Protection of Clearing Member Funds Held by Derivatives Clearing Organizations, 286-307 [2023-28767]
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286
Proposed Rules
Federal Register
Vol. 89, No. 2
Wednesday, January 3, 2024
This section of the FEDERAL REGISTER
contains notices to the public of the proposed
issuance of rules and regulations. The
purpose of these notices is to give interested
persons an opportunity to participate in the
rule making prior to the adoption of the final
rules.
FEDERAL TRADE COMMISSION
16 CFR Part 1
[File No. R407000]
Petition for Rulemaking of PIRG and
iFixit
Federal Trade Commission.
Receipt of petition; request for
comment.
AGENCY:
ACTION:
Please take notice that the
Federal Trade Commission
(‘‘Commission’’) received a petition for
rulemaking from the U.S. Public Interest
Research Group Education Fund and
iFixit. This petition requests that the
Commission initiate a rulemaking to
protect consumers’ right to repair
products they have purchased. The
Commission invites written comments
concerning the petition. Publication of
this petition is pursuant to the
Commission’s Rules of Practice and
Procedure and does not affect the legal
status of the petition or its final
disposition.
DATES: Comments must identify the
petition docket number and be filed by
February 2, 2024.
ADDRESSES: You may view the petition,
identified by docket number FTC–2023–
0077, and submit written comments
concerning its merits by using the
Federal eRulemaking Portal at https://
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instructions for submitting comments.
Do not submit sensitive or confidential
information. You may read background
documents or comments received at
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FOR FURTHER INFORMATION CONTACT: Joel
Christie (phone: 202–468–4593, email:
jchristie@ftc.gov), Office of the
Secretary, Federal Trade Commission,
600 Pennsylvania Avenue NW,
Washington, DC 20580.
SUPPLEMENTARY INFORMATION: Pursuant
to Section 18(a)(1)(B) of the Federal
Trade Commission Act, 15 U.S.C.
57a(1)(B), and FTC Rule 1.31(f), 16 CFR
1.31(f), notice is hereby given that the
above-captioned petition has been filed
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SUMMARY:
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with the Secretary of the Commission
and has been placed on the public
record for a period of 30 days. Any
person may submit comments in
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this petition will become part of the
public record.
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petition’s merits until after the comment
period closes. It may grant or deny the
petition in whole or in part, and it may
deem the petition insufficient to warrant
commencement of a rulemaking
proceeding. The purpose of this
document is to facilitate public
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Commission in determining what, if
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contained in the petition. This
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FTC Rule 4.10(a)(2), 16 CFR 4.10(a)(2).
(Authority: 15 U.S.C. 46; 15 U.S.C. 57a; 5
U.S.C. 601 note.)
Joel Christie,
Acting Secretary.
[FR Doc. 2023–28874 Filed 1–2–24; 8:45 am]
BILLING CODE 6750–01–P
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COMMODITY FUTURES TRADING
COMMISSION
17 CFR Part 39
RIN 3038–AF39
Protection of Clearing Member Funds
Held by Derivatives Clearing
Organizations
Commodity Futures Trading
Commission.
ACTION: Notice of proposed rulemaking.
AGENCY:
The Commodity Futures
Trading Commission (CFTC or
Commission) is proposing regulations to
ensure clearing member funds and
assets receive the proper treatment in
the event the derivatives clearing
organization (DCO) enters bankruptcy
by requiring, among other things, that
clearing member funds be segregated
from the DCO’s own funds and held in
a depository that acknowledges in
writing that the funds belong to clearing
members, not the DCO. In addition, the
Commission is proposing to permit
DCOs to hold customer and clearing
member funds at foreign central banks
subject to certain requirements. Finally,
the Commission is proposing to require
DCOs to conduct a daily calculation and
reconciliation of the amount of funds
owed to customers and clearing
members and the amount actually held
for customers and clearing members.
DATES: Comments must be received by
February 16, 2024.
ADDRESSES: You may submit comments,
identified by RIN 3038–AF39, by any of
the following methods:
• CFTC Comments Portal: https://
comments.cftc.gov. Select the ‘‘Submit
Comments’’ link for this rulemaking and
follow the instructions on the Public
Comment Form.
• Mail: Send to Christopher
Kirkpatrick, Secretary of the
Commission, Commodity Futures
Trading Commission, Three Lafayette
Centre, 1155 21st Street NW,
Washington, DC 20581.
• Hand Delivery/Courier: Follow the
same instructions as for Mail, above.
Please submit your comments using
only one of these methods. Submissions
through the CFTC Comments Portal are
encouraged.
All comments must be submitted in
English, or if not, accompanied by an
English translation. Comments will be
SUMMARY:
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Federal Register / Vol. 89, No. 2 / Wednesday, January 3, 2024 / Proposed Rules
posted as received to https://
comments.cftc.gov. You should submit
only information that you wish to make
available publicly. If you wish the
Commission to consider information
that you believe is exempt from
disclosure under the Freedom of
Information Act (FOIA), a petition for
confidential treatment of the exempt
information may be submitted according
to the procedures established in § 145.9
of the Commission’s regulations.1
The Commission reserves the right,
but shall have no obligation, to review,
pre-screen, filter, redact, refuse or
remove any or all of your submission
from https://comments.cftc.gov that it
may deem to be inappropriate for
publication, such as obscene language.
All submissions that have been redacted
or removed that contain comments on
the merits of the rulemaking will be
retained in the public comment file and
will be considered as required under the
Administrative Procedure Act and other
applicable laws, and may be accessible
under the FOIA.
FOR FURTHER INFORMATION CONTACT:
Eileen A. Donovan, Deputy Director,
202–418–5096, edonovan@cftc.gov,
Division of Clearing and Risk,
Commodity Futures Trading
Commission, Three Lafayette Centre,
1155 21st Street NW, Washington, DC
20581; Theodore Z. Polley, Associate
Director, 312–596–0551, tpolley@
cftc.gov; or Scott Sloan, Special
Counsel, 312–596–0708, ssloan@
cftc.gov; Division of Clearing and Risk,
Commodity Futures Trading
Commission, 77 West Jackson
Boulevard, Suite 800, Chicago, Illinois
60604.
SUPPLEMENTARY INFORMATION:
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I. Background
A. Proprietary Funds
Section 4d of the Commodity
Exchange Act (CEA) and part 1 of the
Commission’s regulations establish a
comprehensive regime to safeguard the
funds belonging to customers of a
futures commission merchant (FCM).2
Commission regulations define a
‘‘customer’’ as any person who uses an
FCM, introducing broker, commodity
trading advisor, or commodity pool
operator as an agent in connection with
trading in any commodity interest, and
1 17 CFR 145.9. Commission regulations referred
to herein are found at 17 CFR chapter I (2022), and
are accessible on the Commission’s website at
https://www.cftc.gov/LawRegulation/
CommodityExchangeAct/index.htm.
2 7 U.S.C. 6d; 17 CFR 1.20–1.39. See also 17 CFR
22.1–22.17, and 30.7 (establishing similar regimes
for cleared swaps customer collateral and foreign
futures customer funds).
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therefore, this customer protection
regime does not apply to the funds of
any person who clears trades directly
through a DCO, who is a ‘‘clearing
member.’’ 3 At the most general level,
the customer protection regime requires
FCMs to segregate customer funds from
their own funds, deposit customer funds
under an account name that clearly
identifies them as customer funds,4 and
obtain a written acknowledgment from
each depository that holds customer
funds.5 These acknowledgment letters,
which must adhere to specific templates
contained in the Commission’s
regulations, require a depository to
acknowledge, among other things, that
the accounts opened by the FCM hold
funds that belong to the FCM’s
customers. The customer protection
regime also establishes accounting and
reporting requirements applicable to
customer funds,6 and limits both the
types of investments that can be made
with customer funds 7 and the type of
depositories that can hold customer
funds.8
Many of the customer protection
requirements that apply to FCMs also
apply to DCOs that receive customer
funds from their FCM clearing members.
DCOs must segregate the customer
funds of their FCM clearing members
from their own funds,9 deposit customer
funds under an account name that
identifies the funds as customer funds,10
obtain acknowledgment letters from
depositories,11 limit the investment of
customer funds to instruments listed in
§ 1.25,12 and limit depositories for
customer funds to those listed in §§ 1.20
and 1.49.13 These protections, however,
do not extend to clearing members of
DCOs. Only section 5b(c)(2)(F) of the
CEA (Core Principle F) and § 39.15
apply to the treatment of clearing
members’ funds and assets held by a
DCO in relation to cleared contracts
(proprietary funds).14 These provisions
require DCOs to establish standards and
procedures that are designed to protect
and ensure the safety of proprietary
funds and require DCOs to hold
proprietary funds in a manner that will
minimize the risk of loss or delay in
access by the DCO to the proprietary
funds.15 These provisions further
require any investment of proprietary
funds to be in instruments with minimal
credit, market, and liquidity risks.16
Section 8a(5) of the CEA grants the
Commission authority to adopt rules it
determines are reasonably necessary to
effectuate, among other things, the DCO
core principles.17 The Commission’s
initial focus in implementing Core
Principle F was on the custody and
safeguarding of customer funds,
consistent with section 4d of the CEA.
This approach was largely responsive to
the historical prevailing model in which
all or nearly all clearing members of a
DCO are FCMs. However, the
Commission has since granted
registration to a number of DCOs that
clear directly for market participants
without the intermediation of FCMs,
including, in most cases, market
participants who are natural persons
(i.e., individuals).18 Additionally, many
DCOs that use the traditional FCM
clearing model have at least some nonFCM clearing members. The
Commission therefore is proposing
safeguards for proprietary funds to
provide protections for clearing
members comparable to those
applicable to customers.19 The
Commission has preliminarily
determined that each of these additional
safeguards is reasonably necessary to
effectuate DCO Core Principle F.20
Specifically, the Commission is
proposing to require a DCO to hold
proprietary funds separately from the
DCO’s own funds, in accounts that are
named to clearly identify the funds as
belonging to clearing members. The
3 17
15 7
4 17
16 Id.
CFR 1.3.
CFR 1.20(a).
5 17 CFR 1.20, 22.5, and 30.7 (requiring an
acknowledgment letter for futures customer funds,
cleared swaps customer collateral, and foreign
futures customer funds, respectively).
6 17 CFR 1.32, 1.33.
7 17 CFR 1.25.
8 17 CFR 1.49.
9 17 CFR 1.20(g)(1); 17 CFR 39.15 (b); 17 CFR
22.3(b)(1).
10 17 CFR 1.20(g)(1).
11 17 CFR 1.20(g)(4); 17 CFR 22.5.
12 17 CFR 39.15(e).
13 17 CFR 1.20(g)(2), (3); 17 CFR 22.3(b) (crossreferencing 17 CFR 22.4).
14 This definition of proprietary funds is only for
explanatory purposes in the background section. As
discussed further below, the Commission is
proposing a definition of ‘‘proprietary funds’’ that
is referred to throughout the remainder of this
proposed rulemaking.
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U.S.C. 7a–1(c)(2)(F); 17 CFR 39.15.
17 7
U.S.C. 12a(5).
CBOE Clear Digital, LLC; CX
Clearinghouse, L.P.; LedgerX, LLC; and North
American Derivatives Exchange Inc. allow
individuals to be direct clearing members. Further,
ICE NGX Canada Inc. clears physically delivered
energy contracts directly for clearing members with
a net worth exceeding CAD $5,000,000 or assets
exceeding CAD $25,000,000.
19 The U.S. Bankruptcy Code requires a
bankruptcy trustee to distribute clearing members’
cash and other assets held by a debtor DCO ratably
among all clearing members. 11 U.S.C. 766(i)(2); 11
U.S.C. 761(9)(D), (10), (16). Therefore, the
Commission cannot effectively create multiple
account classes for the clearing members of a
DCO—e.g., one for FCM proprietary funds and one
for non-FCM proprietary funds—because the
different account classes would not be recognized
by a bankruptcy court.
20 CEA section 5b(c)(2)(F), 7 U.S.C. 7a–1(c)(2)(F).
18 Currently,
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Commission is further proposing to
prohibit a DCO or any depository from
using proprietary funds in any way
other than as belonging to the clearing
member.
Additionally, the proposed rules
include requirements for a DCO to
review, on a daily basis, the amount of
funds owed to each clearing member
with respect to each of its accounts,
both customer (including, as relevant,
futures and cleared swaps) and
proprietary, and to reconcile those
figures to the amount of funds held in
aggregate in each such type of account
across all of the DCO’s depositories.
The Commission is also proposing to
require a DCO to obtain a letter from the
depository for each account holding
proprietary funds (proprietary funds
letter) acknowledging, among other
things, that the funds belong to clearing
members and cannot be used by the
DCO for any other purpose. The
proposed proprietary funds letter is
based on the template acknowledgment
letter that a DCO is required to use in
connection with customer funds.21
In addition to preventing the misuse
of proprietary funds, the proposed
requirements would help ensure that
proprietary funds are appropriately
protected in the event of a DCO
bankruptcy. The U.S. Bankruptcy Code
establishes that in the event of a DCO
bankruptcy, member property, which
includes funds held for clearing
members’ proprietary accounts,22 is
repaid to clearing members pro rata
based on their claims for such funds,
and ahead of most other claims against
the DCO’s estate.23 Further, part 190 of
the Commission’s regulations
establishes how clearing members’
claims against the DCO’s estate should
be determined and how payments
should be allocated among clearing
members.24 By requiring proprietary
funds to be held separately from the
DCO’s funds and easily identified in a
proprietary funds letter, the proposed
rules will enable a bankruptcy court or
trustee to more clearly identify these
funds as member property. Further, the
proposed rules will require the DCO to
verify, on a regular basis, that it is
holding the proper amount of
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21 See
17 CFR 1.20 App. B.
11 U.S.C. 761(16) (defining ‘‘member
property’’ as cash, a security, or other property, or
proceeds of such cash, security, or property, held
by a DCO for a clearing member’s proprietary
account).
23 See 11 U.S.C. 766(i) (providing that member
property is distributed ratably to clearing members
on the basis and to the extent of their allowed net
equity claims based on their proprietary accounts,
and in priority to all other claims, except claims
related to the administration of member property).
24 See 17 CFR 190.00–190.19.
22 See
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proprietary funds, thus ensuring that
these funds would be available for
distribution in the event of a DCO
bankruptcy.
B. Central Bank Depositories
The Commission is also proposing
requirements specific to obtaining
written acknowledgments from central
banks holding customer or proprietary
funds.25 When the Commission adopted
the template acknowledgment letter for
depositories holding customer funds in
2013, it did not require use of the
template letter by Federal Reserve
Banks, due to the ‘‘unique role’’ of the
U.S. central bank.26 The Commission
also recognized that there may be valid
reasons why some foreign depositories
would require modifications to the letter
and stated that, in such circumstances,
the Commission would consider
‘‘alternative approaches’’ on a case-bycase basis.27
Since then, the Commission’s
Division of Clearing and Risk (DCR) has
issued several no-action letters in which
the Division confirmed that it would not
recommend that the Commission take
enforcement action against a DCO for
making certain modifications to the
template acknowledgment letter in
connection with customer accounts
maintained at a foreign central bank.28
To encourage the use of central bank
accounts, which can provide a superior
alternative to holding funds at a
commercial bank from the perspective
of credit and liquidity risk, the
Commission is proposing to allow a
DCO to hold customer and proprietary
funds at certain central banks without
obtaining the template acknowledgment
letter for customer funds or the
proposed proprietary funds letter.
Instead, a DCO would need to obtain
only a written acknowledgment that the
central bank was informed that the
funds deposited with the bank are
customer or proprietary funds (as
applicable) held in accordance with
section 4d or 5b of the CEA, and that the
central bank agrees to respond to
requests from specified Commission
staff for information about the account,
25 ‘‘Central bank’’ is the term used to describe the
authority responsible for policies that affect a
country’s supply of money and credit. See, e.g.,
https://www.clevelandfed.org/publications/
economic-commentary/2007/ec-20071201-a-briefhistory-of-central-banks.
26 Enhancing Protections Afforded Customers and
Customer Funds Held by Futures Commission
Merchants and Derivatives Clearing Organizations,
78 FR 68506, 68535 (Nov. 14, 2013).
27 Id. at 68536.
28 See, e.g., CFTC Letter No. 14–124 (Oct. 8, 2014)
(related to customer accounts held at the Bank of
England); CFTC Letter No. 16–05 (Feb. 1, 2016)
(related to customer accounts held at the Deutsche
Bundesbank).
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including the account balance (modified
written acknowledgments). These
proposed requirements are based on the
requirements the Commission adopted
in 2013 with regard to written
acknowledgments from Federal Reserve
Banks.29
The Commission is proposing to
allow use of the modified written
acknowledgment only by a DCO that
holds customer or proprietary funds at
the central bank of a ‘‘money center
country’’ as defined in § 1.49—Canada,
France, Germany, Italy, Japan, and the
United Kingdom—to limit risks to
customer and proprietary funds. Along
with the United States, these countries
comprise the Group of Seven (G7).
Representatives from the G7 countries
meet several times each year to
coordinate their cooperation on issues
of economic policy, and the United
States and its financial regulatory
agencies have a history of successful
cooperation with the respective
financial regulatory agencies of these
countries. When the definition of
‘‘money center country’’ was first
proposed in connection with the
adoption of § 1.49, a commenter
suggested that the definition include
‘‘other locations with stable currencies
and other indicia that customer funds
will be relatively secure.’’ 30 The
Commission rejected this proposal as
difficult to apply and noted that it
would require the Commission to
expend significant resources to conduct
a broad evaluation of, among other
things, a country’s banking, monetary,
and economic policies and systems.31
The Commission believes that limiting
the proposed change to central banks of
money center countries appropriately
considers security for customer and
proprietary funds, flexibility for DCOs,
and creating a system that is workable
in practice.
Further, the Commission is not
proposing to require a DCO to obtain an
29 Enhancing Protections Afforded Customers and
Customer Funds, 78 FR at 68628. In 2016, the
Commission issued an order under section 4(c) of
the CEA conditionally exempting Federal Reserve
Banks from section 4d of the CEA (Order Exempting
the Federal Reserve Banks from Sections 4d and 22
of the Commodity Exchange Act, 81 FR 53467 (Aug.
12, 2016)). The conditions of the order require
Federal Reserve Banks to keep customer funds
segregated and respond to information requests
from the Commission, making a separate written
acknowledgment from a Federal Reserve Bank
unnecessary. The Commission therefore repealed
the 2013 provision (then § 1.20(g)(4)(ii)) concerning
written acknowledgments from Federal Reserve
Banks and adopted current § 1.20(g)(4)(i), which
excludes Federal Reserve Banks from the written
acknowledgment requirement.
30 See Denomination of Customer Funds and
Location of Depositories, 68 FR at 5546–5547 (Mar.
6, 2003).
31 Id.
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acknowledgment letter from a Federal
Reserve Bank holding proprietary funds.
This is consistent with § 1.20(g)(4),
which states that a DCO does not need
a written acknowledgment to hold
customer funds held at a Federal
Reserve Bank. Federal Reserve Banks
have previously expressed an inability
to agree to all of the terms in the
template acknowledgment letter.32
Because Federal Reserve Banks are the
source of liquidity for U.S. dollar
deposits, a DCO would face lower credit
and liquidity risk with a deposit at a
Federal Reserve Bank than it would
with a deposit at a commercial bank. In
the context of customer funds, the
Commission determined that it would
not require a written acknowledgment
from Federal Reserve Banks in order to
facilitate use of these accounts and help
obtain these benefits that ultimately
serve market participants and the
integrity of the financial markets.33 The
Commission believes that the same
rationale applies with respect to
proprietary funds. Further, the
Commission has required DCOs with
access to accounts and services at a
Federal Reserve Bank to use such
accounts and services where practical,34
and as a policy matter seeks to facilitate
use of those accounts.
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II. Definitions—§ 39.2
The Commission is proposing to add
in § 39.2 a definition for ‘‘money center
country’’ that is identical to the
definition currently in § 1.49. Under the
proposed definition, ‘‘money center
country’’ means Canada, France,
Germany, Italy, Japan, and the United
Kingdom.
The Commission is also proposing a
definition for ‘‘proprietary funds.’’ The
definition uses language similar to that
included in the current definitions of
‘‘futures customer funds’’ in § 1.3 35 and
‘‘cleared swaps customer collateral’’ in
§ 22.1.36 The proposed definition
includes all money, securities, and
property held in a proprietary account 37
on behalf of clearing members used to
margin, guarantee, or secure futures,
foreign futures and swaps contracts, as
well as option premiums and other
funds held in relation to options
contracts. The proposed definition also
32 Enhancing Protections Afforded Customers and
Customer Funds, 78 FR at 68535.
33 Denomination of Customer Funds and Location
of Depositories, 68 FR at 53468 (Mar. 6, 2003).
34 17 CFR 39.33(d)(5).
35 17 CFR 1.3.
36 17 CFR 22.1.
37 See 17 CFR 1.3 (defining ‘‘proprietary account’’
as a commodity futures, commodity options, or
swaps trading account, for the clearing member
itself, or for certain owners and affiliates of the
clearing member).
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includes clearing member contributions
to a guaranty fund to mutualize the
losses resulting from a default by a
clearing member.38
For the avoidance of doubt, a
proprietary account may be the ‘‘house’’
account of a clearing member that is an
FCM, where the clearing member may
also maintain a futures customer and/or
cleared swaps customer account. The
term also would include the account of
a direct clearing member (that may or
may not be a natural person) that does
not intermediate transactions for anyone
else.
III. Treatment of Funds—§ 39.15
A. Holding Customer Funds at Central
Banks—§ 39.15(b)(3)
The Commission is proposing to
amend § 39.15(b) to allow a DCO to hold
customer funds at the central bank of a
money center country. The proposed
amendment would supplement the list
of permissible depositories in § 1.49 and
§§ 22.4 and 22.9. Currently, § 1.49 and
§ 22.9 limit foreign depositories for
customer funds to a bank or trust
company that has in excess of $1 billion
of regulatory capital, an FCM, or a DCO.
Foreign central banks, as independent
government entities, are not structured
to meet regulatory capital requirements
and are therefore excluded from holding
customer funds under § 1.49.
The Commission believes a DCO
holding customer funds at a central
bank can be a superior alternative to
holding commercial bank deposits
because it limits the DCO’s credit and
liquidity risks. The Commission is
therefore proposing new § 39.15(b)(3) to
permit a DCO to hold customer funds at
the central bank of a money center
country if the DCO obtains a modified
written acknowledgment, rather than
the template acknowledgment letter
required by §§ 1.20 and 22.5, to which
some central banks have objected.39 The
proposed rule would require the central
bank of a money center country only to
acknowledge that it was informed that
the funds deposited with the bank are
customer funds held in accordance with
section 4d of the CEA and to agree to
respond to requests from the
Commission for information about the
account, including the account balance.
The Commission believes the proposed
rule would facilitate the holding of
38 These guaranty fund contributions include
those received pursuant to an assessment for
additional guaranty fund contributions when
permitted by a DCO’s rules.
39 See, e.g., CFTC Letter No. 14–124 (Oct. 8,
2014); CFTC Letter No. 16–05 (Feb. 1, 2016)
(regarding modifications to the template
acknowledgment letter to enable certain central
banks to hold customer funds).
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customer funds at the central banks of
money center countries while ensuring
appropriate customer protections.
The Commission believes that central
banks are often the safest place to
deposit customer funds and has
provided exemptions from § 1.49 to
permit customer funds to be held at
foreign central banks in money center
countries.40 The proposed rule would
codify those exemptions and permit
DCOs to hold customer funds with the
central bank of a money center country.
As previously discussed, the
Commission is proposing to limit the
permissible central bank depositories to
those of money center countries after
considering security for customer funds,
flexibility for DCOs, and the need to
create a system that is workable in
practice.
B. Permitted Investments—§ 39.15(e)
The Commission is proposing to
amend § 39.15(e) to permit a DCO to
invest proprietary funds only as
permitted for investment of customer
funds under § 1.25. The proposed
regulation specifies that the DCO would
bear any losses from investments, as is
the case with customer funds.41 The list
of investments in § 1.25 is a
conservative list, and the Commission
believes it is appropriate for all types of
clearing members. Currently,
permissible investments under § 1.25
include, among other investments,
general obligations of the U.S.
government, general obligations of any
U.S. state or municipality, certificates of
deposit, and interests in money market
funds.42 Further, § 1.25 specifies a
number of terms and conditions with
which permitted investments must
comply, including limits on the features
that an investment can contain,
concentration limits, and time to
maturity limits.43 Regulation § 1.25 also
includes specific requirements for
investments in money market funds and
repurchase agreements.44 By limiting
investments of proprietary funds to
investments that meet the requirements
40 See, e.g., CFTC Letter No. 14–124 (Oct. 8,
2014); CFTC Letter No. 16–05 (Feb. 1, 2016)
(granting exemptive relief from § 1.49 to permit
certain central banks to act as a depository for
customer funds).
41 17 CFR 1.29(b).
42 17 CFR 1.25(a); see also Investment of
Customer Funds by [FCMs] and [DCOs], 88 FR
81236 (Nov. 21, 2023) (proposing, among other
changes, to add certain foreign sovereign debt and
certain U.S. Treasury exchange traded funds, both
subject to limitations, to the list of permitted
investments and to limit the types of money market
funds that are permitted investments).
43 17 CFR 1.25(b).
44 17 CFR 1.25(c), (d).
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of § 1.25,45 the proposed rule will
ensure that any investment of
proprietary funds will have minimal
credit, market, and liquidity risk as
required by Core Principle F.46
C. Additional Protections for Proprietary
Funds—§ 39.15(f)
The Commission is proposing new
§ 39.15(f) to establish additional
protections for proprietary funds.
1. Segregation of Proprietary Funds—
§ 39.15(f)(1)
Proposed § 39.15(f)(1) is based on
§ 1.20(a) and would require a DCO to
account for proprietary funds separately
from its own funds, and to hold
proprietary funds in accounts that are
named to clearly identify the funds
being held as belonging to clearing
members. The Commission believes this
would prevent misuse of proprietary
funds by a DCO, and would help a
bankruptcy trustee or judge to easily
identify the funds that should be treated
as member property in the unlikely
event of a DCO bankruptcy. The
proposed rule also would require the
DCO to, at all times, maintain in the
accounts holding proprietary funds
enough resources to cover the total
value of proprietary funds owed to its
clearing members. The proposed rule
would prevent a DCO from
rehypothecating or otherwise using
proprietary funds for its own benefit,
thus ensuring that the funds are
available when needed by clearing
members or the DCO for permitted uses.
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2. Written Acknowledgment from
Depositories—§ 39.15(f)(2)
The Commission is proposing to
require a DCO to obtain from any
depository holding proprietary funds a
written acknowledgment that the funds
belong to the DCO’s clearing members
and cannot be used by the DCO for any
other purpose. The Commission is
proposing a template proprietary funds
letter that DCOs would be required to
use, which would be contained in
proposed appendix D to part 39. The
proposed template proprietary funds
letter is substantively the same as the
current template acknowledgment letter
45 Proposed § 39.15(e) cross-references § 1.25,
which provides that an FCM or DCO may invest
‘‘customer money’’ in certain instruments. The
regulatory text of § 1.25, however, does not refer to
‘‘proprietary funds.’’ The Commission recently
approved proposed amendments to § 1.25. Based on
comments received on those proposed
amendments, if appropriate, the Commission may
consider further amending § 1.25 either in the final
rule or as a re-proposed rule to ensure that the
regulatory text provides clarity on the application
of § 1.25 to a DCO’s investment of ‘‘proprietary
funds,’’ as permitted under § 39.15(e).
46 7 U.S.C. 7a–1(c)(2)(F); 17 CFR 39.15(e).
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for DCO accounts holding futures
customer funds required by § 1.20, and
requires a depository to acknowledge,
among other things, that the accounts
referenced in the letter hold funds that
belong to the DCO’s clearing members,
that the funds should be accounted for
separately from those belonging to the
DCO, and that the funds cannot be used
to cover the DCO’s obligations to the
depository.47 Further, the template
proprietary funds letter would require
the depository to respond to a request
from the director of DCR, or any
successor division, or the director’s
designees, for information about the
account, including the account balance.
Proposed § 39.15(f)(2) also includes the
same procedural requirements as those
in § 1.20. Specifically, it would require
a DCO to file a proprietary funds letter
with the Commission within three days
of opening an account, to update a letter
when certain information it contains
changes, and to maintain a copy of the
letter in accordance with § 1.31.
The Commission believes that
requiring a proprietary funds letter
would ensure that a depository holding
proprietary funds would know that the
funds belong to the DCO’s clearing
members and cannot be used by the
DCO for any other purpose, which will
help prevent the misuse of funds by the
DCO or an employee of the DCO.
Further, having a letter for each
proprietary funds account would help a
bankruptcy court or trustee easily
identify those funds that constitute
member property in the event of a DCO
bankruptcy.
The Commission is proposing to
exclude accounts at Federal Reserve
Banks from the requirement to obtain a
proprietary funds letter. This is
consistent with § 1.20(g)(4), which states
that a DCO does not need a written
acknowledgment to hold customer
funds at a Federal Reserve Bank. As
discussed above, the Commission
believes that Federal Reserve Banks
would be unable to sign the template
proprietary funds letter, and wants to
promote the use of Federal Reserve
Bank accounts by DCOs when possible.
The Commission is also proposing a
simpler written acknowledgment
requirement for accounts held at the
central bank of a money center country.
Although a DCO holding proprietary
funds at the central bank of a money
center country would have to comply
with the same procedural requirements
applicable to other depositories, it
would not have to use the template
proprietary funds letter. The DCO
would only have to obtain a written
47 See
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acknowledgment stating that: (1) the
central bank was informed that the
funds deposited with the bank are
proprietary funds held in accordance
with section 5b(c)(2)(F) of the CEA and
Commission regulations; and (2) the
bank agrees to respond to requests from
the Commission for information about
the account, including the account
balance. As was the case with the
acknowledgment letter used for
accounts holding customer funds, the
Commission believes many central
banks would have issues with the
proposed template proprietary funds
letter. The Commission believes the
proposed rule would allow DCOs to
gain the benefits of holding funds at
central banks while adequately
safeguarding those funds and ensuring
that the Commission has the
information it needs to conduct
oversight of DCOs.
3. Commingling of Proprietary Funds—
§ 39.15(f)(3)
Proposed § 39.15(f)(3) is based on
§ 1.20(e) and (g) applicable to customer
funds, and would permit a DCO to
commingle proprietary funds from
multiple clearing members in a single
account at a depository, but would not
permit a DCO to commingle proprietary
funds with the DCO’s own funds or
customer funds. Having a clear
separation between proprietary funds
and a DCO’s own funds will make it
more difficult for funds to be misused,
and will provide additional clarity in
the event of a DCO bankruptcy
regarding the funds that should be
treated as member property rather than
part of the debtor’s estate. Further, the
ability to commingle proprietary funds
from multiple clearing members in one
account allows DCOs to limit
operational risks by simplifying their
banking processes and procedures.
4. Use of Proprietary Funds—
§ 39.15(f)(4)
Proposed § 39.15(f)(4) is based on
§ 1.20(f) and would require a DCO and
any depository holding proprietary
funds to treat all proprietary funds as
belonging to the clearing members of the
DCO. The Commission believes the
proposed rule will help ensure that
proprietary funds are not
rehypothecated or otherwise used by a
DCO and are readily available if needed
either by the clearing member directly,
or for a permitted clearing member use
by the DCO. However, the Commission
does not intend for this requirement to
interfere with or alter DCOs’ risk
management programs. Proposed
§ 39.15(f)(4)(i)(A) therefore would
clarify that the proprietary funds of a
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clearing member could be used to
satisfy obligations of that clearing
member’s customers, to the extent that
use is permitted by the DCO’s rules and
the DCO’s agreement(s) with the
clearing member. In addition, proposed
§ 39.15(f)(4)(i)(B) further would clarify
that a DCO use contributions of nondefaulting clearing members to a
guaranty fund to cover losses stemming
from a default, to the extent that use is
permitted by the DCO’s rules and its
agreement(s) with its clearing members.
Nothing in the proposed rule would
prevent a DCO from holding guaranty
fund contributions in a separate
proprietary funds account from
proprietary funds held as initial margin.
Moreover, proposed § 39.15(f)(4)(ii)
would provide that a depository
receiving proprietary funds from a DCO
for deposit in a segregated account may
not hold, dispose of, or use such funds
as belonging to any person other than
the clearing members of the depositing
DCO. Unlike the DCO, which is
responsible for separately considering
the proprietary funds owed to each
individual clearing member, a
depository is only responsible for
considering the proprietary funds it has
received as belonging to the clearing
members as a group.
D. Daily Reconciliation—§ 39.15(g)
The Commission is proposing new
§ 39.15(g), which would require a DCO
to conduct a daily reconciliation for
each type of segregated account (futures
customer funds, cleared swaps customer
collateral, and proprietary funds) it
holds for its clearing members. This
proposal is based on the requirement
applicable to FCMs in § 1.32. Under
proposed § 39.15(g), by noon of each
business day, the DCO would have to
perform these reconciliations on
balances held as of the close of the
previous business day. The proposed
requirement is intended to verify, each
business day, that the DCO maintains
sufficient funds in each relevant
account type to cover its aggregate
obligations to clearing members. The
Commission believes that the required
daily calculation and reconciliation and
independent review requirements in the
proposed rule would help a DCO to
identify quickly any misuse or loss of
proprietary or customer funds.
Proposed § 39.15(g)(1), (2), and (3)
would require a DCO to calculate the
amount of, respectively, futures
customer funds, cleared swaps customer
collateral, and proprietary funds owed
to each clearing member. These
provisions would further require the
DCO to reconcile the total amount,
aggregated across all clearing members,
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of each of futures customer funds,
cleared swaps customer collateral, and
proprietary funds, with the amount of
each respective type of funds held in
separate accounts across all
depositories. This reconciliation is
intended to confirm, each business day,
that the DCO maintains, in each type of
account, an adequate value of segregated
funds to meet its obligations to clearing
members.
Requirements for the method of
conducting these calculations are
contained in proposed § 39.15(g)(4).
Proposed § 39.15(g)(4)(i) would require
segregation of duties, consistent with
generally accepted auditing standards.48
Each of the DCO’s calculations and
reconciliations would need to be
approved by a person who did not
prepare the initial calculation or the
related reconciliation, and who does not
report to the person who prepared them.
