Investment of Customer Funds by Futures Commission Merchants and Derivatives Clearing Organizations

Federal RegisterNov 21, 2023

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 22, and 30

RIN 3038-AF24

Investment of Customer Funds by Futures Commission Merchants and Derivatives Clearing Organizations

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Notice of proposed rulemaking.

SUMMARY:

The Commodity Futures Trading Commission (“Commission” or “CFTC”) is proposing to amend its regulations governing the types of investments that futures commission merchants (“FCMs”) and derivatives clearing organizations may make with funds held for the benefit of customers trading futures, foreign futures, and cleared swap transactions. The Commission is also specifying market risk capital charges that an FCM would be required to take on the revised permitted investments in computing the firm's adjusted net capital. The proposed amendments would also amend regulations that require each FCM to report to the Commission and to the firm's designated self-regulatory organization the name, location, and amount of customer funds held by each depository, including any investments of customer funds held by the depository. Lastly, the Commission is proposing to revise its regulations to eliminate the requirement that a depository holding customer funds must provide the Commission with read-only electronic access to such accounts for the FCM to treat the funds held in the accounts as customer segregated fund accounts.

DATES:

Comments must be received on or before January 17, 2024.

ADDRESSES:

You may submit comments, identified by RIN 3038-AF24, 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 Center, 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 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.

17 CFR 145.9. Commission Regulations referred to herein are found at 17 CFR Chapter I, and are accessible on the Commission's website:

https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm.

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:

Amanda L. Olear, Director, (202) 418-5213,

aolear@cftc.gov;

Thomas J. Smith, Deputy Director, 202-418-5495,

tsmith@cftc.gov;

Warren Gorlick, Associate Director, 202-418-5195,

wgorlick@cftc.gov;

Liliya Bozhanova, Special Counsel, 202-418-6232,

lbozhanova@cftc.gov;

Joo Hong, Risk Analyst, (202) 418-6221,

jhong@cftc.gov,

Market Participants Division, or Lihong McPhail, Research Economist, (202) 418-5722,

lmcphail@cftc.gov,

Office of the Chief Economist, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581; 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:

Table of Contents

I. Introduction

A. Background and Statutory Authority

1. Segregation of Customer Funds by Futures Commission Merchants and Derivatives Clearing Organizations

2. Authority for Futures Commission Merchants and Derivatives Clearing Organizations To Invest Customer Funds

II. Requests for Amendments to the List of Permitted Investments

III. Proposal

A. Investment of Customer Funds

1. Interests in Money Market Funds

2. Foreign Sovereign Debt

3. Interests in U.S. Treasury Exchange-Traded Funds

4. Investments in Commercial Paper and Corporate Notes or Bonds

5. Investments in Permitted Investments With Adjustable Rates of Interest

6. Investments in Certificates of Deposit Issued by Banks

B. Asset-Based and Issuer-Based Concentration Limits for Permitted Investments

C. Futures Commission Merchant Capital Charges on Permitted Investments

D. Segregation Investment Detail Report

E. Read-Only Electronic Access to Customer Funds Accounts Maintained by Futures Commission Merchants

F. Proposed Conforming Amendments

IV. Section 4(c) of the Act

V. Administrative Compliance

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

C. Cost-Benefit Considerations

a. Foreign Sovereign Debt, Interests in Exchange-Traded Funds, and Associated Capital Charges

b. Government Money Market Funds, Commercial Paper and Corporate Notes or Bonds, and Certificates of Deposit Issued by Banks

c. SOFR as a Permitted Benchmark

d. Revision of the Read-Only Access Provisions

D. Antitrust Laws

I. Introduction

A. Background and Statutory Authority

1. Segregation of Customer Funds by Futures Commission Merchants and Derivatives Clearing Organizations

A primary objective of the Commodity Exchange Act (“Act”)

and Commission regulations is the establishment of a framework to safeguard funds of customers engaging in CFTC-regulated derivative transactions. A core component of the framework is the requirement for a futures commission merchant (“FCM”) or a derivatives clearing organization (“DCO”) to treat customer funds as belonging to the customers and not as the property of the FCM or DCO, and for the FCM or DCO to segregate customer funds from its own funds by holding the funds in specially designated customer accounts maintained at banks, trust companies, FCMs, or DCOs, as applicable. The segregation of customer funds from an FCM's or DCO's own funds is intended to ensure that customer funds are used

only to support customer trading and transactions, and to facilitate the return of the funds to customers in the event of the insolvency of the FCM or DCO.

7 U.S.C. 1

et seq.

Customer funds are classified into one of three distinct regulatory frameworks that are based on the derivatives markets on which the customers are transacting. Specifically, customer funds are classified as either: (i) “futures customer funds;” (ii) “Cleared Swaps Customer Collateral;” or (iii) “30.7 customer funds.”

The term “futures customer funds” is defined by Regulation 1.3 to mean, in relevant part, all money, securities, and property received by an FCM or a DCO from, for, or on behalf of “futures customers”

to margin, guarantee, or secure futures and options on futures transactions traded on a CFTC-designated contract market, and all money accruing to futures customers as a result of trading futures and options on futures. Section 4d(a)(2) of the Act requires an FCM to treat and deal with futures customer funds received to margin, guarantee, or secure trades or contracts of any futures customer, or accruing to a futures customer as the result of such trades or contracts, as belonging to the futures customer.

Section 4d(a)(2) further provides that an FCM may not commingle futures customer funds of a futures customer with the FCM's own funds, provided, however, that the FCM may commingle the futures customer funds of two or more futures customers and deposit the funds with any bank, trust company, DCO, or other FCM.

