted to permit a depository’s imposition of a lien in a greater number of circumstances than section 4d of the Act allows. NYPC urged the Commission to clarify that DCOs have the right to transform non-cash customer funds into cash to satisfy liquidity needs related to the customer account of a defaulting FCM clearing member not only through the sale of such assets, but also through the use of liquidity arrangements, such as lines of credit and repurchase agreements.255 NYPC recommended that the Commission modify the last sentence in the ‘‘lien’’ paragraph as follows: ‘‘The prohibitions contained in this paragraph do not affect your right to recover funds advanced by you in the form of cash transfers, lines of credit, repurchase agreements or other similar liquidity arrangements in lieu of the liquidation of non-cash assets held in the Account(s) for purposes of variation settlement or posting initial (original) margin with respect to the Account(s).’’ The Commission recognizes that liquidity arrangements are an important aspect of a DCO’s default management plan and agrees that the use of lines of 253 Katten-FIA Comment Letter at 2 (Aug. 2, 2013). 254 Id. 255 NYPC Comment Letter at 3 (Feb. 15, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 credit or repurchase agreements are acceptable alternatives to the liquidation of non-cash assets held in a customer account. As a result, the Commission has determined to modify the sentence in a manner similar to that recommended by NYPC. In response to the other comments, the Commission notes that it has always interpreted and applied section 4d of the Act in a manner consistent with the language in the proposed Template Letters. With respect to a depository’s right of setoff against a customer account, the Commission has long recognized only one very limited circumstance. CFTC Interpretative Letter No. 86–9 allows, with certain limitations,256 a bank’s right of setoff against a customer cash account that does not have sufficient available balances to meet a margin call, where there exists an affiliated custodial account that contains securities purchased with funds from the customer cash account.257 In this case, there is no extension of credit because the accounts, when aggregated, have enough assets to support the cash advance. The Depository Bank Group raised a question about similar circumstances in which a depository might set off amounts owed to a customer segregated account holding U.S. dollars, with amounts held in foreign currency in another customer segregated account.258 To the extent that a depository advances cash in lieu of exchanging foreign currency held in a related 4d account, the same rationale that serves as the basis for CFTC Interpretative Letter No. 86–9 would apply, i.e., the advancement of funds does not represent an extension of credit secured by customer funds. The Commission confirms that a depository holding customer funds in one segregated account may set off amounts withdrawn from another account in cases where the depository advances funds in lieu of converting cash in one currency to cash in a different currency. The Template Letters provide for a depository’s right of setoff against the customer account consistent with Interpretative Letter No. 86–9. The Commission believes that expanding the 256 See CFTC Interpretative Ltr. No. 86–9, [1986– 1987 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶23,015 (April 21, 1986) (limiting a bank’s treatment of customer margin funds ‘‘in particular circumstances by reason of what it knows or reasonably should know of a violation of the Act or other provision of law that would preclude it from obtaining rights to such funds superior to those of one or more customers of the defaulting FCM.’’). 257 Id. 258 Id. at 8. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 scope of a depository’s right of setoff to support extensions of credit to an FCM would violate the requirements of section 4d of the Act and notes that none of the commenters provided a legal analysis that would refute this position. The Commission recognizes, however, that there may be situations similar to those specifically enumerated in the proposed Template Letters for which an advancement of cash and the related imposition of a lien in lieu of liquidating non-cash assets or converting cash in one currency to cash in a different currency may be permissible. To accommodate this, the Commission is revising the language to remove the concluding clause, ‘‘for the purposes of variation settlement or posting initial (original) margin.’’ This change preserves the intended meaning and purpose of the provision without unintentionally limiting its application in other similar circumstances. Accordingly, the Commission is adopting the proposed ‘‘lien’’ language of the Template Letters, modified to include a reference to the depository’s right to recover funds related to certain liquidity arrangements and to eliminate specific examples of circumstances in which imposition of a lien would be permissible. FCMs, DCOs, and depositories are reminded that any permissible advancement of cash and related imposition of a lien on a customer account must be properly documented and recorded in compliance with all applicable recordkeeping requirements. j. Examination of Accounts As proposed, the Template Letters for both FCMs and DCOs would require a depository to agree that accounts holding customer segregated funds could be ‘‘examined at any reasonable time’’ by the Commission or, as applicable, an FCM’s DSRO, and they further provide that the acknowledgment letter ‘‘constitutes the authorization and direction of the undersigned to permit any such examination or audit to take place.’’ Schwartz & Ballen commented that the provision should also provide for the Commission or DSRO to give the depository advance notice before being permitted to examine FCM accounts.259 The Commission is not including this recommended precondition because an examination of this type is likely to be conducted only in response to exigent circumstances and the ‘‘reasonable time’’ provision is sufficient evidence of 259 Schwartz & Ballen Comment Letter at 7 (Feb. 15, 2013). PO 00000 Frm 00037 Fmt 4701 Sfmt 4700 68541 the Commission’s intent to proceed in a commercially reasonable manner under the particular circumstances. The Commission is retaining the examination provision in the FCM Template Letters but is not including it in the DCO Template Letters. Consistent with the Commission’s determination regarding electronic access to DCO account information, the Commission believes that authorization to examine a DCO’s customer segregated account at a depository is not necessary because of the Commission’s ability to obtain account information directly from the depository upon request, and directly from the DCO through daily reporting under § 39.19(c)(1). As a technical matter, the Commission is eliminating use of the term ‘‘audit’’ to clarify that the examination will be targeted and is not intended to be an audit, as that term is used in the field of accounting. 5. Prohibition against Commingling Customer Funds The Commission proposed to amend § 1.20(e) to explicitly address the commingling of customer funds. Proposed § 1.20(e)(1) provides that an FCM may, for convenience, commingle the funds that it receives from, or on behalf of, multiple futures customers in a single account or multiple accounts with one or more of the permitted depositories set forth in § 1.20(b). Proposed § 1.20(e)(2) prohibits an FCM from commingling futures customers funds with any proprietary funds of the FCM, or with any proprietary account of the FCM. Proposed § 1.20(e)(2), however, provides that the prohibition on the commingling of futures customer funds and the FCM’s proprietary funds does not prohibit an FCM from depositing proprietary funds into segregated accounts in accordance with proposed § 1.23 as a buffer to prevent the firm from becoming undersegregated due to normal business activities, such as daily margin payments by the FCM to a DCO. Proposed § 1.20(e)(3) further prohibits an FCM from commingling futures customer funds with funds deposited by 30.7 customers for trading foreign futures or foreign option positions in accordance with part 30 of the Commission’s regulations, or with Cleared Swaps Customer Collateral deposited by Cleared Swaps Customers for Cleared Swaps under part 22 of the Commission’s regulations. Proposed § 1.20(e)(3) permits, however, the commingling of futures customer funds with 30.7 customer funds and/or Cleared Swaps Customer funds if expressly permitted by a Commission E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68542 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations regulation or order, or by a DCO rule approved in accordance with § 39.15(b)(2) of the regulations.260 Similarly, a proposed amendment to § 30.7 would prohibit an FCM from commingling funds required to be deposited in a foreign futures and foreign options secured amount account with funds required to be deposited in a customer segregated account or cleared swaps customer account.261 The Commission received one comment on the proposed amendments to § 1.20(e). FIA stated that it fully supported the proposed amendments, which implement the segregation provisions of section 4d(a) and 4d(f) of the Act.262 FIA further requested that the Commission confirm that the proposed amendments would not prohibit a customer that engages in futures transactions on a designated contract market, foreign futures or options transactions on foreign boards of trade, and Cleared Swaps through a single FCM, from meeting its margin obligations for the three different segregation accounts by making a single payment to the FCM.263 FIA states that such practice is common in the industry today, reduces the FCM’s credit risk, is operationally more efficient for both the FCM and its customers, and indirectly reduces customer settlement risk.264 The Commission confirms, subject to the following conditions, that a receipt of funds from a customer that wishes to meet its multiple margin obligations by making a single deposit payment to the FCM is not prohibited by § 1.20. The FCM, however, must initially receive the customer’s funds into the customer’s section 4d(a)(2) segregation account. The funds may not be directly deposited into the customer’s § 30.7 secured account or Cleared Swaps Segregation Account, as such accounts may present different risks than the section 4d(a)(2) account, and the Commission would like to standardize operationally the practice of how customer funds are received by FCMs by authorizing one approach that would be applicable to all customers to minimize the possibility of transactional errors. In addition, the FCM must simultaneously record the book entry credit to the customer’s § 30.7 secured account and the customer’s Cleared Swaps Account (as applicable) as directed by the customer upon the 260 Regulation 22.2(c)(2) regarding cleared swaps customer accounts already prohibits commingling. 261 Proposed § 30.7(e)(3). 262 FIA Comment Letter at 36 (Feb. 15, 2013). 263 Id. 264 Id. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 receipt and recording of the cash into the customer’s 4d(a)(2) segregation account. Also, the FCM must ensure at the time the book entry credit is made to the customer’s account, that the credit does not result in the FCM having obligations to 30.7 customers or Cleared Swaps Customers that are in excess of the total assets held in such accounts for such customers. Failure of the FCM to hold a sufficient amount of excess funds in the 30.7 customer accounts and Cleared Swaps Customer Accounts at any time to meet its obligations to such customers would be a violation of the Act and the Commission’s regulations. Furthermore, if the FCM permits customers to use one wire transfer to fund more than one account class, the FCM’s policy and procedures for assessing the appropriate amount of targeted residual interest required under § 1.11 must take this practice into consideration and should include appropriate adjustments and estimates to reflect this practice. Finally, the Commission hereby clarifies that all prior guidance concerning the receipt of customer deposits at branch locations or otherwise deposited into the FCM’s proprietary accounts, regardless of excess funds held in segregation, is repealed and withdrawn and such practice is not permitted under § 1.20 as adopted.265 The Commission adopts the amendment as proposed. 6. Limitations on the Use of Customer Funds Proposed § 1.20(f) requires FCMs to treat and deal with the funds of a futures customer as belonging to such futures customer. In addition, the Commission proposed to prohibit an FCM from using, or permitting the use of, the funds of futures customer for any person other than for futures customers, subject to certain limited exceptions. Proposed § 1.20(f) also states that an FCM may obligate futures customers’ funds to a DCO or another FCM solely to purchase, margin, or guarantee futures and options positions of futures customers, and that no person, including any DCO or any depository, that has received futures customer funds for deposit in a segregated account, may hold, dispose of, or use any such funds 265 Previous guidance permitted a branch office of an FCM to deposit customer funds into an unsegregated bank account if the main office of the FCM on the same day deposited the same amount of its funds into a segregated bank account, and kept records fully explaining the transactions. See Commodity Exchange Authority Administrative Determination No. 203 (December 1, 1966). See also CFTC Interpretative Letter No. 90–7 (Secured Amount Account for Foreign Futures and Options, May 1, 1990). This practice is now prohibited. PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 as belonging to any person other than the futures customers of the FCM that deposited such funds. The Commission did not receive any comments regarding proposed § 1.20(f). However, as discussed above, the FIA stated that it agrees that FCMs are required to comply with the segregation provisions of the Act at all times, and expressed general support for the Commissions efforts to implement the Act’s segregation provision.266 The Commission notes that the language in proposed § 1.20(f) largely mirrors the language set forth in current § 1.20, which language was, and continues to be, intended to further implement the segregation provisions of the Act.267 Thus, the Commission is adopting the provision as proposed. 7. Segregation Requirements for DCOs Proposed § 1.20(g) provides segregation requirements applicable to DCOs, as opposed to FCMs. Proposed paragraph (g)(2) lists the permitted depositories for futures funds received by a DCO as any bank or trust company, and clarifies that the term ‘‘bank’’ includes a Federal Reserve Bank. The necessity for this proposed amendment is highlighted by section 806(a) of the Dodd-Frank Act, which provides that a Federal Reserve Bank may establish and maintain a deposit account for a ‘‘financial market utility’’ (in the present case, a DCO) that has been designated as systemically important by the Financial Stability Oversight Council. Proposed paragraph (g)(3) requires DCOs to comply with the provisions of § 1.49 with respect to holding segregated funds outside the U.S. Regulation 1.20(g)(5) prohibits a DCO from commingling futures customer funds with the DCO’s proprietary funds or with any proprietary account of any of its clearing members, and prohibits the DCO from commingling funds held for futures customers with funds deposited by clearing members on behalf of their 266 FIA Comment Letter at 2 (June 20, 2013). See also section II.G.1. above for a further discussion of an FCM’s obligation to be in compliance with its segregation obligation at all times. 267 Accordingly, relevant prior Commission orders and guidance will continue to apply to § 1.20(f). For example, in In re JPMorgan Chase Bank CFTC 12–17 (April 4, 2012), the Commission simultaneously initiated and settled an action against a depository for violating § 1.20(a) and (c) because it unlawfully used customer funds as belonging to someone other than the customers of an FCM. Specifically, the Commission found that a depository’s intra-day extension of credit to an FCM (Lehman Brothers) based upon customer funds the FCM had deposited with a bank (JPMorgan Chase) violated § 1.20(a) and (c). Regulation 1.20(f) would continue to prohibit such use of customer funds, as well as any other type of disposal, holding or use the Commission has previously identified as unlawful. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations Cleared Swaps Customers. DCOs would be permitted to commingle the funds of multiple futures customers in a single account or accounts for operational convenience. The Commission adopts the amendment as proposed. TKELleY on DSK3SPTVN1PROD with RULES2 8. Immediate Availability of Bank and Trust Company Deposits The Commission proposed a paragraph (h) to § 1.20 to require that all futures customer funds deposited with a bank or trust company must be deposited in accounts that do not impose any restrictions on the ability of the FCM or DCO to withdraw such funds upon demand. An FCM or DCO may not deposit customer funds in any account with a bank or trust company that does not, by the terms of the account or operation of banking law, provide for the immediate availability of such deposits upon the demand of the FCM or DCO. Paragraph (h) codifies a long-standing interpretation of the Commission’s Division of Swap Dealer and Intermediary Oversight and predecessor divisions derived from an Administration Determination by the Commission’s predecessor, the Commodity Exchange Authority of the U.S. Department of Agriculture.268 The requirement, as proposed, is a practical necessity to the effective functioning of FCMs and futures markets. In this regard, customer funds deposited with a bank must be maintained in accounts that allow for the immediate availability of the funds in order for the FCM to be assured of meeting its obligation to make any necessary transfers of customer funds to a DCO or to return funds to customers upon their request. The Commission is adopting paragraph (h) as proposed.269 268 See Administrative Determination No. 29 of the Commodity Exchange Authority dated Sept. 28, 1937 stating, ‘‘the deposits, by a futures commission merchant, of customers’ funds * * * under conditions whereby such funds would not be subject to withdrawal upon demand would be repugnant to the spirit and purposes of the Commodity Exchange Act. All funds deposited in a bank should in all cases be subject to withdrawal on demand.’’ 269 CIEBA noted it is comment letter that industry groups are involved in various initiatives to provide customers with the option for full physical segregation of margin collateral, and requested confirmation that § 1.20(h) would not prohibit the use of a full segregation model if developed. See CIEBA Comment Letter at 4 (Feb. 20, 2013). The Commission encourages industry groups to continue to assess alternatives to the current segregation structure in an effort to provide greater protection of customer funds and to ensure the effective operation of the clearing and settlement functions. Regulation 1.20(h) is intended to prohibit situations where an FCM or DCO deposits customer funds into an account that by law or operation limits or potentially limits the FCM’s or DCO’s ability to withdraw the funds from the account for VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 9. Segregated Funds Computation Requirement The Commission proposed to add a new paragraph (i), which mirrored the requirements recently adopted in part 22 for Cleared Swaps Customers. Proposed paragraph (i) was designed to implement, with increased detail, the Net Liquidating Equity Method of calculating segregation requirements. A customer may have positive Net Liquidating Equity (i.e., a credit balance) in his or her account, requiring segregation of his or her funds, but may have insufficient Net Liquidating Equity to cover the margin required for that customer’s open positions. Accordingly, the Commission proposed to require an FCM to record in the accounts of its futures customers the amount of margin required for each customers’ open positions, and to calculate margin deficits (i.e., undermargined amounts) for each of its customers. Moreover, the Commission proposed to require that an FCM maintain residual interest in segregated accounts in an amount that exceeds the sum of all futures customers’ margin deficits (‘‘the Proposed Residual Interest Requirement’’).270 In addition, the Commission proposed an amendment to § 1.22.271 Regulation 1.22 is a longstanding regulation272 and currently provides that an FCM may not use the cash, securities or other property deposited by one futures customer to purchase, margin or settle the trades, contracts, or other positions of another futures customer, or to extend credit to any other person.273 This ‘‘requirement is designed not only to prevent disparate treatment of customers by an FCM, but also to insure that there will be sufficient money in segregation to pay all customer claims if the FCM becomes insolvent.’’ 274 Regulation 1.22 further provides that an FCM may not use the funds deposited by a futures customer to carry trades or positions, unless the trades or positions are traded through a DCM.275 The Commission proposed an amendment to § 1.22 to clarify that it is the use intended (i.e., as performance bond). The Commission would consider any future amendments to § 1.20(h) based upon the developments of alternative segregation modes. 270 See discussion in note 30 above. Therefore, under the Proposed Residual Interest Requirement an FCM would have to maintain at all times in segregated account a sufficient amount of funds to cover the Net Liquidating Equities of each customer and a sufficient amount of residual interest to cover the undermargined amounts of each customer. 271 77 FR 67886. 272 See, e.g., 13 FR, 7820, 7837 (Dec. 18, 1948). 273 17 CFR 1.22. 274 46 FR 11668, 11669 (Feb. 10, 1981). 275 17 CFR 1.22. PO 00000 Frm 00039 Fmt 4701 Sfmt 4700 68543 not permissible for an FCM to be undersegregated at any point in time during the day. As stated in the Proposal, section 4d(a)(2) expressly requires an FCM to segregate futures customers’ funds from its own funds, and prohibits an FCM from using the funds of one customer to margin or extend credit to any other futures customer or person.276 Moreover, to review compliance with these proposed requirements, the Commission proposed that the sum of all margin deficits (i.e., undermargined amounts) be reported on the Segregation Schedule (as discussed previously in section II.A. with respect to amendments to § 1.10) and on the daily segregation calculation.277 The Commission requested comment on all aspects of the Proposed Residual Interest Requirement, including the costs and benefits of this proposed regulation.278 276 77 FR 67886. 277 Id. 278 See 77 FR 67882, 67916. The Commission also specifically requested comments on the following: Whether the Proposed Residual Interest Requirement would serve to increase the protections to customer funds in the event of an FCM bankruptcy? To what extent would the Proposed Residual Interest Requirement increase costs to FCMs and/or futures customers? To what extent would the Proposed Residual Interest Requirement benefit futures customers and/or FCMs? To what extent would the Proposed Residual Interest Requirement increase or mitigated market risk? To what extent would the Proposed Residual Interest Requirement lead to FCMs requiring customers to provide margin for their trades before placing them? To what extent is the Proposed Residual Interest Requirement likely to lead to a re-allocation of costs from customers with excess margin to undermargined customers? For purposes of margin deficit calculations, whether the Commission should address issues surrounding the timing of when an FCM must have sufficient funds in the futures customer account to cover all margin deficits? If so, how should the Commission address such issues? See 77 FR at 67882. With regards to the costs and benefits, the Commission asked the following questions: Whether FCMs typically maintain residual interest in their customer segregated account that is greater than the sum of their customer margin deficits, and data from which the Commission may quantify the average difference between the amount of residual interest an FCM maintains in customer segregated accounts and the sum of customer margin deficit. How much additional residual interest would FCMs need to hold in their customer segregated accounts in order to comply with the Proposed Residual Interest Requirement? What is the opportunity cost to FCMs associated with increasing the amount of capital FCMs place in residual interest, and data that would allow the Commission to replicate and verify the calculated estimates provided. Information regarding the additional amount of capital that FCMs would likely maintain in their customer segregated accounts, if any, to comply with the Proposed Residual Interest Requirement. What is the average cost of capital for an FCM? See 77 FR at 67916. The Commission also specifically requested that commenters provide data and calculations that would allow the Commission to replicate and verify the cost of capital that commenters estimate. See id. E:\FR\FM\14NOR2.SGM 14NOR2 68544 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations The Commission has received and has considered a wide variety of public comments regarding the Proposed Residual Interest Requirement, including comments from panelists made during public roundtables and written submissions from commenters. Several commenters supported the Commission’s Proposed Residual Interest Requirement. CIEBA stated that it strongly supported the Proposed Residual Interest Requirement, arguing that the proposed regulations are consistent with Congressional intent and the Commission’s historical interpretations of the Act and sound economic and systemic risk policy. Highlighting section 4d(a)(2) of the Act and its directive that FCMs ‘‘keep collateral and funds of each individual customer distinct from that of customers and the FCM,’’ CIEBA argued that ‘‘permitting FCMs to use customer funds to cover margin deficits of a different customer and thereby subsidize the FCM’s obligations would’’ contravene well established statutory policy.279 In addition, CIEBA noted that the Dodd-Frank Act was adopted to increase regulatory protections for customers.280 CIEBA also noted several benefits resulting from the Proposed Residual Interest Requirement, including the reduction of systemic risk, competitive benefits for those FCMs that do not use customer excess to meet the obligations of other clients, and the enhancement of customer protection in the event of an FCM bankruptcy.281 ICI also stated that it supported the Proposed Residual Interest Requirement on the basis that it would provide additional protections to customer funds.282 SIFMA asserted that it strongly supported the Proposed Residual Interest Requirement because it preserves the sanctity of each customer’s margin account by maintaining segregation between customer margin accounts through the incorporation of appropriate safeguards to protect customer funds.283 SIFMA stated that the proposal, ‘‘in effect, shifts the costs and burdens of a margin shortfall from customers with excess margin to customers with deficits, 279 CIEBA Comment Letter at 2 (Feb. 20, 2013). TKELleY on DSK3SPTVN1PROD with RULES2 at 3. On this point, CIEBA further noted that allowing an FCM to use customer excess to support other customer’s positions could lead to improper or complex recordkeeping, which can, in turn, jeopardize the ability of a trustee to facilitate the return of customer funds and the porting of positions to a solvent FCM. 282 ICI Comment Letter at 3 (Jan. 14, 2013). See also Franklin Comment Letter at 2 (Feb. 15, 2013) (writing in support of the positions taken in the ICI Comment Letter). 283 SIFMA Comment Letter at 2 (Feb. 21, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 284 Id. 285 Paul/Weiss 280 Id. 281 Id. where it properly belongs.’’ 284 Paul/ Weiss supported the Proposed Residual Interest Requirement ‘‘[i]n principle.’’ 285 Vanguard stated that it was ‘‘particularly supportive’’ of the Proposed Residual Interest Requirement.286 Noting that while an FCM would either have to have its customers pre-fund margin requirements for pending trades or ‘‘lend’’ such customers margin ahead of a margin transfer, Vanguard argued that the ‘‘proposed changes correctly shift the risk to customers in deficit and away from any excess margin transferred by other customers.’’ 287 Vanguard also argued that, in its opinion, comments at the public roundtable that ‘‘suggested same-day margin transfers were overly complicated to achieve and the accelerated capital charge would therefore impose significant added costs to an FCM and, by extension, to its customers,’’ seem overstated particularly because same-day margin transfer is ‘‘the norm in the OTC swap market.’’ 288 In fact, Vanguard stated that ‘‘same-day margin transfer is required in Vanguard’s futures and options agreements, consistent with the longstanding market practice.’’ 289 Vanguard encouraged the Commission to avoid weakening customer protection, ‘‘at least a weakening beyond the need to maintain segregation on no less than a once-a-day basis, with the possibility for clearing house initiated intra-day calls (and corresponding segregation maintenance) as needed in periods of market stress.’’ 290 CFA also supported the Proposed Residual Interest Requirement, asserting its belief ‘‘that no futures customer should be undersegregated at any time during the day for any reason.’’ 291 A number of commenters opposed the Proposed Residual Interest Requirement on the basis that the requirement appeared wholly unrelated to the MFGI and PFGI bankruptcies,292 with other commenters observing that the Proposed Residual Interest Requirement is unnecessary to achieve the regulatory goals, including assuring compliance Comment Letter at 3 (Feb. 15, 2013). 286 Vanguard Comment Letter at 7 (Feb. 22, 2013). 287 Id. 288 Id. 289 Id. 290 Id. at 7–8. 291 CFA Comment Letter at 5–6 (Feb. 13, 2013). 292 See, e.g., CHS Hedging Comment Letter at 1 (Feb. 15, 2013); NFA Comment Letter at 12 (Feb. 15, 2013); JSA Comment Letter at 2 (Feb. 15, 2013); Paragon Comment Letter at 1 (Feb. 15, 2013); NIBA Comment Letter at 2 (Feb. 15, 2013); ICA Comment Letter at 1 (Feb. 15, 2013). PO 00000 Frm 00040 Fmt 4701 Sfmt 4700 with section 4d of the Act, in light of other Commission regulations.293 In addition, several commenters commented on the lack of feasibility of the proposal, interpreting the ‘‘at all times’’ language to require FCMs to continuously calculate the sum of their customers’ margin deficits, and to continuously act on those calculations. For example, RCG stated that it would be virtually impossible for FCMs to satisfy the Proposed Residual Interest Requirement because an accurate assessment of aggregate customer margin deficiencies would be difficult given that (1) ‘‘the underlying markets operate on a 24-hour basis and customer fund transfers occur repeatedly throughout each business day,’’ and (2) ‘‘omnibus account offsets are not provided to clearing FCMs until the end of the trading day or, in some instances, the next business day.’’ 294 MGEX also argued that ‘‘at all times’’ requirement in the Proposed Residual Interest Requirement may be impracticable as it is a constantly moving target,295 and TD Ameritrade argued that because the firm calculates margin calls after it receives its nightly downloads, ‘‘it would be difficult, if not impossible, to assess customer margin deficiencies at any moment in time, because the markets have not closed and the margin requirements are not always known.’’ 296 In addition, CME stated that there does not appear to be a system that currently exists or that could be constructed in the near future that will permit FCMs to accurately calculate customer margin deficiencies, at all times.297 CMC asserted that the ‘‘at all times’’ portion of the Proposed Residual Interest Requirement would ‘‘create liquidity issues and increase costs for FCMs and end users,’’ possibly ‘‘limit the number and type of transactions FCMs clear, the number of customers they service and the amount of financing they provide,’’ and ‘‘require executing FCMs to collect collateral for give-ups so that customer positions are fully margined in the event a trade is rejected by a clearing 293 See, e.g., FIA Comment Letter at 18–21 (Feb. 15, 2013). See also FIA Comment Letter at 2–5 (June 20, 2013). 294 RCG Comment Letter at 3 (Feb. 12, 2013). 295 See MGEX Comment Letter at 2 (Feb. 18, 2013). See also NPPC Comment Letter at 2 (Feb. 15, 2013) (stating that the ‘‘at all times’’ portion of the Proposed Residual Interest Requirement is ‘‘burdensome’’, and that changing margin procedures ‘‘to anticipate future market movements, pre-fund margin calls, [or] make margin call deposits throughout the day based on current market movements is impractical.’’). 296 TD Ameritrade Comment Letter at 4–5 (Feb. 15, 2013). 297 See CME Comment Letter at 5 (Feb. 15, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations FCM,’’ 298 which ‘‘may force many end users to decrease or discontinue hedging and risk management practices.’’ 299 Advantage opposed the Proposed Residual Interest Requirement asserting that it was ‘‘extremely prejudicial to small and midsize firms and their customers.’’ 300 Advantage also stated that the Proposed Residual Interest Requirement would result in FCMs more quickly liquidating customer positions during extreme market moves, which would make markets more volatile.301 Advantage also maintained that calculations of margin for omnibus accounts cannot be determined prior to the receipt of offsets, which may not be obtained until late in the day, thereby adversely impacting an FCM’s ability to assess customer margin deficiencies.302 FIA and LCH.Clearnet opposed the Proposed Residual Interest Requirement, and focused particularly on the ‘‘at all times’’ portion of the requirement.303 FIA stated that the Proposed Residual Interest Requirement may force a number of small to midsized FCMs out of the market, which will decrease access to the futures markets and increase costs for IBs, hedgers, and small traders.304 In addition, FIA argued that the Proposed Residual Interest Requirement would significantly impair the price discovery and risk management purposes of the market.305 Moreover, FIA stated that the Proposed Residual Interest Requirement ‘‘would impose a tremendous operational and financial burden on the industry, requiring the development and implementation of entirely new systems to assure compliance’’ with the ‘‘at all times’’ portion of the requirement.306 FIA also averred that the ‘‘provisions of section 4d of the Act prohibiting an FCM from using the fund of one customer ‘to margin or guarantee the trades or contracts, or to secure or extend the credit, of any customer or person other than the one for whom the same are held,’ has been the lynchpin of customer funds protection since the Commodity Exchange Act was enacted in 1936.’’ 307 In addition, FIA stated that they were not aware that the Commission has interpreted the statute 298 CMC Comment Letter at 2 (Feb. 15, 2013). TKELleY on DSK3SPTVN1PROD with RULES2 299 Id. 300 Advantage Comment Letter at 8 (Feb. 15, 2013). 301 See id. at 7–8. 302 See id. at 7. 303 See FIA Comment Letter at 4–5, 12–26 (Feb. 15, 2013); LCH.Clearnet Comment Letter at 4–5 (Jan. 25, 2013). 304 See FIA Comment Letter at 17 (Feb. 15, 2013). 305 See id. at 4, 17. 306 Id. at 4. See also id. at 13. 307 FIA Comment Letter at 2 (June 20, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 to require the real time calculation of margin deficits.308 Several commenters requested that the Commission refrain from adopting the Proposed Residual Interest Requirement until it conducted further analysis with the industry regarding the costs and benefits of such proposal,309 with others stating that the Proposed Residual Interest Requirement would mark a significant departure from current market practice and could have a material adverse impact on the liquidity and smooth functioning of the futures and swaps markets.310 In addition, the Commission received several specific comments on the potential costs and benefits of the Proposed Residual Interest Requirement. The Congressional Committees requested that the Commission consider the benefits in light of ‘‘both the costs to America’s farmers and ranchers and the potential impact on consolidation in the FCM industry,’’ and in particular the ‘‘consequences of changing the manner or frequency in which ‘residual interest’—the capital an FCM must hold to cover customer positions—is calculated.’’ 311 FIA noted that FCMs would look to avoid the need to use their own resources by seeking to make sure that their customers would not be undermargined, and that this process would involve the FCM collecting greater amounts of collateral from each customer.312 FIA averred that collecting greater amounts of collateral from customers would be contrary to the desire of the market to reduce the amount of funds maintained with FCMs following the failures of MFGI and PFGI.313 Moreover, FIA estimated that compliance with the Proposed Residual 308 Id. 309 See, e.g., AIMA Comment Letter at 3 (Feb. 15, 2013); CCC Comment Letter at 2–3 (Feb. 15, 2013); CHS Hedging Comment Letter at 2–3 (Feb. 15, 2013); CME Comment at 5–7 (Feb. 15, 2013); AFBF Comment Letter at 2 (Feb. 15, 2013); Jefferies Comment Letter at 9 (Feb. 15, 2013); JSA Comment Letter at 1–2 (Feb. 15, 2013); NCBA Comment Letter at 2 (Feb. 15, 2013); NGFA Comment Letter at 5 (Feb. 15, 2013); NIBA Comment Letter at 1–2 (Feb. 15, 2013); TCFA Comment Letter at 2 (Feb. 15, 2013); AFMP Group Comment Letter at 1–2 (Sept. 18, 2013). 310 See, e.g., MGEX Comment Letter at 2 (Feb. 18, 2013); AIMA Comment Letter at 2 (Feb. 15, 2013); CMC Comment Letter at 2 (Feb. 15, 2013); AFMP Group Comment Letter at 1–2 (Sept. 18, 2013); Rice Dairy LLC Comment Letter at 1 (Feb. 13, 2013). 311 Congressional Committees Comment Letter at 1 (Sept. 25, 2013). 312 FIA Comment Letter at 17 (Feb. 15, 2013). 313 Id. at 17. See also AFMP Group Comment Letter at 1 (Sept. 18, 2013) (arguing that ‘‘[m]uch more customer money—maybe twice as much—will be at risk in the event of another FCM insolvency.’’). PO 00000 Frm 00041 Fmt 4701 Sfmt 4700 68545 Interest Requirement would require FCMs or their customers to contribute significantly in excess of $100 billion into customer funds accounts beyond the sum required to meet initial margin requirements, and that the annual financing costs for these increases will range from $810 million to $8.125 billion.314 MFA asserted that applying the Proposed Residual Interest Requirement continuously to FCMs ‘‘could significantly increase the operational burdens and costs on FCMs and their customers,’’ and that ‘‘any pre-funding obligation is an unacceptable imposition on customers’’ because ‘‘[i]t would create margin inefficiencies by causing customers to reserve assets to pre-fund their obligations . . . , and thus, reduce the amount of assets that customers have to use for investment or other purposes.’’ 315 FHLB cautioned that ‘‘[w]hile it cannot be disputed that a residual interest buffer should lower the risk that an FCM will fall out of compliance with its segregation requirements, there will likely be a real economic cost associated with maintaining whatever residual interest buffers is established by an FCM’’ and that ‘‘the prospects of funding an additional residual interest buffer may discourage FCMs from appropriately demanding collateral from customers in excess of DCO requirements.’’ 316 FHLB further noted that the ‘‘funds maintained by an FCM as residual interest can reasonably be expected to earn less than the FCM’s unrestricted funds,’’ thus, the proposal ‘‘represents a real cost to FCMs’’ that will be passed on to customers.317 Jefferies stated that the Proposed Residual Interest Requirement will result in more assets being held at FCMs’ custodial facilities at a time when ‘‘the Commission has been enacting changes that have been shifting capital away from FCMs towards DCO facilities. . . .’’ 318 Newedge also stated that the Proposed Residual Interest Requirement ‘‘will result in many FCMs requiring customers to pre-fund and over-margin their positions, which will increase 314 FIA Comment Letter at 16 (Feb. 15, 2013). Comment Letter at 8 (Feb. 15, 2013). 316 FHLB Comment Letter at 3–4 (Feb. 15, 2013). 317 Id. at 4 n.5. 318 Jefferies Comment Letter at 7 (Feb. 15, 2013). See also CCC Comment Letter at 2 (Feb. 15, 2013) (arguing that ‘‘the practical effect’’ of the Proposed Residual Interest Requirement ‘‘is that FCMs would require commodity customers to contribute significantly more property to their FCM in order to meet new margin requirements far in excess of exchange margin requirements,’’ and expressing concern over any requirement that would require customers ‘‘to contribute even more capital to a system [CCC] believe[s] is flawed.’’) 315 MFA E:\FR\FM\14NOR2.SGM 14NOR2 68546 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations their exposure to FCMs’’ and ‘‘have a significant impact on customers’ own liquidity.’’ 319 Steve Jones expressed the view that ‘‘[w]ith more funds on deposit, a corrupt FCM CEO (or other staff with access to the funds) will simply be more tempted to ‘misappropriate’ the funds.320 In addition, Jefferies stated that requiring an FCM to maintain this level of residual interest ‘‘at all times’’ ‘‘would impose tremendous financial and operational difficulties’’ on FCMs, which would result in tremendous increases to necessary liquidity, and ‘‘negatively impact competitiveness within the industry. . . .’’ 321 Jefferies further stated that the Proposed Residual Interest Requirement would impose heavy costs, and that, under the proposal, Jefferies would be required to increase its residual interest by $15 million (non-peak) or $30 million (peak), respectively.322 Jefferies also stated that the industry would be required to increase its residual interest by $49 billion (non-peak) or $83 billion (peak) at a cost of approximately $2 billion (non-peak) or $5 billion (peak), respectively.323 ISDA asserted that the Proposed Residual Interest Requirement will make customers ‘‘self-guaranteeing’’ and diminish reliance on the FCM, and that, while this would diminish overall risk of FCM default, it comes at a very significant cost to market participants, market volumes and liquidity.324 ISDA estimated the funding needed to comply with ‘‘at all times’’ portion of the Proposed Residual Interest Requirement to be $73.2 billion, with a long term impact of $335 billion.325 CHS Hedging argued that the Proposed Residual Interest Requirement ‘‘would substantially increase the amount of capital an FCM would need on hand at all times.’’ 326 Further, CHS Hedging stated that ‘‘[i]n the current economic environment, the difference between the cost of capital and the return an FCM could reasonably expect through investment of funds in a compliant and prudent manner would result in a material effect on the business of all FCMs.’’ 327 CHS Hedging also stated that FCMs ‘‘could require that customers 319 Newedge TKELleY on DSK3SPTVN1PROD with RULES2 320 Steve Comment Letter at 2 (Feb. 15, 2013). Jones Comment Letter at 1 (Feb. 15, 2013). 321 Jefferies Comment Letter at 7 (Feb. 15, 2013). 322 Id. at 8. 323 Id. 324 ISDA Comment Letter at 3 (Feb. 15, 2013). See also ISDA Comment Letter at 2–3 (May 8, 2013). 325 ISDA Comment Letter at 4–5 (Feb. 15, 2013). 326 CHS Hedging Comment Letter at 2 (Feb. 15, 2013). 327 Id. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 pre-fund their accounts in anticipation of adverse market movement,’’ which ‘‘would likely result in hardship with regard to working capital and may encourage customers to seek alternative methods to hedge their risk. . . .’’ 328 CHS Hedging is also of the view that ‘‘pre-funding accounts concentrates additional funds at FCMs, which seems to contradict the spirit of the’’ customer protection rules.329 Other commenters argued that the Proposed Residual Interest Requirement would be more burdensome on smaller FCMs and customers. Some commenters stated that forcing FCMs to ask customers to pre-fund positions will cause many futures industry participants, including agricultural producers and other customers to suffer a financial burden by tying up capital that is better used in other areas, such as the operation of the feedlot, stocker operation or cow/calf operation,330 with two commenters asserting that increased costs associated with the use of wire transfers, rather than checks, would have a similar impact.331 Moreover, NCFC stated that in addition to increased costs for hedgers, the Proposed Residual Interest Requirement ‘‘would be more burdensome to firms like farmer cooperative-owned FCMs’’ because they ‘‘are largely homogenous, with virtually all of their commercial customers going deficit at the same time.’’ 332 NCFC also asserted that ‘‘[t]o require all deficits to be covered immediately would be overly stringent on these FCMs given the low-risk profile of their customers as hedgers,’’ 333 while NIBA noted that the Proposed Residual Interest Requirement ‘‘will actually limit or deny market access to many customers’’ (such as farmers, ranchers and other agricultural organizations) ‘‘who use the markets to hedge their financial and commercial risks’’ because the proposal ‘‘could raise the cost of hedging product to prohibitive levels.’’ 334 NIBA also stated that if small to mid-sized FCMs are forced out of business, market access ‘‘will become limited and more expensive for IBs and their smaller hedge and speculative 328 Id. 329 Id. 330 TCFA Comment Letter at 2 (Feb. 15, 2013); NCBA Comment Letter at 2 (Feb. 15, 2013); FCStone Comment Letter at 3 (Feb. 15, 2013); Randy Fritsche Comment Letter at 1 (Feb. 15, 2013); Global Commodity Comment Letter at 1 (Feb. 13, 2013); AFMP Group Comment Letter at 1–2 (Sept. 18, 2013). 331 TCFA Comment Letter at 1 (Feb. 15, 2013); NCBA Comment Letter at 1 (Feb. 15, 2013). 332 NCFC Comment Letter at 2 (Feb. 15, 2013). 333 Id. 334 NIBA Comment Letter at 1 (Feb. 15, 2013). PO 00000 Frm 00042 Fmt 4701 Sfmt 4700 clients.’’ 335 JSA argued that the Proposed Residual Interest Requirement would be ‘‘punitive in a highly competitive environment that already places the midsize operator at a disadvantage to his better capitalized multinational competitors.’’ 336 JSA also asserted that the resulting consolidation would cause ‘‘the loss of competitive forces, [the] loss of significant numbers of jobs, and the loss of transparency and liquidity required for a highly functioning hedging environment.’’ 337 Moreover, JSA stated that the cost of the Proposed Residual Interest Requirement would result in a higher cost of hedging, which would be become prohibitive and prompt agricultural users to walk away from the futures market.338 CME averred that mid-sized and smaller FCMs will not have the capital required by the Proposed Residual Interest Requirement and that customers will be required to pre-fund potential margin obligations.339 CME asserted that, given this increase in cost, some customers may transfer their accounts to the larger, better-capitalized FCMs to reduce the cost of trading,340 but that agricultural customers ‘‘likely will not be able to transfer to the larger FCMs because they do not fit their customer profile,’’ thereby making these customers bear more of the cost burden.341 CME also stated that the Proposed Residual Interest Requirement will lead to consolidation among FCMs, which will ‘‘actually increase[] systemic risk by concentrating risk among fewer market participants.’’ 342 Frontier Futures argued that the Proposed Residual Interest Requirement does not give an FCM time to collect margin from customers if the market moves against a customer’s position.343 Because many small customers, including most farmers, do not watch markets constantly, it would be difficult for them to meet margin calls on a 335 Id. at 1–2. NIBA also asserted that ‘‘[t]ransferring accounts between brokerage houses would become very difficult to accomplish’’ because open positions would ‘‘need to be margined at the receiving house as well as the transferring one,’’ thereby restraining Brokers ‘‘to remain with one FCM, or completely close customers’ positions in order to start up again with a different FCM.’’ Id. at 2. 336 JSA Comment Letter at 1 (Feb. 15, 2013). 337 Id. at 1–2. 338 Id. at 2. 339 CME Comment Letter at 5–6 (Feb. 15, 2013). 340 Id. at 6. 341 Id. 342 Id. (emphasis in original). CME also maintained that ‘‘those customers who qualify as [ECPs] can move to the uncleared and less regulated swaps space and decline to use centralized clearing.’’ Id. at 6–7. 343 Frontier Futures Comment Letter at 3 (Feb. 15, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations moment’s notice, thereby causing FCMs to require significantly higher margins or to liquidate customer positions where margin calls cannot be immediately met.344 Frontier Futures also asserted that the proposal ‘‘may force a number of small to mid-sized FCMs out of the market,’’ making it more expensive, if not impossible, for IBs and small members to clear their business, removing ‘‘significant capital from the futures industry,’’ and ‘‘reducing stability to the markets as a whole.’’ 345 RJ O’Brien stated that the Proposed Residual Interest Requirement is impractical because many farmers and agricultural clients still use checks and ACH to meet margin calls.346 Several commenters presented alternative proposals for the Commission’s consideration. For example, two commenters argued that the Commission should consider less costly alternatives to the current residual interest proposal, such as allowing the FCM ‘‘to count guaranty fund deposits with [DCOs] as part of their residual interest,’’ 347 with others stating that the residual interest amount that an FCM must carry should only apply to a limited number of its largest customers.348 Moreover, and as discussed more fully below, other commenters urged the Commission to conform the final version of proposed Rules 1.20(i)(4), 22.2(f)(6), and 30.7(a) to the current method of calculating residual interest buffer for Cleared Swaps by dropping the words ‘‘at all times.’’ 349 For example, ISDA and FIA further urged consideration of an alternative under which the residual interest calculations would be made once a day and that, by the end of a business day, an FCM would be required to maintain a residual interest in its customer funds accounts at least equal to its customers’ aggregate margin deficits for the prior 344 Id. 345 Id. TKELleY on DSK3SPTVN1PROD with RULES2 346 RJ O’Brien Comment Letter at 3 (Feb. 15, 2013). See also ICA Comment Letter at 1–2 (Feb. 15, 2013). 347 Newedge Comment Letter at 3 (Feb. 15, 2013). See also RJ O’Brien Comment Letter at 5 (Feb. 15, 2013). Cf. Frontier Futures Comment Letter at 3 (Feb. 15, 2013) (suggesting further that firm firewalls be put in place between customer funds and an FCM’s proprietary funds in the form of approval by an independent agency for an FCM to transfer customer funds and that FCMs ‘‘do their proprietary trading through another FCM thereby engaging the risk management of a third party.’’) 348 See, e.g., Newedge Comment Letter at 3 (Feb. 15, 2013). 349 See, e.g., LCH.Clearnet Comment Letter at 5 (Feb. 15, 2013); ISDA Comment Letter at 6 (Feb. 15, 2013); RJ O’Brien Comment Letter at 5 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 trade date.350 ISDA stated this alternative ‘‘would rationally reduce’’ FCMs cost of compliance351 and that ‘‘[f]or an FCM with robust credit risk management systems, covering end-ofday customer deficits should not be a significant cost.’’ 352 ISDA also noted that at the end of the day ‘‘typically, all customer calls have been met, and all customer gains have been paid out; all achieved without the FCM having recourse to its own funding resources.’’ 353 FIA asserted that it would ‘‘achieve the Commission’s regulatory goals without imposing the damaging financial and operational burdens on FCMs, and the resulting financial burdens on customers.’’ 354 LCH.Clearnet argued that customer collateral can be protected by performing the ‘‘LSOC Compliance Calculation’’ once per day, prior to settlement at a DCO, because ‘‘prior to meeting a call for an increased requirement, a customer may be under collateralized, but is not collateralized by another customer.’’ 355 ISDA and FIA evaluated the costs associated with requiring FCMs to perform the residual interest calculation once each day at the close of business on the first business day following the trade date.356 ISDA estimated that ‘‘removing the predictive element of FCM funding requirements’’ of the ‘‘at all times’’ method in favor of the alternative approach would permit markets to ‘‘reap the efficiencies of endof-day accounting,’’ 357 thereby significantly reducing the overall cost of compliance with the regulation. ISDA estimated that for futures, the costs associated with the would be the cost of covering the out-standing margin deficits of between 2 and 5% of its futures customers, and thus would impose only ‘‘incremental funding requirements’’ on FCMs.358 ISDA estimated that the costs of the alternate proposal would be even smaller for cleared swaps, due to the ‘‘more 350 See ISDA Comment Letter at 6 (Feb. 15, 2013); FIA Comment Letter at 23–25 (Feb. 15, 2013). 351 ISDA Comment Letter at 6 (Feb. 15, 2013). 352 ISDA Comment Letter at 2 (May 8, 2013). 353 Id. ISDA further recommended that because many FCM customers use custodians across the world, ‘‘many customers cannot assure payment of their morning FCM call before the end of the New York day,’’ and therefore recommended that Commission study the feasibility of reducing the time in which customers have to meet margin calls, if that is ‘‘imperative.’’ Id. at 3. 354 FIA Comment Letter at 23 (Feb. 15, 2013). See also ISDA Comment Letter at 4 (May 8, 2013). 355 LCH.Clearnet Comment Letter at 5 (Feb. 15, 2013). 356 ISDA Comment Letter at 1–2 (May 8, 2013); FIA Comment Letter at 8–10 (June 20, 2013). 357 Id. at 3. 358 ISDA Comment Letter at 3–4 (May 8, 2013). PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 68547 professional’’ nature of the market.359 FIA estimated the financing costs to FCMs of complying with FIA’s proposed alternative and concluded that the costs associated with the Proposed Residual Interest Requirement would be approximately ten times the costs associated with the FIA proposal.360 FIA also concluded that their proposal would not ‘‘impos[e] damaging financial and operational burdens on FCMs . . . and the resulting financial burdens on customers.’’361 RJ O’Brien also recommended that the Commission drop the ‘‘at all times’’ requirement and that the residual interest calculation be done once each day at the close of business on the first business day following the trade date.362 RJ O’Brien asserted that ‘‘this alternative will reduce the substantial financial burdens’’ on customers ‘‘while further enhancing the protection of customer funds.’’ 363 MFA stated that the Commission should modify the proposed FCM residual interest requirement in § 1.20(i)(4) so that it is a ‘‘point of time’’ obligation that requires FCMs to ensure they maintain sufficient residual interest ‘‘as of the close of business EST on the business day after the FCM issues a customer’s margin call.’’ 364 MFA argued that this alternative would ‘‘reduce the stress on the market’’ and ‘‘eliminate[] the need for customer prefunding or intraday margin calls, while also ensuring that * * * FCMs will hold sufficient funds to protect against customer shortfalls.’’ 365 Paul/Weiss stated that the Commission should clarify that the residual interest amount an FCM is required to maintain must be determined ‘‘at the time of any end-ofday, intra-day or special call payment by an FCM to derivatives clearing organization (or other clearing house or clearing intermediary). . . .’’366 Paul/ Weiss argued that these payments are ‘‘the relevant points in time at which 359 Id. at 4. FIA Comment Letter at 8–10 (June 20, 2013). While the rates used by FIA in this exercise may be conservative, and thus the Commission does not purport to opine on the precise estimates reached, the exercise is nevertheless illustrative and useful for the purpose of comparing the costs of the Residual Interest Proposal, the alternate proposal, and the final rule. 361 Id. at 9. 362 RJ O’Brien Comment Letter at 5 (Feb. 15, 2013). 363 Id. 364 MFA Comment Letter at 8–9 (Feb. 15, 2013). 365 Id. 366 Paul/Weiss Comment Letter at 4 (Feb. 15, 2013). 360 See E:\FR\FM\14NOR2.SGM 14NOR2 68548 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations the FCM is obligated to transfer’’ customer margin.367 As a threshold matter, and as noted above, the Commission reiterates that the Act expressly prohibits an FCM from using the collateral of one customer to margin, secure, or guarantee the trades or contracts of other customers.368 Congress specifically added this prohibition in response to concerns that certain customers were carrying the risks and obligations of other favored customers.369 By this token, any customer that is undermargined is being favored over the customers with excess margin, in contravention of section 4d(a)(2) when other customers’ funds are being used to cover the undermargined amounts.370 Moreover, there is an inescapable mathematical fact: When an FCM meets the DCO’s margin requirements, the property used to meet those requirements can only come from one of three sources: the responsible customer, the FCM, or other customers. If the property does not come from the customer whose positions generated the margin requirement or loss, or the FCM itself (that is, the FCM’s residual interest), then it must, of necessity, come from other customers.371 In TKELleY on DSK3SPTVN1PROD with RULES2 367 Id. 368 The Commission further notes that current Commission regulations also include such prohibitions. Namely, § 1.22 states that ‘‘No futures commission merchant shall use, or permit the use of, the futures customer funds of one futures customer to purchase, margin, or settle the trades, contracts, or commodity options of, or to secure or extend the credit of, any person other than such futures customer,’’ and § 22.2(d)(1) states that ‘‘No futures commission merchant shall use, or permit the use of, the Cleared Swaps Customer Collateral of one Cleared Swaps Customer to purchase, margin, or settle the Cleared Swaps or any other trade or contract of, or to secure or extend the credit of, any person other than such Cleared Swaps Customer.’’ 369 See 80 Cong. Rec. 6159, 6162 (1936) (statement of Sen. James. P. Pope) (‘‘It further appears that certain favored dealers have not been required actually to put up the money for margins, and have been extended credit in that respect. This gives these favored dealers an advantage. In some instances, large commission firms have become bankrupt and the funds placed with them by a large number of dealers were lost.’’); ‘‘Regulation of Grain Exchanges: Before the H. Comm. on Agriculture,’’ 73 Cong. 31 (1934) (statement of Dr. J. W. T. Duvel, Chief Grain Futures Admin. Dept. of Agriculture) (‘‘On the commodities exchanges certain classes of speculators and others are able to secure credit but in many cases the credit so extended represents margin money taken from one class of customers and used to extend credit on [sic] margin the trades of others. Our aim is to protect the customers’ margin money and thereby protect the market as a whole.’’). 370 As some commenters report, institutional customers in particular are typically undermargined. This could mean that institutional customers are being favored over individual customers. See, e.g., FIA Comment Letter at 15 (Feb. 15, 2013). 371 As recognized by the Commission previously, the obligation to ensure that one customer’s VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 reviewing the Commission’s customer protection rules in light of MFGI and PFGI, staff identified market practices that were in tension with the plain language of the Act, and, as such, the Commission attempted to clarify acceptable practices with respect to these existing statutory requirements with the Proposed Residual Interest Requirement. As noted above, several commenters strongly supported the Proposed Residual Interest Requirement, noting it is consistent with Congressional intent and the Commission’s historical interpretations of the Act. In general, these commenters argued that the proposal correctly shifts the risk of loss to customers with margin deficiencies and away from customers with excess margin. Some of these commenters questioned market cost estimates and statements regarding the technical challenges associated with same-day margin transfers, and urged the Commission to avoid unnecessarily weakening customer protection. On the other hand, many commenters expressed concern regarding the costs associated with the Proposed Residual Interest Requirement. In particular, commenters stated that requiring the FCM to be in compliance with residual interest requirements ‘‘at all times’’ would disparately impact agricultural producers, small and mid-size FCMs, and hedgers; decrease market liquidity; cause market consolidation; and increase systemic risk. Moreover, the Commission notes that many of the estimates of the amount of additional capital required as a result of the Proposed Residual Interest Requirement seem to result from a particular interpretation of the meaning of the ‘‘at all times’’ portion of the proposal, and seemed to range from $49 billion (nonpeak) and $83 billion (peak),372 to $73.2 property is not used to margin or settle the trades or contracts of another customer rests with the FCM. See 46 FR 11668, 11669. (stating that ‘‘section [4d(a)(2)] of the Act and §§ 1.20 and 1.22 of the Commission’s regulations require an FCM to add its own money into segregation in an amount equal to the sum of all customer deficits.’’). See also CFTC Letter 00–106 (Nov. 22, 2000) (stating that ‘‘each FCM must segregate sufficient funds to cover any amounts it owes to its customers in connection with commodity interest transactions. The funds of multiple customers may be commingled in a single account for the benefit of the customers as a group. If, however, the balance of any one of those customers falls into a deficit, the FCM is obligated to restore the amount of such deficit out of its own funds or property in order to avoid the use of the funds or property or any other customer to meet the obligations of the customer in deficit. The Commission requires FCM’s [sic] to maintain minimum levels of capital to help assure that, among other things, they are able to meet such obligations.’’). 372 See Jefferies Comment Letter at 8–9 (Feb. 15, 2013). Jefferies states that the proposal would PO 00000 Frm 00044 Fmt 4701 Sfmt 4700 billion,373 to upwards of $100 billion.374 Further, commenters asserted that the ‘‘at all times’’ portion of the Proposed Residual Interest Requirement would be operationally unachievable, and argued that the Proposed Residual Interest Requirement would curtail competition, concentrate capital in FCMs at a time when the market would like to reduce the amount of customer collateral held at the FCM, and reduce the number of viable FCMs, thereby negatively impacting overall market risk and market access for smaller customers and agricultural hedgers. Commenters also argued that the Proposed Residual Interest Requirement is unnecessary because in their view, customer funds are not at risk when fellow customer accounts are undermargined.375 Many of the commenters interpreted the proposal to require FCMs to continuously calculate and monitor the margin deficits of their customers. In the final rulemaking, the Commission is, in general, following the concept advanced by Paul/Weiss and LCH.Clearnet—that is, what is required is that the FCM not ‘‘use’’ one customer’s property to margin another customer’s positions. For an interim phase-in period, the Commission is adopting the alternative proposal recommended by several commenters, including FIA. Thus, for the reasons set forth below, by the Residual Interest Deadline, which is defined in § 1.22(c)(5), an FCM would be required to maintain a residual interest in its customer funds accounts at least equal to its customers’ aggregate margin deficits for the prior trade date.376 The commenters asserted, and the Commission agrees that this alternative would significantly and materially reduce the financial burdens that would otherwise be imposed on require them to increase residual interest by $15 million (non-peak) to $30 million (peak). 373 See ISDA Comment Letter at 4–5 (Feb. 15, 2013). ISDA argued that the long term impact of the ‘‘at all times’’ portion of the proposal could be as high as $335 billion. 374 See FIA Comment Letter at 15–17 (Feb. 15, 2013). FIA also estimated that the annual financing costs associated with the $100 billion cost could range from $810 million to $8.125 billion. 375 See Transcript, U.S. Commodity Futures Trading Commission Agricultural Advisory Committee Meeting held on July 25, 2013, available at https://www.cftc.gov/ucm/groups/public/@ newsroom/documents/file/aac_ transcript072513.pdf. 376 See, e.g., Advantage Comment Letter at 8 (Feb. 15, 2013); CMC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5–6 (Feb. 15, 2013); FIA Comment Letter at 4–5 (Feb. 15, 2013); LCH.Clearnet Comment Letter at 4–5 (Jan. 25, 2013); MGEX Comment Letter at 2 (Feb. 18, 2013); NPPC Comment Letter at 2 (Feb. 15, 2013); RCG Comment Letter at 3 (Feb. 12, 2013); RJ O’Brien Comment Letter at 5 (Feb. 15, 2013); TD Ameritrade Comment Letter at 4–5 (Feb. 15, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 customers and FCMs alike under the Commission’s Proposed Residual Interest Requirement 377 because, among other things, this alternate approach would not cause an extreme drain on market liquidity, market consolidation, increase in systemic risk, and detrimental effect on agricultural producers, small and mid-size FCMs, and hedgers.378 After careful consideration of the comments and the applicable statutory provisions, the Commission has decided to adopt the Proposed Residual Interest Requirement with modifications. Section 4d(a)(2) of the Act expressly states that the money, securities, and property received by an FCM from a customer to margin, guarantee, or secure the trades or contracts of that customer shall be separately accounted for and shall not be commingled with the funds of such commission merchant or be used to margin or guarantee the trades or contracts, or to secure or extend the credit, of any customer or person other than the one for whom the same are held.379 Moreover, the Commission notes that when section 22 of the rules and regulations of the Secretary of Agriculture under the Act (the predecessor of § 1.22) was adopted in 1937,380 the year after adoption of the Act, it expressly stated that ‘‘No futures commission merchant shall use, or permit the use of, the money, securities, or property of one customer to margin or settle the trades or contracts, or to secure or extend the credit, of any person other than such customer. The net equity of one customer shall not be used to carry the trades or contracts or to offset the net deficit of any other customer or person or to carry the trades or offset the net deficit of the same customer in goods or property not included in the term ‘commodity’ as defined herein.’’ 381 This language 377 The Commission notes that representatives from FIA, ISDA, and ADM Investor Services have all indicated in meetings with Commission staff that such an alternative would better protect customers, benefit FCMs risk management practices, and materially reduce many costs associated with the Commission’s original proposal. 378 See ISDA Comment Letter at 3 (May 8, 2013) (noting that a substantial majority of customer margin calls are met by 5:00 p.m. on the day the calls are issued and therefore the this approach would not impose the costs and cause the problems associated with the Proposed Residual Interest Requirement); FIA Comment Letter at 9 (June 20, 2013) (estimating that the alternative approach would be 10 times less costly for FCMs to finance). See also MFA Comment Letter at 8–9 (Feb. 15, 2013); RJ O’Brien Comment Letter at 5 (Feb. 15, 2013). 379 See also section 4d(f)(2) of the Commodity Exchange Act, as well as § 1.22 of this section and § 22.2(d)(1) of this chapter. 380 2 FR 1223, 1225 (July 16, 1937). 381 Id. at 1225 (emphasis supplied). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 addresses, by its terms, more than net deficits, and appears to have remained substantively unchanged for the next four decades. In 1981, in its Regulation of Domestic Exchange-Traded Commodity Options, the Commission revised § 1.22 to combine segregation requirements for options with existing segregation requirements for futures.382 In doing so, the Commission generalized the regulatory language and deleted specific references to ‘‘net equity.’’ However, neither the adopting release nor the proposing release for the ‘‘Regulation of Domestic Exchange-Traded Commodity Options’’ rulemaking indicated an intent to alter or modify the existing segregation requirements for futures.383 The current version of § 1.22 states that ‘‘[n]o futures commission merchant shall use, or permit the use of, the futures customer funds of one futures customer to purchase, margin, or settle the trades, contracts, or commodity options of, or to secure or extend the credit of, any person other than such futures customer.’’ The Commission’s Proposed Residual Interest Requirement was intended to ensure compliance with section 4d(a)(2) and § 1.22 by shifting the risk of loss in the event of a double default back to the customer whose positions incurred the loss and away from those customers with excess margin at the FCM. Contrary to the assertion of certain commenters, whenever an FCM uses the funds of customers with excess margin to collateralize the positions of undermargined customers, the customers with excess funds are subject to heightened risk, and diminished availability of those excess funds for transfer in the event the FCM is in financial distress. Nonetheless, commenters asserted that there is ambiguity regarding (1) the point at which an FCM has ‘‘used’’ or ‘‘permitted the use’’ of the futures customer funds of one futures customer to purchase, margin, or settle the trades, contracts, or commodity options of, or to secure or extend the credit of, another futures customer, and (2) what an FCM 382 See 46 FR 54500 (Nov. 3, 1981). id. at 54508 (Final Release) (stating that because the Commission did not receive any comments on its proposed regulations relating to segregation of customer funds, it was adopting the amendments essentially as proposed). In addition, in stating that ‘‘the Commission is now proposing that the option segregation requirements be combined with the existing segregation requirements for futures,’’ the proposing release noted that certain definitions ‘‘have also been added or modified to permit defined terms to be used in the sections, as amended, and thereby simplify the regulations.’’ See 46 FR 33293–01, 33298 (June 29, 1981). 383 See PO 00000 Frm 00045 Fmt 4701 Sfmt 4700 68549 is required to do to comply with this requirement. Accordingly, the Commission is adopting proposed §§ 1.20(i) and 1.22 with certain modifications. First, the Commission is revising proposed § 1.20(i) by removing the Proposed Residual Interest Requirement from paragraph (i)(4). In addition, the Commission is revising the language in § 1.22 to add an amended residual interest requirement and additional technical corrections to § 1.20(i) as described further below. Moreover, the Commission is reorganizing proposed § 1.22 as follows: (1) The sentence that reads ‘‘No futures commission merchant shall use, or permit the use of, the futures customer funds of one futures customer to purchase, margin, or settle the trades, contracts, or commodity options of, or to secure or extend the credit of, any person other than such futures customer.’’ will be in paragraph (a); (2) the remaining language in proposed paragraph (a) will be deleted; (3) the sentence that reads ‘‘Futures customer funds shall not be used to carry trades or positions of the same futures customer other than in contracts for the purchase of sale of any commodity for future delivery or for options thereon traded through the facilities of a designated contract market.’’ will remain in paragraph (b); and (4) as discussed below, a new paragraph (c) will be added to address the revised residual interest requirements. As highlighted above, several commenters questioned the ability of FCMs to measure compliance on a continuous and real-time basis,384 and argued that the potential cost associated with a continuous residual interest requirement would have an adverse impact on the market.385 The Commission is persuaded that continuous calculation and monitoring requirements are not technologically feasible at this time. The Commission is also persuaded that it would not be practical to make such calculations in the futures markets based on intra-day 384 See, e.g., Advantage Comment Letter at 8 (Feb. 15, 2013); CMC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5–6 (Feb. 15, 2013); FIA Comment Letter at 4–5 (Feb. 15, 2013); LCH.Clearnet Comment Letter at 4–5 (Jan. 25, 2013); MGEX Comment Letter at 2 (Feb. 18, 2013); NPPC Comment Letter at 2 (Feb. 15, 2013); RCG Comment Letter at 3 (Feb. 12, 2013); RJ O’Brien Comment Letter at 5 (Feb. 15, 2013); TD Ameritrade Comment Letter at 4–5 (Feb. 15, 2013). 385 See, e.g., CMC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5 (Feb. 15, 2013); MGEX Comment Letter at 2 (Feb. 18, 2013); NPPC Comment Letter at 2 (Feb. 15, 2013); RJ O’Brien Comment Letter at 4 (Feb. 15, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 68550 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 changes.386 However, as discussed in more detail below, the Commission is persuaded that the calculations required by the residual interest requirement are feasible using a point in time approach. As noted above, the Commission is moving the Proposed Residual Interest Requirement from proposed § 1.20(i) to new paragraph (c) in § 1.22. Moreover, and as suggested by commenters,387 the Commission agrees that a point in time approach to the determination of the adequate size of the residual interest amount would ‘‘ensure that an FCM has appropriately sized the residual interest buffer to cover the aggregated gross margin deficiencies in respect of customer transactions in the relevant origin.’’ 388 Further, the Commission agrees that this approach is consistent with the Act and Commission regulations, and would help ensure that the collateral of one customer is never used to margin the positions of another customer.389 Moreover, the Commission notes that a point in time approach is consistent with the current practice with respect to residual interest buffer calculations for Cleared Swaps and with the approach set forth in JAC Update 12–03.390 Accordingly, the Commission is revising the Proposed Residual Interest Requirement as follows. Regulation 1.22 (c)(1) defines the undermargined amount for a futures customer’s account as the amount, if any (i.e., the amount must be greater than or equal to zero), by which (i) the total amount of collateral required for that futures customer’s positions 391 in that account, 386 See, e.g., Advantage Comment Letter at 7 (Feb. 15, 2013); CME Comment Letter at 5 (Feb. 15, 2013); FIA Comment Letter at 4, 15, 21–22 (Feb. 15, 2013); MFA Comment Letter at 8 (Feb. 15, 2013); NPPC Comment Letter at 2 (Feb. 15, 2013); RCG Comment Letter at 3 (Feb. 12, 2013); TD Ameritrade at 4–5 (Feb. 15, 2013). Cf. ISDA Comment Letter at 1–2 (Aug. 27, 2013). 387 See ISDA Comment Letter at 6 (Feb. 15, 2013); FIA Comment Letter at 23–25 (Feb. 15, 2013); LCH.Clearnet comment Letter at 5 (Feb. 15, 2013); Paul/Weiss Comment Letter at 4–5 (Feb. 15, 2013); RJ O’Brien Comment Letter at 5 (Feb. 15, 2013). 388 Paul/Weiss Comment Letter at 4 (Feb. 15, 2013). 389 See generally id.; FIA Comment Letter at 23 (Feb. 15, 2013); ISDA Comment Letter at 4 (May 8, 2013). 390 Joint Audit Committee Regulatory Update # 12–03, Part 22 of CFTC Regulations—Treatment of Cleared Swaps Customer Collateral—Legally Segregated Operationally Commingled (‘‘LSOC’’) Compliance Calculation (Oct. 18, 2012). 391 For purposes of this calculation, the FCM should include as ‘‘positions’’ any trade or contract that (i) would be required to be segregated pursuant to 4d(f) of the Act or (ii) would be subject to § 30.7 of this chapter, but which is, in either case, pursuant to a Commission rule, regulation, or order (or a derivatives clearing organization rule approved in accordance with § 39.15(b)(2) of this chapter), commingled with a contract for the VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 at the time or times referred to in § 1.22(c)(2), exceeds (ii) the value of the net liquidating equity for that account, as calculated in § 1.20(i)(2). An FCM is required to perform the calculation set forth in § 1.22(c)(1) on a customer by customer basis. Regulation 1.22(c)(2) requires an FCM to perform a residual interest buffer calculation, at the close of each business day, based on the information available to the FCM at that time,392 by calculating (i) the undermargined amounts, based on the clearing initial margin that will be required to be maintained by that FCM for its futures customers, at each DCO of which the FCM is a member, at the point of the daily settlement (as described in § 39.14) that will complete during the following business day for each such DCO less (ii) any debit balances referred to in § 1.20(i)(4) included in such undermargined amounts.393 An FCM is required to perform the calculation in § 1.22(c)(2) once per day, based on the information at the close of business on that day, so that it can determine the amount of customer funds which will be needed to avoid using the funds of one customer to margin, guarantee, or secure the positions of another customer. Consistent with this revised residual interest requirement, § 1.20(i)(4) is being amended to state that the amount of funds an FCM is holding in segregation may not be reduced by any debit balances that the futures customers of the FCM have in their accounts. In addition, § 1.20(i)(2)(ii) is being removed because this requirement is now set forth in § 1.22(c). Consistent with Federal Register requirements, § 1.20(i)(2) is being renumbered and, for clarity, the first sentence will be revised to read as follows ‘‘The futures commission merchant must reflect in the account that it maintains for each futures customer the net liquidating equity for each such customer, calculated as follows: the market value of any futures customer funds that it receives from such customer, as adjusted by: . . . .’’ 394 Further, under § 1.22(c)(3), an FCM is required, prior to the Residual Interest Deadline, as defined in § 1.22(c)(5), to have residual interest in the segregated account in an amount that is at least equal to the computation set forth in § 1.22(c)(2).395 However, the amount of residual interest that an FCM must maintain may be reduced to account for payments received from or on behalf of (net of disbursements made to or on behalf of) undermargined futures customers between the close of the previous business day and the Residual Interest Deadline. Regulation 1.22(c)(4) provides that for purposes of § 1.22(c)(2), an FCM should include, as ‘‘clearing initial margin,’’ customer initial margin that the FCM will be required to maintain, for that FCM’s futures customers, at another FCM, and, for purposes of § 1.22(c)(3), must do so prior to the Residual Interest Deadline. In other words, § 1.22(c)(4) is intended to make clear that the requirements with respect to futures customer funds used by an FCM that clears through another FCM are parallel to the requirements applied with respect to futures customer funds used when an FCM clears through a DCO. Regulation 1.22(c)(5) defines the Residual Interest Deadline. Paragraph (c)(5)(i) sets forth that except during the phase-in period defined in paragraph (c)(5)(ii), the Residual Interest Deadline shall be the time of the settlement referenced in paragraph (c)(2)(i), or, as appropriate, (c)(4). However, in response to the comments that urge that achieving compliance with these requirements may take time, and in order to mitigate some of the cost concerns raised by commenters, paragraph (c)(5)(ii) provides that the Residual Interest Deadline during the phase-in period shall be 6:00 p.m. purchase or sale of a commodity for future delivery and any options on such contracts in an account segregated pursuant to section 4d(a) of the Act and should exclude as ‘‘positions’’ any trade or contract that, pursuant to a Commission rule, regulation, or order, is segregated pursuant to section 4d(f) of the Act. This requirement is intended to be analogous to the definition of Cleared Swap in § 22.1 of this chapter. 392 An FCM is not expected to account for changes in circumstances that occur after the close of business and prior to the next business day’s settlement, outside of normal end-of-day reconciliation processes. In other words, an FCM may use the information (such as position and value information) available to it at the close of each business day for this calculation. 393 This subtraction is intended to address the potential double-counting of deficit balances that was pointed out in a number of comments. See, e.g., Vanguard Comment Letter at 8 (Feb. 22, 2013). 394 As noted in the preamble to the proposal, the purpose of the amendments to 1.20(i) is to ‘‘provid[e] more detail implementing the Net Liquidating Method of calculating segregation requirements.’’ 77 FR at 67882. 395 Following the completion of the phase-in period, when the Residual Interest Deadline moves to the time of settlement, an FCM may be subject to multiple Residual Interest Deadlines, in which case the FCM must maintain residual interest prior to the Residual Interest Deadline in an amount that is at least equal to the portion of the computation set forth in § 1.22(c)(2) attributable to the clearing initial margin required by the DCO making such settlement. Thus, where an FCM is a member of more than one DCO and the DCOs conduct their daily settlement cycles at different times, an FCM would be required, at the time of the daily settlement for each DCO, to maintain the proportionate share of residual interest in the futures customer account. PO 00000 Frm 00046 Fmt 4701 Sfmt 4700 E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 Eastern Time on the date of the settlement referenced in paragraph (c)(2)(i) or, as appropriate, (c)(4). The phased compliance schedule for § 1.22(c) is set forth in § 1.22(c)(5)(iii). However, the Residual Interest Deadline of 6:00 p.m. Eastern Time in § 1.22(c)(5)(ii) shall begin one year following the publication of this rule in the Federal Register.396 Additionally, in further response to the commenters’ request for additional study,397 in paragraph (c)(5)(iii)(A), the Commission is directing staff to complete and publish for public comment a report (‘‘the Report’’), no later than 30 months following the date of publication of this release, addressing, to the extent information is practically available, the practicability (for both FCMs and customers) of moving the Residual Interest Deadline from 6:00 p.m. Eastern Time on the date of the settlement referenced in § 1.22(c)(2)(i) to the time of that settlement (or to some other time of day), including whether and on what schedule it would be feasible to do so. The Report is also expected to address cost and benefit considerations of such potential alternatives. Moreover, staff shall, using the Commission’s Web site, solicit public comment and shall conduct a public roundtable regarding specific issues to be covered by the Report. Paragraph (c)(5)(iii)(B) sets forth that within nine months after the publication of the Report, the Commission may (but shall not be required to) do either of the following: (1) terminate the phase-in period, in which case the phase-in shall end as of a date established by order published in the Federal Register, which date shall be no less than one year after the date such order is published, or (2) determine that it is necessary or appropriate in the public interest to propose through rulemaking a different Residual Interest Deadline, in which event, the Commission shall establish, by order published in the Federal Register, a phase-in schedule. Finally, paragraph (c)(5)(iii)(C) provides that if the phase-in schedule has not been 396 For further discussion regarding the phase-in schedule for the requirements in § 1.22(c), see section III.F. 397 See, e.g., AIMA Comment Letter at 3 (Feb. 15, 2013); CCC Comment Letter at 2–3 (Feb. 15, 2013); CHS Hedging Comment Letter at 2–3 (Feb. 15, 2013); CME Comment at 5–7 (Feb. 15, 2013); AFBF Comment Letter at 2 (Feb. 15, 2013); Jefferies Comment Letter at 9 (Feb. 15, 2013); JSA Comment Letter at 1–2 (Feb. 15, 2013); NCBA Comment Letter at 2 (Feb. 15, 2013); NGFA Comment Letter at 5 (Feb. 15, 2013); NIBA Comment Letter at 1–2 (Feb. 15, 2013); TCFA Comment Letter at 2 (Feb. 15, 2013); AFMP Group Comment Letter at 1–2 (Sept. 18, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 amended pursuant to § 1.22(c)(5)(iii)(B), then the phase-in period shall end on December 31, 2018. With respect to the suggestion that a portion (i.e., that portion attributable to customer business) of the funds contributed to an exchange’s guaranty fund by an FCM should be considered in that FCM’s residual interest calculations,398 the Commission notes that contributions to a guarantee fund are not segregated for the benefit of customers. Rather, they are, by design, available to meet the defaults of other clearing members, and thus cannot be counted as customer segregated funds. As such, the Commission declines to adopt this suggestion. The Commission also received several requests for clarifications. CIEBA stated that ‘‘while futures market participants may be familiar with terms such as ‘residual interest’ and the technical features of the proposed rule, other market participants may not appreciate the full scope of the rule and the additional protections provided without further explanation.’’ 399 CIEBA requested that the Commission clarify ‘‘how this requirement is intended to work with examples of its application so as to more broadly communicate the Commission’s intent to bolster the depth of customer protections to minimize customer risk and promote confidence in the markets.’’ 400 The Commission recognizes CIEBA’s concern and, as discussed above, has provided clarification in this release regarding the mechanism by which FCMs measure compliance with the statutory requirement of 4d(a)(2). However, the Commission also recognizes that FCMs engage in a broad range of acceptable business practices and should be given flexibility in how best to tailor their businesses to comply with such requirement. AIMA requested clarification that §§ 1.17(c)(5) and 1.20(i)(4) are not duplicative and therefore does not require FCMs to ‘‘double count’’ residual interest.401 The Commission reiterates that § 1.17(c)(5) and the residual interest requirement now set forth in 1.22(c)(2) are two separate requirements. As discussed above, § 1.17 sets forth the Commission’s minimum capital requirements for FCMs and requires, among other things, an FCM to incur a charge to capital for customer and noncustomer accounts 398 See, e.g., Newedge Comment Letter at 3 (Feb. 15, 2013); RJ O’Brien Comment Letter at 5 (Feb. 15, 2013). 399 CIEBA Comment Letter at 3 (Feb. 15, 2013). 400 Id. 401 See AIMA Comment Letter at 3 (Feb. 15, 2013). PO 00000 Frm 00047 Fmt 4701 Sfmt 4700 68551 that are undermargined beyond a specified period of time.402 The residual interest requirements, on the other hand, are intended to help make sure that the collateral of one customer is never used to margin the positions of another customer. These requirements are, therefore, not duplicative, and the Final Rule does not actually require an FCM to double count the residual interest amount.403 Paul/Weiss requested that the Commission confirm that the requirements of jurisdiction and denomination in § 1.49 do not apply to an FCM’s cash management procedures for meeting its residual interest obligation.404 Paul/Weiss noted that JAC Update 12–03,405 provides that the denomination and jurisdiction requirements set forth in § 1.49 do not apply to the extent that an FCM deposits additional funds in order to cover margin deficiencies in the Cleared Swaps Customer Account prior to a 406 DCO’s settlement.407 The Commission agrees that, for purposes of meeting any undermargined amount in a customer account with a deposit of additional funds prior to payment to any DCO, the requirements of Commission § 1.49 with respect to denomination or jurisdiction should not apply, and accordingly, they will not. FCStone asked the Commission to set price limits at levels equal to or below the margin requirement in all commodities to mitigate the potential for under margined customer positions.408 NPPC requested that the Commission give ‘‘customers the opportunity to ‘opt out’ of allowing segregated funds to be used outside of the customer accounts,’’ so that ‘‘customers can proactively protect their funds from being used for potentially fraudulent purposes’’ and when ‘‘coupled with higher fees to help balance the trade off, customers could determine the level of risk to which they are comfortable subjecting their funds.’’ 409 The Commission notes that 402 See section II.F. above. section II.F. above regarding the requirement set forth § 1.17(c)(5). 404 Paul/Weiss Comment Letter at 6 (Feb. 15, 2013). 405 This update provides that, for purposes of meeting any margin deficiency in the cleared swaps customer account with a deposit of additional funds prior to payment to any DCO, the requirements of Commission § 1.49 with respect to denomination or jurisdiction will not apply. 406 Paul/Weiss Comment Letter at 5–6 (Feb. 15, 2013). 407 Paul/Weiss Comment Letter at 5–6 (Feb. 15, 2013). 408 FCStone Comment Letter at 6 (Feb. 15, 2013). 409 NPPC Comment Letter at 2 (Feb. 15, 2013). 403 See E:\FR\FM\14NOR2.SGM 14NOR2 68552 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations these comments are outside the scope of this rulemaking. FCStone objected to proposed § 1.20(i), believing that the Commission was mandating changing a customer’s account balance to record margin deficits, which they believe would impact the tax treatment of customers’ accounts.410 The Commission clarifies that the proposed amendments were not intended to require any additional charges to individual customer accounts, but to ensure that the FCM separately tracked the sum of such amounts to ensure it was holding residual interest in its segregated accounts greater than the gross total of such undermargined amounts. 10. Segregation Regimes TKELleY on DSK3SPTVN1PROD with RULES2 Several commenters proposed that language contained in customer account agreements used by certain FCMs should be restricted by the Commission. These commenters referred to clauses permitting customer collateral to be pledged, liquidated or transferred by the FCM and asked that the account agreements be viewed as contracts of adhesion due to the necessity to agree to such clauses in order to open a commodity futures trading account.411 These commenters, among other issues, requested that the Commission limit the ability of FCMs to require such contractual language. The Commission notes that any such contractual language does not limit the applicability of the Act and Commission regulations with respect to the treatment of customer property by FCMs. The customer protection regime applies to all segregated customer funds regardless of any broader contractual terms. The specific ability of an FCM to pledge, liquidate or transfer customer collateral is constrained by the Act and Commission regulations regardless of any reference in a customer agreement to such applicable law, or a lack of reference thereto. Section 4d is the relevant provision of the Act that addresses how FCMs must hold customer funds. Section 4d(a)(2) of the Act provides that each FCM must treat and deal with all money, securities, and property received by the FCM to margin, guarantee, or secure the trades or contracts of any customer of the FCM, or accruing to such customer as the 410 FCStone Comment Letter at 4 (Feb. 15, 2013). Premier Metal Services Comment Letter at 2–3 (Jan. 1, 2013) and ISRI Comment Letter at 4– 5 (Dec. 4, 2012), which letters were cited and supported by several other commenters. See also Pilot Flying J Comment Letter at 2 (Feb. 14, 2013), which stated that FCMs should not be permitted to use customer funds for outside investments, capitalization or collateralization. 411 See VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 result of such trades or contracts, as belonging to the customer. Section 4d(a)(2) further provides that customer funds must be separately accounted for and may not be commingled with the funds of the FCM, or be used to margin or guarantee the trades or contracts, or to secure or extend credit, of any customer or person other than the customer that deposited the funds. Commission regulations also set requirements on how customer funds may be held. Regulation 1.20(a) provides that all customer funds must be separately accounted for by the FCM and segregated as belonging to commodity or option customers. The funds, when deposited with a bank, trust company, clearing organization, or another FCM must be deposited under an account name that clearly identifies the funds as belonging to customers and shows that the funds are segregated from the FCM’s own funds as required by Section 4d(a)(2) of the Act. Regulation 1.20(c) provides that each FCM must treat and deal with the customer funds of a customer as belonging to the customer. The FCM must separately accounted for customer funds and may not commingle the funds with the FCM’s own funds, or use the funds to margin, guarantee, or secure futures positions of any person, or extend credit to any person, other than the customer that owns the funds. Regulation 1.25 sets forth requirements on how FCMs may invest customer funds. Pursuant to § 1.25, an FCM is permitted to use customer funds to purchase permitted investments. The investments, however, are required to be separately accounted for by the FCM under § 1.26, and segregated from the FCM’s own assets in accounts that designate the funds as belonging to customers of the FCM and held in segregation as required by the Act and Commission regulations. FCMs also may sell customer deposited securities under agreements to repurchase the securities pursuant to § 1.25(a)(2)(ii). Regulation 1.25(d)(9) provides that the cash transferred to the segregation account for customer-owned securities sold under a repurchase agreement must be on a payment versus delivery basis, and the customer segregated funds account must receive same-day funds credited to the segregated account simultaneously with the delivery or transfer of the securities from the customer segregated accounts. A customer, however, may condition its deposits of securities with an FCM by requiring that that FCM not engage in reverse repurchase transactions with the customer’s collateral. PO 00000 Frm 00048 Fmt 4701 Sfmt 4700 Accordingly, FCMs do not have an unfettered ability to pledge, rehypothecate, or otherwise use customer funds (including customer deposited securities) for their own benefit or purposes. However, FCMs also have the ability, as limited by all such applicable law and regulation for the benefit of customers, to liquidate customer securities if the customer that deposited the securities fails to meet a margin call. FCMs also may pledge customer deposited securities to DCOs as margin for the customer accounts carried by the FCM. The customer collateral pledged to a DCO, however, also must be held in customer segregated accounts. Even if transformed as permissible under the Act and regulations and contemplated by customer agreements, such collateral maintains its character as segregated customer property and remains subject to the customer protection regime. Commission staff has further confirmed that there is variability in the FCM community regarding the specific language included in customer account agreements and that not all agreements include broad authorities to the FCM for the use of customer collateral. However, as noted above, the contractual terms and conditions could not result in an FCM holding or using customer funds in a manner that was not in conformity with the Act and Commission regulations. Several commenters also requested that the Commission provide alternatives to the current segregation regime, including individual segregation, the ability to use third-party custodial accounts, or the ability to optout of segregation.412 While these issues are beyond the scope of the Proposal, the Commission notes that in adopting the final regulations for the protection of Cleared Swaps Customer Collateral in February 2012, it stated that the issue of alternative segregation regimes raise important risk management and cost externality issues, particularly in ensuring that deposited collateral is immediately available to the FCM or DCO in the event of the default of the customer or FCM.413 The Commission directed staff to continue to analyze different proposals with the goal of developing a proposal to provide additional or enhanced customer protection.414 In this regard, staff is continuing to review and meet with 412 See, e.g., ISRI Comment Letter at 6 (Dec. 4, 2013); AIM Comment Letter at 2–7 (Jan. 24, 2013); MFA Comment Letter at 9 (Feb. 15, 2013); State Street Comment Letter at 2 (Jan. 16, 2013). 413 77 FR 6336, 6343 (Feb. 7, 2012). 414 Id. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations industry representatives regarding alternative segregation regimes. In addition, the Commission noted that customer funds held in third-party custodial accounts constitute customer property within the meaning of the Bankruptcy Code. As such, positions and collateral held in third-party accounts are subject to the U.S. Bankruptcy Code and applicable provisions of the Act, which provide for the pro rata share of available customer property. The Commission also received several comments requesting specific and defined protections for funds provided to an FCM by retail counterparties engaged in off-exchange foreign currency transactions.415 The Proposal, however, focused on customer protection issues in the futures market, and the issue of the protection of funds held by an FCM for retail foreign currency counterparties is beyond the scope of the Proposal. H. § 1.22: Use of Futures Customer Funds RCG commented that the proposed amendments to §§ 1.22, 1.23, 30.7(f) and 30.7(g) are inconsistent as to when an FCM should use its own funds to cover margin deficits with § 1.30, which provides that an FCM cannot make an unsecured loan to a customer.416 The Commission does not believe that the regulations are inconsistent. Regulation § 1.30 provides that an FCM may not make a loan to a customer, unless such loan is done a fully secured basis. Regulations 1.22 and 30.7(f) provide that an FCM cannot use the funds of one customer to secure or extend credit to another customer. Regulations 1.23 and 30.7(g) impose conditions upon when an FCM may withdraw proprietary funds from segregated accounts. As discussed in greater detail in section II.G.9. above, the Commission has considered the comments and has revised and reorganized § 1.22. I. § 1.23: Interest of Futures Commission Merchant in Segregated Futures Customer Funds; Additions and Withdrawals TKELleY on DSK3SPTVN1PROD with RULES2 The Commission proposed amending § 1.23 to require additional safeguards with respect to an FCM withdrawing futures customer funds from segregated 415 See forex form letter group: Michael Krall; David Kennedy; Robert Smith; Michael Carmichael; Andrew Jackson; Donald Blais; Suzanne Slade; Patricia Horter; JoDan Traders; Jeff Schlink; Sam Jelovich; Matthew Bauman; Mark Phillips; Deborah Stone; Po Huang; Aaryn Krall; Vael Asset Management; Kos Capital; James Lowe; Tracy Burns; Treasure Island Coins; Clare Colreavy, Brandon Shoemaker. 416 RCG Comment Letter at 7 (Feb. 12, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 accounts that are part of the FCM’s residual interest in such accounts. Proposed § 1.23(a) provides that an FCM may deposit unencumbered proprietary funds, including securities from its own inventory that qualify as permitted investments under § 1.25, into segregated futures customer accounts in order to provide a buffer or cushion of funds to protect against the firm failing to maintain sufficient funds in such accounts to meet its total obligations to futures customers. Under proposed § 1.23(a), an FCM has access to its own funds deposited into futures customer accounts to the extent of the FCM’s residual interest in such funds, subject to the restriction on withdrawal of residual interest required to cover undermargined amounts. However, proposed § 1.23(b) prohibits an FCM from withdrawing its residual interest or excess funds from futures customer accounts (any withdrawal not made to or for the benefit of futures customers would be considered a withdrawal of the FCM’s residual interest) on any given business day unless the FCM had completed the daily calculation of funds in segregation pursuant to § 1.32 as of the close of the previous business day, and the calculation showed that the FCM maintained excess segregated funds in the futures customer accounts as of the close of business on the previous business day. Proposed § 1.23(b) further requires that the FCM adjust the excess segregated funds reported on the daily segregation calculation to reflect other factors, such as overnight and current day market activity and the extent of current customer undermargined or debit balances, to develop a reasonable basis to estimate the amount of excess funds that remain on deposit since the close of business on the previous day prior to initiating a withdrawal. The Commission proposed additional required layers of authorization and documentation if the withdrawal exceeds, individually or in the aggregate with other such withdrawals, 25 percent or more of the FCM’s residual interest computed as of the close of business on the prior business day. Proposed § 1.23(c) prohibits an FCM from withdrawing more than 25 percent of its residual interest in futures customer accounts unless the FCM’s CEO, CFO, or other senior official that is listed as a principal on the firm’s Form 7–R registration statement and is knowledgeable about the FCM’s financial requirements (‘‘Financial Principal’’) pre-approves the withdrawal in writing. Regulation 1.23(c) requires the FCM to immediately file a written notice with PO 00000 Frm 00049 Fmt 4701 Sfmt 4700 68553 the Commission and with the firm’s DSRO of any withdrawal that exceeds 25 percent of its residual interest. The written notice must be signed by the CEO, CFO, or Financial Principal that pre-approved the withdrawal, specifying the amount of the withdrawal, its purpose, its recipient(s), and contain an estimate of the residual interest after the withdrawal. The written notice also must contain a representation from the person that preapproved the withdrawal that to such person’s knowledge and reasonable belief, the FCM remains in compliance with its segregation obligations. Regulation 1.23 further requires that the official, in making this representation, specifically consider any other factors that may cause a material change in the FCM’s residual interest since the close of business on the previous business day, including known unsecured futures customer debits or deficits, current day market activity, and any other withdrawals. The written notice would be required to be filed with the Commission and with the FCM’s DSRO electronically. Proposed § 1.23(d) requires an FCM to deposit proprietary funds sufficient to restore the residual interest targeted amount when a withdrawal of funds from segregated futures customer accounts, not for the benefit of the firm’s customers, causes the firm to fall below its targeted residual interest in such accounts. The FCM must deposit the proprietary funds into such segregated accounts prior to the close of the next business day. Alternatively, the FCM may revise its targeted residual interest amount, if appropriate, in accordance with its written policies and procedures for establishing, documenting, and maintaining its target residual interest, in accordance with the requirements of proposed § 1.11. Proposed § 1.23 also stated that should an FCM’s residual interest, however, be exceeded by the sum of the FCM’s futures customers’ margin deficits (i.e., undermargined amounts), an amount necessary to restore residual interest to that sum must be deposited immediately. Identical requirements with respect to procedures required for withdrawals of residual interest in Cleared Swaps Customer Collateral Accounts and 30.7 secured accounts were proposed in §§ 22.17(c) and 30.7(g), respectively. NFA commented recommending that the Commission revise the language in § 1.23 to keep it consistent with the language in NFA Financial Requirements Section 16 (prohibiting withdrawals that are made ‘‘not for the benefit of commodity and option customers and foreign futures and E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68554 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations foreign options customers’’).417 NFA commented that without a definition of ‘‘proprietary use’’ a withdrawal that may not be for an FCM’s own proprietary use may still be a withdrawal that is not for the benefit of customers and, therefore, would trigger NFA’s approval and notice requirements pursuant to NFA Financial Requirements Section 16, but not the Commission’s approval and notice requirements pursuant to § 1.23.418 NFA also commented that the Commission should remove proposed § 1.23(d)’s reference to ‘‘business days’’ in order to ensure that FCMs understand that the requirements related to withdrawals of 25 percent or more apply at all times.419 The Commission has considered NFA’s comment and is revising § 1.23 to remove the term ‘‘proprietary use’’ and is replacing it with the concept of withdrawals that are not made to or for the benefit of customers. The Commission also is revising § 1.23 to remove the reference to ‘‘business days.’’ The revisions will more closely align the Commission’s and NFA’s regulations governing an FCM’s withdrawal of proprietary funds from a segregated account by making the language and conditions more consistent. This consistency of the Commission and NFA requirements is appropriate as it will allow FCMs to operate under one set of conditions, while also retaining the overall policy goals of the Commission to limit an FCM’s ability to withdraw funds from segregated accounts until the FCM can be reasonably assured that the funds are excess, proprietary funds.420 NFA further requested the Commission to clarify that pre-approval of a series of transactions that in the aggregate exceeded the 25 percent threshold would not require after the fact approvals of the first transactions of the series, but only approvals of the transactions resulting in the 25 percent threshold being exceeded.421 The Commission confirms that an FCM would need to obtain the necessary approvals only for the transaction that caused the withdrawals to exceed the 25 percent threshold. Jefferies commented that it generally supported proposed amendments to § 1.23, but stated that requiring FCMs to report when they draw down more than 25 percent of their residual interest will discourage an FCM from voluntarily 417 NFA adding to its residual interest.422 Jefferies commented that FCMs should be permitted to withdraw any residual interest amount in excess of their target level and to withdraw up to 25 percent of the target level before providing notice, or if the last calculated residual interest was below the target level, the calculation should be 25 percent of the lower amount.423 LCH.Clearnet and the FIA also recommended revising §§ 1.23(d) and 22.17(c) to apply only to withdrawal of FCM funds in excess of 25 percent of the FCM’s targeted residual interest, rather than on 25 percent of the total residual interest in the customer segregated account, specifically to ensure that FCMs have no disincentive to maintain significant excess funds above the targeted residual interest segregation at DCOs for swaps clearing.424 The Commission does not believe that substituting the targeted residual amount for the actual residual interest amount would appropriately focus management attention on significant withdrawals relative to the actual, not just target, excess, as well as clearly establish a chain of responsibility for such withdrawals, as is the intended purpose of the proposed regulation. The Commission clarifies that pre-approval would be required, with respect to a series of transactions, for the transactions which would result in the threshold being exceeded and not earlier transactions in the series. Accordingly, the Commission is adopting § 1.23 and the conforming provisions in §§ 22.17 and 30.7(g), with changes as recommended by NFA substituting language ‘‘not for the benefit of customers’’ (with description of customer as applicable to each such provision) for ‘‘proprietary use’’ and eliminating the reference to business days.425 In addition, and in light of the changes discussed herein with respect to the residual interest requirements set forth in §§ 1.22, 22.2, and 30.7, the Commission is amending § 1.23 and the conforming provisions in §§ 22.17 and 30.7(g) to make clear that if an FCM’s residual interest is less than the amounts required to be maintained in § 1.22, 22.2(f)(6), or 30.7(f), as applicable, at any particular point in time, the FCM must immediately restore the residual interest to exceed the sum of such amounts. Comment Letter at 14 (Feb. 15, 2013). 418 Id. 419 Id. 420 The Commission also is making comparable revisions to §§ 22.17(c) and 30.7(g) in light of NFA’s comments. 421 Id. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 422 Jefferies Comment Letter at 4–6 (Feb. 15, 2013). 423 Id. 424 LCH.Clearnet Comment Letter at 7 (Jan. 25, 2013); FIA Comment Letter at 6 (Feb. 15, 2013). 425 See NFA Comment Letter at 14 (Feb. 15, 2013). PO 00000 Frm 00050 Fmt 4701 Sfmt 4700 J. § 1.25: Investment of Customer Funds 1. General Comments Regarding the Investment of Customer Funds Regulation 1.25 sets forth the financial investments that an FCM or DCO may make with customer funds. The Commission received 32 comment letters regarding the investment and handling of customer funds by FCMs and DCOs.426 In general, all of the commenters supported the position that FCMs and DCOs only be allowed to make safe/non-speculative investments of customer funds and not be allowed to add risk that customers are unaware of or do not sanction. More specifically, 29 of the commenters proposed that the Commission amend its regulations to provide commodity customers with the ability to ‘‘opt out’’ of granting FCMs permission to invest their funds (including hypothecation and rehypothecation).427 Additionally, 426 Schippers Comment Letter (Dec. 10, 2013), Randy Fritsche Comment Letter (Feb. 14, 2013), NPPC Comment Letter at 2 (Feb. 14, 2013), Strelitz/ California Metal X Comment (Jan. 15, 2013), Premier Metal Services Comment Letter at 4 (Jan. 3, 2013), ISRI Comment Letter at 5–7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan. 24, 2013), Kripke Enterprises Comment Letter (Dec. 12, 2012), Manitoba Comment Letter (Dec. 13, 2012), Solomon Metals Corp. Comment Letter (Jan. 15, 2013), Michael Krall Comment Letter (Dec. 17, 2012), David Kennedy Comment Letter (Dec. 17, 2012), Robert Smith Comment Letter (Dec. 17, 2012), Michael Carmichael Comment Letter (Dec. 17, 2012), Andrew Jackson Comment Letter (Dec. 17, 2012), Donald Blais Comment Letter (Dec. 17, 2012), Suzanne Slade Comment Letter (Dec. 17, 2012), Patricia Horter Comment Letter (Dec. 17, 2012), JoDan Traders Comment Letter (Dec. 17, 2012), Jeff Schlink Comment (Dec. 18, 2012), Sam Jelovich Comment Letter (Dec. 18, 2012), Matthew Bauman Comment Letter (Dec. 20, 2012), Mark Phillips Comment Letter (Dec. 22, 2012), Deborah Stone Comment Letter (Dec. 24, 2012), Po Huang Comment Letter (Dec. 24, 2012), Aarynn Krall Comment Letter (Jan. 8, 2013), Vael Asset Management Comment Letter (Jan. 10, 2013), Kos Capital Comment Letter (Jan. 11, 2013), James Lowe Comment Letter (Jan. 13, 2013), Tracy Burns Comment Letter (Jan. 14, 2013), Treasure Island Coins Comment Letter (Jan. 14, 2013), and Clare Colreavy Comment Letter (Jan. 9, 2013). 427 NPPC Comment Letter at 2 (Feb. 14, 2013), Premier Metal Services Comment Letter at 4 (Jan. 3, 2013), ISRI Comment Letter at 5–7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan. 24, 2013), Kripke Enterprises Comment Letter (Dec. 12, 2012), Manitoba Comment Letter (Dec. 13, 2012), Solomon Metals Corp. Comment Letter (Jan. 15, 2013), Michael Krall Comment Letter (Dec. 17, 2012), David Kennedy Comment Letter (Dec. 17, 2012), Robert Smith Comment Letter (Dec. 17, 2012), Michael Carmichael Comment Letter (Dec. 17, 2012), Andrew Jackson Comment Letter (Dec. 17, 2012), Donald Blais Comment Letter (Dec. 17, 2012), Suzanne Slade Comment Letter (Dec. 17, 2012), Patricia Horter Comment Letter (Dec. 17, 2012), JoDan Traders Comment Letter (Dec. 17, 2012), Jeff Schlink Comment Letter (Dec. 18, 2012), Sam Jelovich Comment Letter (Dec. 18, 2012), Matthew Bauman Comment Letter (Dec. 20, 2012), Mark Phillips Comment Letter (Dec. 22, 2012), Deborah Stone Comment Letter (Dec. 24, 2012), Po Huang Comment Letter (Dec. 24, 2012), Aarynn E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations seven of the 29 commenters requested that the Commission also mandate that an FCM cannot prevent a customer who so ‘‘opts out’’ from continuing to trade through that FCM merely because the customer elected to ‘‘opt out.’’ 428 The Commission did not propose to amend the list of permitted investments set forth in § 1.25, and believes that the current investments and regulatory requirements establish an appropriate balance between providing investment opportunities for FCMs with the overall objective of protecting customer funds. As further discussed in section II.L. below, the Commission also is amending § 1.29 to explicitly provide that an FCM is responsible for any losses resulting from the investment of customer funds under § 1.25. The Commission further notes that the current regulatory structure does not provide for a system whereby customers can elect to ‘‘opt-out’’ of segregation or § 1.25. In the event of the insolvency of an FCM, where there also was a shortfall in customer funds, customers would be entitled to a pro-rata distribution of customer property under section 766 of the U.S. bankruptcy code.429 Therefore, even if a customer was permitted by the FCM to ‘‘opt-out’’ of segregation, the funds held by the FCM would be pooled with other customer funds and distributed on a pro-rata basis to all customers participating in that account class. TKELleY on DSK3SPTVN1PROD with RULES2 2. Reverse Repurchase Agreement Counterparty Concentration Limits Regulation 1.25 provides that FCMs and DCOs may use customer funds to purchase securities from a counterparty under an agreement for the resale of the securities back to the counterparty (‘‘reverse repurchase agreements’’). Regulation 1.25 places conditions on reverse repurchase agreements, including, limiting counterparties to certain banks and government securities brokers or dealers, and prohibiting an FCM or DCO from entering into such agreements with an affiliate. Regulation 1.25(b)(3)(v) also imposes a counterparty concentration limit on Krall Comment Letter (Jan. 8, 2013), Vael Asset Management Comment Letter (Jan. 10, 2013), Kos Capital Comment Letter (Jan. 11, 2013), James Lowe Comment Letter (Jan. 13, 2013), Tracy Burns Comment Letter (Jan. 14, 2013), Treasure Island Coins Comment Letter (Jan. 14, 2013), and Clare Colreavy Comment Letter (Jan. 9, 2013). 428 NPPC Comment Letter at 2 (Feb. 14, 2013); Premier Metal Services Comment Letter at 4 (Jan. 3, 2013); ISRI Comment Letter at 6 (Dec. 4, 2012); AIM Comment Letter at 6 (Jan. 24, 2013); Kripke Enterprises Comment Letter (Dec. 10, 2012); Manitoba Comment Letter (Dec. 13, 2012); and Solomon Metals Corp Comment Letter (Jan, 15, 2013). 429 11 U.S.C. 766. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 reverse repurchase agreements that prohibits an FCM or DCO from purchasing securities from a single counterparty that exceeds 25 percent of the total assets held in segregation by the FCM or DCO. The Commission proposed to amend § 1.25(b)(3)(v) to require an FCM or DCO to aggregate the value of the securities purchased under reverse repurchase agreements if the counterparties are under common control or ownership. The aggregate value of the securities purchased under a reverse repurchase agreement from the counterparties under common ownership or control could not exceed 25 percent of the total assets held in segregation by the FCM or DCO. The Commission proposed the amendment as it believed that the expansion of the counterparty concentration limitation to counterparties under common ownership or control is consistent with the original intent of the regulation, and to minimize potential losses or disruptions due to the default of a counterparty. The Commission received comments from LCH.Clearnet and CFA in support of the proposed amendments.430 No other comments were received. The Commission is adopting the amendments as proposed. K. § 1.26: Deposit of Instruments Purchased With Futures Customer Funds Regulation 1.26 requires each FCM or DCO that invests customer funds in instruments listed under § 1.25 to separately account for such instruments and to segregate the instruments from its own funds. An FCM or DCO also must deposit the instruments under an account name which clearly shows that they belong to futures customers and that the instruments are segregated as required by the Act and Commission regulations. The FCM or DCO also must obtain and retain in its files a written acknowledgment from the depository holding the instruments stating that the depository was informed that the instruments belong to futures customers and that the instruments are being held in accordance with the provisions of the Act and Commission regulations. The Commission proposed amending § 1.26 to specify how direct investments by FCMs and DCOs in money market mutual funds (‘‘MMMFs’’) that qualify as permitted investments under § 1.25 must be held, and to adopt a Template Letter to be used with respect to direct investments in qualifying MMMFs. Like the proposed Template Letters for §§ 1.20 and 30.7, the proposed Template Letter for § 1.26 contained provisions providing for read-only access and release of shares upon instruction from the director of the Division of Clearing and Risk, the director of the Division of Swap Dealer and Intermediary Oversight, or any successor divisions, or such directors’ designees. With respect to the Template Letter for MMMFs, ICI noted that costs to create electronic access to FCM accounts at an MMMF would be ‘‘borne by all investors and not just by FCMs,’’ which likely only constitute a small percentage of an MMMF’s investors.431 As an alternative, ICI proposed that the Template Letter be amended to require the MMMF to provide FCM account data promptly (i.e., within 48 hours) upon request.432 ICI also commented that the Commission should confirm: (1) The ‘‘examination or audit’’ of the accounts authorized by the acknowledgment letter is limited to verification of account balances and that further inspection of an MMMF itself would be referred to the SEC as primary regulator; and (2) the proposal would require only those MMMFs in which FCMs directly invest customer funds (as opposed to those held through intermediated positions like omnibus accounts or intermediary-controlled accounts) to agree to provide FCM account information.433 The Commission originally proposed one Template Letter, Appendix A to § 1.26, to be used by both FCMs and DCOs when investing customer funds in an MMMF. However, as noted above in the discussion of the § 1.20 Template Letters, the Commission has determined to eliminate the read-only access requirement for DCOs. Therefore, the Commission is adopting different Template Letters for FCMs and DCOs in § 1.26. The Template Letter specific to FCMs is now set forth in Appendix A to § 1.26, and the Template Letter for DCOs is set forth in Appendix B to § 1.26. The Commission has made other modifications to the § 1.26 Template Letters consistent with the modifications to the § 1.20 Template Letters. The Commission also confirms that examination of accounts authorized by the acknowledgment letter would not involve regulation or examination of the MMMF itself, over which the Commission does not have supervisory or regulatory authority. The examination would be limited to 431 ICI 430 LCH.Clearnet Comment Letter at 4 (Jan. 25, 2013); CFA Comment Letter at 6 (Feb. 13, 2013). PO 00000 Frm 00051 Fmt 4701 Sfmt 4700 68555 Comment Letter at 4–5 (Jan. 14, 2013). at 5. 433 Id. at 4–6 (Jan.14, 2013). 432 Id. E:\FR\FM\14NOR2.SGM 14NOR2 68556 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations verification of the account shares of the FCM or DCO, and the Template Letters required under § 1.26 are solely applicable to directly-held investments in MMMFs. For the purpose of clarification, an FCM or DCO that holds shares of an MMMF in a custodial account at a depository (not directly with the MMMF or its affiliate) is required to execute the Template Letter set forth in Appendix A or B of Regulation 1.20, as applicable. In addition, a MMMF would be required to provide the Commission with read-only access to accounts holding customer funds only if the FCM directly deposits customer funds with the MMMF. Proposed paragraph (b) of § 1.26 has been modified to include a reference to Appendix B to § 1.20. Otherwise, the Commission is adopting § 1.26 as proposed. TKELleY on DSK3SPTVN1PROD with RULES2 L. § 1.29: Increment or Interest Resulting From Investment of Customer Funds 1. FCM’s Responsibility for Losses Incurred on the Investment of Customer Funds Regulation 1.29 currently provides that an FCM or DCO is not required to pass the earnings from the investment of futures customer funds to the futures customers. An FCM or DCO may retain any interest or other earnings from the investment of futures customer funds. The Commission proposed to amend § 1.29 to explicitly provide that an FCM or DCO is responsible for any losses incurred on the investment of customer funds. Investment losses cannot be passed on to futures customers. As the Commission noted in the Proposal, an FCM may not charge or otherwise allocate investment losses to the accounts of the FCM’s customers. To allocate losses on the investment of customer funds would result in the use of customer funds in a manner that is not consistent with section 4d(a)(2) and § 1.20, which provides that customer funds can only be used for the benefit of futures customers and limits withdrawals from futures customer accounts, other than for the purpose of engaging in trading, to certain commissions, brokerage, interest, taxes, storage or other fees or charges lawfully accruing in connection with futures trading.434 Section 4d(b) of the Act also provides that it is unlawful for a DCO to use customer funds as belonging to any person other than the customers of the FCM that deposited the funds with the DCO. Accordingly, such investment losses are the responsibility of the FCM or DCO, as applicable. Similar 434 77 FR 67866, 67888. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 regulations were proposed for Cleared Swaps Customer Collateral under part 22 (§ 22.2(e)(1)), and for 30.7 customer funds under part 30 (§ 30.7(i)). FIA and CFA supported the proposed amendments to § 1.29.435 No other comments were received. The Commission adopts the amendments to §§ 1.29, 22.2(e)(1), and 30.7(i) as proposed. 2. FCM’s Obligation in Event of Bank Default The Commission requested comment on the extent of an FCM’s responsibility to cover losses in the event of a default of by a bank holding customer funds. The CFA commented that FCM’s should be responsible as such an obligation will require that FCMs conduct adequate due diligence on the banks in which they place customers’ funds, a factor that should limit the effect of a related future bank failure.436 The FIA noted that the Commodity Exchange Authority issued an Administrative Determination in 1971 setting out the appropriate standard of liability for an FCM in the event of a bank default.437 The FIA also stated that the deposit of customer funds in a bank or trust company is not an investment of customer funds under § 1.25, but is a requirement by the Act and Commission regulations.438 The FIA stated that FCMs should not be strictly liable for a bank’s failure, and that to hold FCMs to such a standard would presume that FCMs have the ability to know more about a bank than the regulatory 435 FIA Comment Letter at 30–31 (Feb. 15, 2013); CFA Comment Letter at 6 (Feb. 13, 2013). 436 CFA Comment Letter at 6 (Feb. 13, 2013). 437 FIA Comment Letter at 32–33 (Feb. 15, 2013). The Administrative Determination applies to both FCM and DCO deposits at banks, and provides as follows: To: Associate Administrator Division Directors Regional Directors If a futures commission merchant or a clearing association deposits regulated commodity customers’ funds in a bank and the bank is later closed and unable to repay the funds, the liability of the futures commission merchant or clearing association would depend upon the manner in which the account was handled. It would not be liable if it had used due care in selecting the bank, had not otherwise breached its fiduciary responsibilities toward the customers, and had fully complied with the requirements of the Commodity Exchange Act and the regulations thereunder relating to the handling of customers’ funds. If two banks were available in a particular city only one of which was a member of FDIC and the futures commission merchant or clearing association without a compelling reason elected to use the nonmember bank, we would contend that it had not used due care in its selection. Administrative Determination No. 230 issued by Alex Caldwell, Administrator, Commodity Exchange Authority (Nov. 23, 1971). 438 FIA Comment Letter at 32–33 (Feb. 13, 2013). PO 00000 Frm 00052 Fmt 4701 Sfmt 4700 authorities responsible for overseeing the banks.439 The FIA further stated that the Commission’s new § 1.11 will require each FCM to establish and enforce written policies and procedures reasonably designed to assure compliance with the segregation requirements. The policies and procedures also must include a process for the evaluation of depositories, and a program to monitor a depository on an ongoing basis, including a thorough due diligence review of each depository at least annually. FIA notes that the policies and procedures will be subject to Commission and DSRO review, and that either the Commission or DSRO can direct the FCM to make any changes to address identified weaknesses in the policies or procedures, or in their enforcement.440 Advantage stated that the deposit of customer funds into a bank is not an investment of the funds, and FCMs should be able to assume that banks are properly vetted by the relevant banking and futures regulatory authorities.441 The Commission has considered the issue and believes the issue of depository risk raises important legal and policy issues that were not addressed in the Administrative Determination. There are considerable reasons to question whether the Administrative Determination is consistent with the CEA and the Commission’s regulations thereunder. Customers entrust their funds to FCMs, who are required by the Act and Commission regulations to treat the funds as belonging to the customers, to segregate the funds from the FCM’s own funds, and to hold such funds in specially designated accounts that clearly state that the funds belong to commodity customers of the FCM and are being held as required by the Act and Commission regulations. Customers do not select the depositories to hold these funds; FCMs do. FCMs are responsible for conducting the initial due diligence and ongoing monitoring of depositories holding customer funds. Moreover, as a practical matter, FCMs are in a better position than customers to perform these functions, as well as in a better position than the customers individually to make claim in the insolvency proceeding for the depository.442 439 Id. 440 Id. 441 Advantage Comment Letter at 3 (Feb. 15, 2013). 442 By a parity of reasoning, this would also apply to relationships between DCOs and FCMs. Indeed, it would be difficult to see how a DCO would be liable for such losses, but an FCM would not. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations M. § 1.30: Loans by Futures Commission Merchants: Treatment of Proceeds Regulation 1.30 provides that an FCM may lend its own funds to customers on securities and property pledged by such customers, and may repledge or sell such securities and property pursuant to specific written agreement with such customers. This provision generally allows customers to deposit non-cash collateral as initial and variation margin. Absent the provision, an FCM may be required to liquidate the noncash collateral if the customer was subject to a margin call that could not be met with other assets in the customer’s account. Regulation 1.30 further provides that the proceeds of loans used to margin the trades of customers shall be treated and dealt with by an FCM as belonging to such customers, in accordance with and subject to the provisions of the Act and regulations. The Commission proposed to amend § 1.30 by adding that an FCM may not lend funds to a customer for margin purposes on an unsecured basis, or secured by the customer’s trading account. The Commission stated in the Proposal that it did not believe that FCMs extended unsecured credit as a common practice, as the FCM would be required to take a 100 percent charge to capital for the value of the unsecured loan under § 1.17. The Commission also noted that a trading account did not qualify as collateral for the loan under § 1.17 and the FCM would have to take a charge to capital for the full value of the unsecured loan. The Commission further noted that the proposed amendment to § 1.30 was consistent with CME Rule 930.G, which provides that a clearing member may not make loans to account holders to satisfy their performance bond requirements unless such loans are secured by readily marketable collateral that is otherwise unencumbered and which can be readily converted into cash.444 RCG commented that it believes that the proposal prohibiting an FCM from making unsecured loans to customers contradicts proposed § 1.22 as it applies to funding customers’ margin deficits.445 The Commission notes that the requirement in § 1.22 for an FCM to cover an undermargined account with its own funds is intended to ensure that the FCM complies with section 4d of the Act by not using the funds of one futures customer to margin or guarantee the commodity interests of another customer. The FCM is obligated under section 4d to maintain sufficient funds in segregation to cover undermargined accounts. The FCM, however, is not loaning funds to a particular customer as performance bond is contemplated by § 1.30. When the FCM deposits proprietary funds into segregated accounts under § 1.22, the FCM is not loaning any particular customer funds, and the customers with an undermargined account are not credited with an increase in their cash balance. Newedge also requested confirmation the proposed prohibition in § 1.30 preventing an FCM from loaning unsecured funds to a customer to finance such customer’s trading would not prohibit an FCM, when computing a customer’s margin requirement, from giving credit for the customer’s long 443 This discussion does not apply to funds that have been deposited with a third-party depository selected by a customer. 444 See CME rulebook at www.cmegroup.com/ rulebook/CME/I/9/9.pdf. 445 RCG Comment Letter at 4 (Feb. 12, 2013). TKELleY on DSK3SPTVN1PROD with RULES2 Importantly, the AD fails to address the question of precisely which customers are exposed to depository losses, and how much should be allocated to each such customer. This question is particularly important in the context of omnibus customer accounts permitted in the futures industry. Would losses be allocated to persons who are customers at the point the depository becomes insolvent, to persons who were customers at any point the FCM maintained funds at the depository, or to persons who were customers at the point the losses were crystalized? Would losses be allocated to all customers, or could certain favored customers avoid such exposure by negotiation? If the depository lost only securities, would customers who deposited only cash share in the loss? If the depository lost only cash, would customers who deposited only securities share in the loss? Would customers whose margin was all used to cover requirements at the DCO share in losses of funds at a depository other than a DCO? Moreover, would customers to whom losses were allocated share in dividends recovered from the estate of the defaulting depository? How would such customers have the practical opportunity to demonstrate their claims in such a proceeding? How and when would such recoveries be distributed to such customers? These practical questions, none of which was answered in the Administrative Determination, call its wisdom into question.443 Accordingly, the Commission has directed staff to inquire into these issues, and to develop an appropriate proposed rulemaking. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 PO 00000 Frm 00053 Fmt 4701 Sfmt 4700 68557 option value. The Commission confirms that an FCM may continue to consider a customer’s long option value when computing such customer’s overall account value and margin requirements.446 The Commission is adopting the amendments to § 1.30 as proposed. N. § 1.32: (§ 22.2(g) for Cleared Swaps Customers and § 30.7(l) for Foreign Futures and Foreign Options Customers): Segregated Account: Daily Computation and Record The Commission proposed to amend § 1.32 to require additional safeguards with respect to futures customer funds on deposit in segregated accounts, and to require FCMs to provide twice each month a detailed listing to the Commission of depositories holding customer funds.447 Regulation 1.32 requires an FCM to prepare a daily record as of the close of business each day detailing the amount of funds the firm holds in segregated accounts for futures customers trading on designated contract markets, the amount of the firm’s total obligation to such customers computed under the Net Liquidating Equity Method, and the amount of the FCM’s residual interest in the futures customer segregated accounts. In performing the calculation, an FCM is permitted to offset any futures customer’s debit balance by the market value (less haircuts) of any readily marketable securities deposited by the particular customer with the debit balance as margin for the account. The amount of the securities haircuts are as set forth in SEC Rule 15c3– 1(c)(vi). FCMs are required to perform the segregation calculation prior to noon on the next business day, and to retain a record of the calculation in accordance with § 1.31. Both the CME and NFA require their respective member FCMs to file the segregation calculations with the CME and NFA, as appropriate, each business day. FCMs, however, are only required to file a segregation calculation with the Commission at month end as part of the Form 1–FR–FCM (or FOCUS Reports for dual-registrant FCM/BDs). Regulation 1.12, as discussed in section II.C. above, requires the FCM to provide immediate notice to the Commission and to the firm’s DSRO if the FCM is undersegregated at any time. 446 Newedge Comment Letter at 5 (Feb. 15, 2013). Commission also proposed amendments to § 22.2(g) and § 30.7(l) to impose requirements for Cleared Swaps and foreign futures and foreign options transactions, respectively, that correspond to the proposed amendments for § 1.32. The comments for §§ 1.32, 22.2(g), and 30.7(l) are addressed in this section. 447 The E:\FR\FM\14NOR2.SGM 14NOR2 68558 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 The Commission proposed to amend § 1.32 to require each FCM to file its segregation calculation with the Commission and with its DSRO each business day. The Commission also proposed to amend § 1.32 to require FCMs to use the Segregation Schedule contained in the Form 1–FR–FCM (or FOCUS Report for dual-registrant FCM/ BDs) to document its daily segregation calculation.448 As previously noted, the CME and NFA require their respective member FCMs to file their segregation calculations with them on a daily basis. The CME and NFA also require the FCMs to document their segregation calculation using the Segregation Schedule contained in the Form 1–FR– FCM. Therefore, the additional requirement of filing a Segregation Schedule with the Commission is not a material change to the regulation and is consistent with current practices.449 The Commission stated in the Proposal that the filing of daily Segregation Schedules by FCMs will enhance its ability to monitor and protect customer funds as the Commission will be able to determine almost immediately upon receipt of the Segregation Schedule whether a firm is undersegregated and immediately take steps to determine if the firm is experiencing financial difficulty or if customer funds are at risk.450 The Commission also proposed to require an FCM to file its Segregation Schedule with the Commission and with the FCM’s DSRO electronically using a form of user authentication assigned in accordance with procedures established or approved by the Commission. The Commission currently receives the Segregation Schedule electronically via the WinJammer filing system and the proposal would continue to require FCMs to submit the forms using WinJammer. The Commission also proposed to amend § 1.32(b) to provide that in determining the haircuts for commercial paper, convertible debt instruments, and nonconvertible debt instruments 448 Each FCM currently already submits a daily Segregation Schedule to its DSRO pursuant to rules of the CME and NFA. Therefore, the Commission’s amendments are codifying current regulatory practices for each FCM. 449 In fact, since FCMs file the Segregation Schedules with the CME and NFA via WinJammer, the Commission already has access to the filings, and the amendment will not require an FCM to change any of its operating procedures. 450 Each Form 1–FR–FCM and FOCUS Report is received by the Commission via WinJammer. The financial forms are automatically electronically reviewed within several minutes of being received by the Commission and if a firm is undersegregated an alert is immediately issued to Commission staff members via an email notice. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 deposited by customers as margin, the FCM may develop written policies and procedures to assess the credit risk of the securities as proposed by the SEC and discussed more fully in section II.F. above. If the FCM’s assessment of the credit risk is that it is minimal, the FCM may apply haircut percentages that are lower than the 15 percent default percentage under SEC Rule 15c3– 1(c)(2)(vi). The Commission also proposed to amend § 1.32 by requiring each FCM to file detailed information regarding depositories and the substance of the investment of customer funds under § 1.25. Proposed paragraphs (f) and (j) of § 1.32 require each FCM to submit to the Commission and to the firm’s DSRO a listing of every bank, trust company, DCO, other FCM, or other depository or custodian holding customer funds. The listing must specify separately for each depository the total amount of cash and § 1.25 permitted investments held by the depository for the benefit of the FCM’s customers. Specifically, each FCM must list the total amount of cash, U.S. government securities, U.S. agency obligations, municipal securities, certificates of deposit, money market mutual funds, commercial paper, and corporate notes held by each depository, computed at current market values. The listing also must specify: (1) If any of the depositories are affiliated with the FCM; (2) if any of the securities are held pursuant to an agreement to resell the securities to a counterparty (reverse repurchase agreement) and if so, how much; and (3) the depositories holding customer-owned securities and the total amount of customer-owned securities held by each of the depositories. Each FCM is required to submit the listing of the detailed investments to the Commission and to the firm’s DSRO twice each month. The filings must be made as of the 15th day of each month (or the next business day, if the 15th day of the month is not a business day) and the last business day of the month. The filings are due to the Commission and to the firm’s DSRO by 11:59 p.m. on the next business day. Proposed paragraph (k) of § 1.32 requires each FCM to retain the Segregation Statement prepared each business day and the detailed investment information, together with all supporting documentation, in accordance with § 1.31. FIA generally supported the proposal.451 FIA noted that proposed § 1.32(a) requires an FCM to compute its daily segregation requirement on a currency-by-currency basis, and requested that the Commission confirm that a single Segregation Schedule can be completed for each account class (i.e., futures customers funds, Cleared Swaps Customers funds, and § 30.7 customer funds) on a U.S. dollarequivalent basis. FIA further stated that the detail regarding the investment of customer funds provided by NFA on its Web site is the appropriate level of detail that should be made public because additional detail would disclose proprietary financial and business information.452 Jefferies supported the proposal, and recommended that the listing of detailed investments should include all investments, including cash and other investments, regardless of where the investments are held, and should provide greater transparency for the FCMs’ customers.453 MFA supported the proposed amendments to § 1.32 to require FCMs to provide the Commission and their DSROs with: (1) Daily reporting of the segregation and part 30 secured amount computations; and (2) semi-monthly reporting of the location of customer funds and how such funds are invested under § 1.25.454 The Commission has considered the comments and is adopting the amendments to §§ 1.32, 22.2(g), and 30.7(l) as proposed. In response to Jefferies comment, the Commission notes that the proposed and final regulation require an FCM to report all investments, including cash and other investments, regardless of where the investments are held. In response to FIA’s comment, the Commission does not believe that a full disclosure of the investment of customer funds would disclose proprietary information of the FCM. The Commission would require the disclose of investment information in a manner consistent with the current NFA disclosures, which includes, for each FCM, the percentage of the invested customer funds that are held by banks, or invested in U.S. government securities, bank certificates of deposit, money market funds, municipal securities, and U.S. government sponsored enterprise securities. The Commission, however, further believes that FCMs also should disclose the amount of customer funds that are held by clearing organizations and brokers. The Commission also believes that FCMs should disclose the amount of customer-owned securities that are on deposit as margin collateral, and information regarding repurchase 452 Id. at 31. Comment Letter at 4 (Feb. 15, 2013). 454 MFA Comment Letter at 3 (Feb. 15, 2013). 453 Jefferies 451 FIA PO 00000 Comment Letter at 30 (Feb. 15, 2013). Frm 00054 Fmt 4701 Sfmt 4700 E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 transactions involving customer funds or securities. The additional disclosures will provide customers and the market with additional information that may be relevant to their assessment of the risks of placing their funds with a particular FCM. The Commission further notes that it plans to work with the SROs to determine the most efficient and effective method to disclose this information to the public. The Commission also confirms that an FCM satisfies the requirement of § 1.32 if it prepares and submits to the Commission, and to its DSRO, a consolidated Segregation Schedule for each account class on a U.S. dollarequivalent basis. The FCM, however, must prepare segregation records on a daily basis on a currency-by-currency basis to ensure compliance with § 1.49, which governs how FCMs may hold funds in foreign depositories. The FCM is not required under § 1.32 to file the currency-by-currency segregation records with the Commission or with its DSRO. O. § 1.52: Self-regulatory Organization Adoption and Surveillance of Minimum Financial Requirements SROs are required by the Act and Commission regulations to monitor their member FCMs for compliance with the Commission’s and SROs’ minimum financial and related reporting requirements. Specifically, DCM Core Principle 11 provides, in relevant part, that a board of trade shall establish and enforce rules providing for the financial integrity of any member FCM and the protection of customer funds.455 In addition, section 17 of the Act requires NFA to establish minimum capital, segregation, and other financial requirements applicable to its member FCMs, and to audit and enforce compliance with such requirements.456 The Commission also has established in § 1.52 minimum elements that each SRO financial surveillance program must contain to satisfy the statutory objectives of Core Principle 11 and section 17 of the Act. In this regard, § 1.52 requires, in part, each SRO to adopt and to submit for Commission approval rules prescribing minimum financial and related reporting requirements for member FCMs. The rules of the SRO also must be the same as, or more stringent than, the Commission’s requirements for financial statement reporting under § 1.10 and minimum net capital under § 1.17. In addition, the Commission adopted final amendments to § 1.52 on May 10, 455 7 456 7 U.S.C. 7(d)(11). U.S.C. 21(p). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 2012, to codify previously issued CFTC staff guidance regarding the minimum elements of an SRO financial surveillance program.457 In order to effectively and efficiently allocate SRO resources over FCMs that are members of more than one SRO, § 1.52(c) currently permits two or more SROs to enter into an agreement to establish a joint audit plan for the purpose of assigning to one of the SROs (the DSRO) of the joint audit plan the function examining member FCMs for compliance with minimum capital and related financial reporting obligations. The audit plan must be submitted to the Commission for approval. Currently all active SROs are members of a joint audit plan that was approved by the Commission on March 18, 2009.458 The Commission proposed additional amendments to § 1.52 to enhance and strengthen the minimum requirements that SROs must abide by in conducting financial surveillance. As the Commission explained in the Proposal, these amendments are intended to minimize the chances that FCMs engage in unlawful activities that result, or could result, in the loss of customer funds or the inability of the firms to meet their financial obligations to market participants. Proposed § 1.52(a) added a definitions section identifying the terms ‘‘examinations expert,’’ ‘‘material weakness,’’ and ‘‘generally accepted auditing standards.’’ The term ‘‘examinations expert’’ was defined as a ‘‘nationally recognized accounting and auditing firm with substantial expertise in audits of futures commission merchants, risk assessment and internal control reviews, and is an accounting and auditing firm that is acceptable to the Commission.’’ The Commission received several comments regarding the opinion that the examinations expert is required to provide on its review of the SRO programs, which is addressed in section II.O.4 below. The Commission did not, however, receive comments regarding the defined term ‘‘examinations expert’’ and is adopting the definition as proposed. The term ‘‘material weakness’’ was defined as ‘‘as a deficiency, or a 457 77 FR 36611 (June 19, 2012). original signatories of the joint audit plan approved on March 18, 2009 are as follows: Board of Trade of the City of Chicago, Inc.; Board of Trade of Kansas City; CBOE Futures Exchange, LLC; Chicago Climate Futures Exchange, LLC; Chicago Mercantile Exchange Inc.; Commodity Exchange, Inc.; ELX Futures, L.P.; HedgeStreet, Inc.; ICE Futures U.S., Inc.; INET Futures Exchange, L.L.C.; Minneapolis Grain Exchange; NASDAQ OMX Futures Exchange; National Futures Association; New York Mercantile Exchange, Inc.; NYSE Liffe US, L.L.C.; and One Chicago, L.L.C. 458 The PO 00000 Frm 00055 Fmt 4701 Sfmt 4700 68559 combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstating of the entity’s financial statements and regulatory computations will not be prevented or detected on a timely basis by the entity’s internal controls.’’ The Commission has determined not to adopt the definition of material weakness to eliminate the concern that the SROs examinations are intended to replicate the financial statement audits performed by public accountants under § 1.16. Proposed § 1.52(b) requires each SRO to adopt rules prescribing minimum financial and related reporting requirements, and requires its member FCMs to establish a risk management program that is at least as stringent as the risk management program required of FCMs under § 1.11. Proposed amendments to § 1.52 (c) requires each SRO to establish a supervisory program to oversee their member FCMs’ compliance with SRO and Commission minimum capital and related reporting requirements, the obligation to properly segregated customer funds, risk management requirements, financial reporting requirements, and sales practices and other compliance requirements. The supervisory program must address: (1) Levels and independence of SRO examination staff; (2) ongoing surveillance of member FCMs; (3) procedures for identifying high-risk firms; (4) on-site examinations of member firms; and (5) the documentation of all aspects of the supervisory program. The supervisory program also must be based on an understanding of the internal control environment to determine the nature, timing, and extent of controls testing and substantive testing to be performed and must address all areas of risk to which the FCM can reasonably be foreseen to be subject. Proposed § 1.52(c) also requires that all aspects of the SRO’s supervisory program must, at a minimum, conform to generally accepted auditing standards after consideration to the auditing standards issued by the PCAOB. Proposed § 1.52(c) also requires each SRO to engage an ‘‘examinations expert’’ at least once every two years to evaluate the quality of the supervisory oversight program and the SRO’s application of the supervisory program. The SRO must obtain a written report from the examinations expert with an opinion on whether the supervisory program is reasonably likely to identify a material weakness in internal controls over financial and/or regulatory reporting, and in any of the other areas E:\FR\FM\14NOR2.SGM 14NOR2 68560 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations that are subject to the supervisory program. Proposed § 1.52(d) provides that two or more SROs may enter into an agreement to delegate the responsibility of monitoring and examining an FCM that is a member of more than one SRO to a DSRO. The DSRO would monitor the FCM for compliance with the Commission’s and SROs’ minimum financial and related reporting requirements, and risk management requirements, including policies and procedures relating to the receipt, holding, investing and disbursement of customer funds. The Commission received several comments on the proposed amendments to § 1.52 and, with the exception of the issues discussed below, has determined to adopt the amendments as proposed.459 TKELleY on DSK3SPTVN1PROD with RULES2 1. Swap Execution Facilities Excluded From the Scope of Regulation 1.52 The Commission is revising the final § 1.52 by adding a new defined term, ‘‘self-regulatory organization,’’ to paragraph (a). The term ‘‘self-regulatory organization’’ is defined in paragraph (a) to mean, for purpose of § 1.52 only, a contract market, as defined in § 1.3(h), or a registered futures association. The term ‘‘self-regulatory organization’’ is further defined in paragraph (a) to explicitly exclude a swap execution facility (‘‘SEF’’), as defined in § 1.3(rrrr). The revision to definition of selfregulatory organization in § 1.52 is necessary due to the recent amendments to the definition of ‘‘self-regulatory organization’’ set forth in § 1.3(ee), which defines the term as a contract market, as defined in § 1.3(h), a SEF, as defined in § 1.3(rrrr), or a registered futures association under section 17 of the Act.460 Therefore, since § 1.52 applies to each SRO, without including a definition for the term ‘‘self-regulatory organization’’ under § 1.52(a) that excludes SEFs, the full provisions of § 1.52 would apply to SEFs. In adopting new regulations implement core principles and other 459 MGEX stated that the Commission’s Proposal generally supports the current DSRO program by requiring FCMs to file various reports and notices with the Commission and with the firms’ DSROs. MGEX further stated that the Commission should not create a regulatory monopoly and should recognize that an SRO may not wish to join the JAC. The Commission believes that each SRO has a right to elect to perform the financial surveillance required under § 1.52 directly or to participate in a joint audit agreement with other SROs. In addition, § 38.604 requires each SRO to have rules in place that require member FCMs to submit financial information to the SRO. 460 77 FR 66288 (Nov. 2, 2012). Regulation 1.3 is the general definitions provision of the Commission’s regulations. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 requirements for SEFs, the Commission did not require SEFs to adopt minimum capital and related financial reporting requirements for its member firms.461 The Commission further stated that a SEF’s obligation to monitor its member for financial soundness extended only to a requirement to ensure that the members continue to qualify as eligible contract participants as defined in section 1a(18) of the Act.462 Therefore, the Commission previously has determined that the extensive oversight program required of SROs that are contract markets or registered futures associations by § 1.52 is not applicable to SEFs. 2. Revisions to the Current SRO Supervisory Program The Commission received several comments concerning the proposed amendments to § 1.52, many of which varied in support and context. The NFA stated that it fully supports the requirement that the supervisory program include both controls testing and substantive testing, and that the examinations process be driven by the risk profile of the FCM.463 NFA noted that it has been modifying its procedures to enhance its examination of FCM internal controls as well as substantive testing, and also has updated its risk system to create risk profiles of each of its FCMs.464 NFA also agreed that SROs should identify those FCMs that pose a high degree of potential risk so that the SRO can increase its monitoring of those firms and that the examinations should focus on the higher risk areas at each FCM.465 The CME and JAC generally did not support the proposed amendments to § 1.52, stating that the current limited role of regulatory exams is appropriate as its purpose is not intended to give the same level of assurances to the FCM, the FCM’s investors, or third parties as that which external auditors provide in conducting financial statement audits of FCMs.466 The CME also stated that regulatory reviews are not designed to protect investors in FCMs, nor should they be.467 In addition, the CME believes that SROs and DSROs play 461 78 regulatory roles, and it is no more appropriate to have them report to an audit committee of an FCM than it would be to have the Commission itself report to that audit committee.468 The JAC stated that the SRO examinations are compliance reviews focused on the particular and distinctive regulatory requirements and associated risks of the futures industry, including whether FCMs are in compliance with customer regulations and net capital requirements to protect customers and the functioning of the futures industry.469 The JAC further stated that incorporating the full risk management requirements of § 1.11 into the SRO’s examinations of FCMs, and the requirement that the SRO audit program address all areas of risk to which FCMs can reasonably be foreseen to be subject, are overly broad requirements that are impractical, and virtually impossible to meet.470 The JAC further stated that proposed § 1.52 imposes potential duplicative oversight of FCM risk management policies and procedures by SROs and DCOs. The JAC noted that § 39.13(h)(5) requires a DCO to review the risk management policies, procedures, and practices of each of its clearing members.471 The JAC requested clarification on the oversight responsibilities of SROs and DCOs to address potential duplicative requirements.472 Lastly, the JAC stated that expanding the SRO oversight program to include operational and technical risks will require additional expertise, time and resources to perform such reviews and will result in increased costs.473 The Commission believes that the CME, NFA, JAC, SROs and DSROs play a critical role in examining FCMs and other registrants under the selfregulatory structure of the futures industry. Recent events, however, demonstrate that the SROs’ current focus on CFTC and SRO regulatory requirements, including segregation and net capital computations, are not in and of themselves adequate to assess risk and protect customers of the FCM. For instance, a failure in an FCM’s nonfutures operations may pose risks to FR 33476 (June 4, 2013). 462 Id. 468 Id. 463 NFA 469 JAC Comment Letter at 3 (Feb. 15, 2013). See also Paul/Weiss Comment Letter at 2 (Feb. 15 2013), BlackRock Letter at 3 (Feb. 15. 2013), and MFA Comment Letter at 4 (Feb. 15, 2013) expressing general support for the proposed enhancements to the SRO examinations program. 464 Id. 465 Id. 466 CME Comment Letter at 8–9 (Feb. 15, 2013); JAC Comment Letter at 2–4 (Feb. 14, 2013); JAC Comment Letter 2–4 (July 25, 2013). 467 CME Comment Letter at 11 (Feb. 15, 2013). PO 00000 Frm 00056 Fmt 4701 Sfmt 4700 470 Id. Comment Letter at 2 (July 25, 2013). See also JAC Comment Letter at 5 (Feb. 14, 2013). 471 Id. 472 Id. 473 Id. The JAC noted that the examination of the controls and risk management policies and procedures over an FCM’s technology systems would require particular expertise that is different from the knowledge and expertise or regulatory staff, and that SROs will have to hire specialized examiners to conduct such reviews. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 futures customers and the operation of an FCM. In addition, technology failures at an FCM also may pose risks to the operation of an FCM and the overall protection of customer funds. Accordingly, to properly monitor and assess risks to the FCM, the SRO must be aware of non-futures related activities of the FCM. Recent events also demonstrate that the examinations of FCMs must be risk based and that the testing must be based on an understanding of the registrant’s internal control environment to determine the nature, timing and extent of the necessary tests. In order to help ensure an appropriate risk based exam is performed, an examiner must take into account the risk profile of the firm and build the examination program accordingly. For example, if a firm has weak controls over cash, the risk of inaccurate accounting for cash movements is greater and therefore more detailed substantive testing of cash transactions and balances is necessary to provide the examiner with sufficient assurance that reported balances are accurate. To the contrary, if controls are good over cash then less substantive testing is needed. The Commission acknowledges that revised § 1.52 imposes new obligations on SROs by requiring their supervisory programs to include an assessment of whether member FCMs comply with the risk management requirements of § 1.11. However, § 1.52 also requires that the SRO’s examination of FCMs be performed on a risk-based approach. The scope of the examinations should be based upon the SRO’s assessment of risk at the FCM and full, detailed testing is not mandated by § 1.52 in each area. Lastly, the Commission recognizes that DCOs impose certain risk management requirements on clearing FCMs and are required to review the operation of such risk management requirements. While § 39.13(h)(5) is directed at risk that an FCM may pose to a DCO and, therefore, is more narrowly focused than the risk management requirements in § 1.11, SROs may coordinate with a DCO to ensure that duplicative work is not being performed by the separate organizations.474 3. Auditing Standards Utilized in the SRO Supervisory Program Proposed § 1.52(c)(2)(ii) and (d)(2)(ii)(F) require all aspects of an SRO’s or DSRO’s, supervisory program to conform, at a minimum, to U.S. 474 Under the current JAC structure, the CME is the only entity that is both an SRO that performs periodic examinations of FCMs and a DCO that has responsibilities under § 39.13(h)(5) to perform risk management on clearing FCMs. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 GAAS after giving full consideration to the auditing standards issued by the PCAOB. NFA, CME, and JAC questioned what is meant by the term ‘‘after giving full consideration of auditing standards prescribed by the PCAOB.’’ 475 NFA, CME, and JAC did not agree with basing the SRO Supervisory Program framework on either U.S. GAAS or PCAOB standards, largely because the DSRO does not issue a report that expresses an opinion with respect to the FCM’s financial statements or issue an Accountant’s Report on Material Inadequacies.476 Additionally, CME noted that invoking U.S. GAAS and PCAOB standards opens up a complex and detailed regulatory structure, which includes a framework allowing auditor’s to rely on interpretive publications, professional journals and auditing publications from state CPA societies, none of which were designed to address the regulatory function played by an SRO or DSRO.477 However, NFA acknowledged that certain U.S. GAAS and PCAOB accounting standards and practices should be followed by DSROs in performing their regulatory examinations (e.g., those standards focusing on recordkeeping, training and experience, the scope of the examination and testing, the confirmation process, and other related examination practices).478 The Commission notes that the objective of the Proposal was to ensure that the SRO examinations are conducted consistent with the professional standards that CPAs and others are subject to in conducting their examinations. The Commission recognizes that certain U.S. GAAS principles and PCAOB principles would not be applicable to the SRO examinations (such as principles addressing reporting, which provide that the CPA must state whether the financial statements are prepared in accordance with Generally Accepted Accounting Principles). However, other U.S. GAAS and PCAOB standards would be relevant to SRO examinations. Such principles include standards addressing the competency and proficiency of the examinations staff and the obtaining and documenting of adequate audit evidence to support the examiner’s conclusions. The Commission has considered these comments and has revised the proposed language to state that at a minimum, an 475 NFA Comment Letter at 3 (Feb. 15, 2013); CME Comment Letter at 9–10 (Feb. 15, 2013); JAC Comment Letter at 2–3 (Feb 14, 2013). 476 Id. 477 CME Comment Letter at 9–10 (Feb. 15, 2013). 478 NFA Comment Letter at 3–4 (Feb. 15, 2013). PO 00000 Frm 00057 Fmt 4701 Sfmt 4700 68561 examination should conform to PCAOB auditing standards to the extent such standards address non-financial statement audits. While it is acknowledged that PCAOB audit standards are directed at financial statement audits, the concept of many of the standards are just as applicable to an examination performed by an SRO or DSRO, and as such should be adopted in that light. The relevant PCAOB standards would include, but are not limited to, the training and proficiency of the auditor, due professional care in the performance of the work, consideration of fraud in an audit, audit risk, consideration of materiality in planning and performing an audit, audit planning, identifying and assessing risks of material misstatement, the auditor’s responses to the risk of material misstatement, audit documentation, evaluating the audit results, communications with audit committees, and due professional care in the performance of work. In developing the supervisory program, consideration should also be given to other related guidance such as the standards adopted by the Institute of Internal Auditors (Standards & Guidance—International Professional Practices Framework) and the Policy Statement and Supplemental Policy Statement on the Internal Audit Function and its Outsourcing issued by the Board of Governors of the Federal Reserve System, and generally accepted auditing standards issued by the American Institute of Certified Public Accountants.479 4. ‘‘Examinations Expert’’ Reports Proposed § 1.52(c)(2)(iv) and (d)(2)(ii)(I) require each SRO and DSRO, respectively, to engage an examinations expert to evaluate the SROs or DSROs programs and to express an opinion as to whether the program is reasonably likely to identify a material deficiency in internal controls over financial and/ or regulatory reporting and in any of the other areas that are subject to SRO or DSRO review under the programs. The JAC, CME, Center for Audit Quality, Ernst & Young, and PWC did not support the ‘‘examinations expert’’ requirement.480 Several of these commenters expressed concern that the term ‘‘examinations expert’’ as defined 479 The Commission is revising final § 1.52 to remove from paragraph (a) a definition for the term ‘‘U.S. Generally accepted auditing standards’’ as that term is no longer contained in the final regulation. 480 JAC Comment Letter at 3–4 (Feb. 14, 2013); Center for Audit Quality Comment Letter at 3 (Jan. 14, 2013); Ernst & Young Comment Letter at 3–4 (Jan. 14, 2013); PWC Comment Letter at 3 (Jan. 15, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 68562 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 by § 1.52 imposes a criterion that most CPA firms may not possess or would not be willing to issue such a report.481 Moreover, NFA, JAC, and MGEX stated that requiring an ‘‘examinations expert’’ is unnecessary and duplicative of already existing Commission responsibilities, noting that the JAC provides the examination programs to the Commission annually, and that the Commission can perform a review of the examination programs.482 NFA and JAC suggested, as cost effective and more practical solution, inviting individuals meeting the ‘‘examinations expert’’ designation to participate in the already existing JAC audit committee meetings.483 CME suggested that if the proposed structure is adopted, the time frame for review be extended from 18 months to 31⁄2 years, matching that required by the AICPA in its Peer Review program.484 The Commission has taken these comments into consideration and has revised the final regulation by providing that the report of the examinations expert should conform to the consulting services standards of the AICPA. The Commission recognizes that generally accepted auditing standards do not provide a reporting framework by which a certified public accountant can issue an audit opinion consistent with the requirements contained in § 1.52. Accordingly, the Commission has revised the final regulation by removing the requirement that the examinations expert provide an audit opinion. The Commission also does not believe that it is in a position to perform the type of review of the SRO examination reports required by § 1.52 given its limited resources. Furthermore, the examinations expert is an independent party with expert knowledge of risk assessment and internal controls reviews and will be able to provide more thorough and detailed review of the joint audit program than Commission staff can currently devote to such a review. In addition, the Commission staff has communicated to the JAC that it would be very supportive of having the accounting and auditing experts join the JAC meetings to discuss current industry issues. The Commission has also considered the impact of performing such a review 481 CME Comment Letter at 13 (Feb. 15, 2013); Center for Audit Quality Comment Letter at 3 (Jan. 14, 2013); Ernst & Young Comment Letter at 3–4 (Jan. 14, 2013); PWC Comment Letter at 3 (Jan. 15, 2013). 482 NFA Comment Letter at 4–5 (Feb. 15, 2013); JAC Comment Letter at 4 (Feb. 14, 2013) MGEX Comment Letter at 3–4 (Feb. 18, 2013). 483 NFA Comment Letter at 4–5 (Feb. 15, 2013); JAC Comment Letter at 4 (Feb. 14, 2013). 484 CME Comment Letter at 13 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 every two years and has modified the proposal to require such a report on a three year basis. This reflects the fact that the DSROs will be updating their programs as needed and therefore the program should not be stagnant during the intervening years. Finally, it was pointed out that given the nature of the report and to facilitate an open and frank dialogue amongst the examinations expert, the DSROs, and the Commission, such report should be considered confidential. The Commission is revising the regulation to provide that the report is confidential, which is consistent with how the PCAOB conducts its reviews of CPA firms. P. § 1.55: Public Disclosures by Futures Commission Merchants Regulation 1.55(a) currently requires an FCM, or an IB in the case of an introduced account, to provide a customer with a separate written risk disclosure statement prior to opening the customer’s account (‘‘Risk Disclosure Statement’’). Regulation 1.55(a) also provides that the Risk Disclosure Statement may contain only the language set forth in § 1.55(c) (with an exception for non-substantive additions such as captions), except that the Commission may authorize the use of Risk Disclosure Statements approved by foreign regulatory agencies or selfregulatory organizations if the Commission determines that such Risk Disclosure Statements are reasonably calculated to provide the disclosures required by the Commission under § 1.55.485 Regulation 1.55(a) further requires the FCM or IB to receive a signed and dated statement from the customer acknowledging his or her receipt and understanding of the Risk Disclosure Statement.486 The Commission reviewed the adequacy of the current prescribed Risk Disclosure Statement in light of its experience with customer protection issues during the recent failures of two FCMs, MFGI and PFGI. In this regard, in responding to questions and issues raised primarily by non-institutional market participants, including market 485 The Commission has previously approved an alternative ‘‘generic’’ risk disclosure statement for use in the United Kingdom, Ireland and the U.S. 486 FCMs and IBs are permitted to open commodity futures accounts for ‘‘institutional customers’’ pursuant to § 1.55(f) without furnishing such institutional customers with a Risk Disclosure Statement or obtaining the written acknowledgment required by § 1.55. The term ‘‘institutional customer’’ is defined by § 1.3(g) and section 1a of the Act as an eligible contract participant. The Commission did not propose to amend § 1.55(f) to require FCMs or IBs to furnish institutional customers with Risk Disclosure Statements. PO 00000 Frm 00058 Fmt 4701 Sfmt 4700 participants from the agricultural community and retail market participants, the Commission recognized that such market participants would benefit from several additional disclosures regarding the potential general risks of engaging in futures trading through an FCM, and the potential specific risks resulting from the bankruptcy of an FCM. In addition to proposing new general risk disclosures, the Commission proposed to also require each FCM to provide customers and potential customers with information about the FCM, including its business, operations, risk profile, and affiliates. The firm specific disclosures are intended to provide customers with access to material information regarding an FCM to allow the customers to independently assess the risk of entrusting funds to the firm or to use the firm for the execution of orders. 1. Amendments to the Risk Disclosure Statement The mandatory Risk Disclosure Statement currently addresses the risks of engaging in commodity futures trading. The risks that must be disclosed include: (1) The risks that a customer may experiences losses that exceed the amount of funds that he or she contributed to trading and that the customer may be responsible for losses beyond the amount of funds deposited for trading; (2) the risks that under certain market conditions, a customer may find it difficult or impossible to liquidate a position, such as when a market has reached a daily price move limit; (3) the risks that placing certain contingent orders (such as a stop limit order) may not necessarily limit the customer’s losses; (4) the risks associated with the high degree of leverage that may be obtainable from the futures markets; and (5) the risks of trading on non-U.S. markets, which may not provide the same level of protections provided under Commission regulations. As noted above, the Commission proposed several additional disclosures based upon its experience in working with customers, particularly retail and other non-institutional market participants, during the recent failures of MFGI and PFGI. Specifically, the Commission proposed to amend the Risk Disclosure Statement to provide market participants with more information regarding the risks associated with an FCM holding customer funds. In this regard, certain market participants believed that the fact that their funds were segregated from the FCM’s proprietary funds protected them from loss in the event of E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations an FCM bankruptcy. Other customers believed that a DCO guaranteed customer losses, and other customers believed that funds deposited for futures trading were protected by the Securities Investor Protection Corporation in the event of an FCM/BD bankruptcy. To provide greater clarity as to the how customer funds are held and the potential risks associated with FCMs holding customer funds, the Commission proposed to revise the Risk Disclosure Statement by amending § 1.55(b) to include new paragraphs (2) through (7) as follows: (2) The funds you deposit with an FCM for trading futures positions are not protected by insurance in the event of the bankruptcy or insolvency of the futures commission merchant, or in the event your funds are misappropriated due to fraud; (3) The funds you deposit with an FCM for trading futures positions are not protected by the Securities Investor Protection Corporation even if the futures commission merchant is registered with the SEC as a BD; (4) The funds you deposit with an FCM are not guaranteed or insured by a DCO in the event of the bankruptcy or insolvency of the FCM, or if the FCM is otherwise unable to refund your funds; (5) The funds you deposit with an FCM are not held by the FCM in a separate account for your individual benefit. FCMs commingle the funds received from customers in one or more accounts and you may be exposed to losses incurred by other customers if the FCM does not have sufficient capital to cover such other customers’ trading losses; (6) The funds you deposit with an FCM may be invested by the FCM in certain types of financial instruments that have been approved by the Commission for the purpose of such investments. Permitted investments are listed in Commission Regulation 1.25 and include: U.S. government securities; municipal securities; money market mutual funds; and certain corporate notes and bonds. The FCM may retain the interest and other earnings realized from its investment of customer funds. You should be familiar with the types of financial instruments that an FCM may invest customer funds in; and (7) FCMs are permitted to deposit customer funds with affiliated entities, such as affiliated banks, securities brokers or dealers, or foreign brokers. You should inquire as to whether your FCM deposits funds with affiliates and assess whether such deposits by the FCM with its affiliates increases the risks to your funds. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 The Commission received several comments on the proposed amendment to the Risk Disclosure Statement. NFA stated that it fully supported the Commission’s goal of ensuring that customers receive a full description of the risk associated with futures trading, and agreed with the Commission that it is important to update the Risk Disclosure Statement to provide information on the extent to which customer funds are protected when deposited with an FCM as margin or to guarantee performance for trading commodity interest.487 The FIA generally supported the proposed amendments to the general Risk Disclosure Statement set forth in § 1.55(b) and outlined above.488 The FIA stated that many of the Commission’s proposed amendments are consistent with FIA’s recommendations to enhance disclosures set forth in its paper, ‘‘Initial Recommendations for the Protection of Customer Funds,’’ which was published on February 28, 2012 (‘‘Initial Recommendations’’) in response to MFGI.489 FIA also stated that its document, ‘‘Protection of Customer Funds—Frequently Asked Questions,’’ is being used by FCMs to provide customers with increased disclosures on the scope of how the laws and regulations protect customers in the futures market.490 With respect to the Commission’s proposed amendments to § 1.55(b), FIA recommended that the Commission delete the phrase ‘‘due to fraud’’ in § 1.55 (b)(2) because customer funds may be misappropriated for any reason.491 Additionally, FIA suggested the disclosure in § 1.55(b)(4) be revised to take account of the CME Group Family Farmer and Rancher Protection Fund established in the wake of MFGI as this fund will provide up to $25,000 to qualifying individual farmers and ranchers and $100,000 to co-ops that hedge their risk in CME futures markets.492 The Commission has considered FIA’s comments and had determined to revise 487 NFA Comment Letter at 15 (Feb. 15, 2013). Comment Letter at 41 (Feb. 15, 2013). 489 FIA Comment Letter at 2 (Feb. 15, 2013). The FIA formed a special committee to develop and recommend specific measures that could be implemented by both the industry best practices and regulatory change to address the issues arising from the bankruptcy of MFGI. 490 Id. FIA’s ‘‘Protection of Customer Funds— Frequently Asked Questions’’ provides information covering five broad areas: (1) segregation of customer funds; (2) collateral management and investments; (3) basic information on FCMs, such as the purpose of capital requirements and margin processing: (4) issues for joint FCM/BDs; and (5) the role of the DCO guarantee fund. 491 Id. at 41. 492 Id. at 41–42. 488 FIA PO 00000 Frm 00059 Fmt 4701 Sfmt 4700 68563 the proposal. The Commission recognizes that customer funds may be misappropriated as a result of wrongful conduct that does not rise to the level of fraud. Accordingly, the Commission is revising § 1.55(b)(4) by removing the phrase ‘‘due to fraud’’ so that the disclosure provides that customers’ funds are not covered by insurance in the event of the insolvency of the FCM or in the event the funds are misappropriated. The Commission also is revising final § 1.55(b)(4) in response to FIA’s comment to provide an overall statement that customer funds generally are not insured by DCOs. The Commission is further revising final § 1.55(b)(4) to include in the disclosure the fact that a DCO may offer an insurance program, and that a customer should inquire of the FCM the extent of any DCO insurance programs and whether the customer would qualify for coverage and understand the limitations and benefits of the coverage. The Commission believes that this approach is more flexible to address future developments in this area than a direct reference to specific DCO insurance programs that currently are available. NEFI/PMAA questioned whether or not existing and proposed disclosures are sufficient, and further stated that disclosure of customer protections are equally important as the disclosure of potential risks to ensure customer confidence.493 Pilot Flying J stated FCMs must be required to disclose information to their customers on how their accounts and positions will be managed, as well as associated risks and what kinds of financial protections are afforded to customers by the firm, exchange, and the Commission. The Commission agrees with NEFI/ PMAA and Pilot Flying J that a customer’s understanding of the protections is as important as understanding the risks. The Risk Disclosure Statement is the minimum information that an FCM should provide to prospective customers, and is intended to provide a high level summary of the general risk of trading commodity interests. FCMs should provide additional information as necessary to ensure that customers have adequate information. The Commission believes that FIA’s Initial Recommendation and FAQ, which includes the types of information that NEFI/PMAA and Pilot Flying J are requesting, should be made available to all potential customers. FIA should revise the documents, as appropriate, in 493 NEFI/PMAA Comment Letter at 2 (Jan. 14, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68564 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations response to changing market events or other factors. The Commission also requested comment on whether and how the new or revised Risk Disclosure Statement should be provided to existing customers at the effective date of the regulation. Particularly, the Commission requested comment on whether FCMs should be required to obtain new signature acknowledgments from existing customers. FIA stated that it was not opposed to a requirement that FCMs provide the revised Risk Disclosure Statement to existing customers that are otherwise required to receive the disclosure document.494 FIA stated, however, that FCMs should not be required to obtain a written acknowledgment from existing customers. FIA further stated that it should be sufficient if the FCM makes each customer aware of the revised Risk Disclosure Statement by any appropriate means, consistent with the means by which the FCM normally communicates important information to customers, including but not limited to, a separate mailing.495 The CFA stated that it is very important for FCMs and their DSROs to ascertain whether existing and potential customers have acknowledged receipt of the Risk Disclosure Statement, and FCMs should keep records of acknowledgments that the Risk Disclosure Statements were received.496 NGFA noted that providing updated risk disclosure, with signed acknowledgment of such to the FCM, is a sound concept.497 Regulation 1.55(a) will continue to require FCMs to obtain and retain signed acknowledgments from new customers that they received and understand the Risk Disclosure Statement. With respect to existing FCM customers on the effective date of the regulation, the Commission believes that it is adequate for an FCM to provide each of the customers with a revised Risk Disclosure Statement via its normal means of communicating with customers, including the use of a separate mailing, or providing a link on the firm’s Web site to the revised Risk Disclosure Statement, provided that the FCM provides a paper copy of the Risk Disclosure Statement upon the request of a customer. The communication of the revised Risk Disclosure Statement to customers must be highlighted by the FCM in such a manner to reasonably ensure that the customers are 494 FIA Comment Letter at 42–43 (Feb. 15, 2013). adequately apprised of the revised Risk Disclosure Statement. FIA also noted that the Commission previously approved, pursuant to § 1.55(c), an alternative risk disclosure statement for use in the U.S., the United Kingdom, and Ireland.498 The alternative risk disclosure statement is set forth in Appendix A to § 1.55. FIA requested that the Commission confirm whether FCMs may continue to use the alternative risk disclosure statement and further encouraged the Commission to coordinate with other derivatives regulatory authorities to revise the alternative risk disclosure statement to meet its regulatory objectives.499 Regulation 1.55(c) provides that the Commission may approve for use in lieu of the standard Risk Disclosure Statement required by § 1.55(b) a risk disclosure statement approved by one or more foreign regulatory agencies or selfregulatory organizations if the Commission determines that such risk disclosure statement is reasonably calculated to provide the disclosure required by the standard Risk Disclosure Statement. As noted above, the Commission proposed amendments to the Risk Disclosure Statement due to its recent experiences with the MFGI and PFGI insolvencies where certain customers, particularly less sophisticated customers, did not fully comprehend the nature of the protections of customer funds. Based upon this recent experience, the Commission does not believe that the disclosures in the alternative risk disclosure statement contained in Appendix A provide sufficient detailed disclosures to customers regarding the risk of trading futures transactions. Accordingly, the Commission is revising § 1.55(c) to provide that an FCM may continue to use the alternative risk disclosure statement provided that the FCM also provides each customer required to receive a disclosure document with the revised Risk Disclosure Statement and receives such customer’s written acknowledgment that it has received and understands the Risk Disclosure Statement. This will allow FCMs to continue to have a common risk disclosure statement with the United Kingdom and Ireland, and also ensure that customers receive additional risk disclosures to enhance their understanding of engaging in futures trading. 495 Id. 496 CFA Comment Letter at 8 (Feb. 13, 2013). Comment Letter at 5 (Feb. 15, 2013). 497 NGFA VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 498 FIA Comment Letter at 43 (Feb. 15, 2013). 499 Id. PO 00000 Frm 00060 Fmt 4701 Sfmt 4700 a. Firm Specific Disclosure Document i. General Requirements The Commission proposed new paragraphs (i) and (k) to § 1.55 to provide that an FCM may not enter into a customer account agreement or accept funds from a customer unless the FCM discloses to the customer all information about the FCM, including its business, operations, risk profile, and affiliates, that would be material to the customer’s decision to entrust such funds to such FCM and otherwise necessary for full and fair disclosure to customers (‘‘Firm Specific Disclosure Document’’). The Firm Specific Disclosure Document is intended to enable customers to make informed judgments regarding the appropriateness of selecting an FCM by providing information for the meaningful comparisons of business models and risks across FCMs. Such information will greatly enhance the due diligence that a customer can conduct both prior to opening an account and on an ongoing basis, as the proposal will require the FCM to update the Firm Specific Disclosure Document at least once every 12 months and as and when necessary to keep it accurate and complete. The Commission believes that the proposed firm specific Firm Specific Disclosure Document, coupled with the existing Risk Disclosure Statement, will provide customers with a more complete perspective regarding the risks of participating in the futures markets and of opening an account with a particular firm. Proposed § 1.55(j) requires an FCM to make the Firm Specific Disclosure Document available to customers and to the general public by posting the Firm Specific Disclosure Document on the FCM’s Web site. An FCM may, however, use an alternative electronic means to provide the Firm Specific Disclosure document to its customers provided that the electronic version is presented in a format that is readily communicated to the customers. Paper copies of the Firm Specific Disclosure Document also must be available upon the request of a customer. The Commission also proposed that each FCM disclose certain financial information on its Web site to provide the public with additional information on the firm and the customer funds that it holds. The additional financial disclosures are set forth in § 1.55(o) and are discussed below. SIFMA stated that the public disclosure requirements will help empower its members to choose safe and trustworthy FCMs, and that the E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations disclosures will hold FCMs accountable to their customers, allowing the customers to conduct due diligence efficiently, actively monitor FCMs’ financial condition and regulatory compliance, and make informed decisions when selecting and doing business with FCMs.500 Vanguard expressed the view that the best protection for customers is their own due diligence, and that the proposed additional enhancements add significant, and much needed, protections and transparency.501 The FHLB supported the proposal with respect to the publication of the Firm Specific Disclosure Document and strongly endorsed the requirement that the FCM update the document as circumstances warrant.502 FIA stated that it supports enhancing disclosures to customers regarding the FCM through which the customer may elect to trade.503 FIA requested that the Commission confirm that an FCM that is part of a publicly-traded company, whether U.S. or non-U.S., or is otherwise required to prepare and to make public an annual report including information comparable to that required by the Firm Specific Disclosure Document under the proposed regulation, may comply with the regulation by making such annual report, and any amendments thereto, available on its Web site.504 FIA noted that the Management Discussion and Analysis (‘‘MD&A’’) required under SEC rules (17 C.F.R. 229.303) requires publicly traded companies to discuss essentially the same topics required to be discussed under the Commission’s proposal. FIA stated that the topics include business environment; critical accounting policies; use of estimates; results of operations; balance sheet and funding sources; off-balance sheet arrangements and contractual obligations; overview and structure of risk management; liquidity risk management; market risk management; credit risk management; operational risk management; recent accounting developments; and certain risk factors that may affect the company’s business.505 FIA estimated that approximately 90 percent of customer funds are held by FCMs that are also SEC registered or part of a bank holding TKELleY on DSK3SPTVN1PROD with RULES2 500 SIFMA Comment Letter at 2 (Feb. 21, 2013). Comment Letter at 4 (Feb. 2, 2013). See also, Prudential Comment Letter at 2 (Jun. 9, 2013) and Security Benefit Comment Letter at 2 (Jan. 11, 2013 supporting the additional disclosures proposed under § 1.55(i). 502 FHLB Comment Letter at 10 (Feb. 15, 2013). 503 FIA Comment Letter at 41 (Feb. 15, 2013). 504 FIA Comment Letter at 43–44 (Feb. 15, 2013). 505 Id. 501 Vanguard VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 company or publicly-traded company and believes this position is necessary to avoid customer confusion in certain circumstances and to assure that FCMs are not subject to duplicative and, perhaps conflicting, disclosure requirements.506 FIA further requested that the Commission confirm the level of detail required to be provided by privatelyheld FCM companies should be consistent with that provided in the annual reports of publicly-traded companies.507 Additionally, FIA stated that privately-held companies would need a period of time to develop the required disclosures and requested that the Commission make the compliance date of the regulation no sooner than six months after the effective date of the regulation.508 The Commission has considered the comments and is adopting § 1.55(i) and (j) as proposed. In response to FIA’s comments, the Commission confirms that beyond the requirements stated in § 1.55, the Commission is not mandating the form in which the required information is conveyed, provided it is responsive to the information requirements of § 1.55 and provides such information in a clear, concise, and understandable matter. Accordingly an FCM that is part of a publicly traded company, or is otherwise required to prepare and make public an annual report including information comparable to the information required by proposed § 1.55(k), may satisfy the disclosure requirements in § 1.55 by making an annual report, and any amendments thereto, available on its Web site; provided that such annual report provides the information required by § 1.55 in a manner that is clear, concise and understandable. The Commission is similarly confirming that a privately-held company may satisfy the requirements in § 1.55 by making an annual report, and any amendments thereto, available on its Web site; provided that such annual report provides the information required by § 1.55 in a manner that is clear, concise and understandable. In assessing whether the annual report contains the necessary information required by § 1.55 in a clear, concise and understandable manner, the FCM must ensure that the disclosures specifically address the risks at the FCM and are not so general in nature that they reflect that the FCM’s business may not be material to the public or private company for which the 506 Id. 507 Id. annual report is prepared. An FCM is not in compliance with § 1.55 if the annual report information does not disclose the information required by § 1.55 as it relates to the FCM. The objective of the disclosures is to provide prospective and existing customers of the FCM with material information that could have an impact on their decision to engage in a relationship with the FCM. If the annual report does not include information regarding the FCM, or such information is not clear concise and understandable, the FCM would have to enhance the disclosure by providing supplemental material or otherwise making the required disclosures available to customers and the public in a manner that is clear, concise and understandable. In addition, in order to provide customers with clear, concise and understandable disclosures, an FCM may be required to extract information from various sections of its annual report and provide such information in an easy to read format. If customers are required to search through detailed annual reports to locate the required § 1.55 disclosures, the FCM is not providing the information in a clear, concise and understandable manner. ii. Specific Disclosure Information Required (by Rule Paragraph) Proposed § 1.55(k)(1) requires an FCM to disclose contact information for the firm including the address of its principal place of business and its phone number. No comments were received on the proposed § 1.55(k)(1) and the Commission is adopting the amendments as proposed. Proposed § 1.55(k)(2) requires an FCM to disclose the name and business addresses of the FCM’s senior management, including business titles and background, areas of responsibility and nature of duties of each person. The FIA recommended the disclosure be limited to those individuals identified as principals on the NFA BASIC system.509 The term ‘‘principal’’ is defined in § 3.1 to mean, with respect to an FCM: (1) The proprietor and chief compliance officer if the FCM is organized as a sole proprietorship; (2) any general partner and chief compliance officer if the FCM is organized as a partnership; (3) any director, the president, chief executive officer, chief operating officer, chief financial officer, chief compliance officer, and any person in charge of a principal business unit, division or function subject to regulation by the Commission if the FCM is organized as at 44. 508 Id. PO 00000 68565 Frm 00061 509 FIA Fmt 4701 Sfmt 4700 E:\FR\FM\14NOR2.SGM Comment Letter at 51 (Feb. 15, 2013). 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68566 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations a corporation; (4) any director, the president, chief executive officer, chief operating officer, chief financial officer, chief compliance officer, the manager, managing member or those members vested with the management authority for the entity, and any person in charge of a principal business unit, division or function subject to regulation by the Commission if the FCM is organized as a limited liability company or limited liability partnership; and (5) in addition, any person at the FCM occupying a similar status or performing similar functions as described above, having the power, directly or indirectly, through agreement or otherwise, to exercise a controlling influence over the entity’s activities that are subject to regulation by the Commission. The Commission agrees with FIA’s comment and is revising the final regulation to require an FCM to disclose persons that are defined as ‘‘principals’’ of the FCM under § 3.1. Proposed § 1.55(k)(3) requires an FCM to disclose the significant types of activities and product lines that the FCM engages in and the approximate percentage of assets and capital that are contributed to each type of business activity or product line. FIA recommended that an FCM be required to update the description in its annual report, only if it adds a new business activity or product line that requires higher minimum capital under applicable capital rules because the approximate percentage of the FCM’s assets and capital used in each type of activity can change frequently.510 The Commission believes that FIA is defining the requirements of § 1.55(k)(3) too narrowly. The regulation is intended to provide the public with information concerning the major businesses activities that an FCM engages in to provide information regarding the benefits and risks of using such firm to conduct transactions in commodity interests. Minimum capital requirements are generally driven by regulated business, such a being registered as a BD. While such information is material to potential customers and is required to be disclosed under § 1.55(k)(3), the regulation also requires the disclosure of non-regulated business that a firm may engage in. The Commission also recognizes that an FCM’s assets and capital contributed to different business activities can change frequently, but such information may be material for the public in determining to entrust funds with the firm and to perform effective due 510 Id. at 45. VerDate Mar<15>2010 diligence in monitoring the firm. Each FCM will need to assess the materiality of changes and use its judgment to determine whether the Firm Specific Disclosure Document should be revised. In addition, the Commission notes that § 1.55(i) requires that the Firm Specific Disclosure Document must be revised as and when necessary, but at least annually, to keep the information accurate and complete. The Commission has considered the comments and is adopting the amendments as proposed. Proposed § 1.55(k)(4) requires an FCM to disclose its business on behalf of customers, including types of accounts, markets traded, international business, and clearinghouses and carrying brokers used, and its policies and procedures concerning the choice of bank depositories, custodians, and other counterparties. FIA requested the Commission confirm that: (1) The disclosure required under this paragraph is limited to the activities of the FCM in its capacity as such; (2) the term ‘‘accounts’’ means ‘‘customers’’; and (3) the term ‘‘counterparties’’ is limited to counterparties for § 1.25 investments.511 Regulation 1.55(k)(4) is intended to provide customers and the public with information regarding the FCM operating its FCM’s business. Accordingly, the Commission confirms that the disclosures required under § 1.55(k)(4) are limited to the activities of the FCM acting in its capacity as an FCM. The term ‘‘types of accounts’’ in § 1.55(k)(4) should be ‘‘types of customers,’’ and requires the FCM to disclose the nature of its customer base in the futures markets (i.e., institutional, retail, agricultural, hedgers,) to provide the public with information regarding the firm’s experiences with different types of markets and market participants. The Commission also confirms that the term ‘‘counterparties’’ is limited to § 1.25 counterparties. The Commission is revising final § 1.55(k)(4) accordingly. Proposed § 1.55(k)(5) requires an FCM to discuss the material risks, accompanied by an explanation of how such risks may be material to its customers, of entrusting funds to the FCM, including, without limitation, the nature of investments made by the FCM (including credit quality, weighted average maturity, and weighted average coupon); the FCM’s creditworthiness, leverage, capital, liquidity, principal liabilities, balance sheet leverage and other lines of business; risks to the FCM created by its affiliates and their activities, including investment of 511 Id. 19:24 Nov 13, 2013 Jkt 232001 PO 00000 at 47–48. Frm 00062 Fmt 4701 Sfmt 4700 customer funds in an affiliated entity; and any significant liabilities, contingent or otherwise, and material commitments. FIA commented that the word ‘‘risks’’ in § 1.55(k)(5) should be replaced with the word ‘‘information,’’ and that the Commission remove the phrase ‘‘accompanied by an explanation of how such risks may be material to its customers.’’ 512 FIA believed it sufficient that an FCM present the required information to the customer and that it is the customer’s responsibility to analyze this information and determine the extent to which it is important or relevant to the customer’s decision to open or maintain an account with the FCM.513 FIA further stated that if the Commission believes FCMs should provide guidance to customers regarding the potential importance of specific information, FIA believes this guidance should be provided by means of a generic statement.514 In addition, FIA asked the Commission to confirm that the term ‘‘investments’’ is limited to investments of customer funds, and does not include all investments made by the FCM as an entity.515 Additionally, FIA requested that the Commission delete the term ‘‘creditworthiness,’’ stating that such reference is incongruous with instructions under section 939A of the Dodd-Frank Act.516 Moreover, FIA opined that the only lines of business that an FCM should be required to disclose are those that would require higher minimum capital under applicable capital rules, and that this information should only be required to be updated annually.517 Additional clarification was requested by FIA regarding the phrase ‘‘investment of customer funds with an affiliated entity,’’ and whether that phrase refers to the ‘‘deposit of customer funds in an affiliated bank.’’ 518 Further clarification was requested regarding the types of liabilities and commitments requiring disclosure under this section and whether this information should updated no more often than semiannually, consistent with comparable disclosures applicable to 512 FIA Comment Letter at 45 (Feb. 15, 2013). 513 Id. 514 Id. 515 Id. 516 Section 939A required that the Commission, ‘‘remove any reference to or requirement of reliance on credit ratings and to substitute in such regulations such standard of creditworthiness as each respective agency shall determine as appropriate for such regulations.’’ FIA Comment Letter at 46 (Feb. 15, 2013). 517 FIA Comment Letter at 46 (Feb. 15, 2013). 518 Id. at 51. E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations BDs.519 Finally, FIA, while not opposed to providing leverage information, believed that disclosure should not be required until it is certain the calculation provides the most appropriate measure of risk.520 The Commission believes that it is appropriate that § 1.55(k)(5) requires an FCM to identify material risks and to explain how such risks may be material to customers. The Commission further believes, based upon its experiences during MFGI, that customers (particularly retail and less sophisticated customers) would benefit from an FCM providing its assessment of the risks of the firm, accompanied by an explanation of such risks. The Commission notes, in response to FIA’s comments, that § 1.55(k)(5) requires an FCM to provide information regarding its general investments and is not limited to the investment of customer funds. The disclosures contemplated by § 1.55(k)(5) go to the full operation of the FCM and not just its regulated or futures activities. In addition, limiting the disclosures only to investments that result in an increase in minimum capital requirements may result in the non-disclosure of significant operations that may impact a customer’s decision to do business with an FCM. The Commission also notes that the requirement in § 1.55(k)(5) for FCMs to disclose leverage information would be met by an FCM providing the leverage information that each FCM is required to calculate under § 1.10 and in accordance with the regulations of the NFA. An FCM should define the leverage calculation in the Disclosure Document and may provide any other information necessary to make the information meaningful for the public, but if materially different from the then prevailing NFA methodology, should provide an explanation of the differences therefrom. Proposed § 1.55(k)(6) requires an FCM to disclose the name of its DSRO and the DSRO’s Web site, and the location of where the FCM’s annual financial statements are available. The Commission received no comments on proposed § 1.55(k)(6) and is adopting the regulation as proposed. Proposed § 1.55(k)(7) requires an FCM to disclose any material administrative, civil, enforcement, or criminal action then pending, and any enforcement actions taken in the last three years. FIA requested that the Commission confirm that a ‘‘pending’’ action is an action that has been filed but not concluded, and 519 Id. 520 Id. at 46. at 34. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 recommended the Commission confirm that the disclosure required under this paragraph would be limited to matters required to be disclosed in accordance with § 4.24(l)(2).521 The Commission agrees with FIA that the regulation should require an FCM to disclose administrative, civil, enforcement, and criminal actions that have been filed but not concluded. The proposal was not intended to cover open or closed investigations that have not resulted in the filing of a complaint. The Commission is revising § 1.55(k)(7) as appropriate to reflect this concept. The Commission, however, does not agree with FIA’s comment that disclosures under proposed § 1.55(k)(7) should be limited to administrative, civil, enforcement, or criminal matters that would be required to be disclosed under § 4.24(l)(2). Regulation 4.24(l)(2) provides that an action will be deemed material if: (1) The action would be required to be disclosed in the footnotes to a commodity pool’s financial statements under generally accepted accounting principles as adopted in the U.S.; (2) the action was brought by the Commission, provided that if the matter was concluded and did not result in a civil monetary penalty in excess of $50,000, it does not need to be disclosed; and (3) the action was brought by any other federal or state regulatory agency, a non-U.S. regulatory agency, or an SRO and involved allegations of fraud or other willful misconduct. The Commission believes that the regulation’s requirement to disclose material actions is appropriate in the context of disclosures so that a customer can perform adequate due diligence to assess the risk of engaging an FCM to conduct futures business and in entrusting funds to the FCM. In this regard, the Commission believes that FCMs should disclose Commission disciplinary actions that are pending or have been concluded against the FCM without regard to the amount of the civil monetary penalty that may have been imposed. In addition, the Commission believes that there may be circumstances in addition to fraud or other willful misconduct that should be disclosed to customers to allow customers to better appreciate the potential risks of entering into a business relationship with an FCM. Proposed § 1.55(k)(8) requires the Firm Specific Disclosure Document to contain a basic overview of customer fund segregation, collateral management 521 Regulation 4.24(l)(2) requires a CPO to disclose in a disclosure document for a commodity pool certain material administrative, civil, or criminal actions against an FCM that the CPO engages to trade futures. PO 00000 Frm 00063 Fmt 4701 Sfmt 4700 68567 and investments, FCMs, and dual registrant FCM/BDs. The disclosures included under § 1.55(k)(8) should not only include information regarding the segregation of funds for trading on designated contract markets, but should also include information regarding the risk to customers of engaging in foreign futures and foreign options trading. In conjunction with § 1.55(k)(4), which requires an FCM to provide a profile of its customer business, including its international business and clearinghouses and carrying brokers used, an FCM in order to comply with § 1.55(k)(8) should disclose the risks of engaging in trading on foreign markets. The disclosures required by § 1.55(k)(8) should include information that in the event of the insolvency of the FCM, or the insolvency of a foreign broker or foreign depository that is holding customer funds, customer funds held in foreign jurisdictions may be subject to a different bankruptcy regime and legal system than if the funds were held in the U.S. In addition, an FCM should disclose that a customer also is subject to fellow customer risk in foreign jurisdictions and that, for purposes of bankruptcy protection, a customer that trades only in one country or in one market is also exposed to fellow customer risk from losses that may be incurred in other countries and other markets. The Commission did not receive comment on § 1.55(k)(8) and is adopting the amendments as proposed. Proposed § 1.55(k)(9) requires the FCM to include in the Firm Specific Disclosure Document information on how a customer may obtain information regarding filing a complaint with the Commission or the firm’s DSRO. The Commission did not receive comment on § 1.55(k)(9) and is adopting the amendments as proposed. Proposed § 1.55(k)(10) requires the Firm Specific Disclosure Document to include the following financial information for the most recent month end: (1) The FCM’s total equity, regulatory capital, and net worth, all computed in accordance with U.S. Generally Accepted Accounting Principles and the Commission’s capital rule, § 1.17; (2) the dollar value of the FCM’s proprietary margin requirements as a percentage of the aggregated margin requirements for futures customers, Cleared Swaps Customers, and 30.7 customers; (3) the number of futures customers, Cleared Swaps Customers, and 30.7 customers that comprise 50 percent of the funds held for such customers, respectively; (4) the aggregate notional value, by asset class, of all non-hedged, principal over-thecounter transactions into which the E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68568 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations FCM has entered; (5) the amount, generic source and purpose of any unsecured lines of credit or similar short term funding the FCM has obtained but not yet drawn upon; (6) the aggregated amount of financing the FCM provides for customer transactions involving illiquid financial products for which it is difficult to obtain timely and accurate prices; and (7) the percentages of futures customers, Cleared Swaps Customers, and 30.7 customers receivable balances that the FCM had to write-off as uncollectable during the past 12 months, as compared to the current balance held for such customers. CMC generally supported proposed § 1.55(k)(10), as it would enhance transparency to the public.522 NFA provided a general comment supporting the Commission’s objective of providing customers with meaningful information, but expressed concern that much of the information proposed to be disclosed under § 1.55(k)(10) may not be understandable to smaller and less sophisticated customers.523 NFA specifically questioned whether such customers would comprehend: (1) The dollar value of the FCM’s proprietary margin requirements as a percentage of the aggregate margin requirements for futures customers, Cleared Swaps Customers, and 30.7 customers; (2) the number of futures customers, Cleared Swaps Customers, and 30.7 customers that comprise 50 percent of the funds held for such customers, respectively; (3) the aggregate notional value, by asset class, of all non-hedged, principal overthe-counter transactions into which the FCM has entered; (4) the amount, generic source and purpose of any unsecured lines of credit or similar short term funding the FCM has obtained but not yet drawn upon; (5) the aggregate amount of financing the FCM provides for customer transactions involving illiquid financial products for which it is difficult to obtain timely and accurate prices; and (6) the percentages of futures customers, Cleared Swaps Customers, and 30.7 customers receivable balances that the FCM had to write-off as uncollectable during the past 12 months, as compared to the current balance held for such customers.524 NFA noted that as one of its responses to MFGI, its Board of Directors formed a special committee on the protection of customer funds (‘‘Special Committee’’) that was comprised of NFA’s public directors.525 NFA stated that the Special Committee spent a significant amount of time reviewing information that FCMs should make available to customers, while focusing on the needs of smaller, less sophisticated customers, and concluded that much of the information in § 1.55(k)(10) is complicated and not meaningful for less sophisticated customers.526 NFA also noted that more sophisticated institutional customers could request and would likely receive this information directly from an FCM.527 The Commission understands that not all customers would have the same use for the detailed information required by § 1.55(k)(10). In developing the proposal, the Commission sought to balance the information needs of all types of customers and their respective levels of sophistication. While certain customers may not use the full amount of information in assessing risks, the Commission anticipates that other customers will incorporate all or most of the information into their risk management process and will benefit from the disclosures in performing their due diligence. The Commission also believes that the information should be available to all customers without the need for customers to specifically request the § 1.55(k)(10) disclosures from the FCM. FIA agrees that customers should be advised whether an FCM engages in proprietary futures trading but does not believe that FCMs should be required to disclose the dollar value of their proprietary margin requirements as a percentage of customer margin requirements as proposed in § 1.55(k)(10(ii) as such percentages will change frequently.528 FIA also questions the implication that customers may be at greater risk if an FCM carries proprietary futures positions noting, for instances, that the FCM’s funds to margin its proprietary positions would be available to cover a potential customer default.529 RJ Obrien, however, noted that it is important that customers be aware of the nature and extent of a firm’s proprietary trading.530 The Commission believes that information regarding an FCM’s proprietary trading is necessary for customers to appropriately assess the risks of entrusting their funds to an FCM. The risk profile of an FCM is certainly different if it acts primarily as an agent in handling customer funds, or 526 Id. at 16. 527 Id. 522 CMC 523 NFA Comment Letter at 2 (Feb. 15, 2013). Comment Letter at 15–16 (Feb. 15, 2013). 524 Id. 525 Id. Comment Letter at 48 (Feb. 15, 2013). 529 Id. 530 RJ O’Brien Comment Letter at 11 (Feb. 15, 2013). at 1. VerDate Mar<15>2010 528 FIA 19:24 Nov 13, 2013 Jkt 232001 PO 00000 Frm 00064 Fmt 4701 Sfmt 4700 if it acts as agent for customers and also engages in proprietary trading. The Commission further believes that customers would benefit from some measure of the FCM’s proprietary trading rather than a simple statement that the firm does or does not engage in proprietary trading. The dollar value of the FCM’s margin requirements for its proprietary trading listed as a percentage of its customer margin requirements provides a means of measuring how active and extensive a firm’s proprietary trading may be relative to its customer business, which will factor into the public’s risk profile of the firm. FIA requested confirmation that the requirement in § 1.55(k)(10)(iii) for an FCM to disclose the number of futures customers, cleared swap customers, and 30.7 customers that comprise 50 percent of the FCM’s total funds held for such customers, respectively, should be based upon the smallest number of customers that comprise the 50 percent threshold.531 The Commission confirms that FIA’s assumption is correct and is revising the final regulation accordingly. A purpose of the disclosure is to provide information on the extent to which a firm may have customers with large positions relative to the FCM’s general customer base. FIA stated that the requirement in § 1.55(k)(10)(iv) for an FCM to disclose the aggregate notional value, by asset class, of its non-hedged, principal overthe-counter transactions would require the FCM to disclose proprietary information. In addition, FIA stated that providing such information is not practical as firms generally do not manage their books this way and the categorization of a swap transaction as being hedged or not hedged would change each day. The objective of § 1.55(k)(10)(iv) is for an FCM to disclose the extent of the risk it is exposed to from over-the-counter transactions that are not hedged or for which the FCM does not hold margin from the counterparty sufficient to cover the exposure. While the Commission recognizes that such information may change frequently, § 1.55 only requires an FCM to update the information on an annual basis, or more frequently if the changes are material. The information also is in the aggregate, which should minimize the risk of disclosing detailed proprietary information. After considering the comments, the Commission is adopting the regulation as proposed. FIA stated that the Commission should distinguish between committed 531 FIA E:\FR\FM\14NOR2.SGM Comment Letter at 46–47 (Feb. 15, 2013). 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations and uncommitted lines of credit in the requirement in § 1.55(k)(10)(v), which requires an FCM to disclose the amount, generic source and purpose of any unsecured lines of credit it has obtained but not yet drawn upon.532 The Commission agrees that it would be more appropriate to disclose committed lines of credit and to exclude lines of credit that could be withdrawn by the potential lender. The Commission is revising the final regulation to reflect this change. In addition, the Commission is clarifying that the provision in § 1.55(k)(10)(v) that requires the disclosure of the amount, source and purpose of any unsecured lines of credit or similar short-term funding would include secured and unsecured short-term funding. Regulation 1.55(k)(10)(vi) requires an FCM to disclose the aggregated amount of financing the FCM provides for customer transactions involving illiquid financial products for which it is difficult to obtain timely and accurate prices. FIA requested that the Commission define the type of financing covered by the regulation, and also requested that the Commission define the term ‘‘illiquid financial products’’ and confirm whether the information should include secured as well as unsecured financing.533 The Commission notes that the purpose of the disclosure is to provide the public with information regarding the possible extent of exposures an FCM may have if customers failed to meet their financial obligations to the FCM. The Commission is adopting the requirement as proposed. FCMs are required to provide the necessary information in the Disclosure Document, and may explain the factors it uses to determine if a financial product is liquid or illiquid and the extent to which transactions are secured or unsecured. Regulation 1.55(k)(10)(vii) requires an FCM to disclose the percentage of futures customer, Cleared Swaps Customer, and 30.7 customer receivable balances that the FCM had to write-off as uncollectable during the past 12 months, as compared to the current balances of funds held for such customers. Newedge and RJ O’Brien commented that providing this information would provide customers with valuable insight into the strength of an FCM’s credit policies, which benefits all customers.534 FIA, however, 532 Id. commented that it did not recognize the relevance of the requested information, which may be misleading without the proper context (such as whether the losses were caused by one or two large customers or an aggregate of small customers).535 FIA further stated that if the Commission were to adopt the rule, normal business write-offs should be excluded, and the Commission should establish a de minimis threshold were reporting would not be required. The Commission has considered the comments and is adopting the regulation as proposed. The Commission believes that the disclosure of the amount of write-offs an FCM had to incur as a result of customers failing to pay receivable balances will provide information regarding the credit policies of the FCM. The Commission does not believe that there should be any de minimis level or threshold amount before the disclosure of the information becomes a requirement. In response to FIA’s comments that the information may be misleading if not provided in context, the Commission notes that FCMs may include explanatory text in the Disclosure Document provided such information is not misleading. Finally, proposed § 1.55(k)(11) requires a summary of the FCM’s current risk practices, controls and procedures. FIA asked for confirmation that the discussion of the FCM’s current risk practices, controls and procedures may be general in nature, noting that the Commission has recognized that an FCM’s risk practices, controls and procedures may include proprietary information.536 The Commission confirms that the discussion of the current risk practices, controls and procedures may be general in nature so that it does not disclose confidential proprietary information. 2. Public Availability of FCM Financial Information Proposed § 1.55(o) requires each FCM to make the following information available to the public on its Web site: (1) The daily Segregation Schedule, Secured Amount Schedule, and the Cleared Swaps Segregation Schedule for the most current 12-month period; (2) a summary schedule of the FCM’s adjusted net capital, net capital, and excess net capital, all computed in accordance with § 1.17 and reflecting balances as of the month-end for the 12 most recent months; and, (3) the Statement of Financial Condition, the Segregation Schedule, Secured Amount Schedule, and Cleared Swaps 533 Id. 534 Newedge Comment Letter at 4 (Feb. 15, 2013); RJ O’Brien Comment Letter at 11 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 535 FIA 536 FIA PO 00000 Comment Letter at 50 (Feb. 15, 2013). Comment Letter at 50 (Feb. 15, 2013). Frm 00065 Fmt 4701 Sfmt 4700 68569 Segregation Schedule and all related footnotes contained in the FCM’s most recent certified annual financial report. Regulation 1.55(o) also requires each FCM to include a statement on its Web site that additional financial information on the firm and other FCMs may be obtained from the NFA and the Commission, and to include hyperlinks to the NFA and Commission Web sites. MFA, SIFMA, Prudential, Security Benefit, CoBank, and the FHLBs supported the requirement for FCMs to post their daily Segregation Schedule, Secured Amount Schedule, and Cleared Swaps Segregation Schedule on their Web site each day, stating that the disclosure of such information would place customers in a better position to assess an FCM’s stability, and if customers identify concerns and deem appropriate, to transfer their positions and funds to a different FCM.537 MFA, SIFMA, Prudential, Security Benefit, CoBank, and the FHLBs also stated that the Commission should require FCMs to disclose additional information, including the FCM’s monthly Segregation Schedule, Secured Amount Schedule, and Cleared Swaps Segregation Schedule, and monthly summary balance sheet and income statement information, for the most recent 12-month period.538 MFA noted that each FCM’s monthly Segregation Schedule, Secured Amount Schedule, and Cleared Swaps Segregation Schedule are publicly available under § 1.10, and suggested that each FCM should be required to disclose the schedules to the public without the public having to request such statements from the firms as is currently required under § 1.10.539 The ACLI encouraged the Commission to make public as much information as possible regarding FCMs’ financial condition, treatment of customer funds, and regulatory compliance.540 The ACLI also noted that access to these categories of information should be straightforward and simple.541 TIAA–CREF supported the proposed enhanced financial disclosures and encouraged the Commission to require the prompt public disclosure of relevant FCM 537 MFA Comment Letter at 4 (Feb. 15, 2013); SIFMA Comment Letter at 2 (Feb. 21, 2013); Prudential Comment Letter at 2 (Jun. 9, 2013); Security Benefit Comment Letter at 2 (Jan. 11, 2013); CoBank Comment Letter at 2 (Jan. 14, 2013); FHLB Comment Letter at 7 (Feb. 15, 2013). 538 Id. See also The Commercial Energy Working Group Comment Letter at 2–3 (Feb. 12, 2013). 539 MFA Comment Letter at 4–6 (Feb. 15, 2013); SIFMA Comment Letter at 2 (Feb. 21, 2013). 540 ACLI Comment Letter at 2–3 (Feb. 15, 2013). 541 Id. E:\FR\FM\14NOR2.SGM 14NOR2 68570 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations information.542 TIAA–CREF stated that such disclosures would be a positive step towards ensuring a level playing field between each FCM and its customers and among FCMs themselves, and supported the Commission’s efforts to require FCMs to disclose information regarding the FCM’s segregation of customer property (e.g., the Cleared Swaps Segregation Schedule), financial health and creditworthiness and would also support efforts by the Commission to cause such disclosures to be posted on the relevant FCM’s Web site, in lieu of requiring customers to make a request to the Commission to receive such information (which may be administratively burdensome).543 FXCM noted that currently the Commission’s monthly ‘‘net capital’’ reports is the only publicly available way to determine how much money an FCM or RFED has set aside for net capital, but this provides very little insight into how the firm is doing financially.544 FXCM stated that FCMs and RFEDs should be required to publish quarterly consolidated balance sheets and income statements, including holding company financials, for the trading public so they will know the level of risk involved in dealing with a firm.545 FIA stated that the daily segregation, secured amount, and cleared swaps customer account calculations should not be made publicly available. FIA noted that NFA currently makes this information available on its Web site as of the 15th and last business day of each month and believes disclosure twice each month should be sufficient. If the Commission concludes more frequent disclosure is necessary, FIA recommended that disclosure should be required no more often than weekly, i.e., as of the close of business each Friday (or the last business day of the week if Friday is a holiday). Phillip Futures Inc. proposed that the Commission limit the financial data made public to that which is most appropriate for the average customer to make an educated decision regarding his choice of broker.546 It further stated 542 ACLI Comment Letter at 2–3 (Feb. 15, 2013). Comment Letter at 2–3 (Feb. 15, TKELleY on DSK3SPTVN1PROD with RULES2 543 TIAA–CREF 2013). 544 FXCM Comment Letter at 2–3 (Dec. 14, 2013). 545 Id. See also forex form letter group: Michael Krall; David Kennedy; Robert Smith; Michael Carmichael; Andrew Jackson; Donald Blais; Suzanne Slade; Patricia Horter; JoDan Traders; Jeff Schlink; Sam Jelovich; Matthew Bauman; Mark Phillips; Deborah Stone; Po Huang; Aaryn Krall; Vael Asset Management; Kos Capital; James Lowe; Tracy Burns; Treasure Island Coins; Clare Colreavy, Brandon Shoemaker. 546 Phillip Futures Inc. Comment Letter at 3 (Feb. 14, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 that rather than making the financial information public, it should only be provided to customers at their request.547 RCG stated that if the Commission makes the Segregation Schedule, Secured Amount Schedule, and Cleared Swaps Segregation Schedule public, the public will only see a targeted residual interest amount, without realizing and comprehending the many factors that have impacted a particular firm’s determination of its target.548 TD Ameritrade expressed its concern regarding the public disclosure of the firm’s targeted residual interest computation.549 TD Ameritrade stated that the public would not be privy to any of the internal discussions and analysis that goes into the development and setting of the firm’s targeted residual interest, and that any changes to its target could cause market upheaval, volatility, and unintended consequences.550 The Commission has considered the comments and is adopting the regulations as proposed, with the revision to § 1.55(o) to require each FCM to disclose on its Web site its monthly Segregation Schedule, Secured Amount Schedule, and Cleared Swaps Segregation Schedule for the 12 most recent month-end dates. The Commission currently discloses FCM financial data on its Web site. Specifically, § 1.10(g) provides that the Form 1–FR–FCM (or FOCUS Report) is exempt from mandatory public disclosure under the Freedom of Information Act and the Government in the Sunshine Act, except for the following information: (1) The amount of the FCM’s adjusted net capital under § 1.17 as of the reporting date, the amount of adjusted net capital maintained by the firm on the reporting date, and the amount of excess net capital on the reporting date; (2) the Segregation Schedule and Secured Amount Schedule as of the reporting date; and (3) the Statement of Financial Condition in the certified annual report and related footnote disclosures. The Commission summarizes the FCM’s segregation, secured amount and capital information each month and makes such information available to the public on its Web site. The Commission believes that customers should have access to sufficient financial information for each FCM to allow such customers to 547 Id. 548 RCG 549 TD Comment Letter at 6 (Feb. 12, 2013). Ameritrade Comment Letter at 4 (Feb. 15, 2013). 550 Id. PO 00000 Frm 00066 Fmt 4701 Sfmt 4700 adequately assess and monitor the financial condition of firms. The disclosure of the daily segregation and secured amount computations will provide customers with additional information to assess the adequacy of an FCM’s targeted residual interest given the firm’s business operations and amount of customer funds held in segregated or secured accounts. The Commission also believes that the expanded disclosures required under § 1.55 offer each FCM with the ability to provide an explanation describing the rationale and business justification for its computation of the target residual interest to better inform the public. The reporting of segregated and secured account balances on a daily basis also will provide customers with information regarding any trends developing with particular reported balances that the customers may wish to consider as part of their risk assessment of the FCMs. The Commission further believes that customers should have access to an FCM’s financial information by reviewing such information directly on the FCM’s Web site as part of the Firm Specific Disclosures. By reviewing the Firm Specific Disclosures and having access to financial data of the FCM, customers will be able to better assess the risks of engaging a particular FCM. The Commission also believes that customers would benefit from being informed that additional financial information on each FCM is available from the NFA and Commission, and by requiring the FCMs to maintain a hyperlink to the Commission’s and NFA’s Web sites. NFA and Commission data provide historical information that allows customers to assess financial trends on a customer-by-customer basis, and provides sufficient financial information such that customers can compare financial data across FCMs as part of their risk management program. The NFA also discloses additional information regarding how FCMs are holding customer funds and investing customer funds under § 1.25, which is material information for customers in assessing risk at particular FCMs. Regulation 1.10(g) currently requires a customer to request from the FCM monthly Segregation Schedules and Secured Amount Schedules, as well as the Statement of Financial Condition contained in the FCM’s certified annual report. In response to several of the comments, the Commission is revising § 1.55(o) to require each FCM to post such financial information on its Web site. The Commission agrees with the commenters that FCMs should disclose this information, which is currently E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 publicly available under § 1.10(g), without requiring each customer or member of the public having to specifically request such information from the FCM. The Commission is not expanding the required disclosures to include summary income statement information or balance sheet information as requested by several commenters. As noted above, § 1.10(g) currently provides that the Form 1–FR–FCM and FOCUS Reports are not subject to mandatory public disclosure under the Freedom of Information Act or the Government in the Sunshine Act, and the Commission did not propose to amend § 1.10(g) in the Proposal. In addition, the comments addressing quarterly financial statements and consolidated financial statements for FCMs and RFEDs are beyond the scope of the Proposal as the Commission did not propose to amend the regulations to require an FCM or RFED to prepare or file with the Commission quarterly financial statements on either an individual or consolidated basis. Accordingly, the Commission is not revising final § 1.55(o) to require such disclosures. Q. Part 22—Cleared Swaps As discussed above, the Commission adopted final regulations in part 22 that implement certain provisions of the Dodd Frank Act and impose requirements on FCMs and DCOs regarding the treatment of Cleared Swaps Customer contracts (and related collateral).551 Although substantive differences in the segregation regimes between futures and cleared swaps exist at the clearing level under the final part 22 regulations, requirements with respect to collateral which is not posted to clearinghouses and maintained by FCMs for Cleared Swaps Customers replicate or incorporate by reference many of the same regulatory requirements applicable to the segregation of futures customer funds under section 4d(a)(2) of the Act and Commission regulations (for example, holding funds separate and apart from proprietary funds, limitations on the FCM’s use of customer funds, titling of depository accounts, Acknowledgment Letter from depository requirements, and limitations on investment of swap customers’ funds, are currently contained in both part 1 and part 22 regulations). The determination that appropriate enhancements are necessary with respect to the regulatory requirements discussed above for segregated futures 551 See discussion in section I.A. above. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 customer funds under section 4d(a)(2) of the Act is equally applicable to Cleared Swaps Customer Collateral. In this regard, the risk management program that each FCM that holds customer funds is required to implement under § 1.11 encompasses the firm’s business with futures customers, Cleared Swaps Customers, and 30.7 customers. In addition, the Commission proposed amendments to § 22.2(d)(1) and (f)(6) that require an FCM to maintain at all times sufficient residual interest in Cleared Swaps Customer Accounts to exceed the sum of the margin deficits (i.e., undermargined amounts) of all of its Cleared Swaps Customers. The proposed amendments to § 22.2(e)(1) that explicitly provide that an FCM shall bear sole responsibility for any losses resulting from the investment of Cleared Swaps Customer Funds in § 1.25 compliant instruments is consistent with the amendments adopted for § 1.29(b) that require an FCM to bear sole responsibility for any losses resulting from the investment of futures customers funds in § 1.25 compliant instruments. The proposed amendments to § 22.2(f)(4) provide that an FCM must be in compliance at all times with its segregation requirements for Cleared Swaps Customers is consistent with amendments adopted in § 1.20(a) that require an FCM to be in compliance at all times with its segregation requirements for futures customers. The proposed amendments in § 22.2(f)(5)(iii)(B) permit an FCM to develop its own program to assess credit risk for purposes of computing haircuts on securities securing a Cleared Swaps Customer’s deficit account is consistent with the amendments adopted in 1.32 for computing haircuts on securities securing a futures customer’s deficit account. The proposed amendments to § 22.2(g)(2), (3), and (5) require an FCM to prepare and submit to the Commission and the FCM’s DSRO a daily Cleared Swap Segregation Schedule and twice monthly listing of the holding of Cleared Swaps Customer funds is consistent with the amendments adopted to § 1.32 that require an FCM to prepare and submit to the Commission and the FCM’s DSRO a daily Segregation Schedule and twice monthly listing of the holding of futures customer funds. Comments on the substantive provisions being adopted by the Commission under part 22 have been considered and addressed in large part in the discussion of the related substantive provisions in part 1 with respect to futures customer segregated funds. The Commission has considered those comments and, with the exception PO 00000 Frm 00067 Fmt 4701 Sfmt 4700 68571 of the proposed amendments to § 22.2(a) and (f)(6), is adopting the amendments to part 22 as proposed. In addition, several commenters, including MFA, CIEBA and Franklin urged the Commission to adopt a full physical segregation option specific for Cleared Swaps Customer Collateral.552 This comment is outside of the scope of the proposal. The Commission, however, has previously clarified the ability of FCMs to employ third party custodial accounts for Cleared Swaps Customer Collateral, while reiterating that as customer property, in the event of an FCM insolvency, any funds held in such a third party custodial account would be subject to pro-rata distribution along with all other customer property.553 Commission staff is also continuing to explore alternative collateral custody arrangements as directed by the Commission.554 As discussed in more detail above, several commenters objected to proposed residual interest requirements under §§ 1.20(i) and 22.2(f).555 Of those commenters, a number focused on the proposed residual interest requirements for Cleared Swaps and highlighted the inconsistency of the ‘‘at all times’’ requirement with the Commission’s analysis in the part 22 final rules.556 LCH.Clearnet, ISDA, Paul/Weiss, and other commenters specifically stated that the inclusion of the language ‘‘at all times’’ is inconsistent with the LSOC requirement to calculate such deficits at the time of a margin call by a DCO to its clearing FCMs, and with the requirement to have sufficient residual interest to cover such deficit by the time the clearing FCMs are required to meet such payment obligations.557 These commenters argued that when the Commission adopted the part 22 final rules, it considered this point in time 552 MFA Comment Letter at 9 (Feb. 15, 2013); CIEBA Comment Letter at 3–4 (Feb. 20, 2013); Franklin Comment Letter at 2 (Feb. 15, 2013). 553 77 FR 6336, 6343. 554 Id. at 6343–6344. 555 See section II.G.9. above. 556 See LCH.Clearnet Comment Letter at 4–5 (Jan. 25, 2013); FIA Comment Letter at 22–23 (Feb. 15, 2013). 557 See, e.g., LCH.Clearnet Comment Letter at 4– 5 (Jan. 25, 2013); Paul/Weiss Comment Letter at 3– 5 (Feb. 15, 2013); ISDA Comment Letter at 2–3 (Feb. 15, 2013). ISDA further argued that variation margin payments are not ‘‘used’’ until the point of settlement. See ISDA Comment Letter at 1–2 (Aug. 27, 2013) (citing CFTC Letter No. 12–31, ‘‘Staff Interpretation Regarding Part 22,’’ (November 1, 2012) (‘‘Part 22 Staff Interpretation’’) and arguing that the use restriction set forth in 4d(f)(2)(B) of the CEA ‘‘is driven by the meaning of ‘property . . . received’ ’’ and that ‘‘‘received’ in this context cannot be intended to include variation margin fluctuations pre-settlement because it is only upon settlement that an item of property will have been received by the FCM.’’). E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68572 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations approach to be consistent with the Act and sufficient to ensure that the collateral of one Cleared Swaps Customer is never used to margin the positions of another customer.558 In response to these comments, the Commission notes that the proposed amendments to § 22.2(a) and (f)(6) were meant to capture the current practice with respect to residual interest buffer calculations for Cleared Swaps using language that was consistent with the Proposed Residual Interest Requirement for futures. In other words, the Commission did not intend to alter the current residual interest requirements, as set forth in the part 22 final rules.559 Indeed, the Commission notes that Staff guidance from November 1, 2012, states that ‘‘FCMs are prohibited from ‘us[ing] or permit[ing] the use of, the Cleared Swaps Customer Collateral of one Cleared Swaps Customer to purchase, margin, or settle the Cleared Swaps or any other trade or contract of, or to secure or extend the credit of, any person other than such Cleared Swaps Customer.’ Where a Cleared Swaps Customer is undermargined, then the FCM must ensure that, to the extent of such shortfall, its own money, securities, or other property—and not that of other Cleared Swaps Customers—is used to cover a margin call (whether initial or variation) attributable to that Cleared Swaps Customer’s portfolio of rights and obligations.’’ 560 Because of the confusion expressed by commenters regarding the residual interest requirements for Cleared Swaps, the Commission is revising § 22.2(a) and (f). The Commission is revising proposed § 22.2(a) by deleting the last sentence. The Commission is revising § 22.2(f)(6) by replacing the language from the proposal with new language which sets forth the residual interest requirements for Cleared Swaps in a manner that is consistent with current market practice and that parallels the language used in § 1.22. To be clear, and as requested by several commenters, the Commission confirms that the language in § 22.2(f)(6) is not intended to, and thus should not be read to, change current practice with respect to an FCM’s residual interest requirements for Cleared Swaps as set forth in Commission regulations and JAC Update 12–03, and consistent with Staff Interpretation 12–31. Thus, ‘‘where a Cleared Swaps Customer is 558 See LCH.Clearnet Comment Letter at 4–5 (Jan. 25, 2013); FIA Comment Letter at 22–23 (Feb. 15, 2013); ISDA Comment Letter at 2–3 (Feb. 15, 2013). 559 See also Part 22 Staff Interpretation. 560 See id. at 2 (answer to Question 2.1). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 undermargined,561 the FCM must ensure that, to the extent of such shortfall, its own money, securities, or other property—and not that of other Cleared Swaps Customers—is used to cover a margin call (whether initial or variation) attributable to that Cleared Swaps Customer’s portfolio of rights and obligations.’’ 562 Consistent with this revised residual interest requirement, § 22.2(f)(4) is being amended to state that the amount of funds an FCM is holding in segregation may not be reduced by any debit balances that the futures customers of the futures commission merchants have in their accounts. Finally, § 22.2(f)(2) is being revised, consistent with 1.20(i)(2) and current market practice, to clarify that the calculation set forth therein is the Net Liquidating Equity Method. R. Amendments to § 1.3: Definitions; and § 30.7: Treatment of Foreign Futures or Foreign Options Secured Amount Part 30 of the Commission’s regulations was adopted in 1987 and governs the offer and sale in the U.S. of futures contracts and options traded on or subject to the rules of a foreign board of trade.563 The Commission proposed to amend several regulations in part 30 to provide a more coordinated approach to the regulations governing the offer and sales of futures contracts traded on foreign boards of trade and the comparable regulations governing the offer and sale of futures contracts traded on designated contract markets. Aligning the regulations, including regulations governing how an FCM holds funds for customers trading on non-U.S. markets with the requirements for customers trading on U.S. markets, will greatly enhance the protection of customer funds, and avoid competitive imbalances between trading on domestic and foreign contract markets that might result in regulatory arbitrage. The Commission’s Proposal, along with the comments received, is discussed in the sections below. 1. Elimination of the ‘‘Alternative Method’’ for Calculating the Secured Amount Regulation 30.7(a) requires an FCM to set aside in separate accounts for the 561 In this context, a Cleared Swaps Customer is undermargined to the extent that (a) the minimum margin requirement, attributable to that Cleared Swaps Customer’s portfolio of rights and obligations, at the DCO (for an FCM that is clearing such Cleared Swaps Customer’s positions directly) or at the Collecting FCM (for a Depositing FCM) exceeds (b) the customer’s net liquidating value, including securities posted at margin value. 562 See Part 22 Staff Interpretation at 2. 563 52 FR 28980 (Aug. 5, 1987). PO 00000 Frm 00068 Fmt 4701 Sfmt 4700 benefit of its ‘‘foreign futures or foreign options customers’’ an amount of funds defined as the ‘‘foreign futures or foreign options secured amount.’’ The term ‘‘foreign futures or foreign options customer’’ is defined in § 30.1 as any person located in the U.S., its territories, or possessions who trades in foreign futures or foreign options. The term ‘‘foreign futures or foreign options secured amount’’ is defined in § 1.3(rr) as the amount of funds necessary to margin the foreign futures or foreign options positions held by the FCM for its foreign futures or foreign options customers, plus or minus any gains or losses on such open positions. The calculation of the foreign futures or foreign options secured amount as defined in § 1.3(rr) is referred to as the ‘‘Alternative Method.’’ Requirements concerning the collateral of foreign futures or foreign options customers are substantially less robust for funds deposited with an FCM under the Alternative Method than requirements concerning the collateral of futures customers deposited with an FCM under section 4d(a)(2) of the Act or Cleared Swaps Customer Funds deposited under section 4d(f) of the Act. Section 4d(a)(2) of the Act and §§ 1.20 and 1.22 require an FCM to hold in accounts segregated for the benefit of futures customers a sufficient amount of funds to satisfy the full account equities of all of the FCM’s futures customers trading on designated contract markets.564 Section 4d(f) and § 22.2 require an FCM to segregate for the benefit of Cleared Swaps Customers a sufficient amount of funds to satisfy the full account equities of all of the FCM’s Cleared Swaps Customers. The calculations required under sections 4d(a)(2) and 4d(f) of the Act are referred to as the ‘‘Net Liquidating Equity Method.’’ The Alternative Method contrasts with the Net Liquidating Equity Method in that the Alternative Method obligates an FCM to set aside in separate accounts for the benefit of its customers an amount of funds sufficient to cover only the margin required on open foreign futures and foreign option positions, plus or minus any unrealized gains or losses on such positions. Any funds deposited by foreign futures or foreign options customers in excess of the amount required to be set aside in separate accounts may be held by the 564 The Commission is also adopting as final amendments to § 1.20(a) that clarify and provide explicitly that an FCM is required to hold funds in segregated accounts in an amount at all times in excess of its total obligations to all futures customers. See section II.G.9. above for a discussion of the amendments to § 1.20. E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations FCM in operating cash accounts and may be used by the FCM as if it were its own capital. Since an FCM is not required under the Alternative Method to set aside in separate accounts an amount of funds sufficient to repay the full account balances of each of its foreign futures or foreign options customers, the FCM may not be in a financial position to return 100 percent of the account equities (or transfer such account equities to another FCM) of each foreign futures or foreign options customer in the event of the insolvency of the FCM. In addition § 30.7 further differs from the regulations governing how FCMs hold funds for futures customers and Cleared Swap Customers in that § 30.7 requires an FCM to set aside in a separate account funds only for ‘‘foreign futures or foreign options customers.’’ As previously stated, the term ‘‘foreign futures or foreign options customer’’ is defined in § 30.1 as any person located in the U.S., its territories, or possessions who trades in foreign futures or foreign options. Thus, an FCM is not required to set aside in separate accounts funds for foreign-domiciled customers trading on foreign futures markets. Regulation 30.7 permits an FCM to set aside funds for foreign futures customers located outside of the U.S., but an FCM is not obligated under the regulations to do so. Requiring FCMs to include foreigndomiciled customers’ funds in segregated accounts benefits all customers placing funds on deposit for use in trading foreign futures and foreign options. Neither Subchapter IV of Chapter 7 of the Bankruptcy Code nor the Commission’s part 190 regulations discriminate between foreign-domiciled and domestic-domiciled customers. Thus, any deficiency arising from the reduced requirements will impact both foreign and domestic customers pro rata. The Commission proposed various amendments to the part 30 regulations to eliminate the Alternative Method and to require FCMs to use the Net Liquidating Equity Method to compute the amount of funds they must set aside in separate accounts for the benefit of foreign futures or foreign options customers. The Commission also proposed to extend the protections of part 30 to foreign-domiciled customers trading on foreign markets through an FCM. The intent of the proposed amendments is to provide 30.7 customers with equivalent protections available to futures customers and Cleared Swaps Customers by requiring each FCM to hold in secured accounts sufficient funds to cover the full Net VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 68573 Liquidating Equity of each customer trading on foreign futures markets. To implement these revisions, the Commission proposed to define the term ‘‘30.7 customer’’ in § 30.1 to mean any person, whether domiciled within or outside of the U.S., that engages in foreign futures or foreign options transactions through the FCM. The Commission also proposed to amend § 1.3(rr) to match structurally the definition of the term ‘‘customer funds’’ in § 1.3(gg) 565 and to define the term ‘‘foreign futures or foreign options secured amount’’ to mean ‘‘all money, securities and property received by an FCM for, or on behalf of, ‘‘30.7 customers’’ to margin, guarantee, or secure foreign futures and foreign options transactions, and all funds accruing to ‘‘30.7 customers’’ as a result of such foreign futures and foreign options transactions.’’ The effect of the proposed amendments is to adopt the Net Liquidating Equity Method for foreign futures and foreign options by requiring an FCM to set aside in separate accounts a sufficient amount of funds to cover the full account balances (i.e., the Net Liquidating Equities) of both the U.S. and foreign-domiciled customers. The Commission also proposed to amend § 30.7(a) to allow an FCM to use an internal credit risk model to compute the appropriate market deductions, or haircuts, on readily marketable securities deposited by customers that have account deficits. The proposal is consistent with the proposed amendments for computing haircuts on securities under § 1.32(b) in section II.N. above. The result of these amendments as discussed should be consistency between the methodologies applied in the 4d segregation calculation and the § 30.7 calculation. Consistent with proposed changes in § 1.20(i) and part 22, the Commission also proposed to add language to § 30.7(a) to provide that an FCM must hold residual interest in accounts set aside for the benefit of 30.7 customers equal to the sum of all margin deficits (i.e., undermargined amounts) for such accounts, to provide an equivalent clear mechanism for ensuring that the funds of one 30.7 customer are not margining or guaranteeing the positions of another 30.7 customer 2. Funds Held in Non-U.S. Depositories The Commission proposed to amend § 30.7(c) to limit the amount of 30.7 customers’ funds that an FCM could hold in non-U.S. jurisdictions. Under the proposal, an FCM must hold 30.7 customer funds in the U.S., except to the extent that the funds held outside of the U.S. are necessary to margin, guarantee, or secure (including any prefunding obligations) the foreign futures or foreign options positions of an FCM’s 30.7 customers. The proposal further allowed an FCM to deposit additional 30.7 customer funds outside of the U.S. up to a maximum of 10 percent of the total amount of funds required to be held by non-U.S. brokers or foreign clearing organizations for 30.7 customers as a cushion to meet anticipated margin requirements. The proposal also provided that the FCM must hold 30.7 customer funds under the laws and regulations of the foreign jurisdiction that provide the greatest degree of protection to such funds; and that the FCM may not by contract or otherwise waive any of the protections afforded customer funds under the laws of the foreign jurisdiction. Several comments were received on the proposal. Pilot Flying J supported the requirement that 30.7 customer funds, if held outside of the U.S., must be held under the laws of the foreign jurisdiction that provides the funds with the greatest degree of protection.567 FIA and Jefferies each recommended that an FCM be permitted to maintain an excess of up to 50 percent of the amount an FCM is required to deposit with a foreign broker to maintain customer foreign futures and foreign options positions, a position that they 565 The Commission recently adopted final regulations that revised the definitions in § 1.3. In this rulemaking, § 1.3(gg) was renumbered as 1.3(jjj) and re-designated ‘‘futures customer funds.’’ The substance of the definition, however, was not revised and the final rulemaking has no impact on the analysis in this rulemaking. See 77 FR 66288 (Nov. 2, 2012). 566 See section II.R.4. below for a discussion of the residual interest proposal. CFA stated that it generally supported the proposed amendments to § 30.7 and treating customers from all parts of the globe in a similar manner. CFA Comment Letter at 9 (Feb. 13, 2013). 567 Pilot Flying J Comment Letter at 2 (Feb. 14, 2013). PO 00000 Frm 00069 Fmt 4701 Sfmt 4700 With the exception of the residual interest proposal, the Commission did not receive any comments on the various proposed amendments discussed above, including its proposal to eliminate the ‘‘Alternative Method’’ and to require FCMs to use the ‘‘Net Liquidating Equity Method’’ to compute the amount of funds they must set aside in separate accounts for the benefit of its foreign futures or foreign options customers. Accordingly, the amendments referred to above, with the exception of the residual interest proposal as discussed further below, are being adopted by the Commission.566 E:\FR\FM\14NOR2.SGM 14NOR2 68574 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 stated is consistent with § 1.17 that requires an FCM to incur a capital charge for unsecured receivables due from a foreign broker greater than 150 percent of the amount required to maintain positions in accounts with the foreign broker.568 FIA recommended that, at a minimum, a cushion of 20 percent should be provided.569 FIA stated that the proposal is more restrictive than the provisions of § 1.49, which set out the terms and conditions pursuant to which an FCM may hold futures customers’ segregated funds and Cleared Swaps Collateral outside of the U.S. and suggested that the proposal be revised to permit an FCM to hold funds comprising the foreign futures and foreign options secured amount in depositories outside of the U.S. to the same extent that an FCM may hold futures customer segregated funds and Cleared Swaps Collateral outside of the U.S.570 They further recommended that the ‘‘10% limitation’’ apply only to funds deposited with a foreign broker or foreign clearing organization.571 RCG requested the Commission to clarify application of § 30.7(c) as it relates to banks located outside the U.S. that FCMs use for settlement purposes, and how the limitation applies to variation amounts.572 Jefferies stated that the proposed rule disadvantages customers who may no longer deposit ‘‘customer owned’’ securities and would instead have to prefund their obligations with cash.573 Advantage stated that FCMs typically must maintain a relationship with a foreign bank in order to meet cutoff times for payment of fees and clearing on foreign exchanges and that if an FCM can’t maintain funds at a foreign institution, it may inhibit its ability to trade foreign futures.574 The effect, they asserted, could be that U.S. FCMs will be required to use non-U.S. brokers that are not regulated by the Commission for their foreign futures business.575 They further requested that the Commission clarify how the prohibition on keeping non-margin foreign futures funds in an institution outside the U.S. would apply to § 30.7(b), which appears to allow such funds to be held at a bank or trust company outside the U.S.576 568 FIA Comment Letter at 37 (Feb. 15, 2013); Jefferies Bache Comment Letter at 6 (Feb. 15, 2013). 569 FIA Comment Letter at 37 (Feb. 15, 2013). 570 Id. See also RJ O’Brien Comment Letter at 11 (Feb.15, 2013). 571 FIA Comment Letter at 37 (Feb. 15, 2013). 572 RCG Comment Letter at 7 (Feb. 12, 2013). 573 Jefferies Bache Comment Letter at 6 (Feb. 15, 2013). 574 Advantage Letter at 8 (Feb. 15, 2013). 575 Id. at 9. 576 Id. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 In response to commenter concerns, the Commission is adopting the amendments generally as proposed, but the final rule will permit an FCM to post with depositories outside of the U.S. sufficient funds to cover the full margin obligations imposed by foreign brokers or foreign clearing organizations on the FCM’s 30.7 customers’ positions, plus an additional amount equal to 20 percent of the required margin on such positions. The Commission is increasing the amount of 30.7 customer funds that an FCM may hold in a foreign jurisdiction in response to the comments. The Commission is adopting this regulation to provide greater protection to both U.S. and foreign-domiciled customers in the event of the insolvency of the FCM. Recent experience has demonstrated that funds held outside of the U.S, at depositories subject to foreign insolvency regimes, present challenges and potential delays in the ability of the Trustee to return customer property to the customers of the FCM. In increasing the amount of funds an FCM may hold outside of the U.S. from 10 percent of the required margin to 20 percent of the required margin, the Commission is striving to strike a proper balance that would not interfere with the ability of 30.7 customers to trade on foreign markets (and the ability of FCMs to facilitate such transactions by allowing them to meet their 30.7 customers’ margin and other financial obligations to foreign brokers and clearing organizations), with the Commission’s desire to provide 30.7 customers with an appropriate level of protection in the event of the insolvency of an FCM. The Commission believes that, to the maximum extent commercially practicable, funds deposited by 30.7 customers that are not required to margin positions with foreign brokers or foreign clearing organizations should be held within in the U.S. to provide greater assurance that such funds would be subject to the bankruptcy provision of U.S. law and the Commission’s regulations under the jurisdiction of U.S. courts. The Commission further notes that the 20 percent limitation is based upon the amount of margin required on open positions. In response to RCG’s request for clarification, FCMs may transfer funds to foreign depositories to cover variation margin calls and exclude such funds from the calculation of the 20 percent ‘‘cushion.’’ In addition, the Commission notes that FCMs may deposit 30.7 customer funds with any of the foreign depositories listed under § 30.7(b), provided that the FCMs do not exceed the 20 percent limit on the PO 00000 Frm 00070 Fmt 4701 Sfmt 4700 amount of funds that are permitted to be held in foreign jurisdictions. The Commission believes that the ability to post variation margin in foreign jurisdictions and an additional 20 percent cushion should allow FCMs to conduct foreign futures activities on behalf of their customers, while also providing additional protections to the current regulatory regime. 3. Commingling of Positions in Foreign Futures and Foreign Options Accounts Commission staff previously issued an Advisory stating that while it was desirable for FCMs to hold only a customer’s foreign futures transactions (and the funds supporting such transactions) in such customer’s foreign futures account, this limitation was not mandatory and that the FCM could also hold such customer’s unregulated transactions (and the funds supporting such transactions) in the foreign futures accounts.577 Thus, pursuant to this Advisory, FCMs were permitted to commingle the funds supporting a customer’s foreign futures and options transactions with such customer’s unregulated transactions, including over-the-counter transactions. The Advisory was issued before the passage of Dodd-Frank, section 724(a) of which established in section 4d(f) of the CEA a segregation regime for the funds of cleared swaps customers, and the Commission’s promulgation of part 22, implementing that statute. In response to an FIA recommendation at a public roundtable held in advance of the Commission’s publication of the proposal, the Commission proposed to amend § 30.7 by adopting new paragraph (e) to prohibit an FCM from commingling funds from unregulated transactions with funds for foreign futures and options transactions in part 30 secured accounts, except as authorized by Commission order. The prohibition on holding unregulated transactions or other non-foreign futures or foreign option transactions in part 30 set aside accounts is consistent with the treatment applicable under section 4d(a)(2) of the Act for segregated accounts and section 4d(f) of the Act for Cleared Swaps Customers’ accounts. The Commission noted in the proposal that when part 30 was being adopted, commenters cited back office operational difficulties with establishing multiple ‘‘customer’’ account classes or origins.578 Given the technological changes during the intervening decades, and the new statutory and regulatory 577 CFTC 578 See E:\FR\FM\14NOR2.SGM Advisory No. 87–4 (Nov. 18, 1987). 52 FR 28980, 28985–28986. 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations framework, these concerns should no longer dictate the advisability of commingling the funds of regulated foreign futures and foreign options transactions with unregulated transactions. New § 30.7(e) extends the prohibition against commingling of customer funds currently found in section 4d(a)(2) futures customer accounts and section 4d(f) Cleared Swaps Customer Accounts to 30.7 customer accounts, except as otherwise permitted by Commission regulation or order. CIEBA stated that it supported the prohibition on the commingling of funds deposited by futures customers, Cleared Swaps Customers, and 30.7 customers.579 Nodal requested that the Commission make explicit in the adopting release that 30.7 accounts may continue to hold customer funds to margin contracts traded on a market that is pending designation as a contact market at the time the rules become effective, until such market is registered as a DCM or upon the withdrawal or denial of the DCM application.580 LCH.Clearnet noted that while it does not have a position on whether the Commission should prohibit commingling of 30.7 customer funds with the funds of futures customers and Cleared Swaps Customers, if adopted, it urged the Commission to preserve the ability to allow such commingling pursuant to a Commission rule or order.581 The Commission is adopting new § 30.7(e) as proposed. As it noted in the proposal, should there be a need to permit commingling of funds, the Commission will continue to have the ability to permit such commingling under the formalities of processes associated with a Commission order or rule pursuant to section 4d of the CEA. Absent such a rule or order, however, protection for such customer property would not be available under the Commission’s part 190 regulations or the Bankruptcy Code, and thus such commingling would not be permitted. In addition, the Commission does not agree with Nodal’s request that FCMs may continue to hold margin funds in 30.7 accounts for positions that are executed on markets that are pending approval as designed contract markets. As noted above, a purpose of § 30.7(e) is to enhance the protection of 30.7 customers by prohibiting the commingling of 30.7 customer funds with funds held by an FCM for 579 CIEBA Comment Letter at 4 (Feb. 20, 2013). Comment Letter at 1–2 (Jan. 21, 2013). 581 LCH.Clearnet Comment Letter at 6–7 (Jan. 25, 2013). 580 Nodal VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 unregulated transactions. Commingling of unregulated transactions with regulated transactions could also impede the resolution of 30.7 customer claims in the event of the insolvency of the FCM carrying the funds. 4. Further Harmonization With Treatment of Customer Segregated Funds The Commission proposed to adopt new paragraphs (f) and (k) in § 30.7, to extend regulatory provisions from §§ 1.20, 1.21, 1.22 and 1.24, that previously were applicable only to 4d segregated funds, to funds set aside as the foreign futures or foreign options secured amount under § 30.7. These proposed requirements would make clear that: (1) FCMs would not be permitted to use funds set aside as the foreign futures or foreign options secured amount other than for the benefit of 30.7 customers; (2) FCMs must hold sufficient residual interest in 30.7 accounts to make sure that 30.7 customer funds of one 30.7 customer are not used to margin, secure or guarantee the obligations of other customers; (3) funds set aside as the foreign futures or foreign options secured amount should not be invested in any obligations of clearing organizations or boards of trade; and (4) no funds placed at foreign brokers should be included as funds set aside as the foreign futures or foreign options secured amount unless those funds are on deposit to margin the foreign futures or foreign options positions of 30.7 customers. In addition to extending the existing Commission regulations noted above to § 30.7, the Commission also proposed a new requirement prohibiting an FCM from imposing any liens or allowing any liens to be imposed on funds set aside as the foreign futures or foreign options secured amount. This requirement parallels that currently applicable to cleared swap customers with respect to the segregation of Cleared Swaps Collateral.582 As discussed above, the Commission received several comments regarding the residual interest requirements set forth in the Proposal.583 While most of the commenters focused on the impact of the Proposed Residual Interest Requirement to the futures market, some of the more general comments would also apply to the foreign futures or foreign options market. Given the statutory prohibition in sections 4d(a) and 4d(f) of the Act against using one 582 See § 22.2(d)(2). sections II.G.9. and II.Q. above for discussion of the Proposed Residual Interest Requirement. 68575 customer’s funds to margin, secure or guarantee the obligations of another customer, FCMs that participate in the swaps and futures market may not ‘‘use’’ one customer’s property to margin another customer’s positions. Nonetheless, the Commission clarified that an FCM does not ‘‘use’’ a customer’s funds until the time of settlement.584 The Commission recognizes that the statutory prohibitions set forth in sections 4d(a) and 4d(f) of the Act apply to the futures and swaps markets. Conversely, as discussed above, the proposed changes to § 30.7 were intended to provide a more coordinated approach to the regulations governing foreign futures and foreign options, with standards that are consistent with those for the futures and swaps markets. These regulations, including regulations governing how an FCM holds funds for customers trading on non-U.S. markets, would greatly enhance the protection of customer funds and avoid regulatory arbitrage. Such consistency would, to the extent practicable and appropriate, contribute to the goal of having customer protection across futures, swaps and foreign futures markets be substantively similar. The Commission did not receive any comments opposing the concept of having consistent residual interest requirements across markets. The Commission did, however, receive comments regarding the additional complexities associated with trading foreign futures and foreign options.585 As such, the Commission is adopting residual interest requirements in part 30 that are substantively similar to the amended requirement in part 1, but with a modification as to the time by which an FCM must maintain such residual interests that will give FCMs the flexibility necessary to account for differences in the regulatory requirements and market practices applicable to foreign brokers and clearing organizations in other jurisdictions. Thus, the Commission is revising § 30.7(f) as follows. Regulation 30.7(f)(1)(i) sets forth the general requirement that an FCM may not use, or permit the use of, the funds of one 30.7 customer to purchase, margin or settle the trades, contracts, or commodity options of, or to secure or extend credit to, any person other than such 30.7 customer. Regulation 30.7(f)(1)(ii)(A) states that the undermargined amount for a 30.7 customer’s account is the amount, if any (i.e., the must be amount equal to or 583 See PO 00000 Frm 00071 Fmt 4701 Sfmt 4700 584 See 585 See E:\FR\FM\14NOR2.SGM section II.G.9. above. Roundtable Tr. at 266–267 (Feb. 5, 2013). 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68576 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations greater than zero), by which the total amount of collateral required for that 30.7 customer’s positions in that account at a specified time exceeds the value of the 30.7 customer funds in that account, as calculated in new § 30.7(f)(2)(ii). Regulation 30.7(f)(1)(ii)(B) requires FCMs to perform a residual interest buffer calculation, at the close of each business day, based on the information available to the FCM at that time, by calculating (1) the undermargined amounts, based on the clearing initial margin that will be required to be maintained by that FCM for its 30.7 customers, at each clearing organization of which the FCM is a member, at any settlement that will occur before 6:00 p.m. Eastern Time on the following business day for each such clearing organization less (2) any debit balances referred to in § 30.7(f)(2)(B)(iv) that is included in such undermargined amounts. In addition, and for the reasons set forth above, pursuant to § 30.7(f)(1)(ii)(C)(1) FCMs must maintain residual interest prior to 6:00 p.m. Eastern Time on the date referenced in § 30.7(f)(1)(ii)(B) in segregated funds that is equal to or exceeds the computation set forth in (ii)(B). Moreover, § 30.7(f)(1)(ii)(C)(2) provides that an FCM may reduce the amount of residual interest required in § 30.7(f)(1)(ii)(C)(1) to account for payments received from or on behalf of undermargined 30.7 customers (less the sum of any disbursements made to or on behalf of such customers) between the close of business the previous business day and 6:00 p.m. Eastern Time on the following business day. Regulation 30.7(f)(1)(ii)(D) provides that for purposes of § 30.7(f)(1)(ii)(B), an FCM should include, as clearing initial margin, customer initial margin that the FCM will be required to maintain, for that FCM’s 30.7 customers, at a foreign broker, and, for purposes of § 30.7(f)(1)(ii)(C), must do so by 6:00 p.m. Eastern Time. In other words, § 30.7(f)(1)(ii)(D) is intended to make clear that the requirements with respect to 30.7 customer funds that are used by an FCM that clears through a foreign broker are parallel to the requirements applied to 30.7 customer funds that are used when an FCM clears directly on a clearing organization. Finally, to provide greater clarity, the Commission is adding a new subparagraph (2) to paragraph (f), which sets out the requirements as to the FCM’s calculation of the Net Liquidating Equities of their 30.7 customers. Because of the addition of new subparagraph (2), the Commission is renumbering proposed § 30.7(f)(2) and VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 (f)(3) to § 30.7(f)(3) and (f)(4), and since the Commission did not receive any comments on the substantive provisions of these paragraphs, it is adopting them as proposed. The Commission did not receive any comments on the substantive provisions of proposed § 30.7(k) and is adopting this new paragraphs as proposed. MFA, however, requested confirmation that the Commission’s prior guidance with respect to a customer’s authority to grant liens or security interests on its own Cleared Swaps Customer Account under part 22 would also be applicable to customers on their foreign futures or foreign options secured amount under § 30.7.586 The Commission agrees with this position and hereby confirms the applicability of its prior guidance.587 5. Harmonization With Other Commission Proposals The Commission also proposed various other amendments to its part 30 regulations to harmonize the rules with those applicable to U.S. customers under other Commission regulations. As discussed in section II.I. above, the Commission is adopting in this release new limitations on withdrawals of segregated funds in § 1.23. The amendments provide for an FCM’s residual interest in segregated funds, and permit withdrawals from segregated funds for the proprietary use of the FCM to the extent of such residual interest, subject to the requirement that the withdrawal must not occur prior to the completion of the daily segregation computation for the prior day, and should the withdrawal (individually or aggregated with other withdrawals) exceed 25 percent of the prior day residual interest, the withdrawal must be subject to specific approvals by senior management and appropriately 586 MFA Comment Letter at 10 (Feb. 15, 2013). In the Final LSOC Release the Commission clarified: an FCM may not, under any circumstances, grant a lien to any person (other than to a DCO) on its Cleared Swaps Customer Account, or on the FCM’s residual interest in its Cleared Swaps Customer Account. On the other hand, a Cleared Swaps Customer may grant a lien on the Cleared Swaps Customer’s individual cleared swaps account (an ‘FCM customer account’) that is held and maintained at the Cleared Swaps Customer’s FCM. 77 FR at 6352. In addition, Commission Staff issued an interpretive letter that stated: Regulation 22.2(d) does not prohibit a Cleared Swaps Customer from granting security interests in, rights of setoff against, or other rights in its own Cleared Swaps Customer Collateral, regardless of whether those assets are held in the Cleared Swaps Customer’s FCM customer account. Furthermore, nothing in the rule is intended to inhibit this right of the Cleared Swaps Customer. CFTC Letter No. 12–28 at 2 (Oct. 17, 2012). 587 Specifically, PO 00000 Frm 00072 Fmt 4701 Sfmt 4700 documented, and further subject to a complete prohibition on withdrawals of residual interest to the extent necessary to maintain proper residual interest to cover undermargined amounts. The Commission proposed and is adopting paragraph (g) of § 30.7 to apply the same restrictions on withdrawals of an FCM’s residual interest in funds set aside as the foreign futures or foreign options secured amount. Current § 30.7(g) was recently adopted by the Commission to provide that the investment of § 30.7 funds be subject to the investment limitations contained in § 1.25.588 As proposed, the Commission is moving this permitted investment requirement to a new paragraph § 30.7(h), and further is adopting a new paragraph § 30.7(i) to make clear that FCMs are solely responsible for any losses resulting from the permitted investment of funds set aside as the foreign futures or foreign options secured amount. New paragraph § 30.7(i) is intended to apply the same standard as is being adopted in the amendment to § 1.29 for segregated funds discussed above. The Commission also proposed and is adopting an amended paragraph (j) to § 30.7 to clarify the circumstances under which an FCM may make secured loans to 30.7 customers and to adopt the same restriction on unsecured lending to 30.7 customers as has been adopted with respect to futures customers and 4d segregated funds in the amendment to § 1.30 discussed above. Finally, the Commission proposed and is adopting an amended paragraph (l) to § 30.7 to require the daily computation of the foreign futures or foreign options secured amount and the filing of such daily computation with the Commission and DSROs, as well as to require the FCM to provide investment detail of the foreign futures or foreign options secured amount as of the middle and end of the month. The amendments to paragraph (l) of § 30.7 are intended to be consistent with the requirements for the daily segregation calculation for segregated customer funds and the provision of the segregation investment detail which are adopted in § 1.32. No comments were received on the above proposals and the Commission is adopting the amendments as proposed. S. § 3.3: Chief Compliance Officer Annual Report Regulation 3.3 requires each FCM (as well as swap dealers and major swap participants) to designate an individual to serve as its CCO. The CCO is required 588 76 E:\FR\FM\14NOR2.SGM FR 78776, 78802 (December 19, 2011). 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations to be vested with the responsibility and authority to develop, in consultation with the FCM’s board of directors or senior officer, appropriate policies and procedures to fulfill the duties set forth in the Act and Commission regulations relating to the FCM’s activities as an FCM. Regulation 3.3(e) also requires the FCM’s CCO to prepare an annual compliance report that includes a description of any non-compliance events that occurred during the last reporting period along with the action taken to address such events. The annual compliance report currently is required to be filed electronically with the Commission simultaneously with the FCM’s certified annual financial report, and in no event later than 90 days after the firm’s fiscal year end. The Commission proposed a conforming amendment to § 3.3(f)(2) to reflect the amendments to § 1.10(b)(1)(ii), discussed in section II.A. above, that require an FCM to file its annual certified financial statements with the Commission within 60 days of the firm’s fiscal year end. In this regard, the Commission proposed to require that each FCM file the CCO annual report with the Commission simultaneously with the filing of the firm’s certified annual report, and in no event later than 60 days after the FCM’s fiscal year end. The NFA commented that it supported the proposal.589 No other comments were received. The Commission has determined to amend § 3.3 as proposed. TKELleY on DSK3SPTVN1PROD with RULES2 III. Compliance Dates The final regulations will be effective January 13, 2014. The compliance date for the regulations will be the effective date, subject to the following exceptions: A. Financial Reports of FCMs: § 1.10 An FCM that is not dually-registered as a BD currently is required to submit its certified annual report to the Commission within 90 days of the firm’s year end date. The Commission has amended § 1.10(b)(1)(ii) to require such certified annual report to be submitted within 60 days of the firm’s year end date. The Commission recognizes that many FCMs have contracted with public accountants to perform the current year’s audit examination, and that those audits are currently in process. In order to allow the current year audits to be completed, the Commission is setting a compliance date for § 1.10(b)(1)(ii) for FCMs with years ending after June 1, 589 NFA Comment Letter at 9 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 2014. This date will also coincide with several other compliance dates affecting public accountants discussed under § 1.16 below. B. Risk Management Program for FCMs: § 1.11 Section 1.11 requires each FCM that carries customer funds to establish a risk management program. RJ O’Brien requested that the Commission provide at least one year for FCMs to comply with the new risk management regulations in the event the proposed Risk Management Program is adopted. RJ O’Brien stated that the new requirements would likely necessitate a period of time for firms to reorganize, develop the policies and procedures, implement the policies and procedures, acquire adequate personnel, and conduct extensive training of new and existing employees. Advantage stated ‘‘that most aspects of proposed § 1.11 are appropriate and unlikely to be burdensome as FCMs typically have most (if not all) of these requirements in place.’’ 