Proposed § 39.15(g)(4)(ii)(A) would
address the valuation of securities in the
required calculations of amounts owed
and held. Securities would have to be
valued at their current market value,
with haircuts applied in accordance
with existing § 39.11(d)(1).
Proposed § 39.15(g)(4)(ii)(B) would
address mismatches in currencies in the
same account type by permitting a
deficit in one currency to be offset by a
surplus in another currency, with
conversion based on publicly available
exchange rates, and with surpluses
subject to haircuts reasonably
determined by the DCO, applied
consistently.49
Proposed § 39.15(g)(4)(ii)(C) would
address situations in which customer
funds of one type are commingled in a
different type of customer account (e.g.,
futures customer funds in a cleared
swaps customer account). In these
instances, the proposed rule would
require DCOs to treat all funds in a
futures customer account as futures
customer funds and all funds in a
cleared swaps customer account as
cleared swaps customer collateral, both
in terms of funds owed and funds held,
48 See Statement on Auditing Standards 145,
Appendix C, ¶ 21 (‘‘Segregation of duties is
intended to reduce the opportunities to allow any
person to be in a position to both perpetrate and
conceal errors or fraud in the normal course of the
person’s duties’’). See also 17 CFR 1.11(e)(3)(i)(G)
(requiring each FCM’s Risk Management Program to
include 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.)
49 For example, one would expect that the
haircuts the DCO applies to currency mismatches
with respect to its obligations to clearing members
here would be no smaller than the haircuts the DCO
applies to currency mismatches with respect to
collateral posted by a clearing member.
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291
for purposes of the calculation and
reconciliation required by proposed
§ 39.15(g).
Proposed § 39.15(g)(4)(iii) would
address the process by which a DCO
would calculate the amounts owed to
clearing members for each account type
by requiring the DCO to apply, for each
account type, the approach set forth for
FCMs in § 1.20(i). This would include
calculating the net liquidating equity for
each clearing member (in each account
type), taking into account the market
value of funds it receives from the
clearing member, gains and losses on
futures contracts, options, and swaps
(applying this approach to cleared
swaps), fees lawfully accruing in the
normal course of business (which, in the
case of a DCO, would include
transaction fees), and authorized
distributions or transfers of collateral. In
aggregating amounts owed, the DCO
would not reduce the sum of credit
balances owed to clearing members with
debit balances owed by other clearing
members.50
Finally, proposed § 39.15(g)(5) would
require the DCO to immediately report
to the Commission any discrepancy in
any of the relevant calculations or any
one or more of the reconciliations that
reveals that the DCO did not, at the
close of the previous business day,
maintain in separate segregated
accounts money, securities, and
property in an amount sufficient in the
aggregate to cover the total value of
funds owed to all clearing members.
E. Exclusions for Foreign Derivatives
Clearing Organizations—§ 39.15(h)
The Commission is not, at this time,51
proposing to apply the new member
property protections in proposed
§ 39.15(e)(3) (permitted investment of
proprietary funds), (f) (proprietary
funds), and (g)(3) (daily reconciliation of
proprietary funds) to certain DCOs
organized outside the United States
(foreign DCOs). Specifically, proposed
§ 39.15(h) would provide that proposed
§ 39.15(e)(3), (f) and (g)(3) do not apply
to a foreign DCO that would, in the
event of its insolvency, be subject to a
foreign proceeding, as defined in the
U.S. Bankruptcy Code, in the
jurisdiction in which it is organized.52
50 See
17 CFR 1.20(i)(4).
Commission may, in light of ongoing and
future developments with respect to clearing
models at such DCOs, including with respect to the
participation of U.S. market participants
(particularly such market participants who are
natural persons) reconsider these decisions (both
with respect to part 39 and to part 190) in a future
rulemaking.
52 The U.S. Bankruptcy Code defines ‘‘foreign
proceeding’’ as a collective judicial or
51 The
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Member property held at most foreign
DCOs would not be protected under part
190 in the event the DCO enters
bankruptcy,53 and the Commission
wants to avoid potential conflicts with
requirements concerning protection of
member property under the applicable
law in a foreign DCO’s home
jurisdiction.54
IV. Reporting—§ 39.19
The Commission is proposing new
§ 39.19(c)(4)(xxvi) to include, together
with the other event-specific reporting
requirements applicable to DCOs, the
requirement in proposed § 39.15(g)(5)
that a DCO report any discrepancies in
the amount of proprietary or customer
funds it holds. The Commission
believes that including all reporting
requirements applicable to DCOs in
§ 39.19 may assist DCOs in tracking
their reporting obligations.
ddrumheller on DSK120RN23PROD with PROPOSALS1
V. Request for Comment
The Commission is requesting
comments on all aspects of its proposal.
Additionally, the Commission
specifically requests comment on the
following:
administrative proceeding in a foreign country,
including an interim proceeding, under a law
relating to insolvency or adjustment of debt in
which proceeding the assets and affairs of the
debtor are subject to control or supervision by a
foreign court, for the purpose of reorganization or
liquidation. 11 U.S.C. 101(23). Further, the U.S.
Bankruptcy Code defines ‘‘foreign court’’ as a
judicial or other authority competent to control or
supervise a foreign proceeding (emphasis added).
11 U.S.C. 1502(3). Because the definition includes
non-judicial authorities, a resolution proceeding
where the assets and affairs of a foreign DCO are
controlled by a resolution authority would
constitute a foreign proceeding under 11 U.S.C.
101(23), and thus a DCO that is subject to such a
resolution proceeding would fall within the
exclusion of such paragraphs. (See, e.g., In re
Tradex Swiss AG, 384 B.R. 34, 42 (Bankr. D.Mass.
2008) (Swiss Federal Banking Commission ‘‘is an
administrative agency’’ and qualifies as a foreign
court under 1502(3)), In re ENNIA Caribe Holding
N.V., 594 B.R. 631, 639–40 & n. 11(Bankr. S.D.N.Y.
2018) (where the Central Bank of Curac
¸ao and St.
Maarten, as a regulator, controls the affairs of the
foreign debtor, an insurance company, it constitutes
a foreign court under 11 U.S.C. 1502(3)).
53 See 17 CFR 190.11(b).
54 As the Commission noted in revising its part
190 bankruptcy regulations in 2020, in the context
of certain DCOs organized outside the United
States, the Commission has traditionally focused its
efforts on the protection of the customers of FCM
members of such foreign DCOs. Bankruptcy
Regulations, 86 FR 19324, 19366 (April 13, 2021).
In promulgating those regulations, the Commission
attempted to avoid conflicts with insolvency
proceedings in the jurisdiction where a foreign DCO
is organized. Id. Thus, pursuant to 17 CFR
190.11(b), the Commission’s part 190 bankruptcy
regulations are limited to protecting contracts
cleared on behalf of FCM customers at such foreign
DCOs and the property margining or securing such
contracts. The foreign DCOs to which this
limitation applies are those DCOs organized outside
the United States that are subject to a foreign
proceeding, as defined in 11 U.S.C. 101(23), in the
jurisdiction in which it is organized.
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Would classification of guaranty fund
contributions as proprietary funds
inhibit DCOs’ current guaranty fund
programs? The Commission has
proposed to specifically include
guaranty fund deposits in the definition
of proprietary funds, and does not
intend for the inclusion to prevent
DCOs from continuing to use guaranty
funds as one of their default resources.
Should the Commission require DCOs
to report to the Commission the daily
calculations and reconciliations
required by proposed § 39.15(g)?
Anti-money laundering (AML) and
know-your-client (KYC) programs are
required for many entities registered
with the Commission, including
intermediaries such as FCMs. In the
context of intermediated DCOs, FCMs
perform this critical role of assisting
U.S. government agencies in detecting
and preventing money laundering.
However, in the context of nonintermediated DCOs, in the absence of
an FCM, DCOs may be exploited by
actors seeking to engage in illegal and
illicit activities. How might the
Commission ensure AML and KYC
compliance for DCOs that offer direct
clearing services (a market structure that
would not include FCMs or other
intermediaries that are typically
directed to create Bank Secrecy Act
compliance programs)? Should DCOs
offering direct-to-customer services to
non-eligible contract participants or
retail customers be required to comply
with AML and KYC requirements?
Should the Commission require any
additional written acknowledgments (to
those contained in proposed
§ 39.15(b)(3) or § 39.15(f)(2)(vi) as
applicable) from central banks of money
center countries in order for a DCO to
use them to hold futures customer
funds, cleared swaps customer
collateral, or proprietary funds?
VI. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA)
requires that agencies consider whether
the regulations they propose will have
a significant economic impact on a
substantial number of small entities
and, if so, provide a regulatory
flexibility analysis on the impact.55 The
amendments proposed by the
Commission will affect only DCOs. The
Commission has previously established
certain definitions of ‘‘small entities’’ to
be used by the Commission in
evaluating the impact of its regulations
on small entities in accordance with the
55 5
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RFA.56 The Commission has previously
determined that DCOs are not small
entities for the purpose of the RFA.57
Accordingly, the Chairman, on behalf of
the Commission, hereby certifies
pursuant to 5 U.S.C. 605(b) that the
proposed regulations will not have a
significant economic impact on a
substantial number of small entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995
(PRA) 58 imposes certain requirements
on federal agencies, including the
Commission, in connection with
conducting or sponsoring any
‘‘collection of information,’’ as defined
by the PRA. Under the PRA, an 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 from the Office of Management
and budget (OMB).59 The PRA is
intended, in part, to minimize the
paperwork burden created for
individuals, businesses, and other
persons as a result of the collection of
information by federal agencies, and to
ensure the greatest possible benefit and
utility of information created, collected,
maintained, used, shared, and
disseminated by or for the Federal
Government.60 The PRA applies to all
information, regardless of form or
format, whenever the Federal
Government is obtaining, causing to be
obtained, or soliciting information, and
includes required disclosure to third
parties or the public, of facts or
opinions, when the information
collection calls for answers to identical
questions posed to, or identical
reporting or recordkeeping requirements
imposed on, ten or more persons.61
This proposal, if adopted, would
result in a collection of information
within the meaning of the PRA, as
discussed below. This proposed
rulemaking contains collections of
information for which the Commission
has previously received a control
number from OMB. The title for this
existing collection of information is
OMB control number 3038–0076,
Requirements for Derivatives Clearing
Organizations (‘‘OMB Collection 3038–
0076’’).
56 Policy Statement and Establishment of
Definitions of ‘‘Small Entities’’ for Purposes of the
Regulatory Flexibility Act, 47 FR 18618 (Apr. 30,
1982).
57 See A New Regulatory Framework for Clearing
Organizations 66 FR 45604, 45609 (Aug. 29, 2001).
58 44 U.S.C. 3501 et seq.
59 See 44 U.S.C. 3507(a)(3); 5 CFR 1320.5(a)(3).
60 See 44 U.S.C. 3501.
61 See 44 U.S.C. 3502(3).
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The Commission therefore is
submitting this proposal to the OMB for
its review in accordance with the
PRA.62 Responses to this collection of
information would be mandatory. The
Commission will protect any
proprietary information according to the
Freedom of Information Act and part
145 of the Commission’s regulations.63
In addition, section 8(a)(1) of the CEA
strictly prohibits the Commission,
unless specifically authorized by the
CEA, from making public any data and
information that would separately
disclose the business transactions or
market positions of any person and
trade secrets or names of customers.64
Finally, the Commission is also required
to protect certain information contained
in a government system of records
according to the Privacy Act of 1974.65
1. OMB Collection 3038–0076—
Requirements for Derivatives Clearing
Organizations
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The Commission is proposing a new
reporting requirement in § 39.15(f)(2) to
require DCOs based in the United States
to obtain a template proprietary funds
letter from each depository that holds
proprietary funds and to file that letter
with the Commission. The template
letter and filing requirements are
substantially the same as the
requirement in § 1.20(d) for FCMs to file
an acknowledgment letter signed by
each depository holding customer
funds. In OMB control number 3038–
0024, ‘‘Regulations and Forms
Pertaining to Financial Integrity of the
Market Place; Margin Requirements for
SDs/MSPs,’’ 66 the Commission
estimated that each FCM would file
three acknowledgment letters a year and
that filing each letter would take two
hours to complete. Because the
proposed letter and requirements for
DCOs are the same as those for FCMs,
the Commission believes that the
estimates for FCMs filing
acknowledgment letters are appropriate
for DCOs filing proprietary funds letters.
Therefore, the Commission believes that
the proposed requirement will require
each DCO based in the United States to
expend six hours per year to comply,
resulting in a total burden of 60 hours
for DCOs.
62 See
44 U.S.C. 3507(d) 5 CFR 1320.11.
5 U.S.C. 552; see also 17 CFR part 145
(Commission Records and Information).
64 7 U.S.C. 12(a)(1).
65 5 U.S.C. 552a.
66 For the previously approved estimates for this
collection, see ICR Reference No. 202207–3038–001
(conclusion date Aug. 23, 2022, available at https://
www.reginfo.gov/public/do/PRAViewICR?ref_
nbr=202207-3038-001).
63 See
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The aggregate burden estimate for
proprietary funds template letter
reporting in Collection 3038–0076 is as
follows:
Estimated number of respondents: 10.
Estimated annual reports per
respondent: 3.
Estimated total annual responses: 30.
Estimated average burden hours per
response: 2.
Estimated annual burden hours per
respondent: 6.
Estimated total annual reporting
burden for all respondents: 60.
Finally, the Commission is proposing
§ 39.15(g) to require DCOs to report in
accordance with § 39.19(c)(4) any
discrepancies in the results of the
required daily calculations and
reconciliations. This is a new reporting
requirement and thus the Commission is
revising its estimate of the burden
associated with event-specific reporting
under § 39.19(c)(4) in Collection 3038–
0076. A discrepancy in one of the
required calculations or reconciliations
would mean that the DCO is not holding
or accounting for the correct amount of
either customer or proprietary funds,
i.e., that it is not meeting regulatory
requirements. The Commission does not
anticipate DCOs will need to file this
report often, and ideally not at all, such
that even one report per year would
exceed expectations. Nonetheless, to
avoid under-estimating the burden of
the proposed regulation, the
Commission estimates that DCOs will
file the required report once per year.
The Commission believes that each
report will take approximately 30
minutes to complete. The requirement is
for DCOs to file immediately upon
learning of the discrepancy, which will
necessarily limit the amount of time
available to prepare a report. The
current burden estimate in Collection
3038–0076 for event specific reporting
under § 39.19(c) is 14 reports a year per
respondent. Therefore, the Commission
amending Collection 3038–0076 and s
estimating that 13 covered DCOs will
complete an estimated 15 reports per
year per respondent, resulting in a total
burden of seven-and-a-half hours for
event-specific reporting.
The aggregate burden estimate for
event-specific reporting under
§ 39.19(c)(4), as amended by the
proposal, is updated as follows:
Estimated number of respondents: 13.
Estimated annual reports per
respondent: 15.
Estimated total annual responses:
195.
Estimated average hours per response:
0.5.
Estimated annual burden hours per
respondent: 7.5.
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293
Estimated total annual burden hours
for all respondents: 97.5.
The Commission’s existing
recordkeeping rule will require DCOs to
maintain records of the information
generated though compliance with the
proposed rules.67 Specifically, DCOs
will need to maintain records related to
the calculations and reconciliations
required under proposed § 39.15(g) and
the proprietary funds letters required
under proposed § 39.15(f)(2). The
Commission, however, believes that the
impact of the proposed regulations on
the recordkeeping burden in Collection
3038–0076 will be negligible. DCOs are
already required to maintain all
information required to be created,
generated, or reported under part 39.68
DCOs regularly maintain records of
items created through their compliance
with the Commission’s regulations, and
the proposed rules will not raise unique
recordkeeping challenges or burdens.
Therefore, the Commission is retaining
its existing recordkeeping burden
estimates for Collection 3038–0076.
2. Request for Comment
The Commission invites the public
and other Federal agencies to comment
on any aspect of the proposed
information collection requirements
discussed above. Pursuant to 44 U.S.C.
3506(c)(2)(B), the Commission will
consider public comments on this
proposed collection of information in:
(1) Evaluating whether the proposed
collection of information is necessary
for the proper performance of the
functions of the Commission, including
whether the information will have a
practical use;
(2) Evaluating the accuracy of the
estimated burden of the proposed
collection of information, including the
degree to which the methodology and
the assumptions that the Commission
employed were valid;
(3) Enhancing the quality, utility, and
clarity of the information proposed to be
collected; and
(4) Minimizing the burden of the
proposed information collection
requirements on registered entities,
including through the use of appropriate
automated, electronic, mechanical, or
other technological information
collection techniques, e.g., permitting
electronic submission of responses.
The Commission specifically invites
public comment on the accuracy of its
estimates that the proposed regulations
will not impose a new recordkeeping
burden and its determination to retain
67 See
17 CFR 39.20.
68 Id.
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its existing burden estimates for
recordkeeping for Collection 3038–0076.
Copies of the submission from the
Commission to OMB are available from
the CFTC Clearance Officer, 1155 21st
Street NW, Washington, DC 20581, (202)
418–5714 or from https://RegInfo.gov.
Organizations and individuals desiring
to submit comments on the proposed
information collection requirements
should send those comments to:
• The Office of Information and
Regulatory Affairs, Office of
Management and Budget, Room 10235,
New Executive Office Building,
Washington, DC 20503, Attn: Desk
Officer of the Commodity Futures
Trading Commission;
• (202) 395–6566 (fax); or
• OIRAsubmissions@omb.eop.gov
(email).
Please provide the Commission with
a copy of submitted comments so that
all comments can be summarized and
addressed in the final rulemaking, and
please refer to the ADDRESSES section of
this rulemaking for instructions on
submitting comments to the
Commission. OMB is required to make
a decision concerning the proposed
information collection requirements
between 30 and 60 days after
publication of this release in the Federal
Register. Therefore, a comment to OMB
is best assured of receiving full
consideration if OMB receives it within
30 calendar days of publication of this
release. Nothing in the foregoing affects
the deadline enumerated above for
public comment to the Commission on
the proposed rules.
ddrumheller on DSK120RN23PROD with PROPOSALS1
C. Cost-Benefit Considerations
1. Introduction
Section 15(a) of the CEA requires the
Commission to consider the costs and
benefits of its actions before
promulgating a regulation under the
CEA or issuing certain orders.69 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
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) factors (collectively
referred to herein as Section 15(a)
factors).
The Commission recognizes that the
proposed amendments impose costs.
69 7
U.S.C. 19(a).
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The Commission has endeavored to
assess the anticipated costs and benefits
of the proposed amendments in
quantitative terms, including PRArelated costs, where feasible. In
situations where the Commission is
unable to quantify the costs and
benefits, the Commission identifies and
considers the costs and benefits of the
applicable proposed amendments in
qualitative terms. The lack of data and
information to estimate those costs is
attributable in part to the nature of the
proposed amendments. Additionally,
any initial and recurring compliance
costs for any particular DCO will
depend on the size, existing
infrastructure, level of clearing activity,
practices, and cost structure of the DCO.
The Commission generally requests
comment on all aspects of its costbenefit considerations, including the
identification and assessment of any
costs and benefits not discussed herein;
data and any other information to assist
or otherwise inform the Commission’s
ability to quantify or qualitatively
describe the costs and benefits of the
proposed amendments; and
substantiating data, statistics, and any
other information to support positions
posited by commenters with respect to
the Commission’s discussion. The
Commission welcomes comment on
such costs, particularly from existing
DCOs that can provide quantitative cost
data based on their respective
experiences. Commenters may also
suggest other alternatives to the
proposed approach.
The Commission notes that this
consideration is based on its
understanding that the derivatives
market regulated by the Commission
functions internationally with: (1)
transactions that involve entities
organized in the United States occurring
across different international
jurisdictions; (2) some entities organized
outside of the United States that are
prospective Commission registrants; and
(3) some entities that typically operate
both within and outside the United
States and that follow substantially
similar business practices wherever
located. Where the Commission does
not specifically refer to matters of
location, the discussion of costs and
benefits below refers to the effects of the
proposed regulations on all relevant
derivatives activity, whether based on
their actual occurrence in the United
States or on their connection with, or
effect on U.S. commerce.70
70 See,
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2. Baseline
The Commission identifies and
considers the benefits and costs of the
proposed amendments relative to the
baseline of the status quo. In particular,
the baseline for the Commission’s
consideration of the costs and benefits
of this proposed rulemaking is the
existing statutory and regulatory
framework applicable to DCOs,
including: (1) the DCO core principles
set forth in section 5b(c)(2) of the CEA;
(2) the requirements associated with
holding clearing member funds for
positions in futures, foreign futures, and
swaps under § 39.15; (3) the current
DCO reporting requirements under
§ 39.19; and (4) the requirements for
obtaining an acknowledgment letter
from a foreign central bank holding
customer funds, but not member funds.
3. Proposed Amendments to § 39.15(b)
a. Summary of Changes
The Commission is proposing new
§ 39.15(b)(3), which would allow the
central banks of money center countries
to serve as depositories for customer
funds. The proposed regulation would
further allow a DCO holding customer
funds at the central bank of a money
center country to obtain a modified
written acknowledgment that is shorter
and less detailed than the template
acknowledgment letter in §§ 1.20 and
22.4.
b. Benefits
The Commission believes that central
banks are often the best option for
deposit of customer funds. By using a
central bank, DCOs can minimize the
credit and liquidity risks they face when
holding foreign currency cash deposits.
Many foreign central banks do not fit
into any of the categories of permissible
depositories in § 1.49, and some central
banks have expressed unwillingness to
sign the template acknowledgment
letter. By permitting DCOs to deposit
customer funds at the central banks of
money center countries and requiring an
abbreviated written acknowledgment
suitable for the central bank context, the
Commission believes that DCOs will be
able to avail themselves of the risk
management benefits of holding funds
at a central bank.
c. Costs
The Commission does not believe the
proposed rule will impose costs on
DCOs. The proposed rule does not
require DCOs to hold customer funds at
any particular central bank and merely
enables DCOs to hold funds at certain
central banks.
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d. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of the proposed
amendments to § 39.15(b)(3) in light of
the specific considerations identified in
section 15(a) of the CEA. The
Commission believes the proposed rule
would protect market participants by
allowing their funds to be more easily
held at foreign central banks. Central
banks expose depositors to minimal
credit and liquidity risks and are safe
depositories for assets belonging to
market participants. Similarly, the
proposed rules may improve DCOs’ risk
management because of the low credit
and liquidity risks associated with
holding funds at a central bank. The
Commission has considered the other
Section 15(a) factors and believes that
they are not implicated by the proposed
amendments to § 39.15(b)(3).
4. Proposed Amendments to § 39.15(e)
a. Summary of Changes
The Commission is proposing rules
that would limit the investments DCOs
can make with proprietary funds to
those that are permissible for customer
funds under § 1.25. The proposed rule
also states that DCOs would be
responsible for investment losses.
b. Benefits
The proposed rule would limit
investments of proprietary funds to the
safe investments listed in § 1.25. This is
the same list of investments that can be
made with customer funds. The
Commission believes this proposal
would appropriately protect clearing
members from risk of loss by ensuring
that any investment is in instruments
with minimal credit, market, and
liquidity risks.
ddrumheller on DSK120RN23PROD with PROPOSALS1
c. Costs
The proposed rule may impose some
costs on DCOs. Some DCOs may have to
stop investing proprietary funds in
certain instruments that are currently
permitted and may incur some
operational costs in revising the
investments that are offered to clearing
members for their proprietary funds.
Further, to the extent the permitted
investments earn less yield than what a
DCO currently invests in, the regulation
would impose costs in the form of lost
investment revenue for the DCO and
clearing member. The total cost of this
regulation will depend on a number of
factors including the number of clearing
members of the DCO and what, if any,
investments the DCO currently makes
with proprietary funds.
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a. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of the proposed
amendments to § 39.15(e) in light of the
specific considerations identified in
section 15(a) of the CEA. The proposed
rule would benefit clearing member
market participants by ensuring their
funds are invested in instruments that
minimize the risk of loss. While DCOs
currently determine what investments
to make with clearing member funds,
the proposed rule establishes a list of
investments that the Commission
believes is appropriately conservative
for all clearing members. The
Commission has considered the other
Section 15(a) factors and believes that
they are not implicated by the proposed
amendments to § 39.15(e).
5. Proposed Amendments to
§ 39.15(f)(1)
a. Summary of Changes
The Commission is proposing new
§ 39.15(f)(1), which would require DCOs
to segregate proprietary funds from their
own funds, hold the funds in accounts
clearly labeled as holding proprietary
funds, and hold at all times an amount
sufficient in the aggregate to cover the
total value of proprietary funds held for
all clearing members.
b. Benefits
The proposed rule would benefit
clearing members by helping to ensure
that proprietary funds on deposit will
not be misused. Holding proprietary
funds in an account that is exclusively
for proprietary funds and clearly named
as being for proprietary funds would
make it difficult for a DCO or any
employee to use the funds for an
improper purpose without being
detected. Further, the requirement that
accounts hold funds adequate to cover
the total value of proprietary funds held
for all clearing members at all times
would prevent a DCO from
rehypothecating or otherwise using
proprietary funds for its own benefit,
thus ensuring that the funds are
available when needed by clearing
members or the DCO for permitted uses.
The proposed rule would also ensure
funds are readily identifiable in the
event of a DCO bankruptcy, which
would facilitate those funds receiving
the appropriate preferential treatment.
c. Costs
The proposed rule might add some
costs for DCOs if they need to establish
new accounts for proprietary funds.
DCOs would need to establish new
procedures for regularly confirming that
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the accounts hold funds adequate to
cover the total value of proprietary
funds of all clearing members. However,
as a mitigating factor, the Commission
believes that most, if not all, DCOs
currently hold proprietary funds
separately from their own, and that most
DCOs do not rehypothecate or otherwise
use funds for their own purposes. In
such cases, if there are any costs, they
would be related to staff time involved
with renaming current accounts holding
proprietary funds. The exact costs will
depend on a number of factors
including how many accounts a DCO
maintains for proprietary funds.
d. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of the proposed
amendments to § 39.15(f)(1) in light of
the specific considerations identified in
section 15(a) of the CEA. The
Commission believes the proposed rule
would benefit market participants by
helping to ensure their funds are not
misused and by helping to make sure
the funds receive the proper,
preferential treatment in the event of a
DCO bankruptcy. The Commission also
believes that requiring DCOs to hold the
total amount of proprietary funds at all
times would promote sound risk
management because it would ensure
that the funds are available to the DCO
in the event of a clearing member
default. The Commission has
considered the other section 15(a)
factors and believes that they are not
implicated by the proposed
amendments to § 39.15(f)(1).
6. Proposed Amendments to
§ 39.15(f)(2)
a. Summary of Changes
The proposed rule would require
DCOs to obtain a proprietary funds
letter in the form prescribed in the
proposed appendix from each
depository holding proprietary funds.
The proposed letter is based on the
template acknowledgment letter for
DCOs required by § 1.20, and requires
depositories to acknowledge, among
other things, that the funds belong to
clearing members and cannot be used by
the DCO for any other purpose. The
proposed rule would also require a DCO
to file the letters with the Commission
and update the letters when certain
information changes. The proposed rule
would exclude Federal Reserve Banks
from the requirement to obtain a
proprietary funds letter from a
depository holding proprietary funds.
Further, the proposed rule would
require a simpler written
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acknowledgment from the central bank
of a money center country that is
holding proprietary funds than that
required of other depositories.
b. Benefits
The proposed rule would benefit
clearing members by ensuring that all
depositories holding proprietary funds
would know that the funds belong to
clearing members and cannot be used by
the DCO for any other purpose, which
would help prevent the misuse of funds
by the DCO or an employee of the DCO.
Further, having a proprietary funds
letter for each proprietary funds account
would help a bankruptcy court or
trustee easily identify that the funds are
member property in the event of a DCO
bankruptcy.
ddrumheller on DSK120RN23PROD with PROPOSALS1
c. Costs
The proposed rule would impose
costs on DCOs. DCOs would be required
to work with depositories to obtain
proprietary funds letters for existing
accounts and to file the letters with the
Commission. Further, DCOs would need
procedures for obtaining a letter for any
new account and for updating letters as
information changes going forward. The
Commission is attempting to limit the
costs of obtaining proprietary funds
letters by proposing to use a template
that is substantively the same as the
template letter required for customer
funds and is thus already in use by
many DCOs and their depositories. The
costs each DCO would incur would
depend, in large part, on the number of
depositories the DCO uses to hold
proprietary funds. The Commission has
estimated that the PRA costs for this
rule will be $100 per burden hour.
Based on the burden estimate discussed
above of six hours annually per DCO,
the Commission estimates that each
DCO will spend $600 in PRA costs
under this proposed rule.
d. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of the proposed
amendments to § 39.15(f)(2) in light of
the specific considerations identified in
section 15(a) of the CEA. The
Commission believes the proposed rule
would benefit market participants by
ensuring that all depositories holding
proprietary funds know that the funds
belong to clearing members and cannot
be used by the DCO for any other
purpose, thus helping to prevent the
misuse of funds. Having a proprietary
funds letter for each proprietary funds
account would help easily identify
which funds are member property in the
event of a DCO bankruptcy. Finally, the
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helping to prevent the misuse of
proprietary funds would promote sound
risk management by making it more
likely that the funds are available if
needed to cover a clearing member
default. The Commission has
considered the other section 15(a)
factors and believes that they are not
implicated by the proposed
amendments to § 39.15(f)(2).
7. Proposed Amendments to
§ 39.15(f)(3)
a. Summary of Changes
Proposed § 39.15(f)(3) would permit
DCOs to commingle proprietary funds
belonging to multiple clearing members
in the same custodial account. The rule
would prohibit a DCO from
commingling proprietary funds with the
DCO’s own funds or with FCM customer
funds.
b. Benefits
The Commission believes that
permitting DCOs to commingle
proprietary funds from multiple clearing
members in one account would allow
DCOs to minimize operational risk by
simplifying their banking processes and
procedures. Further, the proposed rule
would ensure that proprietary funds are
held separately from the DCO’s funds at
the depository, making it harder for a
DCO or an employee of the DCO to
misuse the funds without detection.
c. Costs
The Commission does not believe
permitting the commingling of multiple
clearing members’ funds in one account
would impose new costs on DCOs.
Currently, many DCOs hold clearing
member funds in a commingled
account, and the proposed rule would
only permit, not require, clearing
member funds to be commingled.
However, the Commission recognizes
that a DCO that currently commingles
clearing member funds with other funds
would need to segregate such funds and
establish a separate account for such
funds, thereby incurring new costs. But
because the prohibition on commingling
a DCO’s funds with its clearing
members’ funds codifies sound
participant protection and risk
management principles that most, if not
all, DCOs already apply, the
Commission does not believe that it
would impose significant new costs on
existing DCOs. Additionally, DCOs are
currently prohibited by the
requirements of section 4d of the Act
and the regulations thereunder from
commingling customer funds with the
funds of clearing members. The
proposed rule would therefore not
impose new costs with regard to holding
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clearing member funds and customer
funds separately.
d. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of the proposed
amendments to § 39.15(f)(3) in light of
the specific considerations identified in
section 15(a) of the CEA. The
Commission believes that prohibiting a
DCO from commingling its own funds
with proprietary funds would benefit
market participants by ensuring a clear
delineation between the DCO’s funds
and proprietary funds. This delineation
would make it more difficult to misuse
proprietary funds and would make
proprietary funds readily identifiable in
the event of a DCO bankruptcy. Further,
the Commission believes that the
proposed rule would promote sound
risk management because ensuring that
clearing members’ funds are held
separately from the DCO’s would make
it more difficult for the funds to be
misused without detection and would
therefore make it more likely that the
funds are available if needed to cover a
clearing member default. The
Commission has considered the other
section 15(a) factors and believes that
they are not implicated by the proposed
amendments to § 39.12(f)(3).
8. Proposed Amendments to
§ 39.15(f)(4)
a. Summary of Changes
The proposed rule would prohibit a
DCO or any of its depositories from
using proprietary funds for any reason
other than as belonging to the DCO’s
clearing members. The rule would
specifically provide that an FCM’s funds
may be used to cover its customers’
losses and as part of a DCO’s mutualized
guaranty fund.
b. Benefits
By eliminating any uses for
proprietary funds other than on behalf
of clearing members, the proposed rule
would help ensure that the funds are
readily available if needed either by the
clearing member directly, or for a
permitted use by the DCO. The
clarifications providing that an FCM’s
funds may be used by a DCO to cover
the FCM’s customers’ losses, or as part
of a clearing member-funded,
mutualized guaranty fund, ensures that
the rule would not hamper DCOs’
existing risk management programs.
c. Costs
Because the proposed rule would
codify sound participant protection and
risk management principles, the
Commission does not believe that it
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would impose significant costs on
DCOs. The Commission does not believe
DCOs are currently using clearing
member funds in a manner that is
inconsistent with this regulation.
Further, the proposed rule would not
require a guaranty fund or any specific
type of FCM guarantee of its customers’
performance, but instead would merely
permit what is currently common risk
management practice among DCOs.
d. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of the proposed
amendments to § 39.15(f)(4) in light of
the specific considerations identified in
section 15(a) of the CEA. The proposed
rule would benefit market participants
by helping to ensure that their funds are
protected and available for their use.
Additionally, the proposed rule would
promote sound risk management by
helping to ensure that clearing member
funds are readily available for permitted
risk management uses by a DCO, such
as in the event of a customer shortfall
or clearing member default. The
Commission has considered the other
section 15(a) factors and believes that
they are not implicated by the proposed
amendments to § 39.12(f)(3).
9. Proposed Amendments to §§ 39.15(g)
and 39.19(c)(4)(xxvi)
ddrumheller on DSK120RN23PROD with PROPOSALS1
a. Summary of Changes
Proposed § 39.15(g) would require
DCOs to, on a daily basis, calculate the
amount of futures customer funds,
cleared swaps customer collateral, and
proprietary funds owed to each clearing
member, separately for each account
class and on a currency by currency
basis. The proposed rule further would
require DCOs to reconcile, separately for
each account class, the amount of funds
owed to all clearing members with the
amount of funds held in depository
accounts for that class of funds. Each
calculation and reconciliation would
have to be approved by a person who
did not prepare the initial calculation or
reconciliation. The calculation and
reconciliation would have to be
performed as of the close of each
business day and completed by noon on
the following business day. The
proposed rule also would require
securities to be valued at their current
market value, subject to the DCO’s
haircuts, and calculations of the amount
owed to be made in a manner consistent
with the requirements of § 1.20(i).