See generally,

17 CFR 1.20 (segregation framework for futures customer funds); 17 CFR 22.2 and 22.3 (segregation framework for Cleared Swaps Customer Collateral); and 17 CFR 30.7 (segregation framework for 30.7 customer funds).

The term “futures customer” is defined by Regulation 1.3 to mean, in relevant part, any person who uses an FCM as an agent in connection with trading in any contract for the purchase or sale of a commodity for future delivery or any option on such contract. 17 CFR 1.3.

7 U.S.C. 6d(a)(2).

Id.

Section 4d(b) of the Act addresses the duties imposed on DCOs and other depositories receiving futures customer funds from FCMs pursuant to Section 4d(a)(2) of the Act.

Section 4d(b) provides that it is unlawful for any person, including a DCO, that has received futures customer funds to hold, dispose of, or use the funds as belonging to the depositing FCM or any person other than the futures customers of the FCM.

The Commission adopted Regulations 1.20 through 1.30, and Regulations 1.32 and 1.49, to implement the segregation requirements for futures customer funds mandated by Sections 4d(a)(2) and 4d(b) of the Act.

7 U.S.C. 6d(b).

Id.

17 CFR 1.20 through 17 CFR 1.30, 17 CFR 1.32, and 17 CFR 1.49.

The term “Cleared Swaps Customer Collateral” is defined by Regulations 1.3 and 22.1

to mean, in relevant part, all money, securities, or other property received by an FCM or a DCO from, for, or on behalf of, a “Cleared Swaps Customer” to margin, guarantee, or secure “Cleared Swap” positions.

Section 4d(f)(2)(A) of the Act requires an FCM to treat Cleared Swaps Customer Collateral received from a Cleared Swaps Customer, or accruing to a Cleared Swaps Customer as a result of Cleared Swap positions, as belonging to the Cleared Swaps Customer.

Section 4d(f)(2)(B) of the Act provides that an FCM may not commingle Cleared Swaps Customer Collateral of a Cleared Swaps Customer with the FCM's own funds,

provided, however, that the FCM may commingle Cleared Swaps Customer Collateral of two or more Cleared Swap Customers and deposit the funds in any bank, trust company, DCO, or other FCM.

Section 4d(f)(6) of the Act provides that it is unlawful for any person, including a DCO and any depository institution, that has received Cleared Swaps Customer Collateral to hold, dispose of, or use the Cleared Swaps Customer Collateral as belonging to the depositing FCM or any person other than the Cleared Swaps Customer of the FCM.

The Commission adopted Regulations 22.2 through 22.13, and Regulations 22.15 through 22.17, to implement the segregation requirements for Cleared Swaps Customer Collateral mandated by Section 4d(f) of the Act.

17 CFR 22.1.

The term “Cleared Swaps Customer” is defined by Regulation 22.1 to mean, in relevant part, any customer entering into a Cleared Swap. The term “Cleared Swap” is defined to mean any swap that is, directly or indirectly, submitted to and cleared by a DCO registered with the Commission.

See

7 U.S.C. 1a(7) and 17 CFR 22.1.

7 U.S.C. 6d(f)(2)(A).

7 U.S.C. 6d(f)(2)(B).

7 U.S.C. 6d(f)(3)(A)(i).

7 U.S.C. 6d(f)(6).

17 CFR 22.2 through 17 CFR 22.13, 17 CFR 22.15 through 17 CFR 22.17.

The term “30.7 customer funds” is defined by Regulation 30.1 to mean any money, securities, or other property received by an FCM from, for, or on behalf of a U.S. person or foreign-domiciled person (a “30.7 customer”)

to margin, guarantee, or secure futures or options on futures positions executed on foreign boards of trade (“foreign futures”).

Section 4(b)(2)(A) of the Act authorizes the Commission to adopt regulations imposing requirements on FCMs regarding the safeguarding of 30.7 customer funds deposited by 30.7 customers for trading on foreign boards of trade.

The Commission adopted Regulation 30.7 pursuant to Section 4(b)(2)(A) of the Act.

Regulation 30.7(e)(2) requires an FCM to segregate 30.7 customer funds from the FCM's own funds, and Regulation 30.7(b) provides that an FCM may hold 30.7 customer funds with designated depositories, including banks, trust companies, DCOs, foreign brokers, and clearing organizations of foreign boards of trade.

The term “30.7 customer” is defined by Regulation 30.1 to mean any person located in the U.S., its territories or possessions, as well as any foreign-domiciled person, who trades in foreign futures or foreign options. 17 CFR 30.1.

17 CFR 30.1.

7 U.S.C. 6(b)(2)(A).

17 CFR 30.7.

17 CFR 30.7(b) and 17 CFR 30.7(e)(2).

Throughout this release, the terms “futures customer funds,” “Cleared Swaps Customer Collateral,” and “30.7 customer funds” are collectively referred to as “Customer Funds,” unless otherwise stated.

2. Authority for Futures Commission Merchants and Derivatives Clearing Organizations To Invest Customer Funds

Section 4d(a)(2) of the Act authorizes FCMs to invest futures customer funds in: (i) obligations of the U.S.; (ii) obligations fully guaranteed as to principal and interest by the U.S.; and (iii) general obligations of any State or of any political subdivision of a State.

Regulation 1.25 was initially adopted to implement Section 4d(a)(2), and authorized FCMs and DCOs to invest futures customer funds in the instruments set forth in Section 4d(a)(2) of the Act (the “Permitted Investments”).