590 The Commission recognizes that some FCMs may need a sufficient period of time to develop and implement a risk management program that complies with § 1.11, but believes that many firms already maintain programs that comply with many of the requirements in § 1.11. Accordingly, FCMs must file their initial Risk Management Program within 180 days of the effective date of the regulation. The filings must be made via electronic transmission to the Commission using the WinJammer electronic filing system. C. Qualifications and Reports of Accountants: § 1.16 The Commission is amending § 1.16 to require a public accountant to meet certain qualification standards in order to be qualified to conduct audits of FCMs. The Commission is amending § 1.16(b) to require that the public accountant: (1) Must be registered with the PCAOB; (2) must have undergone a PCAOB inspection; and (3) may not be subject to a temporary or permanent bar to engage in the audit of public issuers or BDs as a result of a PCAOB disciplinary action. The Commission is further amending § 1.16(c) to require that the public accountant’s audit report must state whether the audit was conducted in accordance with PCAOB auditing standards. The Commission is establishing a compliance date of June 1, 2014 for the amendment to § 1.16(b)(1) that requires 590 Advantage Comment Letter at 2 (Feb. 15, 2013). PO 00000 Frm 00073 Fmt 4701 Sfmt 4700 68577 a public accountant to be registered with the PCAOB in order to conduct an audit of an FCM. The Commission also is establishing a compliance date of June 1, 2014 for the amendment to § 1.16(c) that requires a public accountant to conduct an audit of an FCM in accordance with the standards issued by the PCAOB. A compliance date of June 1, 2014 will allow current year audits to be completed without interruption, and provides sufficient time for public accountants that audit FCMs to register with the PCAOB if such public accountants are not already registered. In addition, a June 1, 2014 compliance date will align the Commission’s requirements for the use of PCAOB standards in the audit of an FCM with the SEC audit standards for public accountants auditing BDs.591 Without such alignment, public accounts of a dually-registered FCM/BD would have to issue two different audit reports; one audit report to the SEC for an examination conducted under PCAOB audit standards, and a second audit report for the Commission for an examination conducted under U.S. GAAS. The Commission also is establishing a compliance date of December 31, 2015 for the requirement in § 1.16 that a public accountant must have undergone an inspection by the PCAOB in order to qualify to conduct an audit of an FCM. The extension of the compliance date to December 31, 2015 will provide additional time for the PCAOB to conduct inspections of public accountants that registered with, but have not been inspected by, the PCAOB. Lastly, the compliance date for the amendment to § 1.16(b)(1) the provides that a public accountant may not be subject to a temporary or permanent bar to engaging in the audit of public issuers or BDs as a result of a PCAOB disciplinary action is the effective date of the amendment. The Commission believes that if a public accountant is registered with the PCAOB and is subject to a PCAOB disciplinary action that temporarily or permanently bars the public accountant from auditing public issuers, the public accountant is not qualified to conduct audits of FCMs. D. Minimum Financial Requirements for FCMs The Commission is amending the capital rule to require an FCM to incur a capital charge for undermargined 591 The SEC recently amended its regulations to require public accountants to conduct audits of BDs pursuant to the audit standards issued by the PCAOB. This requirement is effective for audits of BDs with a year-end of June 1, 2014 or later. See 78 FR 51910 (Aug. 21, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 68578 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations customer, noncustomer, and omnibus accounts that are undermargined more than one business day after a margin call is issued by the FCM. For example, if an account is undermargined on Monday and the FCM issues a margin call on Tuesday, the FCM would have to take a reduction to capital equal to the amount of the margin call that was not met by close of business Wednesday. The Commission is establishing a compliance date for the revised timeframe for the capital charges required by § 1.17(c)(5)(viii) and (ix) of one year following publication of this rule in the Federal Register. The compliance date provides FCMs with a period of time that the Commission believes is sufficient to adjust its systems for issuing and collecting margin from customers and provides customers with an opportunity to adjust their operations, as necessary, to meet its margin obligations on a reduced timeframe for the current regulation. E. Written Acknowledgment Letters: §§ 1.20, 1.26, and 30.7 The Commission is amending §§ 1.20(d) and (g), 1.26(b), and 30.7(d) to require FCMs and DCOs, as applicable, to obtain standard form acknowledgment letters from each depository that the FCMs or DCOs use to hold customer funds.592 The Commission is further requiring FCMs and DCOs to use Template Letters set forth in appendices to the regulations. The Commission is establishing a compliance date of 180 days after the effective date of the regulations in order to provide FCMs and DCOs with sufficient time to obtain from depositories new acknowledgment letters that conform to the Template Letters. F. Undermargined Amounts: §§ 1.22(c), 30.7(f) TKELleY on DSK3SPTVN1PROD with RULES2 The Commission received several comments on the appropriate timing for the effectiveness of the Proposed Residual Interest Requirement. At the public roundtable held on February 5, 2013, several panelists argued that the Proposed Residual Interest Requirement would require substantial time to implement in order to change the behavior of all futures markets 592 The regulations, however, provide that an FCM is not required to obtain an acknowledgment letter from a DCO if the DCO maintains rules that have been submitted to the Commission and that provide for the segregation of customer funds in accordance with all relevant provisions of the Act and Commission regulations or orders. See §§ 1.20(d)(1) and 30.7(d)(1). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 participants.593 In addition, FIA asserted that implementation would require multiple years and ‘‘radical’’ changes to processing procedures for futures market participants,594 and RCG requested that the Commission provide ‘‘with a period of time not less than one year from the promulgation of the relevant final rules for FCMs to implement them.’’ 595 As discussed above, the residual interest requirements set forth in part 22 are the requirements that are currently in place today. As such, FCMs are expected to continue meeting their regulatory requirements. With respect to the residual interest requirements set forth in §§ 1.22(c) and 30.7(f), the Commission recognizes that these requirements represent a significant change in current market practice. Given the costs associated with compliance with these requirements, as well as comments received from the interested parties requesting sufficient time to achieving compliance with these requirements, the Commission has determined that a phased compliance schedule for § 1.22(c) is necessary and appropriate. The phased compliance schedule for § 1.22(c) is set forth in § 1.22(c)(5)(iii). However, the Residual Interest Deadline of 6:00 p.m. Eastern Time in § 1.22(c)(5)(ii) shall begin one year following the publication of this rule in the Federal Register.596 With regards to the residual interest requirements set forth in § 30.7(f), the Commission is establishing a compliance date of one year following the publication of this rule in the Federal Register. G. SRO Minimum Financial Surveillance: § 1.52 The Commission amended § 1.52 to require each SRO to establish a supervisory program to oversee their member FCMs’ compliance with SRO and Commission minimum capital and related reporting requirements, the obligation to properly segregated customer funds, risk management requirements, financial reporting requirements, and sales practices and other compliance requirements. The Commission also amended § 1.52(c) to require each SRO to engage an ‘‘examinations expert’’ at least once every three years to evaluate the quality of the supervisory oversight program and the SRO’s application of the 593 See Roundtable Tr. at 252–255, 257, 266–267 (Feb. 5, 2013). 594 See FIA Comment Letter at 21 (Feb. 15, 2013). 595 See RCG Comment Letter at 8 (Feb. 12, 2013). 596 For further discussion regarding the phase-in schedule for the requirements in § 1.22(c), see section II.G.9. PO 00000 Frm 00074 Fmt 4701 Sfmt 4700 supervisory program. The SRO must obtain a written report from the examinations expert with an opinion on whether the supervisory program is reasonably likely to identify a material weakness in internal controls over financial and/or regulatory reporting, and in any of the other areas that are subject to the supervisory program. The Commission established a compliance date in amended § 1.52(e) that requires each SRO to submit a supervisory program to the Commission for review, together with the examinations expert’s report on the supervisory program, within 180 days of the effective date of the amendments to § 1.52, or such other time as may be approved by the Commission. The Commission further revised § 140.91(10) to delegate the authority to extend the time period for the submission of the initial supervisory program to the Director of the Division of Swap Dealer and Intermediary Oversight and the Director Division of Clearing and Risk, with the concurrence of the General Counsel or, in his or her absence, a Deputy General Counsel.597 Commission staff will consult with the SROs to assess their progress in preparing an initial supervisory program, including the examinations expert’s review, and may adjust compliance dates as appropriate. H. Public Disclosures by FCMs: § 1.55 The Commission has amended § 1.55(b) by revising the Risk Disclosure Statement to include several additional disclosures intended to provide customers and potential customers with enhanced information to further their understanding of the risks of engaging in the futures markets. The Commission recognizes that FCMs will be required to revise the Risk Disclosure Statement to implement the revisions, and is establishing a compliance date for the amendments to 1.52(b) of 90 days after the effective date of the amendments. The Commission believes that this provides sufficient time for FCMs to revise the Risk Disclosure Statement and to modify their systems, if necessary, in the case of firms that 597 The Commission also amended § 1.52(d)(2)(ii)(H) to provide that a Joint Audit Committee must submit an initial Joint Audit Program to the Commission, along with an examinations expert’s report on the Joint Audit Program, within 180 days of the effective date of the regulation. The Director of the Division of Swap Dealer and Intermediary Oversight and the Director of the Division of Clearing and Risk also are authorized under § 1.52(d)(2)(ii)(H) an § 140.91(10), with the concurrence of the General Counsel or, in his or her absence, a Deputy General Counsel, to extend the initial filing deadline if warranted. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations provide electronic account opening documents. The Commission also amended § 1.55(i)–(k) to require each FCM to disclose to customers all information that would be material to the customers’ decision to entrust funds to, or otherwise do business with, the FMC, including its business, operations, risk profile, and affiliates. The Commission is establishing a compliance date of 180 days after the effective date of the regulation to provide adequate time for FCMs to develop the required disclosures and make them available to the public. The Commission also amended § 1.55(o) to require each FCM to disclose on its Web site certain current and historical information regarding its holding of customer funds, and its certified annual report. The Commission is establishing a compliance date of 180 days after the effective date of the regulation to provide FCMs with sufficient time to modify electronic systems, and make any additional operational changes, necessary for the firms to comply with the requirements. TKELleY on DSK3SPTVN1PROD with RULES2 IV. Cost Benefit Considerations Statutory Mandate To Consider the Costs and Benefits of the Commission’s Action: Commodity Exchange Act Section 15(a) Section 15(a) of the Act requires the Commission to consider the costs and benefits of its actions before promulgating a regulation under the Act or issuing certain orders. Section 15(a) further specifies that the costs and benefits shall be evaluated in light of the following five broad areas of market and public concern: (1) Protection of market participants and the public; (2) efficiency, competitiveness and the financial integrity of futures markets; (3) price discovery; (4) sound risk management practices; and (5) other public interest considerations. The Commission considers the costs and benefits resulting from its discretionary determinations with respect to the section 15(a) considerations. In the NPRM, the Commission established, based on the subject matter of the proposals, that it did not consider any of the proposals contained therein to have any significant impact on price discovery. The Commission received no responses from commenters with respect to its analysis regarding price discovery. For the remaining areas, the Commission addressed, section by section, the qualitative substantial benefits perceived to be obtained from the regulatory proposals contained in the NPRM. Where reasonably possible, VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 the Commission has estimated costs quantitatively associated with such proposals section by section. The Commission asked specifically and generally for comments with respect to its analysis of benefits and such cost estimates, and requested information from commenters where the Commission qualitatively considered but could not reasonably quantitatively estimate costs. The underlying purpose of the regulations adopted herein as stated in the NPRM was to bolster the protection of customers and customer funds, in response to the misuse or mishandling of customer funds at specific FCMs like MFGI or PFGI. Further, the purpose of certain proposals was to provide regulators the means by which to detect and deter the misuse or mishandling of customer funds by FCMs, including bolstering standards for the examination and oversight of FCMs by SROs and public accountants. In addition to the significant benefits to the protection of market participants and the public, the Commission determined that a strong package of reforms, including enhanced information and disclosures available to customers, adopted in light of the recent FCM failures resulting in and from misuse of customer funds, would be extremely beneficial to restore trust in the financial integrity of futures markets. The Commission also included certain proposals intended to both increase the protection of customer funds and strengthen FCM risk management, specific to customer funds processes and procedures. As stated in the NPRM, a loss of trust in the financial integrity of futures markets could deter market participants from the benefits of using regulated, transparent markets and clearing. The overarching purpose of the reforms contained in this rulemaking is to produce the benefits that accrue by virtue of avoiding similar defaults in the future. This prevents the costs certain to follow, including lost customer funds, decreased market liquidity that follows from a crisis in confidence, and the potential for the failure of one FCM to cause losses in other clearing members.598 In this rulemaking, the Commission adopted new rules and amended existing rules to improve the protection of customer funds. The content of the Commission’s adopted new rules and amended rules can be categorized in 598 The failure of one clearing member could lead to losses for other clearing members if the losses due to the first member’s failure are large enough to exhaust the guarantee fund and require additional capital infusion from other clearing members. PO 00000 Frm 00075 Fmt 4701 Sfmt 4700 68579 seven parts: (1) requiring FCMs to implement extensive risk management programs including written policies and procedures related to various aspects of their handling of customer funds; (2) increasing reporting requirements for FCMs related to segregated customer funds, including daily reports to the Commission and DSRO; (3) requiring FCMs to establish target amounts of residual interest to be maintained in segregated accounts as well as creating restrictions and increased oversight for FCM withdrawals out of such residual interest in customer segregated accounts, specifically including clear sign off and accountability from senior management for such withdrawals; (4) strengthening requirements for the acknowledgment letters that FCMs and DCOs must obtain from their depositories; (5) eliminating the Alternative Method for calculating 30.7 customer funds segregation requirements and requiring FCMs to include foreign investors’ funds in segregated accounts; (6) strengthening the regulatory requirements applicable to SRO and DSRO oversight of FCMs, including regulating oversight provided under the function of a Joint Audit Committee that would establish standards for, and oversee the execution of, FCM audits; and (7) requiring FCMs to provide additional disclosures to investors. Overview of the Costs and Benefits of the Proposed Rules and Amendments in Light of the 15(a) Considerations— Protection of Market Participants and the Public The Commission designed the adopted reforms to improve the protection of customer funds. The Commission expects each of the seven categories identified above to significantly increase the levels of protection for customer funds. Requiring FCMs to implement risk management programs that include documented policies and procedures regarding various aspects of handling customer funds helps to protect customer funds by promoting robust internal risk controls and reducing the likelihood of errors or fraud that could jeopardize customer funds. In addition, by requiring each FCM to document certain policies and procedures, the rules enable the Commission, DSROs, and other auditors to evaluate each FCM’s compliance with their own policies and procedures. Moreover, the requirement that FCMs establish a program for quarterly audits by independent or external people that is designed to identify any breach of the policies and procedures helps to ensure E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68580 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations regular, independent validation that the procedures are followed diligently. Audits of this sort provide more thorough review of internal procedures than the Commission or DSROs are able to perform regularly with existing resources, which provides helpful scrutiny of each FCM’s procedures on a regular basis. This, together with the requirement that FCMs establish a program of governing supervision that is designed to ensure the policies required in § 1.11 are followed, will tend to promote compliance with the FCM’s own policies and procedures. And by promoting such compliance, the requirements reduce the risk of operational errors, lax risk management, and fraud, and thus the risk of consequent loss of customer funds. Increasing reporting requirements for FCMs related to segregated customer funds helps the Commission and DSRO identify FCMs that should be monitored more closely in order to safeguard customer funds. Moreover, by making some additional reported information public, the rules facilitate additional market discipline that further promotes protection of customer funds. Creating restrictions and increased oversight for FCM withdrawals out of its residual interest in customer segregated accounts, and requiring review by senior management for large withdrawals protects customers by helping to ensure that such withdrawals do not cause segregated account balances to drop below required amounts, which are, in turn, designed to prevent losses of customer funds. Moreover, requiring personal accountability by senior management for withdrawals that affect the balance of such accounts promotes more effective oversight of customer segregated accounts. The acknowledgments and commitments depositories are required to make through §§ 1.20, 1.26, and 30.7 provide additional protection for customer funds by, among other things, requiring depositories that accept customer funds to acknowledge that customer funds cannot be used to secure the FCM’s obligations to the depository. Such an acknowledgment provides additional protection of customer funds and fosters prompt transfer in the event of an FCM’s default. In addition, depositories must agree in the acknowledgment letter to give the Commission and DSROs read-only electronic access to an FCM’s segregated accounts, which benefits customers by enabling the Commission and DSROs to review the accounts for discrepancies between the FCM’s reports and the balances on deposit at various VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 depositories. These enhancements to oversight provide an additional mechanism by which customers would be protected against a shortfall in customer funds due to operational errors or fraud. Requiring FCMs to include foreigndomiciled customers’ funds in segregated accounts benefits all customers placing funds on deposit for use in trading foreign futures and foreign options. Because neither the Bankruptcy Code nor the Commission’s part 190 regulations distinguish between foreign-domiciled and U.S. domiciled customers at the point customer funds are distributed, any shortfall in available funds would be shared among all such customers. As discussed below, the Commission understands that most, if not all, FCMs currently compute secured amount requirements for both U.S.-domiciled and foreign-domiciled customers. However, incorporating foreigndomiciled customers within the calculations required for 30.7 customers ensures that both groups are fully protected. Similarly, eliminating the Alternative Method provides additional protection to customer funds by ensuring that FCMs are not allowed to reduce their segregation requirements for 30.7 accounts during a time of financial strain. As discussed below, this change provides protection to both U.S-domiciled and foreign-domiciled customers with funds in 30.7 accounts. The provisions in § 1.52 include additional requirements for both the supervisory program for SROs as well as for the formation of a Joint Audit Committee to oversee the implementation and operation of a Joint Audit Program that directs audits of FCMs by DSROs. By requiring both the SRO supervisory programs and the Joint Audit Program to comply with U.S. generally accepted audit standards, to develop written policies and procedures, to require controls testing as well as substantive testing, and to have an examinations expert review the programs at least once every two years, the amendments help to ensure that audits of FCMs by SROs or DSROs are thorough, effective, and continue to incorporate emerging best practices for such audits. As a consequence, the amendments help to ensure that audits are as effective as possible at identifying potential fraud, strengthening internal controls, and verifying the integrity of FCMs’ financial reports, each of which tend to provide protection for FCMs’ customers, counterparties, and investors. In addition § 1.55 requires disclosure of firm-specific risks to customers. This PO 00000 Frm 00076 Fmt 4701 Sfmt 4700 additional information should be helpful to customers when selecting an FCM to deposit their funds. In doing so, the rules promote market discipline that incents FCMs to manage their risks carefully and assists customers in understanding how their funds are held and what risks may be relevant to the safety of their funds. Last, FCMs maintaining residual interest in customer accounts is an important aspect of protection for customer funds. While an FCM’s residual interest is not exhausted, it may be used to meet the FCM’s obligations to each customer without using another customer’s funds to do so. All else being equal, the larger the residual interest, the less likely that market participants will lose customer funds posted as collateral, with associated detriment to members of the public with interests in such market participants. Efficiency, Competitiveness and Financial Integrity of Futures Markets The proposed amendments should increase the efficiency and financial integrity of the futures markets by ensuring that FCMs have strong risk management controls that are subject to multiple and enhanced external checks, by enhancing reporting requirements, facilitating increased oversight by the Commission and DSROs, by allowing FCMs flexibility in the development of newly required policies and procedures wherever the Commission has determined that such flexibility is appropriate, and by requiring FCMs to implement training regarding the handling of customer funds. In addition, the rules include some requirements that many industry participants have requested as necessary for the adequate protection of customers and also highlighted as best practices already adopted within the industry. Requiring such standards to be adopted by all FCMs promotes the competitiveness of futures markets by preventing an FCM from skimping on customer protection safeguards. There are also provisions in the proposal that permit FCMs that are not BDs to implement certain securities net capital haircuts that apply to jointly registered FCM/BDs by the SEC. This enhances competition between FCMs that are not dually registered and jointly registered FCM/BDs with respect to such requirements. Smaller FCMs may have more difficulty than large FCMs in absorbing the additional costs created by the requirements of the rules (particularly § 1.22). It is possible that some smaller FCMs may elect to stop operating as FCMs as a result of these costs. The Commission does not anticipate, E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations however, that the rules will have a material effect on FCM pricing due to reduced competition (although the increased costs may affect pricing). More specifically, the amendments to §§ 1.10, 1.11, 1.12, 1.32, 22.2, and 30.7 increase reporting requirements for FCMs related to segregated customer funds, including daily, bi-monthly, and additional event-triggered reports to the Commission and DSROs. The expanded range and frequency of information that the Commission and DSRO receive under the proposed regulations enhances their ability to monitor each FCM’s segregated accounts, which promotes the integrity of futures markets by helping to ensure proper handling of customer funds at FCMs. In addition, the changes facilitate increased oversight by the Commission and DSROs by including additional notification requirements, obligating FCMs to alert the Commission when certain events occur that could indicate an FCM’s financial strength is deteriorating or that important operational errors have occurred. Such notifications should enable the Commission and DSROs to increase monitoring of such FCMs to ensure that customer funds are handled properly in such circumstances. The rules also require FCMs to obtain an acknowledgment letter from depositories that should give the Commission and DSROs electronic access to view customer accounts at each depository when requested by the Commission. That should enable both the Commission and DSROs to verify the presence of customer funds which would provide a safeguard against fraud and would promote the integrity of markets for futures, cleared options, and cleared swaps. The rules also require FCMs to establish policies and procedures regarding several aspects of how they handle customer funds. The rules should give FCMs the flexibility, where appropriate, to develop policies and procedures tailored to the unique composition of their customer base, size, and other operational disincentives. This flexible approach protects FCMs from additional regulatory compliance costs that could otherwise result from rules requiring every FCM to operate in exactly the same way without sacrificing the additional accountability that results from written policies and procedures that the Commission or DSRO can review and use as the basis for FCM audits. The requirement that FCMs provide annual training to all finance, treasury, operations, regulatory, compliance, VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 settlement and other relevant employees regarding the segregation requirements for segregated funds, for notices under § 1.12, procedures for reporting noncompliance, and the consequences of failing to comply with requirements for segregated funds, should enhance the integrity of the futures markets by promoting a culture of compliance by the FCM’s personnel. The training should help to ensure that FCM employees understand the relevant policies and procedures, that they are empowered and incented to abide by them, and that they know how to report non-compliance to appropriate authorities. The rules allow FCMs that are not dual registrants (i.e., are not both FCMs and BDs) to follow the same procedures as dual registrants when determining what regulatory capital haircut applies to certain types of securities in which the FCM invests its own capital or customer funds. This change is needed as the SEC has proposed a change for BDs which would permit joint registrants to possibly apply a lower regulatory haircut for certain securities, but which would not be applicable to FCMs that are not dual registrants without this rule. Therefore, the rule should help to ensure that FCMs that are not dual registrants are not competitively disadvantaged and are able to continue applying the same regulatory capital haircuts for such securities as joint registrants. Last, residual interest is an important aspect of protection for customer funds because it enables the FCM to ensure that it can meet its obligations to each customer without using another customer’s funds to do so. All else being equal, the larger the residual interest, the more secure are customer funds. This contributes to confidence in U.S. futures markets and their financial integrity. Adequate residual interest improves the competition between FCMs, inasmuch as FCMs are competing less by transferring risks from customers with deficit funds to customers with surplus funds. Sound Risk Management The amendments should promote sound risk management by facilitating market discipline, enhancing internal controls, enabling the Commission and DSROs to monitor FCMs for compliance with those controls, by reducing the risk that an FCM’s financial strain could interfere with customers’ ability to manage their positions, by requiring FCMs to notify the Commission in additional circumstances that could indicate emerging financial strain, and by requiring senior management to be PO 00000 Frm 00077 Fmt 4701 Sfmt 4700 68581 involved in the process of setting targets for residual interest. The reporting requirements should enhance market discipline by providing additional information to investors regarding the location of their funds, and the size of residual interest buffer that an FCM targets and maintains in its segregated accounts. This additional information should be valuable to customers selecting an FCM and monitoring the location of their funds deposited with the FCM which should promote market discipline. For example, if an FCM were to establish a low target for residual interest, or maintain a very low residual interest, then market participants are likely to recognize this as a practice that could increase risk to the funds they have on deposit at the FCM. Consequently, customers would likely either apply pressure to the FCM to raise their target, or take their business to a different FCM that maintains a larger residual interest in customer fund accounts. This market discipline should incent FCMs to maintain a level of residual interest that is adequate to ensure that a shortfall does not develop in the customer segregated accounts. The rules should also enhance FCM internal controls by requiring them to establish a risk management program that includes policies and procedures related to various aspects of how segregated customer funds are handled. For example, FCMs are required to establish procedures for continual monitoring of depositories where segregated customer funds are held, and should have to establish a process for evaluating the marketability, liquidity, and accuracy of pricing for § 1.25 compliant investments. In addition, documented policies and procedures should benefit the FCM customers and the public by providing the Commission and DSROs greater ability to monitor and enforce procedures that FCMs perform to ensure that the protection of customer funds is achieved, with the effect that the Commission should have a greater ability to address and protect against operational errors and fraud that put customer funds at risk of loss. Further, through the amendments to § 1.17(a)(4), FCMs will need to manage their access to liquidity so as to be able to certify to the Commission, at its request, that they have sufficient access to liquidity to continue operating as a going concern. This rule should provide the Commission with the flexibility to deal with emerging liquidity drains at FCM s which may endanger customers, potentially prior to instances of regulatory capital non-compliance, E:\FR\FM\14NOR2.SGM 14NOR2 68582 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 allowing customer positions and funds to be transferred intact and quickly to another FCM. This change should promote sound risk management practices by helping to ensure that customers maintain control of their positions without interruption. The proposed additions to notification requirements established in § 1.12 should enhance the Commission’s ability to identify situations that could lead to financial strain for the FCM, which makes it possible for the Commission to monitor further developments with that FCM more carefully and to begin planning earlier for the possibility that the FCM’s customer positions may need to be transferred to other FCMs, in the event that the FCM currently holding those positions defaults. Advance notice helps to ensure customers’ positions are protected by enabling the Commission to work closely with DCOs and DSROs to identify other FCMs that have requisite capital to meet regulatory requirements if they were to take on additional customer positions, thus facilitating smooth transition of those positions in the event that it is necessary. Last, FCMs maintaining residual interest in customer accounts is an important aspect of protection for customer funds. While an FCM’s residual interest is not exhausted, it may be used to meet the FCM’s obligations to each customer without using another customer’s funds to do so. All else being equal, the larger the residual interest, the more secure are customer funds. Moreover, these requirements will create incentives for FCMs to monitor their customers’ undermargined amounts, thereby enhancing the FCM’s risk management. By requiring that senior management set the target for residual interest, and that they conduct adequate due diligence in order to inform that decision, the rule promotes both informed decision making about this important form of protection, and accountability among senior management for this decision, both of which are consistent with sound risk management practices. Other Public Interest Considerations As discussed above, the recent failures of MFGI and PFGI, FCMs to which customers have entrusted their funds, sparked a crisis of confidence regarding the security of those funds. This crisis in confidence could deter market participants from using regulated, transparent markets and clearing which would create additional costs for market participants and losses in efficiency and safety that could create VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 additional burdens for the public. The Commission hopes that this rule will not only address the current crisis of confidence, but that it will produce benefits for the public by virtue of avoiding similar defaults in the future. These amendments are not, however, without costs. First, the most significant costs created by the amendments are those that result from the increased amount of capital that FCMs are required to hold in segregated accounts as part of establishing a target for their residual interest and requiring residual interest for undermargined amounts. Second, additional costs may be created by the amendments that incent FCMs to hold additional capital, and prevent them from holding excess segregated funds overseas. Third, operational costs are likely to arise from amendments that result in the formation of a risk management unit and adoption of new policies and procedures. Multiple rule changes are expect to incent or require FCMs to increase the amount of residual interest that they maintain in segregated accounts including: (1) Requiring FCMs to establish a target for residual interest that reflects proper due diligence on the part of senior management; (2) disclosing the FCMs’ targeted residual interest publicly; (3) requiring them to report to the Commission and their DSROs any time their residual interest drops below that target, and (4) requiring FCMs to hold residual interest large enough to cover their customers’ undermargined amounts. In addition by restricting FCMs’ ability to withdraw residual interest from segregated accounts and obligating FCMs to report to the Commission and their respective DSRO each time the residual interest drops below the target, the regulations should incent FCMs to hold additional capital, which is also likely to be a significant cost. When FCMs hold excess customer funds overseas, such funds will likely be held at depositories that are themselves subject to foreign insolvency regimes. These regimes may provide less effective protections for customer funds than those applicable under U.S. law. By prohibiting FCMs from holding some excess customer funds overseas, and thereby reducing investment opportunities for customer funds, the regulations may reduce the returns that FCMs can obtain on invested customer funds. And last, the requirements related to operational procedures are likely to create significant costs, particularly related to creating and documenting policies and procedures, as well as complying with ongoing training, due PO 00000 Frm 00078 Fmt 4701 Sfmt 4700 diligence, and audit requirements. However, in several cases the implementation costs of the changes should be minor. For example, some proposed requirements should obligate FCMs to provide the Commission and DSROs more regular access to information that FCMs and their depositories are already required to maintain, or in some cases are already reporting to their DSROs. The Commission also anticipates that some of the changes proposed codify best practices for risk management that many FCMs and DCOs may already follow. In such cases, the costs of compliance would be mitigated by the compliance programs or best practices that the firm already has in place. Moreover, in other cases the changes codify practices that are already required by SROs, and therefore would impose no additional costs. The initial and ongoing costs of the rules for FCMs should vary significantly depending on the size of each FCM, the policies and procedures that they already have in place, and the frequency with which they experience certain events that would create additional costs under the rules. In the NPRM, the Commission estimated that the initial operational cost 599 of implementing the rules would be between $193,000 and $1,850,000 per FCM.600 And the initial cost to the SROs and DSROs would be between $41,100 and $63,500 per SRO or DSRO. The Commission estimated 599 The Commission was not able to quantify the costs that would result from increased residual interest held in customer segregated accounts, from increased capital held by the FCM, or from lost investment opportunities due to restrictions on the amount of funds that may be held overseas. The Commission did not have sufficient data to estimate the amount of additional residual interest FCMs are likely to need as a consequence of proposed, the amount of additional capital they may hold for operational purposes, the cost of capital for FCMs, or the opportunity costs FCMs may experience because of restrictions on the amount of customer funds they can hold overseas, each of which would be necessary in order to estimate such costs. 600 The lower bound assumes an FCM requires the minimum estimated number of personnel hours to be compliant with these new rules and that, when possible, they already have policies, procedures, and systems in place that would satisfy the proposed requirements. The upper bound assumes an FCM requires the maximum amount of personnel hours and do not have pre-existing policies, procedures, and systems in place that would satisfy the proposed requirements. The greatest amount of variation within in the range would depend on the number of new depositories an FCM must establish relationships with due to current depositories that would not be willing to sign the required acknowledgment letter. The lower bound assumes that an FCM does not need to establish any new relationships with depositories. The Commission estimates that the largest FCMs may have as many as 30 depositories, and as a conservative estimate, the Commission assumes for the upper bound that an FCM would have to establish new relationships with 15 depositories. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations that the ongoing operational cost to FCMs would be between $287,000 and $2,300,000 per FCM per year.601 As described below in § 1.52, the Commission did not have adequate information to determine the ongoing cost of the proposed requirements for SROs and DSROs. On a minor note, the rules also harmonize the definition of leverage ratio reporting with the definition established by a registered futures association. In the sections that follow, the Commission provides its analysis of cost benefit considerations including comments received, section by section, in light of the relevant 15(a) public interest, cost-benefit considerations. Consideration of Costs and Benefits Section by Section Section 1.3(rr)—Definition of ‘‘Foreign Futures or Foreign Options Secured Amount’’ TKELleY on DSK3SPTVN1PROD with RULES2 The Commission adopted an amendment to § 1.3(rr) replacing the term ‘‘foreign futures or foreign options customers’’ with the term ‘‘30.7 customers.’’ The former only included U.S.-domiciled customers, whereas the term ‘‘30.7 customers’’ includes both U.S.-domiciled and foreign-domiciled customers who place funds in the care of an FCM for trading on foreign boards of trade. This change expanded the range of funds that the FCM must include as part of the foreign futures or foreign options secured amount. In addition, the definition of ‘‘foreign futures or foreign options secured amount’’ was amended so that it is equal to the amount of funds an FCM needs in order to satisfy the full account balances of each of its 30.7 customers at all times. This definitional change is necessary to implement the conversion in § 30.7 from the ‘‘Alternative Method’’ to the ‘‘Net Liquidating Equity Method’’ of calculating the foreign futures or foreign options secured amount. 601 As above, the lower bound assumes that an FCM requires the minimum estimated number of personnel hours to be compliant and that for eventtriggered costs, the FCM bears the minimum number of possible events. The upper bound assumes an FCM requires the maximum number of personnel hours to be compliant. It also assumes an FCM has to notify the Commission pursuant to the proposed amendments in § 1.12 five times per year, and that an FCM withdraws funds from residual interest for proprietary use 50 times per year. The estimate does not include additional costs that would result if FCMs increase the amount of residual interest or capital that they hold in response to the proposed rules, or certain operational costs that the Commission does not have sufficient information to estimate. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 Costs and Benefits These definitional changes determine how much funds are considered part of the ‘‘foreign futures or foreign options secured amount.’’ However, the costs and benefits of these changes are attributable to the substantive requirements related to the definitions and, therefore, are analyzed with respect to changes adopted to § 30.7 and discussed below. Section 1.10—Financial Reports of Futures Commission Merchants and Introducing Brokers The Commission adopted amendments to § 1.10 revising the Form 1–FR–FCM by establishing a new schedule called the ‘‘Cleared Swap Segregation Schedule’’ that is included in the FCM’s monthly report, together with the Segregation Schedule and Secured Amount Schedule. The amendments also provide that the Cleared Swap Segregation Schedule is a public document.602 The Commission also amended the Segregation Schedule and the Secured Amount Schedule to include reporting of the FCM’s target for residual interest in the accounts relevant to that Schedule, as well as a calculation of any surplus or deficit in residual interest with respect to that target. The Commission also required each FCM to report to the Commission monthly leverage information. Costs and Benefits In the NPRM, the Commission considered the amendments to § 1.10 to have significant benefits to the protection of market participants, namely, customers. The Commission anticipated that continuing the public availability of the Segregation Schedule and the Secured Amount Schedule, with the addition of the Cleared Swaps Segregation Schedule, would be beneficial to customers in assessing the financial condition of the FCMs with whom they choose to transact. The Commission posited that FCMs would have competing incentives to set higher or lower targeted residual amounts, but that public disclosure would enhance the quality of the assessment of a reasonable targeted amount of residual interest. The Commission stated that providing publicly the additional information would permit customers to weigh this consideration, along with considerations of price, in selecting an FCM, benefiting the protection of market participants. The Commission also stated that requiring FCMs to report their leverage to the Commission on a 602 The Segregation Schedule and Secured Amount Schedule are already public documents. PO 00000 Frm 00079 Fmt 4701 Sfmt 4700 68583 monthly basis would assist the Commission in monitoring each FCM’s overall risk profile, which would help the Commission to identify FCMs that should be monitored more closely for further developments that could weaken their financial position, enhancing the protection of market participants. The Commission could not quantitatively estimate the cost of FCMs having an incentive by public disclosure to hold higher targeted residual amounts in customer segregated accounts. The Commission did consider that qualitatively it expected that costs would be incurred as a result, as a return available to FCMs on restricted investments permissible under § 1.25 would likely be lower than returns on capital not restricted by being held as target residual amounts subject to the investment requirements of § 1.25, and public disclosure would, other factors being equal, give an incentive to FCMs to hold a larger target residual amount. The Commission estimated quantitatively costs associated with system modifications to produce additional reports for leverage. The Commission did not receive comments regarding its quantitative estimates of those costs or its qualitative analysis that costs would be associated with the amendments to § 1.10, particularly the public disclosure of the Cleared Swaps Segregation Schedule and the changes to the Segregation Schedule and Secured Amount Schedule to include the targeted residual amount. Specifically, the Commission received no comments regarding the assumption that the target residual amount would in fact be higher once publicly disclosed, or as to what forms or costs associated with any additional capital that may be required following disclosure of the target residual amount, if any at all. Nor did the Commission receive comments discussing the quantitative spread difference between § 1.25 investments compared to investments that are not subject to § 1.25. Without comment as to these cost drivers, the Commission is unable to accurately estimate these costs. The Commission received a comment from NFA to consider an alternative to the regulatory language proposed for leverage ratio reporting to refer to the formulation of leverage established by a registered futures association.603 The Commission, believing that this alternative would have no detrimental impact on the benefits anticipated from obtaining reporting of leverage, modified the language in the final regulation to conform to the alternative 603 NFA E:\FR\FM\14NOR2.SGM Comment Letter at 8 (Feb. 15, 2013). 14NOR2 68584 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations suggested by NFA. The alternative language in the final regulation will permit the leverage reporting requirement to stay harmonized with NFA’s leverage reporting requirement as NFA has indicated it intends to update and refine the formulation, which will continue to provide the Commission with information necessary to monitor FCMs for the protection of market participants.604 The Commission received numerous comments regarding the benefits of the public disclosure of the Segregation Schedule, Secured Amount Schedule, and Cleared Swaps Segregation Schedule, and the amounts of the FCM’s targeted residual interest.605 Many commenters reiterated the utility of, and value to, customers of the public availability of the schedules and financial condition information of FCMs.606 However, several FCMs commented, and FIA expressed concern, that the information would not be useful to customers and would be difficult for customers to understand without understanding all the factors involved in setting a target residual amount.607 These commenters were concerned that customers may, to their detriment, overweigh the consideration of the targeted residual amount.608 These comments are discussed in detail at section II.P. above. The Commission understands the concerns of both sets of commenters but believes that the protection of market participants is enhanced in this circumstance by the greater availability of public information, particularly concerning customer funds, to customers and potential customers. Notwithstanding the concerns of FIA and several FCMs particularly questioning the benefits of the public availability of the targeted residual amount, the Commission believes that public disclosure—and consequent market discipline—is an important counterweight to other FCM incentives with respect to establishing the target. The Commission herein has adopted numerous measures increasing disclosures to customers, believing, on balance, that additional disclosures regarding customer funds in particular to have significant benefits to the protection of market participants. TKELleY on DSK3SPTVN1PROD with RULES2 604 Id. 605 See, e.g., SIFMA Comment Letter at 2 (Feb. 21, 2013); SUNY Buffalo Comment Letter at 8 (Mar. 19, 2013); Vanguard Comment Letter at 5–6 (Feb. 22, 2013). 606 Id. 607 See, e.g., FIA Comment Letter at 52 (Feb. 15, 2013); RJ O’Brien Comment Letter at 6 (Feb. 15, 2013). 608 Id. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 Greater availability of information may also provide additional confidence in the financial integrity of futures markets. Finally, the Commission, in its consideration of costs and benefits for the amendments to § 1.10, asked questions for particular comments on the costs and benefits of making public daily segregation and secured amount calculations, or other more frequent calculations, and solicited comments on alternatives. Similar to the comments on the public availability of the Segregation Schedule, Secured Amount Schedule, and the Cleared Swaps Segregation Schedule, some commenters supported and other commenters opposed the public availability of daily margin segregation calculations. The Commercial Energy Working Group noted, generally, that the Commission’s proposals for the publication of information would be a cost-effective mechanism to make FCMs more accountable to their customers.609 The Commercial Energy Working Group posited that additional costs of publication of daily segregation calculations should be nominal.610 There were no other specific comments on the costs of making publicly available daily or more frequent information. The Commission proposed requiring daily segregation disclosures in the amendments adopted to § 1.55, and the benefits of such disclosures will be further discussed in that section, although the only comment received as to the costs of such publication of information was as discussed herein. The NFA commented that the Commission should consider the alternative of directing customers to its BASIC system where certain financial information on FCMs would be available in one place, as opposed to requiring FCMs to publish financial information, including the Segregation Schedule, Secured Amount Schedule, and Cleared Swaps Segregation Schedule on their respective Web sites.611 NFA commented that the Commission should carefully distinguish between categories of information, as those meaningful to all customers which should be readily available, meaningful to regulators but which may be sensitive and subject to misinterpretation if made public, and meaningful to more sophisticated customers that FCMs should be required to provide upon request.612 The 609 Commercial Energy Working Group Comment Letter at 2 (Feb. 12, 2013). 610 Id. at 3 611 NFA Comment Letter at 15 (Feb. 15, 2013). 612 Id. at 16. PO 00000 Frm 00080 Fmt 4701 Sfmt 4700 Commission believes enhanced benefits to the protection of market participants and the financial integrity of futures markets, and market discipline, are best achieved by the public availability of the Segregation Schedules, Secured Amount Schedules, and Cleared Swaps Segregation Schedules in their entirety on a monthly basis, but also agrees with NFA’s concern regarding the sensitivity of information that may be readily available to regulators but not publicly disclosed. The Commission does not agree that there may be a benefit to distinguishing between categories of customers with respect to public availability of information. The Commission agrees there could be enhanced utility to customers by having schedules provided by the NFA through its BASIC portal as an alternative, however, also notes that NFA could implement this under the rule as adopted so long as the schedules are required to be made publicly available and are not exempt from public disclosure. Section 1.11 Risk Management Program for Futures Commission Merchants The Commission adopted new § 1.11 requiring an FCM that carries accounts for customers to establish a risk management unit that is independent from the business unit handling customers or customer funds and reports directly to senior management. In addition, each FCM must establish and document a risk management program, approved by the governing body of the FCM, that, at a minimum: (a) Identifies risks and establishes risk tolerance limits related to various risks that are approved by senior management; (b) includes policies and procedures for detecting breaches of risk tolerance limits, and for reporting them to senior management; (c) provides risk exposure reports quarterly and whenever a material change in the risk exposure of the FCM is identified; (d) includes annual review and testing of the risk management program; and (e) meets specific requirements related to segregation risk, operational risk, and capital risk. Regarding segregation risk, each FCM must establish written policies and procedures that require, at a minimum: (1) Documented criteria for selecting depositories that would hold segregated funds; (2) a program to monitor depositories on an ongoing basis; (3) an account opening process that ensures the depository acknowledges that funds in the account are customers’ funds before any deposits are made to the account, and that also ensures accounts E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 are titled appropriately; (4) a process for determining a residual interest target for the FCM that involves due diligence from senior management; (5) a process for the withdrawal of an FCM’s residual interest when such a withdrawal is not made for the benefit of the FCM’s customers; (6) a process for determining the appropriateness of investing funds in § 1.25 compliant investments; (7) procedures to assure that securities and other non-cash collateral held as segregated funds are properly valued and readily marketable and highly liquid; (8) procedures that help to ensure appropriate separation of duties between those who account for funds and are responsible for statutory and regulatory compliance versus those who act in other capacities with the company (e.g., those who are responsible for treasury functions); (9) a process for the timely recording of all transactions; and (10) a program for annual training of FCM employees regarding the requirements for handling customer funds. The new § 1.11 requires automated financial risk management controls that address operational risk, and written procedures reasonably designed to ensure that an FCM has sufficient capital to be in compliance with the Act and regulations and to meet its liquidity needs for the foreseeable future. Costs and Benefits In the NPRM, the Commission provided a detailed discussion of the significant benefits of the new risk management requirements for FCMs to the protection of market participants and customer funds, sound risk management, and directly as well as by extension, the financial integrity of futures markets. Specifically, the Commission stated that it considered the specific requirements of § 1.11 to reduce the negative impact of conflicts of interest on decision making relating to customer funds, to result in stronger controls which could quickly focus management attention on emerging risks and minimize the risk of a breakdown in control at times of financial stress, and to promote more formal responsibility and require specific accountability up the chain of FCM management and governance for risk controls both generally and specific to customer funds processes and procedures. Documentation requirements for policies and procedures were considered beneficial to promote Commission and SRO oversight of the tools chosen by FCMs in putting the stronger controls in place, although the Commission also determined that permitting flexibility VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 with respect to the manner of the policies and procedures would be beneficial to the efficiency of FCMs in putting the new stronger and more rigorous requirements into practice. The Commission considers the requirements adopted under § 1.11 to be extremely important in eradicating the potential for poor internal controls environments at FCMs, which could be susceptible to fraud or operational error, which in turn could result in losses to customer funds without clear and documented management accountability. Documentation of the criteria for decision making and management determinations with respect to choice of depositories, and other management determinations impacting customer funds such as residual interest and investment choices, as well as requiring periodic review and testing of the risk management program, allows for an iterative process with a clear purpose, the protection of customers and customer funds, transparent to both Commission and SRO examination. Providing clear factors which must be considered by FCMs in their adopted practices, such as selection of depositories, was also considered by the Commission to provide greater clarity to customers with respect to determinations of significant consequence for customers, with a result being likely enhanced market discipline coming from customers evaluating FCMs. In many specific areas, the Commission considered the requirements being adopted to greatly benefit risk management, the protection of market participants and the financial integrity of futures markets as the requirements would necessarily require FCMs to improve internal management communication, internal controls, management accountability, separation of duties, and training of personnel in many respects. The Commission considered that FCMs were already responsible under the Act and existing regulations for the protection of customer funds. The adoption of § 1.11 requires now that FCMs develop written policies and procedures and put programs and controls into practice, to ensure going forward that they have in place consistent and reviewable processes to achieve the required outcomes for protecting customers and customer funds. The Commission, in adopting the rules, was however, cognizant that there would be significant costs involved in compliance with § 1.11, to the extent that for some FCMs these processes and procedures were not already in place or have no equivalent foundation. However, the PO 00000 Frm 00081 Fmt 4701 Sfmt 4700 68585 Commission considered an additional benefit to the requirements to be that there would no longer be a competitive cost advantage to FCMs to not put in place such important measures. Many FCMs are anticipated by the Commission to already have in place strong internal controls and practices similar to what is now specifically being required to be put in place under § 1.11, and those FCMs will not have to bear a competitive disadvantage any longer for doing so with respect to bearing the costs of such practices in order to adequately protect customers. The Commission, cognizant of the significance of its estimates of costs with respect to the requirements, adopted the regulations in a manner that provides FCMs with flexibility in the manner of adopting practices that fulfill the requirements. The Commission did not receive specific comments on its quantitative estimates of the initial and recurring costs of adopting § 1.11. The Commission did receive comments from several FCMs objecting to the requirements of § 1.11 to require the independence of risk management from the business unit (defined to identify parties responsible for customer business or dealing with customer funds or supervising such lines of responsibility). RCG and Phillip Futures cited the loss of a talent pool available to participate in risk management as a negative consequence of the requirement.613 Phillip Futures also recommended that the Commission consider as an alternative that internal controls, senior leadership and training programs could suffice in lieu of required separations between risk management and the business unit.614 Phillip Futures contended that natural conflicts of interest will always exist and can be mitigated by supervisory levels, policies and procedures.615 CHS Hedging and RJ O’Brien cited the difficulty of a small or mid-size FCM having a separate unit for risk management personnel, noting it to be impracticable operationally or financially and not cost effective.616 Frontier Futures generally commented that the costs associated with requiring FCMs to increase risk management standards for the purpose of protecting an FCM’s customers from losses caused by fellow customers, would be prohibitive to smaller FCMs being able 613 RCG Comment Letter at 5 (Feb. 12, 2013); Phillip Futures Comment Letter at 2 (Feb. 14, 2013). 614 Phillip Futures Comment Letter at 2 (Feb. 14, 2013). 615 Id. 616 CHS Hedging Comment Letter at 3 (Feb. 15, 2013); RJ O’Brien Comment Letter at 9–10 (Feb. 15, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 68586 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 to continue operations, and is an area that FCMs were adept at and already have a large incentive to properly manage.617 FIA asked for clarification that § 1.11 does not require formal structured risk management units, provided that the FCM is able to identify all personnel responsible for required risk management activities in order to comply with the line reporting requirements and independence from supervision by the business unit.618 The Commission understands the general concerns of commenters regarding the costs of the requirements of § 1.11, along with the other new provisions being adopted herein by the Commission. The Commission did provide clarity in section II.B. as requested by FIA, which is intended to make clear the amount of flexibility available in complying with the separation of duties of risk management adopted in § 1.11. However, the Commission notes that such separation as a fixed requirement is particularly important to the protection of market participants, as the Commission continues to believe conflicts of interest to be a significant risk to the protection of customer funds during periods of financial or operational stress absent such clear reporting and accountability lines being established. Section 1.12 Maintenance of Minimum Financial Requirements by Futures Commission Merchants and Introducing Brokers The changes to § 1.12 alter the notice requirements so that it is no longer acceptable to give ‘‘telephonic notice to be confirmed, in writing, by facsimile.’’ Instead, all notices from FCMs must be made in writing and submitted through an electronic submission protocol in accordance with instructions issued or approved by the Commission (currently, WinJammer). In addition, the amendments to § 1.12 require that if an FCM has a shortfall in net capital, but is unable to accurately compute its current financial condition, the FCM should not delay reporting the under capitalization to the Commission. The FCM must communicate each piece of information (knowledge of the shortfall and knowledge of the financial condition of the FCM) to the Commission as soon as it is known. The Commission proposed requirements in paragraphs (i), (j), (k) and (l) of § 1.12 to identify additional circumstances in which the FCM must provide immediate written notice to the 617 Frontier Futures Comment Letter at 2 (Feb. 14, 2013). 618 FIA Comment Letter at 55 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 Commission, relevant SRO, and to the SEC if the FCM is also a BD. Those circumstances were: (1) If an FCM discovers that any of the funds in segregated accounts are invested in investments not permitted under § 1.25; (2) if an FCM does not have sufficient funds in any of its segregated accounts to meet its targeted residual interest; (3) if the FCM experiences a material adverse impact to its creditworthiness or ability to fund its obligations; (4) whenever the FCM has a material change in operations including changes to senior management, lines of business, clearing arrangements, or credit arrangements that could have a negative impact on the FCM’s liquidity; and (5) if the FCM receives a notice, examination report, or any other correspondence from a DSRO, the SEC, or a securities industry SRO, the FCM must notify the Commission, and provide a copy of the communication as well as a copy of its response to the Commission. The Commission adopted the proposed additional notification requirements with some changes in response to commenters, narrowing the scope of certain of the new notification requirements. Last, the Commission adopted a new paragraph (n) of § 1.12 that requires that every notice or report filed with the Commission pursuant to § 1.12 include a discussion of how the reporting event originated and what steps have been, or are being taken, to address the event. Costs and Benefits The benefits of requiring that notice to the Commission be given in written form via specified forms of electronic communication not only adapt the rule to account for modern forms of communication, but also reduce the possibility of notification being delayed in reaching appropriate Commission staff. Ensuring that important regulatory notices go directly through electronic systems will result in appropriate staff being alerted as soon as possible and that there are no unnecessary delays to regulatory attention to the notice, which should benefit the protection of market participants and the financial integrity of futures markets, potentially significantly depending on the importance of the issue being addressed. For example, with respect to the adopted change in § 1.12(a)(2), if an FCM knows that it does not have adequate capital to meet the requirements of § 1.17 or other capital requirements, and is also not able to calculate or determine its financial condition, it is likely that the FCM is in a period of extraordinary stress. In these circumstances, time is of the essence for PO 00000 Frm 00082 Fmt 4701 Sfmt 4700 the solvency of the FCM and for the protection of its customers and counterparties. Therefore, it is important that the Commission, DSRO, and SEC (if the FCM is also a BD) be notified immediately so that they can begin assessing the FCM’s condition, and if necessary, make preparations to allow the transfer of the customers’ positions to another FCM in the event that the FCM currently holding those positions has insufficient regulatory capital. These preparations help to ensure that the customers’ funds are protected in the event of the FCM’s default, and that the positions of its customers are transferred expeditiously to another FCM where those customers may continue to hold and control those positions without interruption. The situations enumerated as adopted in § 1.12(i) and (j) are more specific indicators of potential or existing problems in the customer segregated funds accounts. Notifying the Commission in such circumstances enables it to monitor steps the FCM is taking to address a shortfall in targeted residual interest, or to direct the FCM as it takes steps to address improperly invested segregated funds. In either case, the Commission will be able to closely monitor the FCM’s actions, benefiting the continued protection of customer segregated funds. The Commission also asked questions in the NPRM regarding whether public availability of § 1.12 notices would enhance customer protection, but did not propose to make the notifications public as it did other additional disclosures relevant to customer funds, such as the various segregation schedules. Comments were received both in favor of and in opposition to public availability. One commenter, FHLB, posited that the costs of public availability would be negligible because the reporting would already be done and be done electronically, and the benefit substantial, so that the Commission should require public availability.619 However, other commenters, including RJ O’Brien and FIA, raised concerns about potential detrimental market impacts on FCMs from the public availability of § 1.12 notices, at odds with FHLB’s assertion that FCMs could not be impacted by a ‘‘run on the bank’’ scenario and that costs would be negligible, with RJ O’Brien believing a main risk of public availability being precisely a possibly disorderly and erroneous ‘‘run on the bank’’ scenario.620 619 FHLB Comment Letter at 3 (Feb. 15, 2013). Comment Letter at 37 (Feb. 15, 2013); RJ O’Brien Comment Letter at 10 (Feb. 15, 2013). 620 FIA E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations The Commission, although in most circumstances believing there to be substantial benefits to greater availability of public information concerning segregated funds, declined to adopt any requirement for public availability of § 1.12 notices, weighing the comments received, and recognizing an additional benefit to maintaining equivalence of treatment with the SEC for joint registrants, whose similar notices are not made public. The Commission agrees that the risk of the possibility of a disorderly ‘‘run on the bank’’ scenario from § 1.12 notices being made immediately public would be too great relative to the benefit of such publication. The possibility of that result could exacerbate a potentially solvable problem at an FCM and not result in the best protection of market participants. The Commission is adopting other types of additional customer disclosures required of FCMs under § 1.55, which it believes are more beneficial to the protection of customers and appropriate to the disclosure purposes than the public availability of § 1.12 notices. The situations enumerated that were proposed in § 1.12(k) through (l) are circumstances indicating that the FCM is undergoing changes that could indicate or lead to financial strain. Alerting the Commission and relevant SROs in such circumstances will benefit the protection of market participants by fostering their ability to monitor such FCMs more closely in order to ensure that any developing problems are identified quickly and addressed proactively by the FCM with the oversight of the Commission and the relevant SROs. In response to commenters who proposed alternatives, believing the proposals to be overly broad and difficult to clearly comply with, the Commission adopted the requirements but narrowed and provided additional detail for the circumstances under which such notices would be required. The Commission believes the requirements as adopted continue to provide the intended benefits to the protection of market participants. The proposed § 1.12(m) requirement that the FCM notify the Commission whenever it receives a notice or results of an examination from its DSRO, the SEC, or a securities-industry SRO, was intended to ensure that the Commission is aware of any significant developments affecting the FCM that have been observed or communicated by other regulatory bodies. Such communications could prompt the Commission to heighten its monitoring of specific FCMs, or create an VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 opportunity for the Commission to work collaboratively and proactively with other regulators and self-regulatory organizations to address any concerns about how developments in the FCM’s business could affect customer funds. The Commission adopted § 1.12(m), with changes to address the requests of commenters that the scope of the requirement needed to be narrowed in order to provide the benefit intended without potentially overly burdensome costs. TD Ameritrade, in particular, commented that the volume of its filings with securities regulators would make the § 1.12(m) requirement both overly costly with respect to the intended benefit, and also not likely to result in the benefit as intended.621 The Commission believes the narrowed language adopted for § 1.12(m) should appropriately address the comment and provide the benefit intended without overly burdensome costs. The requirement that notifications to the Commission pursuant to § 1.12 include a discussion of what caused the reporting event and what has been, or is being done about the event, would provide additional information to Commission staff that would help them quickly gauge the potential severity of related problems that have been or are developing at the reporting FCM, IB, or SRO. The benefit of requiring the additional information is that it will assist Commission or SRO staff in determining whether the situation is likely to be corrected quickly or to continue deteriorating. Commission staff may be best able to protect market participants with appropriate and timely intervention, with more information received initially regarding how a potential regulatory problem is being handled. The Commission made quantitative estimates of costs for the amendments to § 1.12 in the NPRM, including the new notice requirements, the additional information required to be included in notices, and monitoring that would be necessary in order for FCMs to submit notices and received no comments specific to those estimates. The Commission estimated the costs of requiring electronic filing of notices for FCMs to be negligible as the filing system is already in place, and received no comment on that estimate. The Commission asked specific questions regarding costs for the additional notice requirements and did not receive any response to such questions from commenters. 621 TD Ameritrade Comment Letter at 3 (Feb. 15, 2013). PO 00000 Frm 00083 Fmt 4701 Sfmt 4700 68587 Section 1.16 Qualifications and Reports of Accountants The adopted changes to § 1.16 require that in order for an accountant to be qualified to conduct an audit of an FCM, the accountant would have to be registered with the PCAOB, and have undergone inspection by the PCAOB. In addition, the amendments also would require that the governing body of the FCM ensure that the accountant engaged for an audit is duly qualified, and specifies certain qualifications that must be considered when evaluating an accountant for such purpose. Finally, the amendments require the public accountant to state in the audit opinion that the audit was conducted in accordance with the auditing standards adopted by the PCAOB. Costs and Benefits The Commission adopted amendments to § 1.16 primarily to obtain the benefits of quality control and oversight of accountants and higher standards to apply to certified audits of FCMs, for the greater protection of market participants, and to increase the financial integrity of futures markets. In at least one circumstance of FCM failure, which was an impetus for the package of additional protections to customer funds contained in the Proposal, the experience and quality of the FCM auditor contributed to the audit failure and the inability of an audit to be an effective additional check on the compliance and financial integrity of FCMs and customer funds.622 The Commission also considers the newly adopted requirement for the governing body of the FCM to have accountability for assessing auditor qualifications to be an appropriate tool to ensure responsibility for a lack of conflicts, true independence and a quality audit by experienced auditors to be connected back to the FCM’s governing body and to be clearly understood to be a responsibility of that governing body. The Commission believes this enhanced accountability will benefit the protection of market participants and promote the financial integrity of futures markets by contributing to ensuring audit quality of FCMs. In the NPRM, the Commission did not quantitatively estimate costs associated with the amendments to § 1.16, however, it qualitatively considered the 622 See In the Matter of Jeannie Veraja-Snelling, CFTC Docket No. 13–29, available at https:// www.cftc.gov/ucm/groups/public/@ lrenforcementactions/documents/legalpleading/ enfverajaorder082613.pdf. E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68588 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations likelihood that PCAOB registered accountants would be expected, all else being equal, to have higher audit fees, thereby incurring additional costs. The Commission requested, but did not receive, quantitative information from commenters to better assess these costs. However, the Commission did receive several comments regarding the proposed amendments to § 1.16 and the Commission altered some of the proposed § 1.16 requirements in response to such comments, as discussed in section II.E. above. One commenter, the AICPA, proposed that the Commission consider a practice monitoring program, such as the AICPA peer review, as an alternative to the PCAOB inspection requirement.623 The AICPA stated it did not believe the PCAOB inspection requirement would have the benefit of enhancing audit engagements in situations where inspections are not required (i.e., nonissuer FCMs).624 The Commission does believe the PCAOB inspection requirement will enhance audit quality over time, particularly as inspections become required for the audits of SEC registered BDs. However, in considering the practical impediments to registering and becoming inspected by the PCAOB, the Commission made several clarifications in adopting the amendments.625 Most notably, the Commission extended the compliance date for inspection by the PCAOB until December 31, 2015. As noted above in section II.E., based on the Commission’s most recent review, currently there are only seven CPA firms (auditing fifteen FCMs) that would not meet this requirement. Six of those firms are registered with the PCAOB as and indicate that they will be subject to the PCAOB BD inspection program and will presumably receive a PCAOB inspection in the future. Therefore, the Commission is adopting the inspection requirement as proposed but has extended the compliance date to December 31, 2015 in order to provide additional time for accountants to be subject to PCAOB inspections. The Commission received no comments addressing costs associated with an anticipated increase in audit fees for PCAOB registration. Nor did the Commission receive comment as to any increased costs associated with becoming PCAOB registered. Nonetheless, the Commission believes that currently only one FCM audit firm is not PCAOB registered, and would 623 AICPA Comment Letter at 3 (Feb. 11, 2013). at 2–3. 625 See additional discussion at section II.E. above. 624 Id. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 therefore be required to register to continue to conduct audits of FCMs. Currently, a public accountant that audits less than 49 public issuers is required to pay the PCAOB a registration fee of $500.626 Annual fees for public accountants with less 200 issuers also are $500 per year.627 Therefore, any costs associated with registering the one and only existing accounting firm which would not be in compliance, or any firm in the future that will need to register with the PCAOB, will be nominal. Section 1.17 Minimum Financial Requirements for Futures Commission Merchants and Introducing Brokers Section 4f(b) of the Act provides that no person may be registered as an FCM unless such person meets the minimum financial requirements that the Commission has established by regulation. The Commission’s minimum capital requirements for FCMs are set forth in § 1.17 which, among other things, provides that an FCM must cease operating as an FCM and transfer its customers’ positions to another FCM if the FCM is not in compliance with the minimum capital requirements, or is unable to demonstrate its compliance with the minimum capital requirements. The Commission proposed to amend § 1.17 by adding a new provision that will authorize the Commission to require an FCM to cease operating as an FCM and transfer its customer accounts if the FCM is not able to certify and demonstrate sufficient access to liquidity to continue operating as a going concern. Additionally, FCMs that are also registered BDs will be allowed to use the SEC’s BD approach 628 to evaluate the credit risk of securities that the FCM invests in and assign smaller 626 See https://pcaobus.org/Registration/rasr/ Pages/AnnualFees.aspx. 627 Id. 628 Under the SEC proposal, a BD may impose the default haircuts of 15 percent of the market value of readily marketable commercial paper, convertible debt, and nonconvertible debt instruments or 100 percent of the market value of nonmarketable commercial paper, convertible debt, and nonconvertible debt instruments. A BD, however, may impose lower haircut percentages for commercial paper, convertible debt, and nonconvertible debt instruments that are readily marketable, if the BD determines that the investments have only a minimal amount of credit risk pursuant to its written policies and procedures designed to assess the credit and liquidity risks applicable to a security. A BD that maintains written policies and procedures and determines that the credit risk of a security is minimal is permitted under the SEC proposal to apply the lesser haircut requirement currently specified in the SEC capital rule for commercial paper (i.e., between zero and 1⁄2; of 1 percent), nonconvertible debt (i.e., between 2 percent and 9 percent), and preferred stock (i.e., 10 percent). PO 00000 Frm 00084 Fmt 4701 Sfmt 4700 haircuts 629 to those that are deemed to be a low credit risk.630 The Commission’s amendment to § 1.17(c)(5)(v) allows FCMs that are not dual registrants to use the same approach. Finally, the Commission has adopted amendments revising the period of time that an FCM is permitted to wait before taking an undermargined capital charge from three business days after the call is issued on a customer’s account to one business day, and from two business days after the call is issued on a noncustomer or omnibus account to one business day. Costs and Benefits In the NPRM, the Commission provided a detailed discussion of the benefits the changes to § 1.17 would provide. Regarding the potential transfer of customer accounts if the FCM was unable to certify and demonstrate sufficient access to liquidity to continue operating as a going concern, several commentators stated that the Commission should not adopt the rule before clearly articulated objective standards were established and exigent circumstances that would give the Commission authority to require an FCM to cease operating were defined. The Commission understands the concerns of commenters regarding the process by which the Commission, or the Director of the Division of Swap Dealer and Intermediary Oversight acting pursuant to delegated authority under § 140.91(6), could require immediate cessation of business as an FCM and the transfer of customer accounts. However, that same authority currently exists should a firm fail to meet its minimum capital requirement. The Commission believes the ability to certify, and if requested, demonstrate with verifiable evidence, sufficient liquidity to operate as a going concern to meet immediate financial obligations, is a minimum financial requirement necessary to ensure an FCM will continue to meet its obligations as a registrant under the Act. Moreover, because liquidity difficulties will not be made transparent to the FCM’s customers pursuant to 1.12, it is especially important that the Commission be permitted to act. 629 In computing its adjusted net capital, an FCM is required to reduce the value of proprietary futures and securities positions included in its liquid assets by certain prescribed amounts or percentages of the market value (otherwise known as ‘‘haircuts’’) to discount for potential adverse market movements in the securities. 630 The adoption of the Commission’s rule is conditional upon the SEC adoption as final its proposed rule to eliminate references to credit ratings. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations Regarding the proposed amendment to § 1.17(c)(5)(v) revising the capital charge (or haircut) procedures for FCMs, the Commission notes that it only impacts FCMs that are not dual registrants. Because FCMs that are not dual registrants do not typically invest in securities that would be subject to reduced haircuts under the SEC’s proposed rules, the change should not have a significant impact on the capital requirements for such FCMs. The CFA believes that capital models should be established by the relevant regulatory agencies for use by FCMs or BDs and has serious concerns that internal models used for calculating minimum capital requirements are prone to failure in crisis.631 The Commission appreciates the CFA’s concerns, however, the Commission notes that for securities positions, § 1.17 incorporates by reference the securities haircuts that a BD is required to take in computing its net capital under the SEC’s regulations.632 This is a result of the Commission’s determination to defer to the SEC in areas of its expertise, specifically with respect to market risk and appropriate haircuts on securities positions.633 For FCMs that are duallyregistered as BDs, any changes adopted by the SEC to these securities haircuts will be applicable under § 1.17(c)(5)(v) unless the Commission specifically provides an alternate treatment for FCMs.634 The Commission’s amendment merely allows FCMs that are not dual registrants to follow the same rules as those that are dual registrants. This change would harmonize the regulation of FCMs with respect to minimal financial requirements and would place FCMs that are not dual registrants on a more level playing field with those that are dual registrants, which improves the competition between FCMs. The FCMs that use their own internal models will also be subject to review by regulators, including the SEC, SROs, or securities SROs. Regulation 1.17(c)(5)(viii) required an FCM to take a capital charge if a customer account is undermargined for three business days after the margin call is issued. Likewise, § 1.17(c)(5)(ix) required an FCM to take a capital charge 631 CFA Comment Letter at 4–5 (Feb. 13, 2013). Regulations 1.17(c)(5)(v) and 1.32(b) both incorporate 17 CFR 240.15c3– 1(c)(2)(vi) by reference. 633 See 43 FR 15072, 15077 (Apr. 10, 1978) and 43 FR 39956, 39963 (Sept. 8, 1978). 634 See discussion adopting § 1.17(c)(5)(vi) for options haircuts, with respect to the applicability of provisions incorporating by reference and referring to the rules of the SEC for securities broker dealers also registered as futures commission merchants. 43 FR 39956, 39964. TKELleY on DSK3SPTVN1PROD with RULES2 632 Commission VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 for noncustomer and omnibus accounts that are undermargined for two business days after the margin call is issued. These timeframes were appropriate when the capital rules were adopted in the 1970s, when the use of checks and the mail system were more prevalent for depositing margin with an FCM. They are obsolete, however, in today’s markets with the use of wire transfers to meet margin obligations. Therefore, the Commission has amended § 1.17(c)(5)(viii) and (ix) to require an FCM to take capital charges for undermargined customer, noncustomer, and omnibus accounts that are undermargined for more than one business day after a margin call is issued. FIA stated that while institutional and many commercial market participants generally meet margin calls by means of wire transfers, the proposal creates operational problems because it does not consider delays arising from accounts located in other time zones that cannot settle same day, or ACH settlements, or the requirement to settle or convert certain non-U.S. dollar currencies.635 FIA also stated that a substantial number of customers that do not have the resources of large institutional customers (in particular members of the agricultural community) depend on financing from banks to fund margin requirements, which may require more than one day to obtain.636 RJ O’Brien objected to the proposed amendment because many customers that use the markets to hedge commercial risk still meet margin calls by check or ACH because of the impracticality and costliness of wire transfers to their circumstances.637 RJ O’Brien stated that in many cases, the costs of a wire transfer would exceed the transaction costs paid by the client to its FCMs, and additionally, that some customers in the farming and ranching community finance their margin calls, which can require additional time to arrange for delivery of margin call funds due to routine banking procedures.638 RJ O’Brien also stated that if the proposal is adopted, FCMs that service noninstitutional clients will struggle to remain competitive and the proposal may result in fewer clearing FCMs and greater systemic risk to the marketplace.639 RJ O’Brien further stated that a loss of such smaller FCMs will result in fewer options available to 635 FIA Comment Letter at 26 (Feb. 15, 2013). 636 Id. 637 RJ O’Brien Comment Letter at 3–4 (Feb. 15, 2013). 638 Id. 639 Id. PO 00000 Frm 00085 Fmt 4701 Sfmt 4700 68589 these ranchers, farmers and other commercial market participants that wish to hedge their commercial risks.640 Other commenters expressed the general concern that the proposal will harm the customers it is meant to protect by requiring more capital to be kept in customer accounts, possibly forcing users to hold funds at FCMs well in excess of their margin requirements.641 Those commenters argued that such pre-funding could add significant financial burdens to trading as customers find themselves having to provide excess funds to their brokers which could increase their risk with regard to the magnitude of funds potentially at risk in the event of future FCM insolvencies.642 The commenters generally expressed significant concerns that reducing margin calls to one day will harm many customers as: (1) Many small businesses, farmers, cattle producers and feedlot operators routinely pay by check and forcing them to use wire transfers increases their cost of doing business; (2) clients who make margin calls by ACH payments instead of wire transfers because ACH is cheaper, would no longer be able to do so because there is a one-day lag in availability of funds; and (3) foreign customers would not be able to make margin calls due to time zone differences, the time required to convert certain non-USD currencies, and for whom banking holidays fall on different days.643 The CCC stated that the proposed amendment to the capital rule places an undue burden on the FCMs, which will likely result in FCMs demanding that customers prefund trades to prevent market calls and potential capital charges.644 The CCC also stated that the proposal could result in forced liquidations of customer positions to ensure that the FCM does not incur a capital charge.645 FIA and RJ O’Brien suggested alternatives to the Commission’s 640 Id. 641 NPPC Comment Letter at 2 (Feb. 14, 2013); NGFA Comment Letter at 3 (Feb. 15, 2013); NEFI/ PMAA Comment Letter at 3 (Jan. 14, 2013); AIM Comment Letter at 15 (Jan. 24, 2013); Amarillo Comment Letter at 1 (Feb. 14, 2013); NCFC Comment Letter at 1 (Feb. 15, 2013); NFA Comment Letter at 12–13 (Feb. 15, 2013); FCStone Comment Letter at 3 (Feb. 15, 2013); Advantage Comment Letter at 1–2 (Feb. 15, 2013); AFBF Comment Letter at 2 (Feb. 15, 2013); CCC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5 (Feb. 15, 2013); AIM resubmitted the comment letters of Premier Metal Services, NEFI/PMAA, and the ISRI and indicated its support for the recommendations therein (Jan. 14, 2013). 642 Id. 643 Id. 644 CCC Comment Letter at 2–3 (Feb. 15, 2013). 645 Id. E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68590 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations proposal. Both FIA and RJ O’Brien offered that an FCM be required to take a capital charge for any customer margin deficit exceeding $500,000 that is outstanding for more than one business day.646 FIA further suggested that if the customer’s margin deficit is $500,000 or less, the FCM should take a capital charge if the margin call is outstanding two business days or more after the margin call is issued.647 RJ O’Brien also stated that the Commission should provide at least a one year period of time for any changes to the timeframe for taking a capital charge for undermargined accounts to be effective, and that the Commission should require futures exchanges to increase their margin requirements to 135% of maintenance margin to reduce the number and frequency of margin calls.648 The NFA and FIA stated that if the Commission adopts the amendments regarding residual interest as proposed, then the Commission should consider whether a capital charge for undermargined accounts remains necessary at all because the FCM will have already accounted for an undermargined account by maintaining a residual interest sufficient at all times to exceed the sum of all margin deficits; hence the capital charges related to an undermargined account appear to impose an additional financial burden without any necessary financial protection.649 The Commission has considered the comments and is adopting the amendments to § 1.17(c)(5)(vii) and (ix) as proposed. The revised regulation will provide the intended benefits to customers and the marketplace. Commenters have stated that the proposal would increase customer costs by requiring the prefunding of margin calls, which will also potentially expose more customer funds to FCM control. Commenters, however, did not provide any quantitative estimates or provide any substantive analysis in support of their statements. In addition, the Commission notes that much of this argument is based on the assumption that FCMs would not be able to support the additional capital charge through their existing excess capital. In addition, many FCMs utilize a variety of funding sources from which additional capital may be obtained, if required, and therefore costs could vary significantly 646 FIA Comment Letter at 27 (Feb. 27, 2013); RJ O’Brien Comment Letter at 4 (Feb. 15, 2013). 647 FIA Comment Letter at 27 (Feb. 15, 2013). 648 RJ O’Brien Comment Letter at 4 (Feb. 15, 2013). 649 NFA Comment Letter at 13 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 from one FCM to another FCM. Without quantitative estimates as to how much excess capital FCMs typically maintain, would be required to maintain, or the difference of these costs in relation to aged margin calls between one and three days, the Commission cannot quantify any increase in costs associated with this amendment. Moreover, the Commission believes that the benefits of the final regulation will enhance the protection of the markets and customers. The Commission notes that the timely collection of margin is a critical component of an FCM’s risk management program and is intended to ensure that an FCM holds sufficient funds deposited by account owners to meet potential obligations to a DCO. As guarantor of the financial performance of the customer accounts that it carries, the FCM is financially responsible if the owner of an account cannot meet its margin obligations to the FCM and ultimately to a DCO. Regulation 39.13(g)(2) requires that a sufficient amount of funds is maintained in an account to cover 99 percent of the observed market moves over a specified period of time. Customers that maintain fully margined accounts are exposed to greater risk to the safety of their funds if some of the accounts of their fellow customers are undermargined. The intent of the proposed amendment is to encourage an FCM to require customers to promptly fund margin deficiencies, or to reserve a sufficient amount of capital to cover the amount of the deficiencies. As a consequence, the risk that a debit balance could develop in a customer’s account due to tardy margin call payments would be reduced, and the amount of residual interest that the FCM would need to maintain in the segregated accounts in order to protect against the possibility that such debit balances could cause them to have less that is required in their segregated accounts would also be reduced. This provides benefits for the FCM by reducing the amount of capital that it must contribute to the customer segregated accounts. Customers also benefit by FCMs requiring more prompt payments on undermargined accounts, as it is less likely that FCMs would close out the positions of customers failing to meet margin obligations more quickly, reducing the potential losses that would be passed on to non-defaulting customers in the event of a default of a customer and a default of a clearing member. PO 00000 Frm 00086 Fmt 4701 Sfmt 4700 Section 1.20 Futures Customer Funds To Be Segregated and Separately Accounted for The amendments to § 1.20 reorganize the section and alter the substance of the section’s requirements in certain places. The final § 1.20 includes Appendix A and Appendix B, which set forth the Template Letters for the written acknowledgments that FCMs and DCOs, respectively, must obtain from any depository with which they open an account to hold futures customer funds. The rule requires FCMs and DCOs to use the applicable Template Letter to obtain the required acknowledgment before depositing any funds with a depository. Regulation 1.20 also requires FCMs, DCOs, and depositories to file the written acknowledgment with the Commission within three business days of executing the letter, and to update the written acknowledgment within 120 days of any changes to the business name, address, or account numbers referenced in the letter. The Commission received 15 comment letters related to the proposed acknowledgment letter requirements. Some commenters addressed the costs and benefits associated with these requirements; none of them, however, provided any data to aid the Commission in estimating costs. In the sections that follow, the Commission considers the benefits and costs arising from the adoption of the acknowledgment letter requirements. The Commission also discusses the corresponding comments accordingly. Benefits Regulation 1.20(d)(2) requires an FCM to use the Template Letter in Appendix A to obtain a written acknowledgment from any depository that holds futures customer funds. A depository accepting customer funds is required to: (1) Acknowledge that the funds are customer segregated funds subject to section 4d of the Act and the Commission’s regulations thereunder; (2) acknowledge and agree that the funds cannot be used to secure any obligation of the FCM to the depository or used by the FCM to secure or obtain credit from the depository; (3) agree to reply promptly and directly to any request from the Commission or the FCM’s DSRO for confirmation of account balances or provision of any other information regarding or related to an account; (4) agree that the depository will allow the Commission and the FCM’s DSRO to examine the accounts at any reasonable time; and (5) acknowledge and agree that the E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations depository will provide the Commission with technological connectivity necessary to permit read-only electronic access to the accounts. Regulation 1.20(g)(4) requires a DCO to use the Template Letter in Appendix B to obtain a written acknowledgment from any depository that holds futures customer funds. The DCO Template Letter is largely the same as the FCM Template Letter except that: (1) It does not require read-only electronic access; and (2) it does not require the depository to agree to Commission or DSRO examination of customer accounts. These acknowledgments and commitments would result in important benefits. First, by acknowledging that the funds are subject to the Act and CFTC regulations, the depository recognizes that it must comply with relevant statutory and regulatory requirements related to its handling of those funds. Second, the depository acknowledges that neither the FCM (or DCO) nor the depository is permitted to use customer funds as belonging to any person other than the customer which deposited them, i.e., an FCM or DCO cannot use customer funds to secure its obligations to the depository. Third, the Template Letter for FCMs constitutes written permission by the depository to allow Commission or DSRO officials to examine the FCM’s customer accounts at any reasonable time and to provide the Commission with read-only electronic access to those accounts. As a consequence, the Template Letters would enable both the Commission and the DSRO to monitor actual balances at the depository more readily. This would help to ensure that any discrepancy between balances reported by the FCM on its daily customer segregation account reports and balances actually held by the depository would be identified quickly by the Commission or the DSRO. Moreover, with the explicit agreement from the depository permitting the examination of customer segregated accounts, both the Commission and DSRO would be better able to move quickly to resolve a problem. By requiring FCMs and DCOs to submit copies of the executed Template Letters to both the Commission and, as applicable, an FCM’s DSRO, the Commission and DSROs would be better able to act quickly to protect customer funds because the necessary legal permissions will be in place. In addition, the Template Letters provide account information such as account numbers, essential for management of an FCM or DCO bankruptcy situation. Also, requiring that the Template Letters VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 be retained for five years past the time when customer segregated funds are no longer held by a depository helps ensure that proper documentation of all relevant acknowledgments and commitments is in the possession of each party that relies upon the existence of those commitments. Commenters were generally supportive of adopting the Template Letters. The Depository Bank Group stated that ‘‘the acknowledgment letters will help to facilitate a more efficient process for the establishment and maintenance of customer segregated accounts by FCMs and DCOs and serve to clarify the rights and responsibilities of depository institutions holding customer segregated funds.’’ 650 Eurex expressed their appreciation for ‘‘the potential convenience and increases in certainty and transparency that such a standardized approach would likely afford.’’ 651 CME stated its support for ‘‘the Commission’s efforts to strengthen and standardize the form of acknowledgment letters.’’ 652 Costs To date, FCMs and DCOs have negotiated each acknowledgment letter with depositories; accordingly, the use of standardized non-negotiable language in the Template Letter may result in cost savings. However, FCMs and DCOs are likely to bear some initial and ongoing costs as a result of the requirement to use the Template Letters. Regarding initial costs, some depositories may not be willing to sign the Template Letter, which would require the FCM or DCO to move any customer funds held by that depository to a different depository, creating certain due diligence and operational costs. These cost concerns were discussed in the comment letters from MGEX and RCG.653 In the NPRM, the Commission estimated that the cost of obtaining a new acknowledgment letter from each existing depository is between $1,300 and $4,200.654 The Commission 650 Depository Bank Group Comment Letter at 2 (Feb.15, 2013). 651 Eurex Comment Letter at 1 (Aug. 1, 2013). 652 CME Comment Letter at 7 (Feb. 15, 2013). 653 MGEX Comment Letter at 3 (Feb. 18, 2013) and RCG Comment Letter at 7 (Feb. 12, 2013). 654 This estimate assumed 10–40 hours of time from a compliance attorney and 10–20 hours from an office services supervisor. The average compensation for a compliance attorney is $85.35/ hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*10 = $853.47 and $85.35*40 = $3,413.88. The average compensation for an office services supervisor is $40.15/hour [$61,776.00 per year/(2000 hours per year)*1.3 is $40.15 per hour]; $40.15*10 = $401.54 and $40.15*20 = $803.09. These figures were taken from the 2011 SIFMA Report on Management and Professional Earnings in the Securities Industry. PO 00000 Frm 00087 Fmt 4701 Sfmt 4700 68591 estimated that FCMs and DCOs would have approximately 1 to 30 depositories each, from which they would need to obtain a new acknowledgment letter. Therefore, the Commission estimated that the cost of obtaining new acknowledgment letters from existing depositories would be between $2,700 and $82,000 per FCM or DCO.655 In addition, the Commission estimated that the process of identifying new potential depositories, conducting necessary due diligence, formalizing necessary agreements, opening accounts, and transferring funds to a new depository would likely take between three to six months and would likely require support from compliance attorneys, as well as operations, risk management, and administrative personnel. In the NPRM, the Commission estimated that the cost of moving accounts from an existing depository that is not willing to sign the letter would be between $50,000 and $102,000.656 There may be additional operational costs associated with any changes that would necessitate updating the letter. The per-entity cost of obtaining the letter from new depositories is likely to be the same as it would be for obtaining the letter from existing depositories (i.e., $1,300 and $4,200). In the NPRM, the Commission estimated that the cost associated with changes that would require the acknowledgment letter to be updated would be between $1,100 and $2,800 per year.657 655 Total figures are taken from previous calculation. ($1,255.01+$4,216.97)/2 = $2,735.99; $2,735.99*1 = $2,735.99 and $2,735.99*30 = $82,079.69. 656 This estimate assumed one compliance attorney working full-time for 3–6 months, 50–200 hours from an office services supervisor, 80–160 hours of time from a risk management specialist, and 40–60 hours from an intermediate accountant. The average compensation for a compliance attorney is $85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35 *40 hours/week*4 weeks/month*3 months = $40,966.54 and $85.35 *40 hours/week*4 weeks/month*6 months = $81,933.07. The average compensation for an office services supervisor is $40.15/hour [$61,776.00 per year/(2000 hours per year)*1.3 is $40.15 per hour]; $40.15*50 = $2,007.72 and $40.15*200 = $8,030.88. The average compensation for a risk management specialist is $65.33/hour [$100,500 per year/(2000 hours per year)*1.3 is $65.33 per hour]; $65.33*80 = $5,226.00 and $268.84*160 = $10,452.00. The average compensation for an intermediate accountant is $34.11/hour [$52,484.00 per year/(2000 hours per year)*1.3 is $34.11 per hour]; $34.11*40 = $1,364.58 and $34.11*60 = $2,046.88. These figures were taken from the 2011 SIFMA Report on Management and Professional Earnings in the Securities Industry. 657 This assumed 20–50 hours per year from an office manager for operational costs. The average compensation for an office manager is $55.82/hour [$85,875 per year/(2000 hours per year)*1.3 = $55.82/hour]; $55.82*20 = $1,116.38 and $55.82*50 = $2,790.94. This figure was taken from the 2011 E:\FR\FM\14NOR2.SGM Continued 14NOR2 68592 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 RCG discussed the need to develop policies and procedures as well as train personnel.658 These costs were considered in the NPRM and are discussed above. MGEX asserted, based on the Commission’s estimates in the NPRM, that the costs of using the Template Letters would outweigh the benefits of using them. It did not, however, provide further analysis as to the basis for its conclusion.659 In the NPRM, the Commission quantified some of the potential costs and only discussed the benefits qualitatively. Consequently, there is no direct comparison between the costs and benefits based on the Commission’s estimates in the NPRM. The Depository Bank Group, FIA, and Schwartz & Ballen expressed concern that the Template Letters’ standard of liability provision would shift significant amount of risk onto depository institutions and would likely increase the costs incurred in both monitoring for violations and maintaining customer segregated accounts.660 As discussed in the preamble, the Commission revised the language in the Template Letters to address these concerns. FCStone and Schwartz & Ballen commented that the proposed restriction on depositories placing liens on customer accounts when there is an overdraft in an account would likely lead to losses to depositories. As discussed in the preamble, the Template Letter clarifies that liens on accounts are permitted only in certain limited circumstances and that a depository may not take a lien against a customer account to cover overdrafts. The final Template Letters do not deny a depository the right to recover funds advanced in the form of cash transfers, lines of credit, repurchase agreements or other similar liquidity arrangements made in lieu of liquidating non-cash assets held in an account or in lieu of converting cash in one currency to cash in a different currency. The requirement, embedded in the FCM Template Letter, that depositories provide the Commission with read-only electronic access to customer accounts would create certain costs for depositories that would likely be passed onto FCMs. ICI noted that the read-only access requirement would result in a SIFMA Report on Management and Professional Earnings in the Securities Industry. 658 RCG Comment Letter at 8 (Feb. 12, 2013). 659 MGEX Comment Letter at 3 (Feb.18. 2013). 660 Depository Bank Group Comment Letter at 2 (Feb. 15, 2013), FIA Comment Letter at 40 (Feb. 15, 2013) and Schwartz & Ballen Comment Letter at 6 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 process that might be burdensome.661 The Commission does not have adequate data to estimate the cost for establishing such a system and no data was provided by commenters to aid the Commission in estimating such costs.662 The Commission also has decided not to adopt the read-only electronic access requirement for DCOs.663 FCStone asserted that the ultimate costs of requiring Template Letters will be borne by customers of FCMs.664 ICI noted that the costs with respect to a MMMF Template Letter requirements would be borne by all investors in a MMMF and not just by the FCMs.665 The Commission, however, is unable to forecast how these costs will ultimately be allocated. Section 1.22 Use of Customer Funds Restricted Under current regulations, an FCM is not permitted to use one customer’s funds to purchase, margin, secure, or settle positions for another customer. However, prior regulations did not specify how FCMs should demonstrate compliance with this requirement. Revised regulation 1.22(c) provides such a mechanism. Section 1.22(c)(1) defines the undermargined amount for an account. Sections 1.22(c)(2) and (c)(4) require FCMs to compute, based on the information available to the FCM as of the close of each business day, (i) the undermargined amounts, based on the clearing initial margin that will be required to be maintained by that FCM for its futures customers, at each DCO of which the FCM is a member or FCM through which the FCM clears, at the point of the daily settlement (as described in 39.14) that will complete during the following business day for each such DCO (or FCM through which the FCM clears) less (ii) any debit balances referred to in 1.20(i)(4) included in such undermargined amounts. Moreover, under section 1.22(c)(3), an FCM is required to, prior to the Residual 661 ICI Comment Letter at 5 (Jan. 14, 2013). Although ICI’s comments focused on MMMFs, some of the costs they discussed apply generally to read-only access requirements. 662 The Commission intends to rely primarily on other means of obtaining account information from depositories, and would activate the read-only electronic access only in situations where it was deemed necessary. The Commission will generally seek to obtain account information from the NFA and CME automated daily segregation confirmation system and/or from depositories directly prior to requesting a depository to activate electronic access. 663 DCOs hold omnibus customer segregated accounts that do not reflect funds attributable to individual clearing members or customers. 664 FCStone Comment Letter at (Feb. 15, 2013). 665 ICI Comment Letter at 5 (Jan. 14, 2013). PO 00000 Frm 00088 Fmt 4701 Sfmt 4700 Interest Deadline defined in section 1.22(c)(5), have residual interest in the segregated account in an amount that is at least equal to the computation set forth in section 1.22(c)(2).666 The amount of residual interest that an FCM must maintain may be reduced to account for payments received from or on behalf of undermargined futures customers between the close of the previous business day and the Residual Interest Deadline. Section 1.22(c)(5) defines the Residual Interest Deadline. During an initial phase-in period, the Residual Interest Deadline is 6:00 p.m. Eastern Time on the date of the settlement referenced in (c)(2)(i) or (c)(4). On December 31, 2018, which is the expiration of the phase-in period, the Residual Interest Deadline shifts to the time of the settlement referenced in (c)(2)(i) or (c)(4). In the interim, paragraph 1.22(c)(5)(iii) requires Commission staff to solicit further public comment and conduct further analysis in a report (the ‘‘Report’’) for publication in the Federal Register regarding the practicability of moving the Residual Interest Deadline from 6:00 p.m. Eastern Time on the date of settlement to the time of settlement (or to some other time of day). The Report will discuss whether and on what schedule it would be feasible to move the Residual Interest Deadline, and the cost and benefits of such potential requirements. In addition, staff is instructed to, using the Commission’s Web site, solicit public comment and conduct a public roundtable regarding specific issues to be covered by the Report. Paragraph 1.22(c)(5)(iii)(B) provides that the Commission may, taking into account the Report, (1) terminate the phase-in period, in which case the phase-in shall end as of a date established by Commission order published in the Federal Register, which date shall be no less than one year after the date of such Commission order, or (2) determine that it is necessary and appropriate in the public interest to propose through rulemaking a different Residual Interest Deadline. In that event, the Commission shall establish by order published in the Federal Register, a phase-in schedule. Costs and Benefits The requirement in § 1.22(c) benefits customers whose accounts are not undermargined by reducing the risk that their segregated funds would be used to cover a shortfall in customer funds due 666 See note 395 above regarding the operation of the requirement in § 1.22(c)(3) where an FCM is subject to multiple Residual Interest Deadlines. E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations to a ‘‘double default.’’ 667 When combined with the reporting requirements in §§ 1.10, 1.32, 22.2, and 30.7, the requirement in § 1.22(c) will further provide the Commission and the public with information that should allow them to determine whether FCMs are using one customer’s funds to purchase, margin, secure or settle positions for another customer.668 It would be difficult to quantify these benefits reliably. An estimate would depend on the expected value of losses due to a double default (i.e., a default of both a customer and the FCM) which, in turn, depend on the probability of a double default and the magnitude of deficits that would exist in customer accounts compared to the amount of residual interest at the time of the double default. Given the small number of historical examples, it is unlikely that any estimate of probability would be reliable. Moreover, the magnitude of the impact of a loss of customer funds is dependent on an estimate of the amount of funds lost, a number that is also difficult to predict with any reliability, as well as the loss of market confidence (which may be even more important), which is also difficult to estimate reliably. As discussed above, the Commission has revised the residual interest requirements in the final rule by adopting a point in time approach.669 As a consequence, once the requirement in § 1.22(c) is phased in, FCMs will have several hours between the close of business on a particular day (the point in time upon which the calculation is based), and the time of day when the requisite amount of residual interest must be held in segregation (that is, the time of the daily settlement). Moreover, during the phase-in period described in § 1.22(c)(5), FCMs will initially have a longer period (until 6:00 p.m. Eastern Time on the following business day) to ensure that the requisite amount of residual interest is held in segregation. These adjustments to the final rule will avoid the need for FCMs continuously to monitor whether they are maintaining residual interest in their segregated customer accounts that is sufficient to cover the sum of the undermargined amounts in customers’ accounts. Instead, FCMs will have to ensure that they are able to cover the sum of the undermargined amounts in customers’ accounts by the Residual Interest Deadline. This should significantly reduce the amount of 667 See discussion of double defaults in sections I.D. and II.G.9. above. 668 See the discussion in section II.G.9. above. 669 See the discussion in section II.G.9. above. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 residual interest that an FCM must maintain in segregated accounts on an ongoing basis. In the absence of information regarding what specific changes various market participants might make to their systems and operations in order to expedite margin payments, it is not possible for the Commission to provide an estimate of the costs of such technical changes. Moreover, the FCM’s funding requirement will be reduced to the extent that customers are able to reduce the undermargined amount in their accounts prior to the Residual Interest Deadline. The Commission expects that FCMs will work with customers during the phase-in period to develop the systems and operational patterns that will be necessary to facilitate more prompt margin calls and payments. As a consequence, those FCMs’ customers that do not already have the capability to make margin payments before the Residual Interest Deadline may develop that capability, which will further reduce the funding burden borne by FCMs. The cost associated with maintaining sufficient residual interest to cover undermargined amounts will also depend upon the policies and procedures that FCMs put into place to meet the targeted residual interest requirement set forth in § 1.11. To the extent that the undermargined amount is greater than the targeted residual interest amount that an FCM maintains in its customer accounts, the FCM would have to increase the amount of residual interest it maintains in the customer segregated account by the time it is obligated to make settlement payments to the DCO. Some FCMs may seek to avoid this situation by requiring their customers to pre-fund (i.e., require customers to provide initial margin for a position before the FCM sends the position to a DCO to be cleared, and provide sufficient excess margin to the FCM to reduce any undermargined amount). If the FCM elects to increase the amount of residual interest that it maintains in the customer segregated accounts, this would likely reduce the range of investment options the FCM has for those additional funds and may prompt the FCM to hold additional capital to meet operational needs. Similarly, if the FCM requires additional margin from customers, that will result in capital costs to those customers. On the other hand, to the extent the FCM would otherwise maintain targeted residual interest (i.e., to the extent the targeted residual interest is greater than or is included within the undermargined amount), then the rule PO 00000 Frm 00089 Fmt 4701 Sfmt 4700 68593 would not create any additional funding costs. Despite these revisions to the proposed rule, the Commission recognizes that the requirements of final rule § 1.22(c) will create significant additional costs for FCMs and their customers. Developing and implementing the systems and operational changes necessary to facilitate more rapid margin payments will create costs for FCMs and their customers. Those costs are likely to vary significantly across FCMs depending on the infrastructure and operational patterns that each FCM already has in place, and depending on the specifications of the revised systems and operational patterns that FCMs and customers develop in order to facilitate more rapid margin payments.670 In addition, the Commission expects that some FCMs may choose to require some customers to increase the amount of margin they maintain in their accounts. This is more likely for those customers who are presently not able to make their margin payments prior to the Residual Interest Deadline. Customers subject to increased pre-funding requirements will bear costs from their cost of capital resulting from prefunding multiplied by the amount of the increased pre-funding requirement. The cost of capital for each customer depends on the investment strategy of the individual customer, and the amount of increased pre-funding requirement is likely to vary depending on the ability of the customer to respond to margin calls promptly and the FCM’s ability to cover the customer’s deficits through increased residual interest contributions.671 Last, whatever undermargined amounts are not addressed through customer payments prior to the Residual Interest Deadline will have to be covered through increased residual interest contributions from the FCM. The Commission expects that in order to comply with the requirements of § 1.22(c), FCMs may need to maintain 670 In the absence of information regarding what specific changes various market participants might make to their systems and operations in order to expedite margin payments, it is not possible for the Commission to provide an estimate of these costs. 671 Commenters did not provide, and the Commission does not have, data characterizing the range of investment strategies used by FCM customers, its impact on their cost of capital for additional margin, the extent to which customers will not be able to develop the ability to make more rapid margin payments, or the extent of the margin requirements for those customers. In the absence of this information it is not possible at this time to estimate the additional cost associated with prefunding requirements that some customers may bear. These are subjects that may be addressed in the Report. E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68594 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations additional residual interest in order to cover the sum of undermargined amounts in customers’ accounts that still remain by the Residual Interest Deadline on ordinary trading days, and are likely to acquire and maintain access to additional liquidity that can be accessed rapidly to meet the sum of customers’ gross undermargined amounts in a worst-case-scenario. Therefore, in order to estimate the cost of additional residual interest that FCMs will maintain, it is necessary to estimate the amount of additional residual interest that FCMs will need to maintain in their segregated accounts during ordinary trading days, the amount of additional residual interest that will be needed on highly volatile trading days, the ratio of ordinary to highly volatile trading days on an annual basis, the cost of capital for the additional funds that are deposited into residual interest, and the cost to maintain a revolving credit facility or some other source of funding that can be accessed quickly and that is sufficient to cover the projected largest undermargined amount in aggregate for customers’ accounts. As discussed further below, the Commission believes that the point in time approach adopted in this final rule will significantly reduce the amount of additional residual interest that FCMs need to maintain in their segregated accounts on an ongoing basis in order to comply with § 1.22(c). Several commenters provided estimates of the cost of the ‘‘at all times’’ portion of the proposal. FIA estimated that compliance with the ‘‘at all times’’ portion of the proposal would require FCMs or their customers to deposit significantly in excess of $100 billion into customer funds accounts beyond the sum required to meet initial margin requirements, and that the annual financing costs for these increased deposits will range from $810 million to $8.125 billion.672 FIA estimated the highest single day customer margin deficits per FCM would likely be between $196 million to $6.1 billion per FCM, depending on the size and composition of the FCM’s customer accounts.673 Jefferies estimated that it would be required to increase its own residual interest by $15 million (nonpeak) or $30 million (peak), respectively.674 Jefferies also stated that the industry would be required to increase its residual interest by $49 billion (non-peak) or $83 billion (peak) at a cost of approximately $2 billion 672 FIA 673 See Comment Letter at 14, 16 (Feb. 15, 2013). FIA Comment Letter at 2–3 (June 20, 2013). 674 Id. at 8. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 (non-peak) or $5 billion (peak), respectively.675 ISDA estimated that the highest single day sum of gross customer margin deficits would likely be approximately $73.2 billion for all FCMs combined, with a long term funding impact of $335 billion.676 While the Commission expects that the residual interest requirement will create additional capital costs for most FCMs, the Commission believes that the estimates presented by commenters include certain assumptions that may lead to overstated costs. First, residual interest that is not needed to be pledged as collateral for customers may be invested overnight and during the day in investments that are consistent with the requirements of Commission Regulation 1.25 (‘‘§ 1.25 investments’’).677 The return on residual interest would offset a portion of the cost of funds. That is, the additional funds that FCMs place in residual interest will both incur costs and generate returns for the FCM. Estimates of the effective cost of the additional funds that must be used to increase residual interest must account for both.678 The returns on § 1.25 investments have the potential to reduce the effective cost of funds. Second, both FIA and ISDA confound total residual interest with additional residual interest by assuming that the total amount of residual interest that would be required by the proposed rule is equal to the additional amount of additional interest that would be required by the rule. FCMs, in general, maintained some residual interest prior to this rule, and are required to do so to comply with § 1.23.679 Therefore, it is only the additional residual interest that is necessary because of rule 1.22(c) that is relevant for consideration here. Third, the Commission agrees with FIA that U.S. Treasury securities are an appropriate proxy for the marginal cost of capital for a low-risk project, such as funds to be placed in residual interest. FIA and Jefferies did not explain why they chose long-dated maturities on the yield curve for their estimates. 675 Id. 676 See ISDA Comment Letter at 4 (Feb. 15, 2013). ISDA used market data for FCMs (November 30, 2012) available at https://www.cftc.gov/ MarketReports/FinancialDataforFCMs/index.htm. 677 17 CFR 1.25. 678 For example, FIA cited a historical cost of funds of 8.125% in January 1990. At that time, the constant maturity one month Treasury yield was 7.86%, see https://mortgage-x.com/general/indexes/ cmt_tcm_history.asp?f=m. Thus, using the cost of funds proxy from the commenter, the cost of funds would be closer to 0.365% (calculated as 8.125% ¥ 7.86% + 0.10% (for underwriting and administrative overhead)). 679 See section II.G.10. above. PO 00000 Frm 00090 Fmt 4701 Sfmt 4700 Presumably, an FCM could borrow funds at a much shorter maturity than five years, for example, a month or less, potentially lowering borrowing costs substantially. The Commission notes, and discusses further below, that FCMs might mitigate costs by maintaining a credit facility that is sufficient to cover most of their additional residual interest needs on unusually volatile trading days, but that is not used on the majority of trading days. This approach would not only lower the amount of capital needed, but would also reduce the amount of time during which the capital is borrowed. As discussed further below, the Commission is not able to estimate accurately what fees banks would charge. However, the Commission has considered that FCMs would bear an ongoing cost associated with maintaining an open credit facility that is able to provide rapid access to sufficient liquidity to meet any additional residual interest requirements on highly volatile days. As noted above, several commenters requested the Commission revise the proposal to require that the residual interest calculation be made once a day, specifically by the end of the business day.680 These commenters suggested an alternative (the ‘‘Industry Commenters’ Alternative’’) by which, at this point in time, an FCM would be required to maintain a residual interest in its customer funds accounts at least equal to its customers’ aggregate margin deficits for the prior trade date. ISDA stated this alternative ‘‘would rationally reduce’’ FCMs cost of compliance 681 and that ‘‘[f]or an FCM with robust credit risk management systems, covering end-of-day customer deficits should not be a significant cost.’’ 682 ISDA also noted that at the end of the day ‘‘typically, all customer calls have been met, and all customer gains have been paid out; all achieved without the FCM having recourse to its own funding resources.’’ 683 FIA asserted that it would ‘‘achieve the Commission’s regulatory goals without imposing the 680 See ISDA Comment Letter at 6 (Feb. 15, 2013); FIA Comment Letter at 23–25 (Feb. 15, 2013); LCH.Clearnet comment Letter at 5 (Jan. 25, 2013); Paul/Weiss Comment Letter at 4–5 (Feb. 15, 2013); RJ O’Brien Comment Letter at 5 (Feb. 15, 2013). 681 ISDA Comment Letter at 6 (Feb. 15, 2013). 682 ISDA Comment Letter at 2 (May 8, 2013). 683 Id. ISDA further observed that many FCM customers use custodians across the world, and ‘‘many customers cannot assure payment of their morning FCM call before the end of the New York day,’’ and therefore recommended that Commission study the feasibility of reducing the time in which customers have to meet margin calls, if that is ‘‘imperative.’’ Id. at 3. This will be addressed in the Report. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 damaging financial and operational burdens on FCMs, and the resulting financial burdens on customers.’’ 684 ISDA and FIA evaluated the costs associated with requiring FCMs to perform the residual interest calculation once each day at the close of business on the first business day following the trade date.685 ISDA estimated that ‘‘removing the predictive element of FCM funding requirements’’ of the ‘‘at all times’’ method in favor of the Industry Commenters’ Alternative would permit markets to ‘‘reap the efficiencies of end-of-day accounting,’’ 686 thereby reducing the overall cost of compliance with the regulation. ISDA estimated that for exchange-traded futures, the costs associated with the alternative would be the cost of covering the outstanding margin deficits of between 2% and 5% of an FCM’s futures customers, and thus that approach would impose only ‘‘incremental funding requirements’’ on FCMs.687 ISDA estimated that the costs of the alternative would be even smaller for cleared swaps, due to the ‘‘more professional’’ nature of the market.688 FIA acknowledged that if FCMs were given until the end of the following business day to ensure that the requisite amount of residual interest was maintained, that approach would eliminate approximately 90–95% of the anticipated additional residual interest that larger FCMs would need to maintain in order to meet an at all times requirement.689 FIA estimated the financing costs to FCMs of complying with the Industry Commenters’ Alternative, and concluded that the costs associated with an at all times residual interest requirement would be approximately ten times the costs associated with the Industry Commenters’ Alternative.690 Finally, the FIA concluded that the Industry Commenters’ Alternative would not ‘‘impos[e] damaging financial and operational burdens on FCMs . . . and the resulting financial burdens on customers’’ that would result from the at all times approach.691 684 FIA Comment Letter at 23 (Feb. 15, 2013). See also ISDA Comment Letter at 4 (May 8, 2013). 685 ISDA Comment Letter at 1–2 (May 8, 2013); FIA Comment Letter at 8–10 (June 20, 2013). 686 ISDA Comment Letter at 3 (May 8, 2013). 687 Id. at 3–4. 688 Id. at 4. 689 See FIA Comment Letter at 3 (June 20, 2013). 690 See FIA Comment Letter at 8–10 (June 20, 2013). While the rates used by FIA in this exercise may be conservative, and the Commission does not adopt these precise estimates, the exercise is nevertheless illustrative and useful for the purpose of comparing the costs of the at all times approach and the Industry Commenters’ Alternative. 691 Id. at 9. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 However, the point in time approach adopted in final rule § 1.22(c) gives FCMs until the time of settlement with the DCO (typically the beginning of the following business day for end of day margin calls from the DCO), and also provides an extended phase-in period, during which FCMs have until 6:00 p.m. Eastern Time on the date of such settlement. After the phase-in period, and absent further Commission action following the Report, the final rule does not provide FCMs until the end of the following business day to ensure that the requisite amount of residual interest is held, as would be the case in the Industry Commenters’ Alternative. Therefore, the Commission expects that the point in time approach adopted by the Commission will reap much, but not all, of the cost reduction discussed by the industry commenters.692 During the phase-in period, FCMs would be subject to Industry Commenters’ Alternative (and, thus, all of those cost savings would be realized). The following analysis assumes that the Commission does not take further action to modify the Residual Interest Deadline after considering the results of the Report. It refers to estimates of ongoing costs and benefits that only would be incurred and realized after the end of the phase-in period. The Commission expects that the post-phase-in form of § 1.22(c)—with a point in time requirement corresponding to the time of settlement—will achieve some, but not all of the cost reductions associated with Industry Commenters’ Alternative. Moreover, during the phase-in period, the Commission anticipates that customers and FCMs will improve their abilities to submit and receive margin payments prior to the FCM’s settlement with the DCO, and the Commission will be examining this issue further in the Report. In light of these factors, the Commission believes it is reasonable to suppose that the settlement time approach will significantly reduce— perhaps by 25% to 50%—the amount of additional residual interest that is needed on highly volatile trading days, and by a greater amount on ordinary trading days. In order to reasonably estimate the potential range of the amount of additional capital that is necessary on highly volatile trading days, the Commission uses ISDA’s formulation for the aggregate gross deficit across all 692 FIA estimated that the Industry Commenters’ Alternative would reduce the amount of additional residual interest that is necessary by 90–95% when compared to the at all times approach. See id. at 3 (June 20, 2013). See also ISDA Comment Letter at 1–2 (May 8, 2013). PO 00000 Frm 00091 Fmt 4701 Sfmt 4700 68595 customers. ISDA estimated that on high volatility days, the aggregate amount of all customers’ gross margin deficits for all FCMs would be equal to 60% of initial margin required by all customers’ positions. This estimate is based on an assumption that all of an FCM’s customers will be holding positions in the same commodity (or that all commodities in which customers hold positions will move in unison) and that either shorts or longs will predominate.693 This approach is conservative because it does not take into account diversification effects. For example, while some customers may hold positions in energy products, which may be volatile on a particular day, others may predominately hold positions in interest rates, which may not be volatile on the same day. Moreover, because of the point in time approach adopted by the Commission, FCMs will have time to react to such changes. The Commission’s cost estimates for the amount of additional residual interest that will be required reflect an effort to make a reasonable assumption regarding the potential range of additional residual interest that could be necessary on a volatile trading day. The amount of additional residual interest that could reasonably be expected to be necessary on an ordinary trading day would be much lower because the aggregate of all customers’ gross undermargined amounts would be significantly lower on such days. However, commenters only estimated the aggregate of customers’ gross undermargined amounts on highly volatile days. They did not estimate or provide data regarding the aggregate of customers’ gross undermargined amounts on ordinary trading days. In the absence of either data or estimates from commenters regarding undermargined amounts in customers’ accounts on ordinary trading days, the Commission is not able to quantify the amount of additional residual interest needed by FCMs in ordinary trading conditions, but believes that it is significantly less than what is estimated above for volatile trading days. Commenters did not identify what level of volatility they had in view when offering estimates for additional residual interest that would be necessary for a ‘‘volatile’’ trading day. For example, commenters may have had in mind days that were volatile relative to market conditions over the last year or two, or that are volatile relative to the range of all possible outcomes. Context suggests 693 See ISDA Comment Letter at 4–5 (Feb. 15, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 68596 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 the latter assumption, since commenters asserted elsewhere that FCMs would have to anticipate market movements in order to maintain sufficient residual interest at all times to cover the sum of customers’ undermargined amounts during a highly volatile trading day.694 Given this, the Commission notes that highly volatile days are only a small fraction of all total trading days, and therefore, the costs associated with additional residual interest required on such highly volatile days would only accrue on a correspondingly small fraction of the total trading days in a given year. FCMs would, however, bear an ongoing cost associated with maintaining an open credit facility or some other source of funds that is able to provide rapid access to sufficient liquidity to meet any additional residual interest requirements when highly volatile days do occur. The Commission does not have adequate data to estimate the cost of this credit facility. Since it is not feasible to estimate the costs to FCMs to cover the need for additional residual interest between the times of the daily settlement and the end-of-day by obtaining intraday lines of credit from lenders, the Commission has taken a conservative approach, and has assumed, for the sake of quantification, that firms will raise capital sufficient to meet their residual interest needs on highly volatile trading days, and will keep that amount of capital on all days, holding it either in residual interest or in liquid assets that are available to be deposited into segregation. The Commission is aware that the top-10 largest FCMs (ranked by total amount of customer funds in section 4d(a)(2) segregated accounts and 30.7 accounts as of November 30, 2012) are contained in bank holding companies.695 Most of these bank holding companies have short-term credit ratings of Moody’s P–1, Standard & Poor’s A–1, and Fitch F1, while a few have holding companies with P–2, A–2, and F2 ratings. The FCM subsidiary usually derives its credit standing from the bank holding company, with the rating of the FCM subsidiary being often the same or sometimes one credit grade 694 See, e.g., LCH.Clearnet Comment Letter at 4– 5 (Jan. 25, 2013) (noting that ‘‘regardless of the amount of capital an FCM dedicated to continuous compliance, FCMs would still be at risk of a violation’’). See also CMC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5 (Feb. 15, 2013); FIA Comment Letter at 4, 13, 15 (Feb. 15, 2013); MFA Comment Letter at 8 (Feb. 15, 2013); NPPC Comment Letter at 2 (Feb. 15, 2013); TD Ameritrade Comment Letter at 4–5 (Feb. 15, 2013). 695 See https://www.cftc.gov/MarketReports/ FinancialDataforFCMs/HistoricalFCMReports/ index.htm. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 lower than the holding company. To estimate the interest rate that a bank holding company would charge its FCM subsidiary for funding additional residual interest, the Commission is using as a proxy for the costs of these funds the historical average of 30-day AA-financial commercial paper (consonant with the short-term credit ratings of the bank holding companies) minus the yield on the 4-week constant maturity U.S. Treasury bill (to account for the return that FCMs will earn on investments permitted under Regulation 1.25) and is adding 0.10% for underwriting and administrative overhead costs to issue commercial paper.696 This results in an average cost of funds of 0.35% for the top-10 largest FCMs from July 2001 to July 2013. For the remaining FCMs, the Commission is using as a proxy for the costs of funds the difference between the prime rate and the yield on the 4-week constant maturity U.S. Treasury bill. This results in an average cost of funds of 3.25% from July 2001 to July 2013.697 The Commission is using historical FCM data from November 30, 2012, even though there is more recent data available, to be consistent with the data ISDA used in the analysis in its comment letter.698 As of November 30, 2012, there was approximately $147.1 billion in customer funds in section 4d(a)(2) segregated accounts (excluding excess amounts contributed by FCMs).699 The top-10 FCMs held approximately $111.7 billion in section 4d(a)(2) segregated accounts,700 and the remaining FCMs held approximately $35.4 billion in section 4d(a)(2) segregated accounts.701 ISDA estimated the potential future FCM funding requirement for futures arising from the residual interest proposal by subtracting the existing customer excess. ISDA estimated the futures excess to be between $40–$70 billion and employed the midpoint of this range, $55 billion in its calculations. Using ISDA’s point estimate for existing customer excess of 696 The Commission computes the average yields from July 2001 to July 2013. The constant maturity 4-week Treasury yield time series with month observations begins in July of 2001. See https:// www.federalreserve.gov/releases/H15/data.htm. 697 The Commission recognizes that there may be some FCMs with weak credit ratings that would have to pay even more than the prime interest rate to secure additional residual interest. See id. 698 The Commission believes that the November 30, 2012 FCM data is typical. Moreover, this permits comparison with other estimates in the comment letter. 699 See https://www.cftc.gov/MarketReports/ FinancialDataforFCMs/HistoricalFCMReports/ index.htm. 700 See id. 701 Id. PO 00000 Frm 00092 Fmt 4701 Sfmt 4700 $55 billion, the Commission estimates there was, at the top-10 FCMs, (55/ 177.1) (i.e., 31%) times $111.7 billion or approximately $34.7 billion in existing customer excess in section 4d(a)(2) segregated accounts. Similarly, for the remaining FCMs, the Commission estimates that there was approximately $11 billion in customer excess in section 4d(a)(2) segregated accounts.702 First, the Commission performs its calculations for the residual interest projected in the section 4d(a)(2) segregated accounts based on ISDA’s assumption that residual interest were required ‘‘at all times.’’ For the top-10 FCMs, the Commission subtracts $34.7 billion from $111.7 billion giving approximately $77 billion in required margin. The Commission uses ISDA’s suggestion for additional residual interest needed by FCMs and takes 60% of this figure, approximately $46.2 billion, as the estimate for total residual interest needed. As of November 30, 2012, the top-10 FCMs held approximately $6.5 billion in residual interest.703 Using these figures, the top10 FCMs would need to fund approximately $39.7 billion in additional residual interest. At a cost of funds of 0.35%, this would result in an annual cost of $139 million for the top10 FCMs based on the historical costs of funds. For the remaining FCMs, the Commission subtracts $11 billion (excess margin) from $35.4 billion (balance in 4d(a)(2) accounts) leaving approximately $24.4 billion (required margin in 4d(a)(2) accounts). Again, using ISDA’s 60% formulation gives $14.6 billion in total residual interest needed under an at all times approach. The remaining FCMs are holding approximately $3.9 billion in residual interest.704 Consequently, the remaining FCMs would need to fund approximately $10.7 billion ($14.6 billion–$3.9 billion) in additional residual interest. At a cost of funds of 3.25%, this gives the historical annual cost of approximately $348 million. For all FCMs, the aggregate annual cost is approximately $487 million (that is, $139 million plus $348 million) to fund the additional residual interest needed by FCMs due to § 1.22 if residual interest were required at all times. However, these figures change significantly if residual interest is not required until the daily settlement. As 702 That is, 31% of $35.4 billion and $2.3 billion, respectively. 703 See https://www.cftc.gov/MarketReports/ FinancialDataforFCMs/HistoricalFCMReports/ index.htm. 704 See id. E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations noted above, both FIA and ISDA estimate that the residual interest requirement would be reduced by 90% or more if it were required to be present at the end-of-day on the following business day. As discussed above, the Commission estimates that using the point in time approach with morning settlement (rather than end-of-day) will reduce the need for additional residual interest by 25–50%. The midpoint of this range is 37.5%. A reduction of 37.5% (as a consequence of moving to the point in time approach) leaves a multiplier of 62.5%. Multiplying 62.5% by ISDA’s estimate (for the at all times approach) of 60% of required margin results in a product of 37.5%.705 For the top-10 FCMs, the Commission multiplies the $77 billion in required margin by 37.5% giving approximately $28.9 billion in residual interest needed. The top-10 FCMs are currently holding approximately $6.5 billion in residual interest. The top-10 FCMs would be required to fund approximately $22.4 billion ($28.9 billion–$6.5 billion) in additional residual interest. At a cost of funds of 0.35%, this would result in an annual cost of approximately $78 million for the top-10 FCMs. For the remaining FCMs, the Commission multiplies $24.4 billion (required margin in 4d(a)(2) accounts) by 37.5% giving approximately $9.2 billion. The remaining FCMs are holding $3.9 billion in residual interest.706 Consequently, the remaining FCMs would be required to fund approximately $5.3 billion ($9.2 billion¥$3.9 billion) in additional residual interest. At a cost of funds of 3.25%, this would result in an annual cost of approximately $171 million with current economic conditions. This result in a total annual cost of approximately $249 million to fund the additional residual interest needed by FCMs due to § 1.22 using the Commission’s assumption of 37.5% of initial margin needed for residual interest. As explained above, the final rule does not require FCMs to take this approach. Instead, the Commission believes that firms are likely to manage margin calls to reduce the sum of customers’ gross undermargined amounts prior to the time of settlement. They may also mitigate costs by using revolving credit facilities or other temporary sources of liquidity to meet, 705 The fact that the reduction of 37.5% (the midpoint of 25% and 50%) multiplied by ISDA’s estimate of 60% results in a product that is also 37.5% is coincidental. 706 See https://www.cftc.gov/MarketReports/ FinancialDataforFCMs/HistoricalFCMReports/ index.htm. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 in part, the need for additional residual interest on volatile trading days. The Commission received comments on the proposed costs and benefits of § 1.22. Several commenters supported the proposal, noting that it would prevent customer funds from being used to subsidize an FCM’s obligations, reduce systemic risk, and enhance customer protection, especially in the event of an FCM bankruptcy.707 In particular, SIFMA stated that the proposal, ‘‘in effect, shifts the costs and burdens of a margin shortfall from customers with excess margin to customers with deficits, where it properly belongs.’’ 708 In addition, Vanguard argued that the ‘‘proposed changes correctly shift the risk to customers in deficit and away from any excess margin transferred by other customers.’’ 709 On the other hand, a number of commenters interpreted the ‘‘at all times’’ language to require FCMs to continuously calculate their customers’ aggregate margin deficits and stated that they believe such a requirement is infeasible.710 As a result of this interpretation of the proposal, these commenters argued that the proposal would dramatically increase costs and create liquidity issues for FCMs and their customers.711 Many commenters asserted that the proposal would therefore result in FCMs requiring 707 See, e.g., CFA Comment Letter at 5–6 (Feb. 13, 2013); CIEBA Comment Letter at 2–3 (Feb. 20, 2013); ICI Comment Letter at 3 (Jan. 14, 2013); Franklin Comment Letter at 2 (Feb. 15, 2013); Paul/ Weiss Comment Letter at 3 (Feb. 15, 2013); SIFMA Comment Letter at 2 (Feb. 21, 2013); Vanguard Comment Letter at 7–8 (Feb. 22, 2013). 708 SIFMA Comment Letter at 2 (Feb. 21, 2013). 709 Vanguard Comment Letter at 7 (Feb. 22, 2013). 710 See, e.g. Advantage Comment Letter at 6–8 (Feb. 15, 2013); CMC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5 (Feb. 15, 2013); FIA Comment Letter at 4, 7–8, 13 (Feb. 15, 2013); LCH.Clearnet Comment Letter at 4–5 (Jan. 25, 2013); MFA Comment Letter at 8 (Feb. 15, 2013); MGEX Comment Letter at 2 (Feb. 18, 2013); Newedge Comment Letter at 2 (Feb. 15, 2013); NPPC Comment Letter at 2 (Feb. 15, 2013; RCG Comment Letter at 3 (Feb. 12, 2013); TD Ameritrade Comment Letter at 4–5 (Feb. 15, 2013). 711 See, e.g., Advantage Comment Letter at 8 (Feb. 15, 2013) (‘‘The avalanche of buying or selling that this rule will induce contradicts decades of effort by the industry to thwart market panics and provide markets with liquidity and stability.’’); CMC Comment Letter at 2 (Feb. 15, 2013) (stating that the proposal ‘‘could create liquidity issues and increase costs for FCMs and end users. Such a decrease in liquidity could be substantial, and limit the number and type of transactions FCMs clear, the number of customers they service and the amount of financing they provide.’’); CME Comment Letter at 5–6 (Feb. 15, 2013) (‘‘We believe that this will be a significant and unnecessary drain on liquidity that will make trading significantly more expensive for customers to hedge financial or commercial risks. The liquidity drain will be exacerbated to the extent that the demand for excess margin will increase the costs and limit the activities of market makers.’’). PO 00000 Frm 00093 Fmt 4701 Sfmt 4700 68597 customers to pre-fund their positions.712 FHLB cautioned that ‘‘[w]hile it cannot be disputed that a residual interest buffer should lower the risk that an FCM will fall out of compliance with its segregation requirements, there will likely be a real economic cost associated with maintaining whatever residual interest buffers is established by an FCM.’’ 713 FHLB further noted that the ‘‘funds maintained by an FCM as residual interest can reasonably be expected to earn less than the FCM’s unrestricted funds,’’ thus, the proposal ‘‘represents a real cost to FCMs’’ that will be passed on to customers.714 ISDA stated that the proposal will make customers ‘‘self-guaranteeing’’ and diminish reliance on the FCM, and that, while this would diminish overall risk of FCM default, it comes at a very significant cost to market participants, market volumes, and liquidity.715 CHS Hedging observed that ‘‘pre-funding accounts concentrates additional funds at FCMs, which seems to contradict the spirit of the’’ customer protection rules.716 As noted above, the Commission recognizes that some FCMs may require their customers, or some subset of their customers, to increase the margin they maintain in their accounts in order to cover possible deficits that could materialize during the period of time it would typically take that customer to respond to a margin call. This is particularly the case if and when the Residual Interest Deadline moves to the time of the daily settlement. However, the Commission expects that the number of customers and the amount of additional margin required from those customers would be significantly less than was asserted by some of the commenters because of modifications made to the final rule. As noted above, the final version of the rule allows FCMs to meet the gross sum of the undermargined amounts several hours after (and, during the phase-in period, at the end of the next business day after) 712 See, e.g., FIA Comment Letter at 17 (Feb. 15, 2013); MFA Comment Letter at 8 (Feb. 15, 2013); Newedge Comment Letter at 2 (Feb. 15, 2013). 713 FHLB Comment Letter at 3–4 (Feb. 15, 2013). 714 Id. at 4 n.5. 715 ISDA Comment Letter at 3 (Feb. 15, 2013) (noting that ‘‘[e]ffectively doubling margins will damage futures and swaps markets by destroying the value proposition for many liquidity providers essential to the market’s efficiency.’’). See also ISDA Comment Letter at 2–3 (May 8, 2013) (stating that the proposal would cause customers to pre-fund margin, which ‘‘would remake the cleared swaps and futures markets into one exclusively for ‘selfguaranteeing’ customers,’’ which ‘‘would be damaging to markets by destroying the incentives for continued participation by liquidity providers essential to the markets’ efficiency.’’). 716 Id. E:\FR\FM\14NOR2.SGM 14NOR2 68598 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 the undermargined amount is calculated, which is expected to significantly mitigate the need for FCMs to maintain a ‘‘preventative buffer’’ of residual interest or additional customer margin that is sufficient to cover customers’ potential undermargined amounts in a worst case scenario. Moreover, in cases where customers develop the ability to submit margin payments prior to the Residual Interest Deadline, there will not be any need for additional customer margin on an ongoing basis. It is therefore likely that FCMs will require additional customer margin on an ongoing basis in situations only where (1) a particular customer is not be able to routinely make margin payments prior to the Residual Interest Deadline, and (2) the sum of the undermargined amounts in customers’ accounts that cannot be collected before the Residual Interest Deadline is a relatively large compared to the amount of residual interest that the FCM otherwise chooses to maintain.717 The Commission does not agree that increased residual interest requirements are contrary to the spirit of the customer protection rules. The rules are intended to provide additional protections to funds held at FCMs, not to reduce the amount of funds held at FCMs. The likelihood of customer defaults leading to an FCM default is reduced. So, additional customer funds at FCMs are better protected with the increased residual interest requirements in place. Several commenters argued that the costs associated with the proposal would decrease competition between FCMs.718 In particular, FIA stated that the proposal may force a number of small to mid-sized FCMs out of the market, which will decrease access to the futures markets and increase costs for IBs, hedgers and small traders.719 In 717 The Commission expects that this would happen on normal trading days. On highly volatile trading days, the Commission expects that customers’ gross undermargined amounts would likely be covered by residual interest acquired through a line of credit or credit facility, as discussed above, rather than through customer prefunding since the costs of the former are likely to be considerably less than the costs of the latter. However, the Commission does not, at this time, have data regarding individual customers’ historical gross undermargined amounts and therefore does not have adequate information to estimate the number of FCM and customer combinations where additional customer margin would be required on an ongoing basis. 718 See, e.g., CHS Hedging Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 6 (Feb. 15, 2013); FIA Comment Letter at 17 (Feb. 15, 2013); Frontier Futures Comment Letter at 3 (Feb. 15, 2013); Jefferies Comment Letter at 7 (Feb. 15, 2013); JSA Comment Letter at 1–2 (Feb. 15, 2013); NCFC Comment Letter at 2 (Feb. 15, 2013); NIBA Comment Letter at 1 (Feb. 15, 2013). 719 See FIA Comment Letter at 17 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 addition, FIA argued that the proposal would significantly impair the price discovery and risk management functions served by the market.720 JSA argued that the proposal would be ‘‘punitive in a highly competitive environment that already places the midsize operator at a disadvantage to his better capitalized multinational competitors.’’ 721 Moreover, JSA stated that the cost of the proposal would result in a higher cost of hedging, which would be prohibitive and prompt agricultural users to walk away from the futures market.722 The Congressional Committees requested that the Commission consider these effects in drafting the final rule.723 Other commenters argued that the proposal would disproportionately burden smaller FCMs and the customers of smaller FCMs.724 CME asserted that, given this increase in cost, some customers may transfer their accounts to the larger, better-capitalized FCMs to reduce the cost of trading,725 but that agricultural customers ‘‘likely will not be able to transfer to the larger FCMs because they do not fit their customer profile,’’ thereby making these customers bear more of the cost burden.726 Frontier Futures asserted that many small customers, including most farmers, do not watch markets constantly. Therefore, it would be difficult for them to meet margin calls on a moment’s notice, thereby causing FCMs to require significantly higher margins or to liquidate customer positions where margin calls cannot be immediately met.727 Frontier Futures also asserted that the proposal ‘‘may force a number of small to mid-sized FCMs out of the market,’’ making it more expensive, if not impossible, for IBs and small members to clear their business, removing ‘‘significant capital from the futures industry,’’ and ‘‘reducing stability to the markets as a whole.’’728 RJ O’Brien stated that the proposed residual interest requirement 720 See id. at 4, 17. Comment Letter at 1 (Feb. 15, 2013). 722 Id. at 2. 723 See Congressional Committees Letter at 1 (Sept. 25, 2013). 724 See, e.g., CME Comment Letter at 5–6 (Feb. 15, 2013); FCStone Comment Letter at 3 (Feb. 15, 2013); Global Commodity Comment Letter at 1 (Feb. 13, 2013); Randy Fritsche Comment Letter at 1 (Feb. 15, 2013); JSA Comment Letter at 1 (Feb. 15, 2013); NCBA Comment Letter at 2 (Feb. 15, 2013); NCFC Comment Letter at 2 (Feb. 15, 2013); RJ O’Brien Comment Letter at 3 (Feb. 15, 2013); ICA Comment Letter at 1–2 (Feb. 15, 2013); TCFA Comment Letter at 2 (Feb. 15, 2013). 725 CME Comment Letter at 6 (Feb. 15, 2013). 726 Id. 727 See Frontier Futures Comment Letter at 2–3 (Feb. 14, 2013). 728 Id. 721 JSA PO 00000 Frm 00094 Fmt 4701 Sfmt 4700 is impractical because many farmers and agricultural clients still use checks and ACH to meet margin calls.729 RJ O’Brien also stated that if the proposal is adopted, FCMs that service noninstitutional clients will struggle to remain competitive and the proposal may result in fewer clearing FCMs and greater systemic risk to the marketplace.730 Similarly, CME stated that the proposed residual interest requirement would lead to consolidation among FCMs, which will ‘‘actually increase[ ] systemic risk by concentrating risk among fewer market participants.’’ 731 The Commission recognizes that smaller FCMs may have more difficulty than large FCMs in absorbing the additional costs created by the requirements in § 1.22. In general, it is likely that smaller FCMs have a larger percentage of customers who do not have requisite personnel or systems to receive margin calls and make margin payments in a matter of hours, thus creating a disproportionate need for prefunding or additional residual interest at smaller FCMs. Smaller FCMs are also likely to have higher borrowing costs than larger FCMs, so the impact of obtaining additional capital to meet increased residual interest needs may be more significant for them. If increased costs force some smaller FCMs out of the market, it is possible, though not certain, that smaller customers could have difficulty finding alternative FCMs to service their needs. However, as noted above, the Commission believes that the changes made to § 1.22(c), and the extended phase-in period, in the final rule substantially reduce the costs to FCMs and their customers when compared to the proposed version of the requirement. By reducing the costs, these changes have also reduced some of the associated burdens that would potentially be disproportionately borne by smaller FCMs. The Commission does not agree that a reduced number of FCMs would necessarily reduce competition in a way that impacts the price of services. Any increases in costs to customers are more likely the result of increased costs to the FCM that are passed on to customers, which are the costs that have been mitigated by changes to the final rule. Moreover, the Commission is cognizant of the cost of an FCM failure where customers suffer a loss of segregated funds, both in terms 729 RJ O’Brien Comment Letter at 3 (Feb. 15, 2013). See also ICA Comment Letter at 1–2 (Feb. 15, 2013). 730 RJ O’Brien Comment Letter at 3 (Feb. 15, 2013). 731 CME Comment Letter at 6 (Feb. 15, 2013) (emphasis in original). E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations of costs to the customers who lose such funds (or, if such funds are ultimately recovered, the use of such funds) as well as the industry-wide cost associated with a loss in confidence in the safety of customer funds. These costs support the importance of increasing the safety of the system. Moreover, the Commission will closely review these issues as part of considering the Report. The Commission disagrees with the comments that there would be a consolidation of FCMs that would cause the rule to have a net effect of increasing systemic risk. Instead, the Commission expects that the overall effect of the final rule will be to significantly reduce systemic risk. For example, as noted by CIEBA,732 the residual interest requirement will likely reduce systemic risk by enabling FCMs to ensure that they can meet all customer obligations at any time without using another customer’s funds to do so. Moreover, larger, well-capitalized FCMs are more likely to be able to absorb losses than less well-capitalized FCMs. To the extent that FCMs that are affiliated with large financial institutions take on additional business as a result of a potential reduction in the number of FCMs, the increase in risk to these financial institutions is expected to be small relative to their existing risk and to not materially increase the systemic risk associated with these financial institutions. Finally, some of the costs that commenters asserted could lead to a reduction in the number of FCMs under the proposed rule have been mitigated by changes to the final rule. Several commenters also observed that the proposal would mark a significant departure from current market practice and could have a material adverse impact on the liquidity and smooth functioning of the futures and swaps markets.733 The Commission has chosen to provide an extended phase-in period for the requirement in § 1.22(c) and therefore does not expect that smooth functioning of the futures and swap markets will be disrupted. If customers withdraw from the futures and swap markets as a consequence of the additional costs, liquidity could be negatively affected. However, the Commission believes that by allowing FCMs several hours (and, during the phase-in period, until the end of the next business day) after customer accounts become undermargined to ensure that the requisite amount of 732 See CIEBA Comment Letter at 3 (Feb. 20, 2013). 733 See, e.g., MGEX Comment Letter at 2 (Feb. 18, 2013); AIMA Comment Letter at 3 (Feb. 15, 2013); CMC Comment Letter at 2 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 residual interest is on deposit, the costs associated with the requirement have been mitigated, which reduces the likelihood that customers will be prompted to withdraw from the markets due to related expenses. The Commission also considered several additional alternative proposals raised by the commenters. Newedge suggested that the Commission consider less costly alternatives to the proposed rule, such as allowing the FCM ‘‘to count guaranty fund deposits with [DCOs] as part of their residual interest’’ or limiting the residual interest amount that an FCM must carry to only a limited number of its largest customers.734 The Commission believes, however, that the latter proposal is not consistent with the statutory requirement that ‘‘one customer’s funds may not be used to margin, guarantee, or pay another customer’s obligations’’ and therefore did not adopt this suggestion. Regarding the former alternative, guarantee funds held at the DCO are a critical part of the waterfall that covers losses in the event of an FCM’s default. One of the primary purposes of the customer protection regime is to protect customers from the risk of losses in the event that their FCM defaults. Using funds that may be used to cover the FCM’s proprietary losses (i.e., the guarantee fund) to guarantee customers’ funds could expose customer funds to the FCM’s losses in a double default scenario. The Commission, therefore, does not believe that this alternative is consistent with the goals of the customer protection regime. Frontier Futures suggested that firm firewalls be put in place between customer funds and an FCM’s proprietary funds in the form of approval by an independent agency for an FCM to transfer customer funds.735 Frontier Futures also recommended that FCMs ‘‘do their proprietary trading through another FCM thereby engaging the risk management of a third party.’’ 736 The Commission has chosen not to require FCMs to seek external approval before pulling excess residual interest out of a customer segregated account, or to conduct their proprietary trading through another FCM. The Commission expects that the requirements in § 1.23 will accomplish some of the same benefits—ensuring that FCMs only withdraw significant portions of excess residual interest when they have adequate information to 734 Newedge Comment Letter at 3 (Feb. 15, 2013). See also RJ O’Brien Comment Letter at 5 (Feb. 15, 2013). 735 See Frontier Futures Comment Letter at 3 (Feb. 14, 2013). 736 Id. PO 00000 Frm 00095 Fmt 4701 Sfmt 4700 68599 ensure that it is truly excess and that senior management is accountable for such decisions—with greater efficiency and less operational costs. Internal verification of residual interest balances and obtaining signatures from individuals inside the organization is likely to be considerably faster, and therefore more efficient and less costly. Regarding the second proposal, it is not clear how the commenter expected the third party FCM to augment the first FCM’s risk management or what specific type of risk would be addressed by such an arrangement. A third party FCM would be responsible for collecting margin and for making payments to the DCO for positions related to the first FCM’s proprietary positions. But this arrangement would not help protect customers at the first FCM from ‘‘fellow customer risk.’’ Finally, some commenters requested that the Commission refrain from adopting the proposal until it conducts further analysis with the industry regarding the costs and benefits of such proposal.737 Further, the Congressional Committees requested that the Commission weigh the costs and benefits of the final rule, and in particular ‘‘carefully consider the consequences of changing the manner or frequency in which ‘residual interest’ . . . is calculated.’’ 738 The ‘‘point in time’’ approach adopted by the Commission in this final rule and the extended phase-in period will significantly reduce (as compared to the proposed rule) the amount of additional residual interest that FCMs need to maintain in their segregated accounts on an ongoing basis in order to comply with § 1.22(c). As noted above, the final rule will mitigate some, though not all of the costs associated with pre-funding obligations that commenters expressed concern about, while simultaneously ensuring that the statutory obligations are met and that the corresponding protection from ‘‘fellow customer risk’’ is achieved. In light of these concerns and in response to the commenters’ requests, the Commission is directing staff to, within thirty months of the publication 737 See, e.g., AIMA Comment Letter at 3 (Feb. 15, 2013); CCC Comment Letter at 2–3 (Feb. 15, 2013); CHS Hedging Comment Letter at 2–3 (Feb. 15, 2013); CME Comment at 5–7 (Feb. 15, 2013); AFBF Comment Letter at 2 (Feb. 15, 2013); Jefferies Comment Letter at 9 (Feb. 15, 2013); JSA Comment Letter at 1–2 (Feb. 15, 2013); NCBA Comment Letter at 2 (Feb. 15, 2013); NGFA Comment Letter at 5 (Feb. 15, 2013); NIBA Comment Letter at 1–2 (Feb. 15, 2013); TCFA Comment Letter at 2 (Feb. 15, 2013); AFMP Group Comment Letter at 1–2 (Sept. 18, 2013). 738 Congressional Committees Comment Letter at 1 (Sept. 25, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 68600 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 of this release, solicit further public comment, hold a public roundtable, and conduct further analysis regarding the practicability of moving the Residual Interest Deadline from 6:00 p.m. Eastern Time on the date of settlement to the time of settlement (or to some other time of day). The Report should include an analysis of whether and on what schedule it would be feasible to move the Residual Interest Deadline, and the costs and benefits of such potential requirements. All of this will take place well before the expiration of the phasein period. The Commission will consider the Report and within nine months after the publication of the Report may take additional action regarding the phase-in period by Commission order and may change the Residual Interest Deadline by rulemaking. Section 1.23 Interest of Futures Commission Merchants in Segregated Funds; Additions and Withdrawals Revised § 1.23 places new restrictions regarding an FCM’s withdrawal of residual interest funds not for the benefit of customers. As adopted, an FCM cannot withdraw any residual interest funds not for the benefit of customers unless it has prepared the daily segregation calculation from the previous day and has adjusted the segregation calculation for any activity or events that may have decreased residual interest since the close of business the previous day. In addition, an FCM is permitted to withdraw more than 25 percent of its residual interest for purposes other than the benefit of customers within one day only if it: (1) Obtains a signature from the CEO, CFO or other senior official as described in § 1.23(c)(1) confirming approval to make such a withdrawal; and (2) sends written notice to the Commission and the firm’s DSRO indicating that the requisite approvals from the CEO, CFO or other senior official have been obtained, providing reasons for the withdrawal, listing the names and amounts of funds provided to each recipient, and providing an affirmation from the signatory indicating that he or she has knowledge and reasonable belief that the FCM is still in compliance with segregation requirements after the withdrawal. In addition, if the FCM drops below its target threshold for residual interest because of a withdrawal of residual interest not for the benefit of customers, the next day it must either replenish residual interest sufficient to surpass its target, or if senior leadership believes that the original target is excessive, the FCM may revise its target in accordance VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 with its policies and procedures established in § 1.11. The amendments to § 1.23 were also made for Cleared Swaps and foreign futures at § 22.17, and § 30.7(g) respectively, and the costs and benefits considerations of those amendments are considered to be substantively the same. Costs and Benefits Restrictions on withdrawals of residual interest provide the benefit of an additional layer of protection for customer funds contained in segregated accounts. An FCM may withdraw residual interest as long as it always maintains sufficient FCM funds in the account to cover any shortfall that exists in all of its customers’ segregated accounts. However, as a practical matter, the segregation requirements fluctuate constantly with market movements, and customer surpluses or deficits also fluctuate depending on the speed with which customers meet margin calls. As a consequence, the amount of residual interest an FCM has in a segregated account similarly fluctuates. A sufficient amount of residual interest to cover deficiencies in customers’ accounts at one point in time may appear insufficient by the next settlement cycle in extreme market conditions. Therefore, it is important for an FCM to maintain sufficient residual interest to cover both current deficiencies in customer accounts as well as any additional deficiencies that could develop over a relatively short period of time. Restrictions on withdrawals of residual interest help to ensure that the FCM maintains a stable base of residual interest and not withdraw it for other liquidity needs when doing so may result in jeopardizing customer funds in the segregated account if market conditions change quickly. Prohibiting any withdrawal of residual interest until the customer segregation account calculations are complete for the previous day and requiring the FCM take into account any subsequent developments in the market or the account that could impact the amount of residual interest before withdrawing funds protects customer funds by reducing the likelihood that lack of current information could cause the FCM to make a withdrawal from customer funds that is large enough to cause the account to fall below its segregated funds requirement. The adopted amendments require FCMs to take several steps in order to remove more than 25 percent of their residual interest in a single day. Large, single-day withdrawals of the FCM’s residual interest in the customer PO 00000 Frm 00096 Fmt 4701 Sfmt 4700 segregated account could be an indication of current or impending capital or liquidity strains at the FCM. The additional steps ensure that senior management is knowledgeable of and accountable for such withdrawals, that no shortfall in the customer segregated accounts is created by the withdrawals, and that the CFTC and DSRO are both alerted to allow them to monitor the FCM and its segregated accounts closely over subsequent days and weeks. Additional monitoring will help to ensure that the integrity and sufficiency of the FCM’s customer segregated accounts are protected. In addition, notifying the CFTC and DSRO gives both an opportunity to ask questions about the FCM’s reasonable reliance on its estimations of the adequacy of its funds necessary to meet segregation requirements. Such questions may give the Commission and DSRO comfort that the transaction does not indicate any strain on the FCM’s financial position, or conversely, may raise additional questions and alert the CFTC and DSRO to the need for heightened monitoring of the FCM or further investigation of its activities. The amendment also adds protection by ensuring that the Commission has records regarding the name and address of parties receiving funds from any withdrawal of residual interest in segregated funds not for the benefit of customers. Also, requiring an FCM to replenish its residual funds the following day any time a withdrawal causes it to drop below the FCM’s target amount helps to ensure that residual interest is not used by the firm to address liquidity needs in other parts of the firm unless those needs are very short-term in nature (i.e., less than 24 hours). Finally, the amendments are consistent with rules imposed on all FCMs by the DSROs. In the NPRM, the Commission qualitatively analyzed that the amendments to § 1.23 would create costs for FCMs and quantitatively estimated costs associated with obtaining management approvals for withdrawals exceeding 25 percent of the prior day’s residual interest. The restrictions on withdrawals were anticipated to potentially prevent an FCM from withdrawing funds quickly in order to meet certain operational needs, or to take advantage of specific investment opportunities, and in general could be expected to result in an FCM needing to hold additional capital outside of residual interest in order to meet operational needs. The Commission did not receive comments on its quantitative estimates of the costs of obtaining management approvals. However, the Commission E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations did receive comments on its qualitative analysis of costs, and also received comments that the use of the prior day’s actual residual interest as the amount applicable to the restriction would provide a disincentive to FCMs holding additional funds at DCOs as residual interest, which commenters posited as less beneficial to the protection of customers. Several commenters, including FIA and Jefferies suggested the Commission utilize the targeted residual amount as the threshold for notifications and withdrawal restrictions, in order to not discourage FCMs from holding additional funds as residual interest.739 FIA suggested that the qualitative analysis of the costs was not sufficient and that the amendments would impose a tremendous operational and financial burden on the industry, requiring the development and implementation of entirely new systems to assure compliance and detrimentally impacting liquidity.740 The Commission believes however, that this comment is not directed to the withdrawal restrictions as adopted or the necessity to replenish the targeted residual interest amount, but instead directed at requirements with respect to holding residual interest sufficient to cover customer under margined amounts, which is addressed separately in the cost benefit considerations for § 1.22. Jefferies provided some quantitative estimates of the costs of holding increased residual interest, specifically positing that even a five percent increase in residual interest could cost Jefferies $500,000.741 FIA posited that FCMs currently may increase residual interest day-to-day for expected events, including during stressed market conditions and for the purpose of currency facilitation, and to impose withdrawal restrictions based on the actual, as opposed to targeted, excess would reduce the actual likelihood of FCMs infusing of additional proprietary funds in those circumstances.742 The Commission understands that establishing a target and holding residual interest does have costs, but disagrees with the underlying assumptions of the cost estimates provided by Jefferies. The cost estimates provided by Jefferies imply the cost of holding additional residual interest is the same as the FCM’s cost of capital. However, the cost considered for the amendments should be the difference in what can be earned by more 739 See FIA Comment Letter at 29 (Feb. 15, 2013); Jefferies Comment Letter at 4 (Feb. 15, 2013). 740 FIA Comment Letter at 13 (Feb. 15, 2013). 741 Jefferies Comment Letter at 5 (Feb. 15, 2013). 742 FIA Comment Letter at 27–29 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 conservative investments permitted for segregated funds versus otherwise if held by FCMs as unrestricted capital, unless the targeted residual amount exceeds an FCM’s minimum net capital requirement. The costs of holding some amount of residual interest is an existing cost of doing business as an FCM because, practically speaking, there is a need to hold some amount of residual interest on a day to day basis to remain in segregation compliance. Significant minimum net capital requirements exist for FCMs, currently. Unless the targeted residual interest in fact exceeds a firm’s minimum net capital requirement, the requirement to hold capital as residual interest in customer segregated accounts is not a separate additional capital requirement. Therefore, Jefferies’ contention with respect to the costs of the withdrawal restrictions being represented by the costs of additional required capital for a firm is not persuasive. Such cost is only an incremental cost of the newly adopted requirements of establishing or publicizing targets or imposing withdrawal restrictions. Further, the withdrawal restrictions adopted require a one day delay, and management approval and regulatory notifications. These are not absolute restrictions to the withdrawal of residual interest funds and the costs considered and incentives or disincentives created should not be analyzed as if they were. Even the replenishment requirement adopted, with respect to withdrawals not for the benefit of customers resulting in residual interest dropping below the target for residual interest, in order to maintain the targeted residual amount, provides an FCM with the flexibility to reassess the target as an alternative. However, all these processes must be transparent to the Commission, including the FCM’s management’s accountability for such processes. The Commission is not persuaded that the reduced incentives to provide added funds to residual interest would be a reason to adopt an alternative of using the targeted residual as opposed to the actual prior day residual as the measurement for the 25 percent withdrawal restriction, which is a requirement for notice and approval, and therefore, not an absolute restriction. The rationales for adding funds specific to certain anticipated events could just as easily provide a clear basis for the management approval and notification process required for the subsequent withdrawal of funds after those circumstances, as opposed to making them unlikely to occur at all. The benefits of clear management PO 00000 Frm 00097 Fmt 4701 Sfmt 4700 68601 accountability and regulatory transparency with respect to such practices and related operational risks (such as potentially more volatile cash flows through segregated accounts not for the benefit of customers) would still be obtained. Section 1.25 Investment of Customer Funds Regulation 1.25 sets forth the financial investments that an FCM or DCO may make with customer funds. Among other things, § 1.25 permits FCMs and DCOs to use customer funds to purchase securities from a counterparty under an agreement for the resale of the securities back to the counterparty. This type of transaction is referred to as a reverse repurchase agreement and in effect, is a collateralized loan by the FCM to its counterparty. Regulation 1.25(b)(3)(v) establishes a counterparty concentration limit, prohibiting FCMs and DCOs from using more than 25 percent of the total funds in the customer segregated account to conduct reverse repos with a single counterparty. The Commission’s amendment expands the definition of a counterparty to include additional entities under common ownership or control. Thus, as adopted, the 25percent counterparty concentration limit for reverse repurchase agreements applies not only to a single counterparty, but to all counterparties under common control or ownership. The additional adopted changes to § 1.25 are conforming amendments proposed in order to harmonize this section with other amendments adopted in this release. Costs and Benefits In the NPRM, the Commission discussed how the expansion of the concentration limitation to counterparties under common control or ownership is consistent with the original intention of the concentration limitation, which was to mitigate the potential losses or disruptions due to the default of a counterparty. The Commission has elected to adopt the amendment as a further protection to customer funds, because a default by one counterparty that is under common control or ownership, may adversely impact all of the counterparties to the reverse repurchase agreement and hence adversely impact the FCM and the funds it holds for its customers. Because the amendment incorporates the Commission’s interpretation of the existing rule, it does not alter the rule’s meaning and, therefore, the amendment does not create any incremental costs or benefits. Likewise, the additional E:\FR\FM\14NOR2.SGM 14NOR2 68602 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 changes to § 1.25 are conforming amendments proposed in order to harmonize this section with other amendments proposed in this release, and, therefore, do not create any incremental costs or benefits. Because § 1.25 sets forth the financial investments that an FCM or DCO may make with customer funds, several members of the public 743 expressed their general opinions regarding the investment and handling of customer funds by FCMs and DCOs. In general, all of the commenters supported the position that FCMs and DCOs only be allowed to make safe/non-speculative investments of customer funds and not be allowed to add risk that customers are unaware of or do not sanction. In addition, some of the commenters 744 743 Schippers Comment Letter (Dec. 10, 2013), Randy Fritsche Comment Letter (Feb. 14, 2013), NPPC Comment Letter at 2 (Feb. 14, 2013), Strelitz/ California Metal X Comment Letter (Jan. 15, 2013), Premier Metal Services Comment Letter at 4 (Jan. 3, 2013), ISRI Comment Letter at 5–7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan. 24, 2013), Kripke Enterprises Comment Letter (Dec. 12, 2012), Manitoba Comment Letter (Dec. 13, 2012), Solomon Metals Corp. Comment Letter (Jan. 15, 2013), Michael Krall Comment Letter (Dec. 17, 2012), David Kennedy Comment Letter (Dec. 17, 2012), Robert Smith Comment Letter (Dec. 17, 2012), Michael Carmichael Comment Letter (Dec. 17, 2012), Andrew Jackson Comment Letter (Dec. 17, 2012), Donald Blais Comment Letter (Dec. 17, 2012), Suzanne Slade Comment Letter (Dec. 17, 2012), Patricia Horter Comment Letter (Dec. 17, 2012), JoDan Traders Comment Letter (Dec. 17, 2012), Jeff Schlink Comment Letter (Dec. 18, 2012), Sam Jelovich Comment Letter (Dec. 18, 2012), Matthew Bauman Comment Letter (Dec. 20, 2012), Mark Phillips Comment Letter (Dec. 22, 2012), Deborah Stone Comment Letter (Dec. 24, 2013), Po Huang Comment Letter (Dec. 24, 2012), Aarynn Krall Comment Letter (Jan. 8, 2013), Vael Asset Management Comment Letter (Jan. 10, 2013), Kos Capital Comment Letter (Jan. 11, 2013), James Lowe Comment Letter (Jan. 13, 2013), Tracy Burns Comment Letter (Jan. 14, 2013), Treasure Island Coins Comment Letter (Jan. 14, 2013), and Clare Colreavy Comment Letter (Jan. 9, 2013). 744 NPPC Comment Letter at 2 (Feb. 14, 2013), Premier Metal Services Comment Letter at 4 (Jan. 3, 2013), ISRI Comment Letter at 5–7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan. 24, 2013), Kripke Enterprises Comment Letter (Dec. 12, 2012), Manitoba Comment Letter (Dec. 13, 2012), Solomon Metals Corp. Comment Letter (Jan. 15, 2013), Michael Krall Comment Letter (Dec. 17, 2012), David Kennedy Comment Letter (Dec. 17, 2012), Robert Smith Comment Letter (Dec. 17, 2012), Michael Carmichael Comment Letter (Dec. 17, 2012), Andrew Jackson Comment Letter (Dec. 17, 2012), Donald Blais Comment Letter (Dec. 17, 2012), Suzanne Slade Comment Letter (Dec. 17, 2012), Patricia Horter Comment Letter (Dec. 17, 2012), JoDan Traders Comment Letter (Dec. 17, 2012), Jeff Schlink Comment Letter (Dec. 18, 2012), Sam Jelovich Comment Letter (Dec. 18, 2012), Matthew Bauman Comment Letter (Dec. 20, 2012), Mark Phillips Comment Letter (Dec. 22, 2012), Deborah Stone Comment Letter (Dec. 24, 2013), Po Huang Comment Letter (Dec. 24, 2012), Aarynn Krall Comment Letter (Jan. 8, 2013), Vael Asset Management Comment (Jan. 10, 2013), Kos Capital Comment (Jan. 11, 2013), James Lowe Comment Letter (Jan. 13, 2013), Tracy Burns Comment Letter (Jan. 14, 2013), Treasure Island Coins Comment VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 proposed that the Commission amend its regulations to provide commodity customers with the ability to ‘‘opt out’’ of granting FCMs the ability to invest customer funds (including hypothecation and rehypothecation); seven 745 of which further requested that the Commission mandate that an FCM cannot prevent a customer who so ‘‘opts out’’ from continuing to trade through that FCM merely because the customer elected to ‘‘opt out.’’ Additionally, Vanguard requested that customers have immediate access to the reports indicating that FCMs have failed to comply with various mandates including compliance with § 1.25 margin investment limits; and that customers have access on a twice monthly basis to reports on an FCM’s actual investment of customer assets to determine whether such investments are concentrated in more or less liquid assets as allowed under § 1.25.746 Although the Commission understands the concern of the public regarding the safety and investment of customer funds, because an ‘‘opt out’’ provision was not proposed by the Commission, and would in any case not be effective due to pro-rata distribution in an FCM bankruptcy, this alternative is not adopted in this final rulemaking. Section 1.26 Deposit of Instruments Purchased with Customer Funds Regulation 1.26 requires an FCM or DCO that invests futures customer funds in instruments described in § 1.25 to obtain a written acknowledgment from any depository holding such instruments. The FCM or DCO must use the Template Letters in the appendices to § 1.20, in accordance with the requirements established in § 1.20. The specifics of those requirements, as well as the costs and benefits of them, are detailed in the discussion of costs and benefits for § 1.20. If, however, an FCM or DCO invests funds with a money market mutual fund (MMMF), the FCM or DCO must use the Template Letters in the appendices of § 1.26 rather than the acknowledgment letters in the appendices of § 1.20.747 The content of Letter (Jan. 14, 2013), and Clare Colreavy Comment Letter (Jan. 9, 2013). 745 NPPC Comment Letter at 2 (Feb. 14, 2013); Premier Metal Services Comment Letter at 4 (Jan. 3, 2013); ISRI Comment Letter at 6 (Dec. 4, 2012); AIM Comment Letter at 6 (Jan. 24, 2013); Kripke Enterprises Comment Letter (Dec. 10, 2012); Manitoba Comment Letter (Dec. 13, 2012); and Solomon Metals Corp. Comment Letter (Jan, 15, 2013). 746 Vanguard Comment Letter at 4–6 (Feb. 22, 2013). 747 Further, per § 1.25(c)(3), the FCM or DCO shall obtain the § 1.26 Template Letter from ‘‘an entity that has substantial control over the [MMMF] shares PO 00000 Frm 00098 Fmt 4701 Sfmt 4700 the Template Letters in the appendices to § 1.26 is identical to those in the appendices to § 1.20 except that they include three additional provisions related specifically to funds held by the MMMF or its custodian. Specifically, the Template Letters set out the requirements established in § 1.25(c) that: (1) the value of the fund must be computed and made available to the FCM or DCO by 9:00 a.m. on the following business day; (2) the fund must be legally obligated to redeem shares and make payments to its customers (i.e., the FCM or DCO) by the following business day; and (3) the MMMF does not have any agreements in place that would prevent the FCM or DCO from pledging or transferring fund shares. Benefits The benefits are largely the same as for the Template Letters required under § 1.20, described above in the cost-andbenefit section related to § 1.20. However, there are benefits to requiring FCMs and DCOs to obtain a different Template Letter from MMMFs with respect to customer funds invested in MMMFs. Specifically, MMMFs or their custodians (as applicable) are required to acknowledge their additional obligations under § 1.25(c). Costs The costs are largely the same as for the Template Letters required under § 1.20. The general concerns raised by commenters regarding the costs arising from the Template Letters as well as the Commission’s responses are detailed in the discussion of costs for § 1.20. Section 1.29 Gains and Losses Resulting From Investment of Customer Funds Regulation 1.29 provides that an FCM or DCO may keep as its own any interest or other gain resulting from the investment of customer funds in financial instruments permitted under § 1.25; however, the FCM or DCO must manage the permitted investments consistent with the objectives of preserving principal and maintaining liquidity. The Commission’s amendment also explicitly provides that although an FCM or DCO is not required to pass the earnings on the investment of customer funds back to its futures customers, the FCM or DCO is solely responsible for any losses that result from its investment of customer funds. purchased with customer funds and has the knowledge and authority to facilitate redemption and payment or transfer of the customer funds. Such entity may include the [MMMF] sponsor or depository acting as custodian for [MMMF] shares.’’ E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations Costs and Benefits In the NPRM, the Commission discussed how the amendment clarifies that the allocation of losses on the investment of customer funds by an FCM or DCO to its customers would result in the use of customer funds in a manner that is not consistent with section 4d(a)(2) and § 1.20, as customer funds can only be used for the benefit of futures customers and limits withdrawals from futures customer accounts, other than for the purpose of engaging in trading, to certain commissions, brokerage, interest, taxes, storage or other fees or charges lawfully accruing in connection with futures trading. This change was supported by FIA, which stated its belief that the FCM’s or DCO’s responsibility for losses in § 1.25 investments ‘‘is clear and is implicit in the Act and the Commission’s rules.’’ 748 The Commission believes that market participants already recognize this responsibility and obligation and direct the investment of customer funds accordingly. Therefore, the Commission does not believe that the amendment to § 1.29(b) will create any additional costs; however, the marketplace will benefit in that the amendment provides clarity as to the FCM’s or DCO’s sole responsibility for any losses resulting from the investment of customer funds in the financial instruments listed under § 1.25. FIA filed a comment supporting the proposed amendments to § 1.29.749 No other comments were received. The Commission has adopted the amendments to § 1.29 as proposed. Section 1.30 Loans by Futures Commission Merchants; Treatment of Proceeds The Commission adopted amendments to § 1.30 to clarify that, while an FCM may provide secured loans to a customer with adequate collateral, it may not make loans to a customer on an unsecured basis or use a customer’s futures or options positions as security for a loan from the FCM to that customer. TKELleY on DSK3SPTVN1PROD with RULES2 Costs and Benefits The amendments prohibiting FCMs from providing unsecured loans to customers and from using a customer’s positions to secure loans made to such customers reduce counterparty risk borne by the FCM. The former 748 FIA, ‘‘Initial Recommendations for Customer Funds Protection’’ available at https:// www.futuresindustry.org/downloads/Initial_ Recommendations_for_Customer_Funds_ Protection.pdf. 749 FIA Comment Letter at 30–31 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 prohibition prevents the FCM from accumulating exposures to customers that have not margined their positions, while the latter prevents the additional exposure that otherwise would result from using the same collateral to secure two different risks (i.e., the risks associated with the open positions and the risks associated with the secured loan). Additionally, to the extent that the amendments would force certain customers to obtain loans from another lender, it diversifies the counterparty risk across multiple entities. The amendments also are comparable to rules of the CME for its member firms. The Commission did not quantitatively estimate the potential increase to customers’ operational costs due to the inability of customers who need or desire to use borrowed funds to meet initial and maintenance margin requirements to obtain loans necessary to fund their futures or options positions from a third party lender. The Commission requested, but did not receive, comments regarding the prevalence of FCMs’ extension of loans to customers and the potential costs customers might bear if it were necessary to obtain loans from third parties rather than from the FCMs with whom their segregated customer accounts are held. Neither were any comments received generally suggesting a qualitative burden in complying with the amendments. Section 1.32 Reporting of Segregated Account Computation and Details Regarding the Holding of Customer Funds The adopted amendments to § 1.32 allow an FCM that is not a dual registrant to follow the same procedures as dual registrants (FCM/BDs) when assessing a haircut to securities purchased with customer funds if the FCM determines that those securities have minimal credit risk. This is the same change as adopted in § 1.17, except that in § 1.17 the amendment is with respect to the haircut for securities purchased by an FCM with its own capital, whereas this amendment applies to the haircut ascribed to the collateral value of securities deposited by customers for the purpose of securing customer net debits. The cost benefit considerations are the same as those analyzed with the corresponding amendment to § 1.17. In addition, the adopted amendments (1) require FCMs to submit their daily Segregation Schedules, Secured Amount Schedules, and Cleared Swaps Segregation Schedules to the Commission and their DSROs electronically by noon the following PO 00000 Frm 00099 Fmt 4701 Sfmt 4700 68603 business day; (2) require that twice per month, each FCM submits a detailed list of all the depositories and custodians where customers’ segregated funds are held, including the amount of customer funds held by each entity and a breakdown of the different categories of § 1.25 investments held by each entity, further identifying if any of the depositories are affiliated with the FCM; and (3) require that the detailed list of depositories be submitted to the Commission electronically by 11:59 p.m. the following business day and that both segregation and secured amount statements and the detailed listing of depositories be retained by the FCM in accordance with § 1.31. Costs and Benefits Requiring FCMs to submit their daily segregation and secured amount calculations to the Commission and DSROs will enable the Commission and DSROs to better protect customer funds by more closely monitoring for any discrepancies between the assets in segregated accounts reported by the FCM and their depositories as reported to the DSRO and available to the Commission through an aggregator of depository balances. The ability of the Commission and DSRO to check for discrepancies more regularly, without notice, is likely to provide an additional deterrent to fraud. Moreover, it will enable both the Commission and DSROs to monitor for any trends that would indicate that operational or financial problems are developing at the FCM, which would give the Commission an opportunity to enhance its supervision and to intervene, if necessary, to protect customer segregated funds. In addition, the amendments are consistent with the rules of SROs that currently require each FCM to submit daily segregation and secured amount calculations to the SROs. The detailed list of depositories will provide additional information to the Commission and DSROs beyond what is required under §§ 1.20, 1.26, and 30.7. First, the detailed list of depositories will provide additional account detail including the types of securities and investments that constitute each account’s assets, rather than just the total value. Second, the reports will account for any pending transactions that would not necessarily be apparent from the daily balances submitted to an aggregator by the depositories. Third, FCMs will, in these reports, provide to the Commission and DSROs a reconciled balance, which will not be included with balances provided to the aggregator by depositories. Last, the FCM will be required to specifically E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68604 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations identify any depositories that are affiliated with the FCM. Each of these additional forms of information would enable the Commission and DSROs to provide better oversight and create additional accountability for the FCM, enhancing the protection of market participants. FCMs are already calculating segregated funds information daily and reporting the results to NFA via WinJammer by noon the following day. Similarly, the detailed list of depositories that would be required to be submitted twice per month is already required by NFA to be produced and submitted to NFA via WinJammer.750 Requiring FCMs to submit these reports to the Commission via the same platform is not expected to create any additional costs. FIA commented in support of the amendments to § 1.32 and asked for clarification that on a daily basis, a single U.S. dollar equivalent, as opposed to multiple currency by currency schedules, is what is required to be filed.751 Jefferies commented that the amendments to § 1.32 will not achieve the benefit of transparency to customers because of the way cash and investments are presented separately from balances at other FCMs and DCOs.752 However, this comment appears related to the requirements of disclosure to customers of NFA’s publicly available information, not the requirements of § 1.32, which require similar information to be reported to the Commission and DSROs. The Commission believes the detailed information required, along with all the additional disclosures being provided to customers in the amendments to all rules contained herein, do provide sufficient transparency for customers to be able to assess the risks of depositing funds with FCMs. The specific detailed amounts of cash and securities held in segregation must be provided, by individual depository, including DCOs, under the amendment to § 1.32. The Commission does not believe that customers will misinterpret the liquidity of cash held at DCOs as opposed to other types of depositories, and that therefore the requirements do not provide the transparency intended, although the Commission understands that Jefferies is concerned with the appearance of percentage calculations that are provided publicly on NFA’s portal. The Commission notes, however, 750 See Segregated Investment Detail Report at https://www.nfa.futures.org/NFA-compliance/NFAfutures-commission-merchants/fcm-reporting.pdf. 751 FIA Comment Letter at 30–31 (Feb. 15, 2013). 752 See Jefferies Comment Letter at 3 (Feb. 15, 2013). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 that the amendments to § 1.32 do not require reporting of any percentage calculations. There were no comments received regarding the Commission’s analysis that, due to the existing NFA requirements, the Commission’s amendments to § 1.32 were not expected to result in incremental costs for FCMs. With respect to the adopted changes to allow FCMs to utilize lower haircuts applicable to the market value of customer securities, if such securities are determined to have minimal credit risk, in determining the allowance provided for securing net deficits of customers, the CFA specifically objected to the ability of FCMs to obtain the benefit of lower haircuts by utilizing the process of establishing credit risk proposed in the amendment to the SEC’s rule 15c3–1.753 However, the Commission has determined that the ability of FCMs to utilize haircuts lower than the standard deduction of 15% otherwise applicable under SEC rule 15c3–1 should be equally available to FCMs along with jointly registered BD/ FCMs under the Commission’s adopted amendment to the net capital rule at § 1.17, to promote equity and fairness of competition between FCMs and joint BD/FCMs and to maintain uniformity with the capital rule of the SEC for the treatment of securities as much as practicable. The Commission believes, despite the CFA’s comments indicating the haircut could be manipulated, that the collateral value haircut for the same security for the purpose of securing net deficits should also be determined by reference to the net capital haircut for the same security, and notes both have always been determined by the SEC’s net capital haircuts for securities. The Commission believes the benefits of continuing to have such uniformity are substantial. The alternative, which necessarily would be applying a very substantial standard haircut to a debt security with minimal credit risk collateralizing a short term obligation, would be overly harsh and not accurately reflect the market risk to such collateral for the stated purpose of valuing the extent to which the customer debit is adequately secured. The Commission further notes that the SEC’s rule, which is the basis for these amendments at §§ 1.17, 1.32 and 30.7, and the formulation adopted in these amendments, still provides a standard, although lesser percentage, haircut, not a model-based haircut, and also provides for an audit trail of the BD/ FCM’s determinations supporting the determination of minimal credit risk, which should prevent the ability of 753 See PO 00000 CFA Comment Letter at 7 (Feb. 13, 2013). Frm 00100 Fmt 4701 Sfmt 4700 FCMs to manipulate the haircut, as suggested by CFA. Section 1.52 Self-regulatory Organization Adoption and Surveillance of Minimum Financial Requirements The amendments to 1.52 revise the supervisory program that SROs are required to create and adopt. In addition, for SROs that choose to delegate the function to examine FCMs that are members of two or more SROs to a DSRO, the amended rules require a plan that establishes a Joint Audit Committee which, in turn, must propose, approve, and oversee the implementation of a Joint Audit Program. The amended rules specify a number of additional requirements for the SRO supervisory program as well as for the Joint Audit Program. Costs and Benefits The amendments adopted to § 1.52 provide significant additional protection to market participants and customer of FCMs by helping to ensure that SRO examinations of member FCMs are thorough, effective and risk-based, and include evaluation and testing of internal controls as well as meeting, as applicable, other objective criteria from related professional audit standards. Specifically, an SRO’s audit program must be risk-based (e.g., the scope and focus of such examinations would be determined by the risk profile that the SRO develops for each FCM) and address ‘‘all areas of risk to which FCM can reasonably be foreseen to be subject,’’ and that the examination itself includes both controls testing as well as substantive testing. Requiring regulatory examinations by SROs to include testing and review of internal controls will help ensure that each FCM is not only compliant with capital and segregation requirements at the time of the examination, but that they continue to operate in such a manner without undetected internal controls inadequacies that could jeopardize the FCM and its customers. By requiring that the supervisory program for an SRO to adhere to professional standards for auditing as applicable, the Commission is provided with additional assurance as to standards for aspects of an examination such as the adequacy of the evaluation of evidence obtained supporting examination conclusions; the training and proficiency of the examinations staff; due professional care in the performance of the work; consideration of fraud, audit risk and materiality in conducting an audit; planning and supervision; understanding the entity and its environment and assessing the E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations risk of material misstatement; communication with those charged with governance of the examined entity; and communicating internal control matters identified in an examination. These benefits are obtained by requiring SRO supervisory programs to include consideration of specific issues and be carried out in compliance with professional standards as may be applicable to non-financial audits. The Commission believes more rigorous requirements and the application of professional standards in carrying out such requirements will add additional protection to an FCM’s counterparties and customers. The Commission also proposed to require SROs and as applicable the JAC, to obtain an evaluation of the SRO’s or JAC’s supervisory program at least once every two years from an examinations expert, defined as a nationally recognized accounting and auditing firm with substantial expertise in audits of FCMs, risk assessment and internal control reviews, and that is an accounting and auditing firm that is acceptable to the Commission (as delegated to the Director of the Division of Swap Dealer and Intermediary Oversight). The benefits of such evaluation by examinations experts were expected to be that the Commission would ensure that the supervisory program and SRO audits continue to build on best practices, which further promotes thorough and effective audits of FCMs. The Commission quantitatively estimated costs for making incremental changes to the requirements of the supervisory program for each SRO and members of the JAC in the NPRM. The Commission did not quantitatively estimate the ongoing costs of obtaining an evaluation by an examinations expert or requiring examinations to comply with professional standards, although the Commission did consider that requiring such an evaluation and requiring compliance with such standards and coverage of additional risks would add costs to examinations by SROs and members of the JAC. The Commission received many comment letters regarding the changes proposed to § 1.52. Several of the commenters objected to the requirements for having a review of the examination program by an examinations expert.754 Specifically, PWC raised concern with the ability of nationally recognized accounting and auditing firms to be able to issue any 754 CME, JAC, MGEX, NFA and PWC all commented objecting to or raising concern with this aspect of the amendment to § 1.52. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 type of assurance without a reporting framework.755 NFA, MGEX, and CME all commented that costs would be prohibitive and that benefits would be reduced because such an evaluation would be duplicative to the functions of the Commission in review of the Joint Audit Program. NFA commented that it attempted to obtain cost estimates from a few nationally recognized firms but that such firms represented that they were unable to provide cost information without a better understanding of the type of review the Commission was proposing.756 CME commented that the quantitative estimates of the Commission for revising the program were grossly underestimated.757 CME analogized that requiring adherence to professional standards would result in examination requirements similar to the average man hours applicable to private and public company audits, which were represented at 1,951 and 17,457 respectively.758 CME represented that the costs of compliance with professional standards and expanding the program were prohibitively expensive and requested that only applicable provisions should be carried into JAC protocols.759 CME commented that any benefit from obtaining an evaluation from an examinations expert could be obtained at a much reduced cost by including representatives from such nationally recognized firms in the JAC meetings and in the current process to develop JAC protocols, without obtaining a formal assessment, which such firms would more likely to be willing to do.760 CME further posited that if such alternative was not adopted, the timeframe should be lengthened from two to three and a half years.761 MGEX further commented that if such report were to be required, highly qualified regional firms should be considered as well as nationally recognized firms, as more competition would likely result in more manageable costs.762 In consideration of the concerns of commenters, the Commission has adopted revised amendments to the examinations expert requirement to § 1.52, which extend the time between evaluations required to three years, and clarify that the standard for such evaluation should be that of a consulting services report. The 755 See PWC letter at 3 (Jan. 15, 2013). NFA Comment Letter at 5 (Feb. 15, 2013). 757 CME Comment Letter at 11 (Feb. 15, 2013). 758 Id. 759 Id. 760 Id. 761 See CME Comment Letter at 12–13 (Feb. 15, 2013). 762 See MGEX letter at 4 (Feb. 18, 2013). 756 See PO 00000 Frm 00101 Fmt 4701 Sfmt 4700 68605 Commission also has considered the comments of CME and others with respect to the costs and inapplicability of many aspects of the PCAOB auditing standards to regulatory examination and has adopted, in the revised amendments to the professional standards requirements, that only such standards as would be analogous to non-financial statement audits would be applicable. The JAC also filed an additional comment letter positing that the requirements of proposed § 1.52, requiring review of risk management, would be duplicative to risk reviews required to be performed by DCOs.763 Although the Commission agrees there may be overlapping responsibilities between oversight performed by DCOs and SROs which could result in duplicated costs, the primary focus of DCO requirements are the protection of the DCO, not the protection of customers and market participants. The Commission notes that the same duplication could exist if an FCM were examined by each SRO of which it was a member. The Commission already permits the Joint Audit Committee, the Joint Audit Plan and the DSRO structure for the purpose of mitigating duplicative examination work and costs. As stated in the preamble, a DSRO may be able to fulfill parts of its examination program by incorporating aspects of risk reviews and work already performed by a DCO, but the DSRO would be responsible for ensuring any such work was adequately and specifically incorporated into the DSRO program, and oriented to ensuring the protection of customers and risks to the FCM. Additionally, the Commission notes it was not feasible to quantify any costs associated with utilizing an examinations expert. This is largely because several nationally recognized accounting firms expressed their reluctance to provide such information.764 Such a response is not surprising given the fact that reviewing a DSRO’s examination program is likely a unique and limited engagement for any firm, which would require fully understanding the scope and requirements of the review. Yet, the Commission notes there are several capable firms which would meet the definition of ‘‘examinations expert’’ and could perform the type of review required by the regulation. Thus, the costs for performing such a service will likely be competitive. 763 See JAC Comment Letter at 3–4 (July 25, 2013). 764 See NFA Comment Letter at 5, n.2 (Feb. 15, 2013). E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68606 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations Section 1.55 Public Disclosures by Futures Commission Merchants Amended § 1.55 significantly revises the disclosures that FCMs are required to provide to prospective customers and the public, detailed in § 1.55(b). The new required provisions include a statement that: (1) Customer funds are not protected by insurance in the event of the bankruptcy or insolvency of the FCM, or if customer funds are misappropriated; (2) customer funds are not protected by SIPC, even if the FCM is a BD registered with the SEC; (3) customer funds are not insured by a DCO in the event of the bankruptcy or insolvency of the FCM holding the customer funds; (4) each customer’s funds are not held in an individual segregated account by an FCM, but rather are commingled in one or more accounts; (5) FCMs may invest funds deposited by customers in investments listed in § 1.25; and (6) funds deposited by customers may be deposited with affiliated entities of the FCM, including affiliated banks and brokers. The required additional disclosures must be provided as an addition to the generic risk disclosure statement if used by an FCM as permitted under Appendix A to § 1.55. In addition, the amendments at § 1.55(i), (j) and (k) require each FCM to provide a Firm Specific Disclosure Document that would address firm specific information regarding its business, operations, risk profile, and affiliates that would be material to a customer’s decision to entrust funds to and do business with the FCM. The Firm Specific Disclosure Document is required to be made available electronically, which may be a link to the FCM’s Web site, but must be provided in paper form upon request, and would provide material information about: (1) General firm contact information; (2) the names, business contacts, and backgrounds for the FCM’s senior management and members of the FCM’s board of directors; (3) a discussion of the significant types of business activities and product lines that the FCM engages in and the approximate percentage of the FCM’s assets and capital devoted to each line of business; (4) the FCM’s business on behalf of its customers, including types of accounts, markets traded, international businesses, and clearinghouses and carrying brokers used, and the FCM’s policies and procedures concerning the choice of bank depositories, custodians, and other counterparties; (5) a discussion of the material risks of entrusting funds to the FCM and an explanation of how such VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 risks may be material to its customers 765; (6) the name and Web site address of the FCM’s DSRO and the location of annual audited financial statements; (7) a discussion of any material administrative, civil, criminal, or enforcement actions pending or any enforcement actions taken in the last three years; (8) a basic overview of customer fund segregation, FCM collateral management and investments, and of FCMs and joint FCM/BDs; (9) information regarding how customers may file complaints about the FCM with the Commission or appropriate DSRO; (10) certain financial data from the most recent month-end when the disclosure document is prepared; and (11) a summary of the FCMs’ current risk practices, controls and procedures. FCMs are required to update the Firm Specific Disclosure Document as and when necessary to make the information accurate and complete, but at least annually. The newly adopted § 1.55(l) also requires FCMs to adopt policies and procedures reasonably designed to ensure that advertising and solicitation activities of such FCMs and any introducing brokers associated with the FCMs are not misleading in connection with their decision to entrust funds and do business with such FCMs. FCMs are further required by § 1.55(o) to disclose on their Web sites their daily Segregation Schedule, daily Secured Amount Schedule, and daily Cleared Swaps Segregation Schedule. Each FCM must maintain 12 months of such schedules on its Web site. Each FCM must disclose on its Web site summary schedules of its adjusted net capital, net capital, and excess net capital for the 12 most recent month-end dates, as well as the Statement of Financial Condition, Segregation Schedule, Secured Amount Schedule, Cleared Swaps Segregation Schedule, and all footnotes related to the above statements and schedules from its most current year-end annual report that is certified by an independent public accountant. Costs and Benefits Current regulations require FCMs to provide a risk disclosure to potential 765 The material risks addressed must include, without limitation, ‘‘the nature of investments made by the futures commission merchant (including credit quality, weighted average maturity, and weighted average coupon); the futures commission merchant’s creditworthiness, leverage, capital, liquidity, principal liabilities, balance sheet leverage and other lines of business; risks to the futures commission merchant created by its affiliates and their activities, including investment of customer funds in an affiliated entity; and any significant liabilities, contingent or otherwise, and material commitments.’’ PO 00000 Frm 00102 Fmt 4701 Sfmt 4700 customers before accepting customer funds, which existing risk disclosure statement primarily provides a customer with disclosure of the market risks of engaging in futures trading. The revised disclosure requirements of § 1.55 provide customers with additional information regarding certain non-firmspecific risks that have been relevant in recent FCM bankruptcies and that could be relevant in the event of future FCM bankruptcies or insolvencies. The Firm Specific Disclosure Document required by this amendments address firm-specific risk, which will give potential customers additional information that they may use when conducting due diligence and selecting an FCM. By requiring that the disclosure address several specific topics, the public comparability of information on such topics will be available, to potential customers conducting due diligence on potential FCMs. The nonfirm specific additional disclosures will provide a significant benefit to the protection of market participants as many customers in the aftermath of recent FCM bankruptcies revealed fundamental misconceptions about the protection of their funds. Specifically, certain customers did not fully understand how FCMs held customer funds or the protections extended to such funds. Consequently, certain customers did not make informed choices to help themselves or to provide market discipline to their FCMs. In the NPRM, the Commission described how each additional specific risk disclosure was expected to benefit the protection of market participants by providing more transparency and equal access to information among all customers and the public, enhancing customer’s ability to make comparisons in choosing the FCMs with which they do business. The specific benefits of each disclosure required by the amendments were described in the NPRM, but the essential benefits derived from each additional required disclosure, and the aggregate of all the additional disclosures, are that they will result in more educated consumers of FCM services, and that such consumers will, through the greater transparency resulting from the additional disclosures, be better able to enforce market discipline on aspects of FCM business that are directly relevant to the risks customers accept in dealing with and depositing funds with FCMs. The Commission quantitatively estimated expected costs of providing the additional general and firm specific disclosures in the NPRM and did not receive any comments about its specific estimates. However, the Commission E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations did receive many comments that supported the amendments to § 1.55 reiterating the benefits perceived from transparency resulting from the additional disclosures as are described at section II.P. and noting that these amendments were particularly cost effective at providing such benefits. FHLB stated ‘‘[p]erhaps the most compelling argument for additional public disclosure of certain information addressed in the Proposed Customer Protection Rules is that the benefits should far exceed the additional cost associated with mandating such public disclosures.’’ 766 ACLI and the Commercial Energy Working Group both stated ‘‘the Proposed Customer Protection Rules represent a very costeffective approach/means to making FCMs more accountable to their customers by providing current information that will enable customers to conduct appropriate due diligence regarding prospective FCMs and to actively monitor the financial condition and regulatory compliance of the FCMs to which they have entrusted funds.’’ 767 FIA specifically commented with respect to the disclosures required under § 1.55(k) that FCMs that are part of public companies, or dually registered BDs, or are part of a bank holding company, already have disclosure requirements and that the Commission should confirm that such an FCM may comply with this rule by making the annual reports and amendments thereto available on its Web site, in order to avoid duplicative or conflicting disclosure requirements.768 FIA further commented that the level of detail required of privately owned FCM’s disclosure should be consistent with that provided in the annual reports of publicly-traded companies.769 Newedge commented that all FCMs should be required to disclose similar information in a standard format, and the proposal of FIA to satisfy disclosure requirements by linking to the annual report of a public company places firms without annual report preparation requirements at a competitive disadvantage and discriminates against smaller to midsize FCMs.770 In the preamble discussion at section II.P., the Commission clarified both that disclosures could be satisfied by linking to appropriate existing relevant disclosures that were already required 766 See FHLB Comment Letter at 3 (Feb. 15, 2013). ACLI Comment Letter at 2 (Feb. 15, 2013); Commercial Energy Working Group Comment Letter at 2 (Feb. 13, 2013). 768 See FIA Comment Letter at 43 (Feb. 15, 2013). 769 Id. at 44. 770 Newedge Comment Letter at 4 (Feb. 15, 2013). 767 See VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 for the same matters, but that the disclosures required by the amendments are specific to the FCM and cannot be satisfied with more general disclosure at a holding company level. The Commission believes this clarification addresses the duplication concern raised by commenters. Several commenters posited concerns regarding the benefit of various aspects of the mandated disclosures. The comments addressed the disclosures of leverage, the targeted residual interest, customer write-offs, and that such disclosures could in certain circumstances be potentially misleading to customers.771 With respect to these comments the Commission notes that with all aspects of the mandated additional disclosures, appropriate explanations and additional information to ensure sufficient context should be provided if necessary to clarify anything that an FCM may regard as otherwise being misleading. Concerns raised by commenters that customers may inadequately assess risks particular to their FCM by inappropriately focusing on only one aspect of disclosure, such as leverage, or targeted residual interest, cannot be mitigated by declining wholesale to make relevant information publicly available. Furthermore, FCMs are free to supply additional context and information when they believe that any Firm Specific Disclosure is misleading. Certain commenters have requested that the Commission consider the alternative to further require all § 1.12 notices to be made publicly available, which the Commission has declined to do as is discussed in the costs and benefits discussion of § 1.12. By requiring FCMs to update the disclosures annually, as well as any time there is a ‘‘material change to its business operation, financial condition and other factors material to the customer’s decision to entrust the customer’s funds and otherwise do business with the futures commission merchant,’’ and requiring the FCM to provide each updated disclosure to its customers, § 1.55(i) makes FCMs responsible to communicate with customers whenever such events occur. The Commission notes that there may be overlap in circumstances which give rise to notice obligations under § 1.12 and which require updated public disclosure, although the two are distinct 771 See FCStone Comment Letter at 4 (Feb. 15, 2013); Phillip Futures Inc. Comment Letter at 2 (Feb. 14, 2013); CHS Hedging Comment Letter at 2 (Feb. 15, 2013); RJ O’Brien Comment Letter at 6– 9 (Feb. 15, 2013); TD Ameritrade Comment Letter at 4 (Feb. 15, 2013); Advantage Comment Letter at 4 (Feb. 15, 2013); RCG Comment Letter at 5–6 (Feb. 12, 2013). PO 00000 Frm 00103 Fmt 4701 Sfmt 4700 68607 and separate requirements. This requirement helps to ensure that the FCM’s financial condition, business operations, or other important factors do not change in material ways without customers being able to ascertain such changes, and would likely prompt some customers to conduct additional due diligence in such situations in order to determine whether their funds are at risk, which would provide additional accountability for FCMs. By requiring each FCM to adopt policies and procedures reasonably designed to ensure that its advertising and solicitation activities are not misleading to its FCM customers under § 1.55(l), the Commission is strengthening accountability for communication related to an FCM’s sales and solicitation activities which helps to ensure the purposes of the other requirements for disclosure are not frustrated. By requiring FCMs to provide their daily Segregation Schedules, daily Secured Amount Schedules, and daily Cleared Swaps Segregation Schedules, as well as the same schedules from the most recent certified annual report, the requirements under § 1.55(o) facilitate transparency. Requiring each FCM to post the above schedules and data on its Web site will help to ensure that market participants are aware that it is available, and will improve the speed and efficiency of obtaining it. Similarly, by requiring FCMs to provide a link to the Web site of the NFA’s Basic System facilitate transparency by promoting awareness of the additional information that is public regarding each FCM’s investment of customer funds and by reducing the search costs for obtaining that information. Section 22.2 Futures Commission Merchants: Treatment of Cleared Swaps and Associated Cleared Swap Customer Collateral The adopted amendments to § 22.2 incorporate changes with respect to protection of funds for customers trading cleared swaps that are identical to the changes proposed for protection of futures customer funds.772 Those changes include: (1) Incorporating the same change to haircutting procedures as adopted in § 1.17 and § 1.32 but for Cleared Swaps; (2) requiring the FCM to 772 As noted in section II.Q. above, the revisions to §§ 22.2(a) and (f) merely clarify that the calculation set forth therein is the Net Liquidating Equity Method and thus, the revision is not intended to, and should not be read to, change current practice with respect to an FCM’s residual interest requirements for Cleared Swaps as set forth in Commission regulations and JAC Update 12–03, and consistent with Staff Interpretation 12–31. E:\FR\FM\14NOR2.SGM 14NOR2 68608 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations send daily Segregation Calculations for Cleared Swaps to the Commission and DSROs; and (3) requiring that segregated investment detail reports be produced twice per month, listing assets on deposit at each depository, and sent to Commission and DSROs electronically by 11:59 p.m. the following business day. Records of both reports are required to be maintained in accordance with § 1.31. Costs and Benefits As discussed above, amendments to § 22.2(a) and (f) are not intended to change existing practice and thus do not introduce new costs. The other amendments to § 22.2 noted above are substantively similar to amendments to corresponding part 1 regulations and the relevant costs and benefits are similar to the costs and benefits discussed in those sections. The amendments to § 22.2 have the benefits of harmonizing the protection of customer funds between Cleared Swaps and futures and clarifying further the regulatory requirements for Cleared Swaps. Section 22.17 Policies and Procedures Governing Disbursements of Cleared Swaps Customer Collateral From Cleared Swap Customer Accounts The newly adopted § 22.17 imposes restrictions on an FCM’s withdrawal of its residual interest, and requires that if a withdrawal of residual interest not for the benefit of customers causes the FCM to fall below its targeted residual interest, that the funds be replenished the following business day or the residual interest target be lowered in accordance with its policies and procedures established under § 1.11. TKELleY on DSK3SPTVN1PROD with RULES2 Costs and Benefits The costs and benefits are similar to those created by §§ 1.23 and 1.11 but apply to customer funds in Cleared Swaps Customer Accounts rather than customer segregated accounts, and therefore are as described in §§ 1.23 and 1.11, but incremental thereto with respect to Cleared Swaps Customer Accounts. Section 30.1 Definitions Amendments adopted to § 30.1 establishes new definitions for ‘‘30.7 customer,’’ ‘‘30.7 account,’’ and ‘‘30.7 customer funds.’’ The first is defined as any foreign futures or foreign option customer, together with any foreigndomiciled person who trades in foreign futures or foreign options trough an FCM. ‘‘30.7 account’’ and ‘‘30.7 customer funds’’ are then defined accordingly. These definitions relate to VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 the existing terms ‘‘foreign futures or foreign options customer,’’ ‘‘foreign futures or foreign options customer account,’’ and ‘‘foreign futures or foreign options customer funds,’’ respectively. The term ‘‘foreign futures or foreign options customer’’ only includes U.S.-domiciled customers that deposit funds with an FCM for use in trading foreign futures or foreign options. The new definitions, on the other hand, include both U.S. and foreign-domiciled customers that deposit funds with an FCM for use in trading foreign futures or foreign options. Costs and Benefits These definitions play a ‘gatekeeping’ function with respect to other rules by determining what customers are included as ‘‘30.7 customers.’’ However, the costs and benefits of these changes are attributable to the substantive requirements related to the definitions, and therefore are discussed in the cost benefit considerations related to § 30.7. Section 30.7 Treatment of Foreign Futures or Foreign Options Secured Amount The adopted amendments to § 30.7 (1) Incorporate the funds of foreigndomiciled investors deposited with an FCM for investment in foreign futures and foreign options within the protections provided in § 30.7; (2) eliminate the Alternative Method and require the Net Equity Liquidation Method for calculating 30.7 customer segregation requirements; (3) add specificity to the written acknowledgments that FCMs and DCOs must obtain from their depositories by providing required templates; 773 (4) add restrictions on withdrawing from residual interest not for the benefit of customers; 774 (5) require that 30.7 customer funds deposited in a bank must be available for immediate withdrawal at the request of the FCM; (6) clarify that the FCM is responsible for any losses related to investing 30.7 customer funds in investments that comply with § 1.25; (7) add a prohibition against making unsecured loans to customers or using the funds in the customer’s trading account as security for a loan; (8) require daily segregation reports and a detailed list of 773 The additional specificity incorporates the same requirements for acknowledgment and agreement that are contained in the templates in the appendices of §§ 1.20 and 1.26. 774 The same requirements as are adopted for futures customers’ funds and Cleared Swaps Customers’ Collateral, including a requirement for the FCM to abide by its policies and procedures required by new § 1.11. PO 00000 Frm 00104 Fmt 4701 Sfmt 4700 depositories to be submitted to the Commission and DSRO, and that targeted residual interest be included in both of those reports; (9) allow FCMs that are not dual registrants to use the BD procedure for assigning a smaller net capital haircut to investments of 30.7 customer funds in certain types of instruments with low default risk; (10) establish a limit on the amount of funds in a 30.7 account that can be held outside the U.S.; and (11) require FCMs to, at a specified point in time, maintain residual interest in 30.7 accounts that is at least equal to the sum of all undermargined amounts for 30.7 customers. With the exception of the requirements with respect to limiting funds held outside the U.S., the permissibility of certain depositories outside the U.S., and the requirement that FCMs comply with the highest equivalent custody requirement relevant in a different country, these requirements are substantially similar to equivalent requirements adopted in §§ 1.20, 1.22, 1.23, 1.29, 1.30, 1.32 and 22.2 and 22.17. As a result of the adopted changes with the noted exceptions, the rules in § 30.7 for the protection of 30.7 customer funds are substantially similar to the rules for the protection of segregated customer funds under 4d(a) and §§ 1.11–1.32, and the rules for the protection of cleared swaps customer funds under 4d(f) and in part 22. However, portions of § 30.7 are notably different from rules protecting futures customer funds and cleared swap customer funds. These are: (1) the definition of the minimum amount that must be deposited in a 30.7 account for each 30.7 customer is different than in the corresponding requirements in §§ 1.20 and 22.2, due to the possibility of a higher requirement under a foreign regulatory regime; (2) the list of acceptable depositories for 30.7 customer funds includes banks or trusts outside of the U.S. with more than $1 billion in regulatory capital, and various other participants of foreign boards of trade and their depositories; (3) § 30.7 limits the amount of funds from a 30.7 account that can be held outside the U.S; and (4) the Residual Interest Deadline for 30.7 funds is 6:00 p.m. Eastern Time, whereas the Residual Interest Deadline for futures customer funds will, after the phase-in period and absent further Commission action, move back to the time of the daily settlement. The third and fourth are the only substantive differences in the custody regime created by the adopted amendments compared to the custody regimes put in place in the corresponding sections for domestic E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 futures customer funds and cleared swaps customer funds. Costs and Benefits In the NPRM, the Commission stated it believed a significant benefit of the amendments adopted to § 30.7 would be the likelihood that in an FCM insolvency, the full amount owed to customers trading foreign futures and foreign options, whether such customers were foreign or domestic domiciled, would be intact as required to be held separately in 30.7 accounts. The Commission did not receive comments objecting to the changes to the calculations or the required inclusion of foreign-domiciled customers. The adopted changes also established new regulations for the protection of customer funds deposited for trading in foreign futures and options that, with limited exceptions, are substantively identical to the new protections adopted for futures customer funds and cleared swaps customer funds. Therefore, many of the costs and benefits of the changes that are proposed are identical to those described above in the cost-benefit considerations related to §§ 1.11–1.32 and part 22. Various regulations designed to ensure that the new calculation requirement for the segregation of 30.7 funds is met at all times would also apply, including the § 30.7(g) restrictions on an FCM’s withdrawal of its residual interest which is commingled with 30.7 customer funds, and policies and procedures developed by the FCM pursuant to § 1.11 that are designed to ensure safe handling of such funds. Application of the additional protections designed for customer funds will further ensure the protection of market participants and provide, as much as possible, equivalent protections between domestic and foreign futures trading with respect to the treatment of funds held by the FCMs. The Commission did not quantitatively estimate costs of the amendments to § 30.7, but requested comment as to any costs to FCMs, including whether FCMs would need to obtain additional capital or obtain additional liquidity as a result of formally foreclosing their abilities to utilize the Alternative Method versus the Net Liquidating Equity segregation method in funding operations. The Commission did not receive comments addressing these questions, or addressing its analysis that costs and benefits would be incremental to the costs and benefits analyzed with respect to the same substantive provisions applicable to both 4d(a) (futures) and 4d(f) (Cleared Swaps) segregated funds. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 Moreover, the Commission believes any incremental costs associated with complying with these changes to be minimal, since much of the industry is already held to these standards as a result of previous rule changes made by NFA to its rulebook.775 In the NPRM, the Commission proposed in § 30.7(c) a limitation on the amount of funds from a 30.7 account that can be held outside the U.S. Funds held overseas are subject to different regulatory and bankruptcy regimes that may not offer comparable protections for customer funds, creating additional repatriation risks to those funds. For example, if an FCM carrying 30.7 funds, some of which were held in depositories outside the U.S., were to default, it is possible that the Trustee would not be able to promptly recover sufficient funds to repay all the FCM’s obligations to 30.7 customers. As noted above, this is especially true if the funds are deposited with a foreign affiliate of the FCM, as the likelihood of coincident bankruptcies of affiliated financial firms has been observed to be exceedingly high.776 In such an event, the funds held at the foreign affiliate would be distributed in accordance with the insolvency rules of the foreign jurisdiction. In such a case each 30.7 customer would likely receive a pro-rata share of the funds that the Trustee is able recover, when the Trustee is able to recover them. The proposed limit on the amount of funds that can be held outside the U.S. was intended to assure that as much of the customers’ funds as possible remain subject to the U.S. regulatory and bankruptcy regimes, eliminating repatriation risk to those funds. By eliminating this risk for a larger percentage of the 30.7 funds, the proposed rule promotes higher recovery rates for 30.7 account funds if the FCM defaults, which helps ensure that 30.7 customers receive the largest (and most prompt) pro rata distribution possible. The Commission received comments from FIA, as well as others, that the proposed percentage limitation of 10% of required margin was not adequate in light of account volatility and other factors, and that the limitation should only be applicable to funds deposited with foreign brokers and that otherwise FCMs should be permitted to hold funds in a bank or trust company outside the U.S. to the same extent that an FCM may hold other customer segregated and Cleared Swaps Customer collateral 775 See NFA Interpretive Notice 9066 (Revised, July 1, 2013). 776 See, e.g., Lehman, MFGI. PO 00000 Frm 00105 Fmt 4701 Sfmt 4700 68609 outside the U.S.777 Commenters including Jefferies and Advantage stated that the limitations may inhibit FCMs from trading foreign futures and that customers may need to utilize non-U.S. brokers for their foreign futures business as a result, because they would not be able to accept customer securities outside the U.S. and customers would have to pre-fund with cash instead.778 In response to commenters and upon consideration, the Commission is increasing the limitation from 10% to 20%, but is declining to further expand the permissibility of holding 30.7 funds outside the U.S. due to the increased repatriation risk applicable to excess margin deposited outside the U.S. for 30.7 funds for foreign futures and foreign options. For 30.7 accounts, an FCM must maintain residual interest that is at least equal to undermargined amounts by 6:00 p.m. Eastern Time on the following business day, which is substantively similar to the Industry Commenters’ Alternative discussed above in the cost and benefit considerations related to § 1.22. As noted there, FIA and ISDA estimated that more than 90% of customer’s margin deficits are collected by FCMs by 6:00 p.m. Eastern Time on the next trading day. Thus, the Commission estimates the additional requisite residual interest needed for 30.7 accounts using the analysis described above for futures customer accounts. As of November 30, 2012, there was approximately $30 billion in 30.7 accounts (excluding, here, and in the following amounts, excess amounts contributed by FCMs).779 At the top-10 FCMs, there was approximately $27.7 billion in 30.7 accounts.780 For the remaining FCMs, there was approximately $2.3 billion in 30.7 accounts.781 Using ISDA’s point estimate for excess collateral deposited by customers,782 the Commission estimates that there was, at the top-10 FCMs, approximately $8.6 billion (31% of $27.7 billion) of existing customer excess in 30.7 accounts. Similarly, for the remaining FCMs, the Commission estimates that there was approximately 777 FIA Comment Letter at 36–37 (Feb. 15, 2013); RJ O’Brien Comment Letter at 11 (Feb. 15, 2013). 778 Jefferies Comment Letter at 6 (Feb. 15, 2013); Advantage Comment Letter at 9 (Feb. 15, 2013). 779 See https://www.cftc.gov/MarketReports/ FinancialDataforFCMs/HistoricalFCMReports/ index.htm. 780 See id. 781 See id. 782 As discussed in the analysis of § 1.22(c) above, ISDA estimated the excess to be between $40 and $70 billion and employed the midpoint of this range, $55 billion in its calculations. $55 billion is 31% of the total 177.1 billion held in both section 4d(a)(2) and part 30 secured accounts. E:\FR\FM\14NOR2.SGM 14NOR2 68610 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 $0.7 billion (31% of $2.3 billion) of customer excess corresponding to 30.7 accounts. For the top-10 FCMs, the Commission subtracts $8.6 billion (existing customer excess for these accounts) from $27.7 billion (total funds held in these accounts) leaving approximately $19.1 billion in required margin for 30.7 accounts for these FCMs. Multiplying ISDA’s 60% required margin estimate (which assumed that the residual interest requirement applies at all times) by 10% (i.e., 1–90%) gives 6% of the required margin being needed in residual interest, or $1.1 billion for these FCMs. As of November 30, 2012, the top-10 FCMs were holding approximately $3.3 billion in residual interest in 30.7 accounts.783 Thus, it would appear that the top-10 FCMs are already holding sufficient residual interest for 30.7 accounts. For the remaining FCMs, the Commission subtracts $0.7 billion (existing customer excess for these accounts) from $2.3 billion (total funds held in these accounts) giving approximately $1.6 billion in required margin. Multiplying $1.6 billion by 6% gives approximately $96 million, but FCMs already maintain over $1 billion in residual interest. Consequently, it would appear that the remaining FCMs also already maintain enough residual interest for 30.7 accounts. of customers’ segregated funds and protect the financial condition of FCMs generally.787 The Commission also has previously determined that DCOs are not small entities for the purpose of the RFA.788 Accordingly, the Chairman, on behalf of the Commission, certified pursuant to 5 U.S.C. 605(b) that the proposed regulations would not have a significant economic impact on a substantial number of small entities. The Commission then invited public comment on this determination. The Commission received no comments. B. Paperwork Reduction Act The Paperwork Reduction Act (‘‘PRA’’) provides that a federal agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid control number issued by the Office of Management and Budget (‘‘OMB’’).789 This final rulemaking contains several collections of information that were submitted to OMB in the form of proposed amendments to existing collection 3038–0024 and proposed revisions thereto, as well as pre-existing collections 3038–0052 and 3038–0091. There have been no substantive changes from the proposed rulemaking to this final rulemaking that would require any adjustment to the information collection burdens as they were originally proposed. As required by OMB regulations, the Commission shall V. Related Matters submit to OMB this final rulemaking, A. Regulatory Flexibility Act together with ICRs that have been The Regulatory Flexibility Act updated to include the comment (‘‘RFA’’) 784 requires Federal agencies, in summary contained herein. The collections contained in this promulgating regulations, to consider the impact of those regulations on small rulemaking are mandatory collections. In formulating burden estimates for the entities. As stated in the NPRM, the collections in this rulemaking, to avoid Commission has previously established certain definitions of ‘‘small entities’’ to double accounting of information collections that already have been be used by the Commission in assigned control numbers by OMB, or evaluating the impact of its rules on are covered as burden hours in small entities in accordance with the collections of information pending RFA.785 The proposed regulations before OMB, the PRA analysis provided would affect FCMs and DCOs. in the proposed rulemaking, along with The Commission previously has the information collection request determined that FCMs are not small (‘‘ICR’’) with burden estimates that were entities for purposes of the RFA, and, incorporated into the rulemaking by thus, the requirements of the RFA do reference and submitted to OMB, not apply to FCMs.786 The Commission’s determination was based, accounted only burden estimates for collections of information that have not in part, upon the obligation of FCMs to previously been submitted to OMB. The meet the minimum financial Commission sought comment on the requirements established by the collections of information contained in Commission to enhance the protection 784 5 787 Id. 785 47 U.S.C. 601 et seq. FR 18618 (Apr. 30, 1982). 786 Id. at 18619. 788 See VerDate Mar<15>2010 19:24 Nov 13, 2013 789 44 Jkt 232001 PO 00000 66 FR 45605, 45609 (Aug. 29, 2001). U.S.C. 3501 et seq. Frm 00106 Fmt 4701 Sfmt 4700 the proposed rulemaking only to the extent that the collections in the proposed rulemaking would increase the burden hours contained with respect to each of the related currently valid or proposed collections. The Commission received over 120 written submissions on the proposed rulemaking. Many of these comments discussed in general the need for, effectiveness of, and practicality of various proposed rules. However, none of the commenters questioned the burden estimates provided in the proposed rulemaking or the ICR that was submitted. To the extent that there were comments on the need for, effectiveness and practicality of various proposed rules, they related to the rulemaking as a whole rather than the collections in particular. Accordingly, those comments were addressed above, in the sections of the preamble of this final rulemaking that relate specifically to the proposed rules at issue. As required by the PRA, the Commission submitted the proposed amendments, in the form of information collection requests related to collections 3038–0024, 3038–0052, and 3038–0091 on November 14, 2012, the same date that the proposed rulemaking was published in the Federal Register.790 The Commission did not receive public comments on any of the proposed collections from OMB on or before January 13, 2013, within the 60 days established for such comments in the PRA after the notice of proposed rulemaking and the submission of the certified ICR to OMB.791 Accordingly, the proposed amendments to collections 3038–0024, 3038–0052, and 3038–0091 are deemed to be approved by operation of the PRA.792 The Commission therefore, pursuant to OMB regulations,793 requests the assignment of OMB control numbers to the proposed amendments to collections 3038–0024, 3038–0052, and 3038–0091, which were submitted to OMB for approval on November 14, 2012. 790 See 44 U.S.C. 3507(d)(1)(A), providing for an agency to forward to the Director of OMB or his or her designee a notice of proposed rulemaking with a collection of information subject to notice and comment pursuant to the provisions of 44 U.S.C. 3506(c)(2)(B), on or before the date that the proposed rulemaking is published in the Federal Register, together with the ICR in the form required by OMB in 5 CFR 1320.8 and 1320.9. 791 See 44 U.S.C. 3507(d)(1)(B), cross-referencing 44 U.S.C. 3508. See also 5 CFR 1320.11(c). 792 See 44 U.S.C. 3507(3). 793 See 5 CFR 1320.11(i), implementing 44 U.S.C. 3507(d)(3). E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations 68611 APPENDIX 1 TO SUPPLEMENTARY INFORMATION—TABLE OF COMMENT LETTERS Abbreviation used (if applicable) Full name Advantage .......................... AFMP Group ...................... Advantage Futures LLC. Agricultural Futures Market Participants: AMCOT, American Cotton Shippers Association, American Farm Bureau Federation, American Feed Industry Association, American Soybean Association, CoBank, Commodity Markets Council, National Association of Wheat Growers, National Barley Growers Association, National Cattlemen’s Beef Association, National Corn Growers Association, National Cotton Council, National Council of Farmer Cooperatives, National Grain and Feed Association, National Pork Producers Council, National Sorghum Producers, National Sunflower Association, North American Millers Association, USA Rice Federation, US Canola Association, US Dry Bean Council. Alternative Investment Management Association. Amarillo Brokerage Co. American Council of Life Insurers. American Farm Bureau Federation. American Institute of Certified Public Accountants. American Iron & Metal. BlackRock, Inc. BMO Harris Bank, Barclays Bank, The Bank of New York Mellon and Brown Brothers Harriman & Co. Center for Audit Quality. CFA Institute. Chris Barnard. CHS Hedging, Inc. CME Group Inc. CoBank. Commercial Energy Working Group. TKELleY on DSK3SPTVN1PROD with RULES2 AIMA ................................... Amarillo ............................... ACLI .................................... AFBF .................................. AICPA ................................. AIM ..................................... BlackRock ........................... Depository Bank Group ...... Center for Audit Quality ...... CFA .................................... Chris Barnard ..................... CHS Hedging ..................... CME .................................... CoBank ............................... Commercial Energy Working Group. CIEBA ................................. CCC .................................... Congressional Committees Deloitte ............................... Ernst & Young .................... Eurex .................................. FHLB .................................. Federal Reserve Banks ...... FXCM ................................. Franklin ............................... Frontier Futures .................. FIA ...................................... Global Commodity .............. ISRI ..................................... ISDA ................................... FCStone ............................. ICI ....................................... ICA ...................................... Jefferies .............................. JSA ..................................... JAC ..................................... Katten-FIA .......................... KPMG ................................. Kripke Enterprises .............. LCH.Clearnet ...................... MFA .................................... Manitoba ............................. MGEX ................................. NCBA .................................. NCFC .................................. NFA .................................... NGFA .................................. NIBA ................................... NPPC .................................. NEFI/PMAA ........................ NYPC .................................. Newedge ............................ Nodal .................................. Paul/Weiss .......................... Phillip Futures Inc. .............. Pilot Flying J ....................... Premier Metal Services ...... Prudential ........................... PWC ................................... Randy Fritsche ................... Rice Dairy LLC ................... VerDate Mar<15>2010 Committee on Investment of Employee Benefit Assets. Commodity Customer Coalition. Congress of the United States: Frank D. Lucas, House Committee on Agricultural; Debbie Stabenow, Senate Committee on Agriculture, Nutrition, and Forestry. Deloitte & Touche. Ernst & Young LLP. Eurex Clearing AG. Federal Home Loan Banks. Federal Reserve Banks of New York and Chicago. Forex Capital Markets LLC. Franklin Templeton Investments. Frontier Futures, Inc. Futures Industry Association (Collectively—Barclays, State Street, Goldman Sachs, others). Global Commodity Analytics & Consulting LLC. Institute of Scrap Recycling Industries, Inc. International Swap Dealers Association, Inc. INTL FCStone, Inc. Investment Company Institute. Iowa Cattlemen’s Association. Jefferies Bache, LLC. John Stewart and Associates. Joint Audit Committee. Katten Muchin Rosenman LLP on behalf of the Futures Industry Association. KPMG LLP. Kripke Enterprises. LCH.Clearnet Group Limited. Managed Funds Association. Manitoba Corporation. Minneapolis Grain Exchange, Inc. National Cattlemen’s Beef Association. National Council of Farmer Cooperatives. National Futures Association. National Grain and Feed Association. National Introducing Brokers Association. National Pork Producers Council. New England Fuel Institute Petroleum Marketers Association of America. New York Portfolio Clearing, LLC. Newedge USA, LLC. Nodal Exchange, LLC. Paul, Weiss, Rifkind, Wharton & Garrison LLP. Phillip Futures Inc. Pilot Travel Centers, LLC. Premier Metal Services, LLC. The Prudential Insurance Company of America. PWC LLP. Randy Fritsche. Rice Dairy LLC. 19:24 Nov 13, 2013 Jkt 232001 PO 00000 Frm 00107 Fmt 4701 Sfmt 4700 E:\FR\FM\14NOR2.SGM 14NOR2 68612 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations APPENDIX 1 TO SUPPLEMENTARY INFORMATION—TABLE OF COMMENT LETTERS—Continued Abbreviation used (if applicable) RJ O’Brien .......................... RCG .................................... Schippers ............................ Schwartz & Ballen .............. Security Benefit .................. SIFMA ................................. Solomon Metals Corp. ........ State Street ........................ Steve Jones ........................ SUNY Buffalo ..................... TD Ameritrade .................... TCFA .................................. TIAA–CREF ........................ Strelitz/California Metal X ... Vanguard ............................ Full name R.J. O’Brien & Associates, LLC. Rosenthal Collins Group. Schippers Trading. Schwartz & Ballen LLP. Security Benefit Life Insurance Company. SIFMA Asset Management Group. Solomon Metals Corp. State Street Corporation. Steve Jones. State University of New York at Buffalo Law School. TD Ameritrade, Inc. Texas Cattle Feeder Association. TIAA–CREF. Tim Strelitz/California Metal X. Vanguard. TKELleY on DSK3SPTVN1PROD with RULES2 BILLING CODE 6351–01–P VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 PO 00000 Frm 00108 Fmt 4701 Sfmt 4700 E:\FR\FM\14NOR2.SGM 14NOR2 ~ii: ...1 ~o ... IIII ~ I ID 1~li.I~11ru o. JO r I ~ffi~ 0 10 Ie> Ie> I "flo w i i !( Iii _ ' 'r 010.010 01 0 I '" I i. c i 'I $\1 § .. Jilt J 'I; I e> j 1 q]i ~ I tj I.~ f i~! ~ ,; ~. .~ 1 .. z; I"! i 1 " . .. ! i i.~ i t It i iell" t ff 1I If t i.i i t ii: i iii t fil. lit jft IfJill J ~I tf~ n~!!! § H!!! I U!t!! Ii!!!! I!!! J«IIIU~ ! ;;. 14NOR2 01010 IU liJ \l1 00 1~lfJfil III~'I~I e> 0::& Appendix 2 to Supplementary Information—CFTC Form 1–FR–FCM 01<>' I~ I! Iii Il' m I ,.; I "1 j <= N I'f ... >II <til E:\FR\FM\14NOR2.SGM 0 Sfmt 4725 01 Fmt 4701 ~ B 01 . ::&8 ~I:I 01 ,.: at Frm 00109 , mlru 00 fj] I PO 00000 e } I ~ I: R lit 10 Jkt 232001 '0 i1 0' rn m m 19:24 Nov 13, 2013 ~ VerDate Mar<15>2010 TIn, ~h~' im I !i! TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations 68613 ER14NO13.000</GPH> i 68614 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations 9. ftecIIvabieellan lradel'soo U.S. ecmmC!dity~ i a t=1 '14251 AIIowanoefol" dOll)N ~ 11. lnIIentorieI;OfccslHDmmodllles,1'lrIOI work In progress and lInilihed goods A Covered 11430 1.310 1.320 - ;sr 1300 1315 1325 1350 1345 1360 OM· 1>. 'i3i5 ~. 1«10 10,. Recleivables1,aYlltadn a'l toteIgn bOlllllsof hde. A O.!slomenlebltlWldello;/tllCOCUlll5 1.\:~Il"d~~ $ !'29~ 1305 0:. AIIOWII!I»foI'd~ ~ Q rmo ~ A 0UlIIcmer debit and detliitteCOll!ltt 8. Noncustomerand P!tIPlietary IltlClOUms C..011« 1365 131$ 1370. II!IIItrt.Is. Not~ 12. Se<:ureddemlndnotes vaJue ofCOllalel'al $'--_ _ _-'--_1415 SIIteiy,.. $ 14:21) I 1& 0IbIIrl'lll:elVlbll$8I1dat1YanC8s :::::::::: 1!:I::::::::::~El:::5j A. M~IiCOoUIitS~•. 8, NoInm:ailllltlle C. CommlsslonS:8I1d1lrokeraQa receI\IabIe D. ~lrOrnempkl'feU8I1d ~peniIOIlS 1& E AdVl!II'IC$$ 00 l:88h commodlles F. 1505 't~o tllZO 1525 ~ 1535 1550 1555 !,575 540 1555 ~ 11590 = DI"ldaiIdUndlntenlsl G.T_~ 1530 154i H. RecelVables!tom sub.dlarleelllld alllli8tes I. OIher(ltlllllllZea'la~page) J. AllClfiVllllci!i for dCllb1M IlcCOurlt$ 14. ~glimsonfolWlIIl:I QOIlIracIs IIIld commillllilnls 1£ EXI:fnInge lll!imblllhlj)s lIIC01it MaII<et I/IlIUII $ 11 rmr rmr 'i4ii 1600 11605 1510 15110 .,595 I I I 812 P 1 M1 11830' 11635 I 1'I6is 11810 I I f1i!iD 1'7. Plant, property, eqlipmenl and CIlfIlalNd \eases. CQstnet ofa«llMlI$I6d depMlIIlon 1$215 VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 PO 00000 Frm 00110 Fmt 4701 11675 I '1610 I I!fl ' ,67o t TKELleY on DSK3SPTVN1PROD with RULES2 ~ '1840 Sfmt 4725 I E:\FR\FM\14NOR2.SGM 14NOR2 ER14NO13.001</GPH> end iIInoI1I2iatiOI of $ Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations 68615 Nl'A·IONo: CFTC fORM HR-I'CM STATEMENT OF FINANCIAl. OOHDmON ASOF-1-1_ 21. ~101>lIIIk$ ----1=1 A. SeQnclI_ 8. Un&GcUredtOllllll O. 0\ferG'a1Is lIZ. EqId_ItI_IICIIy ...t<IIIlII.. 1IId ddtefSWl/)lA. OIIo1an_lrad~onU~$._madll)'~ B. OIIoIan_tnKIfnllonI<HQn-........ C. CUstarniits' d...... apIlOn ~ 0. NaMuolan..... _ _ E. F. 2): 24. Gllnal ptrIntrI' will mtmblll'$'lIUIng _nt.(1101 tncIuOclln 0iIfIiII!Ij CutIOm .... lJadlnv "looI...d ~ I'aya!lklIOU.$. ~¢lelllnll ~ Inclllding ttIolt apIlOll \lliue' _ _ _[!!J 0 ----~ PQablelOforeilIncotnmodlY dearingcwganiZllllOllS lIi_gWlrtopllOll\lli!lue$ 0 -----.;-~ _ _ _ _[!!J . . PQabIe IOl'ItIIlstered ltb.iIe$ _mInion m;;;a;uj; ltI. ~,..r.I"IICOIUI!<I""P.m.....n"clhorpa)'lbln A. "--,..r.leand ......... ecIUpentl1i1 a. ~ and """"- poplilit $ada.., _mlUl""" C: T_,..r.'" D. DofwmII_..1M8. E. $eCI\IrtIy c:IoII>oe!l$!lt!cI F. ~lIi!IlIInoit_OIlU. Go Unrealized ~ OIl IOIWI1d ~"'"" CCII1II!1ilment. H. Dwlo ..,lHkIIIrleund d _ I. NCIe$. m~.rtdotl!«l111~ Ga'IiINI~ months J. 0\!IIpU0rt 10 RIllaII I'XQ,IsIOmn (lt1ll!liH on IHpnl1i PIIiIIt) 2210 28. 1IIoIta. mll\Olges; ..d other PlPIYIblft 1101 GaWIINn""lIIO!Ib of'" lID ofWC1lleb!m1ll'lt A. I..InHCured TKELleY on DSK3SPTVN1PROD with RULES2 8. VerDate Mar<15>2010 s.curect 19:24 Nov 13, 2013 Jkt 232001 PO 00000 Frm 00111 Fmt 4701 Sfmt 4725 --f;:J E:\FR\FM\14NOR2.SGM 14NOR2 ER14NO13.002</GPH> It; 0Ihw 68616 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations NPA ID No: CFlC FORM 1.FR..j::CM STATEMENT OF SEGREGATION REQUIREMENTSANO FUI'IOS IN SEGREGATION FOR CUStOMERS TRADING ON U.S. COMMODIlYEXCHANGES AS OF:ot.IJoolrlOoc 1. N«I«!getbldlnce 0 1::1 2. N«IN1IUIIiIed pnft(IoM}1n opcMumOGllftclll bded on it OGIIftct mNket 0 [!![] 3. exChanaewdId IIjIIIaIII A MalIcIt. . . of_ _ c~punba_on. ~mllll<et a MalIcIt_of_ apIlon"""~(oaId)""a _ _ ....rbI 6 ~ Q 15OSII1 , [!!J $ 0 ..- I $ II ~ A Cull 8. &l«nUles~..uQ 0 4. Nlta/llllll/(dlfdl)(llIIIllnn 1. 2. . 3 ) $ 5. Accou......lddlllto. ddclt8nd_... will deblbalan_· '-amount $ o I_I II ~ntreqlllled"'tJe~{add_'Ulld5) 8. IW10 1 MOt! t! Slm!!E!3AIEJjACCOONIS ~iII~lIlId$banka/lCOl!lD 1. A. Cult It !locurilles ........llllnv.-nt;of_.... (lIIm.rbI) U C. SeeudilHlIoIdlDrpanloullr_orapllon ou_IrlIIeu,ofCHh (OIIl11i1l1iaj 0 II. MIOitiJoo .............. _ _ .ro.mU~Of...-.;tm_ A Cull J; $HQdtID~nalnv. . . . . f1f~fullllt(1I1111rb1) 0 0 C. S.....wHIIoId bpol1icullrcu_orapllon _ _ In lleuofou/l (alinarbl} 0 no '20 53 '''' , EEl e.. Nat ...emfttom(!O) ........·ckoIIIIII..........'eclllhetmtlltl. 1 A Vidue of open I0I\l opIlon--' 8. .".... ofopc ..."" ........ _ c ;E 11. Nat«ll'III.nthOlMl:~_ A Netllqul~«II'1IY It SMudIfQ ~lnvelJlmenl$ of_tlnde(almodce\) C. SeouriIInlIoId IDrporil...Ior..................................In lieu of ou/I (IIIm.lIia) II B 0 i3 200 2'0 I!!:J I!D 14. I 13) 15. MlnlpnlllllTQljltAmoulllfat exo-lHIdllll ~ TKELleY on DSK3SPTVN1PROD with RULES2 1&. ex_ VerDate Mar<15>2010 19:24 Nov 13, 2013 {doftC!I!ncWfun4tlnAJJ1lllilllllitIW"'~ Jkt 232001 PO 00000 MonogenIenlTaIgeIAmoIinlEl«lesit Frm 00112 Fmt 4701 Sfmt 4725 0 eo $ ~(~oy)liIndeilu.~ (SubhcthOiumb II Ii l!![J $ II E.J E:\FR\FM\14NOR2.SGM 14NOR2 ER14NO13.003</GPH> $ Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations 68617 NFAIOHo: CFTe FORM 1·FR-FCM. STATEMeNT OF SECUReD AMOUNTS AND FUNOS HelD IN SEPARATE ACOOUNTS PURSUANTTO COMMISSION REGULATION 30.7 AS OF u.Jxxtxxxx FOBSGNfUWflES8ID FOREIGN OpngNS SECURipAMoUNI§ '--_ _~,~!A.nClUnl fll(Jlillld lObe set aside pu!IIUlInlto 1ft, rUle III" reGIlIlItIOn ah\~~ar.naQfa~OI'fI8J1IzatlM aulharindlhonunder t. Net~biafallce. Fcnil'\FllllltanndFaraigltOpllomTradlnO-AjJ Cu$lamllf$ AC.sli a $ 17 o S!aIJIIes(lltmll1u!l) B CJ ~lI'aI::IedcptlOn$ A. MaIl«!!VlIlue OfGfll!ll aptiOjICIlIIlraCis p!InjIIased on It f«aIgn boerd fA trade· 17 8, Mall«!! VlIlued GflI!II opIiqIl CIlIIlraIllt IJ'II)Ied ($Old) on a foreIlIn bOard dllUe· 17 ~$_ _ _..;.D 4, Neteqflily(~(acldln.1,2••n63) 5. Aocoulllt1lquldlllllg 10 .. ddcit IIId dellitbelam:el- .-_1 1IlGGUIII$. ...;..-_,.;..-.......;;.0 _ _ _......;;.0 6. D 0 _____ D 0 AmCIum ~mlO be . . aide ulhaltl:llftd~· Net I.k'IUlcldnQ EilJl,lilyMolh«l $ (add l1li. 4 endS) o TKELleY on DSK3SPTVN1PROD with RULES2 ~$_ _ _.;.O VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 PO 00000 Frm 00113 Fmt 4701 Sfmt 4725 B D E:\FR\FM\14NOR2.SGM 14NOR2 D D ER14NO13.004</GPH> 3, 68618 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations ~IONo: NI'A 10 No: CFTC FORM 1-FR-FCM STATeMENT OF SECUAeOAMOUH'TS AND FUNDS HeLD lit SEPARATeAeCOUH'TS PURSUANT TO COMMiSSION REGULATION 3tH AS OF lOIbodloooI:. fYN£I§ peeosllJPlN SEPARATE REGllLATIC!III3!I.7AGC01lNTs 1. catII in Bank5 A. IllllIIIIOcatelI in lIIe Unilell SWM .. QIIIII' a,nlll qudIIII ...lllrllqUlalilln 30.7 0: I [!!!J 0: [!!J 2. SlcudlH A. II! ~VoIIII bIInllllOcatellIII lIIeUnlIad SlM $ 10.1 B. In~VoIIIIQlllerbllnllJ""edunderRIlQllIlliDn30;7 :~ $ ~ C. UnreaIacI_ (1IlIS) on open tdures CIInImI!I O. VllueOflanllaplan_ E, VW.Of tllOit G\lIiGII CIInImI!I .( Amou ... 11-<$): i hId:.., dnrinlJ....1ntIans otfilnd.. boanIs.Ofhde r!1 $ v "". catII B Se<:UIihs C. Amwnt dull to (tom) ~ OIginlatiOIHIIIJyvllridDll 6 O. Vlluoilanllaplon_ II E. VWeOftilOltG\lliGll_ 0: 0: S. AmIIu... held.., III..,.Ofilnllln bUIIII Oflftlla Nam«s): A. 00II I) 6 B. SRUIIIM c. !J1INI!IIed pin (\HI) 011 open tdures CIInImI!I 0 D. V8J\IeOftangaplan~ E. VW.OftilOltaplonCllnlml!l e. II II ~VoIIII QIII"~ IfNIljnIted"'lIfWligltllalllOflmt !i!j1 Nam«.~ 7.~1UmIa.on_!l(demibe: .. T*fUn.ln~"*,,30.7~(lo~t3.lIIe2) a 111. ~enlTwtIII AmGuIItfilr E'xcen ..... In ~M@" 3O.1_nl1 11. Eroets(ildtllcy)tmds in aparaIe HdIoII30.7 _ TKELleY on DSK3SPTVN1PROD with RULES2 eo-. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 PO 00000 ... over(1lII1IaI/ l\Inagel'lltlll Tupt Frm 00114 Fmt 4701 Sfmt 4725 I!!!J ~ _ _ _-:.0 I!!J ~ _ _ _-:.0 l!!!J 1- I I!!::J ..1'=:==:;0 I-I _ ."' _____ 0 D ...::'"--_ _.:.0 ex-~SelAIide Fumla f«s.curedAinOlml (su1IINiltlne 111ocur114~ .... ' tomLflla8) _ _~Q 11 o 'mol ______ 0 :t £qulllu VoIIII~""" CIOIIIII'IIaIan IIIIl'CIwdI _ _ _....:;.0 _ _ _-:..0 10.1 II~.~ a. I_I t:::l _·____ °0 E:\FR\FM\14NOR2.SGM 14NOR2 ER14NO13.005</GPH> lIam.): I!!J I I!!l -=-__~o 0 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations BILLING CODE 6351–01–C 17 CFR Part 140 List of Subjects Authority delegations (Government agencies), Organization and functions (Government agencies). For the reasons stated in the preamble, the Commodity Futures Trading Commission amends 17 CFR parts 1, 3, 22, 30, and 140 as follows: Brokers, Commodity futures, Consumer protection, Reporting and recordkeeping requirements. 17 CFR Part 3 PART 1—GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT 17 CFR Part 22 TKELleY on DSK3SPTVN1PROD with RULES2 Associated persons, Brokers, Commodity futures, Customer protection, Major swap participants, Registration, Swap dealers. ■ Brokers, Clearing, Consumer protection, Reporting and recordkeeping requirements, Swaps. 17 CFR Part 30 Commodity futures, Consumer protection, Currency, Reporting and recordkeeping requirements. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 1. The authority citation for part 1 is revised to read as follows: Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a–1, 7a–2, 7b, 7b–3, 8, 9, 10a, 12, 12a, 12c, 13a, 13a–1, 16, 16a, 19, 21, 23, and 24, as amended by Title VII of the DoddFrank Wall Street Reform and Consumer Protection Act, Pub. L. 111–203, 124 Stat. 1376 (2010). PO 00000 Frm 00115 Fmt 4701 2. Amend § 1.3 to revise paragraph (rr) to read as follows: ■ Sfmt 4700 § 1.3 Definitions. * * * * * (rr) Foreign futures or foreign options secured amount. This term means all money, securities and property received by a futures commission merchant from, for, or on behalf of 30.7 customers as defined in § 30.1 of this chapter: (1) To margin, guarantee, or secure foreign futures contracts and all money accruing to such 30.7 customers as the result of such contracts; (2) In connection with foreign options transactions representing premiums payable or premiums received, or to guarantee or secure performance on such transactions; and (3) All money accruing to such 30.7 customers as the result of trading in E:\FR\FM\14NOR2.SGM 14NOR2 ER14NO13.006</GPH> 17 CFR Part 1 68619 68620 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations foreign futures contracts or foreign options. * * * * * ■ 3. Amend § 1.10 to: ■ a. Revise paragraph (b)(1)(ii); ■ b. Add paragraph (b)(5); and ■ c. Revise paragraphs (c)(1), (c)(2)(i), (d)(1)(v), (d)(2)(iv), (d)(2)(vi), and (g)(2)(ii). The revisions and addition read as follows: § 1.10 Financial reports of futures commission merchants and introducing brokers. TKELleY on DSK3SPTVN1PROD with RULES2 * * * * * (b) * * * (1) * * * (ii) In addition to the monthly financial reports required by paragraph (b)(1)(i) of this section, each person registered as a futures commission merchant must file a Form 1–FR–FCM as of the close of its fiscal year, which must be certified by an independent public accountant in accordance with § 1.16, and must be filed no later than 60 days after the close of the futures commission merchant’s fiscal year: Provided, however, that a registrant which is registered with the Securities and Exchange Commission as a securities broker or dealer must file this report not later than the time permitted for filing an annual audit report under § 240.17a–5(d)(5) of this title. * * * * * (5) Each futures commission merchant must file with the Commission the measure of the future commission merchant’s leverage as of the close of the business each month. For purpose of this section, the term ‘‘leverage’’ shall be defined by a registered futures association of which the futures commission merchant is a member. The futures commission merchant is required to file the leverage information with the Commission within 17 business days of the close of the futures commission merchant’s month end. (c) Where to file reports. (1) Form 1– FR filed by an introducing broker pursuant to paragraph (b)(2) of this section need be filed only with, and will be considered filed when received by, the National Futures Association. Other reports or information provided for in this section will be considered filed when received by the Regional office of the Commission with jurisdiction over the state in which the registrant’s principal place of business is located (as set forth in § 140.02 of this chapter) and by the designated self-regulatory organization, if any; and reports or other information required to be filed by this section by an applicant for registration VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 will be considered filed when received by the National Futures Association. Any report or information filed with the National Futures Association pursuant to this paragraph shall be deemed for all purposes to be filed with, and to be the official record of, the Commission. (2)(i) All filings or other notices prepared by a futures commission merchant pursuant to this section must be submitted to the Commission in electronic form using a form of user authentication assigned in accordance with procedures established by or approved by the Commission, and otherwise in accordance with instructions issued by or approved by the Commission, if the futures commission merchant or a designated self-regulatory organization has provided the Commission with the means necessary to read and to process the information contained in such report. A Form 1–FR required to be certified by an independent public accountant in accordance with § 1.16 which is filed by a futures commission merchant must be filed electronically. * * * * * (d) * * * (1) * * * (v) For a futures commission merchant only, the statements of segregation requirements and funds in segregation for customers trading on U.S. commodity exchanges and for customers’ dealer options accounts, the statement of secured amounts and funds held in separate accounts for 30.7 customers (as defined in § 30.1 of this chapter) in accordance with § 30.7 of this chapter, and the statement of cleared swaps customer segregation requirements and funds in cleared swaps customer accounts under section 4d(f) of the Act as of the date for which the report is made; and * * * * * (2) * * * (iv) For a futures commission merchant only, the statements of segregation requirements and funds in segregation for customers trading on U.S. commodity exchanges and for customers’ dealer options accounts, the statement of secured amounts and funds held in separate accounts for 30.7 customers (as defined in § 30.1 of this chapter) in accordance with § 30.7 of the chapter, and the statement of cleared swaps customers segregation requirements and funds in cleared swaps customer accounts under section 4d(f) of the Act as of the date for which the report is made; * * * * * (vi) A reconciliation, including appropriate explanations, of the PO 00000 Frm 00116 Fmt 4701 Sfmt 4700 statement of the computation of the minimum capital requirements pursuant to § 1.17 and, for a futures commission merchant only, the statements of segregation requirements and funds in segregation for customers trading on U.S. commodity exchanges and for customers’ dealer option accounts, the statement of secured amounts and funds held in separate accounts for 30.7 customers (as defined in § 30.1 of this chapter) in accordance with § 30.7 of this chapter, and the statement of cleared swaps customer segregation requirements and funds in cleared swaps customer accounts under section 4d(f) of the Act, in the certified Form 1– FR with the applicant’s or registrant’s corresponding uncertified most recent Form 1–FR filing when material differences exist or, if no material differences exist, a statement so indicating; and * * * * * (g) * * * (2) * * * (ii) The following statements and footnote disclosures thereof: the Statement of Financial Condition in the certified annual financial reports of futures commission merchants and introducing brokers; the Statements (to be filed by a futures commission merchant only) of Segregation Requirements and Funds in Segregation for customers trading on U.S. commodity exchanges and for customers’ dealer options accounts, the Statement (to be filed by a futures commission merchant only) of Secured Amounts and Funds held in Separate Accounts for 30.7 Customers (as defined in § 30.1 of this chapter) in accordance with § 30.7 of this chapter, and the Statement (to be filed by futures commission merchants only) of Cleared Swaps Customer Segregation Requirements and Funds in Cleared Swaps Customer Accounts under section 4d(f) of the Act. * * * * * ■ 4. Add § 1.11 to read as follows: § 1.11 Risk Management Program for futures commission merchants. (a) Applicability. Nothing in this section shall apply to a futures commission merchant that does not accept any money, securities, or property (or extend credit in lieu thereof) to margin, guarantee, or secure any trades or contracts that result from soliciting or accepting orders for the purchase or sale of any commodity interest. (b) Definitions. For purposes of this section: (1) Business unit means any department, division, group, or E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations personnel of a futures commission merchant or any of its affiliates, whether or not identified as such that: (i) Engages in soliciting or in accepting orders for the purchase or sale of any commodity interest and that, in or in connection with such solicitation or acceptance of orders, accepts any money, securities, or property (or extends credit in lieu thereof) to margin, guarantee, or secure any trades or contracts that result or may result therefrom; or (ii) Otherwise handles segregated funds, including managing, investing, and overseeing the custody of segregated funds, or any documentation in connection therewith, other than for risk management purposes; and (iii) Any personnel exercising direct supervisory authority of the performance of the activities described in paragraph (b)(1)(i) or (ii) of this section. (2) Customer means a futures customer as defined in § 1.3, Cleared Swaps Customer as defined in § 22.1 of this chapter, and 30.7 customer as defined in § 30.1 of this chapter. (3) Governing body means the proprietor, if the futures commission merchant is a sole proprietorship; a general partner, if the futures commission merchant is a partnership; the board of directors if the futures commission merchant is a corporation; the chief executive officer, the chief financial officer, the manager, the managing member, or those members vested with the management authority if the futures commission merchant is a limited liability company or limited liability partnership. (4) Segregated funds means money, securities, or other property held by a futures commission merchant in separate accounts pursuant to § 1.20 for futures customers, pursuant to § 22.2 of this chapter for Cleared Swaps Customers, and pursuant to § 30.7 of this chapter for 30.7 customers. (5) Senior management means, any officer or officers specifically granted the authority and responsibility to fulfill the requirements of senior management by the governing body. (c) Risk Management Program. (1) Each futures commission merchant shall establish, maintain, and enforce a system of risk management policies and procedures designed to monitor and manage the risks associated with the activities of the futures commission merchant as such. For purposes of this section, such policies and procedures shall be referred to collectively as a ‘‘Risk Management Program.’’ (2) Each futures commission merchant shall maintain written policies and VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 procedures that describe the Risk Management Program of the futures commission merchant. (3) The Risk Management Program and the written risk management policies and procedures, and any material changes thereto, shall be approved in writing by the governing body of the futures commission merchant. (4) Each futures commission merchant shall furnish a copy of its written risk management policies and procedures to the Commission and its designated selfregulatory organization upon application for registration and thereafter upon request. (d) Risk management unit. As part of the Risk Management Program, each futures commission merchant shall establish and maintain a risk management unit with sufficient authority; qualified personnel; and financial, operational, and other resources to carry out the risk management program established pursuant to this section. The risk management unit shall report directly to senior management and shall be independent from the business unit. (e) Elements of the Risk Management Program. The Risk Management Program of each futures commission merchant shall include, at a minimum, the following elements: (1) Identification of risks and risk tolerance limits. (i) The Risk Management Program shall take into account market, credit, liquidity, foreign currency, legal, operational, settlement, segregation, technological, capital, and any other applicable risks together with a description of the risk tolerance limits set by the futures commission merchant and the underlying methodology in the written policies and procedures. The risk tolerance limits shall be reviewed and approved quarterly by senior management and annually by the governing body. Exceptions to risk tolerance limits shall be subject to written policies and procedures. (ii) The Risk Management Program shall take into account risks posed by affiliates, all lines of business of the futures commission merchant, and all other trading activity engaged in by the futures commission merchant. The Risk Management Program shall be integrated into risk management at the consolidated entity level. (iii) The Risk Management Program shall include policies and procedures for detecting breaches of risk tolerance limits set by the futures commission merchant, and alerting supervisors within the risk management unit and senior management, as appropriate. PO 00000 Frm 00117 Fmt 4701 Sfmt 4700 68621 (2) Periodic Risk Exposure Reports. (i) The risk management unit of each futures commission merchant shall provide to senior management and to its governing body quarterly written reports setting forth all applicable risk exposures of the futures commission merchant; any recommended or completed changes to the Risk Management Program; the recommended time frame for implementing recommended changes; and the status of any incomplete implementation of previously recommended changes to the Risk Management Program. For purposes of this section, such reports shall be referred to as ‘‘Risk Exposure Reports.’’ The Risk Exposure Reports also shall be provided to the senior management and the governing body immediately upon detection of any material change in the risk exposure of the futures commission merchant. (ii) Furnishing to the Commission. Each futures commission merchant shall furnish copies of its Risk Exposure Reports to the Commission within five (5) business days of providing such reports to its senior management. (3) Specific risk management considerations. The Risk Management Program of each futures commission merchant shall include, but not be limited to, policies and procedures necessary to monitor and manage the following risks: (i) Segregation risk. The written policies and procedures shall be reasonably designed to ensure that segregated funds are separately accounted for and segregated or secured as belonging to customers as required by the Act and Commission regulations and must, at a minimum, include or address the following: (A) A process for the evaluation of depositories of segregated funds, including, at a minimum, documented criteria that any depository that will hold segregated funds, including an entity affiliated with the futures commission merchant, must meet, including criteria addressing the depository’s capitalization, creditworthiness, operational reliability, and access to liquidity. The criteria should further consider the extent to which segregated funds are concentrated with any depository or group of depositories. The criteria also should include the availability of deposit insurance and the extent of the regulation and supervision of the depository; (B) A program to monitor an approved depository on an ongoing basis to assess its continued satisfaction of the futures commission merchant’s established E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68622 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations criteria, including a thorough due diligence review of each depository at least annually; (C) An account opening process for depositories, including documented authorization requirements, procedures that ensure that segregated funds are not deposited with a depository prior to the futures commission merchant receiving the acknowledgment letter required from such depository pursuant to § 1.20, and §§ 22.2 and 30.7 of this chapter, and procedures that ensure that such account is properly titled to reflect that it is holding segregated funds pursuant to the Act and Commission regulations; (D) A process for establishing a targeted amount of residual interest that the futures commission merchant seeks to maintain as its residual interest in the segregated funds accounts and such process must be designed to reasonably ensure that the futures commission merchant maintains the targeted residual amounts and remains in compliance with the segregated funds requirements at all times. The policies and procedures must require that senior management, in establishing the total amount of the targeted residual interest in the segregated funds accounts, perform appropriate due diligence and consider various factors, as applicable, relating to the nature of the futures commission merchant’s business including, but not limited to, the composition of the futures commission merchant’s customer base, the general creditworthiness of the customer base, the general trading activity of the customers, the types of markets and products traded by the customers, the proprietary trading of the futures commission merchant, the general volatility and liquidity of the markets and products traded by customers, the futures commission merchant’s own liquidity and capital needs, and the historical trends in customer segregated fund balances, including undermargined amounts and net deficit balances in customers’ accounts. The analysis and calculation of the targeted amount of the future commission merchant’s residual interest must be described in writing with the specificity necessary to allow the Commission and the futures commission merchant’s designated self-regulatory organization to duplicate the analysis and calculation and test the assumptions made by the futures commission merchant. The adequacy of the targeted residual interest and the process for establishing the targeted residual interest must be reassessed periodically by Senior Management and revised as necessary; (E) A process for the withdrawal of cash, securities, or other property from VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 accounts holding segregated funds, where the withdrawal is not for the purpose of payments to or on behalf of the futures commission merchant’s customers. Such policies and procedures must satisfy the requirements of § 1.23, § 22.17 of this chapter, or § 30.7 of this chapter, as applicable; (F) A process for assessing the appropriateness of specific investments of segregated funds in permitted investments in accordance with § 1.25. Such policies and procedures must take into consideration the market, credit, counterparty, operational, and liquidity risks associated with such investments, and assess whether such investments comply with the requirements in § 1.25 including that the futures commission merchant manage the permitted investments consistent with the objectives of preserving principal and maintaining liquidity; (G) Procedures requiring the appropriate separation of duties among individuals responsible for compliance with the Act and Commission regulations relating to the protection and financial reporting of segregated funds, including the separation of duties among personnel that are responsible for advising customers on trading activities, approving or overseeing cash receipts and disbursements (including investment operations), and recording and reporting financial transactions. The policies and procedures must require that any movement of funds to affiliated companies and parties are properly approved and documented; (H) A process for the timely recording of all transactions, including transactions impacting customers’ accounts, in the firm’s books of record; (I) A program for conducting annual training of all finance, treasury, operations, regulatory, compliance, settlement, and other relevant officers and employees regarding the segregation requirements for segregated funds required by the Act and regulations, the requirements for notices under § 1.12, procedures for reporting suspected breaches of the policies and procedures required by this section to the chief compliance officer, without fear of retaliation, and the consequences of failing to comply with the segregation requirements of the Act and regulations; and (J) Policies and procedures for assessing the liquidity, marketability and mark-to-market valuation of all securities or other non-cash assets held as segregated funds, including permitted investments under § 1.25, to ensure that all non-cash assets held in the customer segregated accounts, both customer- PO 00000 Frm 00118 Fmt 4701 Sfmt 4700 owned securities and investments in accordance with § 1.25, are readily marketable and highly liquid. Such policies and procedures must require daily measurement of liquidity needs with respect to customers; assessment of procedures to liquidate all non-cash collateral in a timely manner and without significant effect on price; and application of appropriate collateral haircuts that accurately reflect market and credit risk. (ii) Operational risk. The Risk Management Program shall include automated financial risk management controls reasonably designed to prevent the placing of erroneous orders, including those that exceed pre-set capital, credit, or volume thresholds. The Risk Management Program shall ensure that the use of automated trading programs is subject to policies and procedures governing the use, supervision, maintenance, testing, and inspection of such programs. (iii) Capital risk. The written policies and procedures shall be reasonably designed to ensure that the futures commission merchant has sufficient capital to be in compliance with the Act and the regulations, and sufficient capital and liquidity to meet the reasonably foreseeable needs of the futures commission merchant. (4) Supervision of the Risk Management Program. The Risk Management Program shall include a supervisory system that is reasonably designed to ensure that the policies and procedures required by this section are diligently followed. (f) Review and testing. (1) The Risk Management Program of each futures commission merchant shall be reviewed and tested on at least an annual basis, or upon any material change in the business of the futures commission merchant that is reasonably likely to alter the risk profile of the futures commission merchant. (2) The annual reviews of the Risk Management Program shall include an analysis of adherence to, and the effectiveness of, the risk management policies and procedures, and any recommendations for modifications to the Risk Management Program. The annual testing shall be performed by qualified internal audit staff that are independent of the business unit, or by a qualified third party audit service reporting to staff that are independent of the business unit. The results of the annual review of the Risk Management Program shall be promptly reported to and reviewed by the chief compliance officer, senior management, and governing body of the futures commission merchant. E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations (3) Each futures commission merchant shall document all internal and external reviews and testing of its Risk Management Program and written risk management policies and procedures including the date of the review or test; the results; any deficiencies identified; the corrective action taken; and the date that corrective action was taken. Such documentation shall be provided to Commission staff, upon request. (g) Distribution of risk management policies and procedures. The Risk Management Program shall include procedures for the timely distribution of its written risk management policies and procedures to relevant supervisory personnel. Each futures commission merchant shall maintain records of the persons to whom the risk management policies and procedures were distributed and when they were distributed. (h) Recordkeeping. (1) Each futures commission merchant shall maintain copies of all written approvals required by this section. (2) All records or reports, including, but not limited to, the written policies and procedures and any changes thereto that a futures commission merchant is required to maintain pursuant to this regulation shall be maintained in accordance with § 1.31 and shall be made available promptly upon request to representatives of the Commission. ■ 5. Amend § 1.12 to: ■ a. Revise paragraphs (a)(1) and (a)(2); (b)(1), (b)(2), and (b)(4); (c); (d); (e); (f)(2) through (f)(4) and (f)(5)(i); (g); (h); and (i); and ■ b. Add paragraphs (j), (k), (l), (m), and (n). The revisions and additions read as follows: TKELleY on DSK3SPTVN1PROD with RULES2 § 1.12 Maintenance of minimum financial requirements by futures commission merchants and introducing brokers. (a) * * * (1) Give notice, as set forth in paragraph (n) of this section, that the applicant’s or registrant’s adjusted net capital is less than required by § 1.17 or by other capital rule, identifying the applicable capital rule. The notice must be given immediately after the applicant or registrant knows or should have known that its adjusted net capital is less than required by any of the aforesaid rules to which the applicant or registrant is subject; and (2) Provide together with such notice documentation, in such form as necessary, to adequately reflect the applicant’s or registrant’s capital condition as of any date on which such person’s adjusted net capital is less than the minimum required; Provided, VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 however, that if the applicant or registrant cannot calculate or otherwise immediately determine its financial condition, it must provide the notice required by paragraph (a)(1) of this section and include in such notice a statement that the entity cannot presently calculate its financial condition. The applicant or registrant must provide similar documentation of its financial condition for other days as the Commission may request. (b) * * * (1) 150 percent of the minimum dollar amount required by § 1.17(a)(1)(i)(A); (2) 110 percent of the amount required by § 1.17(a)(1)(i)(B); * * * * * (4) For securities brokers or dealers, the amount of net capital specified in Rule 17a-11(c) of the Securities and Exchange Commission (17 CFR 240.17a11(c)), must file notice to that effect, as set forth in paragraph (n) of this section, as soon as possible and no later than twenty-four (24) hours of such event. (c) If an applicant or registrant at any time fails to make or keep current the books and records required by these regulations, such applicant or registrant must, on the same day such event occurs, provide notice of such fact as specified in paragraph (n) of this section, specifying the books and records which have not been made or which are not current, and as soon as possible, but not later than forty-eight (48) hours after giving such notice, file a report as required by paragraph (n) of this section stating what steps have been and are being taken to correct the situation. (d) Whenever any applicant or registrant discovers or is notified by an independent public accountant, pursuant to § 1.16(e)(2), of the existence of any material inadequacy, as specified in § 1.16(d)(2), such applicant or registrant must give notice of such material inadequacy, as provided in paragraph (n) of this section, as soon as possible but not later than twenty-four (24) hours of discovering or being notified of the material inadequacy. The applicant or registrant must file, in the manner provided for under paragraph (n) of this section, a report stating what steps have been and are being taken to correct the material inadequacy within forty-eight (48) hours of filing its notice of the material inadequacy. (e) Whenever any self-regulatory organization learns that a member registrant has failed to file a notice or report as required by this section, that self-regulatory organization must immediately report this failure by notice, as provided in paragraph (n) of this section. PO 00000 Frm 00119 Fmt 4701 Sfmt 4700 68623 (f) * * * (2) Whenever a registered futures commission merchant determines that any position it carries for another registered futures commission merchant or for a registered leverage transaction merchant must be liquidated immediately, transferred immediately or that the trading of any account of such futures commission merchant or leverage transaction merchant shall be only for purposes of liquidation, because the other futures commission merchant or the leverage transaction merchant has failed to meet a call for margin or to make other required deposits, the carrying futures commission merchant must immediately give notice, as provided in paragraph (n) of this section, of such a determination. (3) Whenever a registered futures commission merchant determines that an account which it is carrying is undermargined by an amount which exceeds the futures commission merchant’s adjusted net capital determined in accordance with § 1.17, the futures commission merchant must immediately provide notice, as provided in paragraph (n) of this section, of such a determination to the designated selfregulatory organization and the Commission. This paragraph (f)(3) shall apply to any account carried by the futures commission merchant, whether a customer, noncustomer, omnibus or proprietary account. For purposes of this paragraph, if any person has an interest of 10 percent or more in ownership or equity in, or guarantees, more than one account, or has guaranteed an account in addition to its own account, all such accounts shall be combined. (4) A futures commission merchant shall provide immediate notice, as provided in paragraph (n) of this section, whenever any commodity interest account it carries is subject to a margin call, or call for other deposits required by the futures commission merchant, that exceeds the futures commission merchant’s excess adjusted net capital, determined in accordance with § 1.17, and such call has not been answered by the close of business on the day following the issuance of the call. This applies to all accounts carried by the futures commission merchant, whether customer, noncustomer, or omnibus, that are subject to margining, including commodity futures, cleared swaps, and options. In addition to actual margin deposits by an account owner, a futures commission merchant may also take account of favorable market moves in determining whether E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68624 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations the margin call is required to be reported under this paragraph. (5)(i) A futures commission merchant shall provide immediate notice, as provided in paragraph (n) of this section, whenever its excess adjusted net capital is less than six percent of the maintenance margin required by the futures commission merchant on all positions held in accounts of a noncustomer other than a noncustomer who is subject to the minimum financial requirements of: (A) A futures commission merchant, or (B) The Securities and Exchange Commission for a securities broker or dealer. * * * * * (g) A futures commission merchant shall provide notice, as provided in paragraph (n) of this section, of a substantial reduction in capital as compared to that last reported in a financial report filed with the Commission pursuant to § 1.10. This notice shall be provided as follows: (1) If any event or series of events, including any withdrawal, advance, loan or loss cause, on a net basis, a reduction in net capital (or, if the futures commission merchant is qualified to use the filing option available under § 1.10(h), tentative net capital as defined in the rules of the Securities and Exchange Commission) of 20 percent or more, notice must be provided as provided in paragraph (n) of this section within two business days of the event or series of events causing the reduction stating the reason for the reduction and steps the futures commission merchant will be taking to ensure an appropriate level of net capital is maintained by the futures commission merchant; and (2) If equity capital of the futures commission merchant or a subsidiary or affiliate of the futures commission merchant consolidated pursuant to § 1.17(f) (or 17 CFR 240.15c3–1e) would be withdrawn by action of a stockholder or a partner or a limited liability company member or by redemption or repurchase of shares of stock by any of the consolidated entities or through the payment of dividends or any similar distribution, or an unsecured advance or loan would be made to a stockholder, partner, sole proprietor, limited liability company member, employee or affiliate, such that the withdrawal, advance or loan would cause, on a net basis, a reduction in excess adjusted net capital (or, if the futures commission merchant is qualified to use the filing option available under § 1.10(h), excess net capital as defined in the rules of the VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 Securities and Exchange Commission) of 30 percent or more, notice must be provided as provided in paragraph (n) of this section at least two business days prior to the withdrawal, advance or loan that would cause the reduction: Provided, however, That the provisions of paragraphs (g)(1) and (g)(2) of this section do not apply to any futures or securities transaction in the ordinary course of business between a futures commission merchant and any affiliate where the futures commission merchant makes payment to or on behalf of such affiliate for such transaction and then receives payment from such affiliate for such transaction within two business days from the date of the transaction. (3) Upon receipt of such notice from a futures commission merchant, or upon a reasonable belief that a substantial reduction in capital has occurred or will occur, the Director of the Division of Swap Dealer and Intermediary Oversight or the Director’s designee may require that the futures commission merchant provide or cause a Material Affiliated Person (as that term is defined in § 1.14(a)(2)) to provide, within three business days from the date of request or such shorter period as the Division Director or designee may specify, such other information as the Division Director or designee determines to be necessary based upon market conditions, reports provided by the futures commission merchant, or other available information. (h) Whenever a person registered as a futures commission merchant knows or should know that the total amount of its funds on deposit in segregated accounts on behalf of customers trading on designated contract markets, or the amount of funds on deposit in segregated accounts for customers transacting in Cleared Swaps under part 22 of this chapter, or the total amount set aside on behalf of customers trading on non-United States markets under part 30 of this chapter, is less than the total amount of such funds required by the Act and the regulations to be on deposit in segregated or secured amount accounts on behalf of such customers, the registrant must report such deficiency immediately by notice to the registrant’s designated self-regulatory organization and the Commission, as provided in paragraph (n) of this section. (i) A futures commission merchant must provide immediate notice, as set forth in paragraph (n) of this section, whenever it discovers or is informed that it has invested funds held for futures customers trading on designated contract markets pursuant to § 1.20, Cleared Swaps Customer Collateral, as PO 00000 Frm 00120 Fmt 4701 Sfmt 4700 defined in § 22.1 of this chapter, or 30.7 customer funds, as defined in § 30.1 of this chapter, in instruments that are not permitted investments under § 1.25, or has otherwise violated the requirements governing the investment of funds belonging to customers under § 1.25. (j) A futures commission merchant must provide immediate notice, as provided in paragraph (n) of this section, whenever the futures commission merchant does not hold a sufficient amount of funds in segregated accounts for futures customers under § 1.20, in segregated accounts for Cleared Swaps Customers under part 22 of this chapter, or in secured amount accounts for customers trading on foreign markets under part 30 of this chapter to meet the futures commission merchant’s targeted residual interest in the segregated or secured amount accounts pursuant to its policies and procedures required under § 1.11, or whenever the futures commission merchant’s amount of residual interest is less than the sum of the undermargined amounts in its customer accounts as determined at the point in time that the firm is required to maintain the undermargined amounts under § 1.22, and §§ 22.2 and 30.7 of this chapter. (k) A futures commission merchant must provide immediate notice, as provided in paragraph (n) of this section, whenever the futures commission merchant, or the futures commission merchant’s parent or material affiliate, experiences a material adverse impact to its creditworthiness or ability to fund its obligations, including any change that could adversely impact the firm’s liquidity resources. (l) A futures commission merchant must provide prompt notice, but in no event later than 24 hours, as provided in paragraph (n) of this section, whenever the futures commission merchant experiences a material change in its operations or risk profile, including a change in the senior management of the futures commission merchant, the establishment or termination of a line of business, or a material adverse change in the futures commission merchant’s clearing arrangements. (m) A futures commission merchant must provide notice, if the futures commission merchant has been notified by the Securities and Exchange Commission, a securities self-regulatory organization, or a futures self-regulatory organization, that it is the subject of a formal investigation. A futures commission merchant must provide a copy of any examination report issued E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations to the futures commission merchant by the Securities and Exchange Commission or a securities selfregulatory organization. A futures commission merchant must provide the Commission with notice of any correspondence received from the Securities and Exchange Commission or a securities self-regulatory organization that raises issues with the adequacy of the futures commission merchant’s capital position, liquidity to meet its obligations or otherwise operate its business, or internal controls. The notices and examination reports required by this section must be filed in a prompt manner, but in no event later than 24 hours of the reportable event, and must be filed in accordance with paragraph (n) of the section; Provided, however, that a futures commission merchant is not required to file a notice or copy of an examination report with the Securities and Exchange Commission, a securities self-regulatory organization, or a futures self-regulatory organization if such entity originally provided the communication or report to the futures commission merchant. (n) Notice. (1) Every notice and report required to be filed by this section by a futures commission merchant or a selfregulatory organization must be filed with the Commission, with the designated self-regulatory organization, if any, and with the Securities and Exchange Commission, if such registrant is a securities broker or dealer. Every notice and report required to be filed by this section by an applicant for registration as a futures commission merchant must be filed with the National Futures Association (on behalf of the Commission), with the designated self-regulatory organization, if any, and with the Securities and Exchange Commission, if such applicant is a securities broker or dealer. Every notice or report that is required to be filed by this section by a futures commission merchant or a self-regulatory organization must include a discussion of how the reporting event originated and what steps have been, or are being taken, to address the reporting event. (2) Every notice and report which an introducing broker or applicant for registration as an introducing broker is required to file by paragraphs (a), (c), and (d) of this section must be filed with the National Futures Association (on behalf of the Commission), with the designated self-regulatory organization, if any, and with every futures commission merchant carrying or intending to carry customer accounts for the introducing broker or applicant for registration as an introducing broker. Any notice or report filed with the VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 National Futures Association pursuant to this paragraph shall be deemed for all purposes to be filed with, and to be the official record of, the Commission. Every notice or report that is required to be filed by this section by an introducing broker or applicant for registration as an introducing broker must include a discussion of how the reporting event originated and what steps have been, or are being taken, to address the reporting event. (3) Every notice or report that is required to be filed by a futures commission merchant with the Commission or with a designated selfregulatory organization under this section must be in writing and must be filed via electronic transmission using a form of user authentication assigned in accordance with procedures established by or approved by the Commission, and otherwise in accordance with instructions issued by or approved by the Commission; Provided, however, that if the registered futures commission merchant cannot file the notice or report using the electronic transmission approved by the Commission due to a transmission or systems failure, the futures commission merchant must immediately contact the Commission’s regional office with jurisdiction over the futures commission merchant as provided in § 140.02 of this chapter, and by email to FCMNotice@CFTC.gov. Any such electronic submission must clearly indicate the futures commission merchant on whose behalf such filing is made and the use of such user authentication in submitting such filing will constitute and become a substitute for the manual signature of the authorized signer. ■ 6. Amend § 1.15 to revise paragraph (a)(4) to read as follows: § 1.15 Risk assessment reporting requirements for futures commission merchants. (a) * * * (4) The reports required to be filed pursuant to paragraphs (a)(1) and (2) of this section must be filed via electronic transmission using a form of user authentication assigned in accordance with procedures established by or approved by the Commission, and otherwise in accordance with instructions issued by or approved by the Commission. Any such electronic submission must clearly indicate the registrant on whose behalf such filing is made and the use of such user authentication in submitting such filing will constitute and become a substitute for the manual signature of the authorized signer. * * * * * PO 00000 Frm 00121 Fmt 4701 Sfmt 4700 68625 7. Amend § 1.16 to: a. Revise paragraphs (a)(4), (b)(1), (c)(1) and (c)(2), and (f)(1)(i)(C); and ■ b. Add paragraph (b)(4). The revisions and addition read as follows: ■ ■ § 1.16 Qualifications and reports of accountants. (a) * * * (4) Customer. The term ‘‘customer’’ means customer, as defined in § 1.3, and 30.7 customer, as defined in § 30.1 of this chapter. (b) Qualifications of accountants. (1) The Commission will recognize any person as a certified public accountant who is duly registered and in good standing as such under the laws of the place of his residence or principal office; Provided, however, that a certified public accountant engaged to conduct an examination of a futures commission merchant must be registered with the Public Company Accounting Oversight Board and must have undergone an examination by the Public Company Accounting Oversight Board, and may not be subject to a permanent or temporary bar to engage in the examination of public issuers or brokers or dealers registered with the Securities and Exchange Commission as a result of a Public Company Accounting Oversight Board disciplinary hearing. * * * * * (4) The governing body of each futures commission merchant must ensure that the certified public accountant engaged is duly qualified to perform an audit of the futures commission merchant. Such an evaluation of the qualifications of the certified public accountant should include, among other issues, the certified public accountant’s experience in auditing futures commission merchants, the depth of the certified public accountant’s staff, the certified public accountant’s knowledge of the Act and Regulations, the size and geographic location of the futures commission merchant, and the independence of the certified public accountant. The governing body should also review and consider the inspection reports issued by the Public Company Accounting Oversight Board as part of the assessment of the qualifications of the public accountant to perform an audit of the futures commission merchant. (c) * * * (1) Technical requirements. The accountant’s report must: (i) Be dated; (ii) Indicate the city and State where issued; and E:\FR\FM\14NOR2.SGM 14NOR2 68626 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations (iii) Identify without detailed enumeration the financial statements covered by the report. (2) Representations as to the audit. The accountant’s report must state whether the audit was made in accordance with the auditing standards adopted by the Public Company Accounting Oversight Board, and must designate any auditing procedures deemed necessary by the accountant under the circumstances of the particular case which have been omitted and the reasons for their omission. However, nothing in this paragraph shall be construed to imply authority for the omission of any procedure which independent accountants would ordinarily employ in the course of an audit made for the purposes of expressing the opinion required by paragraph (c)(3) of this section. * * * * * (f)(1) * * * (i) * * * (C) Any copy that under this paragraph is required to be filed with the Commission must be filed via electronic transmission using a form of user authentication assigned in accordance with procedures established by or approved by the Commission, and otherwise in accordance with instructions issued by or approved by the Commission. Any such electronic submission must clearly indicate the registrant on whose behalf such filing is made and the use of such user authentication in submitting such filing will constitute and become a substitute for the manual signature of the authorized signer. * * * * * ■ 8. Amend § 1.17 to revise paragraphs (a)(4), (b)(2), (b)(7), (c)(5)(v), (c)(5)(viii), and (c)(5)(ix) to read as follows: TKELleY on DSK3SPTVN1PROD with RULES2 § 1.17 Minimum financial requirements for futures commission merchants and introducing brokers. (a) * * * (4) A futures commission merchant who is not in compliance with this section, or is unable to demonstrate such compliance as required by paragraph (a)(3) of this section, or who cannot certify to the Commission immediately upon request and demonstrate with verifiable evidence that it has sufficient access to liquidity to continue operating as a going concern, must transfer all customer accounts and immediately cease doing business as a futures commission merchant until such time as the firm is able to demonstrate such compliance; Provided, however, The registrant may trade for liquidation purposes only VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 unless otherwise directed by the Commission and/or the designated selfregulatory organization; And, Provided further, That if such registrant immediately demonstrates to the satisfaction of the Commission or the designated self-regulatory organization the ability to achieve compliance, the Commission or the designated selfregulatory organization may in its discretion allow such registrant up to a maximum of 10 business days in which to achieve compliance without having to transfer accounts and cease doing business as required above. Nothing in this paragraph shall be construed as preventing the Commission or the designated self-regulatory organization from taking action against a registrant for non-compliance with any of the provisions of this section. * * * * * (b) * * * (2) Customer. This term means a futures customer as defined in § 1.3, a cleared over the counter customer as defined in paragraph (b)(10) of this section, and a 30.7 customer as defined in § 30.1 of this chapter. * * * * * (7) Customer account. This term means an account in which commodity futures, options or cleared over the counter derivative positions are carried on the books of the applicant or registrant which is an account that is included in the definition of customer as defined in § 1.17(b)(2). * * * * * (c) * * * (5) * * * (v) In the case of securities and obligations used by the applicant or registrant in computing net capital, and in the case of a futures commission merchant that invests funds deposited by futures customers as defined in § 1.3, Cleared Swaps Customers as defined in § 22.1 of this chapter, and 30.7 customers as defined in § 30.1 of this chapter in securities as permitted investments under § 1.25, the deductions specified in Rule 240.15c3– 1(c)(2)(vi) or Rule 240.15c3–1(c)(2)(vii) of the Securities and Exchange Commission (17 CFR 240.15c3– 1(c)(2)(vi) and 17 CFR 240.15c3– 1(c)(2)(vii)) (‘‘securities haircuts’’). Futures commission merchants that establish and enforce written policies and procedures to assess the credit risk of commercial paper, convertible debt instruments, or nonconvertible debt instruments in accordance with Rule 240.15c3–1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR 240.15c3–1(c)(2)(vi)) may apply the lower haircut percentages specified in PO 00000 Frm 00122 Fmt 4701 Sfmt 4700 Rule 240.15c3–1(c)(2)(vi) for such commercial paper, convertible debt instruments and nonconvertible debt instruments. Futures commission merchants must maintain their written policies and procedures in accordance with § 1.31; * * * * * (viii) In the case of a futures commission merchant, for undermargined customer commodity futures accounts and commodity option customer accounts the amount of funds required in each such account to meet maintenance margin requirements of the applicable board of trade or if there are no such maintenance margin requirements, clearing organization margin requirements applicable to such positions, after application of calls for margin or other required deposits which are outstanding no more than one business day. If there are no such maintenance margin requirements or clearing organization margin requirements, then the amount of funds required to provide margin equal to the amount necessary, after application of calls for margin or other required deposits outstanding no more than one business day, to restore original margin when the original margin has been depleted by 50 percent or more: Provided, To the extent a deficit is excluded from current assets in accordance with paragraph (c)(2)(i) of this section such amount shall not also be deducted under this paragraph. In the event that an owner of a customer account has deposited an asset other than cash to margin, guarantee or secure his account, the value attributable to such asset for purposes of this subparagraph shall be the lesser of: (A) The value attributable to the asset pursuant to the margin rules of the applicable board of trade, or (B) The market value of the asset after application of the percentage deductions specified in paragraph (c)(5) of this section; (ix) In the case of a futures commission merchant, for undermargined commodity futures and commodity option noncustomer and omnibus accounts the amount of funds required in each such account to meet maintenance margin requirements of the applicable board of trade or if there are no such maintenance margin requirements, clearing organization margin requirements applicable to such positions, after application of calls for margin or other required deposits which are outstanding no more than one business day. If there are no such maintenance margin requirements or clearing organization margin E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations requirements, then the amount of funds required to provide margin equal to the amount necessary after application of calls for margin or other required deposits outstanding no more than one business day to restore original margin when the original margin has been depleted by 50 percent or more: Provided, To the extent a deficit is excluded from current assets in accordance with paragraph (c)(2)(i) of this section such amount shall not also be deducted under this paragraph. In the event that an owner of a noncustomer or omnibus account has deposited an asset other than cash to margin, guarantee or secure his account the value attributable to such asset for purposes of this paragraph shall be the lesser of the value attributable to such asset pursuant to the margin rules of the applicable board of trade, or the market value of such asset after application of the percentage deductions specified in paragraph (c)(5) of this section; * * * * * ■ 9. Revise § 1.20 to read as follows: TKELleY on DSK3SPTVN1PROD with RULES2 § 1.20 Futures customer funds to be segregated and separately accounted for. (a) General. A futures commission merchant must separately account for all futures customer funds and segregate such funds as belonging to its futures customers. A futures commission merchant shall deposit futures customer funds under an account name that clearly identifies them as futures customer funds and shows that such funds are segregated as required by sections 4d(a) and 4d(b) of the Act and by this part. A futures commission merchant must at all times maintain in the separate account or accounts money, securities and property in an amount at least sufficient in the aggregate to cover its total obligations to all futures customers as computed under paragraph (i) of this section. The futures commission merchant must perform appropriate due diligence as required by § 1.11 on any and all locations of futures customer funds, as specified in paragraph (b) of this section, to ensure that the location in which the futures commission merchant has deposited such funds is a financially sound entity. (b) Location of futures customer funds. A futures commission merchant may deposit futures customer funds, subject to the risk management policies and procedures of the futures commission merchant required by § 1.11, with the following depositories: (1) A bank or trust company; (2) A derivatives clearing organization; or (3) Another futures commission merchant. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 (c) Limitation on the holding of futures customer funds outside of the United States. A futures commission merchant may hold futures customer funds with a depository outside of the United States only in accordance with § 1.49. (d) Written acknowledgment from depositories. (1) A futures commission merchant must obtain a written acknowledgment from each bank, trust company, derivatives clearing organization, or futures commission merchant prior to or contemporaneously with the opening of an account by the futures commission merchant with such depositories; provided, however, that a written acknowledgment need not be obtained from a derivatives clearing organization that has adopted and submitted to the Commission rules that provide for the segregation of futures customer funds in accordance with all relevant provisions of the Act and the rules and orders promulgated thereunder. (2) The written acknowledgment must be in the form as set out in Appendix A to this part. (3)(i) A futures commission merchant shall deposit futures customer funds only with a depository that agrees to provide the director of the Division of Swap Dealer and Intermediary Oversight, or any successor division, or such director’s designees, with direct, read-only electronic access to transaction and account balance information for futures customer accounts. (ii) The written acknowledgment must contain the futures commission merchant’s authorization to the depository to provide direct, read-only electronic access to futures customer account transaction and account balance information to the director of the Division of Swap Dealer and Intermediary Oversight, or any successor division, or such director’s designees, without further notice to or consent from the futures commission merchant. (4) A futures commission merchant shall deposit futures customer funds only with a depository that agrees to provide the Commission and the futures commission merchant’s designated selfregulatory organization with a copy of the executed written acknowledgment no later than three business days after the opening of the account or the execution of a new written acknowledgment for an existing account, as applicable. The Commission must receive the written acknowledgment from the depository via electronic means, in a format and manner determined by the Commission. PO 00000 Frm 00123 Fmt 4701 Sfmt 4700 68627 The written acknowledgment must contain the futures commission merchant’s authorization to the depository to provide the written acknowledgment to the Commission and to the futures commission merchant’s designated self-regulatory organization without further notice to or consent from the futures commission merchant. (5) A futures commission merchant shall deposit futures customer funds only with a depository that agrees that accounts containing customer funds may be examined at any reasonable time by the director of the Division of Swap Dealer and Intermediary Oversight or the director of the Division of Clearing and Risk, or any successor divisions, or such directors’ designees, or an appropriate officer, agent or employee of the futures commission merchant’s designated self-regulatory organization. The written acknowledgment must contain the futures commission merchant’s authorization to the depository to permit any such examination to take place without further notice to or consent from the futures commission merchant. (6) A futures commission merchant shall deposit futures customer funds only with a depository that agrees to reply promptly and directly to any request from the director of the Division of Swap Dealer and Intermediary Oversight or the director of the Division of Clearing and Risk, or any successor divisions, or such directors’ designees, or an appropriate officer, agent or employee of the futures commission merchant’s designated self-regulatory organization for confirmation of account balances or provision of any other information regarding or related to an account. The written acknowledgment must contain the futures commission merchant’s authorization to the depository to reply promptly and directly as required by this paragraph without further notice to or consent from the futures commission merchant. (7) The futures commission merchant shall promptly file a copy of the written acknowledgment with the Commission in the format and manner specified by the Commission no later than three business days after the opening of the account or the execution of a new written acknowledgment for an existing account, as applicable. (8) A futures commission merchant shall obtain a new written acknowledgment within 120 days of any changes in the following: (i) The name or business address of the futures commission merchant; (ii) The name or business address of the bank, trust company, derivatives E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68628 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations clearing organization or futures commission merchant receiving futures customer funds; or (iii) The account number(s) under which futures customer funds are held. (9) A futures commission merchant shall maintain each written acknowledgment readily accessible in its files in accordance with § 1.31, for as long as the account remains open, and thereafter for the period provided in § 1.31. (e) Commingling. (1) A futures commission merchant may for convenience commingle the futures customer funds that it receives from, or on behalf of, multiple futures customers in a single account or multiple accounts with one or more of the depositories listed in paragraph (b) of this section. (2) A futures commission merchant shall not commingle futures customer funds with the money, securities or property of such futures commission merchant, or with any proprietary account of such futures commission merchant, or use such funds to secure or guarantee the obligation of, or extend credit to, such futures commission merchant or any proprietary account of such futures commission merchant; provided, however, a futures commission merchant may deposit proprietary funds in segregated accounts as permitted under § 1.23. (3) A futures commission merchant may not commingle futures customer funds with funds deposited by 30.7 customers as defined in § 30.1 of this chapter and set aside in separate accounts as required by part 30 of this chapter, or with funds deposited by Cleared Swaps Customers as defined in § 22.1 of this chapter and held in segregated accounts pursuant to section 4d(f) of the Act; provided, however, that a futures commission merchant may commingle futures customer funds with funds deposited by 30.7 customers or Cleared Swaps Customers if expressly permitted by a Commission regulation or order, or by a derivatives clearing organization rule approved in accordance with § 39.15(b)(2) of this chapter. (f) Limitation on use of futures customer funds. (1) A futures commission merchant shall treat and deal with the funds of a futures customer as belonging to such futures customer. A futures commission merchant shall not use the funds of a futures customer to secure or guarantee the commodity interests, or to secure or extend the credit, of any person other than the futures customer for whom the funds are held. (2) A futures commission merchant shall obligate futures customer funds to VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 a derivatives clearing organization, a futures commission merchant, or any depository solely to purchase, margin, guarantee, secure, transfer, adjust or settle trades, contracts or commodity option transactions of futures customers; provided, however, that a futures commission merchant is permitted to use the funds belonging to a futures customer that are necessary in the normal course of business to pay lawfully accruing fees or expenses on behalf of the futures customer’s positions including commissions, brokerage, interest, taxes, storage and other fees and charges. (3) No person, including any derivatives clearing organization or any depository, that has received futures customer funds for deposit in a segregated account, as provided in this section, may hold, dispose of, or use any such funds as belonging to any person other than the futures customers of the futures commission merchant which deposited such funds. (g) Derivatives clearing organizations. (1) General. All futures customer funds received by a derivatives clearing organization from a member to purchase, margin, guarantee, secure or settle the trades, contracts or commodity options of the clearing member’s futures customers and all money accruing to such futures customers as the result of trades, contracts or commodity options so carried shall be separately accounted for and segregated as belonging to such futures customers, and a derivatives clearing organization shall not hold, use or dispose of such futures customer funds except as belonging to such futures customers. A derivatives clearing organization shall deposit futures customer funds under an account name that clearly identifies them as futures customer funds and shows that such funds are segregated as required by sections 4d(a) and 4d(b) of the Act and by this part. (2) Location of futures customer funds. A derivatives clearing organization may deposit futures customer funds with a bank or trust company, which may include a Federal Reserve Bank with respect to deposits of a derivatives clearing organization that is designated by the Financial Stability Oversight Council to be systemically important. (3) Limitation on the holding of futures customer funds outside of the United States. A derivatives clearing organization may hold futures customer funds with a depository outside of the United States only in accordance with § 1.49. (4) Written acknowledgment from depositories. (i) A derivatives clearing PO 00000 Frm 00124 Fmt 4701 Sfmt 4700 organization must obtain a written acknowledgment from each depository prior to or contemporaneously with the opening of a futures customer funds account. (ii) The written acknowledgment must be in the form as set out in Appendix B to this part; provided, however, that a derivatives clearing organization shall obtain from a Federal Reserve Bank only a written acknowledgment that: (A) The Federal Reserve Bank was informed that the customer funds deposited therein are those of customers who trade commodities, options, swaps, and other products and are being held in accordance with the provisions of section 4d of the Act and Commission regulations thereunder; and (B) The Federal Reserve Bank agrees to reply promptly and directly to any request from the director of the Division of Clearing and Risk or the director of the Division of Swap Dealer and Intermediary Oversight, or any successor divisions, or such directors’ designees, for confirmation of account balances or provision of any other information regarding or related to an account. (iii) A derivatives clearing organization shall deposit futures customer funds only with a depository that agrees to provide the Commission with a copy of the executed written acknowledgment no later than three business days after the opening of the account or the execution of a new written acknowledgment for an existing account, as applicable. The Commission must receive the written acknowledgment from the depository via electronic means, in a format and manner determined by the Commission. The written acknowledgment must contain the derivatives clearing organization’s authorization to the depository to provide the written acknowledgment to the Commission without further notice to or consent from the derivatives clearing organization. (iv) A derivatives clearing organization shall deposit futures customer funds only with a depository that agrees to reply promptly and directly to any request from the director of the Division of Clearing and Risk or the director of the Division of Swap Dealer and Intermediary Oversight, or any successor divisions, or such directors’ designees, for confirmation of account balances or provision of any other information regarding or related to an account. The written acknowledgment must contain the derivatives clearing organization’s authorization to the depository to reply promptly and directly as required by E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations this paragraph without further notice to or consent from the derivatives clearing organization. (v) A derivatives clearing organization shall promptly file a copy of the written acknowledgment with the Commission in the format and manner specified by the Commission no later than three business days after the opening of the account or the execution of a new written acknowledgment for an existing account, as applicable. (vi) A derivatives clearing organization shall obtain a new written acknowledgment within 120 days of any changes in the following: (A) The name or business address of the derivatives clearing organization; (B) The name or business address of the depository receiving futures customer funds; or (C) The account number(s) under which futures customer funds are held. (vii) A derivatives clearing organization shall maintain each written acknowledgment readily accessible in its files in accordance with § 1.31, for as long as the account remains open, and thereafter for the period provided in § 1.31. (5) Commingling. (i) A derivatives clearing organization may for convenience commingle the futures customer funds that it receives from, or on behalf of, multiple futures commission merchants in a single account or multiple accounts with one or more of the depositories listed in paragraph (g)(2) of this section. (ii) A derivatives clearing organization shall not commingle futures customer funds with the money, securities or property of such derivatives clearing organization or with any proprietary account of any of its clearing members, or use such funds to secure or guarantee the obligations of, or extend credit to, such derivatives clearing organization or any proprietary account of any of its clearing members. (iii) A derivatives clearing organization may not commingle funds held for futures customers with funds deposited by clearing members on behalf of their 30.7 customers as defined in § 30.1 of this chapter and set aside in separate accounts as required by part 30 of this chapter, or with funds deposited by clearing members on behalf of their Cleared Swaps Customers as defined in § 22.1 of this chapter and held in segregated accounts pursuant section 4d(f) of the Act; provided, however, that a derivatives clearing organization may commingle futures customer funds with funds deposited by clearing members on behalf of their 30.7 customers or Cleared Swaps Customers if expressly permitted by a Commission regulation or order, or VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 by a derivatives clearing organization rule approved in accordance with § 39.15(b)(2) of this chapter. (h) Immediate availability of bank and trust company deposits. All futures customer funds deposited by a futures commission merchant or a derivatives clearing organization with a bank or trust company must be immediately available for withdrawal upon the demand of the futures commission merchant or derivatives clearing organization. (i) Requirements as to amount. (1) For purposes of this paragraph (i), the term ‘‘account’’ shall mean the entries on the books and records of a futures commission merchant pertaining to the futures customer funds of a particular futures customer. (2) The futures commission merchant must reflect in the account that it maintains for each futures customer the net liquidating equity for each such customer, calculated as follows: The market value of any futures customer funds that it receives from such customer, as adjusted by: (i) Any uses permitted under paragraph (f) of this section; (ii) Any accruals on permitted investments of such collateral under § 1.25 that, pursuant to the futures commission merchant’s customer agreement with that customer, are creditable to such customer; (iii) Any gains and losses with respect to contracts for the purchase or sale of a commodity for future delivery and any options on such contracts; (iv) Any charges lawfully accruing to the futures customer, including any commission, brokerage fee, interest, tax, or storage fee; and (v) Any appropriately authorized distribution or transfer of such collateral. (3) If the market value of futures customer funds in the account of a futures customer is positive after adjustments, then that account has a credit balance. If the market value of futures customer funds in the account of a futures customer is negative after adjustments, then that account has a debit balance. (4) The futures commission merchant must maintain in segregation an amount equal to the sum of any credit balances that the futures customers of the futures commission merchant have in their accounts. This balance may not be reduced by any debit balances that the futures customers of the futures commission merchants have in their accounts. PO 00000 Frm 00125 Fmt 4701 Sfmt 4700 68629 Appendix A to § 1.20—Futures Commission Merchant Acknowledgment Letter for CFTC Regulation 1.20 Customer Segregated Account [Date] [Name and Address of Bank, Trust Company, Derivatives Clearing Organization or Futures Commission Merchant] We refer to the Segregated Account(s) which [Name of Futures Commission Merchant] (‘‘we’’ or ‘‘our’’) have opened or will open with [Name of Bank, Trust Company, Derivatives Clearing Organization or Futures Commission Merchant] (‘‘you’’ or ‘‘your’’) entitled: [Name of Futures Commission Merchant] [if applicable, add ‘‘FCM Customer Omnibus Account’’] CFTC Regulation 1.20 Customer Segregated Account under Sections 4d(a) and 4d(b) of the Commodity Exchange Act [and, if applicable, ‘‘, Abbreviated as [short title reflected in the depository’s electronic system]’’] Account Number(s): [ ] (collectively, the ‘‘Account(s)’’). You acknowledge that we have opened or will open the above-referenced Account(s) for the purpose of depositing, as applicable, money, securities and other property (collectively the ‘‘Funds’’) of customers who trade commodities, options, swaps, and other products, as required by Commodity Futures Trading Commission (‘‘CFTC’’) Regulations, including Regulation 1.20, as amended; that the Funds held by you, hereafter deposited in the Account(s) or accruing to the credit of the Account(s), will be separately accounted for and segregated on your books from our own funds and from any other funds or accounts held by us in accordance with the provisions of the Commodity Exchange Act, as amended (the ‘‘Act’’), and Part 1 of the CFTC’s regulations, as amended; and that the Funds must otherwise be treated in accordance with the provisions of Section 4d of the Act and CFTC regulations thereunder. Furthermore, you acknowledge and agree that such Funds may not be used by you or by us to secure or guarantee any obligations that we might owe to you, and they may not be used by us to secure or obtain credit from you. You further acknowledge and agree that the Funds in the Account(s) shall not be subject to any right of offset or lien for or on account of any indebtedness, obligations or liabilities we may now or in the future have owing to you. This prohibition does not affect your right to recover funds advanced in the form of cash transfers, lines of credit, repurchase agreements or other similar liquidity arrangements you make in lieu of liquidating non-cash assets held in the Account(s) or in lieu of converting cash held in the Account(s) to cash in a different currency. In addition, you agree that the Account(s) may be examined at any reasonable time by the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC or the director of the Division of Clearing and Risk of the CFTC, or any successor divisions, or such directors’ designees, or an appropriate officer, agent or employee of our E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68630 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations designated self-regulatory organization (‘‘DSRO’’), [Name of DSRO], and this letter constitutes the authorization and direction of the undersigned on our behalf to permit any such examination to take place without further notice to or consent from us. You agree to reply promptly and directly to any request for confirmation of account balances or provision of any other information regarding or related to the Account(s) from the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC or the director of the Division of Clearing and Risk of the CFTC, or any successor divisions, or such directors’ designees, or an appropriate officer, agent, or employee of [Name of DSRO], acting in its capacity as our DSRO, and this letter constitutes the authorization and direction of the undersigned on our behalf to release the requested information without further notice to or consent from us. You further acknowledge and agree that, pursuant to authorization granted by us to you previously or herein, you have provided, or will promptly provide following the opening of the Account(s), the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC, or any successor division, or such director’s designees, with technological connectivity, which may include provision of hardware, software, and related technology and protocol support, to facilitate direct, read-only electronic access to transaction and account balance information for the Account(s). This letter constitutes the authorization and direction of the undersigned on our behalf for you to establish this connectivity and access if not previously established, without further notice to or consent from us. The parties agree that all actions on your part to respond to the above information and access requests will be made in accordance with, and subject to, such usual and customary authorization verification and authentication policies and procedures as may be employed by you to verify the authority of, and authenticate the identity of, the individual making any such information or access request, in order to provide for the secure transmission and delivery of the requested information or access to the appropriate recipient(s). We will not hold you responsible for acting pursuant to any information or access request from the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC or the director of the Division of Clearing and Risk of the CFTC, or any successor divisions, or such directors’ designees, or an appropriate officer, agent, or employee of [Name of DSRO], acting in its capacity as our DSRO, upon which you have relied after having taken measures in accordance with your applicable policies and procedures to assure that such request was provided to you by an individual authorized to make such a request. In the event that we become subject to either a voluntary or involuntary petition for relief under the U.S. Bankruptcy Code, we acknowledge that you will have no obligation to release the Funds held in the Account(s), except upon instruction of the Trustee in Bankruptcy or pursuant to the Order of the respective U.S. Bankruptcy Court. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 Notwithstanding anything in the foregoing to the contrary, nothing contained herein shall be construed as limiting your right to assert any right of offset or lien on assets that are not Funds maintained in the Account(s), or to impose such charges against us or any proprietary account maintained by us with you. Further, it is understood that amounts represented by checks, drafts or other items shall not be considered to be part of the Account(s) until finally collected. Accordingly, checks, drafts and other items credited to the Account(s) and subsequently dishonored or otherwise returned to you or reversed, for any reason, and any claims relating thereto, including but not limited to claims of alteration or forgery, may be charged back to the Account(s), and we shall be responsible to you as a general endorser of all such items whether or not actually so endorsed. You may conclusively presume that any withdrawal from the Account(s) and the balances maintained therein are in conformity with the Act and CFTC regulations without any further inquiry, provided that, in the ordinary course of your business as a depository, you have no notice of or actual knowledge of a potential violation by us of any provision of the Act or the CFTC regulations that relates to the segregation of customer funds; and you shall not in any manner not expressly agreed to herein be responsible to us for ensuring compliance by us with such provisions of the Act and CFTC regulations; however, the aforementioned presumption does not affect any obligation you may otherwise have under the Act or CFTC regulations. You may, and are hereby authorized to, obey the order, judgment, decree or levy of any court of competent jurisdiction or any governmental agency with jurisdiction, which order, judgment, decree or levy relates in whole or in part to the Account(s). In any event, you shall not be liable by reason of any action or omission to act pursuant to any such order, judgment, decree or levy, to us or to any other person, firm, association or corporation even if thereafter any such order, decree, judgment or levy shall be reversed, modified, set aside or vacated. The terms of this letter agreement shall remain binding upon the parties, their successors and assigns and, for the avoidance of doubt, regardless of a change in the name of either party. This letter agreement supersedes and replaces any prior agreement between the parties in connection with the Account(s), including but not limited to any prior acknowledgment letter agreement, to the extent that such prior agreement is inconsistent with the terms hereof. In the event of any conflict between this letter agreement and any other agreement between the parties in connection with the Account(s), this letter agreement shall govern with respect to matters specific to Section 4d of the Act and the CFTC’s regulations thereunder, as amended. This letter agreement shall be governed by and construed in accordance with the laws of [Insert governing law] without regard to the principles of choice of law. Please acknowledge that you agree to abide by the requirements and conditions set forth PO 00000 Frm 00126 Fmt 4701 Sfmt 4700 above by signing and returning to us the enclosed copy of this letter agreement, and that you further agree to provide a copy of this fully executed letter agreement directly to the CFTC (via electronic means in a format and manner determined by the CFTC) and to [Name of DSRO], acting in its capacity as our DSRO. We hereby authorize and direct you to provide such copies without further notice to or consent from us, no later than three business days after opening the Account(s) or revising this letter agreement, as applicable. [Name of Futures Commission Merchant] By: Print Name: Title: ACKNOWLEDGED AND AGREED: [Name of Bank, Trust Company, Derivatives Clearing Organization or Futures Commission Merchant] By: Print Name: Title: Contact Information: [Insert phone number and email address] DATE: Appendix B to § 1.20—Derivatives Clearing Organization Acknowledgment Letter for CFTC Regulation 1.20 Customer Segregated Account [Date] [Name and Address of Bank or Trust Company] We refer to the Segregated Account(s) which [Name of Derivatives Clearing Organization] (‘‘we’’ or ‘‘our’’) have opened or will open with [Name of Bank or Trust Company] (‘‘you’’ or ‘‘your’’) entitled: [Name of Derivatives Clearing Organization] Futures Customer Omnibus Account, CFTC Regulation 1.20 Customer Segregated Account under Sections 4d(a) and 4d(b) of the Commodity Exchange Act [and, if applicable, ‘‘, Abbreviated as [short title reflected in the depository’s electronic system]’’] Account Number(s): [ ] (collectively, the ‘‘Account(s)’’). You acknowledge that we have opened or will open the above-referenced Account(s) for the purpose of depositing, as applicable, money, securities and other property (collectively the ‘‘Funds’’) of customers who trade commodities, options, swaps, and other products, as required by Commodity Futures Trading Commission (‘‘CFTC’’) Regulations, including Regulation 1.20, as amended; that the Funds held by you, hereafter deposited in the Account(s) or accruing to the credit of the Account(s), will be separately accounted for and segregated on your books from our own funds and from any other funds or accounts held by us in accordance with the provisions of the Commodity Exchange Act, as amended (the ‘‘Act’’), and Part 1 of the CFTC’s regulations, as amended; and that the Funds must otherwise be treated in accordance with the provisions of Section 4d of the Act and CFTC regulations thereunder. Furthermore, you acknowledge and agree that such Funds may not be used by you or by us to secure or guarantee any obligations that we might owe to you, and they may not E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations be used by us to secure or obtain credit from you. You further acknowledge and agree that the Funds in the Account(s) shall not be subject to any right of offset or lien for or on account of any indebtedness, obligations or liabilities we may now or in the future have owing to you. This prohibition does not affect your right to recover funds advanced in the form of cash transfers, lines of credit, repurchase agreements or other similar liquidity arrangements you make in lieu of liquidating non-cash assets held in the Account(s) or in lieu of converting cash held in the Account(s) to cash in a different currency. You agree to reply promptly and directly to any request for confirmation of account balances or provision of any other information regarding or related to the Account(s) from the director of the Division of Clearing and Risk of the CFTC or the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC, or any successor divisions, or such directors’ designees, and this letter constitutes the authorization and direction of the undersigned on our behalf to release the requested information without further notice to or consent from us. The parties agree that all actions on your part to respond to the above information requests will be made in accordance with, and subject to, such usual and customary authorization verification and authentication policies and procedures as may be employed by you to verify the authority of, and authenticate the identity of, the individual making any such information request, in order to provide for the secure transmission and delivery of the requested information to the appropriate recipient(s). We will not hold you responsible for acting pursuant to any information request from the director of the Division of Clearing and Risk of the CFTC or the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC, or any successor divisions, or such directors’ designees, upon which you have relied after having taken measures in accordance with your applicable policies and procedures to assure that such request was provided to you by an individual authorized to make such a request. In the event that we or any of our futures commission merchant clearing members become(s) subject to either a voluntary or involuntary petition for relief under the U.S. Bankruptcy Code, we acknowledge that you will have no obligation to release the Funds held in the Account(s), except upon instruction of the Trustee in Bankruptcy or pursuant to the Order of the respective U.S. Bankruptcy Court. Notwithstanding anything in the foregoing to the contrary, nothing contained herein shall be construed as limiting your right to assert any right of offset or lien on assets that are not Funds maintained in the Account(s), or to impose such charges against us or any proprietary account maintained by us with you. Further, it is understood that amounts represented by checks, drafts or other items shall not be considered to be part of the Account(s) until finally collected. Accordingly, checks, drafts and other items credited to the Account(s) and subsequently VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 dishonored or otherwise returned to you or reversed, for any reason, and any claims relating thereto, including but not limited to claims of alteration or forgery, may be charged back to the Account(s), and we shall be responsible to you as a general endorser of all such items whether or not actually so endorsed. You may conclusively presume that any withdrawal from the Account(s) and the balances maintained therein are in conformity with the Act and CFTC regulations without any further inquiry, provided that, in the ordinary course of your business as a depository, you have no notice of or actual knowledge of a potential violation by us of any provision of the Act or the CFTC regulations that relates to the segregation of customer funds; and you shall not in any manner not expressly agreed to herein be responsible to us for ensuring compliance by us with such provisions of the Act and CFTC regulations; however, the aforementioned presumption does not affect any obligation you may otherwise have under the Act or CFTC regulations. You may, and are hereby authorized to, obey the order, judgment, decree or levy of any court of competent jurisdiction or any governmental agency with jurisdiction, which order, judgment, decree or levy relates in whole or in part to the Account(s). In any event, you shall not be liable by reason of any action or omission to act pursuant to any such order, judgment, decree or levy, to us or to any other person, firm, association or corporation even if thereafter any such order, decree, judgment or levy shall be reversed, modified, set aside or vacated. The terms of this letter agreement shall remain binding upon the parties, their successors and assigns and, for the avoidance of doubt, regardless of a change in the name of either party. This letter agreement supersedes and replaces any prior agreement between the parties in connection with the Account(s), including but not limited to any prior acknowledgment letter agreement, to the extent that such prior agreement is inconsistent with the terms hereof. In the event of any conflict between this letter agreement and any other agreement between the parties in connection with the Account(s), this letter agreement shall govern with respect to matters specific to Section 4d of the Act and the CFTC’s regulations thereunder, as amended. This letter agreement shall be governed by and construed in accordance with the laws of [Insert governing law] without regard to the principles of choice of law. Please acknowledge that you agree to abide by the requirements and conditions set forth above by signing and returning to us the enclosed copy of this letter agreement, and that you further agree to provide a copy of this fully executed letter agreement directly to the CFTC (via electronic means in a format and manner determined by the CFTC). We hereby authorize and direct you to provide such copy without further notice to or consent from us, no later than three business days after opening the Account(s) or revising this letter agreement, as applicable. [Name of Derivatives Clearing Organization] By: PO 00000 Frm 00127 Fmt 4701 Sfmt 4700 68631 Print Name: Title: ACKNOWLEDGED AND AGREED: [Name of Bank or Trust Company] By: Print Name: Title: Contact Information: [Insert phone number and email address] DATE: ■ 10. Revise § 1.22 to read as follows: § 1.22 Use of futures customer funds restricted. (a) No futures commission merchant shall use, or permit the use of, the futures customer funds of one futures customer to purchase, margin, or settle the trades, contracts, or commodity options of, or to secure or extend the credit of, any person other than such futures customer. (b) Futures customer funds shall not be used to carry trades or positions of the same futures customer other than in contracts for the purchase of sale of any commodity for future delivery or for options thereon traded through the facilities of a designated contract market. (c)(1) The undermargined amount for a futures customer’s account is the amount, if any, by which: (i) The total amount of collateral required for that futures customer’s positions in that account, at the time or times referred to in paragraph (c)(2) of this section, exceeds (ii) The value of the futures customer funds for that account, as calculated in § 1.20(i)(2). (2) Each futures commission merchant must compute, based on the information available to the futures commission merchant as of the close of each business day, (i) The undermargined amounts, based on the clearing initial margin that will be required to be maintained by that futures commission merchant for its futures customers, at each derivatives clearing organization of which the futures commission merchant is a member, at the point of the daily settlement (as described in § 39.14 of this chapter) that will complete during the following business day for each such derivatives clearing organization less (ii) Any debit balances referred to in § 1.20(i)(4) included in such undermargined amounts. (3)(i) Prior to the Residual Interest Deadline, such futures commission merchant must maintain residual interest in segregated funds that is at least equal to the computation set forth in paragraph (c)(2) of this section. Where a futures commission merchant is subject to multiple Residual Interest E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68632 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations Deadlines, prior to each Residual Interest Deadline, such futures commission merchant must maintain residual interest in segregated funds that is at least equal to the portion of the computation set forth in paragraph (c)(2) of this section attributable to the clearing initial margin required by the derivatives clearing organization making such settlement. (ii) A futures commission merchant may reduce the amount of residual interest required in paragraph (c)(3)(i) of this section to account for payments received from or on behalf of undermargined futures customers (less the sum of any disbursements made to or on behalf of such customers) between the close of the previous business day and the Residual Interest Deadline. (4) For purposes of paragraph (c)(2) of this section, a futures commission merchant should include, as clearing initial margin, customer initial margin that the futures commission merchant will be required to maintain, for that futures commission merchant’s futures customers, at another futures commission merchant. (5) Residual Interest Deadline defined. (i) Except as provided in paragraph (c)(5)(ii) of this section, the Residual Interest Deadline shall be the time of the settlement referenced in paragraph (c)(2)(i) or, as appropriate, (c)(4), of this section. (ii) Starting on November 14, 2014 and during the phase-in period described in paragraph (c)(5)(iii) of this section, the Residual Interest Deadline shall be 6:00 p.m. Eastern Time on the date of the settlement referenced in paragraph (c)(2)(i) or, as appropriate, (c)(4), of this section. (iii)(A) No later than May 16, 2016, the staff of the Commission shall complete and publish for public comment a report addressing, to the extent information is practically available, the practicability (for both futures commission merchants and customers) of moving that deadline from 6:00 p.m. Eastern Time on the date of the settlement referenced in paragraph (c)(2)(i) or, as appropriate, (c)(4), of this section to the time of that settlement (or to some other time of day), including whether and on what schedule it would be feasible to do so, and the costs and benefits of such potential requirements. Staff shall, using the Commission’s Web site, solicit public comment and shall conduct a public roundtable regarding specific issues to be covered by such report. (B) Nine months after publication of the report required by paragraph (c)(5)(iii)(A) of this section, the Commission may (but shall not be VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 required to) do either or both of the following: (1) Terminate the phase-in period, in which case the phase-in period shall end as of a date established by order published in the Federal Register, which date shall be no less than one year after the date such order is published; or (2) Determine that it is necessary or appropriate in the public interest to propose through rulemaking a different Residual Interest Deadline. In that event, the Commission shall establish, by order published in the Federal Register, a phase-in schedule. (C) If the phase-in schedule has not been amended pursuant to paragraph (c)(5)(iii)(B) of this section, then the phase-in period shall end on December 31, 2018. ■ 11. Revise § 1.23 to read as follows: § 1.23 Interest of futures commission merchant in segregated futures customer funds; additions and withdrawals. (a)(1) The provision in sections 4d(a)(2) and 4d(b) of the Act and the provision in § 1.20 that prohibit the commingling of futures customer funds with the funds of a futures commission merchant, shall not be construed to prevent a futures commission merchant from having a residual financial interest in the futures customer funds segregated as required by the Act and the regulations in this part and set apart for the benefit of futures customers; nor shall such provisions be construed to prevent a futures commission merchant from adding to such segregated futures customer funds such amount or amounts of money, from its own funds or unencumbered securities from its own inventory, of the type set forth in § 1.25 of this part, as it may deem necessary to ensure any and all futures customers’ accounts from becoming undersegregated at any time. (2) If a futures commission merchant discovers at any time that it is holding insufficient funds in segregated accounts to meet its obligations under §§ 1.20 and 1.22, the futures commission merchant shall immediately deposit sufficient funds into segregation to bring the account into compliance. (b) A futures commission merchant may not withdraw funds, except withdrawals that are made to or for the benefit of futures customers, from an account or accounts holding futures customer funds unless the futures commission merchant has prepared the daily segregation calculation required by § 1.32 as of the close of business on the previous business day. A futures commission merchant that has PO 00000 Frm 00128 Fmt 4701 Sfmt 4700 completed its daily segregation calculation may make withdrawals, in addition to withdrawals that are made to or for the benefit of futures customers, to the extent of its actual residual financial interest in funds held in segregated futures accounts, adjusted to reflect market activity and other events that may have decreased the amount of the firm’s residual financial interest since the close of business on the previous business day, including the withdrawal of securities held in segregated safekeeping accounts held by a bank, trust company, derivatives clearing organization or other futures commission merchant. Such withdrawal(s), however, shall not result in the funds of one futures customer being used to purchase, margin or carry the trades, contracts or commodity options, or extend the credit of any other futures customer or other person. (c) Notwithstanding paragraphs (a) and (b) of this section, each futures commission merchant shall establish a targeted residual interest (i.e., excess funds) that is in an amount that, when maintained as its residual interest in the segregated funds accounts, reasonably ensures that the futures commission merchant shall remain in compliance with the segregated funds requirements at all times. Each futures commission merchant shall establish policies and procedures designed to reasonably ensure that the futures commission merchant maintains the targeted residual amounts in segregated funds at all times. The futures commission merchant shall maintain sufficient capital and liquidity, and take such other appropriate steps as are necessary, to reasonably ensure that such amount of targeted residual interest is maintained as the futures commission merchant’s residual interest in the segregated funds accounts at all times. In determining the amount of the targeted residual interest, the futures commission merchant shall analyze all relevant factors affecting the amounts in segregated funds from time to time, including without limitation various factors, as applicable, relating to the nature of the futures commission merchant’s business including, but not limited to, the composition of the futures commission merchant’s customer base, the general creditworthiness of the customer base, the general trading activity of the customers, the types of markets and products traded by the customers, the proprietary trading of the futures commission merchant, the general volatility and liquidity of the markets and products traded by customers, the E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations futures commission merchant’s own liquidity and capital needs, and the historical trends in customer segregated fund balances and debit balances in customers’ and undermargined accounts. The analysis and calculation of the targeted amount of the future commission merchant’s residual interest must be described in writing with the specificity necessary to allow the Commission and the futures commission merchant’s designated selfregulatory organization to duplicate the analysis and calculation and test the assumptions made by the futures commission merchant. The adequacy of the targeted residual interest and the process for establishing the targeted residual interest must be reassessed periodically by the futures commission merchant and revised as necessary. (d) Notwithstanding any other paragraph of this section, a futures commission merchant may not withdraw funds, in a single transaction or a series of transactions, that are not made to or for the benefit of futures customers from futures accounts if such withdrawal(s) would exceed 25 percent of the futures commission merchant’s residual interest in such accounts as reported on the daily segregation calculation required by § 1.32 and computed as of the close of business on the previous business day, unless: (1) The futures commission merchant’s chief executive officer, chief finance officer or other senior official that is listed as a principal of the futures commission merchant on its Form 7–R and is knowledgeable about the futures commission merchant’s financial requirements and financial position preapproves in writing the withdrawal, or series of withdrawals; (2) The futures commission merchant files written notice of the withdrawal or series of withdrawals, with the Commission and with its designated self-regulatory organization immediately after the chief executive officer, chief finance officer or other senior official as described in paragraph (c)(1) of this section pre-approves the withdrawal or series of withdrawals. The written notice must: (i) Be signed by the chief executive officer, chief finance officer or other senior official as described in paragraph (c)(1) of this section that pre-approved the withdrawal, and give notice that the futures commission merchant has withdrawn or intends to withdraw more than 25 percent of its residual interest in segregated accounts holding futures customer funds; (ii) Include a description of the reasons for the withdrawal or series of withdrawals; VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 (iii) List the amount of funds provided to each recipient and each recipient’s name; (iv) Include the current estimate of the amount of the futures commission merchant’s residual interest in the futures accounts after the withdrawal; (v) Contain a representation by the chief executive officer, chief finance officer or other senior official as described in paragraph (c)(1) of this section that pre-approved the withdrawal, or series of withdrawals, that, after due diligence, to such person’s knowledge and reasonable belief, the futures commission merchant remains in compliance with the segregation requirements after the withdrawal. The chief executive officer, chief finance officer or other senior official as described in paragraph (c)(1) of this section must consider the daily segregation calculation as of the close of business on the previous business day and any other factors that may cause a material change in the futures commission merchant’s residual interest since the close of business the previous business day, including known unsecured futures customer debits or deficits, current day market activity and any other withdrawals made from the futures accounts; and (vi) Any such written notice filed with the Commission must be filed via electronic transmission using a form of user authentication assigned in accordance with procedures established by or approved by the Commission, and otherwise in accordance with instruction issued by or approved by the Commission. Any such electronic submission must clearly indicate the registrant on whose behalf such filing is made and the use of such user authentication in submitting such filing will constitute and become a substitute for the manual signature of the authorized signer. Any written notice filed must be followed up with direct communication to the Regional office of the Commission that has supervisory authority over the futures commission merchant whereby the Commission acknowledges receipt of the notice; and (3) After making a withdrawal requiring the approval and notice required in paragraphs (c)(1) and (2) of this section, and before the completion of its next daily segregated funds calculation, no futures commission merchant may make any further withdrawals from accounts holding futures customer funds, except to or for the benefit of futures customers, without, for each withdrawal, obtaining the approval required under paragraph (c)(1) of this section and filing a written notice in the manner specified under PO 00000 Frm 00129 Fmt 4701 Sfmt 4700 68633 paragraph (c)(2) of this section with the Commission and its designated selfregulatory organization signed by the chief executive officer, chief finance officer, or other senior official. The written notice must: (i) List the amount of funds provided to each recipient and each recipient’s name; (ii) Disclose the reason for each withdrawal; (iii) Confirm that the chief executive officer, chief finance officer, or other senior official (and identify of the person if different from the person who signed the notice) pre-approved the withdrawal in writing; (iv) Disclose the current estimate of the futures commission merchant’s remaining total residual interest in the segregated accounts holding futures customer funds after the withdrawal; and (v) Include a representation that, after due diligence, to the best of the notice signatory’s knowledge and reasonable belief the futures commission merchant remains in compliance with the segregation requirements after the withdrawal. (e) If a futures commission merchant withdraws funds from futures accounts that are not made to or for the benefit of futures customers, and the withdrawal causes the futures commission merchant to not hold sufficient funds in the futures accounts to meet its targeted residual interest, as required to be computed under § 1.11, the futures commission merchant should deposit its own funds into the futures accounts to restore the account balance to the targeted residual interest amount by the close of business on the next business day, or, if appropriate, revise the futures commission merchant’s targeted amount of residual interest pursuant to the policies and procedures required by § 1.11. Notwithstanding the foregoing, if a the futures commission merchant’s residual interest in customer accounts is less than the amount required by § 1.22 at any particular point in time, the futures commission merchant must immediately restore the residual interest to exceed the sum of such amounts. Any proprietary funds deposited in the futures accounts must be unencumbered and otherwise compliant with § 1.25, as applicable. ■ 12. Amend § 1.25 to: ■ a. Remove paragraph (b)(6); and ■ b. Revise paragraphs (b)(3)(v), (c)(3), (d)(7), (d)(11), and (e). The revisions read as follows: § 1.25 * E:\FR\FM\14NOR2.SGM Investment of customer funds. * * 14NOR2 * * TKELleY on DSK3SPTVN1PROD with RULES2 68634 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations (b) * * * (3) * * * (v) Counterparty concentration limits. Securities purchased by a futures commission merchant or derivatives clearing organization from a single counterparty, or from one or more counterparties under common ownership or control, subject to an agreement to resell the securities to the counterparty or counterparties, shall not exceed 25 percent of total assets held in segregation or under § 30.7 of this chapter by the futures commission merchant or derivatives clearing organization. * * * * * (c) * * * (3) A futures commission merchant or derivatives clearing organization shall maintain the confirmation relating to the purchase in its records in accordance with § 1.31 and note the ownership of fund shares (by book-entry or otherwise) in a custody account of the futures commission merchant or derivatives clearing organization in accordance with § 1.26. The futures commission merchant or the derivatives clearing organization shall obtain the acknowledgment letter required by § 1.26 from an entity that has substantial control over the fund shares purchased with customer funds and has the knowledge and authority to facilitate redemption and payment or transfer of the customer funds. Such entity may include the fund sponsor or depository acting as custodian for fund shares. * * * * * (d) * * * (7) Securities transferred to the futures commission merchant or derivatives clearing organization under the agreement are held in a safekeeping account with a bank as referred to in paragraph (d)(2) of this section, a Federal Reserve Bank, a derivatives clearing organization, or the Depository Trust Company in an account that complies with the requirements of § 1.26. * * * * * (11) The transactions effecting the agreement are recorded in the record required to be maintained under § 1.27 of investments of customer funds, and the securities subject to such transactions are specifically identified in such record as described in paragraph (d)(1) of this section and further identified in such record as being subject to repurchase and reverse repurchase agreements. * * * * * (e) Deposit of firm-owned securities into segregation. A futures commission merchant may deposit unencumbered VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 securities of the type specified in this section, which it owns for its own account, into a customer account. A futures commission merchant must include such securities, transfers of securities, and disposition of proceeds from the sale or maturity of such securities in the record of investments required to be maintained by § 1.27. All such securities may be segregated in safekeeping only with a bank, trust company, derivatives clearing organization, or other registered futures commission merchant in accordance with the provisions of § 1.20 part. For purposes of this section and §§ 1.27, 1.28, 1.29, and 1.32, securities of the type specified by this section that are owned by the futures commission merchant and deposited into a customer account shall be considered customer funds until such investments are withdrawn from segregation in accordance with the provisions of § 1.23. Investments permitted by § 1.25 that are owned by the futures commission merchant and deposited into a futures customer account pursuant to § 1.26 shall be considered futures customer funds until such investments are withdrawn from segregation in accordance with § 1.23. Investments permitted by § 1.25 that are owned by the futures commission merchant and deposited into a Cleared Swaps Customer Account, as defined in § 22.1 of this chapter, shall be considered Cleared Swaps Customer Collateral, as defined in § 22.1 of this chapter, until such investments are withdrawn from segregation in accordance with § 22.17 of this chapter. * * * * * ■ 13. Revise § 1.26 to read as follows: § 1.26 Deposit of instruments purchased with futures customer funds. (a) Each futures commission merchant who invests futures customer funds in instruments described in § 1.25, except for investments in money market mutual funds, shall separately account for such instruments as futures customer funds and segregate such instruments as funds belonging to such futures customers in accordance with the requirements of § 1.20. Each derivatives clearing organization which invests money belonging or accruing to futures customers of its clearing members in instruments described in § 1.25, except for investments in money market mutual funds, shall separately account for such instruments as customer funds and segregate such instruments as customer funds belonging to such futures customers in accordance with § 1.20. PO 00000 Frm 00130 Fmt 4701 Sfmt 4700 (b) Each futures commission merchant or derivatives clearing organization which invests futures customer funds in money market mutual funds, as permitted by § 1.25, shall separately account for such funds and segregate such funds as belonging to such futures customers. Such funds shall be deposited under an account name that clearly shows that they belong to futures customers and are segregated as required by sections 4d(a) and 4d(b) of the Act and by this part. Each futures commission merchant or derivatives clearing organization, upon opening such an account, shall obtain and maintain readily accessible in its files in accordance with § 1.31, for as long as the account remains open, and thereafter for the period provided in § 1.31, a written acknowledgment and shall file such acknowledgment in accordance with the requirements of § 1.20. In the event such funds are held directly with the money market mutual fund or its affiliate, the written acknowledgment shall be in the form as set out in Appendix A or B to this section. In the event such funds are held with a depository, the written acknowledgment shall be in the form as set out in Appendix A or B to § 1.20. In either case, the written acknowledgment shall be obtained, provided to the Commission and designated selfregulatory organizations, and retained as required under § 1.20. Appendix A to § 1.26—Futures Commission Merchant Acknowledgment Letter for CFTC Regulation 1.26 Customer Segregated Money Market Mutual Fund Account [Date] [Name and Address of Money Market Mutual Fund] We propose to invest funds held by [Name of Futures Commission Merchant] (‘‘we’’ or ‘‘our’’) on behalf of our customers in shares of [Name of Money Market Mutual Fund] (‘‘you’’ or ‘‘your’’) under account(s) entitled (or shares issued to): [Name of Futures Commission Merchant] [if applicable, add ‘‘FCM Customer Omnibus Account’’] CFTC Regulation 1.26 Customer Segregated Money Market Mutual Fund Account under Sections 4d(a) and 4d(b) of the Commodity Exchange Act [and, if applicable, ‘‘, Abbreviated as [short title reflected in the depository’s electronic system]’’] Account Number(s): [ ] (collectively, the ‘‘Account(s)’’). You acknowledge that we are holding these funds, including any shares issued and amounts accruing in connection therewith (collectively, the ‘‘Shares’’), for the benefit of customers who trade commodities, options, swaps and other products (‘‘Commodity Customers’’), as required by Commodity Futures Trading Commission (‘‘CFTC’’) E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations Regulation 1.26, as amended; that the Shares held by you, hereafter deposited in the Account(s) or accruing to the credit of the Account(s), will be separately accounted for and segregated on your books from our own funds and from any other funds or accounts held by us in accordance with the provisions of the Commodity Exchange Act, as amended (the ‘‘Act’’), and part 1 of the CFTC’s regulations, as amended; and that the Shares must otherwise be treated in accordance with the provisions of Section 4d of the Act and CFTC regulations thereunder. Furthermore, you acknowledge and agree that such Shares may not be used by you or by us to secure or guarantee any obligations that we might owe to you, and they may not be used by us to secure or obtain credit from you. You further acknowledge and agree that the Shares in the Account(s) shall not be subject to any right of offset or lien for or on account of any indebtedness, obligations or liabilities we may now or in the future have owing to you. In addition, you agree that the Account(s) may be examined at any reasonable time by the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC or the director of the Division of Clearing and Risk of the CFTC, or any successor divisions, or such directors’ designees, or an appropriate officer, agent or employee of our designated self-regulatory organization (‘‘DSRO’’), [Name of DSRO], and this letter constitutes the authorization and direction of the undersigned on our behalf to permit any such examination to take place without further notice to or consent from us. You agree to reply promptly and directly to any request for confirmation of account balances or provision of any other account information regarding or related to the Account(s) from the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC or the director of the Division of Clearing and Risk of the CFTC, or any successor divisions, or such directors’ designees, or an appropriate officer, agent, or employee of [Name of DSRO], acting in its capacity as our DSRO, and this letter constitutes the authorization and direction of the undersigned on our behalf to release the requested information without further notice to or consent from us. You further acknowledge and agree that, pursuant to the authorization granted by us to you previously or herein, you have provided, or will provide following the opening of the Account(s), the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC, or any successor division, or such director’s designees, with technological connectivity, which may include provision of hardware, software, and related technology and protocol support, to facilitate direct, read-only electronic access to transaction and account balance information for the Account(s). This letter constitutes the authorization and direction of the undersigned on our behalf for you to establish this connectivity and access if not previously established, without further notice to or consent from us. The parties agree that all actions on your part to respond to the above information and access requests will be made in accordance VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 with, and subject to, such usual and customary authorization verification and authentication policies and procedures as may be employed by you to verify the authority of, and authenticate the identity of, the individual making any such information or access request, in order to provide for the secure transmission and delivery of the requested information or access to the appropriate recipient(s). We will not hold you responsible for acting pursuant to any information or access request from the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC or the director of the Division of Clearing and Risk of the CFTC, or any successor divisions, or such directors’ designees, or an appropriate officer, agent, or employee of [Name of DSRO], acting in its capacity as our DSRO, upon which you have relied after having taken measures in accordance with your applicable policies and procedures to assure that such request was provided to you by an individual authorized to make such a request. In the event we become subject to either a voluntary or involuntary petition for relief under the U.S. Bankruptcy Code, we acknowledge that you will have no obligation to release the Shares held in the Account(s), except upon instruction of the Trustee in Bankruptcy or pursuant to the Order of the respective U.S. Bankruptcy Court. Notwithstanding anything in the foregoing to the contrary, nothing contained herein shall be construed as limiting your right to assert any right of offset or lien on assets that are not Shares maintained in the Account(s), or to impose such charges against us or any proprietary account maintained by us with you. Further, it is understood that amounts represented by checks, drafts or other items shall not be considered to be part of the Account(s) until finally collected. Accordingly, checks, drafts and other items credited to the Account(s) and subsequently dishonored or otherwise returned to you or reversed, for any reason and any claims relating thereto, including but not limited to claims of alteration or forgery, may be charged back to the Account(s), and we shall be responsible to you as a general endorser of all such items whether or not actually so endorsed. You may conclusively presume that any withdrawal from the Account(s) and the balances maintained therein are in conformity with the Act and CFTC regulations without any further inquiry, provided that, in the ordinary course of your business as a depository, you have no notice of or actual knowledge of a potential violation by us of any provision of the Act or the CFTC regulations that relates to the segregation of customer funds; and you shall not in any manner not expressly agreed to herein be responsible to us for ensuring compliance by us with such provisions of the Act and CFTC regulations; however, the aforementioned presumption does not affect any obligation you may otherwise have under the Act or CFTC regulations. You may, and are hereby authorized to, obey the order, judgment, decree or levy of any court of competent jurisdiction or any governmental agency with jurisdiction, PO 00000 Frm 00131 Fmt 4701 Sfmt 4700 68635 which order, judgment, decree or levy relates in whole or in part to the Account(s). In any event, you shall not be liable by reason of any action or omission to act pursuant to such order, judgment, decree or levy, to us or to any other person, firm, association or corporation even if thereafter any such order, decree, judgment or levy shall be reversed, modified, set aside or vacated. We are permitted to invest customers’ funds in money market mutual funds pursuant to CFTC Regulation 1.25. That rule sets forth the following conditions, among others, with respect to any investment in a money market mutual fund: (1) The net asset value of the fund must be computed by 9:00 a.m. of the business day following each business day and be made available to us by that time; (2) The fund must be legally obligated to redeem an interest in the fund and make payment in satisfaction thereof by the close of the business day following the day on which we make a redemption request except as otherwise specified in CFTC Regulation 1.25(c)(5)(ii); and, (3) The agreement under which we invest customers’ funds must not contain any provision that would prevent us from pledging or transferring fund shares. The terms of this letter agreement shall remain binding upon the parties, their successors and assigns, and for the avoidance of doubt, regardless of a change in the name of either party. This letter agreement supersedes and replaces any prior agreement between the parties in connection with the Account(s), including but not limited to any prior acknowledgment letter agreement, to the extent that such prior agreement is inconsistent with the terms hereof. In the event of any conflict between this letter agreement and any other agreement between the parties in connection with the Account(s), this letter agreement shall govern with respect to matters specific to Section 4d of the Act and the CFTC’s regulations thereunder, as amended. This letter agreement shall be governed by and construed in accordance with the laws of [Insert governing law] without regard to the principles of choice of law. Please acknowledge that you agree to abide by the requirements and conditions set forth above by signing and returning to us the enclosed copy of this letter agreement, and that you further agree to provide a copy of this fully executed letter agreement directly to the CFTC (via electronic means in a format and manner determined by the CFTC) and to [Name of DSRO], acting in its capacity as our DSRO, in accordance with CFTC Regulation 1.20. We hereby authorize and direct you to provide such copies without further notice to or consent from us, no later than three business days after opening the Account(s) or revising this letter agreement, as applicable. [Name of Futures Commission Merchant] By: Print Name: Title: ACKNOWLEDGED AND AGREED: [Name of Money Market Mutual Fund] By: Print Name: Title: E:\FR\FM\14NOR2.SGM 14NOR2 68636 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations Contact Information: [Insert phone number and email address] Date: TKELleY on DSK3SPTVN1PROD with RULES2 Appendix B to § 1.26—Derivatives Clearing Organization Acknowledgment Letter for CFTC Regulation 1.26 Customer Segregated Money Market Mutual Fund Account [Date] [Name and Address of Money Market Mutual Fund] We propose to invest funds held by [Name of Derivatives Clearing Organization] (‘‘we’’ or ‘‘our’’) on behalf of customers in shares of [Name of Money Market Mutual Fund] (‘‘you’’ or ‘‘your’’) under account(s) entitled (or shares issued to): [Name of Derivatives Clearing Organization] Futures Customer Omnibus Account, CFTC Regulation 1.26 Customer Segregated Money Market Mutual Fund Account under Sections 4d(a) and 4d(b) of the Commodity Exchange Act [and, if applicable, ‘‘, Abbreviated as [short title reflected in the depository’s electronic system]’’] Account Number(s): [ ] (collectively, the ‘‘Account(s)’’). You acknowledge that we are holding these funds, including any shares issued and amounts accruing in connection therewith (collectively, the ‘‘Shares’’), for the benefit of customers who trade commodities, options, swaps and other products, as required by Commodity Futures Trading Commission (‘‘CFTC’’) Regulation 1.26, as amended; that the Shares held by you, hereafter deposited in the Account(s) or accruing to the credit of the Account(s), will be separately accounted for and segregated on your books from our own funds and from any other funds or accounts held by us in accordance with the provisions of the Commodity Exchange Act, as amended (the ‘‘Act’’), and part 1 of the CFTC’s regulations, as amended; and that the Shares must otherwise be treated in accordance with the provisions of Section 4d of the Act and CFTC regulations thereunder. Furthermore, you acknowledge and agree that such Shares may not be used by you or by us to secure or guarantee any obligations that we might owe to you, and they may not be used by us to secure or obtain credit from you. You further acknowledge and agree that the Shares in the Account(s) shall not be subject to any right of offset or lien for or on account of any indebtedness, obligations or liabilities we may now or in the future have owing to you. You agree to reply promptly and directly to any request for confirmation of account balances or provision of any other account information regarding or related to the Account(s) from the director of the Division of Clearing and Risk of the CFTC or the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC, or any successor divisions, or such directors’ designees, and this letter constitutes the authorization and direction of the undersigned on our behalf to release the requested information without further notice to or consent from us. The parties agree that all actions on your part to respond to the above information VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 requests will be made in accordance with, and subject to, such usual and customary authorization verification and authentication policies and procedures as may be employed by you to verify the authority of, and authenticate the identity of, the individual making any such information request, in order to provide for the secure transmission and delivery of the requested information to the appropriate recipient(s). We will not hold you responsible for acting pursuant to any information request from the director of the Division of Clearing and Risk of the CFTC or the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC, or any successor divisions, or such directors’ designees, upon which you have relied after having taken measures in accordance with your applicable policies and procedures to assure that such request was provided to you by an individual authorized to make such a request. In the event that we or any of our futures commission merchant clearing members become(s) subject to either a voluntary or involuntary petition for relief under the U.S. Bankruptcy Code, we acknowledge that you will have no obligation to release the Shares held in the Account(s), except upon instruction of the Trustee in Bankruptcy or pursuant to the Order of the respective U.S. Bankruptcy Court. Notwithstanding anything in the foregoing to the contrary, nothing contained herein shall be construed as limiting your right to assert any right of offset or lien on assets that are not Shares maintained in the Account(s), or to impose such charges against us or any proprietary account maintained by us with you. Further, it is understood that amounts represented by checks, drafts or other items shall not be considered to be part of the Account(s) until finally collected. Accordingly, checks, drafts and other items credited to the Account(s) and subsequently dishonored or otherwise returned to you, or reversed, for any reason and any claims relating thereto, including but not limited to claims of alteration or forgery, may be charged back to the Account(s), and we shall be responsible to you as a general endorser of all such items whether or not actually so endorsed. You may conclusively presume that any withdrawal from the Account(s) and the balances maintained therein are in conformity with the Act and CFTC regulations without any further inquiry, provided that, in the ordinary course of your business as a depository, you have no notice of or actual knowledge of a potential violation by us of any provision of the Act or the CFTC regulations that relates to the segregation of customer funds; and you shall not in any manner not expressly agreed to herein be responsible to us for ensuring compliance by us with such provisions of the Act and CFTC regulations; however, the aforementioned presumption does not affect any obligation you may otherwise have under the Act or CFTC regulations. You may, and are hereby authorized to, obey the order, judgment, decree or levy of any court of competent jurisdiction or any governmental agency with jurisdiction, which order, judgment, decree or levy relates PO 00000 Frm 00132 Fmt 4701 Sfmt 4700 in whole or in part to the Account(s). In any event, you shall not be liable by reason of any action or omission to act pursuant to any such order, judgment, decree or levy, to us or to any other person, firm, association or corporation even if thereafter any such order, decree, judgment or levy shall be reversed, modified, set aside or vacated. We are permitted to invest customers’ funds in money market mutual funds pursuant to CFTC Regulation 1.25. That rule sets forth the following conditions, among others, with respect to any investment in a money market mutual fund: (1) The net asset value of the fund must be computed by 9:00 a.m. of the business day following each business day and be made available to us by that time; (2) The fund must be legally obligated to redeem an interest in the fund and make payment in satisfaction thereof by the close of the business day following the day on which we make a redemption request except as otherwise specified in CFTC Regulation 1.25(c)(5)(ii); and, (3) The agreement under which we invest customers’ funds must not contain any provision that would prevent us from pledging or transferring fund shares. The terms of this letter agreement shall remain binding upon the parties, their successors and assigns, and for the avoidance of doubt, regardless of a change in the name of either party. This letter agreement supersedes and replaces any prior agreement between the parties in connection with the Account(s), including but not limited to any prior acknowledgment letter agreement, to the extent that such prior agreement is inconsistent with the terms hereof. In the event of any conflict between this letter agreement and any other agreement between the parties in connection with the Account(s), this letter agreement shall govern with respect to matters specific to Section 4d of the Act and the CFTC’s regulations thereunder, as amended. This letter agreement shall be governed by and construed in accordance with the laws of [Insert governing law] without regard to the principles of choice of law. Please acknowledge that you agree to abide by the requirements and conditions set forth above by signing and returning to us the enclosed copy of this letter agreement, and you further agree to provide a copy of this fully executed letter agreement directly to the CFTC (via electronic means in a format and manner determined by the CFTC) in accordance with CFTC Regulation 1.20. We hereby authorize and direct you to provide such copies without further notice to or consent from us, no later than three business days after opening the Account(s) or revising this letter agreement, as applicable. [Name of Derivatives Clearing Organization] By: Print Name: Title: ACKNOWLEDGED AND AGREED: [Name of Money Market Mutual Fund] By: Print Name: Title: Contact Information: [Insert phone number and email address] E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations Date: ■ 14. Revise § 1.29 to read as follows: § 1.29 Gains and losses resulting from investment of customer funds. (a) The investment of customer funds in instruments described in § 1.25 shall not prevent the futures commission merchant or derivatives clearing organization so investing such funds from receiving and retaining as its own any incremental income or interest income resulting therefrom. (b) The futures commission merchant or derivatives clearing organization, as applicable, shall bear sole responsibility for any losses resulting from the investment of customer funds in instruments described in § 1.25. No investment losses shall be borne or otherwise allocated to the customers of the futures commission merchant and, if customer funds are invested by a derivatives clearing organization in its discretion, to the futures commission merchant. ■ 15. Revise § 1.30 to read as follows: § 1.30 Loans by futures commission merchants; treatment of proceeds. TKELleY on DSK3SPTVN1PROD with RULES2 Nothing in the regulations in this chapter shall prevent a futures commission merchant from lending its own funds to customers on securities and property pledged by such customers, or from repledging or selling such securities and property pursuant to specific written agreement with such customers. The proceeds of such loans used to purchase, margin, guarantee, or secure the trades, contracts, or commodity options of customers shall be treated and dealt with by a futures commission merchant as belonging to such customers, in accordance with and subject to the provisions of the Act and these regulations. A futures commission merchant may not loan funds on an unsecured basis to finance customers’ trading, nor may a futures commission merchant loan funds to customers secured by the customer accounts of such customers. ■ 16. Amend § 1.32 to: ■ a. Revise the section heading; ■ b. Revise paragraphs (b) and (c); and ■ c. Add paragraphs (d), (e), (f), (g), (h), (i), (j), and (k). The revisions and additions to read as follows: § 1.32 Reporting of segregated account computation and details regarding the holding of futures customer funds * * * * * (b) In computing the amount of futures customer funds required to be in segregated accounts, a futures commission merchant may offset any VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 net deficit in a particular futures customer’s account against the current market value of readily marketable securities, less applicable deductions (i.e., ‘‘securities haircuts’’) as set forth in Rule 15c3–1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR 241.15c3–1(c)(2)(vi)), held for the same futures customer’s account. Futures commission merchants that establish and enforce written policies and procedures to assess the credit risk of commercial paper, convertible debt instruments, or nonconvertible debt instruments in accordance with Rule 240.15c3–1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR 240.15c3–1(c)(2)(vi)) may apply the lower haircut percentages specified in Rule 240.15c3–1(c)(2)(vi) for such commercial paper, convertible debt instruments and nonconvertible debt instruments. The futures commission merchant must maintain a security interest in the securities, including a written authorization to liquidate the securities at the futures commission merchant’s discretion, and must segregate the securities in a safekeeping account with a bank, trust company, derivatives clearing organization, or another futures commission merchant. For purposes of this section, a security will be considered readily marketable if it is traded on a ‘‘ready market’’ as defined in Rule 15c3–1(c)(11)(i) of the Securities and Exchange Commission (17 CFR 240.15c3–1(c)(11)(i)). (c) Each futures commission merchant is required to document its segregation computation required by paragraph (a) of this section by preparing a Statement of Segregation Requirements and Funds in Segregation for Customers Trading on U.S. Commodity Exchanges contained in the Form 1–FR–FCM as of the close of each business day. Nothing in this paragraph shall affect the requirement that a futures commission merchant at all times maintain sufficient money, securities and property to cover its total obligations to all futures customers, in accordance with § 1.20. (d) Each futures commission merchant is required to submit to the Commission and to the firm’s designated self-regulatory organization the daily Statement of Segregation Requirements and Funds in Segregation for Customers Trading on U.S. Commodity Exchanges required by paragraph (c) of this section by noon the following business day. (e) Each futures commission merchant shall file the Statement of Segregation Requirements and Funds in Segregation for Customers Trading on U.S. Commodity Exchanges required by paragraph (c) of this section in an PO 00000 Frm 00133 Fmt 4701 Sfmt 4700 68637 electronic format using a form of user authentication assigned in accordance with procedures established or approved by the Commission. (f) Each futures commission merchant is required to submit to the Commission and to the firm’s designated selfregulatory organization a report listing the names of all banks, trust companies, futures commission merchants, derivatives clearing organizations, or any other depository or custodian holding futures customer funds as of the fifteenth day of the month, or the first business day thereafter, and the last business day of each month. This report must include: (1) The name and location of each entity holding futures customer funds; (2) The total amount of futures customer funds held by each entity listed in paragraph (f)(1) of this section; and (3) The total amount of cash and investments that each entity listed in paragraph (f)(1) of this section holds for the futures commission merchant. The futures commission merchant must report the following investments: (i) Obligations of the United States and obligations fully guaranteed as to principal and interest by the United States (U.S. government securities); (ii) General obligations of any State or of any political subdivision of a State (municipal securities); (iii) General obligation issued by any enterprise sponsored by the United States (government sponsored enterprise securities); (iv) Certificates of deposit issued by a bank; (v) Commercial paper fully guaranteed as to principal and interest by the United States under the Temporary Liquidity Guarantee Program as administered by the Federal Deposit Insurance Corporation; (vi) Corporate notes or bonds fully guaranteed as to principal and interest by the United States under the Temporary Liquidity Guarantee Program as administered by the Federal Deposit Insurance Corporation; and (vii) Interests in money market mutual funds. (g) Each futures commission merchant must report the total amount of futures customer-owned securities held by the futures commission merchant as margin collateral and must list the names and locations of the depositories holding such margin collateral. (h) Each futures commission merchant must report the total amount of futures customer funds that have been used to purchase securities under agreements to resell the securities (reverse repurchase transactions). E:\FR\FM\14NOR2.SGM 14NOR2 68638 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations (i) Each futures commission merchant must report which, if any, of the depositories holding futures customer funds under paragraph (f)(1) of this section are affiliated with the futures commission merchant. (j) Each futures commission merchant shall file the detailed list of depositories required by paragraph (f) of this section by 11:59 p.m. the next business day in an electronic format using a form of user authentication assigned in accordance with procedures established or approved by the Commission. (k) Each futures commission merchant shall retain its daily segregation computation and the Statement of Segregation Requirements and Funds in Segregation for Customers Trading on U.S. Commodity Exchanges required by paragraph (c) of this section, and its detailed list of depositories required by paragraph (f) of this section, together with all supporting documentation, in accordance with the requirements of § 1.31. ■ 17. Revise § 1.52 to read as follows: TKELleY on DSK3SPTVN1PROD with RULES2 § 1.52 Self-regulatory organization adoption and surveillance of minimum financial requirements. (a) For purposes of this section, the following terms are defined as follows: (1) Examinations expert is defined as a Nationally recognized accounting and auditing firm with substantial expertise in audits of futures commission merchants, risk assessment and internal control reviews, and is an accounting and auditing firm that is acceptable to the Commission; and (2) Self-regulatory organization means a contract market (as defined in § 1.3(h)) or a registered futures association under section 17 of the Act. The term ‘‘selfregulatory organization’’ for purpose of this section does not include a swap execution facility (as defined in § 1.3(rrrr)). (b)(1) Each self-regulatory organization must adopt rules prescribing minimum financial and related reporting requirements for members who are registered futures commission merchants or registered retail foreign exchange dealers. Each self-regulatory organization other than a contract market must adopt rules prescribing minimum financial and related reporting requirements for members who are registered introducing brokers. The self-regulatory organization’s minimum financial and related reporting requirements must be the same as, or more stringent than, the requirements contained in §§ 1.10 and 1.17, for futures commission merchants and introducing brokers, and §§ 5.7 and 5.12 of this chapter for retail foreign VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 exchange dealers; provided, however, that a self-regulatory organization may permit its member registrants that are registered with the Securities and Exchange Commission as securities brokers or dealers to file (in accordance with § 1.10(h)) a copy of their Financial and Operational Combined Uniform Single Report under the Securities Exchange Act of 1934 (‘‘FOCUS Report’’), Part II, Part IIA, or Part II CSE, as applicable, in lieu of Form 1–FR; provided, further, that such selfregulatory organization must require such member registrants to provide all information in Form 1–FR that is not included in the FOCUS Report Part II, Part IIA, or Part CSE provided by such member registrant. The definition of adjusted net capital must be the same as that prescribed in § 1.17(c) for futures commission merchants and introducing brokers, and § 5.7(b)(2) of this chapter for futures commission merchants offering or engaging in retail forex transactions and for retail foreign exchange dealers. (2) In addition to the requirements set forth in paragraph (b)(1) of this section, each self-regulatory organization that has a futures commission merchant member registrant must adopt rules prescribing risk management requirements for futures commission merchant member registrants that shall be the same as, or more stringent than, the requirements contained in § 1.11. (c)(1) Each self-regulatory organization must establish and operate a supervisory program that includes written policies and procedures concerning the application of such supervisory program in the examination of its member registrants for the purpose of assessing whether each member registrant is in compliance with the applicable self-regulatory organization and Commission regulations governing minimum net capital and related financial requirements, the obligation to segregate customer funds, risk management requirements, financial reporting requirements, recordkeeping requirements, and sales practice and other compliance requirements. The supervisory program also must address the following elements: (i) Adequate levels and independence of examination staff. A self-regulatory organization must maintain staff of an adequate size, training, and experience to effectively implement a supervisory program. Staff of the self-regulatory organization, including officers, directors, and supervising committee members, must maintain independent judgment and its actions must not impair its independence nor appear to impair its independence in matters PO 00000 Frm 00134 Fmt 4701 Sfmt 4700 related to the supervisory program. The self-regulatory organization must provide annual ethics training to all staff with responsibilities for the supervisory program. (ii) Ongoing surveillance. A selfregulatory organization’s ongoing surveillance of member registrants must include the review and analysis of financial reports and regulatory notices filed by member registrants with the designated self-regulatory organization. (iii) High-risk firms. A self-regulatory organization’s supervisory program must include procedures for identifying member registrants that are determined to pose a high degree of potential financial risk, including the potential risk of loss of customer funds. High-risk member registrants must include firms experiencing financial or operational difficulties, failing to meet segregation or net capital requirements, failing to maintain current books and records, or experiencing material inadequacies in internal controls. Enhanced monitoring for high risk firms should include, as appropriate, daily review of net capital, segregation, and secured calculations, to assess compliance with self-regulatory organization and Commission requirements. (iv) On-site examinations. (A) A selfregulatory organization must conduct routine periodic on-site examinations of member registrants. Member futures commission merchants and retail foreign exchange dealers must be subject to on-site examinations no less frequently than once every eighteen months. A self-regulatory organization shall establish a risk-based method of establishing the scope of each on-site examination; provided, however, that the scope of each on-site examination of a futures commission merchant or retail foreign exchange dealer must include an assessment of whether the registrant is in compliance with applicable Commission and self-regulatory organization minimum capital, customer fund protection, recordkeeping, and reporting requirements. (B) A self-regulatory organization other than a contract market must establish the frequency of on-site examinations of member introducing brokers that do not operate pursuant to guarantee agreements with futures commission merchants or retail foreign exchange dealers using a risk-based approach, which takes into consideration the time elapsed since the self-regulatory organization’s previous examination of the introducing broker. (C) A self-regulatory organization must conduct on-site examinations of member registrants in accordance with E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations uniform examination programs and procedures that have been submitted to the Commission. (v) Adequate documentation. A selfregulatory organization must adequately document all aspects of the operation of the supervisory program, including the conduct of risk-based scope setting and the risk-based surveillance of high-risk member registrants, and the imposition of remedial and punitive action(s) for material violations. (2) In addition to the requirements set forth in paragraph (c)(1) of this section, the supervisory program of a selfregulatory organization that has a registered futures commission merchant member must satisfy the following requirements: (i) The supervisory program must set forth in writing the examination standards that the self-regulatory organization must apply in its examination of its registered futures commission merchant member. The supervisory program must be based on controls testing and substantive testing, and must address all areas of risk to which the futures commission merchant can reasonably be foreseen to be subject. The supervisory program must be based on an understanding of the internal control environment to determine the nature, timing and extent of the controls and substantive testing to be performed. The determination as to which elements of the supervisory program are to be performed on any examination must be based on the risk profile of each registered futures commission merchant member. (ii) All aspects of the supervisory program, including the standards pursuant to paragraph (c)(2)(iii) of this section, must, at minimum, conform to auditing standards issued by the Public Company Accounting Oversight Board as such standards would be applicable to a non-financial statement audit. These standards would include the training and proficiency of the auditor, due professional care in the performance of work, consideration of fraud in an audit, audit risk and materiality in conducting an audit, planning and supervision, understanding the entity and its environment and assessing the risks of material misstatement, performing audit procedures in response to assessed risk and evaluating the audit evidence obtained, auditor’s communication with those charged with governance, and communicating internal control matters identified in an audit. (iii) The supervisory program must, at a minimum, have standards addressing the following: (A) The ethics of an examiner; VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 (B) The independence of an examiner; (C) The supervision, review, and quality control of an examiner’s work product; (D) The evidence and documentation to be reviewed and retained in connection with an examination; (E) The sampling size and techniques used in an examination; (F) The examination risk assessment process; (G) The examination planning process; (H) Materiality assessment; (I) Quality control procedures to ensure that the examinations maintain the level of quality expected; (J) Communications between an examiner and the regulatory oversight committee, or the functional equivalent of the regulatory oversight committee, of the self-regulatory organization of which the futures commission merchant is a member; (K) Communications between an examiner and a futures commission merchant’s audit committee of the board of directors or other similar governing body; (L) Analytical review procedures; (M) Record retention; and (N) Required items for inclusion in the examination report, such as repeat violations, material items, and high risk issues. The examination report is intended solely for the information and use of the self-regulatory organizations and the Commission, and is not intended to be and should not be used by any other person or entity. (iv) A self-regulatory organization must cause an examinations expert to evaluate the supervisory program and such self-regulatory organization’s application of the supervisory program at least once every three years. (A) The self-regulatory organization must obtain from such examinations expert a written report on findings and recommendations issued under the consulting services standards of the American Institute of Certified Public Accountants that includes the following: (1) A statement that the examinations expert has evaluated the supervisory program, including the sufficiency of the risk-based approach and the internal controls testing thereof, and comments and recommendations in connection with such evaluation from such examinations expert; (2) A statement that the examinations expert has evaluated the application of the supervisory program by the selfregulatory organization, and comments and recommendations in connection with such evaluation from such examinations expert; and PO 00000 Frm 00135 Fmt 4701 Sfmt 4700 68639 (3) The examinations expert’s report should include an analysis of the supervisory program’s design to detect material weaknesses in an entity’s internal control environment; (4) A discussion and recommendation of any new or best practices as prescribed by industry sources, including, but not limited to, those from the American Institute of Certified Public Accountants, the Public Company Accounting Oversight Board, the Institute of Internal Auditors, and The Risk Management Association. (B) The self-regulatory organization must provide the written report to the Commission no later than thirty days following the receipt thereof. The selfregulatory organization may also provide to the Commission a response, in writing, to any of the findings, comments or recommendations made by the examinations expert. Upon resolution of any questions or comments raised by the Commission, and upon written notice from the Commission that it has no further comments or questions on the supervisory program as amended (by reason of the examinations expert’s proposals, considerations of the Commission’s questions or comments, or otherwise), the self-regulatory organization shall commence applying such supervisory program as the standard for examining its registered futures commission merchant members for all examinations conducted with an ‘‘as-of’’ date later than the date of the Commission’s written notification. (v) The supervisory program must require the self-regulatory organization to report to its risk and/or audit committee of the board of directors, or a functional equivalent committee, with timely reports of the activities and findings of the supervisory program to assist the risk and/or audit committee of the board of directors, or a functional equivalent committee, to fulfill its responsibility of overseeing the examination function. (vi) The initial supervisory program shall be established as follows. Within 180 days following the effective date of this section, or such other time as the Commission may approve, the selfregulatory organization shall submit a proposed supervisory program to the Commission for its review and comment, together with a written report that includes the elements found in paragraphs (c)(2)(iv)(A)(1) and (3) of this section from an examinations expert who has evaluated the supervisory program. The self-regulatory organization may provide the Commission a written response to any findings, comments or recommendations made by the E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68640 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations examinations expert. Upon resolution of any questions or comments raised by the Commission, and upon written notice from the Commission that it has no further comments or questions on the proposed supervisory program as amended (by reason of the considerations of the Commission’s questions or comments or otherwise), the self-regulatory organizations shall commence applying such supervisory program as the standard for examining its members that are registered as futures commission merchants for all examinations conducted with an ‘‘as-of’’ date later than the date of the Commission’s written notification. (vii) The examinations expert’s report, the self-regulatory organization’s response, as well as any information concerning the supervisory program or any review conducted pursuant to the program that is obtained by the examinations expert, is confidential. Except as expressly provided for in this section, such information may not be disclosed to anyone not involved in the review process. (d)(1) Any two or more self-regulatory organizations may file with the Commission a plan for delegating to a designated self-regulatory organization, for any registered futures commission merchant, retail foreign exchange dealer, or introducing broker that is a member of more than one such selfregulatory organization, the function of: (i) Monitoring and examining for compliance with the minimum financial and related reporting requirements and risk management requirements, including policies and procedures relating to the receipt, holding, investing and disbursement of customer funds, adopted by such self-regulatory organizations and the Commission in accordance with paragraphs (b) and (c) of this section; and (ii) Receiving the financial reports and notices necessitated by such minimum financial and related reporting requirements; provided, however, that the self-regulatory organization that delegates the functions set forth in this paragraph (d)(1) shall remain responsible for its member registrants’ compliance with the regulatory obligations, and if such self-regulatory organization becomes aware that a delegated function is not being performed as required under this section, the self-regulatory organization shall promptly take any necessary steps to address any noncompliance. (2) If a plan established pursuant to paragraph (d)(1) of this section applies to any registered futures commission merchant, then such plan must include the following elements: VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 (i) The Joint Audit Committee. The self-regulatory organizations that choose to participate in the plan shall form a Joint Audit Committee, consisting of all self-regulatory organizations in the plan as members. The members of the Joint Audit Committee shall establish, operate and maintain a Joint Audit Program in accordance with the requirements of this section to ensure an effective and a high quality program for examining futures commission merchants, to designate the designated self-regulatory organizations that will be responsible for the examinations of futures commission merchants pursuant to the Joint Audit Program, and to satisfy such additional obligations set forth in this section in order to facilitate the examinations of futures commission merchants by their respective designated self-regulatory organizations. (ii) The Joint Audit Program. The Joint Audit Program must, at minimum, satisfy the following requirements. (A) The purpose of the Joint Audit Program must be to assess whether each registered futures commission merchant member of the Joint Audit Committee self-regulatory organization members is in compliance with the Joint Audit Program and Commission regulations governing minimum net capital and related financial requirements, the obligation to segregate customer funds, risk management requirements, including policies and procedures relating to the receipt, holding, investment, and disbursement of customer funds, financial reporting requirements, recordkeeping requirements, and sales practice and other compliance requirements. (B) The Joint Audit Program must include written policies and procedures concerning the application of the Joint Audit Program in the examination of the registered futures commission merchant members of the Joint Audit Committee self-regulatory organization members. (C)(1) Adequate levels and independence of examination staff. A designated self-regulatory organization must maintain staff of an adequate size, training, and experience to effectively implement the Joint Audit Program. Staff of the designated self-regulatory organization, including officers, directors, and supervising committee members, must maintain independent judgment and its actions must not impair its independence nor appear to impair its independence in matters related to the Joint Audit Program. The designated self-regulatory organization must provide annual ethics training to all staff with responsibilities for the Joint Audit Program. PO 00000 Frm 00136 Fmt 4701 Sfmt 4700 (2) Ongoing surveillance. A designated self-regulatory organization’s ongoing surveillance of futures commission merchant member registrants over which it has oversight responsibilities must include the review and analysis of financial reports and regulatory notices filed by such member registrants with the designated selfregulatory organization. (3) High-risk firms. The Joint Audit Program must include procedures for identifying futures commission merchant member registrants over which it has oversight responsibilities that are determined to pose a high degree of potential financial risk, including the potential risk of loss of customer funds. High-risk member registrants must include firms experiencing financial or operational difficulties, failing to meet segregation or net capital requirements, failing to maintain current books and records, or experiencing material inadequacies in internal controls. Enhanced monitoring for high risk firms should include, as appropriate, daily review of net capital, segregation, and secured calculations, to assess compliance with self-regulatory and Commission requirements. (4) On-site examinations. A designated self-regulatory organization must conduct routine periodic on-site examinations of futures commission merchant member registrants over which it has oversight responsibilities. Such member registrants must be subject to on-site examinations no less frequently than once every eighteen months. A designated self-regulatory organization shall establish a risk-based method of establishing the scope of each on-site examination, provided, however, that the scope of each on-site examination of a futures commission merchant must include an assessment of whether the registrant is in compliance with applicable Commission and selfregulatory organization minimum capital, customer fund protection, recordkeeping, and reporting requirements. A designated selfregulatory organization must conduct on-site examinations of futures commission merchant registrants in accordance with the Joint Audit Program. (D) The Joint Audit Committee members must adequately document all aspects of the operation of the Joint Audit Program, including the conduct of risk-based scope setting and the riskbased surveillance of high-risk member registrants, and the imposition of remedial and punitive action(s) for material violations. (E) The Joint Audit Program must set forth in writing the examination E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations standards that a designated selfregulatory organization must apply in its examination of a registered futures commission merchant. The Joint Audit Program must be based on controls testing and substantive testing, and must address all areas of risk to which the futures commission merchant can reasonably be foreseen to be subject. The Joint Audit Program must be based on an understanding of the internal control environment to determine the nature, timing and extent of the controls and substantive testing to be performed. The determination as to which elements of the Joint Audit Program are to be performed on any examination must be based on the risk profile of each registered futures commission merchant. (F) All aspects of the Joint Audit Program, including the standards required pursuant to paragraph (d)(2)(ii)(G) of this section, must, at minimum, conform to auditing standards issued by the Public Company Accounting Oversight Board as such standards would be applicable to a nonfinancial statement audit. These standards would include the training and proficiency of the auditor, due professional care in the performance of work, consideration of fraud in an audit, audit risk and materiality in conducting an audit, planning and supervision, understanding the entity and its environment and assessing the risks of material misstatement, performing audit procedures in response to assessed risk and evaluating the audit evidence obtained, auditor’s communication with those charged with governance, and communicating internal control matters identified in an audit. (G) The Joint Audit Program must have standards addressing those items listed in paragraph (c)(2)(iii) of this section. (H) The initial Joint Audit Program shall be established as follows. Within 180 days following the effective date of this section, or such other time as the Commission may approve, the Joint Audit Committee members shall submit a proposed initial Joint Audit Program to the Commission for its review and comment, together with a written report that includes the elements found in paragraphs (d)(2)(ii)(I)(1) and (d)(2)(ii)(I)(3) of this section from an examinations expert who has evaluated the Joint Audit Program. The Joint Audit Committee members may also provide to the Commission a response, in writing, to any of the findings, comments or recommendations made by the examinations expert. Upon resolution of any questions or comments raised by the Commission, and upon VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 written notice from the Commission that it has no further comments or questions on the proposed Joint Audit Program as amended (by reason of the considerations of the Commission’s questions or comments or otherwise), the designated self-regulatory organizations shall commence applying such Joint Audit Program as the standard for examining their respective registered futures commission merchants for all examinations conducted with an ‘‘as-of’’ date later than the date of the Commission’s written notification. (I) Following the establishment of the Joint Audit Program, no less frequently than once every three years, the Joint Audit Committee members must cause an examinations expert to evaluate the Joint Audit Program and each designated self-regulatory organization’s application of the Joint Audit Program. The Joint Audit Committee members must obtain from such examinations expert a written report, and must provide the written report to the Commission no later than forty-five days prior to the annual meeting of the members of the Joint Audit Committee to be held in that year pursuant to paragraph (d)(2)(iii)(A) of this section. The Joint Audit Committee members may also provide to the Commission a response, in writing, to any of the findings, comments or recommendations made by the examinations expert. The examinations expert’s written report must include the following: (1) A statement that the examinations expert has evaluated the Joint Audit Program, including the sufficiency of the risk-based approach and the internal controls testing thereof, and comments and recommendations in connection with such evaluation from such examinations expert; (2) A statement that the examinations expert has evaluated the application of the Joint Audit Program by each designated self-regulatory organization, and comments and recommendations in connection with such evaluation from such examinations expert; (3) The examinations expert’s report on findings and recommendations issued under the consulting services standards of the American Institute of Certified Public Accountants and should include an analysis of the supervisory program’s design to detect material weaknesses in an entities internal control environment; and (4) A discussion and recommendation of any new or best practices as prescribed by industry sources, including, but not limited to, those from the American Institute of Certified PO 00000 Frm 00137 Fmt 4701 Sfmt 4700 68641 Public Accountants, the Public Company Accounting Oversight Board, the Internal Audit Association and The Risk Management Association. (J) The examinations expert’s report, the Joint Audit Committee’s response, as well as any information concerning the supervisory program or any review conducted pursuant to the program that is obtained by the examinations expert, is confidential. Except as expressly provided for in paragraphs (d)(2)(ii)(G) or (d)(2)(ii)(H) of this section, such information may not be disclosed to anyone not involved in the review process. (K) The Joint Audit Program must require each Joint Audit Committee member to provide to its risk and/or audit committee of the board of directors, or a functionally equivalent committee, with timely reports of the activities and findings of the Joint Audit Program to assist the risk and/or audit committee of the board of directors, or a functionally equivalent committee, in fulfilling its responsibility of overseeing the examination function. (iii) Meetings of the Joint Audit Committee. (A) No less frequently than once every year, the Joint Audit Committee members must meet to consider whether changes to the Joint Audit Program are appropriate, and in considering such, in meetings corresponding to the written report obtained from an examinations expert pursuant to paragraph (d)(2)(ii)(I) of this section, the Joint Audit Committee members must consider such written report, including the results of the examinations expert’s assessment of the Joint Audit Program and any additional recommendations. The Commission’s questions, comments and proposals must also be considered. Upon written notice from the Commission that it has no further comments or questions on the Joint Audit Program as amended (by reason of the examinations expert’s proposals, considerations of the Commission’s questions, comments and proposals, or otherwise), the designated self-regulatory organizations shall commence applying such Joint Audit Program as the standard for examining their respective registered futures commission merchants for all examinations conducted with an ‘‘as-of’’ date later than the date of the Commission’s written notification. (B) In addition to the items considered in paragraph (d)(2)(iii)(A) of this section, the Joint Audit Committee members must consider the following items during the annual meeting: (1) The role of the Joint Audit Committee and its members as it relates E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68642 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations to self-regulatory organization responsibilities; (2) Developing and maintaining the Joint Audit Program for all designated self-regulatory organizations to follow with no exceptions; (3) Coordinating self-regulatory organization responsibilities with those of independent certified public accountants, the Commission and other regulators and self-regulatory organizations (e.g., the Securities and Exchange Commission, the Financial Industry Regulatory Authority, and others, as the case may be for futures commission merchants subject to regulation by multiple regulators and self-regulatory organizations); (4) Coordinating and sharing information between the Joint Audit Committee members, including issues and industry concerns in connection with examinations of futures commission merchants; (5) Identifying industry regulatory reporting issues and financial and operational internal control issues and modifying the Joint Audit Program accordingly; (6) Issuing risk alerts for futures commission merchants and/or designated self-regulatory organization examiners on an as-needed basis as issues arise; (7) Issuing an annual examination alert for certified public accountants and designated self-regulatory organization examiners; (8) Responding to industry issues; (9) Providing industry feedback to Commission proposals; and (10) Developing and maintaining a standard of ethics and independence with which all examination units of the Joint Audit Committee members must comply. (C) Minutes must be taken of all meetings and distributed to all members on a timely basis. (D) The Commission must receive timely prior notice of each meeting, have to right to attend and participate in each meeting and receive written copies of the reports and minutes required pursuant to paragraphs (d)(2)(ii)(J) and (d)(2)(iii)(C) of this section, respectively. (3) The plan referenced in paragraph (d)(1) of this section shall not be effective without Commission approval pursuant to paragraph (h) of this section. (e) Any plan filed under this section may contain provisions for the allocation of expenses reasonably incurred by designated self-regulatory organizations among the self-regulatory organizations participating in such a plan. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 (f) A plan’s designated self-regulatory organizations must report to: (1) That plan’s other self-regulatory organizations any violation of such other self-regulatory organizations’ rules and regulations for which the responsibility to monitor or examine has been delegated to such designated selfregulatory organization under this section; and (2) The Director of the Division of Swap Dealer and Intermediary Oversight of the Commission any violation of a self-regulatory organization’s rules and regulations or any violation of the Commission’s regulations for which the responsibility to monitor, audit, or examine has been delegated to such designated selfregulatory organization under this section. (g) The Joint Audit Committee members may, among themselves, establish programs to provide access to any necessary financial or related information. (h) After appropriate notice and opportunity for comment, the Commission may, by written notice, approve such a plan, or any part of the plan, if it finds that the plan, or any part of it: (1) Is necessary or appropriate to serve the public interest; (2) Is for the protection and in the interest of customers; (3) Reduces multiple monitoring and multiple examining for compliance with the minimum financial rules of the Commission and of the self-regulatory organizations submitting the plan of any futures commission merchant, retail foreign exchange dealer, or introducing broker that is a member of more than one self-regulatory organization; (4) Reduces multiple reporting of the financial information necessitated by such minimum financial and related reporting requirements by any futures commission merchant, retail foreign exchange dealer, or introducing broker that is a member of more than one selfregulatory organization; (5) Fosters cooperation and coordination among the self-regulatory organizations; and (6) Does not hinder the development of a registered futures association under section 17 of the Act. (i) After the Commission has approved a plan, or part thereof, under paragraph (h) of this section, a selfregulatory organization delegating the functions described in paragraph (d)(1) of this section must notify each of its members that are subject to such a plan: (1) Of the limited scope of the delegating self-regulatory organization’s responsibility for such a member’s PO 00000 Frm 00138 Fmt 4701 Sfmt 4700 compliance with the Commission’s and self-regulatory organization’s minimum financial and related reporting requirements; and (2) Of the identity of the designated self-regulatory organization that has been delegated responsibility for such a member; provided, however, that the self-regulatory organization that delegates, pursuant to paragraph (d) of this section, the functions set forth in paragraphs (b) and (c) of this section shall remain responsible for its member registrants’ compliance with the regulatory obligations, and if such selfregulatory organization becomes aware that a delegated function is not being performed as required under this section, the self-regulatory organization shall promptly take any necessary steps to address any noncompliance. (j) The Commission may at any time, after appropriate notice and opportunity for hearing, withdraw its approval of any plan, or part thereof, established under this section, if such plan, or part thereof, ceases to adequately effectuate the purposes of section 4f(b) of the Act or of this section. (k) Whenever a registered futures commission merchant, a registered retail foreign exchange dealer, or a registered introducing broker holding membership in a self-regulatory organization ceases to be a member in good standing of that self-regulatory organization, such selfregulatory organization must, on the same day that event takes place, give electronic notice of that event to the Commission at its Washington, DC, headquarters and send a copy of that notification to such futures commission merchant, retail foreign exchange dealer, or introducing broker. (l) Nothing in this section shall preclude the Commission from examining any futures commission merchant, retail foreign exchange dealer, or introducing broker for compliance with the minimum financial and related reporting requirements, and the risk management requirements, as applicable, to which such futures commission merchant, retail foreign exchange dealer, or introducing broker is subject. (m) In the event a plan is not filed and/or approved for each registered futures commission merchant, retail foreign exchange dealer, or introducing broker that is a member of more than one self-regulatory organization, the Commission may design and, after notice and opportunity for comment, approve a plan for those futures commission merchants, retail foreign exchange dealers, or introducing brokers that are not the subject of an approved plan (under paragraph (h) of this E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations section), delegating to a designated selfregulatory organization the responsibilities described in paragraph (d) of this section. ■ 18. Amend § 1.55 to: ■ a. Revise the section heading; ■ b. Revise paragraphs (b)(2) through (b)(8) and (c); and ■ c. Add paragraphs (b)(9) through (b)(14), (i), (j), (k), (l), (m), (n), and (o). The revisions and additions to read as follows: § 1.55 Public disclosures by futures commission merchants. TKELleY on DSK3SPTVN1PROD with RULES2 * * * * * (b) * * * (2) The funds you deposit with a futures commission merchant for trading futures positions are not protected by insurance in the event of the bankruptcy or insolvency of the futures commission merchant, or in the event your funds are misappropriated. (3) The funds you deposit with a futures commission merchant for trading futures positions are not protected by the Securities Investor Protection Corporation even if the futures commission merchant is registered with the Securities and Exchange Commission as a broker or dealer. (4) The funds you deposit with a futures commission merchant are generally not guaranteed or insured by a derivatives clearing organization in the event of the bankruptcy or insolvency of the futures commission merchant, or if the futures commission merchant is otherwise unable to refund your funds. Certain derivatives clearing organizations, however, may have programs that provide limited insurance to customers. You should inquire of your futures commission merchant whether your funds will be insured by a derivatives clearing organization and you should understand the benefits and limitations of such insurance programs. (5) The funds you deposit with a futures commission merchant are not held by the futures commission merchant in a separate account for your individual benefit. Futures commission merchants commingle the funds received from customers in one or more accounts and you may be exposed to losses incurred by other customers if the futures commission merchant does not have sufficient capital to cover such other customers’ trading losses. (6) The funds you deposit with a futures commission merchant may be invested by the futures commission merchant in certain types of financial instruments that have been approved by the Commission for the purpose of such investments. Permitted investments are VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 listed in Commission Regulation 1.25 and include: U.S. government securities; municipal securities; money market mutual funds; and certain corporate notes and bonds. The futures commission merchant may retain the interest and other earnings realized from its investment of customer funds. You should be familiar with the types of financial instruments that a futures commission merchant may invest customer funds in. (7) Futures commission merchants are permitted to deposit customer funds with affiliated entities, such as affiliated banks, securities brokers or dealers, or foreign brokers. You should inquire as to whether your futures commission merchant deposits funds with affiliates and assess whether such deposits by the futures commission merchant with its affiliates increases the risks to your funds. (8) You should consult your futures commission merchant concerning the nature of the protections available to safeguard funds or property deposited for your account. (9) Under certain market conditions, you may find it difficult or impossible to liquidate a position. This can occur, for example, when the market reaches a daily price fluctuation limit (‘‘limit move’’). (10) All futures positions involve risk, and a ‘‘spread’’ position may not be less risky than an outright ‘‘long’’ or ‘‘short’’ position. (11) The high degree of leverage (gearing) that is often obtainable in futures trading because of the small margin requirements can work against you as well as for you. Leverage (gearing) can lead to large losses as well as gains. (12) In addition to the risks noted in the paragraphs enumerated above, you should be familiar with the futures commission merchant you select to entrust your funds for trading futures positions. The Commodity Futures Trading Commission requires each futures commission merchant to make publicly available on its Web site firm specific disclosures and financial information to assist you with your assessment and selection of a futures commission merchant. Information regarding this futures commission merchant may be obtained by visiting our Web site, www.[Web site address]. ALL OF THE POINTS NOTED ABOVE APPLY TO ALL FUTURES TRADING WHETHER FOREIGN OR DOMESTIC. IN ADDITION, IF YOU ARE CONTEMPLATING TRADING FOREIGN FUTURES OR OPTIONS CONTRACTS, PO 00000 Frm 00139 Fmt 4701 Sfmt 4700 68643 YOU SHOULD BE AWARE OF THE FOLLOWING ADDITIONAL RISKS: (13) Foreign futures transactions involve executing and clearing trades on a foreign exchange. This is the case even if the foreign exchange is formally ‘‘linked’’ to a domestic exchange, whereby a trade executed on one exchange liquidates or establishes a position on the other exchange. No domestic organization regulates the activities of a foreign exchange, including the execution, delivery, and clearing of transactions on such an exchange, and no domestic regulator has the power to compel enforcement of the rules of the foreign exchange or the laws of the foreign country. Moreover, such laws or regulations will vary depending on the foreign country in which the transaction occurs. For these reasons, customers who trade on foreign exchanges may not be afforded certain of the protections which apply to domestic transactions, including the right to use domestic alternative dispute resolution procedures. In particular, funds received from customers to margin foreign futures transactions may not be provided the same protections as funds received to margin futures transactions on domestic exchanges. Before you trade, you should familiarize yourself with the foreign rules which will apply to your particular transaction. (14) Finally, you should be aware that the price of any foreign futures or option contract and, therefore, the potential profit and loss resulting therefrom, may be affected by any fluctuation in the foreign exchange rate between the time the order is placed and the foreign futures contract is liquidated or the foreign option contract is liquidated or exercised. THIS BRIEF STATEMENT CANNOT, OF COURSE, DISCLOSE ALL THE RISKS AND OTHER ASPECTS OF THE COMMODITY MARKETS. I hereby acknowledge that I have received and understood this risk disclosure statement. lllllllllllllllllllll Date lllllllllllllllllllll Signature of Customer (c) The Commission may approve for use in lieu of the risk disclosure document required by paragraph (b) of this section a risk disclosure statement approved by one or more foreign regulatory agencies or self-regulatory organizations if the Commission determines that such risk disclosure statement is reasonably calculated to provide the disclosure required by paragraph (b) of this section. Notice of E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68644 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations risk disclosure statements that may be used to satisfy Commission disclosure requirements, what requirements such statements meet and the jurisdictions which accept each format will be set forth in appendix A to this section; Provided, however, that an FCM also provides a customer with the risk disclosure statement required by paragraph (b) of this section and obtains the customer’s acknowledgment that it has read and understands the disclosure document. * * * * * (i) Notwithstanding any other provision of this section, no futures commission merchant may enter into a customer account agreement or first accept funds from a customer, unless the futures commission merchant discloses to the customer all information about the futures commission merchant, including its business, operations, risk profile, and affiliates, that would be material to the customer’s decision to entrust such funds to and otherwise do business with the futures commission merchant and that is otherwise necessary for full and fair disclosure. In connection with the disclosure of such information, the futures commission merchant shall provide material information about the topics described in paragraph (k) of this section, expanding upon such information as necessary to keep such disclosure from being misleading, whether through omission or otherwise. The futures commission merchant shall also disclose the same information required by this paragraph to all customers existing on the effective date of this paragraph even if the futures commission merchant and such existing customers have previously entered into a customer account agreement or the futures commission merchant has already accepted funds from such existing customers. The futures commission merchant shall update the information required by this section as and when necessary, but at least annually, to keep such information accurate and complete and shall promptly disclose such updated information to all of its customers. In connection with such obligation to update information, the futures commission merchant shall take into account any material change to its business operation, financial condition and other factors material to the customer’s decision to entrust the customer’s funds and otherwise do business with the futures commission merchant since its most recent disclosure pursuant to this paragraph, and for this purpose shall without VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 limitation consider events that require periodic reporting required to be filed pursuant to § 1.12. For purposes of this section, the disclosures required pursuant to this paragraph will be referred to as the ‘‘Disclosure Documents.’’ The Disclosure Documents shall provide a detailed table of contents referencing and describing the Disclosure Documents. (j)(1) Each futures commission merchant shall make the Disclosure Documents available to each customer to whom disclosure is required pursuant to paragraph (i) of this section (for purposes of this section, its ‘‘FCM Customers’’) and to the general public. (2) A futures commission merchant shall make the Disclosure Documents available to FCM Customers and to the general public by posting a copy of the Disclosure Documents on the futures commission merchant’s Web site. A futures commission merchant, however, may use an electronic means other than its Web site to make the Disclosure Documents available to its FCM Customers; provided that: (i) The electronic version of the Disclosure Documents shall be presented in a format that is readily communicated to the FCM Customers. Information is readily communicated to the FCM Customers if it is accessible to the ordinary computer user by means of commonly available hardware and software and if the electronically delivered document is organized in substantially the same manner as would be required for a paper document with respect to the order of presentation and the relative prominence of information; and (ii) A complete paper copy of the Disclosure Documents shall be provided to an FCM Customer upon request. (k) Specific topics. The futures commission merchant shall provide material information about the following specific topics: (1) The futures commission merchant’s name, address of its principal place of business, phone number, fax number, and email address; (2) The name, title, business address, business background, areas of responsibility, and the nature of the duties of each person that is defined as a principal of the futures commission merchant pursuant to § 3.1 of this chapter; (3) The significant types of business activities and product lines engaged in by the futures commission merchant, and the approximate percentage of the futures commission merchant’s assets and capital that are used in each type of activity; PO 00000 Frm 00140 Fmt 4701 Sfmt 4700 (4) The futures commission merchant’s business on behalf of its customers, including types of customers, markets traded, international businesses, and clearinghouses and carrying brokers used, and the futures commission merchant’s policies and procedures concerning the choice of bank depositories, custodians, and counterparties to permitted transactions under § 1.25; (5) The material risks, accompanied by an explanation of how such risks may be material to its customers, of entrusting funds to the futures commission merchant, including, without limitation, the nature of investments made by the futures commission merchant (including credit quality, weighted average maturity, and weighted average coupon); the futures commission merchant’s creditworthiness, leverage, capital, liquidity, principal liabilities, balance sheet leverage and other lines of business; risks to the futures commission merchant created by its affiliates and their activities, including investment of customer funds in an affiliated entity; and any significant liabilities, contingent or otherwise, and material commitments; (6) The name of the futures commission merchant’s designated selfregulatory organization and its Web site address and the location where the annual audited financial statements of the futures commission merchant is made available; (7) Any material administrative, civil, enforcement, or criminal complaints or actions filed against the FCM where such complaints or actions have not concluded, and any enforcement complaints or actions filed against the FCM during the last three years; (8) A basic overview of customer fund segregation, futures commission merchant collateral management and investments, futures commission merchants, and joint futures commission merchant/broker dealers; (9) Information on how a customer may obtain information regarding filing a complaint about the futures commission merchant with the Commission or with the firm’s designated self-regulatory organization; and (10) The following financial data as of the most recent month-end when the Disclosure Document is prepared: (i) The futures commission merchant’s total equity, regulatory capital, and net worth, all computed in accordance with U.S. Generally Accepted Accounting Principles and § 1.17, as applicable; E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations (ii) The dollar value of the futures commission merchant’s proprietary margin requirements as a percentage of the aggregate margin requirement for futures customers, Cleared Swaps Customers, and 30.7 customers; (iii) The smallest number of futures customers, Cleared Swaps Customers, and 30.7 customers that comprise 50 percent of the futures commission merchant’s total funds held for futures customers, Cleared Swaps Customers, and 30.7 customers, respectively; (iv) The aggregate notional value, by asset class, of all non-hedged, principal over-the-counter transactions into which the futures commission merchant has entered; (v) The amount, generic source and purpose of any committed unsecured lines of credit (or similar short-term funding) the futures commission merchant has obtained but not yet drawn upon; (vi) The aggregated amount of financing the futures commission merchant provides for customer transactions involving illiquid financial products for which it is difficult to obtain timely and accurate prices; and (vii) The percentage of futures customer, Cleared Swaps Customer, and 30.7 customer receivable balances that the futures commission merchant had to write-off as uncollectable during the past 12-month period, as compared to the current balance of funds held for futures customers, Cleared Swaps Customers, and 30.7 customers; and (11) A summary of the futures commission merchant’s current risk practices, controls and procedures. (l) In addition to the foregoing, each futures commission merchant shall adopt policies and procedures reasonably designed to ensure that advertising and solicitation activities by each such futures commission merchant and any introducing brokers associated with such futures commission merchant are not misleading to its FCM Customers in connection with their decision to entrust funds to and otherwise do business with such futures commission merchant. (m) The Disclosure Document required by paragraph (i) of this section is in addition to the Risk Disclosure Statement required under paragraph (a) of this section. (n) All Disclosure Documents, with each Disclosure Document dated the date of first use, shall be maintained in accordance with § 1.31 and shall be made available promptly upon request to representatives of its designated selfregulatory organization, representatives of the Commission, and representatives of applicable prudential regulators. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 (o)(1) Each futures commission merchant shall make the following financial information publicly available on its Web site: (i) The daily Statement of Segregation Requirements and Funds in Segregation for Customers Trading on U.S. Exchanges for the most current 12month period; (ii) The daily Statement of Secured Amounts and Funds Held in Separate Accounts for 30.7 Customers Pursuant to Commission Regulation 30.7 for the most current 12-month period; (iii) The daily Statement of Cleared Swaps Customer Segregation Requirements and Funds in Cleared Swaps Customer Accounts Under Section 4d(f) of the Act for the most current 12-month period; (iv) A summary schedule of the futures commission merchant’s adjusted net capital, net capital, and excess net capital, all computed in accordance with § 1.17 and reflecting balances as of the month-end for the 12 most recent months; (v) The Statement of Financial Condition, the Statement of Segregation Requirements and Funds in Segregation for Customers Trading on U.S. Exchanges, the Statement of Secured Amounts and Funds Held in Separate Accounts for 30.7 Customers Pursuant to Commission Regulation 30.7, the Statement of Cleared Swaps Customer Segregation Requirements and Funds in Cleared Swaps Customer Accounts Under Section 4d(f) of the Act, an all related footnotes to the above schedules that are part of the futures commission merchant’s most current certified annual report pursuant to § 1.16; and (vi) The Statement of Segregation Requirements and Funds in Segregation for Customers Trading on U.S. Exchanges, the Statement of Secured Amounts and Funds Held in Separate Accounts for 30.7 Customers Pursuant to Commission Regulation30.7, and the Statement of Cleared Swaps Customer Accounts Under Section 4d(f) of the Act that are part of the futures commission merchant’s unaudited Form 1–FR–FCM or Financial and Operational Combined Uniform Single Report under the Securities Exchange Act of 1934 (‘‘FOCUS Report’’) for the most current 12-month period. (2) To the extent any of the financial data identified in paragraph (1) of this section is amended, the FCM must clearly notate that the data has been amended. (3) Each futures commission merchant must include a statement on its Web site that is available to the public that financial information regarding the futures commission merchant, including PO 00000 Frm 00141 Fmt 4701 Sfmt 4700 68645 how the futures commission merchant invests and holds customer funds, may be obtained from the National Futures Association and include a link to the Web site of the National Futures Association’s Basic System where information regarding the futures commission merchant’s investment of customer funds is maintained. (4) Each futures commission merchant must include a statement on its Web site that is available to the public that additional financial information on all futures commission merchants is available from the Commodity Futures Trading Commission, and include a link to the Commodity Futures Trading Commission’s Web page for financial data for futures commission merchants. PART 3—REGISTRATION 19. The authority citation for part 3 continues to read as follows: ■ Authority: 5 U.S.C. 552, 552b; 7 U.S.C. 1a, 2, 6a, 6b, 6b–1, 6c, 6d, 6e, 6f, 6g, 6h, 6i, 6k, 6m, 6n, 6o, 6p, 6s, 8, 9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21, 23. 20. Amend § 3.3 to revise paragraph (f)(2) to read as follows: ■ § 3.3 Chief compliance officer. * * * * * (f) * * * (2) The annual report shall be furnished electronically to the Commission not more than 60 days after the end of the fiscal year of the futures commission merchant, swap dealer, or major swap participant, simultaneously with the submission of Form 1–FR– FCM, as required under § 1.10(b)(2)(ii) of this chapter, simultaneously with the Financial and Operational Combined Uniform Single Report, as required under § 1.10(h) of this chapter, or simultaneously with the financial condition report, as required under section 4s(f) of the Act, as applicable. * * * * * PART 22—CLEARED SWAPS 21. The authority citation for part 22 continues to read as follows: ■ Authority: 7 U.S.C. 1a, 6d, 7a–1 as amended by Pub. L. 111–203, 124 Stat. 1376. 22. Amend § 22.2 to: a. Revise paragraphs (d)(1), (e)(1), (f)(2), (f)(4), (f)(5)(iii)(B), and (g)(2); and ■ c. Add paragraphs (f)(6) and (g)(3) through (g)(10). The revisions and additions read as follows: ■ ■ § 22.2 Futures Commission Merchants: Treatment of Cleared Swaps and Associated Cleared Swaps Customer Collateral. * E:\FR\FM\14NOR2.SGM * * 14NOR2 * * TKELleY on DSK3SPTVN1PROD with RULES2 68646 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations (d) Limitations on use. (1) No futures commission merchant shall use, or permit the use of, the Cleared Swaps Customer Collateral of one Cleared Swaps Customer to purchase, margin, or settle the Cleared Swaps or any other trade or contract of, or to secure or extend the credit of, any person other than such Cleared Swaps Customer. Cleared Swaps Customer Collateral shall not be used to margin, guarantee, or secure trades or contracts of the entity constituting a Cleared Swaps Customer other than in Cleared Swaps, except to the extent permitted by a Commission rule, regulation or order. * * * * * (e) * * * (1) Permitted investments. A futures commission merchant may invest money, securities, or other property constituting Cleared Swaps Customer Collateral in accordance with § 1.25 of this chapter, which shall apply to such money, securities, or other property as if they comprised customer funds or customer money subject to segregation pursuant to section 4d(a) of the Act and the regulations thereunder; Provided, however, that the futures commission merchant shall bear sole responsibility for any losses resulting from the investment of customer funds in instruments described in § 1.25 of this chapter. No investment losses shall be borne or otherwise allocated to Cleared Swaps Customers of the futures commission merchant. * * * * * (f) * * * (2) The futures commission merchant must reflect in the account that it maintains for each Cleared Swaps Customer, the net liquidating equity for each such Cleared Swaps Customer, calculated as follows: The market value of any Cleared Swaps Customer Collateral that it receives from such customer, as adjusted by: (i) Any uses permitted under paragraph (d) of this section; (ii) Any accruals on permitted investments of such collateral under paragraph (e) of this section that, pursuant to the futures commission merchant’s customer agreement with that customer, are creditable to such customer; (iii) Any gains and losses with respect to Cleared Swaps; (iv) Any charges lawfully accruing to the Cleared Swaps Customer, including any commission, brokerage fee, interest, tax, or storage fee; and (v) Any appropriately authorized distribution or transfer of such collateral. * * * * * VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 (4) The futures commission merchant must, at all times, maintain in segregation, in its FCM Physical Locations and/or its Cleared Swaps Customer Accounts at Permitted Depositories, an amount equal to the sum of any credit balances that the Cleared Swaps Customers of the futures commission merchant have in their accounts. This balance may not be reduced by any debit balances that the Cleared Swaps Customers of the futures commission merchants have in their accounts. (5) * * * (iii) * * * (B) Reduce such market value by applicable percentage deductions (i.e., ‘‘securities haircuts’’) as set forth in Rule 15c3–1(c)(2)(vi) of the Securities and Exchange Commission (§ 240.15c3– 1(c)(2)(vi) of this title). Futures commission merchants that establish and enforce written policies and procedures to assess the credit risk of commercial paper, convertible debt instruments, or nonconvertible debt instruments in accordance with Rule 240.15c3–1(c)(2)(vi) of the Securities and Exchange Commission (§ 240.15c3– 1(c)(2)(vi) of this title) may apply the lower haircut percentages specified in Rule 240.15c3–1(c)(2)(vi) for such commercial paper, convertible debt instruments and nonconvertible debt instruments. The portion of the debit balance, not exceeding 100 percent, that is secured by the reduced market value of such readily marketable securities shall be included in calculating the sum referred to in paragraph (f)(4) of this section. (6)(i) The undermargined amount for a Cleared Swaps Customer Account is the amount, if any, by which: (A) The total amount of collateral required for that Cleared Swaps Customer’s Cleared Swaps, at the time or times referred to in paragraph (f)(6)(ii) of this section, exceeds— (B) The value of the Cleared Swaps Customer Collateral for that account, as calculated in paragraph (f)(2) of this section. (ii) Each futures commission merchant must compute, based on the information available to the futures commission merchant as of the close of each business day, (A) The undermargined amounts, based on the clearing initial margin that will be required to be maintained by that futures commission merchant for its Cleared Swaps Customers, at each derivatives clearing organization of which the futures commission merchant is a member, at the point of the daily settlement (as described in § 39.14 of this chapter) that will complete during PO 00000 Frm 00142 Fmt 4701 Sfmt 4700 the following business day for each such derivatives clearing organization less (B) Any debit balances referred to in paragraph (f)(4) of this section included in such undermargined amounts. (iii)(A) Prior to the time of settlement referenced in paragraph (f)(6)(ii)(A) of this section such futures commission merchant must maintain residual interest in segregated funds that is equal to or exceeds the portion of the computation set forth in paragraph (f)(6)(ii) of this section attributable to the clearing initial margin required by the derivatives clearing organization making such settlement. (B) A futures commission merchant may reduce the amount of residual interest required in paragraph (f)(6)(iii)(A) of this section to account for payments received from or on behalf of undermargined Cleared Swaps Customers (less the sum of any disbursements made to or on behalf of such customers) between the close of the previous business day and the time of settlement. (iv) For purposes of paragraph (f)(6)(ii) of this section, a Depositing Futures Commission Merchant should include, as clearing initial margin, customer initial margin that the Depositing Futures Commission Merchant will be required to maintain, for that Depositing Futures Commission Merchant’s Cleared Swaps Customers, at a Collecting Futures Commission Merchant, and, for purposes of paragraph (f)(6)(iii) of this section, must do so prior to the time it must settle with that Collecting Futures Commission Merchant. (g) * * * (2) Each futures commission merchant is required to document its segregation computation required by paragraph (g)(1) of this section by preparing a Statement of Cleared Swaps Customer Segregation Requirements and Funds in Cleared Swaps Customer Accounts Under 4d(f) of the CEA contained in the Form 1–FR–FCM as of the close of business each business day. (3) Each futures commission merchant is required to submit to the Commission and to the firm’s designated selfregulatory organization the daily Statement of Cleared Swaps Customer Segregation Requirements and Funds in Cleared Swaps Customer Accounts Under 4d(f) of the CEA required by paragraph (g)(2) of this section by noon the following business day. (4) Each futures commission merchant shall file the Statement of Cleared Swaps Customer Segregation Requirements and Funds in Cleared Swaps Customer Accounts Under 4d(f) of the CEA required by paragraph (g)(2) E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations of this section in an electronic format using a form of user authentication assigned in accordance with procedures established or approved by the Commission. (5) Each futures commission merchant is required to submit to the Commission and to the firm’s designated selfregulatory organization a report listing the names of all banks, trust companies, futures commission merchants, derivatives clearing organizations, or any other depository or custodian holding Cleared Swaps Customer Collateral as of the fifteenth day of the month, or the first business day thereafter, and the last business day of each month. This report must include: (i) The name and location of each entity holding Cleared Swaps Customer Collateral; (ii) The total amount of Cleared Swaps Customer Collateral held by each entity listed in paragraph (g)(5) of this section; and (iii) The total amount of cash and investments that each entity listed in paragraph (g)(5) of this section holds for the futures commission merchant. The futures commission merchant must report the following investments: (A) Obligations of the United States and obligations fully guaranteed as to principal and interest by the United States (U.S. government securities); (B) General obligations of any State or of any political subdivision of a State (municipal securities); (C) General obligation issued by any enterprise sponsored by the United States (government sponsored enterprise securities); (D) Certificates of deposit issued by a bank; (E) Commercial paper fully guaranteed as to principal and interest by the United States under the Temporary Liquidity Guarantee Program as administered by the Federal Deposit Insurance Corporation; (F) Corporate notes or bonds fully guaranteed as to principal and interest by the United States under the Temporary Liquidity Guarantee Program as administered by the Federal Deposit Insurance Corporation; and (G) Interests in money market mutual funds. (6) Each futures commission merchant must report the total amount of customer owned securities held by the futures commission merchant as Cleared Swaps Customer Collateral and must list the names and locations of the depositories holding customer owned securities. (7) Each futures commission merchant must report the total amount of Cleared Swaps Customer Collateral that has VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 been used to purchase securities under agreements to resell the securities (reverse repurchase transactions). (8) Each futures commission merchant must report which, if any, of the depositories holding Cleared Swaps Customer Collateral under paragraph (g)(5) of this section are affiliated with the futures commission merchant. (9) Each futures commission merchant shall file the detailed list of depositories required by paragraph (g)(5) of this section by 11:59 p.m. the next business day in an electronic format using a form of user authentication assigned in accordance with procedures established or approved by the Commission. (10) Each futures commission merchant shall retain its daily segregation computation and the Statement of Cleared Swaps Customer Segregation Requirements and Funds in Cleared Swaps Customer Accounts under section 4d(f) of the CEA required by paragraph (g)(2) of this section and the detailed listing of depositories required by paragraph (g)(5) of this section, together with all supporting documentation, in accordance with § 1.31 of this chapter. ■ 23. Add § 22.17 to read as follows: § 22.17 Policies and procedures governing disbursements of Cleared Swaps Customer Collateral from Cleared Swaps Customer Accounts. (a) The provision in section 4d(f)(2) of the Act that prohibits the commingling of Cleared Swaps Customer Collateral with the funds of a futures commission merchant, shall not be construed to prevent a futures commission merchant from having a residual financial interest in the funds segregated as required by the Act and the regulations in this part and set apart for the benefit of Cleared Swaps Customers; nor shall such provisions be construed to prevent a futures commission merchant from adding to such segregated funds such amount or amounts of money, from its own funds or unencumbered securities from its own inventory, of the type set forth in § 1.25 of this chapter, as it may deem necessary to ensure any and all Cleared Swaps Customer Accounts are not undersegregated at any time. (b) A futures commission merchant may not withdraw funds, except withdrawals that are made to or for the benefit of Cleared Swaps Customers, from a Cleared Swaps Customer Account unless the futures commission merchant has prepared the daily segregation calculation required by § 22.2 as of the close of business on the previous business day. A futures commission merchant that has completed its daily segregation PO 00000 Frm 00143 Fmt 4701 Sfmt 4700 68647 calculation may make withdrawals, in addition to withdrawals that are made to or for the benefit of Cleared Swaps Customers, to the extent of its actual residual financial interest in funds held in segregated accounts, including the withdrawal of securities held in segregated safekeeping accounts held by a bank, trust company, derivatives clearing organization or other futures commission merchant. Such withdrawal(s) shall not result in the funds of one Cleared Swaps Customer being used to purchase, margin or carry the trades, contracts or swaps positions, or extend the credit of any other Cleared Swaps Customer or other person. (c) A futures commission merchant may not withdraw funds, in a single transaction or a series of transactions, that are not made to or for the benefit of Cleared Swaps Customers from Cleared Swaps Customer Accounts if such withdrawal(s) would exceed 25 percent of the futures commission merchant’s residual interest in such accounts as reported on the daily segregation calculation required by § 22.2 and computed as of the close of business on the previous business day, unless: (1) The futures commission merchant’s chief executive officer, chief finance officer or other senior official that is listed as a principal of the futures commission merchant on its Form 7–R and is knowledgeable about the futures commission merchant’s financial requirements and financial position preapproves in writing the withdrawal, or series of withdrawals; (2) The futures commission merchant files written notice of the withdrawal or series of withdrawals, with the Commission and with its designated self-regulatory organization immediately after the chief executive officer, chief finance officer or other senior official pre-approves the withdrawal or series of withdrawals. The written notice must: (i) Be signed by the chief executive officer, chief finance officer or other senior official that pre-approved the withdrawal, and give notice that the futures commission merchant has withdrawn or intends to withdraw more than 25 percent of its residual interest in such accounts holding Cleared Swaps Customer Accounts funds; (ii) Include a description of the reasons for the withdrawal or series of withdrawals; (iii) List the amount of funds provided to each recipient and the name of each recipient; (iv) Include the current estimate of the amount of the futures commission merchant’s residual interest in the E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68648 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations swaps customer funds after the withdrawal; (v) Contain a representation by the chief executive officer, chief finance officer or other senior official that preapproved the withdrawal, or series of withdrawals, that, after due diligence, to such person’s knowledge and reasonable belief, the futures commission merchant remains in compliance with the segregation requirements after the withdrawal. The chief executive officer, chief finance officer or other senior official must consider the daily segregation calculation as of the close of business on the previous business day and any other factors that may cause a material change in the futures commission’s residual interest since the close of business the previous business day, including known unsecured customer debits or deficits, current day market activity and any other withdrawals made from the Cleared Swaps Customer Accounts; and (vi) Any such written notice filed with the Commission must be filed via electronic transmission using a form of user authentication assigned in accordance with procedures established by or approved by the Commission, and otherwise in accordance with instruction issued by or approved by the Commission. Any such electronic submission must clearly indicate the registrant on whose behalf such filing is made and the use of such user authentication in submitting such filing will constitute and become a substitute for the manual signature of the authorized signer. Any written notice filed must be followed up with direct communication to the Regional office of Commission which has supervisory authority over the futures commission merchant whereby the Commission acknowledges receipt of the notice; and (3) After making a withdrawal requiring the approval and notice required in paragraphs (c)(1) and (c)(2) of this section, and before the next daily segregated funds calculation, no futures commission merchant may make any further withdrawals from accounts holding Cleared Swaps Customer Account funds, except to or for the benefit of Cleared Swaps Customers, without complying with paragraph (c)(1) of this section and filing a written notice with the Commission under paragraph (c)(2)(vi) of this section and its designated self-regulatory organization signed by the chief executive officer, chief finance officer, or other senior official. The written notice must: (i) List the amount of funds provided to each recipient and each recipient’s name; VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 (ii) Disclose the reason for each withdrawal; (iii) Confirm that the chief executive officer, chief finance officer, or other senior official (and identify of the person if different from the person who signed the notice) pre-approved the withdrawal in writing; (iv) Disclose the current estimate of the futures commission merchant’s remaining total residual interest in the segregated accounts holding Cleared Swaps Customer Account funds after the withdrawal; and (v) Include a representation that to the best of the notice signatory’s knowledge and reasonable belief the futures commission merchant remains in compliance with the segregation requirements after the withdrawal. (d) If a futures commission merchant withdraws funds that are not for the benefit of Cleared Swaps Customers from Cleared Swaps Customer Accounts, and the withdrawal causes the futures commission merchant to not hold sufficient funds in Cleared Swaps Customer Accounts to meet its targeted residual interest, as required to be computed under § 1.11 of this chapter, the futures commission merchant must deposit its own funds into the Cleared Swaps Customer Accounts to restore the targeted amount of residual interest on the next business day, or, if appropriate, revise the futures commission merchant’s targeted amount of residual interest pursuant to the policies and procedures required by § 1.11 of this chapter. Notwithstanding the foregoing, if the futures commission merchant’s residual interest in Cleared Swaps Customer Accounts is less than the amount required to be maintained by § 22.2 at any particular point in time, the futures commission merchant must immediately restore the residual interest to exceed the sum of such amounts. Any proprietary funds deposited in Cleared Swaps Customer Accounts must be unencumbered and otherwise compliant with § 1.25 of this chapter, as applicable. (e) Notwithstanding any other provision of this part, a futures commission merchant may not withdraw funds that are not for the benefit of Cleared Swaps Customers from a Cleared Swaps Customer Account unless the futures commission merchant follows its policies and procedures required by § 1.11 of this chapter. PART 30—FOREIGN FUTURES AND FOREIGN OPTIONS TRANSACTIONS 24. The authority citation for part 30 continues to read as follows: ■ PO 00000 Frm 00144 Fmt 4701 Sfmt 4700 Authority: 7 U.S.C. 1a, 2, 6, 6c, and 12a, unless otherwise noted. 25. Amend § 30.1 to add paragraphs (f), (g), and (h) to read as follows: ■ § 30.1 Definitions. * * * * * (f) 30.7 customer means any foreign futures or foreign options customer as defined in paragraph (c) of this section as well as any foreign-domiciled person who trades in foreign futures or foreign options through a futures commission merchant; Provided, however, that an owner or holder of a proprietary account as defined in § 1.3(y) of this chapter shall not be deemed to be a 30.7 customer. (g) 30.7 account means any account maintained by a futures commission merchant for or on behalf of 30.7 customers to hold money, securities, or other property to margin, guarantee, or secure foreign futures or foreign option positions. (h) 30.7 customer funds means any money, securities, or other property received by a futures commission merchant from, for, or on behalf of 30.7 customers to margin, guarantee, or secure foreign futures or foreign option positions, or money, securities, or other property accruing to 30.7 customers as a result of foreign futures and foreign option positions. ■ 26. Revise § 30.7 to read as follows: § 30.7 Treatment of foreign futures or foreign options secured amount. (a) General. Except as provided in this section, a futures commission merchant must at all times maintain in a separate account or accounts money, securities and property in an amount at least sufficient to cover or satisfy all of its obligations to 30.7 customers denominated as the foreign futures or foreign options secured amount. In computing the foreign futures or foreign options secured amount, a futures commission merchant may offset any net deficit in a particular 30.7 customer’s account against the current market value of readily marketable securities held for the same particular 30.7 customer’s account as provided for in paragraph (l) of this section. The amount that must be deposited in such separate account or accounts for 30.7 customers must be no less than the amount required to be held in a separate account or accounts for or on behalf of 30.7 customers pursuant to any law, or rule, regulation or order thereunder, or any rule of any self-regulatory organization authorized thereunder, in the jurisdiction in which the depository or the 30.7 customer, as appropriate, is located. E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations (b) Location of 30.7 customer funds. A futures commission merchant shall deposit the foreign futures or foreign options secured amount under an account name that clearly identifies the funds as belonging to 30.7 customers and shows that the foreign futures or foreign options secured amount is set aside as required by this part. A futures commission merchant may deposit funds set aside as the foreign futures or foreign options secured amount with the following depositories: (1) A bank or trust company located in the United States; (2) A bank or trust company located outside the United States that has in excess of $1 billion of regulatory capital; (3) A futures commission merchant registered as such with the Commission; (4) A derivatives clearing organization; (5) The clearing organization of any foreign board of trade; (6) A member of any foreign board of trade; or (7) Such member’s or clearing organization’s designated depositories. (c) Limitation on holding foreign futures or foreign options secured amount outside of the United States. A futures commission merchant may not deposit or hold the foreign futures or foreign options secured amount in accounts maintained outside of the United States with any of the depositories listed in paragraph (b) of this section except to meet margin requirements, including prefunding margin requirements, established by rule, regulation, or order of foreign boards of trade or foreign clearing organizations, or to meet margin calls issued by foreign brokers carrying the 30.7 customers’ foreign futures and foreign option positions; Provided, however, that a futures commission merchant may deposit an additional amount of up to 20 percent of the total amount of funds necessary to meet margin and prefunding margin requirements to avoid daily transfers of funds between the futures commission merchant’s 30.7 accounts maintained in the United States and those maintained outside of the United States. A futures commission merchant must deposit 30.7 customer funds under the laws and regulations of the foreign jurisdiction that provide the greatest degree of protection to such funds. A futures commission merchant may not by contract or otherwise waive any of the protections afforded customer funds under the laws of the foreign jurisdiction. (d) Written acknowledgment from depositories. (1) A futures commission merchant must obtain a written VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 acknowledgment from each depository prior to or contemporaneously with the opening of an account by the futures commission merchant with such depository. (2) The written acknowledgment must be in the form as set out in appendix E to this part; Provided, however, that if the futures commission merchant invests funds set aside as the foreign futures or foreign options secured amount in money market mutual funds as a permitted investment under paragraph (h) of this section and in accordance with the terms and conditions of § 1.25(c) of this chapter, the written acknowledgment with respect to such investment must be in the form as set out in appendix F to this part. (3)(i) A futures commission merchant shall deposit 30.7 customer funds only with a depository that agrees to provide the director of the Division of Swap Dealer and Intermediary Oversight, or any successor division, or such director’s designees, with direct, readonly electronic access to transaction and account balance information for 30.7 customer accounts. (ii) The written acknowledgment must contain the futures commission merchant’s authorization to the depository to provide direct, read-only electronic access to 30.7 customer account transaction and account balance information to the director of the Division of Swap Dealer and Intermediary Oversight, or any successor division, or such director’s designees, without further notice to or consent from the futures commission merchant. (4) A futures commission merchant shall deposit 30.7 customer funds only with a depository that agrees to provide the Commission and the futures commission merchant’s designated selfregulatory organization with a copy of the executed written acknowledgment no later than three business days after the opening of the account or the execution of a new written acknowledgment for an existing account, as applicable. The Commission must receive the written acknowledgment from the depository via electronic means, in a format and manner determined by the Commission. The written acknowledgment must contain the futures commission merchant’s authorization to the depository to provide the written acknowledgment to the Commission and to the futures commission merchant’s designated self-regulatory organization without further notice to or consent from the futures commission merchant. PO 00000 Frm 00145 Fmt 4701 Sfmt 4700 68649 (5) A futures commission merchant shall deposit 30.7 customer funds only with a depository that agrees that accounts containing 30.7 customer funds may be examined at any reasonable time by the director of the Division of Swap Dealer and Intermediary Oversight or the director of the Division of Clearing and Risk, or any successor divisions, or such directors’ designees, or an appropriate officer, agent or employee of the futures commission merchant’s designated selfregulatory organization. The written acknowledgment must contain the futures commission merchant’s authorization to the depository to permit any such examination to take place without further notice to or consent from the futures commission merchant. (6) A futures commission merchant shall deposit 30.7 customer funds only with a depository that agrees to reply promptly and directly to any request from the director of the Division of Swap Dealer and Intermediary Oversight or the director of the Division of Clearing and Risk, or any successor divisions, or such directors’ designees, or an appropriate officer, agent or employee of the futures commission merchant’s designated self-regulatory organization for confirmation of account balances or provision of any other information regarding or related to an account. The written acknowledgment must contain the futures commission merchant’s authorization to the depository to reply promptly and directly as required by this paragraph without further notice to or consent from the futures commission merchant. (7) A futures commission merchant shall promptly file a copy of the written acknowledgment with the Commission in the format and manner specified by the Commission no later than three business days after the opening of the account or the execution of a new written acknowledgment for an existing account, as applicable. (8) A futures commission merchant shall obtain a new written acknowledgment within 120 days of any changes in the following: (i) The name or business address of the futures commission merchant; (ii) The name or business address of the depository; or (iii) The account number(s) under which the foreign futures or foreign options secured amount are held. (9) A futures commission merchant shall maintain each written acknowledgment readily accessible in its files in accordance with § 1.31 of this chapter, for as long as the account remains open, and thereafter for the E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68650 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations period provided in § 1.31 of this chapter. (e) Commingling. (1) A futures commission merchant may commingle the funds set aside as the foreign futures or foreign options secured amount that it receives from, or on behalf of, multiple 30.7 customers in a single account or multiple accounts with one or more of the depositories listed in paragraph (b) of this section. (2) A futures commission merchant may not commingle the funds set aside as the foreign futures or foreign options secured amount held for 30.7 customers with the money, securities or property of such futures commission merchant, with any proprietary account of such futures commission merchant, or use such funds to secure or guarantee the obligations of, or extend credit to, such futures commission merchant or any proprietary account of such futures commission merchant; Provided, however, a futures commission merchant may deposit proprietary funds into 30.7 customer accounts as permitted under paragraph (g) of this section. (3) A futures commission merchant may not commingle 30.7 customer funds with funds deposited by futures customers as defined in § 1.3 of this chapter and held in segregated accounts pursuant to section 4d(a) and 4d(b) of the Act or with funds deposited by Cleared Swap Customers as defined in § 22.1 of this chapter and held in segregated accounts pursuant to section 4d(f) of the Act, or with funds of any account holders of the futures commission merchant unrelated to trading foreign futures or foreign options; Provided, however, that a futures commission merchant may commingle 30.7 customer funds with funds deposited by futures customers or Cleared Swaps Customers pursuant to the terms of a Commission regulation or order authorizing such commingling. (f) Limitations on use of 30.7 customer funds. (1)(i) A futures commission merchant shall not use, or permit the use of, the funds of one 30.7 customer to purchase, margin or settle the trades, contracts, or commodity options of, or to secure or extend credit to, any person other than such 30.7 customer. (ii)(A) The undermargined amount for a 30.7 customer’s account is the amount, if any, by which (1) The total amount of collateral required for that 30.7 customer’s positions in that account, at the time or times referred to in paragraph (f)(1)(ii)(B) of this section, exceeds (2) The value of the 30.7 customer funds for that account, as calculated in paragraph (f)(2)(ii) of this section. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 (B) Each futures commission merchant must compute, based on the information available to the futures commission merchant as of the close of each business day, (1) The undermargined amounts, based on the clearing initial margin that will be required to be maintained by that futures commission merchant for its 30.7 customers, at each clearing organization of which the futures commission merchant is a member, at 6:00 p.m. Eastern on the following business day for each such clearing organization less (2) Any debit balances referred to in paragraph (f)(2)(iv) of this section included in such undermargined amounts. (C)(1) Prior to 6:00 p.m. Eastern Time on the date of the settlement referenced in paragraph (f)(1)(ii)(B)(1) of this section, such futures commission merchant must maintain residual interest in segregated funds that is at least equal to the computation set forth in paragraph (f)(1)(ii)(B) of this section. (2) A futures commission merchant may reduce the amount of residual interest required in paragraph (f)(1)(ii)(C)(1) of this section to account for payments received from or on behalf of undermargined 30.7 customers (less the sum of any disbursements made to or on behalf of such customers) between the close of the previous business day and 6:00 p.m. Eastern Time on the following business day. (D) For purposes of paragraph (f)(1)(ii)(B) of this section, a futures commission merchant should include, as clearing initial margin, customer initial margin that the futures commission merchant will be required to maintain, for that futures commission merchant’s 30.7 customers, at a foreign broker, and, for purposes of paragraph (f)(1)(ii)(C) of this section, must do so prior to 6:00 p.m. Eastern Time on the date referenced in paragraph (f)(1)(ii)(B)(1) of this section. (2) Requirements as to amount. (i) For purposes of this paragraph (f)(2), the term ‘‘account’’ shall mean the entries on the books and records of a futures commission merchant pertaining to the 30.7 customer funds of a particular 30.7 customer. (ii) The futures commission merchant must reflect in the account that it maintains for each 30.7 customer the net liquidating equity for each such customer, calculated as follows: The market value of any 30.7 customer funds it receives from such customer, as adjusted by: (A) Any uses permitted under paragraph (e) of this section; PO 00000 Frm 00146 Fmt 4701 Sfmt 4700 (B) Any accruals on permitted investments of such collateral under § 1.25 of this chapter that, pursuant to the futures commission merchant’s customer agreement with that customer, are creditable to such customer; (C) Any gains and losses with respect to contracts for the purchase or sale of foreign futures or foreign option positions; (D) Any charges lawfully accruing to the 30.7 customer, including any commission, brokerage fee, interest, tax, or storage fee; and (E) Any appropriately authorized distribution or transfer of such collateral. (iii) If the market value of 30.7 customer funds in the account of a 30.7 customer is positive after adjustments, then that account has a credit balance. If the market value of 30.7 customer funds in the account of a 30.7 customer is negative after adjustments, then that account has a debit balance. (iv) The futures commission merchant must maintain in segregation an amount equal to the sum of any credit balances that 30.7 customers of the futures commission merchant have in their accounts. This balance may not be reduced by any debit balances that the 30.7 customers of the futures commission merchants have in their accounts. (3) A futures commission merchant may not impose or permit the imposition of a lien on any funds set aside as the foreign futures or foreign options secured amount, including any residual financial interest of the futures commission merchant in such funds. (4) A futures commission merchant may not include in funds set aside as the foreign futures or foreign options secured amount any money invested in securities, memberships, or obligations of any clearing organization or board of trade. A futures commission merchant may not include in funds set aside as the foreign futures or foreign options secured amount any other money, securities, or property held by a member of a foreign board of trade, board of trade, or clearing organization, except if the funds are deposited to margin, secure, or guarantee 30.7 customers’ foreign futures or foreign options positions and the futures commission merchant obtains the written acknowledgment from the member of the foreign board of trade, board of trade, or clearing organization as required by paragraph (d) of this section. (g) Futures commission merchant’s residual financial interest and withdrawal of funds. (1) The provision in paragraph (e) of this section, which E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations prohibits the commingling of funds set aside as the foreign futures or foreign options secured amount with the funds of a futures commission merchant, shall not be construed to prevent a futures commission merchant from having a residual financial interest in the funds set aside as required by the regulations in this part for the benefit of 30.7 customers; nor shall such provisions be construed to prevent a futures commission merchant from adding to such set aside funds such amount or amounts of money, from its own funds or unencumbered securities from its own inventory, of the type set forth in § 1.25 of this chapter, as it may deem necessary to ensure any and all 30.7 accounts from becoming undersecured at any time. (2) A futures commission merchant may not withdraw funds, except withdrawals that are made to or for the benefit of 30.7 customers, from an account or accounts holding the foreign futures and foreign options secured amount unless the futures commission merchant has prepared the daily 30.7 calculation required by paragraph (l) of this section as of the close of business on the previous business day. A futures commission merchant that has completed its daily 30.7 calculation may make withdrawals, in addition to withdrawals that are made to or for the benefit of 30.7 customers, to the extent of its actual residual financial interest in funds held in 30.7 accounts, including the withdrawal of securities held in secured amount safekeeping accounts held by a bank, trust company, contract market, clearing organization, member of a foreign board of trade, or other futures commission merchant. Such withdrawal(s) shall not result in the funds of one 30.7 customer being used to purchase, margin or guarantee the foreign futures or foreign options positions, or extend the credit of any other 30.7 customer or other person. (3) A futures commission merchant may not withdraw funds, in a single transaction or a series of transactions, that are not made for the benefit of 30.7 customers from an account or accounts holding 30.7 customer funds if such withdrawal(s) would exceed 25 percent of the futures commission merchant’s residual interest in such accounts as reported on the daily secured amount calculation required by paragraph (l) of this section and computed as of the close of business on the previous business day, unless the futures commission merchant’s chief executive officer, chief finance officer or other senior official that is listed as a principal of the futures commission merchant on its Form 7–R and is VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 knowledgeable about the futures commission merchant’s financial requirements and financial position preapproves in writing the withdrawal, or series of withdrawals. (4) A futures commission merchant must file written notice of the withdrawal or series of withdrawals that exceed 25 percent of the futures commission merchant’s residual interest in 30.7 customer funds as computed under paragraph (h)(2) of this section with the Commission and with its designated self-regulatory organization immediately after the chief executive officer, chief finance officer or other senior official as described in paragraph (g)(2) of this section pre-approves the withdrawal or series of withdrawals. The written notice must: (i) Be signed by the chief executive officer, chief finance officer or other senior official that pre-approved the withdrawal, and give notice that the futures commission merchant has withdrawn or intends to withdraw more than 25 percent of its residual interest in accounts holding 30.7 customer funds; (ii) Include a description of the reasons for the withdrawal or series of withdrawals; (iii) List the amount of funds provided to each recipient and the name of each recipient; (iv) Include the current estimate of the amount of the futures commission merchant’s residual interest in the 30.7 customer funds after the withdrawal; (v) Contain a representation by the chief executive officer, chief finance officer or other senior official as described in paragraph (g)(3) of this section that pre-approved the withdrawal, or series of withdrawals, that to such person’s knowledge and reasonable belief, the futures commission merchant remains in compliance with the secured amount requirements after the withdrawal. The chief executive officer, chief finance officer or other appropriate senior official as described in paragraph (g)(2) of this section must consider the daily 30.7 calculation as of the close of business on the previous business day and any other factors that may cause a material change in the futures commission’s residual interest since the close of business the previous business day, including known unsecured customer debits or deficits, current day market activity and any other withdrawals made from the 30.7 customer accounts; and (vi) Any such written notice filed with the Commission must be filed via electronic transmission using a form of user authentication assigned in PO 00000 Frm 00147 Fmt 4701 Sfmt 4700 68651 accordance with procedures established by or approved by the Commission, and otherwise in accordance with instruction issued by or approved by the Commission. Any such electronic submission must clearly indicate the registrant on whose behalf such filing is made and the use of such user authentication in submitting such filing will constitute and become a substitute for the manual signature of the authorized signer. Any written notice filed must be followed up with direct communication to the regional office of Commission which has supervisory authority over the futures commission merchant whereby the Commission acknowledges receipt of the notice. (5) After making a withdrawal requiring the approval and notice required in paragraphs (c)(1) and (c)(2) of this section, and before the next daily secured amount calculation, no futures commission merchant may make any further withdrawals from accounts holding 30.7 customer funds, except to or for the benefit of 30.7 customers, without, for each withdrawal, obtaining the approval required under paragraph (c)(1) of this section and filing a written notice with the Commission under paragraph (g)(4)(vi) of this section and its designated self-regulatory organization signed by the chief executive officer, chief finance officer, or other senior official. The written notice must: (i) List the amount of funds provided to each recipient and each recipient’s name; (ii) Disclose the reason for each withdrawal; (iii) Confirm that the chief executive officer, chief finance officer, or other senior official (and the identity of the person if different from the person who signed the notice) pre-approved the withdrawal in writing; (iv) Disclose the current estimate of the futures commission merchant’s remaining total residual interest in the secured accounts holding 30.7 customer funds after the withdrawal; and (v) Include a representation that to the best of the notice signatory’s knowledge and reasonable belief the futures commission merchant remains in compliance with the secured amount requirements after the withdrawal. (6) If a futures commission merchant withdraws funds that are not for the benefit of 30.7 customers from the separate accounts holding 30.7 customer funds, and the withdrawal causes the futures commission merchant to not hold sufficient funds in the separate accounts for the benefit of the 30.7 customers to meet its targeted residual interest, as required to be computed E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68652 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations under § 1.11 of this chapter, the futures commission merchant must deposit its own funds into the separate accounts for the benefit of 30.7 customers to restore the account balance to the targeted residual interest amount on the next business day, or, if appropriate, revise the futures commission merchant’s targeted amount of residual interest pursuant to the policies and procedures required by § 1.11 of this chapter. Notwithstanding the foregoing, if the futures commission merchant’s residual interest in separate accounts for the benefit of 30.7 customers is less than the amount required to be maintained by paragraph (f) of this section at any particular point in time, the futures commission merchant must immediately restore the residual interest to exceed the sum of such amounts. Any proprietary funds deposited in the 30.7 customer accounts must be unencumbered and otherwise compliant with § 1.25 of this chapter, as applicable. (7) Notwithstanding any other provision of this part, a futures commission merchant may not withdraw funds from 30.7 accounts, except withdrawals that are made for the benefit of 30.7 customers, unless the futures commission merchant follows its policies and procedures required by § 1.11 of this chapter. (h) Permitted investments and deposits of 30.7 customer funds. (1) A futures commission merchant may invest 30.7 customer funds subject to, and in compliance with, the terms and conditions of § 1.25 of this chapter. Regulation 1.25 of this chapter shall apply to the investment of 30.7 customer funds as if such funds comprised customer funds or customer money subject to segregation pursuant to section 4d of the Act and the regulations thereunder. (2) Each futures commission merchant that invests money, securities or property on behalf of 30.7 customers must keep a record showing the following: (i) The date on which such investments were made; (ii) The name of the person through whom such investments were made; (iii) The amount of money or current market value of securities so invested; (iv) A description of the obligations in which such investments were made, including CUSIP or ISIN numbers; (v) The identity of the depositories or other places where such investments are maintained; (vi) The date on which such investments were liquidated or otherwise disposed of and the amount of money received or current market VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 value of securities received as a result of such disposition; (vii) The name of the person to or through whom such investments were disposed of; and (viii) A daily valuation for each instrument and readily available documentation supporting the daily valuation for each instrument. Such supporting documentation must be sufficient to enable third parties to verify the valuations and the accuracy of any information from external sources used in those valuations. (3) Any 30.7 customer funds deposited in a bank or trust company located in the United States or in a foreign jurisdiction must be available for immediate withdrawal upon the demand of the futures commission merchant. (4) Futures commission merchants that invest 30.7 customer funds in instruments described in § 1.25 of this chapter shall include such instruments in the computation of its secured amount requirements, required under paragraph (l) of this section, at values that at no time exceed current market value, determined as of the close of the market on the date for which such computation is made. (i) Responsibility for § 1.25 investment losses. A futures commission merchant shall bear sole financial responsibility for any losses resulting from the investment of 30.7 customer funds in instruments described in § 1.25 of this chapter. No investment losses shall be borne or otherwise allocated to the 30.7 customers of the futures commission merchant. (j) Loans by futures commission merchants; treatment of proceeds. A futures commission merchant may lend its own funds to 30.7 customers on securities and property pledged, or from repledging or selling such securities and property pursuant to specific written agreement with such 30.7 customers. The proceeds of such loans used to purchase, margin, guarantee, or secure the trades, contracts, or commodity options of 30.7 customers shall be treated and dealt with by a futures commission merchant as belonging to such 30.7 customers. A futures commission merchant may not loan funds on an unsecured basis to finance a 30.7 customer’s foreign futures and foreign options trading, nor may a futures commission merchant loan funds to a 30.7 customer secured by the 30.7 customer’s trading account. (k) Permitted withdrawals. A futures commission merchant may withdraw funds from 30.7 customer accounts in an amount necessary in the normal course of business to margin, guarantee, PO 00000 Frm 00148 Fmt 4701 Sfmt 4700 secure, transfer, or settle 30.7 customers’ foreign futures or foreign option positions with a foreign broker or clearing organization. A futures commission merchant also may withdraw funds from 30.7 customer accounts to pay commissions, brokerage, interest, taxes, storage, and other charges lawfully accruing in connection with the 30.7 customers’ foreign futures and foreign options positions. (l) Daily computation of 30.7 customer secured amount requirement and details regarding the holding and investing of 30.7 customer funds. (1) Each futures commission merchant is required to prepare a Statement of Secured Amounts and Funds Held in Separate Accounts for 30.7 Customers Pursuant to Commission Regulation 30.7 contained in the Form 1–FR–FCM as of the close of each business day. Futures commission merchants that invest funds set aside as the foreign futures or foreign options secured amount in instruments described in § 1.25 of this chapter shall include such instruments in the computation of its secured amount requirements at values that at no time exceed current market value, determined as of the close of the market on the date for which such computation is made. Nothing in this paragraph shall affect the requirement that a futures commission merchant at all times maintain sufficient money, securities and property to cover its total obligations to all 30.7 customers, in accordance with paragraph (a) of this section. (2) A futures commission merchant may offset any net deficit in a particular 30.7 customer’s account against the current market value of readily marketable securities, less deductions (i.e., ‘‘securities haircuts’’) as set forth in Rule 15c3–1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR 240.15c3–1(c)(2)(vi)), held for the same particular 30.7 customer’s account in computing the daily Foreign Futures and Foreign Options Secured Amount. Futures commission merchants that establish and enforce written policies and procedures to assess the credit risk of commercial paper, convertible debt instruments, or nonconvertible debt instruments in accordance with Rule 240.15c3–1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR 240.15c3–1(c)(2)(vi)) may apply the lower haircut percentages specified in Rule 240.15c3–1(c)(2)(vi) for such commercial paper, convertible debt instruments and nonconvertible debt instruments. The futures commission merchant must maintain a security interest in the securities, including a E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations written authorization to liquidate the securities at the futures commission merchant’s discretion, and must set aside the securities in a safekeeping account compliant with paragraph (c) of this section. For purposes of this section, a security will be considered ‘‘readily marketable’’ if it is traded on a ‘‘ready market’’ as defined in Rule 15c3–1(c)(11)(i) of the Securities and Exchange Commission (17 CFR 240.15c3–1(c)(11)(i)). (3) Each futures commission merchant is required to submit to the Commission and to the firm’s designated selfregulatory organization the daily Statement of Secured Amounts and Funds Held in Separate Accounts for 30.7 Customers pursuant to Commission Regulation 30.7 required by paragraph (l)(1) of this section by noon the following business day. (4) Each futures commission merchant shall file the Statement of Secured Amounts and Funds Held in Separate Accounts for 30.7 Customers pursuant to Commission Regulation 30.7 required by paragraph (l)(1) of this section in an electronic format using a form of user authentication assigned in accordance with procedures established or approved by the Commission. (5) Each futures commission merchant is required to submit to the Commission and to the firm’s designated selfregulatory organization a report listing the names of all banks, trust companies, futures commission merchants, derivatives clearing organizations, foreign brokers, foreign clearing organizations, or any other depository or custodian holding 30.7 customer funds as of the fifteenth day of the month, or the first business day thereafter, and the last business day of each month. This report must include: (i) The name and location of each depository holding 30.7 customer funds; (ii) The total amount of 30.7 customer funds held by each depository listed in paragraph (l)(5) of this section; and (iii) The total amount of cash and investments that each depository listed in paragraph (l)(5) of this section holds for the futures commission merchant. The futures commission merchant must report the following investments: (A) Obligations of the United States and obligations fully guaranteed as to principal and interest by the United States (U.S. government securities); (B) General obligations of any State or of any political subdivision of a State (municipal securities); (C) General obligation issued by any enterprise sponsored by the United States (government sponsored enterprise securities); VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 (D) Certificates of deposit issued by a bank; (E) Commercial paper fully guaranteed as to principal and interest by the United States under the Temporary Liquidity Guarantee Program as administered by the Federal Deposit Insurance Corporation; (F) Corporate notes or bonds fully guaranteed as to principal and interest by the United States under the Temporary Liquidity Guarantee Program as administered by the Federal Deposit Insurance Corporation; and (G) Interests in money market mutual funds. (6) Each futures commission merchant must report the total amount of customer-owned securities held by the futures commission merchant as 30.7 customer funds and must list the names and locations of the depositories holding customer-owned securities. (7) Each futures commission merchant must report the total amount of 30.7 customer funds that have been used to purchase securities under agreements to resell the securities (reverse repurchase transactions). (8) Each futures commission merchant must report which, if any, of the depositories holding 30.7 customer funds under paragraph (l)(5) of this section are affiliated with the futures commission merchant. (9) Each futures commission merchant shall file the detailed list of depositories required by paragraph (l)(5) of this section by 11:59 p.m. the next business day in an electronic format using a form of user authentication assigned in accordance with procedures established or approved by the Commission. (10) Each futures commission merchant shall retain its daily secured amount computation, the Statement of Secured Amounts and Funds Held in Separate Accounts for 30.7 Customers pursuant to Commission Regulation 30.7 required by paragraph (l)(1) of this section, and the detailed list of depositories required by paragraph (l)(5) of this section, together with all supporting documentation, in accordance with the requirements of § 1.31 of this chapter. ■ 27. Add appendix E to part 30 to read as follows: Appendix E to Part 30— Acknowledgment Letter for CFTC Regulation 30.7 Customer Secured Account [Date] [Name and Address of Depository] We refer to the Secured Amount Account(s) which [Name of Futures Commission Merchant] (‘‘we’’ or ‘‘our’’) have PO 00000 Frm 00149 Fmt 4701 Sfmt 4700 68653 opened or will open with [Name of Depository] (‘‘you’’ or ‘‘your’’) entitled: [Name of Futures Commission Merchant] [if applicable, add ‘‘FCM Customer Omnibus Account’’] CFTC Regulation 30.7 Customer Secured Account under Section 4(b) of the Commodity Exchange Act [and, if applicable, ‘‘, Abbreviated as [short title reflected in the depository’s electronic system]’’] Account Number(s): [ ] (collectively, the ‘‘Account(s)’’). You acknowledge that we have opened or will open the above-referenced Account(s) for the purpose of depositing, as applicable, money, securities and other property (collectively ‘‘Funds’’) of customers who trade foreign futures and/or foreign options (as such terms are defined in U.S. Commodity Futures Trading Commission (‘‘CFTC’’) Regulation 30.1, as amended); that the Funds held by you, hereafter deposited in the Account(s) or accruing to the credit of the Account(s), will be kept separate and apart and separately accounted for on your books from our own funds and from any other funds or accounts held by us, in accordance with the provisions of the Commodity Exchange Act, as amended (the ‘‘Act’’), and Part 30 of the CFTC’s regulations, as amended; that the Funds may not be commingled with our own funds in any proprietary account we maintain with you; and that the Funds must otherwise be treated in accordance with the provisions of Section 4(b) of the Act and CFTC Regulation 30.7. Furthermore, you acknowledge and agree that such Funds may not be used by you or by us to secure or guarantee any obligations that we might owe to you, and they may not be used by us to secure or obtain credit from you. You further acknowledge and agree that the Funds in the Account(s) shall not be subject to any right of offset or lien for or on account of any indebtedness, obligations or liabilities we may now or in the future have owing to you. This prohibition does not affect your right to recover funds advanced in the form of cash transfers, lines or credit, repurchase agreements or other similar liquidity arrangements you make in lieu of liquidating non-cash assets held in the Account(s) or in lieu of converting cash held in the Account(s) to cash in a different currency. In addition, you agree that the Account(s) may be examined at any reasonable time by the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC or the director of the Division of Clearing and Risk of the CFTC, or any successor divisions, or such directors’ designees, or an appropriate officer, agent or employee of our designated self-regulatory organization (‘‘DSRO’’), [Name of DSRO], and this letter constitutes the authorization and direction of the undersigned on our behalf to permit any such examination to take place without further notice or consent from us. You agree to reply promptly and directly to any request for confirmation of account balances or provision of any other information regarding or related to the Account(s) from the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC or the director of the Division E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 68654 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations of Clearing and Risk of the CFTC, or any successor divisions, or such directors’ designees, or an appropriate officer, agent, or employee of [Name of DSRO], acting in its capacity as our DSRO, and this letter constitutes the authorization and direction of the undersigned on our behalf to release the requested information without further notice to or consent from us. You further acknowledge and agree that, pursuant to authorization granted by us to you previously or herein, you have provided, or will promptly provide following the opening of the Account(s), the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC, or any successor division, or such director’s designees, with technological connectivity, which may include provision of hardware, software, and related technology and protocol support, to facilitate direct, read-only electronic access to transaction and account balance information for the Account(s). This letter constitutes the authorization and direction of the undersigned on our behalf for you to establish this connectivity and access if not previously established, without further notice to or consent from us. The parties agree that all actions on your part to respond to the above information and access requests will be made in accordance with, and subject to, such usual and customary authorization verification and authentication policies and procedures as may be employed by you to verify the authority of, and authenticate the identity of, the individual making any such information or access request, in order to provide for the secure transmission and delivery of the requested information or access to the appropriate recipient(s). We will not hold you responsible for acting pursuant to any information or access request from the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC or the director of the Division of Clearing and Risk of the CFTC, or any successor divisions, or such directors’ designees, or an appropriate officer, agent, or employee of [Name of DSRO], acting in its capacity as our DSRO, upon which you have relied after having taken measures in accordance with your applicable policies and procedures to assure that such request was provided to you by an individual authorized to make such a request. In the event we become subject to either a voluntary or involuntary petition for relief under the U.S. Bankruptcy Code, we acknowledge that you will have no obligation to release the Funds held in the Account(s), except upon instruction of the Trustee in Bankruptcy or pursuant to the Order of the respective U.S. Bankruptcy Court. Notwithstanding anything in the foregoing to the contrary, nothing contained herein shall be construed as limiting your right to assert any right of offset or lien on assets that are not 30.7 customer funds maintained in the Account(s), or to impose such charges against us or any proprietary account maintained by us with you. Further, it is understood that amounts represented by checks, drafts or other items shall not be considered to be part of the Account(s) until finally collected. Accordingly, checks, drafts VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 and other items credited to the Account(s) and subsequently dishonored or otherwise returned to you or reversed, for any reason, and any claims relating thereto, including but not limited to claims of alteration or forgery, may be charged back to the Account(s), and we shall be responsible to you as a general endorser of all such items whether or not actually so endorsed. You may conclusively presume that any withdrawal from the Account(s) and the balances maintained therein are in conformity with the Act and CFTC regulations without any further inquiry, provided that, in the ordinary course of your business as a depository, you have no notice of or actual knowledge of a potential violation by us of any provision of the Act or Part 30 of the CFTC regulations that relates to the holding of customer funds; and you shall not in any manner not expressly agreed to herein be responsible to us for ensuring compliance by us with such provisions of the Act and CFTC regulations; however, the aforementioned presumption does not affect any obligation you may otherwise have under the Act or CFTC regulations. You may, and are hereby authorized to, obey the order, judgment, decree or levy of any court of competent jurisdiction or any governmental agency with jurisdiction, which order, judgment, decree or levy relates in whole or in part to the Account(s). In any event, you shall not be liable by reason of any action or omission to act pursuant to any such order, judgment, decree or levy, to us or to any other person, firm, association or corporation even if thereafter any such order, decree, judgment or levy shall be reversed, modified, set aside or vacated. The terms of this letter agreement shall remain binding upon the parties, their successors and assigns and, for the avoidance of doubt, regardless of a change in the name of either party. This letter agreement supersedes and replaces any prior agreement between the parties in connection with the Account(s), including but not limited to any prior acknowledgment letter agreement, to the extent that such prior agreement is inconsistent with the terms hereof. In the event of any conflict between this letter agreement and any other agreement between the parties in connection with the Account(s), this letter agreement shall govern with respect to matters specific to Section 4(b) of the Act and the CFTC’s regulations thereunder, as amended. This letter agreement shall be governed by and construed in accordance with the laws of [Insert governing law] without regard to the principles of choice of law. Please acknowledge that you agree to abide by the requirements and conditions set forth above by signing and returning to us the enclosed copy of this letter agreement, and that you further agree to provide a copy of this fully executed letter agreement directly to the CFTC (via electronic means in a format and manner determined by the CFTC) and to [Name of DSRO], acting in its capacity as our DSRO. We hereby authorize and direct you to provide such copies without further notice to or consent from us, no later than three business days after opening the Account(s) or revising this letter agreement, as applicable. PO 00000 Frm 00150 Fmt 4701 Sfmt 4700 [Name of Futures Commission Merchant] By: Print Name: Title: ACKNOWLEDGED AND AGREED: [Name of Depository] By: Print Name: Title: Contact Information: [Insert phone number and email address] Date: 28. Add appendix F to part 30 to read as follows: ■ Appendix F to Part 30— Acknowledgment Letter for CFTC Regulation 30.7 Customer Secured Money Market Mutual Fund Account [Date] [Name and Address of Money Market Mutual Fund] We propose to invest funds held by [Name of Futures Commission Merchant] (‘‘we’’ or ‘‘our’’) on behalf of our customers in shares of [Name of Money Market Mutual Fund] (‘‘you’’ or ‘‘your’’) under account(s) entitled (or shares issued to): [Name of Futures Commission Merchant] [if applicable, add ‘‘FCM Customer Omnibus Account’’] CFTC Regulation 30.7 Customer Secured Money Market Mutual Fund Account under Section 4(b) of the Commodity Exchange Act [and, if applicable, ‘‘, Abbreviated as [short title reflected in the depository’s electronic system]’’] Account Number(s): [ ] (collectively, the ‘‘Account(s)’’). You acknowledge that we are holding these funds, including any shares issued and amounts accruing in connection therewith (collectively, the ‘‘Shares’’), for the benefit of customers who trade foreign futures and/or foreign options (as such terms are defined in U.S. Commodity Futures Trading Commission (‘‘CFTC’’) Regulation 30.1, as amended); that the Shares held by you, hereafter deposited in the Account(s) or accruing to the credit of the Account(s), will be kept separate and apart and separately accounted for on your books from our own funds and from any other funds or accounts held by us in accordance with the provisions of the Commodity Exchange Act, as amended (the ‘‘Act’’), and Part 30 of the CFTC’s regulations, as amended; and that the Shares must otherwise be treated in accordance with the provisions of Section 4(b) of the Act and CFTC Regulations 1.25 and 30.7. Furthermore, you acknowledge and agree that such Shares may not be used by you or by us to secure or guarantee any obligations that we might owe to you, and they may not be used by us to secure or obtain credit from you. You further acknowledge and agree that the Shares in the Account(s) shall not be subject to any right of offset or lien for or on account of any indebtedness, obligations or liabilities we may now or in the future have owing to you. In addition, you agree that the Account(s) may be examined at any reasonable time by the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC or E:\FR\FM\14NOR2.SGM 14NOR2 TKELleY on DSK3SPTVN1PROD with RULES2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations the director of the Division of Clearing and Risk of the CFTC, or any successor divisions, or such directors’ designees, or an appropriate officer, agent or employee of our designated self-regulatory organization (‘‘DSRO’’), [Name of DSRO], and this letter constitutes the authorization and direction of the undersigned on our behalf to permit any such examination to take place without further notice to or consent from us. You agree to reply promptly and directly to any request for confirmation of account balances or provision of any other information regarding or related to the Account(s) from the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC or the director of the Division of Clearing and Risk of the CFTC, or any successor divisions, or such directors’ designees, or an appropriate officer, agent, or employee of [Name of DSRO], acting in its capacity as our DSRO, and this letter constitutes the authorization and direction of the undersigned on our behalf to release the requested information, without further notice to or consent from us. You further acknowledge and agree that, pursuant to authorization granted by us to you previously or herein, you have provided, or will promptly provide following the opening of the Account(s), the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC, or any successor division, or such director’s designees, with technological connectivity, which may include provision of hardware, software, and related technology and protocol support, to facilitate direct, read-only electronic access to transaction and account balance information for the Account(s). This letter constitutes the authorization and direction of the undersigned on our behalf for you to establish this connectivity and access if not previously established, without further notice to or consent from us. The parties agree that all actions on your part to respond to the above information and access requests will be made in accordance with, and subject to, such reasonable and customary authorization verification and authentication policies and procedures as may be employed by you to verify the authority of, and authenticate the identity of, the individual making any such information or access request, in order to provide for the secure transmission and delivery of the requested information or access to the appropriate recipient(s). We will not hold you responsible for acting pursuant to any information or access request from the director of the Division of Swap Dealer and Intermediary Oversight of the CFTC or the director of the Division of Clearing and Risk of the CFTC, or any successor divisions, or such directors’ designees, or an appropriate officer, agent, or employee of [Name of DSRO], acting in its capacity as our DSRO, upon which you have relied after having taken measures in accordance with your applicable policies and procedures to assure that such request was provided to you by an individual authorized to make such a request. In the event we become subject to either a voluntary or involuntary petition for relief under the U.S. Bankruptcy Code, we VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 acknowledge that you will have no obligation to release the Shares held in the Account(s), except upon instruction of the Trustee in Bankruptcy or pursuant to the Order of the respective U.S. Bankruptcy Court. Notwithstanding anything in the foregoing to the contrary, nothing contained herein shall be construed as limiting your right to assert any right of offset or lien on assets that are not Shares maintained in the Account(s), or to impose such charges against us or any proprietary account maintained by us with you. Further, it is understood that amounts represented by checks, drafts or other items shall not be considered to be part of the Account(s) until finally collected. Accordingly, checks, drafts and other items credited to the Account(s) and subsequently dishonored or otherwise returned to you or reversed, for any reason and any claims relating thereto, including but not limited to claims of alteration or forgery, may be charged back to the Account(s), and we shall be responsible to you as a general endorser of all such items whether or not actually so endorsed. You may conclusively presume that any withdrawal from the Account(s) and the balances maintained therein are in conformity with the Act and CFTC regulations without any further inquiry, provided that, in the ordinary course of your business as a depository, you have no notice of or actual knowledge of a potential violation by us of any provision of the Act or Part 30 of the CFTC regulations that relates to the holding of customer funds; and you shall not in any manner not expressly agreed to herein be responsible to us for ensuring compliance by us with such provisions of the Act and CFTC regulations; however, the aforementioned presumption does not affect any obligation you may otherwise have under the Act or CFTC regulations. You may, and are hereby authorized to, obey the order, judgment, decree or levy of any court of competent jurisdiction or any governmental agency with jurisdiction, which order, judgment, decree or levy relates in whole or in part to the Account(s). In any event, you shall not be liable by reason of any action or omission to act pursuant to any such order, judgment, decree or levy, to us or to any other person, firm, association or corporation even if thereafter any such order, decree, judgment or levy shall be reversed, modified, set aside or vacated. We are permitted to invest customers’ funds in money market mutual funds pursuant to CFTC Regulation 1.25. That rule sets forth the following conditions, among others, with respect to any investment in a money market mutual fund: (1) The net asset value of the fund must be computed by 9:00 a.m. of the business day following each business day and be made available to us by that time; (2) The fund must be legally obligated to redeem an interest in the fund and make payment in satisfaction thereof by the close of the business day following the day on which we make a redemption request except as otherwise specified in CFTC Regulation 1.25(c)(5)(ii); and, (3) The agreement under which we invest customers’ funds must not contain any PO 00000 Frm 00151 Fmt 4701 Sfmt 4700 68655 provision that would prevent us from pledging or transferring fund shares. The terms of this letter agreement shall remain binding upon the parties, their successors and assigns and, for the avoidance of doubt, regardless of a change in the name of either party. This letter agreement supersedes and replaces any prior agreement between the parties in connection with the Account(s), including but not limited to any prior acknowledgment letter agreement, to the extent that such prior agreement is inconsistent with the terms hereof. In the event of any conflict between this letter agreement and any other agreement between the parties in connection with the Account(s), this letter agreement shall govern with respect to matters specific to Section 4(b) of the Act and the CFTC’s regulations thereunder, as amended. This letter agreement shall be governed by and construed in accordance with the laws of [Insert governing law] without regard to the principles of choice of law. Please acknowledge that you agree to abide by the requirements and conditions set forth above by signing and returning to us the enclosed copy of this letter agreement, and that you further agree to provide a copy of this fully executed letter agreement directly to the CFTC (via electronic means in a format and manner determined by the CFTC) and to [Name of DSRO], acting in its capacity as our DSRO. We hereby authorize and direct you to provide such copies without further notice to or consent from us, no later than three business days after opening the Account(s) or revising this letter agreement, as applicable. [Name of Futures Commission Merchant] By: Print Name: Title: ACKNOWLEDGED AND AGREED: [Name of Money Market Mutual Fund] By: Print Name: Title: Contact Information: [Insert phone number and email address] DATE: PART 140—ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION 29. The authority citation for part 140 is revised to read as follows: ■ Authority: 7 U.S.C. 2(a)(12), 12a, 13(c), 13(d), 13(e), and 16(b). 30. Amend § 140.91 to: a. Revise the section heading; b. Redesignate paragraph (a)(8) as paragraph (a)(12), and paragraph (a)(7) as paragraph (a)(8); ■ c. Add new paragraphs (a)(7), (a)(9), (a)(10), and (a)(11); and ■ d. Revise paragraph (b). The revisions and additions read as follows: ■ ■ ■ § 140.91 Delegation of authority to the Director of the Division of Clearing and Risk and to the Director of the Division of Swap Dealer and Intermediary Oversight. (a) * * * E:\FR\FM\14NOR2.SGM 14NOR2 68656 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations (7) All functions reserved to the Commission in § 1.20 of this chapter. * * * * * (9) All functions reserved to the Commission in § 1.26 of this chapter. (10) All functions reserved to the Commission in § 1.52 of this chapter. (11) All functions reserved to the Commission in § 30.7 of this chapter. * * * * * (b) The Director of the Division of Clearing and Risk and the Director of the Division of Swap Dealer and Intermediary Oversight may submit any matter which has been delegated to him or her under paragraph (a) of this section to the Commission for its consideration. Issued in Washington, DC, on November 1, 2013, by the Commission. Melissa D. Jurgens, Secretary of the Commission. Appendices to Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations—Commission Voting Summary and Statements of Commissioners Note: The following appendices will not appear in the Code of Federal Regulations. Appendix 1—Commission Voting Summary On this matter, Chairman Gensler and Commissioners Chilton and Wetjen voted in the affirmative. Commissioner O’Malia voted in the negative. TKELleY on DSK3SPTVN1PROD with RULES2 Appendix 2—Statement of Chairman Gary Gensler I support this final set of customer protection reforms, which comprehensively enhances the protection around the handling and segregation of futures and swaps customer funds. Segregation of customer funds is the core foundation of the commodity futures and swaps markets. Segregation must be maintained at all times. That means every moment of every day. Market events, though, of these last two years highlighted that the Commission must do everything within our authorities and resources to strengthen oversight programs and protection of customer funds. These reforms are the sixth set of rules finalized by this Commission during a twoyear process to ensure that customers have confidence that their funds are segregated and protected. These reforms benefit from the Commission’s thorough review of existing customer protection rules—looking for any gaps in those rules and the oversight of these markets. They benefit from significant public input, including staff roundtables, the Technology Advisory Committee, the Agricultural Advisory Committee and numerous reports submitted by market participants. VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 They also benefit from input through a coordinated effort of the CFTC with other regulators; the self-regulatory organizations (SROs), such as the CME and the National Futures Association (NFA); as well as congressional reports and input on these matters. I support these rules, in summary, for at least six reasons: • First, FCMs and clearing members must significantly enhance their supervision of and accounting for customer funds. They will have to put in place additional policies and procedures for these new protections. • Second, significant enhancements around outside accounting and auditing— regarding the actual accountants or certified public accountants that audit futures commission merchants (FCMs), and also regarding the SROs and how they audit the FCMs. • Third, significant customer fund protections with regard to how funds are moved around. Basically, when a firm moves money within a firm, how can they move that money around? Some of these reforms were adopted by SROs last year, such as requiring senior management signoff, and the preapproval of moving those monies. There are also significant new changes to required acknowledgement letters from the banks and custodians. • Fourth, reforms related to investing in foreign futures accounts. Our Part 30 regime really had not kept pace with protections for domestic futures accounts. With these reforms and the reforms that the NFA had put in place last year, investing in foreign futures accounts will be significantly aligned with the domestic protections. • Fifth, there’s significant new transparency. Transparency to the regulators—we will be able to see electronically custodial accounts and cash accounts on a daily basis. There is transparency to customers, as well, with the twice-a-month statements regarding the details of their funds in the investment accounts. These reforms also have been put in place by the SROs, but it is important that we do this at the federal level as well, and put them in our rules. • Sixth, the final rules include provisions on capital and residual interest of the FCMs themselves. This was quite possibly the most debated feature of these reforms, but I think they are important. In response to commenters on this provision, we are phasing in compliance to smooth implementation. This section calls for studies and roundtables, and provides for a five-year phase in on these matters. It is important that we look very closely at the law and work to ensure that one customer’s funds or property are not used in some way to secure or guarantee other customer’s positions. Prior to this final rule set, the Commission already had made important improvements to protections for customers: • Amendments to rule 1.25 regarding the investment of funds that bring customers back to protections they had prior to exemptions the Commission granted between 2000 and 2005. Importantly, this prevents use of customer funds for in-house lending through repurchase agreements; PO 00000 Frm 00152 Fmt 4701 Sfmt 4700 • Clearinghouses have to collect margin on a gross basis and FCMs are no longer able to offset one customer’s collateral against another and then send only the net to the clearinghouse; • The so-called ‘‘LSOC rule’’ (legal segregation with operational comingling) for swaps ensures customer money is protected individually all the way to the clearinghouse; • The Commission included customer protection enhancements in the final rule for designated contract markets. These provisions codify into rules staff guidance on minimum requirements for SROs regarding their financial surveillance of FCMs; and • Rules enhancing the protection of customer funds when entering into uncleared swap transactions. These reforms fulfill Congress’ mandate that counterparties of swap dealers be given a choice regarding whether or not they get the protections that come from segregation of monies and collateral they post as initial margin. Appendix 3—Dissenting Statement of Commissioner Scott D. O’Malia— Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations 1 I respectfully dissent from the Commission’s approval today of the final Customer Protection Rules. I supported the proposed rules because I wanted to solicit public comment and engage market participants in an open discussion about how the Commission should improve its customer protection regulatory oversight. In the wake of the global financial crisis, it is extremely important to intensify regulatory efforts to strengthen customer protection policies in order to promote the financial stability of the derivatives markets. There is no dispute customer protection must be the cornerstone of the Commission’s oversight. Sound customer protection policies and measures, such as the electronic customer verification confirmation services will improve the efficiency and transparency of financial markets.2 The Commission must promulgate workable regulations that provide clear guidance to industry participants and ensure cost-effective access to markets. Such regulations must be designed to address real weaknesses in the current regulatory regime and allow industry participants to continue with well-established industry practices that had nothing to do with the financial crisis or the recent bankruptcies of MF Global and Peregrine Financial. Unfortunately, the Commission’s customer protection rules fall short of these objectives. Instead of mitigating customer risk, the rules 1 ‘‘Customer Protection Rules’’ this regard, I applaud the efforts of the Chicago Mercantile Exchange Inc. (CME) and the National Futures Association (NFA) to protect customer accounts by introducing daily electronic confirmation services. This new technology allows CME and NFA to review balances held at bank depositories and compare the balances with customer account information provide by futures commission merchants (FCMs). 2 In E:\FR\FM\14NOR2.SGM 14NOR2 Federal Register / Vol. 78, No. 220 / Thursday, November 14, 2013 / Rules and Regulations TKELleY on DSK3SPTVN1PROD with RULES2 create a false sense of security by imposing broad and ambiguous requirements and introducing another layer of governmental oversight. Even worse, they force a change in a longstanding and generally accepted industry practice that will likely result in seriously harmful consequences for small FCMs and their end-user customers. I do support several provisions that allow customers greater insight into the operations of an FCM. These provisions include: An improved FCM disclosure regime that will give customers new and critical information about their FCM exposures, elimination of the alternative method of calculating segregation requirements for § 30.7 funds (treatment of foreign futures or foreign options), improved reporting of segregated fund balances, and enhancements to risk management procedures. However, I am unable to support the final rule for the reasons stated below. Reinterpretation of the Residual Interest Deadline Will Result in Costly Prefunding of Margin Payments My main concern with the final rules is their radical reinterpretation of the longstanding residual interest deadline. This reinterpretation decreases the time in which customers’ margin calls must arrive to their FCM from the current three days to just one day. Such a change would mean a drastic increase in pre-funding of margin, perhaps nearly double the amounts currently required. As a result, many small agribusiness hedgers will have to consider alternative risk management tools or, even worse, will be forced out of the market.3 I am disappointed that yet again the Commission has rushed to implement a rule that disregards the express Congressional directive to protect end-users. I recognize that the Commodity Exchange Act (CEA) does not permit an FCM to use the money or property of one customer to margin the futures or option positions of another customer.4 Despite this fact, it has been the prevailing industry practice authorized by the Commission for decades. To the extent that the Commission must reinterpret this statutory provision, I believe this reinterpretation must be based on the 3 See e.g.; National Grain and Feed Association Comment Letter at 2 (Dec. 28, 2012) (stating that the Commission’s proposed changes ‘‘could have the unintended impact of disadvantaging smaller and mid-size FCMs that provide ‘hands-on’ service to many of the relatively smaller hedgers in agribusiness’’); Texas Cattle Feeders Association Comment Letter (Jan. 14, 2013) (warning that such changes ‘‘could have the potential to cause unintended consequences such as added costs eventually borne by customers’’); Iowa Cattlemen’s Association Comment Letter (Feb. 15, 2013) (‘‘it is imperative that the CFTC understand all sizes of businesses . . . [in order to have] . . . a better opportunity to write rules that provide a logical fit. Our fear is that if this rule is put in place, we will have members who will not take advantage of the risk management tools . . . .’’). 4 CEA § 4d(a)(2). VerDate Mar<15>2010 19:24 Nov 13, 2013 Jkt 232001 thorough analysis of the market data and the full evaluation of the costs of strict compliance with the statute before implementing policy changes, and not after as is the case with the residual interest deadline. The residual interest deadline rule makes no effort to respond to the commenters’ concerns that the residual interest deadline would be especially costly for smaller FCMs and end-users.5 Given the express Congressional directive to protect end-users, I would have expected the Commission to conduct meaningful cost-benefit analysis to justify the costs when compared to the actual risk to customer accounts and the derivatives markets and to explain why the Commission could not have adopted an alternative approach. Regrettably, the Commission has failed to do so. Even the Commission’s own cost benefit analysis points out, while significantly understating the impact, that: ‘‘Smaller FCMs may have more difficulty than large FCMs in absorbing the additional cost created by the requirements of the rules (particularly § 1.22). It is possible that some smaller FCMs may elect to stop operating as FCMs as a result of these costs.’’ 6 I cannot support a rule that will impose such onerous costs and compliance burdens on the smallest FCMs and small, nonsystemically relevant customers. Finally, although I support a phase-in compliance schedule for the residual interest deadline, I am disappointed that the Commission, in deciding whether to change the deadline at a future time, is not required to make such a decision based on data. Instead, the Commission will simply come up with another arbitrary residual interest deadline that has nothing to do with customer or FCM risk exposure. Yet again, the Commission has chosen to avoid fact-based analysis. I strongly believe that the Commission should utilize facts and data to make an informed decision about the appropriate time for the residual interest deadline. The Rules Fail To Provide a Clear Standard for Compliance. In addition to my serious concerns about the final rules’ treatment of the residual interest deadline, I am concerned that the rules unreasonably expand the scope of the new regulatory compliance regime without providing a clear regulatory objective. For example, the rules require that a SelfRegulatory Organization (SRO) supervisory program ‘‘address all areas of risk to which [FCMs] can reasonably be foreseen to be subject (emphasis added).’’ 7 This broad language requires the SRO to guess at what criteria the programs would be measured against, and under what framework the SRO would make this determination. In short, the new language does nothing but adds more 5 Futures Industry Association Comment Letter at 16 (Feb. 15, 2013). 6 Customer Protection Rules at 313. 7 § 1.52(c)(2). PO 00000 Frm 00153 Fmt 4701 Sfmt 9990 68657 ambiguity to the SRO’s customer protection program and increases the cost of compliance with vague requirements. Examination Experts do not add Value to the Customer Protection Regime I also have concerns about the requirement that each SRO supervisory program of its member FCMs be reviewed by an ‘‘examinations expert.’’ 8 I question the benefit of this requirement given the fact that the Joint Audit Committee (JAC) currently performs this function. The JAC’s primary responsibility is to oversee the practices and procedures that each SRO must follow when it conducts audits and financial reviews of FCMs. This regulatory task is already in place and implemented in a less costly and more efficient manner than set forth in the final rules. Moreover, in light of the Commission’s regulatory oversight of all SROs and the Commission’s review of all JAC examination programs, this additional layer of review does not provide any benefit except for isolating the Commission from its primary responsibility to oversee customer protection programs. Customers Deserve Better Protections in Bankruptcy Proceedings Going forward, the Commission should address key customer protections in the areas of bankruptcy. Congress should make changes to the Bankruptcy Code to ensure that certain bankruptcy protections are afforded to FCM customers. Specifically, Congress should amend the pro-rata distribution rules in bankruptcy. Despite the Commission’s customer segregation requirements, individual customer accounts are still subject to a pro-rata distribution in bankruptcy. In addition to these changes to the Bankruptcy Code, the Commission should amend its rules to allow the Commission to appoint a trustee to oversee derivatives customers’ accounts in the bankruptcy of a broker-dealer FCM. Conclusion I support implementation of a rigorous customer protection program that provides clear and meaningful mechanisms for mitigating customer risks. However, the customer protection rules approved today have missed the mark. In sum, many of the new rules impose overly broad and nonsensical regulatory requirements and, in doing so, impede the industry’s ability to operate in an efficient manner. Regrettably, the negative effects will be felt most by farmers and other end-users, whose ability to hedge risk in a cost-effective manner will be hampered if not eliminated altogether. This is contrary to the Congressional directive, and I cannot support rules that result in such an outcome. [FR Doc. 2013–26665 Filed 11–13–13; 8:45 am] BILLING CODE 6351–01–P 8 § 1.52. E:\FR\FM\14NOR2.SGM 14NOR2