Finally, both proposed §§ 39.15(g)(5)
and 39.19(c)(4)(xxvi) would require
DCOs to immediately report any
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discrepancy in the calculation or
reconciliation to the Commission.
b. Benefits
By requiring a DCO to verify on a
daily basis the amount of futures
customer funds, cleared swaps customer
collateral, and proprietary funds it is
holding, for each clearing member and
across all clearing members, the
proposed rule would facilitate the
prompt discovery of any missing futures
customer funds, cleared swaps customer
collateral, or proprietary funds.
Additionally, by requiring the daily
calculation and reconciliation to be
approved by an independent employee,
the proposed rule would help prevent a
single bad actor at a DCO from misusing
futures customer funds, cleared swaps
customer collateral, or proprietary
funds, and from concealing that misuse.
The requirement to report any
discrepancies to the Commission would
help ensure that the Commission is
immediately made aware of potentially
missing funds, and that it can work with
the DCO to resolve the matter.
c. Costs
The Commission understands that the
daily calculation and reconciliation
would impose costs on DCOs. DCOs
would need to develop procedures that
comply with the timing, valuation, and
calculation requirements in the
proposed rule, to calculate the amount
of funds owed to each clearing member
for each account class and to reconcile
the amount of funds owed to all clearing
members with the amount of funds held
at depositories for each account class.
Further, at least two DCO employees
would have to be involved in the
process of performing and approving the
calculations and reconciliations each
day. DCOs would also need to include
the new reporting requirement in their
process and procedures for eventspecific reporting to the Commission.
The Commission has sought to
minimize the costs of the proposed
regulation by only requiring reporting to
the Commission of discrepancies rather
than the filing of daily reports. The
exact costs would depend on the
account class(es) in which a DCO holds
funds, and the number of clearing
members and customer accounts at
issue. The Commission has estimated
that the PRA costs for event specific
reporting are $79 per hour. Based on the
burden estimate discussed above of .5
hours annually per DCO, the
Commission estimates that each DCO
will spend $39.50 in PRA costs under
this rule.
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297
d. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of the proposed
amendments to § 39.15(f)(5) in light of
the specific considerations identified in
section 15(a) of the CEA. The proposed
rule would benefit market participants
by enabling any loss or theft of funds to
be discovered by the DCO and reported
to the Commission quickly. The
Commission further believes that the
proposed rule would promote sound
risk management by helping to ensure
that the funds are available if needed by
the DCO to cover a clearing member or
customer default. The Commission has
considered the other section 15(a)
factors and believes that they are not
implicated by the proposed
amendments.
10. Proposed Amendment to § 39.15(h)
a. Summary of Changes
The proposed rule would exempt
foreign DCOs from the requirements of
proposed § 39.15(e)(3), (f), and (g)(3)
because in the event of an insolvency,
the clearing member funds held by a
foreign DCO would not be subject to
U.S. bankruptcy law.71
b. Benefits
The Commission has determined to
seek to avoid conflicts with insolvency
proceedings in the jurisdiction where a
foreign DCO is organized. The
Commission believes that certainty
surrounding which insolvency law
would apply would benefit the clearing
members of foreign DCOs.
c. Costs
The Commission does not believe the
rule would impose costs on foreign
DCOs. The proposed rule is preserving
the baseline, that funds belonging to a
foreign DCO’s clearing members will be
treated in accordance with the
insolvency law of the foreign DCO’s
home jurisdiction.
d. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of the proposed
amendments to § 39.15(h) in light of the
specific considerations identified in
section 15(a) of the CEA. The proposed
rule would benefit market participants
by providing certainty regarding which
insolvency law would apply to their
funds in the event a foreign DCO enters
an insolvency proceeding. The
Commission has considered the other
section 15(a) factors and believes that
71 See
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they are not implicated by the proposed
amendments.
D. Antitrust Considerations
Section 15(b) of the CEA requires the
Commission to take into consideration
the public interest to be protected by the
antitrust laws and endeavor to take the
least anticompetitive means of
achieving the purposes of the CEA, in
issuing any order or adopting any
Commission rule or regulation.72
The Commission believes that the
public interest to be protected by the
antitrust laws is the promotion of
competition. The Commission requests
comment on whether the proposed
amendments implicate any other
specific public interest to be protected
by the antitrust laws. The Commission
has considered the proposed rulemaking
to determine whether it is
anticompetitive and has identified no
anticompetitive effects. The
Commission requests comment on
whether the proposed rulemaking is
anticompetitive and, if it is, what the
anticompetitive effects are.
Because the Commission has
determined that the proposed rule
amendments are not anticompetitive
and have no anticompetitive effects, the
Commission has not identified any less
anticompetitive means of achieving the
purposes of the CEA. The Commission
requests comment on whether there are
less anticompetitive means of achieving
the relevant purposes of the CEA that
would otherwise be served by adopting
the proposed rule amendments.
List of Subjects in 17 CFR Part 39
Reporting, Treatment of funds.
For the reasons stated in the
preamble, the Commodity Futures
Trading Commission proposes to amend
17 CFR part 39 as follows:
PART 39—DERIVATIVES CLEARING
ORGANIZATIONS
1. The authority citation for part 39
continues to read as follows:
■
ddrumheller on DSK120RN23PROD with PROPOSALS1
Authority: 7 U.S.C. 2, 6(c), 7a–1, and
12a(5); 12 U.S.C. 5464; 15 U.S.C. 8325;
Section 752 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, Pub. L.
111–203, title VII, sec. 752, July 21, 2010, 124
Stat. 1749.
2. Amend § 39.2 by adding definitions
of the terms ‘‘Money center country’’
and ‘‘Proprietary funds’’ in alphabetical
order to read as follows:
■
§ 39.2
*
Definitions.
*
72 7
*
*
*
U.S.C. 19(b).
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Money center country means Canada,
France, Germany, Italy, Japan, and the
United Kingdom.
*
*
*
*
*
Proprietary funds means all money,
securities, and property received by a
derivatives clearing organization from,
for, or on behalf of, a clearing member
and held in a proprietary account, as
defined in § 1.3 of this chapter:
(1) To margin, guarantee, or secure
contracts for future delivery on or
subject to the rules of a contract market,
derivatives clearing organization, or
foreign board of trade or a cleared swap
contract, and all money accruing to a
clearing member as the result of such
contracts;
(2) In connection with a commodity
option transaction on or subject to the
rules of a contract market, derivatives
clearing organization, or foreign board
of trade:
(i) To be used as a premium for the
purchase of a commodity option
transaction for a clearing member;
(ii) As a premium payable to a
clearing member;
(iii) To guarantee or secure
performance of a commodity option by
a clearing member; or
(iv) Representing accruals (including,
for purchasers of a commodity option
for which the full premium has been
paid, the market value of such
commodity option) to a clearing
member;
(3) That constitutes, if a cleared swap
is in the form or nature of an option, the
settlement value of the option; or
(4) As a contribution to a guaranty
fund to mutualize the losses resulting
from a default by a clearing member by
covering the losses in accordance with
the derivatives clearing organization’s
rules and its agreement(s) with its
clearing members.
*
*
*
*
*
■ 3. Amend § 39.15 by adding paragraph
(b)(3), revising paragraph (e), and
adding paragraphs (f), (g), and (h) to
read as follows:
§ 39.15
Treatment of funds.
*
*
*
*
*
(b) * * *
(3) Central banks. Notwithstanding
anything to the contrary in §§ 1.20, 1.49,
22.4, 22.5, or 22.9 of this chapter, a
derivatives clearing organization may
hold futures customer funds or cleared
swaps customer collateral at the central
bank of a money center country if it
obtains from the central bank a written
acknowledgment that:
(i) The central bank was informed that
the customer funds deposited therein
are those of customers who trade
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commodities, options, swaps, and other
products and are being held in
accordance with the provisions of
section 4d of the Act and applicable
Commission regulations thereunder;
and
(ii) The central 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
Market Participants Division, 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.
*
*
*
*
*
(e) Permitted investments. (1) Funds
and assets belonging to clearing
members and their customers that are
invested by a derivatives clearing
organization shall be held in
instruments with minimal credit,
market, and liquidity risks.
(2) Any investment of customer funds
or assets by a derivatives clearing
organization shall comply with § 1.25 of
this chapter.
(3) A derivatives clearing organization
may invest proprietary funds only in a
manner that would be permitted for
customer funds under § 1.25 of this
chapter. The derivatives clearing
organization shall bear sole
responsibility for any losses resulting
from the investment of proprietary
funds.
(f) Proprietary funds—(1) Segregation.
A derivatives clearing organization must
separately account for and segregate all
proprietary funds as belonging to its
clearing members. A derivatives
clearing organization shall deposit
proprietary funds under an account
name that clearly identifies the funds as
belonging to clearing members and
shows that the funds are segregated as
required by this part. A derivatives
clearing organization must at all times
maintain in the separate segregated
account or accounts money, securities
and property in an amount sufficient in
the aggregate to cover the total value of
proprietary funds owed to all clearing
members.
(2) 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 an account for proprietary
funds by the derivatives clearing
organization with the depositories;
provided, however, a derivatives
clearing organization is not required to
obtain a written acknowledgment from
a Federal Reserve Bank with which it
has opened an account for proprietary
funds.
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(ii) The written acknowledgment must
be in the form as set out in Appendix
D to this part, except as provided in
paragraph (f)(2)(vi) of this section.
(iii) 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.
(iv) 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 proprietary
funds; or
(C) The account number(s) under
which proprietary funds are held.
(v) A derivatives clearing organization
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
period provided in § 1.31 of this
chapter.
(vi) Notwithstanding paragraph
(f)(2)(ii) of this section, a derivatives
clearing organization may deposit
proprietary funds with the central bank
of a money center country if it obtains
from the central bank a written
acknowledgment that:
(A) The central bank was informed
that the proprietary funds deposited
therein are those of clearing members
who trade commodities, options, swaps,
and other products and are being held
in accordance with the provisions of
section 5b(c)(2)(F) of the Act and
Commission regulations thereunder;
and
(B) The central bank agrees to reply
promptly and directly to any request
from the director of the Division of
Clearing and Risk, or any successor
division, or the director’s designees, for
confirmation of account balances or
provision of any other information
regarding or related to an account.
(3) Commingling. (i) A derivatives
clearing organization may for
convenience commingle the proprietary
funds that it receives from, or on behalf
of, clearing members in a single account
or multiple accounts with one or more
depositories.
(ii) A derivatives clearing organization
shall not commingle proprietary funds
with the money, securities or property
of the derivatives clearing organization,
or a customer account of a clearing
member of the derivatives clearing
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organization, or use proprietary funds to
secure or guarantee the obligation of, or
extend credit to, the derivatives clearing
organization.
(4) Limitation on use of proprietary
funds. (i) A derivatives clearing
organization shall not hold, use or
dispose of proprietary funds except as
belonging to the clearing member that
deposited the proprietary funds. The
use of proprietary funds as belonging to
clearing members may include, but is
not limited to:
(A) A derivatives clearing
organization may use the proprietary
funds belonging to a clearing member to
guarantee or cover deficits in a customer
account of that clearing member in
accordance with the derivatives clearing
organization’s rules and its agreement(s)
with the clearing member; and
(B) A derivatives clearing organization
may use non-defaulting clearing
members’ money, securities, or property
that is being held as a guaranty fund to
mutualize the losses resulting from a
default by a clearing member to cover
such losses in accordance with the
derivatives clearing organization’s rules
and its agreement(s) with its clearing
members.
(ii) No person, including any
derivatives clearing organization or any
depository, that has received proprietary
funds for deposit in a segregated
account, as provided in this section,
may hold, dispose of, or use any the
funds as belonging to any person other
than the clearing members of the
derivatives clearing organization which
deposited the funds.
(g) Daily reconciliation—(1) Futures
customer funds. By noon of each
business day, a derivatives clearing
organization that has received futures
customer funds from its clearing
members shall, as of the close of the
previous business day:
(i) Calculate the amount of futures
customer funds owed to each clearing
member, on a currency by currency
basis; and
(ii) Reconcile the total amount of
futures customer funds owed, on a
currency by currency basis, aggregated
across all clearing members, with the
amount of futures customer funds held
in separate accounts across all
depositories.
(2) Cleared swaps customer funds. By
noon of each business day, a derivatives
clearing organization that has received
cleared swaps customer collateral from
its clearing members shall, as of the
close of the previous business day:
(i) Calculate the amount of cleared
swaps customer collateral owed to each
clearing member, on a currency by
currency basis; and
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299
(ii) Reconcile the total amount of
cleared swaps customer collateral owed,
aggregated across all clearing members,
with the amount of cleared swaps
customer collateral held in separate
accounts across all depositories.
(3) Proprietary funds. By noon of each
business day, a derivatives clearing
organization that has received
proprietary funds from its clearing
members shall, as of the close of the
previous business day:
(i) Calculate the amount of proprietary
funds owed to each clearing member, on
a currency by currency basis; and
(ii) Reconcile the total amount of
proprietary funds owed, aggregated
across all clearing members, with the
amount of proprietary funds held in
separate accounts across all
depositories.
(4) Calculations. (i) Each calculation
and reconciliation required by this
paragraph (g) must be approved by a
person who did not prepare the
calculation or reconciliation and who
does not report to the person that
prepared the calculation or
reconciliation.
(ii) In performing the calculations
required by this paragraph (g):
(A) Securities shall be valued at their
current market value, with haircuts
applied in accordance with § 39.11(d);
and
(B) A reconciliation deficit in a
particular account type in one currency
may be offset by a surplus in that same
account type in another currency, based
on publicly available exchange rates,
with the surplus subject to haircuts
reasonably determined by the
derivatives clearing organization,
consistently applied.
(C) Where customer funds, including
funds received to margin, guarantee, or
secure futures, options, foreign futures,
foreign options, or swaps, are, pursuant
to an order of the Commission or a DCO
rule filed pursuant to paragraph (b)(2)of
this section, received for the purpose of
holding such funds in a futures account,
they shall be treated as futures customer
funds, both for purposes of funds owed
and funds held. Where such funds are
received for the purpose of holding such
funds in a cleared swaps customer
account, they shall be treated as cleared
swaps customer collateral, both for
purposes of funds owed and funds held.
(iii) Calculations of amounts owed in
this paragraph (g) shall be made
consistent with the requirements of
§ 1.20(i) of this chapter, as applied to
the accounts of a derivatives clearing
organization with respect to its
members’ futures customer, cleared
swaps customer, and proprietary
accounts.
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(5) A derivatives clearing organization
shall immediately report to the
Commission, pursuant to § 39.19, any
discrepancies in the calculation of the
amount of funds held for each clearing
member and any one or more of the
reconciliations that reveals that the
derivatives clearing organization did
not, at the close of the previous business
day, maintain in separate segregated
accounts money, securities and property
in an amount sufficient in the aggregate
to cover the total value of funds owed
to all clearing members.
(h) Exclusions for foreign derivatives
clearing organizations—Paragraphs
(e)(3), (f) and (g)(3) of this section do not
apply to a derivatives clearing
organization organized outside the
United States that would, in the event
of its insolvency, be subject to a foreign
proceeding, as defined in 11 U.S.C.
101(23), in the jurisdiction in which it
is organized.
■ 4. In § 39.19, add paragraph
(c)(4)(xxvi) to read as follows:
§ 39.19
Reporting.
*
*
*
*
*
(c) * * *
(4) * * *
(xxvi) Discrepancy in customer or
proprietary funds. A derivatives clearing
organization shall immediately report to
the Commission any discrepancies in
the calculation of the amount of funds
held for each clearing member and any
one or more of the reconciliations
required pursuant to § 39.15(g) that
reveals that the derivatives clearing
organization did not, at the close of the
previous business day, maintain in
separate segregated accounts money,
securities and property in an amount
sufficient in the aggregate to cover the
total value of funds owed to all clearing
members.
*
*
*
*
*
■ 5. Add appendix D to part 39 to read
as follows:
ddrumheller on DSK120RN23PROD with PROPOSALS1
Appendix D to Part 39—Derivatives
Clearing Organization
Acknowledgment Letter for CFTC
Regulation § 39.15 Proprietary Funds
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]
Proprietary Funds Account, CFTC
Regulation § 39.15 Proprietary Funds
Account under Section 5b(c)(2)(F) of the
Commodity Exchange Act [and, if
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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 clearing
members who trade commodities, options,
swaps, and other products, as required by
Commodity Futures Trading Commission
(‘‘CFTC’’) Regulations, including Regulation
§ 39.15, 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 39 of the CFTC’s regulations,
as amended; and that the Funds constitute
member property as defined by 11 U.S.C.
761(16) and CFTC Regulation § 190.01.
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.
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 any
successor divisions, or such director’s
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 any successor divisions, or
such director’s designees, upon which you
have relied after having taken measures in
accordance with your applicable policies and
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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
account maintained by us with you for the
purpose of holding our own funds. 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 proprietary 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
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the parties in connection with the
Account(s), this letter agreement shall govern
with respect to matters specific to section
5b(c)(2)(F) of the Act and CFTC Regulation
§ 39.15, 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:
Issued in Washington, DC, on December
26, 2023, by the Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not
appear in the Code of Federal Regulations.
Appendices to Protection of Clearing
Member Funds Held by Derivatives
Clearing Organizations—Commission
Voting Summary, Chairman’s
Statement, and Commissioners’
Statements
Appendix 1—Commission Voting
Summary
On this matter, Chairman Behnam
and Commissioner Johnson voted in the
affirmative. Commissioner Pham
concurred. Commissioners Goldsmith
Romero and Mersinger voted in the
negative.
ddrumheller on DSK120RN23PROD with PROPOSALS1
Appendix 2—Statement of Support of
Chairman Rostin Behnam
I support the issuance and publication of
the proposed rule on the protection of
clearing member funds held by derivatives
clearing organizations (DCOs). The
Commission has longstanding regulations
that provide comprehensive protections for
funds belonging to customers of a Futures
Commission Merchant (FCM).1 Similar
1 See 7 U.S.C. 6d; 17 CFR 1.20 through 1.39. See
also 17 CFR 22.1 through 22.17, and 30.7
(establishing similar regimes for cleared swaps
customer collateral and foreign futures customer
funds, respectively). DCOs that receive customer
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protections, however, do not exist for funds
belonging to clearing members of a DCO,
whether they are individual market
participants or FCMs themselves. The
proposed rule would implement a regime for
the protection of clearing member funds
largely analogous to the current regime
applicable to FCM customer funds.
Specifically, the proposed rule would ensure
that clearing member funds and assets
receive proper treatment if a DCO enters
bankruptcy by requiring segregation of
clearing member funds from the DCO’s own
funds 2 and that the funds be held in a
depository that acknowledges in writing that
the funds belong to clearing members,3 not
the DCO. The proposed rule would require
new regulations regarding the commingling
of clearing member or proprietary funds; 4
limitations on the use of these funds; 5 and
limit investments of the funds to the
investments permitted for customer funds
under Regulation § 1.25.6 In addition, the
proposed rule would permit DCOs to hold
customer and clearing member funds at
foreign central banks subject to certain
requirements. Finally, the proposed rule
would require DCOs to conduct a daily
calculation and reconciliation of the amount
of funds owed to customers and clearing
members and the amount actually held for
customers and clearing members.7
Commission regulations addressing the
custody and safeguarding of customer funds
have historically responded to the
characteristics of the prevailing model in
which all, or nearly all, clearing members of
a DCO were FCMs acting as intermediaries.
However, as noted in the proposed rule, the
Commission has granted registration to a
number of DCOs that clear directly for market
participants without the intermediation of
FCMs.8 Additionally, many DCOs that use
funds from their FCM clearing members must also
apply many of these customer protection
requirements.
2 See also 17 CFR 1.20(a) (requiring FCMs to
segregate customer funds from their own funds); 17
CFR 1.20(g)(1), 17 CFR 39.15 (b), 17 CFR 22.3(b)(1)
(requiring DCOs to segregate the customer funds of
their FCM clearing members from their own funds).
3 See also 17 CFR 1.20, 22.5, and 30.7 (requiring
an FCM to obtain an acknowledgment letter for
futures customer funds, cleared swaps customer
collateral, and foreign futures customer funds,
respectively); 17 CFR 1.20(g)(4), 17 CFR 22.5
(requiring a DCO to obtain an acknowledgment
letter from depositories).
4 See also 17 CFR 1.20(e) and (g).
5 See also 17 CFR 1.20(f).
6 17 CFR 1.25.
7 See also 17 CFR 1.32, 1.33.
8 Currently, CBOE Clear Digital, LLC; CX
Clearinghouse, L.P.; LedgerX, LLC; and North
American Derivatives Exchange Inc. allow
individuals to be direct clearing members. See In
the Matter of the Application of CBOE Clear Digital,
LLC For Registration as a Derivatives Clearing
Organization (June 5, 2023), available at https://
www.cftc.gov/IndustryOversight/IndustryFilings/
ClearingOrganizations/39855; In the Matter of the
Application of CX Clearinghouse, L.P. For
Registration as a Derivatives Clearing Organization
(Aug. 3, 2018), available at https://www.cftc.gov/
IndustryOversight/IndustryFilings/
ClearingOrganizations/16767; In the Matter of the
Application of LedgerX, LLC For Registration as a
Derivatives Clearing Organization (Sept. 2, 2020),
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the traditional FCM clearing model have at
least some non-FCM clearing members. The
growth and evolution of the nonintermediated clearing model necessitates
ensuring that our regulations establish a
regime for the safeguarding and protection of
clearing member funds that addresses the
issues and risks presented.
Lastly, I am pleased that the proposed rule
would, in effect, codify the no-action and
exemptive relief previously given to four
DCOs 9 by permitting DCOs to hold customer
funds at foreign central banks and use a
modified acknowledgment letter. The
proposed rule would also extend these
amended provisions to clearing member
funds. Permitting DCOs to hold customer and
clearing member funds at a central bank
allows them to take advantage of the credit
and liquidity risk management benefits that
central bank accounts provide. This is sound
policy and risk management.
I look forward to hearing the public’s
comments on the proposed rule. The 60-day
comment period will begin upon the
Commission’s publication of the proposed
rule on its website.
Appendix 3—Statement of
Commissioner Kristin N. Johnson
Trust is the core issue that motivates
today’s notice of proposed rulemaking
(Proposed Rule) regarding the protection of
clearing member funds held by derivatives
clearing organizations (DCOs) advanced by
the Division of Clearing and Risk.
On March 30, 2022, I commenced service
as a Commissioner of the Commodity Futures
Trading Commission (Commission or CFTC).
In a hearing before the Senate Agriculture,
Nutrition, and Forestry Committee a few
weeks earlier, I committed to promote the
available at https://www.cftc.gov/
IndustryOversight/IndustryFilings/
ClearingOrganizations/30998; In the Matter of the
Application of the North American Derivatives
Exchange for Registration as a Derivatives Clearing
Organization (Jan. 17, 2014), available at https://
www.cftc.gov/IndustryOversight/IndustryFilings/
ClearingOrganizations/38.
9 See CFTC Letter No. 16–59 (June 21, 2016),
available at https://www.cftc.gov/csl/16-59/
download (granting an exemption to the Chicago
Mercantile Exchange, Inc (CME) from the
requirements of Regulation § 1.49(d)(3) to permit
CME to hold customer funds at the Bank of Canada
and permitting the use of a modified
acknowledgment letter for customer accounts
maintained by the CME. at the Bank of Canada);
CFTC Letter No. 16–05 (Feb. 1, 2016), available at
https://www.cftc.gov/csl/16-05/download (granting
an exemption to Eurex Clearing AG (Eurex) from
the requirements of Regulation § 1.49(d)(3) to
permit Eurex to hold customer funds at Deutsche
Bundesbank and permitting the use of a modified
acknowledgment letter for customer accounts
maintained by Eurex at Deutsche Bundesbank); and
CFTC Letters No. 14–123 (Oct. 8, 2014), available
at https://www.cftc.gov/csl/14-123/download and
14–124 (Oct. 8, 2014), available at https://
www.cftc.gov/csl/14-124/download (granting an
exemption to ICE Clear Europe Limited and LCH
Ltd, respectively, from the requirements of
Regulation § 1.49(d)(3) to permit ICE Clear Europe
Limited and LCH Ltd to hold customer funds at the
Bank of England and permitting the use of a
modified acknowledgment letter for customer
accounts maintained by ICE Clear Europe Limited
and LCH Ltd, respectively, at the Bank of England).
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ddrumheller on DSK120RN23PROD with PROPOSALS1
integrity and stability of our markets and
protect customers, particularly vulnerable
and marginalized individual retail customers
who participate in our markets. This
commitment is among the most compelling
reasons for my public service.
Over the last few decades, the Commission
has adopted and refined protections for
customers of intermediaries in our markets,
namely by imposing rigorous obligations on
intermediaries to segregate the funds of their
customers, designating specific authorized
depositories, and outlining permitted
investments of customer funds.
Over the course of my tenure as a
Commissioner, in numerous public speeches,
statements, and interviews, I have called on
the Commission to advance parallel customer
protections for direct participants of nonintermediated clearinghouses registered with
the Commission as DCOs.1
Today’s Proposed Rule takes the first steps
to close this gap. I support this Proposed
Rule that advances the protection of clearing
member proprietary funds held by a DCO.
Specifically, the Proposed Rule:
• Requires a DCO to segregate clearing
member proprietary funds from the DCO’s
own funds, hold such funds in an account
labeled as proprietary funds, and obtain a
written acknowledgment letter from a
depository;
• Requires a DCO to treat clearing member
proprietary funds as belonging to the clearing
member while permitting the DCO to use
clearing member proprietary funds as part of
the DCO’s default waterfall, consistent with
the DCO’s rules and agreement with its
clearing members;
• Permits the DCO to commingle
proprietary funds of multiple clearing
members in a single omnibus account for
convenience while prohibiting the
commingling of proprietary funds with the
1 Kristin N. Johnson, Commissioner, CFTC,
Statement on Preserving Trust and Preventing the
Erosion of Customer Protection Regulation (Nov. 3,
2023), https://www.cftc.gov/PressRoom/
SpeechesTestimony/johnstatement110323; Kristin
N. Johnson, Commissioner, CFTC, Keynote Address
at the World Federation of Exchanges Annual
Meeting: Creating Rules of the Road for
(Dis)Intermediated and (De)Centralized Markets
(Sept. 21, 2023), https://www.cftc.gov/PressRoom/
SpeechesTestimony/opajohnson5; Kristin N.
Johnson, Commissioner, CFTC, Keynote Address at
Salzburg Global Finance Forum: Future-Proofing
Financial Markets Regulation (June 29, 2023),
https://www.cftc.gov/PressRoom/
SpeechesTestimony/opajohnson4; Kristin N.
Johnson, Commissioner, CFTC, Statement Calling
for the CFTC to Initiate A Rulemaking Process for
CFTC-Registered DCOs Engaged in Crypto or Digital
Asset Clearing Activities (May 30, 2023), https://
www.cftc.gov/PressRoom/SpeechesTestimony/
johnsonstatement053023; Kristin N. Johnson,
Commissioner, CFTC, Keynote Address at Digital
Assets @Duke Conference, Duke’s Pratt School of
Engineering and Duke Financial Economics Center:
Mitigating Crypto-Crises: Applying Lessons Learned
in Governance, Risk Management, and Compliance
(Jan. 26, 2023), https://www.cftc.gov/PressRoom/
SpeechesTestimony/opajohnson2; Kristin N.
Johnson, Commissioner, CFTC, Statement in
Support of Notice of Proposed Amendments to
Reporting and Information Requirements for
Derivatives Clearing Organizations (Nov. 10, 2022),
https://www.cftc.gov/PressRoom/
SpeechesTestimony/johnsonstatement111022b.
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DCO’s own funds or futures commission
merchant (FCM) customer funds;
• Permits the DCO to invest clearing
member proprietary funds in highly liquid
financial instruments pursuant to CFTC
Regulation § 1.25 and requires DCOs to be
responsible for investment losses; and
• Requires the daily reconciliation of
balances of FCM customers and clearing
members and segregated funds and the
reporting of any discrepancies.
In my capacity as a Commissioner at the
CFTC, I have strongly advocated for the
development of these important regulatory
protections that parallel existing protections
in intermediated market structures. This
Proposed Rule reflects the tremendous efforts
of coordination among the Division of
Clearing and Risk, the office of the Chairman,
my office, and my fellow Commissioners’
offices and their staff. Our collective
engagement reflects years of dialogue with
market participants, CFTC staff, other market
and prudential regulators and engagement
with the U.S. Department of the Treasury,
members of Congress, academics, and public
interest advocates.
This Proposed Rule offers a
transformational reform that brings to
markets in which clients may interact
directly with a DCO foundational protections
currently established in CFTC regulations
and enforced in markets that rely on
intermediaries.2
In a direct clearing model (nonintermediated market structure), clearing
members are not customers of
intermediaries,3 and therefore, do not qualify
for the regulatory protections available under
part 1 of the Commission’s regulations,
including the requirement to separately
account for and segregate customer funds as
belonging to customers, deposit customer
funds in specific locations, obtain written
acknowledgment letters from depositories,
and use customer funds as belonging to such
customers.4 The Proposed Rule reflects the
historic development and evolution of
markets and refers to the assets or funds on
deposit from a customer of an intermediary
as ‘‘customer funds.’’ The Proposed Rule
adopts the term ‘‘clearing member’’ to
describe those directly interacting with the
clearinghouse and ‘‘proprietary funds’’ to
describe clearing members’ assets or funds on
deposit.
The Commission acts to ensure parallel
protections in the market for every asset
class, adopting and seeking to implement the
existing, well-tested, and effective regulatory
framework under certain provisions of part 1
of the CFTC’s regulation to the preservation
2 Although the focus of my statement is on direct
participants in the context of non-intermediated
clearing models, the Proposed Rule has broader
implications. It applies to the proprietary funds of
FCMs in the context of an intermediated model as
well.
3 The term ‘‘customer’’ is generally reserved for
the individuals or businesses that rely on an
intermediary such as an FCM to facilitate a
transaction. Where a DCO offers direct services, the
individuals or businesses engaged with the
clearinghouse are generally described as
‘‘members.’’
4 17 CFR 1.20.
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of clearing member proprietary funds. This
may be increasingly important as the
Commission anticipates market participants’
introduction of novel financial products.
In adopting the Proposed Rule, the
Commission seeks to ensure that clearing
member proprietary funds are easily
identified and receive the proper treatment in
the event the DCO enters an insolvency or
bankruptcy proceeding.
Today, the Commission takes a first step to
ensure that there are parallel protections for
both the ‘‘customers’’ of intermediaries, and
the ‘‘clearing members’’ of DCOs who may
include (in a direct clearing model)
individual retail market participants.
Regulatory Gap for Direct Participants in
Non-Intermediated Clearing Models
Section 4d of the Commodity Exchange Act
(CEA) and parts 1, 22 and 30 of the
Commission’s regulations establish a
comprehensive regime to safeguard the funds
belonging to customers of FCMs in the
context of intermediated DCOs.
The customer protection regime requires
FCMs to segregate customer funds from their
own funds, deposit customer funds under an
account name that clearly identifies them as
customer funds, and obtain a written
acknowledgment from each depository that
holds customer funds. The customer
protection regime does not apply to the funds
of a person that clears trades directly through
a DCO and is a ‘‘clearing member’’ because
such market participants do not meet the
legal and regulatory definitions of the term
‘‘customer.’’
Therefore, direct participants that are not
‘‘customers’’ of intermediaries may not
benefit from the Commission’s wellestablished customer protection regime.
The Commission seeks to offer parallel
customer protections to direct participants in
non-intermediated DCOs—clearing
members—to preserve the value of their
proprietary funds, mitigate the risk of loss,
and improve the availability of those funds
for return to the clearing member should the
DCO fail. Section 5b(c)(2)(F) of the CEA (Core
Principle F) and CFTC Regulation § 39.15
apply to the treatment of clearing members’
funds and assets held by a DCO.
CFTC regulations require DCOs to establish
standards and procedures designed to protect
and ensure the safety of proprietary funds
and require DCOs to hold proprietary funds
in a manner that will minimize the risk of
loss or delay in access by the DCO to the
proprietary funds. Section 8a(5) of the CEA
grants the Commission authority to adopt
rules it determines are reasonably necessary
to effectuate the DCO core principles.5 The
safeguards in this Proposed Rule are indeed
reasonably necessary to effectuate DCO Core
Principle F.6
In light of the lack of parallel protections
for ‘‘clearing members’’ who directly
interface with DCOs, there is a significant gap
in the Commission’s ability to ensure the
protection and preservation of funds or assets
of direct participants. This Proposed Rule
closes the gap.
57
67
U.S.C. 12a(5).
U.S.C. 7a–1(c)(2)(F).
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The Collapse of the FTX Complex
The bankruptcy of FTX illustrates the
magnitude of the losses that customers may
experience in the absence of regulation that
prohibits commingling of client assets or
imposes obligations to segregate client assets
for the benefit of customers.
In November 2022, FTX Trading Ltd. d/b/
a/FTX.com (FTX), Alameda Research LLC
(Alameda) and approximately one hundred
and thirty FTX-affiliated entities filed for
bankruptcy in the United States.
Contemporaneous with the bankruptcy filing,
the Department of Justice (DOJ), Commission,
and other federal regulators began to
investigate claims that FTX employed
omnibus accounts that commingled customer
funds with the FTX enterprise resources,
allegedly misappropriating more than $10
billion in client assets.7
The CFTC has alleged that Mr. BankmanFried and FTX solicited customers on the
premise that the FTX platform could be
trusted.8 The CFTC’s complaint alleges that
despite these statements, FTX permitted
Alameda to access customer deposits and
commingle customer assets with Alameda’s
proprietary assets, which were used for
Alameda’s and its executives’ own business
operations, personal purchases, acquisitions
of other businesses, and risky investments.
While soliciting customers to trust in the
integrity of its business, FTX is alleged to
have siphoned off billions in customer
deposits.
ddrumheller on DSK120RN23PROD with PROPOSALS1
The Benefits and Limits of Alternatives to
Regulation: LedgerX
LedgerX, a non-intermediated
clearinghouse registered with the
Commission as a DCO and owned by parent
company FTX, illustrates the importance of
the protections advanced in the proposed
rulemaking.
On October 25, 2021, FTX.US acquired
LedgerX through a Delaware company doing
business as West Realm Shires Services Inc.
