E9-12020. Investment of Customer Funds and Funds Held in an Account for Foreign Futures and Foreign Options Transactions

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Advance notice of proposed rulemaking; request for public comment.

SUMMARY:

The Commodity Futures Trading Commission (Commission) is seeking public comment on possible changes to its regulations regarding the investment of customer funds segregated pursuant to Section 4d of the Commodity Exchange Act (customer segregated funds) and funds held in an account subject to Commission Regulation 30.7 (30.7 funds). Commission Regulation 1.25 provides that a derivatives clearing organization (DCO) or a futures commission merchant (FCM) holding customer segregated funds may invest those funds in certain permitted investments subject to specified requirements that are designed to minimize exposure to credit, liquidity, and market risks. The Commission is considering significantly revising the scope and character of these permitted investments and is seeking public comment before issuing proposed rule amendments. Additionally, in conjunction with its consideration of possible amendments to Regulation 1.25, the Commission is considering applying the investment requirements of Regulation 1.25, including any prospective amendments, to investments of 30.7 funds. The Commission is seeking public comment on this action before issuing proposed rule amendments.

DATES:

Comments must be received on or before July 21, 2009.

ADDRESSES:

Comments may be submitted by any of the following methods:

• Federal eRulemaking Portal: http://www.regulations.gov/​http://frwebgate.access.gpo/​cgi-bin/​leaving. Follow the instructions for submitting comments.
• E-mail: [e-mail]. Include “Advance Notice of Proposed Rulemaking for Regulations 1.25 and 30.7” in the subject line of the message.
• Fax: [phone].
• Mail: Send to David A. Stawick, Secretary, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.
• Courier: Same as mail above.

All comments received will be posted without change to http://www.CFTC.gov/​. Reference should be made to “Advance Notice of Proposed Rulemaking for Regulations 1.25 and 30.7.”

FOR FURTHER INFORMATION CONTACT:

Sarah E. Josephson, Special Counsel, 202-418-5684, [e-mail], or Phyllis P. Dietz, Associate Director, 202-418-5449, [e-mail], Division of Clearing and Intermediary Oversight, Commodity Futures Trading Commission, Three Lafayette Centre, 1151 21st Street, NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

I. Background

A. Regulation 1.25

Under Section 4d(a)(2) of the Commodity Exchange Act (Act),^[1] the investment of customer segregated funds is limited to obligations of the United States and obligations fully guaranteed as to principal and interest by the United States (U.S. government securities), and general obligations of any State or of any political subdivision thereof (municipal securities). Pursuant to authority under section 4(c) of the Act,^[2] the Commission substantially expanded the list of permitted investments by amending Commission Regulation 1.25 in December 2000 to permit investments in general obligations issued by any enterprise sponsored by the United States (government sponsored enterprise securities), bank certificates of deposit, commercial paper, corporate notes, general obligations of a sovereign nation, and interests in money market mutual funds.^[3] In connection with that expansion, the Commission included several provisions intended to control exposure to credit, liquidity, and market risks associated with the additional investments, e.g., requirements that the investments satisfy specified rating standards and concentration limits, and be readily marketable and subject to prompt liquidation.^[4]

The Commission further modified Regulation 1.25 in 2004 and 2005. In February 2004, the Commission adopted amendments regarding repurchase agreements with customer-deposited securities and time-to-maturity requirements for securities deposited in connection with certain collateral management programs of DCOs.^[5] In May 2005, the Commission adopted amendments related to standards for investing in instruments with embedded derivatives, requirements for adjustable rate securities, concentration limits on reverse repurchase agreements, transactions by FCMs that are also registered as securities brokers or dealers (in-house transactions), rating standards and registration requirements for money market mutual funds, an auditability standard for investment records, and certain technical changes.^[6]