Agencies

Commodity Futures Trading Commission

[Federal Register Volume 78, Number 220 (Thursday, November 14, 2013)]
[Rules and Regulations]
[Pages 68505-68657]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-26665]

[[Page 68505]]

Vol. 78

Thursday,

No. 220

November 14, 2013

Part II

Commodity Futures Trading Commission

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17 CFR Parts 1, 3, 22, et al.

Enhancing Protections Afforded Customers and Customer Funds Held by
Futures Commission Merchants and Derivatives Clearing Organizations;
Final Rule

Federal Register / Vol. 78 , No. 220 / Thursday, November 14, 2013 /
Rules and Regulations

[[Page 68506]]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 3, 22, 30, and 140

RIN 3038-AD88

Enhancing Protections Afforded Customers and Customer Funds Held
by Futures Commission Merchants and Derivatives Clearing Organizations

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is adopting new regulations and amending existing regulations
to require enhanced customer protections, risk management programs,
internal monitoring and controls, capital and liquidity standards,
customer disclosures, and auditing and examination programs for futures
commission merchants (``FCMs'').
The regulations also address certain related issues concerning
derivatives clearing organizations (``DCOs'') and chief compliance
officers (``CCOs''). The final rules will afford greater assurances to
market participants that: Customer segregated funds, secured amount
funds, and cleared swaps funds are protected; customers are provided
with appropriate notice of the risks of futures trading and of the FCMs
with which they may choose to do business; FCMs are monitoring and
managing risks in a robust manner; the capital and liquidity of FCMs
are strengthened to safeguard their continued operations; and the
auditing and examination programs of the Commission and the self-
regulatory organizations (``SROs'') are monitoring the activities of
FCMs in a prudent and thorough manner.

DATES: Effective date: January 13, 2014.
Compliance date: The applicable compliance dates are discussed in
the section of the release titled ``III. Compliance Dates.''

FOR FURTHER INFORMATION CONTACT: Division of Swap Dealer and
Intermediary Oversight: Gary Barnett, Director, 202-418-5977,
gbarnett@cftc.gov; Thomas Smith, Deputy Director, 202-418-5495,
tsmith@cftc.gov;mailto: Jennifer Bauer, Special Counsel, 202-418-5472,
jbauer@cftc.gov; Joshua Beale, Attorney-Advisor, 202-418-5446,
jbeale@cftc.gov, Three Lafayette Centre, 1155 21st Street NW.,
Washington, DC 20581; Kevin Piccoli, Deputy Director, 646-746-9834,
kpiccoli@cftc.gov, 140 Broadway, 19th Floor, New York, NY 10005; or
Mark Bretscher, Special Counsel, 312-596-0529, mbretscher@cftc.gov, 525
W. Monroe Street, Suite 1100, Chicago, IL. 60661. Division of Clearing
and Risk: Ananda Radhakrishnan, Director, 202-418-5188,
aradhakrishnan@cftc.gov; Robert B. Wasserman, Chief Counsel, 202-418-
5092, rwasserman@cftc.gov; Phyllis P. Dietz, Deputy Director, 202-418-
5449, pdietz@cftc.gov; M. Laura Astrada, Associate Chief Counsel, 202-
418-7622, lastrada@cftc.gov, Eileen Donovan, Associate Director, 202-
418-5096, edonovan@cftc.gov; Kirsten V. K. Robbins, Special Counsel,
202-418-5313, krobbins@cftc.gov; or Shawn R. Durrani, Attorney-Advisor,
202-418-5048, sdurrani@cftc.gov, Three Lafayette Centre, 1155 21st
Street NW., Washington, DC 20581.
Office of the Chief Economist: Stephen Kane, Research Economist,
skane@cftc.gov, 202-418-5911, Three Lafayette Centre, 1155 21st Street
NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background
A. General Statutory and Current Regulatory Structure
B. Self-Regulatory Structure
C. Futures Commission Merchant Insolvencies and Failures of Risk
Management
D. Recent Commission Rulemakings and Other Initiatives Relating
to Customer Protection
E. The Proposed Amendments
II. Comments on the Notice of Proposed Rulemaking
A. Sec. 1.10: Financial Reports of Futures Commission Merchants
and Introducing Brokers
1. Amendments of the Segregation and Secured Amount Schedules
With Respect to the Reporting of Residual Interest
2. New Cleared Swaps Segregation Schedules
3. Amendments to Form 1-FR-FCM
4. FCM Certified Annual Report Deadline
5. Leverage Ratio Calculation
6. Procedural Filing Requirements
B. Sec. 1.11: Risk Management Program for Futures Commission
Merchants
1. Applicability
2. Definitions
3. Approval of Policies and Procedures and Submission to the
Commission
4. Organizational Requirements of the Risk Management Program
a. Separation of Risk Management Unit From Business Unit
5. Components of the Risk Management Program
6. Annual Review, Distribution of Policies and Procedures and
Recordkeeping
7. CCO or CEO Certification
C. Sec. 1.12: Maintenance of Minimum Financial Requirements by
Futures Commission Merchants and Introducing Brokers
1. Timing of Notices
2. Undercapitalized FCMs and IBs
3. Insufficient Segregation of Funds of Cleared Swaps Customers
4. Investment of Customer Funds in Contravention of Regulation
1.25
5. Notice of Residual Interest Falling Below Targeted Level or
Undermargined Amounts
6. Events Causing Material Adverse Financial Impact or Material
Change in Operations
7. Notice of Correspondence From Other Regulatory Authorities
8. Filing Process and Content
9. Public Disclosure of Early Warning Notices
D. Sec. 1.15: Risk Assessment Reporting Requirement for Futures
Commission Merchants
E. Sec. 1.16: Qualifications and Reports of Accountants
1. Mandatory PCAOB Registration Requirement
2. PCAOB Inspection Requirement
3. Remediation of PCAOB Inspection Findings by the Public
Accountant
4. Auditing Standards
5. Review of Public Accountant's Qualifications by the FCM's
Governing Body
6. Electronic Filing of Certified Annual Reports
F. Sec. 1.17: Minimum Financial Requirements for Futures
Commission Merchants and Introducing Brokers
1. FCM Cessation of Business and Transfer of Customer Accounts
if Unable To Demonstrate Adequate Liquidity
2. Reducing Time Period for FCMs To Incur a Capital Charge for
Undermargined Accounts to One Day after Margin Calls Are Issued
3. Permit an FCM that is not a BD To Develop Policies and
Procedures To Determine Creditworthiness
4. Revisions to Definitions in Regulation 1.17(b)
G. Sec. 1.20: Futures Customer Funds To Be Segregated and
Separately Accounted for
1. Identification of Customer Funds and Due Diligence
2. Permitted Depositories
3. Limitation on the Holding of Futures Customer Funds Outside
of the United States
4. Acknowledgment Letters
a. Background
b. Technical Changes to the Template Letters
c. Federal Reserve Banks as Depositories
d. Foreign Depositories
e. Release of Funds Upon Commission Instruction
f. Read-Only Access and Information Requests
g. Requirement To File New Acknowledgment Letters
h. Standard of Liability
i. Liens
j. Examination of Accounts
5. Prohibition Against Commingling Customer Funds
6. Limitations on the Use of Customer Funds
7. Segregation Requirements for DCOs

[[Page 68507]]

8. Immediate Availability of Bank and Trust Company Deposits
9. Segregated Funds Computation Requirement
10. Segregation Regimes
H. Sec. 1.22: Use of Futures Customer Funds
I. Sec. 1.23: Interest of Futures Commission Merchant in
Segregated Futures Customer Funds; Additions and Withdrawals
J. Sec. 1.25: Investment of Customer Funds
1. General Comments Regarding the Investment of Customer Funds
2. Reverse Repurchase Agreement Counterparty Concentration
Limits
K. Sec. 1.26: Deposit of Instruments Purchased With Futures
Customer Funds
L. Sec. 1.29: Increment or Interest Resulting From Investment
of Customer Funds
1. FCM's Responsibility for Losses Incurred on the Investment of
Customer Funds
2. FCM's Obligation in Event of Bank Default
M. Sec. 1.30: Loans by Futures Commission Merchants: Treatment
of Proceeds
N. Sec. 1.32: (Sec. 22.2(g) for Cleared Swaps Customers and
Sec. 30.7(l) for Foreign Futures and Foreign Options Customers):
Segregated Account: Daily Computation and Record
O. Sec. 1.52: Self-Regulatory Organization Adoption and
Surveillance of Minimum Financial Requirements
1. Swap Execution Facilities Excluded From the Scope of
Regulation 1.52
2. Revisions to the Current SRO Supervisory Program
3. Auditing Standards Utilized in the SRO Supervisory Program
4. ``Examinations Expert'' Reports
P. Sec. 1.55: Public disclosures by Futures Commission
Merchants
1. Amendments to the Risk Disclosure Statement
a. Firm Specific Disclosure Document
i. General Requirements
ii. Specific Disclosure Information Required (by rule paragraph)
2. Public Availability of FCM Financial Information
Q. Part 22--Cleared Swaps
R. Amendments to Sec. 1.3: Definitions; and Sec. 30.7:
Treatment of Foreign Futures or Foreign Options Secured Amount
1. Elimination of the ``Alternative Method'' for Calculating the
Secured Amount
2. Funds Held in Non-U.S. Depositories
3. Commingling of Positions in Foreign Futures and Foreign
Options Accounts
4. Further Harmonization With Treatment of Customer Segregated
Funds
5. Harmonization With Other Commission Proposals
S. Sec. 3.3: Chief Compliance Officer Annual Report
III. Compliance Dates
A. Financial Reports of FCMs: Sec. 1.10
B. Risk Management Program for FCMs: Sec. 1.11
C. Qualifications and Reports of Accountants: Sec. 1.16
D. Minimum Financial Requirements for FCMs
E. Written Acknowledgment Letters: Sec. Sec. 1.20, 1.26, and
30.7
F. Undermargined Amounts: Sec. Sec. 1.22(c), 30.7(a)
G. SRO Minimum Financial Surveillance: Sec. 1.52
H. Public Disclosures by FCMs: Sec. 1.55
IV. Cost Benefit Considerations
V. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
Appendix 1--Table of Comment Letters
Appendix 2--CFTC Form 1-FR-FCM

I. Background

A. General Statutory and Current Regulatory Structure

The protection of customers--and the safeguarding of money,
securities or other property deposited by customers with an FCM--is a
fundamental component of the Commission's disclosure and financial
responsibility framework. Section 4d(a)(2) \1\ of the Commodity
Exchange Act (``the Act'' or ``the CEA'') \2\ requires each FCM to
segregate from its own assets all money, securities, and other property
deposited by futures customers to margin, secure, or guarantee futures
contracts and options on futures contracts traded on designated
contract markets.\3\ Section 4d(a)(2) further requires an FCM to treat
and deal with futures customer funds as belonging to the futures
customer, and prohibits an FCM from using the funds deposited by a
futures customer to margin or extend credit to any person other than
the futures customer that deposited the funds.
---------------------------------------------------------------------------

\1\ 7 U.S.C. 6d(a)(2).
\2\ 7 U.S.C. 1 et seq.
\3\ The term ``futures customer'' is defined in Sec. 1.3(iiii)
of the Commission's regulations to include any person who uses an
FCM as an agent in connection with trading in any contract for the
purchase or sale of a commodity for future delivery or an option on
such contract (excluding any proprietary accounts under Sec.
1.3(y)). The Commission adopted the definition of the term ``futures
customer'' on October 16, 2012 as part of the final rulemaking that
amended existing Commission regulations to incorporate swaps. The
Federal Register release adopting the final rules can be accessed at
https://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister101612.pdf. Commission regulations can be found at 17
CFR Ch. 1.
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Section 4d(f) of the Act, which was added by section 724(a) of the
Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank
Act''),\4\ requires each FCM to segregate from its own assets all
money, securities, and other property deposited by Cleared Swaps
Customers to margin Cleared Swaps.\5\ Section 4d(f) also provides that
an FCM shall treat and deal with all money, securities, and property of
any swaps customer received to margin, guarantee, or secure a swap
cleared by or through a DCO (including money, securities, or property
accruing to the swaps customer as the result of such a swap) as
belonging to the swaps customer. Section 4d(f) further provides that an
FCM shall separately account for and not commingle with its own funds
any money, securities, and property of a swaps customer, and shall not
use such swaps customer's funds to margin, secure, or guarantee any
trades or contracts of any swaps customer or person other than the
person for whom the same are held.
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\4\ See Dodd-Frank 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/DoddFrankAct/index.htm.
\5\ The term ``Cleared Swap'' is defined in section 1a(7) of the
Act as any swap that is, directly or indirectly, submitted to and
cleared by a DCO registered with the Commission. The term ``Cleared
Swaps Customer'' is defined in Sec. 22.1 as any person entering
into a Cleared Swap, but excludes: (1) Any owner or holder of a
Cleared Swaps Proprietary Account with respect to the Cleared Swaps
in such account; and (2) A clearing member of a DCO with respect to
Cleared Swaps cleared on that DCO.
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The Commission adopted Sec. Sec. 1.20 through 1.30, and Sec.
1.32, to implement section 4d(a)(2) of the Act, and adopted part 22 to
implement section 4d(f) of the Act. The purpose of these regulations is
to safeguard funds deposited by futures customers and Cleared Swaps
Customers, respectively.
Regulation 1.20 requires each FCM and DCO to separately account for
and to segregate from its own proprietary funds all money, securities,
or other property deposited by futures customers for trading on
designated contract markets. In addition, all futures customer funds
must be separately accounted for, and may not be commingled with the
money, securities or property of an FCM or of any other person, or be
used to secure or guarantee the trades, contracts or commodity options,
or to secure or extend the credit, of any person other than the one for
whom the same are held. Regulation 1.20 also provides that an FCM or
DCO may deposit futures customer funds only with a bank or trust
company, and for FCMs only, a DCO or another FCM. The funds must be
deposited under an account name that clearly identifies the funds as
belonging to the futures customers of the FCM or DCO and further shows
that the funds are segregated as required by section 4d(a)(2) of the
Act and Commission regulations. FCMs and DCOs also are required to
obtain a written acknowledgment from a depository stating that the
depository was informed that the funds deposited are customer funds
being held in accordance with the Act.
FCMs and DCOs also are restricted in their use of futures customer
funds. Regulation 1.22 prohibits an FCM from using, or permitting the
use of, the

[[Page 68508]]

futures customer funds of one futures customer to purchase, margin, or
settle the trades, contracts, or commodity options of, or to secure or
extend the credit of, any person other than such futures customer. In
addition, Sec. 1.22 provides that futures customer funds may not be
used to carry trades or positions of the same futures customer other
than in commodities or commodity options traded through the facilities
of a contract market. Under Sec. 1.20, an FCM or DCO may, however, for
convenience, commingle and hold funds deposited as margin by multiple
futures customers in the same account or accounts with one of the
recognized depositories. An FCM or DCO also may invest futures customer
funds in certain permitted investments under Sec. 1.25.
Part 22 of the Commission's regulations, which governs Cleared
Swaps, implements section 4d(f) of the Act and parallels many of the
provisions in part 1 that address the manner in which, and the
responsibilities imposed upon, an FCM may hold funds for futures
customers trading on designated contract markets.\6\ For example, Sec.
22.2 requires an FCM to treat and to deal with funds deposited by
Cleared Swaps Customers as belonging to such Cleared Swaps Customers
and to hold such funds separately from the FCM's own funds. Regulation
22.4 provides that an FCM may deposit Cleared Swaps Customer Collateral
with a bank, trust company, DCO, or another registered FCM.\7\
Regulation 22.6 requires that the account holding the Cleared Swaps
Customers Collateral must clearly identify the account as an account
for Cleared Swaps Customers of the FCM engaging in Cleared Swaps and
that the funds maintained in the account are subject to the segregation
provisions of section 4d(f) of the Act and Commission regulations.
---------------------------------------------------------------------------

\6\ The Commission approved the part 22 regulations on January
11, 2012, with an effective date of April 9, 2012. Compliance with
the part 22 regulations was required by November 8, 2012. See
Protection of Cleared Swaps Customer Contracts and Collateral;
Conforming Amendments to the Commodity Broker Bankruptcy Provisions,
77 FR 6336 (Feb. 7, 2012).
\7\ The term ``Cleared Swaps Customer Collateral'' is defined in
Sec. 22.2 to mean all money, securities, or other property
(including accruals) received by an FCM or DCO from, for, or on
behalf of a Cleared Swaps Customer to margin, guarantee, or secure a
Cleared Swap.
---------------------------------------------------------------------------

Regulation 22.2(d) also prohibits an FCM from using the Cleared
Swaps Customer Collateral of one Cleared Swaps Customer to purchase,
margin, or settle the Cleared Swaps or any other trade or contract, or
to secure or extend credit, of any person other than such Cleared Swaps
Customer. Further, Sec. 22.2(c) permits an FCM to commingle the
Cleared Swaps Customer Collateral of multiple Cleared Swaps Customers
into one or more accounts, and Sec. 22.2(e)(1) permits an FCM to
invest Cleared Swaps Customer Collateral in accordance with Sec. 1.25.
In addition to holding funds for futures customers transacting on
designated contract markets and for Cleared Swaps Customers engaging in
Cleared Swaps, FCMs also hold funds for persons trading futures
contracts listed on foreign boards of trade. Section 4(b) of the Act
provides that the Commission may adopt rules and regulations
proscribing fraud and requiring minimum financial standards, the
disclosure of risk, the filing of reports, the keeping of books and
records, the safeguarding of the funds deposited by persons for trading
on foreign markets, and registration with the Commission by any person
located in the United States (``U.S.'') who engages in the offer or
sale of any contract of sale of a commodity for future delivery that is
made subject to the rules of a board of trade located outside of the
U.S. Pursuant to the statutory authority of section 4(b), the
Commission adopted part 30 of its regulations to address foreign
futures and foreign option transactions.
The segregation provisions for funds deposited by foreign futures
or foreign options customers to margin foreign futures or foreign
options transactions under part 30, however, are significantly
different from the requirements set forth in Sec. 1.20 for futures
customers trading on designated contract markets and part 22 for
Cleared Swaps Customers engaging in Cleared Swaps.\8\ Regulation 30.7
provides that an FCM may deposit the funds belonging to foreign futures
or foreign options customers in an account or accounts maintained at a
bank or trust company located in the U.S.; a bank or trust company
located outside of the U.S. that has in excess of $1 billion of
regulatory capital; an FCM registered with the Commission; a DCO; a
member of a foreign board of trade; a foreign clearing organization; or
a depository selected by the member of a foreign board of trade or
foreign clearing organization. The account with the depository must be
titled to clearly specify that the account holds funds belonging to the
foreign futures or foreign options customers of the FCM that are
trading on foreign futures markets. An FCM also is permitted to invest
the funds deposited by foreign futures or foreign option customers in
accordance with Sec. 1.25.
---------------------------------------------------------------------------

\8\ The term ``foreign futures or foreign options customer'' is
defined in Sec. 30.1 to mean any person located in the U.S., its
territories or possessions who trades in foreign futures or foreign
options, with the exception of accounts that are proprietary
accounts under Sec. 1.3. The term ``foreign futures or foreign
option'' is defined in Sec. 30.1 to generally mean any futures and/
or options transactions executed on a foreign board of trade.
---------------------------------------------------------------------------

However, unlike Sec. 1.20 and part 22, which require an FCM to
hold a sufficient amount of funds in segregation to meet the total
account equities of all of the FCM's futures customers and Cleared
Swaps Customers ``at all times'' (i.e., the ``Net Liquidating Equity
Method''), Sec. 30.7 requires an FCM to maintain in separate accounts
an amount of funds only sufficient to cover the margin required on open
foreign futures contracts, plus or minus any unrealized gains or losses
on such open positions, plus any funds representing premiums payable or
received on foreign options (including any additional funds necessary
to secure such options, plus or minus any unrealized gains or losses on
such options) (i.e., the ``Alternative Method''). Thus, under the part
30 Alternative Method an FCM is not required to maintain a sufficient
amount of funds in such separate accounts to pay the full account
balances of all of its foreign futures or foreign options customers at
all times.
In addition to the segregation requirements of sections 4d(a)(2)
and 4d(f) of the Act, and the secured amount requirements in part 30 of
the Commission's regulations, FCMs also are subject to minimum net
capital and financial reporting requirements that are intended to
ensure that such firms meet their financial obligations in a regulated
marketplace, including their financial obligations to customers and
DCOs. Each FCM is required to maintain a minimum level of ``adjusted
net capital,'' which is generally defined under Sec. 1.17 as the
firm's net equity as computed under generally accepted accounting
principles, less all of the firm's liabilities (except for certain
qualifying subordinated debt) and further excluding all assets that are
not liquid or readily marketable. Regulation 1.17(c)(5) further
requires an FCM to impose capital charges (i.e., deductions) on certain
of its liquid assets to protect against possible market risks in such
assets.
FCMs also are subject to financial recordkeeping and reporting
requirements. FCMs that carry customer accounts are required under
Sec. 1.32 to prepare a schedule each business day demonstrating their
compliance with the segregation and secured amount requirements.
Regulation 1.32 requires the calculation to be performed by noon

[[Page 68509]]

each business day, reflecting the account balances and open positions
as of the close of business on the previous business day.
Each FCM also is required by Sec. 1.10 to file with the Commission
and with its designated self-regulatory organization (``DSRO'') monthly
unaudited financial statements and an annual audited financial
report.\9\ Regulation 1.12 requires an FCM to file a notice with the
Commission and with the firm's DSRO whenever, among other things, the
firm: (1) Fails to maintain compliance with the Commission's capital
requirements; (2) fails to hold sufficient funds in segregated or
secured amount accounts to meet its regulatory requirements; (3) fails
to maintain current books and records; or (4) experiences a significant
reduction in capital from the previous month-end. The purpose of the
regulatory notices is to alert the Commission and the firm's DSRO as
early as possible to potential financial issues at the firm that may
adversely impact the ability of the FCM to comply with its obligations
to safeguard customer funds, or to meet its financial obligations to
other FCMs or DCOs.
---------------------------------------------------------------------------

\9\ The term ``self-regulatory organization'' is defined by
Sec. 1.3 to mean a contract market, a swap execution facility, or a
registered futures association. A DSRO is the SRO that is appointed
to be primarily responsible for conducting ongoing financial
surveillance of an FCM that is a member of two or more SROs under a
joint audit agreement submitted to and approved by the Commission
under Sec. 1.52.
---------------------------------------------------------------------------

The statutory mandate to segregate customer funds--to treat them as
belonging to the customer and not use the funds inappropriately--takes
on greater meaning in light of the devastating events experienced over
the last two years. Those events, which are discussed in greater detail
below, demonstrate that the risks of misfeasance and malfeasance, and
the risks of an FCM failing to maintain sufficient excess funds in
segregation: (i) Put customer funds at risk; and (ii) are exacerbated
by stresses on the business of the FCM. Many of those risks can be
mitigated significantly by better risk management systems and controls,
along with an increase in risk-oriented oversight and examination of
the FCMs.
Determining what is a ``sufficient'' amount of excess funds in
segregation for any particular FCM requires a full understanding of the
business of that FCM, including a proper analysis of the factors that
affect the actual amount of segregated funds held by the FCM relative
to the minimum amount of segregated funds it is required to hold.
Further, appropriate care must be taken to avoid withdrawing such
excess funds at times of great stress to cover needs unrelated to the
purposes for which excess segregated and secured funds are maintained.
In times of stress, excess funds may look like an easy liquidity source
to help cover other risks of the business; yet withdrawing such excess
funds makes the funds unavailable when they may be most needed. The
recent market events illustrate both the need to: (i) Require that care
be taken about monitoring excess segregated and secured funds, and the
conditions under and the extent to which such funds may be withdrawn;
and (ii) place appropriate risk management controls around the other
risks of the business to help relieve (A) the likelihood of an exigent
event or, (B) if such an event occurs, the likelihood of a failure to
prepare for such an event, which in either case could create pressures
that result in an inappropriate withdrawal of customer funds.
Although the Commission's existing regulations provide an essential
foundation to fostering a well-functioning marketplace, wherein
customers are protected and institutional risks are minimized, recent
events have demonstrated that additional measures are necessary to
effectuate the fundamental purposes of the statutory provisions
discussed above. Further, concurrently with the enhanced
responsibilities for FCMs that were proposed by the Commission, the
oversight and examination systems must be enhanced to mitigate risks
and effectuate the statutory purposes.

B. Self-Regulatory Structure

The Commission's oversight structure provides that SROs are the
frontline regulators of FCMs, introducing brokers (``IBs''), commodity
pool operators, and commodity trading advisors. In 2000, Congress
affirmed the Commission's reliance on SROs by amending section 3 of the
Act to state: ``It is the purpose of this Act to serve the public
interests through a system of effective self-regulation of trading
facilities, clearing systems, market participants and market
professionals under the oversight of the Commission.''
As part of its oversight responsibility, an SRO is required to
conduct periodic examinations of member FCMs' compliance with
Commission and SRO financial and related reporting requirements,
including the FCMs' holding of customer funds in segregated and secured
accounts. The Commission oversees the SROs by examining them for the
performance of their duties. The Commission recently has moved to
conducting continuous reviews of the SROs' FCM examination program that
includes a process whereby the Commission selects a small sample of the
SRO's FCM work papers to review. In addition, the Commission also
conducts limited-scope reviews of FCMs in ``for cause'' situations that
are sometimes referred to as ``audits,'' but they are not full-scale
audits as accountants commonly use that term.
In addition, because there are multiple SROs who share the same
member FCMs, to avoid subjecting FCMs to duplicative examinations from
SROs, the Commission has a permissive system that allows the SROs to
agree how to allocate FCMs amongst them. An SRO who is allocated
certain FCMs for such examination is referred to as the DSRO of those
FCMs.
Under Commission regulations, FCMs must have their annual financial
statements audited by an independent certified public accountant
following generally accepted auditing standards as adopted in the U.S.
(``U.S. GAAS''). As part of this certified annual report, the
independent accountant also must conduct appropriate reviews and tests
to identify any material inadequacies in systems and controls that
could violate the Commission's capital, segregation or secured amount
requirements. Any such inadequacies are required to be reported to the
FCM's DSRO and to the Commission.

C. Futures Commission Merchant Insolvencies and Failures of Risk
Management

The recent insolvencies of two FCMs demonstrate the need for
revisions to the Commission's customer protection regime. On October
31, 2011, MF Global, Inc. (``MFGI''), which was dually-registered as an
FCM with the Commission and as a securities broker-dealer (``BD'') with
the U.S. Securities and Exchange Commission (``SEC''), was placed into
a liquidation proceeding under the Securities Investor Protection Act
by the Securities Investor Protection Corporation (``SIPC'').
The trustee appointed to oversee the liquidation of MFGI reported a
potential $900 million shortfall of funds necessary to repay the
account balances due to customers trading futures on designated
contract markets, and an approximately $700 million shortfall in funds
immediately available to repay the account balances of customers
trading on foreign futures markets.\10\ The shortfall in customer
segregated accounts was attributed by the MFGI Trustee to significant
transfers of funds

[[Page 68510]]

out of the customer accounts that were used by MFGI for various
purposes other than to meet obligations to or on behalf of customers.
---------------------------------------------------------------------------

\10\ See Report of the Trustee's Investigation and
Recommendations, In re MF Global Inc., No. 11-2790 (MG) SIPA (Bankr.
S.D.N.Y. June 4, 2012).
---------------------------------------------------------------------------

In addition, the Commission filed a civil injunctive complaint in
federal district court on July 10, 2012, against Peregrine Financial
Group, Inc. (``PFGI''), a registered FCM and its Chief Executive
Officer (``CEO'') and sole owner, Russell R. Wasendorf, Sr., alleging
that PFGI and Wasendorf, Sr. committed fraud by misappropriating
customer funds, violated customer fund segregation laws, and made false
statements regarding the amount of funds in customer segregated
accounts in financial statements filed with the Commission. The
complaint states that in July 2012 during an NFA examination PFGI
falsely represented that it held in excess of $220 million of customer
funds when in fact it held approximately $5.1 million.\11\
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\11\ Complaint, U.S. Commodity Futures Trading Commission v.
Peregrine Financial Group, Inc., and Russell R. Wasendorf, Sr., No.
12-cv-5383 (N.D. Ill. July 10, 2012). A copy of the Commission's
complaint has been posted to the Commission's Web site.
---------------------------------------------------------------------------

Recent incidents also have demonstrated the value of establishing
robust risk management systems within FCMs and enhanced early warning
systems to detect and address financial and regulatory issues. In
particular, problems that arise through an FCM's non-futures-related
business can have a direct and significant impact on the FCM's
financial condition, raising questions as to whether the FCM will be
able to protect customer funds \12\ and maintain the minimum financial
requirements mandated by the Act and Commission regulations.\13\
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\12\ The Commission notes that the definition of ``customer
funds'' in Sec. 1.3(gg) includes funds held for customers trading
on designated contract markets and customers engaging in cleared
swap transactions. However, as used in this notice, unless otherwise
specified, the term ``customer funds'' also includes funds held for
customers trading on foreign markets pursuant to part 30 of the
Commission's regulations.
\13\ See, e.g., Edward Krudy, Jed Horowitz and John McCrank,
``Knight's Future in Balance After Trading Disaster,'' Reuters (Aug.
3, 2012), available at https://in.reuters.com/article/2012/08/03/knightcapital-loss-idINL2E8J27QE20120803 (noting that a software
issue caused the firm to incur a $440 million trading loss, which
represented much of the firm's capital).
---------------------------------------------------------------------------

These recent incidents highlighted weaknesses in the customer
protection regime prescribed in the Commission's regulations and
through the self-regulatory system. In particular, questions have
arisen on the requirements surrounding the holding and investment of
customer funds, including the ability of FCMs to withdraw funds from
futures customer segregated accounts and part 30 secured accounts.
Additionally, the incidents have underscored the need for additional
safeguards--such as robust risk management systems, strengthened early-
warning systems surrounding margin and capital requirements, and
enhanced public disclosures--to promote the protection of customer
funds and to minimize the systemic risk posed by certain actions of
market participants. Further questions have arisen on the system of
audits and examinations of FCMs, and whether the system functions
adequately to monitor FCMs' activities, verify segregated funds and
secured amount balances, and detect fraud.

D. Recent Commission Rulemakings and Other Initiatives Relating to
Customer Protection

Since late 2011, the Commission has promulgated rules directly
impacting the protection of customer funds. The Commission also has
studied the current regulatory framework surrounding customer
protection, particularly in light of the recent incidents outlined
above, in order to identify potential enhancements to the systems and
Commission regulations protecting customer funds. The Commission's
efforts have been informed, in part, by efforts undertaken by industry
participants. The proposed rule amendments were informed by the efforts
detailed below.
In December 2011, the Commission adopted final rule amendments
revising the types of investments that an FCM or DCO can make with
customer funds under Sec. 1.25, for the purpose of affording greater
protection for such funds.\14\ Among other changes to Sec. Sec. 1.25
and 30.7, the final rule amendments removed from the list of permitted
investments: (1) Corporate debt obligations not guaranteed by the U.S.
Government; (2) foreign sovereign debt; and (3) in-house and affiliate
transactions.
---------------------------------------------------------------------------

\14\ See Investment of Customer Funds and Funds Held in an
Account for Foreign Futures and Foreign Options Transactions, 76 FR
78776 (Dec. 19, 2011).
---------------------------------------------------------------------------

In adopting the amendments to Sec. 1.25, the Commission was
mindful that customer segregated funds must be invested by FCMs and
DCOs 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. The amendments are
consistent with the general prudential standard contained in Sec.
1.25, which provides that all permitted investments must be
``consistent with the objectives of preserving principal and
maintaining liquidity.''
The Commission also approved final regulations that require DCOs to
collect initial customer margin from FCMs on a gross basis.\15\ Under
the final regulations, FCMs are no longer permitted to offset one
customer's margin requirement against another customer's margin
requirements and deposit only the net margin collateral with the DCO.
As a result of the rule change, a greater portion of customer initial
margin is posted by FCMs to the DCOs.
---------------------------------------------------------------------------

\15\ See Commission Regulation 39.12(g)(8)(i) and Derivatives
Clearing Organization General Provisions and Core Principles, 76 FR
69334 (Nov. 8, 2011).
---------------------------------------------------------------------------

The Commission also approved regulations that impose requirements
on FCMs and DCOs regarding the treatment of Cleared Swaps and Cleared
Swaps Customer Collateral.\16\ Under the traditional futures model,
DCOs hold an FCM's futures customers' funds on an omnibus basis in a
futures customer account. In the event of a double default, which is a
situation where a futures customer defaults on its obligation to its
clearing FCM and the loss is so great that the clearing FCM defaults on
its obligation to the DCO, the DCO is permitted to use the funds held
in the futures customers' omnibus account to cover the loss of the
defaulting futures customer before applying its own capital or the
guaranty fund contributions of non-defaulting FCM members.
---------------------------------------------------------------------------

\16\ See 77 FR 6336 (Feb. 7, 2012).
---------------------------------------------------------------------------

The Commission approved an alternative model for Cleared Swaps.
Under the ``LSOC'' (legal segregation with operational comingling)
model, DCOs may hold Cleared Swaps Customer Collateral on an omnibus
basis in a Cleared Swaps Customer Account.\17\ However, unlike with the
futures model, following a double default the DCO would only be
permitted to access the collateral of the defaulting Cleared Swaps
Customers; it would not be permitted to use the collateral of non-
defaulting Cleared Swaps Customers to cover a defaulting Cleared Swaps
Customer's losses.
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\17\ The term ``Cleared Swaps Customer Account'' is defined in
Sec. 22.1 and generally refers to an account that an FCM or a DCO
maintains at a permitted depository for the Cleared Swaps (and
related collateral) of Cleared Swaps Customers.
---------------------------------------------------------------------------

Pursuant to section 724(c) of the Dodd-Frank Act, the final rule on
segregation for uncleared swaps, approved by the Commission on October
30, 2013, implements the

[[Page 68511]]

requirements of section 4s(l) of the CEA that Swap Dealers (``SDs'')
and Major Swap Participants (``MSPs'') notify their counterparties that
such counterparties have a right to require that any initial margin
which they post to guarantee uncleared swaps be segregated at an
independent custodian. Where the counterparty elects segregation for
its initial margin, the account must be held at a custodian that is
independent of both the counterparty and the SD or MSP.
The Commission also included customer protection enhancements in a
final rulemaking for designated contract markets issued in June 2012.
These enhancements codify into regulations staff guidance on minimum
requirements for SROs regarding their financial surveillance of
FCMs.\18\ The regulations require a DCM to have arrangements and
resources for effective rule enforcement and trade and financial
surveillance programs, including the authority to collect information
and examine books and records of members and market participants. The
regulations also establish minimum financial standards for both member
FCMs and IBs and non-intermediated market participants. The Commission
expressly noted in the preamble of the Federal Register release that
``a DCM's duty to set financial standards for its FCM members involves
setting capital requirements, conducting surveillance of the potential
future exposure of each FCM as compared to its capital, and taking
appropriate action in light of the results of such surveillance.'' \19\
Further, the rules mandate that DCMs adopt rules for the protection of
customer funds, including the segregation of customer and proprietary
funds, the custody of customer funds, the investment standards for
customer funds, intermediary default procedures and related
recordkeeping.
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\18\ See Core Principles and Other Requirements for Designated
Contract Markets, 77 FR 36612 (June 19, 2012).
\19\ Id. at 36646.
---------------------------------------------------------------------------

In addition to the rulemaking efforts outlined above, the
Commission sought additional information through a series of
roundtables and other meetings. On February 29 and March 1, 2012, the
Commission solicited comments and held public roundtables to solicit
input on customer protection issues from a broad cross-section of the
futures industry, including market participants, FCMs, DCOs, SROs,
securities regulators, foreign clearing organizations, and
academics.\20\ The roundtable focused on issues relating to the
advisability and practicality of modifying the segregation models for
customer funds; alternative models for the custody of customer
collateral; enhancing FCM controls over the disbursement of customer
funds; increasing transparency surrounding an FCM's holding and
investment of customer funds; and lessons learned from recent commodity
brokerage bankruptcy proceedings.
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\20\ Further information on the public roundtable, including
video recordings and transcripts of the discussions, have been
posted to the Commission's Web site. See https://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff022912 (relating to Feb. 29,
2012); https://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff030112 (relating to Mar. 1, 2012).
---------------------------------------------------------------------------

The Commission also hosted a public meeting of the Technology
Advisory Committee (``TAC'') on July 26, 2012.\21\ Panelists and TAC
members discussed potential technological solutions directed at
enhancing the protection of customer funds by identifying and exploring
technological issues and possible solutions relating to the ability of
the Commission, SROs and customers to verify the location and status of
funds held in customer segregated accounts.
---------------------------------------------------------------------------

\21\ Additional information, including documents submitted by
meeting participants, has been posted to the Commission's Web site.
See https://www.cftc.gov/PressRoom/Events/opaevent_tac072612.
---------------------------------------------------------------------------

Commission staff hosted an additional roundtable on August 9, 2012,
to discuss SRO requirements for examinations of FCMs and Commission
oversight of SRO examination programs. The roundtable also focused on
the role of the independent public accountant in the FCM examination
process, and proposals addressing various alternatives to the current
system for segregating customer funds.
The Commission also considered industry initiatives to enhance
customer protections. On February 29, 2012, the Futures Industry
Association (``FIA'') initiated steps to educate customers on the
extent of the protections provided under the current regulatory
structure. FIA issued a list of Frequently Asked Questions (``FAQ'')
prepared by members of the FIA Law and Compliance Division addressing
the basics of segregation, collateral management and investments,
capital requirements and other issues for FCMs and joint FCM/BDs, and
clearinghouse guaranty funds.\22\ The FAQ is intended to provide
existing and potential customers with a better understanding of the
risks of engaging in futures trading and a clear explanation of the
extent of the protections provided to customers and their funds under
the Act and Commission regulations.
---------------------------------------------------------------------------

\22\ The FIA's release addressing FAQs on the protection of
customer funds is accessible on the FIA's Web site at https://www.futuresindustry.org/downloads/PCF-FAQs.PDF.
---------------------------------------------------------------------------

FIA also issued a series of initial recommendations for the
protection of customer funds.\23\ The recommendations were prepared by
the Financial Management Committee, whose members include
representatives of FIA member firms, DCOs and depository institutions.
The initial recommendations address enhanced disclosure on the
protection of customer funds, reporting on segregated funds balances by
FCMs, FCM internal controls surrounding the holding and disbursement of
customer funds, and revisions to part 30 regulations to make the
protections comparable to those provided for customers trading on
designated contract markets.
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\23\ The FIA's initial recommendations are accessible on the
FIA's Web site at https://www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer_Funds_Protection.pdf.
---------------------------------------------------------------------------

On July 13, 2012, the Commission approved new FCM financial
requirements proposed by the National Futures Association
(``NFA'').\24\ The NFA Financial Requirements Section 16 and its
related Interpretive Notice entitled ``NFA Financial Requirements
Section 16: FCM Financial Practices and Excess Segregated Funds/Secured
Amount Disbursements'' (collectively referred to as ``the Segregated
Funds Provisions'') were developed in consultation with Commission
staff.
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\24\ For more information relating to the new FCM financial
requirements, see https://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072.
---------------------------------------------------------------------------

NFA's Segregated Funds Provisions require each FCM to: (1) Maintain
written policies and procedures governing the deposit of the FCM's
proprietary funds (i.e., excess or residual funds) in customer
segregated accounts and part 30 secured accounts; (2) maintain a
targeted amount of excess funds in segregate accounts and part 30
secured accounts; (3) file on a daily basis the FCM's segregation and
part 30 secured amount computations with NFA; (4) obtain the approval
of senior management prior to a withdrawal that is not for the benefit
of customers whenever the withdrawal equals 25 percent or more of the
excess segregated or part 30 secured amount funds; (5) file a notice
with NFA of any withdrawal that is not for the benefit of customers
whenever the withdrawal equals 25 percent or more of the excess
segregated or part 30 secured amount funds; (6) file detailed
information regarding the depositories holding customer funds and the
investments made with customer funds as of the 15th day (or

[[Page 68512]]

the next business day if the 15th is not a business day) and the last
business day of each month; and (7) file additional monthly net capital
and leverage information with NFA.
Significantly, NFA's Segregated Funds Provisions also require FCMs
to compute their part 30 secured amount requirement and compute their
targeted excess part 30 secured funds using the same Net Liquidating
Equity Method that is required by the Act and Commission regulations
for computing the segregation requirements for customers trading on
U.S. contract markets under section 4d of the Act. FCMs are not
permitted under the NFA rules to use the Alternative Method to compute
the part 30 secured amount requirement. The failure of an FCM to
maintain its targeted amount of excess part 30 funds computed using the
Net Liquidating Equity Method may result in NFA initiating a Membership
Responsibility Action against the firm.
In addition, in setting the target amount of excess funds, the
FCM's management must perform a due diligence inquiry and consider
various factors relating, as applicable, to the nature of the FCM's
business, including the type and general creditworthiness of the FCM's
customers, the trading activity of the customers, the types and
volatility of the markets and products traded by the FCM's customers,
and the FCM's own liquidity and capital needs. The FCM's Board of
Directors (or similar governing body), CEO or Chief Financial Officer
(``CFO'') must approve in writing the FCM's targeted residual amount,
any changes thereto, and any material changes in the FCM's written
policies and procedures.
The NFA and CME Group Inc. (``CME'') also adopted rules requiring
FCMs to instruct each depository holding futures customer funds to
report such balances on a daily basis to the NFA or CME,
respectively.\25\ Initially, the NFA and CME retained the services of a
third-party vendor which received account balance information directly
from certain banks, custodians of securities, and money market funds,
and passed such information on to the NFA and CME. The CME, however,
took over the role of the third-party vendor effective October 29, 2013
and receives account information directly from all depositories holding
futures customer funds. The CME also provides NFA with daily account
balance information for the FCMs that NFA is the DSRO. The same process
applies to the FCM's customer secured account(s) held for customers
trading on foreign futures exchanges, and for the FCM's Cleared Swaps
Customers engaging in Cleared Swaps.
---------------------------------------------------------------------------

\25\ See NFA Financial Requirements Rules, Section 4. Financial
Requirements and Treatment of Customer Property, and CME Rule 971,
Segregation, Secured, and Cleared Swaps Customer Account
Requirements.
---------------------------------------------------------------------------

In addition, NFA and CME expanded their oversight of FCMs under the
amended rules, by developing programs that compare the daily balances
reported by the depositories with the balances reported by the FCMs in
their daily segregation reports. An immediate alert is generated for
any material discrepancies.

E. The Proposed Amendments

The incidents outlined above, coupled with the information
generated through the recent efforts undertaken by the Commission and
industry participants, demonstrate the need for new rules and
amendments to existing rules. In particular, an examination of FCM
business operations--including the non-futures business of FCMs--and
the currently regulatory framework, evince a need for enhanced customer
protections, risk management programs, disclosure requirements, and
auditing and examination programs. To address these needs, the
Commission issued a Notice of Proposed Rulemaking (``NPRM'') on
November 14, 2012 (``the Proposal'') containing a series of amendments
to enhance customer protections.\26\
---------------------------------------------------------------------------

\26\ 77 FR 67866 (Nov. 14, 2012).
---------------------------------------------------------------------------

The Proposal addressed six main issues. First, recognizing problems
surrounding the treatment of customer segregated funds and foreign
futures or foreign options secured amounts, the Commission proposed to
amend several components of parts 1, 22, and 30 of the Commission's
regulations to provide greater certainty to market participants that
the customer funds entrusted to FCMs will be protected. Second, to
address shortcomings in the risk management of FCMs, the Commission
proposed a new Sec. 1.11 that establishes robust risk management
programs. Third, the Commission determined that the current regulatory
framework should be re-oriented to implement a more risk-based,
forward-looking perspective, affording the Commission and SROs with
read-only access to accounts holding customer funds and additional
information on depositories and the customer assets held in such
depositories. Fourth, given the difficulties that can arise in an FCM's
business, and the direct and significant impact on the FCM's regulatory
capital that can result from such difficulties, the Commission proposed
to amend Sec. 1.17(a)(4) to ensure that an FCM's capital and liquidity
are sufficient to safeguard the continuation of operations at the FCM.
Fifth, to effect the change in orientation needed in FCM examinations
programs, as well as to assure quality control over program contents,
administration and oversight, the Commission proposed to amend Sec.
1.52, which, among other things, addresses the formation of Joint Audit
Committees and the implementation of Joint Audit Programs. And sixth,
recognizing the need to increase the information provided to customers
concerning the risks of futures trading and the FCMs with which they
may choose to conduct business, the Commission proposed amendments to
Sec. 1.55 that enhance the disclosures provided by FCMs.

II. Comments on the Notice of Proposed Rulemaking

The Proposal, aimed at: (1) Amending and enhancing its current
customer protection regime; (2) imposing risk management requirements
on FCMs; (3) requiring additional ``early warning'' notices from FCMs
regarding material changes in their operations or financial condition;
(4) imposing additional liquidity requirements for FCMs; (5) revising
the examination process of FCMs by both the SROs and public
accountants; and (6) requiring additional disclosures to customers
concerning the risks of futures trading and the FCMs that hold customer
funds. The Commission extended the initial 60-day comment period for
approximately 30 additional days at the request of various commenters
and in order to provide interested parties with an additional
opportunity to comment on the proposal.\27\ The comment period closed
on February 15, 2013.
---------------------------------------------------------------------------

\27\ 78 FR 4093 (Jan. 18, 2013).
---------------------------------------------------------------------------

During the comment period the Commission held two public
roundtables to solicit input on issues related to the proposal from a
cross-section of the futures industry, including market participants,
FCMs, DCOs, SROs, securities regulators, foreign clearing
organizations, and academics. The Commission received more than 120
written submissions on the proposing release from a range of
commenters.\28\ Commission staff also met with representatives from at
least eight of the commenters and other

[[Page 68513]]

members of the public. Commenters represented a broad spectrum of
industry participants, trade organizations, law firms, accounting firms
and self-regulatory organizations. The majority of commenters supported
the overall principles proposed by the Commission although many raised
concerns or offered suggestions regarding certain proposal specifics.
---------------------------------------------------------------------------

\28\ The written submissions from the public are available in
the comment file on www.cftc.gov. They include, but are not limited
to, those listed in the table in Appendix 1 to this release. In
citing to the comments received during the discussion of the
comments in this Section, the Commission used the abbreviations set
forth in the table in Appendix 1.
---------------------------------------------------------------------------

The Commission also held a meeting of the Agricultural Advisory
Committee on July 25, 2013, and included in the agenda a discussion of
the Proposal. The transcript of the Agricultural Advisory Committee
meeting is included in the comment file to the Proposal, and the
Commission has considered those comments in finalizing the regulations.
The Commission has carefully considered the comments received and
is adopting the Proposal herein subject to various amendments that
address certain concerns raised or suggestions made by commenters. Each
section of the final rules, including any relevant revisions to the
corresponding section of the Proposal, is discussed in greater detail
in the following sections.

A. Sec. 1.10: Financial Reports of Futures Commission Merchants and
Introducing Brokers

Regulation 1.10 requires each FCM to file with the Commission and
with the firm's DSRO an unaudited financial report each month. The
financial report must be prepared using Form 1-FR-FCM. An FCM that is
dually-registered as a BD, however, may file a Financial and
Operational Combined Uniform Single Report under the Securities
Exchange Act of 1934 (``FOCUS Report'') in lieu of the Form 1-FR-FCM.
Each FCM also is required to file with the Commission and with its DSRO
an annual financial report certified by an independent public
accountant.
The unaudited monthly and certified annual financial reports are
required to contain basic financial statements, including a statement
of financial condition, a statement of income (loss), and a statement
of changes in ownership equity. The financial reports also are required
to include additional schedules designed to address specific regulatory
objectives to demonstrate that the FCM is in compliance with minimum
capital and customer funds segregation requirements. These additional
schedules include a statement of changes in liabilities subordinated to
claims of general creditors, a statement of the computation of the
minimum capital requirements (``Capital Computation Schedule''), a
statement of segregation requirements and funds in segregation for
customers trading on U.S. commodity exchanges (``Segregation
Schedule''), and a statement of secured amounts and funds held in
separate accounts for foreign futures and foreign options customers
(``Secured Amount Schedule''). In addition, the certified annual report
must contain a reconciliation of material differences between the
Capital Computation Schedule, the Segregation Schedule, and the Secured
Amount Schedule contained in the certified annual report and the
unaudited monthly report for the FCM's year-end month.
1. Amendments to the Segregation and Secured Amount Schedules With
Respect to the Reporting of Residual Interest
The Segregation Schedule and the Secured Amount Schedule generally
indicate, respectively, (1) The total amount of funds held by the FCM
in segregated or secured accounts; (2) the total amount of funds that
the FCM must hold in segregated or secured accounts to meet its
regulatory obligations to futures customers and foreign futures or
foreign options customers; and (3) whether the firm holds excess
segregated or secured funds in the segregated or secured accounts as of
the reporting date. FCMs also deposit proprietary funds into customer
segregated and secured accounts to protect against becoming
undersegregated or undersecured by failing to hold a sufficient amount
of funds in such accounts to meet the regulatory requirements. This
cushion of proprietary funds is referred to as the FCM's ``residual
interest'' in the customer segregated and secured accounts.
The Commission proposed to amend Sec. 1.10 to require each FCM to
also disclose in the Segregation Schedule and in the Secured Amount
Schedule its targeted amount of ``residual interest'' that the FCM
seeks to maintain in customer segregated accounts and secured accounts
as computed under Sec. 1.11.\29\ As more fully discussed in section
II.B. below, new Sec. 1.11(e)(3)(i)(D) requires the senior management
of each FCM that carries customer funds to perform appropriate due
diligence in setting the amount of the residual interest. Such due
diligence must consider the nature of the FCM's business including the
type and general creditworthiness of its customer base, the types of
markets and products traded by the firm's customers, the proprietary
trading activities of the FCM, the volatility and liquidity of the
markets and products traded by the customers and by the FCM, the FCM's
own liquidity and capital needs, historical trends in customer
segregation and secured account funds balances, and historical trends
in customer debits and margin deficits (i.e., undermargined
amounts).\30\ The FCM also is required to maintain policies and
procedures establishing the targeted amount of residual interest that
the FCM seeks to maintain as its residual interest in the segregated
and secured accounts. The FCM's due diligence and policies and
procedures must be designed to reasonably ensure that the FCM maintains
the targeted residual interest amount and remains in compliance with
its segregation requirements at all times.\31\
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\29\ The Commission also proposed to revise the title of the
``Secured Amount Schedule'' by adding the term ``30.7 Customer'' to
specify that the secured amount will include both U.S.-domiciled and
foreign-domiciled customers consistent with the proposed amendments
to part 30 of the Commission Regulations discussed in Section II.R.
below. No comments were received regarding the revisions to the
title of the ``Secured Amount Schedule,'' and the Commission is
adopting the revisions as proposed.
\30\ The NPRM explained that a margin deficit occurs when the
value of the customer funds for a customer's account is less than
the total amount of collateral required by DCOs for that account's
contracts. As explained further in the discussion in sections
II.G.9., II.Q., and II.R., the term ``undermargined amount,'' as
defined in Sec. Sec. 1.22(c)(1), 22.2(f)(6)(i), and
30.7(f)(1)(ii)(A), is used in place of the term ``margin deficit''
in the final rule.
\31\ The NFA adopted a similar amendment to its rules, mandating
that FCMs maintain written policies and procedures identifying a
target amount that the FCM will seek to maintain as its residual
interest in customer segregated and secured accounts. See NFA Notice
I-12-14 (July 18, 2012), available at https://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072.
---------------------------------------------------------------------------

The disclosure of the targeted amount of the FCM's residual
interest in segregated or secured accounts will allow the Commission
and the FCM's DSRO to determine whether the FCM actually maintains
funds in segregated and secured accounts in amounts sufficient to cover
the respective targeted residual interest amounts. If a firm does not
maintain sufficient funds to cover the targeted residual interest
amounts, the Commission and/or DSRO will take appropriate steps to
assess whether the FCM is experiencing financial issues that may
indicate potential threats to the overall safety of customer funds. The
disclosure of the amounts of the FCM's targeted residual interest also
will enhance the Commission's and DSROs' surveillance of FCMs by
providing information that will allow for the assessment of the size of
the targeted residual interest relative to both the total funds held in
segregation or secured accounts and to

[[Page 68514]]

the size of the targeted residual interest maintained by other
comparable FCMs. This information will assist the Commission and DSROs
in the overall risk assessment of the FCMs, including the assessment of
the potential risk that a firm may become undersegregated or
undersecured. This additional information will further enhance the
Commission's and DSROs' overall ability to protect customer funds.
The Commission also proposed to amend the Segregation Schedule and
the Secured Amount Schedule to require each FCM filing such schedules
to disclose the sum of the outstanding margin deficits (i.e.,
undermargined amounts) as of the reporting date. The purpose of this
disclosure was to demonstrate that the FCM's residual interest in the
segregated and secured account exceeded the respective customer margin
deficits (i.e., undermargined amounts) as proposed in Sec. Sec. 1.22
and 1.23.
The Commission has considered the proposal and has determined not
to amend the Segregation Schedule and Secured Amount Schedule to
require the disclosure of the undermargined amounts. As further
discussed in sections II.G.9. and II.R. below, the Commission is
revising the proposed amendments to Sec. 1.22 that would have required
an FCM to maintain at all times a residual interest in segregated or
secured accounts in excess of its undermargined amounts. The final
regulations being adopted in Sec. 1.22, Sec. 22.2, and Sec. 30.7
will require computations as of different points in time than that of
the computations reflected on the Segregation Schedule and the Secured
Amount Schedule, which are prepared as of the close of business each
day. The reporting of the undermargined amount information on the
Segregation and Secured Amount Schedules would not be accurate as the
firm's customers may not be undermargined, or may be less
undermargined, at the time the undermargined amount calculations are
required to be performed due, for example, to customers meeting margin
calls.\32\
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\32\ The Commission notes, however, that it will receive notice
under Sec. 1.12 from an FCM if the firm maintains residual interest
in the segregated or secured amount accounts that is less than the
sum of the firm's undermargined amount at the point in time the FCM
is required to maintain such undermargined amounts under Sec. 1.22,
Sec. 22.2, and Sec. 30.7. The notice provision will alert the
Commission and the FCM's DSRO to the fact that the undermargined
amounts exceed the firm's residual interest in the accounts, and the
Commission and DSRO can monitor the firm's actions to restore its
residual interest to a level that is above the undermargined
amounts, or take other actions as appropriate. See section II.C.
below.
---------------------------------------------------------------------------

The Commission has considered the comments and is adopting the
amendments to Sec. 1.10 as proposed, with the above revisions to the
Segregation Schedule and the Secured Amount Schedule.
2. New Cleared Swaps Segregation Schedules
The Commission proposed to amend Sec. 1.10(d) and to revise the
Form 1-FR-FCM to adopt a new ``Statement of Cleared Swap Customer
Segregation Requirements and Funds in Cleared Swap Customer Accounts
Under Section 4d(f) of the Act'' (``Cleared Swaps Segregation
Schedule'').\33\ The Commission proposed the Cleared Swaps Segregation
Schedule to further implement section 724(a) of the Dodd-Frank Act.
Section 724(a) of the Dodd-Frank Act amended section 4d of the Act by
adding a new paragraph (f) to require an FCM to separately account for
and segregate from its own assets Cleared Swaps Customers Collateral
deposited by Cleared Swaps Customers. Section 4d(f) of the Act also
requires FCMs to treat and deal with all the Cleared Swaps Customer
Collateral deposited by a Cleared Swaps Customer as belonging to such
customer, and prohibits an FCM from, with certain exceptions, using the
Cleared Swaps Customer Collateral to margin, secure or guarantee the
Cleared Swaps of any person other than the Cleared Swaps Customer who
deposited the Cleared Swaps Customer Collateral. FCMs currently prepare
a schedule comparable to the Cleared Swaps Segregation Schedule for
Cleared Swaps under applicable contract market or NFA rules, and the
Commission's proposal would codify existing practices.
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\33\ The Commission previously proposed a Cleared Swaps
Segregation Schedule as part of its proposed regulations to adopt
capital requirements for swap dealers and major swap participants.
See Capital Requirements of Swap Dealers and Major Swap
Participants, 76 FR 27802 (May 12, 2011). The Commission re-proposed
the schedule as part of the Proposal in light of the Commission's
decision to revise the schedule by requiring FCMs to separately
disclose their targeted residual interest in Cleared Swaps Customer
Accounts and the sum of margin deficits (i.e., undermargined
amounts) for such accounts. The Commission also has adopted new
regulations requiring FCMs to hold in segregated accounts funds
received from customers engaging in Cleared Swaps to margin, secure
or guarantee their Cleared Swaps in accordance with section 4d(f) of
the Act. See 77 FR 6336 (Feb. 7, 2012).
---------------------------------------------------------------------------

The Commission received one comment on the proposed Cleared Swaps
Segregation Schedule. The Students at the SUNY Buffalo Law School
supported the development of the Cleared Swaps Segregation
Schedule.\34\ The Commission has considered the comment and has
determined to adopt the Cleared Swaps Segregation Schedule as
proposed.\35\
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\34\ SUNY Buffalo Comment Letter at 7 (Mar. 19, 2013).
\35\ The Commission will revise the Cleared Swaps Segregation
Schedule consistent with the revisions to the Segregation Schedule
and Secured Amount Schedule discussed in section II.A.1. to remove
the requirement for the firm to disclose the amount of the margin
deficits as of the close of business on the previous business day.
In addition, Sec. 1.10(h) provides that a dually-registered FCM/BD
may file a FOCUS Report in lieu of the Form 1-FR-FCM provided that
all information that is required to be included in the Form 1-FR-FCM
is included in the FOCUS Report. Currently, dual-registrant FCM/BDs
include a Segregation Schedule and a Secured Amount Schedule in the
FOCUS Report filings as supplemental schedules. Dual-registrant FCM/
BDs that have Cleared Swaps Customers will also have to include a
Cleared Swaps Segregation Schedule to their Focus Report filings.
---------------------------------------------------------------------------

In addition, Sec. 1.10 currently provides that the Commission will
treat the monthly Form 1-FR-FCM reports, and monthly FOCUS Reports
filed in lieu of the Forms 1-FR-FCM, as exempt from mandatory public
disclosure for purposes of the Freedom of Information Act and the
Government in the Sunshine Act.\36\ Regulation 1.10(g)(2) provides,
however, that the following information in Forms 1-FR-FCM, and the same
or equivalent information in FOCUS Reports filed in lieu of Forms 1-FR-
FCM, are publicly available: The amount of the FCM's adjusted net
capital; the amount of the FCM's minimum net capital requirement under
Sec. 1.17; and the amount of its adjusted net capital in excess of its
minimum net capital requirement. In addition, Sec. 1.10(g)(2) further
provides that the FCM's Statement of Financial Condition in the
certified annual financial report and the Segregation Schedule and
Secured Amount Schedule are public documents.
---------------------------------------------------------------------------

\36\ 5 U.S.C. 552.
---------------------------------------------------------------------------

The Commission proposed to amend Sec. 1.10(g)(2)(ii) to add the
Cleared Swaps Segregation Schedule to the list of documents that are
publicly available. The only comment that the Commission received
regarding making the Cleared Swaps Segregation Schedule public was
received from students at the SUNY Buffalo Law School. The students at
the SUNY Buffalo Law School supported the development and
implementation of the Cleared Swaps Segregation Schedule as a
regulatory tool for the Commission to receive additional information
and to provide greater protection to customer funds.\37\ The students,
however, also stated that the public disclosure of the Cleared Swaps
Segregation Schedule and other financial information could

[[Page 68515]]

cause public panic in certain situations.\38\ They cited MFGI and Bear
Stearns as examples of how public panic can rapidly accelerate a
company's collapse by exacerbating the effects of financial injuries
that might otherwise be manageable.\39\
---------------------------------------------------------------------------

\37\ SUNY Buffalo Comment Letter at 8 (Mar. 19, 2013).
\38\ Id. at 8-9.
\39\ Id.
---------------------------------------------------------------------------

The Commission notes that the monthly Segregation Schedules and
Secured Amount Schedules have been available to the public for many
years and provide important information that allows customers to
monitor the financial condition of FCMs. As noted in the Proposal, the
Commission believes that making the Cleared Swaps Segregation Schedule
publicly available will benefit customers and potential customers by
providing greater transparency on the status of the Cleared Swaps
Customer Collateral held by FCMs. This disclosure allows customers and
other members of the public to review an FCM's compliance with its
regulatory obligations to safeguard customer funds. The disclosure of
the Cleared Swaps Segregation Schedule also will provide a certain
amount of detail as to how the FCM holds Cleared Swaps Customer
Collateral, which customers and potential customers will be able to
assess as part of their risk management process.
The disclosure of the status of an FCM's compliance with its
obligation to segregate customer funds, coupled with the additional
firm risk disclosures that the Commission proposed in Sec. 1.55 (and
is adopting in relevant part herein as discussed in detail in section
II.P. below), will provide customers with greater transparency
regarding the risks of entrusting their funds and engaging in
transactions with particular FCMs. The Commission believes that these
benefits to customers outweigh any potential adverse market impact
which, in any event, has not been shown to be an issue based on the
Commission's experience in making FCMs' Segregation Schedules and
Secured Amount Schedules publicly available. The Commission has,
therefore, determined to adopt the amendments to Sec. 1.10(g)(2) as
proposed.
3. Amendments to Form 1-FR-FCM
The Commission proposed to amend several statements in the Form 1-
FR-FCM. The Commission proposed to amend the Statement of Financial
Condition by adding a new line item 1.D. Line 1 currently separately
details: (1) The amount of funds that the FCM holds in segregated
accounts for customers trading on designated contract markets (Line
1.A.); (2) the amount of funds held in segregation for dealer options
(Line 1.B.); and (3) the amount of funds held in secured accounts for
foreign futures and foreign option customers (Line 1.C.).
Proposed line item 1.D. would set forth the amount of funds held by
the FCM in segregated accounts for Cleared Swaps Customers. This
amendment is necessary due to the adoption of the part 22 regulations,
which requires the segregation of Cleared Swaps Customer Collateral and
the proposed adoption of the Cleared Swaps Segregation Schedule as part
of the Form 1-FR-FCM.\40\
---------------------------------------------------------------------------

\40\ See 77 FR 6336 (Feb. 7, 2012).
---------------------------------------------------------------------------

The Commission also proposed to amend the Statement of Financial
Condition by adding a new line item 22.F., which would require the
separate disclosure of the FCM's liability to Cleared Swaps Customers.
The proposed amendments to disclosure the total amount of funds held by
the FCM for Cleared Swaps Customers, and the FCM's total obligation to
Cleared Swaps Customers, is consistent with the reporting required on
the Form 1-FR-FCM for customers trading on designated contract markets.
The Commission also proposed to revise line item 27.J. of the
Statement of Financial Condition to require an FCM to disclose
separately its obligation to retail forex customers. Currently, an
FCM's obligation to retail forex customers is included with other
miscellaneous liabilities and reported under current line item 27.J.
``Other.'' The separate reporting of an FCM's retail forex obligation
will provide greater transparency on the Statement of Financial
Condition regarding the firm's obligations to its retail counterparties
in off-exchange foreign currency transactions, and is appropriate given
the Commission's direct jurisdiction over such activities when
conducted by an FCM under section 2(c) of the Act.\41\
---------------------------------------------------------------------------

\41\ 7 U.S.C. 2(c).
---------------------------------------------------------------------------

NFA filed the only comment addressing the proposed amendments to
the Statement of Financial Condition. NFA noted its full support of the
proposed amendments to line item 27.J of the Statement of Financial
Condition contained in Form 1-FR-FCM, and further requested that the
Commission consider amending the asset section of the Statement of
Financial Condition of Form 1-FR-FCM to require an FCM or Retail
Foreign Exchange Dealer (``RFED'') to report the total funds on deposit
to cover its obligations to retail forex customers as required by
Commission Regulation 5.8.\42\ NFA stated that this revision would
result in more accurate reporting and is consistent with the reporting
for customer segregated funds.\43\
---------------------------------------------------------------------------

\42\ NFA Comment Letter at 9 (Feb. 15, 2013).
\43\ Id.
---------------------------------------------------------------------------

The Commission has considered the comment and has determined to
adopt the amendments as proposed. The Commission also is revising the
Statement of Financial Condition in the Form 1-FR-FCM in response to
the NFA's comment to include a new line item to require FCMs and RFEDs
to separately disclose the assets held in qualifying accounts in excess
of the firms' obligations to retail forex customers as required by
Commission Regulation 5.8.
Regulation 5.8 requires each FCM and RFED offering or engaging in
retail forex transactions to hold, at all times, assets of the type
permissible in Sec. 1.25 in an amount that exceeds the FCM's or RFED's
total obligation to its retail forex customers at qualifying
institutions set forth in the Regulation. The requirement of Regulation
5.8 is to ensure the RFED or FCM holds liquid assets in relation to the
amount of liability to retail forex customers.\44\ However, such retail
forex customer funds are not held in ``segregated accounts'' in manner
comparable to section 4d of the Act, which are provided with explicit
protections in the event of the bankruptcy of the FCM. The Commission
is revising the Statement of Financial Condition of the Form 1-FR-FCM
to require each FCM or RFED to report on line 19.B. the aggregate
amount of funds held in qualifying accounts to meet its total
obligation to retail forex customers as required by Sec. 5.8. Such
disclosure will provide greater transparency as to the firm's
compliance with Commission regulations.
---------------------------------------------------------------------------

\44\ See 75 FR 3282, 3290 (Jan. 20, 2010).
---------------------------------------------------------------------------

4. FCM Certified Annual Report Deadline
The Commission proposed to amend Sec. 1.10(b)(1)(ii) to require an
FCM to submit its certified annual report to the Commission and to the
firm's DSRO within 60 days of its year-end date. Currently, an FCM is
required to submit the annual certified financial statements within 90
days of its year-end date, except for FCMs that also are registered
with the SEC as BDs, which are require to submit the certified annual
report within 60 days of the year-end date under both Commission and
SEC regulations. Therefore, the proposal would impact only FCMs that
are not

[[Page 68516]]

dually-registered as BDs and would align the filing deadlines for both
FCMs and dual registrant FCMs/BDs.
The Commission received one comment on the proposal. NFA supported
the proposal noting that the amendment will provide both the Commission
and DSROs with more timely information for monitoring the financial
condition of an FCM.\45\ The Commission considered the comment received
and is adopting the amendments to Sec. 1.10(b)(1)(ii) as proposed. The
Commission also is cognizant of the fact that public accountants are
currently engaged in the audit of FCMs for the year ending December 31,
2013 and possible for other year-end dates in 2014. Accordingly, in
order to ensure that the amendments do not impede examinations that are
currently in process, the Commission is establishing a compliance date
for FCM annual audits for years ending June 1, 2014 or later. This
compliance date also will align the revised reporting deadline with the
auditing amendments to the auditing standards that public accountants
use in the audit of FCMs and discussed in section II.E. below.
Compliance dates are discussed further in section III below.

---------------------------------------------------------------------------

\45\ NFA Comment Letter at 9 (Feb. 15, 2013).
---------------------------------------------------------------------------

5. Leverage Ratio Calculation
The Commission proposed to add a new requirement in Sec.
1.10(b)(5) to require each FCM to file with the Commission on a monthly
basis its balance sheet leverage ratio. Proposed Sec. 1.10(b)(5)
defined the term ``leverage'' as an FCM's total balance sheet assets,
less any instruments guaranteed by the U.S. Government and held as an
asset or to collateralize an asset (e.g., a reverse repurchase
agreement) divided by the FCM's total capital (i.e., the sum of the
FCM's stockholders' equity and subordinated debt). FCMs currently file
the same leverage information with NFA on a monthly basis using the
same definition of the term ``leverage.'' The leverage ratio would
provide information regarding the amount of assets supported by the
FCM's capital base, and would allow the Commission to enhance its
oversight of FCMs that are highly leveraged relative to their peers or
based upon the Commission's understanding of the firm's business model.
The Commission received three comments with respect to this
proposal. Commenters were concerned that the leverage metrics proposed
might not provide meaningful information and/or that the Commission's
leverage definition was not consistent with those of other regulatory
authorities. NFA noted that while the leverage definition proposed by
the Commission is the same definition as that set forth in NFA
Financial Requirement Section 16, it may not be the most appropriate
measure.\46\ NFA noted that it has been studying an alternative
calculation method and encouraged the Commission to defer codifying a
single definition until it has the opportunity to examine NFA's
calculation results.\47\ NFA also suggested the Commission consider
adopting a requirement that FCMs report a leverage ratio as defined by
a registered futures association rather than including a specific
definition in the Commission's regulations.\48\
---------------------------------------------------------------------------

\46\ NFA Comment Letter at 7-8 (Feb. 15, 2013).
\47\ Id. at 7.
\48\ Id. at 8.
---------------------------------------------------------------------------

FIA indicated that it supported the proposed amendment, but stated
that it is essential that the definition of the term ``leverage'' be
consistent among regulatory authorities with supervision over FCMs and
encouraged the Commission to coordinate with the SEC and the relevant
SROs to ensure consistent treatment across the industry.\49\
---------------------------------------------------------------------------

\49\ FIA Comment Letter at 12 (Feb. 15, 2013).
---------------------------------------------------------------------------

RJ O'Brien objected to the proposal on the grounds that the
definition of ``leverage'' in the proposal ``penalizes'' FCMs that are
not dually-registered as BDs.\50\ RJ O'Brien stated that an FCM-only
entity's balance sheet is primarily composed of funds deposited by
customers for trading commodity interests, and that the leverage ratio
computed under the proposed regulation does not properly reflect the
risk of the firm's business.\51\ RJ O'Brien recommended that the
Commission work with NFA to develop a more meaningful metric and
further recommended that the Commission not permit or require public
disclosure of FCM leverage ratios under the current methodology because
RJ O'Brien believes it could provide the public with misleading
information.\52\
---------------------------------------------------------------------------

\50\ RJ O'Brien Comment Letter at 8-9 (Feb. 15, 2013)
\51\ Id.
\52\ Id.
---------------------------------------------------------------------------

The Commission has considered the comments and has determined to
adopt a final regulation requiring FCMs to submit to the Commission
monthly balance sheet leverage information. As noted above, such
information will enhance the Commission's ability to conduct financial
surveillance of FCMs. The final regulation, however, will define the
term ``leverage'' by referencing to the rules of a registered futures
association as suggested by NFA. This revision to the final regulation
will align the Commission's definition of leverage with the current NFA
definition of leverage.\53\
---------------------------------------------------------------------------

\53\ NFA is currently the only registered futures association.
---------------------------------------------------------------------------

As stated above, in proposing the requirement for FCMs to report
their monthly leverage ratios, the Commission intended for FCMs to file
the same leverage information that they currently file with the NFA. In
this regard, the Commission proposed a definition of leverage that is
identical to the current NFA definition contained in its Financial
Requirement Section 16. Such an approach will enhance the consistency
in how the Commission and the SROs impose leverage reporting
requirements on FCMs and in how leverage is monitored by the
regulators. Furthermore, in response to RJ O'Brien's comment, the
Commission intends to work with NFA and other regulators going forward
on any revisions to the definition of ``leverage'' to maintain as
consistent a definition as practicable.
6. Procedural Filing Requirements
The Commission proposed to amend Sec. 1.10(c)(2)(i) to require
FCMs to electronically file with the Commission their monthly unaudited
Forms 1-FR-FCM or FOCUS Reports and their certified annual financial
reports. FCMs currently file their monthly unaudited financial
statements with the Commission electronically using the WinJammer
Online Filing System (``WinJammer'') and the proposed amendments merely
codify current practices.\54\
---------------------------------------------------------------------------

\54\ WinJammer is a web-based application developed and
maintained jointly by the Chicago Mercantile Exchange and the NFA.
The WinJammer system is provided at no cost to FCMs. FCMs currently
use WinJammer to transmit Forms 1-FR-FCM, FOCUS Reports, and other
financial information and regulatory notices to the Commission and
to the SROs.
---------------------------------------------------------------------------

FCM annual financial reports are filed in paper form with the
Commission. Under the Commission's proposal, an FCM would use the
WinJammer system to electronically file its certified financial report
as a ``PDF'' document.
No comments were received on the proposed amendments to Sec.
1.10(c)(2)(i). The Commission is adopting the amendments as proposed.
The Commission also is adopting a proposed technical amendment to
Sec. 1.10(c)(1) on which no comments were received. Regulation
1.10(c)(1) provides that any report or information required to be
provided to the Commission by an IB or FCM will be considered filed

[[Page 68517]]

when received by the Commission Regional office with jurisdiction over
the state in which the FCM has its principal place of business. The
amendments to Sec. 1.10(c)(1) sets forth the jurisdiction of each of
the Commission's three Regional offices under Sec. 140.02, and is
intended to ensure that FCM's financial reports are filed expeditiously
with the correct Commission Regional office.

B. Sec. 1.11: Risk Management Program for Futures Commission Merchants

The Commission proposed new Sec. 1.11 to require each FCM that
carries customer accounts to establish a ``Risk Management Program,''
as defined in Sec. 1.11(c), designed to monitor and manage the risks
associated with the FCM's activities as an FCM. Under the Commission's
proposal, the Risk Management Program must: (1) consist of written
policies and procedures that have been approved by the ``governing
body'' (defined below) of the FCM and furnished to the Commission; and
(2) establish a risk management unit that is independent from an FCM's
``business unit'' (defined below) to administer the Risk Management
Program.
NFA, FIA, ICI, CFA, Chris Barnard, and Paul/Weiss generally
supported proposed Sec. 1.11.\55\ Advantage stated ``that most aspects
of proposed Sec. 1.11 are appropriate and unlikely to be burdensome as
FCMs typically have most (if not all) of these requirements in place.''
\56\ Several other commenters raised issues with specific components of
the proposed regulation, which are discussed in the sections below. The
Commission has considered the comments received and is adopting Sec.
1.11 as proposed, with the following observations and clarifications.
---------------------------------------------------------------------------

\55\ NFA Comment Letter at 10 (Feb. 15, 2013); FIA Comment
Letter at 52 (Feb. 15, 2013); ICI Comment Letter at 7 (Jan. 14,
2013); CFA Comment Letter at 4 (Feb. 13, 2013); Chris Barnard
Comment Letter at 2 (Dec. 18, 2012); Paul/Weiss Comment Letter at 2
(Feb. 15, 2013).
\56\ Advantage Comment Letter at 2 (Feb. 15, 2013).
---------------------------------------------------------------------------

1. Applicability
Proposed paragraph (a) of Sec. 1.11 provides that the regulation
would only apply to FCMs that accept money, securities, or property (or
extend credit in lieu thereof) to margin, guarantee, or secure any
trades or contracts that result from soliciting or accepting orders for
the purchase or sale of any commodity interest. FCMs that do not accept
or hold customer funds to margin, guarantee or secure commodity
interests are generally not operating as FCMs, and are not subject to
Sec. 1.11. To clarify, the Commission notes that it would expect
registered FCMs that do not accept customer funds to establish a Risk
Management Program that complies with Sec. 1.11 and file such program
with the Commission and with the FCMs' DSROs prior to changing their
business model to begin accepting customer funds.
The Commission also requested comment on whether different risk
management requirements for FCMs should be based upon some measurable
criteria, such as size of the firm, and whether different elements of
Sec. 1.11 should apply to smaller FCMs versus larger FCMs. Advantage
stated that a one-size fits all approach is less than optimal, and that
the Commission could establish minimum risk management standards for
specific business lines/customer type, and then require that FCMs
engaging in those lines of business/clearing that type of customer have
those programs in place.\57\
---------------------------------------------------------------------------

\57\ Advantage Comment Letter at 2 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission has considered the comment and has determined that
Sec. 1.11 provides sufficient flexibility for FCMs to establish a risk
management program that is appropriate to its business operations. To
develop specific requirements for different business activities would
not be appropriate in that each FCM may operate in a different manner.
The Commission believes that each FCM can develop its own program to
meet its business activities using the general framework established by
Sec. 1.11.
The Commission received no additional comments on proposed Sec.
1.11(a) and is adopting the provision as proposed.
2. Definitions
The Commission proposed definitions of the terms ``customer,''
``business unit,'' ``governing body,'' ``segregated funds,'' and
``senior management'' in paragraph (b) of Sec. 1.11. These definitions
are designed to ensure that there is accountability at the highest
levels for the FCM's key internal controls and processes regarding the
FCM's responsibility to meet its obligations as a futures market
participant, including acting as an intermediary for customer
transactions, and its obligation to safeguard customer funds.
The term ``business unit'' was proposed to include generally any
department, division, group or personnel of an FCM or any affiliate
involved in soliciting orders and handling customer money, including
segregation functions, and personnel exercising direct supervisory
authority over the performance of such activities. The definition was
intended to delineate clearly the separation of the risk management
unit required by the regulation from the other personnel of an FCM from
whom the risk management must be independent.
The term ``customer'' was proposed broadly to include futures
customers (as defined in Sec. 1.3) trading futures contracts, or
options on futures contracts listed on designated contract markets,
30.7 customers (as proposed to be defined in Sec. 30.1) trading
futures contracts or options on futures contracts listed on foreign
contract markets, and Cleared Swaps Customers (as defined in Sec.
22.1) engaging in Cleared Swaps.
The term ``governing body'' was proposed to be defined as the sole
proprietor, if the FCM is a sole proprietorship; a general partner, if
the FCM is a partnership; the board of directors, if the FCM is a
corporation; and the chief executive officer, chief financial officer,
the manager, the managing member, or those members vested with the
management authority if the FCM is a limited liability company or
limited liability partnership. The term ``senior management'' was
proposed to mean any officer or officers specifically granted the
authority and responsibility to fulfill the requirements of senior
management under proposed Sec. 1.11 by the governing body.
The term ``segregated funds'' was proposed to mean money,
securities, or other property held by an FCM in separate accounts
pursuant to Sec. 1.20 for futures customers, pursuant to Sec. 22.2
for Cleared Swaps Customers, and pursuant to Sec. 30.7 for 30.7
customers. The proposed definition of ``segregated funds'' makes clear
that the requirements of Sec. 1.11 apply to all customer funds that
may be held by an FCM. The Act and Commission regulations currently
require FCMs to hold each type of segregated funds in separate accounts
and to segregate such segregated funds from the FCM's own funds and to
segregate each class of segregated funds from each other type, except
if otherwise permitted by Commission rule, regulation or order.\58\
---------------------------------------------------------------------------

\58\ See 7 U.S.C. 6d(a)(2) and 7 U.S.C. 6d(f).
---------------------------------------------------------------------------

The Commission did not receive any comments regarding the proposed
definitions in Sec. 1.11(b) and is adopting the amendments as
proposed.
3. Approval of Policies and Procedures and Submission to the Commission
The Commission proposed Sec. 1.11(c) to require each FCM to
establish, maintain, and enforce a system of risk management policies
and procedures

[[Page 68518]]

designed to monitor and manage the risks associated with the activities
of the FCM as an FCM.\59\ The policies and procedures are collectively
referred to as the FCM's Risk Management Program.
---------------------------------------------------------------------------

\59\ Because Sec. 1.11 applies to all FCMs that accept money,
securities, or property (or extend credit in lieu thereof) from
customers, it necessarily applies to any risks generated by the FCMs
customers' trading activities. See, e.g., In re FCStone LLC, CFTC
Docket 13-24, (May 29, 2013), where a customer's trading activities
and the FCM's inadequate risk management practices caused the firm
to lose over $127,000,000.
---------------------------------------------------------------------------

Under proposed Sec. 1.11, the FCM's governing body is required to
approve in writing the FCM's Risk Management Program and any material
changes to the Risk Management Program. The FCM also is required to
provide a copy of the Risk Management Program to the Commission and to
the FCM's DSRO upon application for registration or upon request by the
Commission or by the FCM's DSRO. The filing of the Risk Management
Program is intended to allow the Commission and the FCM's DSRO to
monitor the status of risk management practices among FCMs.
Several commenters expressed general support for the requirement
that an FCM implement a risk management program.\60\ The Commission
received no other comments on proposed Sec. 1.11(c) and is adopting
the amendments as proposed.
---------------------------------------------------------------------------

\60\ See Franklin Comment Letter at 2 (Feb. 15, 2013); AIMA
Comment Letter at 1 and 4 (Feb. 15, 2013); TIAA-CREF Comment Letter
at 3 (Feb. 15, 2013).
---------------------------------------------------------------------------

4. Organizational Requirements of the Risk Management Program
a. Separation of Risk Management Unit from Business Unit
The Commission proposed Sec. 1.11(d), requiring an FCM to
establish a risk management unit that is independent from the FCM's
business unit to administer the Risk Management Program. As part of the
Risk Management Program, each FCM must establish and maintain a risk
management unit with sufficient authority, qualified personnel, and
financial, operational, and other resources to carry out the Risk
Management Program. The risk management unit is required to report
directly to senior management.
Several commenters opposed the separation of the risk management
unit from the business unit. RCG stated that requiring FCMs to separate
the risk management function from the ``business unit'' is unnecessary,
counterproductive, and will likely result in increased risk to the FCM
and its customers.\61\ RCG argued that the proposed requirement removes
a valuable, mature talent pool from participating in risk management,
and the proposal is counterproductive in that it has the potential of
blocking the flow of historical and financial information about a
customer from the business side of the FCM to the risk management side
of the FCM, information that is crucial to evaluating risk.\62\
---------------------------------------------------------------------------

\61\ RCG Comment Letter at 5 (Feb. 12, 2013). See also Phillip
Futures Inc. Comment Letter at 2 (Feb. 14, 2013).
\62\ RCG Comment Letter at 5 (Feb. 12, 2013). See also Phillip
Futures Inc. Comment Letter at 2 (Feb. 14, 2013).
---------------------------------------------------------------------------

Phillip Futures Inc. stated that the proposed separation of the
business unit from the risk management unit will lead to a decrease in
the timeliness of decision making as decisions will have to be filtered
through new supervisory employees that the proposal will ultimately
create, which will hinder each FCM's ability to assess risk.\63\
Phillip Futures Inc. stated that so long as internal controls, senior
leadership, and training programs of a firm are created with the proper
checks and balances which ensure proper supervision of activities
conducted by the business unit and the risk management unit, the
respective units need not be independent from each other.\64\ Phillip
Futures Inc. also asserted that the separation of duties required by
the regulation would require it to hire multiple employees who would
have limited job responsibilities.\65\
---------------------------------------------------------------------------

\63\ Phillip Futures Inc. Comment Letter at 2 (Feb. 14, 2013).
\64\ Id.
\65\ Id.
---------------------------------------------------------------------------

CHS Hedging stated that it would not be realistic or cost effective
for smaller FCMs to establish an entirely separate risk management
unit, and argued that if supervisory risk management personnel report
to senior management separately from the business side to avoid a
conflict of interest, a standalone unit should not be required.\66\
---------------------------------------------------------------------------

\66\ CHS Hedging Comment Letter at 3 (Feb. 15, 2013).
---------------------------------------------------------------------------

RJ O'Brien also argued that requiring FCMs to create a separate
risk management unit is not operationally or financially practical for
all FCMs, particularly small to midsized FCMs, and needlessly increases
the costs of compliance for most firms without producing significant
benefits.\67\ RJ O'Brien stated that supervisors at many small to mid-
sized FCMs have the knowledge and expertise that can be essential to
maintaining a strong risk management program at their firm, however,
such supervisors also may have a role in the business unit
activities.\68\ They proposed that the Commission revise the proposed
regulation such that supervisors of business unit personnel are
permitted to be part of the risk management unit provided that such
supervisors are not compensated in connection with soliciting or
accepting orders for the purchase or sale of any commodity
interest.\69\
---------------------------------------------------------------------------

\67\ RJ O'Brien Comment Letter at 9 (Feb. 15, 2013).
\68\ Id.
\69\ Id.
---------------------------------------------------------------------------

The Commission notes that, as stated above, only employees involved
in soliciting orders and handling customer money (including the
segregation functions), and employees directly supervising such
activities would fall within the definition of ``business unit'' under
Sec. 1.11(b)(1). Therefore, the Commission does not agree with the
assertion that a large pool of employees will be barred from
participating in the risk management unit. Further, the Commission
observes that the independence of the risk management unit required by
proposed Sec. 1.11 does not require FCMs to establish information
partitions between the risk management unit and members of the business
unit, and disagrees with commenters that such independence requirement
would block the flow of historical and financial information about a
customer from the business side of the FCM to the risk management side
of the FCM. In any event, the Commission believes that the freedom from
conflicts of interests that the independence of the risk management
unit provides is critically important to the protection of customer
funds in the custody of the FCM.
The FIA commented that in adopting the rules governing risk
management programs for SDs and MSPs, the Commission clarified the
interpretation of certain provisions, and asked that the Commission
confirm that such clarifications apply equally to the provisions of
Sec. 1.11.\70\ In general, the FIA requested the Commission to
confirm, subject to certain exceptions or requirements, that the
requirements of Sec. 1.11:
---------------------------------------------------------------------------

\70\ See 77 FR 20128 (April 3, 2012).
---------------------------------------------------------------------------

(1) Do not prescribe rigid organization structures;
(2) do not require an FCM's risk management unit to be a formal
division in the FCM's organizational structure, provided that the FCM
will be able to identify all personnel responsible for required risk
management activities

[[Page 68519]]

even if such personnel fulfill other functions; and
(3) Allow FCMs to establish dual reporting lines for risk
management personnel performing functions in addition to their risk
management duties, provided that Sec. 1.11 would not permit a member
of the risk management unit to report to any officer in the business
unit for any non-risk management activity.\71\
---------------------------------------------------------------------------

\71\ FIA Comment Letter at 54-55 (Feb. 15, 2013).
---------------------------------------------------------------------------

The FIA further commented that the ``policies and procedures''
approach provides an adequate amount of flexibility that will allow the
FCMs to rely upon any existing compliance or risk management
capabilities to meet the requirements of the rule.\72\
---------------------------------------------------------------------------

\72\ Id. at 52.
---------------------------------------------------------------------------

The Commission generally agrees with the FIA in that, while the
requirements of Sec. 1.11 represent prudent risk management practices,
they do not prescribe rigid organizational structures. The Commission
also believes that the ``policies and procedures'' approach provides an
adequate amount of flexibility that will allow FCMs to rely upon any
existing compliance or risk management capabilities to meet the
requirements of the final rule. The Commission further believes that
nothing in Sec. 1.11 would prevent FCMs from relying upon existing
compliance and risk management programs to a significant degree.
As the Commission confirmed in its final rulemaking discussing
Sec. 23.600(b) regarding the risk management program for SDs and MSPs,
the Commission also confirms that Sec. 1.11(d) does not require a
registrant's risk management unit to be a formal division in the
registrant's organizational structure, provided that the FCM will be
able to identify all personnel responsible for required risk management
activities as its ``risk management unit'' even if such personnel
fulfill other functions in addition to their risk management
activities; and permits FCMs to establish dual reporting lines for risk
management personnel performing functions in addition to their risk
management duties, but this rule would not permit a member of the risk
management unit to report to any officer in the business unit for any
non-risk management activity.\73\ Such dual reporting invites conflicts
of interest and would violate Sec. 1.11's risk management unit
independence requirement.
---------------------------------------------------------------------------

\73\ 77 FR 20128 (April 3, 2012).
---------------------------------------------------------------------------

The Commission notes that the formal independence of the risk
management unit from the business unit does not relieve an FCM from the
duty to resolve other conflicts of interest that may have an adverse
effect on the effectiveness of the FCM's risk management program. An
FCM's CCO is required under Sec. 3.3(d)(2) to resolve any conflicts of
interest that may arise, in consultation with the FCM's board of
directors or its senior officer. Thus, the Commission would expect an
FCM to recognize and eliminate or appropriately mitigate any conflict
of interest between the FCM's business interests and its duty to
establish and maintain an effective risk management program.
Having considered the comments regarding Sec. 1.11(d), the
Commission is adopting the provision as proposed.
5. Components of the Risk Management Program
The Commission's proposed Sec. 1.11(e) provides for a non-
exclusive list of the elements that must be a part of the Risk
Management Program of an FCM. Those elements include: (1) Identifying
risks (including risks posed by affiliates, all lines of business of
the FCM, and all other trading activity of the FCM) and setting of risk
tolerance limits; (2) providing periodic risk exposure reports to
senior management and the governing body; (3) operational risk
controls; (4) capital controls; and (5) establishing a risk management
program that takes into account risks associated with the safekeeping
and segregation of customer funds.
Proposed Sec. 1.11(e)(1)(ii) requires the Risk Management Program
to take into account risks posed by affiliates, all lines of business
of the FCM, and all other trading activity engaged in by the FCM. The
FIA asked the Commission to confirm its position that, to the extent
that many FCMs are part of a larger holding company structure that may
include affiliates that are engaged in a wide array of business
activities, the Commission understands that, in some instances, the top
level company in the holding company structure, which has the benefit
of an organization-wide view, is in the best position to evaluate the
risks that an affiliate of an FCM may pose to the FCM.\74\ Therefore,
to the extent an FCM is part of a holding company within an integrated
risk management program, the FCM may address affiliate risks and comply
with Sec. 1.11 through its participation in a consolidated entity risk
management program provided that such program does in fact assess the
risks posed to the FCM by its affiliated entities.\75\
---------------------------------------------------------------------------

\74\ FIA Comment Letter at 55 (Feb. 15, 2013).
\75\ Id.
---------------------------------------------------------------------------

The Commission recognizes that some FCMs will be part of a larger
holding company structure that may include affiliates that are engaged
in a wide array of business activities. The Commission understands with
respect to these entities, that in some instances, the top level
company in the holding company structure is in the best position to
evaluate the risks that an affiliate of an FCM may pose to the
enterprise, as it has the benefit of an organization-wide view and
because an affiliate's business may be wholly unrelated to an FCM's
activities. Therefore, to the extent an FCM is part of a holding
company with an integrated risk management program, the Commission
would allow an FCM to address affiliate risks and comply with Sec.
1.11(e)(1)(ii) through its participation in a consolidated entity risk
management program.
In regard to customer funds, the Commission notes that FCMs are
required by the Act and Commission regulations to segregate and
safeguard funds deposited by customers for trading commodity interests.
Recent events have emphasized that it is essential that FCMs maintain
adequate systems of internal controls, involving the participation and
review of the firm's senior management, in order to properly safeguard
customer funds. Accordingly, Sec. 1.11(e)(3)(i) requires that the risk
management policies and procedures of an FCM related to the risks
associated with safekeeping and segregation of customer funds must
include: (1) The evaluation and monitoring of depositories; \76\ (2)
account opening procedures that ensure the FCM obtains the
acknowledgment required under Sec. 1.20 from the depository and that
the account is properly titled as belonging to the customers of the
FCM; \77\ (3) establishing

[[Page 68520]]

and maintaining an adequate targeted amount of excess funds in customer
accounts reasonably designed to ensure the FCM is at all times in
compliance with the segregation requirements for customer funds under
the Act and Commission regulations, as discussed further below; (4)
controls ensuring that the withdrawal of cash, securities, or other
property from accounts holding customer funds not for the benefit of
customers are in compliance with the Act and Commission regulations;
\78\ (5) procedures for assessing the appropriateness of investing
customer funds in accordance with Sec. 1.25; \79\ (6) the valuation,
marketability, and liquidity of customer funds and permitted
investments made with customer funds; (7) the appropriate separation of
duties of personnel responsible for compliance with the Act and
Commission regulations relating to the protection and financial
reporting of customer funds; \80\ (8) procedures for the timely
recording of transactions in the firm's books and records; and (9)
annual training of personnel responsible for compliance with the Act
and Commission regulations relating to the protection and financial
reporting of customer funds.
---------------------------------------------------------------------------

\76\ The evaluation process must include documented criteria
that any depository will be assessed against in order to qualify to
hold funds belonging to customers. The criteria must address a
depository's capitalization, creditworthiness, operational
reliability, and access to liquidity. The criteria must also address
risks associated with concentration of customer funds in any
depository or group of depositories, the availability of deposit
insurance, and the regulation and supervision of depositories. The
evaluation criteria is intended to ensure that the FCM adopts an
evaluation process which reviews potential depositories against
substantive criteria relevant to the safe custody of customer funds
and that the FCM's process for evaluating and selecting depositories
can be reviewed by regulators and auditors. The FCM also must
maintain a documented process addressing the ongoing monitoring of
selected depositories, including a thorough due diligence review of
each depository at least annually.
\77\ As required by Sec. 1.20, such account opening
documentation is necessary to ensure that the depositories are aware
of their obligations regarding the accounts and the statutory and
regulatory protections afforded the funds held in the accounts due
to their status as segregated funds.
\78\ The controls must include the conditions for pre-approval
and the notice to the Commission for such withdrawals required by
Sec. 1.23, Sec. 22.17, or Sec. 30.7, discussed below.
\79\ The FCM's assessment must take into consideration the
market, credit, counterparty, operational, and liquidity risks
associated with the investments.
\80\ The policies and procedures must provide for the separation
of duties among personnel that are responsible for customer trading
activities, and approving and overseeing cash receipts and
disbursements (including investment and treasury operations). The
policies and procedures must further require that any movement of
funds to affiliated companies or parties be approved and documented.
---------------------------------------------------------------------------

Regarding the requirement that FCMs establish and maintain an
adequate targeted amount of excess funds in customer accounts, the
Commission notes that FCMs currently deposit proprietary funds into
both customer segregated accounts and part 30 secured accounts as a
buffer to minimize the possibility of the firm being in violation of
its segregated and secured fund obligations at any time. Under the
final rule, the senior management of the FCM must perform appropriate
due diligence in setting the amount of this buffer and must consider
the nature of the FCM's business including the type and general
creditworthiness of its customer base, the types of markets and
products traded by the firm's customers, the proprietary trading
activities of the FCM, the volatility and liquidity of the markets and
products traded by the customers and the FCM, the FCM's own liquidity
and capital needs, and historical trends in customer segregation and
secured account funds balances, customer debits, and margin deficits
(i.e., undermargined amounts). The FCM also must reassess the adequacy
of the targeted residual interest quarterly.
The Commission believes that each FCM must set the amount of excess
segregated and secured funds required utilizing a quantitative and
qualitative analysis that reasonably ensures compliance at all times
with segregated and secured fund obligations. Such analysis must take
into account the various factors that could affect segregated and
secured balances, and must be sufficiently described in writing to
allow the DSRO of the FCM and the Commission to duplicate the
calculations and test the assumptions. The analysis must provide a
reasonable level of assurance that the excess is at an appropriate
level for the FCM.\81\ A failure to adopt or maintain appropriate risk
management policies and procedures or to implement, monitor and enforce
controls required by Sec. 1.11 may result in a referral to the
Commission's Division of Enforcement for appropriate action.
---------------------------------------------------------------------------

\81\ Separate from requiring the establishment of a target for
residual interest, the Commission is further requiring, as discussed
in more detail under sections II.G.9., II.H., and II.I. for
Sec. Sec. 1.20, 1.22, and 1.23, respectively, that residual
interest exceed the sum of outstanding undermargined amounts to
provide a mechanism for ensuring compliance with the prohibition of
the funds of one customer being used to margin or guarantee the
positions of another customer under the Act and existing
regulations.
---------------------------------------------------------------------------

Proposed Sec. 1.11(e)(3)(i)(G) requires the appropriate separation
of duties among individuals responsible for compliance with the Act and
Commission regulations relating to the protection and financial
reporting of segregated funds, including the separation of duties among
personnel that are responsible for advising customers on trading
activities, approving or overseeing cash receipts and disbursements
(including investment operations), and recording and reporting
financial transactions. Phillip Futures Inc. stated that such a
separation of duties would require it to hire multiple employees that
would have limited job responsibilities, and suggested that as long as
internal controls are adequate and supervisory personnel are properly
registered with the Commission and NFA, the separation of duties is not
necessary.\82\
---------------------------------------------------------------------------

\82\ Phillip Futures Inc. Comment Letter at 2 (Feb. 14, 2013).
---------------------------------------------------------------------------

Regulation 1.11(e)(3)(i)(I) requires that the written policies and
procedures include procedures for the reporting of suspected breaches
of the policies and procedures to the CCO, without fear of retaliation,
and the consequences of failing to comply with the segregation
requirements of the Act and regulations. Chris Barnard recommended that
the procedures for reporting breaches should allow and stress the
complete anonymity of the reporting party (whistleblower).\83\ The
Commission takes note of Mr. Barnard's comments related to
whistleblowers as sound practices. The Commission notes, however, that
such additional requirements were not proposed and, in any event, are
outside the scope of this rulemaking.\84\
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\83\ Chris Barnard Comment Letter at 2 (Dec. 18, 2012).
\84\ The Commission further notes that it maintains a
whistleblower program that provides for the anonymous reporting of
violations of the Act and Commission regulations. See part 165 of
the Commission's regulations.
---------------------------------------------------------------------------

Also, to ensure the effectiveness of a Risk Management Program,
Sec. 1.11(e)(4) requires that the Risk Management Program include a
supervisory system that is reasonably designed to ensure that the risk
management policies and procedures are diligently followed.
The Commission has considered the comments received on the proposal
and, for the reasons stated above, is adopting Sec. 1.11(e) as
proposed.
6. Annual Review, Distribution of Policies and Procedures and
Recordkeeping
The Commission's proposal also includes: (1) Sec. 1.11(f) which
requires an annual review and testing of the adequacy of each FCM's
Risk Management Program by internal audit staff or a qualified
external, third party service; (2) Sec. 1.11(g) which requires the
timely distribution of written risk management policies and procedures
to relevant supervisory personnel; and (3) Sec. 1.11(h) which
discusses recordkeeping and availability of records. The Commission
received no comments on paragraphs (f), (g), and (h) of Sec. 1.11 and
is adopting the paragraphs as proposed.
7. CCO or CEO Certification
Regulation 3.3 requires the CCO or CEO of an FCM to provide an
annual report to the Commission that must review each applicable
requirement under the Act and Commission regulations, and with respect
to each

[[Page 68521]]

applicable requirement, identify the policies and procedures that are
reasonably designed to ensure compliance with the requirement, and
provide an assessment of the effectiveness of the policies and
procedures.\85\ The annual report also must include a certification by
the CCO or CEO that, to the best of his or her knowledge and reasonable
belief, and under penalty of law, the information contained in the
annual report is accurate and complete.
---------------------------------------------------------------------------

\85\ Such report is mandated by Sec. 3.3 of the Commission's
regulations; See Swap Dealer and Major Swap Participant
Recordkeeping, Reporting, and Duties Rules; Futures Commission
Merchant and Introducing Broker Conflicts of Interest Rules; and
Chief Compliance Officer Rules for Swap Dealers, Major Swap
Participants, and Futures Commission Merchants, 77 FR 20128, Apr. 3,
2012 (promulgating final rules concerning the CCOs of FCMs, swap
dealers, and major swap participants); see also Sec. 4d(d) of the
Act, 7 U.S.C. 6d(d).
---------------------------------------------------------------------------

The Commission requested comment on whether the standard for the
CCO's or CEO's certification in the annual report (i.e., based on the
CCO's or CEO's knowledge and reasonable belief) required under Sec.
3.3 is adequate for a certification of the FCM's compliance with
policies and procedures for the safeguarding of customer funds.
Specifically, the Commission requested comment on whether Sec. 1.11
should contain a separate CCO or CEO certification requirement that
would impose a higher duty of strict liability or some other higher
obligation on a CCO or CEO.
The Commission received three comments in this regard. NFA and FIA
believed that the ``knowledge and reasonable belief'' standard in Sec.
3.3 remains appropriate for a CCO's/CEO's certification regarding an
FCM's customer funds safeguards.\86\ That is, the CCO or CEO should not
be liable for matters that are beyond the CCO's/CEO's knowledge and
reasonable belief. Further, NFA stated that the Commission should
reconsider whether the CCO's/CEO's annual report should contain a
separate certification (with the ``knowledge and reasonable belief
language'') executed by the FCM's CEO or CFO regarding the adequacy of
the FCM's customer funds safeguards.\87\ Newedge opposed the imposition
of a strict liability standard on a CCO/CEO for the annual
certifications because the CCO/CEO is relying on internal
representations from other FCM employees that are far more expert
regarding these matters.\88\ Newedge stated that such a standard would
make it difficult to recruit qualified persons to serve as a CCO/
CEO.\89\
---------------------------------------------------------------------------

\86\ FIA Comment Letter at 11 (Feb. 15, 2013); NFA Comment
Letter at 10 (Feb. 15, 2013).
\87\ NFA Comment Letter at 10 (Feb. 15, 2013).
\88\ Newedge Comment Letter at 3 (Feb. 15, 2013).
\89\ Id.
---------------------------------------------------------------------------

In response to these comments, the Commission is not requiring a
separate CCO/CEO certification requirement imposing a higher duty of
strict liability or other standard for the segregation of customer
funds. The Commission also is not imposing a separate certification by
the FCM's CEO or CFO at this time. Commission staff will monitor the
role of the CCO/CEO as the regulation is implemented and propose to the
Commission any amendments to the CCO's/CEO's standard for certifying
compliance as deemed appropriate based upon staff's experiences.

C. Sec. 1.12: Maintenance of Minimum Financial Requirements by Futures
Commission Merchants and Introducing Brokers

The regulatory notices required under Sec. 1.12 are intended to
provide the Commission and SROs with prompt notice of potential adverse
conditions at FCMs that may indicate a possible threat to the financial
condition of the firm or to the safety of customer funds held by the
FCM. Regulation 1.12 currently obligates FCMs to provide notice to the
Commission and to the respective DSROs if certain specified reportable
events occur. Reportable events include: Failing to maintain the
minimum level of required regulatory capital (Sec. 1.12 (a)); failing
to maintain current books and records (Sec. 1.12(c)); and failing to
comply with the requirements to properly segregate customer funds
(Sec. 1.12(h)). As discussed further below, the Commission proposed to
amend Sec. 1.12 to include several additional reportable events and to
revise the process for submitting reportable events to the Commission
and DSROs.
1. Timing of Notices
The proposed new reportable events, discussed individually below,
will require immediate notice to the Commission and the firm's DSRO
upon the occurrence of the relevant event. FIA commented that while it
is not opposed to a requirement for FCMs to provide prompt notice of a
reportable event, it questioned the need for ``immediate'' notice as
proposed by the Commission.\90\ FIA recommended that if the Commission
determined to adopt the proposed early warning notices that it allow 24
hours if the event is financial in nature and 48 hours for business-
related events in order to afford FCMs time to determine the cause of
the event and take an appropriate corrective action.\91\
---------------------------------------------------------------------------

\90\ FIA Comment Letter at 37-38 (Feb. 15, 2013).
\91\ Id.
---------------------------------------------------------------------------

The purpose of the ``early warning'' notice system established
under Sec. 1.12 is to provide the Commission and an FCM's DSRO with
adequate and prompt notice of a reportable event in order to allow
Commission staff to assess the situation and to consult with the
registrant and the SROs to determine if further action is necessary in
order to protect customer funds or to determine if the FCM can continue
to meet its obligations to the marketplace and clearing process. The
filing of a notice is often the first step where the Commission staff
is alerted to a potential issue at a firm. The Commission also
initiates a dialogue with the firm and the firm's DSRO, as necessary,
upon receipt of a Sec. 1.12 notice.
Given the critical role that notices play in the Commission's and
DSRO's surveillance of FCMs, the Commission believes that immediate
notice is necessary when a reportable event is financial in nature
(e.g., the FCM is not in compliance with the Commission's capital or
segregation requirements). In such situations, the firm should file
immediate notice with the Commission. If a firm needs additional time
to assess the cause of the reportable event, or if additional time is
needed to document what steps the FCM will take to remedy the situation
causing the reportable event, it may file an amendment to its initial
notice with the Commission. In addition, in a situation where the
registrant is reporting that it is undercapitalized or undersegregated,
the Commission and DSRO will have initiated an ongoing dialogue whereby
the Commission and the DSRO will be in frequent communication with the
registrant and will receive updated information as the registrant
becomes aware of the facts.
Reportable events that are not related to an FCM's ability to meet
its financial obligations or not directly related to the protection of
customer funds may not be subject to the same sense of immediacy and
the Commission is revising its proposed regulations accordingly. The
revisions to the proposed amendments are discussed in the appropriate
sections below with the comments received on the proposed new notice
provisions.
2. Undercapitalized FCMs and IBs
Regulation 1.12(a) requires an FCM or IB that fails to maintain the
minimum level of adjusted net capital required by Sec. 1.17 to provide
immediate notice to

[[Page 68522]]

the Commission and to the entity's DSRO. The notice must include
additional information to adequately reflect the FCM's or IB's current
capital condition as of any date that the entity is undercapitalized.
The Commission proposed to amend Sec. 1.12(a) to clarify that if
the FCM or IB cannot compute or document its actual capital at the time
it knows that it is undercapitalized, it must still provide the written
notice required by Sec. 1.12(a) immediately and may not delay filing
the notice until it has adequate information to compute its actual
level of adjusted net capital.
NFA commented in support of the Commission's proposal noting that
in situations where an FCM is in potential distress, it may be even
more important for the Commission and the firm's DSRO to become
immediately aware of the situation so that the Commission and DSRO
staff can assist in determining the firm's current, accurate financial
condition.\92\ The Commission agrees that it is imperative that an FCM
or IB provide immediate notice if the firm is undercapitalized and,
accordingly is adopting the amendment as proposed.
---------------------------------------------------------------------------

\92\ NFA Comment Letter at 10 (Feb. 15, 2013).
---------------------------------------------------------------------------

3. Insufficient Segregation of Funds of Cleared Swaps Customers
Regulation 1.12(h) currently requires an FCM that fails to hold
sufficient funds in segregated accounts to meet its obligations to
futures customers, or that fails to hold sufficient funds in separate
accounts for foreign futures or foreign options customers, to provide
immediate notice to the Commission and to the FCM's DSRO. The
Commission proposed to amend paragraph (h) to include an explicit
requirement that an FCM provide immediate notice to the Commission and
to its DSRO if the FCM fails to hold sufficient funds in segregated
accounts for Cleared Swaps Customers to meet its obligation to such
customers.\93\ The amendment will ensure immediate notification of a
failure to hold sufficient funds in segregation for Cleared Swaps
Customers so that the Commission and the firm's DSRO can promptly
assess the financial condition of an FCM and determine if there are
threats to the safety of the Cleared Swaps Customers Collateral held by
the FCM. The amendment also harmonizes the notice requirements whenever
an FCM fails to hold in proper segregated or secured accounts
sufficient funds to meet its total obligations to futures customers,
30.7 customers, and Cleared Swaps Customers.
---------------------------------------------------------------------------

\93\ Commencing November 13, 2012, the compliance date for
certain Commission part 22 regulations, FCMs are required under
Sec. 22.2 to hold a sufficient amount of funds in Cleared Swaps
Customer Accounts to meet the Net Liquidating Equity of each Cleared
Swaps Customer. 77 FR 6336 (Feb. 7, 2012).
---------------------------------------------------------------------------

The Commission did not receive any comments on proposed Sec.
1.12(h). The Commission is adopting the amendments to paragraph (h) as
proposed.
4. Investment of Customer Funds in Contravention of Regulation 1.25
The Commission also proposed to amend Sec. 1.12 by adding new
paragraph (i) to require an FCM to provide immediate notice whenever it
discovers or is informed that it has invested funds held for customers
in investments that are not permitted investments under Sec. 1.25, or
if the FCM holds permitted investments in a manner that is not in
compliance with the provisions of Sec. 1.25, such as the investment
concentration limitations contained in Sec. 1.25(b)(3). The proposal
applies to funds held for futures customers, 30.7 customers, and
Cleared Swaps Customers.
The Commission received no comments on the proposed amendments to
Sec. 1.12(i). The Commission is adopting paragraph (i) as proposed.
5. Notice of Residual Interest Falling Below Targeted Level or
Undermargined Amounts
The Commission proposed to amend Sec. 1.12 to provide a new
paragraph (j) to require an FCM to provide immediate notice to the
Commission and to the firm's DSRO if the FCM does not hold an amount of
funds in segregated accounts for futures customers or for Cleared Swaps
Customers, or if the FCM does not hold sufficient funds in secured
accounts for 30.7 customers, sufficient to meet the firm's targeted
residual interest in one or more of these accounts as computed under
proposed Sec. 1.11, which is being adopted herein, or if its residual
interest in one or more of these accounts is less than the sum of
outstanding margin deficits (i.e., undermargined amounts) for such
accounts. Regulation 1.11, as adopted herein, also requires each FCM
that carries customer funds to calculate an appropriate amount of
excess funds (i.e., proprietary funds) to hold in segregated or secured
accounts to mitigate the possibility of the FCM being undersegregated
or undersecured due to a withdrawal of proprietary funds from a
segregated or secured account.
FIA questioned the necessity of the proposed provision noting that
under the proposed amendments to Sec. 1.32 each FCM holding customer
funds is required to file a report with the Commission on a daily basis
that will disclose if the FCM's residual interest has fallen below the
FCM's targeted amount or if the residual amount is less than the sum of
the customers' margin deficits.\94\ FIA also noted that under current
regulations an FCM's residual interest will frequently fall below its
targeted amount and that if the Commission adopts its proposed
amendments to Sec. Sec. 1.20, 22.2 and 30.7 to require an FCM to use
proprietary funds to cover margin deficits, withdrawals in excess of 25
percent of the firm's residual interest will likely be a daily event
requiring daily notices to be filed with the Commission and with the
FCM's DSRO.\95\
---------------------------------------------------------------------------

\94\ FIA Comment Letter at 38 (Feb. 15, 2013). The Commission is
proposing to require each FCM to file with the Commission and with
the firm's DSRO a daily: (1) Segregation Schedule (Sec. 1.32); (2)
Secured Amount Schedule (Sec. 30.7); and, (3) Cleared Swaps
Segregation Schedule (Sec. 22.2)). The Commission proposed to
include information disclosing the FCM's targeted residual interest
and whether the amount of the actual residual interest exceeds the
targeted residual interest and the total amount of the FCM's margin
deficiencies in the Segregation Schedule, Secured Amount Schedule,
and the Cleared Swaps Segregation Schedule.
\95\ Id.
---------------------------------------------------------------------------

One of the primary objectives of the proposed amendments to Sec.
1.12 is to ensure that the Commission and DSROs receive notice of
potential financial or operational issues at an FCM, or of rule
violations by an FCM, in as timely a manner as possible such that the
Commission and the FCM's DSRO will be in a position to assess the
issues and the potential impact on the FCM's ability to meet its
regulatory obligations and its ability to safeguard customer funds.
While the proposed amendments to Sec. 1.32 do require each FCM holding
customer funds to file on a daily basis a Segregation Schedule, Secured
Amount Schedule, and Cleared Swaps Segregation Schedule (as
appropriate) that includes information concerning the amount of the
firm's actual and targeted residual interests, the notice required by
Sec. 1.12(j) requires the firm to include a discussion of the cause of
the event, and what steps the firm will take to increase the residual
interest. The notice will assist the Commission and the DSROs in
determining what, if any, additional steps may be necessary in order to
mitigate potential market disruptions if the FCM cannot meet its
regulatory obligations, and will enhance the overall safety of customer
funds. In addition, the Commission believes that the filing of a notice
by an FCM will focus greater attention by management at the firm on the
fact that the firm's

[[Page 68523]]

actual residual interest is below its targeted residual interest, which
should result in further reflection by management on the adequacy of
the target amount and/or any changes in operations that may be
appropriate, including increasing the firm's residual interest or using
other sources of liquidity.
The Commission also notes that an FCM's obligation under Sec.
1.12(j) to file a notice when the firm's residual interest is less than
the sum of the undermargined amounts in its customer accounts is
determined at the point in time that the firm is required to maintain
as residual interest the undermargined amounts under Sec. 1.22, Sec.
22.2, and Sec. 30.7. In addition, the Commission further notes that
the obligation to file a notice under Sec. 1.12(j) when the firm's
residual interest is less than the sum of the undermargined amounts in
its customer accounts commences as of the respective compliance dates
for Sec. 1.22, Sec. 22.2, and Sec. 30.7 established by the
Commission and discussed further in section III below.
The Commission has considered the comments and has determined to
adopt new paragraph 1.12(j) as proposed and as clarified above.
6. Events Causing Material Adverse Financial Impact or Material Change
in Operations
The Commission proposed new paragraphs (k) and (l) to Sec. 1.12.
Proposed paragraphs (k) and (l) will require an FCM to provide notice
to the Commission and to the firm's DSRO in the event of a material
adverse impact in the financial condition of the firm or a material
change in the firm's operations. Proposed paragraph (k) will require an
FCM to provide immediate notice if the FCM, its parent, or a material
affiliate, experiences a material adverse impact to its
creditworthiness or its ability to fund its obligations. Indications of
a material adverse impact of an FCM's creditworthiness may include a
bank or other financing entity withdrawing credit facilities, a credit
rating downgrade, or the FCM being placed on ``credit watch'' by a
credit rating agency.
Proposed paragraph (l) will require an FCM to provide immediate
notice of material changes in the operations of the firm, including: A
change in senior management; the establishment or termination of a
material line of business; a material change in the FCM's clearing
arrangements; or a material change in the FCM's credit arrangements.
Paragraph (l) is intended to provide the Commission with notice of
material events, such as the departure of the FCM's CCO, CFO, or CEO.
Two comments were received on the proposal. FIA stated that the
proposed amendments do not provide an FCM sufficient guidance on the
circumstances that would require notice and requested that the
Commission define more precisely the events that would require
notice.\96\ RJ O'Brien similarly stated its concern that the term
``creditworthiness'' as used in proposed Regulation 1.12(k) is
ambiguous and subjective and requires a clearer definition to afford
FCMs the ability to reasonably ascertain their reporting duties and
obligations.\97\
---------------------------------------------------------------------------

\96\ Id.
\97\ RJ O'Brien Comment Letter at 10 (Feb. 15, 2013).
---------------------------------------------------------------------------

FIA also recommended that the Commission coordinate with the SEC
and the banking regulators to establish a uniform standard identifying
``material adverse'' changes or impacts.\98\ Finally, FIA noted that it
does not believe that a change in senior management at an FCM should
require an early warning notice of any kind because such notice is
already provided to NFA in the ordinary course.\99\
---------------------------------------------------------------------------

\98\ FIA Comment Letter at 38 (Feb. 15, 2013).
\99\ Id.
---------------------------------------------------------------------------

The Commission has considered the comments and has determined to
adopt the amendments to Sec. 1.12(k) and (l) as proposed, with the
revision that the notices required by Sec. 1.12(l) must be filed
promptly, but not later than 24 hours after the event, instead of
immediately. By adopting this revision, the Commission acknowledges
that immediate notice is not necessary in all situations.
An FCM should report Sec. 1.12(l) notices in a punctual or prompt
manner, but may do so without the expediency required by an immediate
notice provision that is required, for example, when a firm is
undercapitalized or undersegregated, which may indicate that immediate
Commission or DSRO action is required to assess the financial condition
of the FCM or the safety of customer funds. This revision provides the
appropriate balance between the receipt of timely notices and the
ability of the FCM to document an explanation of the events that
trigger the notice.
As noted above, the Commission proposed additional notice
provisions under Sec. 1.12 in order to ensure that the Commission and
DSROs receive timely information regarding certain events that should
be assessed by the Commission and the DSROs as part of the overall
oversight and risk assessment of FCMs. Regulation 1.12(k) will require
an FCM to provide notice if the FCM or its parent or material affiliate
experiences a material adverse impact to its creditworthiness or its
ability to fund its obligations. Regulation 1.12(l) will require an FCM
to provide notice if there is a material change in the firm's
operations, senior management, clearing arrangements, or a material
line of business.\100\ The purpose of paragraphs (k) and (l) is to
provide the Commission and the relevant DSRO with an opportunity to
initiate a dialogue with the firm regarding any potential adverse
impact that such a material change may have on the ability of the FCM
to meet its obligations as a market intermediary and on the protection
of the customer funds held by the FCM.
---------------------------------------------------------------------------

\100\ Regulation 1.12(k) and (l) both require an FCM to report a
material change in the firm's creditworthiness or its ability to
fund its obligations. Accordingly, the Commission is removing the
reference to the FCM's credit arrangements in Sec. 1.12(l).
---------------------------------------------------------------------------

The Commission is cognizant of the commenters' desire for more
precise guidance on when notices must be filed under Sec. 1.12(k) and
(l). However, FCMs represent a broad range of entities, with diverse
business models. In this regard, some FCMs are small operations with a
minimum level of capital, and others are highly capitalized entities
with more sophisticated operations. Some FCMs focus on retail and/or
agricultural clients, and others focus exclusively on institutional
clients. Some FCMs are standalone entities that do not engage in
proprietary or securities trading, and others are dually-registered
with the SEC as BDs and engage in a significant amount of securities
transactions for both their proprietary and customer accounts.
With FCMs covering such a broad and diverse spectrum of business
organizations and models, the Commission does not believe that it would
be appropriate to define by regulation the scenarios that are material
to an FCM and would automatically require the filing of a regulatory
notice. Instead, the regulation has been developed to allow each FCM to
assess whether any particular or unique event is material to the
specific firm. In making this determination, each FCM should assess the
potential impact that an event may have on the FCM. This would include
whether new lines of business would result in a significant increase in
the firm's capital requirement or otherwise result in a significant
additional financial or operational risk to the FCM's existing
business, or whether the change in credit terms will significantly
impact

[[Page 68524]]

the liquidity resources available to the FCM.
The Commission also considered the comment that FCMs should not be
required to report to the Commission changes in senior management as
such information is reported to NFA. The Commission does not agree with
this comment. As previously noted, the Sec. 1.12 notice provisions are
intended to provide the Commission and DSROs with prompt notice of
material events at FCMs that will allow the Commission and DSROs to
monitor the impact of such material events on FCMs and to factor such
events into the risk assessment of the firm as part of their respective
surveillance programs. The resignation or appointment of a new chief
executive officer or chief risk officer at an FCM is a material change
at an FCM and is information that should be reported to enhance the
Commission's and DSRO's understanding of the firm's operations and the
assessment of risk at the FCM.
7. Notice of Correspondence From Other Regulatory Authorities
The Commission proposed to add a new paragraph (m) to Sec. 1.12 to
require an FCM that receives a notice, examination report, or any other
correspondence from a DSRO, the SEC, or a securities self-regulatory
organization to immediately file a copy of such notice, examination
report, or correspondence with the Commission. The Commission stated in
proposing Sec. 1.12(m) that the receipt of such notices, examination
reports, or correspondence is necessary for the Commission to conduct
appropriate oversight of FCMs.
The Commission received several comments that expressed a general
concern that the language of the proposal is overbroad.\101\ FIA noted
that FCMs receive regular, and often routine, correspondence from their
DSROs and that the amount of correspondence is multiplied for FCMs that
are also registered as BDs and receive similar correspondence from
their securities SROs and the SEC.\102\ NFA agreed with the Commission
that notices of material regulatory actions would provide the
Commission and the DSROs with important information to carry out their
oversight responsibilities, but also encouraged the Commission to
reconsider the breadth of the proposal.\103\ NFA noted that with
respect to futures examinations reports, it already files such reports
with the Commission's Division of Swap Dealer and Intermediary
Oversight.\104\ NFA also requested that the Commission clarify that
FCMs would not have to file notices of public regulatory actions taken
by futures SROs against an FCM because NFA already provides the
complaint associated with these actions to the Commission and makes the
action available on NFA's BASIC system.\105\ TD Ameritrade recommended
that the Commission limit notification to items that pertain to
financial responsibility rules.\106\
---------------------------------------------------------------------------

\101\ FIA Comment Letter at 39 (Feb. 15, 2013); TD Ameritrade
Comment Letter at 3 (Feb. 15, 2013); RCG Comment Letter at 7 (Feb.
12, 2013); CHS Hedging Comment Letter at 3 (Feb. 15, 2013).
\102\ FIA Comment Letter at 39 (Feb. 15, 2013).
\103\ NFA Comment Letter at 10 (Feb. 15, 2013).
\104\ Id. at 11.
\105\ Id.
\106\ TD Ameritrade Comment Letter at 3 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission notes that it was not its intention to require an
FCM to file with the Commission routine or non-material correspondence
from regulators or SROs. Regulation 1.12 in general is intended to
provide the Commission with information regarding an FCM's interaction
with its other regulators regarding the regulators' examinations and
other material communications with FCMs. The Commission would use such
information to enhance its understanding of the firm and its compliance
with regulatory requirements to assess the operations of the firm and
learn of events that may present a potential adverse impact on the
firm, including its ability to properly operate in a regulated
environment or otherwise safeguard customer funds.
The Commission is revising final Sec. 1.12(m) to require an FCM to
file notice with the Commission: (1) if the FCM is informed by the SEC
or a SRO that it is the subject of a formal investigation; (2) if the
FCM is provided with an examination report issued by the SEC or a SRO,
and the FCM is required to file a copy of such examination report with
the Commission; and (3) if the FCM receives notice of any
correspondence from the SEC or a securities SRO that raises issues with
the adequacy of the FCM's capital position, liquidity to meet its
obligations or otherwise operate its business, or internal controls.
The Commission believes that the revised regulation will provide the
Commission with information necessary for the effective oversight of
FCMs and will minimize the notices that dual-registrant FCMs/BDs will
have to file with the Commission.
8. Filing Process and Content
The Commission proposed to amend the process that an FCM uses to
file the notices required by Sec. 1.12. Currently, Sec. 1.12 requires
an FCM to provide the Commission and DSROs with telephonic and
facsimile notice in some situations, and to provide written notice by
mail in other situations. An FCM also is permitted, but not required,
to file notices and written reports with the Commission and with its
DSRO using an electronic filing system in accordance with instructions
issued by, or approved by, the Commission.
The Commission proposed to amend Sec. 1.12(n) to require that all
notices and reports filed by an FCM with the Commission or with the
FCM's DSRO must be in writing and submitted using an electronic filing
system.\107\ Each FCM currently uses WinJammer to file regulatory
notices with the Commission and with the firm's DSRO. The proposed
regulation further provides that if the FCM cannot file a notice due to
the electronic system being inoperable, or for any other reason, it
must contact the Commission's Regional office with jurisdiction over
the firm and make arrangements for the filing of the regulatory notices
with the Commission via electronic mail at a specially designated email
address established by the Commission; fcmnotices@cftc.gov. The
Commission also proposed to amend Sec. 1.12(n) to require that each
notice filed by an FCM, IB, or SRO under Sec. 1.12 include a
discussion of what caused the reportable event, and what steps have
been, or are being taken, to address the reportable event. Additional
amendments to Sec. 1.12(b), (d), (e), (f) and (g) were proposed that
were necessary and technical in nature, and primarily revise internal
cross-references to the filing requirements in Sec. 1.12(n).
---------------------------------------------------------------------------

\107\ The Commission's proposed amendment to require the
electronic filing of reports applies to both registered FCMs and
applicants for registration as FCMs. Applicants for FCM registration
currently file regulatory notices with NFA using WinJammer.
---------------------------------------------------------------------------

The Commission received one comment on the proposed amendments to
Regulation 1.12(n), specifically with respect to the requirement that
notices under the regulation include a discussion of what caused the
reportable event and what steps have been or will be taken to address
the event.\108\ CHS Hedging stated its concern that requiring such a
discussion in the notice is at odds with the requirement that notices
be filed immediately.\109\
---------------------------------------------------------------------------

\108\ CHS Hedging Comment Letter at 3 (Feb. 15, 2013).
\109\ Id.
---------------------------------------------------------------------------

The Commission has determined to adopt the amendments to Sec.
1.12(n) and the technical and related amendments

[[Page 68525]]

in Sec. 1.12(b), (d), (e), (f) and (g) as proposed. In the
Commission's experience, in many cases an FCM has sufficient
information to provide a notice of reportable event and the remedial
steps that can be taken to mitigate future issues upon learning of the
reportable event or very shortly thereafter. The Commission does not
believe that the requirement to provide such information is at odds
with the need to provide the information immediately. In the event that
an FCM does not possess complete information on what caused the event,
or the steps that have been taken or are being taken to address the
event, it may revise its notice at a later date when it has more
complete or accurate information. It is essential, however, that the
Commission receives timely notice of early warning events, and
compliance with the relevant notice time period should be an FCM's
first priority. Accordingly, as noted in the Proposal, even if such
information is not immediately readily available, the reporting entity
may not delay the reporting of a reportable event.
9. Public Disclosure of Early Warning Notices
The Commission requested comment as to whether reportable events
should be made public by the Commission, SROs, or FCMs and what the
benefits and/or negative impact from public disclosure of such events
would be. The Commission received several comments regarding the public
disclosure of reportable events. Several commenters, including FHLB,
the ICI, ACLI, BlackRock, and SIFMA believed that the Commission should
mandate public disclosure of such information.\110\ Two commenters, FIA
and NFA, believed that such events should not be made public.\111\ NFA
did not believe any of the filings should be public, but emphasized
that those events that are not subject to a formal public action
particularly should not be subject to public disclosure.\112\ FIA was
concerned that without context, public disclosure of the notices would
be subject to misinterpretation and could create an adverse market
event.\113\
---------------------------------------------------------------------------

\110\ FHLB Comment Letter at 10 (Feb. 15, 2013); ICI Comment
Letter at 7-8 (Jan. 14, 2013); ACLI Comment Letter at 4 (Feb. 15,
2013); BlackRock Letter at 3 (Feb. 15, 2013); and SIFMA Comment
Letter at 2 (Feb. 21, 2013).
\111\ NFA Comment Letter at 11 (Feb. 15, 2013); FIA Comment
Letter at 38 (Feb. 15, 2013).
\112\ NFA Comment Letter at 11 (Feb. 15, 2013).
\113\ FIA Comment Letter at 38 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission has considered the comments and has determined that
regulatory notices filed under Sec. 1.12 should not be made publicly
available. The notices required under Sec. 1.12 provide a mechanism
whereby Commission and SRO staff are alerted to potential issues at an
FCM. In order to fully assess the potential impact of a reportable
event, Commission and SRO staff generally must contact the firm to
obtain additional information, including up to date information on how
the firm is addressing the matter that caused the reportable event to
develop. If reportable events were disclosed to the public, they may
not provide complete or current information. For example, an FCM may be
required to file immediate notice that it was undersegregated at a
point in time, but the notice may not contain information that the FCM
has taken corrective action and is no longer in violation of the
segregation requirements. The Commission also recognizes that many of
the Sec. 1.12 notices are required to be filed as a result of one-off
processing errors or timing differences that trigger a reportable event
but are immediately rectified by the FCM and do not indicate a failure
of the FCM's control system nor the firm's ability to effectively
operate as an FCM.
In addition, under Sec. 1.12 FCMs that are dually registered BDs
with the SEC are required to file with the Commission copies of certain
regulatory notices that they are required to file with the SEC. The
SEC, however, does not make such notices public. The Commission
believes it is important to ensure consistency such that information
that a firm must file with the SEC and that is otherwise not publicly
disclosed is not made public by the Commission as a result of the firm
also being required to file a notice with the Commission under Sec.
1.12.