(West Realm Shires). When parent company
FTX filed a petition seeking bankruptcy
protection on November 11, 2022, the
bankruptcy court declared LedgerX a nondebtor entity. LedgerX was one of the few
assets within the network of FTX-affiliated
companies that remained solvent.
In 2017, years before the acquisition by
West Realm Shires, LedgerX submitted an
application with the Commission seeking
authorization to register as a DCO offering
fully-collateralized (crypto) derivatives
contracts. The Commission’s order, amended
in September 2020, imposed a number of
important conditions, including a condition
requiring LedgerX to ‘‘at all times maintain
funds of its clearing members separate and
distinct from its own funds.’’ 9
7 FTX Demonstrates Need for More Oversight:
CFTC’s Johnson (Bloomberg TV Nov. 9, 2022),
https://www.bloomberg.com/news/videos/2022-1109/ftx-demonstrates-need-for-more-oversight-cftc-sjohnson.
8 See Commodity Futures Trading Commission v.
Samuel Bankman-Fried, FTX Trading Ltd d/b/a
FTX.com, and Alameda Research LLC (S.D.N.Y.
2022) (Compl.).
9 Press Release No. 8230–20, CFTC, CFTC
Approves LedgerX, LLC to Clear Fully-
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When FTX filed for bankruptcy protection,
the conditions in the LedgerX order and
Commission staff’s enforcement of
compliance with the conditions contributed
significantly to the preservation of LedgerX’s
customer property.10 The LedgerX order
serves as an important precedent for the
framework the Commission must consider
when adopting parallel protections for DCO
direct clients, particularly retail clients, in
the non-intermediated context.
In 2022, LedgerX applied to amend its
order of registration as a DCO to allow it to
modify its existing non-intermediated model
to clear margined products for retail
participants while continuing with a nonintermediated model.
In May 2022, the Commission held a
convening to examine the implications of a
derivatives clearing market structure that
offers direct-to-client services. The convening
outlined important issues addressed in this
Proposed Rule.
The Rise of Non-Intermediated DCOs
DCOs play an increasingly important role
in the financial markets, though DCOs have
been central to facilitating access to the
derivatives market since the founding of our
nation and the futures market. The DoddFrank Act introduced a framework for the
regulation of swaps that imposed central
clearing and trade execution requirements,
registration and comprehensive regulation of
swap dealers, and recordkeeping and realtime reporting requirements.
The clearing market structure has evolved
from a traditional clearing model, where an
FCM served as an intermediary in
transactions between a customer and a DCO,
to a direct clearing model, where the
transactions are between the customer and
the DCO directly.11 As I have previously
stated:
FCMs solicit and accept orders for
derivatives transactions on behalf of
customers and receive customer funds to
margin, guarantee, or secure derivatives
transactions. FCMs are subject to significant
regulatory requirements, including customer
protection safeguards, safety and soundness
capital requirements, risk management,
conflicts of interest requirements, and antimoney laundering and know-your-customer
programs.12
At the core, in a traditional, intermediated
model, customer protection rules apply to
Collateralized Futures and Options on Futures
(Sept. 2, 2020), https://www.cftc.gov/PressRoom/
PressReleases/8230-20.
10 LedgerX’s ‘‘customers’’ are clearing members as
described above and would not otherwise qualify
for protections under parts 1 and 22 of the
Commission’s regulations.
11 Currently, CBOE Clear Digital, LLC, CX
Clearinghouse, L.P.; LedgerX, LLC, and North
American Derivatives Exchange Inc. allow
individuals to be direct clearing members.
Additionally, ICE NGX Canada Inc. clears
physically delivered energy contracts directly for
clearing members with a net worth exceeding CAD
$5,000,000 or assets exceeding CAD $25,000,000.
12 Kristin N. Johnson, Commissioner, CFTC,
Keynote Address at the World Federation of
Exchanges Annual Meeting: Creating Rules of the
Road for (Dis)Intermediated and (De)Centralized
Markets (Sept. 21, 2023), https://www.cftc.gov/
PressRoom/SpeechesTestimony/opajohnson5.
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303
FCMs and require FCMs to segregate
customer funds, including when such funds
are held at a DCO, among other safekeeping
measures.
In newly emerging disintermediated
market structures, the absence of an
intermediary creates a gap in the application
of the CFTC’s customer protection rules
because key customer protections are
triggered by the presence of a ‘‘customer,’’ as
defined by the CFTC, and an FCM that
facilitates the clearing of a customer’s
derivatives transactions at the DCO.13
The Proposed Rule achieves parallel
protections by applying key aspects of the
customer protection regime to proprietary
funds of clearing members and imposing
parallel asset protection requirements on
DCOs—both in intermediated and nonintermediated clearing models.
In addition, the Proposed Rule contains
important requests for comments, soliciting
feedback and engagement from the industry
on a number of potential future actions.
Future Rulemaking: Anti-Money Laundering
Requirements for DCOs
Anti-money laundering (AML) regulations
ensure that all transactions in our markets are
subject to identification verification
standards and prevent illicit activity in our
markets.
It is imperative that the Commission
continue to engage with the U.S. Department
of Treasury to ensure that AML regulations
apply to all applicable market structures
involving activities that create obligations to
comply with AML regulations.
The Proposed Rule includes a request for
comment that asks how might the
Commission ensure AML and KYC
compliance for DCOs that offer direct
clearing services (a market structure that
would not include FCMs or other
intermediaries that are typically directed to
create Bank Secrecy Act compliance
programs)? Should DCOs offering direct-tocustomer services to non-eligible contract
participants or retail customers be required to
comply with AML and KYC requirements?
Following consultation with the U.S.
Department of Treasury, the Commission
may need to engage in a formal rulemaking
that imposes AML requirements on DCOs.14
Technical Clarifications in CFTC Regulation
1.25
The Proposed Rule allows DCOs to invest
proprietary funds in permitted investments
pursuant to CFTC Regulation § 1.25. The
drafting cross-refers to CFTC Regulation
§ 1.25, but the Commission is currently
engaged in a proposed rulemaking that
amends CFTC Regulation § 1.25. My
supporting statements to amendments to
CFTC Regulation § 1.25 note that it is
imperative that the Commission consider an
equivalent application of CFTC Regulation
13 See
supra note 1.
note that the Commission has negotiated the
inclusion of AML requirements in the registration
order for several DCOs, including CBOE Clear
Digital, LLC and LedgerX LLC. I commend DCOs
that have implemented these conditions.
14 I
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§ 1.25 in the context of a DCO’s investment
of the member property of retail customers.15
Comments to the Proposed Rule should
indicate how best to ensure equivalence.16
Periodic Reporting of Daily Reconciliations
The Proposed Rule requires a DCO to
notify the CFTC of discrepancies in its daily
calculations. The Commission exercises
direct oversight with respect to DCOs,
meaning DCOs are not supervised by selfregulatory organizations (SRO) or designated
self-regulatory organizations (DSRO). The
Commission performs the examination
functions. DCOs may benefit from a similar
oversight as FCMs, which involves a regular
reporting of reconciliation and not just the
reporting of discrepancies.17 DCOs are
subject to robust Commission regulations,
examinations, and oversight. It will be
important to receive comments from all
stakeholders regarding the reporting of DCO
reconciliations.
Conclusion
It is my hope that this Proposed Rule will
move forward so that we can begin to
introduce greater protections for clearing
members, including retail customers. I thank
the Division of Clearing and Risk—Clark
Hutchinson, Eileen Donovan, Theodore
Polley, and Scott Sloan—for their
tremendous efforts in advancing this very
important, significant, and transformative
Proposed Rule.
ddrumheller on DSK120RN23PROD with PROPOSALS1
Appendix 4—Dissenting Statement of
Commissioner Christy Goldsmith Romero
This week, the Commission in a split vote,
on which I dissented, approved the first
proposed rule related to FTX’s bespoke
direct-to-retail market structure. That
structure removed the intermediary (known
as a futures commission merchant or FCM)
where the CFTC’s customer protection and
anti-money laundering regimes sit. I believe
that before my tenure, the Commission made
a mistake in approving two clearinghouses
(LedgerX owned by FTX before FTX’s
bankruptcy, and Nadex, which is now
Crypto.com) for this direct-to-retail market
structure before analyzing and addressing the
risks of a lack of AML requirements,
customer protections, and other checks and
balances.
After FTX’s bankruptcy, the CFTC is now
trying to remedy the consequences of its
15 Kristin N. Johnson, Commissioner, CFTC,
Statement on Preserving Trust and Preventing the
Erosion of Customer Protection Regulation (Nov. 3,
2023), https://www.cftc.gov/PressRoom/
SpeechesTestimony/johnstatement110323.
16 In footnote 45 in the Proposed Rule, the
Commission notes: Proposed § 39.15(e) crossreferences § 1.25, which provides that an FCM or
DCO may invest ‘‘customer money’’ in certain
instruments. The regulatory text of § 1.25, however,
does not refer to ‘‘proprietary funds.’’ The
Commission recently approved proposed
amendments to § 1.25. Based on comments received
on those proposed amendments, if appropriate, the
Commission may consider further amending § 1.25
either in the final rule or as a re-proposed rule to
ensure that the regulatory text provides clarity on
the application of § 1.25 to a DCO’s investment of
‘‘proprietary funds,’’ as permitted under § 39.15(e).
17 See supra note 15.
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mistake, one of which is that retail
participants do not have customer
protections under this model because they
lose their status as ‘‘customers,’’ instead
becoming ‘‘clearing members.’’ In the open
meeting, the CFTC staff said that the
proposed rule was an attempt to provide
parallel protections to those individuals who
we would normally consider to be
‘‘customers,’’ but who now are ‘‘members.’’
But it fails to provide parallel protections to
retail participants. The proposed rule
attempts to port over to this direct-to-retail
model one protection (segregation of funds,
which I support) without the other
protections, or checks and balances present
in an intermediated model with an FCM.
I do not know if it is even possible for the
CFTC to give parallel protections to retail
participants under a direct-to-retail model,
because the Commodity Exchange Act and
Commission rules contemplate the presence
of an FCM. Additionally, anti-money
laundering controls sit with the FCM, and
clearinghouses have no AML requirements.
AML is a critical guardrail for national
security and customer protection. The
Financial Stability Oversight Council’s
(FSOC) 2023 Annual Report says, ‘‘Cryptoassets remain susceptible to misuse by
terrorist organizations and other sanctioned
individuals’ efforts to move funds in support
of illicit activities.’’ 1
I do not believe that the rule, which was
rushed in three weeks at the end of the year,
is sufficient to remedy that earlier mistake.
The rule would benefit from more time than
three weeks.2 We should step back and assess
the impact of changing the tried and true
market structure by removing the FCM.
Without addressing a number of serious
issues, the rule may give a false sense of
security about the safety of a direct-to-retail
model, while hiding the threats. The CFTC
staff in the open meeting said that there are
a number of applications pending for this
model and they expect more. Without an
assessment, we may just move risk around
the system, while creating an illusion of
safety.
Such an assessment would implement a
recommendation from the FSOC. In its
October 2022 Report on Digital Asset
Financial Stability Risks and Regulation, the
FSOC recommended that member agencies
(including the CFTC) ‘‘assess the impact of
vertical integration (i.e., direct access to
markets by retail customers) on conflicts of
interest and market volatility, and whether
vertically integrated market structures can or
should be accommodated under existing laws
and regulations.’’ The CFTC has not
conducted this analysis, leaving the CFTC
out of step with FSOC’s recommendation.
1 See Financial Stability Oversight Council,
Annual Report 2023, https://home.treasury.gov/
system/files/261/FSOC2023AnnualReport.pdf,
(December 14, 2023).
2 Commissioners received it late Wednesday, the
day before Thanksgiving, three weeks before the
meeting, with no prior engagement with
Commissioners on the content of the rule. Because,
it raised serious questions, I asked that it be pulled
from the meeting and that Commissioners would
have more time. My request was denied with no
reason given.
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I invite the public to watch this week’s
CFTC public meeting, which showed that
there are serious issues that the CFTC should
assess and address before accommodating
this crypto industry model.3 The first is
whether the CFTC can impose AML
requirements on clearinghouses to prevent
retail funds from being commingled with
funds belonging to terrorists, cyber criminals
and drug cartels—a question on which the
CFTC is in the middle of its analysis.4 This
rule also does not require disclosures to
inform retail participants that they are giving
up customer protections and bankruptcy
customer priority, instead taking the status of
‘‘clearing members,’’ similar to the roles and
duties that normally falls to an FCM such as
a large bank.5 The rule also would not limit
clearinghouses to depositing these ‘‘member’’
funds in only banks or trusts, as FCMs are
required, which would allow the
clearinghouse to deposit funds with an
unregulated affiliate.6
Instead of learning the lessons of FTX, I
worry that rushing to approve this proposal
leaves the Commission out of step with other
federal financial regulators that are asking
whether a direct-to-retail model can or
should be accommodated under current law,
and assessing its implications. I also worry
that this proposed rule will form the basis for
the CFTC to approve more crypto companies
for this direct-to-retail model under the false
impression that this model is safe. I am
concerned about rushing this rule through at
the end of the year in three weeks’ time,
when these are critical post-FTX issues. I
must dissent.
The CFTC’s Laws and Regulations Protect
Customers and Guard Against Illicit Finance
Through a Market Structure That Has Stood
the Test of Time
Clearinghouses play an important public
interest role—they are critical market
infrastructure intended to foster financial
stability, trust, and confidence in U.S.
markets. Dodd-Frank Act reforms increased
central clearing, thereby increasing financial
stability. Those reforms also concentrated
risk in clearinghouses. With that
concentrated risk, it is critical that the
Commission maintain vigilance in its
oversight over clearinghouses to identify and
monitor risk and promote financial stability.
This is most important for the CFTC’s
monitoring of systemic risk.
FCMs also play an important role. First,
they stand as a shock absorber, providing
additional financial support to the
clearinghouse to safeguard the financial
system. Second, because they are customerfacing, they are responsible for providing
customer protections. The customer
protection regime under the Commodity
Exchange Act and CFTC rules are found in
3 See CFTC to Hold and Open Commission
Meeting on December 13, https://
www.youtube.com/watch?v=zANNkH5STzk,
(December 13, 2023) at 2:12:00.
4 See Id. at 3:07:40–3:08:40; 3:16:52–3:17:40.
5 See Id. at 2:37:45–2:39:10.
6 See Id. at 2:44:20–2:44:55.
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requirements for FCMs. In its October 2022
report, the FSOC discussed: 7
The current framework of markets
regulation is generally structured around the
requirement or presumption that markets are
accessed by retail customers through
intermediaries such as broker-dealers or
future commission merchants (FCMs). Those
intermediaries perform many important
functions, such as processing transactions,
acting as agent and obtaining best execution
for customers, extending credit, managing
custody of customer assets, ensuring
compliance with federal regulations, and
guaranteeing performance of contracts. As a
result of the special role these intermediaries
play in traditional market structures, they are
subject to unique regulations often focused
on customer protections, such as regulations
around conflicts of interest, suitability, best
execution, segregation of funds, disclosures,
and fitness standards for employees.
Upending this traditional market structure,
without analysis, can have unintended
consequences.
ddrumheller on DSK120RN23PROD with PROPOSALS1
There Are No Customers or Customer
Protections in a Direct-to-Retail Model
The CFTC does not require disclosures to
retail participants about the consequences of
participating in this model. In the direct-toretail model, customers lose their status as
‘‘customers,’’ thereby losing all of the
customer protections in the CFTC’s
regulatory framework, and instead take the
status of ‘‘clearing members,’’ raising a host
of issues. It is unlikely that retail customers
know and understand that they gave up all
of their customer protections. It is also
unlikely that retail customers know and
understand that in the event of a bankruptcy,
they lose their ‘‘customer’’ priority in a
distribution. It is also a question whether
these retail customers would have to take on
the FCM’s shock absorbing role.
When FTX’s application for authority to
issue margined crypto products 8 was
pending before us, on May 25, 2022, the
CFTC held a roundtable on the
disintermediated model. We heard then and
later received comments from many
stakeholders expressing serious concerns
over this model.
The FSOC also expressed concerns over
direct-to-retail models, warning in its
October 2022 report:
Financial stability implications may arise
from vertically integrated platforms’
approaches to managing risk . . . Direct
exposure by retail investors to rapid
liquidations of this kind also raises investor
and consumer protection issues. Platforms
7 See Financial Stability Oversight Council,
Report on Digital Asset Financial Stability Risks
and Regulation, https://home.treasury.gov/news/
press-releases/jy0986, (October 3, 2022).
8 The CFTC conditioned LedgerX’s registration on
the trades being fully collateralized. FTX applied to
eliminate this condition to issue margined products
directly to customers. I was not in favor of FTX’s
application, and signaled that weeks before FTX’s
failure. See CFTC Commissioner Christy Goldsmith
Romero, Financial Stability Risks of Crypto Assets:
Remarks before the International Swaps and
Derivatives Association’s Crypto Forum 2022,
https://www.cftc.gov/PressRoom/
SpeechesTestimony/oparomero3, (Oct. 26, 2022).
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dealing directly with retail investors would
need to ensure the provision of adequate
disclosures, responsibilities otherwise taken
on by intermediaries. The vertically
integrated model presents conflict of
interest. . . .9
The CFTC has not conducted the
assessment that FSOC recommended more
than one year ago. It is an open question of
whether the CFTC should accommodate
these direct-to-retail models given how much
is lost, including the loss of the CFTC’s
customer protection regime and AML regime.
This Rushed Proposed Rule Does Not
Replace Customer Protections, AML, and
Other Checks and Balances, Lost by
Removing the FCM
The CFTC has had a year to learn the
lessons from FTX’s application and assess
direct-to-retail models as FSOC
recommended. I am strongly in favor of
strengthening customer protections,
particularly for retail, including banning
commingling of customer funds,10 but this
proposal is not about ‘‘customer’’ funds. In a
direct-to-retail model, legally, there are no
customers. I am not in favor of retail losing
their status as customers and losing customer
protections.11 The proposed rule would be
the first post-FTX rule on this model, but it
was rushed and as a result, lacks sufficient
analysis.
The question raised by the FSOC of
whether we should accommodate this market
structure from crypto is a critical one to
answer. The deliberations at last week’s open
meeting confirmed that it may not be
possible to give retail participants the same
protections in a disintermediated model as in
the intermediated model. And just last week,
the FSOC Annual Report again warned about
the vulnerabilities arising from collapsing
regulatory functions into a single entity,
including ‘‘conflicts of interest, inappropriate
use of clients’ funds, and market
manipulation.’’ 12
This rule would not resolve the FSOC’s
concerns. It does not contain the assessment
needed as to risk and what regulatory
requirements would be required in a directto-retail model to meet a ‘‘same risk, same
regulatory outcome approach’’ that makes up
for the checks and balances lost from
removing the FCM. That would require
establishing the basic foundation of customer
9 See Financial Stability Oversight Council,
Report on Digital Asset Financial Stability Risks
and Regulation, https://home.treasury.gov/news/
press-releases/jy0986, (October 3, 2022).
10 See CFTC Commissioner Christy Goldsmith
Romero, Crypto’s Crisis of Trust: Lessons Learned
from the FTX’s Collapse, https://www.cftc.gov/
PressRoom/SpeechesTestimony/oparomero5#_
ftnref10, (Jan 18, 2023) (I warned in the aftermath
of FTX’s collapse about how commingling presents
‘‘a significant threat to customers that can leave
customers in a musical chairs dilemma.’’)
11 All participants, retail or institutional, are
considered clearinghouse members. This is not
some technical, legalistic distinction. Our laws will
treat those retail participants the same as the largest
financial institution.
12 See Financial Stability Oversight Council,
Annual Report 2023, https://home.treasury.gov/
system/files/261/FSOC2023AnnualReport.pdf,
(December 14, 2023).
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305
protections and guardrails (including against
illicit finance). Without that analysis, this
proposal puts the CFTC out of step with
other federal financial regulators.
The Direct to Retail Model Raises Many
Questions the CFTC Has Not Adequately
Considered
My concerns about a direct-to-retail model
include:
1. Losing status of ‘‘customer’’: Regular
people lose their protections as ‘‘customer’’
under the law in the direct-to-retail model.
Instead, they are treated as clearinghouse
‘‘members,’’ a role that traditionally has been
reserved for FCMs, which include the largest
financial institutions. The regular person
trading in bitcoin futures or event contracts
is not the same as J.P. Morgan or Wells Fargo.
Clearing members have obligations to the
clearinghouse to stave off clearinghouse
failure. This presumably would also be the
case for retail acting as members. I have
serious concerns about whether retail
participants understand what they are giving
up and that this is the role they are taking
on. The CFTC should consider requiring
plain English disclosures delivered in a
manner that actually informs people of their
rights and risks, as opposed to a click-wrap
agreement or lengthy legal document.
2. No AML/CTF/KYC: Because the
Commodity Exchange Act envisions the
presence of an FCM that has significant
responsibilities, including anti-money
laundering/Know Your Customer
requirements, clearinghouses do not have
currently have any obligation to implement
Anti-Money Laundering, Countering
Terrorist Financing or Know Your Customer
safeguards, opening up our market to illicit
finance. The Commission staff are still
analyzing what safeguards the CFTC can
require.
3. No requirements to deposit funds in a
regulated entity: FCMs are required to hold
customer funds at a bank, trust or a CFTCregulated entity. That requirement is absent
for member funds and is not added in this
rule, allowing clearinghouses to place the
funds anywhere, even an affiliate. That
means that FTX’s registered clearinghouse
LedgerX could have deposited retail
‘‘member’’ funds with Alameda, the trading
firm involved in the loss of billions of
customer funds.
4. No checks and balances: FCMs who
interface with customers have regulatory
requirements for customer protections, and
have incentives to monitor the clearinghouse
to make sure it is not misusing customer
funds. This role sits empty in a direct-toretail model.
5. No customer bankruptcy priority: In the
case of the clearinghouse bankruptcy under
this model, the bankruptcy code would not
consider retail participants to be
‘‘customers,’’ and they would not receive the
customer priority in any distribution.
More Time Is Needed To Analyze New AML
Requirements for Clearinghouses
I want to call special attention to the
proposal’s lack of anti-money laundering
(AML) and know your customer (KYC)
requirements for clearinghouses. Without
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these protections, retail funds may be at
serious risk of seizure if they are commingled
with funds of terrorist organizations, drug
cartels, or other illicit actors. It is well known
that cryptocurrency transactions are used to
finance cybercrime, terrorism, sanctions
avoidance, and the drug trade.13 News
reports suggest that Hamas used
cryptocurrency to receive significant funding
preceding its October 7th attacks.14
FCMs have regulatory responsibilities to
implement AML and KYC procedures, to
perform standardized diligence, to verify
customer identify and to assess whether
customers may be known or suspected
terrorists or sanctioned individuals. That
AML/CTF/KYC responsibility puts them at
the front lines of combating illicit finance.
The legal requirement also means the CFTC
and the National Futures Association can
examine how FCMs are implementing
required anti-money laundering controls.
That makes it more likely we will identify
material weaknesses before an FCM becomes
a conduit for illicit funds. Reporting
requirements also may make it easier for law
enforcement to identify suspicious patterns
and investigate them.
The proposed rule would not impose any
AML responsibilities for clearinghouses.
Under the proposal, retail participants could
have their funds commingled with those
deposited by terrorist or cybercriminals,
including state-sponsored cybercrime gangs.
In a seizure, the FBI, other law enforcement
or Treasury would seize all of the funds. I
would consider that a very serious risk to
member funds, one that the proposal does
not address.
At the open meeting, when I asked whether
the CFTC could impose AML requirements
on clearinghouses, the CFTC’s General
Counsel said that they had not completed
their analysis, but had not foreclosed the
possibility that the CFTC has authority to
impose AML requirements on clearinghouses
and that ‘‘it has some promise.’’ 15 The
proposed rule contained no analysis of this
issue. That was one of the reasons why I
asked that this proposed rule be pulled off of
the meeting, so that the CFTC could continue
to work on that analysis and include AML
requirements. My request was denied. At the
open meeting, the Office of the General
Counsel said that while the analysis was
ongoing, ‘‘it was decided on a policy basis
that we save that for another day.’’ 16 That
was not a policy decision made by a majority
of the Commission as that was never before
us.
More Analysis Is Needed To Determine
Whether Other Customer Protections and
Other Checks and Balances Can Be Provided
to Clearinghouses in the Direct-to-Retail
Model
This proposal would impose some
safeguards for member funds held at a
disintermediated clearinghouse by banning
commingling and imposing certain limits on
how funds can be used.17 But it is narrowly
targeted, and serious gaps remain, leaving the
proposed requirements far from the same
regulatory outcome as the traditional model.
Location of Deposits
FCMs and clearinghouses in the traditional
model are only permitted to deposit customer
funds with regulated entities—a bank or
trust, a clearinghouse, or another FCM—
giving the CFTC visibility into customer
funds, and layering customer protections.
This proposal would not have the same
limitation because these would not be
‘‘customer’’ funds. This proposed rule could
benefit from adding in the same requirement.
Otherwise, member funds could be deposited
with an unregulated entity, including an
unregulated affiliate with conflicts of
interest, that introduces more risk, leaving
the CFTC blind to risk.18 At the meeting, the
Commission heard from staff that they were
concerned about whether the current
requirement for where FCM’s can deposit
funds provided sufficient protections for
customers.19 The proposal does not have any
analysis of these concerns, likely because it
was rushed.
Oversight From Checks and Balances
The proposal also does not replicate
another important guardrail of traditional
market structure: checks and balances.
Separate clearinghouses and brokers (FCMs)
create natural bumper guards not present in
the direct-to-retail model. However, the
proposed rule contains no analysis of the
impacts of moving forward with this non16 Id.
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13 See
Attorney General, U.S. Department of
Justice, The Role of Law Enforcement in Detecting,
Investigating, and Prosecuting Criminal Activity
Related to Digital Assets, https://www.justice.gov/
d9/2022-12/The%20Report%20of%20the%20
Attorney%20General%20Pursuant%20
to%20Section.pdf, (Sept. 6, 2022).
14 Wall Street Journal, ‘‘Hamas Needed a New
Way to Get Money From Iran. It Turned to Crypto,’’
https://www.wsj.com/world/middle-east/hamasneeded-a-new-way-to-get-money-from-iran-itturned-to-crypto-739619aa?mg=prod/com-wsj,
(Nov. 12, 2023). The CFTC has brought enforcement
actions against two spot crypto exchanges, BitMEX
and Binance, for failing to follow AML controls.
Our action against Binance found that instead of
implementing those controls, Binance turned a
blind eye and even advised users to circumvent the
superficial controls it claimed to have.
15 CFTC to Hold and Open Commission Meeting
on December 13, https://www.youtube.com/
watch?v=zANNkH5STzk, (December 13, 2023) at
3:16:20–3:17:50.
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17 It would require direct clearing customer funds
to be held in a separate account from the
clearinghouse’s funds, in an account identifying
them as belonging to the customers. Those funds
could only be used on behalf of the customer, not
on behalf of the company or its affiliates. The funds
would need to be accounted for daily, and
reconciled with the total amount the clearinghouse
owes its customers. It would also limit what
clearinghouses can invest those funds in, with the
same limits that apply to brokers today under
Commission Regulation § 1.25. These protections
are largely in line with the representations made by
FTX about LedgerX’s rules in its application.
18 See Commissioner Christy Goldsmith Romero,
Crypto’s Crisis of Trust: Lessons Learned from the
FTX’s Collapse, https://www.cftc.gov/PressRoom/
SpeechesTestimony/oparomero5#_ftnref10, (Jan 18,
2023).
19 CFTC to Hold and Open Commission Meeting
on December 13, https://www.youtube.com/
watch?v=zANNkH5STzk, (December 13, 2023) at
2:42:40–2:46:08.
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traditional model. Instead, at the open
meeting, comments were made to the effect
about how certain companies have
determined that they prefer this market
structure, and the staff expect there to be
more applications for this model. It is
concerning to me that this rushed rule may
be used to facilitate expanding the use of this
model, which is not responsible without
further assessment as FSOC recommended.
Bankruptcy Priority for Customers
The failures of FTX and Celsius show
bankruptcy priority is a serious issue,
especially in the retail space. Retail
participants do not have the same ability as
institutions to withstand losses or delay.
Existing bankruptcy law assumes a
traditional market structure.20 Customers
take priority over FCMs in distributions.21
Retail participants in a disintermediated
clearing model may not realize that they are
losing bankruptcy priority as customers
because the CFTC requires no disclosures.
This loss of priority is not discussed in the
proposal. We should consider requiring clear
disclosures.
Conclusion
It is not responsible to rush our first postFTX rule on direct-to-retail models in three
weeks at the end of the year, without
conducting the necessary assessment of the
impact of this model as FSOC recommended
more than one year ago. I asked for this
proposed rule to be pulled off this open
meeting. I am concerned about the lack of
that assessment, including but not limited to
specific analysis of: (1) whether the CFTC
should require disclosures to inform retail
participants that they are losing their
customer status in this direct-to-retail model,
disclosures that describes their rights and
risks; (2) whether it is possible to take a same
risk, same regulatory outcome approach on
issues such as where funds can be deposited
and other concerns raised in comments to the
FTX application about these models; and (3)
whether the CFTC can require clearinghouses
to conduct AML/CTF/KYC. Although there
are some existing retail participants currently
in this model, at the open meeting, the staff
said that they were already ensuring that the
two crypto direct-to-retail clearing houses
were taking steps aligned with the proposed
rule.
Thirteen months after the collapse of FTX,
I am glad that we are starting to address the
direct-to-retail model as I have serious
concerns about it, and remain concerned
about any expansion of that model. However,
the risks to retail, financial stability, market
integrity and our national security, are too
great to rush this in three weeks without
analysis as FSOC recommended. Therefore, I
must dissent.
Appendix 5—Concurring Statement of
Commissioner Caroline D. Pham
I concur on the Notice of Proposed
Rulemaking on Protection of Clearing
20 Called ‘‘customer funds other than member
property.’’ See CFTC, Bankruptcy Regulations, 86
FR 19324 at 19365 (April 13, 2021).
21 Id. at 19378. There are also rules allocating
customer property among account classes.
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Member Funds Held by Derivatives Clearing
Organizations (DCOs) (Proposed
Amendments to Clearing Member Funds
Requirements or Proposal) because it seeks to
protect the proprietary funds of futures
commission merchants (FCMs), and I
understand that it essentially codifies the
existing good practices most of the CFTC’s
registered DCOs already follow. However,
with respect to retail participants, I believe
that the Commission should consider
whether there should be a new registration
category for direct clearing retail DCOs. I also
renew my call for an Office of the Retail
Advocate. Both of these steps would better
ensure customer protection in our regulated
markets.
I would like to thank Scott Sloan, Tad
Polley, Eileen Donovan, and Clark Hutchison
in the Division of Clearing and Risk for their
work on the Proposal. I appreciate the time
staff took to answer my questions.
Existing Protections for Both House
Accounts and Customer Funds Have Worked
Well for Decades Without Issues
First, to be clear, the Commission already
has extensive rules in place for protecting
FCM customer funds.1 Arguably, it is one
thing the CFTC is best-known for. For these
FCM customers, FCMs must segregate
customer funds from their own funds,
deposit customer funds under an account
name that clearly identifies them as customer
funds, and obtain a written acknowledgment
from each depository that holds customer
funds.2 This customer protection regime also
establishes accounting and reporting
requirements applicable to customer funds,
and limits both the types of investments that
can be made with customer funds and the
type of depositories that can hold customer
funds.3
With respect to clearing member
proprietary funds or house accounts,4
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1 Commodity
Exchange Act (CEA) section 4d, 7
U.S.C. 6d, and Regulations §§ 1.20 through 1.39, 17
CFR 1.20 through 1.39 (futures customer funds),
22.1–22.17, 17 CFR 22.1 through 22.17 (cleared
swaps customer collateral) and 30.7, 17 CFR 30.7
(foreign futures) establish a comprehensive
customer protection regime to safeguard the funds
belonging to customers of FCMs.
2 See 17 CFR 1.20, 22.5, and 30.7. The
acknowledgment letters must adhere to specific
templates in the Commission’s regulations, and
require a depository to acknowledge, among other
things, that the accounts opened by the FCM hold
funds that belong to the FCM’s customers.
3 See 17 CFR 1.32, 1.33, 1.25, and 1.49.
4 Regulation § 1.3, 17 CFR 1.3, defines a
‘‘customer’’ as ‘‘any person who uses [an FCM],
introducing broker, [CTA or CPO] as an agent in
connection with trading in any commodity
interest.’’ DCOs have to apply many of the customer
protection requirements that apply to FCMs to the
customer funds DCOs receive from FCM clearing
members. DCOs must segregate the customer funds
of their FCM clearing members from their own
funds, deposit customer funds under an account
name that identifies the funds as customer funds,
obtain acknowledgment letters from depositories,
limit the investment of customer funds to
instruments listed in Regulation § 1.25, and limit
depositories for customer funds to those listed in
Regulations §§ 1.20 and 1.49. See 17 CFR 1.20(g)(1),
39.15 (b), 22.3(b)(1), 1.20(g)(1) and (g)(4), and 22.5.
However, these protections do not apply to DCO
clearing members (i.e., those that are not FCMs).
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consistent with our system of self-regulation
set forth in the Commodity Exchange Act,
DCOs have to establish standards and
procedures designed to protect and ensure
the safety of proprietary funds, and hold
them in a manner that will minimize the risk
of loss or delay in access by the DCO to the
funds.5 DCOs also have to invest clearing
member proprietary funds in instruments
with minimal credit, market, and liquidity
risks.6
Today, the Commission is proposing new
regulations for the protection of clearing
member funds, based largely on the customer
segregation requirements for FCMs and DCOs
in Regulation § 1.20.7 The Proposal explains
that new safeguards are needed for the direct
participants at DCOs because (1) the
Commission has registered a number of DCOs
that clear directly for market participants
without the involvement of FCMs (i.e., these
DCOs are only clearing for individuals), and
(2) many DCOs that use the traditional FCM
clearing model have at least some non-FCM
clearing members.
While I appreciate the intent of today’s
Proposal, with respect to DCOs that have
FCMs as clearing members, I believe we must
be careful in changing a regulatory
framework that has served our markets
without any real issues for decades. I believe
that the Commission must have had a good
reason when it originally distinguished
between house accounts and customer funds.