The Commission has been, and continues to be, mindful that customer segregated funds must be invested in a manner that minimizes their exposure to credit, liquidity, and market risks both to preserve their availability to customers upon demand and to enable these assets to be quickly converted to cash at a predictable value to minimize systemic risk. Toward these ends, Regulation 1.25 establishes a general prudential standard by requiring that all permitted investments be “consistent with the objectives of preserving principal and maintaining liquidity.” ^[7]

In 2007, the Commission's Division of Clearing and Intermediary Oversight (Division) launched a review of the nature and extent of investments of customer segregated funds and 30.7 funds in order to obtain an up-to-date understanding of investment strategies and practices and to assess whether any changes to the regulations would be appropriate. As part of this review, all Commission-registered DCOs and FCMs carrying customer accounts provided responses to a series of questions. As the Division was conducting follow-up interviews with respondents, the market events of September 2008 occurred and changed the financial landscape such that the data previously gathered no longer reflected current market conditions. Recent events in the economy have underscored the importance of conducting periodic reassessments, and through this advance notice of proposed rulemaking the Commission is refocusing its review of permitted investments for customer segregated funds and 30.7 funds.

The Commission believes that DCOs and FCMs have managed customer segregated funds and 30.7 funds responsibly during this difficult economic time. Nonetheless, the market events of the past year, notably the failures of certain government sponsored enterprises, difficulties encountered by certain money market mutual funds in honoring redemption requests, illiquidity of certain adjustable rate securities, and turmoil in the credit ratings industry, have challenged many of the fundamental assumptions regarding investments. As a result, the Commission believes it is an especially appropriate time to review permitted investments for customer segregated funds and 30.7 funds.

B. Regulation 30.7

Regulation 30.7 ^[8] governs an FCM's treatment of customer money, securities, and property associated with positions in foreign futures and foreign options. Regulation 30.7 was issued pursuant to the Commission's plenary authority under Section 4(b) of the Act.^[9] Because Congress did not expressly apply the limitations of Section 4d of the Act to 30.7 funds, the Commission historically has not subjected those funds to the investment limitations applicable to customer segregated funds.

The investment guidelines for 30.7 funds are general in nature.^[10] Although Regulation 1.25 investments offer a safe harbor, the Commission has not limited investments of 30.7 funds to permitted investments under Regulation 1.25. The Commission believes that it may be appropriate to impose such a limitation because the same prudential concerns that arise in the context of customer segregated funds also arise in the context of 30.7 funds. Applying the same standards to both types of funds would be consistent with the Act and would establish a bright line for the industry and the Commission.

II. Public Comment Solicited

The Commission is considering significantly revising the scope and character of permitted investments for customer segregated funds and 30.7 funds and is seeking public comment before issuing any proposed amendments to Regulations 1.25 or 30.7.

In the interest of gathering as much information as possible before reaching any conclusions, the Commission is soliciting comments from the public regarding which instruments should continue to be permitted investments for customer segregated funds under Regulation 1.25. The Commission welcomes comments on which instruments no longer merit inclusion as permitted investments, as well as comments in support of any new instruments that might qualify as permitted investments. The Commission also requests comment on appropriate limitations or safeguards that should be applied to permitted investments.

The Commission is particularly interested in relevant data that commenters can provide regarding the credit, liquidity, and market risk of various investment choices. The Commission is open both to evidence in support of retaining current permitted investments and evidence indicating a need to eliminate certain permitted investments. Additionally, the Commission urges commenters to analyze the benefits and burdens of any potential regulatory modifications in light of current market realities.

Given the substantive and practical concerns that may arise from altering the current list of permitted investments, the Commission is seeking the views of all interested parties before regulatory changes, if any, are proposed. The Commission also will conduct its own research and analysis. Before any regulatory changes are adopted there will be an opportunity for additional public comment.

The Commission requests comment on all aspects of Regulation 1.25, as follows:

A. Permitted Investments Under the Act. U.S. government securities and municipal securities are permitted investments under Section 4d(a)(2) of the Act and Regulation 1.25(a)(1)(i)-(ii). Please provide any comments, information, research, or data regarding appropriate regulatory requirements that might be imposed in order to better safeguard customer segregated funds.