D. Sec. 1.15: Risk Assessment Reporting Requirement for Futures
Commission Merchants

Regulation 1.15 currently requires each FCM subject to the risk
assessment reporting requirements to file certain financial reports
with the Commission within 120 days of the firm's year end. The risk
assessment filings include FCM organizational charts; financial,
operational, and risk management policies, procedures, and systems
maintained by the FCM; and, fiscal year-end consolidated and
consolidating financial information for the FCM and its highest level
material affiliate.
The Commission proposed to amend Sec. 1.15 to require the
financial information to be filed in electronic format. The Commission
received no comments on the proposed amendments to Sec. 1.15. The
Commission is adopting the amendments as proposed. The Commission also
has revised the final regulation to provide that the risk assessment
filings should be filed via transmission using a form of user
authentication assigned in accordance with procedures established by or
approved by the Commission, and otherwise in accordance with
instructions issued by or approved by the Commission. The Commission
will provide direction regarding how FCMs should file the risk
assessment reports in a secure manner with the Commission prior to the
effective date of the regulation.

E. Sec. 1.16: Qualifications and Reports of Accountants

Regulation 1.16 addresses the minimum requirements a public
accountant must meet in order to be recognized by the Commission as
qualified to conduct an examination for the purpose of expressing an
opinion on the financial statements of an FCM. Regulation 1.16(b)
currently provides that the Commission will recognize a person as
qualified if such person is duly registered and in good standing as a
public accountant under the laws of the place of the accountant's
principal office or principal residence.
The Commission proposed several amendments to enhance the
qualifications that a public accountant must meet in order to conduct
an examination of an FCM. Specifically, the Commission proposed to
require that the public accountant must: (1) Be registered with the
Public Company Accounting Oversight Board (``PCAOB''); (2) have
undergone an examination by the PCAOB; and, (3) have remediated to the
satisfaction of the PCAOB any deficiencies identified during the
examination within three years of the PCAOB issuing its report.
The Commission also sought to enhance the quality of the public
accountant's examination of an FCM by proposing to require that the
examination be conducted in accordance with U.S. GAAS after full
consideration of the auditing standards issued by the PCAOB. The
Commission further sought to ensure that the FCM's governing body took
an active role in the assessment and appointment of the public
accountant by imposing an obligation on the governing body to evaluate,
among other things, the accountant's experience auditing FCMs; the
adequacy of the accountant's knowledge of the Act and Commission
regulations; the depth of the accountant's staff; and, the independence
of the accountant.
Additionally, the Commission proposed technical amendments to

[[Page 68526]]

Sec. 1.16. The Commission proposed to amend Sec. 1.16(f)(1)(i)(C) to
require each FCM to submit its certified annual report to the
Commission in an electronic format. The Commission also proposed to
amend Sec. 1.16(c)(2) to remove the requirement that the accountant
manually sign the accountant's report, which would facilitate the
electronic filing of the FCM's certified annual report with the
Commission.
The proposed amendments to Sec. 1.16, including a discussion of
the comments received, are discussed below.
1. Mandatory PCAOB Registration Requirement
Regulation 1.16(b)(1) would continue to require a public accountant
to be registered and in good standing under the laws of the place of
the accountant's principal office or principal residence in order to be
qualified to conduct examinations of FCMs. The Commission proposed to
enhance the qualifications of public accountants by further requiring
the public accountant to be registered with the PCAOB.
The PCAOB is a nonprofit corporation established by Congress under
the Sarbanes-Oxley Act of 2002 (``SOX'') to oversee the audits of
public companies and BDs of securities registered with the SEC in order
to protect investors and the public interest by promoting informative,
accurate, and independent audit reports.\114\ The SEC has oversight
authority over the PCAOB, including the approval of the PCAOB's rules,
auditing and other standards, and budget.\115\
---------------------------------------------------------------------------

\114\ Public Law 107-204, 116 Stat. 745 (July 30, 2002). See
also section 101 of SOX.
\115\ Sections 107 and 109 of SOX.
---------------------------------------------------------------------------

The Commission received several comments on the proposed amendments
to Regulation 1.16, which are discussed below. The commenters, however,
did not oppose the proposed PCAOB registration requirement. In
addition, the Commission does not anticipate that the PCAOB
registration requirement will present a significant issue to FCMs or
public accountants. In this regard, only one public accountant that
currently conducts examinations of FCMs is not registered with the
PCAOB. PCAOB-registered public accountants conducted the examinations
of 103 of the 104 registered FCMs based upon a review of the most
current annual reports submitted by FCMs to the Commission.
Accordingly, after considering the comments, the Commission is adopting
the PCAOB registration requirement as proposed.
2. PCAOB Inspection Requirement
The Commission proposed to amend Sec. 1.16(b)(1) to require that a
public accountant must have undergone a PCAOB examination in order to
be qualified to conduct examinations of FCMs. Section 104 of SOX
requires the PCAOB to conduct an annual inspection of each registered
public accountant that regularly provides audit reports for more than
100 public issuers each year.\116\ Section 104 further requires public
accountants that provide audit reports for 100 or fewer issuers to be
inspected by the PCAOB no less frequently than once every three
years.\117\
---------------------------------------------------------------------------

\116\ Section 104(b)(1)(A) of SOX.
\117\ Section 104(b)(1)(B) of SOX.
---------------------------------------------------------------------------

In addition, the Dodd-Frank Act amended SOX and vested the PCAOB
with new oversight authority over the audits of BDs registered with the
SEC.\118\ The PCAOB was provided with the authority, subject to SEC
approval, to determine the scope and frequency of the inspection of
public accountants of BDs. The SEC also approved a PCAOB temporary rule
implementing an inspection program for BDs.\119\
---------------------------------------------------------------------------

\118\ Section 982 of the Dodd-Frank Act.
\119\ See Public Company Oversight Board; Order Approving
Proposed Temporary Rule for an Interim Program of Inspection Related
to Audits of Brokers and Dealers, 76 FR 52996 (Aug. 24, 2011).
---------------------------------------------------------------------------

Several commenters raised issues with, or objected to, the
proposal. Ernst & Young requested clarification that the term
``examination'' in proposed Sec. 1.16(b)(1) referred to the
``inspections'' that are required under section 104 of SOX.\120\ The
Commission confirms that the term ``examination'' in proposed Sec.
1.16 was intended to refer to the ``inspections'' required under
section 104 of the SOX, and has revised the regulation accordingly.
---------------------------------------------------------------------------

\120\ Section 104 of SOX requires the PCAOB to conduct a
continuing program of inspections to assess the degree of compliance
of each registered public accounting firm and associated persons of
that firm with the provisions of the SOX, the rules of the PCAOB,
the rules of the SEC, or professional standards, in connection with
its performance of audits, issuance of audit reports, and related
matters involving public issuers.
---------------------------------------------------------------------------

Several commenters stated that the proposed inspection requirement
would disqualify public accountants that were registered with the
PCAOB, but had not yet undergone an inspection.\121\ These commenters
stated that the proposal would disqualify accounting firms that
recently registered with the PCAOB, but due to the triennial
inspections schedule may not be subject to a PCAOB inspection for
almost three years.\122\ Commenters also noted that certain PCAOB
registered accounting firms may audit non-issuer BDs and may be subject
to inspection under the PCAOB's temporary or permanent inspection
program, but may not have been selected yet for inspection by the
PCAOB.\123\ The AICPA stated that, while any public accounting firm can
register with the PCAOB, by law only accountants that audit public
issuers or audit certain non-issuer BDs may be inspected by the
PCAOB.\124\ KPMG also stated that the requirement that accounting firms
auditing an FCM must have undergone an inspection makes the rules
governing the audits of FCMs more restrictive than the SEC rules
governing the audits of BDs.\125\ KPMG suggests that the Commission
align the standards required of auditors of FCMs and BDs.\126\
---------------------------------------------------------------------------

\121\ Center for Audit Quality Comment Letter at 2 (Jan. 14,
2013); Deloitte Comment Letter at 2 (Jan. 14, 2013); Ernst & Young
Comment Letter at 2 (Jan. 14, 2013).
\122\ Id.
\123\ Center for Audit Quality Comment Letter at 2 (Jan. 14,
2013); Deloitte Comment Letter at 2 (Jan 14, 2013).
\124\ AICPA Comment Letter at 2 (Feb. 11, 2013).
\125\ KPMG Comment Letter at 2 (Jan. 11, 2013).
\126\ Id.
---------------------------------------------------------------------------

The AICPA also stated that the Commission should permit a practice
monitoring program (such as the AICPA peer review program) that
evaluates and opines on an accounting firm's system of quality control
relevant to the firm's non-issuer accounting and auditing practice as
an alternative to the PCAOB inspection requirement.\127\ The AICPA also
stated that a robust process, such as the AICPA's peer review program,
whereby a team of certified public accountants conducts a comprehensive
evaluation of a public accountant's system of quality control and whose
work is subject to the oversight and approval by a separate group of
certified public accountants should be required rather than having one
certified public accountant review another.\128\
---------------------------------------------------------------------------

\127\ AICPA Comment Letter at 3 (Feb 11, 2013).
\128\ Id.
---------------------------------------------------------------------------

The NFA also supported a temporary alternative to the PCAOB
inspection requirement in order to ensure that public accountants that
are unable to obtain a PCAOB inspection within the time period required
by the Commission will not automatically be prohibited from conducting
FCM examinations.\129\ NFA recommended that the Commission specifically
designate the AICPA's peer review program as the only peer review
program that will be acceptable to alleviate any uncertainty as to
whether a certified public

[[Page 68527]]

accountant is ``qualified'' to conduct the peer review.\130\
---------------------------------------------------------------------------

\129\ NFA Comment Letter at 11 (Feb. 15, 2013).
\130\ Id.
---------------------------------------------------------------------------

As noted in the proposal, FCMs are sophisticated financial market
participants that are entrusted with more than $182 billion of
customers' funds.\131\ FCMs intermediate futures customers activities
and guarantee customers' financial performance to DCOs, other FCMs, and
foreign brokers. In addition, FCMs are anticipated to hold significant
amounts of Cleared Swaps Customer Collateral deposited to margin,
secure or guarantee Cleared Swaps as more provisions of the Dodd-Frank
Act are implemented. FCMs also may conduct proprietary futures and
securities transactions, and handle business for securities customers
in addition to futures customers. The sophistication of the futures
markets and the Commission's regulations, coupled with the critical
role played by FCMs in the futures market (and in the case of many of
the largest FCMs, the securities markets) necessitates the engagement
of competent and experienced accountants to conduct the examinations of
FCMs.
---------------------------------------------------------------------------

\131\ The customer funds information is based upon the 1-FR-FCM
reports and FOCUS Reports filed by FCMs for the month ending April
30, 2013.
---------------------------------------------------------------------------

The Commission believes that registration with the PCAOB and being
subject to the PCAOB inspection program will help to ensure that
accounting firms engaged to conduct audits of FCMs remain competent and
qualified. The PCAOB inspection program involves the review of the
accounting firm's compliance with PCAOB issued audit, quality control,
independence and ethics standards.
In addition, the purpose of the PCAOB registration and inspection
requirement in the final rule is not to ensure that the accounting
firm's audits of FCMs are subject to inspection by the PCAOB. The
Commission acknowledges that the PCAOB's primary jurisdiction and
inspections are directed toward the audits of public issuers and BDs.
However, the Commission's objective is to reasonably ensure the quality
and competence of the public accountants engaged in the audits of FCMs.
The Commission believes that such quality and competence may be
assessed by the PCAOB inspecting the accounting firms' audit process
for issuers and BDs, and is not dependent solely upon the inspection of
the accounting firms' audits of FCMs.
The Commission further believes that its proposed PCAOB inspection
requirement is consistent with the SEC's audit requirements for BDs.
Any auditor of an SEC-registered BD must register with the PCAOB and
will be subject to the PCAOB inspection program.
Moreover, the Commission believes that the imposition of a PCAOB
inspection requirement provides several benefits over a peer review
program. The PCAOB is an entity that was created by Congress and
charged with improving audit quality, reducing the risks of audit
failures in the U.S. public securities markets and promoting public
trust. As previously noted, the PCAOB is subject to oversight by the
SEC, which approves the PCAOB's rules, auditing and other standards,
and budget. A peer review program, while providing many benefits in the
oversight of the accounting profession, is overseen by the accounting
industry and is not subject to oversight by a federal regulator, which
the Commission believes is a key advantage of the PCAOB in the
furtherance of the protection of customer funds.
The Commission also does not anticipate a significant impact on
existing FCMs from the imposition of the PCAOB inspection requirement
on public accountants. As noted above, 103 of the 104 FCMs currently
are subject to examination by public accountants that are registered
with the PCAOB. In addition, only six of the PCAOB-registered public
accountants that conduct examinations of fourteen FCMs have not been
subject to a PCAOB inspection at this time. However, all six of these
firms have indicated in their PCAOB filings that they conduct audits of
BDs and, therefore, will be subject at a future date to the PCAOB
inspection program for the inspection of accountants that conduct
audits of BDs.
The Commission, based upon the analysis above and further
consideration of the comments, has determined to adopt the regulation
as proposed. The Commission recognizes, however, that the audits of
many FCMs with a year-end date of December 31, 2013 or later have
already been initiated. Accordingly, the Commission has determined that
the PCAOB registration requirement will apply for audit reports issued
for the year ending June 1, 2014 or later so as not to unnecessarily
interrupt the examinations that currently are in progress. The
Commission also is adopting a December 31, 2015 compliance date for a
PCAOB inspection. The deferred compliance date will provide public
accountants with additional time to register with, and to be inspected
by, the PCAOB. The compliance dates are discussed further in section
III below.
3. Remediation of PCAOB Inspection Findings by the Public Accountant
The Commission proposed in Sec. 1.16(b)(1) that any deficiencies
noted during a PCAOB inspection must be successfully remediated to the
satisfaction of the PCAOB within three years.
KPMG, the Center for Audit Quality, Deloitte, the AICPA, and PWC
generally argued that it is not clear how the requirement that any
deficiencies noted during the PCAOB exam must have been remediated to
the satisfaction of the PCAOB would work or what it means.\132\ The
commenters also noted that the Commission's proposed requirement that
the public accountant remediate any deficiencies noted in a PCAOB
inspection report is more stringent than the SEC's requirements for
auditors of BDs and public issuers. KPMG also asked who would make a
determination of remediation as there is no procedure for the PCAOB to
communicate such determinations to the public accountant or the
public.\133\ PWC also stated that reliance on the PCAOB inspection
results was misplaced and that the PCAOB inspection comments are issued
in the context of a constructive dialogue to encourage Certified Public
Account (``CPA'') firms to improve their practices and procedures.\134\
PWC further noted that disciplinary sanctions such as revocation of the
firm's right to audit a public company or BD can only be made in the
context of an adjudicative process in which the firm is afforded
procedural rights.\135\ Lastly, PWC asserted that the Commission's
proposal would disqualify a firm without providing any of the
procedural rights or safeguards established by SOX.\136\
---------------------------------------------------------------------------

\132\ KPMG Comment Letter at 2-3 (Jan. 11, 2013); Center for
Audit Quality Comment Letter at 2-3 (Jan. 14, 2013); Deloitte
Comment Letter at 2-3 (Jan. 14, 2013); AICPA Comment Letter at 2
(Feb. 11, 2013); PWC Comment Letter at 2 (Jan. 15, 2013).
\133\ KPMG Comment Letter at 2 (Jan. 11, 2013).
\134\ See PWC Comment Letter at 2 (Jan. 15, 2013).
\135\ Id.
\136\ Id.
---------------------------------------------------------------------------

The Commission has considered the comments and recognizes that the
PCAOB inspection process does not involve a formal process for
communicating that a public accountant has adequately remediated
deficiencies identified during the PCAOB's last inspection. In
addition, the Commission understands that the PCAOB may not always
issue a report at the conclusion of an inspection, or that the report
may contain both public and non-public sections.
In light of these comments, the Commission has determined to revise

[[Page 68528]]

the final regulation by removing the requirement that a public
accountant must remediate any deficiencies identified during a PCAOB
inspection to the satisfaction of the PCAOB within three years of the
inspection. The Commission is further revising Sec. 1.16(b)(1) to
provide that a public accountant that, as a result of the PCAOB
disciplinary process, is subject to a sanction that would permanently
or temporarily bar the public accountant from engaging in the
examination of a public issuer or BD may not conduct the examination of
an FCM. The Commission notes that the PCAOB has the authority to
initiate a disciplinary action against a firm and its associated
persons for failing to adequately address inspection findings or for
other transgressions.
The Commission also is revising Sec. 1.16(b)(4) to require the
governing body of the FCM to review and consider the PCAOB's inspection
reports of the public accountant as part of the governing body's
assessment of the qualifications of the public accountant to perform an
audit of the FCM. The governing body is in a position to request
information from the public accountant regarding the PCAOB inspections
and general oversight of the public accountant and should use such
information in assessing the competency of the accountant to conduct an
examination of the FCM. An FCM's governing body should be concerned if
the PCAOB inspection reports indicate that the public accountant has
significant deficiencies and should take such information into
consideration in assessing the qualifications of the public accountant.
4. Auditing Standards
The Commission proposed to amend Sec. 1.16(c)(2) to require that
the public accountant's report of its examination of an FCM must state
whether the examination was done in accordance with generally accepted
auditing standards promulgated by the Auditing Standards Board of the
AICPA (i.e., U.S. GAAS), after giving full consideration to the
auditing standards issued by the PCAOB. Commenters raised issues with
the proposal noting that there is no existing reporting framework that
requires the application of one set of auditing standards and the
consideration of another set of auditing standards.\137\ Deloitte noted
that public accountants may be specifically engaged to conduct an audit
of an entity under both PCAOB auditing standards and U.S. GAAS, but
that there is no reporting framework for an audit under one set of
auditing standards, after giving ``full consideration'' to a separate
set of auditing standards.\138\
---------------------------------------------------------------------------

\137\ Ernst & Young Comment Letter at 3 (Jan. 14, 2013);
Deloitte Comment Letter at 1 (Jan. 14, 2013); PWC Comment Letter at
3 (Jan. 15, 2013); AICPA Comment Letter at 2 (Feb. 11, 2013); and
KPMG Comment Letter at 3 (Jan. 11, 2013).
\138\ Deloitte Comment Letter at 1 (Jan. 14, 2013).
---------------------------------------------------------------------------

The Commission has reviewed the comments and has determined to
revise the final regulation to provide that the accountant's report
must state whether the examination of the FCM was conducted in
accordance with the auditing standards issued by the PCAOB. The
Commission acknowledges the fact that there is no reporting framework
for public accountants to report on one set of auditing standards after
giving full consideration to another set of auditing standards. Also,
the Commission recognizes that the SEC has recently adopted final
regulations to its Rule 17a-5 to require public accountants to use
PCAOB standards in the examination of the financial statements of
BDs.\139\ Therefore, the Commission's amendments to Sec. 1.16(c)(2) to
require public accountants to use PCAOB standards in conducting the
examination of the financial statements of an FCM is consistent with
the SEC's revisions to its Rule 17a-5. The Commission also is setting a
compliance date for public accountants to use PCAOB auditing standards
for all FCM examinations with a year-end date of June 1, 2014 or later.
The extended compliance date allows FCMs currently subject to an
examination by a public accountant to complete the examination cycle
without having the public accountant adjust the examination for the new
PCAOB standards requirement. The June 1, 2014 compliance date also is
consistent with the SEC's compliance date for revisions to Rule 17a-5
and, therefore, will allow FCMs that are dually-registered as FCMs/BDs
to be subject to uniform CFTC and SEC requirements.\140\ Compliance
dates are discussed further in section III below.
---------------------------------------------------------------------------

\139\ Broker Dealer Reports, 78 FR 51910 (Aug. 21, 2013).
\140\ Id.
---------------------------------------------------------------------------

5. Review of Public Accountant's Qualifications by the FCM's Governing
Body
The Commission proposed to amend Sec. 1.16(b) by adding new
paragraph (4) which would require the FCM's governing body to ensure
that a public accountant engaged to conduct an examination of the FCM
is duly qualified to perform the audit. The proposed new paragraph
further provided that the evaluation should include, among other
things, the public accountant's experience in auditing FCMs, the public
accountant's knowledge of the Act and Commission regulations, the depth
of the public accountant's staff, and the public accountant's size and
geographical location. The proposed requirements are intended to ensure
that the FCM's governing body takes an active role in the assessment
and appointment of the public accountant.
PWC requested clarification of the Commission's expectations for
the criteria that would be expected to be used by the FCM's governing
body for determining qualification. PWC stated that such clarification
may be helpful so that a consistent framework for determining the
qualifications is used across the industry and FCM governing
bodies.\141\
---------------------------------------------------------------------------

\141\ PWC Comment Letter at 3 (Jan. 15, 2013).
---------------------------------------------------------------------------

The Commission has considered the comments and has determined to
adopt the amendments as proposed. FCMs represent a diverse group of
entities and business models. Some FCMs focus primarily on
institutional clients and engage in securities transactions as their
primary business. Other FCMs focus on retail customers and engage in no
proprietary or securities transactions.
With such a wide range of business models, the Commission believes
that it is not practical to provide a uniform set of criteria that each
governing body of each FCM should use to assess the qualifications of a
public accountant. In fact, such a standard list would go against the
Commission's objective of ensuring that the governing body is actively
reviewing the qualifications of the public accountant relative to the
FCM's particular business model. The requirement is not intended to
exclude regional or smaller public accountants from being qualified to
conduct examinations, provided that the governing body is satisfied
that the public accountant has the appropriate skill, knowledge, and
other resources to effectively conduct an examination, and is otherwise
in compliance with the qualification requirements in Sec. 1.16.
The Commission also is revising final Sec. 1.16(b)(4) in response
to the comments received on proposed Sec. 1.16(b)(1) that would have
required that a public accountant remediate any findings issued by the
PCAOB in its inspection report within 3 years of the issuance of the
inspection report. As stated above, commenters noted that there is no
formal mechanism to assess whether a public accountant has remediated
any inspection findings to the satisfaction of

[[Page 68529]]

the PCAOB. Accordingly, the Commission is revising Sec. 1.16(b)(4) to
provide that the governing body of the FCM should review the inspection
report of the public accountant and discuss inspection findings as
appropriate with the public accountant. Such reviews and discussions
will provide additional information to the governing body that will
allow it to better assess the qualifications of the public accountant
to conduct an audit of the FCM.
6. Electronic Filing of Certified Annual Reports
The Commission proposed to amend Sec. 1.16(f)(1)(i)(C) to require
each FCM to submit its certified annual report to the Commission in an
electronic format. The Commission also proposed to amend Sec.
1.16(c)(2) to remove the requirement that the accountant manually sign
the account's report, which will facilitate the electronic filing of
the FCM's certified annual report with the Commission. The Commission
received no comments on the above amendments and is adopting the
amendments as proposed.

F. Sec. 1.17: Minimum Financial Requirements for Futures Commission
Merchants and Introducing Brokers

1. FCM Cessation of Business and Transfer of Customer Accounts if
Unable To Demonstrate Adequate Liquidity
Section 4f(b) of the Act provides that no person may be registered
as an FCM unless it meets the minimum financial requirements that the
Commission has established as necessary to ensure that the FCM meets
its obligations as a registrant at all times, which would include its
obligations to customers and to market participants, including DCOs.
The Commission's minimum capital requirements for FCMs are set forth in
Sec. 1.17 which, among other things, currently provides that an FCM
must cease operating as an FCM and transfer its customers' positions to
another FCM if the FCM is not in compliance or is not able to
demonstrate its compliance with the minimum capital requirements.
The proposed amendments to Sec. 1.17 authorize the Commission to
request certification in writing from an FCM that it has sufficient
liquidity to continue operating as a going concern. If an FCM is not
able to immediately provide the written certification, or is not able
to demonstrate adequate access to liquidity with verifiable evidence,
the FCM must transfer all customer accounts and immediately cease doing
business as an FCM.
The FIA stated that it agreed with the regulatory purpose
underlying this proposed amendment, but stated that the Commission
should not adopt the rule before it clearly articulates the objective
standards by which it will determine that an FCM has ``sufficient
liquidity.'' \142\ Similarly, FCStone requested clarity with respect to
the exigent circumstances that would give the Commission authority to
require an FCM to cease operating.\143\
---------------------------------------------------------------------------

\142\ FIA Comment Letter at 8 (Feb. 15, 2013).
\143\ FCStone Comment Letter at 4 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission understands the concerns of commenters regarding the
process by which the Commission, or the Director of the Division of
Swap Dealer and Intermediary Oversight acting pursuant to delegated
authority under Sec. 140.91(6), could require immediate cessation of
business as an FCM and the transfer of customer accounts; however, that
same authority currently exists should a firm fail to meet its minimum
capital requirement. The Commission believes the ability to certify,
and if requested, demonstrate with verifiable evidence, access to
sufficient liquidity to operate as a going concern to meet immediate
financial obligations is a minimum financial requirement necessary to
ensure an FCM will continue to meet its obligations as a registrant as
set forth under section 4f(b) of the Act. Further, the Commission notes
that the ``going concern'' standard is well defined in accounting
literature and practice, and generally means an ability to continue
operating in the near term.
The proposed liquidity provision is intended to cover circumstances
that require immediate attention and would provide the Commission with
a means of addressing exigent circumstances by requiring an FCM to
produce a written analysis showing the sources and uses of funds over a
short period of time not to exceed one week. The purpose of the
provision is to address situations where an FCM may currently be in
compliance with minimum financial requirements, but lacks liquidity to
meet pending, non-discretionary obligations such that the firm's
ability to continue operating in the near term is in serious jeopardy.
In such a situation, it is expected that the Commission and the FCM's
DSRO and applicable DCOs would be in frequent communication with the
firm to review the FCM's options and plans to continue operating as a
going concern and to assess what actions were necessary to ensure the
firm continues to meet its obligations as a market intermediary and to
protect customer funds. If an FCM's management cannot in good faith
certify that the FCM has sufficient liquidity to permit it to operate
throughout the following week, then the FCM has failed to meet its
minimum financial requirements necessary to ensure that the firm will
continue to meet its obligations as a registrant and the Commission
would have to determine how to minimize the impact of a potential FCM
insolvency or default.
The Commission has considered the comments and has determined to
adopt the amendments as proposed.
2. Reducing Time Period for FCMs To Incur a Capital Charge for
Undermargined Accounts to One Day After Margin Calls Are Issued
Regulation 1.17 requires an FCM to incur a charge to capital for
customer and noncustomer accounts that are undermargined beyond a
specified period of time.\144\ Regulation 1.17(c)(5)(viii) currently
requires an FCM to reduce its capital (i.e., take a capital charge) if
a customer account is undermargined for three business days after the
margin call is issued.\145\ Regulation 1.17(c)(5)(ix) requires an FCM
to take a capital charge for noncustomer and omnibus accounts that are
undermargined for two business days after the margin call is issued.
---------------------------------------------------------------------------

\144\ Noncustomers are defined in Sec. 1.17(b)(4) as accounts
carried by the FCM that are not customer accounts or proprietary
accounts. Noncustomer accounts are generally accounts carried by an
FCM for affiliates and certain employees of the FCM.
\145\ For purposes of these Commission regulations, a margin
call is presumed to be issued by the FCM the day after an account
becomes undermargined.
---------------------------------------------------------------------------

The Commission proposed to amend Sec. 1.17(c)(5)(viii) and (ix) to
require an FCM to take capital charges for undermargined customer,
noncustomer, and omnibus accounts that are undermargined for more than
one business day after a margin call is issued. Thus, for example,
under the proposal, if an account carried by an FCM became
undermargined on Monday, the operation of the regulation assumes that
the FCM would issue a margin call on Tuesday, and the FCM would have to
incur a capital charge at the close of business on Wednesday if the
margin call was still outstanding.
Vanguard commented that it supported the Commission's proposal,
stating that the accelerated timetable makes sense given modern trading
and asset transfer timing.\146\ Vanguard further stated that each
customer must stand up for its trades and promptly post margin, and it
further stated that it believes the overall market may be weakened to
the extent an FCM is

[[Page 68530]]

extending significant amounts of credit over an extended period to
cover a customer's margin deficit.\147\
---------------------------------------------------------------------------

\146\ Vanguard Comment Letter at 7 (Feb. 22, 2013).
\147\ Id.
---------------------------------------------------------------------------

MFA objected to the proposal noting that, while in the ordinary
course of business, few margin calls remain outstanding for more than
two business days, the proposal does recognize the practical reasons
why a margin call may be outstanding more than 2 business days after
the call issued.\148\ MFA cited disputes between an FCM and its
customer as to the appropriate level of margin, and good faith errors
that may cause a delay beyond 2 days for a margin call to be met.\149\
MFA also stated that an increase in costs resulting from the regulation
will ultimately be passed on the customers.
---------------------------------------------------------------------------

\148\ MFA Comment Letter at 7 (Feb. 15, 2013).
\149\ Id.
---------------------------------------------------------------------------

The NCBA stated that the proposal may require market participants
to use wire transfers in lieu of checks, which will increase the costs
and impose a significant financial burden to the cattle industry.\150\
The NCBA also stated that the proposal will cause customers to prefund
their accounts for anticipated margin requirements, which will reduce
customers' capital and impede their other business operations.\151\ The
NCBA further noted that the proposal is not related to the MFGI and
PFGI failures, which were not caused by customers failing to meet
margin calls.\152\
---------------------------------------------------------------------------

\150\ NCBA Comment Letter at 2 (Feb. 15, 2013).
\151\ Id.
\152\ Id. See also JSA Comment Letter at 2 (Feb. 15, 2013) and
ICA Comment Letter at 1-2 (Feb. 15, 2013).
---------------------------------------------------------------------------

JSA stated that an effective increase in a capital charge for
undermargined customer accounts could cause an increase in requirements
for customers to prefund their accounts, which would be punitive in a
highly competitive environment that already places midsized FCMs and
FCMs that are not affiliated with a banking institution at a
disadvantage to larger, more highly capitalized firms, or FCMs that are
affiliated with banking institutions.\153\ JSA also stated that if
smaller FCMs are forced out of the market, larger FCMs or FCMs
affiliated with banks may not be willing to service customers that are
farmers, ranchers, retail, or introduced brokerage accounts, for which
they have historically shown little interest.\154\
---------------------------------------------------------------------------

\153\ JSA Comment Letter at 2 (Feb. 15, 2013). See also Frontier
Futures Comment Letter at 2-3 (Feb. 14, 2013).
\154\ Id.
---------------------------------------------------------------------------

FIA stated that while institutional and many commercial market
participants generally meet margin calls by means of wire transfers,
the proposal, creates operational problems because it does not consider
delays arising from accounts located in other time zones that cannot
settle same day, or ACH settlements, or the requirement to settle or
convert certain non-U.S. dollar currencies.\155\ FIA also stated that a
substantial number of customers that do not have the resources of large
institutional customers (in particular members of the agricultural
community) depend on financing from banks to fund margin requirements,
which may require more than one day to obtain.\156\
---------------------------------------------------------------------------

\155\ FIA Comment Letter at 26 (Feb. 15, 2013).
\156\ Id.
---------------------------------------------------------------------------

RJ O'Brien stated that it recognized that the collection of margin
is a critical component of an FCM's risk management program, however,
it objected to the proposed amendment.\157\ RJ O'Brien stated that as
the largest independent FCM serving a client base that includes a great
number of farmers and ranchers, it is well aware that many customers
that use the markets to hedge commercial risk still meet margin calls
by check or ACH because of the impracticality and costliness of wire
transfers in their circumstances.\158\ RJ O'Brien stated that in many
cases, the costs of a wire transfer would exceed the transaction costs
paid by the client to its FCMs, and additionally, that some customers
in the farming and ranching community finance their margin calls, which
can require additional time to arrange for delivery of margin call
funds due to routine banking procedures.\159\
---------------------------------------------------------------------------

\157\ RJ O'Brien Comment Letter at 3-4 (Feb. 15, 2013).
\158\ Id. See also RCG Comment Letter at 5 (Feb. 12, 2013). RCG
also recommended that the Commission implement a pilot program that
requires FCMs to provide the Commission with daily undermargined
reports. The Commission does not believe that a pilot program is
necessary for gathering additional information.
\159\ Id.
---------------------------------------------------------------------------

RJ O'Brien also stated that if the proposal is adopted, FCMs that
service non-institutional clients will struggle to remain competitive
and the proposal may result in fewer clearing FCMs and greater systemic
risk to the marketplace.\160\ RJ O'Brien further stated that many of
the larger FCM/BDs likely have little interest in servicing smaller
rancher and farmer clients, as was evidenced in the wake of MFGI's
failure, and that a loss of such smaller FCMs will result in fewer
options available to these ranchers, farmers and other commercial
market participants that wish to hedge their commercial risks.\161\
---------------------------------------------------------------------------

\160\ Id.
\161\ Id.
---------------------------------------------------------------------------

TD Ameritrade stated that it did not support the proposed
amendments to Sec. 1.17(c)(5)(viii) and (ix) as it would impose
financial hardships on customers that the Proposal was intended to
protect.\162\ TD Ameritrade stated that a large number of retail
customers do not currently use wire transfers to meet a margin
requirement in one business day.\163\ TD Ameritrade also noted that
non-U.S. customer accounts are faced with time zone differences and
inherent delays in meeting margin calls.\164\
---------------------------------------------------------------------------

\162\ TD Ameritrade Comment Letter at 3-4 (Feb. 15, 2013).
\163\ Id.
\164\ Id.
---------------------------------------------------------------------------

Other commenters expressed the general concern that the proposal
will harm the customers it is meant to protect by requiring more
capital to be kept in customer accounts, possibly forcing users to hold
funds at FCMs well in excess of their margin requirements, or resulting
in certain segments of the market to forego the futures markets to
hedge their commercial operations.\165\ Those commenters argued that
such pre-funding could add significant financial burdens to trading as
customers find themselves having to provide excess funds to their
brokers which could increase their risk with regard to the magnitude of
funds potentially at risk in the event of future FCM insolvencies.\166\
The commenters general expressed significant concerns that reducing
margin calls to one day will harm many customers as: (1) Many small
businesses, farmers, cattle producers and feedlot operators routinely
pay by check and forcing them to use wire transfers increases their
cost of doing business; (2) clients who make margin calls by ACH
payments instead of wire transfers because ACH is cheaper, would no
longer be able to do so because there is a one-day lag in availability
of funds; and (3) foreign customers would not be able to make margin
calls due to time zone differences, the time required to convert
certain non-USD currencies, and for

[[Page 68531]]

whom banking holidays fall on different days.\167\
---------------------------------------------------------------------------

\165\ NPPC Comment Letter at 2 (Feb. 14, 2013); RCG Comment
Letter at 4-5 (Feb. 12, 2013); NGFA Comment Letter at 3 (Feb. 15,
2013); NEFI/PMAA Comment Letter at 3 (Jan. 14, 2013); AIM Comment
Letter at 15 (Jan. 24, 2013); Amarillo Comment Letter at 1 (Feb. 14,
2013); NCFC Comment Letter at 1 (Feb. 15,2013); NFA Comment Letter
at 12-13 (Feb. 15, 2013); FCStone Comment Letter at 3 (Feb. 15,
2013); Advantage Comment Letter at 1-2 (Feb. 15, 2013); AFBF Comment
Letter at 2 (Feb. 15, 2013); CCC Comment Letter at 2 (Feb. 15,
2013); Steve Jones Comment Letter at 1 (Feb. 14, 2013); ICA Comment
letter at 1-2 (Feb. 15, 2013);TCFA Comment Letter at 1-2 (Feb. 15,
2013); CME Comment Letter at 5 (Feb. 15, 2013). AIM resubmitted the
comment letters of Premier Metal Services, NEFI/PMAA, and the ISRI
and indicated its support for the recommendations therein (Jan. 14,
2013).
\166\ Id.
\167\ Id.
---------------------------------------------------------------------------

The CCC stated that the proposed amendment to the capital rule
places an undue burden on the FCMs, which will likely result in FCMs
demanding that customers prefund trades to prevent market calls and
potential capital charges.\168\ The CCC also stated that the proposal
could result in forced liquidations of customer positions to ensure
that the FCM does not incur a capital charge.\169\
---------------------------------------------------------------------------

\168\ CCC Comment Letter at 2-3 (Feb. 15, 2013).
\169\ Id.
---------------------------------------------------------------------------

FIA and RJ O'Brien provided alternatives to the Commission's
proposal. Both FIA and RJ O'Brien offered that an FCM be required to
take a capital charge for any customer margin deficit exceeding
$500,000 that is outstanding for more than one business day.\170\ FIA
further suggested that if the customer's margin deficit is $500,000 or
less, the FCM should take a capital charge if the margin call is
outstanding two business days or more after the margin call is
issued.\171\ RJ O'Brien's comment letter does not address the timing of
the capital charge for accounts with a margin deficit of $500,000 or
less.
---------------------------------------------------------------------------

\170\ FIA Comment Letter at 27 (Feb. 27, 2013); RJ O'Brien
Comment Letter at 4 (Feb. 15, 2013).
\171\ FIA Comment Letter at 27 (Feb. 15, 2013).
---------------------------------------------------------------------------

NFA, FIA, MFA and AIMA stated that if the Commission adopts the
amendments regarding residual interest as proposed, then the Commission
should consider whether a capital charge for undermargined accounts
remains necessary at all because the FCM will have already accounted
for an undermargined account by maintaining a residual interest
sufficient at all times to exceed the sum of all margin deficits; hence
the capital charges related to an undermargined account appear to
impose an additional financial burden without any necessary financial
protection.\172\
---------------------------------------------------------------------------

\172\ NFA Comment Letter at 13 (Feb. 15, 2013); FIA Comment
Letter at 26 (Feb. 15, 2013); MFA Comment Letter at 6-7 (Feb. 15,
2013); and AIMA Comment Letter at 3 (Feb. 15, 2013).
---------------------------------------------------------------------------

RJ O'Brien also stated that the Commission should provide at least
a one-year period of time for any changes to the timeframe for taking a
capital charge for undermargined accounts to be effective.\173\ RJ
O'Brien stated that FCMs will need to educate and develop systems to
assist their clients in meeting margin calls in an expedited
timeframe.\174\ Lastly, RJ O'Brien stated that the Commission should
require futures exchanges to increase their margin requirements to 135%
of maintenance margin to reduce the number and frequency of margin
calls.\175\
---------------------------------------------------------------------------

\173\ RJ O'Brien Comment Letter at 4 (Feb. 15, 2013).
\174\ Id.
\175\ Id.
---------------------------------------------------------------------------

With respect to the reduction of the timeframe in Sec.
1.17(c)(5)(viii) for an FCM to incur a capital charge for undermargined
customer accounts, the Commission has considered the comments and has
determined to adopt the amendments as proposed. The timely collection
of margin is a critical component of an FCM's risk management program
and is intended to ensure that an FCM holds sufficient funds deposited
by customers to meet their potential obligations to a DCO. As guarantor
of the financial performance of the customer accounts that it carries,
the FCM is financially responsible if the owner of an account cannot
meet its margin obligations to the FCM and ultimately to a DCO.
The timeframe for meeting margin calls currently provided in Sec.
1.17(c)(5)(viii) was established in the 1970s when the use of checks
and the mail system were more prevalent for depositing margin with an
FCM. However, in today's markets, with the increasing use of
technology, 24-hour-a-day trading, and the use of wire transfers to
meet margin obligations, the Commission believes that the timeframe for
taking a capital charge should be reduced both to give an incentive to
FCMs to exercise prudent risk management and to strengthen the
financial protections of FCMs, and to enhance the safety of the
clearing systems and other customers by requiring FCMs to reserve
capital for undermargined customer accounts that fail to meet a margin
call on a timely basis.
Several commenters have stated that the proposal would harm
customers by increasing costs to customers or by exposing more of the
customers' funds to the FCM.\176\ The Commission notes that the final
regulation provides for at least two full days from the point in time
that a customer's account is undermargined to the time the FCM is
required to incur a capital charge for the undermargined account. Under
the regulation, if a customer's account becomes undermargined at some
point before close of business on Monday, the FCM will have until the
close of business on Wednesday before it is required to take a capital
charge. Customers are responsible for monitoring the activity in their
account and should have information that would allow them to determine
that their trading account is undermargined prior to the close of
business on Monday.
---------------------------------------------------------------------------

\176\ See, e.g., NCBA Comment Letter at 2 (Feb. 15, 2013); NGFA
Comment Letter at 3-4 (Feb. 15, 2013).
---------------------------------------------------------------------------

The alternative proposed by FIA and RJ O'Brien is premised on their
belief that the regulation would not provide an adequate amount of time
for a customer to meet a margin call before the FCM would have to take
a capital charge for an undermargined account. As noted above, the
Commission believes that the regulation, which provides at least two
full business days for a customer to fund its undermargined account,
does provide an adequate period of time for margin calls to be met. In
situations involving customers located in foreign jurisdictions and the
associated issues of time zone differences and differences in banking
holidays, the Commission believes that the FCM should include such
factors in its risk management program and operating procedures with
such customers in an effort to ensure compliance with the regulations.
The Commission believes that the time period provided in Sec.
1.17(c)(5)(viii) is adequate in most situations for a customer to
receive and fund a margin call. The intent of margin is to ensure that
a customer maintains a sufficient amount of funds in its account to
cover 99 percent of the observed market moves of its portfolio of
positions over a specified period of time. Customers that maintain
fully margined accounts are exposed to greater risk to the safety of
their funds if other customer accounts carried by the FCM are
undermargined. In order to provide greater protection to the customers
that are fully margined or maintain excess margin on deposit, and to
provide greater assurance that the FCM can continue to meet its
financial obligations to DCOs, the Commission believes that the FCM
should maintain a sufficient amount of capital to cover the potential
shortfall in undermargined customers' accounts.
The Commission also has considered the comments on the proposed
amendments to Sec. 1.17(c)(5)(ix), which reduce the timeframe for an
FCM to incur a capital charge on an undermargined noncustomer or
omnibus account from two days after the call was issued to one day
after the call was issued. The Commission notes that the majority of
the comments addressed the undermargined charge on customer accounts,
but considered the comments generally in reviewing the proposed
amendments to Sec. 1.17(c)(5)(ix).
The Commission has considered the proposal and is adopting the
amendments to Sec. 1.17(c)(5)(ix) as

[[Page 68532]]

proposed. As noted above, Sec. 1.17(c)(5)(ix) applies to noncustomers
and omnibus accounts carried by an FCM. Many of the concerns raised by
the comments regarding the ability to fund a margin call under Sec.
1.17(c)(5)(viii) do not apply to accounts held by an affiliate or an
omnibus accounts. Such accounts should pay margin calls promptly and by
wire transfer to reduce the potential exposure to the FCM resulting
from undermargined accounts.
The Commission also believes that the amendments to Sec.
1.17(c)(5)(viii) and (ix) are appropriate even if the Commission amends
its regulations to require an FCM to maintain residual interest in
segregated accounts in excess of the undermargined amount of customer
accounts. The purpose of the capital rule is to ensure that an FCM
maintains sufficient liquid assets to meet its obligations as a going
concern. Proprietary funds held in segregated accounts that exceed the
total obligation to customers are included in an FCM's capital
computation. However, in situations where the FCM's residual interest
in segregated accounts is covering an undermargined customer account, a
capital charge is appropriate because the FCM's residual interest is
necessary to cover potential market losses on the undermargined
accounts.
3. Permit an FCM That Is Not a BD To Develop Policies and Procedures To
Determine Creditworthiness
The Commissions proposed to amend Sec. 1.17(c)(v) to permit an FCM
that is not a BD to develop a framework to establish, maintain and
enforce written policies and procedures for determining
creditworthiness of commercial paper, convertible debt, and
nonconvertible debt instruments that are readily marketable. In
recommending the proposal, the Commission noted that the SEC proposed
to permit a BD to establish written policies and procedures to assess
the credit risk of commercial paper, convertible debt, and
nonconvertible debt instruments that are readily marketable.\177\
---------------------------------------------------------------------------

\177\ The SEC has proposed rule amendments to implement the
Dodd-Frank Act requirement to remove references to credit ratings in
its regulations and substitute a standard for creditworthiness
deemed appropriate. See 76 FR 26550 (May 6, 2011).
---------------------------------------------------------------------------

Under both the Commission's proposal and the SEC's proposal, an FCM
or BD would assess the security's credit risk using the following
factors, to the extent appropriate:
Credit spreads (i.e., whether it is possible to
demonstrate that a position in commercial paper, nonconvertible debt,
and preferred stock is subject to a minimal amount of credit risk based
on the spread between the security's yield and the yield of Treasury or
other securities, or based on credit default swap spreads that
reference the security);
Securities-related research (i.e., whether providers of
securities-related research believe the issuer of the security will be
able to meet its financial commitments, generally, or specifically,
with respect to securities held by the FCM or BD);
Internal or external credit risk assessments (i.e.,
whether credit assessments developed internally by the FCM or BD or
externally by a credit rating agency, irrespective of its status as an
NRSRO, express a view as to the credit risk associated with a
particular security);
Default statistics (i.e., whether providers of credit
information relating to securities express a view that specific
securities have a probability of default consistent with other
securities with a minimal amount of credit risk);
Inclusion on an index (i.e., whether a security, or issuer
of the security, is included as a component of a recognized index of
instruments that are subject to a minimal amount of credit risk);
Priorities and enhancements (i.e., the extent to which a
security is covered by credit enhancements, such as
overcollateralization and reserve accounts, or has priority under
applicable bankruptcy or creditors' rights provisions);
Price, yield and/or volume (i.e., whether the price and
yield of a security or a credit default swap that references the
security are consistent with other securities that the FCM or BD has
determined are subject to a minimal amount of credit risk and whether
the price resulted from active trading); and
Asset class-specific factors (e.g., in the case of
structured finance products, the quality of the underlying assets).
An FCM that maintains written policies and procedures and
determines that the credit risk of a security is minimal is permitted
under the proposal to apply the lesser haircut requirement currently
specified in the SEC capital rule for commercial paper (i.e., between
zero and \1/2\ of 1 percent), nonconvertible debt (i.e., between 2
percent and 9 percent), and preferred stock (i.e., 10 percent).
The CFA does not believe it is appropriate for FCMs to use internal
models to determine minimum required capital.\178\ The CFA believes
that capital models should be established by the relevant regulatory
agencies for use by FCMs or BDs.\179\ It has serious concerns that
internal models used for calculating minimum capital requirements are
prone to failure in a crisis.\180\ The CFA states that the regulatory
agency should provide an objective and clear minimum risk-based capital
baseline.\181\
---------------------------------------------------------------------------

\178\ CFA Comment Letter at 4-5 (Feb. 13, 2013).
\179\ Id.
\180\ Id.
\181\ Id.
---------------------------------------------------------------------------

As noted above, the SEC has proposed amendments to its net capital
rule to allow BDs to take a lower net capital charge on certain
securities based on the BDs' own determinations that certain securities
have minimal credit risk, pursuant to the BDs having protocols for
assessing the credit risk and maintaining appropriate documentations.
If the SEC approves the proposal, the SEC capital charges would apply
to an FCM that is dually-registered as an FCM/BD. In the absence of the
Commission adopting a similar provision, certificates of deposit,
bankers acceptances, commercial paper and nonconvertible debt
securities held by standalone FCMs that have very low credit and market
risk securities would be subject to the minimum default securities
haircut of 15 percent.
The Commission proposed that standalone FCMs be permitted the same
flexibility as FCM/BDs with respect to taking a lower capital charges
for certain securities that may be determined to have minimal credit
risk. The Commission also notes that based upon a review of Forms 1-FR-
FCM filed with the Commission, standalone FCMs generally have limited
investments in the types of securities that would be subject to the
internal models, and such haircuts are not material to most standalone
FCM's adjusted net capital.
The Commission has considered the proposal and is adopting the
amendments as proposed.
4. Revisions to Definitions in Regulation 1.17(b)
The Commission proposed technical amendments to certain definitions
in Sec. 1.17(b)(2) and (7) to reflect proposed changes the term ``30.7
customer'' and to remove surplus language due to other revisions to the
regulations. No comments were received on these proposed changes and
the Commission is adopting the proposal as final.
Regulation 1.17(a) requires each FCM, in computing its minimum
capital requirement, to include 8 percent of the risk margin required
on futures and over the counter derivative instruments that the FCM
carries in customer and non-

[[Page 68533]]

customer accounts. Regulation 1.17(b)(9) defines the term ``over the
counter derivative instruments'' as those instruments set forth in 12
U.S.C. 4421. Section 740 of the Dodd-Frank Act, however, repealed 12
U.S.C. 4421.
The Commission, however, has not revised its capital requirements
and continues to require FCMs to include over the counter derivative
instruments that it carries in customer and non-customer accounts in
their minimum capital computations. The Commission interprets Sec.
1.17(b)(9) to require an FCM to include the types of derivative
transactions or instruments that were previously set forth in 12 U.S.C.
4421 in its computation of its minimum capital requirement. The
Commission also has directed staff to develop a rulemaking to amend
Regulation 1.17(b)(9) to account for the repeal of 12 U.S.C. 4421.

G. Sec. 1.20: Futures Customer Funds To Be Segregated and Separately
Accounted for

Regulation 1.20 imposes obligations on FCMs, DCOs, and other
depositories regarding the holding, and accounting for, customer funds.
The Commission proposed to reorganize the structure of Sec. 1.20 by
providing additional subparagraphs to the existing specific
requirements, and by applying headings to the regulation to assist in
the reading and understanding of the regulation. The Commission also
proposed new provisions discussed below to enhance the protection of
customer funds.
1. Identification of Customer Funds and Due Diligence
The Commission proposed to amend Sec. 1.20(a) to more clearly
define the requirements regarding how FCMs must hold customer funds.
Proposed paragraph (a) of Sec. 1.20 requires an FCM to separately
account for all futures customer funds and to segregate futures
customer funds from its own funds. The proposed amendments further
provide that an FCM shall deposit customer funds with a depository
under an account name that clearly identifies the funds as futures
customer funds and shows that the funds are segregated as required by
the Act and Commission regulations. Proposed paragraph (a) also
provides that an FCM must perform due diligence of each depository
holding customer segregated funds (including depositories affiliated
with the FCM), as required by new Sec. 1.11, and to update its due
diligence on at least an annual basis.
Proposed paragraph (a) also provides that an FCM must maintain at
all times in the separate account or accounts funds in an amount at
least sufficient in the aggregate to cover its total obligations to all
futures customers. Proposed paragraph (a) further provides that an FCM
computes its ``total obligations'' to futures customers as the
aggregate amount of funds necessary to cover the Net Liquidating
Equities of all futures customers as set forth in paragraph Sec.
1.20(i).
The Commission stated in the Proposal that it is not sufficient for
an FCM to be in compliance with its segregation requirement at the end
of a business day, but fail to hold sufficient funds in segregation to
meet the Net Liquidating Equities of each of its customers on an intra-
day basis. This provision explicitly clarifies the Commission's long-
standing interpretation of existing statutory and regulatory
requirements on how FCMs must hold customer funds. Section 4d(a)(2) of
the Act requires an FCM to treat and deal with all money, securities,
and property received by the FCM to margin, guarantee, or secure the
trades or contracts of any customer of the FCM, or accruing to such
customer as the result of such trades or contracts, as belonging to
such customer. Section 4d(a)(2) further provides that funds belonging
to a customer must be separately accounted for by the FCM and may not
be commingled with the funds of the FCM or be used to margin or
guarantee the trades or contracts, or extend the credit, of any
customer or person other than the customer for whom the FCM holds the
funds. The separate treatment of customer funds is further set forth in
Sec. 1.22 which provides that no FCM shall use, or permit the use of,
the funds of one customer to purchase, margin, or settle the trades,
contracts, or commodity options of, or to secure or extend the credit
of, any person other than such customer. Therefore, the current
statutory and regulatory regime requires an FCM to maintain at all
times a sufficient amount of funds in segregation to cover the full
amount of the firm's obligations to its customers (i.e., the aggregate
Net Liquidating Equity of each customer) to prevent the FCM from using
the funds of one customer to margin or guarantee the commodity
interests of other customers, or to extend credit to other customers.
In its letter, the FIA stated that ``[t]he Commission has stated,
and [FIA] agrees, that FCMs are required to comply with the segregation
provisions of the Act at all times.'' \182\ FIA further cited to a
Commission 1998 rulemaking where the Commission stated the segregation
rules require compliance at all times.\183\ If an FCM is not in
compliance with its obligation to maintain a sufficient amount of funds
in segregation to meet the Net Liquidating Equities of all of its
customer on an intra-day basis, the FCM would be using the funds of one
customer to margin positions of another customer, or to cover the
losses of another customer in violation of section 4d of the Act and
Commission regulations.
---------------------------------------------------------------------------

\182\ FIA Comment Letter at 2 (Jun 20, 2013). In addition, FIA
expressed its agreement with the existing requirement for an FCM to
maintain sufficient funds in segregation at all times to cover its
total obligation to its customers.
\183\ Id. (citing 63 FR 2188, 2190 (Jan. 14, 1998)).
---------------------------------------------------------------------------

The Commission did not receive any comments on revised paragraph
(a) and is adopting the amendments as proposed.
2. Permitted Depositories
Proposed paragraph (b) of Sec. 1.20 lists the permitted
depositories for futures customer funds as any bank, trust company,
DCO, or another FCM, subject to compliance with the FCM's risk
management policies and procedures required in new Sec. 1.11. The
Commission did not propose changes to the list of permitted
depositories for FCMs. The Commission did not receive any comments on
paragraph (b) and is adopting the amendments as proposed.
3. Limitation on the Holding of Futures Customer Funds Outside of the
United States
Proposed paragraph (c) of Sec. 1.20 provides that an FCM may hold
futures customer funds in depositories outside of the U.S. only in
accordance with the current provisions of Sec. 1.49. The Commission
received no comments on paragraph (c) and is adopting the amendments as
proposed.
4. Acknowledgment Letters
a. Background
Proposed paragraph (d) of Sec. 1.20 would require an FCM to obtain
a written acknowledgment from each bank, trust company, DCO, or FCM
with which the FCM opens an account to hold futures customer funds,
with the exception of a DCO that has Commission-approved rules
providing for the segregation of such funds. Similarly, proposed Sec.
1.20(g)(4) would require a DCO to obtain a written acknowledgment from
each depository prior to or contemporaneously with the opening of a
futures customer funds account. Paragraphs (d) and (g) further
enumerate requirements for acknowledgment letters, expanding upon the
requirements set forth in current Sec. 1.20. Proposed Sec. 1.26,
which would require an FCM or DCO that

[[Page 68534]]

invests customer funds in instruments described in Sec. 1.25 to obtain
an acknowledgment letter from the depository holding such
instruments,\184\ and proposed Sec. 30.7(c)(2), which would require an
FCM to obtain an acknowledgment letter from each depository with which
it opens an account to hold funds on behalf of its foreign futures and
foreign options customers, are consistent with proposed Sec. 1.20(a)
and (g)(4). The Commission proposed to repeal and replace Sec.
30.7(c)(2), but retain the requirement to obtain an acknowledgment
letter in proposed Sec. 30.7(d).
---------------------------------------------------------------------------

\184\ Section 22.5 applies the written acknowledgment
requirements of Sec. Sec. 1.20 and 1.26 to FCMs and DCOs in
connection with depositing Cleared Swaps Customer Collateral in an
account at a permitted depository.
---------------------------------------------------------------------------

The Commission has proposed amendments to the acknowledgment letter
requirements in Sec. Sec. 1.20, 1.26, and 30.7 in three separate
notices of proposed rulemaking, the first being published on February
20, 2009 (the ``Original Proposal'').\185\ The Original Proposal set
out specific representations that would have been required to be
included in all acknowledgment letters in order to reaffirm and to
clarify the obligations that depositories incur when accepting customer
funds.
---------------------------------------------------------------------------

\185\ 74 FR 7838 (Feb. 20, 2009).
---------------------------------------------------------------------------

In light of the comments on the Original Proposal, in 2010 the
Commission re-proposed the amendments with several changes made in
response to comments (the ``First Revised Proposal'').\186\ As part of
the First Revised Proposal, the Commission proposed the required use of
standard template acknowledgment letters, which were included as
Appendix A to each of Sec. Sec. 1.20 and 1.26, and Appendix E to part
30 of the Commission's regulations (referred to herein as the
``Template Letters'').
---------------------------------------------------------------------------

\186\ 75 FR 47738 (Aug. 9, 2010).
---------------------------------------------------------------------------

The Commission received nine comment letters on the First Revised
Proposal. In general, the commenters were supportive of the First
Revised Proposal and, in particular, were very supportive of requiring
the use of Template Letters. It was noted by certain commenters that
use of a standard letter would simplify the process of obtaining an
acknowledgment letter. In addition, commenters were in agreement that
uniformity of acknowledgment letters would provide consistency and
greater legal certainty across the commodities and banking industries.
The Commission proposed further refinements to the acknowledgment
letter requirements in 2012 to address several issues that had arisen
in the context of the MFGI and PFGI failures and their adverse impact
on customers of those FCMs (``Second Revised Proposal'').\187\ In the
Second Revised Proposal, the Commission also addressed comments it had
received in response to the First Revised Proposal and incorporated
related changes to the Template Letters.
---------------------------------------------------------------------------

\187\ 77 FR 67866 (Nov. 14, 2012).
---------------------------------------------------------------------------

The Commission received 15 comment letters related to the Template
Letters in response to the Second Revised Proposal.\188\ Again, the
commenters were generally supportive of the Commission's proposal and,
in particular, were supportive of the mandatory use of Template
Letters. The Depository Bank Group commented that the Template Letters
will help ``facilitate a more efficient process for the establishment
and maintenance of customer segregated accounts'' and clarify the
rights and responsibilities of depositories.\189\ Eurex noted that it
appreciated the ``potential convenience'' and increased certainty and
transparency afforded by the Template Letters.\190\ CME supported the
Commission's efforts to ``strengthen and standardize'' the Template
Letters.\191\
---------------------------------------------------------------------------

\188\ Letters were submitted by Schwartz & Ballen, FIA,
LCH.Clearnet, MGEX, the Federal Reserve Banks, NYPC, CME, the
Depository Bank Group, Eurex, RJ O'Brien, RCG, NFA, FCStone, ICI,
and Katten-FIA.
\189\ Depository Bank Group Comment Letter at 2 (Feb. 15, 2013).
\190\ Eurex Comment Letter at 1 (Aug. 1, 2013).
\191\ CME Comment Letter at 7 (Feb. 15, 2013).
---------------------------------------------------------------------------

While many of the comments were supportive of the Template Letters,
FCStone expressed the view that ``prescriptive rules'' could drive
participants out of the futures industry.\192\ MGEX commented that the
required use of a Template Letter appeared to be a ``dramatic shift''
from the current requirements and questioned whether depositories would
be willing to sign the Template Letter due to the ``access and timing
information requirements.'' \193\ RCG stated that early indications
were that many depositories ``with extensive experience servicing
FCMs'' are unwilling to sign the Template Letter and expressed concern
that if such depositories refuse to sign, customer funds will become
concentrated with depositories ``less experienced in carrying FCM
accounts.'' \194\
---------------------------------------------------------------------------

\192\ FCStone Comment Letter at 5 (Feb. 15, 2013).
\193\ MGEX Comment Letter at 3 (Feb. 18, 2013).
\194\ RCG Comment Letter at 7 (Feb. 12, 2013).
---------------------------------------------------------------------------

Regulation 1.20 in its current form already requires FCMs and DCOs
to obtain acknowledgment letters, and the Commission believes that use
of a standardized Template Letter will reduce negotiation costs, create
efficiencies for Commission registrants as well as non-registrant
depositories, provide greater legal certainty as to the rights and
obligations of parties under the Act and CFTC regulations, and
facilitate consistent treatment of customer funds across FCMs, DCOs,
and depositories. In addition, the use of a standardized letter is the
approach that has been proposed by the Financial Conduct Authority
(``FCA'') in the United Kingdom (``U.K.'').\195\
---------------------------------------------------------------------------

\195\ See Financial Conduct Authority, ``Review of the client
assets regime for investment business,'' Consultation Paper CP13/5
(July 2013).
---------------------------------------------------------------------------

The Commission has taken into consideration the comments and
recommendations provided by FCMs, DCOs, and depositories, and it
believes the final rules and Template Letters largely address the
concerns they have expressed. The Commission's response to comments on
the major issues raised by commenters is discussed by subject matter,
below.
b. Technical Changes to the Template Letters
Proposed paragraphs (d)(2) and (g)(4)(ii) of Sec. 1.20 would
require FCMs and DCOs, respectively, to use the Template Letter set
forth in Appendix A to Sec. 1.20 when opening a customer segregated
account with a depository. In response to the comments, and in
recognition of the different functions FCMs and DCOs perform in
relation to customer funds, the Commission has determined to finalize
different versions of the Template Letters for FCMs and DCOs. The
Template Letter specific to FCMs is being adopted as Appendix A to
Sec. 1.20, and the Template Letter for DCOs is being adopted as
Appendix B to Sec. 1.20. Paragraph (g)(4)(ii) has been revised to
require DCOs to use the Template Letter in Appendix B.
Another change concerns the full account name as it appears in the
Template Letter. Proposed Sec. 1.20(a) and (g)(1) provides in part
that customer funds shall be deposited ``under an account name that
clearly identifies them as futures customer funds and shows that such
funds are segregated as required by sections 4d(a) and 4d(b) of the Act
and [part 1 of the Commission's regulations].'' Schwartz & Ballen noted
that operational constraints limit the number of characters available
for account names, and requested additional flexibility with regard to
account titles ``so long as the accounts are clearly identified as
custodial

[[Page 68535]]

accounts held for the benefit of the FCM's customers.'' \196\
---------------------------------------------------------------------------

\196\ Schwartz & Ballen Comment Letter at 8 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission has modified the Template Letters to accommodate a
depository's account titling conventions. The Commission will permit a
depository to abbreviate the account name when the full name as set
forth in the Template Letter is too long for a depository's operational
system to include all characters, provided that (i) the Template Letter
includes both the full and abbreviated account name(s) and (ii) the
abbreviated account name clearly identifies the account as a
Commission-regulated segregated/secured account that holds customer
funds (e.g., ``segregated'' may be shortened to ``seg;'' ``customer''
may be shortened to ``cust;'' ``account'' to ``acct;'' etc.).
FIA recommended several modifications to the Template Letters,
including the addition of a clause to address banking practices used to
provide third-party access to account information. As a result, the
Commission has added the following language to the FCM Template Letter
(and similar language to the other Template Letters): ``The parties
agree that all actions on your part to respond to the above information
and access requests will be made in accordance with, and subject to,
such usual and customary authorization verification and authentication
policies and procedures as may be employed by you to verify the
authority of, and authenticate the identity of, the individual making
any such information or access request, in order to provide for the
secure transmission and delivery of the requested information or access
to the appropriate recipient(s).''
In addition, the proposed Template Letters, as well as proposed
Sec. Sec. 1.20(d)(4) and (g)(4)(iv) and 30.7(d)(4), would require the
depository to agree to provide a copy of the executed acknowledgment
letter to the Commission at a specific email address. The email address
has been deleted from the Template Letters, and the depository is now
required to provide a copy to the Commission via electronic means in a
format and manner determined by the Commission. The rule text has been
revised accordingly (and Sec. 1.20(g)(4)(iv) has been renumbered as
Sec. 1.20(g)(4)(iii)).
Finally, the Commission has made minor technical revisions to the
Template Letters in the form of grammatical and stylistic changes to
clarify meaning and provide consistency among the letters.
c. Federal Reserve Banks as Depositories
Pursuant to Sec. 806(a) of the Dodd-Frank Act, the Board of
Governors of the Federal Reserve System (the ``Board'') may authorize a
Federal Reserve Bank to establish and maintain an account for
systemically important DCOs (``SIDCOs'') that have been designated by
the Financial Stability Oversight Council (``FSOC'') as systemically
important financial market utilities (``Designated FMUs'').\197\ In
their comment letter, the Federal Reserve Banks stated: ``Absent
clarification, the [Federal] Reserve Banks must assume that we would be
treated as depository institutions under the proposed rules if we were
to hold Designated FMU customer funds.'' The Federal Reserve Banks
commented that they do not believe that they can accept all of the
terms of the Template Letters given the ``unique nature of the
[Federal] Reserve Banks and of Designated FMUs.'' \198\
---------------------------------------------------------------------------

\197\ Section 806(a) of the Dodd-Frank Act; see also Federal
Reserve Banks Comment Letter at 1 (Feb. 22, 2013).
\198\ Federal Reserve Banks Comment Letter at 2 (Feb. 22, 2013).
---------------------------------------------------------------------------

The Federal Reserve Banks raised specific concerns with two terms
of the Template Letters: (1) The provision authorizing the Commission
to order the immediate release of customer funds; and (2) the provision
that allows a depository to presume legality for any withdrawal of
customer funds, provided the depository has no knowledge of, or could
not reasonably know of, any violation of the law. The Federal Reserve
Banks suggested that under ``exceptional circumstances, such as a
prospective insolvency of the SIDCO that threatens customer funds,'' a
Commission-authorized withdrawal would need to be considered in the
context of a larger coordinated effort, which would include FSOC.\199\
The Federal Reserve Banks further asserted that, due to their dual
roles as both supervisory bodies and providers of financial services,
coupled with the Board prohibition on sharing supervisory information
with personnel performing financial services, the standard of liability
leaves them in the ``untenable position of not being able to rely on
the presumption of legality.'' \200\
---------------------------------------------------------------------------

\199\ Id. at 1.
\200\ Id. at 2.
---------------------------------------------------------------------------

The Commission is adopting, as proposed, Sec. 1.20(g)(2), which
confirms that the Federal Reserve Banks are depositories for purposes
of section 4d of the Act and Commission regulations thereunder.
Accordingly, a Federal Reserve Bank would be required to execute a
written acknowledgment when it accepts customer funds from a SIDCO or
other DCO for which it holds customer funds. However, the Commission
recognizes the unique role of the Federal Reserve Bank and is therefore
modifying proposed Sec. 1.20(g)(4)(ii) to provide an exception for
Federal Reserve Banks from the requirement that depositories accepting
customer funds from DCOs execute the Template Letter in Appendix B to
Sec. 1.20. Rather, a Federal Reserve Bank will be required only to
execute a written acknowledgment that: (1) It was informed that the
customer funds deposited therein are those of customers who trade
commodities, options, swaps, and other products and are being held in
accordance with the provisions of section 4d of the Act and Commission
regulations thereunder; and (2) it agrees to reply promptly and
directly to any request from the director of the Division of Clearing
and Risk or the director of the Division of Swap Dealer and
Intermediary Oversight, or any successor divisions, or such directors'
designees, for confirmation of account balances or provision of any
other information regarding or related to an account.
The Commission is modifying proposed Sec. 1.20(g)(2) from ``A
[DCO] may deposit futures customer funds with a bank or trust company,
which shall include a Federal Reserve Bank with respect to deposits of
a systemically important [DCO]'' to ``A [DCO] may deposit futures
customer funds with a bank or trust company, which may include a
Federal Reserve Bank with respect to deposits of a [DCO] that is
designated by the Financial Stability Oversight Council to be
systemically important.'' Changing the phrase ``which shall include a
Federal Reserve Bank'' to ``which may include a Federal Reserve Bank,''
avoids possible ambiguity as to whether the DCO is required to deposit
futures customer funds with a Federal Reserve Bank. By revising the
description of the DCO, the Commission has effectively captured any
DCO, such as one that is also registered with the SEC as a clearing
agency and has been designated to be systemically important in that
capacity, which could hold customer funds at a Federal Reserve
Bank.\201\
---------------------------------------------------------------------------

\201\ For example, The Options Clearing Corporation is a
registered DCO that has been designated as ``systemically
important'' but is not a SIDCO as defined in Sec. 39.2 of the
Commission's regulations. A Federal Reserve Bank would be required
to segregate customer funds and provide an acknowledgment letter
under Sec. 1.20 with respect to any customer account subject to
section 4d of the Act and opened by The Options Clearing Corporation
in its capacity as a DCO.

---------------------------------------------------------------------------

[[Page 68536]]

d. Foreign Depositories
In its comment letter, Eurex questioned whether foreign
depositories could fully comply with the proposed regulations and
execute the Template Letters, noting the probability of ``strong
resistance'' by foreign depositories to providing the Commission with
read-only electronic access to account information.\202\ Eurex pointed
to the ``detailed nature of the representations'' in the Template
Letters and further expressed its belief that foreign depositories
would not be permitted to legally execute the Template Letters.\203\
Eurex recommended that the Commission consider alternative methods for
achieving the goal of the Template Letters, such as authorizing
Commission staff to ``accept alternate language'' from foreign
depositories.\204\ FIA commented that it had not discussed the Template
Letters with foreign depositories and thus did not know whether the
Template Letters would ``cause concern'' under a foreign jurisdiction's
laws.\205\
---------------------------------------------------------------------------

\202\ Eurex Comment Letter at 1 (Aug. 1, 2013).
\203\ Id. at 2.
\204\ Id.
\205\ FIA Comment Letter at 40 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission appreciates these perspectives related to foreign
depositories, but notes that the comments are of a general nature and
do not provide any specific examples to support the commenters'
assertions. The Commission did not receive a comment letter from any
foreign depository holding customer funds.
As noted above, the FCA recently proposed the use of template
acknowledgment letters for purposes of satisfying FCA acknowledgment
letter requirements. The proposed letters are similar in many respects
to the Template Letters the Commission is adopting herein, and FCA
regulations would require both U.K. and non-U.K. depositories to
execute the template acknowledgment letters.
The Commission recognizes that there may be valid reasons why some
foreign depositories would require modifications to the Template
Letters. In such circumstances, the Commission would consider
alternative approaches, including no-action relief, on a case-by-case
basis.
e. Release of Funds Upon Commission Instruction
As proposed, the Template Letters would require a depository to
release funds immediately upon instruction from the director of the
Division of Clearing and Risk, the director of the Division of Swap
Dealer and Intermediary Oversight, or any successor divisions, or such
directors' designees. The purpose of this provision was to enable the
Commission to expeditiously carry out measures to protect customer
funds in exceptional circumstances, such as the imminent bankruptcy of
an FCM. Commenters expressed concerns about this requirement, citing
liability that might arise from a depository acting or failing to act
``immediately,'' \206\ and the need for the depository to implement
proper security and authorization procedures in connection with acting
upon instructions from the Commission rather than the account
holder.\207\
---------------------------------------------------------------------------

\206\ Depository Bank Group Comment Letter at 10.
\207\ Id. at 11; Schwartz & Ballen Comment Letter at 2 (Feb. 15,
2013); Katten-FIA Comment Letter at 2 (Aug. 2, 2013).
---------------------------------------------------------------------------

With respect to DCOs in particular, NYPC pointed out that a DCO
normally holds customer funds in a segregated account without further
subdivision by customer or clearing member and, as a result, a DCO
would effectuate a transfer of customer funds from a defaulting
clearing member to a non-defaulting clearing member by book entry on
the DCO's books and records.\208\ NYPC noted that no transfer of funds
may be required if the DCO holds the funds at the same depository.
---------------------------------------------------------------------------

\208\ NYPC Comment Letter at 2 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Depository Bank Group commented that the term ``immediately''
may subject a depository to potential claims by FCMs, DCOs or the
Commission in the event of a delay in the transfer of customer funds,
even if such delay is the result of reasonable actions or events beyond
the control of the depository.\209\ As previously noted, the Federal
Reserve Banks commented that during such ``exceptional circumstances''
in which instructions to transfer funds from a SIDCO's account would
likely be made, the FSOC would be involved.\210\ The Depository Bank
Group, FIA, and Schwartz & Ballen all commented that the proposal is
``inconsistent'' with a depository's security policies and
procedures.\211\ CME requested that the Commission clarify the
exceptional circumstances that would give rise to the Commission's
request for an immediate release of customer funds and the impact such
an instruction could have on the timely payment of obligations to a
DCO.\212\
---------------------------------------------------------------------------

\209\ Depository Bank Group Comment Letter at 10 (Feb. 15,
2013).
\210\ Federal Reserve Banks Comment Letter at 1 (Feb. 22, 2013).
\211\ Id. at 11; Katten-FIA Comment Letter at 2 (Aug. 2, 2013);
and Schwartz & Ballen Comment Letter at 5 (Feb. 15, 2013).
\212\ CME Comment Letter at 7 (Feb. 15, 2013).
---------------------------------------------------------------------------

After considering the concerns raised by the commenters, the
Commission has determined not to require depositories to agree to
release or transfer customer funds upon its instruction. The Commission
notes that in exceptional circumstances such as the imminent bankruptcy
of an FCM, Commission staff would be in regular communication with the
FCM, its DSRO, DCOs, and depositories in an effort to protect customer
funds.
f. Read-Only Access and Information Requests
Proposed paragraphs (d)(3) and (g)(4)(iii) of Sec. 1.20, proposed
Sec. 30.7(d)(3), and the proposed Template Letters, including the
Template Letters for Sec. 1.26 investments in money market mutual
funds, would require depositories to provide the Commission with 24-
hour, read-only electronic access to accounts holding customer funds.
The Commission received eight comment letters on this requirement.
As a preliminary matter, FIA noted that significant time for
development would be necessary to implement such a requirement.\213\
Schwartz & Ballen observed that the read-only access approach conflicts
with bank procedures used to provide account information to third
parties, which typically involve allowing the customer to grant access
to a third party, rather than the bank doing so.\214\ The Depository
Bank Group and FIA also pointed out that Commission staff would be
required to comply with the depository's security policies and
procedures.\215\ The Depository Bank Group recommended that the
Template Letters expressly authorize the depository to provide access
to the Commission and suggested language that could be incorporated
into the Template Letters.\216\ RJ O'Brien agreed with the Depository
Bank Group's position on read-only access.\217\
---------------------------------------------------------------------------

\213\ FIA Comment Letter at 40 (Feb. 15, 2013).
\214\ Schwartz & Ballen Comment Letter at 4 (Feb. 15, 2013).
\215\ Depository Bank Group Comment Letter at 13 (Feb. 15,
2013); Katten-FIA Comment Letter at 2 (Aug. 2, 2013).
\216\ Depository Bank Group Comment Letter at 13 (Feb. 15,
2013).
\217\ RJ O'Brien Comment Letter at 11 (Feb. 15, 2013).
---------------------------------------------------------------------------

FCStone noted that time differences and geographic locations may
make it difficult for foreign commodity brokers to satisfy the 24-hour-
a-day requirement and respond promptly to requests made

[[Page 68537]]

by the Commission.\218\ The Depository Bank Group commented that often
a bank denies access during routine maintenance to technology systems,
and asked that the Commission remove the ``24-hour'' requirement.\219\
---------------------------------------------------------------------------

\218\ FCStone Comment Letter at 5 (Feb. 15, 2013).
\219\ Depository Bank Group Comment Letter at 13 (Feb. 15,
2013).
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NYPC commented that, because DCOs hold customer funds on behalf of
all their clearing members in omnibus accounts that are not further
subdivided by each customer, the account information to which the
Commission would have access at a DCO's depository ``would not provide
the level of detail that would permit reconciliation between either the
DCO's FCM clearing members or those clearing members' underlying
customers.'' \220\ In addition, Schwartz & Ballen contended that the
requirement would not achieve the Commission's goal of quickly
identifying discrepancies between FCM-reported balances and balances at
a depository because the depository typically posts all credits and
debits after the close of business.\221\
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\220\ NYPC Comment Letter at 2 (Feb. 15, 2013).
\221\ Schwartz & Ballen Comment Letter at 4 (Feb. 15, 2013).
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LCH.Clearnet recommended that the Commission consider ``alternative
approaches'' for routine access to account balance information at
depositories holding customer funds. For central banks, LCH.Clearnet
suggested that the Commission should accept confirmation of balance
information directly from the central bank in a form acceptable to the
central bank, but it did not explain why central banks should be
treated differently than other depositories. For other depositories,
LCH.Clearnet believes the Commission should consider ``following the
lead of the [NFA].'' \222\
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\222\ LCH.Clearnet Comment Letter at 3 (Jan. 25, 2013).
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NFA pointed out that its board of directors had adopted a financial
requirements rule in August 2012.\223\ NFA explained that instead of
adopting a read-only access provision of its own in this rule, it
instead chose to use, in conjunction with CME, an automated daily
segregation confirmation system to monitor customer segregated and
secured amount accounts and their balances.\224\ NFA requested that the
Commission rescind its proposed read-only access requirement.\225\
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\223\ NFA Comment Letter at 6 (Feb. 15, 2013).
\224\ Id.
\225\ Id. at 7.
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With the goal of achieving the highest degree of customer
protection, the Commission has determined to adopt, with certain
modifications, the requirement that a depository agree to provide the
Commission with read-only access to accounts maintained by an FCM.
Regulations 1.20(d)(3) and 30.7(d)(3) require the depository to agree
to provide the Commission with ``the technological connectivity, which
may include provision of hardware, software, and related technology and
protocol support, to facilitate direct, read-only electronic access to
transaction and account balance information.'' In the Template Letters,
the parties further acknowledge and agree that the connectivity has
either been provided (in the case of a new letter that covers existing
accounts) or will be provided promptly following the opening of the
account(s) (with respect to new accounts). However, the Commission is
not requiring read-only electronic access for an FCM's DSRO, as
proposed. The Commission was advised by the DSROs that they intend to
rely on the NFA and CME automated daily segregation confirmation
system.
The Commission does not anticipate that its staff would access FCM
accounts on a regular basis to monitor account activity; rather, staff
would make use of the read-only access only when necessary to obtain
account balances and other information that staff could not obtain via
the NFA and CME automated daily segregation confirmation system, or
otherwise directly from the depositories, as discussed below. In this
regard, the CME and NFA will provide the Commission on a daily basis
with the account balances reported to them by each depository holding
customer funds, under the CME and NFA's daily confirmation process. In
addition, as discussed in section N below, each FCM that completes a
daily Segregation Schedule, Secured Amount Schedule, and/or Cleared
Swaps Segregation Schedule will be required to file such schedules with
the Commission on a daily basis. The Commission anticipates that the
combination of receipt of daily account balances reported by
depositories and the Commission's ability to confirm account balances
and transactions directly with depositories will diminish the need to
rely upon direct electronic access to account information at
depositories.
With respect to depositories holding customer funds in accounts
maintained by a DCO, the Commission has decided not to adopt the
electronic access requirement. Given that DCOs hold omnibus customer
accounts that are not subdivided by clearing member or individual
customer, read-only access to a DCO's customer account would not
provide the kind of information that would identify inaccuracies in FCM
reporting. Accordingly, proposed Sec. 1.20(g)(4)(iii), which would
require a DCO to deposit futures customer funds only with a depository
that provides read-only access to the Commission, is not being adopted,
and the remaining subparagraphs of Sec. 1.20(g)(4) are renumbered
accordingly.
The Commission also is adopting Sec. Sec. 1.20(d)(6),
1.20(g)(4)(iv), and 30.7(d)(6), which require an FCM or DCO to deposit
customer funds only with a depository that agrees to reply promptly and
directly to any request from the director of the Division of Swap
Dealer and Intermediary Oversight, the director of the Division of
Clearing and Risk, or any successor divisions, or such directors'
designees,\226\ (or, in the case of an FCM, an appropriate officer,
agent or employee of the FCM's DSRO), for confirmation of account
balances or provision of any other information regarding or related to
an account, without further notice to or consent from the FCM or
DCO.\227\ For DCOs, the Commission believes that this ability, in
addition to the daily reporting of various accounts by customer origin
pursuant to Sec. 39.19(c)(1), will enable it to verify DCO account
balances with a depository as necessary.
---------------------------------------------------------------------------

\226\ Proposed Sec. Sec. 1.20(d)(5) and (g)(4)(v) and
30.7(d)(5) would require the depository to reply promptly and
directly to ``the Commission's'' requests, and the authority to make
such requests was delegated to the director of the Division of Swap
Dealer and Intermediary Oversight and the director of the Division
of Clearing and Risk under proposed Sec. 140.91(a)(7) and (11). The
proposed Template Letters would require the depository to agree ``to
respond promptly and directly to requests for confirmation of
account balances and other account information from an appropriate
officer, agent, or employee of the CFTC'' and ``immediately upon
instruction by the director of the Division of Swap Dealer and
Intermediary Oversight of the CFTC or the director of the Division
of Clearing and Risk of the CFTC, or any successor divisions, or
such directors' designees . . . provide any and all information
regarding or related to the Funds or the Accounts as shall be
specified in such instruction and as directed in such instruction.''
The Commission is revising the rule text and the Template Letters so
that all such requests will come from the director of the Division
of Swap Dealer and Intermediary Oversight or the director of the
Division of Clearing and Risk, or any successor divisions, or such
directors' designees.
\227\ To assist a depository in verifying authority and
authenticating identity in connection with a request for information
or electronic access, the Commission intends to post on its Web site
an up-to-date list of names (including title and contact
information) of the directors of the Division of Swap Dealer and
Intermediary Oversight and the Division of Clearing and Risk, or any
successor divisions, and the directors' designees, if any, for the
relevant purpose.

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[[Page 68538]]

g. Requirement To File New Acknowledgment Letters
Proposed paragraphs (d)(7) and (g)(4)(vii) of Sec. 1.20 and
proposed Sec. 30.7(d)(7) would require FCMs and DCOs to file amended
acknowledgment letters with the Commission upon a change to a
depository's name or other information specified in the regulation. The
Commission received three comments on this requirement. Schwartz &
Ballen recommended that the Commission remove this requirement from the
Template Letters and instead include ``binding effect'' language to
ensure that the counterparties remain subject to the terms of the
acknowledgment letter even if a party's name has changed.\228\
LCH.Clearnet recommended a six-month timeframe after the publication of
these rules by which DCOs and FCMs must obtain acknowledgment
letters.\229\ NYPC commented that the proposed requirements impose ``an
onerous periodic validation process with depositories'' and, given
this, it suggested that depositories provide written notice to a DCO of
a name or address change no later than 30 days after any such change in
order to permit a DCO to execute a new Template Letter.\230\
---------------------------------------------------------------------------

\228\ Schwartz & Ballen Comment Letter at 7 (Feb. 15, 2013).
\229\ LCH.Clearnet Comment Letter at 4 (Jan. 25, 2013).
\230\ NYPC Comment Letter at 4 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission believes that acknowledgment letters should be as
current and up-to-date as possible in order to maintain the clear legal
status of the customer account, which will better protect customers in
the event of an FCM failure. Accordingly, the Commission is adopting
(renumbered) Sec. Sec. 1.20(d)(8) and (g)(4)(vi) and 30.7(d)(8) as
proposed, except that instead of providing for an ``amended'' letter,
the regulation requires that a ``new'' letter be executed. The purpose
of this technical change is to avoid problems in locating the accounts
covered by a single letter that has been amended multiple times to
reflect various changes. The Commission expects that a depository would
notify account holders of a name change as a matter of practice and
does not believe that it is too burdensome to expect a DCO or FCM to be
aware of such changes. Any new acknowledgment letter reflecting a
change enumerated in the regulation must be executed within 120 days of
such changes, and then filed with the Commission within three business
days of executing the new letter.
The Commission also is adopting (renumbered) Sec. Sec. 1.20(d)(7)
and (g)(4)(v) and 30.7(d)(7), which require an FCM or DCO to submit a
copy of the acknowledgment letter to the Commission within three
business days of the opening of an account or obtaining a new
acknowledgment letter for an existing account; and Sec. Sec.
1.20(d)(4) and (g)(4)(iii) and 30.7(d)(4), which require an FCM or DCO
to deposit customer funds only with a depository that agrees to provide
a copy of the acknowledgment letter to the Commission (and, in the case
of an FCM, the FCM's DSRO) within the same time frame.\231\ The
Commission is, however, giving FCMs, DCOs, and depositories 180 days
from the effective date of the final rules to replace existing
acknowledgment letters with new ones that conform to the Template
Letters.
---------------------------------------------------------------------------

\231\ The acknowledgment letter must be executed upon the
opening of the account, regardless of when customer funds are
deposited in the account.
---------------------------------------------------------------------------

As an additional matter, the Commission advises that it expects an
FCM or DCO to follow customary authorization verification and signature
authentication policies and procedures to ensure that an acknowledgment
letter is executed by an individual authorized to bind the depository
to the terms of the letter, and that the signature that appears on the
letter is authentic. For example, an FCM or DCO may request from the
depository a list of authorized signatories, a duly executed power of
attorney, or other such documentation.
h. Standard of Liability
The proposed Template Letters would provide that a depository ``may
conclusively presume that any withdrawal from the Account(s) and the
balances maintained therein are in conformity with the Act and CFTC
regulations without any further inquiry, provided that [the depository
has] no notice of or actual knowledge of, or could not reasonably know
of, a violation of the Act or other provision of law by [the FCM or
DCO]; and [the depository] shall not in any manner not expressly agreed
to [in the letter] be responsible for ensuring compliance by [the FCM
or DCO] with the provisions of the Act and CFTC regulations.''
The Depository Bank Group commented that this ``standard of
liability'' provision would impose a burden beyond that currently
expected of depository institutions.\232\ In this regard, the
Depository Bank Group asserted that the phrase ``violation of the Act
or other provision of law'' encompasses much more than section 4d of
the Act and would effectively require that the depository monitor and
ensure the FCM's or DCO's compliance with all other laws, even those
unrelated to the deposit of customer funds.\233\ The Depository Bank
Group further contended that the proposed standard, ``could not
reasonably know of a violation'' would likely be read to require
depositories to ``perform some undefined level of diligence'' which
would be highly problematic.\234\ The Depository Bank Group also stated
that this requirement would likely delay transfers or withdrawals, and
result in depositories passing on related costs to FCMs and DCOs and,
in turn, to their clients, although the Depository Bank Group did not
quantify the costs.\235\ FIA similarly expressed concern that the
requirement could cause delays and increased costs, again, without
providing specific details and quantifying costs.\236\
---------------------------------------------------------------------------

\232\ Depository Bank Group Comment Letter at 3 (Feb. 15, 2013).
See also RJ O'Brien Comment Letter at 11 (Feb. 15, 2013).
\233\ Depository Bank Group Comment Letter at 5 (Feb. 15, 2013).
See also Katten-FIA Comment Letter at 2 (Aug. 2, 2013); Schwartz &
Ballen Comment Letter at 6 (Feb. 15, 2013); and CME Comment Letter
at 7 (Feb. 15, 2013).
\234\ Depository Bank Group Comment Letter at 3 (Feb. 15, 2013).
\235\ Id. at 5.
\236\ FIA Comment Letter at 40 (Feb. 15, 2013).
---------------------------------------------------------------------------

Schwartz & Ballen asserted that banks have no ability to determine
what uses an FCM is making of funds it withdraws from the account.\237\
As noted above, the Federal Reserve Banks, which may act as
depositories for Designated FMUs, commented that the ``actual
knowledge'' standard, which typically imputes knowledge to a legal
person as a whole, is not feasible for them because of the Board policy
to not share supervisory information with Federal Reserve Bank
personnel performing financial services.
---------------------------------------------------------------------------

\237\ Schwartz & Ballen Comment Letter at 6 (Feb. 15, 2013).
---------------------------------------------------------------------------

In response to concerns expressed by commenters, the Commission
clarifies that it does not intend to use the Template Letters as means
to expand the scope of a depository's liability to FCM or DCO account
holders, or to alter the responsibility that an FCM or DCO bears for
its own compliance with the customer funds segregation requirements
under the Act and Commission regulations. The use of standardized
acknowledgment letters is intended to promote a uniform understanding
among FCMs, DCOs, and depositories as to their obligations under the
Act and Commission regulations with respect to the proper treatment of
customer funds. In light of the public comments, the Commission is
revising the language in the Template

[[Page 68539]]

Letters to more precisely articulate the intended scope of the
depository's responsibility.
The provision, as adopted, reads as follows: ``You [the depository]
may conclusively presume that any withdrawal from the Account(s) and
the balances maintained therein are in conformity with the Act and CFTC
regulations without any further inquiry, provided that, in the ordinary
course of your business as a depository, you have no notice of or
actual knowledge of a potential violation by us of any provision of the
Act or CFTC regulations that relates to the segregation of customer
funds; and you shall not in any manner not expressly agreed to [in the
letter] be responsible to us [the FCM or DCO] for ensuring compliance
by us with the provisions of the Act and CFTC regulations; however, the
aforementioned presumption does not affect any obligation you may
otherwise have under the Act or CFTC regulations.'' Changes from the
proposed language are discussed below.
The Depository Bank Group recommended inserting the phrase ``in the
ordinary course of your business as a depository,'' and the Commission
has accepted this recommendation to clarify the context in which the
presumption of the FCM's or DCO's compliance is effective. As proposed,
the presumption would be effective so long as the depository has ``no
notice of or actual knowledge of, or could not reasonably know of, a
violation.'' Given the concerns expressed by commenters as to the
implications of the ``reasonably know'' standard, the Commission has
determined to eliminate that clause in the final Template Letters.
In considering the various circumstances in which the conclusive
presumptions would no longer be effective, the Commission has
determined that the proposed reference to notice or actual knowledge of
a ``violation,'' does not adequately capture all of the relevant
circumstances. This is because the depository might receive information
that calls into question the conduct of the FCM or DCO account holder,
but it might not be apparent whether or not the activity rises to the
level of being an actual violation of the law. Indeed, some actions
will not be deemed to be ``violations'' until a judicial decision is
rendered. As a result, the Commission has revised the language to refer
to a ``potential violation'' so as not to inadvertently exclude
circumstances which would warrant further inquiry by a depository.
The Commission agrees that the broad reference to ``the Act and
CFTC regulations'' should be narrowed with respect to the description
of the potential violation. Therefore, the Commission is adopting the
Depository Bank Group's suggestions that the reference to the violation
specify that it is limited to ``any provision of the Act or the CFTC
regulations that relates to the segregation of customer funds.'' The
Commission has made a similar change in the 30.7 Template Letters,
referring to ``any provision of the Act or Part 30 of the CFTC
regulations that relates to the holding of customer funds.'' This more
precisely identifies the legal requirements that are the subject of the
parties' obligations and the acknowledgment letter as a whole.
As an additional matter, the Commission has added to the standard
of liability provision the following proviso: ``however, the
aforementioned presumption does not affect any obligation you may
otherwise have under the Act or CFTC regulations.'' This statement
affirms the depository's understanding that its statutory and
regulatory obligations with respect to the customer funds on deposit
are not limited by the presumption upon which it relies in its dealings
with FCM or DCO account holders.
The Commission notes that a depository's obligation to comply with
the segregation requirements under section 4d of the Act is explicitly
imposed upon depositories by section 4d(b) of the Act,\238\ and legal
precedent has established a standard of liability to which the
Commission holds depositories and which is not dependent upon
affirmation in the Template Letters. The Commission reaffirms its long-
held position that the depository will be held liable for the improper
transfers of customer funds by an FCM or DCO if it knew or should have
known that the transfer was improper.\239\
---------------------------------------------------------------------------

\238\ Section 4d(b) of the Act explicitly provides that it is
unlawful for any clearing agency of a contract market and any
depository that has received customer funds to hold, dispose of, or
use any such funds as belonging to the depositing FCM or any person
other than the customers of such FCM. See also section 4d(f)(6) of
the Act (applying the same requirement to Cleared Swaps Customer
Collateral).
\239\ See, e.g., CFTC Interpretative Ltr. No. 79-1, [1977-1980
Transfer Binder] Comm. Fut. L. Rep. (CCH) ]20,835 (May 29, 1979) at
page 2. As long ago as 1979, the Commission found that ``if a bank,
with prior notice, permits or acquiesces in the withdraw [sic] or
use of customers' funds by a futures commission merchant for an
unlawful purpose, the bank would violate or be aiding and abetting a
violation of the Act.''
---------------------------------------------------------------------------

The Commission recognizes that a depository's treatment of customer
funds may be limited in particular circumstances on the basis of what
it knows or reasonably should know of a violation of the Act that would
preclude it from obtaining rights to such funds superior to those of
one or more customers of the defaulting FCM.\240\ Such a violation
could occur, for example, in circumstances in which the depository
received particular margin funds with actual knowledge, or in
circumstances in which it is reasonable to conclude that the depository
should have known, that the depositing FCM or DCO has breached its duty
under section 4d. The depository's participation in such use of
customer funds could subject it to liability for violating section 4d
or aiding and abetting a violation of the Act under section 13(a) of
the Act (7 U.S.C. 13c).\241\
---------------------------------------------------------------------------

\240\ See CFTC Interpretative Ltr. No. 86-9, [1986-1987 Transfer
Binder] Comm. Fut. L. Rep. (CCH) ]23,015 (April 21, 1986) (limiting
a bank's treatment of customer margin funds ``in particular
circumstances by reason of what it knows or reasonably should know
of a violation of the Act or other provision of law that would
preclude it from obtaining rights to such funds superior to those of
one or more customers of the defaulting FCM.'').
\241\ Id. See also CFTC Interpretative Statement. No. 85-3
[1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) ]22,703 (Aug.
12, 1985). A DCO's rights with respect to the use of customer margin
funds may be limited in particular circumstances by reason of the
clearing organization's knowledge of or participation in a violation
of the Act or other provision of law that precludes it from
obtaining rights to such funds superior to those of one or more
customers of the defaulting clearing member. The letter provides
that a DCO could be subject to aiding and abetting liability under
section 13(a) of the Act if the DCO knowingly participates in a
violation of the Act.
---------------------------------------------------------------------------

The Commission emphasizes that while the depository has no
affirmative obligation to police or monitor an FCM or DCO account
holder's compliance with the Act or Commission regulations, the
depository cannot ignore signs of wrongdoing. Should a depository know
or suspect that funds held in a customer account have been improperly
withdrawn or otherwise improperly used in violation of section 4d of
the Act or the Commission's regulations related to segregation of
customer funds, the Commission expects the depository to immediately
report its concern to the Division of Swap Dealer and Intermediary
Oversight, the Division of Clearing and Risk, the Division of
Enforcement, or the Commission's Whistleblower Office.\242\
---------------------------------------------------------------------------

\242\ See CFTC Interpretative Ltr. No. 79-1 (stating ``if a bank
subsequently becomes aware of an unauthorized withdrawal or use of
customers' funds by an FCM, we would expect the bank to notify the
Commission immediately'').
---------------------------------------------------------------------------

i. Liens
The proposed Template Letters would include the following language:
``Furthermore, [the depository]

[[Page 68540]]

acknowledge[s] and agree[s] that such Funds may not be used by [the
depository] or by [the FCM or DCO] to secure or guarantee any
obligations that [the FCM or DCO] might owe to [the depository], nor
may they be used by [the FCM or DCO] to secure credit from [the
depository]. [The depository] further acknowledge[s] and agree[s] that
the Funds in the Account(s) shall not be subject to any right of offset
or lien for or on account of any indebtedness, obligations or
liabilities [the FCM or DCO] may now or in the future have owing to
[the depository]. This prohibition does not affect [the depository's]
right to recover funds advanced in the form of cash transfers [the
depository] make[s] in lieu of liquidating non-cash assets held in the
Account(s) for purposes of variation settlement or posting initial
(original) margin.'' This language is consistent with section 4d(b) of
the Act, which states: ``It shall be unlawful for any person, including
but not limited to . . . any depository, that has received any money,
securities, or property for deposit in a separate account as provided
in [section 4d(a)(2) of the Act], to hold, dispose of, or use any such
money, securities, or property as belonging to the depositing [FCM] or
any person other than the customers of such [FCM].''
Schwartz & Ballen asserted that because many FCMs hold only cash
assets in the accounts, the language in the letter should be expanded
to permit banks to recover funds they advance that result in overdrafts
in the accounts.\243\ Schwartz & Ballen further stated that the failure
to permit banks to recover such advances whether or not there are non-
cash assets in the account will likely lead to banks incurring
losses.\244\ FCStone elaborated on this issue, explaining that a
customer receives a margin call through an account statement, which is
transmitted overnight, and the customer wires funds the following
day.\245\ The DCO, however, automatically drafts the funds from the
FCM's account at 9:00 a.m. on the basis of a depository's intraday
daylight overdraft.\246\ Without granting a depository a lien on
customer funds, FCStone stated that an FCM would be required to
``front'' all funds for customers until the customer has wired funds to
the FCM.\247\ FCStone contended that a change of this sort could
``threaten the continued operations of small to mid-sized FCMs not
affiliated with banks'' and cause a substantial liquidity strain.\248\
The Depository Bank Group additionally warned that a depository may not
be willing to provide intraday advances to the customer segregated
account without the right to take a lien on the account or the right to
set off between multiple customer segregated accounts and would,
therefore, not be in a position to provide liquidity.\249\ As a result,
an FCM or DCO would likely need to maintain a buffer of its own funds
in the segregated customer accounts to fully pre-fund transactions
related to such accounts.\250\ The Depository Bank Group contended that
the impact on small- to mid-sized FCMs would be that of a lesser
ability to enter into ``everyday transactions'' for the customer
segregated account, which could result in exclusion from the
industry.\251\ The Depository Bank Group cited as support a comment
letter that staff of the Federal Reserve Bank of Chicago submitted in
2010.\252\
---------------------------------------------------------------------------

\243\ Schwartz & Ballen Comment Letter at 6-7 (Feb. 15, 2013).
\244\ Id.
\245\ FCStone Comment Letter at 4.
\246\ Id.
\247\ Id. at 5.
\248\ Id.
\249\ Depository Bank Group Comment Letter at 7 (Feb. 15, 2013).
\250\ Id.
\251\ Id.
\252\ Comment letter from David A. Marshall, Federal Reserve
Bank of Chicago, dated September 8, 2010.
---------------------------------------------------------------------------

The Commission recognizes that a depository may not want to provide
unsecured overdraft coverage. However, a depository taking a lien on a
customer account to facilitate intraday payments presents a serious
problem if an FCM's customer does not satisfy a margin call and the
FCM, in turn, cannot cover the call and becomes insolvent before the
depository can be repaid.
The Commission interprets the requirements of section 4d of the Act
to prohibit a lien on customer funds to satisfy an intraday extension
of credit to an FCM to meet margin requirements at a DCO. As an
alternative to taking a lien on the customer account, the depository
could take a lien on a proprietary account held by the FCM at the
depository, or the FCM could add its own funds to the segregated
account or collect more margin from its customers in order to provide a
more substantial financial cushion. It is not the Commission's
intention to disadvantage mid-size and smaller FCMs in applying this
standard across all FCMs, regardless of size.
The Commission notes that no commenter has proffered information or
data that would indicate intraday advances are a commonplace, routine
occurrence. Indeed, it may be cause for concern if a large number of
FCMs cannot meet intraday margin calls for customer accounts on a
regular basis.
Without expressing a view of the Commission's position concerning
section 4d of the Act, FIA recommended expanding the circumstances in
which a depository could impose a lien with respect to customer
funds.\253\ FIA recommended revising the language to read: ``You
further acknowledge and agree that the Funds in the Account(s) shall
not be subject to any right of offset or lien for or on account of any
indebtedness, obligations or liabilities we may now or in the future
have owing to you except to recover from the Account(s) (or from any
other CFTC Regulation 1.20 Customer Segregated Account(s) we have with
you), Funds you may advance from time to time to facilitate
transactions by or on behalf of, or on account of, or otherwise for the
benefit of, the Account(s) or our customers whose Funds are held in the
Account(s).'' \254\ The Commission confirms that a depository can
possess a lien across multiple accounts of the same FCM as long as the
accounts are of the same account class (i.e., 4d(a) cash and custodial
accounts). However, the Commission believes FIA's suggested
modification is overbroad and has the potential to be interpreted to
permit a depository's imposition of a lien in a greater number of
circumstances than section 4d of the Act allows.
---------------------------------------------------------------------------

\253\ Katten-FIA Comment Letter at 2 (Aug. 2, 2013).
\254\ Id.
---------------------------------------------------------------------------

NYPC urged the Commission to clarify that DCOs have the right to
transform non-cash customer funds into cash to satisfy liquidity needs
related to the customer account of a defaulting FCM clearing member not
only through the sale of such assets, but also through the use of
liquidity arrangements, such as lines of credit and repurchase
agreements.\255\ NYPC recommended that the Commission modify the last
sentence in the ``lien'' paragraph as follows: ``The prohibitions
contained in this paragraph do not affect your right to recover funds
advanced by you in the form of cash transfers, lines of credit,
repurchase agreements or other similar liquidity arrangements in lieu
of the liquidation of non-cash assets held in the Account(s) for
purposes of variation settlement or posting initial (original) margin
with respect to the Account(s).'' The Commission recognizes that
liquidity arrangements are an important aspect of a DCO's default
management plan and agrees that the use of lines of

[[Page 68541]]

credit or repurchase agreements are acceptable alternatives to the
liquidation of non-cash assets held in a customer account. As a result,
the Commission has determined to modify the sentence in a manner
similar to that recommended by NYPC.
---------------------------------------------------------------------------

\255\ NYPC Comment Letter at 3 (Feb. 15, 2013).
---------------------------------------------------------------------------

In response to the other comments, the Commission notes that it has
always interpreted and applied section 4d of the Act in a manner
consistent with the language in the proposed Template Letters. With
respect to a depository's right of setoff against a customer account,
the Commission has long recognized only one very limited circumstance.
CFTC Interpretative Letter No. 86-9 allows, with certain
limitations,\256\ a bank's right of setoff against a customer cash
account that does not have sufficient available balances to meet a
margin call, where there exists an affiliated custodial account that
contains securities purchased with funds from the customer cash
account.\257\ In this case, there is no extension of credit because the
accounts, when aggregated, have enough assets to support the cash
advance.
---------------------------------------------------------------------------

\256\ See CFTC Interpretative Ltr. No. 86-9, [1986-1987 Transfer
Binder] Comm. Fut. L. Rep. (CCH) ]23,015 (April 21, 1986) (limiting
a bank's treatment of customer margin funds ``in particular
circumstances by reason of what it knows or reasonably should know
of a violation of the Act or other provision of law that would
preclude it from obtaining rights to such funds superior to those of
one or more customers of the defaulting FCM.'').
\257\ Id.
---------------------------------------------------------------------------

The Depository Bank Group raised a question about similar
circumstances in which a depository might set off amounts owed to a
customer segregated account holding U.S. dollars, with amounts held in
foreign currency in another customer segregated account.\258\ To the
extent that a depository advances cash in lieu of exchanging foreign
currency held in a related 4d account, the same rationale that serves
as the basis for CFTC Interpretative Letter No. 86-9 would apply, i.e.,
the advancement of funds does not represent an extension of credit
secured by customer funds. The Commission confirms that a depository
holding customer funds in one segregated account may set off amounts
withdrawn from another account in cases where the depository advances
funds in lieu of converting cash in one currency to cash in a different
currency.
---------------------------------------------------------------------------

\258\ Id. at 8.
---------------------------------------------------------------------------

The Template Letters provide for a depository's right of setoff
against the customer account consistent with Interpretative Letter No.
86-9. The Commission believes that expanding the scope of a
depository's right of setoff to support extensions of credit to an FCM
would violate the requirements of section 4d of the Act and notes that
none of the commenters provided a legal analysis that would refute this
position.
The Commission recognizes, however, that there may be situations
similar to those specifically enumerated in the proposed Template
Letters for which an advancement of cash and the related imposition of
a lien in lieu of liquidating non-cash assets or converting cash in one
currency to cash in a different currency may be permissible. To
accommodate this, the Commission is revising the language to remove the
concluding clause, ``for the purposes of variation settlement or
posting initial (original) margin.'' This change preserves the intended
meaning and purpose of the provision without unintentionally limiting
its application in other similar circumstances.
Accordingly, the Commission is adopting the proposed ``lien''
language of the Template Letters, modified to include a reference to
the depository's right to recover funds related to certain liquidity
arrangements and to eliminate specific examples of circumstances in
which imposition of a lien would be permissible. FCMs, DCOs, and
depositories are reminded that any permissible advancement of cash and
related imposition of a lien on a customer account must be properly
documented and recorded in compliance with all applicable recordkeeping
requirements.
j. Examination of Accounts
As proposed, the Template Letters for both FCMs and DCOs would
require a depository to agree that accounts holding customer segregated
funds could be ``examined at any reasonable time'' by the Commission
or, as applicable, an FCM's DSRO, and they further provide that the
acknowledgment letter ``constitutes the authorization and direction of
the undersigned to permit any such examination or audit to take
place.'' Schwartz & Ballen commented that the provision should also
provide for the Commission or DSRO to give the depository advance
notice before being permitted to examine FCM accounts.\259\ The
Commission is not including this recommended precondition because an
examination of this type is likely to be conducted only in response to
exigent circumstances and the ``reasonable time'' provision is
sufficient evidence of the Commission's intent to proceed in a
commercially reasonable manner under the particular circumstances.
---------------------------------------------------------------------------

\259\ Schwartz & Ballen Comment Letter at 7 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission is retaining the examination provision in the FCM
Template Letters but is not including it in the DCO Template Letters.
Consistent with the Commission's determination regarding electronic
access to DCO account information, the Commission believes that
authorization to examine a DCO's customer segregated account at a
depository is not necessary because of the Commission's ability to
obtain account information directly from the depository upon request,
and directly from the DCO through daily reporting under Sec.
39.19(c)(1).
As a technical matter, the Commission is eliminating use of the
term ``audit'' to clarify that the examination will be targeted and is
not intended to be an audit, as that term is used in the field of
accounting.
5. Prohibition against Commingling Customer Funds
The Commission proposed to amend Sec. 1.20(e) to explicitly
address the commingling of customer funds. Proposed Sec. 1.20(e)(1)
provides that an FCM may, for convenience, commingle the funds that it
receives from, or on behalf of, multiple futures customers in a single
account or multiple accounts with one or more of the permitted
depositories set forth in Sec. 1.20(b).
Proposed Sec. 1.20(e)(2) prohibits an FCM from commingling futures
customers funds with any proprietary funds of the FCM, or with any
proprietary account of the FCM. Proposed Sec. 1.20(e)(2), however,
provides that the prohibition on the commingling of futures customer
funds and the FCM's proprietary funds does not prohibit an FCM from
depositing proprietary funds into segregated accounts in accordance
with proposed Sec. 1.23 as a buffer to prevent the firm from becoming
undersegregated due to normal business activities, such as daily margin
payments by the FCM to a DCO.
Proposed Sec. 1.20(e)(3) further prohibits an FCM from commingling
futures customer funds with funds deposited by 30.7 customers for
trading foreign futures or foreign option positions in accordance with
part 30 of the Commission's regulations, or with Cleared Swaps Customer
Collateral deposited by Cleared Swaps Customers for Cleared Swaps under
part 22 of the Commission's regulations. Proposed Sec. 1.20(e)(3)
permits, however, the commingling of futures customer funds with 30.7
customer funds and/or Cleared Swaps Customer funds if expressly
permitted by a Commission

[[Page 68542]]

regulation or order, or by a DCO rule approved in accordance with Sec.
39.15(b)(2) of the regulations.\260\
---------------------------------------------------------------------------

\260\ Regulation 22.2(c)(2) regarding cleared swaps customer
accounts already prohibits commingling.
---------------------------------------------------------------------------

Similarly, a proposed amendment to Sec. 30.7 would prohibit an FCM
from commingling funds required to be deposited in a foreign futures
and foreign options secured amount account with funds required to be
deposited in a customer segregated account or cleared swaps customer
account.\261\
---------------------------------------------------------------------------

\261\ Proposed Sec. 30.7(e)(3).
---------------------------------------------------------------------------

The Commission received one comment on the proposed amendments to
Sec. 1.20(e). FIA stated that it fully supported the proposed
amendments, which implement the segregation provisions of section 4d(a)
and 4d(f) of the Act.\262\
---------------------------------------------------------------------------

\262\ FIA Comment Letter at 36 (Feb. 15, 2013).
---------------------------------------------------------------------------

FIA further requested that the Commission confirm that the proposed
amendments would not prohibit a customer that engages in futures
transactions on a designated contract market, foreign futures or
options transactions on foreign boards of trade, and Cleared Swaps
through a single FCM, from meeting its margin obligations for the three
different segregation accounts by making a single payment to the
FCM.\263\ FIA states that such practice is common in the industry
today, reduces the FCM's credit risk, is operationally more efficient
for both the FCM and its customers, and indirectly reduces customer
settlement risk.\264\
---------------------------------------------------------------------------

\263\ Id.
\264\ Id.
---------------------------------------------------------------------------

The Commission confirms, subject to the following conditions, that
a receipt of funds from a customer that wishes to meet its multiple
margin obligations by making a single deposit payment to the FCM is not
prohibited by Sec. 1.20. The FCM, however, must initially receive the
customer's funds into the customer's section 4d(a)(2) segregation
account. The funds may not be directly deposited into the customer's
Sec. 30.7 secured account or Cleared Swaps Segregation Account, as
such accounts may present different risks than the section 4d(a)(2)
account, and the Commission would like to standardize operationally the
practice of how customer funds are received by FCMs by authorizing one
approach that would be applicable to all customers to minimize the
possibility of transactional errors.
In addition, the FCM must simultaneously record the book entry
credit to the customer's Sec. 30.7 secured account and the customer's
Cleared Swaps Account (as applicable) as directed by the customer upon
the receipt and recording of the cash into the customer's 4d(a)(2)
segregation account. Also, the FCM must ensure at the time the book
entry credit is made to the customer's account, that the credit does
not result in the FCM having obligations to 30.7 customers or Cleared
Swaps Customers that are in excess of the total assets held in such
accounts for such customers. Failure of the FCM to hold a sufficient
amount of excess funds in the 30.7 customer accounts and Cleared Swaps
Customer Accounts at any time to meet its obligations to such customers
would be a violation of the Act and the Commission's regulations.
Furthermore, if the FCM permits customers to use one wire transfer
to fund more than one account class, the FCM's policy and procedures
for assessing the appropriate amount of targeted residual interest
required under Sec. 1.11 must take this practice into consideration
and should include appropriate adjustments and estimates to reflect
this practice. Finally, the Commission hereby clarifies that all prior
guidance concerning the receipt of customer deposits at branch
locations or otherwise deposited into the FCM's proprietary accounts,
regardless of excess funds held in segregation, is repealed and
withdrawn and such practice is not permitted under Sec. 1.20 as
adopted.\265\
---------------------------------------------------------------------------

\265\ Previous guidance permitted a branch office of an FCM to
deposit customer funds into an unsegregated bank account if the main
office of the FCM on the same day deposited the same amount of its
funds into a segregated bank account, and kept records fully
explaining the transactions. See Commodity Exchange Authority
Administrative Determination No. 203 (December 1, 1966). See also
CFTC Interpretative Letter No. 90-7 (Secured Amount Account for
Foreign Futures and Options, May 1, 1990). This practice is now
prohibited.
---------------------------------------------------------------------------

The Commission adopts the amendment as proposed.
6. Limitations on the Use of Customer Funds
Proposed Sec. 1.20(f) requires FCMs to treat and deal with the
funds of a futures customer as belonging to such futures customer. In
addition, the Commission proposed to prohibit an FCM from using, or
permitting the use of, the funds of futures customer for any person
other than for futures customers, subject to certain limited
exceptions. Proposed Sec. 1.20(f) also states that an FCM may obligate
futures customers' funds to a DCO or another FCM solely to purchase,
margin, or guarantee futures and options positions of futures
customers, and that no person, including any DCO or any depository,
that has received futures customer funds for deposit in a segregated
account, may hold, dispose of, or use any such funds as belonging to
any person other than the futures customers of the FCM that deposited
such funds.
The Commission did not receive any comments regarding proposed
Sec. 1.20(f). However, as discussed above, the FIA stated that it
agrees that FCMs are required to comply with the segregation provisions
of the Act at all times, and expressed general support for the
Commissions efforts to implement the Act's segregation provision.\266\
The Commission notes that the language in proposed Sec. 1.20(f)
largely mirrors the language set forth in current Sec. 1.20, which
language was, and continues to be, intended to further implement the
segregation provisions of the Act.\267\ Thus, the Commission is
adopting the provision as proposed.
---------------------------------------------------------------------------

\266\ FIA Comment Letter at 2 (June 20, 2013). See also section
II.G.1. above for a further discussion of an FCM's obligation to be
in compliance with its segregation obligation at all times.
\267\ Accordingly, relevant prior Commission orders and guidance
will continue to apply to Sec. 1.20(f). For example, in In re
JPMorgan Chase Bank CFTC 12-17 (April 4, 2012), the Commission
simultaneously initiated and settled an action against a depository
for violating Sec. 1.20(a) and (c) because it unlawfully used
customer funds as belonging to someone other than the customers of
an FCM. Specifically, the Commission found that a depository's
intra-day extension of credit to an FCM (Lehman Brothers) based upon
customer funds the FCM had deposited with a bank (JPMorgan Chase)
violated Sec. 1.20(a) and (c). Regulation 1.20(f) would continue to
prohibit such use of customer funds, as well as any other type of
disposal, holding or use the Commission has previously identified as
unlawful.
---------------------------------------------------------------------------

7. Segregation Requirements for DCOs
Proposed Sec. 1.20(g) provides segregation requirements applicable
to DCOs, as opposed to FCMs. Proposed paragraph (g)(2) lists the
permitted depositories for futures funds received by a DCO as any bank
or trust company, and clarifies that the term ``bank'' includes a
Federal Reserve Bank. The necessity for this proposed amendment is
highlighted by section 806(a) of the Dodd-Frank Act, which provides
that a Federal Reserve Bank may establish and maintain a deposit
account for a ``financial market utility'' (in the present case, a DCO)
that has been designated as systemically important by the Financial
Stability Oversight Council. Proposed paragraph (g)(3) requires DCOs to
comply with the provisions of Sec. 1.49 with respect to holding
segregated funds outside the U.S. Regulation 1.20(g)(5) prohibits a DCO
from commingling futures customer funds with the DCO's proprietary
funds or with any proprietary account of any of its clearing members,
and prohibits the DCO from commingling funds held for futures customers
with funds deposited by clearing members on behalf of their

[[Page 68543]]

Cleared Swaps Customers. DCOs would be permitted to commingle the funds
of multiple futures customers in a single account or accounts for
operational convenience. The Commission adopts the amendment as
proposed.
8. Immediate Availability of Bank and Trust Company Deposits
The Commission proposed a paragraph (h) to Sec. 1.20 to require
that all futures customer funds deposited with a bank or trust company
must be deposited in accounts that do not impose any restrictions on
the ability of the FCM or DCO to withdraw such funds upon demand. An
FCM or DCO may not deposit customer funds in any account with a bank or
trust company that does not, by the terms of the account or operation
of banking law, provide for the immediate availability of such deposits
upon the demand of the FCM or DCO.
Paragraph (h) codifies a long-standing interpretation of the
Commission's Division of Swap Dealer and Intermediary Oversight and
predecessor divisions derived from an Administration Determination by
the Commission's predecessor, the Commodity Exchange Authority of the
U.S. Department of Agriculture.\268\ The requirement, as proposed, is a
practical necessity to the effective functioning of FCMs and futures
markets. In this regard, customer funds deposited with a bank must be
maintained in accounts that allow for the immediate availability of the
funds in order for the FCM to be assured of meeting its obligation to
make any necessary transfers of customer funds to a DCO or to return
funds to customers upon their request. The Commission is adopting
paragraph (h) as proposed.\269\
---------------------------------------------------------------------------

\268\ See Administrative Determination No. 29 of the Commodity
Exchange Authority dated Sept. 28, 1937 stating, ``the deposits, by
a futures commission merchant, of customers' funds * * * under
conditions whereby such funds would not be subject to withdrawal
upon demand would be repugnant to the spirit and purposes of the
Commodity Exchange Act. All funds deposited in a bank should in all
cases be subject to withdrawal on demand.''
\269\ CIEBA noted it is comment letter that industry groups are
involved in various initiatives to provide customers with the option
for full physical segregation of margin collateral, and requested
confirmation that Sec. 1.20(h) would not prohibit the use of a full
segregation model if developed. See CIEBA Comment Letter at 4 (Feb.
20, 2013). The Commission encourages industry groups to continue to
assess alternatives to the current segregation structure in an
effort to provide greater protection of customer funds and to ensure
the effective operation of the clearing and settlement functions.
Regulation 1.20(h) is intended to prohibit situations where an FCM
or DCO deposits customer funds into an account that by law or
operation limits or potentially limits the FCM's or DCO's ability to
withdraw the funds from the account for the use intended (i.e., as
performance bond). The Commission would consider any future
amendments to Sec. 1.20(h) based upon the developments of
alternative segregation modes.
---------------------------------------------------------------------------

9. Segregated Funds Computation Requirement
The Commission proposed to add a new paragraph (i), which mirrored
the requirements recently adopted in part 22 for Cleared Swaps
Customers. Proposed paragraph (i) was designed to implement, with
increased detail, the Net Liquidating Equity Method of calculating
segregation requirements. A customer may have positive Net Liquidating
Equity (i.e., a credit balance) in his or her account, requiring
segregation of his or her funds, but may have insufficient Net
Liquidating Equity to cover the margin required for that customer's
open positions.
Accordingly, the Commission proposed to require an FCM to record in
the accounts of its futures customers the amount of margin required for
each customers' open positions, and to calculate margin deficits (i.e.,
undermargined amounts) for each of its customers. Moreover, the
Commission proposed to require that an FCM maintain residual interest
in segregated accounts in an amount that exceeds the sum of all futures
customers' margin deficits (``the Proposed Residual Interest
Requirement'').\270\
---------------------------------------------------------------------------

\270\ See discussion in note 30 above. Therefore, under the
Proposed Residual Interest Requirement an FCM would have to maintain
at all times in segregated account a sufficient amount of funds to
cover the Net Liquidating Equities of each customer and a sufficient
amount of residual interest to cover the undermargined amounts of
each customer.
---------------------------------------------------------------------------

In addition, the Commission proposed an amendment to Sec.
1.22.\271\ Regulation 1.22 is a longstanding regulation\272\ and
currently provides that an FCM may not use the cash, securities or
other property deposited by one futures customer to purchase, margin or
settle the trades, contracts, or other positions of another futures
customer, or to extend credit to any other person.\273\ This
``requirement is designed not only to prevent disparate treatment of
customers by an FCM, but also to insure that there will be sufficient
money in segregation to pay all customer claims if the FCM becomes
insolvent.'' \274\ Regulation 1.22 further provides that an FCM may not
use the funds deposited by a futures customer to carry trades or
positions, unless the trades or positions are traded through a
DCM.\275\
---------------------------------------------------------------------------

\271\ 77 FR 67886.
\272\ See, e.g., 13 FR, 7820, 7837 (Dec. 18, 1948).
\273\ 17 CFR 1.22.
\274\ 46 FR 11668, 11669 (Feb. 10, 1981).
\275\ 17 CFR 1.22.
---------------------------------------------------------------------------

The Commission proposed an amendment to Sec. 1.22 to clarify that
it is not permissible for an FCM to be undersegregated at any point in
time during the day. As stated in the Proposal, section 4d(a)(2)
expressly requires an FCM to segregate futures customers' funds from
its own funds, and prohibits an FCM from using the funds of one
customer to margin or extend credit to any other futures customer or
person.\276\ Moreover, to review compliance with these proposed
requirements, the Commission proposed that the sum of all margin
deficits (i.e., undermargined amounts) be reported on the Segregation
Schedule (as discussed previously in section II.A. with respect to
amendments to Sec. 1.10) and on the daily segregation
calculation.\277\
---------------------------------------------------------------------------

\276\ 77 FR 67886.
\277\ Id.
---------------------------------------------------------------------------

The Commission requested comment on all aspects of the Proposed
Residual Interest Requirement, including the costs and benefits of this
proposed regulation.\278\
---------------------------------------------------------------------------

\278\ See 77 FR 67882, 67916. The Commission also specifically
requested comments on the following: Whether the Proposed Residual
Interest Requirement would serve to increase the protections to
customer funds in the event of an FCM bankruptcy? To what extent
would the Proposed Residual Interest Requirement increase costs to
FCMs and/or futures customers? To what extent would the Proposed
Residual Interest Requirement benefit futures customers and/or FCMs?
To what extent would the Proposed Residual Interest Requirement
increase or mitigated market risk? To what extent would the Proposed
Residual Interest Requirement lead to FCMs requiring customers to
provide margin for their trades before placing them? To what extent
is the Proposed Residual Interest Requirement likely to lead to a
re-allocation of costs from customers with excess margin to
undermargined customers? For purposes of margin deficit
calculations, whether the Commission should address issues
surrounding the timing of when an FCM must have sufficient funds in
the futures customer account to cover all margin deficits? If so,
how should the Commission address such issues? See 77 FR at 67882.
With regards to the costs and benefits, the Commission asked the
following questions: Whether FCMs typically maintain residual
interest in their customer segregated account that is greater than
the sum of their customer margin deficits, and data from which the
Commission may quantify the average difference between the amount of
residual interest an FCM maintains in customer segregated accounts
and the sum of customer margin deficit. How much additional residual
interest would FCMs need to hold in their customer segregated
accounts in order to comply with the Proposed Residual Interest
Requirement? What is the opportunity cost to FCMs associated with
increasing the amount of capital FCMs place in residual interest,
and data that would allow the Commission to replicate and verify the
calculated estimates provided. Information regarding the additional
amount of capital that FCMs would likely maintain in their customer
segregated accounts, if any, to comply with the Proposed Residual
Interest Requirement. What is the average cost of capital for an
FCM? See 77 FR at 67916.
The Commission also specifically requested that commenters
provide data and calculations that would allow the Commission to
replicate and verify the cost of capital that commenters estimate.
See id.

---------------------------------------------------------------------------

[[Page 68544]]

The Commission has received and has considered a wide variety of
public comments regarding the Proposed Residual Interest Requirement,
including comments from panelists made during public roundtables and
written submissions from commenters.
Several commenters supported the Commission's Proposed Residual
Interest Requirement. CIEBA stated that it strongly supported the
Proposed Residual Interest Requirement, arguing that the proposed
regulations are consistent with Congressional intent and the
Commission's historical interpretations of the Act and sound economic
and systemic risk policy. Highlighting section 4d(a)(2) of the Act and
its directive that FCMs ``keep collateral and funds of each individual
customer distinct from that of customers and the FCM,'' CIEBA argued
that ``permitting FCMs to use customer funds to cover margin deficits
of a different customer and thereby subsidize the FCM's obligations
would'' contravene well established statutory policy.\279\ In addition,
CIEBA noted that the Dodd-Frank Act was adopted to increase regulatory
protections for customers.\280\ CIEBA also noted several benefits
resulting from the Proposed Residual Interest Requirement, including
the reduction of systemic risk, competitive benefits for those FCMs
that do not use customer excess to meet the obligations of other
clients, and the enhancement of customer protection in the event of an
FCM bankruptcy.\281\ ICI also stated that it supported the Proposed
Residual Interest Requirement on the basis that it would provide
additional protections to customer funds.\282\ SIFMA asserted that it
strongly supported the Proposed Residual Interest Requirement because
it preserves the sanctity of each customer's margin account by
maintaining segregation between customer margin accounts through the
incorporation of appropriate safeguards to protect customer funds.\283\
SIFMA stated that the proposal, ``in effect, shifts the costs and
burdens of a margin shortfall from customers with excess margin to
customers with deficits, where it properly belongs.'' \284\ Paul/Weiss
supported the Proposed Residual Interest Requirement ``[i]n
principle.'' \285\ Vanguard stated that it was ``particularly
supportive'' of the Proposed Residual Interest Requirement.\286\ Noting
that while an FCM would either have to have its customers pre-fund
margin requirements for pending trades or ``lend'' such customers
margin ahead of a margin transfer, Vanguard argued that the ``proposed
changes correctly shift the risk to customers in deficit and away from
any excess margin transferred by other customers.'' \287\ Vanguard also
argued that, in its opinion, comments at the public roundtable that
``suggested same-day margin transfers were overly complicated to
achieve and the accelerated capital charge would therefore impose
significant added costs to an FCM and, by extension, to its
customers,'' seem overstated particularly because same-day margin
transfer is ``the norm in the OTC swap market.'' \288\ In fact,
Vanguard stated that ``same-day margin transfer is required in
Vanguard's futures and options agreements, consistent with the long-
standing market practice.'' \289\ Vanguard encouraged the Commission to
avoid weakening customer protection, ``at least a weakening beyond the
need to maintain segregation on no less than a once-a-day basis, with
the possibility for clearing house initiated intra-day calls (and
corresponding segregation maintenance) as needed in periods of market
stress.'' \290\ CFA also supported the Proposed Residual Interest
Requirement, asserting its belief ``that no futures customer should be
under-segregated at any time during the day for any reason.'' \291\
---------------------------------------------------------------------------

\279\ CIEBA Comment Letter at 2 (Feb. 20, 2013).
\280\ Id.
\281\ Id. at 3. On this point, CIEBA further noted that allowing
an FCM to use customer excess to support other customer's positions
could lead to improper or complex recordkeeping, which can, in turn,
jeopardize the ability of a trustee to facilitate the return of
customer funds and the porting of positions to a solvent FCM.
\282\ ICI Comment Letter at 3 (Jan. 14, 2013). See also Franklin
Comment Letter at 2 (Feb. 15, 2013) (writing in support of the
positions taken in the ICI Comment Letter).
\283\ SIFMA Comment Letter at 2 (Feb. 21, 2013).
\284\ Id.
\285\ Paul/Weiss Comment Letter at 3 (Feb. 15, 2013).
\286\ Vanguard Comment Letter at 7 (Feb. 22, 2013).
\287\ Id.
\288\ Id.
\289\ Id.
\290\ Id. at 7-8.
\291\ CFA Comment Letter at 5-6 (Feb. 13, 2013).
---------------------------------------------------------------------------

A number of commenters opposed the Proposed Residual Interest
Requirement on the basis that the requirement appeared wholly unrelated
to the MFGI and PFGI bankruptcies,\292\ with other commenters observing
that the Proposed Residual Interest Requirement is unnecessary to
achieve the regulatory goals, including assuring compliance with
section 4d of the Act, in light of other Commission regulations.\293\
---------------------------------------------------------------------------

\292\ See, e.g., CHS Hedging Comment Letter at 1 (Feb. 15,
2013); NFA Comment Letter at 12 (Feb. 15, 2013); JSA Comment Letter
at 2 (Feb. 15, 2013); Paragon Comment Letter at 1 (Feb. 15, 2013);
NIBA Comment Letter at 2 (Feb. 15, 2013); ICA Comment Letter at 1
(Feb. 15, 2013).
\293\ See, e.g., FIA Comment Letter at 18-21 (Feb. 15, 2013).
See also FIA Comment Letter at 2-5 (June 20, 2013).
---------------------------------------------------------------------------

In addition, several commenters commented on the lack of
feasibility of the proposal, interpreting the ``at all times'' language
to require FCMs to continuously calculate the sum of their customers'
margin deficits, and to continuously act on those calculations. For
example, RCG stated that it would be virtually impossible for FCMs to
satisfy the Proposed Residual Interest Requirement because an accurate
assessment of aggregate customer margin deficiencies would be difficult
given that (1) ``the underlying markets operate on a 24-hour basis and
customer fund transfers occur repeatedly throughout each business
day,'' and (2) ``omnibus account offsets are not provided to clearing
FCMs until the end of the trading day or, in some instances, the next
business day.'' \294\ MGEX also argued that ``at all times''
requirement in the Proposed Residual Interest Requirement may be
impracticable as it is a constantly moving target,\295\ and TD
Ameritrade argued that because the firm calculates margin calls after
it receives its nightly downloads, ``it would be difficult, if not
impossible, to assess customer margin deficiencies at any moment in
time, because the markets have not closed and the margin requirements
are not always known.'' \296\ In addition, CME stated that there does
not appear to be a system that currently exists or that could be
constructed in the near future that will permit FCMs to accurately
calculate customer margin deficiencies, at all times.\297\ CMC asserted
that the ``at all times'' portion of the Proposed Residual Interest
Requirement would ``create liquidity issues and increase costs for FCMs
and end users,'' possibly ``limit the number and type of transactions
FCMs clear, the number of customers they service and the amount of
financing they provide,'' and ``require executing FCMs to collect
collateral for give-ups so that customer positions are fully margined
in the event a trade is rejected by a clearing

[[Page 68545]]

FCM,'' \298\ which ``may force many end users to decrease or
discontinue hedging and risk management practices.'' \299\ Advantage
opposed the Proposed Residual Interest Requirement asserting that it
was ``extremely prejudicial to small and midsize firms and their
customers.'' \300\ Advantage also stated that the Proposed Residual
Interest Requirement would result in FCMs more quickly liquidating
customer positions during extreme market moves, which would make
markets more volatile.\301\ Advantage also maintained that calculations
of margin for omnibus accounts cannot be determined prior to the
receipt of offsets, which may not be obtained until late in the day,
thereby adversely impacting an FCM's ability to assess customer margin
deficiencies.\302\
---------------------------------------------------------------------------

\294\ RCG Comment Letter at 3 (Feb. 12, 2013).
\295\ See MGEX Comment Letter at 2 (Feb. 18, 2013). See also
NPPC Comment Letter at 2 (Feb. 15, 2013) (stating that the ``at all
times'' portion of the Proposed Residual Interest Requirement is
``burdensome'', and that changing margin procedures ``to anticipate
future market movements, pre-fund margin calls, [or] make margin
call deposits throughout the day based on current market movements
is impractical.'').
\296\ TD Ameritrade Comment Letter at 4-5 (Feb. 15, 2013).
\297\ See CME Comment Letter at 5 (Feb. 15, 2013).
\298\ CMC Comment Letter at 2 (Feb. 15, 2013).
\299\ Id.
\300\ Advantage Comment Letter at 8 (Feb. 15, 2013).
\301\ See id. at 7-8.
\302\ See id. at 7.
---------------------------------------------------------------------------

FIA and LCH.Clearnet opposed the Proposed Residual Interest
Requirement, and focused particularly on the ``at all times'' portion
of the requirement.\303\ FIA stated that the Proposed Residual Interest
Requirement may force a number of small to mid-sized FCMs out of the
market, which will decrease access to the futures markets and increase
costs for IBs, hedgers, and small traders.\304\ In addition, FIA argued
that the Proposed Residual Interest Requirement would significantly
impair the price discovery and risk management purposes of the
market.\305\ Moreover, FIA stated that the Proposed Residual Interest
Requirement ``would impose a tremendous operational and financial
burden on the industry, requiring the development and implementation of
entirely new systems to assure compliance'' with the ``at all times''
portion of the requirement.\306\ FIA also averred that the ``provisions
of section 4d of the Act prohibiting an FCM from using the fund of one
customer `to margin or guarantee the trades or contracts, or to secure
or extend the credit, of any customer or person other than the one for
whom the same are held,' has been the lynchpin of customer funds
protection since the Commodity Exchange Act was enacted in 1936.''
\307\ In addition, FIA stated that they were not aware that the
Commission has interpreted the statute to require the real time
calculation of margin deficits.\308\
---------------------------------------------------------------------------

\303\ See FIA Comment Letter at 4-5, 12-26 (Feb. 15, 2013);
LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013).
\304\ See FIA Comment Letter at 17 (Feb. 15, 2013).
\305\ See id. at 4, 17.
\306\ Id. at 4. See also id. at 13.
\307\ FIA Comment Letter at 2 (June 20, 2013).
\308\ Id.
---------------------------------------------------------------------------

Several commenters requested that the Commission refrain from
adopting the Proposed Residual Interest Requirement until it conducted
further analysis with the industry regarding the costs and benefits of
such proposal,\309\ with others stating that the Proposed Residual
Interest Requirement would mark a significant departure from current
market practice and could have a material adverse impact on the
liquidity and smooth functioning of the futures and swaps markets.\310\
---------------------------------------------------------------------------

\309\ See, e.g., AIMA Comment Letter at 3 (Feb. 15, 2013); CCC
Comment Letter at 2-3 (Feb. 15, 2013); CHS Hedging Comment Letter at
2-3 (Feb. 15, 2013); CME Comment at 5-7 (Feb. 15, 2013); AFBF
Comment Letter at 2 (Feb. 15, 2013); Jefferies Comment Letter at 9
(Feb. 15, 2013); JSA Comment Letter at 1-2 (Feb. 15, 2013); NCBA
Comment Letter at 2 (Feb. 15, 2013); NGFA Comment Letter at 5 (Feb.
15, 2013); NIBA Comment Letter at 1-2 (Feb. 15, 2013); TCFA Comment
Letter at 2 (Feb. 15, 2013); AFMP Group Comment Letter at 1-2 (Sept.
18, 2013).
\310\ See, e.g., MGEX Comment Letter at 2 (Feb. 18, 2013); AIMA
Comment Letter at 2 (Feb. 15, 2013); CMC Comment Letter at 2 (Feb.
15, 2013); AFMP Group Comment Letter at 1-2 (Sept. 18, 2013); Rice
Dairy LLC Comment Letter at 1 (Feb. 13, 2013).
---------------------------------------------------------------------------

In addition, the Commission received several specific comments on
the potential costs and benefits of the Proposed Residual Interest
Requirement. The Congressional Committees requested that the Commission
consider the benefits in light of ``both the costs to America's farmers
and ranchers and the potential impact on consolidation in the FCM
industry,'' and in particular the ``consequences of changing the manner
or frequency in which `residual interest'--the capital an FCM must hold
to cover customer positions--is calculated.'' \311\
---------------------------------------------------------------------------

\311\ Congressional Committees Comment Letter at 1 (Sept. 25,
2013).
---------------------------------------------------------------------------

FIA noted that FCMs would look to avoid the need to use their own
resources by seeking to make sure that their customers would not be
undermargined, and that this process would involve the FCM collecting
greater amounts of collateral from each customer.\312\ FIA averred that
collecting greater amounts of collateral from customers would be
contrary to the desire of the market to reduce the amount of funds
maintained with FCMs following the failures of MFGI and PFGI.\313\
Moreover, FIA estimated that compliance with the Proposed Residual
Interest Requirement would require FCMs or their customers to
contribute significantly in excess of $100 billion into customer funds
accounts beyond the sum required to meet initial margin requirements,
and that the annual financing costs for these increases will range from
$810 million to $8.125 billion.\314\
---------------------------------------------------------------------------

\312\ FIA Comment Letter at 17 (Feb. 15, 2013).
\313\ Id. at 17. See also AFMP Group Comment Letter at 1 (Sept.
18, 2013) (arguing that ``[m]uch more customer money--maybe twice as
much--will be at risk in the event of another FCM insolvency.'').
\314\ FIA Comment Letter at 16 (Feb. 15, 2013).
---------------------------------------------------------------------------

MFA asserted that applying the Proposed Residual Interest
Requirement continuously to FCMs ``could significantly increase the
operational burdens and costs on FCMs and their customers,'' and that
``any pre-funding obligation is an unacceptable imposition on
customers'' because ``[i]t would create margin inefficiencies by
causing customers to reserve assets to pre-fund their obligations . . .
, and thus, reduce the amount of assets that customers have to use for
investment or other purposes.'' \315\ FHLB cautioned that ``[w]hile it
cannot be disputed that a residual interest buffer should lower the
risk that an FCM will fall out of compliance with its segregation
requirements, there will likely be a real economic cost associated with
maintaining whatever residual interest buffers is established by an
FCM'' and that ``the prospects of funding an additional residual
interest buffer may discourage FCMs from appropriately demanding
collateral from customers in excess of DCO requirements.'' \316\ FHLB
further noted that the ``funds maintained by an FCM as residual
interest can reasonably be expected to earn less than the FCM's
unrestricted funds,'' thus, the proposal ``represents a real cost to
FCMs'' that will be passed on to customers.\317\ Jefferies stated that
the Proposed Residual Interest Requirement will result in more assets
being held at FCMs' custodial facilities at a time when ``the
Commission has been enacting changes that have been shifting capital
away from FCMs towards DCO facilities. . . .'' \318\ Newedge also
stated that the Proposed Residual Interest Requirement ``will result in
many FCMs requiring customers to pre-fund and over-margin their
positions, which will increase

[[Page 68546]]

their exposure to FCMs'' and ``have a significant impact on customers'
own liquidity.'' \319\
---------------------------------------------------------------------------

\315\ MFA Comment Letter at 8 (Feb. 15, 2013).
\316\ FHLB Comment Letter at 3-4 (Feb. 15, 2013).
\317\ Id. at 4 n.5.
\318\ Jefferies Comment Letter at 7 (Feb. 15, 2013). See also
CCC Comment Letter at 2 (Feb. 15, 2013) (arguing that ``the
practical effect'' of the Proposed Residual Interest Requirement
``is that FCMs would require commodity customers to contribute
significantly more property to their FCM in order to meet new margin
requirements far in excess of exchange margin requirements,'' and
expressing concern over any requirement that would require customers
``to contribute even more capital to a system [CCC] believe[s] is
flawed.'')
\319\ Newedge Comment Letter at 2 (Feb. 15, 2013).
---------------------------------------------------------------------------

Steve Jones expressed the view that ``[w]ith more funds on deposit,
a corrupt FCM CEO (or other staff with access to the funds) will simply
be more tempted to `misappropriate' the funds.\320\ In addition,
Jefferies stated that requiring an FCM to maintain this level of
residual interest ``at all times'' ``would impose tremendous financial
and operational difficulties'' on FCMs, which would result in
tremendous increases to necessary liquidity, and ``negatively impact
competitiveness within the industry. . . .'' \321\ Jefferies further
stated that the Proposed Residual Interest Requirement would impose
heavy costs, and that, under the proposal, Jefferies would be required
to increase its residual interest by $15 million (non-peak) or $30
million (peak), respectively.\322\ Jefferies also stated that the
industry would be required to increase its residual interest by $49
billion (non-peak) or $83 billion (peak) at a cost of approximately $2
billion (non-peak) or $5 billion (peak), respectively.\323\
---------------------------------------------------------------------------

\320\ Steve Jones Comment Letter at 1 (Feb. 15, 2013).
\321\ Jefferies Comment Letter at 7 (Feb. 15, 2013).
\322\ Id. at 8.
\323\ Id.
---------------------------------------------------------------------------

ISDA asserted that the Proposed Residual Interest Requirement will
make customers ``self-guaranteeing'' and diminish reliance on the FCM,
and that, while this would diminish overall risk of FCM default, it
comes at a very significant cost to market participants, market volumes
and liquidity.\324\ ISDA estimated the funding needed to comply with
``at all times'' portion of the Proposed Residual Interest Requirement
to be $73.2 billion, with a long term impact of $335 billion.\325\ CHS
Hedging argued that the Proposed Residual Interest Requirement ``would
substantially increase the amount of capital an FCM would need on hand
at all times.'' \326\ Further, CHS Hedging stated that ``[i]n the
current economic environment, the difference between the cost of
capital and the return an FCM could reasonably expect through
investment of funds in a compliant and prudent manner would result in a
material effect on the business of all FCMs.'' \327\ CHS Hedging also
stated that FCMs ``could require that customers pre-fund their accounts
in anticipation of adverse market movement,'' which ``would likely
result in hardship with regard to working capital and may encourage
customers to seek alternative methods to hedge their risk. . . .''
\328\ CHS Hedging is also of the view that ``pre-funding accounts
concentrates additional funds at FCMs, which seems to contradict the
spirit of the'' customer protection rules.\329\
---------------------------------------------------------------------------

\324\ ISDA Comment Letter at 3 (Feb. 15, 2013). See also ISDA
Comment Letter at 2-3 (May 8, 2013).
\325\ ISDA Comment Letter at 4-5 (Feb. 15, 2013).
\326\ CHS Hedging Comment Letter at 2 (Feb. 15, 2013).
\327\ Id.
\328\ Id.
\329\ Id.
---------------------------------------------------------------------------

Other commenters argued that the Proposed Residual Interest
Requirement would be more burdensome on smaller FCMs and customers.
Some commenters stated that forcing FCMs to ask customers to pre-fund
positions will cause many futures industry participants, including
agricultural producers and other customers to suffer a financial burden
by tying up capital that is better used in other areas, such as the
operation of the feedlot, stocker operation or cow/calf operation,\330\
with two commenters asserting that increased costs associated with the
use of wire transfers, rather than checks, would have a similar
impact.\331\ Moreover, NCFC stated that in addition to increased costs
for hedgers, the Proposed Residual Interest Requirement ``would be more
burdensome to firms like farmer cooperative-owned FCMs'' because they
``are largely homogenous, with virtually all of their commercial
customers going deficit at the same time.'' \332\ NCFC also asserted
that ``[t]o require all deficits to be covered immediately would be
overly stringent on these FCMs given the low-risk profile of their
customers as hedgers,'' \333\ while NIBA noted that the Proposed
Residual Interest Requirement ``will actually limit or deny market
access to many customers'' (such as farmers, ranchers and other
agricultural organizations) ``who use the markets to hedge their
financial and commercial risks'' because the proposal ``could raise the
cost of hedging product to prohibitive levels.'' \334\ NIBA also stated
that if small to mid-sized FCMs are forced out of business, market
access ``will become limited and more expensive for IBs and their
smaller hedge and speculative clients.'' \335\ JSA argued that the
Proposed Residual Interest Requirement would be ``punitive in a highly
competitive environment that already places the midsize operator at a
disadvantage to his better capitalized multinational competitors.''
\336\ JSA also asserted that the resulting consolidation would cause
``the loss of competitive forces, [the] loss of significant numbers of
jobs, and the loss of transparency and liquidity required for a highly
functioning hedging environment.'' \337\ Moreover, JSA stated that the
cost of the Proposed Residual Interest Requirement would result in a
higher cost of hedging, which would be become prohibitive and prompt
agricultural users to walk away from the futures market.\338\ CME
averred that mid-sized and smaller FCMs will not have the capital
required by the Proposed Residual Interest Requirement and that
customers will be required to pre-fund potential margin
obligations.\339\ CME asserted that, given this increase in cost, some
customers may transfer their accounts to the larger, better-capitalized
FCMs to reduce the cost of trading,\340\ but that agricultural
customers ``likely will not be able to transfer to the larger FCMs
because they do not fit their customer profile,'' thereby making these
customers bear more of the cost burden.\341\ CME also stated that the
Proposed Residual Interest Requirement will lead to consolidation among
FCMs, which will ``actually increase[] systemic risk by concentrating
risk among fewer market participants.'' \342\ Frontier Futures argued
that the Proposed Residual Interest Requirement does not give an FCM
time to collect margin from customers if the market moves against a
customer's position.\343\ Because many small customers, including most
farmers, do not watch markets constantly, it would be difficult for
them to meet margin calls on a

[[Page 68547]]

moment's notice, thereby causing FCMs to require significantly higher
margins or to liquidate customer positions where margin calls cannot be
immediately met.\344\ Frontier Futures also asserted that the proposal
``may force a number of small to mid-sized FCMs out of the market,''
making it more expensive, if not impossible, for IBs and small members
to clear their business, removing ``significant capital from the
futures industry,'' and ``reducing stability to the markets as a
whole.'' \345\ RJ O'Brien stated that the Proposed Residual Interest
Requirement is impractical because many farmers and agricultural
clients still use checks and ACH to meet margin calls.\346\
---------------------------------------------------------------------------

\330\ TCFA Comment Letter at 2 (Feb. 15, 2013); NCBA Comment
Letter at 2 (Feb. 15, 2013); FCStone Comment Letter at 3 (Feb. 15,
2013); Randy Fritsche Comment Letter at 1 (Feb. 15, 2013); Global
Commodity Comment Letter at 1 (Feb. 13, 2013); AFMP Group Comment
Letter at 1-2 (Sept. 18, 2013).
\331\ TCFA Comment Letter at 1 (Feb. 15, 2013); NCBA Comment
Letter at 1 (Feb. 15, 2013).
\332\ NCFC Comment Letter at 2 (Feb. 15, 2013).
\333\ Id.
\334\ NIBA Comment Letter at 1 (Feb. 15, 2013).
\335\ Id. at 1-2. NIBA also asserted that ``[t]ransferring
accounts between brokerage houses would become very difficult to
accomplish'' because open positions would ``need to be margined at
the receiving house as well as the transferring one,'' thereby
restraining Brokers ``to remain with one FCM, or completely close
customers' positions in order to start up again with a different
FCM.'' Id. at 2.
\336\ JSA Comment Letter at 1 (Feb. 15, 2013).
\337\ Id. at 1-2.
\338\ Id. at 2.
\339\ CME Comment Letter at 5-6 (Feb. 15, 2013).
\340\ Id. at 6.
\341\ Id.
\342\ Id. (emphasis in original). CME also maintained that
``those customers who qualify as [ECPs] can move to the uncleared
and less regulated swaps space and decline to use centralized
clearing.'' Id. at 6-7.
\343\ Frontier Futures Comment Letter at 3 (Feb. 15, 2013).
\344\ Id.
\345\ Id.
\346\ RJ O'Brien Comment Letter at 3 (Feb. 15, 2013). See also
ICA Comment Letter at 1-2 (Feb. 15, 2013).
---------------------------------------------------------------------------

Several commenters presented alternative proposals for the
Commission's consideration. For example, two commenters argued that the
Commission should consider less costly alternatives to the current
residual interest proposal, such as allowing the FCM ``to count
guaranty fund deposits with [DCOs] as part of their residual
interest,'' \347\ with others stating that the residual interest amount
that an FCM must carry should only apply to a limited number of its
largest customers.\348\
---------------------------------------------------------------------------

\347\ Newedge Comment Letter at 3 (Feb. 15, 2013). See also RJ
O'Brien Comment Letter at 5 (Feb. 15, 2013). Cf. Frontier Futures
Comment Letter at 3 (Feb. 15, 2013) (suggesting further that firm
firewalls be put in place between customer funds and an FCM's
proprietary funds in the form of approval by an independent agency
for an FCM to transfer customer funds and that FCMs ``do their
proprietary trading through another FCM thereby engaging the risk
management of a third party.'')
\348\ See, e.g., Newedge Comment Letter at 3 (Feb. 15, 2013).
---------------------------------------------------------------------------

Moreover, and as discussed more fully below, other commenters urged
the Commission to conform the final version of proposed Rules
1.20(i)(4), 22.2(f)(6), and 30.7(a) to the current method of
calculating residual interest buffer for Cleared Swaps by dropping the
words ``at all times.'' \349\ For example, ISDA and FIA further urged
consideration of an alternative under which the residual interest
calculations would be made once a day and that, by the end of a
business day, an FCM would be required to maintain a residual interest
in its customer funds accounts at least equal to its customers'
aggregate margin deficits for the prior trade date.\350\ ISDA stated
this alternative ``would rationally reduce'' FCMs cost of
compliance\351\ and that ``[f]or an FCM with robust credit risk
management systems, covering end-of-day customer deficits should not be
a significant cost.'' \352\ ISDA also noted that at the end of the day
``typically, all customer calls have been met, and all customer gains
have been paid out; all achieved without the FCM having recourse to its
own funding resources.'' \353\ FIA asserted that it would ``achieve the
Commission's regulatory goals without imposing the damaging financial
and operational burdens on FCMs, and the resulting financial burdens on
customers.'' \354\ LCH.Clearnet argued that customer collateral can be
protected by performing the ``LSOC Compliance Calculation'' once per
day, prior to settlement at a DCO, because ``prior to meeting a call
for an increased requirement, a customer may be under collateralized,
but is not collateralized by another customer.'' \355\ ISDA and FIA
evaluated the costs associated with requiring FCMs to perform the
residual interest calculation once each day at the close of business on
the first business day following the trade date.\356\ ISDA estimated
that ``removing the predictive element of FCM funding requirements'' of
the ``at all times'' method in favor of the alternative approach would
permit markets to ``reap the efficiencies of end-of-day accounting,''
\357\ thereby significantly reducing the overall cost of compliance
with the regulation. ISDA estimated that for futures, the costs
associated with the would be the cost of covering the out-standing
margin deficits of between 2 and 5% of its futures customers, and thus
would impose only ``incremental funding requirements'' on FCMs.\358\
ISDA estimated that the costs of the alternate proposal would be even
smaller for cleared swaps, due to the ``more professional'' nature of
the market.\359\ FIA estimated the financing costs to FCMs of complying
with FIA's proposed alternative and concluded that the costs associated
with the Proposed Residual Interest Requirement would be approximately
ten times the costs associated with the FIA proposal.\360\ FIA also
concluded that their proposal would not ``impos[e] damaging financial
and operational burdens on FCMs . . . and the resulting financial
burdens on customers.''\361\
---------------------------------------------------------------------------

\349\ See, e.g., LCH.Clearnet Comment Letter at 5 (Feb. 15,
2013); ISDA Comment Letter at 6 (Feb. 15, 2013); RJ O'Brien Comment
Letter at 5 (Feb. 15, 2013).
\350\ See ISDA Comment Letter at 6 (Feb. 15, 2013); FIA Comment
Letter at 23-25 (Feb. 15, 2013).
\351\ ISDA Comment Letter at 6 (Feb. 15, 2013).
\352\ ISDA Comment Letter at 2 (May 8, 2013).
\353\ Id. ISDA further recommended that because many FCM
customers use custodians across the world, ``many customers cannot
assure payment of their morning FCM call before the end of the New
York day,'' and therefore recommended that Commission study the
feasibility of reducing the time in which customers have to meet
margin calls, if that is ``imperative.'' Id. at 3.
\354\ FIA Comment Letter at 23 (Feb. 15, 2013). See also ISDA
Comment Letter at 4 (May 8, 2013).
\355\ LCH.Clearnet Comment Letter at 5 (Feb. 15, 2013).
\356\ ISDA Comment Letter at 1-2 (May 8, 2013); FIA Comment
Letter at 8-10 (June 20, 2013).
\357\ Id. at 3.
\358\ ISDA Comment Letter at 3-4 (May 8, 2013).
\359\ Id. at 4.
\360\ See FIA Comment Letter at 8-10 (June 20, 2013). While the
rates used by FIA in this exercise may be conservative, and thus the
Commission does not purport to opine on the precise estimates
reached, the exercise is nevertheless illustrative and useful for
the purpose of comparing the costs of the Residual Interest
Proposal, the alternate proposal, and the final rule.
\361\ Id. at 9.
---------------------------------------------------------------------------

RJ O'Brien also recommended that the Commission drop the ``at all
times'' requirement and that the residual interest calculation be done
once each day at the close of business on the first business day
following the trade date.\362\ RJ O'Brien asserted that ``this
alternative will reduce the substantial financial burdens'' on
customers ``while further enhancing the protection of customer funds.''
\363\
---------------------------------------------------------------------------

\362\ RJ O'Brien Comment Letter at 5 (Feb. 15, 2013).
\363\ Id.
---------------------------------------------------------------------------

MFA stated that the Commission should modify the proposed FCM
residual interest requirement in Sec. 1.20(i)(4) so that it is a
``point of time'' obligation that requires FCMs to ensure they maintain
sufficient residual interest ``as of the close of business EST on the
business day after the FCM issues a customer's margin call.'' \364\ MFA
argued that this alternative would ``reduce the stress on the market''
and ``eliminate[] the need for customer pre-funding or intraday margin
calls, while also ensuring that * * * FCMs will hold sufficient funds
to protect against customer shortfalls.'' \365\
---------------------------------------------------------------------------

\364\ MFA Comment Letter at 8-9 (Feb. 15, 2013).
\365\ Id.
---------------------------------------------------------------------------

Paul/Weiss stated that the Commission should clarify that the
residual interest amount an FCM is required to maintain must be
determined ``at the time of any end-of-day, intra-day or special call
payment by an FCM to derivatives clearing organization (or other
clearing house or clearing intermediary). . . .''\366\ Paul/Weiss
argued that these payments are ``the relevant points in time at which

[[Page 68548]]

the FCM is obligated to transfer'' customer margin.\367\
---------------------------------------------------------------------------

\366\ Paul/Weiss Comment Letter at 4 (Feb. 15, 2013).
\367\ Id.
---------------------------------------------------------------------------

As a threshold matter, and as noted above, the Commission
reiterates that the Act expressly prohibits an FCM from using the
collateral of one customer to margin, secure, or guarantee the trades
or contracts of other customers.\368\ Congress specifically added this
prohibition in response to concerns that certain customers were
carrying the risks and obligations of other favored customers.\369\ By
this token, any customer that is undermargined is being favored over
the customers with excess margin, in contravention of section 4d(a)(2)
when other customers' funds are being used to cover the undermargined
amounts.\370\
---------------------------------------------------------------------------

\368\ The Commission further notes that current Commission
regulations also include such prohibitions. Namely, Sec. 1.22
states that ``No futures commission merchant shall use, or permit
the use of, the futures customer funds of one futures customer to
purchase, margin, or settle the trades, contracts, or commodity
options of, or to secure or extend the credit of, any person other
than such futures customer,'' and Sec. 22.2(d)(1) states that ``No
futures commission merchant shall use, or permit the use of, the
Cleared Swaps Customer Collateral of one Cleared Swaps Customer to
purchase, margin, or settle the Cleared Swaps or any other trade or
contract of, or to secure or extend the credit of, any person other
than such Cleared Swaps Customer.''
\369\ See 80 Cong. Rec. 6159, 6162 (1936) (statement of Sen.
James. P. Pope) (``It further appears that certain favored dealers
have not been required actually to put up the money for margins, and
have been extended credit in that respect. This gives these favored
dealers an advantage. In some instances, large commission firms have
become bankrupt and the funds placed with them by a large number of
dealers were lost.''); ``Regulation of Grain Exchanges: Before the
H. Comm. on Agriculture,'' 73 Cong. 31 (1934) (statement of Dr. J.
W. T. Duvel, Chief Grain Futures Admin. Dept. of Agriculture) (``On
the commodities exchanges certain classes of speculators and others
are able to secure credit but in many cases the credit so extended
represents margin money taken from one class of customers and used
to extend credit on [sic] margin the trades of others. Our aim is to
protect the customers' margin money and thereby protect the market
as a whole.'').
\370\ As some commenters report, institutional customers in
particular are typically undermargined. This could mean that
institutional customers are being favored over individual customers.
See, e.g., FIA Comment Letter at 15 (Feb. 15, 2013).
---------------------------------------------------------------------------

Moreover, there is an inescapable mathematical fact: When an FCM
meets the DCO's margin requirements, the property used to meet those
requirements can only come from one of three sources: the responsible
customer, the FCM, or other customers. If the property does not come
from the customer whose positions generated the margin requirement or
loss, or the FCM itself (that is, the FCM's residual interest), then it
must, of necessity, come from other customers.\371\ In reviewing the
Commission's customer protection rules in light of MFGI and PFGI, staff
identified market practices that were in tension with the plain
language of the Act, and, as such, the Commission attempted to clarify
acceptable practices with respect to these existing statutory
requirements with the Proposed Residual Interest Requirement.
---------------------------------------------------------------------------

\371\ As recognized by the Commission previously, the obligation
to ensure that one customer's property is not used to margin or
settle the trades or contracts of another customer rests with the
FCM. See 46 FR 11668, 11669. (stating that ``section [4d(a)(2)] of
the Act and Sec. Sec. 1.20 and 1.22 of the Commission's regulations
require an FCM to add its own money into segregation in an amount
equal to the sum of all customer deficits.''). See also CFTC Letter
00-106 (Nov. 22, 2000) (stating that ``each FCM must segregate
sufficient funds to cover any amounts it owes to its customers in
connection with commodity interest transactions. The funds of
multiple customers may be commingled in a single account for the
benefit of the customers as a group. If, however, the balance of any
one of those customers falls into a deficit, the FCM is obligated to
restore the amount of such deficit out of its own funds or property
in order to avoid the use of the funds or property or any other
customer to meet the obligations of the customer in deficit. The
Commission requires FCM's [sic] to maintain minimum levels of
capital to help assure that, among other things, they are able to
meet such obligations.'').
---------------------------------------------------------------------------

As noted above, several commenters strongly supported the Proposed
Residual Interest Requirement, noting it is consistent with
Congressional intent and the Commission's historical interpretations of
the Act. In general, these commenters argued that the proposal
correctly shifts the risk of loss to customers with margin deficiencies
and away from customers with excess margin. Some of these commenters
questioned market cost estimates and statements regarding the technical
challenges associated with same-day margin transfers, and urged the
Commission to avoid unnecessarily weakening customer protection.
On the other hand, many commenters expressed concern regarding the
costs associated with the Proposed Residual Interest Requirement. In
particular, commenters stated that requiring the FCM to be in
compliance with residual interest requirements ``at all times'' would
disparately impact agricultural producers, small and mid-size FCMs, and
hedgers; decrease market liquidity; cause market consolidation; and
increase systemic risk. Moreover, the Commission notes that many of the
estimates of the amount of additional capital required as a result of
the Proposed Residual Interest Requirement seem to result from a
particular interpretation of the meaning of the ``at all times''
portion of the proposal, and seemed to range from $49 billion (non-
peak) and $83 billion (peak),\372\ to $73.2 billion,\373\ to upwards of
$100 billion.\374\ Further, commenters asserted that the ``at all
times'' portion of the Proposed Residual Interest Requirement would be
operationally unachievable, and argued that the Proposed Residual
Interest Requirement would curtail competition, concentrate capital in
FCMs at a time when the market would like to reduce the amount of
customer collateral held at the FCM, and reduce the number of viable
FCMs, thereby negatively impacting overall market risk and market
access for smaller customers and agricultural hedgers. Commenters also
argued that the Proposed Residual Interest Requirement is unnecessary
because in their view, customer funds are not at risk when fellow
customer accounts are undermargined.\375\
---------------------------------------------------------------------------

\372\ See Jefferies Comment Letter at 8-9 (Feb. 15, 2013).
Jefferies states that the proposal would require them to increase
residual interest by $15 million (non-peak) to $30 million (peak).
\373\ See ISDA Comment Letter at 4-5 (Feb. 15, 2013). ISDA
argued that the long term impact of the ``at all times'' portion of
the proposal could be as high as $335 billion.
\374\ See FIA Comment Letter at 15-17 (Feb. 15, 2013). FIA also
estimated that the annual financing costs associated with the $100
billion cost could range from $810 million to $8.125 billion.
\375\ See Transcript, U.S. Commodity Futures Trading Commission
Agricultural Advisory Committee Meeting held on July 25, 2013,
available at https://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/aac_transcript072513.pdf.
_____________________________________-

Many of the commenters interpreted the proposal to require FCMs to
continuously calculate and monitor the margin deficits of their
customers. In the final rulemaking, the Commission is, in general,
following the concept advanced by Paul/Weiss and LCH.Clearnet--that is,
what is required is that the FCM not ``use'' one customer's property to
margin another customer's positions. For an interim phase-in period,
the Commission is adopting the alternative proposal recommended by
several commenters, including FIA. Thus, for the reasons set forth
below, by the Residual Interest Deadline, which is defined in Sec.
1.22(c)(5), an FCM would be required to maintain a residual interest in
its customer funds accounts at least equal to its customers' aggregate
margin deficits for the prior trade date.\376\ The commenters asserted,
and the Commission agrees that this alternative would significantly and
materially reduce the financial burdens that would otherwise be imposed
on

[[Page 68549]]

customers and FCMs alike under the Commission's Proposed Residual
Interest Requirement \377\ because, among other things, this alternate
approach would not cause an extreme drain on market liquidity, market
consolidation, increase in systemic risk, and detrimental effect on
agricultural producers, small and mid-size FCMs, and hedgers.\378\
---------------------------------------------------------------------------

\376\ See, e.g., Advantage Comment Letter at 8 (Feb. 15, 2013);
CMC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5-6
(Feb. 15, 2013); FIA Comment Letter at 4-5 (Feb. 15, 2013);
LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013); MGEX Comment
Letter at 2 (Feb. 18, 2013); NPPC Comment Letter at 2 (Feb. 15,
2013); RCG Comment Letter at 3 (Feb. 12, 2013); RJ O'Brien Comment
Letter at 5 (Feb. 15, 2013); TD Ameritrade Comment Letter at 4-5
(Feb. 15, 2013).
\377\ The Commission notes that representatives from FIA, ISDA,
and ADM Investor Services have all indicated in meetings with
Commission staff that such an alternative would better protect
customers, benefit FCMs risk management practices, and materially
reduce many costs associated with the Commission's original
proposal.
\378\ See ISDA Comment Letter at 3 (May 8, 2013) (noting that a
substantial majority of customer margin calls are met by 5:00 p.m.
on the day the calls are issued and therefore the this approach
would not impose the costs and cause the problems associated with
the Proposed Residual Interest Requirement); FIA Comment Letter at 9
(June 20, 2013) (estimating that the alternative approach would be
10 times less costly for FCMs to finance). See also MFA Comment
Letter at 8-9 (Feb. 15, 2013); RJ O'Brien Comment Letter at 5 (Feb.
15, 2013).
---------------------------------------------------------------------------

After careful consideration of the comments and the applicable
statutory provisions, the Commission has decided to adopt the Proposed
Residual Interest Requirement with modifications.
Section 4d(a)(2) of the Act expressly states that the money,
securities, and property received by an FCM from a customer to margin,
guarantee, or secure the trades or contracts of that customer shall be
separately accounted for and shall not be commingled with the funds of
such commission merchant or be used to margin or guarantee the trades
or contracts, or to secure or extend the credit, of any customer or
person other than the one for whom the same are held.\379\ Moreover,
the Commission notes that when section 22 of the rules and regulations
of the Secretary of Agriculture under the Act (the predecessor of Sec.
1.22) was adopted in 1937,\380\ the year after adoption of the Act, it
expressly stated that ``No futures commission merchant shall use, or
permit the use of, the money, securities, or property of one customer
to margin or settle the trades or contracts, or to secure or extend the
credit, of any person other than such customer. The net equity of one
customer shall not be used to carry the trades or contracts or to
offset the net deficit of any other customer or person or to carry the
trades or offset the net deficit of the same customer in goods or
property not included in the term `commodity' as defined herein.''
\381\ This language addresses, by its terms, more than net deficits,
and appears to have remained substantively unchanged for the next four
decades.
---------------------------------------------------------------------------

\379\ See also section 4d(f)(2) of the Commodity Exchange Act,
as well as Sec. 1.22 of this section and Sec. 22.2(d)(1) of this
chapter.
\380\ 2 FR 1223, 1225 (July 16, 1937).
\381\ Id. at 1225 (emphasis supplied).
---------------------------------------------------------------------------

In 1981, in its Regulation of Domestic Exchange-Traded Commodity
Options, the Commission revised Sec. 1.22 to combine segregation
requirements for options with existing segregation requirements for
futures.\382\ In doing so, the Commission generalized the regulatory
language and deleted specific references to ``net equity.'' However,
neither the adopting release nor the proposing release for the
``Regulation of Domestic Exchange-Traded Commodity Options'' rulemaking
indicated an intent to alter or modify the existing segregation
requirements for futures.\383\
---------------------------------------------------------------------------

\382\ See 46 FR 54500 (Nov. 3, 1981).
\383\ See id. at 54508 (Final Release) (stating that because the
Commission did not receive any comments on its proposed regulations
relating to segregation of customer funds, it was adopting the
amendments essentially as proposed). In addition, in stating that
``the Commission is now proposing that the option segregation
requirements be combined with the existing segregation requirements
for futures,'' the proposing release noted that certain definitions
``have also been added or modified to permit defined terms to be
used in the sections, as amended, and thereby simplify the
regulations.'' See 46 FR 33293-01, 33298 (June 29, 1981).
---------------------------------------------------------------------------

The current version of Sec. 1.22 states that ``[n]o futures
commission merchant shall use, or permit the use of, the futures
customer funds of one futures customer to purchase, margin, or settle
the trades, contracts, or commodity options of, or to secure or extend
the credit of, any person other than such futures customer.''
The Commission's Proposed Residual Interest Requirement was
intended to ensure compliance with section 4d(a)(2) and Sec. 1.22 by
shifting the risk of loss in the event of a double default back to the
customer whose positions incurred the loss and away from those
customers with excess margin at the FCM. Contrary to the assertion of
certain commenters, whenever an FCM uses the funds of customers with
excess margin to collateralize the positions of undermargined
customers, the customers with excess funds are subject to heightened
risk, and diminished availability of those excess funds for transfer in
the event the FCM is in financial distress.
Nonetheless, commenters asserted that there is ambiguity regarding
(1) the point at which an FCM has ``used'' or ``permitted the use'' of
the futures customer funds of one futures customer to purchase, margin,
or settle the trades, contracts, or commodity options of, or to secure
or extend the credit of, another futures customer, and (2) what an FCM
is required to do to comply with this requirement. Accordingly, the
Commission is adopting proposed Sec. Sec. 1.20(i) and 1.22 with
certain modifications.
First, the Commission is revising proposed Sec. 1.20(i) by
removing the Proposed Residual Interest Requirement from paragraph
(i)(4). In addition, the Commission is revising the language in Sec.
1.22 to add an amended residual interest requirement and additional
technical corrections to Sec. 1.20(i) as described further below.
Moreover, the Commission is reorganizing proposed Sec. 1.22 as
follows: (1) The sentence that reads ``No futures commission merchant
shall use, or permit the use of, the futures customer funds of one
futures customer to purchase, margin, or settle the trades, contracts,
or commodity options of, or to secure or extend the credit of, any
person other than such futures customer.'' will be in paragraph (a);
(2) the remaining language in proposed paragraph (a) will be deleted;
(3) the sentence that reads ``Futures customer funds shall not be used
to carry trades or positions of the same futures customer other than in
contracts for the purchase of sale of any commodity for future delivery
or for options thereon traded through the facilities of a designated
contract market.'' will remain in paragraph (b); and (4) as discussed
below, a new paragraph (c) will be added to address the revised
residual interest requirements.
As highlighted above, several commenters questioned the ability of
FCMs to measure compliance on a continuous and real-time basis,\384\
and argued that the potential cost associated with a continuous
residual interest requirement would have an adverse impact on the
market.\385\ The Commission is persuaded that continuous calculation
and monitoring requirements are not technologically feasible at this
time. The Commission is also persuaded that it would not be practical
to make such calculations in the futures markets based on intra-day

[[Page 68550]]

changes.\386\ However, as discussed in more detail below, the
Commission is persuaded that the calculations required by the residual
interest requirement are feasible using a point in time approach.
---------------------------------------------------------------------------

\384\ See, e.g., Advantage Comment Letter at 8 (Feb. 15, 2013);
CMC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5-6
(Feb. 15, 2013); FIA Comment Letter at 4-5 (Feb. 15, 2013);
LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013); MGEX Comment
Letter at 2 (Feb. 18, 2013); NPPC Comment Letter at 2 (Feb. 15,
2013); RCG Comment Letter at 3 (Feb. 12, 2013); RJ O'Brien Comment
Letter at 5 (Feb. 15, 2013); TD Ameritrade Comment Letter at 4-5
(Feb. 15, 2013).
\385\ See, e.g., CMC Comment Letter at 2 (Feb. 15, 2013); CME
Comment Letter at 5 (Feb. 15, 2013); MGEX Comment Letter at 2 (Feb.
18, 2013); NPPC Comment Letter at 2 (Feb. 15, 2013); RJ O'Brien
Comment Letter at 4 (Feb. 15, 2013).
\386\ See, e.g., Advantage Comment Letter at 7 (Feb. 15, 2013);
CME Comment Letter at 5 (Feb. 15, 2013); FIA Comment Letter at 4,
15, 21-22 (Feb. 15, 2013); MFA Comment Letter at 8 (Feb. 15, 2013);
NPPC Comment Letter at 2 (Feb. 15, 2013); RCG Comment Letter at 3
(Feb. 12, 2013); TD Ameritrade at 4-5 (Feb. 15, 2013). Cf. ISDA
Comment Letter at 1-2 (Aug. 27, 2013).
---------------------------------------------------------------------------

As noted above, the Commission is moving the Proposed Residual
Interest Requirement from proposed Sec. 1.20(i) to new paragraph (c)
in Sec. 1.22. Moreover, and as suggested by commenters,\387\ the
Commission agrees that a point in time approach to the determination of
the adequate size of the residual interest amount would ``ensure that
an FCM has appropriately sized the residual interest buffer to cover
the aggregated gross margin deficiencies in respect of customer
transactions in the relevant origin.'' \388\ Further, the Commission
agrees that this approach is consistent with the Act and Commission
regulations, and would help ensure that the collateral of one customer
is never used to margin the positions of another customer.\389\
Moreover, the Commission notes that a point in time approach is
consistent with the current practice with respect to residual interest
buffer calculations for Cleared Swaps and with the approach set forth
in JAC Update 12-03.\390\
---------------------------------------------------------------------------

\387\ See ISDA Comment Letter at 6 (Feb. 15, 2013); FIA Comment
Letter at 23-25 (Feb. 15, 2013); LCH.Clearnet comment Letter at 5
(Feb. 15, 2013); Paul/Weiss Comment Letter at 4-5 (Feb. 15, 2013);
RJ O'Brien Comment Letter at 5 (Feb. 15, 2013).
\388\ Paul/Weiss Comment Letter at 4 (Feb. 15, 2013).
\389\ See generally id.; FIA Comment Letter at 23 (Feb. 15,
2013); ISDA Comment Letter at 4 (May 8, 2013).
\390\ Joint Audit Committee Regulatory Update 12-03,
Part 22 of CFTC Regulations--Treatment of Cleared Swaps Customer
Collateral--Legally Segregated Operationally Commingled (``LSOC'')
Compliance Calculation (Oct. 18, 2012).
---------------------------------------------------------------------------

Accordingly, the Commission is revising the Proposed Residual
Interest Requirement as follows. Regulation 1.22 (c)(1) defines the
undermargined amount for a futures customer's account as the amount, if
any (i.e., the amount must be greater than or equal to zero), by which
(i) the total amount of collateral required for that futures customer's
positions \391\ in that account, at the time or times referred to in
Sec. 1.22(c)(2), exceeds (ii) the value of the net liquidating equity
for that account, as calculated in Sec. 1.20(i)(2). An FCM is required
to perform the calculation set forth in Sec. 1.22(c)(1) on a customer
by customer basis. Regulation 1.22(c)(2) requires an FCM to perform a
residual interest buffer calculation, at the close of each business
day, based on the information available to the FCM at that time,\392\
by calculating (i) the undermargined amounts, based on the clearing
initial margin that will be required to be maintained by that FCM for
its futures customers, at each DCO of which the FCM is a member, at the
point of the daily settlement (as described in Sec. 39.14) that will
complete during the following business day for each such DCO less (ii)
any debit balances referred to in Sec. 1.20(i)(4) included in such
undermargined amounts.\393\
---------------------------------------------------------------------------

\391\ For purposes of this calculation, the FCM should include
as ``positions'' any trade or contract that (i) would be required to
be segregated pursuant to 4d(f) of the Act or (ii) would be subject
to Sec. 30.7 of this chapter, but which is, in either case,
pursuant to a Commission rule, regulation, or order (or a
derivatives clearing organization rule approved in accordance with
Sec. 39.15(b)(2) of this chapter), commingled with a contract for
the purchase or sale of a commodity for future delivery and any
options on such contracts in an account segregated pursuant to
section 4d(a) of the Act and should exclude as ``positions'' any
trade or contract that, pursuant to a Commission rule, regulation,
or order, is segregated pursuant to section 4d(f) of the Act. This
requirement is intended to be analogous to the definition of Cleared
Swap in Sec. 22.1 of this chapter.
\392\ An FCM is not expected to account for changes in
circumstances that occur after the close of business and prior to
the next business day's settlement, outside of normal end-of-day
reconciliation processes. In other words, an FCM may use the
information (such as position and value information) available to it
at the close of each business day for this calculation.
\393\ This subtraction is intended to address the potential
double-counting of deficit balances that was pointed out in a number
of comments. See, e.g., Vanguard Comment Letter at 8 (Feb. 22,
2013).
---------------------------------------------------------------------------

An FCM is required to perform the calculation in Sec. 1.22(c)(2)
once per day, based on the information at the close of business on that
day, so that it can determine the amount of customer funds which will
be needed to avoid using the funds of one customer to margin,
guarantee, or secure the positions of another customer. Consistent with
this revised residual interest requirement, Sec. 1.20(i)(4) is being
amended to state that the amount of funds an FCM is holding in
segregation may not be reduced by any debit balances that the futures
customers of the FCM have in their accounts. In addition, Sec.
1.20(i)(2)(ii) is being removed because this requirement is now set
forth in Sec. 1.22(c). Consistent with Federal Register requirements,
Sec. 1.20(i)(2) is being renumbered and, for clarity, the first
sentence will be revised to read as follows ``The futures commission
merchant must reflect in the account that it maintains for each futures
customer the net liquidating equity for each such customer, calculated
as follows: the market value of any futures customer funds that it
receives from such customer, as adjusted by: . . . .'' \394\ Further,
under Sec. 1.22(c)(3), an FCM is required, prior to the Residual
Interest Deadline, as defined in Sec. 1.22(c)(5), to have residual
interest in the segregated account in an amount that is at least equal
to the computation set forth in Sec. 1.22(c)(2).\395\ However, the
amount of residual interest that an FCM must maintain may be reduced to
account for payments received from or on behalf of (net of
disbursements made to or on behalf of) undermargined futures customers
between the close of the previous business day and the Residual
Interest Deadline.
---------------------------------------------------------------------------

\394\ As noted in the preamble to the proposal, the purpose of
the amendments to 1.20(i) is to ``provid[e] more detail implementing
the Net Liquidating Method of calculating segregation
requirements.'' 77 FR at 67882.
\395\ Following the completion of the phase-in period, when the
Residual Interest Deadline moves to the time of settlement, an FCM
may be subject to multiple Residual Interest Deadlines, in which
case the FCM must maintain residual interest prior to the Residual
Interest Deadline in an amount that is at least equal to the portion
of the computation set forth in Sec. 1.22(c)(2) attributable to the
clearing initial margin required by the DCO making such settlement.
Thus, where an FCM is a member of more than one DCO and the DCOs
conduct their daily settlement cycles at different times, an FCM
would be required, at the time of the daily settlement for each DCO,
to maintain the proportionate share of residual interest in the
futures customer account.
---------------------------------------------------------------------------

Regulation 1.22(c)(4) provides that for purposes of Sec.
1.22(c)(2), an FCM should include, as ``clearing initial margin,''
customer initial margin that the FCM will be required to maintain, for
that FCM's futures customers, at another FCM, and, for purposes of
Sec. 1.22(c)(3), must do so prior to the Residual Interest Deadline.
In other words, Sec. 1.22(c)(4) is intended to make clear that the
requirements with respect to futures customer funds used by an FCM that
clears through another FCM are parallel to the requirements applied
with respect to futures customer funds used when an FCM clears through
a DCO.
Regulation 1.22(c)(5) defines the Residual Interest Deadline.
Paragraph (c)(5)(i) sets forth that except during the phase-in period
defined in paragraph (c)(5)(ii), the Residual Interest Deadline shall
be the time of the settlement referenced in paragraph (c)(2)(i), or, as
appropriate, (c)(4). However, in response to the comments that urge
that achieving compliance with these requirements may take time, and in
order to mitigate some of the cost concerns raised by commenters,
paragraph (c)(5)(ii) provides that the Residual Interest Deadline
during the phase-in period shall be 6:00 p.m.

[[Page 68551]]

Eastern Time on the date of the settlement referenced in paragraph
(c)(2)(i) or, as appropriate, (c)(4). The phased compliance schedule
for Sec. 1.22(c) is set forth in Sec. 1.22(c)(5)(iii). However, the
Residual Interest Deadline of 6:00 p.m. Eastern Time in Sec.
1.22(c)(5)(ii) shall begin one year following the publication of this
rule in the Federal Register.\396\
---------------------------------------------------------------------------

\396\ For further discussion regarding the phase-in schedule for
the requirements in Sec. 1.22(c), see section III.F.
---------------------------------------------------------------------------

Additionally, in further response to the commenters' request for
additional study,\397\ in paragraph (c)(5)(iii)(A), the Commission is
directing staff to complete and publish for public comment a report
(``the Report''), no later than 30 months following the date of
publication of this release, addressing, to the extent information is
practically available, the practicability (for both FCMs and customers)
of moving the Residual Interest Deadline from 6:00 p.m. Eastern Time on
the date of the settlement referenced in Sec. 1.22(c)(2)(i) to the
time of that settlement (or to some other time of day), including
whether and on what schedule it would be feasible to do so. The Report
is also expected to address cost and benefit considerations of such
potential alternatives. Moreover, staff shall, using the Commission's
Web site, solicit public comment and shall conduct a public roundtable
regarding specific issues to be covered by the Report. Paragraph
(c)(5)(iii)(B) sets forth that within nine months after the publication
of the Report, the Commission may (but shall not be required to) do
either of the following: (1) terminate the phase-in period, in which
case the phase-in shall end as of a date established by order published
in the Federal Register, which date shall be no less than one year
after the date such order is published, or (2) determine that it is
necessary or appropriate in the public interest to propose through
rulemaking a different Residual Interest Deadline, in which event, the
Commission shall establish, by order published in the Federal Register,
a phase-in schedule. Finally, paragraph (c)(5)(iii)(C) provides that if
the phase-in schedule has not been amended pursuant to Sec.
1.22(c)(5)(iii)(B), then the phase-in period shall end on December 31,
2018.
---------------------------------------------------------------------------

\397\ See, e.g., AIMA Comment Letter at 3 (Feb. 15, 2013); CCC
Comment Letter at 2-3 (Feb. 15, 2013); CHS Hedging Comment Letter at
2-3 (Feb. 15, 2013); CME Comment at 5-7 (Feb. 15, 2013); AFBF
Comment Letter at 2 (Feb. 15, 2013); Jefferies Comment Letter at 9
(Feb. 15, 2013); JSA Comment Letter at 1-2 (Feb. 15, 2013); NCBA
Comment Letter at 2 (Feb. 15, 2013); NGFA Comment Letter at 5 (Feb.
15, 2013); NIBA Comment Letter at 1-2 (Feb. 15, 2013); TCFA Comment
Letter at 2 (Feb. 15, 2013); AFMP Group Comment Letter at 1-2 (Sept.
18, 2013).
---------------------------------------------------------------------------

With respect to the suggestion that a portion (i.e., that portion
attributable to customer business) of the funds contributed to an
exchange's guaranty fund by an FCM should be considered in that FCM's
residual interest calculations,\398\ the Commission notes that
contributions to a guarantee fund are not segregated for the benefit of
customers. Rather, they are, by design, available to meet the defaults
of other clearing members, and thus cannot be counted as customer
segregated funds. As such, the Commission declines to adopt this
suggestion.
---------------------------------------------------------------------------

\398\ See, e.g., Newedge Comment Letter at 3 (Feb. 15, 2013); RJ
O'Brien Comment Letter at 5 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission also received several requests for clarifications.
CIEBA stated that ``while futures market participants may be familiar
with terms such as `residual interest' and the technical features of
the proposed rule, other market participants may not appreciate the
full scope of the rule and the additional protections provided without
further explanation.'' \399\ CIEBA requested that the Commission
clarify ``how this requirement is intended to work with examples of its
application so as to more broadly communicate the Commission's intent
to bolster the depth of customer protections to minimize customer risk
and promote confidence in the markets.'' \400\ The Commission
recognizes CIEBA's concern and, as discussed above, has provided
clarification in this release regarding the mechanism by which FCMs
measure compliance with the statutory requirement of 4d(a)(2). However,
the Commission also recognizes that FCMs engage in a broad range of
acceptable business practices and should be given flexibility in how
best to tailor their businesses to comply with such requirement.
---------------------------------------------------------------------------

\399\ CIEBA Comment Letter at 3 (Feb. 15, 2013).
\400\ Id.
---------------------------------------------------------------------------

AIMA requested clarification that Sec. Sec. 1.17(c)(5) and
1.20(i)(4) are not duplicative and therefore does not require FCMs to
``double count'' residual interest.\401\ The Commission reiterates that
Sec. 1.17(c)(5) and the residual interest requirement now set forth in
1.22(c)(2) are two separate requirements. As discussed above, Sec.
1.17 sets forth the Commission's minimum capital requirements for FCMs
and requires, among other things, an FCM to incur a charge to capital
for customer and noncustomer accounts that are undermargined beyond a
specified period of time.\402\ The residual interest requirements, on
the other hand, are intended to help make sure that the collateral of
one customer is never used to margin the positions of another customer.
These requirements are, therefore, not duplicative, and the Final Rule
does not actually require an FCM to double count the residual interest
amount.\403\
---------------------------------------------------------------------------

\401\ See AIMA Comment Letter at 3 (Feb. 15, 2013).
\402\ See section II.F. above.
\403\ See section II.F. above regarding the requirement set
forth Sec. 1.17(c)(5).
---------------------------------------------------------------------------

Paul/Weiss requested that the Commission confirm that the
requirements of jurisdiction and denomination in Sec. 1.49 do not
apply to an FCM's cash management procedures for meeting its residual
interest obligation.\404\ Paul/Weiss noted that JAC Update 12-03,\405\
provides that the denomination and jurisdiction requirements set forth
in Sec. 1.49 do not apply to the extent that an FCM deposits
additional funds in order to cover margin deficiencies in the Cleared
Swaps Customer Account prior to a \406\ DCO's settlement.\407\ The
Commission agrees that, for purposes of meeting any undermargined
amount in a customer account with a deposit of additional funds prior
to payment to any DCO, the requirements of Commission Sec. 1.49 with
respect to denomination or jurisdiction should not apply, and
accordingly, they will not.
---------------------------------------------------------------------------

\404\ Paul/Weiss Comment Letter at 6 (Feb. 15, 2013).
\405\ This update provides that, for purposes of meeting any
margin deficiency in the cleared swaps customer account with a
deposit of additional funds prior to payment to any DCO, the
requirements of Commission Sec. 1.49 with respect to denomination
or jurisdiction will not apply.
\406\ Paul/Weiss Comment Letter at 5-6 (Feb. 15, 2013).
\407\ Paul/Weiss Comment Letter at 5-6 (Feb. 15, 2013).
---------------------------------------------------------------------------

FCStone asked the Commission to set price limits at levels equal to
or below the margin requirement in all commodities to mitigate the
potential for under margined customer positions.\408\ NPPC requested
that the Commission give ``customers the opportunity to `opt out' of
allowing segregated funds to be used outside of the customer
accounts,'' so that ``customers can proactively protect their funds
from being used for potentially fraudulent purposes'' and when
``coupled with higher fees to help balance the trade off, customers
could determine the level of risk to which they are comfortable
subjecting their funds.'' \409\ The Commission notes that

[[Page 68552]]

these comments are outside the scope of this rulemaking.
---------------------------------------------------------------------------

\408\ FCStone Comment Letter at 6 (Feb. 15, 2013).
\409\ NPPC Comment Letter at 2 (Feb. 15, 2013).
---------------------------------------------------------------------------

FCStone objected to proposed Sec. 1.20(i), believing that the
Commission was mandating changing a customer's account balance to
record margin deficits, which they believe would impact the tax
treatment of customers' accounts.\410\ The Commission clarifies that
the proposed amendments were not intended to require any additional
charges to individual customer accounts, but to ensure that the FCM
separately tracked the sum of such amounts to ensure it was holding
residual interest in its segregated accounts greater than the gross
total of such undermargined amounts.
---------------------------------------------------------------------------

\410\ FCStone Comment Letter at 4 (Feb. 15, 2013).
---------------------------------------------------------------------------

10. Segregation Regimes
Several commenters proposed that language contained in customer
account agreements used by certain FCMs should be restricted by the
Commission. These commenters referred to clauses permitting customer
collateral to be pledged, liquidated or transferred by the FCM and
asked that the account agreements be viewed as contracts of adhesion
due to the necessity to agree to such clauses in order to open a
commodity futures trading account.\411\ These commenters, among other
issues, requested that the Commission limit the ability of FCMs to
require such contractual language.
---------------------------------------------------------------------------

\411\ See Premier Metal Services Comment Letter at 2-3 (Jan. 1,
2013) and ISRI Comment Letter at 4-5 (Dec. 4, 2012), which letters
were cited and supported by several other commenters. See also Pilot
Flying J Comment Letter at 2 (Feb. 14, 2013), which stated that FCMs
should not be permitted to use customer funds for outside
investments, capitalization or collateralization.
---------------------------------------------------------------------------

The Commission notes that any such contractual language does not
limit the applicability of the Act and Commission regulations with
respect to the treatment of customer property by FCMs. The customer
protection regime applies to all segregated customer funds regardless
of any broader contractual terms.
The specific ability of an FCM to pledge, liquidate or transfer
customer collateral is constrained by the Act and Commission
regulations regardless of any reference in a customer agreement to such
applicable law, or a lack of reference thereto. Section 4d is the
relevant provision of the Act that addresses how FCMs must hold
customer funds. Section 4d(a)(2) of the Act provides that each FCM must
treat and deal with all money, securities, and property received by the
FCM to margin, guarantee, or secure the trades or contracts of any
customer of the FCM, or accruing to such customer as the result of such
trades or contracts, as belonging to the customer. Section 4d(a)(2)
further provides that customer funds must be separately accounted for
and may not be commingled with the funds of the FCM, or be used to
margin or guarantee the trades or contracts, or to secure or extend
credit, of any customer or person other than the customer that
deposited the funds.
Commission regulations also set requirements on how customer funds
may be held. Regulation 1.20(a) provides that all customer funds must
be separately accounted for by the FCM and segregated as belonging to
commodity or option customers. The funds, when deposited with a bank,
trust company, clearing organization, or another FCM must be deposited
under an account name that clearly identifies the funds as belonging to
customers and shows that the funds are segregated from the FCM's own
funds as required by Section 4d(a)(2) of the Act. Regulation 1.20(c)
provides that each FCM must treat and deal with the customer funds of a
customer as belonging to the customer. The FCM must separately
accounted for customer funds and may not commingle the funds with the
FCM's own funds, or use the funds to margin, guarantee, or secure
futures positions of any person, or extend credit to any person, other
than the customer that owns the funds.
Regulation 1.25 sets forth requirements on how FCMs may invest
customer funds. Pursuant to Sec. 1.25, an FCM is permitted to use
customer funds to purchase permitted investments. The investments,
however, are required to be separately accounted for by the FCM under
Sec. 1.26, and segregated from the FCM's own assets in accounts that
designate the funds as belonging to customers of the FCM and held in
segregation as required by the Act and Commission regulations.
FCMs also may sell customer deposited securities under agreements
to repurchase the securities pursuant to Sec. 1.25(a)(2)(ii).
Regulation 1.25(d)(9) provides that the cash transferred to the
segregation account for customer-owned securities sold under a
repurchase agreement must be on a payment versus delivery basis, and
the customer segregated funds account must receive same-day funds
credited to the segregated account simultaneously with the delivery or
transfer of the securities from the customer segregated accounts. A
customer, however, may condition its deposits of securities with an FCM
by requiring that that FCM not engage in reverse repurchase
transactions with the customer's collateral.
Accordingly, FCMs do not have an unfettered ability to pledge,
rehypothecate, or otherwise use customer funds (including customer
deposited securities) for their own benefit or purposes. However, FCMs
also have the ability, as limited by all such applicable law and
regulation for the benefit of customers, to liquidate customer
securities if the customer that deposited the securities fails to meet
a margin call. FCMs also may pledge customer deposited securities to
DCOs as margin for the customer accounts carried by the FCM. The
customer collateral pledged to a DCO, however, also must be held in
customer segregated accounts.
Even if transformed as permissible under the Act and regulations
and contemplated by customer agreements, such collateral maintains its
character as segregated customer property and remains subject to the
customer protection regime. Commission staff has further confirmed that
there is variability in the FCM community regarding the specific
language included in customer account agreements and that not all
agreements include broad authorities to the FCM for the use of customer
collateral. However, as noted above, the contractual terms and
conditions could not result in an FCM holding or using customer funds
in a manner that was not in conformity with the Act and Commission
regulations.
Several commenters also requested that the Commission provide
alternatives to the current segregation regime, including individual
segregation, the ability to use third-party custodial accounts, or the
ability to opt-out of segregation.\412\ While these issues are beyond
the scope of the Proposal, the Commission notes that in adopting the
final regulations for the protection of Cleared Swaps Customer
Collateral in February 2012, it stated that the issue of alternative
segregation regimes raise important risk management and cost
externality issues, particularly in ensuring that deposited collateral
is immediately available to the FCM or DCO in the event of the default
of the customer or FCM.\413\ The Commission directed staff to continue
to analyze different proposals with the goal of developing a proposal
to provide additional or enhanced customer protection.\414\ In this
regard, staff is continuing to review and meet with

[[Page 68553]]

industry representatives regarding alternative segregation regimes.
---------------------------------------------------------------------------

\412\ See, e.g., ISRI Comment Letter at 6 (Dec. 4, 2013); AIM
Comment Letter at 2-7 (Jan. 24, 2013); MFA Comment Letter at 9 (Feb.
15, 2013); State Street Comment Letter at 2 (Jan. 16, 2013).
\413\ 77 FR 6336, 6343 (Feb. 7, 2012).
\414\ Id.
---------------------------------------------------------------------------

In addition, the Commission noted that customer funds held in
third-party custodial accounts constitute customer property within the
meaning of the Bankruptcy Code. As such, positions and collateral held
in third-party accounts are subject to the U.S. Bankruptcy Code and
applicable provisions of the Act, which provide for the pro rata share
of available customer property. The Commission also received several
comments requesting specific and defined protections for funds provided
to an FCM by retail counterparties engaged in off-exchange foreign
currency transactions.\415\ The Proposal, however, focused on customer
protection issues in the futures market, and the issue of the
protection of funds held by an FCM for retail foreign currency
counterparties is beyond the scope of the Proposal.
---------------------------------------------------------------------------

\415\ See forex form letter group: Michael Krall; David Kennedy;
Robert Smith; Michael Carmichael; Andrew Jackson; Donald Blais;
Suzanne Slade; Patricia Horter; JoDan Traders; Jeff Schlink; Sam
Jelovich; Matthew Bauman; Mark Phillips; Deborah Stone; Po Huang;
Aaryn Krall; Vael Asset Management; Kos Capital; James Lowe; Tracy
Burns; Treasure Island Coins; Clare Colreavy, Brandon Shoemaker.
---------------------------------------------------------------------------

H. Sec. 1.22: Use of Futures Customer Funds

RCG commented that the proposed amendments to Sec. Sec. 1.22,
1.23, 30.7(f) and 30.7(g) are inconsistent as to when an FCM should use
its own funds to cover margin deficits with Sec. 1.30, which provides
that an FCM cannot make an unsecured loan to a customer.\416\ The
Commission does not believe that the regulations are inconsistent.
Regulation Sec. 1.30 provides that an FCM may not make a loan to a
customer, unless such loan is done a fully secured basis. Regulations
1.22 and 30.7(f) provide that an FCM cannot use the funds of one
customer to secure or extend credit to another customer. Regulations
1.23 and 30.7(g) impose conditions upon when an FCM may withdraw
proprietary funds from segregated accounts.
---------------------------------------------------------------------------

\416\ RCG Comment Letter at 7 (Feb. 12, 2013).
---------------------------------------------------------------------------

As discussed in greater detail in section II.G.9. above, the
Commission has considered the comments and has revised and reorganized
Sec. 1.22.