There have been a lot of spectres raised today
that have nothing to do with our actual
regulated markets. Speaking from a practical
perspective, I worry that ‘‘if it ain’t broke,
don’t fix it.’’ For example, we should
recognize that DCOs might have operational
reasons for the accounts distinction in our
current rules. I encourage the public to
comment on whether the Proposal is
workable for DCOs in that regard.
There Should Be a New Registration
Category for Direct Clearing Retail DCOs
and an Office of the Retail Advocate To
Ensure Customer Protection
I share the concerns where DCOs clear
directly for retail participants without FCMs.
I would go further and state that I am
concerned that the Proposal’s targeted
approach may miss larger issues. When a
DCO faces direct retail participants that our
rules categorize as clearing members, we
effectively allow a model that eliminates
intermediaries and the protections that they
5 See CEA section 5b(c)(2)(F), 7 U.S.C. 7a–
1(c)(2)(F) (Core Principle F), and 17 CFR 39.15.
6 Id.
7 For instance, the Commission is proposing to
require a DCO to hold proprietary funds separately
from the DCO’s own funds, in accounts that are
named to clearly identify the funds as belonging to
clearing members, to prohibit a DCO or any
depository from using proprietary funds in any way
other than as belonging to the clearing member, to
have DCOs review, on a daily basis, the amount of
funds owed to each clearing member with respect
to each of its accounts, both customer (including,
as relevant, futures and cleared swaps) and
proprietary, and to reconcile those figures to the
amount of funds held in aggregate in each such type
of account across all of the DCO’s depositories, and,
to have DCOs obtain proprietary funds
acknowledgment letters.
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307
provide for customers. Intermediaries
perform critical functions, and that is why
markets all over the world require registered
brokers and stringent protections for
customers.
If the Commission anticipates this type of
DCO clearing model to proliferate, we should
step back and consider all issues that these
direct clearing retail DCOs raise.8 These
types of concerns around retail participants
are why I have proposed that the
Commission needs an Office of the Retail
Advocate.9 I continue to believe that having
an Office of the Retail Advocate is a triedand-true way to advance customer
protection, and may be especially effective in
the area raised by today’s Proposal.
For example, perhaps there should be a
distinct registration category and
requirements for direct clearing retail DCOs
because they raise singular issues, risks, and
concerns—foremost, who provides retail
customer protection when there are no
brokers or intermediaries.
Frankly, I dislike a model where DCOs
have clearing members that are retail. To
achieve the same market structure outcome,
I think it is better that a DCO has an affiliated
FCM that only provides services for its retail
participants on an affiliated DCM and DCO
and would provide customer protections
required under our rules. This would,
therefore, not disrupt our existing regulatory
framework and the current scope and
application of the Bank Secrecy Act.10
Conclusion
I believe the Commission should further
study the direct clearing model for retail
participants, together with the increase in
retail binary option contracts. I hope that my
proposal for an Office of the Retail Advocate
comes to fruition, and that this is one of the
first issues that we tackle.
Again, I thank staff for the hard work on
the Proposal. I look forward to the public’s
comments on the Proposed Amendments to
Clearing Member Funds Requirements.
Thank you.
[FR Doc. 2023–28767 Filed 1–2–24; 8:45 am]
BILLING CODE 6351–01–P
8 The Commission provided exemptions from the
current regulations for these DCOs in 2020. See
Derivatives Clearing Organization General
Provisions and Core Principles, 85 FR 4800 (Jan. 27,
2020). However, I am suggesting a more holistic
assessment of these DCOs and their clearing
members.
9 Keynote Address by Commissioner Caroline D.
Pham at CordaCon 2022 (Sept. 27, 2022), available
at https://www.cftc.gov/PressRoom/
SpeechesTestimony/opapham5.
10 31 U.S.C. 5311 et seq.
E:\FR\FM\03JAP1.SGM
03JAP1
]]>Agencies
[Federal Register Volume 89, Number 2 (Wednesday, January 3, 2024)]
[Proposed Rules]
[Pages 286-307]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-28767]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 39
RIN 3038-AF39
Protection of Clearing Member Funds Held by Derivatives Clearing
Organizations
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (CFTC or Commission)
is proposing regulations to ensure clearing member funds and assets
receive the proper treatment in the event the derivatives clearing
organization (DCO) enters bankruptcy by requiring, among other things,
that clearing member funds be segregated from the DCO's own funds and
held in a depository that acknowledges in writing that the funds belong
to clearing members, not the DCO. In addition, the Commission is
proposing to permit DCOs to hold customer and clearing member funds at
foreign central banks subject to certain requirements. Finally, the
Commission is proposing to require DCOs to conduct a daily calculation
and reconciliation of the amount of funds owed to customers and
clearing members and the amount actually held for customers and
clearing members.
DATES: Comments must be received by February 16, 2024.
ADDRESSES: You may submit comments, identified by RIN 3038-AF39, by any
of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above. Please submit your comments using only one of these
methods. Submissions through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be
[[Page 287]]
posted as received to https://comments.cftc.gov. You should submit only
information that you wish to make available publicly. If you wish the
Commission to consider information that you believe is exempt from
disclosure under the Freedom of Information Act (FOIA), a petition for
confidential treatment of the exempt information may be submitted
according to the procedures established in Sec. 145.9 of the
Commission's regulations.\1\
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\1\ 17 CFR 145.9. Commission regulations referred to herein are
found at 17 CFR chapter I (2022), and are accessible on the
Commission's website at https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from https://comments.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
the FOIA.
FOR FURTHER INFORMATION CONTACT: Eileen A. Donovan, Deputy Director,
202-418-5096, [email protected], Division of Clearing and Risk,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street NW, Washington, DC 20581; Theodore Z. Polley, Associate
Director, 312-596-0551, [email protected]; or Scott Sloan, Special
Counsel, 312-596-0708, [email protected]; Division of Clearing and Risk,
Commodity Futures Trading Commission, 77 West Jackson Boulevard, Suite
800, Chicago, Illinois 60604.
SUPPLEMENTARY INFORMATION:
I. Background
A. Proprietary Funds
Section 4d of the Commodity Exchange Act (CEA) and part 1 of the
Commission's regulations establish a comprehensive regime to safeguard
the funds belonging to customers of a futures commission merchant
(FCM).\2\ Commission regulations define a ``customer'' as any person
who uses an FCM, introducing broker, commodity trading advisor, or
commodity pool operator as an agent in connection with trading in any
commodity interest, and therefore, this customer protection regime does
not apply to the funds of any person who clears trades directly through
a DCO, who is a ``clearing member.'' \3\ At the most general level, the
customer protection regime requires FCMs to segregate customer funds
from their own funds, deposit customer funds under an account name that
clearly identifies them as customer funds,\4\ and obtain a written
acknowledgment from each depository that holds customer funds.\5\ These
acknowledgment letters, which must adhere to specific templates
contained in the Commission's regulations, require a depository to
acknowledge, among other things, that the accounts opened by the FCM
hold funds that belong to the FCM's customers. The customer protection
regime also establishes accounting and reporting requirements
applicable to customer funds,\6\ and limits both the types of
investments that can be made with customer funds \7\ and the type of
depositories that can hold customer funds.\8\
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\2\ 7 U.S.C. 6d; 17 CFR 1.20-1.39. See also 17 CFR 22.1-22.17,
and 30.7 (establishing similar regimes for cleared swaps customer
collateral and foreign futures customer funds).
\3\ 17 CFR 1.3.
\4\ 17 CFR 1.20(a).
\5\ 17 CFR 1.20, 22.5, and 30.7 (requiring an acknowledgment
letter for futures customer funds, cleared swaps customer
collateral, and foreign futures customer funds, respectively).
\6\ 17 CFR 1.32, 1.33.
\7\ 17 CFR 1.25.
\8\ 17 CFR 1.49.
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Many of the customer protection requirements that apply to FCMs
also apply to DCOs that receive customer funds from their FCM clearing
members. DCOs must segregate the customer funds of their FCM clearing
members from their own funds,\9\ deposit customer funds under an
account name that identifies the funds as customer funds,\10\ obtain
acknowledgment letters from depositories,\11\ limit the investment of
customer funds to instruments listed in Sec. 1.25,\12\ and limit
depositories for customer funds to those listed in Sec. Sec. 1.20 and
1.49.\13\ These protections, however, do not extend to clearing members
of DCOs. Only section 5b(c)(2)(F) of the CEA (Core Principle F) and
Sec. 39.15 apply to the treatment of clearing members' funds and
assets held by a DCO in relation to cleared contracts (proprietary
funds).\14\ These provisions require DCOs to establish standards and
procedures that are designed to protect and ensure the safety of
proprietary funds and require DCOs to hold proprietary funds in a
manner that will minimize the risk of loss or delay in access by the
DCO to the proprietary funds.\15\ These provisions further require any
investment of proprietary funds to be in instruments with minimal
credit, market, and liquidity risks.\16\
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\9\ 17 CFR 1.20(g)(1); 17 CFR 39.15 (b); 17 CFR 22.3(b)(1).
\10\ 17 CFR 1.20(g)(1).
\11\ 17 CFR 1.20(g)(4); 17 CFR 22.5.
\12\ 17 CFR 39.15(e).
\13\ 17 CFR 1.20(g)(2), (3); 17 CFR 22.3(b) (cross-referencing
17 CFR 22.4).
\14\ This definition of proprietary funds is only for
explanatory purposes in the background section. As discussed further
below, the Commission is proposing a definition of ``proprietary
funds'' that is referred to throughout the remainder of this
proposed rulemaking.
\15\ 7 U.S.C. 7a-1(c)(2)(F); 17 CFR 39.15.
\16\ Id.
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Section 8a(5) of the CEA grants the Commission authority to adopt
rules it determines are reasonably necessary to effectuate, among other
things, the DCO core principles.\17\ The Commission's initial focus in
implementing Core Principle F was on the custody and safeguarding of
customer funds, consistent with section 4d of the CEA. This approach
was largely responsive to the historical prevailing model in which all
or nearly all clearing members of a DCO are FCMs. However, the
Commission has since granted registration to a number of DCOs that
clear directly for market participants without the intermediation of
FCMs, including, in most cases, market participants who are natural
persons (i.e., individuals).\18\ Additionally, many DCOs that use the
traditional FCM clearing model have at least some non-FCM clearing
members. The Commission therefore is proposing safeguards for
proprietary funds to provide protections for clearing members
comparable to those applicable to customers.\19\ The Commission has
preliminarily determined that each of these additional safeguards is
reasonably necessary to effectuate DCO Core Principle F.\20\
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\17\ 7 U.S.C. 12a(5).
\18\ Currently, CBOE Clear Digital, LLC; CX Clearinghouse, L.P.;
LedgerX, LLC; and North American Derivatives Exchange Inc. allow
individuals to be direct clearing members. Further, ICE NGX Canada
Inc. clears physically delivered energy contracts directly for
clearing members with a net worth exceeding CAD $5,000,000 or assets
exceeding CAD $25,000,000.
\19\ The U.S. Bankruptcy Code requires a bankruptcy trustee to
distribute clearing members' cash and other assets held by a debtor
DCO ratably among all clearing members. 11 U.S.C. 766(i)(2); 11
U.S.C. 761(9)(D), (10), (16). Therefore, the Commission cannot
effectively create multiple account classes for the clearing members
of a DCO--e.g., one for FCM proprietary funds and one for non-FCM
proprietary funds--because the different account classes would not
be recognized by a bankruptcy court.
\20\ CEA section 5b(c)(2)(F), 7 U.S.C. 7a-1(c)(2)(F).
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Specifically, the Commission is proposing to require a DCO to hold
proprietary funds separately from the DCO's own funds, in accounts that
are named to clearly identify the funds as belonging to clearing
members. The
[[Page 288]]
Commission is further proposing to prohibit a DCO or any depository
from using proprietary funds in any way other than as belonging to the
clearing member.
Additionally, the proposed rules include requirements for a DCO to
review, on a daily basis, the amount of funds owed to each clearing
member with respect to each of its accounts, both customer (including,
as relevant, futures and cleared swaps) and proprietary, and to
reconcile those figures to the amount of funds held in aggregate in
each such type of account across all of the DCO's depositories.
The Commission is also proposing to require a DCO to obtain a
letter from the depository for each account holding proprietary funds
(proprietary funds letter) acknowledging, among other things, that the
funds belong to clearing members and cannot be used by the DCO for any
other purpose. The proposed proprietary funds letter is based on the
template acknowledgment letter that a DCO is required to use in
connection with customer funds.\21\
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\21\ See 17 CFR 1.20 App. B.
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In addition to preventing the misuse of proprietary funds, the
proposed requirements would help ensure that proprietary funds are
appropriately protected in the event of a DCO bankruptcy. The U.S.
Bankruptcy Code establishes that in the event of a DCO bankruptcy,
member property, which includes funds held for clearing members'
proprietary accounts,\22\ is repaid to clearing members pro rata based
on their claims for such funds, and ahead of most other claims against
the DCO's estate.\23\ Further, part 190 of the Commission's regulations
establishes how clearing members' claims against the DCO's estate
should be determined and how payments should be allocated among
clearing members.\24\ By requiring proprietary funds to be held
separately from the DCO's funds and easily identified in a proprietary
funds letter, the proposed rules will enable a bankruptcy court or
trustee to more clearly identify these funds as member property.
Further, the proposed rules will require the DCO to verify, on a
regular basis, that it is holding the proper amount of proprietary
funds, thus ensuring that these funds would be available for
distribution in the event of a DCO bankruptcy.
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\22\ See 11 U.S.C. 761(16) (defining ``member property'' as
cash, a security, or other property, or proceeds of such cash,
security, or property, held by a DCO for a clearing member's
proprietary account).
\23\ See 11 U.S.C. 766(i) (providing that member property is
distributed ratably to clearing members on the basis and to the
extent of their allowed net equity claims based on their proprietary
accounts, and in priority to all other claims, except claims related
to the administration of member property).
\24\ See 17 CFR 190.00-190.19.
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B. Central Bank Depositories
The Commission is also proposing requirements specific to obtaining
written acknowledgments from central banks holding customer or
proprietary funds.\25\ When the Commission adopted the template
acknowledgment letter for depositories holding customer funds in 2013,
it did not require use of the template letter by Federal Reserve Banks,
due to the ``unique role'' of the U.S. central bank.\26\ The Commission
also recognized that there may be valid reasons why some foreign
depositories would require modifications to the letter and stated that,
in such circumstances, the Commission would consider ``alternative
approaches'' on a case-by-case basis.\27\
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\25\ ``Central bank'' is the term used to describe the authority
responsible for policies that affect a country's supply of money and
credit. See, e.g., https://www.clevelandfed.org/publications/economic-commentary/2007/ec-20071201-a-brief-history-of-central-banks.
\26\ Enhancing Protections Afforded Customers and Customer Funds
Held by Futures Commission Merchants and Derivatives Clearing
Organizations, 78 FR 68506, 68535 (Nov. 14, 2013).
\27\ Id. at 68536.
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Since then, the Commission's Division of Clearing and Risk (DCR)
has issued several no-action letters in which the Division confirmed
that it would not recommend that the Commission take enforcement action
against a DCO for making certain modifications to the template
acknowledgment letter in connection with customer accounts maintained
at a foreign central bank.\28\ To encourage the use of central bank
accounts, which can provide a superior alternative to holding funds at
a commercial bank from the perspective of credit and liquidity risk,
the Commission is proposing to allow a DCO to hold customer and
proprietary funds at certain central banks without obtaining the
template acknowledgment letter for customer funds or the proposed
proprietary funds letter. Instead, a DCO would need to obtain only a
written acknowledgment that the central bank was informed that the
funds deposited with the bank are customer or proprietary funds (as
applicable) held in accordance with section 4d or 5b of the CEA, and
that the central bank agrees to respond to requests from specified
Commission staff for information about the account, including the
account balance (modified written acknowledgments). These proposed
requirements are based on the requirements the Commission adopted in
2013 with regard to written acknowledgments from Federal Reserve
Banks.\29\
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\28\ See, e.g., CFTC Letter No. 14-124 (Oct. 8, 2014) (related
to customer accounts held at the Bank of England); CFTC Letter No.
16-05 (Feb. 1, 2016) (related to customer accounts held at the
Deutsche Bundesbank).
\29\ Enhancing Protections Afforded Customers and Customer
Funds, 78 FR at 68628. In 2016, the Commission issued an order under
section 4(c) of the CEA conditionally exempting Federal Reserve
Banks from section 4d of the CEA (Order Exempting the Federal
Reserve Banks from Sections 4d and 22 of the Commodity Exchange Act,
81 FR 53467 (Aug. 12, 2016)). The conditions of the order require
Federal Reserve Banks to keep customer funds segregated and respond
to information requests from the Commission, making a separate
written acknowledgment from a Federal Reserve Bank unnecessary. The
Commission therefore repealed the 2013 provision (then Sec.
1.20(g)(4)(ii)) concerning written acknowledgments from Federal
Reserve Banks and adopted current Sec. 1.20(g)(4)(i), which
excludes Federal Reserve Banks from the written acknowledgment
requirement.
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The Commission is proposing to allow use of the modified written
acknowledgment only by a DCO that holds customer or proprietary funds
at the central bank of a ``money center country'' as defined in Sec.
1.49--Canada, France, Germany, Italy, Japan, and the United Kingdom--to
limit risks to customer and proprietary funds. Along with the United
States, these countries comprise the Group of Seven (G7).
Representatives from the G7 countries meet several times each year to
coordinate their cooperation on issues of economic policy, and the
United States and its financial regulatory agencies have a history of
successful cooperation with the respective financial regulatory
agencies of these countries. When the definition of ``money center
country'' was first proposed in connection with the adoption of Sec.
1.49, a commenter suggested that the definition include ``other
locations with stable currencies and other indicia that customer funds
will be relatively secure.'' \30\ The Commission rejected this proposal
as difficult to apply and noted that it would require the Commission to
expend significant resources to conduct a broad evaluation of, among
other things, a country's banking, monetary, and economic policies and
systems.\31\ The Commission believes that limiting the proposed change
to central banks of money center countries appropriately considers
security for customer and proprietary funds, flexibility for DCOs, and
creating a system that is workable in practice.
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\30\ See Denomination of Customer Funds and Location of
Depositories, 68 FR at 5546-5547 (Mar. 6, 2003).
\31\ Id.
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Further, the Commission is not proposing to require a DCO to obtain
an
[[Page 289]]
acknowledgment letter from a Federal Reserve Bank holding proprietary
funds. This is consistent with Sec. 1.20(g)(4), which states that a
DCO does not need a written acknowledgment to hold customer funds held
at a Federal Reserve Bank. Federal Reserve Banks have previously
expressed an inability to agree to all of the terms in the template
acknowledgment letter.\32\ Because Federal Reserve Banks are the source
of liquidity for U.S. dollar deposits, a DCO would face lower credit
and liquidity risk with a deposit at a Federal Reserve Bank than it
would with a deposit at a commercial bank. In the context of customer
funds, the Commission determined that it would not require a written
acknowledgment from Federal Reserve Banks in order to facilitate use of
these accounts and help obtain these benefits that ultimately serve
market participants and the integrity of the financial markets.\33\ The
Commission believes that the same rationale applies with respect to
proprietary funds. Further, the Commission has required DCOs with
access to accounts and services at a Federal Reserve Bank to use such
accounts and services where practical,\34\ and as a policy matter seeks
to facilitate use of those accounts.
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\32\ Enhancing Protections Afforded Customers and Customer
Funds, 78 FR at 68535.
\33\ Denomination of Customer Funds and Location of
Depositories, 68 FR at 53468 (Mar. 6, 2003).
\34\ 17 CFR 39.33(d)(5).
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II. Definitions--Sec. 39.2
The Commission is proposing to add in Sec. 39.2 a definition for
``money center country'' that is identical to the definition currently
in Sec. 1.49. Under the proposed definition, ``money center country''
means Canada, France, Germany, Italy, Japan, and the United Kingdom.
The Commission is also proposing a definition for ``proprietary
funds.'' The definition uses language similar to that included in the
current definitions of ``futures customer funds'' in Sec. 1.3 \35\ and
``cleared swaps customer collateral'' in Sec. 22.1.\36\ The proposed
definition includes all money, securities, and property held in a
proprietary account \37\ on behalf of clearing members used to margin,
guarantee, or secure futures, foreign futures and swaps contracts, as
well as option premiums and other funds held in relation to options
contracts. The proposed definition also includes clearing member
contributions to a guaranty fund to mutualize the losses resulting from
a default by a clearing member.\38\
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\35\ 17 CFR 1.3.
\36\ 17 CFR 22.1.
\37\ See 17 CFR 1.3 (defining ``proprietary account'' as a
commodity futures, commodity options, or swaps trading account, for
the clearing member itself, or for certain owners and affiliates of
the clearing member).
\38\ These guaranty fund contributions include those received
pursuant to an assessment for additional guaranty fund contributions
when permitted by a DCO's rules.
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For the avoidance of doubt, a proprietary account may be the
``house'' account of a clearing member that is an FCM, where the
clearing member may also maintain a futures customer and/or cleared
swaps customer account. The term also would include the account of a
direct clearing member (that may or may not be a natural person) that
does not intermediate transactions for anyone else.
III. Treatment of Funds--Sec. 39.15
A. Holding Customer Funds at Central Banks--Sec. 39.15(b)(3)
The Commission is proposing to amend Sec. 39.15(b) to allow a DCO
to hold customer funds at the central bank of a money center country.
The proposed amendment would supplement the list of permissible
depositories in Sec. 1.49 and Sec. Sec. 22.4 and 22.9. Currently,
Sec. 1.49 and Sec. 22.9 limit foreign depositories for customer funds
to a bank or trust company that has in excess of $1 billion of
regulatory capital, an FCM, or a DCO. Foreign central banks, as
independent government entities, are not structured to meet regulatory
capital requirements and are therefore excluded from holding customer
funds under Sec. 1.49.
The Commission believes a DCO holding customer funds at a central
bank can be a superior alternative to holding commercial bank deposits
because it limits the DCO's credit and liquidity risks. The Commission
is therefore proposing new Sec. 39.15(b)(3) to permit a DCO to hold
customer funds at the central bank of a money center country if the DCO
obtains a modified written acknowledgment, rather than the template
acknowledgment letter required by Sec. Sec. 1.20 and 22.5, to which
some central banks have objected.\39\ The proposed rule would require
the central bank of a money center country only to acknowledge that it
was informed that the funds deposited with the bank are customer funds
held in accordance with section 4d of the CEA and to agree to respond
to requests from the Commission for information about the account,
including the account balance. The Commission believes the proposed
rule would facilitate the holding of customer funds at the central
banks of money center countries while ensuring appropriate customer
protections.
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\39\ See, e.g., CFTC Letter No. 14-124 (Oct. 8, 2014); CFTC
Letter No. 16-05 (Feb. 1, 2016) (regarding modifications to the
template acknowledgment letter to enable certain central banks to
hold customer funds).
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The Commission believes that central banks are often the safest
place to deposit customer funds and has provided exemptions from Sec.
1.49 to permit customer funds to be held at foreign central banks in
money center countries.\40\ The proposed rule would codify those
exemptions and permit DCOs to hold customer funds with the central bank
of a money center country. As previously discussed, the Commission is
proposing to limit the permissible central bank depositories to those
of money center countries after considering security for customer
funds, flexibility for DCOs, and the need to create a system that is
workable in practice.
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\40\ See, e.g., CFTC Letter No. 14-124 (Oct. 8, 2014); CFTC
Letter No. 16-05 (Feb. 1, 2016) (granting exemptive relief from
Sec. 1.49 to permit certain central banks to act as a depository
for customer funds).
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B. Permitted Investments--Sec. 39.15(e)
The Commission is proposing to amend Sec. 39.15(e) to permit a DCO
to invest proprietary funds only as permitted for investment of
customer funds under Sec. 1.25. The proposed regulation specifies that
the DCO would bear any losses from investments, as is the case with
customer funds.\41\ The list of investments in Sec. 1.25 is a
conservative list, and the Commission believes it is appropriate for
all types of clearing members. Currently, permissible investments under
Sec. 1.25 include, among other investments, general obligations of the
U.S. government, general obligations of any U.S. state or municipality,
certificates of deposit, and interests in money market funds.\42\
Further, Sec. 1.25 specifies a number of terms and conditions with
which permitted investments must comply, including limits on the
features that an investment can contain, concentration limits, and time
to maturity limits.\43\ Regulation Sec. 1.25 also includes specific
requirements for investments in money market funds and repurchase
agreements.\44\ By limiting investments of proprietary funds to
investments that meet the requirements
[[Page 290]]
of Sec. 1.25,\45\ the proposed rule will ensure that any investment of
proprietary funds will have minimal credit, market, and liquidity risk
as required by Core Principle F.\46\
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\41\ 17 CFR 1.29(b).
\42\ 17 CFR 1.25(a); see also Investment of Customer Funds by
[FCMs] and [DCOs], 88 FR 81236 (Nov. 21, 2023) (proposing, among
other changes, to add certain foreign sovereign debt and certain
U.S. Treasury exchange traded funds, both subject to limitations, to
the list of permitted investments and to limit the types of money
market funds that are permitted investments).
\43\ 17 CFR 1.25(b).
\44\ 17 CFR 1.25(c), (d).
\45\ Proposed Sec. 39.15(e) cross-references Sec. 1.25, which
provides that an FCM or DCO may invest ``customer money'' in certain
instruments. The regulatory text of Sec. 1.25, however, does not
refer to ``proprietary funds.'' The Commission recently approved
proposed amendments to Sec. 1.25. Based on comments received on
those proposed amendments, if appropriate, the Commission may
consider further amending Sec. 1.25 either in the final rule or as
a re-proposed rule to ensure that the regulatory text provides
clarity on the application of Sec. 1.25 to a DCO's investment of
``proprietary funds,'' as permitted under Sec. 39.15(e).
\46\ 7 U.S.C. 7a-1(c)(2)(F); 17 CFR 39.15(e).
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C. Additional Protections for Proprietary Funds--Sec. 39.15(f)
The Commission is proposing new Sec. 39.15(f) to establish
additional protections for proprietary funds.
1. Segregation of Proprietary Funds--Sec. 39.15(f)(1)
Proposed Sec. 39.15(f)(1) is based on Sec. 1.20(a) and would
require a DCO to account for proprietary funds separately from its own
funds, and to hold proprietary funds in accounts that are named to
clearly identify the funds being held as belonging to clearing members.
The Commission believes this would prevent misuse of proprietary funds
by a DCO, and would help a bankruptcy trustee or judge to easily
identify the funds that should be treated as member property in the
unlikely event of a DCO bankruptcy. The proposed rule also would
require the DCO to, at all times, maintain in the accounts holding
proprietary funds enough resources to cover the total value of
proprietary funds owed to its clearing members. The proposed rule would
prevent a DCO from rehypothecating or otherwise using proprietary funds
for its own benefit, thus ensuring that the funds are available when
needed by clearing members or the DCO for permitted uses.
2. Written Acknowledgment from Depositories--Sec. 39.15(f)(2)
The Commission is proposing to require a DCO to obtain from any
depository holding proprietary funds a written acknowledgment that the
funds belong to the DCO's clearing members and cannot be used by the
DCO for any other purpose. The Commission is proposing a template
proprietary funds letter that DCOs would be required to use, which
would be contained in proposed appendix D to part 39. The proposed
template proprietary funds letter is substantively the same as the
current template acknowledgment letter for DCO accounts holding futures
customer funds required by Sec. 1.20, and requires a depository to
acknowledge, among other things, that the accounts referenced in the
letter hold funds that belong to the DCO's clearing members, that the
funds should be accounted for separately from those belonging to the
DCO, and that the funds cannot be used to cover the DCO's obligations
to the depository.\47\ Further, the template proprietary funds letter
would require the depository to respond to a request from the director
of DCR, or any successor division, or the director's designees, for
information about the account, including the account balance. Proposed
Sec. 39.15(f)(2) also includes the same procedural requirements as
those in Sec. 1.20. Specifically, it would require a DCO to file a
proprietary funds letter with the Commission within three days of
opening an account, to update a letter when certain information it
contains changes, and to maintain a copy of the letter in accordance
with Sec. 1.31.
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\47\ See 17 CFR 1.20 App. B.
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The Commission believes that requiring a proprietary funds letter
would ensure that a depository holding proprietary funds would know
that the funds belong to the DCO's clearing members and cannot be used
by the DCO for any other purpose, which will help prevent the misuse of
funds by the DCO or an employee of the DCO. Further, having a letter
for each proprietary funds account would help a bankruptcy court or
trustee easily identify those funds that constitute member property in
the event of a DCO bankruptcy.
The Commission is proposing to exclude accounts at Federal Reserve
Banks from the requirement to obtain a proprietary funds letter. This
is consistent with Sec. 1.20(g)(4), which states that a DCO does not
need a written acknowledgment to hold customer funds at a Federal
Reserve Bank. As discussed above, the Commission believes that Federal
Reserve Banks would be unable to sign the template proprietary funds
letter, and wants to promote the use of Federal Reserve Bank accounts
by DCOs when possible.
The Commission is also proposing a simpler written acknowledgment
requirement for accounts held at the central bank of a money center
country. Although a DCO holding proprietary funds at the central bank
of a money center country would have to comply with the same procedural
requirements applicable to other depositories, it would not have to use
the template proprietary funds letter. The DCO would only have to
obtain a written acknowledgment stating that: (1) the central bank was
informed that the funds deposited with the bank are proprietary funds
held in accordance with section 5b(c)(2)(F) of the CEA and Commission
regulations; and (2) the bank agrees to respond to requests from the
Commission for information about the account, including the account
balance. As was the case with the acknowledgment letter used for
accounts holding customer funds, the Commission believes many central
banks would have issues with the proposed template proprietary funds
letter. The Commission believes the proposed rule would allow DCOs to
gain the benefits of holding funds at central banks while adequately
safeguarding those funds and ensuring that the Commission has the
information it needs to conduct oversight of DCOs.
3. Commingling of Proprietary Funds--Sec. 39.15(f)(3)
Proposed Sec. 39.15(f)(3) is based on Sec. 1.20(e) and (g)
applicable to customer funds, and would permit a DCO to commingle
proprietary funds from multiple clearing members in a single account at
a depository, but would not permit a DCO to commingle proprietary funds
with the DCO's own funds or customer funds. Having a clear separation
between proprietary funds and a DCO's own funds will make it more
difficult for funds to be misused, and will provide additional clarity
in the event of a DCO bankruptcy regarding the funds that should be
treated as member property rather than part of the debtor's estate.
Further, the ability to commingle proprietary funds from multiple
clearing members in one account allows DCOs to limit operational risks
by simplifying their banking processes and procedures.
4. Use of Proprietary Funds--Sec. 39.15(f)(4)
Proposed Sec. 39.15(f)(4) is based on Sec. 1.20(f) and would
require a DCO and any depository holding proprietary funds to treat all
proprietary funds as belonging to the clearing members of the DCO. The
Commission believes the proposed rule will help ensure that proprietary
funds are not rehypothecated or otherwise used by a DCO and are readily
available if needed either by the clearing member directly, or for a
permitted clearing member use by the DCO. However, the Commission does
not intend for this requirement to interfere with or alter DCOs' risk
management programs. Proposed Sec. 39.15(f)(4)(i)(A) therefore would
clarify that the proprietary funds of a
[[Page 291]]
clearing member could be used to satisfy obligations of that clearing
member's customers, to the extent that use is permitted by the DCO's
rules and the DCO's agreement(s) with the clearing member. In addition,
proposed Sec. 39.15(f)(4)(i)(B) further would clarify that a DCO use
contributions of non-defaulting clearing members to a guaranty fund to
cover losses stemming from a default, to the extent that use is
permitted by the DCO's rules and its agreement(s) with its clearing
members. Nothing in the proposed rule would prevent a DCO from holding
guaranty fund contributions in a separate proprietary funds account
from proprietary funds held as initial margin.
Moreover, proposed Sec. 39.15(f)(4)(ii) would provide that a
depository receiving proprietary funds from a DCO for deposit in a
segregated account may not hold, dispose of, or use such funds as
belonging to any person other than the clearing members of the
depositing DCO. Unlike the DCO, which is responsible for separately
considering the proprietary funds owed to each individual clearing
member, a depository is only responsible for considering the
proprietary funds it has received as belonging to the clearing members
as a group.
D. Daily Reconciliation--Sec. 39.15(g)
The Commission is proposing new Sec. 39.15(g), which would require
a DCO to conduct a daily reconciliation for each type of segregated
account (futures customer funds, cleared swaps customer collateral, and
proprietary funds) it holds for its clearing members. This proposal is
based on the requirement applicable to FCMs in Sec. 1.32. Under
proposed Sec. 39.15(g), by noon of each business day, the DCO would
have to perform these reconciliations on balances held as of the close
of the previous business day. The proposed requirement is intended to
verify, each business day, that the DCO maintains sufficient funds in
each relevant account type to cover its aggregate obligations to
clearing members. The Commission believes that the required daily
calculation and reconciliation and independent review requirements in
the proposed rule would help a DCO to identify quickly any misuse or
loss of proprietary or customer funds.
Proposed Sec. 39.15(g)(1), (2), and (3) would require a DCO to
calculate the amount of, respectively, futures customer funds, cleared
swaps customer collateral, and proprietary funds owed to each clearing
member. These provisions would further require the DCO to reconcile the
total amount, aggregated across all clearing members, of each of
futures customer funds, cleared swaps customer collateral, and
proprietary funds, with the amount of each respective type of funds
held in separate accounts across all depositories. This reconciliation
is intended to confirm, each business day, that the DCO maintains, in
each type of account, an adequate value of segregated funds to meet its
obligations to clearing members.
Requirements for the method of conducting these calculations are
contained in proposed Sec. 39.15(g)(4). Proposed Sec. 39.15(g)(4)(i)
would require segregation of duties, consistent with generally accepted
auditing standards.\48\ Each of the DCO's calculations and
reconciliations would need to be approved by a person who did not
prepare the initial calculation or the related reconciliation, and who
does not report to the person who prepared them.
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\48\ See Statement on Auditing Standards 145, Appendix C, ] 21
(``Segregation of duties is intended to reduce the opportunities to
allow any person to be in a position to both perpetrate and conceal
errors or fraud in the normal course of the person's duties''). See
also 17 CFR 1.11(e)(3)(i)(G) (requiring each FCM's Risk Management
Program to include 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.)