7 U.S.C. 6d(a)(2).

See Title 17—Commodity and Securities Exchanges,

33 FR 14454 (Sept. 26, 1968), amending Regulation 1.25 and providing that FCMs and clearing organizations may invest customer funds in obligations of the U.S., in general obligations of any State or of any political subdivision of any State, or in obligations fully guaranteed as to principal and interest by the U.S.

The Commission, in 2000, expanded the Permitted Investments beyond the investments specifically stated in Section 4d(a)(2) of the Act to include certificates of deposit, commercial paper, corporate notes, foreign sovereign debt, and interests in money market funds.

In addition, the Commission

authorized an FCM or a DCO to buy the Permitted Investments under agreements to resell the securities (“reverse repurchase agreements”) and to sell the Permitted Investments under agreements to repurchase the securities (“repurchase agreements”).

To minimize credit risk, market risk, and liquidity risk, the Commission also imposed conditions that Permitted Investments were required to meet, including a restriction on the dollar-weighted average of the time-to-maturity of securities held in the segregated portfolio, asset-based and issuer-based concentration limits, and prohibitions on certain investments containing embedded derivatives.

More generally, Regulation 1.25 requires all Permitted Investments to be “consistent with the objectives of preserving principal and maintaining liquidity.”

The 2000 Permitted Investments Amendment was adopted under the authority of Section 4(c) of the Act.

In adopting the amendment, the Commission stated that the expanded list of Permitted Investments would enhance the yield available to FCMs, DCOs, and their customers without compromising the safety of futures customer funds.

See Rules Relating to Intermediaries of Commodity Interest Transactions,

65 FR 77993 (Dec. 13, 2000) (publishing final rules); and

Investment of Customer Funds,

65 FR 82270 (Dec. 28, 2000) (making technical corrections and accelerating the effective date of the final rules from

February 12, 2001 to December 28, 2000) (collectively, the “2000 Permitted Investments Amendment”).

Id.

Reverse repurchase agreements and repurchase agreements are collectively referred to as “Repurchase Transactions” in the Proposal.

17 CFR 1.25(b).

Id.

Section 4(c)(1) of the Act empowers the Commission to “promote responsible economic or financial innovation and fair competition” by exempting any transaction or class of transactions (including any person or class of persons offering, entering into, rendering advice or rendering other services with respect to, the agreement, contract, or transaction), from any of the provisions of the Act, subject to certain exceptions. The Commission may grant such an exemption by rule, regulation, or order, after notice and opportunity for hearing, and may do so on application of any person or on its own initiative.

See

7 U.S.C. 6(c). A further discussion of Section 4(c)(1) of the Act is set forth in Section IV of this

Federal Register

release.

See

2000 Permitted Investments Amendment at 78007.

Following the 2000 Permitted Investments Amendment, the list of Permitted Investments has undergone several revisions.

In its current form, Regulation 1.25 lists seven categories of investments that qualify as Permitted Investments: (i) obligations of the U.S. and obligations fully guaranteed as to principal and interest by the U.S. (“U.S. government securities”); (ii) general obligations of any State or political subdivision of a State (“municipal securities”); (iii) obligations of any U.S. government corporation or enterprise sponsored by the U.S. (“U.S. agency obligations”); (iv) certificates of deposit issued by a bank; (v) commercial paper fully guaranteed by the U.S. under the Temporary Liquidity Guarantee Program (“TLGP”) as administered by the Federal Deposit Insurance Corporation (“FDIC”) (“commercial paper”); (vi) corporate notes and bonds fully guaranteed as to principal and interest by the U.S. under the TLGP (“corporate notes and bonds”); and (vii) interests in money market mutual funds.

In addition, Regulation 1.25(a)(2) permits FCMs and DCOs to buy and sell the Permitted Investments under Repurchase Transactions.

See Investment of Customer Funds and Record of Investments,

70 FR 28190 (May 17, 2005) (“2005 Permitted Investments Amendment”), and

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

76 FR 78776 (Dec. 19, 2011) (“2011 Permitted Investments Amendment”).

17 CFR 1.25(a)(1).

17 CFR 1.25(a)(2).

Section 4(b)(2)(A) of the Act grants the Commission the plenary authority to adopt rules and regulations regarding an FCM's safeguarding of 30.7 customer funds.

Prior to 2011, an FCM was not subject to restrictions on the investments that it could enter into with 30.7 customer funds.

In 2011, the Commission extended the requirements of Regulation 1.25 to an FCM's investment of 30.7 customer funds for trading foreign futures positions. Specifically, the Commission amended Regulation 30.7 to provide that to the extent an FCM invested 30.7 customer funds, it must invest such funds subject to, and in compliance with, the terms and conditions of Regulation 1.25.

The Commission exercised its plenary authority under Section 4(b) of the Act to adopt Regulation 30.7.

7 U.S.C. 6(b)(2)(A).

2011 Permitted Investments Amendment at 78777, providing that because Congress did not expressly apply the investment limitations set forth in Section 4d of the Act to 30.7 customer funds, the Commission historically has not subjected such funds to the investment limitations applicable to futures customer funds.

See

17 CFR 30.7. The Commission stated that it was appropriate to align the investment standards of Regulation 30.7 with those of Regulation 1.25 as many of the same prudential concerns arise with respect to both futures customer funds and 30.7 customer funds.

See

2011 Permitted Investment Amendment at 78791.

The Commission also extended the requirements of Regulation 1.25 to FCMs and DCOs investing Cleared Swaps Customer Collateral.

Regulations 22.2 and 22.3 were adopted in 2012 under the authority of Section 4d(f)(4) of the Act,

which provides that Cleared Swaps Customer Collateral may be invested by an FCM or a DCO in: (i) obligations of the U.S.; (ii) general obligations of any State or of any political subdivision of a State; (iii) obligations fully guaranteed as to principal and interest by the U.S.; and, (iv) any other investment that the Commission may by rule or regulation prescribe.