I. Sec. 1.23: Interest of Futures Commission Merchant in Segregated
Futures Customer Funds; Additions and Withdrawals

The Commission proposed amending Sec. 1.23 to require additional
safeguards with respect to an FCM withdrawing futures customer funds
from segregated accounts that are part of the FCM's residual interest
in such accounts.
Proposed Sec. 1.23(a) provides that an FCM may deposit
unencumbered proprietary funds, including securities from its own
inventory that qualify as permitted investments under Sec. 1.25, into
segregated futures customer accounts in order to provide a buffer or
cushion of funds to protect against the firm failing to maintain
sufficient funds in such accounts to meet its total obligations to
futures customers.
Under proposed Sec. 1.23(a), an FCM has access to its own funds
deposited into futures customer accounts to the extent of the FCM's
residual interest in such funds, subject to the restriction on
withdrawal of residual interest required to cover undermargined
amounts. However, proposed Sec. 1.23(b) prohibits an FCM from
withdrawing its residual interest or excess funds from futures customer
accounts (any withdrawal not made to or for the benefit of futures
customers would be considered a withdrawal of the FCM's residual
interest) on any given business day unless the FCM had completed the
daily calculation of funds in segregation pursuant to Sec. 1.32 as of
the close of the previous business day, and the calculation showed that
the FCM maintained excess segregated funds in the futures customer
accounts as of the close of business on the previous business day.
Proposed Sec. 1.23(b) further requires that the FCM adjust the excess
segregated funds reported on the daily segregation calculation to
reflect other factors, such as overnight and current day market
activity and the extent of current customer undermargined or debit
balances, to develop a reasonable basis to estimate the amount of
excess funds that remain on deposit since the close of business on the
previous day prior to initiating a withdrawal.
The Commission proposed additional required layers of authorization
and documentation if the withdrawal exceeds, individually or in the
aggregate with other such withdrawals, 25 percent or more of the FCM's
residual interest computed as of the close of business on the prior
business day. Proposed Sec. 1.23(c) prohibits an FCM from withdrawing
more than 25 percent of its residual interest in futures customer
accounts unless the FCM's CEO, CFO, or other senior official that is
listed as a principal on the firm's Form 7-R registration statement and
is knowledgeable about the FCM's financial requirements (``Financial
Principal'') pre-approves the withdrawal in writing.
Regulation 1.23(c) requires the FCM to immediately file a written
notice with the Commission and with the firm's DSRO of any withdrawal
that exceeds 25 percent of its residual interest. The written notice
must be signed by the CEO, CFO, or Financial Principal that pre-
approved the withdrawal, specifying the amount of the withdrawal, its
purpose, its recipient(s), and contain an estimate of the residual
interest after the withdrawal. The written notice also must contain a
representation from the person that pre-approved the withdrawal that to
such person's knowledge and reasonable belief, the FCM remains in
compliance with its segregation obligations. Regulation 1.23 further
requires that the official, in making this representation, specifically
consider any other factors that may cause a material change in the
FCM's residual interest since the close of business on the previous
business day, including known unsecured futures customer debits or
deficits, current day market activity, and any other withdrawals. The
written notice would be required to be filed with the Commission and
with the FCM's DSRO electronically.
Proposed Sec. 1.23(d) requires an FCM to deposit proprietary funds
sufficient to restore the residual interest targeted amount when a
withdrawal of funds from segregated futures customer accounts, not for
the benefit of the firm's customers, causes the firm to fall below its
targeted residual interest in such accounts. The FCM must deposit the
proprietary funds into such segregated accounts prior to the close of
the next business day. Alternatively, the FCM may revise its targeted
residual interest amount, if appropriate, in accordance with its
written policies and procedures for establishing, documenting, and
maintaining its target residual interest, in accordance with the
requirements of proposed Sec. 1.11. Proposed Sec. 1.23 also stated
that should an FCM's residual interest, however, be exceeded by the sum
of the FCM's futures customers' margin deficits (i.e., undermargined
amounts), an amount necessary to restore residual interest to that sum
must be deposited immediately. Identical requirements with respect to
procedures required for withdrawals of residual interest in Cleared
Swaps Customer Collateral Accounts and 30.7 secured accounts were
proposed in Sec. Sec. 22.17(c) and 30.7(g), respectively.
NFA commented recommending that the Commission revise the language
in Sec. 1.23 to keep it consistent with the language in NFA Financial
Requirements Section 16 (prohibiting withdrawals that are made ``not
for the benefit of commodity and option customers and foreign futures
and

[[Page 68554]]

foreign options customers'').\417\ NFA commented that without a
definition of ``proprietary use'' a withdrawal that may not be for an
FCM's own proprietary use may still be a withdrawal that is not for the
benefit of customers and, therefore, would trigger NFA's approval and
notice requirements pursuant to NFA Financial Requirements Section 16,
but not the Commission's approval and notice requirements pursuant to
Sec. 1.23.\418\ NFA also commented that the Commission should remove
proposed Sec. 1.23(d)'s reference to ``business days'' in order to
ensure that FCMs understand that the requirements related to
withdrawals of 25 percent or more apply at all times.\419\
---------------------------------------------------------------------------

\417\ NFA Comment Letter at 14 (Feb. 15, 2013).
\418\ Id.
\419\ Id.
---------------------------------------------------------------------------

The Commission has considered NFA's comment and is revising Sec.
1.23 to remove the term ``proprietary use'' and is replacing it with
the concept of withdrawals that are not made to or for the benefit of
customers. The Commission also is revising Sec. 1.23 to remove the
reference to ``business days.'' The revisions will more closely align
the Commission's and NFA's regulations governing an FCM's withdrawal of
proprietary funds from a segregated account by making the language and
conditions more consistent. This consistency of the Commission and NFA
requirements is appropriate as it will allow FCMs to operate under one
set of conditions, while also retaining the overall policy goals of the
Commission to limit an FCM's ability to withdraw funds from segregated
accounts until the FCM can be reasonably assured that the funds are
excess, proprietary funds.\420\
---------------------------------------------------------------------------

\420\ The Commission also is making comparable revisions to
Sec. Sec. 22.17(c) and 30.7(g) in light of NFA's comments.
---------------------------------------------------------------------------

NFA further requested the Commission to clarify that pre-approval
of a series of transactions that in the aggregate exceeded the 25
percent threshold would not require after the fact approvals of the
first transactions of the series, but only approvals of the
transactions resulting in the 25 percent threshold being exceeded.\421\
The Commission confirms that an FCM would need to obtain the necessary
approvals only for the transaction that caused the withdrawals to
exceed the 25 percent threshold.
---------------------------------------------------------------------------

\421\ Id.
---------------------------------------------------------------------------

Jefferies commented that it generally supported proposed amendments
to Sec. 1.23, but stated that requiring FCMs to report when they draw
down more than 25 percent of their residual interest will discourage an
FCM from voluntarily adding to its residual interest.\422\ Jefferies
commented that FCMs should be permitted to withdraw any residual
interest amount in excess of their target level and to withdraw up to
25 percent of the target level before providing notice, or if the last
calculated residual interest was below the target level, the
calculation should be 25 percent of the lower amount.\423\ LCH.Clearnet
and the FIA also recommended revising Sec. Sec. 1.23(d) and 22.17(c)
to apply only to withdrawal of FCM funds in excess of 25 percent of the
FCM's targeted residual interest, rather than on 25 percent of the
total residual interest in the customer segregated account,
specifically to ensure that FCMs have no disincentive to maintain
significant excess funds above the targeted residual interest
segregation at DCOs for swaps clearing.\424\
---------------------------------------------------------------------------

\422\ Jefferies Comment Letter at 4-6 (Feb. 15, 2013).
\423\ Id.
\424\ LCH.Clearnet Comment Letter at 7 (Jan. 25, 2013); FIA
Comment Letter at 6 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission does not believe that substituting the targeted
residual amount for the actual residual interest amount would
appropriately focus management attention on significant withdrawals
relative to the actual, not just target, excess, as well as clearly
establish a chain of responsibility for such withdrawals, as is the
intended purpose of the proposed regulation. The Commission clarifies
that pre-approval would be required, with respect to a series of
transactions, for the transactions which would result in the threshold
being exceeded and not earlier transactions in the series. Accordingly,
the Commission is adopting Sec. 1.23 and the conforming provisions in
Sec. Sec. 22.17 and 30.7(g), with changes as recommended by NFA
substituting language ``not for the benefit of customers'' (with
description of customer as applicable to each such provision) for
``proprietary use'' and eliminating the reference to business
days.\425\
---------------------------------------------------------------------------

\425\ See NFA Comment Letter at 14 (Feb. 15, 2013).
---------------------------------------------------------------------------

In addition, and in light of the changes discussed herein with
respect to the residual interest requirements set forth in Sec. Sec.
1.22, 22.2, and 30.7, the Commission is amending Sec. 1.23 and the
conforming provisions in Sec. Sec. 22.17 and 30.7(g) to make clear
that if an FCM's residual interest is less than the amounts required to
be maintained in Sec. 1.22, 22.2(f)(6), or 30.7(f), as applicable, at
any particular point in time, the FCM must immediately restore the
residual interest to exceed the sum of such amounts.

J. Sec. 1.25: Investment of Customer Funds

1. General Comments Regarding the Investment of Customer Funds
Regulation 1.25 sets forth the financial investments that an FCM or
DCO may make with customer funds. The Commission received 32 comment
letters regarding the investment and handling of customer funds by FCMs
and DCOs.\426\ In general, all of the commenters supported the position
that FCMs and DCOs only be allowed to make safe/non-speculative
investments of customer funds and not be allowed to add risk that
customers are unaware of or do not sanction. More specifically, 29 of
the commenters proposed that the Commission amend its regulations to
provide commodity customers with the ability to ``opt out'' of granting
FCMs permission to invest their funds (including hypothecation and
rehypothecation).\427\ Additionally,

[[Page 68555]]

seven of the 29 commenters requested that the Commission also mandate
that an FCM cannot prevent a customer who so ``opts out'' from
continuing to trade through that FCM merely because the customer
elected to ``opt out.'' \428\
---------------------------------------------------------------------------

\426\ Schippers Comment Letter (Dec. 10, 2013), Randy Fritsche
Comment Letter (Feb. 14, 2013), NPPC Comment Letter at 2 (Feb. 14,
2013), Strelitz/California Metal X Comment (Jan. 15, 2013), Premier
Metal Services Comment Letter at 4 (Jan. 3, 2013), ISRI Comment
Letter at 5-7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan. 24,
2013), Kripke Enterprises Comment Letter (Dec. 12, 2012), Manitoba
Comment Letter (Dec. 13, 2012), Solomon Metals Corp. Comment Letter
(Jan. 15, 2013), Michael Krall Comment Letter (Dec. 17, 2012), David
Kennedy Comment Letter (Dec. 17, 2012), Robert Smith Comment Letter
(Dec. 17, 2012), Michael Carmichael Comment Letter (Dec. 17, 2012),
Andrew Jackson Comment Letter (Dec. 17, 2012), Donald Blais Comment
Letter (Dec. 17, 2012), Suzanne Slade Comment Letter (Dec. 17,
2012), Patricia Horter Comment Letter (Dec. 17, 2012), JoDan Traders
Comment Letter (Dec. 17, 2012), Jeff Schlink Comment (Dec. 18,
2012), Sam Jelovich Comment Letter (Dec. 18, 2012), Matthew Bauman
Comment Letter (Dec. 20, 2012), Mark Phillips Comment Letter (Dec.
22, 2012), Deborah Stone Comment Letter (Dec. 24, 2012), Po Huang
Comment Letter (Dec. 24, 2012), Aarynn Krall Comment Letter (Jan. 8,
2013), Vael Asset Management Comment Letter (Jan. 10, 2013), Kos
Capital Comment Letter (Jan. 11, 2013), James Lowe Comment Letter
(Jan. 13, 2013), Tracy Burns Comment Letter (Jan. 14, 2013),
Treasure Island Coins Comment Letter (Jan. 14, 2013), and Clare
Colreavy Comment Letter (Jan. 9, 2013).
\427\ NPPC Comment Letter at 2 (Feb. 14, 2013), Premier Metal
Services Comment Letter at 4 (Jan. 3, 2013), ISRI Comment Letter at
5-7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan. 24, 2013), Kripke
Enterprises Comment Letter (Dec. 12, 2012), Manitoba Comment Letter
(Dec. 13, 2012), Solomon Metals Corp. Comment Letter (Jan. 15,
2013), Michael Krall Comment Letter (Dec. 17, 2012), David Kennedy
Comment Letter (Dec. 17, 2012), Robert Smith Comment Letter (Dec.
17, 2012), Michael Carmichael Comment Letter (Dec. 17, 2012), Andrew
Jackson Comment Letter (Dec. 17, 2012), Donald Blais Comment Letter
(Dec. 17, 2012), Suzanne Slade Comment Letter (Dec. 17, 2012),
Patricia Horter Comment Letter (Dec. 17, 2012), JoDan Traders
Comment Letter (Dec. 17, 2012), Jeff Schlink Comment Letter (Dec.
18, 2012), Sam Jelovich Comment Letter (Dec. 18, 2012), Matthew
Bauman Comment Letter (Dec. 20, 2012), Mark Phillips Comment Letter
(Dec. 22, 2012), Deborah Stone Comment Letter (Dec. 24, 2012), Po
Huang Comment Letter (Dec. 24, 2012), Aarynn Krall Comment Letter
(Jan. 8, 2013), Vael Asset Management Comment Letter (Jan. 10,
2013), Kos Capital Comment Letter (Jan. 11, 2013), James Lowe
Comment Letter (Jan. 13, 2013), Tracy Burns Comment Letter (Jan. 14,
2013), Treasure Island Coins Comment Letter (Jan. 14, 2013), and
Clare Colreavy Comment Letter (Jan. 9, 2013).
\428\ NPPC Comment Letter at 2 (Feb. 14, 2013); Premier Metal
Services Comment Letter at 4 (Jan. 3, 2013); ISRI Comment Letter at
6 (Dec. 4, 2012); AIM Comment Letter at 6 (Jan. 24, 2013); Kripke
Enterprises Comment Letter (Dec. 10, 2012); Manitoba Comment Letter
(Dec. 13, 2012); and Solomon Metals Corp Comment Letter (Jan, 15,
2013).
---------------------------------------------------------------------------

The Commission did not propose to amend the list of permitted
investments set forth in Sec. 1.25, and believes that the current
investments and regulatory requirements establish an appropriate
balance between providing investment opportunities for FCMs with the
overall objective of protecting customer funds. As further discussed in
section II.L. below, the Commission also is amending Sec. 1.29 to
explicitly provide that an FCM is responsible for any losses resulting
from the investment of customer funds under Sec. 1.25.
The Commission further notes that the current regulatory structure
does not provide for a system whereby customers can elect to ``opt-
out'' of segregation or Sec. 1.25. In the event of the insolvency of
an FCM, where there also was a shortfall in customer funds, customers
would be entitled to a pro-rata distribution of customer property under
section 766 of the U.S. bankruptcy code.\429\ Therefore, even if a
customer was permitted by the FCM to ``opt-out'' of segregation, the
funds held by the FCM would be pooled with other customer funds and
distributed on a pro-rata basis to all customers participating in that
account class.
---------------------------------------------------------------------------

\429\ 11 U.S.C. 766.
---------------------------------------------------------------------------

2. Reverse Repurchase Agreement Counterparty Concentration Limits
Regulation 1.25 provides that FCMs and DCOs may use customer funds
to purchase securities from a counterparty under an agreement for the
resale of the securities back to the counterparty (``reverse repurchase
agreements''). Regulation 1.25 places conditions on reverse repurchase
agreements, including, limiting counterparties to certain banks and
government securities brokers or dealers, and prohibiting an FCM or DCO
from entering into such agreements with an affiliate. Regulation
1.25(b)(3)(v) also imposes a counterparty concentration limit on
reverse repurchase agreements that prohibits an FCM or DCO from
purchasing securities from a single counterparty that exceeds 25
percent of the total assets held in segregation by the FCM or DCO.
The Commission proposed to amend Sec. 1.25(b)(3)(v) to require an
FCM or DCO to aggregate the value of the securities purchased under
reverse repurchase agreements if the counterparties are under common
control or ownership. The aggregate value of the securities purchased
under a reverse repurchase agreement from the counterparties under
common ownership or control could not exceed 25 percent of the total
assets held in segregation by the FCM or DCO. The Commission proposed
the amendment as it believed that the expansion of the counterparty
concentration limitation to counterparties under common ownership or
control is consistent with the original intent of the regulation, and
to minimize potential losses or disruptions due to the default of a
counterparty.
The Commission received comments from LCH.Clearnet and CFA in
support of the proposed amendments.\430\ No other comments were
received. The Commission is adopting the amendments as proposed.
---------------------------------------------------------------------------

\430\ LCH.Clearnet Comment Letter at 4 (Jan. 25, 2013); CFA
Comment Letter at 6 (Feb. 13, 2013).
---------------------------------------------------------------------------

K. Sec. 1.26: Deposit of Instruments Purchased With Futures Customer
Funds

Regulation 1.26 requires each FCM or DCO that invests customer
funds in instruments listed under Sec. 1.25 to separately account for
such instruments and to segregate the instruments from its own funds.
An FCM or DCO also must deposit the instruments under an account name
which clearly shows that they belong to futures customers and that the
instruments are segregated as required by the Act and Commission
regulations. The FCM or DCO also must obtain and retain in its files a
written acknowledgment from the depository holding the instruments
stating that the depository was informed that the instruments belong to
futures customers and that the instruments are being held in accordance
with the provisions of the Act and Commission regulations.
The Commission proposed amending Sec. 1.26 to specify how direct
investments by FCMs and DCOs in money market mutual funds (``MMMFs'')
that qualify as permitted investments under Sec. 1.25 must be held,
and to adopt a Template Letter to be used with respect to direct
investments in qualifying MMMFs. Like the proposed Template Letters for
Sec. Sec. 1.20 and 30.7, the proposed Template Letter for Sec. 1.26
contained provisions providing for read-only access and release of
shares upon instruction from the director of the Division of Clearing
and Risk, the director of the Division of Swap Dealer and Intermediary
Oversight, or any successor divisions, or such directors' designees.
With respect to the Template Letter for MMMFs, ICI noted that costs
to create electronic access to FCM accounts at an MMMF would be ``borne
by all investors and not just by FCMs,'' which likely only constitute a
small percentage of an MMMF's investors.\431\ As an alternative, ICI
proposed that the Template Letter be amended to require the MMMF to
provide FCM account data promptly (i.e., within 48 hours) upon
request.\432\ ICI also commented that the Commission should confirm:
(1) The ``examination or audit'' of the accounts authorized by the
acknowledgment letter is limited to verification of account balances
and that further inspection of an MMMF itself would be referred to the
SEC as primary regulator; and (2) the proposal would require only those
MMMFs in which FCMs directly invest customer funds (as opposed to those
held through intermediated positions like omnibus accounts or
intermediary-controlled accounts) to agree to provide FCM account
information.\433\
---------------------------------------------------------------------------

\431\ ICI Comment Letter at 4-5 (Jan. 14, 2013).
\432\ Id. at 5.
\433\ Id. at 4-6 (Jan.14, 2013).
---------------------------------------------------------------------------

The Commission originally proposed one Template Letter, Appendix A
to Sec. 1.26, to be used by both FCMs and DCOs when investing customer
funds in an MMMF. However, as noted above in the discussion of the
Sec. 1.20 Template Letters, the Commission has determined to eliminate
the read-only access requirement for DCOs. Therefore, the Commission is
adopting different Template Letters for FCMs and DCOs in Sec. 1.26.
The Template Letter specific to FCMs is now set forth in Appendix A to
Sec. 1.26, and the Template Letter for DCOs is set forth in Appendix B
to Sec. 1.26. The Commission has made other modifications to the Sec.
1.26 Template Letters consistent with the modifications to the Sec.
1.20 Template Letters.
The Commission also confirms that examination of accounts
authorized by the acknowledgment letter would not involve regulation or
examination of the MMMF itself, over which the Commission does not have
supervisory or regulatory authority. The examination would be limited
to

[[Page 68556]]

verification of the account shares of the FCM or DCO, and the Template
Letters required under Sec. 1.26 are solely applicable to directly-
held investments in MMMFs. For the purpose of clarification, an FCM or
DCO that holds shares of an MMMF in a custodial account at a depository
(not directly with the MMMF or its affiliate) is required to execute
the Template Letter set forth in Appendix A or B of Regulation 1.20, as
applicable. In addition, a MMMF would be required to provide the
Commission with read-only access to accounts holding customer funds
only if the FCM directly deposits customer funds with the MMMF.
Proposed paragraph (b) of Sec. 1.26 has been modified to include a
reference to Appendix B to Sec. 1.20. Otherwise, the Commission is
adopting Sec. 1.26 as proposed.

L. Sec. 1.29: Increment or Interest Resulting From Investment of
Customer Funds

1. FCM's Responsibility for Losses Incurred on the Investment of
Customer Funds
Regulation 1.29 currently provides that an FCM or DCO is not
required to pass the earnings from the investment of futures customer
funds to the futures customers. An FCM or DCO may retain any interest
or other earnings from the investment of futures customer funds.
The Commission proposed to amend Sec. 1.29 to explicitly provide
that an FCM or DCO is responsible for any losses incurred on the
investment of customer funds. Investment losses cannot be passed on to
futures customers. As the Commission noted in the Proposal, an FCM may
not charge or otherwise allocate investment losses to the accounts of
the FCM's customers. To allocate losses on the investment of customer
funds would result in the use of customer funds in a manner that is not
consistent with section 4d(a)(2) and Sec. 1.20, which provides that
customer funds can only be used for the benefit of futures customers
and limits withdrawals from futures customer accounts, other than for
the purpose of engaging in trading, to certain commissions, brokerage,
interest, taxes, storage or other fees or charges lawfully accruing in
connection with futures trading.\434\ Section 4d(b) of the Act also
provides that it is unlawful for a DCO to use customer funds as
belonging to any person other than the customers of the FCM that
deposited the funds with the DCO. Accordingly, such investment losses
are the responsibility of the FCM or DCO, as applicable. Similar
regulations were proposed for Cleared Swaps Customer Collateral under
part 22 (Sec. 22.2(e)(1)), and for 30.7 customer funds under part 30
(Sec. 30.7(i)).
---------------------------------------------------------------------------

\434\ 77 FR 67866, 67888.
---------------------------------------------------------------------------

FIA and CFA supported the proposed amendments to Sec. 1.29.\435\
No other comments were received. The Commission adopts the amendments
to Sec. Sec. 1.29, 22.2(e)(1), and 30.7(i) as proposed.
---------------------------------------------------------------------------

\435\ FIA Comment Letter at 30-31 (Feb. 15, 2013); CFA Comment
Letter at 6 (Feb. 13, 2013).
---------------------------------------------------------------------------

2. FCM's Obligation in Event of Bank Default
The Commission requested comment on the extent of an FCM's
responsibility to cover losses in the event of a default of by a bank
holding customer funds. The CFA commented that FCM's should be
responsible as such an obligation will require that FCMs conduct
adequate due diligence on the banks in which they place customers'
funds, a factor that should limit the effect of a related future bank
failure.\436\
---------------------------------------------------------------------------

\436\ CFA Comment Letter at 6 (Feb. 13, 2013).
---------------------------------------------------------------------------

The FIA noted that the Commodity Exchange Authority issued an
Administrative Determination in 1971 setting out the appropriate
standard of liability for an FCM in the event of a bank default.\437\
The FIA also stated that the deposit of customer funds in a bank or
trust company is not an investment of customer funds under Sec. 1.25,
but is a requirement by the Act and Commission regulations.\438\ The
FIA stated that FCMs should not be strictly liable for a bank's
failure, and that to hold FCMs to such a standard would presume that
FCMs have the ability to know more about a bank than the regulatory
authorities responsible for overseeing the banks.\439\
---------------------------------------------------------------------------

\437\ FIA Comment Letter at 32-33 (Feb. 15, 2013). The
Administrative Determination applies to both FCM and DCO deposits at
banks, and provides as follows:
To: Associate Administrator
Division Directors
Regional Directors
If a futures commission merchant or a clearing association
deposits regulated commodity customers' funds in a bank and the bank
is later closed and unable to repay the funds, the liability of the
futures commission merchant or clearing association would depend
upon the manner in which the account was handled. It would not be
liable if it had used due care in selecting the bank, had not
otherwise breached its fiduciary responsibilities toward the
customers, and had fully complied with the requirements of the
Commodity Exchange Act and the regulations thereunder relating to
the handling of customers' funds. If two banks were available in a
particular city only one of which was a member of FDIC and the
futures commission merchant or clearing association without a
compelling reason elected to use the nonmember bank, we would
contend that it had not used due care in its selection.
Administrative Determination No. 230 issued by Alex Caldwell,
Administrator, Commodity Exchange Authority (Nov. 23, 1971).
\438\ FIA Comment Letter at 32-33 (Feb. 13, 2013).
\439\ Id.
---------------------------------------------------------------------------

The FIA further stated that the Commission's new Sec. 1.11 will
require each FCM to establish and enforce written policies and
procedures reasonably designed to assure compliance with the
segregation requirements. The policies and procedures also must include
a process for the evaluation of depositories, and a program to monitor
a depository on an ongoing basis, including a thorough due diligence
review of each depository at least annually. FIA notes that the
policies and procedures will be subject to Commission and DSRO review,
and that either the Commission or DSRO can direct the FCM to make any
changes to address identified weaknesses in the policies or procedures,
or in their enforcement.\440\
---------------------------------------------------------------------------

\440\ Id.
---------------------------------------------------------------------------

Advantage stated that the deposit of customer funds into a bank is
not an investment of the funds, and FCMs should be able to assume that
banks are properly vetted by the relevant banking and futures
regulatory authorities.\441\
---------------------------------------------------------------------------

\441\ Advantage Comment Letter at 3 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission has considered the issue and believes the issue of
depository risk raises important legal and policy issues that were not
addressed in the Administrative Determination. There are considerable
reasons to question whether the Administrative Determination is
consistent with the CEA and the Commission's regulations thereunder.
Customers entrust their funds to FCMs, who are required by the Act and
Commission regulations to treat the funds as belonging to the
customers, to segregate the funds from the FCM's own funds, and to hold
such funds in specially designated accounts that clearly state that the
funds belong to commodity customers of the FCM and are being held as
required by the Act and Commission regulations. Customers do not select
the depositories to hold these funds; FCMs do. FCMs are responsible for
conducting the initial due diligence and ongoing monitoring of
depositories holding customer funds. Moreover, as a practical matter,
FCMs are in a better position than customers to perform these
functions, as well as in a better position than the customers
individually to make claim in the insolvency proceeding for the
depository.\442\
---------------------------------------------------------------------------

\442\ By a parity of reasoning, this would also apply to
relationships between DCOs and FCMs. Indeed, it would be difficult
to see how a DCO would be liable for such losses, but an FCM would
not.

---------------------------------------------------------------------------

[[Page 68557]]

Importantly, the AD fails to address the question of precisely
which customers are exposed to depository losses, and how much should
be allocated to each such customer. This question is particularly
important in the context of omnibus customer accounts permitted in the
futures industry. Would losses be allocated to persons who are
customers at the point the depository becomes insolvent, to persons who
were customers at any point the FCM maintained funds at the depository,
or to persons who were customers at the point the losses were
crystalized? Would losses be allocated to all customers, or could
certain favored customers avoid such exposure by negotiation? If the
depository lost only securities, would customers who deposited only
cash share in the loss? If the depository lost only cash, would
customers who deposited only securities share in the loss? Would
customers whose margin was all used to cover requirements at the DCO
share in losses of funds at a depository other than a DCO? Moreover,
would customers to whom losses were allocated share in dividends
recovered from the estate of the defaulting depository? How would such
customers have the practical opportunity to demonstrate their claims in
such a proceeding? How and when would such recoveries be distributed to
such customers? These practical questions, none of which was answered
in the Administrative Determination, call its wisdom into
question.\443\
---------------------------------------------------------------------------

\443\ This discussion does not apply to funds that have been
deposited with a third-party depository selected by a customer.
---------------------------------------------------------------------------

Accordingly, the Commission has directed staff to inquire into
these issues, and to develop an appropriate proposed rulemaking.

M. Sec. 1.30: Loans by Futures Commission Merchants: Treatment of
Proceeds

Regulation 1.30 provides that an FCM may lend its own funds to
customers on securities and property pledged by such customers, and may
repledge or sell such securities and property pursuant to specific
written agreement with such customers. This provision generally allows
customers to deposit non-cash collateral as initial and variation
margin. Absent the provision, an FCM may be required to liquidate the
non-cash collateral if the customer was subject to a margin call that
could not be met with other assets in the customer's account.
Regulation 1.30 further provides that the proceeds of loans used to
margin the trades of customers shall be treated and dealt with by an
FCM as belonging to such customers, in accordance with and subject to
the provisions of the Act and regulations.
The Commission proposed to amend Sec. 1.30 by adding that an FCM
may not lend funds to a customer for margin purposes on an unsecured
basis, or secured by the customer's trading account. The Commission
stated in the Proposal that it did not believe that FCMs extended
unsecured credit as a common practice, as the FCM would be required to
take a 100 percent charge to capital for the value of the unsecured
loan under Sec. 1.17. The Commission also noted that a trading account
did not qualify as collateral for the loan under Sec. 1.17 and the FCM
would have to take a charge to capital for the full value of the
unsecured loan. The Commission further noted that the proposed
amendment to Sec. 1.30 was consistent with CME Rule 930.G, which
provides that a clearing member may not make loans to account holders
to satisfy their performance bond requirements unless such loans are
secured by readily marketable collateral that is otherwise unencumbered
and which can be readily converted into cash.\444\
---------------------------------------------------------------------------

\444\ See CME rulebook at www.cmegroup.com/rulebook/CME/I/9/9.pdf.
---------------------------------------------------------------------------

RCG commented that it believes that the proposal prohibiting an FCM
from making unsecured loans to customers contradicts proposed Sec.
1.22 as it applies to funding customers' margin deficits.\445\ The
Commission notes that the requirement in Sec. 1.22 for an FCM to cover
an undermargined account with its own funds is intended to ensure that
the FCM complies with section 4d of the Act by not using the funds of
one futures customer to margin or guarantee the commodity interests of
another customer. The FCM is obligated under section 4d to maintain
sufficient funds in segregation to cover undermargined accounts. The
FCM, however, is not loaning funds to a particular customer as
performance bond is contemplated by Sec. 1.30. When the FCM deposits
proprietary funds into segregated accounts under Sec. 1.22, the FCM is
not loaning any particular customer funds, and the customers with an
undermargined account are not credited with an increase in their cash
balance.
---------------------------------------------------------------------------

\445\ RCG Comment Letter at 4 (Feb. 12, 2013).
---------------------------------------------------------------------------

Newedge also requested confirmation the proposed prohibition in
Sec. 1.30 preventing an FCM from loaning unsecured funds to a customer
to finance such customer's trading would not prohibit an FCM, when
computing a customer's margin requirement, from giving credit for the
customer's long option value. The Commission confirms that an FCM may
continue to consider a customer's long option value when computing such
customer's overall account value and margin requirements.\446\
---------------------------------------------------------------------------

\446\ Newedge Comment Letter at 5 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission is adopting the amendments to Sec. 1.30 as
proposed.

N. Sec. 1.32: (Sec. 22.2(g) for Cleared Swaps Customers and Sec.
30.7(l) for Foreign Futures and Foreign Options Customers): Segregated
Account: Daily Computation and Record

The Commission proposed to amend Sec. 1.32 to require additional
safeguards with respect to futures customer funds on deposit in
segregated accounts, and to require FCMs to provide twice each month a
detailed listing to the Commission of depositories holding customer
funds.\447\
---------------------------------------------------------------------------

\447\ The Commission also proposed amendments to Sec. 22.2(g)
and Sec. 30.7(l) to impose requirements for Cleared Swaps and
foreign futures and foreign options transactions, respectively, that
correspond to the proposed amendments for Sec. 1.32. The comments
for Sec. Sec. 1.32, 22.2(g), and 30.7(l) are addressed in this
section.
---------------------------------------------------------------------------

Regulation 1.32 requires an FCM to prepare a daily record as of the
close of business each day detailing the amount of funds the firm holds
in segregated accounts for futures customers trading on designated
contract markets, the amount of the firm's total obligation to such
customers computed under the Net Liquidating Equity Method, and the
amount of the FCM's residual interest in the futures customer
segregated accounts. In performing the calculation, an FCM is permitted
to offset any futures customer's debit balance by the market value
(less haircuts) of any readily marketable securities deposited by the
particular customer with the debit balance as margin for the account.
The amount of the securities haircuts are as set forth in SEC Rule
15c3-1(c)(vi).
FCMs are required to perform the segregation calculation prior to
noon on the next business day, and to retain a record of the
calculation in accordance with Sec. 1.31. Both the CME and NFA require
their respective member FCMs to file the segregation calculations with
the CME and NFA, as appropriate, each business day. FCMs, however, are
only required to file a segregation calculation with the Commission at
month end as part of the Form 1-FR-FCM (or FOCUS Reports for dual-
registrant FCM/BDs). Regulation 1.12, as discussed in section II.C.
above, requires the FCM to provide immediate notice to the Commission
and to the firm's DSRO if the FCM is undersegregated at any time.

[[Page 68558]]

The Commission proposed to amend Sec. 1.32 to require each FCM to
file its segregation calculation with the Commission and with its DSRO
each business day. The Commission also proposed to amend Sec. 1.32 to
require FCMs to use the Segregation Schedule contained in the Form 1-
FR-FCM (or FOCUS Report for dual-registrant FCM/BDs) to document its
daily segregation calculation.\448\
---------------------------------------------------------------------------

\448\ Each FCM currently already submits a daily Segregation
Schedule to its DSRO pursuant to rules of the CME and NFA.
Therefore, the Commission's amendments are codifying current
regulatory practices for each FCM.
---------------------------------------------------------------------------

As previously noted, the CME and NFA require their respective
member FCMs to file their segregation calculations with them on a daily
basis. The CME and NFA also require the FCMs to document their
segregation calculation using the Segregation Schedule contained in the
Form 1-FR-FCM. Therefore, the additional requirement of filing a
Segregation Schedule with the Commission is not a material change to
the regulation and is consistent with current practices.\449\
---------------------------------------------------------------------------

\449\ In fact, since FCMs file the Segregation Schedules with
the CME and NFA via WinJammer, the Commission already has access to
the filings, and the amendment will not require an FCM to change any
of its operating procedures.
---------------------------------------------------------------------------

The Commission stated in the Proposal that the filing of daily
Segregation Schedules by FCMs will enhance its ability to monitor and
protect customer funds as the Commission will be able to determine
almost immediately upon receipt of the Segregation Schedule whether a
firm is undersegregated and immediately take steps to determine if the
firm is experiencing financial difficulty or if customer funds are at
risk.\450\
---------------------------------------------------------------------------

\450\ Each Form 1-FR-FCM and FOCUS Report is received by the
Commission via WinJammer. The financial forms are automatically
electronically reviewed within several minutes of being received by
the Commission and if a firm is undersegregated an alert is
immediately issued to Commission staff members via an email notice.
---------------------------------------------------------------------------

The Commission also proposed to require an FCM to file its
Segregation Schedule with the Commission and with the FCM's DSRO
electronically using a form of user authentication assigned in
accordance with procedures established or approved by the Commission.
The Commission currently receives the Segregation Schedule
electronically via the WinJammer filing system and the proposal would
continue to require FCMs to submit the forms using WinJammer.
The Commission also proposed to amend Sec. 1.32(b) to provide that
in determining the haircuts for commercial paper, convertible debt
instruments, and nonconvertible debt instruments deposited by customers
as margin, the FCM may develop written policies and procedures to
assess the credit risk of the securities as proposed by the SEC and
discussed more fully in section II.F. above. If the FCM's assessment of
the credit risk is that it is minimal, the FCM may apply haircut
percentages that are lower than the 15 percent default percentage under
SEC Rule 15c3-1(c)(2)(vi).
The Commission also proposed to amend Sec. 1.32 by requiring each
FCM to file detailed information regarding depositories and the
substance of the investment of customer funds under Sec. 1.25.
Proposed paragraphs (f) and (j) of Sec. 1.32 require each FCM to
submit to the Commission and to the firm's DSRO a listing of every
bank, trust company, DCO, other FCM, or other depository or custodian
holding customer funds. The listing must specify separately for each
depository the total amount of cash and Sec. 1.25 permitted
investments held by the depository for the benefit of the FCM's
customers. Specifically, each FCM must list the total amount of cash,
U.S. government securities, U.S. agency obligations, municipal
securities, certificates of deposit, money market mutual funds,
commercial paper, and corporate notes held by each depository, computed
at current market values. The listing also must specify: (1) If any of
the depositories are affiliated with the FCM; (2) if any of the
securities are held pursuant to an agreement to resell the securities
to a counterparty (reverse repurchase agreement) and if so, how much;
and (3) the depositories holding customer-owned securities and the
total amount of customer-owned securities held by each of the
depositories.
Each FCM is required to submit the listing of the detailed
investments to the Commission and to the firm's DSRO twice each month.
The filings must be made as of the 15th day of each month (or the next
business day, if the 15th day of the month is not a business day) and
the last business day of the month. The filings are due to the
Commission and to the firm's DSRO by 11:59 p.m. on the next business
day.
Proposed paragraph (k) of Sec. 1.32 requires each FCM to retain
the Segregation Statement prepared each business day and the detailed
investment information, together with all supporting documentation, in
accordance with Sec. 1.31.
FIA generally supported the proposal.\451\ FIA noted that proposed
Sec. 1.32(a) requires an FCM to compute its daily segregation
requirement on a currency-by-currency basis, and requested that the
Commission confirm that a single Segregation Schedule can be completed
for each account class (i.e., futures customers funds, Cleared Swaps
Customers funds, and Sec. 30.7 customer funds) on a U.S. dollar-
equivalent basis. FIA further stated that the detail regarding the
investment of customer funds provided by NFA on its Web site is the
appropriate level of detail that should be made public because
additional detail would disclose proprietary financial and business
information.\452\
---------------------------------------------------------------------------

\451\ FIA Comment Letter at 30 (Feb. 15, 2013).
\452\ Id. at 31.
---------------------------------------------------------------------------

Jefferies supported the proposal, and recommended that the listing
of detailed investments should include all investments, including cash
and other investments, regardless of where the investments are held,
and should provide greater transparency for the FCMs' customers.\453\
MFA supported the proposed amendments to Sec. 1.32 to require FCMs to
provide the Commission and their DSROs with: (1) Daily reporting of the
segregation and part 30 secured amount computations; and (2) semi-
monthly reporting of the location of customer funds and how such funds
are invested under Sec. 1.25.\454\
---------------------------------------------------------------------------

\453\ Jefferies Comment Letter at 4 (Feb. 15, 2013).
\454\ MFA Comment Letter at 3 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission has considered the comments and is adopting the
amendments to Sec. Sec. 1.32, 22.2(g), and 30.7(l) as proposed. In
response to Jefferies comment, the Commission notes that the proposed
and final regulation require an FCM to report all investments,
including cash and other investments, regardless of where the
investments are held.
In response to FIA's comment, the Commission does not believe that
a full disclosure of the investment of customer funds would disclose
proprietary information of the FCM. The Commission would require the
disclose of investment information in a manner consistent with the
current NFA disclosures, which includes, for each FCM, the percentage
of the invested customer funds that are held by banks, or invested in
U.S. government securities, bank certificates of deposit, money market
funds, municipal securities, and U.S. government sponsored enterprise
securities. The Commission, however, further believes that FCMs also
should disclose the amount of customer funds that are held by clearing
organizations and brokers. The Commission also believes that FCMs
should disclose the amount of customer-owned securities that are on
deposit as margin collateral, and information regarding repurchase

[[Page 68559]]

transactions involving customer funds or securities. The additional
disclosures will provide customers and the market with additional
information that may be relevant to their assessment of the risks of
placing their funds with a particular FCM. The Commission further notes
that it plans to work with the SROs to determine the most efficient and
effective method to disclose this information to the public.
The Commission also confirms that an FCM satisfies the requirement
of Sec. 1.32 if it prepares and submits to the Commission, and to its
DSRO, a consolidated Segregation Schedule for each account class on a
U.S. dollar-equivalent basis. The FCM, however, must prepare
segregation records on a daily basis on a currency-by-currency basis to
ensure compliance with Sec. 1.49, which governs how FCMs may hold
funds in foreign depositories. The FCM is not required under Sec. 1.32
to file the currency-by-currency segregation records with the
Commission or with its DSRO.

O. Sec. 1.52: Self-regulatory Organization Adoption and Surveillance
of Minimum Financial Requirements

SROs are required by the Act and Commission regulations to monitor
their member FCMs for compliance with the Commission's and SROs'
minimum financial and related reporting requirements. Specifically, DCM
Core Principle 11 provides, in relevant part, that a board of trade
shall establish and enforce rules providing for the financial integrity
of any member FCM and the protection of customer funds.\455\ In
addition, section 17 of the Act requires NFA to establish minimum
capital, segregation, and other financial requirements applicable to
its member FCMs, and to audit and enforce compliance with such
requirements.\456\
---------------------------------------------------------------------------

\455\ 7 U.S.C. 7(d)(11).
\456\ 7 U.S.C. 21(p).
---------------------------------------------------------------------------

The Commission also has established in Sec. 1.52 minimum elements
that each SRO financial surveillance program must contain to satisfy
the statutory objectives of Core Principle 11 and section 17 of the
Act. In this regard, Sec. 1.52 requires, in part, each SRO to adopt
and to submit for Commission approval rules prescribing minimum
financial and related reporting requirements for member FCMs. The rules
of the SRO also must be the same as, or more stringent than, the
Commission's requirements for financial statement reporting under Sec.
1.10 and minimum net capital under Sec. 1.17.
In addition, the Commission adopted final amendments to Sec. 1.52
on May 10, 2012, to codify previously issued CFTC staff guidance
regarding the minimum elements of an SRO financial surveillance
program.\457\ In order to effectively and efficiently allocate SRO
resources over FCMs that are members of more than one SRO, Sec.
1.52(c) currently permits two or more SROs to enter into an agreement
to establish a joint audit plan for the purpose of assigning to one of
the SROs (the DSRO) of the joint audit plan the function examining
member FCMs for compliance with minimum capital and related financial
reporting obligations. The audit plan must be submitted to the
Commission for approval. Currently all active SROs are members of a
joint audit plan that was approved by the Commission on March 18,
2009.\458\
---------------------------------------------------------------------------

\457\ 77 FR 36611 (June 19, 2012).
\458\ The original signatories of the joint audit plan approved
on March 18, 2009 are as follows: Board of Trade of the City of
Chicago, Inc.; Board of Trade of Kansas City; CBOE Futures Exchange,
LLC; Chicago Climate Futures Exchange, LLC; Chicago Mercantile
Exchange Inc.; Commodity Exchange, Inc.; ELX Futures, L.P.;
HedgeStreet, Inc.; ICE Futures U.S., Inc.; INET Futures Exchange,
L.L.C.; Minneapolis Grain Exchange; NASDAQ OMX Futures Exchange;
National Futures Association; New York Mercantile Exchange, Inc.;
NYSE Liffe US, L.L.C.; and One Chicago, L.L.C.
---------------------------------------------------------------------------

The Commission proposed additional amendments to Sec. 1.52 to
enhance and strengthen the minimum requirements that SROs must abide by
in conducting financial surveillance. As the Commission explained in
the Proposal, these amendments are intended to minimize the chances
that FCMs engage in unlawful activities that result, or could result,
in the loss of customer funds or the inability of the firms to meet
their financial obligations to market participants. Proposed Sec.
1.52(a) added a definitions section identifying the terms
``examinations expert,'' ``material weakness,'' and ``generally
accepted auditing standards.''
The term ``examinations expert'' was defined as a ``nationally
recognized accounting and auditing firm with substantial expertise in
audits of futures commission merchants, risk assessment and internal
control reviews, and is an accounting and auditing firm that is
acceptable to the Commission.'' The Commission received several
comments regarding the opinion that the examinations expert is required
to provide on its review of the SRO programs, which is addressed in
section II.O.4 below. The Commission did not, however, receive comments
regarding the defined term ``examinations expert'' and is adopting the
definition as proposed.
The term ``material weakness'' was defined as ``as a deficiency, or
a combination of deficiencies, in internal control over financial
reporting such that there is a reasonable possibility that a material
misstating of the entity's financial statements and regulatory
computations will not be prevented or detected on a timely basis by the
entity's internal controls.'' The Commission has determined not to
adopt the definition of material weakness to eliminate the concern that
the SROs examinations are intended to replicate the financial statement
audits performed by public accountants under Sec. 1.16.
Proposed Sec. 1.52(b) requires each SRO to adopt rules prescribing
minimum financial and related reporting requirements, and requires its
member FCMs to establish a risk management program that is at least as
stringent as the risk management program required of FCMs under Sec.
1.11. Proposed amendments to Sec. 1.52 (c) requires each SRO to
establish a supervisory program to oversee their member FCMs'
compliance with SRO and Commission minimum capital and related
reporting requirements, the obligation to properly segregated customer
funds, risk management requirements, financial reporting requirements,
and sales practices and other compliance requirements. The supervisory
program must address: (1) Levels and independence of SRO examination
staff; (2) ongoing surveillance of member FCMs; (3) procedures for
identifying high-risk firms; (4) on-site examinations of member firms;
and (5) the documentation of all aspects of the supervisory program.
The supervisory program also must be based on an understanding of the
internal control environment to determine the nature, timing, and
extent of controls testing and substantive testing to be performed and
must address all areas of risk to which the FCM can reasonably be
foreseen to be subject. Proposed Sec. 1.52(c) also requires that all
aspects of the SRO's supervisory program must, at a minimum, conform to
generally accepted auditing standards after consideration to the
auditing standards issued by the PCAOB.
Proposed Sec. 1.52(c) also requires each SRO to engage an
``examinations expert'' at least once every two years to evaluate the
quality of the supervisory oversight program and the SRO's application
of the supervisory program. The SRO must obtain a written report from
the examinations expert with an opinion on whether the supervisory
program is reasonably likely to identify a material weakness in
internal controls over financial and/or regulatory reporting, and in
any of the other areas

[[Page 68560]]

that are subject to the supervisory program.
Proposed Sec. 1.52(d) provides that two or more SROs may enter
into an agreement to delegate the responsibility of monitoring and
examining an FCM that is a member of more than one SRO to a DSRO. The
DSRO would monitor the FCM for compliance with the Commission's and
SROs' minimum financial and related reporting requirements, and risk
management requirements, including policies and procedures relating to
the receipt, holding, investing and disbursement of customer funds.
The Commission received several comments on the proposed amendments
to Sec. 1.52 and, with the exception of the issues discussed below,
has determined to adopt the amendments as proposed.\459\
---------------------------------------------------------------------------

\459\ MGEX stated that the Commission's Proposal generally
supports the current DSRO program by requiring FCMs to file various
reports and notices with the Commission and with the firms' DSROs.
MGEX further stated that the Commission should not create a
regulatory monopoly and should recognize that an SRO may not wish to
join the JAC. The Commission believes that each SRO has a right to
elect to perform the financial surveillance required under Sec.
1.52 directly or to participate in a joint audit agreement with
other SROs. In addition, Sec. 38.604 requires each SRO to have
rules in place that require member FCMs to submit financial
information to the SRO.
---------------------------------------------------------------------------

1. Swap Execution Facilities Excluded From the Scope of Regulation 1.52
The Commission is revising the final Sec. 1.52 by adding a new
defined term, ``self-regulatory organization,'' to paragraph (a). The
term ``self-regulatory organization'' is defined in paragraph (a) to
mean, for purpose of Sec. 1.52 only, a contract market, as defined in
Sec. 1.3(h), or a registered futures association. The term ``self-
regulatory organization'' is further defined in paragraph (a) to
explicitly exclude a swap execution facility (``SEF''), as defined in
Sec. 1.3(rrrr).
The revision to definition of self-regulatory organization in Sec.
1.52 is necessary due to the recent amendments to the definition of
``self-regulatory organization'' set forth in Sec. 1.3(ee), which
defines the term as a contract market, as defined in Sec. 1.3(h), a
SEF, as defined in Sec. 1.3(rrrr), or a registered futures association
under section 17 of the Act.\460\ Therefore, since Sec. 1.52 applies
to each SRO, without including a definition for the term ``self-
regulatory organization'' under Sec. 1.52(a) that excludes SEFs, the
full provisions of Sec. 1.52 would apply to SEFs.
---------------------------------------------------------------------------

\460\ 77 FR 66288 (Nov. 2, 2012). Regulation 1.3 is the general
definitions provision of the Commission's regulations.
---------------------------------------------------------------------------

In adopting new regulations implement core principles and other
requirements for SEFs, the Commission did not require SEFs to adopt
minimum capital and related financial reporting requirements for its
member firms.\461\ The Commission further stated that a SEF's
obligation to monitor its member for financial soundness extended only
to a requirement to ensure that the members continue to qualify as
eligible contract participants as defined in section 1a(18) of the
Act.\462\ Therefore, the Commission previously has determined that the
extensive oversight program required of SROs that are contract markets
or registered futures associations by Sec. 1.52 is not applicable to
SEFs.
---------------------------------------------------------------------------

\461\ 78 FR 33476 (June 4, 2013).
\462\ Id.
---------------------------------------------------------------------------

2. Revisions to the Current SRO Supervisory Program
The Commission received several comments concerning the proposed
amendments to Sec. 1.52, many of which varied in support and context.
The NFA stated that it fully supports the requirement that the
supervisory program include both controls testing and substantive
testing, and that the examinations process be driven by the risk
profile of the FCM.\463\ NFA noted that it has been modifying its
procedures to enhance its examination of FCM internal controls as well
as substantive testing, and also has updated its risk system to create
risk profiles of each of its FCMs.\464\ NFA also agreed that SROs
should identify those FCMs that pose a high degree of potential risk so
that the SRO can increase its monitoring of those firms and that the
examinations should focus on the higher risk areas at each FCM.\465\
---------------------------------------------------------------------------

\463\ NFA Comment Letter at 3 (Feb. 15, 2013). See also Paul/
Weiss Comment Letter at 2 (Feb. 15 2013), BlackRock Letter at 3
(Feb. 15. 2013), and MFA Comment Letter at 4 (Feb. 15, 2013)
expressing general support for the proposed enhancements to the SRO
examinations program.
\464\ Id.
\465\ Id.
---------------------------------------------------------------------------

The CME and JAC generally did not support the proposed amendments
to Sec. 1.52, stating that the current limited role of regulatory
exams is appropriate as its purpose is not intended to give the same
level of assurances to the FCM, the FCM's investors, or third parties
as that which external auditors provide in conducting financial
statement audits of FCMs.\466\ The CME also stated that regulatory
reviews are not designed to protect investors in FCMs, nor should they
be.\467\ In addition, the CME believes that SROs and DSROs play
regulatory roles, and it is no more appropriate to have them report to
an audit committee of an FCM than it would be to have the Commission
itself report to that audit committee.\468\
---------------------------------------------------------------------------

\466\ CME Comment Letter at 8-9 (Feb. 15, 2013); JAC Comment
Letter at 2-4 (Feb. 14, 2013); JAC Comment Letter 2-4 (July 25,
2013).
\467\ CME Comment Letter at 11 (Feb. 15, 2013).
\468\ Id.
---------------------------------------------------------------------------

The JAC stated that the SRO examinations are compliance reviews
focused on the particular and distinctive regulatory requirements and
associated risks of the futures industry, including whether FCMs are in
compliance with customer regulations and net capital requirements to
protect customers and the functioning of the futures industry.\469\ The
JAC further stated that incorporating the full risk management
requirements of Sec. 1.11 into the SRO's examinations of FCMs, and the
requirement that the SRO audit program address all areas of risk to
which FCMs can reasonably be foreseen to be subject, are overly broad
requirements that are impractical, and virtually impossible to
meet.\470\
---------------------------------------------------------------------------

\469\ JAC Comment Letter at 2 (July 25, 2013).
\470\ Id. See also JAC Comment Letter at 5 (Feb. 14, 2013).
---------------------------------------------------------------------------

The JAC further stated that proposed Sec. 1.52 imposes potential
duplicative oversight of FCM risk management policies and procedures by
SROs and DCOs. The JAC noted that Sec. 39.13(h)(5) requires a DCO to
review the risk management policies, procedures, and practices of each
of its clearing members.\471\ The JAC requested clarification on the
oversight responsibilities of SROs and DCOs to address potential
duplicative requirements.\472\ Lastly, the JAC stated that expanding
the SRO oversight program to include operational and technical risks
will require additional expertise, time and resources to perform such
reviews and will result in increased costs.\473\
---------------------------------------------------------------------------

\471\ Id.
\472\ Id.
\473\ Id. The JAC noted that the examination of the controls and
risk management policies and procedures over an FCM's technology
systems would require particular expertise that is different from
the knowledge and expertise or regulatory staff, and that SROs will
have to hire specialized examiners to conduct such reviews.
---------------------------------------------------------------------------

The Commission believes that the CME, NFA, JAC, SROs and DSROs play
a critical role in examining FCMs and other registrants under the self-
regulatory structure of the futures industry. Recent events, however,
demonstrate that the SROs' current focus on CFTC and SRO regulatory
requirements, including segregation and net capital computations, are
not in and of themselves adequate to assess risk and protect customers
of the FCM. For instance, a failure in an FCM's non-futures operations
may pose risks to

[[Page 68561]]

futures customers and the operation of an FCM. In addition, technology
failures at an FCM also may pose risks to the operation of an FCM and
the overall protection of customer funds. Accordingly, to properly
monitor and assess risks to the FCM, the SRO must be aware of non-
futures related activities of the FCM.
Recent events also demonstrate that the examinations of FCMs must
be risk based and that the testing must be based on an understanding of
the registrant's internal control environment to determine the nature,
timing and extent of the necessary tests. In order to help ensure an
appropriate risk based exam is performed, an examiner must take into
account the risk profile of the firm and build the examination program
accordingly. For example, if a firm has weak controls over cash, the
risk of inaccurate accounting for cash movements is greater and
therefore more detailed substantive testing of cash transactions and
balances is necessary to provide the examiner with sufficient assurance
that reported balances are accurate. To the contrary, if controls are
good over cash then less substantive testing is needed.
The Commission acknowledges that revised Sec. 1.52 imposes new
obligations on SROs by requiring their supervisory programs to include
an assessment of whether member FCMs comply with the risk management
requirements of Sec. 1.11. However, Sec. 1.52 also requires that the
SRO's examination of FCMs be performed on a risk-based approach. The
scope of the examinations should be based upon the SRO's assessment of
risk at the FCM and full, detailed testing is not mandated by Sec.
1.52 in each area. Lastly, the Commission recognizes that DCOs impose
certain risk management requirements on clearing FCMs and are required
to review the operation of such risk management requirements. While
Sec. 39.13(h)(5) is directed at risk that an FCM may pose to a DCO
and, therefore, is more narrowly focused than the risk management
requirements in Sec. 1.11, SROs may coordinate with a DCO to ensure
that duplicative work is not being performed by the separate
organizations.\474\
---------------------------------------------------------------------------

\474\ Under the current JAC structure, the CME is the only
entity that is both an SRO that performs periodic examinations of
FCMs and a DCO that has responsibilities under Sec. 39.13(h)(5) to
perform risk management on clearing FCMs.
---------------------------------------------------------------------------

3. Auditing Standards Utilized in the SRO Supervisory Program
Proposed Sec. 1.52(c)(2)(ii) and (d)(2)(ii)(F) require all aspects
of an SRO's or DSRO's, supervisory program to conform, at a minimum, to
U.S. GAAS after giving full consideration to the auditing standards
issued by the PCAOB. NFA, CME, and JAC questioned what is meant by the
term ``after giving full consideration of auditing standards prescribed
by the PCAOB.'' \475\ NFA, CME, and JAC did not agree with basing the
SRO Supervisory Program framework on either U.S. GAAS or PCAOB
standards, largely because the DSRO does not issue a report that
expresses an opinion with respect to the FCM's financial statements or
issue an Accountant's Report on Material Inadequacies.\476\
Additionally, CME noted that invoking U.S. GAAS and PCAOB standards
opens up a complex and detailed regulatory structure, which includes a
framework allowing auditor's to rely on interpretive publications,
professional journals and auditing publications from state CPA
societies, none of which were designed to address the regulatory
function played by an SRO or DSRO.\477\ However, NFA acknowledged that
certain U.S. GAAS and PCAOB accounting standards and practices should
be followed by DSROs in performing their regulatory examinations (e.g.,
those standards focusing on recordkeeping, training and experience, the
scope of the examination and testing, the confirmation process, and
other related examination practices).\478\
---------------------------------------------------------------------------

\475\ NFA Comment Letter at 3 (Feb. 15, 2013); CME Comment
Letter at 9-10 (Feb. 15, 2013); JAC Comment Letter at 2-3 (Feb 14,
2013).
\476\ Id.
\477\ CME Comment Letter at 9-10 (Feb. 15, 2013).
\478\ NFA Comment Letter at 3-4 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission notes that the objective of the Proposal was to
ensure that the SRO examinations are conducted consistent with the
professional standards that CPAs and others are subject to in
conducting their examinations. The Commission recognizes that certain
U.S. GAAS principles and PCAOB principles would not be applicable to
the SRO examinations (such as principles addressing reporting, which
provide that the CPA must state whether the financial statements are
prepared in accordance with Generally Accepted Accounting Principles).
However, other U.S. GAAS and PCAOB standards would be relevant to SRO
examinations. Such principles include standards addressing the
competency and proficiency of the examinations staff and the obtaining
and documenting of adequate audit evidence to support the examiner's
conclusions.
The Commission has considered these comments and has revised the
proposed language to state that at a minimum, an examination should
conform to PCAOB auditing standards to the extent such standards
address non-financial statement audits. While it is acknowledged that
PCAOB audit standards are directed at financial statement audits, the
concept of many of the standards are just as applicable to an
examination performed by an SRO or DSRO, and as such should be adopted
in that light. The relevant PCAOB standards would include, but are not
limited to, the training and proficiency of the auditor, due
professional care in the performance of the work, consideration of
fraud in an audit, audit risk, consideration of materiality in planning
and performing an audit, audit planning, identifying and assessing
risks of material misstatement, the auditor's responses to the risk of
material misstatement, audit documentation, evaluating the audit
results, communications with audit committees, and due professional
care in the performance of work. In developing the supervisory program,
consideration should also be given to other related guidance such as
the standards adopted by the Institute of Internal Auditors (Standards
& Guidance--International Professional Practices Framework) and the
Policy Statement and Supplemental Policy Statement on the Internal
Audit Function and its Outsourcing issued by the Board of Governors of
the Federal Reserve System, and generally accepted auditing standards
issued by the American Institute of Certified Public Accountants.\479\
---------------------------------------------------------------------------

\479\ The Commission is revising final Sec. 1.52 to remove from
paragraph (a) a definition for the term ``U.S. Generally accepted
auditing standards'' as that term is no longer contained in the
final regulation.
---------------------------------------------------------------------------

4. ``Examinations Expert'' Reports
Proposed Sec. 1.52(c)(2)(iv) and (d)(2)(ii)(I) require each SRO
and DSRO, respectively, to engage an examinations expert to evaluate
the SROs or DSROs programs and to express an opinion as to whether the
program is reasonably likely to identify a material deficiency in
internal controls over financial and/or regulatory reporting and in any
of the other areas that are subject to SRO or DSRO review under the
programs. The JAC, CME, Center for Audit Quality, Ernst & Young, and
PWC did not support the ``examinations expert'' requirement.\480\
Several of these commenters expressed concern that the term
``examinations expert'' as defined

[[Page 68562]]

by Sec. 1.52 imposes a criterion that most CPA firms may not possess
or would not be willing to issue such a report.\481\ Moreover, NFA,
JAC, and MGEX stated that requiring an ``examinations expert'' is
unnecessary and duplicative of already existing Commission
responsibilities, noting that the JAC provides the examination programs
to the Commission annually, and that the Commission can perform a
review of the examination programs.\482\
---------------------------------------------------------------------------

\480\ JAC Comment Letter at 3-4 (Feb. 14, 2013); Center for
Audit Quality Comment Letter at 3 (Jan. 14, 2013); Ernst & Young
Comment Letter at 3-4 (Jan. 14, 2013); PWC Comment Letter at 3 (Jan.
15, 2013).
\481\ CME Comment Letter at 13 (Feb. 15, 2013); Center for Audit
Quality Comment Letter at 3 (Jan. 14, 2013); Ernst & Young Comment
Letter at 3-4 (Jan. 14, 2013); PWC Comment Letter at 3 (Jan. 15,
2013).
\482\ NFA Comment Letter at 4-5 (Feb. 15, 2013); JAC Comment
Letter at 4 (Feb. 14, 2013) MGEX Comment Letter at 3-4 (Feb. 18,
2013).
---------------------------------------------------------------------------

NFA and JAC suggested, as cost effective and more practical
solution, inviting individuals meeting the ``examinations expert''
designation to participate in the already existing JAC audit committee
meetings.\483\ CME suggested that if the proposed structure is adopted,
the time frame for review be extended from 18 months to 3\1/2\ years,
matching that required by the AICPA in its Peer Review program.\484\
---------------------------------------------------------------------------

\483\ NFA Comment Letter at 4-5 (Feb. 15, 2013); JAC Comment
Letter at 4 (Feb. 14, 2013).
\484\ CME Comment Letter at 13 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission has taken these comments into consideration and has
revised the final regulation by providing that the report of the
examinations expert should conform to the consulting services standards
of the AICPA. The Commission recognizes that generally accepted
auditing standards do not provide a reporting framework by which a
certified public accountant can issue an audit opinion consistent with
the requirements contained in Sec. 1.52. Accordingly, the Commission
has revised the final regulation by removing the requirement that the
examinations expert provide an audit opinion.
The Commission also does not believe that it is in a position to
perform the type of review of the SRO examination reports required by
Sec. 1.52 given its limited resources. Furthermore, the examinations
expert is an independent party with expert knowledge of risk assessment
and internal controls reviews and will be able to provide more thorough
and detailed review of the joint audit program than Commission staff
can currently devote to such a review. In addition, the Commission
staff has communicated to the JAC that it would be very supportive of
having the accounting and auditing experts join the JAC meetings to
discuss current industry issues.
The Commission has also considered the impact of performing such a
review every two years and has modified the proposal to require such a
report on a three year basis. This reflects the fact that the DSROs
will be updating their programs as needed and therefore the program
should not be stagnant during the intervening years. Finally, it was
pointed out that given the nature of the report and to facilitate an
open and frank dialogue amongst the examinations expert, the DSROs, and
the Commission, such report should be considered confidential. The
Commission is revising the regulation to provide that the report is
confidential, which is consistent with how the PCAOB conducts its
reviews of CPA firms.

P. Sec. 1.55: Public Disclosures by Futures Commission Merchants

Regulation 1.55(a) currently requires an FCM, or an IB in the case
of an introduced account, to provide a customer with a separate written
risk disclosure statement prior to opening the customer's account
(``Risk Disclosure Statement''). Regulation 1.55(a) also provides that
the Risk Disclosure Statement may contain only the language set forth
in Sec. 1.55(c) (with an exception for non-substantive additions such
as captions), except that the Commission may authorize the use of Risk
Disclosure Statements approved by foreign regulatory agencies or self-
regulatory organizations if the Commission determines that such Risk
Disclosure Statements are reasonably calculated to provide the
disclosures required by the Commission under Sec. 1.55.\485\
Regulation 1.55(a) further requires the FCM or IB to receive a signed
and dated statement from the customer acknowledging his or her receipt
and understanding of the Risk Disclosure Statement.\486\
---------------------------------------------------------------------------

\485\ The Commission has previously approved an alternative
``generic'' risk disclosure statement for use in the United Kingdom,
Ireland and the U.S.
\486\ FCMs and IBs are permitted to open commodity futures
accounts for ``institutional customers'' pursuant to Sec. 1.55(f)
without furnishing such institutional customers with a Risk
Disclosure Statement or obtaining the written acknowledgment
required by Sec. 1.55. The term ``institutional customer'' is
defined by Sec. 1.3(g) and section 1a of the Act as an eligible
contract participant. The Commission did not propose to amend Sec.
1.55(f) to require FCMs or IBs to furnish institutional customers
with Risk Disclosure Statements.
---------------------------------------------------------------------------

The Commission reviewed the adequacy of the current prescribed Risk
Disclosure Statement in light of its experience with customer
protection issues during the recent failures of two FCMs, MFGI and
PFGI. In this regard, in responding to questions and issues raised
primarily by non-institutional market participants, including market
participants from the agricultural community and retail market
participants, the Commission recognized that such market participants
would benefit from several additional disclosures regarding the
potential general risks of engaging in futures trading through an FCM,
and the potential specific risks resulting from the bankruptcy of an
FCM. In addition to proposing new general risk disclosures, the
Commission proposed to also require each FCM to provide customers and
potential customers with information about the FCM, including its
business, operations, risk profile, and affiliates. The firm specific
disclosures are intended to provide customers with access to material
information regarding an FCM to allow the customers to independently
assess the risk of entrusting funds to the firm or to use the firm for
the execution of orders.
1. Amendments to the Risk Disclosure Statement
The mandatory Risk Disclosure Statement currently addresses the
risks of engaging in commodity futures trading. The risks that must be
disclosed include: (1) The risks that a customer may experiences losses
that exceed the amount of funds that he or she contributed to trading
and that the customer may be responsible for losses beyond the amount
of funds deposited for trading; (2) the risks that under certain market
conditions, a customer may find it difficult or impossible to liquidate
a position, such as when a market has reached a daily price move limit;
(3) the risks that placing certain contingent orders (such as a stop
limit order) may not necessarily limit the customer's losses; (4) the
risks associated with the high degree of leverage that may be
obtainable from the futures markets; and (5) the risks of trading on
non-U.S. markets, which may not provide the same level of protections
provided under Commission regulations.
As noted above, the Commission proposed several additional
disclosures based upon its experience in working with customers,
particularly retail and other non-institutional market participants,
during the recent failures of MFGI and PFGI. Specifically, the
Commission proposed to amend the Risk Disclosure Statement to provide
market participants with more information regarding the risks
associated with an FCM holding customer funds. In this regard, certain
market participants believed that the fact that their funds were
segregated from the FCM's proprietary funds protected them from loss in
the event of

[[Page 68563]]

an FCM bankruptcy. Other customers believed that a DCO guaranteed
customer losses, and other customers believed that funds deposited for
futures trading were protected by the Securities Investor Protection
Corporation in the event of an FCM/BD bankruptcy.
To provide greater clarity as to the how customer funds are held
and the potential risks associated with FCMs holding customer funds,
the Commission proposed to revise the Risk Disclosure Statement by
amending Sec. 1.55(b) to include new paragraphs (2) through (7) as
follows:
(2) The funds you deposit with an FCM for trading futures positions
are not protected by insurance in the event of the bankruptcy or
insolvency of the futures commission merchant, or in the event your
funds are misappropriated due to fraud;
(3) The funds you deposit with an FCM for trading futures positions
are not protected by the Securities Investor Protection Corporation
even if the futures commission merchant is registered with the SEC as a
BD;
(4) The funds you deposit with an FCM are not guaranteed or insured
by a DCO in the event of the bankruptcy or insolvency of the FCM, or if
the FCM is otherwise unable to refund your funds;
(5) The funds you deposit with an FCM are not held by the FCM in a
separate account for your individual benefit. FCMs commingle the funds
received from customers in one or more accounts and you may be exposed
to losses incurred by other customers if the FCM does not have
sufficient capital to cover such other customers' trading losses;
(6) The funds you deposit with an FCM may be invested by the FCM in
certain types of financial instruments that have been approved by the
Commission for the purpose of such investments. Permitted investments
are listed in Commission Regulation 1.25 and include: U.S. government
securities; municipal securities; money market mutual funds; and
certain corporate notes and bonds. The FCM may retain the interest and
other earnings realized from its investment of customer funds. You
should be familiar with the types of financial instruments that an FCM
may invest customer funds in; and
(7) FCMs are permitted to deposit customer funds with affiliated
entities, such as affiliated banks, securities brokers or dealers, or
foreign brokers. You should inquire as to whether your FCM deposits
funds with affiliates and assess whether such deposits by the FCM with
its affiliates increases the risks to your funds.
The Commission received several comments on the proposed amendment
to the Risk Disclosure Statement. NFA stated that it fully supported
the Commission's goal of ensuring that customers receive a full
description of the risk associated with futures trading, and agreed
with the Commission that it is important to update the Risk Disclosure
Statement to provide information on the extent to which customer funds
are protected when deposited with an FCM as margin or to guarantee
performance for trading commodity interest.\487\
---------------------------------------------------------------------------

\487\ NFA Comment Letter at 15 (Feb. 15, 2013).
---------------------------------------------------------------------------

The FIA generally supported the proposed amendments to the general
Risk Disclosure Statement set forth in Sec. 1.55(b) and outlined
above.\488\ The FIA stated that many of the Commission's proposed
amendments are consistent with FIA's recommendations to enhance
disclosures set forth in its paper, ``Initial Recommendations for the
Protection of Customer Funds,'' which was published on February 28,
2012 (``Initial Recommendations'') in response to MFGI.\489\ FIA also
stated that its document, ``Protection of Customer Funds--Frequently
Asked Questions,'' is being used by FCMs to provide customers with
increased disclosures on the scope of how the laws and regulations
protect customers in the futures market.\490\
---------------------------------------------------------------------------

\488\ FIA Comment Letter at 41 (Feb. 15, 2013).
\489\ FIA Comment Letter at 2 (Feb. 15, 2013). The FIA formed a
special committee to develop and recommend specific measures that
could be implemented by both the industry best practices and
regulatory change to address the issues arising from the bankruptcy
of MFGI.
\490\ Id. FIA's ``Protection of Customer Funds--Frequently Asked
Questions'' provides information covering five broad areas: (1)
segregation of customer funds; (2) collateral management and
investments; (3) basic information on FCMs, such as the purpose of
capital requirements and margin processing: (4) issues for joint
FCM/BDs; and (5) the role of the DCO guarantee fund.
---------------------------------------------------------------------------

With respect to the Commission's proposed amendments to Sec.
1.55(b), FIA recommended that the Commission delete the phrase ``due to
fraud'' in Sec. 1.55 (b)(2) because customer funds may be
misappropriated for any reason.\491\ Additionally, FIA suggested the
disclosure in Sec. 1.55(b)(4) be revised to take account of the CME
Group Family Farmer and Rancher Protection Fund established in the wake
of MFGI as this fund will provide up to $25,000 to qualifying
individual farmers and ranchers and $100,000 to co-ops that hedge their
risk in CME futures markets.\492\
---------------------------------------------------------------------------

\491\ Id. at 41.
\492\ Id. at 41-42.
---------------------------------------------------------------------------

The Commission has considered FIA's comments and had determined to
revise the proposal. The Commission recognizes that customer funds may
be misappropriated as a result of wrongful conduct that does not rise
to the level of fraud. Accordingly, the Commission is revising Sec.
1.55(b)(4) by removing the phrase ``due to fraud'' so that the
disclosure provides that customers' funds are not covered by insurance
in the event of the insolvency of the FCM or in the event the funds are
misappropriated.
The Commission also is revising final Sec. 1.55(b)(4) in response
to FIA's comment to provide an overall statement that customer funds
generally are not insured by DCOs. The Commission is further revising
final Sec. 1.55(b)(4) to include in the disclosure the fact that a DCO
may offer an insurance program, and that a customer should inquire of
the FCM the extent of any DCO insurance programs and whether the
customer would qualify for coverage and understand the limitations and
benefits of the coverage. The Commission believes that this approach is
more flexible to address future developments in this area than a direct
reference to specific DCO insurance programs that currently are
available.
NEFI/PMAA questioned whether or not existing and proposed
disclosures are sufficient, and further stated that disclosure of
customer protections are equally important as the disclosure of
potential risks to ensure customer confidence.\493\ Pilot Flying J
stated FCMs must be required to disclose information to their customers
on how their accounts and positions will be managed, as well as
associated risks and what kinds of financial protections are afforded
to customers by the firm, exchange, and the Commission.
---------------------------------------------------------------------------

\493\ NEFI/PMAA Comment Letter at 2 (Jan. 14, 2013).
---------------------------------------------------------------------------

The Commission agrees with NEFI/PMAA and Pilot Flying J that a
customer's understanding of the protections is as important as
understanding the risks. The Risk Disclosure Statement is the minimum
information that an FCM should provide to prospective customers, and is
intended to provide a high level summary of the general risk of trading
commodity interests. FCMs should provide additional information as
necessary to ensure that customers have adequate information. The
Commission believes that FIA's Initial Recommendation and FAQ, which
includes the types of information that NEFI/PMAA and Pilot Flying J are
requesting, should be made available to all potential customers. FIA
should revise the documents, as appropriate, in

[[Page 68564]]

response to changing market events or other factors.
The Commission also requested comment on whether and how the new or
revised Risk Disclosure Statement should be provided to existing
customers at the effective date of the regulation. Particularly, the
Commission requested comment on whether FCMs should be required to
obtain new signature acknowledgments from existing customers.
FIA stated that it was not opposed to a requirement that FCMs
provide the revised Risk Disclosure Statement to existing customers
that are otherwise required to receive the disclosure document.\494\
FIA stated, however, that FCMs should not be required to obtain a
written acknowledgment from existing customers. FIA further stated that
it should be sufficient if the FCM makes each customer aware of the
revised Risk Disclosure Statement by any appropriate means, consistent
with the means by which the FCM normally communicates important
information to customers, including but not limited to, a separate
mailing.\495\ The CFA stated that it is very important for FCMs and
their DSROs to ascertain whether existing and potential customers have
acknowledged receipt of the Risk Disclosure Statement, and FCMs should
keep records of acknowledgments that the Risk Disclosure Statements
were received.\496\ NGFA noted that providing updated risk disclosure,
with signed acknowledgment of such to the FCM, is a sound concept.\497\
---------------------------------------------------------------------------

\494\ FIA Comment Letter at 42-43 (Feb. 15, 2013).
\495\ Id.
\496\ CFA Comment Letter at 8 (Feb. 13, 2013).
\497\ NGFA Comment Letter at 5 (Feb. 15, 2013).
---------------------------------------------------------------------------

Regulation 1.55(a) will continue to require FCMs to obtain and
retain signed acknowledgments from new customers that they received and
understand the Risk Disclosure Statement. With respect to existing FCM
customers on the effective date of the regulation, the Commission
believes that it is adequate for an FCM to provide each of the
customers with a revised Risk Disclosure Statement via its normal means
of communicating with customers, including the use of a separate
mailing, or providing a link on the firm's Web site to the revised Risk
Disclosure Statement, provided that the FCM provides a paper copy of
the Risk Disclosure Statement upon the request of a customer. The
communication of the revised Risk Disclosure Statement to customers
must be highlighted by the FCM in such a manner to reasonably ensure
that the customers are adequately apprised of the revised Risk
Disclosure Statement.
FIA also noted that the Commission previously approved, pursuant to
Sec. 1.55(c), an alternative risk disclosure statement for use in the
U.S., the United Kingdom, and Ireland.\498\ The alternative risk
disclosure statement is set forth in Appendix A to Sec. 1.55. FIA
requested that the Commission confirm whether FCMs may continue to use
the alternative risk disclosure statement and further encouraged the
Commission to coordinate with other derivatives regulatory authorities
to revise the alternative risk disclosure statement to meet its
regulatory objectives.\499\
---------------------------------------------------------------------------

\498\ FIA Comment Letter at 43 (Feb. 15, 2013).
\499\ Id.
---------------------------------------------------------------------------

Regulation 1.55(c) provides that the Commission may approve for use
in lieu of the standard Risk Disclosure Statement required by Sec.
1.55(b) a risk disclosure statement approved by one or more foreign
regulatory agencies or self-regulatory organizations if the Commission
determines that such risk disclosure statement is reasonably calculated
to provide the disclosure required by the standard Risk Disclosure
Statement. As noted above, the Commission proposed amendments to the
Risk Disclosure Statement due to its recent experiences with the MFGI
and PFGI insolvencies where certain customers, particularly less
sophisticated customers, did not fully comprehend the nature of the
protections of customer funds. Based upon this recent experience, the
Commission does not believe that the disclosures in the alternative
risk disclosure statement contained in Appendix A provide sufficient
detailed disclosures to customers regarding the risk of trading futures
transactions. Accordingly, the Commission is revising Sec. 1.55(c) to
provide that an FCM may continue to use the alternative risk disclosure
statement provided that the FCM also provides each customer required to
receive a disclosure document with the revised Risk Disclosure
Statement and receives such customer's written acknowledgment that it
has received and understands the Risk Disclosure Statement. This will
allow FCMs to continue to have a common risk disclosure statement with
the United Kingdom and Ireland, and also ensure that customers receive
additional risk disclosures to enhance their understanding of engaging
in futures trading.
a. Firm Specific Disclosure Document
i. General Requirements
The Commission proposed new paragraphs (i) and (k) to Sec. 1.55 to
provide that an FCM may not enter into a customer account agreement or
accept funds from a customer unless the FCM discloses to the customer
all information about the FCM, including its business, operations, risk
profile, and affiliates, that would be material to the customer's
decision to entrust such funds to such FCM and otherwise necessary for
full and fair disclosure to customers (``Firm Specific Disclosure
Document'').
The Firm Specific Disclosure Document is intended to enable
customers to make informed judgments regarding the appropriateness of
selecting an FCM by providing information for the meaningful
comparisons of business models and risks across FCMs. Such information
will greatly enhance the due diligence that a customer can conduct both
prior to opening an account and on an ongoing basis, as the proposal
will require the FCM to update the Firm Specific Disclosure Document at
least once every 12 months and as and when necessary to keep it
accurate and complete. The Commission believes that the proposed firm
specific Firm Specific Disclosure Document, coupled with the existing
Risk Disclosure Statement, will provide customers with a more complete
perspective regarding the risks of participating in the futures markets
and of opening an account with a particular firm.
Proposed Sec. 1.55(j) requires an FCM to make the Firm Specific
Disclosure Document available to customers and to the general public by
posting the Firm Specific Disclosure Document on the FCM's Web site. An
FCM may, however, use an alternative electronic means to provide the
Firm Specific Disclosure document to its customers provided that the
electronic version is presented in a format that is readily
communicated to the customers. Paper copies of the Firm Specific
Disclosure Document also must be available upon the request of a
customer. The Commission also proposed that each FCM disclose certain
financial information on its Web site to provide the public with
additional information on the firm and the customer funds that it
holds. The additional financial disclosures are set forth in Sec.
1.55(o) and are discussed below.
SIFMA stated that the public disclosure requirements will help
empower its members to choose safe and trustworthy FCMs, and that the

[[Page 68565]]

disclosures will hold FCMs accountable to their customers, allowing the
customers to conduct due diligence efficiently, actively monitor FCMs'
financial condition and regulatory compliance, and make informed
decisions when selecting and doing business with FCMs.\500\ Vanguard
expressed the view that the best protection for customers is their own
due diligence, and that the proposed additional enhancements add
significant, and much needed, protections and transparency.\501\ The
FHLB supported the proposal with respect to the publication of the Firm
Specific Disclosure Document and strongly endorsed the requirement that
the FCM update the document as circumstances warrant.\502\
---------------------------------------------------------------------------

\500\ SIFMA Comment Letter at 2 (Feb. 21, 2013).
\501\ Vanguard Comment Letter at 4 (Feb. 2, 2013). See also,
Prudential Comment Letter at 2 (Jun. 9, 2013) and Security Benefit
Comment Letter at 2 (Jan. 11, 2013 supporting the additional
disclosures proposed under Sec. 1.55(i).
\502\ FHLB Comment Letter at 10 (Feb. 15, 2013).
---------------------------------------------------------------------------

FIA stated that it supports enhancing disclosures to customers
regarding the FCM through which the customer may elect to trade.\503\
FIA requested that the Commission confirm that an FCM that is part of a
publicly-traded company, whether U.S. or non-U.S., or is otherwise
required to prepare and to make public an annual report including
information comparable to that required by the Firm Specific Disclosure
Document under the proposed regulation, may comply with the regulation
by making such annual report, and any amendments thereto, available on
its Web site.\504\ FIA noted that the Management Discussion and
Analysis (``MD&A'') required under SEC rules (17 C.F.R. 229.303)
requires publicly traded companies to discuss essentially the same
topics required to be discussed under the Commission's proposal. FIA
stated that the topics include business environment; critical
accounting policies; use of estimates; results of operations; balance
sheet and funding sources; off-balance sheet arrangements and
contractual obligations; overview and structure of risk management;
liquidity risk management; market risk management; credit risk
management; operational risk management; recent accounting
developments; and certain risk factors that may affect the company's
business.\505\ FIA estimated that approximately 90 percent of customer
funds are held by FCMs that are also SEC registered or part of a bank
holding company or publicly-traded company and believes this position
is necessary to avoid customer confusion in certain circumstances and
to assure that FCMs are not subject to duplicative and, perhaps
conflicting, disclosure requirements.\506\
---------------------------------------------------------------------------

\503\ FIA Comment Letter at 41 (Feb. 15, 2013).
\504\ FIA Comment Letter at 43-44 (Feb. 15, 2013).
\505\ Id.
\506\ Id.
---------------------------------------------------------------------------

FIA further requested that the Commission confirm the level of
detail required to be provided by privately-held FCM companies should
be consistent with that provided in the annual reports of publicly-
traded companies.\507\ Additionally, FIA stated that privately-held
companies would need a period of time to develop the required
disclosures and requested that the Commission make the compliance date
of the regulation no sooner than six months after the effective date of
the regulation.\508\
---------------------------------------------------------------------------

\507\ Id. at 44.
\508\ Id.
---------------------------------------------------------------------------

The Commission has considered the comments and is adopting Sec.
1.55(i) and (j) as proposed. In response to FIA's comments, the
Commission confirms that beyond the requirements stated in Sec. 1.55,
the Commission is not mandating the form in which the required
information is conveyed, provided it is responsive to the information
requirements of Sec. 1.55 and provides such information in a clear,
concise, and understandable matter. Accordingly an FCM that is part of
a publicly traded company, or is otherwise required to prepare and make
public an annual report including information comparable to the
information required by proposed Sec. 1.55(k), may satisfy the
disclosure requirements in Sec. 1.55 by making an annual report, and
any amendments thereto, available on its Web site; provided that such
annual report provides the information required by Sec. 1.55 in a
manner that is clear, concise and understandable. The Commission is
similarly confirming that a privately-held company may satisfy the
requirements in Sec. 1.55 by making an annual report, and any
amendments thereto, available on its Web site; provided that such
annual report provides the information required by Sec. 1.55 in a
manner that is clear, concise and understandable.
In assessing whether the annual report contains the necessary
information required by Sec. 1.55 in a clear, concise and
understandable manner, the FCM must ensure that the disclosures
specifically address the risks at the FCM and are not so general in
nature that they reflect that the FCM's business may not be material to
the public or private company for which the annual report is prepared.
An FCM is not in compliance with Sec. 1.55 if the annual report
information does not disclose the information required by Sec. 1.55 as
it relates to the FCM. The objective of the disclosures is to provide
prospective and existing customers of the FCM with material information
that could have an impact on their decision to engage in a relationship
with the FCM. If the annual report does not include information
regarding the FCM, or such information is not clear concise and
understandable, the FCM would have to enhance the disclosure by
providing supplemental material or otherwise making the required
disclosures available to customers and the public in a manner that is
clear, concise and understandable. In addition, in order to provide
customers with clear, concise and understandable disclosures, an FCM
may be required to extract information from various sections of its
annual report and provide such information in an easy to read format.
If customers are required to search through detailed annual reports to
locate the required Sec. 1.55 disclosures, the FCM is not providing
the information in a clear, concise and understandable manner.
ii. Specific Disclosure Information Required (by Rule Paragraph)
Proposed Sec. 1.55(k)(1) requires an FCM to disclose contact
information for the firm including the address of its principal place
of business and its phone number. No comments were received on the
proposed Sec. 1.55(k)(1) and the Commission is adopting the amendments
as proposed.
Proposed Sec. 1.55(k)(2) requires an FCM to disclose the name and
business addresses of the FCM's senior management, including business
titles and background, areas of responsibility and nature of duties of
each person. The FIA recommended the disclosure be limited to those
individuals identified as principals on the NFA BASIC system.\509\
---------------------------------------------------------------------------

\509\ FIA Comment Letter at 51 (Feb. 15, 2013).
---------------------------------------------------------------------------

The term ``principal'' is defined in Sec. 3.1 to mean, with
respect to an FCM: (1) The proprietor and chief compliance officer if
the FCM is organized as a sole proprietorship; (2) any general partner
and chief compliance officer if the FCM is organized as a partnership;
(3) any director, the president, chief executive officer, chief
operating officer, chief financial officer, chief compliance officer,
and any person in charge of a principal business unit, division or
function subject to regulation by the Commission if the FCM is
organized as

[[Page 68566]]

a corporation; (4) any director, the president, chief executive
officer, chief operating officer, chief financial officer, chief
compliance officer, the manager, managing member or those members
vested with the management authority for the entity, and any person in
charge of a principal business unit, division or function subject to
regulation by the Commission if the FCM is organized as a limited
liability company or limited liability partnership; and (5) in
addition, any person at the FCM occupying a similar status or
performing similar functions as described above, having the power,
directly or indirectly, through agreement or otherwise, to exercise a
controlling influence over the entity's activities that are subject to
regulation by the Commission.
The Commission agrees with FIA's comment and is revising the final
regulation to require an FCM to disclose persons that are defined as
``principals'' of the FCM under Sec. 3.1.
Proposed Sec. 1.55(k)(3) requires an FCM to disclose the
significant types of activities and product lines that the FCM engages
in and the approximate percentage of assets and capital that are
contributed to each type of business activity or product line. FIA
recommended that an FCM be required to update the description in its
annual report, only if it adds a new business activity or product line
that requires higher minimum capital under applicable capital rules
because the approximate percentage of the FCM's assets and capital used
in each type of activity can change frequently.\510\
---------------------------------------------------------------------------

\510\ Id. at 45.
---------------------------------------------------------------------------

The Commission believes that FIA is defining the requirements of
Sec. 1.55(k)(3) too narrowly. The regulation is intended to provide
the public with information concerning the major businesses activities
that an FCM engages in to provide information regarding the benefits
and risks of using such firm to conduct transactions in commodity
interests. Minimum capital requirements are generally driven by
regulated business, such a being registered as a BD. While such
information is material to potential customers and is required to be
disclosed under Sec. 1.55(k)(3), the regulation also requires the
disclosure of non-regulated business that a firm may engage in.
The Commission also recognizes that an FCM's assets and capital
contributed to different business activities can change frequently, but
such information may be material for the public in determining to
entrust funds with the firm and to perform effective due diligence in
monitoring the firm. Each FCM will need to assess the materiality of
changes and use its judgment to determine whether the Firm Specific
Disclosure Document should be revised. In addition, the Commission
notes that Sec. 1.55(i) requires that the Firm Specific Disclosure
Document must be revised as and when necessary, but at least annually,
to keep the information accurate and complete. The Commission has
considered the comments and is adopting the amendments as proposed.
Proposed Sec. 1.55(k)(4) requires an FCM to disclose its business
on behalf of customers, including types of accounts, markets traded,
international business, and clearinghouses and carrying brokers used,
and its policies and procedures concerning the choice of bank
depositories, custodians, and other counterparties. FIA requested the
Commission confirm that: (1) The disclosure required under this
paragraph is limited to the activities of the FCM in its capacity as
such; (2) the term ``accounts'' means ``customers''; and (3) the term
``counterparties'' is limited to counterparties for Sec. 1.25
investments.\511\
---------------------------------------------------------------------------

\511\ Id. at 47-48.
---------------------------------------------------------------------------

Regulation 1.55(k)(4) is intended to provide customers and the
public with information regarding the FCM operating its FCM's business.
Accordingly, the Commission confirms that the disclosures required
under Sec. 1.55(k)(4) are limited to the activities of the FCM acting
in its capacity as an FCM. The term ``types of accounts'' in Sec.
1.55(k)(4) should be ``types of customers,'' and requires the FCM to
disclose the nature of its customer base in the futures markets (i.e.,
institutional, retail, agricultural, hedgers,) to provide the public
with information regarding the firm's experiences with different types
of markets and market participants. The Commission also confirms that
the term ``counterparties'' is limited to Sec. 1.25 counterparties.
The Commission is revising final Sec. 1.55(k)(4) accordingly.
Proposed Sec. 1.55(k)(5) requires an FCM to discuss the material
risks, accompanied by an explanation of how such risks may be material
to its customers, of entrusting funds to the FCM, including, without
limitation, the nature of investments made by the FCM (including credit
quality, weighted average maturity, and weighted average coupon); the
FCM's creditworthiness, leverage, capital, liquidity, principal
liabilities, balance sheet leverage and other lines of business; risks
to the FCM created by its affiliates and their activities, including
investment of customer funds in an affiliated entity; and any
significant liabilities, contingent or otherwise, and material
commitments.
FIA commented that the word ``risks'' in Sec. 1.55(k)(5) should be
replaced with the word ``information,'' and that the Commission remove
the phrase ``accompanied by an explanation of how such risks may be
material to its customers.'' \512\ FIA believed it sufficient that an
FCM present the required information to the customer and that it is the
customer's responsibility to analyze this information and determine the
extent to which it is important or relevant to the customer's decision
to open or maintain an account with the FCM.\513\ FIA further stated
that if the Commission believes FCMs should provide guidance to
customers regarding the potential importance of specific information,
FIA believes this guidance should be provided by means of a generic
statement.\514\ In addition, FIA asked the Commission to confirm that
the term ``investments'' is limited to investments of customer funds,
and does not include all investments made by the FCM as an entity.\515\
Additionally, FIA requested that the Commission delete the term
``creditworthiness,'' stating that such reference is incongruous with
instructions under section 939A of the Dodd-Frank Act.\516\ Moreover,
FIA opined that the only lines of business that an FCM should be
required to disclose are those that would require higher minimum
capital under applicable capital rules, and that this information
should only be required to be updated annually.\517\ Additional
clarification was requested by FIA regarding the phrase ``investment of
customer funds with an affiliated entity,'' and whether that phrase
refers to the ``deposit of customer funds in an affiliated bank.''
\518\ Further clarification was requested regarding the types of
liabilities and commitments requiring disclosure under this section and
whether this information should updated no more often than
semiannually, consistent with comparable disclosures applicable to

[[Page 68567]]

BDs.\519\ Finally, FIA, while not opposed to providing leverage
information, believed that disclosure should not be required until it
is certain the calculation provides the most appropriate measure of
risk.\520\
---------------------------------------------------------------------------

\512\ FIA Comment Letter at 45 (Feb. 15, 2013).
\513\ Id.
\514\ Id.
\515\ Id.
\516\ Section 939A required that the Commission, ``remove any
reference to or requirement of reliance on credit ratings and to
substitute in such regulations such standard of creditworthiness as
each respective agency shall determine as appropriate for such
regulations.'' FIA Comment Letter at 46 (Feb. 15, 2013).
\517\ FIA Comment Letter at 46 (Feb. 15, 2013).
\518\ Id. at 51.
\519\ Id. at 46.
\520\ Id. at 34.
---------------------------------------------------------------------------

The Commission believes that it is appropriate that Sec.
1.55(k)(5) requires an FCM to identify material risks and to explain
how such risks may be material to customers. The Commission further
believes, based upon its experiences during MFGI, that customers
(particularly retail and less sophisticated customers) would benefit
from an FCM providing its assessment of the risks of the firm,
accompanied by an explanation of such risks.
The Commission notes, in response to FIA's comments, that Sec.
1.55(k)(5) requires an FCM to provide information regarding its general
investments and is not limited to the investment of customer funds. The
disclosures contemplated by Sec. 1.55(k)(5) go to the full operation
of the FCM and not just its regulated or futures activities. In
addition, limiting the disclosures only to investments that result in
an increase in minimum capital requirements may result in the non-
disclosure of significant operations that may impact a customer's
decision to do business with an FCM.
The Commission also notes that the requirement in Sec. 1.55(k)(5)
for FCMs to disclose leverage information would be met by an FCM
providing the leverage information that each FCM is required to
calculate under Sec. 1.10 and in accordance with the regulations of
the NFA. An FCM should define the leverage calculation in the
Disclosure Document and may provide any other information necessary to
make the information meaningful for the public, but if materially
different from the then prevailing NFA methodology, should provide an
explanation of the differences therefrom.
Proposed Sec. 1.55(k)(6) requires an FCM to disclose the name of
its DSRO and the DSRO's Web site, and the location of where the FCM's
annual financial statements are available. The Commission received no
comments on proposed Sec. 1.55(k)(6) and is adopting the regulation as
proposed.
Proposed Sec. 1.55(k)(7) requires an FCM to disclose any material
administrative, civil, enforcement, or criminal action then pending,
and any enforcement actions taken in the last three years. FIA
requested that the Commission confirm that a ``pending'' action is an
action that has been filed but not concluded, and recommended the
Commission confirm that the disclosure required under this paragraph
would be limited to matters required to be disclosed in accordance with
Sec. 4.24(l)(2).\521\
---------------------------------------------------------------------------

\521\ Regulation 4.24(l)(2) requires a CPO to disclose in a
disclosure document for a commodity pool certain material
administrative, civil, or criminal actions against an FCM that the
CPO engages to trade futures.
---------------------------------------------------------------------------

The Commission agrees with FIA that the regulation should require
an FCM to disclose administrative, civil, enforcement, and criminal
actions that have been filed but not concluded. The proposal was not
intended to cover open or closed investigations that have not resulted
in the filing of a complaint. The Commission is revising Sec.
1.55(k)(7) as appropriate to reflect this concept.
The Commission, however, does not agree with FIA's comment that
disclosures under proposed Sec. 1.55(k)(7) should be limited to
administrative, civil, enforcement, or criminal matters that would be
required to be disclosed under Sec. 4.24(l)(2). Regulation 4.24(l)(2)
provides that an action will be deemed material if: (1) The action
would be required to be disclosed in the footnotes to a commodity
pool's financial statements under generally accepted accounting
principles as adopted in the U.S.; (2) the action was brought by the
Commission, provided that if the matter was concluded and did not
result in a civil monetary penalty in excess of $50,000, it does not
need to be disclosed; and (3) the action was brought by any other
federal or state regulatory agency, a non-U.S. regulatory agency, or an
SRO and involved allegations of fraud or other willful misconduct. The
Commission believes that the regulation's requirement to disclose
material actions is appropriate in the context of disclosures so that a
customer can perform adequate due diligence to assess the risk of
engaging an FCM to conduct futures business and in entrusting funds to
the FCM. In this regard, the Commission believes that FCMs should
disclose Commission disciplinary actions that are pending or have been
concluded against the FCM without regard to the amount of the civil
monetary penalty that may have been imposed. In addition, the
Commission believes that there may be circumstances in addition to
fraud or other willful misconduct that should be disclosed to customers
to allow customers to better appreciate the potential risks of entering
into a business relationship with an FCM.
Proposed Sec. 1.55(k)(8) requires the Firm Specific Disclosure
Document to contain a basic overview of customer fund segregation,
collateral management and investments, FCMs, and dual registrant FCM/
BDs. The disclosures included under Sec. 1.55(k)(8) should not only
include information regarding the segregation of funds for trading on
designated contract markets, but should also include information
regarding the risk to customers of engaging in foreign futures and
foreign options trading. In conjunction with Sec. 1.55(k)(4), which
requires an FCM to provide a profile of its customer business,
including its international business and clearinghouses and carrying
brokers used, an FCM in order to comply with Sec. 1.55(k)(8) should
disclose the risks of engaging in trading on foreign markets. The
disclosures required by Sec. 1.55(k)(8) should include information
that in the event of the insolvency of the FCM, or the insolvency of a
foreign broker or foreign depository that is holding customer funds,
customer funds held in foreign jurisdictions may be subject to a
different bankruptcy regime and legal system than if the funds were
held in the U.S. In addition, an FCM should disclose that a customer
also is subject to fellow customer risk in foreign jurisdictions and
that, for purposes of bankruptcy protection, a customer that trades
only in one country or in one market is also exposed to fellow customer
risk from losses that may be incurred in other countries and other
markets. The Commission did not receive comment on Sec. 1.55(k)(8) and
is adopting the amendments as proposed.
Proposed Sec. 1.55(k)(9) requires the FCM to include in the Firm
Specific Disclosure Document information on how a customer may obtain
information regarding filing a complaint with the Commission or the
firm's DSRO. The Commission did not receive comment on Sec. 1.55(k)(9)
and is adopting the amendments as proposed.
Proposed Sec. 1.55(k)(10) requires the Firm Specific Disclosure
Document to include the following financial information for the most
recent month end: (1) The FCM's total equity, regulatory capital, and
net worth, all computed in accordance with U.S. Generally Accepted
Accounting Principles and the Commission's capital rule, Sec. 1.17;
(2) the dollar value of the FCM's proprietary margin requirements as a
percentage of the aggregated margin requirements for futures customers,
Cleared Swaps Customers, and 30.7 customers; (3) the number of futures
customers, Cleared Swaps Customers, and 30.7 customers that comprise 50
percent of the funds held for such customers, respectively; (4) the
aggregate notional value, by asset class, of all non-hedged, principal
over-the-counter transactions into which the

[[Page 68568]]

FCM has entered; (5) the amount, generic source and purpose of any
unsecured lines of credit or similar short term funding the FCM has
obtained but not yet drawn upon; (6) the aggregated amount of financing
the FCM provides for customer transactions involving illiquid financial
products for which it is difficult to obtain timely and accurate
prices; and (7) the percentages of futures customers, Cleared Swaps
Customers, and 30.7 customers receivable balances that the FCM had to
write-off as uncollectable during the past 12 months, as compared to
the current balance held for such customers.
CMC generally supported proposed Sec. 1.55(k)(10), as it would
enhance transparency to the public.\522\ NFA provided a general comment
supporting the Commission's objective of providing customers with
meaningful information, but expressed concern that much of the
information proposed to be disclosed under Sec. 1.55(k)(10) may not be
understandable to smaller and less sophisticated customers.\523\ NFA
specifically questioned whether such customers would comprehend: (1)
The dollar value of the FCM's proprietary margin requirements as a
percentage of the aggregate margin requirements for futures customers,
Cleared Swaps Customers, and 30.7 customers; (2) the number of futures
customers, Cleared Swaps Customers, and 30.7 customers that comprise 50
percent of the funds held for such customers, respectively; (3) the
aggregate notional value, by asset class, of all non-hedged, principal
over-the-counter transactions into which the FCM has entered; (4) the
amount, generic source and purpose of any unsecured lines of credit or
similar short term funding the FCM has obtained but not yet drawn upon;
(5) the aggregate amount of financing the FCM provides for customer
transactions involving illiquid financial products for which it is
difficult to obtain timely and accurate prices; and (6) the percentages
of futures customers, Cleared Swaps Customers, and 30.7 customers
receivable balances that the FCM had to write-off as uncollectable
during the past 12 months, as compared to the current balance held for
such customers.\524\ NFA noted that as one of its responses to MFGI,
its Board of Directors formed a special committee on the protection of
customer funds (``Special Committee'') that was comprised of NFA's
public directors.\525\ NFA stated that the Special Committee spent a
significant amount of time reviewing information that FCMs should make
available to customers, while focusing on the needs of smaller, less
sophisticated customers, and concluded that much of the information in
Sec. 1.55(k)(10) is complicated and not meaningful for less
sophisticated customers.\526\ NFA also noted that more sophisticated
institutional customers could request and would likely receive this
information directly from an FCM.\527\
---------------------------------------------------------------------------

\522\ CMC Comment Letter at 2 (Feb. 15, 2013).
\523\ NFA Comment Letter at 15-16 (Feb. 15, 2013).
\524\ Id.
\525\ Id. at 1.
\526\ Id. at 16.
\527\ Id.
---------------------------------------------------------------------------

The Commission understands that not all customers would have the
same use for the detailed information required by Sec. 1.55(k)(10). In
developing the proposal, the Commission sought to balance the
information needs of all types of customers and their respective levels
of sophistication. While certain customers may not use the full amount
of information in assessing risks, the Commission anticipates that
other customers will incorporate all or most of the information into
their risk management process and will benefit from the disclosures in
performing their due diligence. The Commission also believes that the
information should be available to all customers without the need for
customers to specifically request the Sec. 1.55(k)(10) disclosures
from the FCM.
FIA agrees that customers should be advised whether an FCM engages
in proprietary futures trading but does not believe that FCMs should be
required to disclose the dollar value of their proprietary margin
requirements as a percentage of customer margin requirements as
proposed in Sec. 1.55(k)(10(ii) as such percentages will change
frequently.\528\ FIA also questions the implication that customers may
be at greater risk if an FCM carries proprietary futures positions
noting, for instances, that the FCM's funds to margin its proprietary
positions would be available to cover a potential customer
default.\529\ RJ Obrien, however, noted that it is important that
customers be aware of the nature and extent of a firm's proprietary
trading.\530\
---------------------------------------------------------------------------

\528\ FIA Comment Letter at 48 (Feb. 15, 2013).
\529\ Id.
\530\ RJ O'Brien Comment Letter at 11 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission believes that information regarding an FCM's
proprietary trading is necessary for customers to appropriately assess
the risks of entrusting their funds to an FCM. The risk profile of an
FCM is certainly different if it acts primarily as an agent in handling
customer funds, or if it acts as agent for customers and also engages
in proprietary trading. The Commission further believes that customers
would benefit from some measure of the FCM's proprietary trading rather
than a simple statement that the firm does or does not engage in
proprietary trading. The dollar value of the FCM's margin requirements
for its proprietary trading listed as a percentage of its customer
margin requirements provides a means of measuring how active and
extensive a firm's proprietary trading may be relative to its customer
business, which will factor into the public's risk profile of the firm.
FIA requested confirmation that the requirement in Sec.
1.55(k)(10)(iii) for an FCM to disclose the number of futures
customers, cleared swap customers, and 30.7 customers that comprise 50
percent of the FCM's total funds held for such customers, respectively,
should be based upon the smallest number of customers that comprise the
50 percent threshold.\531\ The Commission confirms that FIA's
assumption is correct and is revising the final regulation accordingly.
A purpose of the disclosure is to provide information on the extent to
which a firm may have customers with large positions relative to the
FCM's general customer base.
---------------------------------------------------------------------------

\531\ FIA Comment Letter at 46-47 (Feb. 15, 2013).
---------------------------------------------------------------------------

FIA stated that the requirement in Sec. 1.55(k)(10)(iv) for an FCM
to disclose the aggregate notional value, by asset class, of its non-
hedged, principal over-the-counter transactions would require the FCM
to disclose proprietary information. In addition, FIA stated that
providing such information is not practical as firms generally do not
manage their books this way and the categorization of a swap
transaction as being hedged or not hedged would change each day.
The objective of Sec. 1.55(k)(10)(iv) is for an FCM to disclose
the extent of the risk it is exposed to from over-the-counter
transactions that are not hedged or for which the FCM does not hold
margin from the counterparty sufficient to cover the exposure. While
the Commission recognizes that such information may change frequently,
Sec. 1.55 only requires an FCM to update the information on an annual
basis, or more frequently if the changes are material. The information
also is in the aggregate, which should minimize the risk of disclosing
detailed proprietary information. After considering the comments, the
Commission is adopting the regulation as proposed.
FIA stated that the Commission should distinguish between committed

[[Page 68569]]

and uncommitted lines of credit in the requirement in Sec.
1.55(k)(10)(v), which requires an FCM to disclose the amount, generic
source and purpose of any unsecured lines of credit it has obtained but
not yet drawn upon.\532\ The Commission agrees that it would be more
appropriate to disclose committed lines of credit and to exclude lines
of credit that could be withdrawn by the potential lender. The
Commission is revising the final regulation to reflect this change. In
addition, the Commission is clarifying that the provision in Sec.
1.55(k)(10)(v) that requires the disclosure of the amount, source and
purpose of any unsecured lines of credit or similar short-term funding
would include secured and unsecured short-term funding.
---------------------------------------------------------------------------

\532\ Id.
---------------------------------------------------------------------------

Regulation 1.55(k)(10)(vi) requires an FCM to disclose the
aggregated amount of financing the FCM provides for customer
transactions involving illiquid financial products for which it is
difficult to obtain timely and accurate prices. FIA requested that the
Commission define the type of financing covered by the regulation, and
also requested that the Commission define the term ``illiquid financial
products'' and confirm whether the information should include secured
as well as unsecured financing.\533\
---------------------------------------------------------------------------

\533\ Id.
---------------------------------------------------------------------------

The Commission notes that the purpose of the disclosure is to
provide the public with information regarding the possible extent of
exposures an FCM may have if customers failed to meet their financial
obligations to the FCM. The Commission is adopting the requirement as
proposed. FCMs are required to provide the necessary information in the
Disclosure Document, and may explain the factors it uses to determine
if a financial product is liquid or illiquid and the extent to which
transactions are secured or unsecured.
Regulation 1.55(k)(10)(vii) requires an FCM to disclose the
percentage of futures customer, Cleared Swaps Customer, and 30.7
customer receivable balances that the FCM had to write-off as
uncollectable during the past 12 months, as compared to the current
balances of funds held for such customers.
Newedge and RJ O'Brien commented that providing this information
would provide customers with valuable insight into the strength of an
FCM's credit policies, which benefits all customers.\534\ FIA, however,
commented that it did not recognize the relevance of the requested
information, which may be misleading without the proper context (such
as whether the losses were caused by one or two large customers or an
aggregate of small customers).\535\ FIA further stated that if the
Commission were to adopt the rule, normal business write-offs should be
excluded, and the Commission should establish a de minimis threshold
were reporting would not be required.
---------------------------------------------------------------------------

\534\ Newedge Comment Letter at 4 (Feb. 15, 2013); RJ O'Brien
Comment Letter at 11 (Feb. 15, 2013).
\535\ FIA Comment Letter at 50 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission has considered the comments and is adopting the
regulation as proposed. The Commission believes that the disclosure of
the amount of write-offs an FCM had to incur as a result of customers
failing to pay receivable balances will provide information regarding
the credit policies of the FCM. The Commission does not believe that
there should be any de minimis level or threshold amount before the
disclosure of the information becomes a requirement. In response to
FIA's comments that the information may be misleading if not provided
in context, the Commission notes that FCMs may include explanatory text
in the Disclosure Document provided such information is not misleading.
Finally, proposed Sec. 1.55(k)(11) requires a summary of the FCM's
current risk practices, controls and procedures. FIA asked for
confirmation that the discussion of the FCM's current risk practices,
controls and procedures may be general in nature, noting that the
Commission has recognized that an FCM's risk practices, controls and
procedures may include proprietary information.\536\ The Commission
confirms that the discussion of the current risk practices, controls
and procedures may be general in nature so that it does not disclose
confidential proprietary information.
---------------------------------------------------------------------------

\536\ FIA Comment Letter at 50 (Feb. 15, 2013).
---------------------------------------------------------------------------

2. Public Availability of FCM Financial Information
Proposed Sec. 1.55(o) requires each FCM to make the following
information available to the public on its Web site: (1) The daily
Segregation Schedule, Secured Amount Schedule, and the Cleared Swaps
Segregation Schedule for the most current 12-month period; (2) a
summary schedule of the FCM's adjusted net capital, net capital, and
excess net capital, all computed in accordance with Sec. 1.17 and
reflecting balances as of the month-end for the 12 most recent months;
and, (3) the Statement of Financial Condition, the Segregation
Schedule, Secured Amount Schedule, and Cleared Swaps Segregation
Schedule and all related footnotes contained in the FCM's most recent
certified annual financial report. Regulation 1.55(o) also requires
each FCM to include a statement on its Web site that additional
financial information on the firm and other FCMs may be obtained from
the NFA and the Commission, and to include hyperlinks to the NFA and
Commission Web sites.
MFA, SIFMA, Prudential, Security Benefit, CoBank, and the FHLBs
supported the requirement for FCMs to post their daily Segregation
Schedule, Secured Amount Schedule, and Cleared Swaps Segregation
Schedule on their Web site each day, stating that the disclosure of
such information would place customers in a better position to assess
an FCM's stability, and if customers identify concerns and deem
appropriate, to transfer their positions and funds to a different
FCM.\537\ MFA, SIFMA, Prudential, Security Benefit, CoBank, and the
FHLBs also stated that the Commission should require FCMs to disclose
additional information, including the FCM's monthly Segregation
Schedule, Secured Amount Schedule, and Cleared Swaps Segregation
Schedule, and monthly summary balance sheet and income statement
information, for the most recent 12-month period.\538\ MFA noted that
each FCM's monthly Segregation Schedule, Secured Amount Schedule, and
Cleared Swaps Segregation Schedule are publicly available under Sec.
1.10, and suggested that each FCM should be required to disclose the
schedules to the public without the public having to request such
statements from the firms as is currently required under Sec.
1.10.\539\
---------------------------------------------------------------------------

\537\ MFA Comment Letter at 4 (Feb. 15, 2013); SIFMA Comment
Letter at 2 (Feb. 21, 2013); Prudential Comment Letter at 2 (Jun. 9,
2013); Security Benefit Comment Letter at 2 (Jan. 11, 2013); CoBank
Comment Letter at 2 (Jan. 14, 2013); FHLB Comment Letter at 7 (Feb.
15, 2013).
\538\ Id. See also The Commercial Energy Working Group Comment
Letter at 2-3 (Feb. 12, 2013).
\539\ MFA Comment Letter at 4-6 (Feb. 15, 2013); SIFMA Comment
Letter at 2 (Feb. 21, 2013).
---------------------------------------------------------------------------

The ACLI encouraged the Commission to make public as much
information as possible regarding FCMs' financial condition, treatment
of customer funds, and regulatory compliance.\540\ The ACLI also noted
that access to these categories of information should be
straightforward and simple.\541\ TIAA-CREF supported the proposed
enhanced financial disclosures and encouraged the Commission to require
the prompt public disclosure of relevant FCM

[[Page 68570]]

information.\542\ TIAA-CREF stated that such disclosures would be a
positive step towards ensuring a level playing field between each FCM
and its customers and among FCMs themselves, and supported the
Commission's efforts to require FCMs to disclose information regarding
the FCM's segregation of customer property (e.g., the Cleared Swaps
Segregation Schedule), financial health and creditworthiness and would
also support efforts by the Commission to cause such disclosures to be
posted on the relevant FCM's Web site, in lieu of requiring customers
to make a request to the Commission to receive such information (which
may be administratively burdensome).\543\
---------------------------------------------------------------------------

\540\ ACLI Comment Letter at 2-3 (Feb. 15, 2013).
\541\ Id.
\542\ ACLI Comment Letter at 2-3 (Feb. 15, 2013).
\543\ TIAA-CREF Comment Letter at 2-3 (Feb. 15, 2013).
---------------------------------------------------------------------------

FXCM noted that currently the Commission's monthly ``net capital''
reports is the only publicly available way to determine how much money
an FCM or RFED has set aside for net capital, but this provides very
little insight into how the firm is doing financially.\544\ FXCM stated
that FCMs and RFEDs should be required to publish quarterly
consolidated balance sheets and income statements, including holding
company financials, for the trading public so they will know the level
of risk involved in dealing with a firm.\545\
---------------------------------------------------------------------------

\544\ FXCM Comment Letter at 2-3 (Dec. 14, 2013).
\545\ Id. See also forex form letter group: Michael Krall; David
Kennedy; Robert Smith; Michael Carmichael; Andrew Jackson; Donald
Blais; Suzanne Slade; Patricia Horter; JoDan Traders; Jeff Schlink;
Sam Jelovich; Matthew Bauman; Mark Phillips; Deborah Stone; Po
Huang; Aaryn Krall; Vael Asset Management; Kos Capital; James Lowe;
Tracy Burns; Treasure Island Coins; Clare Colreavy, Brandon
Shoemaker.
---------------------------------------------------------------------------

FIA stated that the daily segregation, secured amount, and cleared
swaps customer account calculations should not be made publicly
available. FIA noted that NFA currently makes this information
available on its Web site as of the 15th and last business day of each
month and believes disclosure twice each month should be sufficient. If
the Commission concludes more frequent disclosure is necessary, FIA
recommended that disclosure should be required no more often than
weekly, i.e., as of the close of business each Friday (or the last
business day of the week if Friday is a holiday).
Phillip Futures Inc. proposed that the Commission limit the
financial data made public to that which is most appropriate for the
average customer to make an educated decision regarding his choice of
broker.\546\ It further stated that rather than making the financial
information public, it should only be provided to customers at their
request.\547\
---------------------------------------------------------------------------

\546\ Phillip Futures Inc. Comment Letter at 3 (Feb. 14, 2013).
\547\ Id.
---------------------------------------------------------------------------

RCG stated that if the Commission makes the Segregation Schedule,
Secured Amount Schedule, and Cleared Swaps Segregation Schedule public,
the public will only see a targeted residual interest amount, without
realizing and comprehending the many factors that have impacted a
particular firm's determination of its target.\548\
---------------------------------------------------------------------------

\548\ RCG Comment Letter at 6 (Feb. 12, 2013).
---------------------------------------------------------------------------

TD Ameritrade expressed its concern regarding the public disclosure
of the firm's targeted residual interest computation.\549\ TD
Ameritrade stated that the public would not be privy to any of the
internal discussions and analysis that goes into the development and
setting of the firm's targeted residual interest, and that any changes
to its target could cause market upheaval, volatility, and unintended
consequences.\550\
---------------------------------------------------------------------------

\549\ TD Ameritrade Comment Letter at 4 (Feb. 15, 2013).
\550\ Id.
---------------------------------------------------------------------------

The Commission has considered the comments and is adopting the
regulations as proposed, with the revision to Sec. 1.55(o) to require
each FCM to disclose on its Web site its monthly Segregation Schedule,
Secured Amount Schedule, and Cleared Swaps Segregation Schedule for the
12 most recent month-end dates.
The Commission currently discloses FCM financial data on its Web
site. Specifically, Sec. 1.10(g) provides that the Form 1-FR-FCM (or
FOCUS Report) is exempt from mandatory public disclosure under the
Freedom of Information Act and the Government in the Sunshine Act,
except for the following information: (1) The amount of the FCM's
adjusted net capital under Sec. 1.17 as of the reporting date, the
amount of adjusted net capital maintained by the firm on the reporting
date, and the amount of excess net capital on the reporting date; (2)
the Segregation Schedule and Secured Amount Schedule as of the
reporting date; and (3) the Statement of Financial Condition in the
certified annual report and related footnote disclosures. The
Commission summarizes the FCM's segregation, secured amount and capital
information each month and makes such information available to the
public on its Web site.
The Commission believes that customers should have access to
sufficient financial information for each FCM to allow such customers
to adequately assess and monitor the financial condition of firms. The
disclosure of the daily segregation and secured amount computations
will provide customers with additional information to assess the
adequacy of an FCM's targeted residual interest given the firm's
business operations and amount of customer funds held in segregated or
secured accounts. The Commission also believes that the expanded
disclosures required under Sec. 1.55 offer each FCM with the ability
to provide an explanation describing the rationale and business
justification for its computation of the target residual interest to
better inform the public. The reporting of segregated and secured
account balances on a daily basis also will provide customers with
information regarding any trends developing with particular reported
balances that the customers may wish to consider as part of their risk
assessment of the FCMs.
The Commission further believes that customers should have access
to an FCM's financial information by reviewing such information
directly on the FCM's Web site as part of the Firm Specific
Disclosures. By reviewing the Firm Specific Disclosures and having
access to financial data of the FCM, customers will be able to better
assess the risks of engaging a particular FCM. The Commission also
believes that customers would benefit from being informed that
additional financial information on each FCM is available from the NFA
and Commission, and by requiring the FCMs to maintain a hyperlink to
the Commission's and NFA's Web sites. NFA and Commission data provide
historical information that allows customers to assess financial trends
on a customer-by-customer basis, and provides sufficient financial
information such that customers can compare financial data across FCMs
as part of their risk management program. The NFA also discloses
additional information regarding how FCMs are holding customer funds
and investing customer funds under Sec. 1.25, which is material
information for customers in assessing risk at particular FCMs.
Regulation 1.10(g) currently requires a customer to request from
the FCM monthly Segregation Schedules and Secured Amount Schedules, as
well as the Statement of Financial Condition contained in the FCM's
certified annual report. In response to several of the comments, the
Commission is revising Sec. 1.55(o) to require each FCM to post such
financial information on its Web site. The Commission agrees with the
commenters that FCMs should disclose this information, which is
currently

[[Page 68571]]

publicly available under Sec. 1.10(g), without requiring each customer
or member of the public having to specifically request such information
from the FCM.
The Commission is not expanding the required disclosures to include
summary income statement information or balance sheet information as
requested by several commenters. As noted above, Sec. 1.10(g)
currently provides that the Form 1-FR-FCM and FOCUS Reports are not
subject to mandatory public disclosure under the Freedom of Information
Act or the Government in the Sunshine Act, and the Commission did not
propose to amend Sec. 1.10(g) in the Proposal. In addition, the
comments addressing quarterly financial statements and consolidated
financial statements for FCMs and RFEDs are beyond the scope of the
Proposal as the Commission did not propose to amend the regulations to
require an FCM or RFED to prepare or file with the Commission quarterly
financial statements on either an individual or consolidated basis.
Accordingly, the Commission is not revising final Sec. 1.55(o) to
require such disclosures.

Q. Part 22--Cleared Swaps

As discussed above, the Commission adopted final regulations in
part 22 that implement certain provisions of the Dodd Frank Act and
impose requirements on FCMs and DCOs regarding the treatment of Cleared
Swaps Customer contracts (and related collateral).\551\ Although
substantive differences in the segregation regimes between futures and
cleared swaps exist at the clearing level under the final part 22
regulations, requirements with respect to collateral which is not
posted to clearinghouses and maintained by FCMs for Cleared Swaps
Customers replicate or incorporate by reference many of the same
regulatory requirements applicable to the segregation of futures
customer funds under section 4d(a)(2) of the Act and Commission
regulations (for example, holding funds separate and apart from
proprietary funds, limitations on the FCM's use of customer funds,
titling of depository accounts, Acknowledgment Letter from depository
requirements, and limitations on investment of swap customers' funds,
are currently contained in both part 1 and part 22 regulations).
---------------------------------------------------------------------------

\551\ See discussion in section I.A. above.
---------------------------------------------------------------------------

The determination that appropriate enhancements are necessary with
respect to the regulatory requirements discussed above for segregated
futures customer funds under section 4d(a)(2) of the Act is equally
applicable to Cleared Swaps Customer Collateral. In this regard, the
risk management program that each FCM that holds customer funds is
required to implement under Sec. 1.11 encompasses the firm's business
with futures customers, Cleared Swaps Customers, and 30.7 customers.
In addition, the Commission proposed amendments to Sec. 22.2(d)(1)
and (f)(6) that require an FCM to maintain at all times sufficient
residual interest in Cleared Swaps Customer Accounts to exceed the sum
of the margin deficits (i.e., undermargined amounts) of all of its
Cleared Swaps Customers. The proposed amendments to Sec. 22.2(e)(1)
that explicitly provide that an FCM shall bear sole responsibility for
any losses resulting from the investment of Cleared Swaps Customer
Funds in Sec. 1.25 compliant instruments is consistent with the
amendments adopted for Sec. 1.29(b) that require an FCM to bear sole
responsibility for any losses resulting from the investment of futures
customers funds in Sec. 1.25 compliant instruments. The proposed
amendments to Sec. 22.2(f)(4) provide that an FCM must be in
compliance at all times with its segregation requirements for Cleared
Swaps Customers is consistent with amendments adopted in Sec. 1.20(a)
that require an FCM to be in compliance at all times with its
segregation requirements for futures customers. The proposed amendments
in Sec. 22.2(f)(5)(iii)(B) permit an FCM to develop its own program to
assess credit risk for purposes of computing haircuts on securities
securing a Cleared Swaps Customer's deficit account is consistent with
the amendments adopted in 1.32 for computing haircuts on securities
securing a futures customer's deficit account. The proposed amendments
to Sec. 22.2(g)(2), (3), and (5) require an FCM to prepare and submit
to the Commission and the FCM's DSRO a daily Cleared Swap Segregation
Schedule and twice monthly listing of the holding of Cleared Swaps
Customer funds is consistent with the amendments adopted to Sec. 1.32
that require an FCM to prepare and submit to the Commission and the
FCM's DSRO a daily Segregation Schedule and twice monthly listing of
the holding of futures customer funds.
Comments on the substantive provisions being adopted by the
Commission under part 22 have been considered and addressed in large
part in the discussion of the related substantive provisions in part 1
with respect to futures customer segregated funds. The Commission has
considered those comments and, with the exception of the proposed
amendments to Sec. 22.2(a) and (f)(6), is adopting the amendments to
part 22 as proposed.
In addition, several commenters, including MFA, CIEBA and Franklin
urged the Commission to adopt a full physical segregation option
specific for Cleared Swaps Customer Collateral.\552\ This comment is
outside of the scope of the proposal. The Commission, however, has
previously clarified the ability of FCMs to employ third party
custodial accounts for Cleared Swaps Customer Collateral, while
reiterating that as customer property, in the event of an FCM
insolvency, any funds held in such a third party custodial account
would be subject to pro-rata distribution along with all other customer
property.\553\ Commission staff is also continuing to explore
alternative collateral custody arrangements as directed by the
Commission.\554\
---------------------------------------------------------------------------

\552\ MFA Comment Letter at 9 (Feb. 15, 2013); CIEBA Comment
Letter at 3-4 (Feb. 20, 2013); Franklin Comment Letter at 2 (Feb.
15, 2013).
\553\ 77 FR 6336, 6343.
\554\ Id. at 6343-6344.
---------------------------------------------------------------------------

As discussed in more detail above, several commenters objected to
proposed residual interest requirements under Sec. Sec. 1.20(i) and
22.2(f).\555\ Of those commenters, a number focused on the proposed
residual interest requirements for Cleared Swaps and highlighted the
inconsistency of the ``at all times'' requirement with the Commission's
analysis in the part 22 final rules.\556\ LCH.Clearnet, ISDA, Paul/
Weiss, and other commenters specifically stated that the inclusion of
the language ``at all times'' is inconsistent with the LSOC requirement
to calculate such deficits at the time of a margin call by a DCO to its
clearing FCMs, and with the requirement to have sufficient residual
interest to cover such deficit by the time the clearing FCMs are
required to meet such payment obligations.\557\ These commenters argued
that when the Commission adopted the part 22 final rules, it considered
this point in time

[[Page 68572]]

approach to be consistent with the Act and sufficient to ensure that
the collateral of one Cleared Swaps Customer is never used to margin
the positions of another customer.\558\
---------------------------------------------------------------------------