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Proposed Sec. 39.15(g)(4)(ii)(A) would address the valuation of
securities in the required calculations of amounts owed and held.
Securities would have to be valued at their current market value, with
haircuts applied in accordance with existing Sec. 39.11(d)(1).
Proposed Sec. 39.15(g)(4)(ii)(B) would address mismatches in
currencies in the same account type by permitting a deficit in one
currency to be offset by a surplus in another currency, with conversion
based on publicly available exchange rates, and with surpluses subject
to haircuts reasonably determined by the DCO, applied consistently.\49\
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\49\ For example, one would expect that the haircuts the DCO
applies to currency mismatches with respect to its obligations to
clearing members here would be no smaller than the haircuts the DCO
applies to currency mismatches with respect to collateral posted by
a clearing member.
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Proposed Sec. 39.15(g)(4)(ii)(C) would address situations in which
customer funds of one type are commingled in a different type of
customer account (e.g., futures customer funds in a cleared swaps
customer account). In these instances, the proposed rule would require
DCOs to treat all funds in a futures customer account as futures
customer funds and all funds in a cleared swaps customer account as
cleared swaps customer collateral, both in terms of funds owed and
funds held, for purposes of the calculation and reconciliation required
by proposed Sec. 39.15(g).
Proposed Sec. 39.15(g)(4)(iii) would address the process by which
a DCO would calculate the amounts owed to clearing members for each
account type by requiring the DCO to apply, for each account type, the
approach set forth for FCMs in Sec. 1.20(i). This would include
calculating the net liquidating equity for each clearing member (in
each account type), taking into account the market value of funds it
receives from the clearing member, gains and losses on futures
contracts, options, and swaps (applying this approach to cleared
swaps), fees lawfully accruing in the normal course of business (which,
in the case of a DCO, would include transaction fees), and authorized
distributions or transfers of collateral. In aggregating amounts owed,
the DCO would not reduce the sum of credit balances owed to clearing
members with debit balances owed by other clearing members.\50\
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\50\ See 17 CFR 1.20(i)(4).
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Finally, proposed Sec. 39.15(g)(5) would require the DCO to
immediately report to the Commission any discrepancy in any of the
relevant calculations or any one or more of the reconciliations that
reveals that the DCO did not, at the close of the previous business
day, maintain in separate segregated accounts money, securities, and
property in an amount sufficient in the aggregate to cover the total
value of funds owed to all clearing members.
E. Exclusions for Foreign Derivatives Clearing Organizations--Sec.
39.15(h)
The Commission is not, at this time,\51\ proposing to apply the new
member property protections in proposed Sec. 39.15(e)(3) (permitted
investment of proprietary funds), (f) (proprietary funds), and (g)(3)
(daily reconciliation of proprietary funds) to certain DCOs organized
outside the United States (foreign DCOs). Specifically, proposed Sec.
39.15(h) would provide that proposed Sec. 39.15(e)(3), (f) and (g)(3)
do not apply to a foreign DCO that would, in the event of its
insolvency, be subject to a foreign proceeding, as defined in the U.S.
Bankruptcy Code, in the jurisdiction in which it is organized.\52\
[[Page 292]]
Member property held at most foreign DCOs would not be protected under
part 190 in the event the DCO enters bankruptcy,\53\ and the Commission
wants to avoid potential conflicts with requirements concerning
protection of member property under the applicable law in a foreign
DCO's home jurisdiction.\54\
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\51\ The Commission may, in light of ongoing and future
developments with respect to clearing models at such DCOs, including
with respect to the participation of U.S. market participants
(particularly such market participants who are natural persons)
reconsider these decisions (both with respect to part 39 and to part
190) in a future rulemaking.
\52\ The U.S. Bankruptcy Code defines ``foreign proceeding'' as
a collective judicial or administrative proceeding in a foreign
country, including an interim proceeding, under a law relating to
insolvency or adjustment of debt in which proceeding the assets and
affairs of the debtor are subject to control or supervision by a
foreign court, for the purpose of reorganization or liquidation. 11
U.S.C. 101(23). Further, the U.S. Bankruptcy Code defines ``foreign
court'' as a judicial or other authority competent to control or
supervise a foreign proceeding (emphasis added). 11 U.S.C. 1502(3).
Because the definition includes non-judicial authorities, a
resolution proceeding where the assets and affairs of a foreign DCO
are controlled by a resolution authority would constitute a foreign
proceeding under 11 U.S.C. 101(23), and thus a DCO that is subject
to such a resolution proceeding would fall within the exclusion of
such paragraphs. (See, e.g., In re Tradex Swiss AG, 384 B.R. 34, 42
(Bankr. D.Mass. 2008) (Swiss Federal Banking Commission ``is an
administrative agency'' and qualifies as a foreign court under
1502(3)), In re ENNIA Caribe Holding N.V., 594 B.R. 631, 639-40 & n.
11(Bankr. S.D.N.Y. 2018) (where the Central Bank of Cura[ccedil]ao
and St. Maarten, as a regulator, controls the affairs of the foreign
debtor, an insurance company, it constitutes a foreign court under
11 U.S.C. 1502(3)).
\53\ See 17 CFR 190.11(b).
\54\ As the Commission noted in revising its part 190 bankruptcy
regulations in 2020, in the context of certain DCOs organized
outside the United States, the Commission has traditionally focused
its efforts on the protection of the customers of FCM members of
such foreign DCOs. Bankruptcy Regulations, 86 FR 19324, 19366 (April
13, 2021). In promulgating those regulations, the Commission
attempted to avoid conflicts with insolvency proceedings in the
jurisdiction where a foreign DCO is organized. Id. Thus, pursuant to
17 CFR 190.11(b), the Commission's part 190 bankruptcy regulations
are limited to protecting contracts cleared on behalf of FCM
customers at such foreign DCOs and the property margining or
securing such contracts. The foreign DCOs to which this limitation
applies are those DCOs organized outside the United States that are
subject to a foreign proceeding, as defined in 11 U.S.C. 101(23), in
the jurisdiction in which it is organized.
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IV. Reporting--Sec. 39.19
The Commission is proposing new Sec. 39.19(c)(4)(xxvi) to include,
together with the other event-specific reporting requirements
applicable to DCOs, the requirement in proposed Sec. 39.15(g)(5) that
a DCO report any discrepancies in the amount of proprietary or customer
funds it holds. The Commission believes that including all reporting
requirements applicable to DCOs in Sec. 39.19 may assist DCOs in
tracking their reporting obligations.
V. Request for Comment
The Commission is requesting comments on all aspects of its
proposal. Additionally, the Commission specifically requests comment on
the following:
Would classification of guaranty fund contributions as proprietary
funds inhibit DCOs' current guaranty fund programs? The Commission has
proposed to specifically include guaranty fund deposits in the
definition of proprietary funds, and does not intend for the inclusion
to prevent DCOs from continuing to use guaranty funds as one of their
default resources.
Should the Commission require DCOs to report to the Commission the
daily calculations and reconciliations required by proposed Sec.
39.15(g)?
Anti-money laundering (AML) and know-your-client (KYC) programs are
required for many entities registered with the Commission, including
intermediaries such as FCMs. In the context of intermediated DCOs, FCMs
perform this critical role of assisting U.S. government agencies in
detecting and preventing money laundering. However, in the context of
non-intermediated DCOs, in the absence of an FCM, DCOs may be exploited
by actors seeking to engage in illegal and illicit activities. How
might the Commission ensure AML and KYC compliance for DCOs that offer
direct clearing services (a market structure that would not include
FCMs or other intermediaries that are typically directed to create Bank
Secrecy Act compliance programs)? Should DCOs offering direct-to-
customer services to non-eligible contract participants or retail
customers be required to comply with AML and KYC requirements?
Should the Commission require any additional written
acknowledgments (to those contained in proposed Sec. 39.15(b)(3) or
Sec. 39.15(f)(2)(vi) as applicable) from central banks of money center
countries in order for a DCO to use them to hold futures customer
funds, cleared swaps customer collateral, or proprietary funds?
VI. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) requires that agencies
consider whether the regulations they propose will have a significant
economic impact on a substantial number of small entities and, if so,
provide a regulatory flexibility analysis on the impact.\55\ The
amendments proposed by the Commission will affect only DCOs. The
Commission has previously established certain definitions of ``small
entities'' to be used by the Commission in evaluating the impact of its
regulations on small entities in accordance with the RFA.\56\ The
Commission has previously determined that DCOs are not small entities
for the purpose of the RFA.\57\ Accordingly, the Chairman, on behalf of
the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that the
proposed regulations will not have a significant economic impact on a
substantial number of small entities.
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\55\ 5 U.S.C. 601 et seq.
\56\ Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618 (Apr. 30, 1982).
\57\ See A New Regulatory Framework for Clearing Organizations
66 FR 45604, 45609 (Aug. 29, 2001).
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B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (PRA) \58\ imposes certain
requirements on federal agencies, including the Commission, in
connection with conducting or sponsoring any ``collection of
information,'' as defined by the PRA. Under the PRA, an 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 from the Office of Management and budget (OMB).\59\ The PRA is
intended, in part, to minimize the paperwork burden created for
individuals, businesses, and other persons as a result of the
collection of information by federal agencies, and to ensure the
greatest possible benefit and utility of information created,
collected, maintained, used, shared, and disseminated by or for the
Federal Government.\60\ The PRA applies to all information, regardless
of form or format, whenever the Federal Government is obtaining,
causing to be obtained, or soliciting information, and includes
required disclosure to third parties or the public, of facts or
opinions, when the information collection calls for answers to
identical questions posed to, or identical reporting or recordkeeping
requirements imposed on, ten or more persons.\61\
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\58\ 44 U.S.C. 3501 et seq.
\59\ See 44 U.S.C. 3507(a)(3); 5 CFR 1320.5(a)(3).
\60\ See 44 U.S.C. 3501.
\61\ See 44 U.S.C. 3502(3).
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This proposal, if adopted, would result in a collection of
information within the meaning of the PRA, as discussed below. This
proposed rulemaking contains collections of information for which the
Commission has previously received a control number from OMB. The title
for this existing collection of information is OMB control number 3038-
0076, Requirements for Derivatives Clearing Organizations (``OMB
Collection 3038-0076'').
[[Page 293]]
The Commission therefore is submitting this proposal to the OMB for
its review in accordance with the PRA.\62\ Responses to this collection
of information would be mandatory. The Commission will protect any
proprietary information according to the Freedom of Information Act and
part 145 of the Commission's regulations.\63\ In addition, section
8(a)(1) of the CEA strictly prohibits the Commission, unless
specifically authorized by the CEA, from making public any data and
information that would separately disclose the business transactions or
market positions of any person and trade secrets or names of
customers.\64\ Finally, the Commission is also required to protect
certain information contained in a government system of records
according to the Privacy Act of 1974.\65\
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\62\ See 44 U.S.C. 3507(d) 5 CFR 1320.11.
\63\ See 5 U.S.C. 552; see also 17 CFR part 145 (Commission
Records and Information).
\64\ 7 U.S.C. 12(a)(1).
\65\ 5 U.S.C. 552a.
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1. OMB Collection 3038-0076--Requirements for Derivatives Clearing
Organizations
The Commission is proposing a new reporting requirement in Sec.
39.15(f)(2) to require DCOs based in the United States to obtain a
template proprietary funds letter from each depository that holds
proprietary funds and to file that letter with the Commission. The
template letter and filing requirements are substantially the same as
the requirement in Sec. 1.20(d) for FCMs to file an acknowledgment
letter signed by each depository holding customer funds. In OMB control
number 3038-0024, ``Regulations and Forms Pertaining to Financial
Integrity of the Market Place; Margin Requirements for SDs/MSPs,'' \66\
the Commission estimated that each FCM would file three acknowledgment
letters a year and that filing each letter would take two hours to
complete. Because the proposed letter and requirements for DCOs are the
same as those for FCMs, the Commission believes that the estimates for
FCMs filing acknowledgment letters are appropriate for DCOs filing
proprietary funds letters. Therefore, the Commission believes that the
proposed requirement will require each DCO based in the United States
to expend six hours per year to comply, resulting in a total burden of
60 hours for DCOs.
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\66\ For the previously approved estimates for this collection,
see ICR Reference No. 202207-3038-001 (conclusion date Aug. 23,
2022, available at https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=202207-3038-001).
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The aggregate burden estimate for proprietary funds template letter
reporting in Collection 3038-0076 is as follows:
Estimated number of respondents: 10.
Estimated annual reports per respondent: 3.
Estimated total annual responses: 30.
Estimated average burden hours per response: 2.
Estimated annual burden hours per respondent: 6.
Estimated total annual reporting burden for all respondents: 60.
Finally, the Commission is proposing Sec. 39.15(g) to require DCOs
to report in accordance with Sec. 39.19(c)(4) any discrepancies in the
results of the required daily calculations and reconciliations. This is
a new reporting requirement and thus the Commission is revising its
estimate of the burden associated with event-specific reporting under
Sec. 39.19(c)(4) in Collection 3038-0076. A discrepancy in one of the
required calculations or reconciliations would mean that the DCO is not
holding or accounting for the correct amount of either customer or
proprietary funds, i.e., that it is not meeting regulatory
requirements. The Commission does not anticipate DCOs will need to file
this report often, and ideally not at all, such that even one report
per year would exceed expectations. Nonetheless, to avoid under-
estimating the burden of the proposed regulation, the Commission
estimates that DCOs will file the required report once per year. The
Commission believes that each report will take approximately 30 minutes
to complete. The requirement is for DCOs to file immediately upon
learning of the discrepancy, which will necessarily limit the amount of
time available to prepare a report. The current burden estimate in
Collection 3038-0076 for event specific reporting under Sec. 39.19(c)
is 14 reports a year per respondent. Therefore, the Commission amending
Collection 3038-0076 and s estimating that 13 covered DCOs will
complete an estimated 15 reports per year per respondent, resulting in
a total burden of seven-and-a-half hours for event-specific reporting.
The aggregate burden estimate for event-specific reporting under
Sec. 39.19(c)(4), as amended by the proposal, is updated as follows:
Estimated number of respondents: 13.
Estimated annual reports per respondent: 15.
Estimated total annual responses: 195.
Estimated average hours per response: 0.5.
Estimated annual burden hours per respondent: 7.5.
Estimated total annual burden hours for all respondents: 97.5.
The Commission's existing recordkeeping rule will require DCOs to
maintain records of the information generated though compliance with
the proposed rules.\67\ Specifically, DCOs will need to maintain
records related to the calculations and reconciliations required under
proposed Sec. 39.15(g) and the proprietary funds letters required
under proposed Sec. 39.15(f)(2). The Commission, however, believes
that the impact of the proposed regulations on the recordkeeping burden
in Collection 3038-0076 will be negligible. DCOs are already required
to maintain all information required to be created, generated, or
reported under part 39.\68\ DCOs regularly maintain records of items
created through their compliance with the Commission's regulations, and
the proposed rules will not raise unique recordkeeping challenges or
burdens. Therefore, the Commission is retaining its existing
recordkeeping burden estimates for Collection 3038-0076.
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\67\ See 17 CFR 39.20.
\68\ Id.
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2. Request for Comment
The Commission invites the public and other Federal agencies to
comment on any aspect of the proposed information collection
requirements discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the
Commission will consider public comments on this proposed collection of
information in:
(1) Evaluating whether the proposed collection of information is
necessary for the proper performance of the functions of the
Commission, including whether the information will have a practical
use;
(2) Evaluating the accuracy of the estimated burden of the proposed
collection of information, including the degree to which the
methodology and the assumptions that the Commission employed were
valid;
(3) Enhancing the quality, utility, and clarity of the information
proposed to be collected; and
(4) Minimizing the burden of the proposed information collection
requirements on registered entities, including through the use of
appropriate automated, electronic, mechanical, or other technological
information collection techniques, e.g., permitting electronic
submission of responses.
The Commission specifically invites public comment on the accuracy
of its estimates that the proposed regulations will not impose a new
recordkeeping burden and its determination to retain
[[Page 294]]
its existing burden estimates for recordkeeping for Collection 3038-
0076.
Copies of the submission from the Commission to OMB are available
from the CFTC Clearance Officer, 1155 21st Street NW, Washington, DC
20581, (202) 418-5714 or from https://RegInfo.gov. Organizations and
individuals desiring to submit comments on the proposed information
collection requirements should send those comments to:
The Office of Information and Regulatory Affairs, Office
of Management and Budget, Room 10235, New Executive Office Building,
Washington, DC 20503, Attn: Desk Officer of the Commodity Futures
Trading Commission;
(202) 395-6566 (fax); or
[email protected] (email).
Please provide the Commission with a copy of submitted comments so
that all comments can be summarized and addressed in the final
rulemaking, and please refer to the ADDRESSES section of this
rulemaking for instructions on submitting comments to the Commission.
OMB is required to make a decision concerning the proposed information
collection requirements between 30 and 60 days after publication of
this release in the Federal Register. Therefore, a comment to OMB is
best assured of receiving full consideration if OMB receives it within
30 calendar days of publication of this release. Nothing in the
foregoing affects the deadline enumerated above for public comment to
the Commission on the proposed rules.
C. Cost-Benefit Considerations
1. Introduction
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders.\69\ 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 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) factors (collectively referred to herein as
Section 15(a) factors).
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\69\ 7 U.S.C. 19(a).
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The Commission recognizes that the proposed amendments impose
costs. The Commission has endeavored to assess the anticipated costs
and benefits of the proposed amendments in quantitative terms,
including PRA-related costs, where feasible. In situations where the
Commission is unable to quantify the costs and benefits, the Commission
identifies and considers the costs and benefits of the applicable
proposed amendments in qualitative terms. The lack of data and
information to estimate those costs is attributable in part to the
nature of the proposed amendments. Additionally, any initial and
recurring compliance costs for any particular DCO will depend on the
size, existing infrastructure, level of clearing activity, practices,
and cost structure of the DCO.
The Commission generally requests comment on all aspects of its
cost-benefit considerations, including the identification and
assessment of any costs and benefits not discussed herein; data and any
other information to assist or otherwise inform the Commission's
ability to quantify or qualitatively describe the costs and benefits of
the proposed amendments; and substantiating data, statistics, and any
other information to support positions posited by commenters with
respect to the Commission's discussion. The Commission welcomes comment
on such costs, particularly from existing DCOs that can provide
quantitative cost data based on their respective experiences.
Commenters may also suggest other alternatives to the proposed
approach.
The Commission notes that this consideration is based on its
understanding that the derivatives market regulated by the Commission
functions internationally with: (1) transactions that involve entities
organized in the United States occurring across different international
jurisdictions; (2) some entities organized outside of the United States
that are prospective Commission registrants; and (3) some entities that
typically operate both within and outside the United States and that
follow substantially similar business practices wherever located. Where
the Commission does not specifically refer to matters of location, the
discussion of costs and benefits below refers to the effects of the
proposed regulations on all relevant derivatives activity, whether
based on their actual occurrence in the United States or on their
connection with, or effect on U.S. commerce.\70\
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\70\ See, e.g. 7 U.S.C. 2(i).
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2. Baseline
The Commission identifies and considers the benefits and costs of
the proposed amendments relative to the baseline of the status quo. In
particular, the baseline for the Commission's consideration of the
costs and benefits of this proposed rulemaking is the existing
statutory and regulatory framework applicable to DCOs, including: (1)
the DCO core principles set forth in section 5b(c)(2) of the CEA; (2)
the requirements associated with holding clearing member funds for
positions in futures, foreign futures, and swaps under Sec. 39.15; (3)
the current DCO reporting requirements under Sec. 39.19; and (4) the
requirements for obtaining an acknowledgment letter from a foreign
central bank holding customer funds, but not member funds.
3. Proposed Amendments to Sec. 39.15(b)
a. Summary of Changes
The Commission is proposing new Sec. 39.15(b)(3), which would
allow the central banks of money center countries to serve as
depositories for customer funds. The proposed regulation would further
allow a DCO holding customer funds at the central bank of a money
center country to obtain a modified written acknowledgment that is
shorter and less detailed than the template acknowledgment letter in
Sec. Sec. 1.20 and 22.4.
b. Benefits
The Commission believes that central banks are often the best
option for deposit of customer funds. By using a central bank, DCOs can
minimize the credit and liquidity risks they face when holding foreign
currency cash deposits. Many foreign central banks do not fit into any
of the categories of permissible depositories in Sec. 1.49, and some
central banks have expressed unwillingness to sign the template
acknowledgment letter. By permitting DCOs to deposit customer funds at
the central banks of money center countries and requiring an
abbreviated written acknowledgment suitable for the central bank
context, the Commission believes that DCOs will be able to avail
themselves of the risk management benefits of holding funds at a
central bank.
c. Costs
The Commission does not believe the proposed rule will impose costs
on DCOs. The proposed rule does not require DCOs to hold customer funds
at any particular central bank and merely enables DCOs to hold funds at
certain central banks.
[[Page 295]]
d. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(b)(3)
in light of the specific considerations identified in section 15(a) of
the CEA. The Commission believes the proposed rule would protect market
participants by allowing their funds to be more easily held at foreign
central banks. Central banks expose depositors to minimal credit and
liquidity risks and are safe depositories for assets belonging to
market participants. Similarly, the proposed rules may improve DCOs'
risk management because of the low credit and liquidity risks
associated with holding funds at a central bank. The Commission has
considered the other Section 15(a) factors and believes that they are
not implicated by the proposed amendments to Sec. 39.15(b)(3).
4. Proposed Amendments to Sec. 39.15(e)
a. Summary of Changes
The Commission is proposing rules that would limit the investments
DCOs can make with proprietary funds to those that are permissible for
customer funds under Sec. 1.25. The proposed rule also states that
DCOs would be responsible for investment losses.
b. Benefits
The proposed rule would limit investments of proprietary funds to
the safe investments listed in Sec. 1.25. This is the same list of
investments that can be made with customer funds. The Commission
believes this proposal would appropriately protect clearing members
from risk of loss by ensuring that any investment is in instruments
with minimal credit, market, and liquidity risks.
c. Costs
The proposed rule may impose some costs on DCOs. Some DCOs may have
to stop investing proprietary funds in certain instruments that are
currently permitted and may incur some operational costs in revising
the investments that are offered to clearing members for their
proprietary funds. Further, to the extent the permitted investments
earn less yield than what a DCO currently invests in, the regulation
would impose costs in the form of lost investment revenue for the DCO
and clearing member. The total cost of this regulation will depend on a
number of factors including the number of clearing members of the DCO
and what, if any, investments the DCO currently makes with proprietary
funds.
a. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(e) in
light of the specific considerations identified in section 15(a) of the
CEA. The proposed rule would benefit clearing member market
participants by ensuring their funds are invested in instruments that
minimize the risk of loss. While DCOs currently determine what
investments to make with clearing member funds, the proposed rule
establishes a list of investments that the Commission believes is
appropriately conservative for all clearing members. The Commission has
considered the other Section 15(a) factors and believes that they are
not implicated by the proposed amendments to Sec. 39.15(e).
5. Proposed Amendments to Sec. 39.15(f)(1)
a. Summary of Changes
The Commission is proposing new Sec. 39.15(f)(1), which would
require DCOs to segregate proprietary funds from their own funds, hold
the funds in accounts clearly labeled as holding proprietary funds, and
hold at all times an amount sufficient in the aggregate to cover the
total value of proprietary funds held for all clearing members.
b. Benefits
The proposed rule would benefit clearing members by helping to
ensure that proprietary funds on deposit will not be misused. Holding
proprietary funds in an account that is exclusively for proprietary
funds and clearly named as being for proprietary funds would make it
difficult for a DCO or any employee to use the funds for an improper
purpose without being detected. Further, the requirement that accounts
hold funds adequate to cover the total value of proprietary funds held
for all clearing members at all times would prevent a DCO from
rehypothecating or otherwise using proprietary funds for its own
benefit, thus ensuring that the funds are available when needed by
clearing members or the DCO for permitted uses. The proposed rule would
also ensure funds are readily identifiable in the event of a DCO
bankruptcy, which would facilitate those funds receiving the
appropriate preferential treatment.
c. Costs
The proposed rule might add some costs for DCOs if they need to
establish new accounts for proprietary funds. DCOs would need to
establish new procedures for regularly confirming that the accounts
hold funds adequate to cover the total value of proprietary funds of
all clearing members. However, as a mitigating factor, the Commission
believes that most, if not all, DCOs currently hold proprietary funds
separately from their own, and that most DCOs do not rehypothecate or
otherwise use funds for their own purposes. In such cases, if there are
any costs, they would be related to staff time involved with renaming
current accounts holding proprietary funds. The exact costs will depend
on a number of factors including how many accounts a DCO maintains for
proprietary funds.
d. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(f)(1)
in light of the specific considerations identified in section 15(a) of
the CEA. The Commission believes the proposed rule would benefit market
participants by helping to ensure their funds are not misused and by
helping to make sure the funds receive the proper, preferential
treatment in the event of a DCO bankruptcy. The Commission also
believes that requiring DCOs to hold the total amount of proprietary
funds at all times would promote sound risk management because it would
ensure that the funds are available to the DCO in the event of a
clearing member default. The Commission has considered the other
section 15(a) factors and believes that they are not implicated by the
proposed amendments to Sec. 39.15(f)(1).
6. Proposed Amendments to Sec. 39.15(f)(2)
a. Summary of Changes
The proposed rule would require DCOs to obtain a proprietary funds
letter in the form prescribed in the proposed appendix from each
depository holding proprietary funds. The proposed letter is based on
the template acknowledgment letter for DCOs required by Sec. 1.20, and
requires depositories to acknowledge, among other things, that the
funds belong to clearing members and cannot be used by the DCO for any
other purpose. The proposed rule would also require a DCO to file the
letters with the Commission and update the letters when certain
information changes. The proposed rule would exclude Federal Reserve
Banks from the requirement to obtain a proprietary funds letter from a
depository holding proprietary funds. Further, the proposed rule would
require a simpler written
[[Page 296]]
acknowledgment from the central bank of a money center country that is
holding proprietary funds than that required of other depositories.
b. Benefits
The proposed rule would benefit clearing members by ensuring that
all depositories holding proprietary funds would know that the funds
belong to clearing members and cannot be used by the DCO for any other
purpose, which would help prevent the misuse of funds by the DCO or an
employee of the DCO. Further, having a proprietary funds letter for
each proprietary funds account would help a bankruptcy court or trustee
easily identify that the funds are member property in the event of a
DCO bankruptcy.
c. Costs
The proposed rule would impose costs on DCOs. DCOs would be
required to work with depositories to obtain proprietary funds letters
for existing accounts and to file the letters with the Commission.
Further, DCOs would need procedures for obtaining a letter for any new
account and for updating letters as information changes going forward.
The Commission is attempting to limit the costs of obtaining
proprietary funds letters by proposing to use a template that is
substantively the same as the template letter required for customer
funds and is thus already in use by many DCOs and their depositories.
The costs each DCO would incur would depend, in large part, on the
number of depositories the DCO uses to hold proprietary funds. The
Commission has estimated that the PRA costs for this rule will be $100
per burden hour. Based on the burden estimate discussed above of six
hours annually per DCO, the Commission estimates that each DCO will
spend $600 in PRA costs under this proposed rule.
d. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(f)(2)
in light of the specific considerations identified in section 15(a) of
the CEA. The Commission believes the proposed rule would benefit market
participants by ensuring that all depositories holding proprietary
funds know that the funds belong to clearing members and cannot be used
by the DCO for any other purpose, thus helping to prevent the misuse of
funds. Having a proprietary funds letter for each proprietary funds
account would help easily identify which funds are member property in
the event of a DCO bankruptcy. Finally, the helping to prevent the
misuse of proprietary funds would promote sound risk management by
making it more likely that the funds are available if needed to cover a
clearing member default. The Commission has considered the other
section 15(a) factors and believes that they are not implicated by the
proposed amendments to Sec. 39.15(f)(2).
7. Proposed Amendments to Sec. 39.15(f)(3)
a. Summary of Changes
Proposed Sec. 39.15(f)(3) would permit DCOs to commingle
proprietary funds belonging to multiple clearing members in the same
custodial account. The rule would prohibit a DCO from commingling
proprietary funds with the DCO's own funds or with FCM customer funds.
b. Benefits
The Commission believes that permitting DCOs to commingle
proprietary funds from multiple clearing members in one account would
allow DCOs to minimize operational risk by simplifying their banking
processes and procedures. Further, the proposed rule would ensure that
proprietary funds are held separately from the DCO's funds at the
depository, making it harder for a DCO or an employee of the DCO to
misuse the funds without detection.
c. Costs
The Commission does not believe permitting the commingling of
multiple clearing members' funds in one account would impose new costs
on DCOs. Currently, many DCOs hold clearing member funds in a
commingled account, and the proposed rule would only permit, not
require, clearing member funds to be commingled. However, the
Commission recognizes that a DCO that currently commingles clearing
member funds with other funds would need to segregate such funds and
establish a separate account for such funds, thereby incurring new
costs. But because the prohibition on commingling a DCO's funds with
its clearing members' funds codifies sound participant protection and
risk management principles that most, if not all, DCOs already apply,
the Commission does not believe that it would impose significant new
costs on existing DCOs. Additionally, DCOs are currently prohibited by
the requirements of section 4d of the Act and the regulations
thereunder from commingling customer funds with the funds of clearing
members. The proposed rule would therefore not impose new costs with
regard to holding clearing member funds and customer funds separately.
d. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(f)(3)
in light of the specific considerations identified in section 15(a) of
the CEA. The Commission believes that prohibiting a DCO from
commingling its own funds with proprietary funds would benefit market
participants by ensuring a clear delineation between the DCO's funds
and proprietary funds. This delineation would make it more difficult to
misuse proprietary funds and would make proprietary funds readily
identifiable in the event of a DCO bankruptcy. Further, the Commission
believes that the proposed rule would promote sound risk management
because ensuring that clearing members' funds are held separately from
the DCO's would make it more difficult for the funds to be misused
without detection and would therefore make it more likely that the
funds are available if needed to cover a clearing member default. The
Commission has considered the other section 15(a) factors and believes
that they are not implicated by the proposed amendments to Sec.
39.12(f)(3).
8. Proposed Amendments to Sec. 39.15(f)(4)
a. Summary of Changes
The proposed rule would prohibit a DCO or any of its depositories
from using proprietary funds for any reason other than as belonging to
the DCO's clearing members. The rule would specifically provide that an
FCM's funds may be used to cover its customers' losses and as part of a
DCO's mutualized guaranty fund.
b. Benefits
By eliminating any uses for proprietary funds other than on behalf
of clearing members, the proposed rule would help ensure that the funds
are readily available if needed either by the clearing member directly,
or for a permitted use by the DCO. The clarifications providing that an
FCM's funds may be used by a DCO to cover the FCM's customers' losses,
or as part of a clearing member-funded, mutualized guaranty fund,
ensures that the rule would not hamper DCOs' existing risk management
programs.
c. Costs
Because the proposed rule would codify sound participant protection
and risk management principles, the Commission does not believe that it
[[Page 297]]
would impose significant costs on DCOs. The Commission does not believe
DCOs are currently using clearing member funds in a manner that is
inconsistent with this regulation. Further, the proposed rule would not
require a guaranty fund or any specific type of FCM guarantee of its
customers' performance, but instead would merely permit what is
currently common risk management practice among DCOs.
d. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(f)(4)
in light of the specific considerations identified in section 15(a) of
the CEA. The proposed rule would benefit market participants by helping
to ensure that their funds are protected and available for their use.
Additionally, the proposed rule would promote sound risk management by
helping to ensure that clearing member funds are readily available for
permitted risk management uses by a DCO, such as in the event of a
customer shortfall or clearing member default. The Commission has
considered the other section 15(a) factors and believes that they are
not implicated by the proposed amendments to Sec. 39.12(f)(3).
9. Proposed Amendments to Sec. Sec. 39.15(g) and 39.19(c)(4)(xxvi)
a. Summary of Changes
Proposed Sec. 39.15(g) would require DCOs to, on a daily basis,
calculate the amount of futures customer funds, cleared swaps customer
collateral, and proprietary funds owed to each clearing member,
separately for each account class and on a currency by currency basis.
The proposed rule further would require DCOs to reconcile, separately
for each account class, the amount of funds owed to all clearing
members with the amount of funds held in depository accounts for that
class of funds. Each calculation and reconciliation would have to be
approved by a person who did not prepare the initial calculation or
reconciliation. The calculation and reconciliation would have to be
performed as of the close of each business day and completed by noon on
the following business day. The proposed rule also would require
securities to be valued at their current market value, subject to the
DCO's haircuts, and calculations of the amount owed to be made in a
manner consistent with the requirements of Sec. 1.20(i). Finally, both
proposed Sec. Sec. 39.15(g)(5) and 39.19(c)(4)(xxvi) would require
DCOs to immediately report any discrepancy in the calculation or
reconciliation to the Commission.
b. Benefits
By requiring a DCO to verify on a daily basis the amount of futures
customer funds, cleared swaps customer collateral, and proprietary
funds it is holding, for each clearing member and across all clearing
members, the proposed rule would facilitate the prompt discovery of any
missing futures customer funds, cleared swaps customer collateral, or
proprietary funds. Additionally, by requiring the daily calculation and
reconciliation to be approved by an independent employee, the proposed
rule would help prevent a single bad actor at a DCO from misusing
futures customer funds, cleared swaps customer collateral, or
proprietary funds, and from concealing that misuse. The requirement to
report any discrepancies to the Commission would help ensure that the
Commission is immediately made aware of potentially missing funds, and
that it can work with the DCO to resolve the matter.
c. Costs
The Commission understands that the daily calculation and
reconciliation would impose costs on DCOs. DCOs would need to develop
procedures that comply with the timing, valuation, and calculation
requirements in the proposed rule, to calculate the amount of funds
owed to each clearing member for each account class and to reconcile
the amount of funds owed to all clearing members with the amount of
funds held at depositories for each account class. Further, at least
two DCO employees would have to be involved in the process of
performing and approving the calculations and reconciliations each day.
DCOs would also need to include the new reporting requirement in their
process and procedures for event-specific reporting to the Commission.