Section 4d(f)(4) of the Act further provides that the investments must be made in accordance with the rules and regulations, and subject to any conditions, as the Commission prescribes.

See

17 CFR 22.2(e)(1) and 17 CFR 22.3(d).

7 U.S.C. 6d(f).

See Protection of Cleared Swaps Customer Contracts and Collateral; Conforming Amendments to the Commodity Amendments to the Commodity Broker Bankruptcy Provisions,

77 FR 6336 (Feb. 7, 2012).

See

7 U.S.C. 6d(f)(4).

In addition to setting forth the Permitted Investments that FCMs and DCOs may enter into with Customer Funds, Regulation 1.25 also includes several conditions on the investment of Customer Funds. Regulation 1.25(b)(3) contains both asset-based and issuer-based concentration limits applicable to Permitted Investments. The asset-based concentration limit restricts the total amount of Customer Funds that an FCM or a DCO may invest in a particular Permitted Investment to a defined percentage of the total funds held in segregation by the FCM or DCO.

The issuer-based concentration limit caps the total amount of Customer Funds that may be invested in instruments offered by, or managed by, a particular issuer to a defined percentage of the total funds held in segregation by the FCM or DCO.

17 CFR 1.25(b)(3)(i).

17 CFR 1.25(b)(3)(ii).

Consistent with the objective of limiting customer risk, Commission regulations also provide that FCMs and DCOs are financially responsible for any losses resulting from Permitted Investments, and are explicitly prohibited from allocating investment losses to customers or clearing FCMs, respectively.

Regulation 1.29 provides that FCMs or DCOs, as applicable, shall bear sole responsibility for any losses resulting from the investment of futures customer funds, and further provides that no investment losses shall be borne or otherwise allocated to FCM customers or to FCMs clearing customer accounts at DCOs. 17 CFR 1.29(b).

Regulation 22.2(e)(1) provides that an FCM shall bear sole responsibility for any losses resulting from the investment of Cleared Swaps Customer Collateral and may not allocate investment losses to Cleared Swaps Customers of the FCM. 17 CFR 22(e)(1).

Regulation 30.7(i) provides that an FCM shall bear sole financial responsibility for any losses resulting from the investment of 30.7 customer funds, and further provides that no investment losses may be allocated to the 30.7 customers of the FCM. 17 CFR 30.7(i).

In addition, Regulation 22.3(d) provides that DCOs may invest Cleared Swaps Customer

Collateral in Permitted Investments set forth in Regulation 1.25. The regulation, however, does not provide that a DCO is responsible for investment losses. The Commission is proposing to amend Regulation 22.3(d) to explicitly provide that a DCO shall bear sole responsibility for any losses resulting from the investment of Cleared Swaps Customer Collateral, and may not allocate such losses to Cleared Swaps Customers.

See

Section III.C. below. 17 CFR 22.3(d).

The Commission has previously noted the importance of conducting periodic reassessments of Regulation 1.25 “and, as necessary, revising regulatory policies to strengthen safeguards designed to minimize risk while retaining an appropriate degree of investment flexibility and opportunities for capital efficiency for DCOs and FCMs investing customer segregated funds.”

In furtherance of these objectives and in consideration of the requests for amendments to Regulation 1.25 discussed in Section II below, the Commission is proposing to amend the list of Permitted Investments in Regulation 1.25 to: (i) add two new asset classes (

i.e.,

specified foreign sovereign debt instruments and certain exchange-traded funds (“ETFs”)), subject to certain conditions, (ii) limit the scope of money market funds (“MMFs”) whose interests qualify as Permitted Investments, and (iii) remove corporate notes, corporate bonds, and commercial paper. In connection with the proposed amendments to the list of Permitted Investments, the Commission is further proposing changes to the counterparty and depository requirements of Regulation 1.25(d)(2) and (7) and revisions to the concentration limits for Permitted Investments set forth in Regulation 1.25(b)(3), and is specifying the capital charges that would apply to the proposed new categories of Permitted Investments. Additionally, the Commission is proposing an amendment to Regulation 22.3(d) to clarify that DCOs are financially responsible for any losses resulting from investments of Cleared Swap Customer Collateral in Permitted Investments, consistent with Regulation 1.29, which addresses financial responsibility for losses resulting from investment of futures customer funds. The proposed amendment reflects the Commission's original intent to permit investments of Cleared Swaps Customer Collateral within the parameters applicable to investments of futures customer funds.

The Commission is also proposing to replace the London Interbank Offered Rate (“LIBOR”) with the Secured Overnight Financing Rate (“SOFR”) as a permitted benchmark for variable and floating interest rates for securities that qualify as Permitted Investments. Each of the proposed amendments is discussed below.

2011 Permitted Investments Amendment at 78777.

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

78 FR 68506 (Nov. 14, 2013) (“2013 Protections of Customer Funds”) at 68556.

II. Requests for Amendments to the List of Permitted Investments

The Futures Industry Association (“FIA) and CME Group Inc. (“CME”) (collectively, the “Petitioners”) submitted a joint petition requesting the Commission to issue an order under Section 4(c) of the Act, or to take such other action as the Commission deems appropriate, to expand investments that FCMs and DCOs may enter into with Customer Funds.

The Petitioners request that the Commission take action to permit FCMs and DCOs to invest Customer Funds in the foreign sovereign debt of Canada, France, Germany, Japan, and the United Kingdom (“Specified Foreign Sovereign Debt”), subject to the condition that the investment in the foreign sovereign debt is limited to balances owed by FCMs and DCOs to customers and FCM clearing firms, respectively, denominated in the applicable currency of Canada, France, Germany, Japan, or the United Kingdom.