\555\ See section II.G.9. above.
\556\ See LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013);
FIA Comment Letter at 22-23 (Feb. 15, 2013).
\557\ See, e.g., LCH.Clearnet Comment Letter at 4-5 (Jan. 25,
2013); Paul/Weiss Comment Letter at 3-5 (Feb. 15, 2013); ISDA
Comment Letter at 2-3 (Feb. 15, 2013). ISDA further argued that
variation margin payments are not ``used'' until the point of
settlement. See ISDA Comment Letter at 1-2 (Aug. 27, 2013) (citing
CFTC Letter No. 12-31, ``Staff Interpretation Regarding Part 22,''
(November 1, 2012) (``Part 22 Staff Interpretation'') and arguing
that the use restriction set forth in 4d(f)(2)(B) of the CEA ``is
driven by the meaning of `property . . . received' '' and that
```received' in this context cannot be intended to include variation
margin fluctuations pre-settlement because it is only upon
settlement that an item of property will have been received by the
FCM.'').
\558\ See LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013);
FIA Comment Letter at 22-23 (Feb. 15, 2013); ISDA Comment Letter at
2-3 (Feb. 15, 2013).
---------------------------------------------------------------------------

In response to these comments, the Commission notes that the
proposed amendments to Sec. 22.2(a) and (f)(6) were meant to capture
the current practice with respect to residual interest buffer
calculations for Cleared Swaps using language that was consistent with
the Proposed Residual Interest Requirement for futures. In other words,
the Commission did not intend to alter the current residual interest
requirements, as set forth in the part 22 final rules.\559\ Indeed, the
Commission notes that Staff guidance from November 1, 2012, states that
``FCMs are prohibited from `us[ing] or permit[ing] the use of, the
Cleared Swaps Customer Collateral of one Cleared Swaps Customer to
purchase, margin, or settle the Cleared Swaps or any other trade or
contract of, or to secure or extend the credit of, any person other
than such Cleared Swaps Customer.' Where a Cleared Swaps Customer is
undermargined, then the FCM must ensure that, to the extent of such
shortfall, its own money, securities, or other property--and not that
of other Cleared Swaps Customers--is used to cover a margin call
(whether initial or variation) attributable to that Cleared Swaps
Customer's portfolio of rights and obligations.'' \560\
---------------------------------------------------------------------------

\559\ See also Part 22 Staff Interpretation.
\560\ See id. at 2 (answer to Question 2.1).
---------------------------------------------------------------------------

Because of the confusion expressed by commenters regarding the
residual interest requirements for Cleared Swaps, the Commission is
revising Sec. 22.2(a) and (f). The Commission is revising proposed
Sec. 22.2(a) by deleting the last sentence. The Commission is revising
Sec. 22.2(f)(6) by replacing the language from the proposal with new
language which sets forth the residual interest requirements for
Cleared Swaps in a manner that is consistent with current market
practice and that parallels the language used in Sec. 1.22. To be
clear, and as requested by several commenters, the Commission confirms
that the language in Sec. 22.2(f)(6) is not intended to, and thus
should not be read to, change current practice with respect to an FCM's
residual interest requirements for Cleared Swaps as set forth in
Commission regulations and JAC Update 12-03, and consistent with Staff
Interpretation 12-31. Thus, ``where a Cleared Swaps Customer is
undermargined,\561\ the FCM must ensure that, to the extent of such
shortfall, its own money, securities, or other property--and not that
of other Cleared Swaps Customers--is used to cover a margin call
(whether initial or variation) attributable to that Cleared Swaps
Customer's portfolio of rights and obligations.'' \562\ Consistent with
this revised residual interest requirement, Sec. 22.2(f)(4) is being
amended to state that the amount of funds an FCM is holding in
segregation may not be reduced by any debit balances that the futures
customers of the futures commission merchants have in their accounts.
Finally, Sec. 22.2(f)(2) is being revised, consistent with 1.20(i)(2)
and current market practice, to clarify that the calculation set forth
therein is the Net Liquidating Equity Method.
---------------------------------------------------------------------------

\561\ In this context, a Cleared Swaps Customer is undermargined
to the extent that (a) the minimum margin requirement, attributable
to that Cleared Swaps Customer's portfolio of rights and
obligations, at the DCO (for an FCM that is clearing such Cleared
Swaps Customer's positions directly) or at the Collecting FCM (for a
Depositing FCM) exceeds (b) the customer's net liquidating value,
including securities posted at margin value.
\562\ See Part 22 Staff Interpretation at 2.
---------------------------------------------------------------------------

R. Amendments to Sec. 1.3: Definitions; and Sec. 30.7: Treatment of
Foreign Futures or Foreign Options Secured Amount

Part 30 of the Commission's regulations was adopted in 1987 and
governs the offer and sale in the U.S. of futures contracts and options
traded on or subject to the rules of a foreign board of trade.\563\ The
Commission proposed to amend several regulations in part 30 to provide
a more coordinated approach to the regulations governing the offer and
sales of futures contracts traded on foreign boards of trade and the
comparable regulations governing the offer and sale of futures
contracts traded on designated contract markets. Aligning the
regulations, including regulations governing how an FCM holds funds for
customers trading on non-U.S. markets with the requirements for
customers trading on U.S. markets, will greatly enhance the protection
of customer funds, and avoid competitive imbalances between trading on
domestic and foreign contract markets that might result in regulatory
arbitrage. The Commission's Proposal, along with the comments received,
is discussed in the sections below.
---------------------------------------------------------------------------

\563\ 52 FR 28980 (Aug. 5, 1987).
---------------------------------------------------------------------------

1. Elimination of the ``Alternative Method'' for Calculating the
Secured Amount
Regulation 30.7(a) requires an FCM to set aside in separate
accounts for the benefit of its ``foreign futures or foreign options
customers'' an amount of funds defined as the ``foreign futures or
foreign options secured amount.'' The term ``foreign futures or foreign
options customer'' is defined in Sec. 30.1 as any person located in
the U.S., its territories, or possessions who trades in foreign futures
or foreign options. The term ``foreign futures or foreign options
secured amount'' is defined in Sec. 1.3(rr) as the amount of funds
necessary to margin the foreign futures or foreign options positions
held by the FCM for its foreign futures or foreign options customers,
plus or minus any gains or losses on such open positions. The
calculation of the foreign futures or foreign options secured amount as
defined in Sec. 1.3(rr) is referred to as the ``Alternative Method.''
Requirements concerning the collateral of foreign futures or
foreign options customers are substantially less robust for funds
deposited with an FCM under the Alternative Method than requirements
concerning the collateral of futures customers deposited with an FCM
under section 4d(a)(2) of the Act or Cleared Swaps Customer Funds
deposited under section 4d(f) of the Act. Section 4d(a)(2) of the Act
and Sec. Sec. 1.20 and 1.22 require an FCM to hold in accounts
segregated for the benefit of futures customers a sufficient amount of
funds to satisfy the full account equities of all of the FCM's futures
customers trading on designated contract markets.\564\ Section 4d(f)
and Sec. 22.2 require an FCM to segregate for the benefit of Cleared
Swaps Customers a sufficient amount of funds to satisfy the full
account equities of all of the FCM's Cleared Swaps Customers. The
calculations required under sections 4d(a)(2) and 4d(f) of the Act are
referred to as the ``Net Liquidating Equity Method.''
---------------------------------------------------------------------------

\564\ The Commission is also adopting as final amendments to
Sec. 1.20(a) that clarify and provide explicitly that an FCM is
required to hold funds in segregated accounts in an amount at all
times in excess of its total obligations to all futures customers.
See section II.G.9. above for a discussion of the amendments to
Sec. 1.20.
---------------------------------------------------------------------------

The Alternative Method contrasts with the Net Liquidating Equity
Method in that the Alternative Method obligates an FCM to set aside in
separate accounts for the benefit of its customers an amount of funds
sufficient to cover only the margin required on open foreign futures
and foreign option positions, plus or minus any unrealized gains or
losses on such positions. Any funds deposited by foreign futures or
foreign options customers in excess of the amount required to be set
aside in separate accounts may be held by the

[[Page 68573]]

FCM in operating cash accounts and may be used by the FCM as if it were
its own capital. Since an FCM is not required under the Alternative
Method to set aside in separate accounts an amount of funds sufficient
to repay the full account balances of each of its foreign futures or
foreign options customers, the FCM may not be in a financial position
to return 100 percent of the account equities (or transfer such account
equities to another FCM) of each foreign futures or foreign options
customer in the event of the insolvency of the FCM.
In addition Sec. 30.7 further differs from the regulations
governing how FCMs hold funds for futures customers and Cleared Swap
Customers in that Sec. 30.7 requires an FCM to set aside in a separate
account funds only for ``foreign futures or foreign options
customers.'' As previously stated, the term ``foreign futures or
foreign options customer'' is defined in Sec. 30.1 as any person
located in the U.S., its territories, or possessions who trades in
foreign futures or foreign options. Thus, an FCM is not required to set
aside in separate accounts funds for foreign-domiciled customers
trading on foreign futures markets. Regulation 30.7 permits an FCM to
set aside funds for foreign futures customers located outside of the
U.S., but an FCM is not obligated under the regulations to do so.
Requiring FCMs to include foreign-domiciled customers' funds in
segregated accounts benefits all customers placing funds on deposit for
use in trading foreign futures and foreign options. Neither Subchapter
IV of Chapter 7 of the Bankruptcy Code nor the Commission's part 190
regulations discriminate between foreign-domiciled and domestic-
domiciled customers. Thus, any deficiency arising from the reduced
requirements will impact both foreign and domestic customers pro rata.
The Commission proposed various amendments to the part 30
regulations to eliminate the Alternative Method and to require FCMs to
use the Net Liquidating Equity Method to compute the amount of funds
they must set aside in separate accounts for the benefit of foreign
futures or foreign options customers. The Commission also proposed to
extend the protections of part 30 to foreign-domiciled customers
trading on foreign markets through an FCM. The intent of the proposed
amendments is to provide 30.7 customers with equivalent protections
available to futures customers and Cleared Swaps Customers by requiring
each FCM to hold in secured accounts sufficient funds to cover the full
Net Liquidating Equity of each customer trading on foreign futures
markets.
To implement these revisions, the Commission proposed to define the
term ``30.7 customer'' in Sec. 30.1 to mean any person, whether
domiciled within or outside of the U.S., that engages in foreign
futures or foreign options transactions through the FCM. The Commission
also proposed to amend Sec. 1.3(rr) to match structurally the
definition of the term ``customer funds'' in Sec. 1.3(gg) \565\ and to
define the term ``foreign futures or foreign options secured amount''
to mean ``all money, securities and property received by an FCM for, or
on behalf of, ``30.7 customers'' to margin, guarantee, or secure
foreign futures and foreign options transactions, and all funds
accruing to ``30.7 customers'' as a result of such foreign futures and
foreign options transactions.'' The effect of the proposed amendments
is to adopt the Net Liquidating Equity Method for foreign futures and
foreign options by requiring an FCM to set aside in separate accounts a
sufficient amount of funds to cover the full account balances (i.e.,
the Net Liquidating Equities) of both the U.S. and foreign-domiciled
customers.
---------------------------------------------------------------------------

\565\ The Commission recently adopted final regulations that
revised the definitions in Sec. 1.3. In this rulemaking, Sec.
1.3(gg) was renumbered as 1.3(jjj) and re-designated ``futures
customer funds.'' The substance of the definition, however, was not
revised and the final rulemaking has no impact on the analysis in
this rulemaking. See 77 FR 66288 (Nov. 2, 2012).
---------------------------------------------------------------------------

The Commission also proposed to amend Sec. 30.7(a) to allow an FCM
to use an internal credit risk model to compute the appropriate market
deductions, or haircuts, on readily marketable securities deposited by
customers that have account deficits. The proposal is consistent with
the proposed amendments for computing haircuts on securities under
Sec. 1.32(b) in section II.N. above. The result of these amendments as
discussed should be consistency between the methodologies applied in
the 4d segregation calculation and the Sec. 30.7 calculation.
Consistent with proposed changes in Sec. 1.20(i) and part 22, the
Commission also proposed to add language to Sec. 30.7(a) to provide
that an FCM must hold residual interest in accounts set aside for the
benefit of 30.7 customers equal to the sum of all margin deficits
(i.e., undermargined amounts) for such accounts, to provide an
equivalent clear mechanism for ensuring that the funds of one 30.7
customer are not margining or guaranteeing the positions of another
30.7 customer
With the exception of the residual interest proposal, the
Commission did not receive any comments on the various proposed
amendments discussed above, including its proposal to eliminate the
``Alternative Method'' and to require FCMs to use the ``Net Liquidating
Equity Method'' to compute the amount of funds they must set aside in
separate accounts for the benefit of its foreign futures or foreign
options customers. Accordingly, the amendments referred to above, with
the exception of the residual interest proposal as discussed further
below, are being adopted by the Commission.\566\
---------------------------------------------------------------------------

\566\ See section II.R.4. below for a discussion of the residual
interest proposal. CFA stated that it generally supported the
proposed amendments to Sec. 30.7 and treating customers from all
parts of the globe in a similar manner. CFA Comment Letter at 9
(Feb. 13, 2013).
---------------------------------------------------------------------------

2. Funds Held in Non-U.S. Depositories
The Commission proposed to amend Sec. 30.7(c) to limit the amount
of 30.7 customers' funds that an FCM could hold in non-U.S.
jurisdictions. Under the proposal, an FCM must hold 30.7 customer funds
in the U.S., except to the extent that the funds held outside of the
U.S. are necessary to margin, guarantee, or secure (including any
prefunding obligations) the foreign futures or foreign options
positions of an FCM's 30.7 customers. The proposal further allowed an
FCM to deposit additional 30.7 customer funds outside of the U.S. up to
a maximum of 10 percent of the total amount of funds required to be
held by non-U.S. brokers or foreign clearing organizations for 30.7
customers as a cushion to meet anticipated margin requirements. The
proposal also provided that the FCM must hold 30.7 customer funds under
the laws and regulations of the foreign jurisdiction that provide the
greatest degree of protection to such funds; and that the FCM may not
by contract or otherwise waive any of the protections afforded customer
funds under the laws of the foreign jurisdiction.
Several comments were received on the proposal. Pilot Flying J
supported the requirement that 30.7 customer funds, if held outside of
the U.S., must be held under the laws of the foreign jurisdiction that
provides the funds with the greatest degree of protection.\567\
---------------------------------------------------------------------------

\567\ Pilot Flying J Comment Letter at 2 (Feb. 14, 2013).
---------------------------------------------------------------------------

FIA and Jefferies each recommended that an FCM be permitted to
maintain an excess of up to 50 percent of the amount an FCM is required
to deposit with a foreign broker to maintain customer foreign futures
and foreign options positions, a position that they

[[Page 68574]]

stated is consistent with Sec. 1.17 that requires an FCM to incur a
capital charge for unsecured receivables due from a foreign broker
greater than 150 percent of the amount required to maintain positions
in accounts with the foreign broker.\568\ FIA recommended that, at a
minimum, a cushion of 20 percent should be provided.\569\ FIA stated
that the proposal is more restrictive than the provisions of Sec.
1.49, which set out the terms and conditions pursuant to which an FCM
may hold futures customers' segregated funds and Cleared Swaps
Collateral outside of the U.S. and suggested that the proposal be
revised to permit an FCM to hold funds comprising the foreign futures
and foreign options secured amount in depositories outside of the U.S.
to the same extent that an FCM may hold futures customer segregated
funds and Cleared Swaps Collateral outside of the U.S.\570\ They
further recommended that the ``10% limitation'' apply only to funds
deposited with a foreign broker or foreign clearing organization.\571\
---------------------------------------------------------------------------

\568\ FIA Comment Letter at 37 (Feb. 15, 2013); Jefferies Bache
Comment Letter at 6 (Feb. 15, 2013).
\569\ FIA Comment Letter at 37 (Feb. 15, 2013).
\570\ Id. See also RJ O'Brien Comment Letter at 11 (Feb.15,
2013).
\571\ FIA Comment Letter at 37 (Feb. 15, 2013).
---------------------------------------------------------------------------

RCG requested the Commission to clarify application of Sec.
30.7(c) as it relates to banks located outside the U.S. that FCMs use
for settlement purposes, and how the limitation applies to variation
amounts.\572\
---------------------------------------------------------------------------

\572\ RCG Comment Letter at 7 (Feb. 12, 2013).
---------------------------------------------------------------------------

Jefferies stated that the proposed rule disadvantages customers who
may no longer deposit ``customer owned'' securities and would instead
have to prefund their obligations with cash.\573\
---------------------------------------------------------------------------

\573\ Jefferies Bache Comment Letter at 6 (Feb. 15, 2013).
---------------------------------------------------------------------------

Advantage stated that FCMs typically must maintain a relationship
with a foreign bank in order to meet cutoff times for payment of fees
and clearing on foreign exchanges and that if an FCM can't maintain
funds at a foreign institution, it may inhibit its ability to trade
foreign futures.\574\ The effect, they asserted, could be that U.S.
FCMs will be required to use non-U.S. brokers that are not regulated by
the Commission for their foreign futures business.\575\ They further
requested that the Commission clarify how the prohibition on keeping
non-margin foreign futures funds in an institution outside the U.S.
would apply to Sec. 30.7(b), which appears to allow such funds to be
held at a bank or trust company outside the U.S.\576\
---------------------------------------------------------------------------

\574\ Advantage Letter at 8 (Feb. 15, 2013).
\575\ Id. at 9.
\576\ Id.
---------------------------------------------------------------------------

In response to commenter concerns, the Commission is adopting the
amendments generally as proposed, but the final rule will permit an FCM
to post with depositories outside of the U.S. sufficient funds to cover
the full margin obligations imposed by foreign brokers or foreign
clearing organizations on the FCM's 30.7 customers' positions, plus an
additional amount equal to 20 percent of the required margin on such
positions.
The Commission is increasing the amount of 30.7 customer funds that
an FCM may hold in a foreign jurisdiction in response to the comments.
The Commission is adopting this regulation to provide greater
protection to both U.S. and foreign-domiciled customers in the event of
the insolvency of the FCM. Recent experience has demonstrated that
funds held outside of the U.S, at depositories subject to foreign
insolvency regimes, present challenges and potential delays in the
ability of the Trustee to return customer property to the customers of
the FCM. In increasing the amount of funds an FCM may hold outside of
the U.S. from 10 percent of the required margin to 20 percent of the
required margin, the Commission is striving to strike a proper balance
that would not interfere with the ability of 30.7 customers to trade on
foreign markets (and the ability of FCMs to facilitate such
transactions by allowing them to meet their 30.7 customers' margin and
other financial obligations to foreign brokers and clearing
organizations), with the Commission's desire to provide 30.7 customers
with an appropriate level of protection in the event of the insolvency
of an FCM. The Commission believes that, to the maximum extent
commercially practicable, funds deposited by 30.7 customers that are
not required to margin positions with foreign brokers or foreign
clearing organizations should be held within in the U.S. to provide
greater assurance that such funds would be subject to the bankruptcy
provision of U.S. law and the Commission's regulations under the
jurisdiction of U.S. courts.
The Commission further notes that the 20 percent limitation is
based upon the amount of margin required on open positions. In response
to RCG's request for clarification, FCMs may transfer funds to foreign
depositories to cover variation margin calls and exclude such funds
from the calculation of the 20 percent ``cushion.'' In addition, the
Commission notes that FCMs may deposit 30.7 customer funds with any of
the foreign depositories listed under Sec. 30.7(b), provided that the
FCMs do not exceed the 20 percent limit on the amount of funds that are
permitted to be held in foreign jurisdictions. The Commission believes
that the ability to post variation margin in foreign jurisdictions and
an additional 20 percent cushion should allow FCMs to conduct foreign
futures activities on behalf of their customers, while also providing
additional protections to the current regulatory regime.
3. Commingling of Positions in Foreign Futures and Foreign Options
Accounts
Commission staff previously issued an Advisory stating that while
it was desirable for FCMs to hold only a customer's foreign futures
transactions (and the funds supporting such transactions) in such
customer's foreign futures account, this limitation was not mandatory
and that the FCM could also hold such customer's unregulated
transactions (and the funds supporting such transactions) in the
foreign futures accounts.\577\ Thus, pursuant to this Advisory, FCMs
were permitted to commingle the funds supporting a customer's foreign
futures and options transactions with such customer's unregulated
transactions, including over-the-counter transactions. The Advisory was
issued before the passage of Dodd-Frank, section 724(a) of which
established in section 4d(f) of the CEA a segregation regime for the
funds of cleared swaps customers, and the Commission's promulgation of
part 22, implementing that statute.
---------------------------------------------------------------------------

\577\ CFTC Advisory No. 87-4 (Nov. 18, 1987).
---------------------------------------------------------------------------

In response to an FIA recommendation at a public roundtable held in
advance of the Commission's publication of the proposal, the Commission
proposed to amend Sec. 30.7 by adopting new paragraph (e) to prohibit
an FCM from commingling funds from unregulated transactions with funds
for foreign futures and options transactions in part 30 secured
accounts, except as authorized by Commission order. The prohibition on
holding unregulated transactions or other non-foreign futures or
foreign option transactions in part 30 set aside accounts is consistent
with the treatment applicable under section 4d(a)(2) of the Act for
segregated accounts and section 4d(f) of the Act for Cleared Swaps
Customers' accounts.
The Commission noted in the proposal that when part 30 was being
adopted, commenters cited back office operational difficulties with
establishing multiple ``customer'' account classes or origins.\578\
Given the technological changes during the intervening decades, and the
new statutory and regulatory

[[Page 68575]]

framework, these concerns should no longer dictate the advisability of
commingling the funds of regulated foreign futures and foreign options
transactions with unregulated transactions.
---------------------------------------------------------------------------

\578\ See 52 FR 28980, 28985-28986.
---------------------------------------------------------------------------

New Sec. 30.7(e) extends the prohibition against commingling of
customer funds currently found in section 4d(a)(2) futures customer
accounts and section 4d(f) Cleared Swaps Customer Accounts to 30.7
customer accounts, except as otherwise permitted by Commission
regulation or order.
CIEBA stated that it supported the prohibition on the commingling
of funds deposited by futures customers, Cleared Swaps Customers, and
30.7 customers.\579\ Nodal requested that the Commission make explicit
in the adopting release that 30.7 accounts may continue to hold
customer funds to margin contracts traded on a market that is pending
designation as a contact market at the time the rules become effective,
until such market is registered as a DCM or upon the withdrawal or
denial of the DCM application.\580\ LCH.Clearnet noted that while it
does not have a position on whether the Commission should prohibit
commingling of 30.7 customer funds with the funds of futures customers
and Cleared Swaps Customers, if adopted, it urged the Commission to
preserve the ability to allow such commingling pursuant to a Commission
rule or order.\581\
---------------------------------------------------------------------------

\579\ CIEBA Comment Letter at 4 (Feb. 20, 2013).
\580\ Nodal Comment Letter at 1-2 (Jan. 21, 2013).
\581\ LCH.Clearnet Comment Letter at 6-7 (Jan. 25, 2013).
---------------------------------------------------------------------------

The Commission is adopting new Sec. 30.7(e) as proposed. As it
noted in the proposal, should there be a need to permit commingling of
funds, the Commission will continue to have the ability to permit such
commingling under the formalities of processes associated with a
Commission order or rule pursuant to section 4d of the CEA. Absent such
a rule or order, however, protection for such customer property would
not be available under the Commission's part 190 regulations or the
Bankruptcy Code, and thus such commingling would not be permitted. In
addition, the Commission does not agree with Nodal's request that FCMs
may continue to hold margin funds in 30.7 accounts for positions that
are executed on markets that are pending approval as designed contract
markets. As noted above, a purpose of Sec. 30.7(e) is to enhance the
protection of 30.7 customers by prohibiting the commingling of 30.7
customer funds with funds held by an FCM for unregulated transactions.
Commingling of unregulated transactions with regulated transactions
could also impede the resolution of 30.7 customer claims in the event
of the insolvency of the FCM carrying the funds.
4. Further Harmonization With Treatment of Customer Segregated Funds
The Commission proposed to adopt new paragraphs (f) and (k) in
Sec. 30.7, to extend regulatory provisions from Sec. Sec. 1.20, 1.21,
1.22 and 1.24, that previously were applicable only to 4d segregated
funds, to funds set aside as the foreign futures or foreign options
secured amount under Sec. 30.7. These proposed requirements would make
clear that: (1) FCMs would not be permitted to use funds set aside as
the foreign futures or foreign options secured amount other than for
the benefit of 30.7 customers; (2) FCMs must hold sufficient residual
interest in 30.7 accounts to make sure that 30.7 customer funds of one
30.7 customer are not used to margin, secure or guarantee the
obligations of other customers; (3) funds set aside as the foreign
futures or foreign options secured amount should not be invested in any
obligations of clearing organizations or boards of trade; and (4) no
funds placed at foreign brokers should be included as funds set aside
as the foreign futures or foreign options secured amount unless those
funds are on deposit to margin the foreign futures or foreign options
positions of 30.7 customers. In addition to extending the existing
Commission regulations noted above to Sec. 30.7, the Commission also
proposed a new requirement prohibiting an FCM from imposing any liens
or allowing any liens to be imposed on funds set aside as the foreign
futures or foreign options secured amount. This requirement parallels
that currently applicable to cleared swap customers with respect to the
segregation of Cleared Swaps Collateral.\582\
---------------------------------------------------------------------------

\582\ See Sec. 22.2(d)(2).
---------------------------------------------------------------------------

As discussed above, the Commission received several comments
regarding the residual interest requirements set forth in the
Proposal.\583\ While most of the commenters focused on the impact of
the Proposed Residual Interest Requirement to the futures market, some
of the more general comments would also apply to the foreign futures or
foreign options market. Given the statutory prohibition in sections
4d(a) and 4d(f) of the Act against using one customer's funds to
margin, secure or guarantee the obligations of another customer, FCMs
that participate in the swaps and futures market may not ``use'' one
customer's property to margin another customer's positions.
Nonetheless, the Commission clarified that an FCM does not ``use'' a
customer's funds until the time of settlement.\584\
---------------------------------------------------------------------------

\583\ See sections II.G.9. and II.Q. above for discussion of the
Proposed Residual Interest Requirement.
\584\ See section II.G.9. above.
---------------------------------------------------------------------------

The Commission recognizes that the statutory prohibitions set forth
in sections 4d(a) and 4d(f) of the Act apply to the futures and swaps
markets. Conversely, as discussed above, the proposed changes to Sec.
30.7 were intended to provide a more coordinated approach to the
regulations governing foreign futures and foreign options, with
standards that are consistent with those for the futures and swaps
markets. These regulations, including regulations governing how an FCM
holds funds for customers trading on non-U.S. markets, would greatly
enhance the protection of customer funds and avoid regulatory
arbitrage. Such consistency would, to the extent practicable and
appropriate, contribute to the goal of having customer protection
across futures, swaps and foreign futures markets be substantively
similar.
The Commission did not receive any comments opposing the concept of
having consistent residual interest requirements across markets. The
Commission did, however, receive comments regarding the additional
complexities associated with trading foreign futures and foreign
options.\585\ As such, the Commission is adopting residual interest
requirements in part 30 that are substantively similar to the amended
requirement in part 1, but with a modification as to the time by which
an FCM must maintain such residual interests that will give FCMs the
flexibility necessary to account for differences in the regulatory
requirements and market practices applicable to foreign brokers and
clearing organizations in other jurisdictions. Thus, the Commission is
revising Sec. 30.7(f) as follows.
---------------------------------------------------------------------------

\585\ See Roundtable Tr. at 266-267 (Feb. 5, 2013).
---------------------------------------------------------------------------

Regulation 30.7(f)(1)(i) sets forth the general requirement that an
FCM may not use, or permit the use of, the funds of one 30.7 customer
to purchase, margin or settle the trades, contracts, or commodity
options of, or to secure or extend credit to, any person other than
such 30.7 customer. Regulation 30.7(f)(1)(ii)(A) states that the
undermargined amount for a 30.7 customer's account is the amount, if
any (i.e., the must be amount equal to or

[[Page 68576]]

greater than zero), by which the total amount of collateral required
for that 30.7 customer's positions in that account at a specified time
exceeds the value of the 30.7 customer funds in that account, as
calculated in new Sec. 30.7(f)(2)(ii). Regulation 30.7(f)(1)(ii)(B)
requires FCMs to perform a residual interest buffer calculation, at the
close of each business day, based on the information available to the
FCM at that time, by calculating (1) the undermargined amounts, based
on the clearing initial margin that will be required to be maintained
by that FCM for its 30.7 customers, at each clearing organization of
which the FCM is a member, at any settlement that will occur before
6:00 p.m. Eastern Time on the following business day for each such
clearing organization less (2) any debit balances referred to in Sec.
30.7(f)(2)(B)(iv) that is included in such undermargined amounts.
In addition, and for the reasons set forth above, pursuant to Sec.
30.7(f)(1)(ii)(C)(1) FCMs must maintain residual interest prior to 6:00
p.m. Eastern Time on the date referenced in Sec. 30.7(f)(1)(ii)(B) in
segregated funds that is equal to or exceeds the computation set forth
in (ii)(B). Moreover, Sec. 30.7(f)(1)(ii)(C)(2) provides that an FCM
may reduce the amount of residual interest required in Sec.
30.7(f)(1)(ii)(C)(1) to account for payments received from or on behalf
of undermargined 30.7 customers (less the sum of any disbursements made
to or on behalf of such customers) between the close of business the
previous business day and 6:00 p.m. Eastern Time on the following
business day. Regulation 30.7(f)(1)(ii)(D) provides that for purposes
of Sec. 30.7(f)(1)(ii)(B), an FCM should include, as clearing initial
margin, customer initial margin that the FCM will be required to
maintain, for that FCM's 30.7 customers, at a foreign broker, and, for
purposes of Sec. 30.7(f)(1)(ii)(C), must do so by 6:00 p.m. Eastern
Time. In other words, Sec. 30.7(f)(1)(ii)(D) is intended to make clear
that the requirements with respect to 30.7 customer funds that are used
by an FCM that clears through a foreign broker are parallel to the
requirements applied to 30.7 customer funds that are used when an FCM
clears directly on a clearing organization.
Finally, to provide greater clarity, the Commission is adding a new
subparagraph (2) to paragraph (f), which sets out the requirements as
to the FCM's calculation of the Net Liquidating Equities of their 30.7
customers. Because of the addition of new subparagraph (2), the
Commission is renumbering proposed Sec. 30.7(f)(2) and (f)(3) to Sec.
30.7(f)(3) and (f)(4), and since the Commission did not receive any
comments on the substantive provisions of these paragraphs, it is
adopting them as proposed.
The Commission did not receive any comments on the substantive
provisions of proposed Sec. 30.7(k) and is adopting this new
paragraphs as proposed.
MFA, however, requested confirmation that the Commission's prior
guidance with respect to a customer's authority to grant liens or
security interests on its own Cleared Swaps Customer Account under part
22 would also be applicable to customers on their foreign futures or
foreign options secured amount under Sec. 30.7.\586\ The Commission
agrees with this position and hereby confirms the applicability of its
prior guidance.\587\
---------------------------------------------------------------------------

\586\ MFA Comment Letter at 10 (Feb. 15, 2013).
\587\ Specifically, In the Final LSOC Release the Commission
clarified:
an FCM may not, under any circumstances, grant a lien to any
person (other than to a DCO) on its Cleared Swaps Customer Account,
or on the FCM's residual interest in its Cleared Swaps Customer
Account. On the other hand, a Cleared Swaps Customer may grant a
lien on the Cleared Swaps Customer's individual cleared swaps
account (an `FCM customer account') that is held and maintained at
the Cleared Swaps Customer's FCM.
77 FR at 6352.
In addition, Commission Staff issued an interpretive letter that
stated:
Regulation 22.2(d) does not prohibit a Cleared Swaps Customer
from granting security interests in, rights of setoff against, or
other rights in its own Cleared Swaps Customer Collateral,
regardless of whether those assets are held in the Cleared Swaps
Customer's FCM customer account. Furthermore, nothing in the rule is
intended to inhibit this right of the Cleared Swaps Customer.
CFTC Letter No. 12-28 at 2 (Oct. 17, 2012).
---------------------------------------------------------------------------

5. Harmonization With Other Commission Proposals
The Commission also proposed various other amendments to its part
30 regulations to harmonize the rules with those applicable to U.S.
customers under other Commission regulations.
As discussed in section II.I. above, the Commission is adopting in
this release new limitations on withdrawals of segregated funds in
Sec. 1.23. The amendments provide for an FCM's residual interest in
segregated funds, and permit withdrawals from segregated funds for the
proprietary use of the FCM to the extent of such residual interest,
subject to the requirement that the withdrawal must not occur prior to
the completion of the daily segregation computation for the prior day,
and should the withdrawal (individually or aggregated with other
withdrawals) exceed 25 percent of the prior day residual interest, the
withdrawal must be subject to specific approvals by senior management
and appropriately documented, and further subject to a complete
prohibition on withdrawals of residual interest to the extent necessary
to maintain proper residual interest to cover undermargined amounts.
The Commission proposed and is adopting paragraph (g) of Sec. 30.7 to
apply the same restrictions on withdrawals of an FCM's residual
interest in funds set aside as the foreign futures or foreign options
secured amount.
Current Sec. 30.7(g) was recently adopted by the Commission to
provide that the investment of Sec. 30.7 funds be subject to the
investment limitations contained in Sec. 1.25.\588\ As proposed, the
Commission is moving this permitted investment requirement to a new
paragraph Sec. 30.7(h), and further is adopting a new paragraph Sec.
30.7(i) to make clear that FCMs are solely responsible for any losses
resulting from the permitted investment of funds set aside as the
foreign futures or foreign options secured amount. New paragraph Sec.
30.7(i) is intended to apply the same standard as is being adopted in
the amendment to Sec. 1.29 for segregated funds discussed above.
---------------------------------------------------------------------------

\588\ 76 FR 78776, 78802 (December 19, 2011).
---------------------------------------------------------------------------

The Commission also proposed and is adopting an amended paragraph
(j) to Sec. 30.7 to clarify the circumstances under which an FCM may
make secured loans to 30.7 customers and to adopt the same restriction
on unsecured lending to 30.7 customers as has been adopted with respect
to futures customers and 4d segregated funds in the amendment to Sec.
1.30 discussed above.
Finally, the Commission proposed and is adopting an amended
paragraph (l) to Sec. 30.7 to require the daily computation of the
foreign futures or foreign options secured amount and the filing of
such daily computation with the Commission and DSROs, as well as to
require the FCM to provide investment detail of the foreign futures or
foreign options secured amount as of the middle and end of the month.
The amendments to paragraph (l) of Sec. 30.7 are intended to be
consistent with the requirements for the daily segregation calculation
for segregated customer funds and the provision of the segregation
investment detail which are adopted in Sec. 1.32.
No comments were received on the above proposals and the Commission
is adopting the amendments as proposed.

S. Sec. 3.3: Chief Compliance Officer Annual Report

Regulation 3.3 requires each FCM (as well as swap dealers and major
swap participants) to designate an individual to serve as its CCO. The
CCO is required

[[Page 68577]]

to be vested with the responsibility and authority to develop, in
consultation with the FCM's board of directors or senior officer,
appropriate policies and procedures to fulfill the duties set forth in
the Act and Commission regulations relating to the FCM's activities as
an FCM. Regulation 3.3(e) also requires the FCM's CCO to prepare an
annual compliance report that includes a description of any non-
compliance events that occurred during the last reporting period along
with the action taken to address such events. The annual compliance
report currently is required to be filed electronically with the
Commission simultaneously with the FCM's certified annual financial
report, and in no event later than 90 days after the firm's fiscal year
end.
The Commission proposed a conforming amendment to Sec. 3.3(f)(2)
to reflect the amendments to Sec. 1.10(b)(1)(ii), discussed in section
II.A. above, that require an FCM to file its annual certified financial
statements with the Commission within 60 days of the firm's fiscal year
end. In this regard, the Commission proposed to require that each FCM
file the CCO annual report with the Commission simultaneously with the
filing of the firm's certified annual report, and in no event later
than 60 days after the FCM's fiscal year end.
The NFA commented that it supported the proposal.\589\ No other
comments were received. The Commission has determined to amend Sec.
3.3 as proposed.
---------------------------------------------------------------------------

\589\ NFA Comment Letter at 9 (Feb. 15, 2013).
---------------------------------------------------------------------------

III. Compliance Dates

The final regulations will be effective January 13, 2014. The
compliance date for the regulations will be the effective date, subject
to the following exceptions:

A. Financial Reports of FCMs: Sec. 1.10

An FCM that is not dually-registered as a BD currently is required
to submit its certified annual report to the Commission within 90 days
of the firm's year end date. The Commission has amended Sec.
1.10(b)(1)(ii) to require such certified annual report to be submitted
within 60 days of the firm's year end date.
The Commission recognizes that many FCMs have contracted with
public accountants to perform the current year's audit examination, and
that those audits are currently in process. In order to allow the
current year audits to be completed, the Commission is setting a
compliance date for Sec. 1.10(b)(1)(ii) for FCMs with years ending
after June 1, 2014. This date will also coincide with several other
compliance dates affecting public accountants discussed under Sec.
1.16 below.

B. Risk Management Program for FCMs: Sec. 1.11

Section 1.11 requires each FCM that carries customer funds to
establish a risk management program. RJ O'Brien requested that the
Commission provide at least one year for FCMs to comply with the new
risk management regulations in the event the proposed Risk Management
Program is adopted. RJ O'Brien stated that the new requirements would
likely necessitate a period of time for firms to reorganize, develop
the policies and procedures, implement the policies and procedures,
acquire adequate personnel, and conduct extensive training of new and
existing employees. Advantage stated ``that most aspects of proposed
Sec. 1.11 are appropriate and unlikely to be burdensome as FCMs
typically have most (if not all) of these requirements in place.''
\590\
---------------------------------------------------------------------------

\590\ Advantage Comment Letter at 2 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission recognizes that some FCMs may need a sufficient
period of time to develop and implement a risk management program that
complies with Sec. 1.11, but believes that many firms already maintain
programs that comply with many of the requirements in Sec. 1.11.
Accordingly, FCMs must file their initial Risk Management Program
within 180 days of the effective date of the regulation. The filings
must be made via electronic transmission to the Commission using the
WinJammer electronic filing system.

C. Qualifications and Reports of Accountants: Sec. 1.16

The Commission is amending Sec. 1.16 to require a public
accountant to meet certain qualification standards in order to be
qualified to conduct audits of FCMs. The Commission is amending Sec.
1.16(b) to require that the public accountant: (1) Must be registered
with the PCAOB; (2) must have undergone a PCAOB inspection; and (3) may
not be subject to a temporary or permanent bar to engage in the audit
of public issuers or BDs as a result of a PCAOB disciplinary action.
The Commission is further amending Sec. 1.16(c) to require that the
public accountant's audit report must state whether the audit was
conducted in accordance with PCAOB auditing standards.
The Commission is establishing a compliance date of June 1, 2014
for the amendment to Sec. 1.16(b)(1) that requires a public accountant
to be registered with the PCAOB in order to conduct an audit of an FCM.
The Commission also is establishing a compliance date of June 1, 2014
for the amendment to Sec. 1.16(c) that requires a public accountant to
conduct an audit of an FCM in accordance with the standards issued by
the PCAOB. A compliance date of June 1, 2014 will allow current year
audits to be completed without interruption, and provides sufficient
time for public accountants that audit FCMs to register with the PCAOB
if such public accountants are not already registered. In addition, a
June 1, 2014 compliance date will align the Commission's requirements
for the use of PCAOB standards in the audit of an FCM with the SEC
audit standards for public accountants auditing BDs.\591\ Without such
alignment, public accounts of a dually-registered FCM/BD would have to
issue two different audit reports; one audit report to the SEC for an
examination conducted under PCAOB audit standards, and a second audit
report for the Commission for an examination conducted under U.S. GAAS.
---------------------------------------------------------------------------

\591\ The SEC recently amended its regulations to require public
accountants to conduct audits of BDs pursuant to the audit standards
issued by the PCAOB. This requirement is effective for audits of BDs
with a year-end of June 1, 2014 or later. See 78 FR 51910 (Aug. 21,
2013).
---------------------------------------------------------------------------

The Commission also is establishing a compliance date of December
31, 2015 for the requirement in Sec. 1.16 that a public accountant
must have undergone an inspection by the PCAOB in order to qualify to
conduct an audit of an FCM. The extension of the compliance date to
December 31, 2015 will provide additional time for the PCAOB to conduct
inspections of public accountants that registered with, but have not
been inspected by, the PCAOB.
Lastly, the compliance date for the amendment to Sec. 1.16(b)(1)
the provides that a public accountant may not be subject to a temporary
or permanent bar to engaging in the audit of public issuers or BDs as a
result of a PCAOB disciplinary action is the effective date of the
amendment. The Commission believes that if a public accountant is
registered with the PCAOB and is subject to a PCAOB disciplinary action
that temporarily or permanently bars the public accountant from
auditing public issuers, the public accountant is not qualified to
conduct audits of FCMs.

D. Minimum Financial Requirements for FCMs

The Commission is amending the capital rule to require an FCM to
incur a capital charge for undermargined

[[Page 68578]]

customer, noncustomer, and omnibus accounts that are undermargined more
than one business day after a margin call is issued by the FCM. For
example, if an account is undermargined on Monday and the FCM issues a
margin call on Tuesday, the FCM would have to take a reduction to
capital equal to the amount of the margin call that was not met by
close of business Wednesday.
The Commission is establishing a compliance date for the revised
timeframe for the capital charges required by Sec. 1.17(c)(5)(viii)
and (ix) of one year following publication of this rule in the Federal
Register. The compliance date provides FCMs with a period of time that
the Commission believes is sufficient to adjust its systems for issuing
and collecting margin from customers and provides customers with an
opportunity to adjust their operations, as necessary, to meet its
margin obligations on a reduced timeframe for the current regulation.

E. Written Acknowledgment Letters: Sec. Sec. 1.20, 1.26, and 30.7

The Commission is amending Sec. Sec. 1.20(d) and (g), 1.26(b), and
30.7(d) to require FCMs and DCOs, as applicable, to obtain standard
form acknowledgment letters from each depository that the FCMs or DCOs
use to hold customer funds.\592\ The Commission is further requiring
FCMs and DCOs to use Template Letters set forth in appendices to the
regulations.
---------------------------------------------------------------------------

\592\ The regulations, however, provide that an FCM is not
required to obtain an acknowledgment letter from a DCO if the DCO
maintains rules that have been submitted to the Commission and that
provide for the segregation of customer funds in accordance with all
relevant provisions of the Act and Commission regulations or orders.
See Sec. Sec. 1.20(d)(1) and 30.7(d)(1).
---------------------------------------------------------------------------

The Commission is establishing a compliance date of 180 days after
the effective date of the regulations in order to provide FCMs and DCOs
with sufficient time to obtain from depositories new acknowledgment
letters that conform to the Template Letters.

F. Undermargined Amounts: Sec. Sec. 1.22(c), 30.7(f)

The Commission received several comments on the appropriate timing
for the effectiveness of the Proposed Residual Interest Requirement. At
the public roundtable held on February 5, 2013, several panelists
argued that the Proposed Residual Interest Requirement would require
substantial time to implement in order to change the behavior of all
futures markets participants.\593\ In addition, FIA asserted that
implementation would require multiple years and ``radical'' changes to
processing procedures for futures market participants,\594\ and RCG
requested that the Commission provide ``with a period of time not less
than one year from the promulgation of the relevant final rules for
FCMs to implement them.'' \595\
---------------------------------------------------------------------------

\593\ See Roundtable Tr. at 252-255, 257, 266-267 (Feb. 5,
2013).
\594\ See FIA Comment Letter at 21 (Feb. 15, 2013).
\595\ See RCG Comment Letter at 8 (Feb. 12, 2013).
---------------------------------------------------------------------------

As discussed above, the residual interest requirements set forth in
part 22 are the requirements that are currently in place today. As
such, FCMs are expected to continue meeting their regulatory
requirements. With respect to the residual interest requirements set
forth in Sec. Sec. 1.22(c) and 30.7(f), the Commission recognizes that
these requirements represent a significant change in current market
practice. Given the costs associated with compliance with these
requirements, as well as comments received from the interested parties
requesting sufficient time to achieving compliance with these
requirements, the Commission has determined that a phased compliance
schedule for Sec. 1.22(c) is necessary and appropriate. The phased
compliance schedule for Sec. 1.22(c) is set forth in Sec.
1.22(c)(5)(iii). However, the Residual Interest Deadline of 6:00 p.m.
Eastern Time in Sec. 1.22(c)(5)(ii) shall begin one year following the
publication of this rule in the Federal Register.\596\ With regards to
the residual interest requirements set forth in Sec. 30.7(f), the
Commission is establishing a compliance date of one year following the
publication of this rule in the Federal Register.
---------------------------------------------------------------------------

\596\ For further discussion regarding the phase-in schedule for
the requirements in Sec. 1.22(c), see section II.G.9.
---------------------------------------------------------------------------

G. SRO Minimum Financial Surveillance: Sec. 1.52

The Commission amended Sec. 1.52 to require each SRO to establish
a supervisory program to oversee their member FCMs' compliance with SRO
and Commission minimum capital and related reporting requirements, the
obligation to properly segregated customer funds, risk management
requirements, financial reporting requirements, and sales practices and
other compliance requirements. The Commission also amended Sec.
1.52(c) to require each SRO to engage an ``examinations expert'' at
least once every three years to evaluate the quality of the supervisory
oversight program and the SRO's application of the supervisory program.
The SRO must obtain a written report from the examinations expert with
an opinion on whether the supervisory program is reasonably likely to
identify a material weakness in internal controls over financial and/or
regulatory reporting, and in any of the other areas that are subject to
the supervisory program.
The Commission established a compliance date in amended Sec.
1.52(e) that requires each SRO to submit a supervisory program to the
Commission for review, together with the examinations expert's report
on the supervisory program, within 180 days of the effective date of
the amendments to Sec. 1.52, or such other time as may be approved by
the Commission. The Commission further revised Sec. 140.91(10) to
delegate the authority to extend the time period for the submission of
the initial supervisory program to the Director of the Division of Swap
Dealer and Intermediary Oversight and the Director Division of Clearing
and Risk, with the concurrence of the General Counsel or, in his or her
absence, a Deputy General Counsel.\597\
---------------------------------------------------------------------------

\597\ The Commission also amended Sec. 1.52(d)(2)(ii)(H) to
provide that a Joint Audit Committee must submit an initial Joint
Audit Program to the Commission, along with an examinations expert's
report on the Joint Audit Program, within 180 days of the effective
date of the regulation. The Director of the Division of Swap Dealer
and Intermediary Oversight and the Director of the Division of
Clearing and Risk also are authorized under Sec. 1.52(d)(2)(ii)(H)
an Sec. 140.91(10), with the concurrence of the General Counsel or,
in his or her absence, a Deputy General Counsel, to extend the
initial filing deadline if warranted.
---------------------------------------------------------------------------

Commission staff will consult with the SROs to assess their
progress in preparing an initial supervisory program, including the
examinations expert's review, and may adjust compliance dates as
appropriate.

H. Public Disclosures by FCMs: Sec. 1.55

The Commission has amended Sec. 1.55(b) by revising the Risk
Disclosure Statement to include several additional disclosures intended
to provide customers and potential customers with enhanced information
to further their understanding of the risks of engaging in the futures
markets. The Commission recognizes that FCMs will be required to revise
the Risk Disclosure Statement to implement the revisions, and is
establishing a compliance date for the amendments to 1.52(b) of 90 days
after the effective date of the amendments. The Commission believes
that this provides sufficient time for FCMs to revise the Risk
Disclosure Statement and to modify their systems, if necessary, in the
case of firms that

[[Page 68579]]

provide electronic account opening documents.
The Commission also amended Sec. 1.55(i)-(k) to require each FCM
to disclose to customers all information that would be material to the
customers' decision to entrust funds to, or otherwise do business with,
the FMC, including its business, operations, risk profile, and
affiliates. The Commission is establishing a compliance date of 180
days after the effective date of the regulation to provide adequate
time for FCMs to develop the required disclosures and make them
available to the public.
The Commission also amended Sec. 1.55(o) to require each FCM to
disclose on its Web site certain current and historical information
regarding its holding of customer funds, and its certified annual
report. The Commission is establishing a compliance date of 180 days
after the effective date of the regulation to provide FCMs with
sufficient time to modify electronic systems, and make any additional
operational changes, necessary for the firms to comply with the
requirements.

IV. Cost Benefit Considerations

Statutory Mandate To Consider the Costs and Benefits of the
Commission's Action: Commodity Exchange Act Section 15(a)

Section 15(a) of the Act requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the Act or issuing certain orders. Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
the following five broad areas of market and public concern: (1)
Protection of market participants and the public; (2) efficiency,
competitiveness and the financial integrity of futures markets; (3)
price discovery; (4) sound risk management practices; and (5) other
public interest considerations. The Commission considers the costs and
benefits resulting from its discretionary determinations with respect
to the section 15(a) considerations.
In the NPRM, the Commission established, based on the subject
matter of the proposals, that it did not consider any of the proposals
contained therein to have any significant impact on price discovery.
The Commission received no responses from commenters with respect to
its analysis regarding price discovery. For the remaining areas, the
Commission addressed, section by section, the qualitative substantial
benefits perceived to be obtained from the regulatory proposals
contained in the NPRM. Where reasonably possible, the Commission has
estimated costs quantitatively associated with such proposals section
by section. The Commission asked specifically and generally for
comments with respect to its analysis of benefits and such cost
estimates, and requested information from commenters where the
Commission qualitatively considered but could not reasonably
quantitatively estimate costs.
The underlying purpose of the regulations adopted herein as stated
in the NPRM was to bolster the protection of customers and customer
funds, in response to the misuse or mishandling of customer funds at
specific FCMs like MFGI or PFGI. Further, the purpose of certain
proposals was to provide regulators the means by which to detect and
deter the misuse or mishandling of customer funds by FCMs, including
bolstering standards for the examination and oversight of FCMs by SROs
and public accountants. In addition to the significant benefits to the
protection of market participants and the public, the Commission
determined that a strong package of reforms, including enhanced
information and disclosures available to customers, adopted in light of
the recent FCM failures resulting in and from misuse of customer funds,
would be extremely beneficial to restore trust in the financial
integrity of futures markets. The Commission also included certain
proposals intended to both increase the protection of customer funds
and strengthen FCM risk management, specific to customer funds
processes and procedures.
As stated in the NPRM, a loss of trust in the financial integrity
of futures markets could deter market participants from the benefits of
using regulated, transparent markets and clearing. The overarching
purpose of the reforms contained in this rulemaking is to produce the
benefits that accrue by virtue of avoiding similar defaults in the
future. This prevents the costs certain to follow, including lost
customer funds, decreased market liquidity that follows from a crisis
in confidence, and the potential for the failure of one FCM to cause
losses in other clearing members.\598\
---------------------------------------------------------------------------

\598\ The failure of one clearing member could lead to losses
for other clearing members if the losses due to the first member's
failure are large enough to exhaust the guarantee fund and require
additional capital infusion from other clearing members.
---------------------------------------------------------------------------

In this rulemaking, the Commission adopted new rules and amended
existing rules to improve the protection of customer funds. The content
of the Commission's adopted new rules and amended rules can be
categorized in seven parts: (1) requiring FCMs to implement extensive
risk management programs including written policies and procedures
related to various aspects of their handling of customer funds; (2)
increasing reporting requirements for FCMs related to segregated
customer funds, including daily reports to the Commission and DSRO; (3)
requiring FCMs to establish target amounts of residual interest to be
maintained in segregated accounts as well as creating restrictions and
increased oversight for FCM withdrawals out of such residual interest
in customer segregated accounts, specifically including clear sign off
and accountability from senior management for such withdrawals; (4)
strengthening requirements for the acknowledgment letters that FCMs and
DCOs must obtain from their depositories; (5) eliminating the
Alternative Method for calculating 30.7 customer funds segregation
requirements and requiring FCMs to include foreign investors' funds in
segregated accounts; (6) strengthening the regulatory requirements
applicable to SRO and DSRO oversight of FCMs, including regulating
oversight provided under the function of a Joint Audit Committee that
would establish standards for, and oversee the execution of, FCM
audits; and (7) requiring FCMs to provide additional disclosures to
investors.

Overview of the Costs and Benefits of the Proposed Rules and Amendments
in Light of the 15(a) Considerations--Protection of Market Participants
and the Public

The Commission designed the adopted reforms to improve the
protection of customer funds. The Commission expects each of the seven
categories identified above to significantly increase the levels of
protection for customer funds. Requiring FCMs to implement risk
management programs that include documented policies and procedures
regarding various aspects of handling customer funds helps to protect
customer funds by promoting robust internal risk controls and reducing
the likelihood of errors or fraud that could jeopardize customer funds.
In addition, by requiring each FCM to document certain policies and
procedures, the rules enable the Commission, DSROs, and other auditors
to evaluate each FCM's compliance with their own policies and
procedures. Moreover, the requirement that FCMs establish a program for
quarterly audits by independent or external people that is designed to
identify any breach of the policies and procedures helps to ensure

[[Page 68580]]

regular, independent validation that the procedures are followed
diligently. Audits of this sort provide more thorough review of
internal procedures than the Commission or DSROs are able to perform
regularly with existing resources, which provides helpful scrutiny of
each FCM's procedures on a regular basis. This, together with the
requirement that FCMs establish a program of governing supervision that
is designed to ensure the policies required in Sec. 1.11 are followed,
will tend to promote compliance with the FCM's own policies and
procedures. And by promoting such compliance, the requirements reduce
the risk of operational errors, lax risk management, and fraud, and
thus the risk of consequent loss of customer funds.
Increasing reporting requirements for FCMs related to segregated
customer funds helps the Commission and DSRO identify FCMs that should
be monitored more closely in order to safeguard customer funds.
Moreover, by making some additional reported information public, the
rules facilitate additional market discipline that further promotes
protection of customer funds.
Creating restrictions and increased oversight for FCM withdrawals
out of its residual interest in customer segregated accounts, and
requiring review by senior management for large withdrawals protects
customers by helping to ensure that such withdrawals do not cause
segregated account balances to drop below required amounts, which are,
in turn, designed to prevent losses of customer funds. Moreover,
requiring personal accountability by senior management for withdrawals
that affect the balance of such accounts promotes more effective
oversight of customer segregated accounts.
The acknowledgments and commitments depositories are required to
make through Sec. Sec. 1.20, 1.26, and 30.7 provide additional
protection for customer funds by, among other things, requiring
depositories that accept customer funds to acknowledge that customer
funds cannot be used to secure the FCM's obligations to the depository.
Such an acknowledgment provides additional protection of customer funds
and fosters prompt transfer in the event of an FCM's default.
In addition, depositories must agree in the acknowledgment letter
to give the Commission and DSROs read-only electronic access to an
FCM's segregated accounts, which benefits customers by enabling the
Commission and DSROs to review the accounts for discrepancies between
the FCM's reports and the balances on deposit at various depositories.
These enhancements to oversight provide an additional mechanism by
which customers would be protected against a shortfall in customer
funds due to operational errors or fraud.
Requiring FCMs to include foreign-domiciled customers' funds in
segregated accounts benefits all customers placing funds on deposit for
use in trading foreign futures and foreign options. Because neither the
Bankruptcy Code nor the Commission's part 190 regulations distinguish
between foreign-domiciled and U.S. domiciled customers at the point
customer funds are distributed, any shortfall in available funds would
be shared among all such customers. As discussed below, the Commission
understands that most, if not all, FCMs currently compute secured
amount requirements for both U.S.-domiciled and foreign-domiciled
customers. However, incorporating foreign-domiciled customers within
the calculations required for 30.7 customers ensures that both groups
are fully protected. Similarly, eliminating the Alternative Method
provides additional protection to customer funds by ensuring that FCMs
are not allowed to reduce their segregation requirements for 30.7
accounts during a time of financial strain. As discussed below, this
change provides protection to both U.S-domiciled and foreign-domiciled
customers with funds in 30.7 accounts.
The provisions in Sec. 1.52 include additional requirements for
both the supervisory program for SROs as well as for the formation of a
Joint Audit Committee to oversee the implementation and operation of a
Joint Audit Program that directs audits of FCMs by DSROs. By requiring
both the SRO supervisory programs and the Joint Audit Program to comply
with U.S. generally accepted audit standards, to develop written
policies and procedures, to require controls testing as well as
substantive testing, and to have an examinations expert review the
programs at least once every two years, the amendments help to ensure
that audits of FCMs by SROs or DSROs are thorough, effective, and
continue to incorporate emerging best practices for such audits. As a
consequence, the amendments help to ensure that audits are as effective
as possible at identifying potential fraud, strengthening internal
controls, and verifying the integrity of FCMs' financial reports, each
of which tend to provide protection for FCMs' customers,
counterparties, and investors.
In addition Sec. 1.55 requires disclosure of firm-specific risks
to customers. This additional information should be helpful to
customers when selecting an FCM to deposit their funds. In doing so,
the rules promote market discipline that incents FCMs to manage their
risks carefully and assists customers in understanding how their funds
are held and what risks may be relevant to the safety of their funds.
Last, FCMs maintaining residual interest in customer accounts is an
important aspect of protection for customer funds. While an FCM's
residual interest is not exhausted, it may be used to meet the FCM's
obligations to each customer without using another customer's funds to
do so. All else being equal, the larger the residual interest, the less
likely that market participants will lose customer funds posted as
collateral, with associated detriment to members of the public with
interests in such market participants.

Efficiency, Competitiveness and Financial Integrity of Futures Markets

The proposed amendments should increase the efficiency and
financial integrity of the futures markets by ensuring that FCMs have
strong risk management controls that are subject to multiple and
enhanced external checks, by enhancing reporting requirements,
facilitating increased oversight by the Commission and DSROs, by
allowing FCMs flexibility in the development of newly required policies
and procedures wherever the Commission has determined that such
flexibility is appropriate, and by requiring FCMs to implement training
regarding the handling of customer funds. In addition, the rules
include some requirements that many industry participants have
requested as necessary for the adequate protection of customers and
also highlighted as best practices already adopted within the industry.
Requiring such standards to be adopted by all FCMs promotes the
competitiveness of futures markets by preventing an FCM from skimping
on customer protection safeguards. There are also provisions in the
proposal that permit FCMs that are not BDs to implement certain
securities net capital haircuts that apply to jointly registered FCM/
BDs by the SEC. This enhances competition between FCMs that are not
dually registered and jointly registered FCM/BDs with respect to such
requirements.
Smaller FCMs may have more difficulty than large FCMs in absorbing
the additional costs created by the requirements of the rules
(particularly Sec. 1.22). It is possible that some smaller FCMs may
elect to stop operating as FCMs as a result of these costs. The
Commission does not anticipate,

[[Page 68581]]

however, that the rules will have a material effect on FCM pricing due
to reduced competition (although the increased costs may affect
pricing).
More specifically, the amendments to Sec. Sec. 1.10, 1.11, 1.12,
1.32, 22.2, and 30.7 increase reporting requirements for FCMs related
to segregated customer funds, including daily, bi-monthly, and
additional event-triggered reports to the Commission and DSROs. The
expanded range and frequency of information that the Commission and
DSRO receive under the proposed regulations enhances their ability to
monitor each FCM's segregated accounts, which promotes the integrity of
futures markets by helping to ensure proper handling of customer funds
at FCMs.
In addition, the changes facilitate increased oversight by the
Commission and DSROs by including additional notification requirements,
obligating FCMs to alert the Commission when certain events occur that
could indicate an FCM's financial strength is deteriorating or that
important operational errors have occurred. Such notifications should
enable the Commission and DSROs to increase monitoring of such FCMs to
ensure that customer funds are handled properly in such circumstances.
The rules also require FCMs to obtain an acknowledgment letter from
depositories that should give the Commission and DSROs electronic
access to view customer accounts at each depository when requested by
the Commission. That should enable both the Commission and DSROs to
verify the presence of customer funds which would provide a safeguard
against fraud and would promote the integrity of markets for futures,
cleared options, and cleared swaps.
The rules also require FCMs to establish policies and procedures
regarding several aspects of how they handle customer funds. The rules
should give FCMs the flexibility, where appropriate, to develop
policies and procedures tailored to the unique composition of their
customer base, size, and other operational disincentives. This flexible
approach protects FCMs from additional regulatory compliance costs that
could otherwise result from rules requiring every FCM to operate in
exactly the same way without sacrificing the additional accountability
that results from written policies and procedures that the Commission
or DSRO can review and use as the basis for FCM audits.
The requirement that FCMs provide annual training to all finance,
treasury, operations, regulatory, compliance, settlement and other
relevant employees regarding the segregation requirements for
segregated funds, for notices under Sec. 1.12, procedures for
reporting non-compliance, and the consequences of failing to comply
with requirements for segregated funds, should enhance the integrity of
the futures markets by promoting a culture of compliance by the FCM's
personnel. The training should help to ensure that FCM employees
understand the relevant policies and procedures, that they are
empowered and incented to abide by them, and that they know how to
report non-compliance to appropriate authorities.
The rules allow FCMs that are not dual registrants (i.e., are not
both FCMs and BDs) to follow the same procedures as dual registrants
when determining what regulatory capital haircut applies to certain
types of securities in which the FCM invests its own capital or
customer funds. This change is needed as the SEC has proposed a change
for BDs which would permit joint registrants to possibly apply a lower
regulatory haircut for certain securities, but which would not be
applicable to FCMs that are not dual registrants without this rule.
Therefore, the rule should help to ensure that FCMs that are not dual
registrants are not competitively disadvantaged and are able to
continue applying the same regulatory capital haircuts for such
securities as joint registrants.
Last, residual interest is an important aspect of protection for
customer funds because it enables the FCM to ensure that it can meet
its obligations to each customer without using another customer's funds
to do so. All else being equal, the larger the residual interest, the
more secure are customer funds. This contributes to confidence in U.S.
futures markets and their financial integrity. Adequate residual
interest improves the competition between FCMs, inasmuch as FCMs are
competing less by transferring risks from customers with deficit funds
to customers with surplus funds.

Sound Risk Management

The amendments should promote sound risk management by facilitating
market discipline, enhancing internal controls, enabling the Commission
and DSROs to monitor FCMs for compliance with those controls, by
reducing the risk that an FCM's financial strain could interfere with
customers' ability to manage their positions, by requiring FCMs to
notify the Commission in additional circumstances that could indicate
emerging financial strain, and by requiring senior management to be
involved in the process of setting targets for residual interest.
The reporting requirements should enhance market discipline by
providing additional information to investors regarding the location of
their funds, and the size of residual interest buffer that an FCM
targets and maintains in its segregated accounts. This additional
information should be valuable to customers selecting an FCM and
monitoring the location of their funds deposited with the FCM which
should promote market discipline. For example, if an FCM were to
establish a low target for residual interest, or maintain a very low
residual interest, then market participants are likely to recognize
this as a practice that could increase risk to the funds they have on
deposit at the FCM. Consequently, customers would likely either apply
pressure to the FCM to raise their target, or take their business to a
different FCM that maintains a larger residual interest in customer
fund accounts. This market discipline should incent FCMs to maintain a
level of residual interest that is adequate to ensure that a shortfall
does not develop in the customer segregated accounts.
The rules should also enhance FCM internal controls by requiring
them to establish a risk management program that includes policies and
procedures related to various aspects of how segregated customer funds
are handled. For example, FCMs are required to establish procedures for
continual monitoring of depositories where segregated customer funds
are held, and should have to establish a process for evaluating the
marketability, liquidity, and accuracy of pricing for Sec. 1.25
compliant investments.
In addition, documented policies and procedures should benefit the
FCM customers and the public by providing the Commission and DSROs
greater ability to monitor and enforce procedures that FCMs perform to
ensure that the protection of customer funds is achieved, with the
effect that the Commission should have a greater ability to address and
protect against operational errors and fraud that put customer funds at
risk of loss.
Further, through the amendments to Sec. 1.17(a)(4), FCMs will need
to manage their access to liquidity so as to be able to certify to the
Commission, at its request, that they have sufficient access to
liquidity to continue operating as a going concern. This rule should
provide the Commission with the flexibility to deal with emerging
liquidity drains at FCM s which may endanger customers, potentially
prior to instances of regulatory capital non-compliance,

[[Page 68582]]

allowing customer positions and funds to be transferred intact and
quickly to another FCM. This change should promote sound risk
management practices by helping to ensure that customers maintain
control of their positions without interruption.
The proposed additions to notification requirements established in
Sec. 1.12 should enhance the Commission's ability to identify
situations that could lead to financial strain for the FCM, which makes
it possible for the Commission to monitor further developments with
that FCM more carefully and to begin planning earlier for the
possibility that the FCM's customer positions may need to be
transferred to other FCMs, in the event that the FCM currently holding
those positions defaults. Advance notice helps to ensure customers'
positions are protected by enabling the Commission to work closely with
DCOs and DSROs to identify other FCMs that have requisite capital to
meet regulatory requirements if they were to take on additional
customer positions, thus facilitating smooth transition of those
positions in the event that it is necessary.
Last, FCMs maintaining residual interest in customer accounts is an
important aspect of protection for customer funds. While an FCM's
residual interest is not exhausted, it may be used to meet the FCM's
obligations to each customer without using another customer's funds to
do so. All else being equal, the larger the residual interest, the more
secure are customer funds. Moreover, these requirements will create
incentives for FCMs to monitor their customers' undermargined amounts,
thereby enhancing the FCM's risk management. By requiring that senior
management set the target for residual interest, and that they conduct
adequate due diligence in order to inform that decision, the rule
promotes both informed decision making about this important form of
protection, and accountability among senior management for this
decision, both of which are consistent with sound risk management
practices.

Other Public Interest Considerations

As discussed above, the recent failures of MFGI and PFGI, FCMs to
which customers have entrusted their funds, sparked a crisis of
confidence regarding the security of those funds. This crisis in
confidence could deter market participants from using regulated,
transparent markets and clearing which would create additional costs
for market participants and losses in efficiency and safety that could
create additional burdens for the public. The Commission hopes that
this rule will not only address the current crisis of confidence, but
that it will produce benefits for the public by virtue of avoiding
similar defaults in the future.
These amendments are not, however, without costs. First, the most
significant costs created by the amendments are those that result from
the increased amount of capital that FCMs are required to hold in
segregated accounts as part of establishing a target for their residual
interest and requiring residual interest for undermargined amounts.
Second, additional costs may be created by the amendments that incent
FCMs to hold additional capital, and prevent them from holding excess
segregated funds overseas. Third, operational costs are likely to arise
from amendments that result in the formation of a risk management unit
and adoption of new policies and procedures.
Multiple rule changes are expect to incent or require FCMs to
increase the amount of residual interest that they maintain in
segregated accounts including: (1) Requiring FCMs to establish a target
for residual interest that reflects proper due diligence on the part of
senior management; (2) disclosing the FCMs' targeted residual interest
publicly; (3) requiring them to report to the Commission and their
DSROs any time their residual interest drops below that target, and (4)
requiring FCMs to hold residual interest large enough to cover their
customers' undermargined amounts. In addition by restricting FCMs'
ability to withdraw residual interest from segregated accounts and
obligating FCMs to report to the Commission and their respective DSRO
each time the residual interest drops below the target, the regulations
should incent FCMs to hold additional capital, which is also likely to
be a significant cost.
When FCMs hold excess customer funds overseas, such funds will
likely be held at depositories that are themselves subject to foreign
insolvency regimes. These regimes may provide less effective
protections for customer funds than those applicable under U.S. law. By
prohibiting FCMs from holding some excess customer funds overseas, and
thereby reducing investment opportunities for customer funds, the
regulations may reduce the returns that FCMs can obtain on invested
customer funds.
And last, the requirements related to operational procedures are
likely to create significant costs, particularly related to creating
and documenting policies and procedures, as well as complying with
ongoing training, due diligence, and audit requirements. However, in
several cases the implementation costs of the changes should be minor.
For example, some proposed requirements should obligate FCMs to provide
the Commission and DSROs more regular access to information that FCMs
and their depositories are already required to maintain, or in some
cases are already reporting to their DSROs. The Commission also
anticipates that some of the changes proposed codify best practices for
risk management that many FCMs and DCOs may already follow. In such
cases, the costs of compliance would be mitigated by the compliance
programs or best practices that the firm already has in place.
Moreover, in other cases the changes codify practices that are already
required by SROs, and therefore would impose no additional costs.
The initial and ongoing costs of the rules for FCMs should vary
significantly depending on the size of each FCM, the policies and
procedures that they already have in place, and the frequency with
which they experience certain events that would create additional costs
under the rules. In the NPRM, the Commission estimated that the initial
operational cost \599\ of implementing the rules would be between
$193,000 and $1,850,000 per FCM.\600\ And the initial cost to the SROs
and DSROs would be between $41,100 and $63,500 per SRO or DSRO. The
Commission estimated

[[Page 68583]]

that the ongoing operational cost to FCMs would be between $287,000 and
$2,300,000 per FCM per year.\601\ As described below in Sec. 1.52, the
Commission did not have adequate information to determine the ongoing
cost of the proposed requirements for SROs and DSROs.
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\599\ The Commission was not able to quantify the costs that
would result from increased residual interest held in customer
segregated accounts, from increased capital held by the FCM, or from
lost investment opportunities due to restrictions on the amount of
funds that may be held overseas. The Commission did not have
sufficient data to estimate the amount of additional residual
interest FCMs are likely to need as a consequence of proposed, the
amount of additional capital they may hold for operational purposes,
the cost of capital for FCMs, or the opportunity costs FCMs may
experience because of restrictions on the amount of customer funds
they can hold overseas, each of which would be necessary in order to
estimate such costs.
\600\ The lower bound assumes an FCM requires the minimum
estimated number of personnel hours to be compliant with these new
rules and that, when possible, they already have policies,
procedures, and systems in place that would satisfy the proposed
requirements. The upper bound assumes an FCM requires the maximum
amount of personnel hours and do not have pre-existing policies,
procedures, and systems in place that would satisfy the proposed
requirements. The greatest amount of variation within in the range
would depend on the number of new depositories an FCM must establish
relationships with due to current depositories that would not be
willing to sign the required acknowledgment letter. The lower bound
assumes that an FCM does not need to establish any new relationships
with depositories. The Commission estimates that the largest FCMs
may have as many as 30 depositories, and as a conservative estimate,
the Commission assumes for the upper bound that an FCM would have to
establish new relationships with 15 depositories.
\601\ As above, the lower bound assumes that an FCM requires the
minimum estimated number of personnel hours to be compliant and that
for event-triggered costs, the FCM bears the minimum number of
possible events. The upper bound assumes an FCM requires the maximum
number of personnel hours to be compliant. It also assumes an FCM
has to notify the Commission pursuant to the proposed amendments in
Sec. 1.12 five times per year, and that an FCM withdraws funds from
residual interest for proprietary use 50 times per year. The
estimate does not include additional costs that would result if FCMs
increase the amount of residual interest or capital that they hold
in response to the proposed rules, or certain operational costs that
the Commission does not have sufficient information to estimate.
---------------------------------------------------------------------------

On a minor note, the rules also harmonize the definition of
leverage ratio reporting with the definition established by a
registered futures association.
In the sections that follow, the Commission provides its analysis
of cost benefit considerations including comments received, section by
section, in light of the relevant 15(a) public interest, cost-benefit
considerations.

Consideration of Costs and Benefits Section by Section

Section 1.3(rr)--Definition of ``Foreign Futures or Foreign Options
Secured Amount''
The Commission adopted an amendment to Sec. 1.3(rr) replacing the
term ``foreign futures or foreign options customers'' with the term
``30.7 customers.'' The former only included U.S.-domiciled customers,
whereas the term ``30.7 customers'' includes both U.S.-domiciled and
foreign-domiciled customers who place funds in the care of an FCM for
trading on foreign boards of trade. This change expanded the range of
funds that the FCM must include as part of the foreign futures or
foreign options secured amount.
In addition, the definition of ``foreign futures or foreign options
secured amount'' was amended so that it is equal to the amount of funds
an FCM needs in order to satisfy the full account balances of each of
its 30.7 customers at all times. This definitional change is necessary
to implement the conversion in Sec. 30.7 from the ``Alternative
Method'' to the ``Net Liquidating Equity Method'' of calculating the
foreign futures or foreign options secured amount.
Costs and Benefits
These definitional changes determine how much funds are considered
part of the ``foreign futures or foreign options secured amount.''
However, the costs and benefits of these changes are attributable to
the substantive requirements related to the definitions and, therefore,
are analyzed with respect to changes adopted to Sec. 30.7 and
discussed below.
Section 1.10--Financial Reports of Futures Commission Merchants and
Introducing Brokers
The Commission adopted amendments to Sec. 1.10 revising the Form
1-FR-FCM by establishing a new schedule called the ``Cleared Swap
Segregation Schedule'' that is included in the FCM's monthly report,
together with the Segregation Schedule and Secured Amount Schedule. The
amendments also provide that the Cleared Swap Segregation Schedule is a
public document.\602\ The Commission also amended the Segregation
Schedule and the Secured Amount Schedule to include reporting of the
FCM's target for residual interest in the accounts relevant to that
Schedule, as well as a calculation of any surplus or deficit in
residual interest with respect to that target. The Commission also
required each FCM to report to the Commission monthly leverage
information.
---------------------------------------------------------------------------

\602\ The Segregation Schedule and Secured Amount Schedule are
already public documents.
---------------------------------------------------------------------------

Costs and Benefits
In the NPRM, the Commission considered the amendments to Sec. 1.10
to have significant benefits to the protection of market participants,
namely, customers. The Commission anticipated that continuing the
public availability of the Segregation Schedule and the Secured Amount
Schedule, with the addition of the Cleared Swaps Segregation Schedule,
would be beneficial to customers in assessing the financial condition
of the FCMs with whom they choose to transact. The Commission posited
that FCMs would have competing incentives to set higher or lower
targeted residual amounts, but that public disclosure would enhance the
quality of the assessment of a reasonable targeted amount of residual
interest. The Commission stated that providing publicly the additional
information would permit customers to weigh this consideration, along
with considerations of price, in selecting an FCM, benefiting the
protection of market participants. The Commission also stated that
requiring FCMs to report their leverage to the Commission on a monthly
basis would assist the Commission in monitoring each FCM's overall risk
profile, which would help the Commission to identify FCMs that should
be monitored more closely for further developments that could weaken
their financial position, enhancing the protection of market
participants.
The Commission could not quantitatively estimate the cost of FCMs
having an incentive by public disclosure to hold higher targeted
residual amounts in customer segregated accounts. The Commission did
consider that qualitatively it expected that costs would be incurred as
a result, as a return available to FCMs on restricted investments
permissible under Sec. 1.25 would likely be lower than returns on
capital not restricted by being held as target residual amounts subject
to the investment requirements of Sec. 1.25, and public disclosure
would, other factors being equal, give an incentive to FCMs to hold a
larger target residual amount.
The Commission estimated quantitatively costs associated with
system modifications to produce additional reports for leverage. The
Commission did not receive comments regarding its quantitative
estimates of those costs or its qualitative analysis that costs would
be associated with the amendments to Sec. 1.10, particularly the
public disclosure of the Cleared Swaps Segregation Schedule and the
changes to the Segregation Schedule and Secured Amount Schedule to
include the targeted residual amount. Specifically, the Commission
received no comments regarding the assumption that the target residual
amount would in fact be higher once publicly disclosed, or as to what
forms or costs associated with any additional capital that may be
required following disclosure of the target residual amount, if any at
all. Nor did the Commission receive comments discussing the
quantitative spread difference between Sec. 1.25 investments compared
to investments that are not subject to Sec. 1.25. Without comment as
to these cost drivers, the Commission is unable to accurately estimate
these costs.
The Commission received a comment from NFA to consider an
alternative to the regulatory language proposed for leverage ratio
reporting to refer to the formulation of leverage established by a
registered futures association.\603\ The Commission, believing that
this alternative would have no detrimental impact on the benefits
anticipated from obtaining reporting of leverage, modified the language
in the final regulation to conform to the alternative

[[Page 68584]]

suggested by NFA. The alternative language in the final regulation will
permit the leverage reporting requirement to stay harmonized with NFA's
leverage reporting requirement as NFA has indicated it intends to
update and refine the formulation, which will continue to provide the
Commission with information necessary to monitor FCMs for the
protection of market participants.\604\
---------------------------------------------------------------------------

\603\ NFA Comment Letter at 8 (Feb. 15, 2013).
\604\ Id.
---------------------------------------------------------------------------

The Commission received numerous comments regarding the benefits of
the public disclosure of the Segregation Schedule, Secured Amount
Schedule, and Cleared Swaps Segregation Schedule, and the amounts of
the FCM's targeted residual interest.\605\ Many commenters reiterated
the utility of, and value to, customers of the public availability of
the schedules and financial condition information of FCMs.\606\
However, several FCMs commented, and FIA expressed concern, that the
information would not be useful to customers and would be difficult for
customers to understand without understanding all the factors involved
in setting a target residual amount.\607\ These commenters were
concerned that customers may, to their detriment, overweigh the
consideration of the targeted residual amount.\608\ These comments are
discussed in detail at section II.P. above.
---------------------------------------------------------------------------

\605\ See, e.g., SIFMA Comment Letter at 2 (Feb. 21, 2013); SUNY
Buffalo Comment Letter at 8 (Mar. 19, 2013); Vanguard Comment Letter
at 5-6 (Feb. 22, 2013).
\606\ Id.
\607\ See, e.g., FIA Comment Letter at 52 (Feb. 15, 2013); RJ
O'Brien Comment Letter at 6 (Feb. 15, 2013).
\608\ Id.
---------------------------------------------------------------------------

The Commission understands the concerns of both sets of commenters
but believes that the protection of market participants is enhanced in
this circumstance by the greater availability of public information,
particularly concerning customer funds, to customers and potential
customers. Notwithstanding the concerns of FIA and several FCMs
particularly questioning the benefits of the public availability of the
targeted residual amount, the Commission believes that public
disclosure--and consequent market discipline--is an important
counterweight to other FCM incentives with respect to establishing the
target. The Commission herein has adopted numerous measures increasing
disclosures to customers, believing, on balance, that additional
disclosures regarding customer funds in particular to have significant
benefits to the protection of market participants. Greater availability
of information may also provide additional confidence in the financial
integrity of futures markets.
Finally, the Commission, in its consideration of costs and benefits
for the amendments to Sec. 1.10, asked questions for particular
comments on the costs and benefits of making public daily segregation
and secured amount calculations, or other more frequent calculations,
and solicited comments on alternatives. Similar to the comments on the
public availability of the Segregation Schedule, Secured Amount
Schedule, and the Cleared Swaps Segregation Schedule, some commenters
supported and other commenters opposed the public availability of daily
margin segregation calculations.
The Commercial Energy Working Group noted, generally, that the
Commission's proposals for the publication of information would be a
cost-effective mechanism to make FCMs more accountable to their
customers.\609\ The Commercial Energy Working Group posited that
additional costs of publication of daily segregation calculations
should be nominal.\610\ There were no other specific comments on the
costs of making publicly available daily or more frequent information.
The Commission proposed requiring daily segregation disclosures in the
amendments adopted to Sec. 1.55, and the benefits of such disclosures
will be further discussed in that section, although the only comment
received as to the costs of such publication of information was as
discussed herein.
---------------------------------------------------------------------------

\609\ Commercial Energy Working Group Comment Letter at 2 (Feb.
12, 2013).
\610\ Id. at 3
---------------------------------------------------------------------------

The NFA commented that the Commission should consider the
alternative of directing customers to its BASIC system where certain
financial information on FCMs would be available in one place, as
opposed to requiring FCMs to publish financial information, including
the Segregation Schedule, Secured Amount Schedule, and Cleared Swaps
Segregation Schedule on their respective Web sites.\611\ NFA commented
that the Commission should carefully distinguish between categories of
information, as those meaningful to all customers which should be
readily available, meaningful to regulators but which may be sensitive
and subject to misinterpretation if made public, and meaningful to more
sophisticated customers that FCMs should be required to provide upon
request.\612\ The Commission believes enhanced benefits to the
protection of market participants and the financial integrity of
futures markets, and market discipline, are best achieved by the public
availability of the Segregation Schedules, Secured Amount Schedules,
and Cleared Swaps Segregation Schedules in their entirety on a monthly
basis, but also agrees with NFA's concern regarding the sensitivity of
information that may be readily available to regulators but not
publicly disclosed. The Commission does not agree that there may be a
benefit to distinguishing between categories of customers with respect
to public availability of information. The Commission agrees there
could be enhanced utility to customers by having schedules provided by
the NFA through its BASIC portal as an alternative, however, also notes
that NFA could implement this under the rule as adopted so long as the
schedules are required to be made publicly available and are not exempt
from public disclosure.
---------------------------------------------------------------------------

\611\ NFA Comment Letter at 15 (Feb. 15, 2013).
\612\ Id. at 16.
---------------------------------------------------------------------------

Section 1.11 Risk Management Program for Futures Commission Merchants
The Commission adopted new Sec. 1.11 requiring an FCM that carries
accounts for customers to establish a risk management unit that is
independent from the business unit handling customers or customer funds
and reports directly to senior management. In addition, each FCM must
establish and document a risk management program, approved by the
governing body of the FCM, that, at a minimum: (a) Identifies risks and
establishes risk tolerance limits related to various risks that are
approved by senior management; (b) includes policies and procedures for
detecting breaches of risk tolerance limits, and for reporting them to
senior management; (c) provides risk exposure reports quarterly and
whenever a material change in the risk exposure of the FCM is
identified; (d) includes annual review and testing of the risk
management program; and (e) meets specific requirements related to
segregation risk, operational risk, and capital risk.
Regarding segregation risk, each FCM must establish written
policies and procedures that require, at a minimum: (1) Documented
criteria for selecting depositories that would hold segregated funds;
(2) a program to monitor depositories on an ongoing basis; (3) an
account opening process that ensures the depository acknowledges that
funds in the account are customers' funds before any deposits are made
to the account, and that also ensures accounts

[[Page 68585]]

are titled appropriately; (4) a process for determining a residual
interest target for the FCM that involves due diligence from senior
management; (5) a process for the withdrawal of an FCM's residual
interest when such a withdrawal is not made for the benefit of the
FCM's customers; (6) a process for determining the appropriateness of
investing funds in Sec. 1.25 compliant investments; (7) procedures to
assure that securities and other non-cash collateral held as segregated
funds are properly valued and readily marketable and highly liquid; (8)
procedures that help to ensure appropriate separation of duties between
those who account for funds and are responsible for statutory and
regulatory compliance versus those who act in other capacities with the
company (e.g., those who are responsible for treasury functions); (9) a
process for the timely recording of all transactions; and (10) a
program for annual training of FCM employees regarding the requirements
for handling customer funds.
The new Sec. 1.11 requires automated financial risk management
controls that address operational risk, and written procedures
reasonably designed to ensure that an FCM has sufficient capital to be
in compliance with the Act and regulations and to meet its liquidity
needs for the foreseeable future.
Costs and Benefits
In the NPRM, the Commission provided a detailed discussion of the
significant benefits of the new risk management requirements for FCMs
to the protection of market participants and customer funds, sound risk
management, and directly as well as by extension, the financial
integrity of futures markets. Specifically, the Commission stated that
it considered the specific requirements of Sec. 1.11 to reduce the
negative impact of conflicts of interest on decision making relating to
customer funds, to result in stronger controls which could quickly
focus management attention on emerging risks and minimize the risk of a
breakdown in control at times of financial stress, and to promote more
formal responsibility and require specific accountability up the chain
of FCM management and governance for risk controls both generally and
specific to customer funds processes and procedures. Documentation
requirements for policies and procedures were considered beneficial to
promote Commission and SRO oversight of the tools chosen by FCMs in
putting the stronger controls in place, although the Commission also
determined that permitting flexibility with respect to the manner of
the policies and procedures would be beneficial to the efficiency of
FCMs in putting the new stronger and more rigorous requirements into
practice. The Commission considers the requirements adopted under Sec.
1.11 to be extremely important in eradicating the potential for poor
internal controls environments at FCMs, which could be susceptible to
fraud or operational error, which in turn could result in losses to
customer funds without clear and documented management accountability.
Documentation of the criteria for decision making and management
determinations with respect to choice of depositories, and other
management determinations impacting customer funds such as residual
interest and investment choices, as well as requiring periodic review
and testing of the risk management program, allows for an iterative
process with a clear purpose, the protection of customers and customer
funds, transparent to both Commission and SRO examination. Providing
clear factors which must be considered by FCMs in their adopted
practices, such as selection of depositories, was also considered by
the Commission to provide greater clarity to customers with respect to
determinations of significant consequence for customers, with a result
being likely enhanced market discipline coming from customers
evaluating FCMs. In many specific areas, the Commission considered the
requirements being adopted to greatly benefit risk management, the
protection of market participants and the financial integrity of
futures markets as the requirements would necessarily require FCMs to
improve internal management communication, internal controls,
management accountability, separation of duties, and training of
personnel in many respects. The Commission considered that FCMs were
already responsible under the Act and existing regulations for the
protection of customer funds. The adoption of Sec. 1.11 requires now
that FCMs develop written policies and procedures and put programs and
controls into practice, to ensure going forward that they have in place
consistent and reviewable processes to achieve the required outcomes
for protecting customers and customer funds. The Commission, in
adopting the rules, was however, cognizant that there would be
significant costs involved in compliance with Sec. 1.11, to the extent
that for some FCMs these processes and procedures were not already in
place or have no equivalent foundation. However, the Commission
considered an additional benefit to the requirements to be that there
would no longer be a competitive cost advantage to FCMs to not put in
place such important measures. Many FCMs are anticipated by the
Commission to already have in place strong internal controls and
practices similar to what is now specifically being required to be put
in place under Sec. 1.11, and those FCMs will not have to bear a
competitive disadvantage any longer for doing so with respect to
bearing the costs of such practices in order to adequately protect
customers. The Commission, cognizant of the significance of its
estimates of costs with respect to the requirements, adopted the
regulations in a manner that provides FCMs with flexibility in the
manner of adopting practices that fulfill the requirements. The
Commission did not receive specific comments on its quantitative
estimates of the initial and recurring costs of adopting Sec. 1.11.
The Commission did receive comments from several FCMs objecting to
the requirements of Sec. 1.11 to require the independence of risk
management from the business unit (defined to identify parties
responsible for customer business or dealing with customer funds or
supervising such lines of responsibility). RCG and Phillip Futures
cited the loss of a talent pool available to participate in risk
management as a negative consequence of the requirement.\613\ Phillip
Futures also recommended that the Commission consider as an alternative
that internal controls, senior leadership and training programs could
suffice in lieu of required separations between risk management and the
business unit.\614\ Phillip Futures contended that natural conflicts of
interest will always exist and can be mitigated by supervisory levels,
policies and procedures.\615\
---------------------------------------------------------------------------

\613\ RCG Comment Letter at 5 (Feb. 12, 2013); Phillip Futures
Comment Letter at 2 (Feb. 14, 2013).
\614\ Phillip Futures Comment Letter at 2 (Feb. 14, 2013).
\615\ Id.
---------------------------------------------------------------------------

CHS Hedging and RJ O'Brien cited the difficulty of a small or mid-
size FCM having a separate unit for risk management personnel, noting
it to be impracticable operationally or financially and not cost
effective.\616\ Frontier Futures generally commented that the costs
associated with requiring FCMs to increase risk management standards
for the purpose of protecting an FCM's customers from losses caused by
fellow customers, would be prohibitive to smaller FCMs being able

[[Page 68586]]

to continue operations, and is an area that FCMs were adept at and
already have a large incentive to properly manage.\617\ FIA asked for
clarification that Sec. 1.11 does not require formal structured risk
management units, provided that the FCM is able to identify all
personnel responsible for required risk management activities in order
to comply with the line reporting requirements and independence from
supervision by the business unit.\618\
---------------------------------------------------------------------------

\616\ CHS Hedging Comment Letter at 3 (Feb. 15, 2013); RJ
O'Brien Comment Letter at 9-10 (Feb. 15, 2013).
\617\ Frontier Futures Comment Letter at 2 (Feb. 14, 2013).
\618\ FIA Comment Letter at 55 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission understands the general concerns of commenters
regarding the costs of the requirements of Sec. 1.11, along with the
other new provisions being adopted herein by the Commission. The
Commission did provide clarity in section II.B. as requested by FIA,
which is intended to make clear the amount of flexibility available in
complying with the separation of duties of risk management adopted in
Sec. 1.11. However, the Commission notes that such separation as a
fixed requirement is particularly important to the protection of market
participants, as the Commission continues to believe conflicts of
interest to be a significant risk to the protection of customer funds
during periods of financial or operational stress absent such clear
reporting and accountability lines being established.
Section 1.12 Maintenance of Minimum Financial Requirements by Futures
Commission Merchants and Introducing Brokers
The changes to Sec. 1.12 alter the notice requirements so that it
is no longer acceptable to give ``telephonic notice to be confirmed, in
writing, by facsimile.'' Instead, all notices from FCMs must be made in
writing and submitted through an electronic submission protocol in
accordance with instructions issued or approved by the Commission
(currently, WinJammer).
In addition, the amendments to Sec. 1.12 require that if an FCM
has a shortfall in net capital, but is unable to accurately compute its
current financial condition, the FCM should not delay reporting the
under capitalization to the Commission. The FCM must communicate each
piece of information (knowledge of the shortfall and knowledge of the
financial condition of the FCM) to the Commission as soon as it is
known.
The Commission proposed requirements in paragraphs (i), (j), (k)
and (l) of Sec. 1.12 to identify additional circumstances in which the
FCM must provide immediate written notice to the Commission, relevant
SRO, and to the SEC if the FCM is also a BD. Those circumstances were:
(1) If an FCM discovers that any of the funds in segregated accounts
are invested in investments not permitted under Sec. 1.25; (2) if an
FCM does not have sufficient funds in any of its segregated accounts to
meet its targeted residual interest; (3) if the FCM experiences a
material adverse impact to its creditworthiness or ability to fund its
obligations; (4) whenever the FCM has a material change in operations
including changes to senior management, lines of business, clearing
arrangements, or credit arrangements that could have a negative impact
on the FCM's liquidity; and (5) if the FCM receives a notice,
examination report, or any other correspondence from a DSRO, the SEC,
or a securities industry SRO, the FCM must notify the Commission, and
provide a copy of the communication as well as a copy of its response
to the Commission. The Commission adopted the proposed additional
notification requirements with some changes in response to commenters,
narrowing the scope of certain of the new notification requirements.
Last, the Commission adopted a new paragraph (n) of Sec. 1.12 that
requires that every notice or report filed with the Commission pursuant
to Sec. 1.12 include a discussion of how the reporting event
originated and what steps have been, or are being taken, to address the
event.
Costs and Benefits
The benefits of requiring that notice to the Commission be given in
written form via specified forms of electronic communication not only
adapt the rule to account for modern forms of communication, but also
reduce the possibility of notification being delayed in reaching
appropriate Commission staff. Ensuring that important regulatory
notices go directly through electronic systems will result in
appropriate staff being alerted as soon as possible and that there are
no unnecessary delays to regulatory attention to the notice, which
should benefit the protection of market participants and the financial
integrity of futures markets, potentially significantly depending on
the importance of the issue being addressed.
For example, with respect to the adopted change in Sec.
1.12(a)(2), if an FCM knows that it does not have adequate capital to
meet the requirements of Sec. 1.17 or other capital requirements, and
is also not able to calculate or determine its financial condition, it
is likely that the FCM is in a period of extraordinary stress. In these
circumstances, time is of the essence for the solvency of the FCM and
for the protection of its customers and counterparties. Therefore, it
is important that the Commission, DSRO, and SEC (if the FCM is also a
BD) be notified immediately so that they can begin assessing the FCM's
condition, and if necessary, make preparations to allow the transfer of
the customers' positions to another FCM in the event that the FCM
currently holding those positions has insufficient regulatory capital.
These preparations help to ensure that the customers' funds are
protected in the event of the FCM's default, and that the positions of
its customers are transferred expeditiously to another FCM where those
customers may continue to hold and control those positions without
interruption.
The situations enumerated as adopted in Sec. 1.12(i) and (j) are
more specific indicators of potential or existing problems in the
customer segregated funds accounts. Notifying the Commission in such
circumstances enables it to monitor steps the FCM is taking to address
a shortfall in targeted residual interest, or to direct the FCM as it
takes steps to address improperly invested segregated funds. In either
case, the Commission will be able to closely monitor the FCM's actions,
benefiting the continued protection of customer segregated funds.
The Commission also asked questions in the NPRM regarding whether
public availability of Sec. 1.12 notices would enhance customer
protection, but did not propose to make the notifications public as it
did other additional disclosures relevant to customer funds, such as
the various segregation schedules. Comments were received both in favor
of and in opposition to public availability. One commenter, FHLB,
posited that the costs of public availability would be negligible
because the reporting would already be done and be done electronically,
and the benefit substantial, so that the Commission should require
public availability.\619\ However, other commenters, including RJ
O'Brien and FIA, raised concerns about potential detrimental market
impacts on FCMs from the public availability of Sec. 1.12 notices, at
odds with FHLB's assertion that FCMs could not be impacted by a ``run
on the bank'' scenario and that costs would be negligible, with RJ
O'Brien believing a main risk of public availability being precisely a
possibly disorderly and erroneous ``run on the bank'' scenario.\620\
---------------------------------------------------------------------------

\619\ FHLB Comment Letter at 3 (Feb. 15, 2013).
\620\ FIA Comment Letter at 37 (Feb. 15, 2013); RJ O'Brien
Comment Letter at 10 (Feb. 15, 2013).

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[[Page 68587]]

The Commission, although in most circumstances believing there to
be substantial benefits to greater availability of public information
concerning segregated funds, declined to adopt any requirement for
public availability of Sec. 1.12 notices, weighing the comments
received, and recognizing an additional benefit to maintaining
equivalence of treatment with the SEC for joint registrants, whose
similar notices are not made public. The Commission agrees that the
risk of the possibility of a disorderly ``run on the bank'' scenario
from Sec. 1.12 notices being made immediately public would be too
great relative to the benefit of such publication. The possibility of
that result could exacerbate a potentially solvable problem at an FCM
and not result in the best protection of market participants. The
Commission is adopting other types of additional customer disclosures
required of FCMs under Sec. 1.55, which it believes are more
beneficial to the protection of customers and appropriate to the
disclosure purposes than the public availability of Sec. 1.12 notices.
The situations enumerated that were proposed in Sec. 1.12(k)
through (l) are circumstances indicating that the FCM is undergoing
changes that could indicate or lead to financial strain. Alerting the
Commission and relevant SROs in such circumstances will benefit the
protection of market participants by fostering their ability to monitor
such FCMs more closely in order to ensure that any developing problems
are identified quickly and addressed proactively by the FCM with the
oversight of the Commission and the relevant SROs. In response to
commenters who proposed alternatives, believing the proposals to be
overly broad and difficult to clearly comply with, the Commission
adopted the requirements but narrowed and provided additional detail
for the circumstances under which such notices would be required. The
Commission believes the requirements as adopted continue to provide the
intended benefits to the protection of market participants.
The proposed Sec. 1.12(m) requirement that the FCM notify the
Commission whenever it receives a notice or results of an examination
from its DSRO, the SEC, or a securities-industry SRO, was intended to
ensure that the Commission is aware of any significant developments
affecting the FCM that have been observed or communicated by other
regulatory bodies. Such communications could prompt the Commission to
heighten its monitoring of specific FCMs, or create an opportunity for
the Commission to work collaboratively and proactively with other
regulators and self-regulatory organizations to address any concerns
about how developments in the FCM's business could affect customer
funds.
The Commission adopted Sec. 1.12(m), with changes to address the
requests of commenters that the scope of the requirement needed to be
narrowed in order to provide the benefit intended without potentially
overly burdensome costs. TD Ameritrade, in particular, commented that
the volume of its filings with securities regulators would make the
Sec. 1.12(m) requirement both overly costly with respect to the
intended benefit, and also not likely to result in the benefit as
intended.\621\ The Commission believes the narrowed language adopted
for Sec. 1.12(m) should appropriately address the comment and provide
the benefit intended without overly burdensome costs.
---------------------------------------------------------------------------

\621\ TD Ameritrade Comment Letter at 3 (Feb. 15, 2013).
---------------------------------------------------------------------------

The requirement that notifications to the Commission pursuant to
Sec. 1.12 include a discussion of what caused the reporting event and
what has been, or is being done about the event, would provide
additional information to Commission staff that would help them quickly
gauge the potential severity of related problems that have been or are
developing at the reporting FCM, IB, or SRO. The benefit of requiring
the additional information is that it will assist Commission or SRO
staff in determining whether the situation is likely to be corrected
quickly or to continue deteriorating. Commission staff may be best able
to protect market participants with appropriate and timely
intervention, with more information received initially regarding how a
potential regulatory problem is being handled.
The Commission made quantitative estimates of costs for the
amendments to Sec. 1.12 in the NPRM, including the new notice
requirements, the additional information required to be included in
notices, and monitoring that would be necessary in order for FCMs to
submit notices and received no comments specific to those estimates.
The Commission estimated the costs of requiring electronic filing of
notices for FCMs to be negligible as the filing system is already in
place, and received no comment on that estimate. The Commission asked
specific questions regarding costs for the additional notice
requirements and did not receive any response to such questions from
commenters.
Section 1.16 Qualifications and Reports of Accountants
The adopted changes to Sec. 1.16 require that in order for an
accountant to be qualified to conduct an audit of an FCM, the
accountant would have to be registered with the PCAOB, and have
undergone inspection by the PCAOB. In addition, the amendments also
would require that the governing body of the FCM ensure that the
accountant engaged for an audit is duly qualified, and specifies
certain qualifications that must be considered when evaluating an
accountant for such purpose. Finally, the amendments require the public
accountant to state in the audit opinion that the audit was conducted
in accordance with the auditing standards adopted by the PCAOB.
Costs and Benefits
The Commission adopted amendments to Sec. 1.16 primarily to obtain
the benefits of quality control and oversight of accountants and higher
standards to apply to certified audits of FCMs, for the greater
protection of market participants, and to increase the financial
integrity of futures markets. In at least one circumstance of FCM
failure, which was an impetus for the package of additional protections
to customer funds contained in the Proposal, the experience and quality
of the FCM auditor contributed to the audit failure and the inability
of an audit to be an effective additional check on the compliance and
financial integrity of FCMs and customer funds.\622\
---------------------------------------------------------------------------

\622\ See In the Matter of Jeannie Veraja-Snelling, CFTC Docket
No. 13-29, available at https://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfverajaorder082613.pdf.
---------------------------------------------------------------------------

The Commission also considers the newly adopted requirement for the
governing body of the FCM to have accountability for assessing auditor
qualifications to be an appropriate tool to ensure responsibility for a
lack of conflicts, true independence and a quality audit by experienced
auditors to be connected back to the FCM's governing body and to be
clearly understood to be a responsibility of that governing body. The
Commission believes this enhanced accountability will benefit the
protection of market participants and promote the financial integrity
of futures markets by contributing to ensuring audit quality of FCMs.
In the NPRM, the Commission did not quantitatively estimate costs
associated with the amendments to Sec. 1.16, however, it qualitatively
considered the

[[Page 68588]]

likelihood that PCAOB registered accountants would be expected, all
else being equal, to have higher audit fees, thereby incurring
additional costs. The Commission requested, but did not receive,
quantitative information from commenters to better assess these costs.
However, the Commission did receive several comments regarding the
proposed amendments to Sec. 1.16 and the Commission altered some of
the proposed Sec. 1.16 requirements in response to such comments, as
discussed in section II.E. above.
One commenter, the AICPA, proposed that the Commission consider a
practice monitoring program, such as the AICPA peer review, as an
alternative to the PCAOB inspection requirement.\623\ The AICPA stated
it did not believe the PCAOB inspection requirement would have the
benefit of enhancing audit engagements in situations where inspections
are not required (i.e., non-issuer FCMs).\624\ The Commission does
believe the PCAOB inspection requirement will enhance audit quality
over time, particularly as inspections become required for the audits
of SEC registered BDs.
---------------------------------------------------------------------------

\623\ AICPA Comment Letter at 3 (Feb. 11, 2013).
\624\ Id. at 2-3.
---------------------------------------------------------------------------

However, in considering the practical impediments to registering
and becoming inspected by the PCAOB, the Commission made several
clarifications in adopting the amendments.\625\ Most notably, the
Commission extended the compliance date for inspection by the PCAOB
until December 31, 2015. As noted above in section II.E., based on the
Commission's most recent review, currently there are only seven CPA
firms (auditing fifteen FCMs) that would not meet this requirement. Six
of those firms are registered with the PCAOB as and indicate that they
will be subject to the PCAOB BD inspection program and will presumably
receive a PCAOB inspection in the future. Therefore, the Commission is
adopting the inspection requirement as proposed but has extended the
compliance date to December 31, 2015 in order to provide additional
time for accountants to be subject to PCAOB inspections.
---------------------------------------------------------------------------

\625\ See additional discussion at section II.E. above.
---------------------------------------------------------------------------

The Commission received no comments addressing costs associated
with an anticipated increase in audit fees for PCAOB registration. Nor
did the Commission receive comment as to any increased costs associated
with becoming PCAOB registered. Nonetheless, the Commission believes
that currently only one FCM audit firm is not PCAOB registered, and
would therefore be required to register to continue to conduct audits
of FCMs. Currently, a public accountant that audits less than 49 public
issuers is required to pay the PCAOB a registration fee of $500.\626\
Annual fees for public accountants with less 200 issuers also are $500
per year.\627\ Therefore, any costs associated with registering the one
and only existing accounting firm which would not be in compliance, or
any firm in the future that will need to register with the PCAOB, will
be nominal.
---------------------------------------------------------------------------

\626\ See https://pcaobus.org/Registration/rasr/Pages/AnnualFees.aspx.
\627\ Id.
---------------------------------------------------------------------------

Section 1.17 Minimum Financial Requirements for Futures Commission
Merchants and Introducing Brokers
Section 4f(b) of the Act provides that no person may be registered
as an FCM unless such person meets the minimum financial requirements
that the Commission has established by regulation. The Commission's
minimum capital requirements for FCMs are set forth in Sec. 1.17
which, among other things, provides that an FCM must cease operating as
an FCM and transfer its customers' positions to another FCM if the FCM
is not in compliance with the minimum capital requirements, or is
unable to demonstrate its compliance with the minimum capital
requirements. The Commission proposed to amend Sec. 1.17 by adding a
new provision that will authorize the Commission to require an FCM to
cease operating as an FCM and transfer its customer accounts if the FCM
is not able to certify and demonstrate sufficient access to liquidity
to continue operating as a going concern. Additionally, FCMs that are
also registered BDs will be allowed to use the SEC's BD approach \628\
to evaluate the credit risk of securities that the FCM invests in and
assign smaller haircuts \629\ to those that are deemed to be a low
credit risk.\630\ The Commission's amendment to Sec. 1.17(c)(5)(v)
allows FCMs that are not dual registrants to use the same approach.
Finally, the Commission has adopted amendments revising the period of
time that an FCM is permitted to wait before taking an undermargined
capital charge from three business days after the call is issued on a
customer's account to one business day, and from two business days
after the call is issued on a noncustomer or omnibus account to one
business day.
---------------------------------------------------------------------------

\628\ Under the SEC proposal, a BD may impose the default
haircuts of 15 percent of the market value of readily marketable
commercial paper, convertible debt, and nonconvertible debt
instruments or 100 percent of the market value of nonmarketable
commercial paper, convertible debt, and nonconvertible debt
instruments. A BD, however, may impose lower haircut percentages for
commercial paper, convertible debt, and nonconvertible debt
instruments that are readily marketable, if the BD determines that
the investments have only a minimal amount of credit risk pursuant
to its written policies and procedures designed to assess the credit
and liquidity risks applicable to a security. A BD that maintains
written policies and procedures and determines that the credit risk
of a security is minimal is permitted under the SEC proposal to
apply the lesser haircut requirement currently specified in the SEC
capital rule for commercial paper (i.e., between zero and \1/2\; of
1 percent), nonconvertible debt (i.e., between 2 percent and 9
percent), and preferred stock (i.e., 10 percent).
\629\ In computing its adjusted net capital, an FCM is required
to reduce the value of proprietary futures and securities positions
included in its liquid assets by certain prescribed amounts or
percentages of the market value (otherwise known as ``haircuts'') to
discount for potential adverse market movements in the securities.
\630\ The adoption of the Commission's rule is conditional upon
the SEC adoption as final its proposed rule to eliminate references
to credit ratings.
---------------------------------------------------------------------------

Costs and Benefits
In the NPRM, the Commission provided a detailed discussion of the
benefits the changes to Sec. 1.17 would provide. Regarding the
potential transfer of customer accounts if the FCM was unable to
certify and demonstrate sufficient access to liquidity to continue
operating as a going concern, several commentators stated that the
Commission should not adopt the rule before clearly articulated
objective standards were established and exigent circumstances that
would give the Commission authority to require an FCM to cease
operating were defined. The Commission understands the concerns of
commenters regarding the process by which the Commission, or the
Director of the Division of Swap Dealer and Intermediary Oversight
acting pursuant to delegated authority under Sec. 140.91(6), could
require immediate cessation of business as an FCM and the transfer of
customer accounts.
However, that same authority currently exists should a firm fail to
meet its minimum capital requirement. The Commission believes the
ability to certify, and if requested, demonstrate with verifiable
evidence, sufficient liquidity to operate as a going concern to meet
immediate financial obligations, is a minimum financial requirement
necessary to ensure an FCM will continue to meet its obligations as a
registrant under the Act. Moreover, because liquidity difficulties will
not be made transparent to the FCM's customers pursuant to 1.12, it is
especially important that the Commission be permitted to act.

[[Page 68589]]

Regarding the proposed amendment to Sec. 1.17(c)(5)(v) revising
the capital charge (or haircut) procedures for FCMs, the Commission
notes that it only impacts FCMs that are not dual registrants. Because
FCMs that are not dual registrants do not typically invest in
securities that would be subject to reduced haircuts under the SEC's
proposed rules, the change should not have a significant impact on the
capital requirements for such FCMs. The CFA believes that capital
models should be established by the relevant regulatory agencies for
use by FCMs or BDs and has serious concerns that internal models used
for calculating minimum capital requirements are prone to failure in
crisis.\631\ The Commission appreciates the CFA's concerns, however,
the Commission notes that for securities positions, Sec. 1.17
incorporates by reference the securities haircuts that a BD is required
to take in computing its net capital under the SEC's regulations.\632\
This is a result of the Commission's determination to defer to the SEC
in areas of its expertise, specifically with respect to market risk and
appropriate haircuts on securities positions.\633\ For FCMs that are
dually-registered as BDs, any changes adopted by the SEC to these
securities haircuts will be applicable under Sec. 1.17(c)(5)(v) unless
the Commission specifically provides an alternate treatment for
FCMs.\634\ The Commission's amendment merely allows FCMs that are not
dual registrants to follow the same rules as those that are dual
registrants. This change would harmonize the regulation of FCMs with
respect to minimal financial requirements and would place FCMs that are
not dual registrants on a more level playing field with those that are
dual registrants, which improves the competition between FCMs. The FCMs
that use their own internal models will also be subject to review by
regulators, including the SEC, SROs, or securities SROs.
---------------------------------------------------------------------------

\631\ CFA Comment Letter at 4-5 (Feb. 13, 2013).
\632\ Commission Regulations 1.17(c)(5)(v) and 1.32(b) both
incorporate 17 CFR 240.15c3-1(c)(2)(vi) by reference.
\633\ See 43 FR 15072, 15077 (Apr. 10, 1978) and 43 FR 39956,
39963 (Sept. 8, 1978).
\634\ See discussion adopting Sec. 1.17(c)(5)(vi) for options
haircuts, with respect to the applicability of provisions
incorporating by reference and referring to the rules of the SEC for
securities broker dealers also registered as futures commission
merchants. 43 FR 39956, 39964.
---------------------------------------------------------------------------

Regulation 1.17(c)(5)(viii) required an FCM to take a capital
charge if a customer account is undermargined for three business days
after the margin call is issued. Likewise, Sec. 1.17(c)(5)(ix)
required an FCM to take a capital charge for noncustomer and omnibus
accounts that are undermargined for two business days after the margin
call is issued. These timeframes were appropriate when the capital
rules were adopted in the 1970s, when the use of checks and the mail
system were more prevalent for depositing margin with an FCM. They are
obsolete, however, in today's markets with the use of wire transfers to
meet margin obligations. Therefore, the Commission has amended Sec.
1.17(c)(5)(viii) and (ix) to require an FCM to take capital charges for
undermargined customer, noncustomer, and omnibus accounts that are
undermargined for more than one business day after a margin call is
issued.
FIA stated that while institutional and many commercial market
participants generally meet margin calls by means of wire transfers,
the proposal creates operational problems because it does not consider
delays arising from accounts located in other time zones that cannot
settle same day, or ACH settlements, or the requirement to settle or
convert certain non-U.S. dollar currencies.\635\ FIA also stated that a
substantial number of customers that do not have the resources of large
institutional customers (in particular members of the agricultural
community) depend on financing from banks to fund margin requirements,
which may require more than one day to obtain.\636\
---------------------------------------------------------------------------

\635\ FIA Comment Letter at 26 (Feb. 15, 2013).
\636\ Id.
---------------------------------------------------------------------------

RJ O'Brien objected to the proposed amendment because many
customers that use the markets to hedge commercial risk still meet
margin calls by check or ACH because of the impracticality and
costliness of wire transfers to their circumstances.\637\ RJ O'Brien
stated that in many cases, the costs of a wire transfer would exceed
the transaction costs paid by the client to its FCMs, and additionally,
that some customers in the farming and ranching community finance their
margin calls, which can require additional time to arrange for delivery
of margin call funds due to routine banking procedures.\638\ RJ O'Brien
also stated that if the proposal is adopted, FCMs that service non-
institutional clients will struggle to remain competitive and the
proposal may result in fewer clearing FCMs and greater systemic risk to
the marketplace.\639\ RJ O'Brien further stated that a loss of such
smaller FCMs will result in fewer options available to these ranchers,
farmers and other commercial market participants that wish to hedge
their commercial risks.\640\
---------------------------------------------------------------------------

\637\ RJ O'Brien Comment Letter at 3-4 (Feb. 15, 2013).
\638\ Id.
\639\ Id.
\640\ Id.
---------------------------------------------------------------------------

Other commenters expressed the general concern that the proposal
will harm the customers it is meant to protect by requiring more
capital to be kept in customer accounts, possibly forcing users to hold
funds at FCMs well in excess of their margin requirements.\641\ Those
commenters argued that such pre-funding could add significant financial
burdens to trading as customers find themselves having to provide
excess funds to their brokers which could increase their risk with
regard to the magnitude of funds potentially at risk in the event of
future FCM insolvencies.\642\ The commenters generally expressed
significant concerns that reducing margin calls to one day will harm
many customers as: (1) Many small businesses, farmers, cattle producers
and feedlot operators routinely pay by check and forcing them to use
wire transfers increases their cost of doing business; (2) clients who
make margin calls by ACH payments instead of wire transfers because ACH
is cheaper, would no longer be able to do so because there is a one-day
lag in availability of funds; and (3) foreign customers would not be
able to make margin calls due to time zone differences, the time
required to convert certain non-USD currencies, and for whom banking
holidays fall on different days.\643\
---------------------------------------------------------------------------

\641\ NPPC Comment Letter at 2 (Feb. 14, 2013); NGFA Comment
Letter at 3 (Feb. 15, 2013); NEFI/PMAA Comment Letter at 3 (Jan. 14,
2013); AIM Comment Letter at 15 (Jan. 24, 2013); Amarillo Comment
Letter at 1 (Feb. 14, 2013); NCFC Comment Letter at 1 (Feb. 15,
2013); NFA Comment Letter at 12-13 (Feb. 15, 2013); FCStone Comment
Letter at 3 (Feb. 15, 2013); Advantage Comment Letter at 1-2 (Feb.
15, 2013); AFBF Comment Letter at 2 (Feb. 15, 2013); CCC Comment
Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5 (Feb. 15,
2013); AIM resubmitted the comment letters of Premier Metal
Services, NEFI/PMAA, and the ISRI and indicated its support for the
recommendations therein (Jan. 14, 2013).
\642\ Id.
\643\ Id.
---------------------------------------------------------------------------

The CCC stated that the proposed amendment to the capital rule
places an undue burden on the FCMs, which will likely result in FCMs
demanding that customers prefund trades to prevent market calls and
potential capital charges.\644\ The CCC also stated that the proposal
could result in forced liquidations of customer positions to ensure
that the FCM does not incur a capital charge.\645\
---------------------------------------------------------------------------

\644\ CCC Comment Letter at 2-3 (Feb. 15, 2013).
\645\ Id.
---------------------------------------------------------------------------

FIA and RJ O'Brien suggested alternatives to the Commission's

[[Page 68590]]

proposal. Both FIA and RJ O'Brien offered that an FCM be required to
take a capital charge for any customer margin deficit exceeding
$500,000 that is outstanding for more than one business day.\646\ FIA
further suggested that if the customer's margin deficit is $500,000 or
less, the FCM should take a capital charge if the margin call is
outstanding two business days or more after the margin call is
issued.\647\ RJ O'Brien also stated that the Commission should provide
at least a one year period of time for any changes to the timeframe for
taking a capital charge for undermargined accounts to be effective, and
that the Commission should require futures exchanges to increase their
margin requirements to 135% of maintenance margin to reduce the number
and frequency of margin calls.\648\
---------------------------------------------------------------------------

\646\ FIA Comment Letter at 27 (Feb. 27, 2013); RJ O'Brien
Comment Letter at 4 (Feb. 15, 2013).
\647\ FIA Comment Letter at 27 (Feb. 15, 2013).
\648\ RJ O'Brien Comment Letter at 4 (Feb. 15, 2013).
---------------------------------------------------------------------------

The NFA and FIA stated that if the Commission adopts the amendments
regarding residual interest as proposed, then the Commission should
consider whether a capital charge for undermargined accounts remains
necessary at all because the FCM will have already accounted for an
undermargined account by maintaining a residual interest sufficient at
all times to exceed the sum of all margin deficits; hence the capital
charges related to an undermargined account appear to impose an
additional financial burden without any necessary financial
protection.\649\
---------------------------------------------------------------------------

\649\ NFA Comment Letter at 13 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission has considered the comments and is adopting the
amendments to Sec. 1.17(c)(5)(vii) and (ix) as proposed. The revised
regulation will provide the intended benefits to customers and the
marketplace. Commenters have stated that the proposal would increase
customer costs by requiring the prefunding of margin calls, which will
also potentially expose more customer funds to FCM control. Commenters,
however, did not provide any quantitative estimates or provide any
substantive analysis in support of their statements. In addition, the
Commission notes that much of this argument is based on the assumption
that FCMs would not be able to support the additional capital charge
through their existing excess capital. In addition, many FCMs utilize a
variety of funding sources from which additional capital may be
obtained, if required, and therefore costs could vary significantly
from one FCM to another FCM. Without quantitative estimates as to how
much excess capital FCMs typically maintain, would be required to
maintain, or the difference of these costs in relation to aged margin
calls between one and three days, the Commission cannot quantify any
increase in costs associated with this amendment.
Moreover, the Commission believes that the benefits of the final
regulation will enhance the protection of the markets and customers.
The Commission notes that the timely collection of margin is a critical
component of an FCM's risk management program and is intended to ensure
that an FCM holds sufficient funds deposited by account owners to meet
potential obligations to a DCO. As guarantor of the financial
performance of the customer accounts that it carries, the FCM is
financially responsible if the owner of an account cannot meet its
margin obligations to the FCM and ultimately to a DCO.
Regulation 39.13(g)(2) requires that a sufficient amount of funds
is maintained in an account to cover 99 percent of the observed market
moves over a specified period of time. Customers that maintain fully
margined accounts are exposed to greater risk to the safety of their
funds if some of the accounts of their fellow customers are
undermargined. The intent of the proposed amendment is to encourage an
FCM to require customers to promptly fund margin deficiencies, or to
reserve a sufficient amount of capital to cover the amount of the
deficiencies. As a consequence, the risk that a debit balance could
develop in a customer's account due to tardy margin call payments would
be reduced, and the amount of residual interest that the FCM would need
to maintain in the segregated accounts in order to protect against the
possibility that such debit balances could cause them to have less that
is required in their segregated accounts would also be reduced. This
provides benefits for the FCM by reducing the amount of capital that it
must contribute to the customer segregated accounts. Customers also
benefit by FCMs requiring more prompt payments on undermargined
accounts, as it is less likely that FCMs would close out the positions
of customers failing to meet margin obligations more quickly, reducing
the potential losses that would be passed on to non-defaulting
customers in the event of a default of a customer and a default of a
clearing member.
Section 1.20 Futures Customer Funds To Be Segregated and Separately
Accounted for
The amendments to Sec. 1.20 reorganize the section and alter the
substance of the section's requirements in certain places.
The final Sec. 1.20 includes Appendix A and Appendix B, which set
forth the Template Letters for the written acknowledgments that FCMs
and DCOs, respectively, must obtain from any depository with which they
open an account to hold futures customer funds. The rule requires FCMs
and DCOs to use the applicable Template Letter to obtain the required
acknowledgment before depositing any funds with a depository.
Regulation 1.20 also requires FCMs, DCOs, and depositories to file the
written acknowledgment with the Commission within three business days
of executing the letter, and to update the written acknowledgment
within 120 days of any changes to the business name, address, or
account numbers referenced in the letter.
The Commission received 15 comment letters related to the proposed
acknowledgment letter requirements. Some commenters addressed the costs
and benefits associated with these requirements; none of them, however,
provided any data to aid the Commission in estimating costs. In the
sections that follow, the Commission considers the benefits and costs
arising from the adoption of the acknowledgment letter requirements.
The Commission also discusses the corresponding comments accordingly.
Benefits
Regulation 1.20(d)(2) requires an FCM to use the Template Letter in
Appendix A to obtain a written acknowledgment from any depository that
holds futures customer funds. A depository accepting customer funds is
required to: (1) Acknowledge that the funds are customer segregated
funds subject to section 4d of the Act and the Commission's regulations
thereunder; (2) acknowledge and agree that the funds cannot be used to
secure any obligation of the FCM to the depository or used by the FCM
to secure or obtain credit from the depository; (3) agree to reply
promptly and directly to any request from the Commission or the FCM's
DSRO for confirmation of account balances or provision of any other
information regarding or related to an account; (4) agree that the
depository will allow the Commission and the FCM's DSRO to examine the
accounts at any reasonable time; and (5) acknowledge and agree that the

[[Page 68591]]

depository will provide the Commission with technological connectivity
necessary to permit read-only electronic access to the accounts.
Regulation 1.20(g)(4) requires a DCO to use the Template Letter in
Appendix B to obtain a written acknowledgment from any depository that
holds futures customer funds. The DCO Template Letter is largely the
same as the FCM Template Letter except that: (1) It does not require
read-only electronic access; and (2) it does not require the depository
to agree to Commission or DSRO examination of customer accounts.
These acknowledgments and commitments would result in important
benefits. First, by acknowledging that the funds are subject to the Act
and CFTC regulations, the depository recognizes that it must comply
with relevant statutory and regulatory requirements related to its
handling of those funds. Second, the depository acknowledges that
neither the FCM (or DCO) nor the depository is permitted to use
customer funds as belonging to any person other than the customer which
deposited them, i.e., an FCM or DCO cannot use customer funds to secure
its obligations to the depository. Third, the Template Letter for FCMs
constitutes written permission by the depository to allow Commission or
DSRO officials to examine the FCM's customer accounts at any reasonable
time and to provide the Commission with read-only electronic access to
those accounts. As a consequence, the Template Letters would enable
both the Commission and the DSRO to monitor actual balances at the
depository more readily. This would help to ensure that any discrepancy
between balances reported by the FCM on its daily customer segregation
account reports and balances actually held by the depository would be
identified quickly by the Commission or the DSRO. Moreover, with the
explicit agreement from the depository permitting the examination of
customer segregated accounts, both the Commission and DSRO would be
better able to move quickly to resolve a problem.
By requiring FCMs and DCOs to submit copies of the executed
Template Letters to both the Commission and, as applicable, an FCM's
DSRO, the Commission and DSROs would be better able to act quickly to
protect customer funds because the necessary legal permissions will be
in place. In addition, the Template Letters provide account information
such as account numbers, essential for management of an FCM or DCO
bankruptcy situation. Also, requiring that the Template Letters be
retained for five years past the time when customer segregated funds
are no longer held by a depository helps ensure that proper
documentation of all relevant acknowledgments and commitments is in the
possession of each party that relies upon the existence of those
commitments.
Commenters were generally supportive of adopting the Template
Letters. The Depository Bank Group stated that ``the acknowledgment
letters will help to facilitate a more efficient process for the
establishment and maintenance of customer segregated accounts by FCMs
and DCOs and serve to clarify the rights and responsibilities of
depository institutions holding customer segregated funds.'' \650\
Eurex expressed their appreciation for ``the potential convenience and
increases in certainty and transparency that such a standardized
approach would likely afford.'' \651\ CME stated its support for ``the
Commission's efforts to strengthen and standardize the form of
acknowledgment letters.'' \652\
---------------------------------------------------------------------------

\650\ Depository Bank Group Comment Letter at 2 (Feb.15, 2013).
\651\ Eurex Comment Letter at 1 (Aug. 1, 2013).
\652\ CME Comment Letter at 7 (Feb. 15, 2013).
---------------------------------------------------------------------------

Costs
To date, FCMs and DCOs have negotiated each acknowledgment letter
with depositories; accordingly, the use of standardized non-negotiable
language in the Template Letter may result in cost savings. However,
FCMs and DCOs are likely to bear some initial and ongoing costs as a
result of the requirement to use the Template Letters. Regarding
initial costs, some depositories may not be willing to sign the
Template Letter, which would require the FCM or DCO to move any
customer funds held by that depository to a different depository,
creating certain due diligence and operational costs. These cost
concerns were discussed in the comment letters from MGEX and RCG.\653\
---------------------------------------------------------------------------

\653\ MGEX Comment Letter at 3 (Feb. 18, 2013) and RCG Comment
Letter at 7 (Feb. 12, 2013).
---------------------------------------------------------------------------

In the NPRM, the Commission estimated that the cost of obtaining a
new acknowledgment letter from each existing depository is between
$1,300 and $4,200.\654\ The Commission estimated that FCMs and DCOs
would have approximately 1 to 30 depositories each, from which they
would need to obtain a new acknowledgment letter. Therefore, the
Commission estimated that the cost of obtaining new acknowledgment
letters from existing depositories would be between $2,700 and $82,000
per FCM or DCO.\655\ In addition, the Commission estimated that the
process of identifying new potential depositories, conducting necessary
due diligence, formalizing necessary agreements, opening accounts, and
transferring funds to a new depository would likely take between three
to six months and would likely require support from compliance
attorneys, as well as operations, risk management, and administrative
personnel. In the NPRM, the Commission estimated that the cost of
moving accounts from an existing depository that is not willing to sign
the letter would be between $50,000 and $102,000.\656\
---------------------------------------------------------------------------

\654\ This estimate assumed 10-40 hours of time from a
compliance attorney and 10-20 hours from an office services
supervisor. The average compensation for a compliance attorney is
$85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35
per hour]; $85.35*10 = $853.47 and $85.35*40 = $3,413.88. The
average compensation for an office services supervisor is $40.15/
hour [$61,776.00 per year/(2000 hours per year)*1.3 is $40.15 per
hour]; $40.15*10 = $401.54 and $40.15*20 = $803.09. These figures
were taken from the 2011 SIFMA Report on Management and Professional
Earnings in the Securities Industry.
\655\ Total figures are taken from previous calculation.
($1,255.01+$4,216.97)/2 = $2,735.99; $2,735.99*1 = $2,735.99 and
$2,735.99*30 = $82,079.69.
\656\ This estimate assumed one compliance attorney working
full-time for 3-6 months, 50-200 hours from an office services
supervisor, 80-160 hours of time from a risk management specialist,
and 40-60 hours from an intermediate accountant. The average
compensation for a compliance attorney is $85.35/hour [$131,303 per
year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35 *40
hours/week*4 weeks/month*3 months = $40,966.54 and $85.35 *40 hours/
week*4 weeks/month*6 months = $81,933.07. The average compensation
for an office services supervisor is $40.15/hour [$61,776.00 per
year/(2000 hours per year)*1.3 is $40.15 per hour]; $40.15*50 =
$2,007.72 and $40.15*200 = $8,030.88. The average compensation for a
risk management specialist is $65.33/hour [$100,500 per year/(2000
hours per year)*1.3 is $65.33 per hour]; $65.33*80 = $5,226.00 and
$268.84*160 = $10,452.00. The average compensation for an
intermediate accountant is $34.11/hour [$52,484.00 per year/(2000
hours per year)*1.3 is $34.11 per hour]; $34.11*40 = $1,364.58 and
$34.11*60 = $2,046.88. These figures were taken from the 2011 SIFMA
Report on Management and Professional Earnings in the Securities
Industry.
---------------------------------------------------------------------------

There may be additional operational costs associated with any
changes that would necessitate updating the letter. The per-entity cost
of obtaining the letter from new depositories is likely to be the same
as it would be for obtaining the letter from existing depositories
(i.e., $1,300 and $4,200). In the NPRM, the Commission estimated that
the cost associated with changes that would require the acknowledgment
letter to be updated would be between $1,100 and $2,800 per year.\657\
---------------------------------------------------------------------------

\657\ This assumed 20-50 hours per year from an office manager
for operational costs. The average compensation for an office
manager is $55.82/hour [$85,875 per year/(2000 hours per year)*1.3 =
$55.82/hour]; $55.82*20 = $1,116.38 and $55.82*50 = $2,790.94. This
figure was taken from the 2011 SIFMA Report on Management and
Professional Earnings in the Securities Industry.

---------------------------------------------------------------------------

[[Page 68592]]

RCG discussed the need to develop policies and procedures as well
as train personnel.\658\ These costs were considered in the NPRM and
are discussed above. MGEX asserted, based on the Commission's estimates
in the NPRM, that the costs of using the Template Letters would
outweigh the benefits of using them. It did not, however, provide
further analysis as to the basis for its conclusion.\659\ In the NPRM,
the Commission quantified some of the potential costs and only
discussed the benefits qualitatively. Consequently, there is no direct
comparison between the costs and benefits based on the Commission's
estimates in the NPRM.
---------------------------------------------------------------------------

\658\ RCG Comment Letter at 8 (Feb. 12, 2013).
\659\ MGEX Comment Letter at 3 (Feb.18. 2013).
---------------------------------------------------------------------------

The Depository Bank Group, FIA, and Schwartz & Ballen expressed
concern that the Template Letters' standard of liability provision
would shift significant amount of risk onto depository institutions and
would likely increase the costs incurred in both monitoring for
violations and maintaining customer segregated accounts.\660\ As
discussed in the preamble, the Commission revised the language in the
Template Letters to address these concerns. FCStone and Schwartz &
Ballen commented that the proposed restriction on depositories placing
liens on customer accounts when there is an overdraft in an account
would likely lead to losses to depositories. As discussed in the
preamble, the Template Letter clarifies that liens on accounts are
permitted only in certain limited circumstances and that a depository
may not take a lien against a customer account to cover overdrafts. The
final Template Letters do not deny a depository the right to recover
funds advanced in the form of cash transfers, lines of credit,
repurchase agreements or other similar liquidity arrangements made in
lieu of liquidating non-cash assets held in an account or in lieu of
converting cash in one currency to cash in a different currency.
---------------------------------------------------------------------------

\660\ Depository Bank Group Comment Letter at 2 (Feb. 15, 2013),
FIA Comment Letter at 40 (Feb. 15, 2013) and Schwartz & Ballen
Comment Letter at 6 (Feb. 15, 2013).
---------------------------------------------------------------------------

The requirement, embedded in the FCM Template Letter, that
depositories provide the Commission with read-only electronic access to
customer accounts would create certain costs for depositories that
would likely be passed onto FCMs. ICI noted that the read-only access
requirement would result in a process that might be burdensome.\661\
The Commission does not have adequate data to estimate the cost for
establishing such a system and no data was provided by commenters to
aid the Commission in estimating such costs.\662\ The Commission also
has decided not to adopt the read-only electronic access requirement
for DCOs.\663\
---------------------------------------------------------------------------

\661\ ICI Comment Letter at 5 (Jan. 14, 2013). Although ICI's
comments focused on MMMFs, some of the costs they discussed apply
generally to read-only access requirements.
\662\ The Commission intends to rely primarily on other means of
obtaining account information from depositories, and would activate
the read-only electronic access only in situations where it was
deemed necessary. The Commission will generally seek to obtain
account information from the NFA and CME automated daily segregation
confirmation system and/or from depositories directly prior to
requesting a depository to activate electronic access.
\663\ DCOs hold omnibus customer segregated accounts that do not
reflect funds attributable to individual clearing members or
customers.
---------------------------------------------------------------------------

FCStone asserted that the ultimate costs of requiring Template
Letters will be borne by customers of FCMs.\664\ ICI noted that the
costs with respect to a MMMF Template Letter requirements would be
borne by all investors in a MMMF and not just by the FCMs.\665\ The
Commission, however, is unable to forecast how these costs will
ultimately be allocated.
---------------------------------------------------------------------------

\664\ FCStone Comment Letter at (Feb. 15, 2013).
\665\ ICI Comment Letter at 5 (Jan. 14, 2013).
---------------------------------------------------------------------------

Section 1.22 Use of Customer Funds Restricted
Under current regulations, an FCM is not permitted to use one
customer's funds to purchase, margin, secure, or settle positions for
another customer. However, prior regulations did not specify how FCMs
should demonstrate compliance with this requirement. Revised regulation
1.22(c) provides such a mechanism.
Section 1.22(c)(1) defines the undermargined amount for an account.
Sections 1.22(c)(2) and (c)(4) require FCMs to compute, based on the
information available to the FCM as of the close of each business day,
(i) the undermargined amounts, based on the clearing initial margin
that will be required to be maintained by that FCM for its futures
customers, at each DCO of which the FCM is a member or FCM through
which the FCM clears, at the point of the daily settlement (as
described in 39.14) that will complete during the following business
day for each such DCO (or FCM through which the FCM clears) less (ii)
any debit balances referred to in 1.20(i)(4) included in such
undermargined amounts.
Moreover, under section 1.22(c)(3), an FCM is required to, prior to
the Residual Interest Deadline defined in section 1.22(c)(5), have
residual interest in the segregated account in an amount that is at
least equal to the computation set forth in section 1.22(c)(2).\666\
The amount of residual interest that an FCM must maintain may be
reduced to account for payments received from or on behalf of
undermargined futures customers between the close of the previous
business day and the Residual Interest Deadline.
---------------------------------------------------------------------------

\666\ See note 395 above regarding the operation of the
requirement in Sec. 1.22(c)(3) where an FCM is subject to multiple
Residual Interest Deadlines.
---------------------------------------------------------------------------

Section 1.22(c)(5) defines the Residual Interest Deadline. During
an initial phase-in period, the Residual Interest Deadline is 6:00 p.m.
Eastern Time on the date of the settlement referenced in (c)(2)(i) or
(c)(4). On December 31, 2018, which is the expiration of the phase-in
period, the Residual Interest Deadline shifts to the time of the
settlement referenced in (c)(2)(i) or (c)(4). In the interim, paragraph
1.22(c)(5)(iii) requires Commission staff to solicit further public
comment and conduct further analysis in a report (the ``Report'') for
publication in the Federal Register regarding the practicability of
moving the Residual Interest Deadline from 6:00 p.m. Eastern Time on
the date of settlement to the time of settlement (or to some other time
of day). The Report will discuss whether and on what schedule it would
be feasible to move the Residual Interest Deadline, and the cost and
benefits of such potential requirements. In addition, staff is
instructed to, using the Commission's Web site, solicit public comment
and conduct a public roundtable regarding specific issues to be covered
by the Report. Paragraph 1.22(c)(5)(iii)(B) provides that the
Commission may, taking into account the Report, (1) terminate the
phase-in period, in which case the phase-in shall end as of a date
established by Commission order published in the Federal Register,
which date shall be no less than one year after the date of such
Commission order, or (2) determine that it is necessary and appropriate
in the public interest to propose through rulemaking a different
Residual Interest Deadline. In that event, the Commission shall
establish by order published in the Federal Register, a phase-in
schedule.
Costs and Benefits
The requirement in Sec. 1.22(c) benefits customers whose accounts
are not undermargined by reducing the risk that their segregated funds
would be used to cover a shortfall in customer funds due

[[Page 68593]]

to a ``double default.'' \667\ When combined with the reporting
requirements in Sec. Sec. 1.10, 1.32, 22.2, and 30.7, the requirement
in Sec. 1.22(c) will further provide the Commission and the public
with information that should allow them to determine whether FCMs are
using one customer's funds to purchase, margin, secure or settle
positions for another customer.\668\
---------------------------------------------------------------------------

\667\ See discussion of double defaults in sections I.D. and
II.G.9. above.
\668\ See the discussion in section II.G.9. above.
---------------------------------------------------------------------------

It would be difficult to quantify these benefits reliably. An
estimate would depend on the expected value of losses due to a double
default (i.e., a default of both a customer and the FCM) which, in
turn, depend on the probability of a double default and the magnitude
of deficits that would exist in customer accounts compared to the
amount of residual interest at the time of the double default. Given
the small number of historical examples, it is unlikely that any
estimate of probability would be reliable. Moreover, the magnitude of
the impact of a loss of customer funds is dependent on an estimate of
the amount of funds lost, a number that is also difficult to predict
with any reliability, as well as the loss of market confidence (which
may be even more important), which is also difficult to estimate
reliably.
As discussed above, the Commission has revised the residual
interest requirements in the final rule by adopting a point in time
approach.\669\ As a consequence, once the requirement in Sec. 1.22(c)
is phased in, FCMs will have several hours between the close of
business on a particular day (the point in time upon which the
calculation is based), and the time of day when the requisite amount of
residual interest must be held in segregation (that is, the time of the
daily settlement). Moreover, during the phase-in period described in
Sec. 1.22(c)(5), FCMs will initially have a longer period (until 6:00
p.m. Eastern Time on the following business day) to ensure that the
requisite amount of residual interest is held in segregation.
---------------------------------------------------------------------------

\669\ See the discussion in section II.G.9. above.
---------------------------------------------------------------------------

These adjustments to the final rule will avoid the need for FCMs
continuously to monitor whether they are maintaining residual interest
in their segregated customer accounts that is sufficient to cover the
sum of the undermargined amounts in customers' accounts. Instead, FCMs
will have to ensure that they are able to cover the sum of the
undermargined amounts in customers' accounts by the Residual Interest
Deadline. This should significantly reduce the amount of residual
interest that an FCM must maintain in segregated accounts on an ongoing
basis. In the absence of information regarding what specific changes
various market participants might make to their systems and operations
in order to expedite margin payments, it is not possible for the
Commission to provide an estimate of the costs of such technical
changes.
Moreover, the FCM's funding requirement will be reduced to the
extent that customers are able to reduce the undermargined amount in
their accounts prior to the Residual Interest Deadline. The Commission
expects that FCMs will work with customers during the phase-in period
to develop the systems and operational patterns that will be necessary
to facilitate more prompt margin calls and payments. As a consequence,
those FCMs' customers that do not already have the capability to make
margin payments before the Residual Interest Deadline may develop that
capability, which will further reduce the funding burden borne by FCMs.
The cost associated with maintaining sufficient residual interest
to cover undermargined amounts will also depend upon the policies and
procedures that FCMs put into place to meet the targeted residual
interest requirement set forth in Sec. 1.11. To the extent that the
undermargined amount is greater than the targeted residual interest
amount that an FCM maintains in its customer accounts, the FCM would
have to increase the amount of residual interest it maintains in the
customer segregated account by the time it is obligated to make
settlement payments to the DCO. Some FCMs may seek to avoid this
situation by requiring their customers to pre-fund (i.e., require
customers to provide initial margin for a position before the FCM sends
the position to a DCO to be cleared, and provide sufficient excess
margin to the FCM to reduce any undermargined amount). If the FCM
elects to increase the amount of residual interest that it maintains in
the customer segregated accounts, this would likely reduce the range of
investment options the FCM has for those additional funds and may
prompt the FCM to hold additional capital to meet operational needs.
Similarly, if the FCM requires additional margin from customers, that
will result in capital costs to those customers.
On the other hand, to the extent the FCM would otherwise maintain
targeted residual interest (i.e., to the extent the targeted residual
interest is greater than or is included within the undermargined
amount), then the rule would not create any additional funding costs.
Despite these revisions to the proposed rule, the Commission
recognizes that the requirements of final rule Sec. 1.22(c) will
create significant additional costs for FCMs and their customers.
Developing and implementing the systems and operational changes
necessary to facilitate more rapid margin payments will create costs
for FCMs and their customers. Those costs are likely to vary
significantly across FCMs depending on the infrastructure and
operational patterns that each FCM already has in place, and depending
on the specifications of the revised systems and operational patterns
that FCMs and customers develop in order to facilitate more rapid
margin payments.\670\
---------------------------------------------------------------------------

\670\ In the absence of information regarding what specific
changes various market participants might make to their systems and
operations in order to expedite margin payments, it is not possible
for the Commission to provide an estimate of these costs.
---------------------------------------------------------------------------

In addition, the Commission expects that some FCMs may choose to
require some customers to increase the amount of margin they maintain
in their accounts. This is more likely for those customers who are
presently not able to make their margin payments prior to the Residual
Interest Deadline. Customers subject to increased pre-funding
requirements will bear costs from their cost of capital resulting from
pre-funding multiplied by the amount of the increased pre-funding
requirement. The cost of capital for each customer depends on the
investment strategy of the individual customer, and the amount of
increased pre-funding requirement is likely to vary depending on the
ability of the customer to respond to margin calls promptly and the
FCM's ability to cover the customer's deficits through increased
residual interest contributions.\671\
---------------------------------------------------------------------------

\671\ Commenters did not provide, and the Commission does not
have, data characterizing the range of investment strategies used by
FCM customers, its impact on their cost of capital for additional
margin, the extent to which customers will not be able to develop
the ability to make more rapid margin payments, or the extent of the
margin requirements for those customers. In the absence of this
information it is not possible at this time to estimate the
additional cost associated with pre-funding requirements that some
customers may bear. These are subjects that may be addressed in the
Report.
---------------------------------------------------------------------------

Last, whatever undermargined amounts are not addressed through
customer payments prior to the Residual Interest Deadline will have to
be covered through increased residual interest contributions from the
FCM.
The Commission expects that in order to comply with the
requirements of Sec. 1.22(c), FCMs may need to maintain

[[Page 68594]]

additional residual interest in order to cover the sum of undermargined
amounts in customers' accounts that still remain by the Residual
Interest Deadline on ordinary trading days, and are likely to acquire
and maintain access to additional liquidity that can be accessed
rapidly to meet the sum of customers' gross undermargined amounts in a
worst-case-scenario. Therefore, in order to estimate the cost of
additional residual interest that FCMs will maintain, it is necessary
to estimate the amount of additional residual interest that FCMs will
need to maintain in their segregated accounts during ordinary trading
days, the amount of additional residual interest that will be needed on
highly volatile trading days, the ratio of ordinary to highly volatile
trading days on an annual basis, the cost of capital for the additional
funds that are deposited into residual interest, and the cost to
maintain a revolving credit facility or some other source of funding
that can be accessed quickly and that is sufficient to cover the
projected largest undermargined amount in aggregate for customers'
accounts.
As discussed further below, the Commission believes that the point
in time approach adopted in this final rule will significantly reduce
the amount of additional residual interest that FCMs need to maintain
in their segregated accounts on an ongoing basis in order to comply
with Sec. 1.22(c).
Several commenters provided estimates of the cost of the ``at all
times'' portion of the proposal. FIA estimated that compliance with the
``at all times'' portion of the proposal would require FCMs or their
customers to deposit significantly in excess of $100 billion into
customer funds accounts beyond the sum required to meet initial margin
requirements, and that the annual financing costs for these increased
deposits will range from $810 million to $8.125 billion.\672\ FIA
estimated the highest single day customer margin deficits per FCM would
likely be between $196 million to $6.1 billion per FCM, depending on
the size and composition of the FCM's customer accounts.\673\ Jefferies
estimated that it would be required to increase its own residual
interest by $15 million (non-peak) or $30 million (peak),
respectively.\674\ Jefferies also stated that the industry would be
required to increase its residual interest by $49 billion (non-peak) or
$83 billion (peak) at a cost of approximately $2 billion (non-peak) or
$5 billion (peak), respectively.\675\ ISDA estimated that the highest
single day sum of gross customer margin deficits would likely be
approximately $73.2 billion for all FCMs combined, with a long term
funding impact of $335 billion.\676\
---------------------------------------------------------------------------

\672\ FIA Comment Letter at 14, 16 (Feb. 15, 2013).
\673\ See FIA Comment Letter at 2-3 (June 20, 2013).
\674\ Id. at 8.
\675\ Id.
\676\ See ISDA Comment Letter at 4 (Feb. 15, 2013). ISDA used
market data for FCMs (November 30, 2012) available at https://www.cftc.gov/MarketReports/FinancialDataforFCMs/index.htm.
---------------------------------------------------------------------------

While the Commission expects that the residual interest requirement
will create additional capital costs for most FCMs, the Commission
believes that the estimates presented by commenters include certain
assumptions that may lead to overstated costs. First, residual interest
that is not needed to be pledged as collateral for customers may be
invested overnight and during the day in investments that are
consistent with the requirements of Commission Regulation 1.25 (``Sec.
1.25 investments'').\677\ The return on residual interest would offset
a portion of the cost of funds. That is, the additional funds that FCMs
place in residual interest will both incur costs and generate returns
for the FCM. Estimates of the effective cost of the additional funds
that must be used to increase residual interest must account for
both.\678\ The returns on Sec. 1.25 investments have the potential to
reduce the effective cost of funds.
---------------------------------------------------------------------------

\677\ 17 CFR 1.25.
\678\ For example, FIA cited a historical cost of funds of
8.125% in January 1990. At that time, the constant maturity one
month Treasury yield was 7.86%, see https://mortgage-x.com/general/indexes/cmt_tcm_history.asp?f=m. Thus, using the cost of funds
proxy from the commenter, the cost of funds would be closer to
0.365% (calculated as 8.125% - 7.86% + 0.10% (for underwriting and
administrative overhead)).
---------------------------------------------------------------------------

Second, both FIA and ISDA confound total residual interest with
additional residual interest by assuming that the total amount of
residual interest that would be required by the proposed rule is equal
to the additional amount of additional interest that would be required
by the rule. FCMs, in general, maintained some residual interest prior
to this rule, and are required to do so to comply with Sec. 1.23.\679\
Therefore, it is only the additional residual interest that is
necessary because of rule 1.22(c) that is relevant for consideration
here.
---------------------------------------------------------------------------

\679\ See section II.G.10. above.
---------------------------------------------------------------------------

Third, the Commission agrees with FIA that U.S. Treasury securities
are an appropriate proxy for the marginal cost of capital for a low-
risk project, such as funds to be placed in residual interest. FIA and
Jefferies did not explain why they chose long-dated maturities on the
yield curve for their estimates. Presumably, an FCM could borrow funds
at a much shorter maturity than five years, for example, a month or
less, potentially lowering borrowing costs substantially.
The Commission notes, and discusses further below, that FCMs might
mitigate costs by maintaining a credit facility that is sufficient to
cover most of their additional residual interest needs on unusually
volatile trading days, but that is not used on the majority of trading
days. This approach would not only lower the amount of capital needed,
but would also reduce the amount of time during which the capital is
borrowed. As discussed further below, the Commission is not able to
estimate accurately what fees banks would charge. However, the
Commission has considered that FCMs would bear an ongoing cost
associated with maintaining an open credit facility that is able to
provide rapid access to sufficient liquidity to meet any additional
residual interest requirements on highly volatile days.
As noted above, several commenters requested the Commission revise
the proposal to require that the residual interest calculation be made
once a day, specifically by the end of the business day.\680\ These
commenters suggested an alternative (the ``Industry Commenters'
Alternative'') by which, at this point in time, an FCM would be
required to maintain a residual interest in its customer funds accounts
at least equal to its customers' aggregate margin deficits for the
prior trade date. ISDA stated this alternative ``would rationally
reduce'' FCMs cost of compliance \681\ and that ``[f]or an FCM with
robust credit risk management systems, covering end-of-day customer
deficits should not be a significant cost.'' \682\ ISDA also noted that
at the end of the day ``typically, all customer calls have been met,
and all customer gains have been paid out; all achieved without the FCM
having recourse to its own funding resources.'' \683\ FIA asserted that
it would ``achieve the Commission's regulatory goals without imposing
the

[[Page 68595]]

damaging financial and operational burdens on FCMs, and the resulting
financial burdens on customers.'' \684\
---------------------------------------------------------------------------

\680\ See ISDA Comment Letter at 6 (Feb. 15, 2013); FIA Comment
Letter at 23-25 (Feb. 15, 2013); LCH.Clearnet comment Letter at 5
(Jan. 25, 2013); Paul/Weiss Comment Letter at 4-5 (Feb. 15, 2013);
RJ O'Brien Comment Letter at 5 (Feb. 15, 2013).
\681\ ISDA Comment Letter at 6 (Feb. 15, 2013).
\682\ ISDA Comment Letter at 2 (May 8, 2013).
\683\ Id. ISDA further observed that many FCM customers use
custodians across the world, and ``many customers cannot assure
payment of their morning FCM call before the end of the New York
day,'' and therefore recommended that Commission study the
feasibility of reducing the time in which customers have to meet
margin calls, if that is ``imperative.'' Id. at 3. This will be
addressed in the Report.
\684\ FIA Comment Letter at 23 (Feb. 15, 2013). See also ISDA
Comment Letter at 4 (May 8, 2013).
---------------------------------------------------------------------------

ISDA and FIA evaluated the costs associated with requiring FCMs to
perform the residual interest calculation once each day at the close of
business on the first business day following the trade date.\685\ ISDA
estimated that ``removing the predictive element of FCM funding
requirements'' of the ``at all times'' method in favor of the Industry
Commenters' Alternative would permit markets to ``reap the efficiencies
of end-of-day accounting,'' \686\ thereby reducing the overall cost of
compliance with the regulation. ISDA estimated that for exchange-traded
futures, the costs associated with the alternative would be the cost of
covering the outstanding margin deficits of between 2% and 5% of an
FCM's futures customers, and thus that approach would impose only
``incremental funding requirements'' on FCMs.\687\ ISDA estimated that
the costs of the alternative would be even smaller for cleared swaps,
due to the ``more professional'' nature of the market.\688\ FIA
acknowledged that if FCMs were given until the end of the following
business day to ensure that the requisite amount of residual interest
was maintained, that approach would eliminate approximately 90-95% of
the anticipated additional residual interest that larger FCMs would
need to maintain in order to meet an at all times requirement.\689\ FIA
estimated the financing costs to FCMs of complying with the Industry
Commenters' Alternative, and concluded that the costs associated with
an at all times residual interest requirement would be approximately
ten times the costs associated with the Industry Commenters'
Alternative.\690\ Finally, the FIA concluded that the Industry
Commenters' Alternative would not ``impos[e] damaging financial and
operational burdens on FCMs . . . and the resulting financial burdens
on customers'' that would result from the at all times approach.\691\
---------------------------------------------------------------------------

\685\ ISDA Comment Letter at 1-2 (May 8, 2013); FIA Comment
Letter at 8-10 (June 20, 2013).
\686\ ISDA Comment Letter at 3 (May 8, 2013).
\687\ Id. at 3-4.
\688\ Id. at 4.
\689\ See FIA Comment Letter at 3 (June 20, 2013).
\690\ See FIA Comment Letter at 8-10 (June 20, 2013). While the
rates used by FIA in this exercise may be conservative, and the
Commission does not adopt these precise estimates, the exercise is
nevertheless illustrative and useful for the purpose of comparing
the costs of the at all times approach and the Industry Commenters'
Alternative.
\691\ Id. at 9.
---------------------------------------------------------------------------

However, the point in time approach adopted in final rule Sec.
1.22(c) gives FCMs until the time of settlement with the DCO (typically
the beginning of the following business day for end of day margin calls
from the DCO), and also provides an extended phase-in period, during
which FCMs have until 6:00 p.m. Eastern Time on the date of such
settlement. After the phase-in period, and absent further Commission
action following the Report, the final rule does not provide FCMs until
the end of the following business day to ensure that the requisite
amount of residual interest is held, as would be the case in the
Industry Commenters' Alternative. Therefore, the Commission expects
that the point in time approach adopted by the Commission will reap
much, but not all, of the cost reduction discussed by the industry
commenters.\692\
---------------------------------------------------------------------------

\692\ FIA estimated that the Industry Commenters' Alternative
would reduce the amount of additional residual interest that is
necessary by 90-95% when compared to the at all times approach. See
id. at 3 (June 20, 2013). See also ISDA Comment Letter at 1-2 (May
8, 2013).
---------------------------------------------------------------------------

During the phase-in period, FCMs would be subject to Industry
Commenters' Alternative (and, thus, all of those cost savings would be
realized).
The following analysis assumes that the Commission does not take
further action to modify the Residual Interest Deadline after
considering the results of the Report. It refers to estimates of
ongoing costs and benefits that only would be incurred and realized
after the end of the phase-in period.
The Commission expects that the post-phase-in form of Sec.
1.22(c)--with a point in time requirement corresponding to the time of
settlement--will achieve some, but not all of the cost reductions
associated with Industry Commenters' Alternative. Moreover, during the
phase-in period, the Commission anticipates that customers and FCMs
will improve their abilities to submit and receive margin payments
prior to the FCM's settlement with the DCO, and the Commission will be
examining this issue further in the Report. In light of these factors,
the Commission believes it is reasonable to suppose that the settlement
time approach will significantly reduce--perhaps by 25% to 50%--the
amount of additional residual interest that is needed on highly
volatile trading days, and by a greater amount on ordinary trading
days.
In order to reasonably estimate the potential range of the amount
of additional capital that is necessary on highly volatile trading
days, the Commission uses ISDA's formulation for the aggregate gross
deficit across all customers. ISDA estimated that on high volatility
days, the aggregate amount of all customers' gross margin deficits for
all FCMs would be equal to 60% of initial margin required by all
customers' positions. This estimate is based on an assumption that all
of an FCM's customers will be holding positions in the same commodity
(or that all commodities in which customers hold positions will move in
unison) and that either shorts or longs will predominate.\693\ This
approach is conservative because it does not take into account
diversification effects. For example, while some customers may hold
positions in energy products, which may be volatile on a particular
day, others may predominately hold positions in interest rates, which
may not be volatile on the same day. Moreover, because of the point in
time approach adopted by the Commission, FCMs will have time to react
to such changes.
---------------------------------------------------------------------------

\693\ See ISDA Comment Letter at 4-5 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission's cost estimates for the amount of additional
residual interest that will be required reflect an effort to make a
reasonable assumption regarding the potential range of additional
residual interest that could be necessary on a volatile trading day.
The amount of additional residual interest that could reasonably be
expected to be necessary on an ordinary trading day would be much lower
because the aggregate of all customers' gross undermargined amounts
would be significantly lower on such days. However, commenters only
estimated the aggregate of customers' gross undermargined amounts on
highly volatile days. They did not estimate or provide data regarding
the aggregate of customers' gross undermargined amounts on ordinary
trading days. In the absence of either data or estimates from
commenters regarding undermargined amounts in customers' accounts on
ordinary trading days, the Commission is not able to quantify the
amount of additional residual interest needed by FCMs in ordinary
trading conditions, but believes that it is significantly less than
what is estimated above for volatile trading days.
Commenters did not identify what level of volatility they had in
view when offering estimates for additional residual interest that
would be necessary for a ``volatile'' trading day. For example,
commenters may have had in mind days that were volatile relative to
market conditions over the last year or two, or that are volatile
relative to the range of all possible outcomes. Context suggests

[[Page 68596]]

the latter assumption, since commenters asserted elsewhere that FCMs
would have to anticipate market movements in order to maintain
sufficient residual interest at all times to cover the sum of
customers' undermargined amounts during a highly volatile trading
day.\694\ Given this, the Commission notes that highly volatile days
are only a small fraction of all total trading days, and therefore, the
costs associated with additional residual interest required on such
highly volatile days would only accrue on a correspondingly small
fraction of the total trading days in a given year.
---------------------------------------------------------------------------

\694\ See, e.g., LCH.Clearnet Comment Letter at 4-5 (Jan. 25,
2013) (noting that ``regardless of the amount of capital an FCM
dedicated to continuous compliance, FCMs would still be at risk of a
violation''). See also CMC Comment Letter at 2 (Feb. 15, 2013); CME
Comment Letter at 5 (Feb. 15, 2013); FIA Comment Letter at 4, 13, 15
(Feb. 15, 2013); MFA Comment Letter at 8 (Feb. 15, 2013); NPPC
Comment Letter at 2 (Feb. 15, 2013); TD Ameritrade Comment Letter at
4-5 (Feb. 15, 2013).
---------------------------------------------------------------------------

FCMs would, however, bear an ongoing cost associated with
maintaining an open credit facility or some other source of funds that
is able to provide rapid access to sufficient liquidity to meet any
additional residual interest requirements when highly volatile days do
occur. The Commission does not have adequate data to estimate the cost
of this credit facility. Since it is not feasible to estimate the costs
to FCMs to cover the need for additional residual interest between the
times of the daily settlement and the end-of-day by obtaining intraday
lines of credit from lenders, the Commission has taken a conservative
approach, and has assumed, for the sake of quantification, that firms
will raise capital sufficient to meet their residual interest needs on
highly volatile trading days, and will keep that amount of capital on
all days, holding it either in residual interest or in liquid assets
that are available to be deposited into segregation.
The Commission is aware that the top-10 largest FCMs (ranked by
total amount of customer funds in section 4d(a)(2) segregated accounts
and 30.7 accounts as of November 30, 2012) are contained in bank
holding companies.\695\ Most of these bank holding companies have
short-term credit ratings of Moody's P-1, Standard & Poor's A-1, and
Fitch F1, while a few have holding companies with P-2, A-2, and F2
ratings. The FCM subsidiary usually derives its credit standing from
the bank holding company, with the rating of the FCM subsidiary being
often the same or sometimes one credit grade lower than the holding
company. To estimate the interest rate that a bank holding company
would charge its FCM subsidiary for funding additional residual
interest, the Commission is using as a proxy for the costs of these
funds the historical average of 30-day AA-financial commercial paper
(consonant with the short-term credit ratings of the bank holding
companies) minus the yield on the 4-week constant maturity U.S.
Treasury bill (to account for the return that FCMs will earn on
investments permitted under Regulation 1.25) and is adding 0.10% for
underwriting and administrative overhead costs to issue commercial
paper.\696\ This results in an average cost of funds of 0.35% for the
top-10 largest FCMs from July 2001 to July 2013. For the remaining
FCMs, the Commission is using as a proxy for the costs of funds the
difference between the prime rate and the yield on the 4-week constant
maturity U.S. Treasury bill. This results in an average cost of funds
of 3.25% from July 2001 to July 2013.\697\ The Commission is using
historical FCM data from November 30, 2012, even though there is more
recent data available, to be consistent with the data ISDA used in the
analysis in its comment letter.\698\ As of November 30, 2012, there was
approximately $147.1 billion in customer funds in section 4d(a)(2)
segregated accounts (excluding excess amounts contributed by
FCMs).\699\ The top-10 FCMs held approximately $111.7 billion in
section 4d(a)(2) segregated accounts,\700\ and the remaining FCMs held
approximately $35.4 billion in section 4d(a)(2) segregated
accounts.\701\
---------------------------------------------------------------------------

\695\ See https://www.cftc.gov/MarketReports/FinancialDataforFCMs/HistoricalFCMReports/index.htm.
\696\ The Commission computes the average yields from July 2001
to July 2013. The constant maturity 4-week Treasury yield time
series with month observations begins in July of 2001. See https://www.federalreserve.gov/releases/H15/data.htm.
\697\ The Commission recognizes that there may be some FCMs with
weak credit ratings that would have to pay even more than the prime
interest rate to secure additional residual interest. See id.
\698\ The Commission believes that the November 30, 2012 FCM
data is typical. Moreover, this permits comparison with other
estimates in the comment letter.
\699\ See https://www.cftc.gov/MarketReports/FinancialDataforFCMs/HistoricalFCMReports/index.htm.
\700\ See id.
\701\ Id.
---------------------------------------------------------------------------

ISDA estimated the potential future FCM funding requirement for
futures arising from the residual interest proposal by subtracting the
existing customer excess. ISDA estimated the futures excess to be
between $40-$70 billion and employed the midpoint of this range, $55
billion in its calculations. Using ISDA's point estimate for existing
customer excess of $55 billion, the Commission estimates there was, at
the top-10 FCMs, (55/177.1) (i.e., 31%) times $111.7 billion or
approximately $34.7 billion in existing customer excess in section
4d(a)(2) segregated accounts. Similarly, for the remaining FCMs, the
Commission estimates that there was approximately $11 billion in
customer excess in section 4d(a)(2) segregated accounts.\702\
---------------------------------------------------------------------------

\702\ That is, 31% of $35.4 billion and $2.3 billion,
respectively.
---------------------------------------------------------------------------

First, the Commission performs its calculations for the residual
interest projected in the section 4d(a)(2) segregated accounts based on
ISDA's assumption that residual interest were required ``at all
times.'' For the top-10 FCMs, the Commission subtracts $34.7 billion
from $111.7 billion giving approximately $77 billion in required
margin. The Commission uses ISDA's suggestion for additional residual
interest needed by FCMs and takes 60% of this figure, approximately
$46.2 billion, as the estimate for total residual interest needed. As
of November 30, 2012, the top-10 FCMs held approximately $6.5 billion
in residual interest.\703\ Using these figures, the top-10 FCMs would
need to fund approximately $39.7 billion in additional residual
interest. At a cost of funds of 0.35%, this would result in an annual
cost of $139 million for the top-10 FCMs based on the historical costs
of funds.
---------------------------------------------------------------------------

\703\ See https://www.cftc.gov/MarketReports/FinancialDataforFCMs/HistoricalFCMReports/index.htm.
---------------------------------------------------------------------------

For the remaining FCMs, the Commission subtracts $11 billion
(excess margin) from $35.4 billion (balance in 4d(a)(2) accounts)
leaving approximately $24.4 billion (required margin in 4d(a)(2)
accounts). Again, using ISDA's 60% formulation gives $14.6 billion in
total residual interest needed under an at all times approach. The
remaining FCMs are holding approximately $3.9 billion in residual
interest.\704\ Consequently, the remaining FCMs would need to fund
approximately $10.7 billion ($14.6 billion-$3.9 billion) in additional
residual interest. At a cost of funds of 3.25%, this gives the
historical annual cost of approximately $348 million.
---------------------------------------------------------------------------

\704\ See id.
---------------------------------------------------------------------------

For all FCMs, the aggregate annual cost is approximately $487
million (that is, $139 million plus $348 million) to fund the
additional residual interest needed by FCMs due to Sec. 1.22 if
residual interest were required at all times.
However, these figures change significantly if residual interest is
not required until the daily settlement. As

[[Page 68597]]

noted above, both FIA and ISDA estimate that the residual interest
requirement would be reduced by 90% or more if it were required to be
present at the end-of-day on the following business day. As discussed
above, the Commission estimates that using the point in time approach
with morning settlement (rather than end-of-day) will reduce the need
for additional residual interest by 25-50%. The midpoint of this range
is 37.5%. A reduction of 37.5% (as a consequence of moving to the point
in time approach) leaves a multiplier of 62.5%. Multiplying 62.5% by
ISDA's estimate (for the at all times approach) of 60% of required
margin results in a product of 37.5%.\705\ For the top-10 FCMs, the
Commission multiplies the $77 billion in required margin by 37.5%
giving approximately $28.9 billion in residual interest needed. The
top-10 FCMs are currently holding approximately $6.5 billion in
residual interest. The top-10 FCMs would be required to fund
approximately $22.4 billion ($28.9 billion-$6.5 billion) in additional
residual interest. At a cost of funds of 0.35%, this would result in an
annual cost of approximately $78 million for the top-10 FCMs.
---------------------------------------------------------------------------

\705\ The fact that the reduction of 37.5% (the midpoint of 25%
and 50%) multiplied by ISDA's estimate of 60% results in a product
that is also 37.5% is coincidental.
---------------------------------------------------------------------------

For the remaining FCMs, the Commission multiplies $24.4 billion
(required margin in 4d(a)(2) accounts) by 37.5% giving approximately
$9.2 billion. The remaining FCMs are holding $3.9 billion in residual
interest.\706\ Consequently, the remaining FCMs would be required to
fund approximately $5.3 billion ($9.2 billion-$3.9 billion) in
additional residual interest. At a cost of funds of 3.25%, this would
result in an annual cost of approximately $171 million with current
economic conditions. This result in a total annual cost of
approximately $249 million to fund the additional residual interest
needed by FCMs due to Sec. 1.22 using the Commission's assumption of
37.5% of initial margin needed for residual interest.
---------------------------------------------------------------------------

\706\ See https://www.cftc.gov/MarketReports/FinancialDataforFCMs/HistoricalFCMReports/index.htm.
---------------------------------------------------------------------------

As explained above, the final rule does not require FCMs to take
this approach. Instead, the Commission believes that firms are likely
to manage margin calls to reduce the sum of customers' gross
undermargined amounts prior to the time of settlement. They may also
mitigate costs by using revolving credit facilities or other temporary
sources of liquidity to meet, in part, the need for additional residual
interest on volatile trading days. The Commission received comments on
the proposed costs and benefits of Sec. 1.22. Several commenters
supported the proposal, noting that it would prevent customer funds
from being used to subsidize an FCM's obligations, reduce systemic
risk, and enhance customer protection, especially in the event of an
FCM bankruptcy.\707\ In particular, SIFMA stated that the proposal,
``in effect, shifts the costs and burdens of a margin shortfall from
customers with excess margin to customers with deficits, where it
properly belongs.'' \708\ In addition, Vanguard argued that the
``proposed changes correctly shift the risk to customers in deficit and
away from any excess margin transferred by other customers.'' \709\
---------------------------------------------------------------------------

\707\ See, e.g., CFA Comment Letter at 5-6 (Feb. 13, 2013);
CIEBA Comment Letter at 2-3 (Feb. 20, 2013); ICI Comment Letter at 3
(Jan. 14, 2013); Franklin Comment Letter at 2 (Feb. 15, 2013); Paul/
Weiss Comment Letter at 3 (Feb. 15, 2013); SIFMA Comment Letter at 2
(Feb. 21, 2013); Vanguard Comment Letter at 7-8 (Feb. 22, 2013).
\708\ SIFMA Comment Letter at 2 (Feb. 21, 2013).
\709\ Vanguard Comment Letter at 7 (Feb. 22, 2013).
---------------------------------------------------------------------------

On the other hand, a number of commenters interpreted the ``at all
times'' language to require FCMs to continuously calculate their
customers' aggregate margin deficits and stated that they believe such
a requirement is infeasible.\710\ As a result of this interpretation of
the proposal, these commenters argued that the proposal would
dramatically increase costs and create liquidity issues for FCMs and
their customers.\711\ Many commenters asserted that the proposal would
therefore result in FCMs requiring customers to pre-fund their
positions.\712\ FHLB cautioned that ``[w]hile it cannot be disputed
that a residual interest buffer should lower the risk that an FCM will
fall out of compliance with its segregation requirements, there will
likely be a real economic cost associated with maintaining whatever
residual interest buffers is established by an FCM.'' \713\ FHLB
further noted that the ``funds maintained by an FCM as residual
interest can reasonably be expected to earn less than the FCM's
unrestricted funds,'' thus, the proposal ``represents a real cost to
FCMs'' that will be passed on to customers.\714\ ISDA stated that the
proposal will make customers ``self-guaranteeing'' and diminish
reliance on the FCM, and that, while this would diminish overall risk
of FCM default, it comes at a very significant cost to market
participants, market volumes, and liquidity.\715\ CHS Hedging observed
that ``pre-funding accounts concentrates additional funds at FCMs,
which seems to contradict the spirit of the'' customer protection
rules.\716\
---------------------------------------------------------------------------

\710\ See, e.g. Advantage Comment Letter at 6-8 (Feb. 15, 2013);
CMC Comment Letter at 2 (Feb. 15, 2013); CME Comment Letter at 5
(Feb. 15, 2013); FIA Comment Letter at 4, 7-8, 13 (Feb. 15, 2013);
LCH.Clearnet Comment Letter at 4-5 (Jan. 25, 2013); MFA Comment
Letter at 8 (Feb. 15, 2013); MGEX Comment Letter at 2 (Feb. 18,
2013); Newedge Comment Letter at 2 (Feb. 15, 2013); NPPC Comment
Letter at 2 (Feb. 15, 2013; RCG Comment Letter at 3 (Feb. 12, 2013);
TD Ameritrade Comment Letter at 4-5 (Feb. 15, 2013).
\711\ See, e.g., Advantage Comment Letter at 8 (Feb. 15, 2013)
(``The avalanche of buying or selling that this rule will induce
contradicts decades of effort by the industry to thwart market
panics and provide markets with liquidity and stability.''); CMC
Comment Letter at 2 (Feb. 15, 2013) (stating that the proposal
``could create liquidity issues and increase costs for FCMs and end
users. Such a decrease in liquidity could be substantial, and limit
the number and type of transactions FCMs clear, the number of
customers they service and the amount of financing they provide.'');
CME Comment Letter at 5-6 (Feb. 15, 2013) (``We believe that this
will be a significant and unnecessary drain on liquidity that will
make trading significantly more expensive for customers to hedge
financial or commercial risks. The liquidity drain will be
exacerbated to the extent that the demand for excess margin will
increase the costs and limit the activities of market makers.'').
\712\ See, e.g., FIA Comment Letter at 17 (Feb. 15, 2013); MFA
Comment Letter at 8 (Feb. 15, 2013); Newedge Comment Letter at 2
(Feb. 15, 2013).
\713\ FHLB Comment Letter at 3-4 (Feb. 15, 2013).
\714\ Id. at 4 n.5.
\715\ ISDA Comment Letter at 3 (Feb. 15, 2013) (noting that
``[e]ffectively doubling margins will damage futures and swaps
markets by destroying the value proposition for many liquidity
providers essential to the market's efficiency.''). See also ISDA
Comment Letter at 2-3 (May 8, 2013) (stating that the proposal would
cause customers to pre-fund margin, which ``would remake the cleared
swaps and futures markets into one exclusively for `self-
guaranteeing' customers,'' which ``would be damaging to markets by
destroying the incentives for continued participation by liquidity
providers essential to the markets' efficiency.'').
\716\ Id.
---------------------------------------------------------------------------

As noted above, the Commission recognizes that some FCMs may
require their customers, or some subset of their customers, to increase
the margin they maintain in their accounts in order to cover possible
deficits that could materialize during the period of time it would
typically take that customer to respond to a margin call. This is
particularly the case if and when the Residual Interest Deadline moves
to the time of the daily settlement. However, the Commission expects
that the number of customers and the amount of additional margin
required from those customers would be significantly less than was
asserted by some of the commenters because of modifications made to the
final rule. As noted above, the final version of the rule allows FCMs
to meet the gross sum of the undermargined amounts several hours after
(and, during the phase-in period, at the end of the next business day
after)

[[Page 68598]]

the undermargined amount is calculated, which is expected to
significantly mitigate the need for FCMs to maintain a ``preventative
buffer'' of residual interest or additional customer margin that is
sufficient to cover customers' potential undermargined amounts in a
worst case scenario. Moreover, in cases where customers develop the
ability to submit margin payments prior to the Residual Interest
Deadline, there will not be any need for additional customer margin on
an ongoing basis. It is therefore likely that FCMs will require
additional customer margin on an ongoing basis in situations only where
(1) a particular customer is not be able to routinely make margin
payments prior to the Residual Interest Deadline, and (2) the sum of
the undermargined amounts in customers' accounts that cannot be
collected before the Residual Interest Deadline is a relatively large
compared to the amount of residual interest that the FCM otherwise
chooses to maintain.\717\
---------------------------------------------------------------------------

\717\ The Commission expects that this would happen on normal
trading days. On highly volatile trading days, the Commission
expects that customers' gross undermargined amounts would likely be
covered by residual interest acquired through a line of credit or
credit facility, as discussed above, rather than through customer
pre-funding since the costs of the former are likely to be
considerably less than the costs of the latter.
However, the Commission does not, at this time, have data
regarding individual customers' historical gross undermargined
amounts and therefore does not have adequate information to estimate
the number of FCM and customer combinations where additional
customer margin would be required on an ongoing basis.
---------------------------------------------------------------------------

The Commission does not agree that increased residual interest
requirements are contrary to the spirit of the customer protection
rules. The rules are intended to provide additional protections to
funds held at FCMs, not to reduce the amount of funds held at FCMs. The
likelihood of customer defaults leading to an FCM default is reduced.
So, additional customer funds at FCMs are better protected with the
increased residual interest requirements in place.
Several commenters argued that the costs associated with the
proposal would decrease competition between FCMs.\718\ In particular,
FIA stated that the proposal may force a number of small to mid-sized
FCMs out of the market, which will decrease access to the futures
markets and increase costs for IBs, hedgers and small traders.\719\ In
addition, FIA argued that the proposal would significantly impair the
price discovery and risk management functions served by the
market.\720\ JSA argued that the proposal would be ``punitive in a
highly competitive environment that already places the midsize operator
at a disadvantage to his better capitalized multinational
competitors.'' \721\ Moreover, JSA stated that the cost of the proposal
would result in a higher cost of hedging, which would be prohibitive
and prompt agricultural users to walk away from the futures
market.\722\ The Congressional Committees requested that the Commission
consider these effects in drafting the final rule.\723\
---------------------------------------------------------------------------

\718\ See, e.g., CHS Hedging Comment Letter at 2 (Feb. 15,
2013); CME Comment Letter at 6 (Feb. 15, 2013); FIA Comment Letter
at 17 (Feb. 15, 2013); Frontier Futures Comment Letter at 3 (Feb.
15, 2013); Jefferies Comment Letter at 7 (Feb. 15, 2013); JSA
Comment Letter at 1-2 (Feb. 15, 2013); NCFC Comment Letter at 2
(Feb. 15, 2013); NIBA Comment Letter at 1 (Feb. 15, 2013).
\719\ See FIA Comment Letter at 17 (Feb. 15, 2013).
\720\ See id. at 4, 17.
\721\ JSA Comment Letter at 1 (Feb. 15, 2013).
\722\ Id. at 2.
\723\ See Congressional Committees Letter at 1 (Sept. 25, 2013).
---------------------------------------------------------------------------

Other commenters argued that the proposal would disproportionately
burden smaller FCMs and the customers of smaller FCMs.\724\ CME
asserted that, given this increase in cost, some customers may transfer
their accounts to the larger, better-capitalized FCMs to reduce the
cost of trading,\725\ but that agricultural customers ``likely will not
be able to transfer to the larger FCMs because they do not fit their
customer profile,'' thereby making these customers bear more of the
cost burden.\726\ Frontier Futures asserted that many small customers,
including most farmers, do not watch markets constantly. Therefore, it
would be difficult for them to meet margin calls on a moment's notice,
thereby causing FCMs to require significantly higher margins or to
liquidate customer positions where margin calls cannot be immediately
met.\727\ Frontier Futures also asserted that the proposal ``may force
a number of small to mid-sized FCMs out of the market,'' making it more
expensive, if not impossible, for IBs and small members to clear their
business, removing ``significant capital from the futures industry,''
and ``reducing stability to the markets as a whole.''\728\ RJ O'Brien
stated that the proposed residual interest requirement is impractical
because many farmers and agricultural clients still use checks and ACH
to meet margin calls.\729\ RJ O'Brien also stated that if the proposal
is adopted, FCMs that service non-institutional clients will struggle
to remain competitive and the proposal may result in fewer clearing
FCMs and greater systemic risk to the marketplace.\730\ Similarly, CME
stated that the proposed residual interest requirement would lead to
consolidation among FCMs, which will ``actually increase[ ] systemic
risk by concentrating risk among fewer market participants.'' \731\
---------------------------------------------------------------------------

\724\ See, e.g., CME Comment Letter at 5-6 (Feb. 15, 2013);
FCStone Comment Letter at 3 (Feb. 15, 2013); Global Commodity
Comment Letter at 1 (Feb. 13, 2013); Randy Fritsche Comment Letter
at 1 (Feb. 15, 2013); JSA Comment Letter at 1 (Feb. 15, 2013); NCBA
Comment Letter at 2 (Feb. 15, 2013); NCFC Comment Letter at 2 (Feb.
15, 2013); RJ O'Brien Comment Letter at 3 (Feb. 15, 2013); ICA
Comment Letter at 1-2 (Feb. 15, 2013); TCFA Comment Letter at 2
(Feb. 15, 2013).
\725\ CME Comment Letter at 6 (Feb. 15, 2013).
\726\ Id.
\727\ See Frontier Futures Comment Letter at 2-3 (Feb. 14,
2013).
\728\ Id.
\729\ RJ O'Brien Comment Letter at 3 (Feb. 15, 2013). See also
ICA Comment Letter at 1-2 (Feb. 15, 2013).
\730\ RJ O'Brien Comment Letter at 3 (Feb. 15, 2013).
\731\ CME Comment Letter at 6 (Feb. 15, 2013) (emphasis in
original).
---------------------------------------------------------------------------

The Commission recognizes that smaller FCMs may have more
difficulty than large FCMs in absorbing the additional costs created by
the requirements in Sec. 1.22. In general, it is likely that smaller
FCMs have a larger percentage of customers who do not have requisite
personnel or systems to receive margin calls and make margin payments
in a matter of hours, thus creating a disproportionate need for pre-
funding or additional residual interest at smaller FCMs. Smaller FCMs
are also likely to have higher borrowing costs than larger FCMs, so the
impact of obtaining additional capital to meet increased residual
interest needs may be more significant for them. If increased costs
force some smaller FCMs out of the market, it is possible, though not
certain, that smaller customers could have difficulty finding
alternative FCMs to service their needs. However, as noted above, the
Commission believes that the changes made to Sec. 1.22(c), and the
extended phase-in period, in the final rule substantially reduce the
costs to FCMs and their customers when compared to the proposed version
of the requirement. By reducing the costs, these changes have also
reduced some of the associated burdens that would potentially be
disproportionately borne by smaller FCMs. The Commission does not agree
that a reduced number of FCMs would necessarily reduce competition in a
way that impacts the price of services. Any increases in costs to
customers are more likely the result of increased costs to the FCM that
are passed on to customers, which are the costs that have been
mitigated by changes to the final rule. Moreover, the Commission is
cognizant of the cost of an FCM failure where customers suffer a loss
of segregated funds, both in terms

[[Page 68599]]

of costs to the customers who lose such funds (or, if such funds are
ultimately recovered, the use of such funds) as well as the industry-
wide cost associated with a loss in confidence in the safety of
customer funds. These costs support the importance of increasing the
safety of the system. Moreover, the Commission will closely review
these issues as part of considering the Report.
The Commission disagrees with the comments that there would be a
consolidation of FCMs that would cause the rule to have a net effect of
increasing systemic risk. Instead, the Commission expects that the
overall effect of the final rule will be to significantly reduce
systemic risk. For example, as noted by CIEBA,\732\ the residual
interest requirement will likely reduce systemic risk by enabling FCMs
to ensure that they can meet all customer obligations at any time
without using another customer's funds to do so. Moreover, larger,
well-capitalized FCMs are more likely to be able to absorb losses than
less well-capitalized FCMs. To the extent that FCMs that are affiliated
with large financial institutions take on additional business as a
result of a potential reduction in the number of FCMs, the increase in
risk to these financial institutions is expected to be small relative
to their existing risk and to not materially increase the systemic risk
associated with these financial institutions. Finally, some of the
costs that commenters asserted could lead to a reduction in the number
of FCMs under the proposed rule have been mitigated by changes to the
final rule.
---------------------------------------------------------------------------

\732\ See CIEBA Comment Letter at 3 (Feb. 20, 2013).
---------------------------------------------------------------------------

Several commenters also observed that the proposal would mark a
significant departure from current market practice and could have a
material adverse impact on the liquidity and smooth functioning of the
futures and swaps markets.\733\ The Commission has chosen to provide an
extended phase-in period for the requirement in Sec. 1.22(c) and
therefore does not expect that smooth functioning of the futures and
swap markets will be disrupted. If customers withdraw from the futures
and swap markets as a consequence of the additional costs, liquidity
could be negatively affected. However, the Commission believes that by
allowing FCMs several hours (and, during the phase-in period, until the
end of the next business day) after customer accounts become
undermargined to ensure that the requisite amount of residual interest
is on deposit, the costs associated with the requirement have been
mitigated, which reduces the likelihood that customers will be prompted
to withdraw from the markets due to related expenses.
---------------------------------------------------------------------------

\733\ See, e.g., MGEX Comment Letter at 2 (Feb. 18, 2013); AIMA
Comment Letter at 3 (Feb. 15, 2013); CMC Comment Letter at 2 (Feb.
15, 2013).
---------------------------------------------------------------------------

The Commission also considered several additional alternative
proposals raised by the commenters.
Newedge suggested that the Commission consider less costly
alternatives to the proposed rule, such as allowing the FCM ``to count
guaranty fund deposits with [DCOs] as part of their residual interest''
or limiting the residual interest amount that an FCM must carry to only
a limited number of its largest customers.\734\ The Commission
believes, however, that the latter proposal is not consistent with the
statutory requirement that ``one customer's funds may not be used to
margin, guarantee, or pay another customer's obligations'' and
therefore did not adopt this suggestion. Regarding the former
alternative, guarantee funds held at the DCO are a critical part of the
waterfall that covers losses in the event of an FCM's default. One of
the primary purposes of the customer protection regime is to protect
customers from the risk of losses in the event that their FCM defaults.
Using funds that may be used to cover the FCM's proprietary losses
(i.e., the guarantee fund) to guarantee customers' funds could expose
customer funds to the FCM's losses in a double default scenario. The
Commission, therefore, does not believe that this alternative is
consistent with the goals of the customer protection regime.
---------------------------------------------------------------------------

\734\ Newedge Comment Letter at 3 (Feb. 15, 2013). See also RJ
O'Brien Comment Letter at 5 (Feb. 15, 2013).
---------------------------------------------------------------------------

Frontier Futures suggested that firm firewalls be put in place
between customer funds and an FCM's proprietary funds in the form of
approval by an independent agency for an FCM to transfer customer
funds.\735\ Frontier Futures also recommended that FCMs ``do their
proprietary trading through another FCM thereby engaging the risk
management of a third party.'' \736\ The Commission has chosen not to
require FCMs to seek external approval before pulling excess residual
interest out of a customer segregated account, or to conduct their
proprietary trading through another FCM. The Commission expects that
the requirements in Sec. 1.23 will accomplish some of the same
benefits--ensuring that FCMs only withdraw significant portions of
excess residual interest when they have adequate information to ensure
that it is truly excess and that senior management is accountable for
such decisions--with greater efficiency and less operational costs.
Internal verification of residual interest balances and obtaining
signatures from individuals inside the organization is likely to be
considerably faster, and therefore more efficient and less costly.
---------------------------------------------------------------------------

\735\ See Frontier Futures Comment Letter at 3 (Feb. 14, 2013).
\736\ Id.
---------------------------------------------------------------------------

Regarding the second proposal, it is not clear how the commenter
expected the third party FCM to augment the first FCM's risk management
or what specific type of risk would be addressed by such an
arrangement. A third party FCM would be responsible for collecting
margin and for making payments to the DCO for positions related to the
first FCM's proprietary positions. But this arrangement would not help
protect customers at the first FCM from ``fellow customer risk.''
Finally, some commenters requested that the Commission refrain from
adopting the proposal until it conducts further analysis with the
industry regarding the costs and benefits of such proposal.\737\
Further, the Congressional Committees requested that the Commission
weigh the costs and benefits of the final rule, and in particular
``carefully consider the consequences of changing the manner or
frequency in which `residual interest' . . . is calculated.'' \738\ The
``point in time'' approach adopted by the Commission in this final rule
and the extended phase-in period will significantly reduce (as compared
to the proposed rule) the amount of additional residual interest that
FCMs need to maintain in their segregated accounts on an ongoing basis
in order to comply with Sec. 1.22(c). As noted above, the final rule
will mitigate some, though not all of the costs associated with pre-
funding obligations that commenters expressed concern about, while
simultaneously ensuring that the statutory obligations are met and that
the corresponding protection from ``fellow customer risk'' is achieved.
---------------------------------------------------------------------------

\737\ See, e.g., AIMA Comment Letter at 3 (Feb. 15, 2013); CCC
Comment Letter at 2-3 (Feb. 15, 2013); CHS Hedging Comment Letter at
2-3 (Feb. 15, 2013); CME Comment at 5-7 (Feb. 15, 2013); AFBF
Comment Letter at 2 (Feb. 15, 2013); Jefferies Comment Letter at 9
(Feb. 15, 2013); JSA Comment Letter at 1-2 (Feb. 15, 2013); NCBA
Comment Letter at 2 (Feb. 15, 2013); NGFA Comment Letter at 5 (Feb.
15, 2013); NIBA Comment Letter at 1-2 (Feb. 15, 2013); TCFA Comment
Letter at 2 (Feb. 15, 2013); AFMP Group Comment Letter at 1-2 (Sept.
18, 2013).
\738\ Congressional Committees Comment Letter at 1 (Sept. 25,
2013).
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In light of these concerns and in response to the commenters'
requests, the Commission is directing staff to, within thirty months of
the publication

[[Page 68600]]

of this release, solicit further public comment, hold a public
roundtable, and conduct further analysis regarding the practicability
of moving the Residual Interest Deadline from 6:00 p.m. Eastern Time on
the date of settlement to the time of settlement (or to some other time
of day). The Report should include an analysis of whether and on what
schedule it would be feasible to move the Residual Interest Deadline,
and the costs and benefits of such potential requirements. All of this
will take place well before the expiration of the phase-in period. The
Commission will consider the Report and within nine months after the
publication of the Report may take additional action regarding the
phase-in period by Commission order and may change the Residual
Interest Deadline by rulemaking.
Section 1.23 Interest of Futures Commission Merchants in Segregated
Funds; Additions and Withdrawals
Revised Sec. 1.23 places new restrictions regarding an FCM's
withdrawal of residual interest funds not for the benefit of customers.
As adopted, an FCM cannot withdraw any residual interest funds not for
the benefit of customers unless it has prepared the daily segregation
calculation from the previous day and has adjusted the segregation
calculation for any activity or events that may have decreased residual
interest since the close of business the previous day. In addition, an
FCM is permitted to withdraw more than 25 percent of its residual
interest for purposes other than the benefit of customers within one
day only if it: (1) Obtains a signature from the CEO, CFO or other
senior official as described in Sec. 1.23(c)(1) confirming approval to
make such a withdrawal; and (2) sends written notice to the Commission
and the firm's DSRO indicating that the requisite approvals from the
CEO, CFO or other senior official have been obtained, providing reasons
for the withdrawal, listing the names and amounts of funds provided to
each recipient, and providing an affirmation from the signatory
indicating that he or she has knowledge and reasonable belief that the
FCM is still in compliance with segregation requirements after the
withdrawal.
In addition, if the FCM drops below its target threshold for
residual interest because of a withdrawal of residual interest not for
the benefit of customers, the next day it must either replenish
residual interest sufficient to surpass its target, or if senior
leadership believes that the original target is excessive, the FCM may
revise its target in accordance with its policies and procedures
established in Sec. 1.11. The amendments to Sec. 1.23 were also made
for Cleared Swaps and foreign futures at Sec. 22.17, and Sec. 30.7(g)
respectively, and the costs and benefits considerations of those
amendments are considered to be substantively the same.
Costs and Benefits
Restrictions on withdrawals of residual interest provide the
benefit of an additional layer of protection for customer funds
contained in segregated accounts. An FCM may withdraw residual interest
as long as it always maintains sufficient FCM funds in the account to
cover any shortfall that exists in all of its customers' segregated
accounts. However, as a practical matter, the segregation requirements
fluctuate constantly with market movements, and customer surpluses or
deficits also fluctuate depending on the speed with which customers
meet margin calls. As a consequence, the amount of residual interest an
FCM has in a segregated account similarly fluctuates. A sufficient
amount of residual interest to cover deficiencies in customers'
accounts at one point in time may appear insufficient by the next
settlement cycle in extreme market conditions. Therefore, it is
important for an FCM to maintain sufficient residual interest to cover
both current deficiencies in customer accounts as well as any
additional deficiencies that could develop over a relatively short
period of time. Restrictions on withdrawals of residual interest help
to ensure that the FCM maintains a stable base of residual interest and
not withdraw it for other liquidity needs when doing so may result in
jeopardizing customer funds in the segregated account if market
conditions change quickly.
Prohibiting any withdrawal of residual interest until the customer
segregation account calculations are complete for the previous day and
requiring the FCM take into account any subsequent developments in the
market or the account that could impact the amount of residual interest
before withdrawing funds protects customer funds by reducing the
likelihood that lack of current information could cause the FCM to make
a withdrawal from customer funds that is large enough to cause the
account to fall below its segregated funds requirement.
The adopted amendments require FCMs to take several steps in order
to remove more than 25 percent of their residual interest in a single
day. Large, single-day withdrawals of the FCM's residual interest in
the customer segregated account could be an indication of current or
impending capital or liquidity strains at the FCM. The additional steps
ensure that senior management is knowledgeable of and accountable for
such withdrawals, that no shortfall in the customer segregated accounts
is created by the withdrawals, and that the CFTC and DSRO are both
alerted to allow them to monitor the FCM and its segregated accounts
closely over subsequent days and weeks. Additional monitoring will help
to ensure that the integrity and sufficiency of the FCM's customer
segregated accounts are protected. In addition, notifying the CFTC and
DSRO gives both an opportunity to ask questions about the FCM's
reasonable reliance on its estimations of the adequacy of its funds
necessary to meet segregation requirements. Such questions may give the
Commission and DSRO comfort that the transaction does not indicate any
strain on the FCM's financial position, or conversely, may raise
additional questions and alert the CFTC and DSRO to the need for
heightened monitoring of the FCM or further investigation of its
activities. The amendment also adds protection by ensuring that the
Commission has records regarding the name and address of parties
receiving funds from any withdrawal of residual interest in segregated
funds not for the benefit of customers. Also, requiring an FCM to
replenish its residual funds the following day any time a withdrawal
causes it to drop below the FCM's target amount helps to ensure that
residual interest is not used by the firm to address liquidity needs in
other parts of the firm unless those needs are very short-term in
nature (i.e., less than 24 hours). Finally, the amendments are
consistent with rules imposed on all FCMs by the DSROs.
In the NPRM, the Commission qualitatively analyzed that the
amendments to Sec. 1.23 would create costs for FCMs and quantitatively
estimated costs associated with obtaining management approvals for
withdrawals exceeding 25 percent of the prior day's residual interest.
The restrictions on withdrawals were anticipated to potentially prevent
an FCM from withdrawing funds quickly in order to meet certain
operational needs, or to take advantage of specific investment
opportunities, and in general could be expected to result in an FCM
needing to hold additional capital outside of residual interest in
order to meet operational needs.
The Commission did not receive comments on its quantitative
estimates of the costs of obtaining management approvals. However, the
Commission

[[Page 68601]]

did receive comments on its qualitative analysis of costs, and also
received comments that the use of the prior day's actual residual
interest as the amount applicable to the restriction would provide a
disincentive to FCMs holding additional funds at DCOs as residual
interest, which commenters posited as less beneficial to the protection
of customers. Several commenters, including FIA and Jefferies suggested
the Commission utilize the targeted residual amount as the threshold
for notifications and withdrawal restrictions, in order to not
discourage FCMs from holding additional funds as residual
interest.\739\ FIA suggested that the qualitative analysis of the costs
was not sufficient and that the amendments would impose a tremendous
operational and financial burden on the industry, requiring the
development and implementation of entirely new systems to assure
compliance and detrimentally impacting liquidity.\740\ The Commission
believes however, that this comment is not directed to the withdrawal
restrictions as adopted or the necessity to replenish the targeted
residual interest amount, but instead directed at requirements with
respect to holding residual interest sufficient to cover customer under
margined amounts, which is addressed separately in the cost benefit
considerations for Sec. 1.22.
---------------------------------------------------------------------------

\739\ See FIA Comment Letter at 29 (Feb. 15, 2013); Jefferies
Comment Letter at 4 (Feb. 15, 2013).
\740\ FIA Comment Letter at 13 (Feb. 15, 2013).
---------------------------------------------------------------------------

Jefferies provided some quantitative estimates of the costs of
holding increased residual interest, specifically positing that even a
five percent increase in residual interest could cost Jefferies
$500,000.\741\ FIA posited that FCMs currently may increase residual
interest day-to-day for expected events, including during stressed
market conditions and for the purpose of currency facilitation, and to
impose withdrawal restrictions based on the actual, as opposed to
targeted, excess would reduce the actual likelihood of FCMs infusing of
additional proprietary funds in those circumstances.\742\
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\741\ Jefferies Comment Letter at 5 (Feb. 15, 2013).
\742\ FIA Comment Letter at 27-29 (Feb. 15, 2013).
---------------------------------------------------------------------------

The Commission understands that establishing a target and holding
residual interest does have costs, but disagrees with the underlying
assumptions of the cost estimates provided by Jefferies. The cost
estimates provided by Jefferies imply the cost of holding additional
residual interest is the same as the FCM's cost of capital. However,
the cost considered for the amendments should be the difference in what
can be earned by more conservative investments permitted for segregated
funds versus otherwise if held by FCMs as unrestricted capital, unless
the targeted residual amount exceeds an FCM's minimum net capital
requirement. The costs of holding some amount of residual interest is
an existing cost of doing business as an FCM because, practically
speaking, there is a need to hold some amount of residual interest on a
day to day basis to remain in segregation compliance. Significant
minimum net capital requirements exist for FCMs, currently. Unless the
targeted residual interest in fact exceeds a firm's minimum net capital
requirement, the requirement to hold capital as residual interest in
customer segregated accounts is not a separate additional capital
requirement. Therefore, Jefferies' contention with respect to the costs
of the withdrawal restrictions being represented by the costs of
additional required capital for a firm is not persuasive. Such cost is
only an incremental cost of the newly adopted requirements of
establishing or publicizing targets or imposing withdrawal
restrictions. Further, the withdrawal restrictions adopted require a
one day delay, and management approval and regulatory notifications.
These are not absolute restrictions to the withdrawal of residual
interest funds and the costs considered and incentives or disincentives
created should not be analyzed as if they were. Even the replenishment
requirement adopted, with respect to withdrawals not for the benefit of
customers resulting in residual interest dropping below the target for
residual interest, in order to maintain the targeted residual amount,
provides an FCM with the flexibility to reassess the target as an
alternative. However, all these processes must be transparent to the
Commission, including the FCM's management's accountability for such
processes.
The Commission is not persuaded that the reduced incentives to
provide added funds to residual interest would be a reason to adopt an
alternative of using the targeted residual as opposed to the actual
prior day residual as the measurement for the 25 percent withdrawal
restriction, which is a requirement for notice and approval, and
therefore, not an absolute restriction. The rationales for adding funds
specific to certain anticipated events could just as easily provide a
clear basis for the management approval and notification process
required for the subsequent withdrawal of funds after those
circumstances, as opposed to making them unlikely to occur at all. The
benefits of clear management accountability and regulatory transparency
with respect to such practices and related operational risks (such as
potentially more volatile cash flows through segregated accounts not
for the benefit of customers) would still be obtained.
Section 1.25 Investment of Customer Funds
Regulation 1.25 sets forth the financial investments that an FCM or
DCO may make with customer funds. Among other things, Sec. 1.25
permits FCMs and DCOs to use customer funds to purchase securities from
a counterparty under an agreement for the resale of the securities back
to the counterparty. This type of transaction is referred to as a
reverse repurchase agreement and in effect, is a collateralized loan by
the FCM to its counterparty. Regulation 1.25(b)(3)(v) establishes a
counterparty concentration limit, prohibiting FCMs and DCOs from using
more than 25 percent of the total funds in the customer segregated
account to conduct reverse repos with a single counterparty. The
Commission's amendment expands the definition of a counterparty to
include additional entities under common ownership or control. Thus, as
adopted, the 25-percent counterparty concentration limit for reverse
repurchase agreements applies not only to a single counterparty, but to
all counterparties under common control or ownership. The additional
adopted changes to Sec. 1.25 are conforming amendments proposed in
order to harmonize this section with other amendments adopted in this
release.
Costs and Benefits
In the NPRM, the Commission discussed how the expansion of the
concentration limitation to counterparties under common control or
ownership is consistent with the original intention of the
concentration limitation, which was to mitigate the potential losses or
disruptions due to the default of a counterparty. The Commission has
elected to adopt the amendment as a further protection to customer
funds, because a default by one counterparty that is under common
control or ownership, may adversely impact all of the counterparties to
the reverse repurchase agreement and hence adversely impact the FCM and
the funds it holds for its customers. Because the amendment
incorporates the Commission's interpretation of the existing rule, it
does not alter the rule's meaning and, therefore, the amendment does
not create any incremental costs or benefits. Likewise, the additional

[[Page 68602]]

changes to Sec. 1.25 are conforming amendments proposed in order to
harmonize this section with other amendments proposed in this release,
and, therefore, do not create any incremental costs or benefits.
Because Sec. 1.25 sets forth the financial investments that an FCM
or DCO may make with customer funds, several members of the public
\743\ expressed their general opinions regarding the investment and
handling of customer funds by FCMs and DCOs. In general, all of the
commenters supported the position that FCMs and DCOs only be allowed to
make safe/non-speculative investments of customer funds and not be
allowed to add risk that customers are unaware of or do not sanction.
In addition, some of the commenters \744\ proposed that the Commission
amend its regulations to provide commodity customers with the ability
to ``opt out'' of granting FCMs the ability to invest customer funds
(including hypothecation and rehypothecation); seven \745\ of which
further requested that the Commission mandate that an FCM cannot
prevent a customer who so ``opts out'' from continuing to trade through
that FCM merely because the customer elected to ``opt out.''
Additionally, Vanguard requested that customers have immediate access
to the reports indicating that FCMs have failed to comply with various
mandates including compliance with Sec. 1.25 margin investment limits;
and that customers have access on a twice monthly basis to reports on
an FCM's actual investment of customer assets to determine whether such
investments are concentrated in more or less liquid assets as allowed
under Sec. 1.25.\746\ Although the Commission understands the concern
of the public regarding the safety and investment of customer funds,
because an ``opt out'' provision was not proposed by the Commission,
and would in any case not be effective due to pro-rata distribution in
an FCM bankruptcy, this alternative is not adopted in this final
rulemaking.
---------------------------------------------------------------------------

\743\ Schippers Comment Letter (Dec. 10, 2013), Randy Fritsche
Comment Letter (Feb. 14, 2013), NPPC Comment Letter at 2 (Feb. 14,
2013), Strelitz/California Metal X Comment Letter (Jan. 15, 2013),
Premier Metal Services Comment Letter at 4 (Jan. 3, 2013), ISRI
Comment Letter at 5-7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan.
24, 2013), Kripke Enterprises Comment Letter (Dec. 12, 2012),
Manitoba Comment Letter (Dec. 13, 2012), Solomon Metals Corp.
Comment Letter (Jan. 15, 2013), Michael Krall Comment Letter (Dec.
17, 2012), David Kennedy Comment Letter (Dec. 17, 2012), Robert
Smith Comment Letter (Dec. 17, 2012), Michael Carmichael Comment
Letter (Dec. 17, 2012), Andrew Jackson Comment Letter (Dec. 17,
2012), Donald Blais Comment Letter (Dec. 17, 2012), Suzanne Slade
Comment Letter (Dec. 17, 2012), Patricia Horter Comment Letter (Dec.
17, 2012), JoDan Traders Comment Letter (Dec. 17, 2012), Jeff
Schlink Comment Letter (Dec. 18, 2012), Sam Jelovich Comment Letter
(Dec. 18, 2012), Matthew Bauman Comment Letter (Dec. 20, 2012), Mark
Phillips Comment Letter (Dec. 22, 2012), Deborah Stone Comment
Letter (Dec. 24, 2013), Po Huang Comment Letter (Dec. 24, 2012),
Aarynn Krall Comment Letter (Jan. 8, 2013), Vael Asset Management
Comment Letter (Jan. 10, 2013), Kos Capital Comment Letter (Jan. 11,
2013), James Lowe Comment Letter (Jan. 13, 2013), Tracy Burns
Comment Letter (Jan. 14, 2013), Treasure Island Coins Comment Letter
(Jan. 14, 2013), and Clare Colreavy Comment Letter (Jan. 9, 2013).
\744\ NPPC Comment Letter at 2 (Feb. 14, 2013), Premier Metal
Services Comment Letter at 4 (Jan. 3, 2013), ISRI Comment Letter at
5-7 (Dec. 4, 2012), AIM Comment Letter at 4 (Jan. 24, 2013), Kripke
Enterprises Comment Letter (Dec. 12, 2012), Manitoba Comment Letter
(Dec. 13, 2012), Solomon Metals Corp. Comment Letter (Jan. 15,
2013), Michael Krall Comment Letter (Dec. 17, 2012), David Kennedy
Comment Letter (Dec. 17, 2012), Robert Smith Comment Letter (Dec.
17, 2012), Michael Carmichael Comment Letter (Dec. 17, 2012), Andrew
Jackson Comment Letter (Dec. 17, 2012), Donald Blais Comment Letter
(Dec. 17, 2012), Suzanne Slade Comment Letter (Dec. 17, 2012),
Patricia Horter Comment Letter (Dec. 17, 2012), JoDan Traders
Comment Letter (Dec. 17, 2012), Jeff Schlink Comment Letter (Dec.
18, 2012), Sam Jelovich Comment Letter (Dec. 18, 2012), Matthew
Bauman Comment Letter (Dec. 20, 2012), Mark Phillips Comment Letter
(Dec. 22, 2012), Deborah Stone Comment Letter (Dec. 24, 2013), Po
Huang Comment Letter (Dec. 24, 2012), Aarynn Krall Comment Letter
(Jan. 8, 2013), Vael Asset Management Comment (Jan. 10, 2013), Kos
Capital Comment (Jan. 11, 2013), James Lowe Comment Letter (Jan. 13,
2013), Tracy Burns Comment Letter (Jan. 14, 2013), Treasure Island
Coins Comment Letter (Jan. 14, 2013), and Clare Colreavy Comment
Letter (Jan. 9, 2013).
\745\ NPPC Comment Letter at 2 (Feb. 14, 2013); Premier Metal
Services Comment Letter at 4 (Jan. 3, 2013); ISRI Comment Letter at
6 (Dec. 4, 2012); AIM Comment Letter at 6 (Jan. 24, 2013); Kripke
Enterprises Comment Letter (Dec. 10, 2012); Manitoba Comment Letter
(Dec. 13, 2012); and Solomon Metals Corp. Comment Letter (Jan, 15,
2013).
\746\ Vanguard Comment Letter at 4-6 (Feb. 22, 2013).
---------------------------------------------------------------------------

Section 1.26 Deposit of Instruments Purchased with Customer Funds
Regulation 1.26 requires an FCM or DCO that invests futures
customer funds in instruments described in Sec. 1.25 to obtain a
written acknowledgment from any depository holding such instruments.
The FCM or DCO must use the Template Letters in the appendices to Sec.
1.20, in accordance with the requirements established in Sec. 1.20.
The specifics of those requirements, as well as the costs and benefits
of them, are detailed in the discussion of costs and benefits for Sec.
1.20. If, however, an FCM or DCO invests funds with a money market
mutual fund (MMMF), the FCM or DCO must use the Template Letters in the
appendices of Sec. 1.26 rather than the acknowledgment letters in the
appendices of Sec. 1.20.\747\ The content of the Template Letters in
the appendices to Sec. 1.26 is identical to those in the appendices to
Sec. 1.20 except that they include three additional provisions related
specifically to funds held by the MMMF or its custodian. Specifically,
the Template Letters set out the requirements established in Sec.
1.25(c) that: (1) the value of the fund must be computed and made
available to the FCM or DCO by 9:00 a.m. on the following business day;
(2) the fund must be legally obligated to redeem shares and make
payments to its customers (i.e., the FCM or DCO) by the following
business day; and (3) the MMMF does not have any agreements in place
that would prevent the FCM or DCO from pledging or transferring fund
shares.
---------------------------------------------------------------------------

\747\ Further, per Sec. 1.25(c)(3), the FCM or DCO shall obtain
the Sec. 1.26 Template Letter from ``an entity that has substantial
control over the [MMMF] shares purchased with customer funds and has
the knowledge and authority to facilitate redemption and payment or
transfer of the customer funds. Such entity may include the [MMMF]
sponsor or depository acting as custodian for [MMMF] shares.''
---------------------------------------------------------------------------

Benefits
The benefits are largely the same as for the Template Letters
required under Sec. 1.20, described above in the cost-and-benefit
section related to Sec. 1.20. However, there are benefits to requiring
FCMs and DCOs to obtain a different Template Letter from MMMFs with
respect to customer funds invested in MMMFs. Specifically, MMMFs or
their custodians (as applicable) are required to acknowledge their
additional obligations under Sec. 1.25(c).
Costs
The costs are largely the same as for the Template Letters required
under Sec. 1.20. The general concerns raised by commenters regarding
the costs arising from the Template Letters as well as the Commission's
responses are detailed in the discussion of costs for Sec. 1.20.
Section 1.29 Gains and Losses Resulting From Investment of Customer
Funds
Regulation 1.29 provides that an FCM or DCO may keep as its own any
interest or other gain resulting from the investment of customer funds
in financial instruments permitted under Sec. 1.25; however, the FCM
or DCO must manage the permitted investments consistent with the
objectives of preserving principal and maintaining liquidity. The
Commission's amendment also explicitly provides that although an FCM or
DCO is not required to pass the earnings on the investment of customer
funds back to its futures customers, the FCM or DCO is solely
responsible for any losses that result from its investment of customer
funds.

[[Page 68603]]

Costs and Benefits
In the NPRM, the Commission discussed how the amendment clarifies
that the allocation of losses on the investment of customer funds by an
FCM or DCO to its customers would result in the use of customer funds
in a manner that is not consistent with section 4d(a)(2) and Sec.
1.20, as customer funds can only be used for the benefit of futures
customers and limits withdrawals from futures customer accounts, other
than for the purpose of engaging in trading, to certain commissions,
brokerage, interest, taxes, storage or other fees or charges lawfully
accruing in connection with futures trading. This change was supported
by FIA, which stated its belief that the FCM's or DCO's responsibility
for losses in Sec. 1.25 investments ``is clear and is implicit in the
Act and the Commission's rules.'' \748\ The Commission believes that
market participants already recognize this responsibility and
obligation and direct the investment of customer funds accordingly.
Therefore, the Commission does not believe that the amendment to Sec.
1.29(b) will create any additional costs; however, the marketplace will
benefit in that the amendment provides clarity as to the FCM's or DCO's
sole responsibility for any losses resulting from the investment of
customer funds in the financial instruments listed under Sec. 1.25.
FIA filed a comment supporting the proposed amendments to Sec.
1.29.\749\ No other comments were received. The Commission has adopted
the amendments to Sec. 1.29 as proposed.
---------------------------------------------------------------------------

\748\ FIA, ``Initial Recommendations for Customer Funds
Protection'' available at https://www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer_Funds_Protection.pdf.
\749\ FIA Comment Letter at 30-31 (Feb. 15, 2013).
---------------------------------------------------------------------------

Section 1.30 Loans by Futures Commission Merchants; Treatment of
Proceeds
The Commission adopted amendments to Sec. 1.30 to clarify that,
while an FCM may provide secured loans to a customer with adequate
collateral, it may not make loans to a customer on an unsecured basis
or use a customer's futures or options positions as security for a loan
from the FCM to that customer.
Costs and Benefits
The amendments prohibiting FCMs from providing unsecured loans to
customers and from using a customer's positions to secure loans made to
such customers reduce counterparty risk borne by the FCM. The former
prohibition prevents the FCM from accumulating exposures to customers
that have not margined their positions, while the latter prevents the
additional exposure that otherwise would result from using the same
collateral to secure two different risks (i.e., the risks associated
with the open positions and the risks associated with the secured
loan). Additionally, to the extent that the amendments would force
certain customers to obtain loans from another lender, it diversifies
the counterparty risk across multiple entities. The amendments also are
comparable to rules of the CME for its member firms.
The Commission did not quantitatively estimate the potential
increase to customers' operational costs due to the inability of
customers who need or desire to use borrowed funds to meet initial and
maintenance margin requirements to obtain loans necessary to fund their
futures or options positions from a third party lender. The Commission
requested, but did not receive, comments regarding the prevalence of
FCMs' extension of loans to customers and the potential costs customers
might bear if it were necessary to obtain loans from third parties
rather than from the FCMs with whom their segregated customer accounts
are held. Neither were any comments received generally suggesting a
qualitative burden in complying with the amendments.
Section 1.32 Reporting of Segregated Account Computation and Details
Regarding the Holding of Customer Funds
The adopted amendments to Sec. 1.32 allow an FCM that is not a
dual registrant to follow the same procedures as dual registrants (FCM/
BDs) when assessing a haircut to securities purchased with customer
funds if the FCM determines that those securities have minimal credit
risk. This is the same change as adopted in Sec. 1.17, except that in
Sec. 1.17 the amendment is with respect to the haircut for securities
purchased by an FCM with its own capital, whereas this amendment
applies to the haircut ascribed to the collateral value of securities
deposited by customers for the purpose of securing customer net debits.
The cost benefit considerations are the same as those analyzed with the
corresponding amendment to Sec. 1.17.
In addition, the adopted amendments (1) require FCMs to submit
their daily Segregation Schedules, Secured Amount Schedules, and
Cleared Swaps Segregation Schedules to the Commission and their DSROs
electronically by noon the following business day; (2) require that
twice per month, each FCM submits a detailed list of all the
depositories and custodians where customers' segregated funds are held,
including the amount of customer funds held by each entity and a break-
down of the different categories of Sec. 1.25 investments held by each
entity, further identifying if any of the depositories are affiliated
with the FCM; and (3) require that the detailed list of depositories be
submitted to the Commission electronically by 11:59 p.m. the following
business day and that both segregation and secured amount statements
and the detailed listing of depositories be retained by the FCM in
accordance with Sec. 1.31.
Costs and Benefits
Requiring FCMs to submit their daily segregation and secured amount
calculations to the Commission and DSROs will enable the Commission and
DSROs to better protect customer funds by more closely monitoring for
any discrepancies between the assets in segregated accounts reported by
the FCM and their depositories as reported to the DSRO and available to
the Commission through an aggregator of depository balances. The
ability of the Commission and DSRO to check for discrepancies more
regularly, without notice, is likely to provide an additional deterrent
to fraud. Moreover, it will enable both the Commission and DSROs to
monitor for any trends that would indicate that operational or
financial problems are developing at the FCM, which would give the
Commission an opportunity to enhance its supervision and to intervene,
if necessary, to protect customer segregated funds. In addition, the
amendments are consistent with the rules of SROs that currently require
each FCM to submit daily segregation and secured amount calculations to
the SROs.
The detailed list of depositories will provide additional
information to the Commission and DSROs beyond what is required under
Sec. Sec. 1.20, 1.26, and 30.7. First, the detailed list of
depositories will provide additional account detail including the types
of securities and investments that constitute each account's assets,
rather than just the total value. Second, the reports will account for
any pending transactions that would not necessarily be apparent from
the daily balances submitted to an aggregator by the depositories.
Third, FCMs will, in these reports, provide to the Commission and DSROs
a reconciled balance, which will not be included with balances provided
to the aggregator by depositories. Last, the FCM will be required to
specifically

[[Page 68604]]

identify any depositories that are affiliated with the FCM. Each of
these additional forms of information would enable the Commission and
DSROs to provide better oversight and create additional accountability
for the FCM, enhancing the protection of market participants.
FCMs are already calculating segregated funds information daily and
reporting the results to NFA via WinJammer by noon the following day.
Similarly, the detailed list of depositories that would be required to
be submitted twice per month is already required by NFA to be produced
and submitted to NFA via WinJammer.\750\ Requiring FCMs to submit these
reports to the Commission via the same platform is not expected to
create any additional costs.
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\750\ See Segregated Investment Detail Report at https://www.nfa.futures.org/NFA-compliance/NFA-futures-commission-merchants/fcm-reporting.pdf.
---------------------------------------------------------------------------

FIA commented in support of the amendments to Sec. 1.32 and asked
for clarification that on a daily basis, a single U.S. dollar
equivalent, as opposed to multiple currency by currency schedules, is
what is required to be filed.\751\ Jefferies commented that the
amendments to Sec. 1.32 will not achieve the benefit of transparency
to customers because of the way cash and investments are presented
separately from balances at other FCMs and DCOs.\752\ However, this
comment appears related to the requirements of disclosure to customers
of NFA's publicly available information, not the requirements of Sec.
1.32, which require similar information to be reported to the
Commission and DSROs. The Commission believes the detailed information
required, along with all the additional disclosures being provided to
customers in the amendments to all rules contained herein, do provide
sufficient transparency for customers to be able to assess the risks of
depositing funds with FCMs. The specific detailed amounts of cash and
securities held in segregation must be provided, by individual
depository, including DCOs, under the amendment to Sec. 1.32. The
Commission does not believe that customers will misinterpret the
liquidity of cash held at DCOs as opposed to other types of
depositories, and that therefore the requirements do not provide the
transparency intended, although the Commission understands that
Jefferies is concerned with the appearance of percentage calculations
that are provided publicly on NFA's portal. The Commission notes,
however, that the amendments to Sec. 1.32 do not require reporting of
any percentage calculations. There were no comments received regarding
the Commission's analysis that, due to the existing NFA requirements,
the Commission's amendments to Sec. 1.32 were not expected to result
in incremental costs for FCMs.
---------------------------------------------------------------------------

\751\ FIA Comment Letter at 30-31 (Feb. 15, 2013).
\752\ See Jefferies Comment Letter at 3 (Feb. 15, 2013).
---------------------------------------------------------------------------

With respect to the adopted changes to allow FCMs to utilize lower
haircuts applicable to the market value of customer securities, if such
securities are determined to have minimal credit risk, in determining
the allowance provided for securing net deficits of customers, the CFA
specifically objected to the ability of FCMs to obtain the benefit of
lower haircuts by utilizing the process of establishing credit risk
proposed in the amendment to the SEC's rule 15c3-1.\753\ However, the
Commission has determined that the ability of FCMs to utilize haircuts
lower than the standard deduction of 15% otherwise applicable under SEC
rule 15c3-1 should be equally available to FCMs along with jointly
registered BD/FCMs under the Commission's adopted amendment to the net
capital rule at Sec. 1.17, to promote equity and fairness of
competition between FCMs and joint BD/FCMs and to maintain uniformity
with the capital rule of the SEC for the treatment of securities as
much as practicable. The Commission believes, despite the CFA's
comments indicating the haircut could be manipulated, that the
collateral value haircut for the same security for the purpose of
securing net deficits should also be determined by reference to the net
capital haircut for the same security, and notes both have always been
determined by the SEC's net capital haircuts for securities. The
Commission believes the benefits of continuing to have such uniformity
are substantial. The alternative, which necessarily would be applying a
very substantial standard haircut to a debt security with minimal
credit risk collateralizing a short term obligation, would be overly
harsh and not accurately reflect the market risk to such collateral for
the stated purpose of valuing the extent to which the customer debit is
adequately secured. The Commission further notes that the SEC's rule,
which is the basis for these amendments at Sec. Sec. 1.17, 1.32 and
30.7, and the formulation adopted in these amendments, still provides a
standard, although lesser percentage, haircut, not a model-based
haircut, and also provides for an audit trail of the BD/FCM's
determinations supporting the determination of minimal credit risk,
which should prevent the ability of FCMs to manipulate the haircut, as
suggested by CFA.
---------------------------------------------------------------------------

\753\ See CFA Comment Letter at 7 (Feb. 13, 2013).
---------------------------------------------------------------------------

Section 1.52 Self-regulatory Organization Adoption and Surveillance of
Minimum Financial Requirements
The amendments to 1.52 revise the supervisory program that SROs are
required to create and adopt. In addition, for SROs that choose to
delegate the function to examine FCMs that are members of two or more
SROs to a DSRO, the amended rules require a plan that establishes a
Joint Audit Committee which, in turn, must propose, approve, and
oversee the implementation of a Joint Audit Program. The amended rules
specify a number of additional requirements for the SRO supervisory
program as well as for the Joint Audit Program.
Costs and Benefits
The amendments adopted to Sec. 1.52 provide significant additional
protection to market participants and customer of FCMs by helping to
ensure that SRO examinations of member FCMs are thorough, effective and
risk-based, and include evaluation and testing of internal controls as
well as meeting, as applicable, other objective criteria from related
professional audit standards. Specifically, an SRO's audit program must
be risk-based (e.g., the scope and focus of such examinations would be
determined by the risk profile that the SRO develops for each FCM) and
address ``all areas of risk to which FCM can reasonably be foreseen to
be subject,'' and that the examination itself includes both controls
testing as well as substantive testing. Requiring regulatory
examinations by SROs to include testing and review of internal controls
will help ensure that each FCM is not only compliant with capital and
segregation requirements at the time of the examination, but that they
continue to operate in such a manner without undetected internal
controls inadequacies that could jeopardize the FCM and its customers.
By requiring that the supervisory program for an SRO to adhere to
professional standards for auditing as applicable, the Commission is
provided with additional assurance as to standards for aspects of an
examination such as the adequacy of the evaluation of evidence obtained
supporting examination conclusions; the training and proficiency of the
examinations staff; due professional care in the performance of the
work; consideration of fraud, audit risk and materiality in conducting
an audit; planning and supervision; understanding the entity and its
environment and assessing the

[[Page 68605]]

risk of material misstatement; communication with those charged with
governance of the examined entity; and communicating internal control
matters identified in an examination. These benefits are obtained by
requiring SRO supervisory programs to include consideration of specific
issues and be carried out in compliance with professional standards as
may be applicable to non-financial audits. The Commission believes more
rigorous requirements and the application of professional standards in
carrying out such requirements will add additional protection to an
FCM's counterparties and customers.
The Commission also proposed to require SROs and as applicable the
JAC, to obtain an evaluation of the SRO's or JAC's supervisory program
at least once every two years from an examinations expert, defined as a
nationally recognized accounting and auditing firm with substantial
expertise in audits of FCMs, risk assessment and internal control
reviews, and that is an accounting and auditing firm that is acceptable
to the Commission (as delegated to the Director of the Division of Swap
Dealer and Intermediary Oversight). The benefits of such evaluation by
examinations experts were expected to be that the Commission would
ensure that the supervisory program and SRO audits continue to build on
best practices, which further promotes thorough and effective audits of
FCMs. The Commission quantitatively estimated costs for making
incremental changes to the requirements of the supervisory program for
each SRO and members of the JAC in the NPRM. The Commission did not
quantitatively estimate the ongoing costs of obtaining an evaluation by
an examinations expert or requiring examinations to comply with
professional standards, although the Commission did consider that
requiring such an evaluation and requiring compliance with such
standards and coverage of additional risks would add costs to
examinations by SROs and members of the JAC.
The Commission received many comment letters regarding the changes
proposed to Sec. 1.52. Several of the commenters objected to the
requirements for having a review of the examination program by an
examinations expert.\754\ Specifically, PWC raised concern with the
ability of nationally recognized accounting and auditing firms to be
able to issue any type of assurance without a reporting framework.\755\
NFA, MGEX, and CME all commented that costs would be prohibitive and
that benefits would be reduced because such an evaluation would be
duplicative to the functions of the Commission in review of the Joint
Audit Program. NFA commented that it attempted to obtain cost estimates
from a few nationally recognized firms but that such firms represented
that they were unable to provide cost information without a better
understanding of the type of review the Commission was proposing.\756\
CME commented that the quantitative estimates of the Commission for
revising the program were grossly underestimated.\757\ CME analogized
that requiring adherence to professional standards would result in
examination requirements similar to the average man hours applicable to
private and public company audits, which were represented at 1,951 and
17,457 respectively.\758\ CME represented that the costs of compliance
with professional standards and expanding the program were
prohibitively expensive and requested that only applicable provisions
should be carried into JAC protocols.\759\ CME commented that any
benefit from obtaining an evaluation from an examinations expert could
be obtained at a much reduced cost by including representatives from
such nationally recognized firms in the JAC meetings and in the current
process to develop JAC protocols, without obtaining a formal
assessment, which such firms would more likely to be willing to
do.\760\ CME further posited that if such alternative was not adopted,
the timeframe should be lengthened from two to three and a half
years.\761\ MGEX further commented that if such report were to be
required, highly qualified regional firms should be considered as well
as nationally recognized firms, as more competition would likely result
in more manageable costs.\762\
---------------------------------------------------------------------------

\754\ CME, JAC, MGEX, NFA and PWC all commented objecting to or
raising concern with this aspect of the amendment to Sec. 1.52.
\755\ See PWC letter at 3 (Jan. 15, 2013).
\756\ See NFA Comment Letter at 5 (Feb. 15, 2013).
\757\ CME Comment Letter at 11 (Feb. 15, 2013).
\758\ Id.
\759\ Id.
\760\ Id.
\761\ See CME Comment Letter at 12-13 (Feb. 15, 2013).
\762\ See MGEX letter at 4 (Feb. 18, 2013).
---------------------------------------------------------------------------

In consideration of the concerns of commenters, the Commission has
adopted revised amendments to the examinations expert requirement to
Sec. 1.52, which extend the time between evaluations required to three
years, and clarify that the standard for such evaluation should be that
of a consulting services report. The Commission also has considered the
comments of CME and others with respect to the costs and
inapplicability of many aspects of the PCAOB auditing standards to
regulatory examination and has adopted, in the revised amendments to
the professional standards requirements, that only such standards as
would be analogous to non-financial statement audits would be
applicable.
The JAC also filed an additional comment letter positing that the
requirements of proposed Sec. 1.52, requiring review of risk
management, would be duplicative to risk reviews required to be
performed by DCOs.\763\ Although the Commission agrees there may be
overlapping responsibilities between oversight performed by DCOs and
SROs which could result in duplicated costs, the primary focus of DCO
requirements are the protection of the DCO, not the protection of
customers and market participants. The Commission notes that the same
duplication could exist if an FCM were examined by each SRO of which it
was a member. The Commission already permits the Joint Audit Committee,
the Joint Audit Plan and the DSRO structure for the purpose of
mitigating duplicative examination work and costs. As stated in the
preamble, a DSRO may be able to fulfill parts of its examination
program by incorporating aspects of risk reviews and work already
performed by a DCO, but the DSRO would be responsible for ensuring any
such work was adequately and specifically incorporated into the DSRO
program, and oriented to ensuring the protection of customers and risks
to the FCM.
---------------------------------------------------------------------------

\763\ See JAC Comment Letter at 3-4 (July 25, 2013).
---------------------------------------------------------------------------

Additionally, the Commission notes it was not feasible to quantify
any costs associated with utilizing an examinations expert. This is
largely because several nationally recognized accounting firms
expressed their reluctance to provide such information.\764\ Such a
response is not surprising given the fact that reviewing a DSRO's
examination program is likely a unique and limited engagement for any
firm, which would require fully understanding the scope and
requirements of the review. Yet, the Commission notes there are several
capable firms which would meet the definition of ``examinations
expert'' and could perform the type of review required by the
regulation. Thus, the costs for performing such a service will likely
be competitive.
---------------------------------------------------------------------------

\764\ See NFA Comment Letter at 5, n.2 (Feb. 15, 2013).

---------------------------------------------------------------------------

[[Page 68606]]

Section 1.55 Public Disclosures by Futures Commission Merchants
Amended Sec. 1.55 significantly revises the disclosures that FCMs
are required to provide to prospective customers and the public,
detailed in Sec. 1.55(b). The new required provisions include a
statement that: (1) Customer funds are not protected by insurance in
the event of the bankruptcy or insolvency of the FCM, or if customer
funds are misappropriated; (2) customer funds are not protected by
SIPC, even if the FCM is a BD registered with the SEC; (3) customer
funds are not insured by a DCO in the event of the bankruptcy or
insolvency of the FCM holding the customer funds; (4) each customer's
funds are not held in an individual segregated account by an FCM, but
rather are commingled in one or more accounts; (5) FCMs may invest
funds deposited by customers in investments listed in Sec. 1.25; and
(6) funds deposited by customers may be deposited with affiliated
entities of the FCM, including affiliated banks and brokers. The
required additional disclosures must be provided as an addition to the
generic risk disclosure statement if used by an FCM as permitted under
Appendix A to Sec. 1.55.
In addition, the amendments at Sec. 1.55(i), (j) and (k) require
each FCM to provide a Firm Specific Disclosure Document that would
address firm specific information regarding its business, operations,
risk profile, and affiliates that would be material to a customer's
decision to entrust funds to and do business with the FCM.
The Firm Specific Disclosure Document is required to be made
available electronically, which may be a link to the FCM's Web site,
but must be provided in paper form upon request, and would provide
material information about: (1) General firm contact information; (2)
the names, business contacts, and backgrounds for the FCM's senior
management and members of the FCM's board of directors; (3) a
discussion of the significant types of business activities and product
lines that the FCM engages in and the approximate percentage of the
FCM's assets and capital devoted to each line of business; (4) the
FCM's business on behalf of its customers, including types of accounts,
markets traded, international businesses, and clearinghouses and
carrying brokers used, and the FCM's policies and procedures concerning
the choice of bank depositories, custodians, and other counterparties;
(5) a discussion of the material risks of entrusting funds to the FCM
and an explanation of how such risks may be material to its customers
\765\; (6) the name and Web site address of the FCM's DSRO and the
location of annual audited financial statements; (7) a discussion of
any material administrative, civil, criminal, or enforcement actions
pending or any enforcement actions taken in the last three years; (8) a
basic overview of customer fund segregation, FCM collateral management
and investments, and of FCMs and joint FCM/BDs; (9) information
regarding how customers may file complaints about the FCM with the
Commission or appropriate DSRO; (10) certain financial data from the
most recent month-end when the disclosure document is prepared; and
(11) a summary of the FCMs' current risk practices, controls and
procedures. FCMs are required to update the Firm Specific Disclosure
Document as and when necessary to make the information accurate and
complete, but at least annually.
---------------------------------------------------------------------------

\765\ The material risks addressed must include, without
limitation, ``the nature of investments made by the futures
commission merchant (including credit quality, weighted average
maturity, and weighted average coupon); the futures commission
merchant's creditworthiness, leverage, capital, liquidity, principal
liabilities, balance sheet leverage and other lines of business;
risks to the futures commission merchant created by its affiliates
and their activities, including investment of customer funds in an
affiliated entity; and any significant liabilities, contingent or
otherwise, and material commitments.''
---------------------------------------------------------------------------

The newly adopted Sec. 1.55(l) also requires FCMs to adopt
policies and procedures reasonably designed to ensure that advertising
and solicitation activities of such FCMs and any introducing brokers
associated with the FCMs are not misleading in connection with their
decision to entrust funds and do business with such FCMs.
FCMs are further required by Sec. 1.55(o) to disclose on their Web
sites their daily Segregation Schedule, daily Secured Amount Schedule,
and daily Cleared Swaps Segregation Schedule. Each FCM must maintain 12
months of such schedules on its Web site. Each FCM must disclose on its
Web site summary schedules of its adjusted net capital, net capital,
and excess net capital for the 12 most recent month-end dates, as well
as the Statement of Financial Condition, Segregation Schedule, Secured
Amount Schedule, Cleared Swaps Segregation Schedule, and all footnotes
related to the above statements and schedules from its most current
year-end annual report that is certified by an independent public
accountant.
Costs and Benefits
Current regulations require FCMs to provide a risk disclosure to
potential customers before accepting customer funds, which existing
risk disclosure statement primarily provides a customer with disclosure
of the market risks of engaging in futures trading. The revised
disclosure requirements of Sec. 1.55 provide customers with additional
information regarding certain non-firm-specific risks that have been
relevant in recent FCM bankruptcies and that could be relevant in the
event of future FCM bankruptcies or insolvencies.
The Firm Specific Disclosure Document required by this amendments
address firm-specific risk, which will give potential customers
additional information that they may use when conducting due diligence
and selecting an FCM. By requiring that the disclosure address several
specific topics, the public comparability of information on such topics
will be available, to potential customers conducting due diligence on
potential FCMs. The non-firm specific additional disclosures will
provide a significant benefit to the protection of market participants
as many customers in the aftermath of recent FCM bankruptcies revealed
fundamental misconceptions about the protection of their funds.
Specifically, certain customers did not fully understand how FCMs held
customer funds or the protections extended to such funds. Consequently,
certain customers did not make informed choices to help themselves or
to provide market discipline to their FCMs.
In the NPRM, the Commission described how each additional specific
risk disclosure was expected to benefit the protection of market
participants by providing more transparency and equal access to
information among all customers and the public, enhancing customer's
ability to make comparisons in choosing the FCMs with which they do
business. The specific benefits of each disclosure required by the
amendments were described in the NPRM, but the essential benefits
derived from each additional required disclosure, and the aggregate of
all the additional disclosures, are that they will result in more
educated consumers of FCM services, and that such consumers will,
through the greater transparency resulting from the additional
disclosures, be better able to enforce market discipline on aspects of
FCM business that are directly relevant to the risks customers accept
in dealing with and depositing funds with FCMs.
The Commission quantitatively estimated expected costs of providing
the additional general and firm specific disclosures in the NPRM and
did not receive any comments about its specific estimates. However, the
Commission

[[Page 68607]]

did receive many comments that supported the amendments to Sec. 1.55
reiterating the benefits perceived from transparency resulting from the
additional disclosures as are described at section II.P. and noting
that these amendments were particularly cost effective at providing
such benefits. FHLB stated ``[p]erhaps the most compelling argument for
additional public disclosure of certain information addressed in the
Proposed Customer Protection Rules is that the benefits should far
exceed the additional cost associated with mandating such public
disclosures.'' \766\ ACLI and the Commercial Energy Working Group both
stated ``the Proposed Customer Protection Rules represent a very cost-
effective approach/means to making FCMs more accountable to their
customers by providing current information that will enable customers
to conduct appropriate due diligence regarding prospective FCMs and to
actively monitor the financial condition and regulatory compliance of
the FCMs to which they have entrusted funds.'' \767\
---------------------------------------------------------------------------

\766\ See FHLB Comment Letter at 3 (Feb. 15, 2013).
\767\ See ACLI Comment Letter at 2 (Feb. 15, 2013); Commercial
Energy Working Group Comment Letter at 2 (Feb. 13, 2013).
---------------------------------------------------------------------------

FIA specifically commented with respect to the disclosures required
under Sec. 1.55(k) that FCMs that are part of public companies, or
dually registered BDs, or are part of a bank holding company, already
have disclosure requirements and that the Commission should confirm
that such an FCM may comply with this rule by making the annual reports
and amendments thereto available on its Web site, in order to avoid
duplicative or conflicting disclosure requirements.\768\ FIA further
commented that the level of detail required of privately owned FCM's
disclosure should be consistent with that provided in the annual
reports of publicly-traded companies.\769\ Newedge commented that all
FCMs should be required to disclose similar information in a standard
format, and the proposal of FIA to satisfy disclosure requirements by
linking to the annual report of a public company places firms without
annual report preparation requirements at a competitive disadvantage
and discriminates against smaller to mid-size FCMs.\770\
---------------------------------------------------------------------------

\768\ See FIA Comment Letter at 43 (Feb. 15, 2013).
\769\ Id. at 44.
\770\ Newedge Comment Letter at 4 (Feb. 15, 2013).
---------------------------------------------------------------------------

In the preamble discussion at section II.P., the Commission
clarified both that disclosures could be satisfied by linking to
appropriate existing relevant disclosures that were already required
for the same matters, but that the disclosures required by the
amendments are specific to the FCM and cannot be satisfied with more
general disclosure at a holding company level. The Commission believes
this clarification addresses the duplication concern raised by
commenters.
Several commenters posited concerns regarding the benefit of
various aspects of the mandated disclosures. The comments addressed the
disclosures of leverage, the targeted residual interest, customer
write-offs, and that such disclosures could in certain circumstances be
potentially misleading to customers.\771\ With respect to these
comments the Commission notes that with all aspects of the mandated
additional disclosures, appropriate explanations and additional
information to ensure sufficient context should be provided if
necessary to clarify anything that an FCM may regard as otherwise being
misleading. Concerns raised by commenters that customers may
inadequately assess risks particular to their FCM by inappropriately
focusing on only one aspect of disclosure, such as leverage, or
targeted residual interest, cannot be mitigated by declining wholesale
to make relevant information publicly available. Furthermore, FCMs are
free to supply additional context and information when they believe
that any Firm Specific Disclosure is misleading.
---------------------------------------------------------------------------

\771\ See FCStone Comment Letter at 4 (Feb. 15, 2013); Phillip
Futures Inc. Comment Letter at 2 (Feb. 14, 2013); CHS Hedging
Comment Letter at 2 (Feb. 15, 2013); RJ O'Brien Comment Letter at 6-
9 (Feb. 15, 2013); TD Ameritrade Comment Letter at 4 (Feb. 15,
2013); Advantage Comment Letter at 4 (Feb. 15, 2013); RCG Comment
Letter at 5-6 (Feb. 12, 2013).
---------------------------------------------------------------------------

Certain commenters have requested that the Commission consider the
alternative to further require all Sec. 1.12 notices to be made
publicly available, which the Commission has declined to do as is
discussed in the costs and benefits discussion of Sec. 1.12. By
requiring FCMs to update the disclosures annually, as well as any time
there is a ``material change to its business operation, financial
condition and other factors material to the customer's decision to
entrust the customer's funds and otherwise do business with the futures
commission merchant,'' and requiring the FCM to provide each updated
disclosure to its customers, Sec. 1.55(i) makes FCMs responsible to
communicate with customers whenever such events occur. The Commission
notes that there may be overlap in circumstances which give rise to
notice obligations under Sec. 1.12 and which require updated public
disclosure, although the two are distinct and separate requirements.
This requirement helps to ensure that the FCM's financial condition,
business operations, or other important factors do not change in
material ways without customers being able to ascertain such changes,
and would likely prompt some customers to conduct additional due
diligence in such situations in order to determine whether their funds
are at risk, which would provide additional accountability for FCMs.
By requiring each FCM to adopt policies and procedures reasonably
designed to ensure that its advertising and solicitation activities are
not misleading to its FCM customers under Sec. 1.55(l), the Commission
is strengthening accountability for communication related to an FCM's
sales and solicitation activities which helps to ensure the purposes of
the other requirements for disclosure are not frustrated.
By requiring FCMs to provide their daily Segregation Schedules,
daily Secured Amount Schedules, and daily Cleared Swaps Segregation
Schedules, as well as the same schedules from the most recent certified
annual report, the requirements under Sec. 1.55(o) facilitate
transparency. Requiring each FCM to post the above schedules and data
on its Web site will help to ensure that market participants are aware
that it is available, and will improve the speed and efficiency of
obtaining it. Similarly, by requiring FCMs to provide a link to the Web
site of the NFA's Basic System facilitate transparency by promoting
awareness of the additional information that is public regarding each
FCM's investment of customer funds and by reducing the search costs for
obtaining that information.
Section 22.2 Futures Commission Merchants: Treatment of Cleared Swaps
and Associated Cleared Swap Customer Collateral
The adopted amendments to Sec. 22.2 incorporate changes with
respect to protection of funds for customers trading cleared swaps that
are identical to the changes proposed for protection of futures
customer funds.\772\ Those changes include: (1) Incorporating the same
change to haircutting procedures as adopted in Sec. 1.17 and Sec.
1.32 but for Cleared Swaps; (2) requiring the FCM to

[[Page 68608]]

send daily Segregation Calculations for Cleared Swaps to the Commission
and DSROs; and (3) requiring that segregated investment detail reports
be produced twice per month, listing assets on deposit at each
depository, and sent to Commission and DSROs electronically by 11:59
p.m. the following business day. Records of both reports are required
to be maintained in accordance with Sec. 1.31.
---------------------------------------------------------------------------

\772\ As noted in section II.Q. above, the revisions to
Sec. Sec. 22.2(a) and (f) merely clarify that the calculation set
forth therein is the Net Liquidating Equity Method and thus, the
revision is not intended to, and should not be read to, change
current practice with respect to an FCM's residual interest
requirements for Cleared Swaps as set forth in Commission
regulations and JAC Update 12-03, and consistent with Staff
Interpretation 12-31.
---------------------------------------------------------------------------

Costs and Benefits
As discussed above, amendments to Sec. 22.2(a) and (f) are not
intended to change existing practice and thus do not introduce new
costs. The other amendments to Sec. 22.2 noted above are substantively
similar to amendments to corresponding part 1 regulations and the
relevant costs and benefits are similar to the costs and benefits
discussed in those sections.
The amendments to Sec. 22.2 have the benefits of harmonizing the
protection of customer funds between Cleared Swaps and futures and
clarifying further the regulatory requirements for Cleared Swaps.
Section 22.17 Policies and Procedures Governing Disbursements of
Cleared Swaps Customer Collateral From Cleared Swap Customer Accounts
The newly adopted Sec. 22.17 imposes restrictions on an FCM's
withdrawal of its residual interest, and requires that if a withdrawal
of residual interest not for the benefit of customers causes the FCM to
fall below its targeted residual interest, that the funds be
replenished the following business day or the residual interest target
be lowered in accordance with its policies and procedures established
under Sec. 1.11.
Costs and Benefits
The costs and benefits are similar to those created by Sec. Sec.
1.23 and 1.11 but apply to customer funds in Cleared Swaps Customer
Accounts rather than customer segregated accounts, and therefore are as
described in Sec. Sec. 1.23 and 1.11, but incremental thereto with
respect to Cleared Swaps Customer Accounts.
Section 30.1 Definitions
Amendments adopted to Sec. 30.1 establishes new definitions for
``30.7 customer,'' ``30.7 account,'' and ``30.7 customer funds.'' The
first is defined as any foreign futures or foreign option customer,
together with any foreign-domiciled person who trades in foreign
futures or foreign options trough an FCM. ``30.7 account'' and ``30.7
customer funds'' are then defined accordingly. These definitions relate
to the existing terms ``foreign futures or foreign options customer,''
``foreign futures or foreign options customer account,'' and ``foreign
futures or foreign options customer funds,'' respectively. The term
``foreign futures or foreign options customer'' only includes U.S.-
domiciled customers that deposit funds with an FCM for use in trading
foreign futures or foreign options. The new definitions, on the other
hand, include both U.S. and foreign-domiciled customers that deposit
funds with an FCM for use in trading foreign futures or foreign
options.
Costs and Benefits
These definitions play a `gatekeeping' function with respect to
other rules by determining what customers are included as ``30.7
customers.'' However, the costs and benefits of these changes are
attributable to the substantive requirements related to the
definitions, and therefore are discussed in the cost benefit
considerations related to Sec. 30.7.
Section 30.7 Treatment of Foreign Futures or Foreign Options Secured
Amount
The adopted amendments to Sec. 30.7 (1) Incorporate the funds of
foreign-domiciled investors deposited with an FCM for investment in
foreign futures and foreign options within the protections provided in
Sec. 30.7; (2) eliminate the Alternative Method and require the Net
Equity Liquidation Method for calculating 30.7 customer segregation
requirements; (3) add specificity to the written acknowledgments that
FCMs and DCOs must obtain from their depositories by providing required
templates; \773\ (4) add restrictions on withdrawing from residual
interest not for the benefit of customers; \774\ (5) require that 30.7
customer funds deposited in a bank must be available for immediate
withdrawal at the request of the FCM; (6) clarify that the FCM is
responsible for any losses related to investing 30.7 customer funds in
investments that comply with Sec. 1.25; (7) add a prohibition against
making unsecured loans to customers or using the funds in the
customer's trading account as security for a loan; (8) require daily
segregation reports and a detailed list of depositories to be submitted
to the Commission and DSRO, and that targeted residual interest be
included in both of those reports; (9) allow FCMs that are not dual
registrants to use the BD procedure for assigning a smaller net capital
haircut to investments of 30.7 customer funds in certain types of
instruments with low default risk; (10) establish a limit on the amount
of funds in a 30.7 account that can be held outside the U.S.; and (11)
require FCMs to, at a specified point in time, maintain residual
interest in 30.7 accounts that is at least equal to the sum of all
undermargined amounts for 30.7 customers. With the exception of the
requirements with respect to limiting funds held outside the U.S., the
permissibility of certain depositories outside the U.S., and the
requirement that FCMs comply with the highest equivalent custody
requirement relevant in a different country, these requirements are
substantially similar to equivalent requirements adopted in Sec. Sec.
1.20, 1.22, 1.23, 1.29, 1.30, 1.32 and 22.2 and 22.17. As a result of
the adopted changes with the noted exceptions, the rules in Sec. 30.7
for the protection of 30.7 customer funds are substantially similar to
the rules for the protection of segregated customer funds under 4d(a)
and Sec. Sec. 1.11-1.32, and the rules for the protection of cleared
swaps customer funds under 4d(f) and in part 22. However, portions of
Sec. 30.7 are notably different from rules protecting futures customer
funds and cleared swap customer funds. These are: (1) the definition of
the minimum amount that must be deposited in a 30.7 account for each
30.7 customer is different than in the corresponding requirements in
Sec. Sec. 1.20 and 22.2, due to the possibility of a higher
requirement under a foreign regulatory regime; (2) the list of
acceptable depositories for 30.7 customer funds includes banks or
trusts outside of the U.S. with more than $1 billion in regulatory
capital, and various other participants of foreign boards of trade and
their depositories; (3) Sec. 30.7 limits the amount of funds from a
30.7 account that can be held outside the U.S; and (4) the Residual
Interest Deadline for 30.7 funds is 6:00 p.m. Eastern Time, whereas the
Residual Interest Deadline for futures customer funds will, after the
phase-in period and absent further Commission action, move back to the
time of the daily settlement.
---------------------------------------------------------------------------

\773\ The additional specificity incorporates the same
requirements for acknowledgment and agreement that are contained in
the templates in the appendices of Sec. Sec. 1.20 and 1.26.
\774\ The same requirements as are adopted for futures
customers' funds and Cleared Swaps Customers' Collateral, including
a requirement for the FCM to abide by its policies and procedures
required by new Sec. 1.11.
---------------------------------------------------------------------------

The third and fourth are the only substantive differences in the
custody regime created by the adopted amendments compared to the
custody regimes put in place in the corresponding sections for domestic

[[Page 68609]]

futures customer funds and cleared swaps customer funds.
Costs and Benefits
In the NPRM, the Commission stated it believed a significant
benefit of the amendments adopted to Sec. 30.7 would be the likelihood
that in an FCM insolvency, the full amount owed to customers trading
foreign futures and foreign options, whether such customers were
foreign or domestic domiciled, would be intact as required to be held
separately in 30.7 accounts. The Commission did not receive comments
objecting to the changes to the calculations or the required inclusion
of foreign-domiciled customers. The adopted changes also established
new regulations for the protection of customer funds deposited for
trading in foreign futures and options that, with limited exceptions,
are substantively identical to the new protections adopted for futures
customer funds and cleared swaps customer funds. Therefore, many of the
costs and benefits of the changes that are proposed are identical to
those described above in the cost-benefit considerations related to
Sec. Sec. 1.11-1.32 and part 22.
Various regulations designed to ensure that the new calculation
requirement for the segregation of 30.7 funds is met at all times would
also apply, including the Sec. 30.7(g) restrictions on an FCM's
withdrawal of its residual interest which is commingled with 30.7
customer funds, and policies and procedures developed by the FCM
pursuant to Sec. 1.11 that are designed to ensure safe handling of
such funds. Application of the additional protections designed for
customer funds will further ensure the protection of market
participants and provide, as much as possible, equivalent protections
between domestic and foreign futures trading with respect to the
treatment of funds held by the FCMs. The Commission did not
quantitatively estimate costs of the amendments to Sec. 30.7, but
requested comment as to any costs to FCMs, including whether FCMs would
need to obtain additional capital or obtain additional liquidity as a
result of formally foreclosing their abilities to utilize the
Alternative Method versus the Net Liquidating Equity segregation method
in funding operations. The Commission did not receive comments
addressing these questions, or addressing its analysis that costs and
benefits would be incremental to the costs and benefits analyzed with
respect to the same substantive provisions applicable to both 4d(a)
(futures) and 4d(f) (Cleared Swaps) segregated funds. Moreover, the
Commission believes any incremental costs associated with complying
with these changes to be minimal, since much of the industry is already
held to these standards as a result of previous rule changes made by
NFA to its rulebook.\775\
---------------------------------------------------------------------------

\775\ See NFA Interpretive Notice 9066 (Revised, July 1, 2013).
---------------------------------------------------------------------------