The Commission has sought to minimize the costs of the proposed
regulation by only requiring reporting to the Commission of
discrepancies rather than the filing of daily reports. The exact costs
would depend on the account class(es) in which a DCO holds funds, and
the number of clearing members and customer accounts at issue. The
Commission has estimated that the PRA costs for event specific
reporting are $79 per hour. Based on the burden estimate discussed
above of .5 hours annually per DCO, the Commission estimates that each
DCO will spend $39.50 in PRA costs under this rule.
d. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(f)(5)
in light of the specific considerations identified in section 15(a) of
the CEA. The proposed rule would benefit market participants by
enabling any loss or theft of funds to be discovered by the DCO and
reported to the Commission quickly. The Commission further believes
that the proposed rule would promote sound risk management by helping
to ensure that the funds are available if needed by the DCO to cover a
clearing member or customer default. The Commission has considered the
other section 15(a) factors and believes that they are not implicated
by the proposed amendments.
10. Proposed Amendment to Sec. 39.15(h)
a. Summary of Changes
The proposed rule would exempt foreign DCOs from the requirements
of proposed Sec. 39.15(e)(3), (f), and (g)(3) because in the event of
an insolvency, the clearing member funds held by a foreign DCO would
not be subject to U.S. bankruptcy law.\71\
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\71\ See 17 CFR 190.11(b).
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b. Benefits
The Commission has determined to seek to avoid conflicts with
insolvency proceedings in the jurisdiction where a foreign DCO is
organized. The Commission believes that certainty surrounding which
insolvency law would apply would benefit the clearing members of
foreign DCOs.
c. Costs
The Commission does not believe the rule would impose costs on
foreign DCOs. The proposed rule is preserving the baseline, that funds
belonging to a foreign DCO's clearing members will be treated in
accordance with the insolvency law of the foreign DCO's home
jurisdiction.
d. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 39.15(h) in
light of the specific considerations identified in section 15(a) of the
CEA. The proposed rule would benefit market participants by providing
certainty regarding which insolvency law would apply to their funds in
the event a foreign DCO enters an insolvency proceeding. The Commission
has considered the other section 15(a) factors and believes that
[[Page 298]]
they are not implicated by the proposed amendments.
D. Antitrust Considerations
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the CEA, in issuing any order or adopting any Commission
rule or regulation.\72\
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\72\ 7 U.S.C. 19(b).
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The Commission believes that the public interest to be protected by
the antitrust laws is the promotion of competition. The Commission
requests comment on whether the proposed amendments implicate any other
specific public interest to be protected by the antitrust laws. The
Commission has considered the proposed rulemaking to determine whether
it is anticompetitive and has identified no anticompetitive effects.
The Commission requests comment on whether the proposed rulemaking is
anticompetitive and, if it is, what the anticompetitive effects are.
Because the Commission has determined that the proposed rule
amendments are not anticompetitive and have no anticompetitive effects,
the Commission has not identified any less anticompetitive means of
achieving the purposes of the CEA. The Commission requests comment on
whether there are less anticompetitive means of achieving the relevant
purposes of the CEA that would otherwise be served by adopting the
proposed rule amendments.
List of Subjects in 17 CFR Part 39
Reporting, Treatment of funds.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR part 39 as follows:
PART 39--DERIVATIVES CLEARING ORGANIZATIONS
0
1. The authority citation for part 39 continues to read as follows:
Authority: 7 U.S.C. 2, 6(c), 7a-1, and 12a(5); 12 U.S.C. 5464;
15 U.S.C. 8325; Section 752 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111-203, title VII, sec. 752, July
21, 2010, 124 Stat. 1749.
0
2. Amend Sec. 39.2 by adding definitions of the terms ``Money center
country'' and ``Proprietary funds'' in alphabetical order to read as
follows:
Sec. 39.2 Definitions.
* * * * *
Money center country means Canada, France, Germany, Italy, Japan,
and the United Kingdom.
* * * * *
Proprietary funds means all money, securities, and property
received by a derivatives clearing organization from, for, or on behalf
of, a clearing member and held in a proprietary account, as defined in
Sec. 1.3 of this chapter:
(1) To margin, guarantee, or secure contracts for future delivery
on or subject to the rules of a contract market, derivatives clearing
organization, or foreign board of trade or a cleared swap contract, and
all money accruing to a clearing member as the result of such
contracts;
(2) In connection with a commodity option transaction on or subject
to the rules of a contract market, derivatives clearing organization,
or foreign board of trade:
(i) To be used as a premium for the purchase of a commodity option
transaction for a clearing member;
(ii) As a premium payable to a clearing member;
(iii) To guarantee or secure performance of a commodity option by a
clearing member; or
(iv) Representing accruals (including, for purchasers of a
commodity option for which the full premium has been paid, the market
value of such commodity option) to a clearing member;
(3) That constitutes, if a cleared swap is in the form or nature of
an option, the settlement value of the option; or
(4) As a contribution to a guaranty fund to mutualize the losses
resulting from a default by a clearing member by covering the losses in
accordance with the derivatives clearing organization's rules and its
agreement(s) with its clearing members.
* * * * *
0
3. Amend Sec. 39.15 by adding paragraph (b)(3), revising paragraph
(e), and adding paragraphs (f), (g), and (h) to read as follows:
Sec. 39.15 Treatment of funds.
* * * * *
(b) * * *
(3) Central banks. Notwithstanding anything to the contrary in
Sec. Sec. 1.20, 1.49, 22.4, 22.5, or 22.9 of this chapter, a
derivatives clearing organization may hold futures customer funds or
cleared swaps customer collateral at the central bank of a money center
country if it obtains from the central bank a written acknowledgment
that:
(i) The central 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 applicable Commission regulations
thereunder; and
(ii) The central 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 Market Participants Division, 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.
* * * * *
(e) Permitted investments. (1) Funds and assets belonging to
clearing members and their customers that are invested by a derivatives
clearing organization shall be held in instruments with minimal credit,
market, and liquidity risks.
(2) Any investment of customer funds or assets by a derivatives
clearing organization shall comply with Sec. 1.25 of this chapter.
(3) A derivatives clearing organization may invest proprietary
funds only in a manner that would be permitted for customer funds under
Sec. 1.25 of this chapter. The derivatives clearing organization shall
bear sole responsibility for any losses resulting from the investment
of proprietary funds.
(f) Proprietary funds--(1) Segregation. A derivatives clearing
organization must separately account for and segregate all proprietary
funds as belonging to its clearing members. A derivatives clearing
organization shall deposit proprietary funds under an account name that
clearly identifies the funds as belonging to clearing members and shows
that the funds are segregated as required by this part. A derivatives
clearing organization must at all times maintain in the separate
segregated account or accounts money, securities and property in an
amount sufficient in the aggregate to cover the total value of
proprietary funds owed to all clearing members.
(2) 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 an account
for proprietary funds by the derivatives clearing organization with the
depositories; provided, however, a derivatives clearing organization is
not required to obtain a written acknowledgment from a Federal Reserve
Bank with which it has opened an account for proprietary funds.
[[Page 299]]
(ii) The written acknowledgment must be in the form as set out in
Appendix D to this part, except as provided in paragraph (f)(2)(vi) of
this section.
(iii) 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.
(iv) 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
proprietary funds; or
(C) The account number(s) under which proprietary funds are held.
(v) A derivatives clearing organization 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 period provided in Sec. 1.31 of this chapter.
(vi) Notwithstanding paragraph (f)(2)(ii) of this section, a
derivatives clearing organization may deposit proprietary funds with
the central bank of a money center country if it obtains from the
central bank a written acknowledgment that:
(A) The central bank was informed that the proprietary funds
deposited therein are those of clearing members who trade commodities,
options, swaps, and other products and are being held in accordance
with the provisions of section 5b(c)(2)(F) of the Act and Commission
regulations thereunder; and
(B) The central bank agrees to reply promptly and directly to any
request from the director of the Division of Clearing and Risk, or any
successor division, or the director's designees, for confirmation of
account balances or provision of any other information regarding or
related to an account.
(3) Commingling. (i) A derivatives clearing organization may for
convenience commingle the proprietary funds that it receives from, or
on behalf of, clearing members in a single account or multiple accounts
with one or more depositories.
(ii) A derivatives clearing organization shall not commingle
proprietary funds with the money, securities or property of the
derivatives clearing organization, or a customer account of a clearing
member of the derivatives clearing organization, or use proprietary
funds to secure or guarantee the obligation of, or extend credit to,
the derivatives clearing organization.
(4) Limitation on use of proprietary funds. (i) A derivatives
clearing organization shall not hold, use or dispose of proprietary
funds except as belonging to the clearing member that deposited the
proprietary funds. The use of proprietary funds as belonging to
clearing members may include, but is not limited to:
(A) A derivatives clearing organization may use the proprietary
funds belonging to a clearing member to guarantee or cover deficits in
a customer account of that clearing member in accordance with the
derivatives clearing organization's rules and its agreement(s) with the
clearing member; and
(B) A derivatives clearing organization may use non-defaulting
clearing members' money, securities, or property that is being held as
a guaranty fund to mutualize the losses resulting from a default by a
clearing member to cover such losses in accordance with the derivatives
clearing organization's rules and its agreement(s) with its clearing
members.
(ii) No person, including any derivatives clearing organization or
any depository, that has received proprietary funds for deposit in a
segregated account, as provided in this section, may hold, dispose of,
or use any the funds as belonging to any person other than the clearing
members of the derivatives clearing organization which deposited the
funds.
(g) Daily reconciliation--(1) Futures customer funds. By noon of
each business day, a derivatives clearing organization that has
received futures customer funds from its clearing members shall, as of
the close of the previous business day:
(i) Calculate the amount of futures customer funds owed to each
clearing member, on a currency by currency basis; and
(ii) Reconcile the total amount of futures customer funds owed, on
a currency by currency basis, aggregated across all clearing members,
with the amount of futures customer funds held in separate accounts
across all depositories.
(2) Cleared swaps customer funds. By noon of each business day, a
derivatives clearing organization that has received cleared swaps
customer collateral from its clearing members shall, as of the close of
the previous business day:
(i) Calculate the amount of cleared swaps customer collateral owed
to each clearing member, on a currency by currency basis; and
(ii) Reconcile the total amount of cleared swaps customer
collateral owed, aggregated across all clearing members, with the
amount of cleared swaps customer collateral held in separate accounts
across all depositories.
(3) Proprietary funds. By noon of each business day, a derivatives
clearing organization that has received proprietary funds from its
clearing members shall, as of the close of the previous business day:
(i) Calculate the amount of proprietary funds owed to each clearing
member, on a currency by currency basis; and
(ii) Reconcile the total amount of proprietary funds owed,
aggregated across all clearing members, with the amount of proprietary
funds held in separate accounts across all depositories.
(4) Calculations. (i) Each calculation and reconciliation required
by this paragraph (g) must be approved by a person who did not prepare
the calculation or reconciliation and who does not report to the person
that prepared the calculation or reconciliation.
(ii) In performing the calculations required by this paragraph (g):
(A) Securities shall be valued at their current market value, with
haircuts applied in accordance with Sec. 39.11(d); and
(B) A reconciliation deficit in a particular account type in one
currency may be offset by a surplus in that same account type in
another currency, based on publicly available exchange rates, with the
surplus subject to haircuts reasonably determined by the derivatives
clearing organization, consistently applied.
(C) Where customer funds, including funds received to margin,
guarantee, or secure futures, options, foreign futures, foreign
options, or swaps, are, pursuant to an order of the Commission or a DCO
rule filed pursuant to paragraph (b)(2)of this section, received for
the purpose of holding such funds in a futures account, they shall be
treated as futures customer funds, both for purposes of funds owed and
funds held. Where such funds are received for the purpose of holding
such funds in a cleared swaps customer account, they shall be treated
as cleared swaps customer collateral, both for purposes of funds owed
and funds held.
(iii) Calculations of amounts owed in this paragraph (g) shall be
made consistent with the requirements of Sec. 1.20(i) of this chapter,
as applied to the accounts of a derivatives clearing organization with
respect to its members' futures customer, cleared swaps customer, and
proprietary accounts.
[[Page 300]]
(5) A derivatives clearing organization shall immediately report to
the Commission, pursuant to Sec. 39.19, any discrepancies in the
calculation of the amount of funds held for each clearing member and
any one or more of the reconciliations that reveals that the
derivatives clearing organization did not, at the close of the previous
business day, maintain in separate segregated accounts money,
securities and property in an amount sufficient in the aggregate to
cover the total value of funds owed to all clearing members.
(h) Exclusions for foreign derivatives clearing organizations--
Paragraphs (e)(3), (f) and (g)(3) of this section do not apply to a
derivatives clearing organization organized outside the United States
that would, in the event of its insolvency, be subject to a foreign
proceeding, as defined in 11 U.S.C. 101(23), in the jurisdiction in
which it is organized.
0
4. In Sec. 39.19, add paragraph (c)(4)(xxvi) to read as follows:
Sec. 39.19 Reporting.
* * * * *
(c) * * *
(4) * * *
(xxvi) Discrepancy in customer or proprietary funds. A derivatives
clearing organization shall immediately report to the Commission any
discrepancies in the calculation of the amount of funds held for each
clearing member and any one or more of the reconciliations required
pursuant to Sec. 39.15(g) that reveals that the derivatives clearing
organization did not, at the close of the previous business day,
maintain in separate segregated accounts money, securities and property
in an amount sufficient in the aggregate to cover the total value of
funds owed to all clearing members.
* * * * *
0
5. Add appendix D to part 39 to read as follows:
Appendix D to Part 39--Derivatives Clearing Organization Acknowledgment
Letter for CFTC Regulation Sec. 39.15 Proprietary Funds 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] Proprietary Funds
Account, CFTC Regulation Sec. 39.15 Proprietary Funds Account under
Section 5b(c)(2)(F) 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
clearing members who trade commodities, options, swaps, and other
products, as required by Commodity Futures Trading Commission
(``CFTC'') Regulations, including Regulation Sec. 39.15, 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 39 of the CFTC's regulations, as amended; and
that the Funds constitute member property as defined by 11 U.S.C.
761(16) and CFTC Regulation Sec. 190.01.
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.
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 any successor
divisions, or such director's 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 any successor divisions, or such director's
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 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 account maintained by us with you for the purpose of holding
our own funds. 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 proprietary 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
[[Page 301]]
the parties in connection with the Account(s), this letter agreement
shall govern with respect to matters specific to section 5b(c)(2)(F)
of the Act and CFTC Regulation Sec. 39.15, 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:
Issued in Washington, DC, on December 26, 2023, by the
Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Protection of Clearing Member Funds Held by Derivatives
Clearing Organizations--Commission Voting Summary, Chairman's
Statement, and Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Behnam and Commissioner Johnson voted in
the affirmative. Commissioner Pham concurred. Commissioners Goldsmith
Romero and Mersinger voted in the negative.
Appendix 2--Statement of Support of Chairman Rostin Behnam
I support the issuance and publication of the proposed rule on
the protection of clearing member funds held by derivatives clearing
organizations (DCOs). The Commission has longstanding regulations
that provide comprehensive protections for funds belonging to
customers of a Futures Commission Merchant (FCM).\1\ Similar
protections, however, do not exist for funds belonging to clearing
members of a DCO, whether they are individual market participants or
FCMs themselves. The proposed rule would implement a regime for the
protection of clearing member funds largely analogous to the current
regime applicable to FCM customer funds. Specifically, the proposed
rule would ensure that clearing member funds and assets receive
proper treatment if a DCO enters bankruptcy by requiring segregation
of clearing member funds from the DCO's own funds \2\ and that the
funds be held in a depository that acknowledges in writing that the
funds belong to clearing members,\3\ not the DCO. The proposed rule
would require new regulations regarding the commingling of clearing
member or proprietary funds; \4\ limitations on the use of these
funds; \5\ and limit investments of the funds to the investments
permitted for customer funds under Regulation Sec. 1.25.\6\ In
addition, the proposed rule would permit DCOs to hold customer and
clearing member funds at foreign central banks subject to certain
requirements. Finally, the proposed rule would require DCOs to
conduct a daily calculation and reconciliation of the amount of
funds owed to customers and clearing members and the amount actually
held for customers and clearing members.\7\
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\1\ See 7 U.S.C. 6d; 17 CFR 1.20 through 1.39. See also 17 CFR
22.1 through 22.17, and 30.7 (establishing similar regimes for
cleared swaps customer collateral and foreign futures customer
funds, respectively). DCOs that receive customer funds from their
FCM clearing members must also apply many of these customer
protection requirements.
\2\ See also 17 CFR 1.20(a) (requiring FCMs to segregate
customer funds from their own funds); 17 CFR 1.20(g)(1), 17 CFR
39.15 (b), 17 CFR 22.3(b)(1) (requiring DCOs to segregate the
customer funds of their FCM clearing members from their own funds).
\3\ See also 17 CFR 1.20, 22.5, and 30.7 (requiring an FCM to
obtain an acknowledgment letter for futures customer funds, cleared
swaps customer collateral, and foreign futures customer funds,
respectively); 17 CFR 1.20(g)(4), 17 CFR 22.5 (requiring a DCO to
obtain an acknowledgment letter from depositories).
\4\ See also 17 CFR 1.20(e) and (g).
\5\ See also 17 CFR 1.20(f).
\6\ 17 CFR 1.25.
\7\ See also 17 CFR 1.32, 1.33.
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Commission regulations addressing the custody and safeguarding
of customer funds have historically responded to the characteristics
of the prevailing model in which all, or nearly all, clearing
members of a DCO were FCMs acting as intermediaries. However, as
noted in the proposed rule, the Commission has granted registration
to a number of DCOs that clear directly for market participants
without the intermediation of FCMs.\8\ Additionally, many DCOs that
use the traditional FCM clearing model have at least some non-FCM
clearing members. The growth and evolution of the non-intermediated
clearing model necessitates ensuring that our regulations establish
a regime for the safeguarding and protection of clearing member
funds that addresses the issues and risks presented.
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\8\ Currently, CBOE Clear Digital, LLC; CX Clearinghouse, L.P.;
LedgerX, LLC; and North American Derivatives Exchange Inc. allow
individuals to be direct clearing members. See In the Matter of the
Application of CBOE Clear Digital, LLC For Registration as a
Derivatives Clearing Organization (June 5, 2023), available at
https://www.cftc.gov/IndustryOversight/IndustryFilings/ClearingOrganizations/39855; In the Matter of the Application of CX
Clearinghouse, L.P. For Registration as a Derivatives Clearing
Organization (Aug. 3, 2018), available at https://www.cftc.gov/IndustryOversight/IndustryFilings/ClearingOrganizations/16767; In
the Matter of the Application of LedgerX, LLC For Registration as a
Derivatives Clearing Organization (Sept. 2, 2020), available at
https://www.cftc.gov/IndustryOversight/IndustryFilings/ClearingOrganizations/30998; In the Matter of the Application of the
North American Derivatives Exchange for Registration as a
Derivatives Clearing Organization (Jan. 17, 2014), available at
https://www.cftc.gov/IndustryOversight/IndustryFilings/ClearingOrganizations/38.
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Lastly, I am pleased that the proposed rule would, in effect,
codify the no-action and exemptive relief previously given to four
DCOs \9\ by permitting DCOs to hold customer funds at foreign
central banks and use a modified acknowledgment letter. The proposed
rule would also extend these amended provisions to clearing member
funds. Permitting DCOs to hold customer and clearing member funds at
a central bank allows them to take advantage of the credit and
liquidity risk management benefits that central bank accounts
provide. This is sound policy and risk management.
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\9\ See CFTC Letter No. 16-59 (June 21, 2016), available at
https://www.cftc.gov/csl/16-59/download (granting an exemption to
the Chicago Mercantile Exchange, Inc (CME) from the requirements of
Regulation Sec. 1.49(d)(3) to permit CME to hold customer funds at
the Bank of Canada and permitting the use of a modified
acknowledgment letter for customer accounts maintained by the CME.
at the Bank of Canada); CFTC Letter No. 16-05 (Feb. 1, 2016),
available at https://www.cftc.gov/csl/16-05/download (granting an
exemption to Eurex Clearing AG (Eurex) from the requirements of
Regulation Sec. 1.49(d)(3) to permit Eurex to hold customer funds
at Deutsche Bundesbank and permitting the use of a modified
acknowledgment letter for customer accounts maintained by Eurex at
Deutsche Bundesbank); and CFTC Letters No. 14-123 (Oct. 8, 2014),
available at https://www.cftc.gov/csl/14-123/download and 14-124
(Oct. 8, 2014), available at https://www.cftc.gov/csl/14-124/download (granting an exemption to ICE Clear Europe Limited and LCH
Ltd, respectively, from the requirements of Regulation Sec.
1.49(d)(3) to permit ICE Clear Europe Limited and LCH Ltd to hold
customer funds at the Bank of England and permitting the use of a
modified acknowledgment letter for customer accounts maintained by
ICE Clear Europe Limited and LCH Ltd, respectively, at the Bank of
England).
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I look forward to hearing the public's comments on the proposed
rule. The 60-day comment period will begin upon the Commission's
publication of the proposed rule on its website.
Appendix 3--Statement of Commissioner Kristin N. Johnson
Trust is the core issue that motivates today's notice of
proposed rulemaking (Proposed Rule) regarding the protection of
clearing member funds held by derivatives clearing organizations
(DCOs) advanced by the Division of Clearing and Risk.
On March 30, 2022, I commenced service as a Commissioner of the
Commodity Futures Trading Commission (Commission or CFTC). In a
hearing before the Senate Agriculture, Nutrition, and Forestry
Committee a few weeks earlier, I committed to promote the
[[Page 302]]
integrity and stability of our markets and protect customers,
particularly vulnerable and marginalized individual retail customers
who participate in our markets. This commitment is among the most
compelling reasons for my public service.
Over the last few decades, the Commission has adopted and
refined protections for customers of intermediaries in our markets,
namely by imposing rigorous obligations on intermediaries to
segregate the funds of their customers, designating specific
authorized depositories, and outlining permitted investments of
customer funds.
Over the course of my tenure as a Commissioner, in numerous
public speeches, statements, and interviews, I have called on the
Commission to advance parallel customer protections for direct
participants of non-intermediated clearinghouses registered with the
Commission as DCOs.\1\
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\1\ Kristin N. Johnson, Commissioner, CFTC, Statement on
Preserving Trust and Preventing the Erosion of Customer Protection
Regulation (Nov. 3, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnstatement110323; Kristin N. Johnson,
Commissioner, CFTC, Keynote Address at the World Federation of
Exchanges Annual Meeting: Creating Rules of the Road for
(Dis)Intermediated and (De)Centralized Markets (Sept. 21, 2023),
https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson5;
Kristin N. Johnson, Commissioner, CFTC, Keynote Address at Salzburg
Global Finance Forum: Future-Proofing Financial Markets Regulation
(June 29, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson4; Kristin N. Johnson, Commissioner, CFTC, Statement
Calling for the CFTC to Initiate A Rulemaking Process for CFTC-
Registered DCOs Engaged in Crypto or Digital Asset Clearing
Activities (May 30, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement053023; Kristin N. Johnson,
Commissioner, CFTC, Keynote Address at Digital Assets @Duke
Conference, Duke's Pratt School of Engineering and Duke Financial
Economics Center: Mitigating Crypto-Crises: Applying Lessons Learned
in Governance, Risk Management, and Compliance (Jan. 26, 2023),
https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson2;
Kristin N. Johnson, Commissioner, CFTC, Statement in Support of
Notice of Proposed Amendments to Reporting and Information
Requirements for Derivatives Clearing Organizations (Nov. 10, 2022),
https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement111022b.
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Today's Proposed Rule takes the first steps to close this gap. I
support this Proposed Rule that advances the protection of clearing
member proprietary funds held by a DCO. Specifically, the Proposed
Rule:
Requires a DCO to segregate clearing member proprietary
funds from the DCO's own funds, hold such funds in an account
labeled as proprietary funds, and obtain a written acknowledgment
letter from a depository;
Requires a DCO to treat clearing member proprietary
funds as belonging to the clearing member while permitting the DCO
to use clearing member proprietary funds as part of the DCO's
default waterfall, consistent with the DCO's rules and agreement
with its clearing members;
Permits the DCO to commingle proprietary funds of
multiple clearing members in a single omnibus account for
convenience while prohibiting the commingling of proprietary funds
with the DCO's own funds or futures commission merchant (FCM)
customer funds;
Permits the DCO to invest clearing member proprietary
funds in highly liquid financial instruments pursuant to CFTC
Regulation Sec. 1.25 and requires DCOs to be responsible for
investment losses; and
Requires the daily reconciliation of balances of FCM
customers and clearing members and segregated funds and the
reporting of any discrepancies.
In my capacity as a Commissioner at the CFTC, I have strongly
advocated for the development of these important regulatory
protections that parallel existing protections in intermediated
market structures. This Proposed Rule reflects the tremendous
efforts of coordination among the Division of Clearing and Risk, the
office of the Chairman, my office, and my fellow Commissioners'
offices and their staff. Our collective engagement reflects years of
dialogue with market participants, CFTC staff, other market and
prudential regulators and engagement with the U.S. Department of the
Treasury, members of Congress, academics, and public interest
advocates.
This Proposed Rule offers a transformational reform that brings
to markets in which clients may interact directly with a DCO
foundational protections currently established in CFTC regulations
and enforced in markets that rely on intermediaries.\2\
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\2\ Although the focus of my statement is on direct participants
in the context of non-intermediated clearing models, the Proposed
Rule has broader implications. It applies to the proprietary funds
of FCMs in the context of an intermediated model as well.
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In a direct clearing model (non-intermediated market structure),
clearing members are not customers of intermediaries,\3\ and
therefore, do not qualify for the regulatory protections available
under part 1 of the Commission's regulations, including the
requirement to separately account for and segregate customer funds
as belonging to customers, deposit customer funds in specific
locations, obtain written acknowledgment letters from depositories,
and use customer funds as belonging to such customers.\4\ The
Proposed Rule reflects the historic development and evolution of
markets and refers to the assets or funds on deposit from a customer
of an intermediary as ``customer funds.'' The Proposed Rule adopts
the term ``clearing member'' to describe those directly interacting
with the clearinghouse and ``proprietary funds'' to describe
clearing members' assets or funds on deposit.
---------------------------------------------------------------------------
\3\ The term ``customer'' is generally reserved for the
individuals or businesses that rely on an intermediary such as an
FCM to facilitate a transaction. Where a DCO offers direct services,
the individuals or businesses engaged with the clearinghouse are
generally described as ``members.''
\4\ 17 CFR 1.20.
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The Commission acts to ensure parallel protections in the market
for every asset class, adopting and seeking to implement the
existing, well-tested, and effective regulatory framework under
certain provisions of part 1 of the CFTC's regulation to the
preservation of clearing member proprietary funds. This may be
increasingly important as the Commission anticipates market
participants' introduction of novel financial products.
In adopting the Proposed Rule, the Commission seeks to ensure
that clearing member proprietary funds are easily identified and
receive the proper treatment in the event the DCO enters an
insolvency or bankruptcy proceeding.
Today, the Commission takes a first step to ensure that there
are parallel protections for both the ``customers'' of
intermediaries, and the ``clearing members'' of DCOs who may include
(in a direct clearing model) individual retail market participants.
Regulatory Gap for Direct Participants in Non-Intermediated Clearing
Models
Section 4d of the Commodity Exchange Act (CEA) and parts 1, 22
and 30 of the Commission's regulations establish a comprehensive
regime to safeguard the funds belonging to customers of FCMs in the
context of intermediated DCOs.
The customer protection regime requires FCMs to segregate
customer funds from their own funds, deposit customer funds under an
account name that clearly identifies them as customer funds, and
obtain a written acknowledgment from each depository that holds
customer funds. The customer protection regime does not apply to the
funds of a person that clears trades directly through a DCO and is a
``clearing member'' because such market participants do not meet the
legal and regulatory definitions of the term ``customer.''
Therefore, direct participants that are not ``customers'' of
intermediaries may not benefit from the Commission's well-
established customer protection regime.
The Commission seeks to offer parallel customer protections to
direct participants in non-intermediated DCOs--clearing members--to
preserve the value of their proprietary funds, mitigate the risk of
loss, and improve the availability of those funds for return to the
clearing member should the DCO fail. Section 5b(c)(2)(F) of the CEA
(Core Principle F) and CFTC Regulation Sec. 39.15 apply to the
treatment of clearing members' funds and assets held by a DCO.
CFTC regulations require DCOs to establish standards and
procedures designed to protect and ensure the safety of proprietary
funds and require DCOs to hold proprietary funds in a manner that
will minimize the risk of loss or delay in access by the DCO to the
proprietary funds. Section 8a(5) of the CEA grants the Commission
authority to adopt rules it determines are reasonably necessary to
effectuate the DCO core principles.\5\ The safeguards in this
Proposed Rule are indeed reasonably necessary to effectuate DCO Core
Principle F.\6\
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\5\ 7 U.S.C. 12a(5).
\6\ 7 U.S.C. 7a-1(c)(2)(F).
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In light of the lack of parallel protections for ``clearing
members'' who directly interface with DCOs, there is a significant
gap in the Commission's ability to ensure the protection and
preservation of funds or assets of direct participants. This
Proposed Rule closes the gap.
[[Page 303]]
The Collapse of the FTX Complex
The bankruptcy of FTX illustrates the magnitude of the losses
that customers may experience in the absence of regulation that
prohibits commingling of client assets or imposes obligations to
segregate client assets for the benefit of customers.
In November 2022, FTX Trading Ltd. d/b/a/FTX.com (FTX), Alameda
Research LLC (Alameda) and approximately one hundred and thirty FTX-
affiliated entities filed for bankruptcy in the United States.
Contemporaneous with the bankruptcy filing, the Department of
Justice (DOJ), Commission, and other federal regulators began to
investigate claims that FTX employed omnibus accounts that
commingled customer funds with the FTX enterprise resources,
allegedly misappropriating more than $10 billion in client
assets.\7\
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\7\ FTX Demonstrates Need for More Oversight: CFTC's Johnson
(Bloomberg TV Nov. 9, 2022), https://www.bloomberg.com/news/videos/2022-11-09/ftx-demonstrates-need-for-more-oversight-cftc-s-johnson.
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The CFTC has alleged that Mr. Bankman-Fried and FTX solicited
customers on the premise that the FTX platform could be trusted.\8\
The CFTC's complaint alleges that despite these statements, FTX
permitted Alameda to access customer deposits and commingle customer
assets with Alameda's proprietary assets, which were used for
Alameda's and its executives' own business operations, personal
purchases, acquisitions of other businesses, and risky investments.
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\8\ See Commodity Futures Trading Commission v. Samuel Bankman-
Fried, FTX Trading Ltd d/b/a FTX.com, and Alameda Research LLC
(S.D.N.Y. 2022) (Compl.).
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While soliciting customers to trust in the integrity of its
business, FTX is alleged to have siphoned off billions in customer
deposits.
The Benefits and Limits of Alternatives to Regulation: LedgerX
LedgerX, a non-intermediated clearinghouse registered with the
Commission as a DCO and owned by parent company FTX, illustrates the
importance of the protections advanced in the proposed rulemaking.
On October 25, 2021, FTX.US acquired LedgerX through a Delaware
company doing business as West Realm Shires Services Inc. (West
Realm Shires). When parent company FTX filed a petition seeking
bankruptcy protection on November 11, 2022, the bankruptcy court
declared LedgerX a non-debtor entity. LedgerX was one of the few
assets within the network of FTX-affiliated companies that remained
solvent.
In 2017, years before the acquisition by West Realm Shires,
LedgerX submitted an application with the Commission seeking
authorization to register as a DCO offering fully-collateralized
(crypto) derivatives contracts. The Commission's order, amended in
September 2020, imposed a number of important conditions, including
a condition requiring LedgerX to ``at all times maintain funds of
its clearing members separate and distinct from its own funds.'' \9\
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\9\ Press Release No. 8230-20, CFTC, CFTC Approves LedgerX, LLC
to Clear Fully-Collateralized Futures and Options on Futures (Sept.
2, 2020), https://www.cftc.gov/PressRoom/PressReleases/8230-20.
---------------------------------------------------------------------------
When FTX filed for bankruptcy protection, the conditions in the
LedgerX order and Commission staff's enforcement of compliance with
the conditions contributed significantly to the preservation of
LedgerX's customer property.\10\ The LedgerX order serves as an
important precedent for the framework the Commission must consider
when adopting parallel protections for DCO direct clients,
particularly retail clients, in the non-intermediated context.
---------------------------------------------------------------------------
\10\ LedgerX's ``customers'' are clearing members as described
above and would not otherwise qualify for protections under parts 1
and 22 of the Commission's regulations.
---------------------------------------------------------------------------
In 2022, LedgerX applied to amend its order of registration as a
DCO to allow it to modify its existing non-intermediated model to
clear margined products for retail participants while continuing
with a non-intermediated model.
In May 2022, the Commission held a convening to examine the
implications of a derivatives clearing market structure that offers
direct-to-client services. The convening outlined important issues
addressed in this Proposed Rule.
The Rise of Non-Intermediated DCOs
DCOs play an increasingly important role in the financial
markets, though DCOs have been central to facilitating access to the
derivatives market since the founding of our nation and the futures
market. The Dodd-Frank Act introduced a framework for the regulation
of swaps that imposed central clearing and trade execution
requirements, registration and comprehensive regulation of swap
dealers, and recordkeeping and real-time reporting requirements.
The clearing market structure has evolved from a traditional
clearing model, where an FCM served as an intermediary in
transactions between a customer and a DCO, to a direct clearing
model, where the transactions are between the customer and the DCO
directly.\11\ As I have previously stated:
---------------------------------------------------------------------------
\11\ Currently, CBOE Clear Digital, LLC, CX Clearinghouse, L.P.;
LedgerX, LLC, and North American Derivatives Exchange Inc. allow
individuals to be direct clearing members. Additionally, ICE NGX
Canada Inc. clears physically delivered energy contracts directly
for clearing members with a net worth exceeding CAD $5,000,000 or
assets exceeding CAD $25,000,000.
---------------------------------------------------------------------------
FCMs solicit and accept orders for derivatives transactions on
behalf of customers and receive customer funds to margin, guarantee,
or secure derivatives transactions. FCMs are subject to significant
regulatory requirements, including customer protection safeguards,
safety and soundness capital requirements, risk management,
conflicts of interest requirements, and anti-money laundering and
know-your-customer programs.\12\
---------------------------------------------------------------------------
\12\ Kristin N. Johnson, Commissioner, CFTC, Keynote Address at
the World Federation of Exchanges Annual Meeting: Creating Rules of
the Road for (Dis)Intermediated and (De)Centralized Markets (Sept.
21, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson5.