The Petitioners further request that the Commission exempt FCMs and DCOs from the provisions of Regulation 1.25(d)(2) to authorize FCMs and DCOs to enter into Repurchase Transactions involving Specified Foreign Sovereign Debt with foreign banks and foreign securities brokers or dealers and to hold Specified Foreign Sovereign Debt in safekeeping accounts at foreign banks.

Petition for Order under Section 4(c) of the Commodity Exchange Act,

dated May 24, 2023 (the “Joint Petition”). On September 22, 2023, the Petitioners submitted updated data in support of the Joint Petition and corrected an inadvertent transposition of data items in the Joint Petition.

Supplement to Petition for Order under Section 4(c) of the Commodity Exchange Act

(“Supplement to Joint Petition”). The Joint Petition and the Supplement to Joint Petition are available on the Commission's website,

https://www.cftc.gov/media/9531/FIA_CMEPetition_Regulation125_052423/download

and

https://www.cftc.gov/media/9536/FIALetterSupplementing_Regulation125_092223/download.

Joint Petition at p. 4.

Joint Petition at p. 5.

In support of the request, the Petitioners note that the Commission issued an order in 2018 pursuant to Section 4(c) of the Act providing a limited exemption to Section 4d of the Act and Regulation 1.25 to permit DCOs to invest futures customer funds and Cleared Swaps Customer Collateral in the foreign sovereign debt of France and Germany.

The exemption for DCOs to invest in French and German sovereign debt is subject to conditions, including that: (i) investment in French or German sovereign debt is limited to investments made with euro-denominated balances owed to the futures customers and Cleared Swaps Customers of FCM clearing members; (ii) the dollar-weighted average of the remaining time-to-maturity of a DCO's portfolio of investments in each of French and German sovereign debt may not exceed 60 days; and (iii) a DCO may not make a direct investment in any sovereign debt instrument of France or Germany that has a remaining time-to-maturity in excess of 180 calendar days.

The 2018 Order also provides that if the two-year credit default spread of the French or German sovereign debt exceeds 45 basis points (“BPS”), the DCO may not make any new direct investments in the relevant sovereign debt using futures customer funds or Cleared Swaps Customer Collateral, and must discontinue investing futures customer funds and Cleared Swaps Customer Collateral in the relevant debt through Repurchase Transactions as soon as practicable under the circumstances.

Order Granting Exemption from Certain Provisions of the Commodity Exchange Act Regarding Investment of Customer Funds and from Certain Related Commission Regulations,

83 FR 35241 (Jul. 25, 2018) (“2018 Order”). The 2018 Order provides an exemption only to DCOs. FCMs are not subject to the 2018 Order, and currently may not invest Customer Funds in any foreign sovereign debt.

Conditions (3)(a), 3(c), and 3(d) of the 2018 Order at 35245.

Condition (3)(b) of the 2018 Order at 35245.

The 2018 Order also grants an exemption from Regulation 1.25(d)(2) to permit DCOs to enter into Repurchase Transactions involving French or German sovereign debt with foreign banks and foreign securities brokers or dealers as counterparties.

A DCO may

enter into Repurchase Transactions with a foreign bank or foreign securities broker or dealer provided that the such firm qualifies as a permitted depository under Regulation 1.49(d)(3) and is located in a money center country or in another jurisdiction that has adopted the euro as its currency.

The 2018 Order further grants an exemption from the requirement in Regulation 1.25(d)(7) that securities transferred to an FCM or a DCO under reverse repurchase agreements must be held in safekeeping accounts with certain U.S.-domiciled banks, a Federal Reserve Bank, a DCO, or the Depository Trust Company,

to permit DCOs to hold French or German sovereign debt received under reverse repurchase agreements in a safekeeping account with foreign banks that qualify as depositories for Customer Funds under Regulation 1.49(d)(3).

As noted above, Regulation 1.25(d)(2) provides that an FCM or a DCO may enter into Repurchase Transactions only with the following counterparties: (i) a bank as defined in Section 3(a)(6) of the Securities Exchange Act of 1934; (ii) a domestic branch of a foreign bank insured by the FDIC; (iii) an SEC-registered securities broker or dealer; or (iv) an SEC-registered government securities broker or dealer. Section 3(a)(6) of the Securities Exchange Act of 1934 defines the term “bank” to mean: (i) a banking institution organized under the laws of the U.S. or a Federal savings association; (ii) a member bank of the Federal Reserve System; (iii) any other banking institution or savings association doing business under the laws of any State or the U.S., a substantial portion of the business of which consists of receiving deposits or exercising fiduciary powers similar to those permitted to national banks under the authority of the Comptroller of the Currency, and which is supervised and examined by a State or Federal authority having supervision over banks or savings associations; and (iv) a receiver,

conservator, or other liquidating agent of any institution or firm included in clauses (i), (ii), or (iii) above (“Section 3(a)(6) bank”). 15 U.S.C. 78

et seq.

Foreign-domiciled banks and foreign securities brokers or dealers are not authorized counterparties for Repurchase Transactions under Regulation 1.25(d)(2).

Regulation 1.49(d)(3) provides that a foreign depository must be a bank or trust company that has in excess of $1 billion in regulatory capital, a registered FCM, or a DCO in order to be a qualified counterparty to Repurchase Transactions.