In the NPRM, the Commission proposed in Sec. 30.7(c) a limitation
on the amount of funds from a 30.7 account that can be held outside the
U.S. Funds held overseas are subject to different regulatory and
bankruptcy regimes that may not offer comparable protections for
customer funds, creating additional repatriation risks to those funds.
For example, if an FCM carrying 30.7 funds, some of which were held in
depositories outside the U.S., were to default, it is possible that the
Trustee would not be able to promptly recover sufficient funds to repay
all the FCM's obligations to 30.7 customers. As noted above, this is
especially true if the funds are deposited with a foreign affiliate of
the FCM, as the likelihood of coincident bankruptcies of affiliated
financial firms has been observed to be exceedingly high.\776\ In such
an event, the funds held at the foreign affiliate would be distributed
in accordance with the insolvency rules of the foreign jurisdiction. In
such a case each 30.7 customer would likely receive a pro-rata share of
the funds that the Trustee is able recover, when the Trustee is able to
recover them. The proposed limit on the amount of funds that can be
held outside the U.S. was intended to assure that as much of the
customers' funds as possible remain subject to the U.S. regulatory and
bankruptcy regimes, eliminating repatriation risk to those funds. By
eliminating this risk for a larger percentage of the 30.7 funds, the
proposed rule promotes higher recovery rates for 30.7 account funds if
the FCM defaults, which helps ensure that 30.7 customers receive the
largest (and most prompt) pro rata distribution possible.
---------------------------------------------------------------------------

\776\ See, e.g., Lehman, MFGI.
---------------------------------------------------------------------------

The Commission received comments from FIA, as well as others, that
the proposed percentage limitation of 10% of required margin was not
adequate in light of account volatility and other factors, and that the
limitation should only be applicable to funds deposited with foreign
brokers and that otherwise FCMs should be permitted to hold funds in a
bank or trust company outside the U.S. to the same extent that an FCM
may hold other customer segregated and Cleared Swaps Customer
collateral outside the U.S.\777\ Commenters including Jefferies and
Advantage stated that the limitations may inhibit FCMs from trading
foreign futures and that customers may need to utilize non-U.S. brokers
for their foreign futures business as a result, because they would not
be able to accept customer securities outside the U.S. and customers
would have to pre-fund with cash instead.\778\ In response to
commenters and upon consideration, the Commission is increasing the
limitation from 10% to 20%, but is declining to further expand the
permissibility of holding 30.7 funds outside the U.S. due to the
increased repatriation risk applicable to excess margin deposited
outside the U.S. for 30.7 funds for foreign futures and foreign
options.
---------------------------------------------------------------------------

\777\ FIA Comment Letter at 36-37 (Feb. 15, 2013); RJ O'Brien
Comment Letter at 11 (Feb. 15, 2013).
\778\ Jefferies Comment Letter at 6 (Feb. 15, 2013); Advantage
Comment Letter at 9 (Feb. 15, 2013).
---------------------------------------------------------------------------

For 30.7 accounts, an FCM must maintain residual interest that is
at least equal to undermargined amounts by 6:00 p.m. Eastern Time on
the following business day, which is substantively similar to the
Industry Commenters' Alternative discussed above in the cost and
benefit considerations related to Sec. 1.22. As noted there, FIA and
ISDA estimated that more than 90% of customer's margin deficits are
collected by FCMs by 6:00 p.m. Eastern Time on the next trading day.
Thus, the Commission estimates the additional requisite residual
interest needed for 30.7 accounts using the analysis described above
for futures customer accounts. As of November 30, 2012, there was
approximately $30 billion in 30.7 accounts (excluding, here, and in the
following amounts, excess amounts contributed by FCMs).\779\ At the
top-10 FCMs, there was approximately $27.7 billion in 30.7
accounts.\780\ For the remaining FCMs, there was approximately $2.3
billion in 30.7 accounts.\781\ Using ISDA's point estimate for excess
collateral deposited by customers,\782\ the Commission estimates that
there was, at the top-10 FCMs, approximately $8.6 billion (31% of $27.7
billion) of existing customer excess in 30.7 accounts. Similarly, for
the remaining FCMs, the Commission estimates that there was
approximately

[[Page 68610]]

$0.7 billion (31% of $2.3 billion) of customer excess corresponding to
30.7 accounts.
---------------------------------------------------------------------------

\779\ See https://www.cftc.gov/MarketReports/FinancialDataforFCMs/HistoricalFCMReports/index.htm.
\780\ See id.
\781\ See id.
\782\ As discussed in the analysis of Sec. 1.22(c) above, ISDA
estimated the excess to be between $40 and $70 billion and employed
the midpoint of this range, $55 billion in its calculations. $55
billion is 31% of the total 177.1 billion held in both section
4d(a)(2) and part 30 secured accounts.
---------------------------------------------------------------------------

For the top-10 FCMs, the Commission subtracts $8.6 billion
(existing customer excess for these accounts) from $27.7 billion (total
funds held in these accounts) leaving approximately $19.1 billion in
required margin for 30.7 accounts for these FCMs. Multiplying ISDA's
60% required margin estimate (which assumed that the residual interest
requirement applies at all times) by 10% (i.e., 1-90%) gives 6% of the
required margin being needed in residual interest, or $1.1 billion for
these FCMs. As of November 30, 2012, the top-10 FCMs were holding
approximately $3.3 billion in residual interest in 30.7 accounts.\783\
Thus, it would appear that the top-10 FCMs are already holding
sufficient residual interest for 30.7 accounts. For the remaining FCMs,
the Commission subtracts $0.7 billion (existing customer excess for
these accounts) from $2.3 billion (total funds held in these accounts)
giving approximately $1.6 billion in required margin. Multiplying $1.6
billion by 6% gives approximately $96 million, but FCMs already
maintain over $1 billion in residual interest. Consequently, it would
appear that the remaining FCMs also already maintain enough residual
interest for 30.7 accounts.

V. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA'') \784\ requires Federal
agencies, in promulgating regulations, to consider the impact of those
regulations on small entities. As stated in the NPRM, the Commission
has previously established certain definitions of ``small entities'' to
be used by the Commission in evaluating the impact of its rules on
small entities in accordance with the RFA.\785\ The proposed
regulations would affect FCMs and DCOs.
---------------------------------------------------------------------------

\784\ 5 U.S.C. 601 et seq.
\785\ 47 FR 18618 (Apr. 30, 1982).
---------------------------------------------------------------------------

The Commission previously has determined that FCMs are not small
entities for purposes of the RFA, and, thus, the requirements of the
RFA do not apply to FCMs.\786\ The Commission's determination was
based, in part, upon the obligation of FCMs to meet the minimum
financial requirements established by the Commission to enhance the
protection of customers' segregated funds and protect the financial
condition of FCMs generally.\787\ The Commission also has previously
determined that DCOs are not small entities for the purpose of the
RFA.\788\ Accordingly, the Chairman, on behalf of the Commission,
certified pursuant to 5 U.S.C. 605(b) that the proposed regulations
would not have a significant economic impact on a substantial number of
small entities. The Commission then invited public comment on this
determination. The Commission received no comments.
---------------------------------------------------------------------------

\786\ Id. at 18619.
\787\ Id.
\788\ See 66 FR 45605, 45609 (Aug. 29, 2001).
---------------------------------------------------------------------------

B. Paperwork Reduction Act

The Paperwork Reduction Act (``PRA'') provides that a federal
agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information unless it displays a currently
valid control number issued by the Office of Management and Budget
(``OMB'').\789\ This final rulemaking contains several collections of
information that were submitted to OMB in the form of proposed
amendments to existing collection 3038-0024 and proposed revisions
thereto, as well as pre-existing collections 3038-0052 and 3038-0091.
There have been no substantive changes from the proposed rulemaking to
this final rulemaking that would require any adjustment to the
information collection burdens as they were originally proposed. As
required by OMB regulations, the Commission shall submit to OMB this
final rulemaking, together with ICRs that have been updated to include
the comment summary contained herein.
---------------------------------------------------------------------------

\789\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

The collections contained in this rulemaking are mandatory
collections. In formulating burden estimates for the collections in
this rulemaking, to avoid double accounting of information collections
that already have been assigned control numbers by OMB, or are covered
as burden hours in collections of information pending before OMB, the
PRA analysis provided in the proposed rulemaking, along with the
information collection request (``ICR'') with burden estimates that
were incorporated into the rulemaking by reference and submitted to
OMB, accounted only burden estimates for collections of information
that have not previously been submitted to OMB. The Commission sought
comment on the collections of information contained in the proposed
rulemaking only to the extent that the collections in the proposed
rulemaking would increase the burden hours contained with respect to
each of the related currently valid or proposed collections.
The Commission received over 120 written submissions on the
proposed rulemaking. Many of these comments discussed in general the
need for, effectiveness of, and practicality of various proposed rules.
However, none of the commenters questioned the burden estimates
provided in the proposed rulemaking or the ICR that was submitted. To
the extent that there were comments on the need for, effectiveness and
practicality of various proposed rules, they related to the rulemaking
as a whole rather than the collections in particular. Accordingly,
those comments were addressed above, in the sections of the preamble of
this final rulemaking that relate specifically to the proposed rules at
issue.
As required by the PRA, the Commission submitted the proposed
amendments, in the form of information collection requests related to
collections 3038-0024, 3038-0052, and 3038-0091 on November 14, 2012,
the same date that the proposed rulemaking was published in the Federal
Register.\790\ The Commission did not receive public comments on any of
the proposed collections from OMB on or before January 13, 2013, within
the 60 days established for such comments in the PRA after the notice
of proposed rulemaking and the submission of the certified ICR to
OMB.\791\ Accordingly, the proposed amendments to collections 3038-
0024, 3038-0052, and 3038-0091 are deemed to be approved by operation
of the PRA.\792\ The Commission therefore, pursuant to OMB
regulations,\793\ requests the assignment of OMB control numbers to the
proposed amendments to collections 3038-0024, 3038-0052, and 3038-0091,
which were submitted to OMB for approval on November 14, 2012.
---------------------------------------------------------------------------

\790\ See 44 U.S.C. 3507(d)(1)(A), providing for an agency to
forward to the Director of OMB or his or her designee a notice of
proposed rulemaking with a collection of information subject to
notice and comment pursuant to the provisions of 44 U.S.C.
3506(c)(2)(B), on or before the date that the proposed rulemaking is
published in the Federal Register, together with the ICR in the form
required by OMB in 5 CFR 1320.8 and 1320.9.
\791\ See 44 U.S.C. 3507(d)(1)(B), cross-referencing 44 U.S.C.
3508. See also 5 CFR 1320.11(c).
\792\ See 44 U.S.C. 3507(3).
\793\ See 5 CFR 1320.11(i), implementing 44 U.S.C. 3507(d)(3).

[[Page 68611]]

Appendix 1 to Supplementary Information--Table of Comment Letters
------------------------------------------------------------------------
Abbreviation used (if applicable) Full name
------------------------------------------------------------------------
Advantage................................. Advantage Futures LLC.
AFMP Group................................ Agricultural Futures Market
Participants: AMCOT,
American Cotton Shippers
Association, American Farm
Bureau Federation, American
Feed Industry Association,
American Soybean
Association, CoBank,
Commodity Markets Council,
National Association of
Wheat Growers, National
Barley Growers Association,
National Cattlemen's Beef
Association, National Corn
Growers Association,
National Cotton Council,
National Council of Farmer
Cooperatives, National
Grain and Feed Association,
National Pork Producers
Council, National Sorghum
Producers, National
Sunflower Association,
North American Millers
Association, USA Rice
Federation, US Canola
Association, US Dry Bean
Council.
AIMA...................................... Alternative Investment
Management Association.
Amarillo.................................. Amarillo Brokerage Co.
ACLI...................................... American Council of Life
Insurers.
AFBF...................................... American Farm Bureau
Federation.
AICPA..................................... American Institute of
Certified Public
Accountants.
AIM....................................... American Iron & Metal.
BlackRock................................. BlackRock, Inc.
Depository Bank Group..................... BMO Harris Bank, Barclays
Bank, The Bank of New York
Mellon and Brown Brothers
Harriman & Co.
Center for Audit Quality.................. Center for Audit Quality.
CFA....................................... CFA Institute.
Chris Barnard............................. Chris Barnard.
CHS Hedging............................... CHS Hedging, Inc.
CME....................................... CME Group Inc.
CoBank.................................... CoBank.
Commercial Energy Working Group........... Commercial Energy Working
Group.
CIEBA..................................... Committee on Investment of
Employee Benefit Assets.
CCC....................................... Commodity Customer
Coalition.
Congressional Committees.................. Congress of the United
States: Frank D. Lucas,
House Committee on
Agricultural; Debbie
Stabenow, Senate Committee
on Agriculture, Nutrition,
and Forestry.
Deloitte.................................. Deloitte & Touche.
Ernst & Young............................. Ernst & Young LLP.
Eurex..................................... Eurex Clearing AG.
FHLB...................................... Federal Home Loan Banks.
Federal Reserve Banks..................... Federal Reserve Banks of New
York and Chicago.
FXCM...................................... Forex Capital Markets LLC.
Franklin.................................. Franklin Templeton
Investments.
Frontier Futures.......................... Frontier Futures, Inc.
FIA....................................... Futures Industry Association
(Collectively--Barclays,
State Street, Goldman
Sachs, others).
Global Commodity.......................... Global Commodity Analytics &
Consulting LLC.
ISRI...................................... Institute of Scrap Recycling
Industries, Inc.
ISDA...................................... International Swap Dealers
Association, Inc.
FCStone................................... INTL FCStone, Inc.
ICI....................................... Investment Company
Institute.
ICA....................................... Iowa Cattlemen's
Association.
Jefferies................................. Jefferies Bache, LLC.
JSA....................................... John Stewart and Associates.
JAC....................................... Joint Audit Committee.
Katten-FIA................................ Katten Muchin Rosenman LLP
on behalf of the Futures
Industry Association.
KPMG...................................... KPMG LLP.
Kripke Enterprises........................ Kripke Enterprises.
LCH.Clearnet.............................. LCH.Clearnet Group Limited.
MFA....................................... Managed Funds Association.
Manitoba.................................. Manitoba Corporation.
MGEX...................................... Minneapolis Grain Exchange,
Inc.
NCBA...................................... National Cattlemen's Beef
Association.
NCFC...................................... National Council of Farmer
Cooperatives.
NFA....................................... National Futures
Association.
NGFA...................................... National Grain and Feed
Association.
NIBA...................................... National Introducing Brokers
Association.
NPPC...................................... National Pork Producers
Council.
NEFI/PMAA................................. New England Fuel Institute
Petroleum Marketers
Association of America.
NYPC...................................... New York Portfolio Clearing,
LLC.
Newedge................................... Newedge USA, LLC.
Nodal..................................... Nodal Exchange, LLC.
Paul/Weiss................................ Paul, Weiss, Rifkind,
Wharton & Garrison LLP.
Phillip Futures Inc....................... Phillip Futures Inc.
Pilot Flying J............................ Pilot Travel Centers, LLC.
Premier Metal Services.................... Premier Metal Services, LLC.
Prudential................................ The Prudential Insurance
Company of America.
PWC....................................... PWC LLP.
Randy Fritsche............................ Randy Fritsche.
Rice Dairy LLC............................ Rice Dairy LLC.

[[Page 68612]]

RJ O'Brien................................ R.J. O'Brien & Associates,
LLC.
RCG....................................... Rosenthal Collins Group.
Schippers................................. Schippers Trading.
Schwartz & Ballen......................... Schwartz & Ballen LLP.
Security Benefit.......................... Security Benefit Life
Insurance Company.
SIFMA..................................... SIFMA Asset Management
Group.
Solomon Metals Corp....................... Solomon Metals Corp.
State Street.............................. State Street Corporation.
Steve Jones............................... Steve Jones.
SUNY Buffalo.............................. State University of New York
at Buffalo Law School.
TD Ameritrade............................. TD Ameritrade, Inc.
TCFA...................................... Texas Cattle Feeder
Association.
TIAA-CREF................................. TIAA-CREF.
Strelitz/California Metal X............... Tim Strelitz/California
Metal X.
Vanguard.................................. Vanguard.
------------------------------------------------------------------------

BILLING CODE 6351-01-P

[[Page 68613]]

Appendix 2 to Supplementary Information--CFTC Form 1-FR-FCM
[GRAPHIC] [TIFF OMITTED] TR14NO13.000

[[Page 68614]]

[GRAPHIC] [TIFF OMITTED] TR14NO13.001

[[Page 68615]]

[GRAPHIC] [TIFF OMITTED] TR14NO13.002

[[Page 68616]]

[GRAPHIC] [TIFF OMITTED] TR14NO13.003

[[Page 68617]]

[GRAPHIC] [TIFF OMITTED] TR14NO13.004

[[Page 68618]]

[GRAPHIC] [TIFF OMITTED] TR14NO13.005

[[Page 68619]]

[GRAPHIC] [TIFF OMITTED] TR14NO13.006

BILLING CODE 6351-01-C

List of Subjects

17 CFR Part 1

Brokers, Commodity futures, Consumer protection, Reporting and
recordkeeping requirements.

17 CFR Part 3

Associated persons, Brokers, Commodity futures, Customer
protection, Major swap participants, Registration, Swap dealers.

17 CFR Part 22

Brokers, Clearing, Consumer protection, Reporting and recordkeeping
requirements, Swaps.

17 CFR Part 30

Commodity futures, Consumer protection, Currency, Reporting and
recordkeeping requirements.

17 CFR Part 140

Authority delegations (Government agencies), Organization and
functions (Government agencies).

For the reasons stated in the preamble, the Commodity Futures
Trading Commission amends 17 CFR parts 1, 3, 22, 30, and 140 as
follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

0
1. The authority citation for part 1 is revised to read as follows:

Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g,
6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8,
9, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24, as
amended by Title VII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

0
2. Amend Sec. 1.3 to revise paragraph (rr) to read as follows:

Sec. 1.3 Definitions.

* * * * *
(rr) Foreign futures or foreign options secured amount. This term
means all money, securities and property received by a futures
commission merchant from, for, or on behalf of 30.7 customers as
defined in Sec. 30.1 of this chapter:
(1) To margin, guarantee, or secure foreign futures contracts and
all money accruing to such 30.7 customers as the result of such
contracts;
(2) In connection with foreign options transactions representing
premiums payable or premiums received, or to guarantee or secure
performance on such transactions; and
(3) All money accruing to such 30.7 customers as the result of
trading in

[[Page 68620]]

foreign futures contracts or foreign options.
* * * * *

0
3. Amend Sec. 1.10 to:
0
a. Revise paragraph (b)(1)(ii);
0
b. Add paragraph (b)(5); and
0
c. Revise paragraphs (c)(1), (c)(2)(i), (d)(1)(v), (d)(2)(iv),
(d)(2)(vi), and (g)(2)(ii).
The revisions and addition read as follows:

Sec. 1.10 Financial reports of futures commission merchants and
introducing brokers.

* * * * *
(b) * * *
(1) * * *
(ii) In addition to the monthly financial reports required by
paragraph (b)(1)(i) of this section, each person registered as a
futures commission merchant must file a Form 1-FR-FCM as of the close
of its fiscal year, which must be certified by an independent public
accountant in accordance with Sec. 1.16, and must be filed no later
than 60 days after the close of the futures commission merchant's
fiscal year: Provided, however, that a registrant which is registered
with the Securities and Exchange Commission as a securities broker or
dealer must file this report not later than the time permitted for
filing an annual audit report under Sec. 240.17a-5(d)(5) of this
title.
* * * * *
(5) Each futures commission merchant must file with the Commission
the measure of the future commission merchant's leverage as of the
close of the business each month. For purpose of this section, the term
``leverage'' shall be defined by a registered futures association of
which the futures commission merchant is a member. The futures
commission merchant is required to file the leverage information with
the Commission within 17 business days of the close of the futures
commission merchant's month end.
(c) Where to file reports. (1) Form 1-FR filed by an introducing
broker pursuant to paragraph (b)(2) of this section need be filed only
with, and will be considered filed when received by, the National
Futures Association. Other reports or information provided for in this
section will be considered filed when received by the Regional office
of the Commission with jurisdiction over the state in which the
registrant's principal place of business is located (as set forth in
Sec. 140.02 of this chapter) and by the designated self-regulatory
organization, if any; and reports or other information required to be
filed by this section by an applicant for registration will be
considered filed when received by the National Futures Association. Any
report or information filed with the National Futures Association
pursuant to this paragraph shall be deemed for all purposes to be filed
with, and to be the official record of, the Commission.
(2)(i) All filings or other notices prepared by a futures
commission merchant pursuant to this section must be submitted to the
Commission in electronic form using a form of user authentication
assigned in accordance with procedures established by or approved by
the Commission, and otherwise in accordance with instructions issued by
or approved by the Commission, if the futures commission merchant or a
designated self-regulatory organization has provided the Commission
with the means necessary to read and to process the information
contained in such report. A Form 1-FR required to be certified by an
independent public accountant in accordance with Sec. 1.16 which is
filed by a futures commission merchant must be filed electronically.
* * * * *
(d) * * *
(1) * * *
(v) For a futures commission merchant only, the statements of
segregation requirements and funds in segregation for customers trading
on U.S. commodity exchanges and for customers' dealer options accounts,
the statement of secured amounts and funds held in separate accounts
for 30.7 customers (as defined in Sec. 30.1 of this chapter) in
accordance with Sec. 30.7 of this chapter, and the statement of
cleared swaps customer segregation requirements and funds in cleared
swaps customer accounts under section 4d(f) of the Act as of the date
for which the report is made; and
* * * * *
(2) * * *
(iv) For a futures commission merchant only, the statements of
segregation requirements and funds in segregation for customers trading
on U.S. commodity exchanges and for customers' dealer options accounts,
the statement of secured amounts and funds held in separate accounts
for 30.7 customers (as defined in Sec. 30.1 of this chapter) in
accordance with Sec. 30.7 of the chapter, and the statement of cleared
swaps customers segregation requirements and funds in cleared swaps
customer accounts under section 4d(f) of the Act as of the date for
which the report is made;
* * * * *
(vi) A reconciliation, including appropriate explanations, of the
statement of the computation of the minimum capital requirements
pursuant to Sec. 1.17 and, for a futures commission merchant only, the
statements of segregation requirements and funds in segregation for
customers trading on U.S. commodity exchanges and for customers' dealer
option accounts, the statement of secured amounts and funds held in
separate accounts for 30.7 customers (as defined in Sec. 30.1 of this
chapter) in accordance with Sec. 30.7 of this chapter, and the
statement of cleared swaps customer segregation requirements and funds
in cleared swaps customer accounts under section 4d(f) of the Act, in
the certified Form 1-FR with the applicant's or registrant's
corresponding uncertified most recent Form 1-FR filing when material
differences exist or, if no material differences exist, a statement so
indicating; and
* * * * *
(g) * * *
(2) * * *
(ii) The following statements and footnote disclosures thereof: the
Statement of Financial Condition in the certified annual financial
reports of futures commission merchants and introducing brokers; the
Statements (to be filed by a futures commission merchant only) of
Segregation Requirements and Funds in Segregation for customers trading
on U.S. commodity exchanges and for customers' dealer options accounts,
the Statement (to be filed by a futures commission merchant only) of
Secured Amounts and Funds held in Separate Accounts for 30.7 Customers
(as defined in Sec. 30.1 of this chapter) in accordance with Sec.
30.7 of this chapter, and the Statement (to be filed by futures
commission merchants only) of Cleared Swaps Customer Segregation
Requirements and Funds in Cleared Swaps Customer Accounts under section
4d(f) of the Act.
* * * * *

0
4. Add Sec. 1.11 to read as follows:

Sec. 1.11 Risk Management Program for futures commission merchants.

(a) Applicability. Nothing in this section shall apply to a futures
commission merchant that does not accept any money, securities, or
property (or extend credit in lieu thereof) to margin, guarantee, or
secure any trades or contracts that result from soliciting or accepting
orders for the purchase or sale of any commodity interest.
(b) Definitions. For purposes of this section:
(1) Business unit means any department, division, group, or

[[Page 68621]]

personnel of a futures commission merchant or any of its affiliates,
whether or not identified as such that:
(i) Engages in soliciting or in accepting orders for the purchase
or sale of any commodity interest and that, in or in connection with
such solicitation or acceptance of orders, accepts any money,
securities, or property (or extends credit in lieu thereof) to margin,
guarantee, or secure any trades or contracts that result or may result
therefrom; or
(ii) Otherwise handles segregated funds, including managing,
investing, and overseeing the custody of segregated funds, or any
documentation in connection therewith, other than for risk management
purposes; and
(iii) Any personnel exercising direct supervisory authority of the
performance of the activities described in paragraph (b)(1)(i) or (ii)
of this section.
(2) Customer means a futures customer as defined in Sec. 1.3,
Cleared Swaps Customer as defined in Sec. 22.1 of this chapter, and
30.7 customer as defined in Sec. 30.1 of this chapter.
(3) Governing body means the proprietor, if the futures commission
merchant is a sole proprietorship; a general partner, if the futures
commission merchant is a partnership; the board of directors if the
futures commission merchant is a corporation; the chief executive
officer, the chief financial officer, the manager, the managing member,
or those members vested with the management authority if the futures
commission merchant is a limited liability company or limited liability
partnership.
(4) Segregated funds means money, securities, or other property
held by a futures commission merchant in separate accounts pursuant to
Sec. 1.20 for futures customers, pursuant to Sec. 22.2 of this
chapter for Cleared Swaps Customers, and pursuant to Sec. 30.7 of this
chapter for 30.7 customers.
(5) Senior management means, any officer or officers specifically
granted the authority and responsibility to fulfill the requirements of
senior management by the governing body.
(c) Risk Management Program. (1) Each futures commission merchant
shall establish, maintain, and enforce a system of risk management
policies and procedures designed to monitor and manage the risks
associated with the activities of the futures commission merchant as
such. For purposes of this section, such policies and procedures shall
be referred to collectively as a ``Risk Management Program.''
(2) Each futures commission merchant shall maintain written
policies and procedures that describe the Risk Management Program of
the futures commission merchant.
(3) The Risk Management Program and the written risk management
policies and procedures, and any material changes thereto, shall be
approved in writing by the governing body of the futures commission
merchant.
(4) Each futures commission merchant shall furnish a copy of its
written risk management policies and procedures to the Commission and
its designated self-regulatory organization upon application for
registration and thereafter upon request.
(d) Risk management unit. As part of the Risk Management Program,
each futures commission merchant shall establish and maintain a risk
management unit with sufficient authority; qualified personnel; and
financial, operational, and other resources to carry out the risk
management program established pursuant to this section. The risk
management unit shall report directly to senior management and shall be
independent from the business unit.
(e) Elements of the Risk Management Program. The Risk Management
Program of each futures commission merchant shall include, at a
minimum, the following elements:
(1) Identification of risks and risk tolerance limits. (i) The Risk
Management Program shall take into account market, credit, liquidity,
foreign currency, legal, operational, settlement, segregation,
technological, capital, and any other applicable risks together with a
description of the risk tolerance limits set by the futures commission
merchant and the underlying methodology in the written policies and
procedures. The risk tolerance limits shall be reviewed and approved
quarterly by senior management and annually by the governing body.
Exceptions to risk tolerance limits shall be subject to written
policies and procedures.
(ii) The Risk Management Program shall take into account risks
posed by affiliates, all lines of business of the futures commission
merchant, and all other trading activity engaged in by the futures
commission merchant. The Risk Management Program shall be integrated
into risk management at the consolidated entity level.
(iii) The Risk Management Program shall include policies and
procedures for detecting breaches of risk tolerance limits set by the
futures commission merchant, and alerting supervisors within the risk
management unit and senior management, as appropriate.
(2) Periodic Risk Exposure Reports. (i) The risk management unit of
each futures commission merchant shall provide to senior management and
to its governing body quarterly written reports setting forth all
applicable risk exposures of the futures commission merchant; any
recommended or completed changes to the Risk Management Program; the
recommended time frame for implementing recommended changes; and the
status of any incomplete implementation of previously recommended
changes to the Risk Management Program. For purposes of this section,
such reports shall be referred to as ``Risk Exposure Reports.'' The
Risk Exposure Reports also shall be provided to the senior management
and the governing body immediately upon detection of any material
change in the risk exposure of the futures commission merchant.
(ii) Furnishing to the Commission. Each futures commission merchant
shall furnish copies of its Risk Exposure Reports to the Commission
within five (5) business days of providing such reports to its senior
management.
(3) Specific risk management considerations. The Risk Management
Program of each futures commission merchant shall include, but not be
limited to, policies and procedures necessary to monitor and manage the
following risks:
(i) Segregation risk. The written policies and procedures shall be
reasonably designed to ensure that segregated funds are separately
accounted for and segregated or secured as belonging to customers as
required by the Act and Commission regulations and must, at a minimum,
include or address the following:
(A) A process for the evaluation of depositories of segregated
funds, including, at a minimum, documented criteria that any depository
that will hold segregated funds, including an entity affiliated with
the futures commission merchant, must meet, including criteria
addressing the depository's capitalization, creditworthiness,
operational reliability, and access to liquidity. The criteria should
further consider the extent to which segregated funds are concentrated
with any depository or group of depositories. The criteria also should
include the availability of deposit insurance and the extent of the
regulation and supervision of the depository;
(B) A program to monitor an approved depository on an ongoing basis
to assess its continued satisfaction of the futures commission
merchant's established

[[Page 68622]]

criteria, including a thorough due diligence review of each depository
at least annually;
(C) An account opening process for depositories, including
documented authorization requirements, procedures that ensure that
segregated funds are not deposited with a depository prior to the
futures commission merchant receiving the acknowledgment letter
required from such depository pursuant to Sec. 1.20, and Sec. Sec.
22.2 and 30.7 of this chapter, and procedures that ensure that such
account is properly titled to reflect that it is holding segregated
funds pursuant to the Act and Commission regulations;
(D) A process for establishing a targeted amount of residual
interest that the futures commission merchant seeks to maintain as its
residual interest in the segregated funds accounts and such process
must be designed to reasonably ensure that the futures commission
merchant maintains the targeted residual amounts and remains in
compliance with the segregated funds requirements at all times. The
policies and procedures must require that senior management, in
establishing the total amount of the targeted residual interest in the
segregated funds accounts, perform appropriate due diligence and
consider various factors, as applicable, relating to the nature of the
futures commission merchant's business including, but not limited to,
the composition of the futures commission merchant's customer base, the
general creditworthiness of the customer base, the general trading
activity of the customers, the types of markets and products traded by
the customers, the proprietary trading of the futures commission
merchant, the general volatility and liquidity of the markets and
products traded by customers, the futures commission merchant's own
liquidity and capital needs, and the historical trends in customer
segregated fund balances, including undermargined amounts and net
deficit balances in customers' accounts. The analysis and calculation
of the targeted amount of the future commission merchant's residual
interest must be described in writing with the specificity necessary to
allow the Commission and the futures commission merchant's designated
self-regulatory organization to duplicate the analysis and calculation
and test the assumptions made by the futures commission merchant. The
adequacy of the targeted residual interest and the process for
establishing the targeted residual interest must be reassessed
periodically by Senior Management and revised as necessary;
(E) A process for the withdrawal of cash, securities, or other
property from accounts holding segregated funds, where the withdrawal
is not for the purpose of payments to or on behalf of the futures
commission merchant's customers. Such policies and procedures must
satisfy the requirements of Sec. 1.23, Sec. 22.17 of this chapter, or
Sec. 30.7 of this chapter, as applicable;
(F) A process for assessing the appropriateness of specific
investments of segregated funds in permitted investments in accordance
with Sec. 1.25. Such policies and procedures must take into
consideration the market, credit, counterparty, operational, and
liquidity risks associated with such investments, and assess whether
such investments comply with the requirements in Sec. 1.25 including
that the futures commission merchant manage the permitted investments
consistent with the objectives of preserving principal and maintaining
liquidity;
(G) Procedures requiring the appropriate separation of duties among
individuals responsible for compliance with the Act and Commission
regulations relating to the protection and financial reporting of
segregated funds, including the separation of duties among personnel
that are responsible for advising customers on trading activities,
approving or overseeing cash receipts and disbursements (including
investment operations), and recording and reporting financial
transactions. The policies and procedures must require that any
movement of funds to affiliated companies and parties are properly
approved and documented;
(H) A process for the timely recording of all transactions,
including transactions impacting customers' accounts, in the firm's
books of record;
(I) A program for conducting annual training of all finance,
treasury, operations, regulatory, compliance, settlement, and other
relevant officers and employees regarding the segregation requirements
for segregated funds required by the Act and regulations, the
requirements for notices under Sec. 1.12, procedures for reporting
suspected breaches of the policies and procedures required by this
section to the chief compliance officer, without fear of retaliation,
and the consequences of failing to comply with the segregation
requirements of the Act and regulations; and
(J) Policies and procedures for assessing the liquidity,
marketability and mark-to-market valuation of all securities or other
non-cash assets held as segregated funds, including permitted
investments under Sec. 1.25, to ensure that all non-cash assets held
in the customer segregated accounts, both customer-owned securities and
investments in accordance with Sec. 1.25, are readily marketable and
highly liquid. Such policies and procedures must require daily
measurement of liquidity needs with respect to customers; assessment of
procedures to liquidate all non-cash collateral in a timely manner and
without significant effect on price; and application of appropriate
collateral haircuts that accurately reflect market and credit risk.
(ii) Operational risk. The Risk Management Program shall include
automated financial risk management controls reasonably designed to
prevent the placing of erroneous orders, including those that exceed
pre-set capital, credit, or volume thresholds. The Risk Management
Program shall ensure that the use of automated trading programs is
subject to policies and procedures governing the use, supervision,
maintenance, testing, and inspection of such programs.
(iii) Capital risk. The written policies and procedures shall be
reasonably designed to ensure that the futures commission merchant has
sufficient capital to be in compliance with the Act and the
regulations, and sufficient capital and liquidity to meet the
reasonably foreseeable needs of the futures commission merchant.
(4) Supervision of the Risk Management Program. The Risk Management
Program shall include a supervisory system that is reasonably designed
to ensure that the policies and procedures required by this section are
diligently followed.
(f) Review and testing. (1) The Risk Management Program of each
futures commission merchant shall be reviewed and tested on at least an
annual basis, or upon any material change in the business of the
futures commission merchant that is reasonably likely to alter the risk
profile of the futures commission merchant.
(2) The annual reviews of the Risk Management Program shall include
an analysis of adherence to, and the effectiveness of, the risk
management policies and procedures, and any recommendations for
modifications to the Risk Management Program. The annual testing shall
be performed by qualified internal audit staff that are independent of
the business unit, or by a qualified third party audit service
reporting to staff that are independent of the business unit. The
results of the annual review of the Risk Management Program shall be
promptly reported to and reviewed by the chief compliance officer,
senior management, and governing body of the futures commission
merchant.

[[Page 68623]]

(3) Each futures commission merchant shall document all internal
and external reviews and testing of its Risk Management Program and
written risk management policies and procedures including the date of
the review or test; the results; any deficiencies identified; the
corrective action taken; and the date that corrective action was taken.
Such documentation shall be provided to Commission staff, upon request.
(g) Distribution of risk management policies and procedures. The
Risk Management Program shall include procedures for the timely
distribution of its written risk management policies and procedures to
relevant supervisory personnel. Each futures commission merchant shall
maintain records of the persons to whom the risk management policies
and procedures were distributed and when they were distributed.
(h) Recordkeeping. (1) Each futures commission merchant shall
maintain copies of all written approvals required by this section.
(2) All records or reports, including, but not limited to, the
written policies and procedures and any changes thereto that a futures
commission merchant is required to maintain pursuant to this regulation
shall be maintained in accordance with Sec. 1.31 and shall be made
available promptly upon request to representatives of the Commission.

0
5. Amend Sec. 1.12 to:
0
a. Revise paragraphs (a)(1) and (a)(2); (b)(1), (b)(2), and (b)(4);
(c); (d); (e); (f)(2) through (f)(4) and (f)(5)(i); (g); (h); and (i);
and
0
b. Add paragraphs (j), (k), (l), (m), and (n).
The revisions and additions read as follows:

Sec. 1.12 Maintenance of minimum financial requirements by futures
commission merchants and introducing brokers.

(a) * * *
(1) Give notice, as set forth in paragraph (n) of this section,
that the applicant's or registrant's adjusted net capital is less than
required by Sec. 1.17 or by other capital rule, identifying the
applicable capital rule. The notice must be given immediately after the
applicant or registrant knows or should have known that its adjusted
net capital is less than required by any of the aforesaid rules to
which the applicant or registrant is subject; and
(2) Provide together with such notice documentation, in such form
as necessary, to adequately reflect the applicant's or registrant's
capital condition as of any date on which such person's adjusted net
capital is less than the minimum required; Provided, however, that if
the applicant or registrant cannot calculate or otherwise immediately
determine its financial condition, it must provide the notice required
by paragraph (a)(1) of this section and include in such notice a
statement that the entity cannot presently calculate its financial
condition. The applicant or registrant must provide similar
documentation of its financial condition for other days as the
Commission may request.
(b) * * *
(1) 150 percent of the minimum dollar amount required by Sec.
1.17(a)(1)(i)(A);
(2) 110 percent of the amount required by Sec. 1.17(a)(1)(i)(B);
* * * * *
(4) For securities brokers or dealers, the amount of net capital
specified in Rule 17a-11(c) of the Securities and Exchange Commission
(17 CFR 240.17a-11(c)), must file notice to that effect, as set forth
in paragraph (n) of this section, as soon as possible and no later than
twenty-four (24) hours of such event.
(c) If an applicant or registrant at any time fails to make or keep
current the books and records required by these regulations, such
applicant or registrant must, on the same day such event occurs,
provide notice of such fact as specified in paragraph (n) of this
section, specifying the books and records which have not been made or
which are not current, and as soon as possible, but not later than
forty-eight (48) hours after giving such notice, file a report as
required by paragraph (n) of this section stating what steps have been
and are being taken to correct the situation.
(d) Whenever any applicant or registrant discovers or is notified
by an independent public accountant, pursuant to Sec. 1.16(e)(2), of
the existence of any material inadequacy, as specified in Sec.
1.16(d)(2), such applicant or registrant must give notice of such
material inadequacy, as provided in paragraph (n) of this section, as
soon as possible but not later than twenty-four (24) hours of
discovering or being notified of the material inadequacy. The applicant
or registrant must file, in the manner provided for under paragraph (n)
of this section, a report stating what steps have been and are being
taken to correct the material inadequacy within forty-eight (48) hours
of filing its notice of the material inadequacy.
(e) Whenever any self-regulatory organization learns that a member
registrant has failed to file a notice or report as required by this
section, that self-regulatory organization must immediately report this
failure by notice, as provided in paragraph (n) of this section.
(f) * * *
(2) Whenever a registered futures commission merchant determines
that any position it carries for another registered futures commission
merchant or for a registered leverage transaction merchant must be
liquidated immediately, transferred immediately or that the trading of
any account of such futures commission merchant or leverage transaction
merchant shall be only for purposes of liquidation, because the other
futures commission merchant or the leverage transaction merchant has
failed to meet a call for margin or to make other required deposits,
the carrying futures commission merchant must immediately give notice,
as provided in paragraph (n) of this section, of such a determination.
(3) Whenever a registered futures commission merchant determines
that an account which it is carrying is undermargined by an amount
which exceeds the futures commission merchant's adjusted net capital
determined in accordance with Sec. 1.17, the futures commission
merchant must immediately provide notice, as provided in paragraph (n)
of this section, of such a determination to the designated self-
regulatory organization and the Commission. This paragraph (f)(3) shall
apply to any account carried by the futures commission merchant,
whether a customer, noncustomer, omnibus or proprietary account. For
purposes of this paragraph, if any person has an interest of 10 percent
or more in ownership or equity in, or guarantees, more than one
account, or has guaranteed an account in addition to its own account,
all such accounts shall be combined.
(4) A futures commission merchant shall provide immediate notice,
as provided in paragraph (n) of this section, whenever any commodity
interest account it carries is subject to a margin call, or call for
other deposits required by the futures commission merchant, that
exceeds the futures commission merchant's excess adjusted net capital,
determined in accordance with Sec. 1.17, and such call has not been
answered by the close of business on the day following the issuance of
the call. This applies to all accounts carried by the futures
commission merchant, whether customer, noncustomer, or omnibus, that
are subject to margining, including commodity futures, cleared swaps,
and options. In addition to actual margin deposits by an account owner,
a futures commission merchant may also take account of favorable market
moves in determining whether

[[Page 68624]]

the margin call is required to be reported under this paragraph.
(5)(i) A futures commission merchant shall provide immediate
notice, as provided in paragraph (n) of this section, whenever its
excess adjusted net capital is less than six percent of the maintenance
margin required by the futures commission merchant on all positions
held in accounts of a noncustomer other than a noncustomer who is
subject to the minimum financial requirements of:
(A) A futures commission merchant, or
(B) The Securities and Exchange Commission for a securities broker
or dealer.
* * * * *
(g) A futures commission merchant shall provide notice, as provided
in paragraph (n) of this section, of a substantial reduction in capital
as compared to that last reported in a financial report filed with the
Commission pursuant to Sec. 1.10. This notice shall be provided as
follows:
(1) If any event or series of events, including any withdrawal,
advance, loan or loss cause, on a net basis, a reduction in net capital
(or, if the futures commission merchant is qualified to use the filing
option available under Sec. 1.10(h), tentative net capital as defined
in the rules of the Securities and Exchange Commission) of 20 percent
or more, notice must be provided as provided in paragraph (n) of this
section within two business days of the event or series of events
causing the reduction stating the reason for the reduction and steps
the futures commission merchant will be taking to ensure an appropriate
level of net capital is maintained by the futures commission merchant;
and
(2) If equity capital of the futures commission merchant or a
subsidiary or affiliate of the futures commission merchant consolidated
pursuant to Sec. 1.17(f) (or 17 CFR 240.15c3-1e) would be withdrawn by
action of a stockholder or a partner or a limited liability company
member or by redemption or repurchase of shares of stock by any of the
consolidated entities or through the payment of dividends or any
similar distribution, or an unsecured advance or loan would be made to
a stockholder, partner, sole proprietor, limited liability company
member, employee or affiliate, such that the withdrawal, advance or
loan would cause, on a net basis, a reduction in excess adjusted net
capital (or, if the futures commission merchant is qualified to use the
filing option available under Sec. 1.10(h), excess net capital as
defined in the rules of the Securities and Exchange Commission) of 30
percent or more, notice must be provided as provided in paragraph (n)
of this section at least two business days prior to the withdrawal,
advance or loan that would cause the reduction: Provided, however, That
the provisions of paragraphs (g)(1) and (g)(2) of this section do not
apply to any futures or securities transaction in the ordinary course
of business between a futures commission merchant and any affiliate
where the futures commission merchant makes payment to or on behalf of
such affiliate for such transaction and then receives payment from such
affiliate for such transaction within two business days from the date
of the transaction.
(3) Upon receipt of such notice from a futures commission merchant,
or upon a reasonable belief that a substantial reduction in capital has
occurred or will occur, the Director of the Division of Swap Dealer and
Intermediary Oversight or the Director's designee may require that the
futures commission merchant provide or cause a Material Affiliated
Person (as that term is defined in Sec. 1.14(a)(2)) to provide, within
three business days from the date of request or such shorter period as
the Division Director or designee may specify, such other information
as the Division Director or designee determines to be necessary based
upon market conditions, reports provided by the futures commission
merchant, or other available information.
(h) Whenever a person registered as a futures commission merchant
knows or should know that the total amount of its funds on deposit in
segregated accounts on behalf of customers trading on designated
contract markets, or the amount of funds on deposit in segregated
accounts for customers transacting in Cleared Swaps under part 22 of
this chapter, or the total amount set aside on behalf of customers
trading on non-United States markets under part 30 of this chapter, is
less than the total amount of such funds required by the Act and the
regulations to be on deposit in segregated or secured amount accounts
on behalf of such customers, the registrant must report such deficiency
immediately by notice to the registrant's designated self-regulatory
organization and the Commission, as provided in paragraph (n) of this
section.
(i) A futures commission merchant must provide immediate notice, as
set forth in paragraph (n) of this section, whenever it discovers or is
informed that it has invested funds held for futures customers trading
on designated contract markets pursuant to Sec. 1.20, Cleared Swaps
Customer Collateral, as defined in Sec. 22.1 of this chapter, or 30.7
customer funds, as defined in Sec. 30.1 of this chapter, in
instruments that are not permitted investments under Sec. 1.25, or has
otherwise violated the requirements governing the investment of funds
belonging to customers under Sec. 1.25.
(j) A futures commission merchant must provide immediate notice, as
provided in paragraph (n) of this section, whenever the futures
commission merchant does not hold a sufficient amount of funds in
segregated accounts for futures customers under Sec. 1.20, in
segregated accounts for Cleared Swaps Customers under part 22 of this
chapter, or in secured amount accounts for customers trading on foreign
markets under part 30 of this chapter to meet the futures commission
merchant's targeted residual interest in the segregated or secured
amount accounts pursuant to its policies and procedures required under
Sec. 1.11, or whenever the futures commission merchant's amount of
residual interest is less than the sum of the undermargined amounts in
its customer accounts as determined at the point in time that the firm
is required to maintain the undermargined amounts under Sec. 1.22, and
Sec. Sec. 22.2 and 30.7 of this chapter.
(k) A futures commission merchant must provide immediate notice, as
provided in paragraph (n) of this section, whenever the futures
commission merchant, or the futures commission merchant's parent or
material affiliate, experiences a material adverse impact to its
creditworthiness or ability to fund its obligations, including any
change that could adversely impact the firm's liquidity resources.
(l) A futures commission merchant must provide prompt notice, but
in no event later than 24 hours, as provided in paragraph (n) of this
section, whenever the futures commission merchant experiences a
material change in its operations or risk profile, including a change
in the senior management of the futures commission merchant, the
establishment or termination of a line of business, or a material
adverse change in the futures commission merchant's clearing
arrangements.
(m) A futures commission merchant must provide notice, if the
futures commission merchant has been notified by the Securities and
Exchange Commission, a securities self-regulatory organization, or a
futures self-regulatory organization, that it is the subject of a
formal investigation. A futures commission merchant must provide a copy
of any examination report issued

[[Page 68625]]

to the futures commission merchant by the Securities and Exchange
Commission or a securities self-regulatory organization. A futures
commission merchant must provide the Commission with notice of any
correspondence received from the Securities and Exchange Commission or
a securities self-regulatory organization that raises issues with the
adequacy of the futures commission merchant's capital position,
liquidity to meet its obligations or otherwise operate its business, or
internal controls. The notices and examination reports required by this
section must be filed in a prompt manner, but in no event later than 24
hours of the reportable event, and must be filed in accordance with
paragraph (n) of the section; Provided, however, that a futures
commission merchant is not required to file a notice or copy of an
examination report with the Securities and Exchange Commission, a
securities self-regulatory organization, or a futures self-regulatory
organization if such entity originally provided the communication or
report to the futures commission merchant.
(n) Notice. (1) Every notice and report required to be filed by
this section by a futures commission merchant or a self-regulatory
organization must be filed with the Commission, with the designated
self-regulatory organization, if any, and with the Securities and
Exchange Commission, if such registrant is a securities broker or
dealer. Every notice and report required to be filed by this section by
an applicant for registration as a futures commission merchant must be
filed with the National Futures Association (on behalf of the
Commission), with the designated self-regulatory organization, if any,
and with the Securities and Exchange Commission, if such applicant is a
securities broker or dealer. Every notice or report that is required to
be filed by this section by a futures commission merchant or a self-
regulatory organization must include a discussion of how the reporting
event originated and what steps have been, or are being taken, to
address the reporting event.
(2) Every notice and report which an introducing broker or
applicant for registration as an introducing broker is required to file
by paragraphs (a), (c), and (d) of this section must be filed with the
National Futures Association (on behalf of the Commission), with the
designated self-regulatory organization, if any, and with every futures
commission merchant carrying or intending to carry customer accounts
for the introducing broker or applicant for registration as an
introducing broker. Any notice or report filed with the National
Futures Association pursuant to this paragraph shall be deemed for all
purposes to be filed with, and to be the official record of, the
Commission. Every notice or report that is required to be filed by this
section by an introducing broker or applicant for registration as an
introducing broker must include a discussion of how the reporting event
originated and what steps have been, or are being taken, to address the
reporting event.
(3) Every notice or report that is required to be filed by a
futures commission merchant with the Commission or with a designated
self-regulatory organization under this section must be in writing and
must be filed via electronic transmission using a form of user
authentication assigned in accordance with procedures established by or
approved by the Commission, and otherwise in accordance with
instructions issued by or approved by the Commission; Provided,
however, that if the registered futures commission merchant cannot file
the notice or report using the electronic transmission approved by the
Commission due to a transmission or systems failure, the futures
commission merchant must immediately contact the Commission's regional
office with jurisdiction over the futures commission merchant as
provided in Sec. 140.02 of this chapter, and by email to
FCMNotice@CFTC.gov. Any such electronic submission must clearly
indicate the futures commission merchant on whose behalf such filing is
made and the use of such user authentication in submitting such filing
will constitute and become a substitute for the manual signature of the
authorized signer.

0
6. Amend Sec. 1.15 to revise paragraph (a)(4) to read as follows:

Sec. 1.15 Risk assessment reporting requirements for futures
commission merchants.

(a) * * *
(4) The reports required to be filed pursuant to paragraphs (a)(1)
and (2) of this section must be filed via electronic transmission using
a form of user authentication assigned in accordance with procedures
established by or approved by the Commission, and otherwise in
accordance with instructions issued by or approved by the Commission.
Any such electronic submission must clearly indicate the registrant on
whose behalf such filing is made and the use of such user
authentication in submitting such filing will constitute and become a
substitute for the manual signature of the authorized signer.
* * * * *

0
7. Amend Sec. 1.16 to:
0
a. Revise paragraphs (a)(4), (b)(1), (c)(1) and (c)(2), and
(f)(1)(i)(C); and
0
b. Add paragraph (b)(4).
The revisions and addition read as follows:

Sec. 1.16 Qualifications and reports of accountants.

(a) * * *
(4) Customer. The term ``customer'' means customer, as defined in
Sec. 1.3, and 30.7 customer, as defined in Sec. 30.1 of this chapter.
(b) Qualifications of accountants. (1) The Commission will
recognize any person as a certified public accountant who is duly
registered and in good standing as such under the laws of the place of
his residence or principal office; Provided, however, that a certified
public accountant engaged to conduct an examination of a futures
commission merchant must be registered with the Public Company
Accounting Oversight Board and must have undergone an examination by
the Public Company Accounting Oversight Board, and may not be subject
to a permanent or temporary bar to engage in the examination of public
issuers or brokers or dealers registered with the Securities and
Exchange Commission as a result of a Public Company Accounting
Oversight Board disciplinary hearing.
* * * * *
(4) The governing body of each futures commission merchant must
ensure that the certified public accountant engaged is duly qualified
to perform an audit of the futures commission merchant. Such an
evaluation of the qualifications of the certified public accountant
should include, among other issues, the certified public accountant's
experience in auditing futures commission merchants, the depth of the
certified public accountant's staff, the certified public accountant's
knowledge of the Act and Regulations, the size and geographic location
of the futures commission merchant, and the independence of the
certified public accountant. The governing body should also review and
consider the inspection reports issued by the Public Company Accounting
Oversight Board as part of the assessment of the qualifications of the
public accountant to perform an audit of the futures commission
merchant.
(c) * * *
(1) Technical requirements. The accountant's report must:
(i) Be dated;
(ii) Indicate the city and State where issued; and

[[Page 68626]]

(iii) Identify without detailed enumeration the financial
statements covered by the report.
(2) Representations as to the audit. The accountant's report must
state whether the audit was made in accordance with the auditing
standards adopted by the Public Company Accounting Oversight Board, and
must designate any auditing procedures deemed necessary by the
accountant under the circumstances of the particular case which have
been omitted and the reasons for their omission. However, nothing in
this paragraph shall be construed to imply authority for the omission
of any procedure which independent accountants would ordinarily employ
in the course of an audit made for the purposes of expressing the
opinion required by paragraph (c)(3) of this section.
* * * * *
(f)(1) * * *
(i) * * *
(C) Any copy that under this paragraph is required to be filed with
the Commission must be filed via electronic transmission using a form
of user authentication assigned in accordance with procedures
established by or approved by the Commission, and otherwise in
accordance with instructions issued by or approved by the Commission.
Any such electronic submission must clearly indicate the registrant on
whose behalf such filing is made and the use of such user
authentication in submitting such filing will constitute and become a
substitute for the manual signature of the authorized signer.
* * * * *

0
8. Amend Sec. 1.17 to revise paragraphs (a)(4), (b)(2), (b)(7),
(c)(5)(v), (c)(5)(viii), and (c)(5)(ix) to read as follows:

Sec. 1.17 Minimum financial requirements for futures commission
merchants and introducing brokers.

(a) * * *
(4) A futures commission merchant who is not in compliance with
this section, or is unable to demonstrate such compliance as required
by paragraph (a)(3) of this section, or who cannot certify to the
Commission immediately upon request and demonstrate with verifiable
evidence that it has sufficient access to liquidity to continue
operating as a going concern, must transfer all customer accounts and
immediately cease doing business as a futures commission merchant until
such time as the firm is able to demonstrate such compliance; Provided,
however, The registrant may trade for liquidation purposes only unless
otherwise directed by the Commission and/or the designated self-
regulatory organization; And, Provided further, That if such registrant
immediately demonstrates to the satisfaction of the Commission or the
designated self-regulatory organization the ability to achieve
compliance, the Commission or the designated self-regulatory
organization may in its discretion allow such registrant up to a
maximum of 10 business days in which to achieve compliance without
having to transfer accounts and cease doing business as required above.
Nothing in this paragraph shall be construed as preventing the
Commission or the designated self-regulatory organization from taking
action against a registrant for non-compliance with any of the
provisions of this section.
* * * * *
(b) * * *
(2) Customer. This term means a futures customer as defined in
Sec. 1.3, a cleared over the counter customer as defined in paragraph
(b)(10) of this section, and a 30.7 customer as defined in Sec. 30.1
of this chapter.
* * * * *
(7) Customer account. This term means an account in which commodity
futures, options or cleared over the counter derivative positions are
carried on the books of the applicant or registrant which is an account
that is included in the definition of customer as defined in Sec.
1.17(b)(2).
* * * * *
(c) * * *
(5) * * *
(v) In the case of securities and obligations used by the applicant
or registrant in computing net capital, and in the case of a futures
commission merchant that invests funds deposited by futures customers
as defined in Sec. 1.3, Cleared Swaps Customers as defined in Sec.
22.1 of this chapter, and 30.7 customers as defined in Sec. 30.1 of
this chapter in securities as permitted investments under Sec. 1.25,
the deductions specified in Rule 240.15c3-1(c)(2)(vi) or Rule 240.15c3-
1(c)(2)(vii) of the Securities and Exchange Commission (17 CFR
240.15c3-1(c)(2)(vi) and 17 CFR 240.15c3-1(c)(2)(vii)) (``securities
haircuts''). Futures commission merchants that establish and enforce
written policies and procedures to assess the credit risk of commercial
paper, convertible debt instruments, or nonconvertible debt instruments
in accordance with Rule 240.15c3-1(c)(2)(vi) of the Securities and
Exchange Commission (17 CFR 240.15c3-1(c)(2)(vi)) may apply the lower
haircut percentages specified in Rule 240.15c3-1(c)(2)(vi) for such
commercial paper, convertible debt instruments and nonconvertible debt
instruments. Futures commission merchants must maintain their written
policies and procedures in accordance with Sec. 1.31;
* * * * *
(viii) In the case of a futures commission merchant, for
undermargined customer commodity futures accounts and commodity option
customer accounts the amount of funds required in each such account to
meet maintenance margin requirements of the applicable board of trade
or if there are no such maintenance margin requirements, clearing
organization margin requirements applicable to such positions, after
application of calls for margin or other required deposits which are
outstanding no more than one business day. If there are no such
maintenance margin requirements or clearing organization margin
requirements, then the amount of funds required to provide margin equal
to the amount necessary, after application of calls for margin or other
required deposits outstanding no more than one business day, to restore
original margin when the original margin has been depleted by 50
percent or more: Provided, To the extent a deficit is excluded from
current assets in accordance with paragraph (c)(2)(i) of this section
such amount shall not also be deducted under this paragraph. In the
event that an owner of a customer account has deposited an asset other
than cash to margin, guarantee or secure his account, the value
attributable to such asset for purposes of this subparagraph shall be
the lesser of:
(A) The value attributable to the asset pursuant to the margin
rules of the applicable board of trade, or
(B) The market value of the asset after application of the
percentage deductions specified in paragraph (c)(5) of this section;
(ix) In the case of a futures commission merchant, for
undermargined commodity futures and commodity option noncustomer and
omnibus accounts the amount of funds required in each such account to
meet maintenance margin requirements of the applicable board of trade
or if there are no such maintenance margin requirements, clearing
organization margin requirements applicable to such positions, after
application of calls for margin or other required deposits which are
outstanding no more than one business day. If there are no such
maintenance margin requirements or clearing organization margin

[[Page 68627]]

requirements, then the amount of funds required to provide margin equal
to the amount necessary after application of calls for margin or other
required deposits outstanding no more than one business day to restore
original margin when the original margin has been depleted by 50
percent or more: Provided, To the extent a deficit is excluded from
current assets in accordance with paragraph (c)(2)(i) of this section
such amount shall not also be deducted under this paragraph. In the
event that an owner of a noncustomer or omnibus account has deposited
an asset other than cash to margin, guarantee or secure his account the
value attributable to such asset for purposes of this paragraph shall
be the lesser of the value attributable to such asset pursuant to the
margin rules of the applicable board of trade, or the market value of
such asset after application of the percentage deductions specified in
paragraph (c)(5) of this section;
* * * * *

0
9. Revise Sec. 1.20 to read as follows:

Sec. 1.20 Futures customer funds to be segregated and separately
accounted for.

(a) General. A futures commission merchant must separately account
for all futures customer funds and segregate such funds as belonging to
its futures customers. A futures commission merchant shall deposit
futures customer funds under an account name that clearly identifies
them as futures customer funds and shows that such funds are segregated
as required by sections 4d(a) and 4d(b) of the Act and by this part. A
futures commission merchant must at all times maintain in the separate
account or accounts money, securities and property in an amount at
least sufficient in the aggregate to cover its total obligations to all
futures customers as computed under paragraph (i) of this section. The
futures commission merchant must perform appropriate due diligence as
required by Sec. 1.11 on any and all locations of futures customer
funds, as specified in paragraph (b) of this section, to ensure that
the location in which the futures commission merchant has deposited
such funds is a financially sound entity.
(b) Location of futures customer funds. A futures commission
merchant may deposit futures customer funds, subject to the risk
management policies and procedures of the futures commission merchant
required by Sec. 1.11, with the following depositories:
(1) A bank or trust company;
(2) A derivatives clearing organization; or
(3) Another futures commission merchant.
(c) Limitation on the holding of futures customer funds outside of
the United States. A futures commission merchant may hold futures
customer funds with a depository outside of the United States only in
accordance with Sec. 1.49.
(d) Written acknowledgment from depositories. (1) A futures
commission merchant must obtain a written acknowledgment from each
bank, trust company, derivatives clearing organization, or futures
commission merchant prior to or contemporaneously with the opening of
an account by the futures commission merchant with such depositories;
provided, however, that a written acknowledgment need not be obtained
from a derivatives clearing organization that has adopted and submitted
to the Commission rules that provide for the segregation of futures
customer funds in accordance with all relevant provisions of the Act
and the rules and orders promulgated thereunder.
(2) The written acknowledgment must be in the form as set out in
Appendix A to this part.
(3)(i) A futures commission merchant shall deposit futures customer
funds only with a depository that agrees to provide the director of the
Division of Swap Dealer and Intermediary Oversight, or any successor
division, or such director's designees, with direct, read-only
electronic access to transaction and account balance information for
futures customer accounts.
(ii) The written acknowledgment must contain the futures commission
merchant's authorization to the depository to provide direct, read-only
electronic access to futures customer account transaction and account
balance information to the director of the Division of Swap Dealer and
Intermediary Oversight, or any successor division, or such director's
designees, without further notice to or consent from the futures
commission merchant.
(4) A futures commission merchant shall deposit futures customer
funds only with a depository that agrees to provide the Commission and
the futures commission merchant's designated self-regulatory
organization with a copy of the executed written acknowledgment no
later than three business days after the opening of the account or the
execution of a new written acknowledgment for an existing account, as
applicable. The Commission must receive the written acknowledgment from
the depository via electronic means, in a format and manner determined
by the Commission. The written acknowledgment must contain the futures
commission merchant's authorization to the depository to provide the
written acknowledgment to the Commission and to the futures commission
merchant's designated self-regulatory organization without further
notice to or consent from the futures commission merchant.
(5) A futures commission merchant shall deposit futures customer
funds only with a depository that agrees that accounts containing
customer funds may be examined at any reasonable time by the director
of the Division of Swap Dealer and Intermediary Oversight or the
director of the Division of Clearing and Risk, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent or employee of the futures commission merchant's designated self-
regulatory organization. The written acknowledgment must contain the
futures commission merchant's authorization to the depository to permit
any such examination to take place without further notice to or consent
from the futures commission merchant.
(6) A futures commission merchant shall deposit futures customer
funds only with a depository that agrees to reply promptly and directly
to any request from the director of the Division of Swap Dealer and
Intermediary Oversight or the director of the Division of Clearing and
Risk, or any successor divisions, or such directors' designees, or an
appropriate officer, agent or employee of the futures commission
merchant's designated self-regulatory organization for confirmation of
account balances or provision of any other information regarding or
related to an account. The written acknowledgment must contain the
futures commission merchant's authorization to the depository to reply
promptly and directly as required by this paragraph without further
notice to or consent from the futures commission merchant.
(7) The futures commission merchant shall promptly file a copy of
the written acknowledgment with the Commission in the format and manner
specified by the Commission no later than three business days after the
opening of the account or the execution of a new written acknowledgment
for an existing account, as applicable.
(8) A futures commission merchant shall obtain a new written
acknowledgment within 120 days of any changes in the following:
(i) The name or business address of the futures commission
merchant;
(ii) The name or business address of the bank, trust company,
derivatives

[[Page 68628]]

clearing organization or futures commission merchant receiving futures
customer funds; or
(iii) The account number(s) under which futures customer funds are
held.
(9) A futures commission merchant shall maintain each written
acknowledgment readily accessible in its files in accordance with Sec.
1.31, for as long as the account remains open, and thereafter for the
period provided in Sec. 1.31.
(e) Commingling. (1) A futures commission merchant may for
convenience commingle the futures customer funds that it receives from,
or on behalf of, multiple futures customers in a single account or
multiple accounts with one or more of the depositories listed in
paragraph (b) of this section.
(2) A futures commission merchant shall not commingle futures
customer funds with the money, securities or property of such futures
commission merchant, or with any proprietary account of such futures
commission merchant, or use such funds to secure or guarantee the
obligation of, or extend credit to, such futures commission merchant or
any proprietary account of such futures commission merchant; provided,
however, a futures commission merchant may deposit proprietary funds in
segregated accounts as permitted under Sec. 1.23.
(3) A futures commission merchant may not commingle futures
customer funds with funds deposited by 30.7 customers as defined in
Sec. 30.1 of this chapter and set aside in separate accounts as
required by part 30 of this chapter, or with funds deposited by Cleared
Swaps Customers as defined in Sec. 22.1 of this chapter and held in
segregated accounts pursuant to section 4d(f) of the Act; provided,
however, that a futures commission merchant may commingle futures
customer funds with funds deposited by 30.7 customers or Cleared Swaps
Customers if expressly permitted by a Commission regulation or order,
or by a derivatives clearing organization rule approved in accordance
with Sec. 39.15(b)(2) of this chapter.
(f) Limitation on use of futures customer funds. (1) A futures
commission merchant shall treat and deal with the funds of a futures
customer as belonging to such futures customer. A futures commission
merchant shall not use the funds of a futures customer to secure or
guarantee the commodity interests, or to secure or extend the credit,
of any person other than the futures customer for whom the funds are
held.
(2) A futures commission merchant shall obligate futures customer
funds to a derivatives clearing organization, a futures commission
merchant, or any depository solely to purchase, margin, guarantee,
secure, transfer, adjust or settle trades, contracts or commodity
option transactions of futures customers; provided, however, that a
futures commission merchant is permitted to use the funds belonging to
a futures customer that are necessary in the normal course of business
to pay lawfully accruing fees or expenses on behalf of the futures
customer's positions including commissions, brokerage, interest, taxes,
storage and other fees and charges.
(3) No person, including any derivatives clearing organization or
any depository, that has received futures customer funds for deposit in
a segregated account, as provided in this section, may hold, dispose
of, or use any such funds as belonging to any person other than the
futures customers of the futures commission merchant which deposited
such funds.
(g) Derivatives clearing organizations. (1) General. All futures
customer funds received by a derivatives clearing organization from a
member to purchase, margin, guarantee, secure or settle the trades,
contracts or commodity options of the clearing member's futures
customers and all money accruing to such futures customers as the
result of trades, contracts or commodity options so carried shall be
separately accounted for and segregated as belonging to such futures
customers, and a derivatives clearing organization shall not hold, use
or dispose of such futures customer funds except as belonging to such
futures customers. A derivatives clearing organization shall deposit
futures customer funds under an account name that clearly identifies
them as futures customer funds and shows that such funds are segregated
as required by sections 4d(a) and 4d(b) of the Act and by this part.
(2) Location of futures customer funds. A derivatives clearing
organization may deposit futures customer funds with a bank or trust
company, which may include a Federal Reserve Bank with respect to
deposits of a derivatives clearing organization that is designated by
the Financial Stability Oversight Council to be systemically important.
(3) Limitation on the holding of futures customer funds outside of
the United States. A derivatives clearing organization may hold futures
customer funds with a depository outside of the United States only in
accordance with Sec. 1.49.
(4) Written acknowledgment from depositories. (i) A derivatives
clearing organization must obtain a written acknowledgment from each
depository prior to or contemporaneously with the opening of a futures
customer funds account.
(ii) The written acknowledgment must be in the form as set out in
Appendix B to this part; provided, however, that a derivatives clearing
organization shall obtain from a Federal Reserve Bank only a written
acknowledgment that:
(A) The Federal Reserve Bank was informed that the customer funds
deposited therein are those of customers who trade commodities,
options, swaps, and other products and are being held in accordance
with the provisions of section 4d of the Act and Commission regulations
thereunder; and
(B) The Federal Reserve Bank agrees to reply promptly and directly
to any request from the director of the Division of Clearing and Risk
or the director of the Division of Swap Dealer and Intermediary
Oversight, or any successor divisions, or such directors' designees,
for confirmation of account balances or provision of any other
information regarding or related to an account.
(iii) A derivatives clearing organization shall deposit futures
customer funds only with a depository that agrees to provide the
Commission with a copy of the executed written acknowledgment no later
than three business days after the opening of the account or the
execution of a new written acknowledgment for an existing account, as
applicable. The Commission must receive the written acknowledgment from
the depository via electronic means, in a format and manner determined
by the Commission. The written acknowledgment must contain the
derivatives clearing organization's authorization to the depository to
provide the written acknowledgment to the Commission without further
notice to or consent from the derivatives clearing organization.
(iv) A derivatives clearing organization shall deposit futures
customer funds only with a depository that agrees to reply promptly and
directly to any request from the director of the Division of Clearing
and Risk or the director of the Division of Swap Dealer and
Intermediary Oversight, or any successor divisions, or such directors'
designees, for confirmation of account balances or provision of any
other information regarding or related to an account. The written
acknowledgment must contain the derivatives clearing organization's
authorization to the depository to reply promptly and directly as
required by

[[Page 68629]]

this paragraph without further notice to or consent from the
derivatives clearing organization.
(v) A derivatives clearing organization shall promptly file a copy
of the written acknowledgment with the Commission in the format and
manner specified by the Commission no later than three business days
after the opening of the account or the execution of a new written
acknowledgment for an existing account, as applicable.
(vi) A derivatives clearing organization shall obtain a new written
acknowledgment within 120 days of any changes in the following:
(A) The name or business address of the derivatives clearing
organization;
(B) The name or business address of the depository receiving
futures customer funds; or
(C) The account number(s) under which futures customer funds are
held.
(vii) A derivatives clearing organization shall maintain each
written acknowledgment readily accessible in its files in accordance
with Sec. 1.31, for as long as the account remains open, and
thereafter for the period provided in Sec. 1.31.
(5) Commingling. (i) A derivatives clearing organization may for
convenience commingle the futures customer funds that it receives from,
or on behalf of, multiple futures commission merchants in a single
account or multiple accounts with one or more of the depositories
listed in paragraph (g)(2) of this section.
(ii) A derivatives clearing organization shall not commingle
futures customer funds with the money, securities or property of such
derivatives clearing organization or with any proprietary account of
any of its clearing members, or use such funds to secure or guarantee
the obligations of, or extend credit to, such derivatives clearing
organization or any proprietary account of any of its clearing members.
(iii) A derivatives clearing organization may not commingle funds
held for futures customers with funds deposited by clearing members on
behalf of their 30.7 customers as defined in Sec. 30.1 of this chapter
and set aside in separate accounts as required by part 30 of this
chapter, or with funds deposited by clearing members on behalf of their
Cleared Swaps Customers as defined in Sec. 22.1 of this chapter and
held in segregated accounts pursuant section 4d(f) of the Act;
provided, however, that a derivatives clearing organization may
commingle futures customer funds with funds deposited by clearing
members on behalf of their 30.7 customers or Cleared Swaps Customers if
expressly permitted by a Commission regulation or order, or by a
derivatives clearing organization rule approved in accordance with
Sec. 39.15(b)(2) of this chapter.
(h) Immediate availability of bank and trust company deposits. All
futures customer funds deposited by a futures commission merchant or a
derivatives clearing organization with a bank or trust company must be
immediately available for withdrawal upon the demand of the futures
commission merchant or derivatives clearing organization.
(i) Requirements as to amount. (1) For purposes of this paragraph
(i), the term ``account'' shall mean the entries on the books and
records of a futures commission merchant pertaining to the futures
customer funds of a particular futures customer.
(2) The futures commission merchant must reflect in the account
that it maintains for each futures customer the net liquidating equity
for each such customer, calculated as follows: The market value of any
futures customer funds that it receives from such customer, as adjusted
by:
(i) Any uses permitted under paragraph (f) of this section;
(ii) Any accruals on permitted investments of such collateral under
Sec. 1.25 that, pursuant to the futures commission merchant's customer
agreement with that customer, are creditable to such customer;
(iii) Any gains and losses with respect to contracts for the
purchase or sale of a commodity for future delivery and any options on
such contracts;
(iv) Any charges lawfully accruing to the futures customer,
including any commission, brokerage fee, interest, tax, or storage fee;
and
(v) Any appropriately authorized distribution or transfer of such
collateral.
(3) If the market value of futures customer funds in the account of
a futures customer is positive after adjustments, then that account has
a credit balance. If the market value of futures customer funds in the
account of a futures customer is negative after adjustments, then that
account has a debit balance.
(4) The futures commission merchant must maintain in segregation an
amount equal to the sum of any credit balances that the futures
customers of the futures commission merchant have in their accounts.
This balance may not be reduced by any debit balances that the futures
customers of the futures commission merchants have in their accounts.

Appendix A to Sec. 1.20--Futures Commission Merchant Acknowledgment
Letter for CFTC Regulation 1.20 Customer Segregated Account

[Date]
[Name and Address of Bank, Trust Company, Derivatives Clearing
Organization or Futures Commission Merchant]

We refer to the Segregated Account(s) which [Name of Futures
Commission Merchant] (``we'' or ``our'') have opened or will open
with [Name of Bank, Trust Company, Derivatives Clearing Organization
or Futures Commission Merchant] (``you'' or ``your'') entitled:

[Name of Futures Commission Merchant] [if applicable, add ``FCM
Customer Omnibus Account''] CFTC Regulation 1.20 Customer Segregated
Account under Sections 4d(a) and 4d(b) of the Commodity Exchange Act
[and, if applicable, ``, Abbreviated as [short title reflected in
the depository's electronic system]'']
Account Number(s): [ ]
(collectively, the ``Account(s)'').

You acknowledge that we have opened or will open the above-
referenced Account(s) for the purpose of depositing, as applicable,
money, securities and other property (collectively the ``Funds'') of
customers who trade commodities, options, swaps, and other products,
as required by Commodity Futures Trading Commission (``CFTC'')
Regulations, including Regulation 1.20, as amended; that the Funds
held by you, hereafter deposited in the Account(s) or accruing to
the credit of the Account(s), will be separately accounted for and
segregated on your books from our own funds and from any other funds
or accounts held by us in accordance with the provisions of the
Commodity Exchange Act, as amended (the ``Act''), and Part 1 of the
CFTC's regulations, as amended; and that the Funds must otherwise be
treated in accordance with the provisions of Section 4d of the Act
and CFTC regulations thereunder.
Furthermore, you acknowledge and agree that such Funds may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, and they may not be used by us to secure or
obtain credit from you. You further acknowledge and agree that the
Funds in the Account(s) shall not be subject to any right of offset
or lien for or on account of any indebtedness, obligations or
liabilities we may now or in the future have owing to you. This
prohibition does not affect your right to recover funds advanced in
the form of cash transfers, lines of credit, repurchase agreements
or other similar liquidity arrangements you make in lieu of
liquidating non-cash assets held in the Account(s) or in lieu of
converting cash held in the Account(s) to cash in a different
currency.
In addition, you agree that the Account(s) may be examined at
any reasonable time by the director of the Division of Swap Dealer
and Intermediary Oversight of the CFTC or the director of the
Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent or employee of our

[[Page 68630]]

designated self-regulatory organization (``DSRO''), [Name of DSRO],
and this letter constitutes the authorization and direction of the
undersigned on our behalf to permit any such examination to take
place without further notice to or consent from us.
You agree to reply promptly and directly to any request for
confirmation of account balances or provision of any other
information regarding or related to the Account(s) from the director
of the Division of Swap Dealer and Intermediary Oversight of the
CFTC or the director of the Division of Clearing and Risk of the
CFTC, or any successor divisions, or such directors' designees, or
an appropriate officer, agent, or employee of [Name of DSRO], acting
in its capacity as our DSRO, and this letter constitutes the
authorization and direction of the undersigned on our behalf to
release the requested information without further notice to or
consent from us.
You further acknowledge and agree that, pursuant to
authorization granted by us to you previously or herein, you have
provided, or will promptly provide following the opening of the
Account(s), the director of the Division of Swap Dealer and
Intermediary Oversight of the CFTC, or any successor division, or
such director's designees, with technological connectivity, which
may include provision of hardware, software, and related technology
and protocol support, to facilitate direct, read-only electronic
access to transaction and account balance information for the
Account(s). This letter constitutes the authorization and direction
of the undersigned on our behalf for you to establish this
connectivity and access if not previously established, without
further notice to or consent from us.
The parties agree that all actions on your part to respond to
the above information and access requests will be made in accordance
with, and subject to, such usual and customary authorization
verification and authentication policies and procedures as may be
employed by you to verify the authority of, and authenticate the
identity of, the individual making any such information or access
request, in order to provide for the secure transmission and
delivery of the requested information or access to the appropriate
recipient(s). We will not hold you responsible for acting pursuant
to any information or access request from the director of the
Division of Swap Dealer and Intermediary Oversight of the CFTC or
the director of the Division of Clearing and Risk of the CFTC, or
any successor divisions, or such directors' designees, or an
appropriate officer, agent, or employee of [Name of DSRO], acting in
its capacity as our DSRO, upon which you have relied after having
taken measures in accordance with your applicable policies and
procedures to assure that such request was provided to you by an
individual authorized to make such a request.
In the event that we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Funds
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of offset or lien on assets that are not Funds
maintained in the Account(s), or to impose such charges against us
or any proprietary account maintained by us with you. Further, it is
understood that amounts represented by checks, drafts or other items
shall not be considered to be part of the Account(s) until finally
collected. Accordingly, checks, drafts and other items credited to
the Account(s) and subsequently dishonored or otherwise returned to
you or reversed, for any reason, and any claims relating thereto,
including but not limited to claims of alteration or forgery, may be
charged back to the Account(s), and we shall be responsible to you
as a general endorser of all such items whether or not actually so
endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that, in the ordinary course of your business as a
depository, you have no notice of or actual knowledge of a potential
violation by us of any provision of the Act or the CFTC regulations
that relates to the segregation of customer funds; and you shall not
in any manner not expressly agreed to herein be responsible to us
for ensuring compliance by us with such provisions of the Act and
CFTC regulations; however, the aforementioned presumption does not
affect any obligation you may otherwise have under the Act or CFTC
regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any action or omission to act
pursuant to any such order, judgment, decree or levy, to us or to
any other person, firm, association or corporation even if
thereafter any such order, decree, judgment or levy shall be
reversed, modified, set aside or vacated.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns and, for the avoidance of
doubt, regardless of a change in the name of either party. This
letter agreement supersedes and replaces any prior agreement between
the parties in connection with the Account(s), including but not
limited to any prior acknowledgment letter agreement, to the extent
that such prior agreement is inconsistent with the terms hereof. In
the event of any conflict between this letter agreement and any
other agreement between the parties in connection with the
Account(s), this letter agreement shall govern with respect to
matters specific to Section 4d of the Act and the CFTC's regulations
thereunder, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning to us the
enclosed copy of this letter agreement, and that you further agree
to provide a copy of this fully executed letter agreement directly
to the CFTC (via electronic means in a format and manner determined
by the CFTC) and to [Name of DSRO], acting in its capacity as our
DSRO. We hereby authorize and direct you to provide such copies
without further notice to or consent from us, no later than three
business days after opening the Account(s) or revising this letter
agreement, as applicable.

[Name of Futures Commission Merchant]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Bank, Trust Company, Derivatives Clearing Organization or
Futures Commission Merchant]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
DATE:

Appendix B to Sec. 1.20--Derivatives Clearing Organization
Acknowledgment Letter for CFTC Regulation 1.20 Customer Segregated
Account

[Date]
[Name and Address of Bank or Trust Company]

We refer to the Segregated Account(s) which [Name of Derivatives
Clearing Organization] (``we'' or ``our'') have opened or will open
with [Name of Bank or Trust Company] (``you'' or ``your'') entitled:

[Name of Derivatives Clearing Organization] Futures Customer Omnibus
Account, CFTC Regulation 1.20 Customer Segregated Account under
Sections 4d(a) and 4d(b) of the Commodity Exchange Act [and, if
applicable, ``, Abbreviated as [short title reflected in the
depository's electronic system]'']
Account Number(s): [ ]
(collectively, the ``Account(s)'').

[[Page 68631]]

be used by us to secure or obtain credit from you. You further
acknowledge and agree that the Funds in the Account(s) shall not be
subject to any right of offset or lien for or on account of any
indebtedness, obligations or liabilities we may now or in the future
have owing to you. This prohibition does not affect your right to
recover funds advanced in the form of cash transfers, lines of
credit, repurchase agreements or other similar liquidity
arrangements you make in lieu of liquidating non-cash assets held in
the Account(s) or in lieu of converting cash held in the Account(s)
to cash in a different currency.
You agree to reply promptly and directly to any request for
confirmation of account balances or provision of any other
information regarding or related to the Account(s) from the director
of the Division of Clearing and Risk of the CFTC or the director of
the Division of Swap Dealer and Intermediary Oversight of the CFTC,
or any successor divisions, or such directors' designees, and this
letter constitutes the authorization and direction of the
undersigned on our behalf to release the requested information
without further notice to or consent from us.
The parties agree that all actions on your part to respond to
the above information requests will be made in accordance with, and
subject to, such usual and customary authorization verification and
authentication policies and procedures as may be employed by you to
verify the authority of, and authenticate the identity of, the
individual making any such information request, in order to provide
for the secure transmission and delivery of the requested
information to the appropriate recipient(s). We will not hold you
responsible for acting pursuant to any information request from the
director of the Division of Clearing and Risk of the CFTC or the
director of the Division of Swap Dealer and Intermediary Oversight
of the CFTC, or any successor divisions, or such directors'
designees, upon which you have relied after having taken measures in
accordance with your applicable policies and procedures to assure
that such request was provided to you by an individual authorized to
make such a request.
In the event that we or any of our futures commission merchant
clearing members become(s) subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Funds
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of offset or lien on assets that are not Funds
maintained in the Account(s), or to impose such charges against us
or any proprietary account maintained by us with you. Further, it is
understood that amounts represented by checks, drafts or other items
shall not be considered to be part of the Account(s) until finally
collected. Accordingly, checks, drafts and other items credited to
the Account(s) and subsequently dishonored or otherwise returned to
you or reversed, for any reason, and any claims relating thereto,
including but not limited to claims of alteration or forgery, may be
charged back to the Account(s), and we shall be responsible to you
as a general endorser of all such items whether or not actually so
endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that, in the ordinary course of your business as a
depository, you have no notice of or actual knowledge of a potential
violation by us of any provision of the Act or the CFTC regulations
that relates to the segregation of customer funds; and you shall not
in any manner not expressly agreed to herein be responsible to us
for ensuring compliance by us with such provisions of the Act and
CFTC regulations; however, the aforementioned presumption does not
affect any obligation you may otherwise have under the Act or CFTC
regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any action or omission to act
pursuant to any such order, judgment, decree or levy, to us or to
any other person, firm, association or corporation even if
thereafter any such order, decree, judgment or levy shall be
reversed, modified, set aside or vacated.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns and, for the avoidance of
doubt, regardless of a change in the name of either party. This
letter agreement supersedes and replaces any prior agreement between
the parties in connection with the Account(s), including but not
limited to any prior acknowledgment letter agreement, to the extent
that such prior agreement is inconsistent with the terms hereof. In
the event of any conflict between this letter agreement and any
other agreement between the parties in connection with the
Account(s), this letter agreement shall govern with respect to
matters specific to Section 4d of the Act and the CFTC's regulations
thereunder, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning to us the
enclosed copy of this letter agreement, and that you further agree
to provide a copy of this fully executed letter agreement directly
to the CFTC (via electronic means in a format and manner determined
by the CFTC). We hereby authorize and direct you to provide such
copy without further notice to or consent from us, no later than
three business days after opening the Account(s) or revising this
letter agreement, as applicable.

[Name of Derivatives Clearing Organization]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Bank or Trust Company]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
DATE:

0
10. Revise Sec. 1.22 to read as follows:

Sec. 1.22 Use of futures customer funds restricted.

(a) No futures commission merchant shall use, or permit the use of,
the futures customer funds of one futures customer to purchase, margin,
or settle the trades, contracts, or commodity options of, or to secure
or extend the credit of, any person other than such futures customer.
(b) Futures customer funds shall not be used to carry trades or
positions of the same futures customer other than in contracts for the
purchase of sale of any commodity for future delivery or for options
thereon traded through the facilities of a designated contract market.
(c)(1) The undermargined amount for a futures customer's account is
the amount, if any, by which:
(i) The total amount of collateral required for that futures
customer's positions in that account, at the time or times referred to
in paragraph (c)(2) of this section, exceeds
(ii) The value of the futures customer funds for that account, as
calculated in Sec. 1.20(i)(2).
(2) Each futures commission merchant must compute, based on the
information available to the futures commission merchant as of the
close of each business day,
(i) The undermargined amounts, based on the clearing initial margin
that will be required to be maintained by that futures commission
merchant for its futures customers, at each derivatives clearing
organization of which the futures commission merchant is a member, at
the point of the daily settlement (as described in Sec. 39.14 of this
chapter) that will complete during the following business day for each
such derivatives clearing organization less
(ii) Any debit balances referred to in Sec. 1.20(i)(4) included in
such undermargined amounts.
(3)(i) Prior to the Residual Interest Deadline, such futures
commission merchant must maintain residual interest in segregated funds
that is at least equal to the computation set forth in paragraph (c)(2)
of this section. Where a futures commission merchant is subject to
multiple Residual Interest

[[Page 68632]]

Deadlines, prior to each Residual Interest Deadline, such futures
commission merchant must maintain residual interest in segregated funds
that is at least equal to the portion of the computation set forth in
paragraph (c)(2) of this section attributable to the clearing initial
margin required by the derivatives clearing organization making such
settlement.
(ii) A futures commission merchant may reduce the amount of
residual interest required in paragraph (c)(3)(i) of this section to
account for payments received from or on behalf of undermargined
futures customers (less the sum of any disbursements made to or on
behalf of such customers) between the close of the previous business
day and the Residual Interest Deadline.
(4) For purposes of paragraph (c)(2) of this section, a futures
commission merchant should include, as clearing initial margin,
customer initial margin that the futures commission merchant will be
required to maintain, for that futures commission merchant's futures
customers, at another futures commission merchant.
(5) Residual Interest Deadline defined. (i) Except as provided in
paragraph (c)(5)(ii) of this section, the Residual Interest Deadline
shall be the time of the settlement referenced in paragraph (c)(2)(i)
or, as appropriate, (c)(4), of this section.
(ii) Starting on November 14, 2014 and during the phase-in period
described in paragraph (c)(5)(iii) of this section, the Residual
Interest Deadline shall be 6:00 p.m. Eastern Time on the date of the
settlement referenced in paragraph (c)(2)(i) or, as appropriate,
(c)(4), of this section.
(iii)(A) No later than May 16, 2016, the staff of the Commission
shall complete and publish for public comment a report addressing, to
the extent information is practically available, the practicability
(for both futures commission merchants and customers) of moving that
deadline from 6:00 p.m. Eastern Time on the date of the settlement
referenced in paragraph (c)(2)(i) or, as appropriate, (c)(4), of this
section to the time of that settlement (or to some other time of day),
including whether and on what schedule it would be feasible to do so,
and the costs and benefits of such potential requirements. Staff shall,
using the Commission's Web site, solicit public comment and shall
conduct a public roundtable regarding specific issues to be covered by
such report.
(B) Nine months after publication of the report required by
paragraph (c)(5)(iii)(A) of this section, the Commission may (but shall
not be required to) do either or both of the following:
(1) Terminate the phase-in period, in which case the phase-in
period shall end as of a date established by order published in the
Federal Register, which date shall be no less than one year after the
date such order is published; or
(2) Determine that it is necessary or appropriate in the public
interest to propose through rulemaking a different Residual Interest
Deadline. In that event, the Commission shall establish, by order
published in the Federal Register, a phase-in schedule.
(C) If the phase-in schedule has not been amended pursuant to
paragraph (c)(5)(iii)(B) of this section, then the phase-in period
shall end on December 31, 2018.

0
11. Revise Sec. 1.23 to read as follows:

Sec. 1.23 Interest of futures commission merchant in segregated
futures customer funds; additions and withdrawals.

(a)(1) The provision in sections 4d(a)(2) and 4d(b) of the Act and
the provision in Sec. 1.20 that prohibit the commingling of futures
customer funds with the funds of a futures commission merchant, shall
not be construed to prevent a futures commission merchant from having a
residual financial interest in the futures customer funds segregated as
required by the Act and the regulations in this part and set apart for
the benefit of futures customers; nor shall such provisions be
construed to prevent a futures commission merchant from adding to such
segregated futures customer funds such amount or amounts of money, from
its own funds or unencumbered securities from its own inventory, of the
type set forth in Sec. 1.25 of this part, as it may deem necessary to
ensure any and all futures customers' accounts from becoming
undersegregated at any time.
(2) If a futures commission merchant discovers at any time that it
is holding insufficient funds in segregated accounts to meet its
obligations under Sec. Sec. 1.20 and 1.22, the futures commission
merchant shall immediately deposit sufficient funds into segregation to
bring the account into compliance.
(b) A futures commission merchant may not withdraw funds, except
withdrawals that are made to or for the benefit of futures customers,
from an account or accounts holding futures customer funds unless the
futures commission merchant has prepared the daily segregation
calculation required by Sec. 1.32 as of the close of business on the
previous business day. A futures commission merchant that has completed
its daily segregation calculation may make withdrawals, in addition to
withdrawals that are made to or for the benefit of futures customers,
to the extent of its actual residual financial interest in funds held
in segregated futures accounts, adjusted to reflect market activity and
other events that may have decreased the amount of the firm's residual
financial interest since the close of business on the previous business
day, including the withdrawal of securities held in segregated
safekeeping accounts held by a bank, trust company, derivatives
clearing organization or other futures commission merchant. Such
withdrawal(s), however, shall not result in the funds of one futures
customer being used to purchase, margin or carry the trades, contracts
or commodity options, or extend the credit of any other futures
customer or other person.
(c) Notwithstanding paragraphs (a) and (b) of this section, each
futures commission merchant shall establish a targeted residual
interest (i.e., excess funds) that is in an amount that, when
maintained as its residual interest in the segregated funds accounts,
reasonably ensures that the futures commission merchant shall remain in
compliance with the segregated funds requirements at all times. Each
futures commission merchant shall establish policies and procedures
designed to reasonably ensure that the futures commission merchant
maintains the targeted residual amounts in segregated funds at all
times. The futures commission merchant shall maintain sufficient
capital and liquidity, and take such other appropriate steps as are
necessary, to reasonably ensure that such amount of targeted residual
interest is maintained as the futures commission merchant's residual
interest in the segregated funds accounts at all times. In determining
the amount of the targeted residual interest, the futures commission
merchant shall analyze all relevant factors affecting the amounts in
segregated funds from time to time, including without limitation
various factors, as applicable, relating to the nature of the futures
commission merchant's business including, but not limited to, the
composition of the futures commission merchant's customer base, the
general creditworthiness of the customer base, the general trading
activity of the customers, the types of markets and products traded by
the customers, the proprietary trading of the futures commission
merchant, the general volatility and liquidity of the markets and
products traded by customers, the

[[Page 68633]]

futures commission merchant's own liquidity and capital needs, and the
historical trends in customer segregated fund balances and debit
balances in customers' and undermargined accounts. The analysis and
calculation of the targeted amount of the future commission merchant's
residual interest must be described in writing with the specificity
necessary to allow the Commission and the futures commission merchant's
designated self-regulatory organization to duplicate the analysis and
calculation and test the assumptions made by the futures commission
merchant. The adequacy of the targeted residual interest and the
process for establishing the targeted residual interest must be
reassessed periodically by the futures commission merchant and revised
as necessary.
(d) Notwithstanding any other paragraph of this section, a futures
commission merchant may not withdraw funds, in a single transaction or
a series of transactions, that are not made to or for the benefit of
futures customers from futures accounts if such withdrawal(s) would
exceed 25 percent of the futures commission merchant's residual
interest in such accounts as reported on the daily segregation
calculation required by Sec. 1.32 and computed as of the close of
business on the previous business day, unless:
(1) The futures commission merchant's chief executive officer,
chief finance officer or other senior official that is listed as a
principal of the futures commission merchant on its Form 7-R and is
knowledgeable about the futures commission merchant's financial
requirements and financial position pre-approves in writing the
withdrawal, or series of withdrawals;
(2) The futures commission merchant files written notice of the
withdrawal or series of withdrawals, with the Commission and with its
designated self-regulatory organization immediately after the chief
executive officer, chief finance officer or other senior official as
described in paragraph (c)(1) of this section pre-approves the
withdrawal or series of withdrawals. The written notice must:
(i) Be signed by the chief executive officer, chief finance officer
or other senior official as described in paragraph (c)(1) of this
section that pre-approved the withdrawal, and give notice that the
futures commission merchant has withdrawn or intends to withdraw more
than 25 percent of its residual interest in segregated accounts holding
futures customer funds;
(ii) Include a description of the reasons for the withdrawal or
series of withdrawals;
(iii) List the amount of funds provided to each recipient and each
recipient's name;
(iv) Include the current estimate of the amount of the futures
commission merchant's residual interest in the futures accounts after
the withdrawal;
(v) Contain a representation by the chief executive officer, chief
finance officer or other senior official as described in paragraph
(c)(1) of this section that pre-approved the withdrawal, or series of
withdrawals, that, after due diligence, to such person's knowledge and
reasonable belief, the futures commission merchant remains in
compliance with the segregation requirements after the withdrawal. The
chief executive officer, chief finance officer or other senior official
as described in paragraph (c)(1) of this section must consider the
daily segregation calculation as of the close of business on the
previous business day and any other factors that may cause a material
change in the futures commission merchant's residual interest since the
close of business the previous business day, including known unsecured
futures customer debits or deficits, current day market activity and
any other withdrawals made from the futures accounts; and
(vi) Any such written notice filed with the Commission must be
filed via electronic transmission using a form of user authentication
assigned in accordance with procedures established by or approved by
the Commission, and otherwise in accordance with instruction issued by
or approved by the Commission. Any such electronic submission must
clearly indicate the registrant on whose behalf such filing is made and
the use of such user authentication in submitting such filing will
constitute and become a substitute for the manual signature of the
authorized signer. Any written notice filed must be followed up with
direct communication to the Regional office of the Commission that has
supervisory authority over the futures commission merchant whereby the
Commission acknowledges receipt of the notice; and
(3) After making a withdrawal requiring the approval and notice
required in paragraphs (c)(1) and (2) of this section, and before the
completion of its next daily segregated funds calculation, no futures
commission merchant may make any further withdrawals from accounts
holding futures customer funds, except to or for the benefit of futures
customers, without, for each withdrawal, obtaining the approval
required under paragraph (c)(1) of this section and filing a written
notice in the manner specified under paragraph (c)(2) of this section
with the Commission and its designated self-regulatory organization
signed by the chief executive officer, chief finance officer, or other
senior official. The written notice must:
(i) List the amount of funds provided to each recipient and each
recipient's name;
(ii) Disclose the reason for each withdrawal;
(iii) Confirm that the chief executive officer, chief finance
officer, or other senior official (and identify of the person if
different from the person who signed the notice) pre-approved the
withdrawal in writing;
(iv) Disclose the current estimate of the futures commission
merchant's remaining total residual interest in the segregated accounts
holding futures customer funds after the withdrawal; and
(v) Include a representation that, after due diligence, to the best
of the notice signatory's knowledge and reasonable belief the futures
commission merchant remains in compliance with the segregation
requirements after the withdrawal.
(e) If a futures commission merchant withdraws funds from futures
accounts that are not made to or for the benefit of futures customers,
and the withdrawal causes the futures commission merchant to not hold
sufficient funds in the futures accounts to meet its targeted residual
interest, as required to be computed under Sec. 1.11, the futures
commission merchant should deposit its own funds into the futures
accounts to restore the account balance to the targeted residual
interest amount by the close of business on the next business day, or,
if appropriate, revise the futures commission merchant's targeted
amount of residual interest pursuant to the policies and procedures
required by Sec. 1.11. Notwithstanding the foregoing, if a the futures
commission merchant's residual interest in customer accounts is less
than the amount required by Sec. 1.22 at any particular point in time,
the futures commission merchant must immediately restore the residual
interest to exceed the sum of such amounts. Any proprietary funds
deposited in the futures accounts must be unencumbered and otherwise
compliant with Sec. 1.25, as applicable.

0
12. Amend Sec. 1.25 to:
0
a. Remove paragraph (b)(6); and
0
b. Revise paragraphs (b)(3)(v), (c)(3), (d)(7), (d)(11), and (e).
The revisions read as follows:

Sec. 1.25 Investment of customer funds.

* * * * *

[[Page 68634]]

(b) * * *
(3) * * *
(v) Counterparty concentration limits. Securities purchased by a
futures commission merchant or derivatives clearing organization from a
single counterparty, or from one or more counterparties under common
ownership or control, subject to an agreement to resell the securities
to the counterparty or counterparties, shall not exceed 25 percent of
total assets held in segregation or under Sec. 30.7 of this chapter by
the futures commission merchant or derivatives clearing organization.
* * * * *
(c) * * *
(3) A futures commission merchant or derivatives clearing
organization shall maintain the confirmation relating to the purchase
in its records in accordance with Sec. 1.31 and note the ownership of
fund shares (by book-entry or otherwise) in a custody account of the
futures commission merchant or derivatives clearing organization in
accordance with Sec. 1.26. The futures commission merchant or the
derivatives clearing organization shall obtain the acknowledgment
letter required by Sec. 1.26 from an entity that has substantial
control over the fund shares purchased with customer funds and has the
knowledge and authority to facilitate redemption and payment or
transfer of the customer funds. Such entity may include the fund
sponsor or depository acting as custodian for fund shares.
* * * * *
(d) * * *
(7) Securities transferred to the futures commission merchant or
derivatives clearing organization under the agreement are held in a
safekeeping account with a bank as referred to in paragraph (d)(2) of
this section, a Federal Reserve Bank, a derivatives clearing
organization, or the Depository Trust Company in an account that
complies with the requirements of Sec. 1.26.
* * * * *
(11) The transactions effecting the agreement are recorded in the
record required to be maintained under Sec. 1.27 of investments of
customer funds, and the securities subject to such transactions are
specifically identified in such record as described in paragraph (d)(1)
of this section and further identified in such record as being subject
to repurchase and reverse repurchase agreements.
* * * * *
(e) Deposit of firm-owned securities into segregation. A futures
commission merchant may deposit unencumbered securities of the type
specified in this section, which it owns for its own account, into a
customer account. A futures commission merchant must include such
securities, transfers of securities, and disposition of proceeds from
the sale or maturity of such securities in the record of investments
required to be maintained by Sec. 1.27. All such securities may be
segregated in safekeeping only with a bank, trust company, derivatives
clearing organization, or other registered futures commission merchant
in accordance with the provisions of Sec. 1.20 part. For purposes of
this section and Sec. Sec. 1.27, 1.28, 1.29, and 1.32, securities of
the type specified by this section that are owned by the futures
commission merchant and deposited into a customer account shall be
considered customer funds until such investments are withdrawn from
segregation in accordance with the provisions of Sec. 1.23.
Investments permitted by Sec. 1.25 that are owned by the futures
commission merchant and deposited into a futures customer account
pursuant to Sec. 1.26 shall be considered futures customer funds until
such investments are withdrawn from segregation in accordance with
Sec. 1.23. Investments permitted by Sec. 1.25 that are owned by the
futures commission merchant and deposited into a Cleared Swaps Customer
Account, as defined in Sec. 22.1 of this chapter, shall be considered
Cleared Swaps Customer Collateral, as defined in Sec. 22.1 of this
chapter, until such investments are withdrawn from segregation in
accordance with Sec. 22.17 of this chapter.
* * * * *

0
13. Revise Sec. 1.26 to read as follows:

Sec. 1.26 Deposit of instruments purchased with futures customer
funds.

(a) Each futures commission merchant who invests futures customer
funds in instruments described in Sec. 1.25, except for investments in
money market mutual funds, shall separately account for such
instruments as futures customer funds and segregate such instruments as
funds belonging to such futures customers in accordance with the
requirements of Sec. 1.20. Each derivatives clearing organization
which invests money belonging or accruing to futures customers of its
clearing members in instruments described in Sec. 1.25, except for
investments in money market mutual funds, shall separately account for
such instruments as customer funds and segregate such instruments as
customer funds belonging to such futures customers in accordance with
Sec. 1.20.
(b) Each futures commission merchant or derivatives clearing
organization which invests futures customer funds in money market
mutual funds, as permitted by Sec. 1.25, shall separately account for
such funds and segregate such funds as belonging to such futures
customers. Such funds shall be deposited under an account name that
clearly shows that they belong to futures customers and are segregated
as required by sections 4d(a) and 4d(b) of the Act and by this part.
Each futures commission merchant or derivatives clearing organization,
upon opening such an account, shall obtain and maintain readily
accessible in its files in accordance with Sec. 1.31, for as long as
the account remains open, and thereafter for the period provided in
Sec. 1.31, a written acknowledgment and shall file such acknowledgment
in accordance with the requirements of Sec. 1.20. In the event such
funds are held directly with the money market mutual fund or its
affiliate, the written acknowledgment shall be in the form as set out
in Appendix A or B to this section. In the event such funds are held
with a depository, the written acknowledgment shall be in the form as
set out in Appendix A or B to Sec. 1.20. In either case, the written
acknowledgment shall be obtained, provided to the Commission and
designated self-regulatory organizations, and retained as required
under Sec. 1.20.

Appendix A to Sec. 1.26--Futures Commission Merchant Acknowledgment
Letter for CFTC Regulation 1.26 Customer Segregated Money Market Mutual
Fund Account

[Date]
[Name and Address of Money Market Mutual Fund]

We propose to invest funds held by [Name of Futures Commission
Merchant] (``we'' or ``our'') on behalf of our customers in shares
of [Name of Money Market Mutual Fund] (``you'' or ``your'') under
account(s) entitled (or shares issued to):

[Name of Futures Commission Merchant] [if applicable, add ``FCM
Customer Omnibus Account''] CFTC Regulation 1.26 Customer Segregated
Money Market Mutual Fund Account under Sections 4d(a) and 4d(b) of
the Commodity Exchange Act [and, if applicable, ``, Abbreviated as
[short title reflected in the depository's electronic system]'']
Account Number(s): [ ]
(collectively, the ``Account(s)'').

[[Page 68635]]

Regulation 1.26, as amended; that the Shares held by you, hereafter
deposited in the Account(s) or accruing to the credit of the
Account(s), will be separately accounted for and segregated on your
books from our own funds and from any other funds or accounts held
by us in accordance with the provisions of the Commodity Exchange
Act, as amended (the ``Act''), and part 1 of the CFTC's regulations,
as amended; and that the Shares must otherwise be treated in
accordance with the provisions of Section 4d of the Act and CFTC
regulations thereunder.
Furthermore, you acknowledge and agree that such Shares may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, and they may not be used by us to secure or
obtain credit from you. You further acknowledge and agree that the
Shares in the Account(s) shall not be subject to any right of offset
or lien for or on account of any indebtedness, obligations or
liabilities we may now or in the future have owing to you.
In addition, you agree that the Account(s) may be examined at
any reasonable time by the director of the Division of Swap Dealer
and Intermediary Oversight of the CFTC or the director of the
Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent or employee of our designated self-regulatory organization
(``DSRO''), [Name of DSRO], and this letter constitutes the
authorization and direction of the undersigned on our behalf to
permit any such examination to take place without further notice to
or consent from us.
You agree to reply promptly and directly to any request for
confirmation of account balances or provision of any other account
information regarding or related to the Account(s) from the director
of the Division of Swap Dealer and Intermediary Oversight of the
CFTC or the director of the Division of Clearing and Risk of the
CFTC, or any successor divisions, or such directors' designees, or
an appropriate officer, agent, or employee of [Name of DSRO], acting
in its capacity as our DSRO, and this letter constitutes the
authorization and direction of the undersigned on our behalf to
release the requested information without further notice to or
consent from us.
You further acknowledge and agree that, pursuant to the
authorization granted by us to you previously or herein, you have
provided, or will provide following the opening of the Account(s),
the director of the Division of Swap Dealer and Intermediary
Oversight of the CFTC, or any successor division, or such director's
designees, with technological connectivity, which may include
provision of hardware, software, and related technology and protocol
support, to facilitate direct, read-only electronic access to
transaction and account balance information for the Account(s). This
letter constitutes the authorization and direction of the
undersigned on our behalf for you to establish this connectivity and
access if not previously established, without further notice to or
consent from us.
The parties agree that all actions on your part to respond to
the above information and access requests will be made in accordance
with, and subject to, such usual and customary authorization
verification and authentication policies and procedures as may be
employed by you to verify the authority of, and authenticate the
identity of, the individual making any such information or access
request, in order to provide for the secure transmission and
delivery of the requested information or access to the appropriate
recipient(s).
We will not hold you responsible for acting pursuant to any
information or access request from the director of the Division of
Swap Dealer and Intermediary Oversight of the CFTC or the director
of the Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent, or employee of [Name of DSRO], acting in its capacity as our
DSRO, upon which you have relied after having taken measures in
accordance with your applicable policies and procedures to assure
that such request was provided to you by an individual authorized to
make such a request.
In the event we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Shares
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of offset or lien on assets that are not Shares
maintained in the Account(s), or to impose such charges against us
or any proprietary account maintained by us with you. Further, it is
understood that amounts represented by checks, drafts or other items
shall not be considered to be part of the Account(s) until finally
collected. Accordingly, checks, drafts and other items credited to
the Account(s) and subsequently dishonored or otherwise returned to
you or reversed, for any reason and any claims relating thereto,
including but not limited to claims of alteration or forgery, may be
charged back to the Account(s), and we shall be responsible to you
as a general endorser of all such items whether or not actually so
endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that, in the ordinary course of your business as a
depository, you have no notice of or actual knowledge of a potential
violation by us of any provision of the Act or the CFTC regulations
that relates to the segregation of customer funds; and you shall not
in any manner not expressly agreed to herein be responsible to us
for ensuring compliance by us with such provisions of the Act and
CFTC regulations; however, the aforementioned presumption does not
affect any obligation you may otherwise have under the Act or CFTC
regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any action or omission to act
pursuant to such order, judgment, decree or levy, to us or to any
other person, firm, association or corporation even if thereafter
any such order, decree, judgment or levy shall be reversed,
modified, set aside or vacated.
We are permitted to invest customers' funds in money market
mutual funds pursuant to CFTC Regulation 1.25. That rule sets forth
the following conditions, among others, with respect to any
investment in a money market mutual fund:
(1) The net asset value of the fund must be computed by 9:00
a.m. of the business day following each business day and be made
available to us by that time;
(2) The fund must be legally obligated to redeem an interest in
the fund and make payment in satisfaction thereof by the close of
the business day following the day on which we make a redemption
request except as otherwise specified in CFTC Regulation
1.25(c)(5)(ii); and,
(3) The agreement under which we invest customers' funds must
not contain any provision that would prevent us from pledging or
transferring fund shares.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns, and for the avoidance of
doubt, regardless of a change in the name of either party. This
letter agreement supersedes and replaces any prior agreement between
the parties in connection with the Account(s), including but not
limited to any prior acknowledgment letter agreement, to the extent
that such prior agreement is inconsistent with the terms hereof. In
the event of any conflict between this letter agreement and any
other agreement between the parties in connection with the
Account(s), this letter agreement shall govern with respect to
matters specific to Section 4d of the Act and the CFTC's regulations
thereunder, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning to us the
enclosed copy of this letter agreement, and that you further agree
to provide a copy of this fully executed letter agreement directly
to the CFTC (via electronic means in a format and manner determined
by the CFTC) and to [Name of DSRO], acting in its capacity as our
DSRO, in accordance with CFTC Regulation 1.20. We hereby authorize
and direct you to provide such copies without further notice to or
consent from us, no later than three business days after opening the
Account(s) or revising this letter agreement, as applicable.

[Name of Futures Commission Merchant]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Money Market Mutual Fund]
By:
Print Name:
Title:

[[Page 68636]]

Contact Information: [Insert phone number and email address]
Date:

Appendix B to Sec. 1.26--Derivatives Clearing Organization
Acknowledgment Letter for CFTC Regulation 1.26 Customer Segregated
Money Market Mutual Fund Account

[Date]
[Name and Address of Money Market Mutual Fund]

We propose to invest funds held by [Name of Derivatives Clearing
Organization] (``we'' or ``our'') on behalf of customers in shares
of [Name of Money Market Mutual Fund] (``you'' or ``your'') under
account(s) entitled (or shares issued to):

[Name of Derivatives Clearing Organization] Futures Customer Omnibus
Account, CFTC Regulation 1.26 Customer Segregated Money Market
Mutual Fund Account under Sections 4d(a) and 4d(b) of the Commodity
Exchange Act [and, if applicable, ``, Abbreviated as [short title
reflected in the depository's electronic system]'']
Account Number(s): [ ]
(collectively, the ``Account(s)'').

You acknowledge that we are holding these funds, including any
shares issued and amounts accruing in connection therewith
(collectively, the ``Shares''), for the benefit of customers who
trade commodities, options, swaps and other products, as required by
Commodity Futures Trading Commission (``CFTC'') Regulation 1.26, as
amended; that the Shares held by you, hereafter deposited in the
Account(s) or accruing to the credit of the Account(s), will be
separately accounted for and segregated on your books from our own
funds and from any other funds or accounts held by us in accordance
with the provisions of the Commodity Exchange Act, as amended (the
``Act''), and part 1 of the CFTC's regulations, as amended; and that
the Shares must otherwise be treated in accordance with the
provisions of Section 4d of the Act and CFTC regulations thereunder.
Furthermore, you acknowledge and agree that such Shares may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, and they may not be used by us to secure or
obtain credit from you. You further acknowledge and agree that the
Shares in the Account(s) shall not be subject to any right of offset
or lien for or on account of any indebtedness, obligations or
liabilities we may now or in the future have owing to you.
You agree to reply promptly and directly to any request for
confirmation of account balances or provision of any other account
information regarding or related to the Account(s) from the director
of the Division of Clearing and Risk of the CFTC or the director of
the Division of Swap Dealer and Intermediary Oversight of the CFTC,
or any successor divisions, or such directors' designees, and this
letter constitutes the authorization and direction of the
undersigned on our behalf to release the requested information
without further notice to or consent from us.
The parties agree that all actions on your part to respond to
the above information requests will be made in accordance with, and
subject to, such usual and customary authorization verification and
authentication policies and procedures as may be employed by you to
verify the authority of, and authenticate the identity of, the
individual making any such information request, in order to provide
for the secure transmission and delivery of the requested
information to the appropriate recipient(s).
We will not hold you responsible for acting pursuant to any
information request from the director of the Division of Clearing
and Risk of the CFTC or the director of the Division of Swap Dealer
and Intermediary Oversight of the CFTC, or any successor divisions,
or such directors' designees, upon which you have relied after
having taken measures in accordance with your applicable policies
and procedures to assure that such request was provided to you by an
individual authorized to make such a request.
In the event that we or any of our futures commission merchant
clearing members become(s) subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Shares
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of offset or lien on assets that are not Shares
maintained in the Account(s), or to impose such charges against us
or any proprietary account maintained by us with you. Further, it is
understood that amounts represented by checks, drafts or other items
shall not be considered to be part of the Account(s) until finally
collected. Accordingly, checks, drafts and other items credited to
the Account(s) and subsequently dishonored or otherwise returned to
you, or reversed, for any reason and any claims relating thereto,
including but not limited to claims of alteration or forgery, may be
charged back to the Account(s), and we shall be responsible to you
as a general endorser of all such items whether or not actually so
endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that, in the ordinary course of your business as a
depository, you have no notice of or actual knowledge of a potential
violation by us of any provision of the Act or the CFTC regulations
that relates to the segregation of customer funds; and you shall not
in any manner not expressly agreed to herein be responsible to us
for ensuring compliance by us with such provisions of the Act and
CFTC regulations; however, the aforementioned presumption does not
affect any obligation you may otherwise have under the Act or CFTC
regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any action or omission to act
pursuant to any such order, judgment, decree or levy, to us or to
any other person, firm, association or corporation even if
thereafter any such order, decree, judgment or levy shall be
reversed, modified, set aside or vacated.
We are permitted to invest customers' funds in money market
mutual funds pursuant to CFTC Regulation 1.25. That rule sets forth
the following conditions, among others, with respect to any
investment in a money market mutual fund:
(1) The net asset value of the fund must be computed by 9:00
a.m. of the business day following each business day and be made
available to us by that time;
(2) The fund must be legally obligated to redeem an interest in
the fund and make payment in satisfaction thereof by the close of
the business day following the day on which we make a redemption
request except as otherwise specified in CFTC Regulation
1.25(c)(5)(ii); and,
(3) The agreement under which we invest customers' funds must
not contain any provision that would prevent us from pledging or
transferring fund shares.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns, and for the avoidance of
doubt, regardless of a change in the name of either party. This
letter agreement supersedes and replaces any prior agreement between
the parties in connection with the Account(s), including but not
limited to any prior acknowledgment letter agreement, to the extent
that such prior agreement is inconsistent with the terms hereof. In
the event of any conflict between this letter agreement and any
other agreement between the parties in connection with the
Account(s), this letter agreement shall govern with respect to
matters specific to Section 4d of the Act and the CFTC's regulations
thereunder, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning to us the
enclosed copy of this letter agreement, and you further agree to
provide a copy of this fully executed letter agreement directly to
the CFTC (via electronic means in a format and manner determined by
the CFTC) in accordance with CFTC Regulation 1.20. We hereby
authorize and direct you to provide such copies without further
notice to or consent from us, no later than three business days
after opening the Account(s) or revising this letter agreement, as
applicable.

[Name of Derivatives Clearing Organization]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Money Market Mutual Fund]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]

[[Page 68637]]

Date:

0
14. Revise Sec. 1.29 to read as follows:

Sec. 1.29 Gains and losses resulting from investment of customer
funds.

(a) The investment of customer funds in instruments described in
Sec. 1.25 shall not prevent the futures commission merchant or
derivatives clearing organization so investing such funds from
receiving and retaining as its own any incremental income or interest
income resulting therefrom.
(b) The futures commission merchant or derivatives clearing
organization, as applicable, shall bear sole responsibility for any
losses resulting from the investment of customer funds in instruments
described in Sec. 1.25. No investment losses shall be borne or
otherwise allocated to the customers of the futures commission merchant
and, if customer funds are invested by a derivatives clearing
organization in its discretion, to the futures commission merchant.

0
15. Revise Sec. 1.30 to read as follows:

Sec. 1.30 Loans by futures commission merchants; treatment of
proceeds.

Nothing in the regulations in this chapter shall prevent a futures
commission merchant from lending its own funds to customers on
securities and property pledged by such customers, or from repledging
or selling such securities and property pursuant to specific written
agreement with such customers. The proceeds of such loans used to
purchase, margin, guarantee, or secure the trades, contracts, or
commodity options of customers shall be treated and dealt with by a
futures commission merchant as belonging to such customers, in
accordance with and subject to the provisions of the Act and these
regulations. A futures commission merchant may not loan funds on an
unsecured basis to finance customers' trading, nor may a futures
commission merchant loan funds to customers secured by the customer
accounts of such customers.

0
16. Amend Sec. 1.32 to:
0
a. Revise the section heading;
0
b. Revise paragraphs (b) and (c); and
0
c. Add paragraphs (d), (e), (f), (g), (h), (i), (j), and (k).
The revisions and additions to read as follows:

Sec. 1.32 Reporting of segregated account computation and details
regarding the holding of futures customer funds

* * * * *
(b) In computing the amount of futures customer funds required to
be in segregated accounts, a futures commission merchant may offset any
net deficit in a particular futures customer's account against the
current market value of readily marketable securities, less applicable
deductions (i.e., ``securities haircuts'') as set forth in Rule 15c3-
1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR 241.15c3-
1(c)(2)(vi)), held for the same futures customer's account. Futures
commission merchants that establish and enforce written policies and
procedures to assess the credit risk of commercial paper, convertible
debt instruments, or nonconvertible debt instruments in accordance with
Rule 240.15c3-1(c)(2)(vi) of the Securities and Exchange Commission (17
CFR 240.15c3-1(c)(2)(vi)) may apply the lower haircut percentages
specified in Rule 240.15c3-1(c)(2)(vi) for such commercial paper,
convertible debt instruments and nonconvertible debt instruments. The
futures commission merchant must maintain a security interest in the
securities, including a written authorization to liquidate the
securities at the futures commission merchant's discretion, and must
segregate the securities in a safekeeping account with a bank, trust
company, derivatives clearing organization, or another futures
commission merchant. For purposes of this section, a security will be
considered readily marketable if it is traded on a ``ready market'' as
defined in Rule 15c3-1(c)(11)(i) of the Securities and Exchange
Commission (17 CFR 240.15c3-1(c)(11)(i)).
(c) Each futures commission merchant is required to document its
segregation computation required by paragraph (a) of this section by
preparing a Statement of Segregation Requirements and Funds in
Segregation for Customers Trading on U.S. Commodity Exchanges contained
in the Form 1-FR-FCM as of the close of each business day. Nothing in
this paragraph shall affect the requirement that a futures commission
merchant at all times maintain sufficient money, securities and
property to cover its total obligations to all futures customers, in
accordance with Sec. 1.20.
(d) Each futures commission merchant is required to submit to the
Commission and to the firm's designated self-regulatory organization
the daily Statement of Segregation Requirements and Funds in
Segregation for Customers Trading on U.S. Commodity Exchanges required
by paragraph (c) of this section by noon the following business day.
(e) Each futures commission merchant shall file the Statement of
Segregation Requirements and Funds in Segregation for Customers Trading
on U.S. Commodity Exchanges required by paragraph (c) of this section
in an electronic format using a form of user authentication assigned in
accordance with procedures established or approved by the Commission.
(f) Each futures commission merchant is required to submit to the
Commission and to the firm's designated self-regulatory organization a
report listing the names of all banks, trust companies, futures
commission merchants, derivatives clearing organizations, or any other
depository or custodian holding futures customer funds as of the
fifteenth day of the month, or the first business day thereafter, and
the last business day of each month. This report must include:
(1) The name and location of each entity holding futures customer
funds;
(2) The total amount of futures customer funds held by each entity
listed in paragraph (f)(1) of this section; and
(3) The total amount of cash and investments that each entity
listed in paragraph (f)(1) of this section holds for the futures
commission merchant. The futures commission merchant must report the
following investments:
(i) Obligations of the United States and obligations fully
guaranteed as to principal and interest by the United States (U.S.
government securities);
(ii) General obligations of any State or of any political
subdivision of a State (municipal securities);
(iii) General obligation issued by any enterprise sponsored by the
United States (government sponsored enterprise securities);
(iv) Certificates of deposit issued by a bank;
(v) Commercial paper fully guaranteed as to principal and interest
by the United States under the Temporary Liquidity Guarantee Program as
administered by the Federal Deposit Insurance Corporation;
(vi) Corporate notes or bonds fully guaranteed as to principal and
interest by the United States under the Temporary Liquidity Guarantee
Program as administered by the Federal Deposit Insurance Corporation;
and
(vii) Interests in money market mutual funds.
(g) Each futures commission merchant must report the total amount
of futures customer-owned securities held by the futures commission
merchant as margin collateral and must list the names and locations of
the depositories holding such margin collateral.
(h) Each futures commission merchant must report the total amount
of futures customer funds that have been used to purchase securities
under agreements to resell the securities (reverse repurchase
transactions).

[[Page 68638]]

(i) Each futures commission merchant must report which, if any, of
the depositories holding futures customer funds under paragraph (f)(1)
of this section are affiliated with the futures commission merchant.
(j) Each futures commission merchant shall file the detailed list
of depositories required by paragraph (f) of this section by 11:59 p.m.
the next business day in an electronic format using a form of user
authentication assigned in accordance with procedures established or
approved by the Commission.
(k) Each futures commission merchant shall retain its daily
segregation computation and the Statement of Segregation Requirements
and Funds in Segregation for Customers Trading on U.S. Commodity
Exchanges required by paragraph (c) of this section, and its detailed
list of depositories required by paragraph (f) of this section,
together with all supporting documentation, in accordance with the
requirements of Sec. 1.31.

0
17. Revise Sec. 1.52 to read as follows:

Sec. 1.52 Self-regulatory organization adoption and surveillance of
minimum financial requirements.

(a) For purposes of this section, the following terms are defined
as follows:
(1) Examinations expert is defined as a Nationally recognized
accounting and auditing firm with substantial expertise in audits of
futures commission merchants, risk assessment and internal control
reviews, and is an accounting and auditing firm that is acceptable to
the Commission; and
(2) Self-regulatory organization means a contract market (as
defined in Sec. 1.3(h)) or a registered futures association under
section 17 of the Act. The term ``self-regulatory organization'' for
purpose of this section does not include a swap execution facility (as
defined in Sec. 1.3(rrrr)).
(b)(1) Each self-regulatory organization must adopt rules
prescribing minimum financial and related reporting requirements for
members who are registered futures commission merchants or registered
retail foreign exchange dealers. Each self-regulatory organization
other than a contract market must adopt rules prescribing minimum
financial and related reporting requirements for members who are
registered introducing brokers. The self-regulatory organization's
minimum financial and related reporting requirements must be the same
as, or more stringent than, the requirements contained in Sec. Sec.
1.10 and 1.17, for futures commission merchants and introducing
brokers, and Sec. Sec. 5.7 and 5.12 of this chapter for retail foreign
exchange dealers; provided, however, that a self-regulatory
organization may permit its member registrants that are registered with
the Securities and Exchange Commission as securities brokers or dealers
to file (in accordance with Sec. 1.10(h)) a copy of their Financial
and Operational Combined Uniform Single Report under the Securities
Exchange Act of 1934 (``FOCUS Report''), Part II, Part IIA, or Part II
CSE, as applicable, in lieu of Form 1-FR; provided, further, that such
self-regulatory organization must require such member registrants to
provide all information in Form 1-FR that is not included in the FOCUS
Report Part II, Part IIA, or Part CSE provided by such member
registrant. The definition of adjusted net capital must be the same as
that prescribed in Sec. 1.17(c) for futures commission merchants and
introducing brokers, and Sec. 5.7(b)(2) of this chapter for futures
commission merchants offering or engaging in retail forex transactions
and for retail foreign exchange dealers.
(2) In addition to the requirements set forth in paragraph (b)(1)
of this section, each self-regulatory organization that has a futures
commission merchant member registrant must adopt rules prescribing risk
management requirements for futures commission merchant member
registrants that shall be the same as, or more stringent than, the
requirements contained in Sec. 1.11.
(c)(1) Each self-regulatory organization must establish and operate
a supervisory program that includes written policies and procedures
concerning the application of such supervisory program in the
examination of its member registrants for the purpose of assessing
whether each member registrant is in compliance with the applicable
self-regulatory organization and Commission regulations governing
minimum net capital and related financial requirements, the obligation
to segregate customer funds, risk management requirements, financial
reporting requirements, recordkeeping requirements, and sales practice
and other compliance requirements. The supervisory program also must
address the following elements:
(i) Adequate levels and independence of examination staff. A self-
regulatory organization must maintain staff of an adequate size,
training, and experience to effectively implement a supervisory
program. Staff of the self-regulatory organization, including officers,
directors, and supervising committee members, must maintain independent
judgment and its actions must not impair its independence nor appear to
impair its independence in matters related to the supervisory program.
The self-regulatory organization must provide annual ethics training to
all staff with responsibilities for the supervisory program.
(ii) Ongoing surveillance. A self-regulatory organization's ongoing
surveillance of member registrants must include the review and analysis
of financial reports and regulatory notices filed by member registrants
with the designated self-regulatory organization.
(iii) High-risk firms. A self-regulatory organization's supervisory
program must include procedures for identifying member registrants that
are determined to pose a high degree of potential financial risk,
including the potential risk of loss of customer funds. High-risk
member registrants must include firms experiencing financial or
operational difficulties, failing to meet segregation or net capital
requirements, failing to maintain current books and records, or
experiencing material inadequacies in internal controls. Enhanced
monitoring for high risk firms should include, as appropriate, daily
review of net capital, segregation, and secured calculations, to assess
compliance with self-regulatory organization and Commission
requirements.
(iv) On-site examinations. (A) A self-regulatory organization must
conduct routine periodic on-site examinations of member registrants.
Member futures commission merchants and retail foreign exchange dealers
must be subject to on-site examinations no less frequently than once
every eighteen months. A self-regulatory organization shall establish a
risk-based method of establishing the scope of each on-site
examination; provided, however, that the scope of each on-site
examination of a futures commission merchant or retail foreign exchange
dealer must include an assessment of whether the registrant is in
compliance with applicable Commission and self-regulatory organization
minimum capital, customer fund protection, recordkeeping, and reporting
requirements.
(B) A self-regulatory organization other than a contract market
must establish the frequency of on-site examinations of member
introducing brokers that do not operate pursuant to guarantee
agreements with futures commission merchants or retail foreign exchange
dealers using a risk-based approach, which takes into consideration the
time elapsed since the self-regulatory organization's previous
examination of the introducing broker.
(C) A self-regulatory organization must conduct on-site
examinations of member registrants in accordance with

[[Page 68639]]

uniform examination programs and procedures that have been submitted to
the Commission.
(v) Adequate documentation. A self-regulatory organization must
adequately document all aspects of the operation of the supervisory
program, including the conduct of risk-based scope setting and the
risk-based surveillance of high-risk member registrants, and the
imposition of remedial and punitive action(s) for material violations.
(2) In addition to the requirements set forth in paragraph (c)(1)
of this section, the supervisory program of a self-regulatory
organization that has a registered futures commission merchant member
must satisfy the following requirements:
(i) The supervisory program must set forth in writing the
examination standards that the self-regulatory organization must apply
in its examination of its registered futures commission merchant
member. The supervisory program must be based on controls testing and
substantive testing, and must address all areas of risk to which the
futures commission merchant can reasonably be foreseen to be subject.
The supervisory program must be based on an understanding of the
internal control environment to determine the nature, timing and extent
of the controls and substantive testing to be performed. The
determination as to which elements of the supervisory program are to be
performed on any examination must be based on the risk profile of each
registered futures commission merchant member.
(ii) All aspects of the supervisory program, including the
standards pursuant to paragraph (c)(2)(iii) of this section, must, at
minimum, conform to auditing standards issued by the Public Company
Accounting Oversight Board as such standards would be applicable to a
non-financial statement audit. These standards would include the
training and proficiency of the auditor, due professional care in the
performance of work, consideration of fraud in an audit, audit risk and
materiality in conducting an audit, planning and supervision,
understanding the entity and its environment and assessing the risks of
material misstatement, performing audit procedures in response to
assessed risk and evaluating the audit evidence obtained, auditor's
communication with those charged with governance, and communicating
internal control matters identified in an audit.
(iii) The supervisory program must, at a minimum, have standards
addressing the following:
(A) The ethics of an examiner;
(B) The independence of an examiner;
(C) The supervision, review, and quality control of an examiner's
work product;
(D) The evidence and documentation to be reviewed and retained in
connection with an examination;
(E) The sampling size and techniques used in an examination;
(F) The examination risk assessment process;
(G) The examination planning process;
(H) Materiality assessment;
(I) Quality control procedures to ensure that the examinations
maintain the level of quality expected;
(J) Communications between an examiner and the regulatory oversight
committee, or the functional equivalent of the regulatory oversight
committee, of the self-regulatory organization of which the futures
commission merchant is a member;
(K) Communications between an examiner and a futures commission
merchant's audit committee of the board of directors or other similar
governing body;
(L) Analytical review procedures;
(M) Record retention; and
(N) Required items for inclusion in the examination report, such as
repeat violations, material items, and high risk issues. The
examination report is intended solely for the information and use of
the self-regulatory organizations and the Commission, and is not
intended to be and should not be used by any other person or entity.
(iv) A self-regulatory organization must cause an examinations
expert to evaluate the supervisory program and such self-regulatory
organization's application of the supervisory program at least once
every three years.
(A) The self-regulatory organization must obtain from such
examinations expert a written report on findings and recommendations
issued under the consulting services standards of the American
Institute of Certified Public Accountants that includes the following:
(1) A statement that the examinations expert has evaluated the
supervisory program, including the sufficiency of the risk-based
approach and the internal controls testing thereof, and comments and
recommendations in connection with such evaluation from such
examinations expert;
(2) A statement that the examinations expert has evaluated the
application of the supervisory program by the self-regulatory
organization, and comments and recommendations in connection with such
evaluation from such examinations expert; and
(3) The examinations expert's report should include an analysis of
the supervisory program's design to detect material weaknesses in an
entity's internal control environment;
(4) A discussion and recommendation of any new or best practices as
prescribed by industry sources, including, but not limited to, those
from the American Institute of Certified Public Accountants, the Public
Company Accounting Oversight Board, the Institute of Internal Auditors,
and The Risk Management Association.
(B) The self-regulatory organization must provide the written
report to the Commission no later than thirty days following the
receipt thereof. The self-regulatory organization may also provide to
the Commission a response, in writing, to any of the findings, comments
or recommendations made by the examinations expert. Upon resolution of
any questions or comments raised by the Commission, and upon written
notice from the Commission that it has no further comments or questions
on the supervisory program as amended (by reason of the examinations
expert's proposals, considerations of the Commission's questions or
comments, or otherwise), the self-regulatory organization shall
commence applying such supervisory program as the standard for
examining its registered futures commission merchant members for all
examinations conducted with an ``as-of'' date later than the date of
the Commission's written notification.
(v) The supervisory program must require the self-regulatory
organization to report to its risk and/or audit committee of the board
of directors, or a functional equivalent committee, with timely reports
of the activities and findings of the supervisory program to assist the
risk and/or audit committee of the board of directors, or a functional
equivalent committee, to fulfill its responsibility of overseeing the
examination function.
(vi) The initial supervisory program shall be established as
follows. Within 180 days following the effective date of this section,
or such other time as the Commission may approve, the self-regulatory
organization shall submit a proposed supervisory program to the
Commission for its review and comment, together with a written report
that includes the elements found in paragraphs (c)(2)(iv)(A)(1) and (3)
of this section from an examinations expert who has evaluated the
supervisory program. The self-regulatory organization may provide the
Commission a written response to any findings, comments or
recommendations made by the

[[Page 68640]]

examinations expert. Upon resolution of any questions or comments
raised by the Commission, and upon written notice from the Commission
that it has no further comments or questions on the proposed
supervisory program as amended (by reason of the considerations of the
Commission's questions or comments or otherwise), the self-regulatory
organizations shall commence applying such supervisory program as the
standard for examining its members that are registered as futures
commission merchants for all examinations conducted with an ``as-of''
date later than the date of the Commission's written notification.
(vii) The examinations expert's report, the self-regulatory
organization's response, as well as any information concerning the
supervisory program or any review conducted pursuant to the program
that is obtained by the examinations expert, is confidential. Except as
expressly provided for in this section, such information may not be
disclosed to anyone not involved in the review process.
(d)(1) Any two or more self-regulatory organizations may file with
the Commission a plan for delegating to a designated self-regulatory
organization, for any registered futures commission merchant, retail
foreign exchange dealer, or introducing broker that is a member of more
than one such self-regulatory organization, the function of:
(i) Monitoring and examining for compliance with the minimum
financial and related reporting requirements and risk management
requirements, including policies and procedures relating to the
receipt, holding, investing and disbursement of customer funds, adopted
by such self-regulatory organizations and the Commission in accordance
with paragraphs (b) and (c) of this section; and
(ii) Receiving the financial reports and notices necessitated by
such minimum financial and related reporting requirements; provided,
however, that the self-regulatory organization that delegates the
functions set forth in this paragraph (d)(1) shall remain responsible
for its member registrants' compliance with the regulatory obligations,
and if such self-regulatory organization becomes aware that a delegated
function is not being performed as required under this section, the
self-regulatory organization shall promptly take any necessary steps to
address any noncompliance.
(2) If a plan established pursuant to paragraph (d)(1) of this
section applies to any registered futures commission merchant, then
such plan must include the following elements:
(i) The Joint Audit Committee. The self-regulatory organizations
that choose to participate in the plan shall form a Joint Audit
Committee, consisting of all self-regulatory organizations in the plan
as members. The members of the Joint Audit Committee shall establish,
operate and maintain a Joint Audit Program in accordance with the
requirements of this section to ensure an effective and a high quality
program for examining futures commission merchants, to designate the
designated self-regulatory organizations that will be responsible for
the examinations of futures commission merchants pursuant to the Joint
Audit Program, and to satisfy such additional obligations set forth in
this section in order to facilitate the examinations of futures
commission merchants by their respective designated self-regulatory
organizations.
(ii) The Joint Audit Program. The Joint Audit Program must, at
minimum, satisfy the following requirements.
(A) The purpose of the Joint Audit Program must be to assess
whether each registered futures commission merchant member of the Joint
Audit Committee self-regulatory organization members is in compliance
with the Joint Audit Program and Commission regulations governing
minimum net capital and related financial requirements, the obligation
to segregate customer funds, risk management requirements, including
policies and procedures relating to the receipt, holding, investment,
and disbursement of customer funds, financial reporting requirements,
recordkeeping requirements, and sales practice and other compliance
requirements.
(B) The Joint Audit Program must include written policies and
procedures concerning the application of the Joint Audit Program in the
examination of the registered futures commission merchant members of
the Joint Audit Committee self-regulatory organization members.
(C)(1) Adequate levels and independence of examination staff. A
designated self-regulatory organization must maintain staff of an
adequate size, training, and experience to effectively implement the
Joint Audit Program. Staff of the designated self-regulatory
organization, including officers, directors, and supervising committee
members, must maintain independent judgment and its actions must not
impair its independence nor appear to impair its independence in
matters related to the Joint Audit Program. The designated self-
regulatory organization must provide annual ethics training to all
staff with responsibilities for the Joint Audit Program.
(2) Ongoing surveillance. A designated self-regulatory
organization's ongoing surveillance of futures commission merchant
member registrants over which it has oversight responsibilities must
include the review and analysis of financial reports and regulatory
notices filed by such member registrants with the designated self-
regulatory organization.
(3) High-risk firms. The Joint Audit Program must include
procedures for identifying futures commission merchant member
registrants over which it has oversight responsibilities that are
determined to pose a high degree of potential financial risk, including
the potential risk of loss of customer funds. High-risk member
registrants must include firms experiencing financial or operational
difficulties, failing to meet segregation or net capital requirements,
failing to maintain current books and records, or experiencing material
inadequacies in internal controls. Enhanced monitoring for high risk
firms should include, as appropriate, daily review of net capital,
segregation, and secured calculations, to assess compliance with self-
regulatory and Commission requirements.
(4) On-site examinations. A designated self-regulatory organization
must conduct routine periodic on-site examinations of futures
commission merchant member registrants over which it has oversight
responsibilities. Such member registrants must be subject to on-site
examinations no less frequently than once every eighteen months. A
designated self-regulatory organization shall establish a risk-based
method of establishing the scope of each on-site examination, provided,
however, that the scope of each on-site examination of a futures
commission merchant must include an assessment of whether the
registrant is in compliance with applicable Commission and self-
regulatory organization minimum capital, customer fund protection,
recordkeeping, and reporting requirements. A designated self-regulatory
organization must conduct on-site examinations of futures commission
merchant registrants in accordance with the Joint Audit Program.
(D) The Joint Audit Committee members must adequately document all
aspects of the operation of the Joint Audit Program, including the
conduct of risk-based scope setting and the risk-based surveillance of
high-risk member registrants, and the imposition of remedial and
punitive action(s) for material violations.
(E) The Joint Audit Program must set forth in writing the
examination

[[Page 68641]]

standards that a designated self-regulatory organization must apply in
its examination of a registered futures commission merchant. The Joint
Audit Program must be based on controls testing and substantive
testing, and must address all areas of risk to which the futures
commission merchant can reasonably be foreseen to be subject. The Joint
Audit Program must be based on an understanding of the internal control
environment to determine the nature, timing and extent of the controls
and substantive testing to be performed. The determination as to which
elements of the Joint Audit Program are to be performed on any
examination must be based on the risk profile of each registered
futures commission merchant.
(F) All aspects of the Joint Audit Program, including the standards
required pursuant to paragraph (d)(2)(ii)(G) of this section, must, at
minimum, conform to auditing standards issued by the Public Company
Accounting Oversight Board as such standards would be applicable to a
non-financial statement audit. These standards would include the
training and proficiency of the auditor, due professional care in the
performance of work, consideration of fraud in an audit, audit risk and
materiality in conducting an audit, planning and supervision,
understanding the entity and its environment and assessing the risks of
material misstatement, performing audit procedures in response to
assessed risk and evaluating the audit evidence obtained, auditor's
communication with those charged with governance, and communicating
internal control matters identified in an audit.
(G) The Joint Audit Program must have standards addressing those
items listed in paragraph (c)(2)(iii) of this section.
(H) The initial Joint Audit Program shall be established as
follows. Within 180 days following the effective date of this section,
or such other time as the Commission may approve, the Joint Audit
Committee members shall submit a proposed initial Joint Audit Program
to the Commission for its review and comment, together with a written
report that includes the elements found in paragraphs (d)(2)(ii)(I)(1)
and (d)(2)(ii)(I)(3) of this section from an examinations expert who
has evaluated the Joint Audit Program. The Joint Audit Committee
members may also provide to the Commission a response, in writing, to
any of the findings, comments or recommendations made by the
examinations expert. Upon resolution of any questions or comments
raised by the Commission, and upon written notice from the Commission
that it has no further comments or questions on the proposed Joint
Audit Program as amended (by reason of the considerations of the
Commission's questions or comments or otherwise), the designated self-
regulatory organizations shall commence applying such Joint Audit
Program as the standard for examining their respective registered
futures commission merchants for all examinations conducted with an
``as-of'' date later than the date of the Commission's written
notification.
(I) Following the establishment of the Joint Audit Program, no less
frequently than once every three years, the Joint Audit Committee
members must cause an examinations expert to evaluate the Joint Audit
Program and each designated self-regulatory organization's application
of the Joint Audit Program. The Joint Audit Committee members must
obtain from such examinations expert a written report, and must provide
the written report to the Commission no later than forty-five days
prior to the annual meeting of the members of the Joint Audit Committee
to be held in that year pursuant to paragraph (d)(2)(iii)(A) of this
section. The Joint Audit Committee members may also provide to the
Commission a response, in writing, to any of the findings, comments or
recommendations made by the examinations expert. The examinations
expert's written report must include the following:
(1) A statement that the examinations expert has evaluated the
Joint Audit Program, including the sufficiency of the risk-based
approach and the internal controls testing thereof, and comments and
recommendations in connection with such evaluation from such
examinations expert;
(2) A statement that the examinations expert has evaluated the
application of the Joint Audit Program by each designated self-
regulatory organization, and comments and recommendations in connection
with such evaluation from such examinations expert;
(3) The examinations expert's report on findings and
recommendations issued under the consulting services standards of the
American Institute of Certified Public Accountants and should include
an analysis of the supervisory program's design to detect material
weaknesses in an entities internal control environment; and
(4) A discussion and recommendation of any new or best practices as
prescribed by industry sources, including, but not limited to, those
from the American Institute of Certified Public Accountants, the Public
Company Accounting Oversight Board, the Internal Audit Association and
The Risk Management Association.
(J) The examinations expert's report, the Joint Audit Committee's
response, as well as any information concerning the supervisory program
or any review conducted pursuant to the program that is obtained by the
examinations expert, is confidential. Except as expressly provided for
in paragraphs (d)(2)(ii)(G) or (d)(2)(ii)(H) of this section, such
information may not be disclosed to anyone not involved in the review
process.
(K) The Joint Audit Program must require each Joint Audit Committee
member to provide to its risk and/or audit committee of the board of
directors, or a functionally equivalent committee, with timely reports
of the activities and findings of the Joint Audit Program to assist the
risk and/or audit committee of the board of directors, or a
functionally equivalent committee, in fulfilling its responsibility of
overseeing the examination function.
(iii) Meetings of the Joint Audit Committee. (A) No less frequently
than once every year, the Joint Audit Committee members must meet to
consider whether changes to the Joint Audit Program are appropriate,
and in considering such, in meetings corresponding to the written
report obtained from an examinations expert pursuant to paragraph
(d)(2)(ii)(I) of this section, the Joint Audit Committee members must
consider such written report, including the results of the examinations
expert's assessment of the Joint Audit Program and any additional
recommendations. The Commission's questions, comments and proposals
must also be considered. Upon written notice from the Commission that
it has no further comments or questions on the Joint Audit Program as
amended (by reason of the examinations expert's proposals,
considerations of the Commission's questions, comments and proposals,
or otherwise), the designated self-regulatory organizations shall
commence applying such Joint Audit Program as the standard for
examining their respective registered futures commission merchants for
all examinations conducted with an ``as-of'' date later than the date
of the Commission's written notification.
(B) In addition to the items considered in paragraph (d)(2)(iii)(A)
of this section, the Joint Audit Committee members must consider the
following items during the annual meeting:
(1) The role of the Joint Audit Committee and its members as it
relates

[[Page 68642]]

to self-regulatory organization responsibilities;
(2) Developing and maintaining the Joint Audit Program for all
designated self-regulatory organizations to follow with no exceptions;
(3) Coordinating self-regulatory organization responsibilities with
those of independent certified public accountants, the Commission and
other regulators and self-regulatory organizations (e.g., the
Securities and Exchange Commission, the Financial Industry Regulatory
Authority, and others, as the case may be for futures commission
merchants subject to regulation by multiple regulators and self-
regulatory organizations);
(4) Coordinating and sharing information between the Joint Audit
Committee members, including issues and industry concerns in connection
with examinations of futures commission merchants;
(5) Identifying industry regulatory reporting issues and financial
and operational internal control issues and modifying the Joint Audit
Program accordingly;
(6) Issuing risk alerts for futures commission merchants and/or
designated self-regulatory organization examiners on an as-needed basis
as issues arise;
(7) Issuing an annual examination alert for certified public
accountants and designated self-regulatory organization examiners;
(8) Responding to industry issues;
(9) Providing industry feedback to Commission proposals; and
(10) Developing and maintaining a standard of ethics and
independence with which all examination units of the Joint Audit
Committee members must comply.
(C) Minutes must be taken of all meetings and distributed to all
members on a timely basis.
(D) The Commission must receive timely prior notice of each
meeting, have to right to attend and participate in each meeting and
receive written copies of the reports and minutes required pursuant to
paragraphs (d)(2)(ii)(J) and (d)(2)(iii)(C) of this section,
respectively.
(3) The plan referenced in paragraph (d)(1) of this section shall
not be effective without Commission approval pursuant to paragraph (h)
of this section.
(e) Any plan filed under this section may contain provisions for
the allocation of expenses reasonably incurred by designated self-
regulatory organizations among the self-regulatory organizations
participating in such a plan.
(f) A plan's designated self-regulatory organizations must report
to:
(1) That plan's other self-regulatory organizations any violation
of such other self-regulatory organizations' rules and regulations for
which the responsibility to monitor or examine has been delegated to
such designated self-regulatory organization under this section; and
(2) The Director of the Division of Swap Dealer and Intermediary
Oversight of the Commission any violation of a self-regulatory
organization's rules and regulations or any violation of the
Commission's regulations for which the responsibility to monitor,
audit, or examine has been delegated to such designated self-regulatory
organization under this section.
(g) The Joint Audit Committee members may, among themselves,
establish programs to provide access to any necessary financial or
related information.
(h) After appropriate notice and opportunity for comment, the
Commission may, by written notice, approve such a plan, or any part of
the plan, if it finds that the plan, or any part of it:
(1) Is necessary or appropriate to serve the public interest;
(2) Is for the protection and in the interest of customers;
(3) Reduces multiple monitoring and multiple examining for
compliance with the minimum financial rules of the Commission and of
the self-regulatory organizations submitting the plan of any futures
commission merchant, retail foreign exchange dealer, or introducing
broker that is a member of more than one self-regulatory organization;
(4) Reduces multiple reporting of the financial information
necessitated by such minimum financial and related reporting
requirements by any futures commission merchant, retail foreign
exchange dealer, or introducing broker that is a member of more than
one self-regulatory organization;
(5) Fosters cooperation and coordination among the self-regulatory
organizations; and
(6) Does not hinder the development of a registered futures
association under section 17 of the Act.
(i) After the Commission has approved a plan, or part thereof,
under paragraph (h) of this section, a self-regulatory organization
delegating the functions described in paragraph (d)(1) of this section
must notify each of its members that are subject to such a plan:
(1) Of the limited scope of the delegating self-regulatory
organization's responsibility for such a member's compliance with the
Commission's and self-regulatory organization's minimum financial and
related reporting requirements; and
(2) Of the identity of the designated self-regulatory organization
that has been delegated responsibility for such a member; provided,
however, that the self-regulatory organization that delegates, pursuant
to paragraph (d) of this section, the functions set forth in paragraphs
(b) and (c) of this section shall remain responsible for its member
registrants' compliance with the regulatory obligations, and if such
self-regulatory organization becomes aware that a delegated function is
not being performed as required under this section, the self-regulatory
organization shall promptly take any necessary steps to address any
noncompliance.
(j) The Commission may at any time, after appropriate notice and
opportunity for hearing, withdraw its approval of any plan, or part
thereof, established under this section, if such plan, or part thereof,
ceases to adequately effectuate the purposes of section 4f(b) of the
Act or of this section.
(k) Whenever a registered futures commission merchant, a registered
retail foreign exchange dealer, or a registered introducing broker
holding membership in a self-regulatory organization ceases to be a
member in good standing of that self-regulatory organization, such
self-regulatory organization must, on the same day that event takes
place, give electronic notice of that event to the Commission at its
Washington, DC, headquarters and send a copy of that notification to
such futures commission merchant, retail foreign exchange dealer, or
introducing broker.
(l) Nothing in this section shall preclude the Commission from
examining any futures commission merchant, retail foreign exchange
dealer, or introducing broker for compliance with the minimum financial
and related reporting requirements, and the risk management
requirements, as applicable, to which such futures commission merchant,
retail foreign exchange dealer, or introducing broker is subject.
(m) In the event a plan is not filed and/or approved for each
registered futures commission merchant, retail foreign exchange dealer,
or introducing broker that is a member of more than one self-regulatory
organization, the Commission may design and, after notice and
opportunity for comment, approve a plan for those futures commission
merchants, retail foreign exchange dealers, or introducing brokers that
are not the subject of an approved plan (under paragraph (h) of this

[[Page 68643]]

section), delegating to a designated self-regulatory organization the
responsibilities described in paragraph (d) of this section.

0
18. Amend Sec. 1.55 to:
0
a. Revise the section heading;
0
b. Revise paragraphs (b)(2) through (b)(8) and (c); and
0
c. Add paragraphs (b)(9) through (b)(14), (i), (j), (k), (l), (m), (n),
and (o).
The revisions and additions to read as follows:

Sec. 1.55 Public disclosures by futures commission merchants.

* * * * *
(b) * * *
(2) The funds you deposit with a futures commission merchant for
trading futures positions are not protected by insurance in the event
of the bankruptcy or insolvency of the futures commission merchant, or
in the event your funds are misappropriated.
(3) The funds you deposit with a futures commission merchant for
trading futures positions are not protected by the Securities Investor
Protection Corporation even if the futures commission merchant is
registered with the Securities and Exchange Commission as a broker or
dealer.
(4) The funds you deposit with a futures commission merchant are
generally not guaranteed or insured by a derivatives clearing
organization in the event of the bankruptcy or insolvency of the
futures commission merchant, or if the futures commission merchant is
otherwise unable to refund your funds. Certain derivatives clearing
organizations, however, may have programs that provide limited
insurance to customers. You should inquire of your futures commission
merchant whether your funds will be insured by a derivatives clearing
organization and you should understand the benefits and limitations of
such insurance programs.
(5) The funds you deposit with a futures commission merchant are
not held by the futures commission merchant in a separate account for
your individual benefit. Futures commission merchants commingle the
funds received from customers in one or more accounts and you may be
exposed to losses incurred by other customers if the futures commission
merchant does not have sufficient capital to cover such other
customers' trading losses.
(6) The funds you deposit with a futures commission merchant may be
invested by the futures commission merchant in certain types of
financial instruments that have been approved by the Commission for the
purpose of such investments. Permitted investments are listed in
Commission Regulation 1.25 and include: U.S. government securities;
municipal securities; money market mutual funds; and certain corporate
notes and bonds. The futures commission merchant may retain the
interest and other earnings realized from its investment of customer
funds. You should be familiar with the types of financial instruments
that a futures commission merchant may invest customer funds in.
(7) Futures commission merchants are permitted to deposit customer
funds with affiliated entities, such as affiliated banks, securities
brokers or dealers, or foreign brokers. You should inquire as to
whether your futures commission merchant deposits funds with affiliates
and assess whether such deposits by the futures commission merchant
with its affiliates increases the risks to your funds.
(8) You should consult your futures commission merchant concerning
the nature of the protections available to safeguard funds or property
deposited for your account.
(9) Under certain market conditions, you may find it difficult or
impossible to liquidate a position. This can occur, for example, when
the market reaches a daily price fluctuation limit (``limit move'').
(10) All futures positions involve risk, and a ``spread'' position
may not be less risky than an outright ``long'' or ``short'' position.
(11) The high degree of leverage (gearing) that is often obtainable
in futures trading because of the small margin requirements can work
against you as well as for you. Leverage (gearing) can lead to large
losses as well as gains.
(12) In addition to the risks noted in the paragraphs enumerated
above, you should be familiar with the futures commission merchant you
select to entrust your funds for trading futures positions. The
Commodity Futures Trading Commission requires each futures commission
merchant to make publicly available on its Web site firm specific
disclosures and financial information to assist you with your
assessment and selection of a futures commission merchant. Information
regarding this futures commission merchant may be obtained by visiting
our Web site, www.[Web site address].

ALL OF THE POINTS NOTED ABOVE APPLY TO ALL FUTURES TRADING WHETHER
FOREIGN OR DOMESTIC. IN ADDITION, IF YOU ARE CONTEMPLATING TRADING
FOREIGN FUTURES OR OPTIONS CONTRACTS, YOU SHOULD BE AWARE OF THE
FOLLOWING ADDITIONAL RISKS:

(13) Foreign futures transactions involve executing and clearing
trades on a foreign exchange. This is the case even if the foreign
exchange is formally ``linked'' to a domestic exchange, whereby a trade
executed on one exchange liquidates or establishes a position on the
other exchange. No domestic organization regulates the activities of a
foreign exchange, including the execution, delivery, and clearing of
transactions on such an exchange, and no domestic regulator has the
power to compel enforcement of the rules of the foreign exchange or the
laws of the foreign country. Moreover, such laws or regulations will
vary depending on the foreign country in which the transaction occurs.
For these reasons, customers who trade on foreign exchanges may not be
afforded certain of the protections which apply to domestic
transactions, including the right to use domestic alternative dispute
resolution procedures. In particular, funds received from customers to
margin foreign futures transactions may not be provided the same
protections as funds received to margin futures transactions on
domestic exchanges. Before you trade, you should familiarize yourself
with the foreign rules which will apply to your particular transaction.
(14) Finally, you should be aware that the price of any foreign
futures or option contract and, therefore, the potential profit and
loss resulting therefrom, may be affected by any fluctuation in the
foreign exchange rate between the time the order is placed and the
foreign futures contract is liquidated or the foreign option contract
is liquidated or exercised.

THIS BRIEF STATEMENT CANNOT, OF COURSE, DISCLOSE ALL THE RISKS AND
OTHER ASPECTS OF THE COMMODITY MARKETS.

I hereby acknowledge that I have received and understood this risk
disclosure statement.
-----------------------------------------------------------------------
Date
-----------------------------------------------------------------------
Signature of Customer
(c) The Commission may approve for use in lieu of the risk
disclosure document required by paragraph (b) of this section a risk
disclosure statement approved by one or more foreign regulatory
agencies or self-regulatory organizations if the Commission determines
that such risk disclosure statement is reasonably calculated to provide
the disclosure required by paragraph (b) of this section. Notice of

[[Page 68644]]

risk disclosure statements that may be used to satisfy Commission
disclosure requirements, what requirements such statements meet and the
jurisdictions which accept each format will be set forth in appendix A
to this section; Provided, however, that an FCM also provides a
customer with the risk disclosure statement required by paragraph (b)
of this section and obtains the customer's acknowledgment that it has
read and understands the disclosure document.
* * * * *
(i) Notwithstanding any other provision of this section, no futures
commission merchant may enter into a customer account agreement or
first accept funds from a customer, unless the futures commission
merchant discloses to the customer all information about the futures
commission merchant, including its business, operations, risk profile,
and affiliates, that would be material to the customer's decision to
entrust such funds to and otherwise do business with the futures
commission merchant and that is otherwise necessary for full and fair
disclosure. In connection with the disclosure of such information, the
futures commission merchant shall provide material information about
the topics described in paragraph (k) of this section, expanding upon
such information as necessary to keep such disclosure from being
misleading, whether through omission or otherwise. The futures
commission merchant shall also disclose the same information required
by this paragraph to all customers existing on the effective date of
this paragraph even if the futures commission merchant and such
existing customers have previously entered into a customer account
agreement or the futures commission merchant has already accepted funds
from such existing customers. The futures commission merchant shall
update the information required by this section as and when necessary,
but at least annually, to keep such information accurate and complete
and shall promptly disclose such updated information to all of its
customers. In connection with such obligation to update information,
the futures commission merchant shall take into account any material
change to its business operation, financial condition and other factors
material to the customer's decision to entrust the customer's funds and
otherwise do business with the futures commission merchant since its
most recent disclosure pursuant to this paragraph, and for this purpose
shall without limitation consider events that require periodic
reporting required to be filed pursuant to Sec. 1.12. For purposes of
this section, the disclosures required pursuant to this paragraph will
be referred to as the ``Disclosure Documents.'' The Disclosure
Documents shall provide a detailed table of contents referencing and
describing the Disclosure Documents.
(j)(1) Each futures commission merchant shall make the Disclosure
Documents available to each customer to whom disclosure is required
pursuant to paragraph (i) of this section (for purposes of this
section, its ``FCM Customers'') and to the general public.
(2) A futures commission merchant shall make the Disclosure
Documents available to FCM Customers and to the general public by
posting a copy of the Disclosure Documents on the futures commission
merchant's Web site. A futures commission merchant, however, may use an
electronic means other than its Web site to make the Disclosure
Documents available to its FCM Customers; provided that:
(i) The electronic version of the Disclosure Documents shall be
presented in a format that is readily communicated to the FCM
Customers. Information is readily communicated to the FCM Customers if
it is accessible to the ordinary computer user by means of commonly
available hardware and software and if the electronically delivered
document is organized in substantially the same manner as would be
required for a paper document with respect to the order of presentation
and the relative prominence of information; and
(ii) A complete paper copy of the Disclosure Documents shall be
provided to an FCM Customer upon request.
(k) Specific topics. The futures commission merchant shall provide
material information about the following specific topics:
(1) The futures commission merchant's name, address of its
principal place of business, phone number, fax number, and email
address;
(2) The name, title, business address, business background, areas
of responsibility, and the nature of the duties of each person that is
defined as a principal of the futures commission merchant pursuant to
Sec. 3.1 of this chapter;
(3) The significant types of business activities and product lines
engaged in by the futures commission merchant, and the approximate
percentage of the futures commission merchant's assets and capital that
are used in each type of activity;
(4) The futures commission merchant's business on behalf of its
customers, including types of customers, markets traded, international
businesses, and clearinghouses and carrying brokers used, and the
futures commission merchant's policies and procedures concerning the
choice of bank depositories, custodians, and counterparties to
permitted transactions under Sec. 1.25;
(5) The material risks, accompanied by an explanation of how such
risks may be material to its customers, of entrusting funds to the
futures commission merchant, including, without limitation, the nature
of investments made by the futures commission merchant (including
credit quality, weighted average maturity, and weighted average
coupon); the futures commission merchant's creditworthiness, leverage,
capital, liquidity, principal liabilities, balance sheet leverage and
other lines of business; risks to the futures commission merchant
created by its affiliates and their activities, including investment of
customer funds in an affiliated entity; and any significant
liabilities, contingent or otherwise, and material commitments;
(6) The name of the futures commission merchant's designated self-
regulatory organization and its Web site address and the location where
the annual audited financial statements of the futures commission
merchant is made available;
(7) Any material administrative, civil, enforcement, or criminal
complaints or actions filed against the FCM where such complaints or
actions have not concluded, and any enforcement complaints or actions
filed against the FCM during the last three years;
(8) A basic overview of customer fund segregation, futures
commission merchant collateral management and investments, futures
commission merchants, and joint futures commission merchant/broker
dealers;
(9) Information on how a customer may obtain information regarding
filing a complaint about the futures commission merchant with the
Commission or with the firm's designated self-regulatory organization;
and
(10) The following financial data as of the most recent month-end
when the Disclosure Document is prepared:
(i) The futures commission merchant's total equity, regulatory
capital, and net worth, all computed in accordance with U.S. Generally
Accepted Accounting Principles and Sec. 1.17, as applicable;

[[Page 68645]]

(ii) The dollar value of the futures commission merchant's
proprietary margin requirements as a percentage of the aggregate margin
requirement for futures customers, Cleared Swaps Customers, and 30.7
customers;
(iii) The smallest number of futures customers, Cleared Swaps
Customers, and 30.7 customers that comprise 50 percent of the futures
commission merchant's total funds held for futures customers, Cleared
Swaps Customers, and 30.7 customers, respectively;
(iv) The aggregate notional value, by asset class, of all non-
hedged, principal over-the-counter transactions into which the futures
commission merchant has entered;
(v) The amount, generic source and purpose of any committed
unsecured lines of credit (or similar short-term funding) the futures
commission merchant has obtained but not yet drawn upon;
(vi) The aggregated amount of financing the futures commission
merchant provides for customer transactions involving illiquid
financial products for which it is difficult to obtain timely and
accurate prices; and
(vii) The percentage of futures customer, Cleared Swaps Customer,
and 30.7 customer receivable balances that the futures commission
merchant had to write-off as uncollectable during the past 12-month
period, as compared to the current balance of funds held for futures
customers, Cleared Swaps Customers, and 30.7 customers; and
(11) A summary of the futures commission merchant's current risk
practices, controls and procedures.
(l) In addition to the foregoing, each futures commission merchant
shall adopt policies and procedures reasonably designed to ensure that
advertising and solicitation activities by each such futures commission
merchant and any introducing brokers associated with such futures
commission merchant are not misleading to its FCM Customers in
connection with their decision to entrust funds to and otherwise do
business with such futures commission merchant.
(m) The Disclosure Document required by paragraph (i) of this
section is in addition to the Risk Disclosure Statement required under
paragraph (a) of this section.
(n) All Disclosure Documents, with each Disclosure Document dated
the date of first use, shall be maintained in accordance with Sec.
1.31 and shall be made available promptly upon request to
representatives of its designated self-regulatory organization,
representatives of the Commission, and representatives of applicable
prudential regulators.
(o)(1) Each futures commission merchant shall make the following
financial information publicly available on its Web site:
(i) The daily Statement of Segregation Requirements and Funds in
Segregation for Customers Trading on U.S. Exchanges for the most
current 12-month period;
(ii) The daily Statement of Secured Amounts and Funds Held in
Separate Accounts for 30.7 Customers Pursuant to Commission Regulation
30.7 for the most current 12-month period;
(iii) The daily Statement of Cleared Swaps Customer Segregation
Requirements and Funds in Cleared Swaps Customer Accounts Under Section
4d(f) of the Act for the most current 12-month period;
(iv) A summary schedule of the futures commission merchant's
adjusted net capital, net capital, and excess net capital, all computed
in accordance with Sec. 1.17 and reflecting balances as of the month-
end for the 12 most recent months;
(v) The Statement of Financial Condition, the Statement of
Segregation Requirements and Funds in Segregation for Customers Trading
on U.S. Exchanges, the Statement of Secured Amounts and Funds Held in
Separate Accounts for 30.7 Customers Pursuant to Commission Regulation
30.7, the Statement of Cleared Swaps Customer Segregation Requirements
and Funds in Cleared Swaps Customer Accounts Under Section 4d(f) of the
Act, an all related footnotes to the above schedules that are part of
the futures commission merchant's most current certified annual report
pursuant to Sec. 1.16; and
(vi) The Statement of Segregation Requirements and Funds in
Segregation for Customers Trading on U.S. Exchanges, the Statement of
Secured Amounts and Funds Held in Separate Accounts for 30.7 Customers
Pursuant to Commission Regulation30.7, and the Statement of Cleared
Swaps Customer Accounts Under Section 4d(f) of the Act that are part of
the futures commission merchant's unaudited Form 1-FR-FCM or Financial
and Operational Combined Uniform Single Report under the Securities
Exchange Act of 1934 (``FOCUS Report'') for the most current 12-month
period.
(2) To the extent any of the financial data identified in paragraph
(1) of this section is amended, the FCM must clearly notate that the
data has been amended.
(3) Each futures commission merchant must include a statement on
its Web site that is available to the public that financial information
regarding the futures commission merchant, including how the futures
commission merchant invests and holds customer funds, may be obtained
from the National Futures Association and include a link to the Web
site of the National Futures Association's Basic System where
information regarding the futures commission merchant's investment of
customer funds is maintained.
(4) Each futures commission merchant must include a statement on
its Web site that is available to the public that additional financial
information on all futures commission merchants is available from the
Commodity Futures Trading Commission, and include a link to the
Commodity Futures Trading Commission's Web page for financial data for
futures commission merchants.

PART 3--REGISTRATION

0
19. The authority citation for part 3 continues to read as follows:

Authority: 5 U.S.C. 552, 552b; 7 U.S.C. 1a, 2, 6a, 6b, 6b-1, 6c,
6d, 6e, 6f, 6g, 6h, 6i, 6k, 6m, 6n, 6o, 6p, 6s, 8, 9, 9a, 12, 12a,
13b, 13c, 16a, 18, 19, 21, 23.

0
20. Amend Sec. 3.3 to revise paragraph (f)(2) to read as follows:

Sec. 3.3 Chief compliance officer.

* * * * *
(f) * * *
(2) The annual report shall be furnished electronically to the
Commission not more than 60 days after the end of the fiscal year of
the futures commission merchant, swap dealer, or major swap
participant, simultaneously with the submission of Form 1-FR-FCM, as
required under Sec. 1.10(b)(2)(ii) of this chapter, simultaneously
with the Financial and Operational Combined Uniform Single Report, as
required under Sec. 1.10(h) of this chapter, or simultaneously with
the financial condition report, as required under section 4s(f) of the
Act, as applicable.
* * * * *

PART 22--CLEARED SWAPS

0
21. The authority citation for part 22 continues to read as follows:

Authority: 7 U.S.C. 1a, 6d, 7a-1 as amended by Pub. L. 111-203,
124 Stat. 1376.

0
22. Amend Sec. 22.2 to:
0
a. Revise paragraphs (d)(1), (e)(1), (f)(2), (f)(4), (f)(5)(iii)(B),
and (g)(2); and
0
c. Add paragraphs (f)(6) and (g)(3) through (g)(10).
The revisions and additions read as follows:

Sec. 22.2 Futures Commission Merchants: Treatment of Cleared Swaps
and Associated Cleared Swaps Customer Collateral.

* * * * *

[[Page 68646]]

(d) Limitations on use. (1) No futures commission merchant shall
use, or permit the use of, the Cleared Swaps Customer Collateral of one
Cleared Swaps Customer to purchase, margin, or settle the Cleared Swaps
or any other trade or contract of, or to secure or extend the credit
of, any person other than such Cleared Swaps Customer. Cleared Swaps
Customer Collateral shall not be used to margin, guarantee, or secure
trades or contracts of the entity constituting a Cleared Swaps Customer
other than in Cleared Swaps, except to the extent permitted by a
Commission rule, regulation or order.
* * * * *
(e) * * *
(1) Permitted investments. A futures commission merchant may invest
money, securities, or other property constituting Cleared Swaps
Customer Collateral in accordance with Sec. 1.25 of this chapter,
which shall apply to such money, securities, or other property as if
they comprised customer funds or customer money subject to segregation
pursuant to section 4d(a) of the Act and the regulations thereunder;
Provided, however, that the futures commission merchant shall bear sole
responsibility for any losses resulting from the investment of customer
funds in instruments described in Sec. 1.25 of this chapter. No
investment losses shall be borne or otherwise allocated to Cleared
Swaps Customers of the futures commission merchant.
* * * * *
(f) * * *
(2) The futures commission merchant must reflect in the account
that it maintains for each Cleared Swaps Customer, the net liquidating
equity for each such Cleared Swaps Customer, calculated as follows: The
market value of any Cleared Swaps Customer Collateral that it receives
from such customer, as adjusted by:
(i) Any uses permitted under paragraph (d) of this section;
(ii) Any accruals on permitted investments of such collateral under
paragraph (e) of this section that, pursuant to the futures commission
merchant's customer agreement with that customer, are creditable to
such customer;
(iii) Any gains and losses with respect to Cleared Swaps;
(iv) Any charges lawfully accruing to the Cleared Swaps Customer,
including any commission, brokerage fee, interest, tax, or storage fee;
and
(v) Any appropriately authorized distribution or transfer of such
collateral.
* * * * *
(4) The futures commission merchant must, at all times, maintain in
segregation, in its FCM Physical Locations and/or its Cleared Swaps
Customer Accounts at Permitted Depositories, an amount equal to the sum
of any credit balances that the Cleared Swaps Customers of the futures
commission merchant have in their accounts. This balance may not be
reduced by any debit balances that the Cleared Swaps Customers of the
futures commission merchants have in their accounts.
(5) * * *
(iii) * * *
(B) Reduce such market value by applicable percentage deductions
(i.e., ``securities haircuts'') as set forth in Rule 15c3-1(c)(2)(vi)
of the Securities and Exchange Commission (Sec. 240.15c3-1(c)(2)(vi)
of this title). Futures commission merchants that establish and enforce
written policies and procedures to assess the credit risk of commercial
paper, convertible debt instruments, or nonconvertible debt instruments
in accordance with Rule 240.15c3-1(c)(2)(vi) of the Securities and
Exchange Commission (Sec. 240.15c3-1(c)(2)(vi) of this title) may
apply the lower haircut percentages specified in Rule 240.15c3-
1(c)(2)(vi) for such commercial paper, convertible debt instruments and
nonconvertible debt instruments. The portion of the debit balance, not
exceeding 100 percent, that is secured by the reduced market value of
such readily marketable securities shall be included in calculating the
sum referred to in paragraph (f)(4) of this section.
(6)(i) The undermargined amount for a Cleared Swaps Customer
Account is the amount, if any, by which:
(A) The total amount of collateral required for that Cleared Swaps
Customer's Cleared Swaps, at the time or times referred to in paragraph
(f)(6)(ii) of this section, exceeds--
(B) The value of the Cleared Swaps Customer Collateral for that
account, as calculated in paragraph (f)(2) of this section.
(ii) Each futures commission merchant must compute, based on the
information available to the futures commission merchant as of the
close of each business day,
(A) The undermargined amounts, based on the clearing initial margin
that will be required to be maintained by that futures commission
merchant for its Cleared Swaps Customers, at each derivatives clearing
organization of which the futures commission merchant is a member, at
the point of the daily settlement (as described in Sec. 39.14 of this
chapter) that will complete during the following business day for each
such derivatives clearing organization less
(B) Any debit balances referred to in paragraph (f)(4) of this
section included in such undermargined amounts.
(iii)(A) Prior to the time of settlement referenced in paragraph
(f)(6)(ii)(A) of this section such futures commission merchant must
maintain residual interest in segregated funds that is equal to or
exceeds the portion of the computation set forth in paragraph
(f)(6)(ii) of this section attributable to the clearing initial margin
required by the derivatives clearing organization making such
settlement.
(B) A futures commission merchant may reduce the amount of residual
interest required in paragraph (f)(6)(iii)(A) of this section to
account for payments received from or on behalf of undermargined
Cleared Swaps Customers (less the sum of any disbursements made to or
on behalf of such customers) between the close of the previous business
day and the time of settlement.
(iv) For purposes of paragraph (f)(6)(ii) of this section, a
Depositing Futures Commission Merchant should include, as clearing
initial margin, customer initial margin that the Depositing Futures
Commission Merchant will be required to maintain, for that Depositing
Futures Commission Merchant's Cleared Swaps Customers, at a Collecting
Futures Commission Merchant, and, for purposes of paragraph (f)(6)(iii)
of this section, must do so prior to the time it must settle with that
Collecting Futures Commission Merchant.
(g) * * *
(2) Each futures commission merchant is required to document its
segregation computation required by paragraph (g)(1) of this section by
preparing a Statement of Cleared Swaps Customer Segregation
Requirements and Funds in Cleared Swaps Customer Accounts Under 4d(f)
of the CEA contained in the Form 1-FR-FCM as of the close of business
each business day.
(3) Each futures commission merchant is required to submit to the
Commission and to the firm's designated self-regulatory organization
the daily Statement of Cleared Swaps Customer Segregation Requirements
and Funds in Cleared Swaps Customer Accounts Under 4d(f) of the CEA
required by paragraph (g)(2) of this section by noon the following
business day.
(4) Each futures commission merchant shall file the Statement of
Cleared Swaps Customer Segregation Requirements and Funds in Cleared
Swaps Customer Accounts Under 4d(f) of the CEA required by paragraph
(g)(2)

[[Page 68647]]

of this section in an electronic format using a form of user
authentication assigned in accordance with procedures established or
approved by the Commission.
(5) Each futures commission merchant is required to submit to the
Commission and to the firm's designated self-regulatory organization a
report listing the names of all banks, trust companies, futures
commission merchants, derivatives clearing organizations, or any other
depository or custodian holding Cleared Swaps Customer Collateral as of
the fifteenth day of the month, or the first business day thereafter,
and the last business day of each month. This report must include:
(i) The name and location of each entity holding Cleared Swaps
Customer Collateral;
(ii) The total amount of Cleared Swaps Customer Collateral held by
each entity listed in paragraph (g)(5) of this section; and
(iii) The total amount of cash and investments that each entity
listed in paragraph (g)(5) of this section holds for the futures
commission merchant. The futures commission merchant must report the
following investments:
(A) Obligations of the United States and obligations fully
guaranteed as to principal and interest by the United States (U.S.
government securities);
(B) General obligations of any State or of any political
subdivision of a State (municipal securities);
(C) General obligation issued by any enterprise sponsored by the
United States (government sponsored enterprise securities);
(D) Certificates of deposit issued by a bank;
(E) Commercial paper fully guaranteed as to principal and interest
by the United States under the Temporary Liquidity Guarantee Program as
administered by the Federal Deposit Insurance Corporation;
(F) Corporate notes or bonds fully guaranteed as to principal and
interest by the United States under the Temporary Liquidity Guarantee
Program as administered by the Federal Deposit Insurance Corporation;
and
(G) Interests in money market mutual funds.
(6) Each futures commission merchant must report the total amount
of customer owned securities held by the futures commission merchant as
Cleared Swaps Customer Collateral and must list the names and locations
of the depositories holding customer owned securities.
(7) Each futures commission merchant must report the total amount
of Cleared Swaps Customer Collateral that has been used to purchase
securities under agreements to resell the securities (reverse
repurchase transactions).
(8) Each futures commission merchant must report which, if any, of
the depositories holding Cleared Swaps Customer Collateral under
paragraph (g)(5) of this section are affiliated with the futures
commission merchant.
(9) Each futures commission merchant shall file the detailed list
of depositories required by paragraph (g)(5) of this section by 11:59
p.m. the next business day in an electronic format using a form of user
authentication assigned in accordance with procedures established or
approved by the Commission.
(10) Each futures commission merchant shall retain its daily
segregation computation and the Statement of Cleared Swaps Customer
Segregation Requirements and Funds in Cleared Swaps Customer Accounts
under section 4d(f) of the CEA required by paragraph (g)(2) of this
section and the detailed listing of depositories required by paragraph
(g)(5) of this section, together with all supporting documentation, in
accordance with Sec. 1.31 of this chapter.

0
23. Add Sec. 22.17 to read as follows:

Sec. 22.17 Policies and procedures governing disbursements of Cleared
Swaps Customer Collateral from Cleared Swaps Customer Accounts.

(a) The provision in section 4d(f)(2) of the Act that prohibits the
commingling of Cleared Swaps Customer Collateral with the funds of a
futures commission merchant, shall not be construed to prevent a
futures commission merchant from having a residual financial interest
in the funds segregated as required by the Act and the regulations in
this part and set apart for the benefit of Cleared Swaps Customers; nor
shall such provisions be construed to prevent a futures commission
merchant from adding to such segregated funds such amount or amounts of
money, from its own funds or unencumbered securities from its own
inventory, of the type set forth in Sec. 1.25 of this chapter, as it
may deem necessary to ensure any and all Cleared Swaps Customer
Accounts are not undersegregated at any time.
(b) A futures commission merchant may not withdraw funds, except
withdrawals that are made to or for the benefit of Cleared Swaps
Customers, from a Cleared Swaps Customer Account unless the futures
commission merchant has prepared the daily segregation calculation
required by Sec. 22.2 as of the close of business on the previous
business day. A futures commission merchant that has completed its
daily segregation calculation may make withdrawals, in addition to
withdrawals that are made to or for the benefit of Cleared Swaps
Customers, to the extent of its actual residual financial interest in
funds held in segregated accounts, including the withdrawal of
securities held in segregated safekeeping accounts held by a bank,
trust company, derivatives clearing organization or other futures
commission merchant. Such withdrawal(s) shall not result in the funds
of one Cleared Swaps Customer being used to purchase, margin or carry
the trades, contracts or swaps positions, or extend the credit of any
other Cleared Swaps Customer or other person.
(c) A futures commission merchant may not withdraw funds, in a
single transaction or a series of transactions, that are not made to or
for the benefit of Cleared Swaps Customers from Cleared Swaps Customer
Accounts if such withdrawal(s) would exceed 25 percent of the futures
commission merchant's residual interest in such accounts as reported on
the daily segregation calculation required by Sec. 22.2 and computed
as of the close of business on the previous business day, unless:
(1) The futures commission merchant's chief executive officer,
chief finance officer or other senior official that is listed as a
principal of the futures commission merchant on its Form 7-R and is
knowledgeable about the futures commission merchant's financial
requirements and financial position pre-approves in writing the
withdrawal, or series of withdrawals;
(2) The futures commission merchant files written notice of the
withdrawal or series of withdrawals, with the Commission and with its
designated self-regulatory organization immediately after the chief
executive officer, chief finance officer or other senior official pre-
approves the withdrawal or series of withdrawals. The written notice
must:
(i) Be signed by the chief executive officer, chief finance officer
or other senior official that pre-approved the withdrawal, and give
notice that the futures commission merchant has withdrawn or intends to
withdraw more than 25 percent of its residual interest in such accounts
holding Cleared Swaps Customer Accounts funds;
(ii) Include a description of the reasons for the withdrawal or
series of withdrawals;
(iii) List the amount of funds provided to each recipient and the
name of each recipient;
(iv) Include the current estimate of the amount of the futures
commission merchant's residual interest in the

[[Page 68648]]

swaps customer funds after the withdrawal;
(v) Contain a representation by the chief executive officer, chief
finance officer or other senior official that pre-approved the
withdrawal, or series of withdrawals, that, after due diligence, to
such person's knowledge and reasonable belief, the futures commission
merchant remains in compliance with the segregation requirements after
the withdrawal. The chief executive officer, chief finance officer or
other senior official must consider the daily segregation calculation
as of the close of business on the previous business day and any other
factors that may cause a material change in the futures commission's
residual interest since the close of business the previous business
day, including known unsecured customer debits or deficits, current day
market activity and any other withdrawals made from the Cleared Swaps
Customer Accounts; and
(vi) Any such written notice filed with the Commission must be
filed via electronic transmission using a form of user authentication
assigned in accordance with procedures established by or approved by
the Commission, and otherwise in accordance with instruction issued by
or approved by the Commission. Any such electronic submission must
clearly indicate the registrant on whose behalf such filing is made and
the use of such user authentication in submitting such filing will
constitute and become a substitute for the manual signature of the
authorized signer. Any written notice filed must be followed up with
direct communication to the Regional office of Commission which has
supervisory authority over the futures commission merchant whereby the
Commission acknowledges receipt of the notice; and
(3) After making a withdrawal requiring the approval and notice
required in paragraphs (c)(1) and (c)(2) of this section, and before
the next daily segregated funds calculation, no futures commission
merchant may make any further withdrawals from accounts holding Cleared
Swaps Customer Account funds, except to or for the benefit of Cleared
Swaps Customers, without complying with paragraph (c)(1) of this
section and filing a written notice with the Commission under paragraph
(c)(2)(vi) of this section and its designated self-regulatory
organization signed by the chief executive officer, chief finance
officer, or other senior official. The written notice must:
(i) List the amount of funds provided to each recipient and each
recipient's name;
(ii) Disclose the reason for each withdrawal;
(iii) Confirm that the chief executive officer, chief finance
officer, or other senior official (and identify of the person if
different from the person who signed the notice) pre-approved the
withdrawal in writing;
(iv) Disclose the current estimate of the futures commission
merchant's remaining total residual interest in the segregated accounts
holding Cleared Swaps Customer Account funds after the withdrawal; and
(v) Include a representation that to the best of the notice
signatory's knowledge and reasonable belief the futures commission
merchant remains in compliance with the segregation requirements after
the withdrawal.
(d) If a futures commission merchant withdraws funds that are not
for the benefit of Cleared Swaps Customers from Cleared Swaps Customer
Accounts, and the withdrawal causes the futures commission merchant to
not hold sufficient funds in Cleared Swaps Customer Accounts to meet
its targeted residual interest, as required to be computed under Sec.
1.11 of this chapter, the futures commission merchant must deposit its
own funds into the Cleared Swaps Customer Accounts to restore the
targeted amount of residual interest on the next business day, or, if
appropriate, revise the futures commission merchant's targeted amount
of residual interest pursuant to the policies and procedures required
by Sec. 1.11 of this chapter. Notwithstanding the foregoing, if the
futures commission merchant's residual interest in Cleared Swaps
Customer Accounts is less than the amount required to be maintained by
Sec. 22.2 at any particular point in time, the futures commission
merchant must immediately restore the residual interest to exceed the
sum of such amounts. Any proprietary funds deposited in Cleared Swaps
Customer Accounts must be unencumbered and otherwise compliant with
Sec. 1.25 of this chapter, as applicable.
(e) Notwithstanding any other provision of this part, a futures
commission merchant may not withdraw funds that are not for the benefit
of Cleared Swaps Customers from a Cleared Swaps Customer Account unless
the futures commission merchant follows its policies and procedures
required by Sec. 1.11 of this chapter.

PART 30--FOREIGN FUTURES AND FOREIGN OPTIONS TRANSACTIONS

0
24. The authority citation for part 30 continues to read as follows:

Authority: 7 U.S.C. 1a, 2, 6, 6c, and 12a, unless otherwise
noted.

0
25. Amend Sec. 30.1 to add paragraphs (f), (g), and (h) to read as
follows:

Sec. 30.1 Definitions.

* * * * *
(f) 30.7 customer means any foreign futures or foreign options
customer as defined in paragraph (c) of this section as well as any
foreign-domiciled person who trades in foreign futures or foreign
options through a futures commission merchant; Provided, however, that
an owner or holder of a proprietary account as defined in Sec. 1.3(y)
of this chapter shall not be deemed to be a 30.7 customer.
(g) 30.7 account means any account maintained by a futures
commission merchant for or on behalf of 30.7 customers to hold money,
securities, or other property to margin, guarantee, or secure foreign
futures or foreign option positions.
(h) 30.7 customer funds means any money, securities, or other
property received by a futures commission merchant from, for, or on
behalf of 30.7 customers to margin, guarantee, or secure foreign
futures or foreign option positions, or money, securities, or other
property accruing to 30.7 customers as a result of foreign futures and
foreign option positions.

0
26. Revise Sec. 30.7 to read as follows:

Sec. 30.7 Treatment of foreign futures or foreign options secured
amount.

(a) General. Except as provided in this section, a futures
commission merchant must at all times maintain in a separate account or
accounts money, securities and property in an amount at least
sufficient to cover or satisfy all of its obligations to 30.7 customers
denominated as the foreign futures or foreign options secured amount.
In computing the foreign futures or foreign options secured amount, a
futures commission merchant may offset any net deficit in a particular
30.7 customer's account against the current market value of readily
marketable securities held for the same particular 30.7 customer's
account as provided for in paragraph (l) of this section. The amount
that must be deposited in such separate account or accounts for 30.7
customers must be no less than the amount required to be held in a
separate account or accounts for or on behalf of 30.7 customers
pursuant to any law, or rule, regulation or order thereunder, or any
rule of any self-regulatory organization authorized thereunder, in the
jurisdiction in which the depository or the 30.7 customer, as
appropriate, is located.

[[Page 68649]]

(b) Location of 30.7 customer funds. A futures commission merchant
shall deposit the foreign futures or foreign options secured amount
under an account name that clearly identifies the funds as belonging to
30.7 customers and shows that the foreign futures or foreign options
secured amount is set aside as required by this part. A futures
commission merchant may deposit funds set aside as the foreign futures
or foreign options secured amount with the following depositories:
(1) A bank or trust company located in the United States;
(2) A bank or trust company located outside the United States that
has in excess of $1 billion of regulatory capital;
(3) A futures commission merchant registered as such with the
Commission;
(4) A derivatives clearing organization;
(5) The clearing organization of any foreign board of trade;
(6) A member of any foreign board of trade; or
(7) Such member's or clearing organization's designated
depositories.
(c) Limitation on holding foreign futures or foreign options
secured amount outside of the United States. A futures commission
merchant may not deposit or hold the foreign futures or foreign options
secured amount in accounts maintained outside of the United States with
any of the depositories listed in paragraph (b) of this section except
to meet margin requirements, including prefunding margin requirements,
established by rule, regulation, or order of foreign boards of trade or
foreign clearing organizations, or to meet margin calls issued by
foreign brokers carrying the 30.7 customers' foreign futures and
foreign option positions; Provided, however, that a futures commission
merchant may deposit an additional amount of up to 20 percent of the
total amount of funds necessary to meet margin and prefunding margin
requirements to avoid daily transfers of funds between the futures
commission merchant's 30.7 accounts maintained in the United States and
those maintained outside of the United States. A futures commission
merchant must deposit 30.7 customer funds under the laws and
regulations of the foreign jurisdiction that provide the greatest
degree of protection to such funds. A futures commission merchant may
not by contract or otherwise waive any of the protections afforded
customer funds under the laws of the foreign jurisdiction.
(d) Written acknowledgment from depositories. (1) A futures
commission merchant must obtain a written acknowledgment from each
depository prior to or contemporaneously with the opening of an account
by the futures commission merchant with such depository.
(2) The written acknowledgment must be in the form as set out in
appendix E to this part; Provided, however, that if the futures
commission merchant invests funds set aside as the foreign futures or
foreign options secured amount in money market mutual funds as a
permitted investment under paragraph (h) of this section and in
accordance with the terms and conditions of Sec. 1.25(c) of this
chapter, the written acknowledgment with respect to such investment
must be in the form as set out in appendix F to this part.
(3)(i) A futures commission merchant shall deposit 30.7 customer
funds only with a depository that agrees to provide the director of the
Division of Swap Dealer and Intermediary Oversight, or any successor
division, or such director's designees, with direct, read-only
electronic access to transaction and account balance information for
30.7 customer accounts.
(ii) The written acknowledgment must contain the futures commission
merchant's authorization to the depository to provide direct, read-only
electronic access to 30.7 customer account transaction and account
balance information to the director of the Division of Swap Dealer and
Intermediary Oversight, or any successor division, or such director's
designees, without further notice to or consent from the futures
commission merchant.
(4) A futures commission merchant shall deposit 30.7 customer funds
only with a depository that agrees to provide the Commission and the
futures commission merchant's designated self-regulatory organization
with a copy of the executed written acknowledgment no later than three
business days after the opening of the account or the execution of a
new written acknowledgment for an existing account, as applicable. The
Commission must receive the written acknowledgment from the depository
via electronic means, in a format and manner determined by the
Commission. The written acknowledgment must contain the futures
commission merchant's authorization to the depository to provide the
written acknowledgment to the Commission and to the futures commission
merchant's designated self-regulatory organization without further
notice to or consent from the futures commission merchant.
(5) A futures commission merchant shall deposit 30.7 customer funds
only with a depository that agrees that accounts containing 30.7
customer funds may be examined at any reasonable time by the director
of the Division of Swap Dealer and Intermediary Oversight or the
director of the Division of Clearing and Risk, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent or employee of the futures commission merchant's designated self-
regulatory organization. The written acknowledgment must contain the
futures commission merchant's authorization to the depository to permit
any such examination to take place without further notice to or consent
from the futures commission merchant.
(6) A futures commission merchant shall deposit 30.7 customer funds
only with a depository that agrees to reply promptly and directly to
any request from the director of the Division of Swap Dealer and
Intermediary Oversight or the director of the Division of Clearing and
Risk, or any successor divisions, or such directors' designees, or an
appropriate officer, agent or employee of the futures commission
merchant's designated self-regulatory organization for confirmation of
account balances or provision of any other information regarding or
related to an account. The written acknowledgment must contain the
futures commission merchant's authorization to the depository to reply
promptly and directly as required by this paragraph without further
notice to or consent from the futures commission merchant.
(7) A futures commission merchant shall promptly file a copy of the
written acknowledgment with the Commission in the format and manner
specified by the Commission no later than three business days after the
opening of the account or the execution of a new written acknowledgment
for an existing account, as applicable.
(8) A futures commission merchant shall obtain a new written
acknowledgment within 120 days of any changes in the following:
(i) The name or business address of the futures commission
merchant;
(ii) The name or business address of the depository; or
(iii) The account number(s) under which the foreign futures or
foreign options secured amount are held.
(9) A futures commission merchant shall maintain each written
acknowledgment readily accessible in its files in accordance with Sec.
1.31 of this chapter, for as long as the account remains open, and
thereafter for the

[[Page 68650]]

period provided in Sec. 1.31 of this chapter.
(e) Commingling. (1) A futures commission merchant may commingle
the funds set aside as the foreign futures or foreign options secured
amount that it receives from, or on behalf of, multiple 30.7 customers
in a single account or multiple accounts with one or more of the
depositories listed in paragraph (b) of this section.
(2) A futures commission merchant may not commingle the funds set
aside as the foreign futures or foreign options secured amount held for
30.7 customers with the money, securities or property of such futures
commission merchant, with any proprietary account of such futures
commission merchant, or use such funds to secure or guarantee the
obligations of, or extend credit to, such futures commission merchant
or any proprietary account of such futures commission merchant;
Provided, however, a futures commission merchant may deposit
proprietary funds into 30.7 customer accounts as permitted under
paragraph (g) of this section.
(3) A futures commission merchant may not commingle 30.7 customer
funds with funds deposited by futures customers as defined in Sec. 1.3
of this chapter and held in segregated accounts pursuant to section
4d(a) and 4d(b) of the Act or with funds deposited by Cleared Swap
Customers as defined in Sec. 22.1 of this chapter and held in
segregated accounts pursuant to section 4d(f) of the Act, or with funds
of any account holders of the futures commission merchant unrelated to
trading foreign futures or foreign options; Provided, however, that a
futures commission merchant may commingle 30.7 customer funds with
funds deposited by futures customers or Cleared Swaps Customers
pursuant to the terms of a Commission regulation or order authorizing
such commingling.
(f) Limitations on use of 30.7 customer funds. (1)(i) A futures
commission merchant shall not use, or permit the use of, the funds of
one 30.7 customer to purchase, margin or settle the trades, contracts,
or commodity options of, or to secure or extend credit to, any person
other than such 30.7 customer.
(ii)(A) The undermargined amount for a 30.7 customer's account is
the amount, if any, by which
(1) The total amount of collateral required for that 30.7
customer's positions in that account, at the time or times referred to
in paragraph (f)(1)(ii)(B) of this section, exceeds
(2) The value of the 30.7 customer funds for that account, as
calculated in paragraph (f)(2)(ii) of this section.
(B) Each futures commission merchant must compute, based on the
information available to the futures commission merchant as of the
close of each business day,
(1) The undermargined amounts, based on the clearing initial margin
that will be required to be maintained by that futures commission
merchant for its 30.7 customers, at each clearing organization of which
the futures commission merchant is a member, at 6:00 p.m. Eastern on
the following business day for each such clearing organization less
(2) Any debit balances referred to in paragraph (f)(2)(iv) of this
section included in such undermargined amounts.
(C)(1) Prior to 6:00 p.m. Eastern Time on the date of the
settlement referenced in paragraph (f)(1)(ii)(B)(1) of this section,
such futures commission merchant must maintain residual interest in
segregated funds that is at least equal to the computation set forth in
paragraph (f)(1)(ii)(B) of this section.
(2) A futures commission merchant may reduce the amount of residual
interest required in paragraph (f)(1)(ii)(C)(1) of this section to
account for payments received from or on behalf of undermargined 30.7
customers (less the sum of any disbursements made to or on behalf of
such customers) between the close of the previous business day and 6:00
p.m. Eastern Time on the following business day.
(D) For purposes of paragraph (f)(1)(ii)(B) of this section, a
futures commission merchant should include, as clearing initial margin,
customer initial margin that the futures commission merchant will be
required to maintain, for that futures commission merchant's 30.7
customers, at a foreign broker, and, for purposes of paragraph
(f)(1)(ii)(C) of this section, must do so prior to 6:00 p.m. Eastern
Time on the date referenced in paragraph (f)(1)(ii)(B)(1) of this
section.
(2) Requirements as to amount. (i) For purposes of this paragraph
(f)(2), the term ``account'' shall mean the entries on the books and
records of a futures commission merchant pertaining to the 30.7
customer funds of a particular 30.7 customer.
(ii) The futures commission merchant must reflect in the account
that it maintains for each 30.7 customer the net liquidating equity for
each such customer, calculated as follows: The market value of any 30.7
customer funds it receives from such customer, as adjusted by:
(A) Any uses permitted under paragraph (e) of this section;
(B) Any accruals on permitted investments of such collateral under
Sec. 1.25 of this chapter that, pursuant to the futures commission
merchant's customer agreement with that customer, are creditable to
such customer;
(C) Any gains and losses with respect to contracts for the purchase
or sale of foreign futures or foreign option positions;
(D) Any charges lawfully accruing to the 30.7 customer, including
any commission, brokerage fee, interest, tax, or storage fee; and
(E) Any appropriately authorized distribution or transfer of such
collateral.
(iii) If the market value of 30.7 customer funds in the account of
a 30.7 customer is positive after adjustments, then that account has a
credit balance. If the market value of 30.7 customer funds in the
account of a 30.7 customer is negative after adjustments, then that
account has a debit balance.
(iv) The futures commission merchant must maintain in segregation
an amount equal to the sum of any credit balances that 30.7 customers
of the futures commission merchant have in their accounts. This balance
may not be reduced by any debit balances that the 30.7 customers of the
futures commission merchants have in their accounts.
(3) A futures commission merchant may not impose or permit the
imposition of a lien on any funds set aside as the foreign futures or
foreign options secured amount, including any residual financial
interest of the futures commission merchant in such funds.
(4) A futures commission merchant may not include in funds set
aside as the foreign futures or foreign options secured amount any
money invested in securities, memberships, or obligations of any
clearing organization or board of trade. A futures commission merchant
may not include in funds set aside as the foreign futures or foreign
options secured amount any other money, securities, or property held by
a member of a foreign board of trade, board of trade, or clearing
organization, except if the funds are deposited to margin, secure, or
guarantee 30.7 customers' foreign futures or foreign options positions
and the futures commission merchant obtains the written acknowledgment
from the member of the foreign board of trade, board of trade, or
clearing organization as required by paragraph (d) of this section.
(g) Futures commission merchant's residual financial interest and
withdrawal of funds. (1) The provision in paragraph (e) of this
section, which

[[Page 68651]]

prohibits the commingling of funds set aside as the foreign futures or
foreign options secured amount with the funds of a futures commission
merchant, shall not be construed to prevent a futures commission
merchant from having a residual financial interest in the funds set
aside as required by the regulations in this part for the benefit of
30.7 customers; nor shall such provisions be construed to prevent a
futures commission merchant from adding to such set aside funds such
amount or amounts of money, from its own funds or unencumbered
securities from its own inventory, of the type set forth in Sec. 1.25
of this chapter, as it may deem necessary to ensure any and all 30.7
accounts from becoming undersecured at any time.
(2) A futures commission merchant may not withdraw funds, except
withdrawals that are made to or for the benefit of 30.7 customers, from
an account or accounts holding the foreign futures and foreign options
secured amount unless the futures commission merchant has prepared the
daily 30.7 calculation required by paragraph (l) of this section as of
the close of business on the previous business day. A futures
commission merchant that has completed its daily 30.7 calculation may
make withdrawals, in addition to withdrawals that are made to or for
the benefit of 30.7 customers, to the extent of its actual residual
financial interest in funds held in 30.7 accounts, including the
withdrawal of securities held in secured amount safekeeping accounts
held by a bank, trust company, contract market, clearing organization,
member of a foreign board of trade, or other futures commission
merchant. Such withdrawal(s) shall not result in the funds of one 30.7
customer being used to purchase, margin or guarantee the foreign
futures or foreign options positions, or extend the credit of any other
30.7 customer or other person.
(3) A futures commission merchant may not withdraw funds, in a
single transaction or a series of transactions, that are not made for
the benefit of 30.7 customers from an account or accounts holding 30.7
customer funds if such withdrawal(s) would exceed 25 percent of the
futures commission merchant's residual interest in such accounts as
reported on the daily secured amount calculation required by paragraph
(l) of this section and computed as of the close of business on the
previous business day, unless the futures commission merchant's chief
executive officer, chief finance officer or other senior official that
is listed as a principal of the futures commission merchant on its Form
7-R and is knowledgeable about the futures commission merchant's
financial requirements and financial position pre-approves in writing
the withdrawal, or series of withdrawals.
(4) A futures commission merchant must file written notice of the
withdrawal or series of withdrawals that exceed 25 percent of the
futures commission merchant's residual interest in 30.7 customer funds
as computed under paragraph (h)(2) of this section with the Commission
and with its designated self-regulatory organization immediately after
the chief executive officer, chief finance officer or other senior
official as described in paragraph (g)(2) of this section pre-approves
the withdrawal or series of withdrawals. The written notice must:
(i) Be signed by the chief executive officer, chief finance officer
or other senior official that pre-approved the withdrawal, and give
notice that the futures commission merchant has withdrawn or intends to
withdraw more than 25 percent of its residual interest in accounts
holding 30.7 customer funds;
(ii) Include a description of the reasons for the withdrawal or
series of withdrawals;
(iii) List the amount of funds provided to each recipient and the
name of each recipient;
(iv) Include the current estimate of the amount of the futures
commission merchant's residual interest in the 30.7 customer funds
after the withdrawal;
(v) Contain a representation by the chief executive officer, chief
finance officer or other senior official as described in paragraph
(g)(3) of this section that pre-approved the withdrawal, or series of
withdrawals, that to such person's knowledge and reasonable belief, the
futures commission merchant remains in compliance with the secured
amount requirements after the withdrawal. The chief executive officer,
chief finance officer or other appropriate senior official as described
in paragraph (g)(2) of this section must consider the daily 30.7
calculation as of the close of business on the previous business day
and any other factors that may cause a material change in the futures
commission's residual interest since the close of business the previous
business day, including known unsecured customer debits or deficits,
current day market activity and any other withdrawals made from the
30.7 customer accounts; and
(vi) Any such written notice filed with the Commission must be
filed via electronic transmission using a form of user authentication
assigned in accordance with procedures established by or approved by
the Commission, and otherwise in accordance with instruction issued by
or approved by the Commission. Any such electronic submission must
clearly indicate the registrant on whose behalf such filing is made and
the use of such user authentication in submitting such filing will
constitute and become a substitute for the manual signature of the
authorized signer. Any written notice filed must be followed up with
direct communication to the regional office of Commission which has
supervisory authority over the futures commission merchant whereby the
Commission acknowledges receipt of the notice.
(5) After making a withdrawal requiring the approval and notice
required in paragraphs (c)(1) and (c)(2) of this section, and before
the next daily secured amount calculation, no futures commission
merchant may make any further withdrawals from accounts holding 30.7
customer funds, except to or for the benefit of 30.7 customers,
without, for each withdrawal, obtaining the approval required under
paragraph (c)(1) of this section and filing a written notice with the
Commission under paragraph (g)(4)(vi) of this section and its
designated self-regulatory organization signed by the chief executive
officer, chief finance officer, or other senior official. The written
notice must:
(i) List the amount of funds provided to each recipient and each
recipient's name;
(ii) Disclose the reason for each withdrawal;
(iii) Confirm that the chief executive officer, chief finance
officer, or other senior official (and the identity of the person if
different from the person who signed the notice) pre-approved the
withdrawal in writing;
(iv) Disclose the current estimate of the futures commission
merchant's remaining total residual interest in the secured accounts
holding 30.7 customer funds after the withdrawal; and
(v) Include a representation that to the best of the notice
signatory's knowledge and reasonable belief the futures commission
merchant remains in compliance with the secured amount requirements
after the withdrawal.
(6) If a futures commission merchant withdraws funds that are not
for the benefit of 30.7 customers from the separate accounts holding
30.7 customer funds, and the withdrawal causes the futures commission
merchant to not hold sufficient funds in the separate accounts for the
benefit of the 30.7 customers to meet its targeted residual interest,
as required to be computed

[[Page 68652]]

under Sec. 1.11 of this chapter, the futures commission merchant must
deposit its own funds into the separate accounts for the benefit of
30.7 customers to restore the account balance to the targeted residual
interest amount on the next business day, or, if appropriate, revise
the futures commission merchant's targeted amount of residual interest
pursuant to the policies and procedures required by Sec. 1.11 of this
chapter. Notwithstanding the foregoing, if the futures commission
merchant's residual interest in separate accounts for the benefit of
30.7 customers is less than the amount required to be maintained by
paragraph (f) of this section at any particular point in time, the
futures commission merchant must immediately restore the residual
interest to exceed the sum of such amounts. Any proprietary funds
deposited in the 30.7 customer accounts must be unencumbered and
otherwise compliant with Sec. 1.25 of this chapter, as applicable.
(7) Notwithstanding any other provision of this part, a futures
commission merchant may not withdraw funds from 30.7 accounts, except
withdrawals that are made for the benefit of 30.7 customers, unless the
futures commission merchant follows its policies and procedures
required by Sec. 1.11 of this chapter.
(h) Permitted investments and deposits of 30.7 customer funds. (1)
A futures commission merchant may invest 30.7 customer funds subject
to, and in compliance with, the terms and conditions of Sec. 1.25 of
this chapter. Regulation 1.25 of this chapter shall apply to the
investment of 30.7 customer funds as if such funds comprised customer
funds or customer money subject to segregation pursuant to section 4d
of the Act and the regulations thereunder.
(2) Each futures commission merchant that invests money, securities
or property on behalf of 30.7 customers must keep a record showing the
following:
(i) The date on which such investments were made;
(ii) The name of the person through whom such investments were
made;
(iii) The amount of money or current market value of securities so
invested;
(iv) A description of the obligations in which such investments
were made, including CUSIP or ISIN numbers;
(v) The identity of the depositories or other places where such
investments are maintained;
(vi) The date on which such investments were liquidated or
otherwise disposed of and the amount of money received or current
market value of securities received as a result of such disposition;
(vii) The name of the person to or through whom such investments
were disposed of; and
(viii) A daily valuation for each instrument and readily available
documentation supporting the daily valuation for each instrument. Such
supporting documentation must be sufficient to enable third parties to
verify the valuations and the accuracy of any information from external
sources used in those valuations.
(3) Any 30.7 customer funds deposited in a bank or trust company
located in the United States or in a foreign jurisdiction must be
available for immediate withdrawal upon the demand of the futures
commission merchant.
(4) Futures commission merchants that invest 30.7 customer funds in
instruments described in Sec. 1.25 of this chapter shall include such
instruments in the computation of its secured amount requirements,
required under paragraph (l) of this section, at values that at no time
exceed current market value, determined as of the close of the market
on the date for which such computation is made.
(i) Responsibility for Sec. 1.25 investment losses. A futures
commission merchant shall bear sole financial responsibility for any
losses resulting from the investment of 30.7 customer funds in
instruments described in Sec. 1.25 of this chapter. No investment
losses shall be borne or otherwise allocated to the 30.7 customers of
the futures commission merchant.
(j) Loans by futures commission merchants; treatment of proceeds. A
futures commission merchant may lend its own funds to 30.7 customers on
securities and property pledged, or from repledging or selling such
securities and property pursuant to specific written agreement with
such 30.7 customers. The proceeds of such loans used to purchase,
margin, guarantee, or secure the trades, contracts, or commodity
options of 30.7 customers shall be treated and dealt with by a futures
commission merchant as belonging to such 30.7 customers. A futures
commission merchant may not loan funds on an unsecured basis to finance
a 30.7 customer's foreign futures and foreign options trading, nor may
a futures commission merchant loan funds to a 30.7 customer secured by
the 30.7 customer's trading account.
(k) Permitted withdrawals. A futures commission merchant may
withdraw funds from 30.7 customer accounts in an amount necessary in
the normal course of business to margin, guarantee, secure, transfer,
or settle 30.7 customers' foreign futures or foreign option positions
with a foreign broker or clearing organization. A futures commission
merchant also may withdraw funds from 30.7 customer accounts to pay
commissions, brokerage, interest, taxes, storage, and other charges
lawfully accruing in connection with the 30.7 customers' foreign
futures and foreign options positions.
(l) Daily computation of 30.7 customer secured amount requirement
and details regarding the holding and investing of 30.7 customer funds.
(1) Each futures commission merchant is required to prepare a Statement
of Secured Amounts and Funds Held in Separate Accounts for 30.7
Customers Pursuant to Commission Regulation 30.7 contained in the Form
1-FR-FCM as of the close of each business day. Futures commission
merchants that invest funds set aside as the foreign futures or foreign
options secured amount in instruments described in Sec. 1.25 of this
chapter shall include such instruments in the computation of its
secured amount requirements at values that at no time exceed current
market value, determined as of the close of the market on the date for
which such computation is made. Nothing in this paragraph shall affect
the requirement that a futures commission merchant at all times
maintain sufficient money, securities and property to cover its total
obligations to all 30.7 customers, in accordance with paragraph (a) of
this section.
(2) A futures commission merchant may offset any net deficit in a
particular 30.7 customer's account against the current market value of
readily marketable securities, less deductions (i.e., ``securities
haircuts'') as set forth in Rule 15c3-1(c)(2)(vi) of the Securities and
Exchange Commission (17 CFR 240.15c3-1(c)(2)(vi)), held for the same
particular 30.7 customer's account in computing the daily Foreign
Futures and Foreign Options Secured Amount. Futures commission
merchants that establish and enforce written policies and procedures to
assess the credit risk of commercial paper, convertible debt
instruments, or nonconvertible debt instruments in accordance with Rule
240.15c3-1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR
240.15c3-1(c)(2)(vi)) may apply the lower haircut percentages specified
in Rule 240.15c3-1(c)(2)(vi) for such commercial paper, convertible
debt instruments and nonconvertible debt instruments. The futures
commission merchant must maintain a security interest in the
securities, including a

[[Page 68653]]

written authorization to liquidate the securities at the futures
commission merchant's discretion, and must set aside the securities in
a safekeeping account compliant with paragraph (c) of this section. For
purposes of this section, a security will be considered ``readily
marketable'' if it is traded on a ``ready market'' as defined in Rule
15c3-1(c)(11)(i) of the Securities and Exchange Commission (17 CFR
240.15c3-1(c)(11)(i)).
(3) Each futures commission merchant is required to submit to the
Commission and to the firm's designated self-regulatory organization
the daily Statement of Secured Amounts and Funds Held in Separate
Accounts for 30.7 Customers pursuant to Commission Regulation 30.7
required by paragraph (l)(1) of this section by noon the following
business day.
(4) Each futures commission merchant shall file the Statement of
Secured Amounts and Funds Held in Separate Accounts for 30.7 Customers
pursuant to Commission Regulation 30.7 required by paragraph (l)(1) of
this section in an electronic format using a form of user
authentication assigned in accordance with procedures established or
approved by the Commission.
(5) Each futures commission merchant is required to submit to the
Commission and to the firm's designated self-regulatory organization a
report listing the names of all banks, trust companies, futures
commission merchants, derivatives clearing organizations, foreign
brokers, foreign clearing organizations, or any other depository or
custodian holding 30.7 customer funds as of the fifteenth day of the
month, or the first business day thereafter, and the last business day
of each month. This report must include:
(i) The name and location of each depository holding 30.7 customer
funds;
(ii) The total amount of 30.7 customer funds held by each
depository listed in paragraph (l)(5) of this section; and
(iii) The total amount of cash and investments that each depository
listed in paragraph (l)(5) of this section holds for the futures
commission merchant. The futures commission merchant must report the
following investments:
(A) Obligations of the United States and obligations fully
guaranteed as to principal and interest by the United States (U.S.
government securities);
(B) General obligations of any State or of any political
subdivision of a State (municipal securities);
(C) General obligation issued by any enterprise sponsored by the
United States (government sponsored enterprise securities);
(D) Certificates of deposit issued by a bank;
(E) Commercial paper fully guaranteed as to principal and interest
by the United States under the Temporary Liquidity Guarantee Program as
administered by the Federal Deposit Insurance Corporation;
(F) Corporate notes or bonds fully guaranteed as to principal and
interest by the United States under the Temporary Liquidity Guarantee
Program as administered by the Federal Deposit Insurance Corporation;
and
(G) Interests in money market mutual funds.
(6) Each futures commission merchant must report the total amount
of customer-owned securities held by the futures commission merchant as
30.7 customer funds and must list the names and locations of the
depositories holding customer-owned securities.
(7) Each futures commission merchant must report the total amount
of 30.7 customer funds that have been used to purchase securities under
agreements to resell the securities (reverse repurchase transactions).
(8) Each futures commission merchant must report which, if any, of
the depositories holding 30.7 customer funds under paragraph (l)(5) of
this section are affiliated with the futures commission merchant.
(9) Each futures commission merchant shall file the detailed list
of depositories required by paragraph (l)(5) of this section by 11:59
p.m. the next business day in an electronic format using a form of user
authentication assigned in accordance with procedures established or
approved by the Commission.
(10) Each futures commission merchant shall retain its daily
secured amount computation, the Statement of Secured Amounts and Funds
Held in Separate Accounts for 30.7 Customers pursuant to Commission
Regulation 30.7 required by paragraph (l)(1) of this section, and the
detailed list of depositories required by paragraph (l)(5) of this
section, together with all supporting documentation, in accordance with
the requirements of Sec. 1.31 of this chapter.

0
27. Add appendix E to part 30 to read as follows:

Appendix E to Part 30--Acknowledgment Letter for CFTC Regulation 30.7
Customer Secured Account

[Date]
[Name and Address of Depository]

We refer to the Secured Amount Account(s) which [Name of Futures
Commission Merchant] (``we'' or ``our'') have opened or will open
with [Name of Depository] (``you'' or ``your'') entitled:

[Name of Futures Commission Merchant] [if applicable, add ``FCM
Customer Omnibus Account''] CFTC Regulation 30.7 Customer Secured
Account under Section 4(b) of the Commodity Exchange Act [and, if
applicable, ``, Abbreviated as [short title reflected in the
depository's electronic system]'']
Account Number(s): [ ]
(collectively, the ``Account(s)'').
You acknowledge that we have opened or will open the above-
referenced Account(s) for the purpose of depositing, as applicable,
money, securities and other property (collectively ``Funds'') of
customers who trade foreign futures and/or foreign options (as such
terms are defined in U.S. Commodity Futures Trading Commission
(``CFTC'') Regulation 30.1, as amended); that the Funds held by you,
hereafter deposited in the Account(s) or accruing to the credit of
the Account(s), will be kept separate and apart and separately
accounted for on your books from our own funds and from any other
funds or accounts held by us, in accordance with the provisions of
the Commodity Exchange Act, as amended (the ``Act''), and Part 30 of
the CFTC's regulations, as amended; that the Funds may not be
commingled with our own funds in any proprietary account we maintain
with you; and that the Funds must otherwise be treated in accordance
with the provisions of Section 4(b) of the Act and CFTC Regulation
30.7.
Furthermore, you acknowledge and agree that such Funds may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, and they may not be used by us to secure or
obtain credit from you. You further acknowledge and agree that the
Funds in the Account(s) shall not be subject to any right of offset
or lien for or on account of any indebtedness, obligations or
liabilities we may now or in the future have owing to you. This
prohibition does not affect your right to recover funds advanced in
the form of cash transfers, lines or credit, repurchase agreements
or other similar liquidity arrangements you make in lieu of
liquidating non-cash assets held in the Account(s) or in lieu of
converting cash held in the Account(s) to cash in a different
currency.
In addition, you agree that the Account(s) may be examined at
any reasonable time by the director of the Division of Swap Dealer
and Intermediary Oversight of the CFTC or the director of the
Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent or employee of our designated self-regulatory organization
(``DSRO''), [Name of DSRO], and this letter constitutes the
authorization and direction of the undersigned on our behalf to
permit any such examination to take place without further notice or
consent from us.
You agree to reply promptly and directly to any request for
confirmation of account balances or provision of any other
information regarding or related to the Account(s) from the director
of the Division of Swap Dealer and Intermediary Oversight of the
CFTC or the director of the Division

[[Page 68654]]

of Clearing and Risk of the CFTC, or any successor divisions, or
such directors' designees, or an appropriate officer, agent, or
employee of [Name of DSRO], acting in its capacity as our DSRO, and
this letter constitutes the authorization and direction of the
undersigned on our behalf to release the requested information
without further notice to or consent from us.
You further acknowledge and agree that, pursuant to
authorization granted by us to you previously or herein, you have
provided, or will promptly provide following the opening of the
Account(s), the director of the Division of Swap Dealer and
Intermediary Oversight of the CFTC, or any successor division, or
such director's designees, with technological connectivity, which
may include provision of hardware, software, and related technology
and protocol support, to facilitate direct, read-only electronic
access to transaction and account balance information for the
Account(s). This letter constitutes the authorization and direction
of the undersigned on our behalf for you to establish this
connectivity and access if not previously established, without
further notice to or consent from us.
The parties agree that all actions on your part to respond to
the above information and access requests will be made in accordance
with, and subject to, such usual and customary authorization
verification and authentication policies and procedures as may be
employed by you to verify the authority of, and authenticate the
identity of, the individual making any such information or access
request, in order to provide for the secure transmission and
delivery of the requested information or access to the appropriate
recipient(s).
We will not hold you responsible for acting pursuant to any
information or access request from the director of the Division of
Swap Dealer and Intermediary Oversight of the CFTC or the director
of the Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent, or employee of [Name of DSRO], acting in its capacity as our
DSRO, upon which you have relied after having taken measures in
accordance with your applicable policies and procedures to assure
that such request was provided to you by an individual authorized to
make such a request.
In the event we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Funds
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of offset or lien on assets that are not 30.7
customer funds maintained in the Account(s), or to impose such
charges against us or any proprietary account maintained by us with
you. Further, it is understood that amounts represented by checks,
drafts or other items shall not be considered to be part of the
Account(s) until finally collected. Accordingly, checks, drafts and
other items credited to the Account(s) and subsequently dishonored
or otherwise returned to you or reversed, for any reason, and any
claims relating thereto, including but not limited to claims of
alteration or forgery, may be charged back to the Account(s), and we
shall be responsible to you as a general endorser of all such items
whether or not actually so endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that, in the ordinary course of your business as a
depository, you have no notice of or actual knowledge of a potential
violation by us of any provision of the Act or Part 30 of the CFTC
regulations that relates to the holding of customer funds; and you
shall not in any manner not expressly agreed to herein be
responsible to us for ensuring compliance by us with such provisions
of the Act and CFTC regulations; however, the aforementioned
presumption does not affect any obligation you may otherwise have
under the Act or CFTC regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any action or omission to act
pursuant to any such order, judgment, decree or levy, to us or to
any other person, firm, association or corporation even if
thereafter any such order, decree, judgment or levy shall be
reversed, modified, set aside or vacated.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns and, for the avoidance of
doubt, regardless of a change in the name of either party. This
letter agreement supersedes and replaces any prior agreement between
the parties in connection with the Account(s), including but not
limited to any prior acknowledgment letter agreement, to the extent
that such prior agreement is inconsistent with the terms hereof. In
the event of any conflict between this letter agreement and any
other agreement between the parties in connection with the
Account(s), this letter agreement shall govern with respect to
matters specific to Section 4(b) of the Act and the CFTC's
regulations thereunder, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning to us the
enclosed copy of this letter agreement, and that you further agree
to provide a copy of this fully executed letter agreement directly
to the CFTC (via electronic means in a format and manner determined
by the CFTC) and to [Name of DSRO], acting in its capacity as our
DSRO. We hereby authorize and direct you to provide such copies
without further notice to or consent from us, no later than three
business days after opening the Account(s) or revising this letter
agreement, as applicable.

[Name of Futures Commission Merchant]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Depository]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
Date:

0
28. Add appendix F to part 30 to read as follows:

Appendix F to Part 30--Acknowledgment Letter for CFTC Regulation 30.7
Customer Secured Money Market Mutual Fund Account

[Date]
[Name and Address of Money Market Mutual Fund]

[Name of Futures Commission Merchant] [if applicable, add ``FCM
Customer Omnibus Account''] CFTC Regulation 30.7 Customer Secured
Money Market Mutual Fund Account under Section 4(b) of the Commodity
Exchange Act [and, if applicable, ``, Abbreviated as [short title
reflected in the depository's electronic system]'']
Account Number(s): [ ]
(collectively, the ``Account(s)'').
You acknowledge that we are holding these funds, including any
shares issued and amounts accruing in connection therewith
(collectively, the ``Shares''), for the benefit of customers who
trade foreign futures and/or foreign options (as such terms are
defined in U.S. Commodity Futures Trading Commission (``CFTC'')
Regulation 30.1, as amended); that the Shares held by you, hereafter
deposited in the Account(s) or accruing to the credit of the
Account(s), will be kept separate and apart and separately accounted
for on your books from our own funds and from any other funds or
accounts held by us in accordance with the provisions of the
Commodity Exchange Act, as amended (the ``Act''), and Part 30 of the
CFTC's regulations, as amended; and that the Shares must otherwise
be treated in accordance with the provisions of Section 4(b) of the
Act and CFTC Regulations 1.25 and 30.7.
Furthermore, you acknowledge and agree that such Shares may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, and they may not be used by us to secure or
obtain credit from you. You further acknowledge and agree that the
Shares in the Account(s) shall not be subject to any right of offset
or lien for or on account of any indebtedness, obligations or
liabilities we may now or in the future have owing to you.
In addition, you agree that the Account(s) may be examined at
any reasonable time by the director of the Division of Swap Dealer
and Intermediary Oversight of the CFTC or

[[Page 68655]]

the director of the Division of Clearing and Risk of the CFTC, or
any successor divisions, or such directors' designees, or an
appropriate officer, agent or employee of our designated self-
regulatory organization (``DSRO''), [Name of DSRO], and this letter
constitutes the authorization and direction of the undersigned on
our behalf to permit any such examination to take place without
further notice to or consent from us.
You agree to reply promptly and directly to any request for
confirmation of account balances or provision of any other
information regarding or related to the Account(s) from the director
of the Division of Swap Dealer and Intermediary Oversight of the
CFTC or the director of the Division of Clearing and Risk of the
CFTC, or any successor divisions, or such directors' designees, or
an appropriate officer, agent, or employee of [Name of DSRO], acting
in its capacity as our DSRO, and this letter constitutes the
authorization and direction of the undersigned on our behalf to
release the requested information, without further notice to or
consent from us.
You further acknowledge and agree that, pursuant to
authorization granted by us to you previously or herein, you have
provided, or will promptly provide following the opening of the
Account(s), the director of the Division of Swap Dealer and
Intermediary Oversight of the CFTC, or any successor division, or
such director's designees, with technological connectivity, which
may include provision of hardware, software, and related technology
and protocol support, to facilitate direct, read-only electronic
access to transaction and account balance information for the
Account(s). This letter constitutes the authorization and direction
of the undersigned on our behalf for you to establish this
connectivity and access if not previously established, without
further notice to or consent from us.
The parties agree that all actions on your part to respond to
the above information and access requests will be made in accordance
with, and subject to, such reasonable and customary authorization
verification and authentication policies and procedures as may be
employed by you to verify the authority of, and authenticate the
identity of, the individual making any such information or access
request, in order to provide for the secure transmission and
delivery of the requested information or access to the appropriate
recipient(s).
We will not hold you responsible for acting pursuant to any
information or access request from the director of the Division of
Swap Dealer and Intermediary Oversight of the CFTC or the director
of the Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors' designees, or an appropriate officer,
agent, or employee of [Name of DSRO], acting in its capacity as our
DSRO, upon which you have relied after having taken measures in
accordance with your applicable policies and procedures to assure
that such request was provided to you by an individual authorized to
make such a request.
In the event we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Shares
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of offset or lien on assets that are not Shares
maintained in the Account(s), or to impose such charges against us
or any proprietary account maintained by us with you. Further, it is
understood that amounts represented by checks, drafts or other items
shall not be considered to be part of the Account(s) until finally
collected. Accordingly, checks, drafts and other items credited to
the Account(s) and subsequently dishonored or otherwise returned to
you or reversed, for any reason and any claims relating thereto,
including but not limited to claims of alteration or forgery, may be
charged back to the Account(s), and we shall be responsible to you
as a general endorser of all such items whether or not actually so
endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that, in the ordinary course of your business as a
depository, you have no notice of or actual knowledge of a potential
violation by us of any provision of the Act or Part 30 of the CFTC
regulations that relates to the holding of customer funds; and you
shall not in any manner not expressly agreed to herein be
responsible to us for ensuring compliance by us with such provisions
of the Act and CFTC regulations; however, the aforementioned
presumption does not affect any obligation you may otherwise have
under the Act or CFTC regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any action or omission to act
pursuant to any such order, judgment, decree or levy, to us or to
any other person, firm, association or corporation even if
thereafter any such order, decree, judgment or levy shall be
reversed, modified, set aside or vacated.
We are permitted to invest customers' funds in money market
mutual funds pursuant to CFTC Regulation 1.25. That rule sets forth
the following conditions, among others, with respect to any
investment in a money market mutual fund:
(1) The net asset value of the fund must be computed by 9:00
a.m. of the business day following each business day and be made
available to us by that time;
(2) The fund must be legally obligated to redeem an interest in
the fund and make payment in satisfaction thereof by the close of
the business day following the day on which we make a redemption
request except as otherwise specified in CFTC Regulation
1.25(c)(5)(ii); and,
(3) The agreement under which we invest customers' funds must
not contain any provision that would prevent us from pledging or
transferring fund shares.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns and, for the avoidance of
doubt, regardless of a change in the name of either party. This
letter agreement supersedes and replaces any prior agreement between
the parties in connection with the Account(s), including but not
limited to any prior acknowledgment letter agreement, to the extent
that such prior agreement is inconsistent with the terms hereof. In
the event of any conflict between this letter agreement and any
other agreement between the parties in connection with the
Account(s), this letter agreement shall govern with respect to
matters specific to Section 4(b) of the Act and the CFTC's
regulations thereunder, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning to us the
enclosed copy of this letter agreement, and that you further agree
to provide a copy of this fully executed letter agreement directly
to the CFTC (via electronic means in a format and manner determined
by the CFTC) and to [Name of DSRO], acting in its capacity as our
DSRO. We hereby authorize and direct you to provide such copies
without further notice to or consent from us, no later than three
business days after opening the Account(s) or revising this letter
agreement, as applicable.
[Name of Futures Commission Merchant]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Money Market Mutual Fund]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
DATE:

PART 140--ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION

0
29. The authority citation for part 140 is revised to read as follows:

Authority: 7 U.S.C. 2(a)(12), 12a, 13(c), 13(d), 13(e), and
16(b).

0
30. Amend Sec. 140.91 to:
0
a. Revise the section heading;
0
b. Redesignate paragraph (a)(8) as paragraph (a)(12), and paragraph
(a)(7) as paragraph (a)(8);
0
c. Add new paragraphs (a)(7), (a)(9), (a)(10), and (a)(11); and
0
d. Revise paragraph (b).
The revisions and additions read as follows:

Sec. 140.91 Delegation of authority to the Director of the Division
of Clearing and Risk and to the Director of the Division of Swap Dealer
and Intermediary Oversight.

(a) * * *

[[Page 68656]]

(7) All functions reserved to the Commission in Sec. 1.20 of this
chapter.
* * * * *
(9) All functions reserved to the Commission in Sec. 1.26 of this
chapter.
(10) All functions reserved to the Commission in Sec. 1.52 of this
chapter.
(11) All functions reserved to the Commission in Sec. 30.7 of this
chapter.
* * * * *
(b) The Director of the Division of Clearing and Risk and the
Director of the Division of Swap Dealer and Intermediary Oversight may
submit any matter which has been delegated to him or her under
paragraph (a) of this section to the Commission for its consideration.

Issued in Washington, DC, on November 1, 2013, by the
Commission.
Melissa D. Jurgens,
Secretary of the Commission.

Appendices to Enhancing Protections Afforded Customers and Customer
Funds Held by Futures Commission Merchants and Derivatives Clearing
Organizations--Commission Voting Summary and Statements of
Commissioners

Note: The following appendices will not appear in the Code of
Federal Regulations.

Appendix 1--Commission Voting Summary

On this matter, Chairman Gensler and Commissioners Chilton and
Wetjen voted in the affirmative. Commissioner O'Malia voted in the
negative.

Appendix 2--Statement of Chairman Gary Gensler

I support this final set of customer protection reforms, which
comprehensively enhances the protection around the handling and
segregation of futures and swaps customer funds.
Segregation of customer funds is the core foundation of the
commodity futures and swaps markets. Segregation must be maintained
at all times. That means every moment of every day.
Market events, though, of these last two years highlighted that
the Commission must do everything within our authorities and
resources to strengthen oversight programs and protection of
customer funds.
These reforms are the sixth set of rules finalized by this
Commission during a two-year process to ensure that customers have
confidence that their funds are segregated and protected. These
reforms benefit from the Commission's thorough review of existing
customer protection rules--looking for any gaps in those rules and
the oversight of these markets.
They benefit from significant public input, including staff
roundtables, the Technology Advisory Committee, the Agricultural
Advisory Committee and numerous reports submitted by market
participants.
They also benefit from input through a coordinated effort of the
CFTC with other regulators; the self-regulatory organizations
(SROs), such as the CME and the National Futures Association (NFA);
as well as congressional reports and input on these matters. I
support these rules, in summary, for at least six reasons:
First, FCMs and clearing members must significantly
enhance their supervision of and accounting for customer funds. They
will have to put in place additional policies and procedures for
these new protections.
Second, significant enhancements around outside
accounting and auditing--regarding the actual accountants or
certified public accountants that audit futures commission merchants
(FCMs), and also regarding the SROs and how they audit the FCMs.
Third, significant customer fund protections with
regard to how funds are moved around. Basically, when a firm moves
money within a firm, how can they move that money around? Some of
these reforms were adopted by SROs last year, such as requiring
senior management signoff, and the pre-approval of moving those
monies. There are also significant new changes to required
acknowledgement letters from the banks and custodians.
Fourth, reforms related to investing in foreign futures
accounts. Our Part 30 regime really had not kept pace with
protections for domestic futures accounts. With these reforms and
the reforms that the NFA had put in place last year, investing in
foreign futures accounts will be significantly aligned with the
domestic protections.
Fifth, there's significant new transparency.
Transparency to the regulators--we will be able to see
electronically custodial accounts and cash accounts on a daily
basis. There is transparency to customers, as well, with the twice-
a-month statements regarding the details of their funds in the
investment accounts. These reforms also have been put in place by
the SROs, but it is important that we do this at the federal level
as well, and put them in our rules.
Sixth, the final rules include provisions on capital
and residual interest of the FCMs themselves. This was quite
possibly the most debated feature of these reforms, but I think they
are important. In response to commenters on this provision, we are
phasing in compliance to smooth implementation. This section calls
for studies and roundtables, and provides for a five-year phase in
on these matters.
It is important that we look very closely at the law and work to
ensure that one customer's funds or property are not used in some
way to secure or guarantee other customer's positions.
Prior to this final rule set, the Commission already had made
important improvements to protections for customers:
Amendments to rule 1.25 regarding the investment of
funds that bring customers back to protections they had prior to
exemptions the Commission granted between 2000 and 2005.
Importantly, this prevents use of customer funds for in-house
lending through repurchase agreements;
Clearinghouses have to collect margin on a gross basis
and FCMs are no longer able to offset one customer's collateral
against another and then send only the net to the clearinghouse;
The so-called ``LSOC rule'' (legal segregation with
operational comingling) for swaps ensures customer money is
protected individually all the way to the clearinghouse;
The Commission included customer protection
enhancements in the final rule for designated contract markets.
These provisions codify into rules staff guidance on minimum
requirements for SROs regarding their financial surveillance of
FCMs; and
Rules enhancing the protection of customer funds when
entering into uncleared swap transactions. These reforms fulfill
Congress' mandate that counterparties of swap dealers be given a
choice regarding whether or not they get the protections that come
from segregation of monies and collateral they post as initial
margin.

Appendix 3--Dissenting Statement of Commissioner Scott D. O'Malia--
Enhancing Protections Afforded Customers and Customer Funds Held by
Futures Commission Merchants and Derivatives Clearing Organizations \1\
---------------------------------------------------------------------------

\1\ ``Customer Protection Rules''

October 30, 2013I respectfully dissent from the Commission's
approval today of the final Customer Protection Rules.
I supported the proposed rules because I wanted to solicit
public comment and engage market participants in an open discussion
about how the Commission should improve its customer protection
regulatory oversight.
In the wake of the global financial crisis, it is extremely
important to intensify regulatory efforts to strengthen customer
protection policies in order to promote the financial stability of
the derivatives markets. There is no dispute customer protection
must be the cornerstone of the Commission's oversight. Sound
customer protection policies and measures, such as the electronic
customer verification confirmation services will improve the
efficiency and transparency of financial markets.\2\
---------------------------------------------------------------------------

\2\ In this regard, I applaud the efforts of the Chicago
Mercantile Exchange Inc. (CME) and the National Futures Association
(NFA) to protect customer accounts by introducing daily electronic
confirmation services. This new technology allows CME and NFA to
review balances held at bank depositories and compare the balances
with customer account information provide by futures commission
merchants (FCMs).
---------------------------------------------------------------------------

The Commission must promulgate workable regulations that provide
clear guidance to industry participants and ensure cost-effective
access to markets. Such regulations must be designed to address real
weaknesses in the current regulatory regime and allow industry
participants to continue with well-established industry practices
that had nothing to do with the financial crisis or the recent
bankruptcies of MF Global and Peregrine Financial.
Unfortunately, the Commission's customer protection rules fall
short of these objectives. Instead of mitigating customer risk, the
rules

[[Page 68657]]

create a false sense of security by imposing broad and ambiguous
requirements and introducing another layer of governmental
oversight. Even worse, they force a change in a longstanding and
generally accepted industry practice that will likely result in
seriously harmful consequences for small FCMs and their end-user
customers.
I do support several provisions that allow customers greater
insight into the operations of an FCM. These provisions include: An
improved FCM disclosure regime that will give customers new and
critical information about their FCM exposures, elimination of the
alternative method of calculating segregation requirements for Sec.
30.7 funds (treatment of foreign futures or foreign options),
improved reporting of segregated fund balances, and enhancements to
risk management procedures. However, I am unable to support the
final rule for the reasons stated below.

Reinterpretation of the Residual Interest Deadline Will Result in
Costly Prefunding of Margin Payments

My main concern with the final rules is their radical
reinterpretation of the longstanding residual interest deadline.
This reinterpretation decreases the time in which customers' margin
calls must arrive to their FCM from the current three days to just
one day.
Such a change would mean a drastic increase in pre-funding of
margin, perhaps nearly double the amounts currently required. As a
result, many small agribusiness hedgers will have to consider
alternative risk management tools or, even worse, will be forced out
of the market.\3\ I am disappointed that yet again the Commission
has rushed to implement a rule that disregards the express
Congressional directive to protect end-users.
---------------------------------------------------------------------------

\3\ See e.g.; National Grain and Feed Association Comment Letter
at 2 (Dec. 28, 2012) (stating that the Commission's proposed changes
``could have the unintended impact of disadvantaging smaller and
mid-size FCMs that provide `hands-on' service to many of the
relatively smaller hedgers in agribusiness''); Texas Cattle Feeders
Association Comment Letter (Jan. 14, 2013) (warning that such
changes ``could have the potential to cause unintended consequences
such as added costs eventually borne by customers''); Iowa
Cattlemen's Association Comment Letter (Feb. 15, 2013) (``it is
imperative that the CFTC understand all sizes of businesses . . .
[in order to have] . . . a better opportunity to write rules that
provide a logical fit. Our fear is that if this rule is put in
place, we will have members who will not take advantage of the risk
management tools . . . .'').
---------------------------------------------------------------------------

I recognize that the Commodity Exchange Act (CEA) does not
permit an FCM to use the money or property of one customer to margin
the futures or option positions of another customer.\4\ Despite this
fact, it has been the prevailing industry practice authorized by the
Commission for decades.
---------------------------------------------------------------------------

\4\ CEA Sec. 4d(a)(2).
---------------------------------------------------------------------------

To the extent that the Commission must reinterpret this
statutory provision, I believe this reinterpretation must be based
on the thorough analysis of the market data and the full evaluation
of the costs of strict compliance with the statute before
implementing policy changes, and not after as is the case with the
residual interest deadline.
The residual interest deadline rule makes no effort to respond
to the commenters' concerns that the residual interest deadline
would be especially costly for smaller FCMs and end-users.\5\ Given
the express Congressional directive to protect end-users, I would
have expected the Commission to conduct meaningful cost-benefit
analysis to justify the costs when compared to the actual risk to
customer accounts and the derivatives markets and to explain why the
Commission could not have adopted an alternative approach.
Regrettably, the Commission has failed to do so.
---------------------------------------------------------------------------

\5\ Futures Industry Association Comment Letter at 16 (Feb. 15,
2013).
---------------------------------------------------------------------------

Even the Commission's own cost benefit analysis points out,
while significantly understating the impact, that:
``Smaller FCMs may have more difficulty than large FCMs in
absorbing the additional cost created by the requirements of the
rules (particularly Sec. 1.22). It is possible that some smaller
FCMs may elect to stop operating as FCMs as a result of these
costs.'' \6\
---------------------------------------------------------------------------

\6\ Customer Protection Rules at 313.
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I cannot support a rule that will impose such onerous costs and
compliance burdens on the smallest FCMs and small, non-systemically
relevant customers.
Finally, although I support a phase-in compliance schedule for
the residual interest deadline, I am disappointed that the
Commission, in deciding whether to change the deadline at a future
time, is not required to make such a decision based on data.
Instead, the Commission will simply come up with another arbitrary
residual interest deadline that has nothing to do with customer or
FCM risk exposure.
Yet again, the Commission has chosen to avoid fact-based
analysis. I strongly believe that the Commission should utilize
facts and data to make an informed decision about the appropriate
time for the residual interest deadline.

The Rules Fail To Provide a Clear Standard for Compliance.

In addition to my serious concerns about the final rules'
treatment of the residual interest deadline, I am concerned that the
rules unreasonably expand the scope of the new regulatory compliance
regime without providing a clear regulatory objective.
For example, the rules require that a Self-Regulatory
Organization (SRO) supervisory program ``address all areas of risk
to which [FCMs] can reasonably be foreseen to be subject (emphasis
added).'' \7\ This broad language requires the SRO to guess at what
criteria the programs would be measured against, and under what
framework the SRO would make this determination. In short, the new
language does nothing but adds more ambiguity to the SRO's customer
protection program and increases the cost of compliance with vague
requirements.
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\7\ Sec. 1.52(c)(2).
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Examination Experts do not add Value to the Customer Protection Regime

I also have concerns about the requirement that each SRO
supervisory program of its member FCMs be reviewed by an
``examinations expert.'' \8\ I question the benefit of this
requirement given the fact that the Joint Audit Committee (JAC)
currently performs this function. The JAC's primary responsibility
is to oversee the practices and procedures that each SRO must follow
when it conducts audits and financial reviews of FCMs. This
regulatory task is already in place and implemented in a less costly
and more efficient manner than set forth in the final rules.
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\8\ Sec. 1.52.
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Moreover, in light of the Commission's regulatory oversight of
all SROs and the Commission's review of all JAC examination
programs, this additional layer of review does not provide any
benefit except for isolating the Commission from its primary
responsibility to oversee customer protection programs.

Customers Deserve Better Protections in Bankruptcy Proceedings

Going forward, the Commission should address key customer
protections in the areas of bankruptcy. Congress should make changes
to the Bankruptcy Code to ensure that certain bankruptcy protections
are afforded to FCM customers. Specifically, Congress should amend
the pro-rata distribution rules in bankruptcy. Despite the
Commission's customer segregation requirements, individual customer
accounts are still subject to a pro-rata distribution in bankruptcy.
In addition to these changes to the Bankruptcy Code, the Commission
should amend its rules to allow the Commission to appoint a trustee
to oversee derivatives customers' accounts in the bankruptcy of a
broker-dealer FCM.

Conclusion

I support implementation of a rigorous customer protection
program that provides clear and meaningful mechanisms for mitigating
customer risks. However, the customer protection rules approved
today have missed the mark.
In sum, many of the new rules impose overly broad and
nonsensical regulatory requirements and, in doing so, impede the
industry's ability to operate in an efficient manner. Regrettably,
the negative effects will be felt most by farmers and other end-
users, whose ability to hedge risk in a cost-effective manner will
be hampered if not eliminated altogether. This is contrary to the
Congressional directive, and I cannot support rules that result in
such an outcome.

[FR Doc. 2013-26665 Filed 11-13-13; 8:45 am]
BILLING CODE 6351-01-P

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