---------------------------------------------------------------------------
At the core, in a traditional, intermediated model, customer
protection rules apply to FCMs and require FCMs to segregate
customer funds, including when such funds are held at a DCO, among
other safekeeping measures.
In newly emerging disintermediated market structures, the
absence of an intermediary creates a gap in the application of the
CFTC's customer protection rules because key customer protections
are triggered by the presence of a ``customer,'' as defined by the
CFTC, and an FCM that facilitates the clearing of a customer's
derivatives transactions at the DCO.\13\
---------------------------------------------------------------------------
\13\ See supra note 1.
---------------------------------------------------------------------------
The Proposed Rule achieves parallel protections by applying key
aspects of the customer protection regime to proprietary funds of
clearing members and imposing parallel asset protection requirements
on DCOs--both in intermediated and non-intermediated clearing
models.
In addition, the Proposed Rule contains important requests for
comments, soliciting feedback and engagement from the industry on a
number of potential future actions.
Future Rulemaking: Anti-Money Laundering Requirements for DCOs
Anti-money laundering (AML) regulations ensure that all
transactions in our markets are subject to identification
verification standards and prevent illicit activity in our markets.
It is imperative that the Commission continue to engage with the
U.S. Department of Treasury to ensure that AML regulations apply to
all applicable market structures involving activities that create
obligations to comply with AML regulations.
The Proposed Rule includes a request for comment that asks how
might the Commission ensure AML and KYC compliance for DCOs that
offer direct clearing services (a market structure that would not
include FCMs or other intermediaries that are typically directed to
create Bank Secrecy Act compliance programs)? Should DCOs offering
direct-to-customer services to non-eligible contract participants or
retail customers be required to comply with AML and KYC
requirements?
Following consultation with the U.S. Department of Treasury, the
Commission may need to engage in a formal rulemaking that imposes
AML requirements on DCOs.\14\
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\14\ I note that the Commission has negotiated the inclusion of
AML requirements in the registration order for several DCOs,
including CBOE Clear Digital, LLC and LedgerX LLC. I commend DCOs
that have implemented these conditions.
---------------------------------------------------------------------------
Technical Clarifications in CFTC Regulation 1.25
The Proposed Rule allows DCOs to invest proprietary funds in
permitted investments pursuant to CFTC Regulation Sec. 1.25. The
drafting cross-refers to CFTC Regulation Sec. 1.25, but the
Commission is currently engaged in a proposed rulemaking that amends
CFTC Regulation Sec. 1.25. My supporting statements to amendments
to CFTC Regulation Sec. 1.25 note that it is imperative that the
Commission consider an equivalent application of CFTC Regulation
[[Page 304]]
Sec. 1.25 in the context of a DCO's investment of the member
property of retail customers.\15\
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\15\ Kristin N. Johnson, Commissioner, CFTC, Statement on
Preserving Trust and Preventing the Erosion of Customer Protection
Regulation (Nov. 3, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnstatement110323.
---------------------------------------------------------------------------
Comments to the Proposed Rule should indicate how best to ensure
equivalence.\16\
---------------------------------------------------------------------------
\16\ In footnote 45 in the Proposed Rule, the Commission notes:
Proposed Sec. 39.15(e) cross-references Sec. 1.25, which provides
that an FCM or DCO may invest ``customer money'' in certain
instruments. The regulatory text of Sec. 1.25, however, does not
refer to ``proprietary funds.'' The Commission recently approved
proposed amendments to Sec. 1.25. Based on comments received on
those proposed amendments, if appropriate, the Commission may
consider further amending Sec. 1.25 either in the final rule or as
a re-proposed rule to ensure that the regulatory text provides
clarity on the application of Sec. 1.25 to a DCO's investment of
``proprietary funds,'' as permitted under Sec. 39.15(e).
---------------------------------------------------------------------------
Periodic Reporting of Daily Reconciliations
The Proposed Rule requires a DCO to notify the CFTC of
discrepancies in its daily calculations. The Commission exercises
direct oversight with respect to DCOs, meaning DCOs are not
supervised by self-regulatory organizations (SRO) or designated
self-regulatory organizations (DSRO). The Commission performs the
examination functions. DCOs may benefit from a similar oversight as
FCMs, which involves a regular reporting of reconciliation and not
just the reporting of discrepancies.\17\ DCOs are subject to robust
Commission regulations, examinations, and oversight. It will be
important to receive comments from all stakeholders regarding the
reporting of DCO reconciliations.
---------------------------------------------------------------------------
\17\ See supra note 15.
---------------------------------------------------------------------------
Conclusion
It is my hope that this Proposed Rule will move forward so that
we can begin to introduce greater protections for clearing members,
including retail customers. I thank the Division of Clearing and
Risk--Clark Hutchinson, Eileen Donovan, Theodore Polley, and Scott
Sloan--for their tremendous efforts in advancing this very
important, significant, and transformative Proposed Rule.
Appendix 4--Dissenting Statement of Commissioner Christy Goldsmith
Romero
This week, the Commission in a split vote, on which I dissented,
approved the first proposed rule related to FTX's bespoke direct-to-
retail market structure. That structure removed the intermediary
(known as a futures commission merchant or FCM) where the CFTC's
customer protection and anti-money laundering regimes sit. I believe
that before my tenure, the Commission made a mistake in approving
two clearinghouses (LedgerX owned by FTX before FTX's bankruptcy,
and Nadex, which is now Crypto.com) for this direct-to-retail market
structure before analyzing and addressing the risks of a lack of AML
requirements, customer protections, and other checks and balances.
After FTX's bankruptcy, the CFTC is now trying to remedy the
consequences of its mistake, one of which is that retail
participants do not have customer protections under this model
because they lose their status as ``customers,'' instead becoming
``clearing members.'' In the open meeting, the CFTC staff said that
the proposed rule was an attempt to provide parallel protections to
those individuals who we would normally consider to be
``customers,'' but who now are ``members.'' But it fails to provide
parallel protections to retail participants. The proposed rule
attempts to port over to this direct-to-retail model one protection
(segregation of funds, which I support) without the other
protections, or checks and balances present in an intermediated
model with an FCM.
I do not know if it is even possible for the CFTC to give
parallel protections to retail participants under a direct-to-retail
model, because the Commodity Exchange Act and Commission rules
contemplate the presence of an FCM. Additionally, anti-money
laundering controls sit with the FCM, and clearinghouses have no AML
requirements. AML is a critical guardrail for national security and
customer protection. The Financial Stability Oversight Council's
(FSOC) 2023 Annual Report says, ``Crypto-assets remain susceptible
to misuse by terrorist organizations and other sanctioned
individuals' efforts to move funds in support of illicit
activities.'' \1\
---------------------------------------------------------------------------
\1\ See Financial Stability Oversight Council, Annual Report
2023, https://home.treasury.gov/system/files/261/FSOC2023AnnualReport.pdf, (December 14, 2023).
---------------------------------------------------------------------------
I do not believe that the rule, which was rushed in three weeks
at the end of the year, is sufficient to remedy that earlier
mistake. The rule would benefit from more time than three weeks.\2\
We should step back and assess the impact of changing the tried and
true market structure by removing the FCM. Without addressing a
number of serious issues, the rule may give a false sense of
security about the safety of a direct-to-retail model, while hiding
the threats. The CFTC staff in the open meeting said that there are
a number of applications pending for this model and they expect
more. Without an assessment, we may just move risk around the
system, while creating an illusion of safety.
---------------------------------------------------------------------------
\2\ Commissioners received it late Wednesday, the day before
Thanksgiving, three weeks before the meeting, with no prior
engagement with Commissioners on the content of the rule. Because,
it raised serious questions, I asked that it be pulled from the
meeting and that Commissioners would have more time. My request was
denied with no reason given.
---------------------------------------------------------------------------
Such an assessment would implement a recommendation from the
FSOC. In its October 2022 Report on Digital Asset Financial
Stability Risks and Regulation, the FSOC recommended that member
agencies (including the CFTC) ``assess the impact of vertical
integration (i.e., direct access to markets by retail customers) on
conflicts of interest and market volatility, and whether vertically
integrated market structures can or should be accommodated under
existing laws and regulations.'' The CFTC has not conducted this
analysis, leaving the CFTC out of step with FSOC's recommendation.
I invite the public to watch this week's CFTC public meeting,
which showed that there are serious issues that the CFTC should
assess and address before accommodating this crypto industry
model.\3\ The first is whether the CFTC can impose AML requirements
on clearinghouses to prevent retail funds from being commingled with
funds belonging to terrorists, cyber criminals and drug cartels--a
question on which the CFTC is in the middle of its analysis.\4\ This
rule also does not require disclosures to inform retail participants
that they are giving up customer protections and bankruptcy customer
priority, instead taking the status of ``clearing members,'' similar
to the roles and duties that normally falls to an FCM such as a
large bank.\5\ The rule also would not limit clearinghouses to
depositing these ``member'' funds in only banks or trusts, as FCMs
are required, which would allow the clearinghouse to deposit funds
with an unregulated affiliate.\6\
---------------------------------------------------------------------------
\3\ See CFTC to Hold and Open Commission Meeting on December 13,
https://www.youtube.com/watch?v=zANNkH5STzk, (December 13, 2023) at
2:12:00.
\4\ See Id. at 3:07:40-3:08:40; 3:16:52-3:17:40.
\5\ See Id. at 2:37:45-2:39:10.
\6\ See Id. at 2:44:20-2:44:55.
---------------------------------------------------------------------------
Instead of learning the lessons of FTX, I worry that rushing to
approve this proposal leaves the Commission out of step with other
federal financial regulators that are asking whether a direct-to-
retail model can or should be accommodated under current law, and
assessing its implications. I also worry that this proposed rule
will form the basis for the CFTC to approve more crypto companies
for this direct-to-retail model under the false impression that this
model is safe. I am concerned about rushing this rule through at the
end of the year in three weeks' time, when these are critical post-
FTX issues. I must dissent.
The CFTC's Laws and Regulations Protect Customers and Guard Against
Illicit Finance Through a Market Structure That Has Stood the Test of
Time
Clearinghouses play an important public interest role--they are
critical market infrastructure intended to foster financial
stability, trust, and confidence in U.S. markets. Dodd-Frank Act
reforms increased central clearing, thereby increasing financial
stability. Those reforms also concentrated risk in clearinghouses.
With that concentrated risk, it is critical that the Commission
maintain vigilance in its oversight over clearinghouses to identify
and monitor risk and promote financial stability. This is most
important for the CFTC's monitoring of systemic risk.
FCMs also play an important role. First, they stand as a shock
absorber, providing additional financial support to the
clearinghouse to safeguard the financial system. Second, because
they are customer-facing, they are responsible for providing
customer protections. The customer protection regime under the
Commodity Exchange Act and CFTC rules are found in
[[Page 305]]
requirements for FCMs. In its October 2022 report, the FSOC
discussed: \7\
---------------------------------------------------------------------------
\7\ See Financial Stability Oversight Council, Report on Digital
Asset Financial Stability Risks and Regulation, https://home.treasury.gov/news/press-releases/jy0986, (October 3, 2022).
---------------------------------------------------------------------------
The current framework of markets regulation is generally
structured around the requirement or presumption that markets are
accessed by retail customers through intermediaries such as broker-
dealers or future commission merchants (FCMs). Those intermediaries
perform many important functions, such as processing transactions,
acting as agent and obtaining best execution for customers,
extending credit, managing custody of customer assets, ensuring
compliance with federal regulations, and guaranteeing performance of
contracts. As a result of the special role these intermediaries play
in traditional market structures, they are subject to unique
regulations often focused on customer protections, such as
regulations around conflicts of interest, suitability, best
execution, segregation of funds, disclosures, and fitness standards
for employees.
Upending this traditional market structure, without analysis,
can have unintended consequences.
There Are No Customers or Customer Protections in a Direct-to-Retail
Model
The CFTC does not require disclosures to retail participants
about the consequences of participating in this model. In the
direct-to-retail model, customers lose their status as
``customers,'' thereby losing all of the customer protections in the
CFTC's regulatory framework, and instead take the status of
``clearing members,'' raising a host of issues. It is unlikely that
retail customers know and understand that they gave up all of their
customer protections. It is also unlikely that retail customers know
and understand that in the event of a bankruptcy, they lose their
``customer'' priority in a distribution. It is also a question
whether these retail customers would have to take on the FCM's shock
absorbing role.
When FTX's application for authority to issue margined crypto
products \8\ was pending before us, on May 25, 2022, the CFTC held a
roundtable on the disintermediated model. We heard then and later
received comments from many stakeholders expressing serious concerns
over this model.
---------------------------------------------------------------------------
\8\ The CFTC conditioned LedgerX's registration on the trades
being fully collateralized. FTX applied to eliminate this condition
to issue margined products directly to customers. I was not in favor
of FTX's application, and signaled that weeks before FTX's failure.
See CFTC Commissioner Christy Goldsmith Romero, Financial Stability
Risks of Crypto Assets: Remarks before the International Swaps and
Derivatives Association's Crypto Forum 2022, https://www.cftc.gov/PressRoom/SpeechesTestimony/oparomero3, (Oct. 26, 2022).
---------------------------------------------------------------------------
The FSOC also expressed concerns over direct-to-retail models,
warning in its October 2022 report:
Financial stability implications may arise from vertically
integrated platforms' approaches to managing risk . . . Direct
exposure by retail investors to rapid liquidations of this kind also
raises investor and consumer protection issues. Platforms dealing
directly with retail investors would need to ensure the provision of
adequate disclosures, responsibilities otherwise taken on by
intermediaries. The vertically integrated model presents conflict of
interest. . . .\9\
---------------------------------------------------------------------------
\9\ See Financial Stability Oversight Council, Report on Digital
Asset Financial Stability Risks and Regulation, https://home.treasury.gov/news/press-releases/jy0986, (October 3, 2022).
---------------------------------------------------------------------------
The CFTC has not conducted the assessment that FSOC recommended
more than one year ago. It is an open question of whether the CFTC
should accommodate these direct-to-retail models given how much is
lost, including the loss of the CFTC's customer protection regime
and AML regime.
This Rushed Proposed Rule Does Not Replace Customer Protections, AML,
and Other Checks and Balances, Lost by Removing the FCM
The CFTC has had a year to learn the lessons from FTX's
application and assess direct-to-retail models as FSOC recommended.
I am strongly in favor of strengthening customer protections,
particularly for retail, including banning commingling of customer
funds,\10\ but this proposal is not about ``customer'' funds. In a
direct-to-retail model, legally, there are no customers. I am not in
favor of retail losing their status as customers and losing customer
protections.\11\ The proposed rule would be the first post-FTX rule
on this model, but it was rushed and as a result, lacks sufficient
analysis.
---------------------------------------------------------------------------
\10\ See CFTC Commissioner Christy Goldsmith Romero, Crypto's
Crisis of Trust: Lessons Learned from the FTX's Collapse, https://www.cftc.gov/PressRoom/SpeechesTestimony/oparomero5#_ftnref10, (Jan
18, 2023) (I warned in the aftermath of FTX's collapse about how
commingling presents ``a significant threat to customers that can
leave customers in a musical chairs dilemma.'')
\11\ All participants, retail or institutional, are considered
clearinghouse members. This is not some technical, legalistic
distinction. Our laws will treat those retail participants the same
as the largest financial institution.
---------------------------------------------------------------------------
The question raised by the FSOC of whether we should accommodate
this market structure from crypto is a critical one to answer. The
deliberations at last week's open meeting confirmed that it may not
be possible to give retail participants the same protections in a
disintermediated model as in the intermediated model. And just last
week, the FSOC Annual Report again warned about the vulnerabilities
arising from collapsing regulatory functions into a single entity,
including ``conflicts of interest, inappropriate use of clients'
funds, and market manipulation.'' \12\
---------------------------------------------------------------------------
\12\ See Financial Stability Oversight Council, Annual Report
2023, https://home.treasury.gov/system/files/261/FSOC2023AnnualReport.pdf, (December 14, 2023).
---------------------------------------------------------------------------
This rule would not resolve the FSOC's concerns. It does not
contain the assessment needed as to risk and what regulatory
requirements would be required in a direct-to-retail model to meet a
``same risk, same regulatory outcome approach'' that makes up for
the checks and balances lost from removing the FCM. That would
require establishing the basic foundation of customer protections
and guardrails (including against illicit finance). Without that
analysis, this proposal puts the CFTC out of step with other federal
financial regulators.
The Direct to Retail Model Raises Many Questions the CFTC Has Not
Adequately Considered
My concerns about a direct-to-retail model include:
1. Losing status of ``customer'': Regular people lose their
protections as ``customer'' under the law in the direct-to-retail
model. Instead, they are treated as clearinghouse ``members,'' a
role that traditionally has been reserved for FCMs, which include
the largest financial institutions. The regular person trading in
bitcoin futures or event contracts is not the same as J.P. Morgan or
Wells Fargo. Clearing members have obligations to the clearinghouse
to stave off clearinghouse failure. This presumably would also be
the case for retail acting as members. I have serious concerns about
whether retail participants understand what they are giving up and
that this is the role they are taking on. The CFTC should consider
requiring plain English disclosures delivered in a manner that
actually informs people of their rights and risks, as opposed to a
click-wrap agreement or lengthy legal document.
2. No AML/CTF/KYC: Because the Commodity Exchange Act envisions
the presence of an FCM that has significant responsibilities,
including anti-money laundering/Know Your Customer requirements,
clearinghouses do not have currently have any obligation to
implement Anti-Money Laundering, Countering Terrorist Financing or
Know Your Customer safeguards, opening up our market to illicit
finance. The Commission staff are still analyzing what safeguards
the CFTC can require.
3. No requirements to deposit funds in a regulated entity: FCMs
are required to hold customer funds at a bank, trust or a CFTC-
regulated entity. That requirement is absent for member funds and is
not added in this rule, allowing clearinghouses to place the funds
anywhere, even an affiliate. That means that FTX's registered
clearinghouse LedgerX could have deposited retail ``member'' funds
with Alameda, the trading firm involved in the loss of billions of
customer funds.
4. No checks and balances: FCMs who interface with customers
have regulatory requirements for customer protections, and have
incentives to monitor the clearinghouse to make sure it is not
misusing customer funds. This role sits empty in a direct-to-retail
model.
5. No customer bankruptcy priority: In the case of the
clearinghouse bankruptcy under this model, the bankruptcy code would
not consider retail participants to be ``customers,'' and they would
not receive the customer priority in any distribution.
More Time Is Needed To Analyze New AML Requirements for Clearinghouses
I want to call special attention to the proposal's lack of anti-
money laundering (AML) and know your customer (KYC) requirements for
clearinghouses. Without
[[Page 306]]
these protections, retail funds may be at serious risk of seizure if
they are commingled with funds of terrorist organizations, drug
cartels, or other illicit actors. It is well known that
cryptocurrency transactions are used to finance cybercrime,
terrorism, sanctions avoidance, and the drug trade.\13\ News reports
suggest that Hamas used cryptocurrency to receive significant
funding preceding its October 7th attacks.\14\
---------------------------------------------------------------------------
\13\ See Attorney General, U.S. Department of Justice, The Role
of Law Enforcement in Detecting, Investigating, and Prosecuting
Criminal Activity Related to Digital Assets, https://www.justice.gov/d9/2022-12/The%20Report%20of%20the%20Attorney%20General%20Pursuant%20to%20Section.pdf, (Sept. 6, 2022).
\14\ Wall Street Journal, ``Hamas Needed a New Way to Get Money
From Iran. It Turned to Crypto,'' https://www.wsj.com/world/middle-east/hamas-needed-a-new-way-to-get-money-from-iran-it-turned-to-crypto-739619aa?mg=prod/com-wsj, (Nov. 12, 2023). The CFTC has
brought enforcement actions against two spot crypto exchanges,
BitMEX and Binance, for failing to follow AML controls. Our action
against Binance found that instead of implementing those controls,
Binance turned a blind eye and even advised users to circumvent the
superficial controls it claimed to have.
---------------------------------------------------------------------------
FCMs have regulatory responsibilities to implement AML and KYC
procedures, to perform standardized diligence, to verify customer
identify and to assess whether customers may be known or suspected
terrorists or sanctioned individuals. That AML/CTF/KYC
responsibility puts them at the front lines of combating illicit
finance. The legal requirement also means the CFTC and the National
Futures Association can examine how FCMs are implementing required
anti-money laundering controls. That makes it more likely we will
identify material weaknesses before an FCM becomes a conduit for
illicit funds. Reporting requirements also may make it easier for
law enforcement to identify suspicious patterns and investigate
them.
The proposed rule would not impose any AML responsibilities for
clearinghouses. Under the proposal, retail participants could have
their funds commingled with those deposited by terrorist or
cybercriminals, including state-sponsored cybercrime gangs. In a
seizure, the FBI, other law enforcement or Treasury would seize all
of the funds. I would consider that a very serious risk to member
funds, one that the proposal does not address.
At the open meeting, when I asked whether the CFTC could impose
AML requirements on clearinghouses, the CFTC's General Counsel said
that they had not completed their analysis, but had not foreclosed
the possibility that the CFTC has authority to impose AML
requirements on clearinghouses and that ``it has some promise.''
\15\ The proposed rule contained no analysis of this issue. That was
one of the reasons why I asked that this proposed rule be pulled off
of the meeting, so that the CFTC could continue to work on that
analysis and include AML requirements. My request was denied. At the
open meeting, the Office of the General Counsel said that while the
analysis was ongoing, ``it was decided on a policy basis that we
save that for another day.'' \16\ That was not a policy decision
made by a majority of the Commission as that was never before us.
---------------------------------------------------------------------------
\15\ CFTC to Hold and Open Commission Meeting on December 13,
https://www.youtube.com/watch?v=zANNkH5STzk, (December 13, 2023) at
3:16:20-3:17:50.
\16\ Id.
---------------------------------------------------------------------------
More Analysis Is Needed To Determine Whether Other Customer Protections
and Other Checks and Balances Can Be Provided to Clearinghouses in the
Direct-to-Retail Model
This proposal would impose some safeguards for member funds held
at a disintermediated clearinghouse by banning commingling and
imposing certain limits on how funds can be used.\17\ But it is
narrowly targeted, and serious gaps remain, leaving the proposed
requirements far from the same regulatory outcome as the traditional
model.
---------------------------------------------------------------------------
\17\ It would require direct clearing customer funds to be held
in a separate account from the clearinghouse's funds, in an account
identifying them as belonging to the customers. Those funds could
only be used on behalf of the customer, not on behalf of the company
or its affiliates. The funds would need to be accounted for daily,
and reconciled with the total amount the clearinghouse owes its
customers. It would also limit what clearinghouses can invest those
funds in, with the same limits that apply to brokers today under
Commission Regulation Sec. 1.25. These protections are largely in
line with the representations made by FTX about LedgerX's rules in
its application.
---------------------------------------------------------------------------
Location of Deposits
FCMs and clearinghouses in the traditional model are only
permitted to deposit customer funds with regulated entities--a bank
or trust, a clearinghouse, or another FCM--giving the CFTC
visibility into customer funds, and layering customer protections.
This proposal would not have the same limitation because these would
not be ``customer'' funds. This proposed rule could benefit from
adding in the same requirement. Otherwise, member funds could be
deposited with an unregulated entity, including an unregulated
affiliate with conflicts of interest, that introduces more risk,
leaving the CFTC blind to risk.\18\ At the meeting, the Commission
heard from staff that they were concerned about whether the current
requirement for where FCM's can deposit funds provided sufficient
protections for customers.\19\ The proposal does not have any
analysis of these concerns, likely because it was rushed.
---------------------------------------------------------------------------
\18\ See Commissioner Christy Goldsmith Romero, Crypto's Crisis
of Trust: Lessons Learned from the FTX's Collapse, https://www.cftc.gov/PressRoom/SpeechesTestimony/oparomero5#_ftnref10, (Jan
18, 2023).
\19\ CFTC to Hold and Open Commission Meeting on December 13,
https://www.youtube.com/watch?v=zANNkH5STzk, (December 13, 2023) at
2:42:40-2:46:08.
---------------------------------------------------------------------------
Oversight From Checks and Balances
The proposal also does not replicate another important guardrail
of traditional market structure: checks and balances. Separate
clearinghouses and brokers (FCMs) create natural bumper guards not
present in the direct-to-retail model. However, the proposed rule
contains no analysis of the impacts of moving forward with this non-
traditional model. Instead, at the open meeting, comments were made
to the effect about how certain companies have determined that they
prefer this market structure, and the staff expect there to be more
applications for this model. It is concerning to me that this rushed
rule may be used to facilitate expanding the use of this model,
which is not responsible without further assessment as FSOC
recommended.
Bankruptcy Priority for Customers
The failures of FTX and Celsius show bankruptcy priority is a
serious issue, especially in the retail space. Retail participants
do not have the same ability as institutions to withstand losses or
delay. Existing bankruptcy law assumes a traditional market
structure.\20\ Customers take priority over FCMs in
distributions.\21\ Retail participants in a disintermediated
clearing model may not realize that they are losing bankruptcy
priority as customers because the CFTC requires no disclosures. This
loss of priority is not discussed in the proposal. We should
consider requiring clear disclosures.
---------------------------------------------------------------------------
\20\ Called ``customer funds other than member property.'' See
CFTC, Bankruptcy Regulations, 86 FR 19324 at 19365 (April 13, 2021).
\21\ Id. at 19378. There are also rules allocating customer
property among account classes.
---------------------------------------------------------------------------
Conclusion
It is not responsible to rush our first post-FTX rule on direct-
to-retail models in three weeks at the end of the year, without
conducting the necessary assessment of the impact of this model as
FSOC recommended more than one year ago. I asked for this proposed
rule to be pulled off this open meeting. I am concerned about the
lack of that assessment, including but not limited to specific
analysis of: (1) whether the CFTC should require disclosures to
inform retail participants that they are losing their customer
status in this direct-to-retail model, disclosures that describes
their rights and risks; (2) whether it is possible to take a same
risk, same regulatory outcome approach on issues such as where funds
can be deposited and other concerns raised in comments to the FTX
application about these models; and (3) whether the CFTC can require
clearinghouses to conduct AML/CTF/KYC. Although there are some
existing retail participants currently in this model, at the open
meeting, the staff said that they were already ensuring that the two
crypto direct-to-retail clearing houses were taking steps aligned
with the proposed rule.
Thirteen months after the collapse of FTX, I am glad that we are
starting to address the direct-to-retail model as I have serious
concerns about it, and remain concerned about any expansion of that
model. However, the risks to retail, financial stability, market
integrity and our national security, are too great to rush this in
three weeks without analysis as FSOC recommended. Therefore, I must
dissent.
Appendix 5--Concurring Statement of Commissioner Caroline D. Pham
I concur on the Notice of Proposed Rulemaking on Protection of
Clearing
[[Page 307]]
Member Funds Held by Derivatives Clearing Organizations (DCOs)
(Proposed Amendments to Clearing Member Funds Requirements or
Proposal) because it seeks to protect the proprietary funds of
futures commission merchants (FCMs), and I understand that it
essentially codifies the existing good practices most of the CFTC's
registered DCOs already follow. However, with respect to retail
participants, I believe that the Commission should consider whether
there should be a new registration category for direct clearing
retail DCOs. I also renew my call for an Office of the Retail
Advocate. Both of these steps would better ensure customer
protection in our regulated markets.
I would like to thank Scott Sloan, Tad Polley, Eileen Donovan,
and Clark Hutchison in the Division of Clearing and Risk for their
work on the Proposal. I appreciate the time staff took to answer my
questions.
Existing Protections for Both House Accounts and Customer Funds Have
Worked Well for Decades Without Issues
First, to be clear, the Commission already has extensive rules
in place for protecting FCM customer funds.\1\ Arguably, it is one
thing the CFTC is best-known for. For these FCM customers, FCMs must
segregate customer funds from their own funds, deposit customer
funds under an account name that clearly identifies them as customer
funds, and obtain a written acknowledgment from each depository that
holds customer funds.\2\ This customer protection regime also
establishes accounting and reporting requirements applicable to
customer funds, and limits both the types of investments that can be
made with customer funds and the type of depositories that can hold
customer funds.\3\
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\1\ Commodity Exchange Act (CEA) section 4d, 7 U.S.C. 6d, and
Regulations Sec. Sec. 1.20 through 1.39, 17 CFR 1.20 through 1.39
(futures customer funds), 22.1-22.17, 17 CFR 22.1 through 22.17
(cleared swaps customer collateral) and 30.7, 17 CFR 30.7 (foreign
futures) establish a comprehensive customer protection regime to
safeguard the funds belonging to customers of FCMs.
\2\ See 17 CFR 1.20, 22.5, and 30.7. The acknowledgment letters
must adhere to specific templates in the Commission's regulations,
and require a depository to acknowledge, among other things, that
the accounts opened by the FCM hold funds that belong to the FCM's
customers.
\3\ See 17 CFR 1.32, 1.33, 1.25, and 1.49.
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With respect to clearing member proprietary funds or house
accounts,\4\ consistent with our system of self-regulation set forth
in the Commodity Exchange Act, DCOs have to establish standards and
procedures designed to protect and ensure the safety of proprietary
funds, and hold them in a manner that will minimize the risk of loss
or delay in access by the DCO to the funds.\5\ DCOs also have to
invest clearing member proprietary funds in instruments with minimal
credit, market, and liquidity risks.\6\
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\4\ Regulation Sec. 1.3, 17 CFR 1.3, defines a ``customer'' as
``any person who uses [an FCM], introducing broker, [CTA or CPO] as
an agent in connection with trading in any commodity interest.''
DCOs have to apply many of the customer protection requirements that
apply to FCMs to the customer funds DCOs receive from FCM clearing
members. DCOs must segregate the customer funds of their FCM
clearing members from their own funds, deposit customer funds under
an account name that identifies the funds as customer funds, obtain
acknowledgment letters from depositories, limit the investment of
customer funds to instruments listed in Regulation Sec. 1.25, and
limit depositories for customer funds to those listed in Regulations
Sec. Sec. 1.20 and 1.49. See 17 CFR 1.20(g)(1), 39.15 (b),
22.3(b)(1), 1.20(g)(1) and (g)(4), and 22.5. However, these
protections do not apply to DCO clearing members (i.e., those that
are not FCMs).
\5\ See CEA section 5b(c)(2)(F), 7 U.S.C. 7a-1(c)(2)(F) (Core
Principle F), and 17 CFR 39.15.
\6\ Id.
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Today, the Commission is proposing new regulations for the
protection of clearing member funds, based largely on the customer
segregation requirements for FCMs and DCOs in Regulation Sec.
1.20.\7\ The Proposal explains that new safeguards are needed for
the direct participants at DCOs because (1) the Commission has
registered a number of DCOs that clear directly for market
participants without the involvement of FCMs (i.e., these DCOs are
only clearing for individuals), and (2) many DCOs that use the
traditional FCM clearing model have at least some non-FCM clearing
members.
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\7\ For instance, the Commission is proposing to require a DCO
to hold proprietary funds separately from the DCO's own funds, in
accounts that are named to clearly identify the funds as belonging
to clearing members, to prohibit a DCO or any depository from using
proprietary funds in any way other than as belonging to the clearing
member, to have DCOs review, on a daily basis, the amount of funds
owed to each clearing member with respect to each of its accounts,
both customer (including, as relevant, futures and cleared swaps)
and proprietary, and to reconcile those figures to the amount of
funds held in aggregate in each such type of account across all of
the DCO's depositories, and, to have DCOs obtain proprietary funds
acknowledgment letters.
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While I appreciate the intent of today's Proposal, with respect
to DCOs that have FCMs as clearing members, I believe we must be
careful in changing a regulatory framework that has served our
markets without any real issues for decades. I believe that the
Commission must have had a good reason when it originally
distinguished between house accounts and customer funds. There have
been a lot of spectres raised today that have nothing to do with our
actual regulated markets. Speaking from a practical perspective, I
worry that ``if it ain't broke, don't fix it.'' For example, we
should recognize that DCOs might have operational reasons for the
accounts distinction in our current rules. I encourage the public to
comment on whether the Proposal is workable for DCOs in that regard.
There Should Be a New Registration Category for Direct Clearing Retail
DCOs and an Office of the Retail Advocate To Ensure Customer Protection
I share the concerns where DCOs clear directly for retail
participants without FCMs. I would go further and state that I am
concerned that the Proposal's targeted approach may miss larger
issues. When a DCO faces direct retail participants that our rules
categorize as clearing members, we effectively allow a model that
eliminates intermediaries and the protections that they provide for
customers. Intermediaries perform critical functions, and that is
why markets all over the world require registered brokers and
stringent protections for customers.
If the Commission anticipates this type of DCO clearing model to
proliferate, we should step back and consider all issues that these
direct clearing retail DCOs raise.\8\ These types of concerns around
retail participants are why I have proposed that the Commission
needs an Office of the Retail Advocate.\9\ I continue to believe
that having an Office of the Retail Advocate is a tried-and-true way
to advance customer protection, and may be especially effective in
the area raised by today's Proposal.
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\8\ The Commission provided exemptions from the current
regulations for these DCOs in 2020. See Derivatives Clearing
Organization General Provisions and Core Principles, 85 FR 4800
(Jan. 27, 2020). However, I am suggesting a more holistic assessment
of these DCOs and their clearing members.
\9\ Keynote Address by Commissioner Caroline D. Pham at CordaCon
2022 (Sept. 27, 2022), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/opapham5.
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For example, perhaps there should be a distinct registration
category and requirements for direct clearing retail DCOs because
they raise singular issues, risks, and concerns--foremost, who
provides retail customer protection when there are no brokers or
intermediaries.
Frankly, I dislike a model where DCOs have clearing members that
are retail. To achieve the same market structure outcome, I think it
is better that a DCO has an affiliated FCM that only provides
services for its retail participants on an affiliated DCM and DCO
and would provide customer protections required under our rules.
This would, therefore, not disrupt our existing regulatory framework
and the current scope and application of the Bank Secrecy Act.\10\
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\10\ 31 U.S.C. 5311 et seq.
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Conclusion
I believe the Commission should further study the direct
clearing model for retail participants, together with the increase
in retail binary option contracts. I hope that my proposal for an
Office of the Retail Advocate comes to fruition, and that this is
one of the first issues that we tackle.
Again, I thank staff for the hard work on the Proposal. I look
forward to the public's comments on the Proposed Amendments to
Clearing Member Funds Requirements. Thank you.
[FR Doc. 2023-28767 Filed 1-2-24; 8:45 am]
BILLING CODE 6351-01-P