Specifically, Regulation 1.25(d)(7) provides that securities transferred to an FCM or a DCO under a reverse repurchase agreement must be held in a safekeeping account only with the following depositories: (i) a Section 3(a)(6) bank; (ii) a domestic branch of a foreign bank insured by the FDIC; (iii) a Federal Reserve Bank; (iv) a DCO; or (v) the Depository Trust Company. A foreign-domiciled bank is currently not an authorized depository for securities transferred to an FCM or a DCO under Regulation 1.25(d)(7).

The Petitioners further request that FCMs and DCOs be permitted to invest Customer Funds in certain ETFs that invest primarily in short-term U.S. Treasury securities (“U.S. Treasury ETFs”).

In support of their request, the Petitioners state that U.S. Treasury ETFs have characteristics that may be consistent with those of other Permitted Investments and may provide FCMs and DCOs with an opportunity to diversify further their investments of customer funds.

Joint Petition at pp. 8-9.

Id.

The Commission also received a petition from Invesco Capital Management LLC (“Invesco”), which serves as a sponsor of various ETFs, advocating for the addition of U.S. Treasury ETF securities to the list of Permitted Investments.

Invesco states that U.S. Treasury ETFs will provide FCMs and DCOs with additional investment choices for customer funds, promote operational efficiencies and offer potentially better investment returns for FCMs, DCOs, and their customers, and facilitate financial market innovation.

Invesco further states that permitting investments of U.S. Treasury ETFs would be consistent with, and promote, the public interest goals enumerated in the Act.

Invesco further notes that U.S. Treasury ETFs invest in a sub-set of the same high-quality liquid instruments that are Permitted Investments under Regulation 1.25 (

i.e.,

U.S. government securities), and as such, the ETFs offer an indirect, possibly simpler, and more cost-efficient way for FCMs and DCOs to invest Customer Funds in U.S. Treasury securities and obligations fully guaranteed as to principal and interest by the U.S. as the ETFs eliminate the need for FCMs and DCOs to administer investments in individual U.S. government securities.

Letter from Anna Paglia, Chief Executive Officer, Invesco Capital Management LLC, dated September 28, 2023 (“Invesco Petition”).

See https://www.cftc.gov/media/9541/Invesco_CFTCPetition_Regulation125_092823/download.

Invesco is a registered with the Commission as a commodity pool operator and commodity trading advisor, and is registered with the Securities and Exchange Commission (“SEC”) as an investment adviser.

Invesco Petition at p. 1.

Id.

See

Invesco Petition at p. 2.

Finally, the Petitioners also request that the Commission amend its regulations consistent with CFTC Staff Letter 21-02 and CFTC Staff Letter 22-21,

to permit FCMs and DCOs to invest Customer Funds in qualifying Permitted Investments that have adjustable rates of interest that correlate closely to SOFR.

CFTC Staff Letter 21-02—

CFTC Regulation 1.25—Investment of Customer Funds—Time-Limited No-Action Position for Investments in Securities with an Adjustable Rate of Interest Benchmarked to the Secured Overnight Financing Rate,

issued January 4, 2021 (“Staff Letter 21-02”); CFTC Staff Letter 22-21—

CFTC Regulation 1.25—Investment of Customer Funds in Securities with an Adjustable Rate of Interest Benchmarked to the Secured Overnight Financing Rate—Extension of Time-Limited No-Action Position Concerning Investments by Futures Commission Merchants and No-Action Position Concerning Investments by Derivatives Clearing

Organizations, issued December 23, 2022 (“Staff Letter 22-21”).

See

Joint Petition at p. 4.

III. Proposal

As part of its periodic assessment of Regulation 1.25 and in consideration of the information set forth in the Joint Petition and the Invesco Petition, the Commission is proposing to amend the list of Permitted Investments, subject to certain terms and conditions, as discussed in detail below. In connection with the proposed amendments to the list of Permitted Investments, the Commission is further proposing changes to the counterparty and depository requirements of Regulation 1.25(d)(2) and (7), and revisions to the concentration limits for Permitted Investments set forth in Regulation 1.25(b)(3). Separately, the Commission is specifying capital charges that FCMs would apply to the revised list of Permitted Investments as proposed, and is proposing a clarifying amendment to Regulation 22.3(d) to specify that DCOs bear the financial responsibility for losses resulting from Permitted Investments. The Commission is also proposing to replace LIBOR with SOFR as a permitted benchmark for the interest rate of adjustable rate securities that qualify as Permitted Investments. Lastly, the Commission is proposing to revise its regulations to eliminate the requirement that a depository holding customer funds must provide the Commission with read-only electronic access to such accounts for the FCM to treat the accounts as customer segregated fund accounts. Collectively, the proposed revisions and amendments are referred to as the “Proposal.”

A. Investment of Customer Funds

1. Interests in Money Market Funds

Regulation 1.25(a)(1)(vii) currently provides that FCMs and DCOs may invest Customer Funds in interests in MMFs, subject to specified terms and conditions.

To qualify as a Permitted Investment, a MMF must: (i) be an investment company that is registered with the SEC under the Investment Company Act of 1940

and hold itself out to investors as a MMF in accordance with SEC Rule 2a-7;

(ii) be sponsored by a federally-regulated financial institution, a Section 3(a)(6) bank,

an investment adviser registered under the Investment Advisers Act of 1940,

or a domestic branch of a foreign bank insured by the FDIC; and (iii) compute the net asset value (“NAV”) of the fund by 9 a.m. of the business day following each business day and make the NAV available to MMF shareholders by that time.

17 CFR 1.25(a)(vii).

15 U.S.C. 80a-1—80a-64.

17 CFR 270.2a-7.

For a definition of Section 3(a)(6) bank,

see supra

note 51.