B. Other Permitted Investments Under Regulation 1.25. Please provide any comments, information, research, or data in support of retaining, rescinding, or modifying authorization to invest customer segregated funds in the following instruments:

1. Government sponsored enterprise securities (Regulation 1.25(a)(1)(iii));

2. Certificates of deposit issued by a bank as defined in section 3(a)(6) of the Securities Exchange Act of 1934,^[11] or a domestic branch of a foreign bank that carries deposits insured by the Federal Deposit Insurance Corporation (Regulation 1.25(a)(1)(iv));

3. Commercial paper (Regulation 1.25(a)(1)(v));

4. Corporate notes or bonds (Regulation 1.25(a)(1)(vi));

5. General obligations of a sovereign nation (Regulation 1.25(a)(1)(vii)); and

6. Interests in money market mutual funds (Regulation 1.25(a)(1)(viii)).

C. Transactions in Permitted Investments. Please provide any comments, information, research, or data in support of retaining, rescinding, or modifying authorization to enter into the following transactions, and please consider the effect that a more limited list of permitted investments would have on:

1. Repurchase and reverse repurchase transactions using customer cash or securities purchased with customer cash (Regulation 1.25(a)(2)(i));

2. Repurchase transactions using customer-deposited securities (Regulation 1.25(a)(2)(ii)); and

3. In-house transactions by FCMs that are also registered as securities brokers or dealers (Regulation 1.25(a)(3)(i)-(iii)).

D. Limitations and Safeguards. Please provide any comments, information, research, or data regarding the general terms and conditions of permitted instruments, including:

1. Marketability/liquidity (Regulation 1.25(b)(1));

2. Rating requirements (Regulation 1.25(b)(2));

3. Restrictions on instrument features, such as instruments that contain an embedded derivative and adjustable rate securities (Regulation 1.25(b)(3));

4. Issuer concentration limits (Regulation 1.25(b)(4));

5. Time-to-maturity (for an investment portfolio or individual instruments) (Regulation 1.25(b)(5));

6. Investments in instruments issued by affiliates (Regulation 1.25(b)(6));

7. Requirements specific to interests in money market mutual funds (Regulation 1.25(c));

8. Requirements specific to repurchase agreements and reverse repurchase agreements (Regulation 1.25(d)); and

9. Requirements specific to in-house transactions (Regulation 1.25(e)).

The Commission requests comment on Regulation 30.7, as follows:

Please provide comments, information, research, or data on the effect of applying the requirements of Regulation 1.25 to investments of 30.7 funds. The Commission also requests comments, information, research, or data relating to whether there is any basis supporting the continued application of two different investment standards.

Issued in Washington, DC, on May 19, 2009, by the Commission.

David A. Stawick,

Secretary of the Commission.

Footnotes

1.  7 U.S.C. 6d(a)(2).

2.  7 U.S.C. 6(c).

3.  17 CFR 1.25. See 65 FR 77993 (Dec. 13, 2000) (publishing final rules); and 65 FR 82270 (Dec. 28, 2000) (making technical corrections and accelerating effective date of final rules from February 12, 2001 to December 28, 2000).

4.  Id.

5.  69 FR 6140 (Feb. 10, 2004).

6.  70 FR 28190 (May 17, 2005).

7.  17 CFR 1.25(b).

8.  17 CFR 30.7.

9.  7 U.S.C. 6(b).

10.  See Commission Form 1-FR-FCM Instructions at 12-9 (Mar. 31, 2007) (“In investing funds required to be maintained in separate section 30.7 account(s), FCMs are bound by their fiduciary obligations to customers and the requirement that the secured amount required to be set aside be at all times liquid and sufficient to cover all obligations to such customers. Regulation 1.25 investments would be appropriate, as would investments in any other readily marketable securities.”).

11.  15 U.S.C. 78c(a)(6).