15 U.S.C. 80b-1—80b-21.

17 CFR 1.25(c).

The Commission is proposing to amend Regulation 1.25(a)(1)(vii) to limit the scope of MMFs whose interests qualify as Permitted Investments to “government money market funds,” as defined in SEC Rule 2a-7, in response to two sets of amendments that the SEC adopted to its rules governing MMFs

discussed below.

A Government MMF is defined in SEC Rule 2a-7 as a fund that invests 99.5 percent or more of its total assets in cash, “government securities,” and/or Repurchase Transactions that are collateralized fully by cash or “government securities.”

A “government security” is defined as “any security issued or guaranteed as to principal or interest by the United States, or by a person controlled or supervised by and acting as instrumentality of the Government of the United States pursuant to authority granted by the Congress of the United States; or any certificate of deposit of any of the foregoing.”

Therefore, a “government security” encompasses “U.S. government securities” and “U.S. agency obligations” as defined under Regulation 1.25(a)(1)(i) and (iii), respectively.

SEC Rule 2a-7 addresses MMFs that primarily invest in securities issued or guaranteed by the U.S. government (“government money market funds” or “Government MMFs”), MMFs that primarily invest in short-term corporate debt securities (“Prime MMFs”), and other types of MMFs that are not relevant to this Proposal, such as tax-exempt funds. 17 CFR 270.2a-7.

17 CFR 270.2a-7(a)(14).

15 U.S.C. 80a-2(a)(16).

Regulation 1.25(a)(1)(i) and (iii) defines “U.S. government securities” as obligations of the U.S. and obligations fully guaranteed as to principal and interest by the U.S. and “U.S. agency obligations” as obligations of any U.S. government corporation or enterprise sponsored by the U.S. government, respectively.

As noted above, the Commission is proposing to amend Regulation 1.25 to limit the scope of MMFs that qualify as Permitted Investments in response to SEC revisions to its MMF rules. In that regard, in 2014, the SEC amended Rule 2a-7 to permit an MMF to impose liquidity fees on participant redemptions or to temporarily suspend participant redemptions if the MMF's investment portfolio triggered certain liquidity thresholds.

The 2014 SEC MMF Final Rule was adopted to mitigate the adverse effects on fund liquidity resulting from increased participant redemptions during times of financial stress.

Money Market Fund Reform; Amendments to Form PF,

79 FR 47736 (Aug. 14, 2014) (“2014 SEC MMF Final Rule”).

See

17 CFR 270.2a-7(c)(2).

2014 SEC MMF Final Rule at 47747.

The 2014 SEC MMF Final Rule provides that a MMF that invests less than 30 percent of its total assets in instruments defined as “weekly liquid assets”

may impose a liquidity fee of up to two percent of the value of any shares redeemed, or may temporarily suspend participants' redemptions for up to 10 business days in a 90-day period, if the MMF's board of directors determines that imposing the liquidity fee or suspending redemptions is in the best interest of the MMF.

In addition, if a MMF invests less than 10 percent of its total assets in weekly liquid assets, the MMF must impose a liquidity fee of at least one percent, and not more than two percent, on the value of any shares redeemed, unless the MMF's board of directors determines that the fee is not in the best interest of the MMF.

The SEC Redemption Provisions are directly applicable to Prime MMFs, and Government MMFs may voluntarily elect to impose such provisions (“Electing Government MMFs”).

The term “weekly liquid assets” is generally defined as: (i) cash; (ii) direct obligations of the U.S. Government; (iii) U.S. Agency securities that are issued at a discount to the principal amount to be repaid at maturity and have a remaining time to maturity of 60 days or less; (iv) securities that mature, or are subject to a demand feature that is exercisable and payable, within 5 business days; or (v) amounts receivable and due unconditionally within 5 business days on pending sales of portfolio securities. 17 CFR 270-2a-7(c)(a)(28).

17 CFR 270.2a-7(c)(2)(i).

17 CFR 270.2a-7(c)(2)(ii). (The liquidity fees and suspension of redemptions provisions of SEC Rule 2a-7(c)(2) are referred to as the “SEC Redemption Provisions” in this document.)

17 CFR 270.2a-7(c)(2)(iii).

Commission staff subsequently received inquiries from market participants concerning the permissibility of investing Customer Funds in MMF interests under Regulation 1.25 in light of the SEC Redemption Provisions. The Commission's Division of Swap Dealer and Intermediary Oversight (“DSIO”), currently known as the Market Participants Division (“MPD”) issued CFTC Staff Letter 16-68

and the Commission's Division of Clearing and Risk (“DCR”) issued CFTC Staff Letter 16-69

addressing the SEC Redemption Provisions and the investment of Customer Funds in MMFs by FCMs and DCOs, respectively. Staff Letter 16-68

expressed DSIO staff's view that the SEC Redemption Provisions conflict with paragraphs (b)(1)

and (c)(5)(i)

of Regulation 1.25, as the Redemption Provisions have the effect of potentially reducing the liquidity of Prime MMFs and Electing Government MMFs. Therefore, in connection with the no-action position taken in the staff letter, DSIO indicated that FCMs may no longer invest Customer Funds in such MMFs.

CFTC Letter No. 16-68,

No-Action Relief with Respect to CFTC Regulation 1.25 Regarding Money Market Funds

(Aug. 8, 2016) (“Staff Letter 16-68”). CFTC Staff Letters are available at the Commission's website,

www.cftc.gov.

As noted above, Staff Letter 16-68 was issued by DSIO, which was subsequently renamed MPD. For purposes of clarity, the Commission notes that the formal division name change is not reflected in the proposed amendments to existing Commission regulations and appendices discussed in this Proposal, as the Commission plans to address the name change in a separate Commission rulemaking. The new division name, however, appears in the newly introduced proposed appendices H and I to Part 1 and Appendix G to Part 30, as these appendices do not currently exist in Commission's regulations and would not be addressed in the above-referenced separate rulemaking.

CFTC Letter No. 16-69,

Staff Interpretation Regarding CFTC Part 39 In Light Of Revised SEC Rule 2a-7

(Aug. 8, 2016) (“Staff Letter 16-69”).

see also

17 CFR 1.20(a) (providing that FCMs must separately account for futures customer funds and segregate such funds as belonging to their futures customers) and 17 CFR 1.20(g) (providing that DCOs must separately account for and segregate futures customer funds as belonging to futures customers); 17 CFR 22.2 (providing that FCMs must segregate Cleared Customer Collateral) and 17 CFR 22.3 (requiring that DCOs segregate Cleared Customer Collateral); and 17 CFR 30.7(b) (providing that FCMs must deposit 30.7 funds under an account name that clearly identifies the funds as belonging to 30.7 customers).

192

17 CFR 1.20(a), 17 CFR 22.2(f), and 17 CFR 30.7(a).

193

17 CFR 1.20(b), 17 CFR 22.2(b) and 17 CFR 30.7(b). With respect to 30.7 customer funds, Regulation 30.7(b) also permits funds to be deposited with the clearing organization of any foreign board of trade, a member of any foreign board of trade, or such member's or clearing organization's designated depositories. 17 CFR 30.7(b).

To address these two concerns, the Commission proposes to require an FCM or a DCO that invests Customer Funds in the shares of a Qualified ETF to be an authorized participant of the ETF.

194

The Commission believes that this approach would permit Customer Funds to be maintained in a segregated account in accordance with Section 4d or Part 30, as applicable, with a permitted depository (

i.e.,

a bank, trust company, DCO, or another FCM), given that the Customer Funds would not need to be transferred to an authorized participant unaffiliated with the FCM or DCO. In addition, because an FCM or a DCO acting as an authorized participant would be able to redeem the shares without relying on a separate authorized participant, the Commission believes that the FCM or DCO would be able to better manage completing the redemption and liquidation of the Qualified ETFs shares within one business day, as required by Regulation 1.25.

194

Proposed paragraph (c)(8) of Regulation 1.25.

The Commission, however, understands that FCMs and DCOs may have access to other means of purchasing or liquidating interest in ETFs. For instance, an FCM or a DCO may be able to acquire interests in an ETF on a delivery-versus-payment basis through a securities broker or dealer at price equal to the next calculated NAV amount per share or another agreed-upon price that approximates the last calculated NAV. Similarly, an FCM or a DCO may be able to sell Qualified ETF shares to a broker or dealer willing to buy them at a price corresponding to the NAV amount per share and later redeem them from the fund. To be able to assess the feasibility of such arrangements and the potential associated risks, the Commission requests additional information on the availability and functioning of alternative mechanisms of purchasing and liquidating Qualified ETF interests in a manner compliant with Regulation 1.25 and compliant with the segregation requirements for Customer Funds.

The Commission is also proposing that Qualified ETFs be required to redeem their shares in cash.

195

The Commission understands that ETFs typically redeem interests in kind, although they may also redeem in cash or both in kind and in cash. The Commission also notes that CME, in announcing its acceptance of short-term U.S. Treasury ETFs as performance bond, stated that it would accept short-term U.S. Treasury ETFs that redeem their shares in cash or in kind.

196

As discussed above, the Commission is requiring that Qualified ETFs redeem their shares within one business day following the submission of the redemption request, consistent with the time limit for redemptions applicable to MMFs under Regulation 1.25(c)(5). In addition, under Regulation 1.25(c)(1), the shares of Qualified ETFs, as a Permitted Investment, would be required to be convertible into cash within one business day without material discount in value. As such, given these time limits for the redemption and liquidation of Qualified ETF shares, the Commission is proposing to require Qualified ETFs to redeem their shares in cash because in-cash redemptions may allow for a more expeditious liquidation of the shares than in-kind redemptions.

195

Proposed Regulation 1.25(c)(8)(i).

196

2022 CME Advisory Notice at 1.

In this regard, the Commission notes that in-kind redemptions may introduce a time lag between the redemption of the ETF shares and the ultimate liquidation of the shares, as the assets received in in-kind redemptions would need to be sold or otherwise converted into cash to complete the liquidation of the ETF shares, hindering the ability to liquidate the ETF shares within one business day, as required by Regulation 1.25(b)(1). As such, the Commission is proposing to require that Qualified ETFs redeem their shares only in cash. The Commission, however, is requesting information on the availability and functioning of potential mechanisms or arrangements that may allow FCMs and DCOs to liquidate a Qualified ETF's shares in a manner compliant with Regulation 1.25 and the segregation requirements if the fund's interests were redeemed in kind.

The Commission is also proposing to require, as a condition for qualification as a Permitted Investment, that Qualified ETFs be acceptable by a DCO as performance bond from clearing members to margin customer trades.

197

Although qualification as acceptable collateral by a DCO is not determinative of qualification as a Permitted Investment, the Commission preliminarily believes that limiting Qualified ETFs to funds that have met a DCO's criteria of eligibility as performance bond represents an additional safeguard. In addition, as noted above, the possibility that ETF shares could be pledged by an FCM as margin collateral is an important consideration for the Commission in determining whether to add the interests of ETFs to the list of Permitted Investments.

197

Proposed Regulation 1.25(c)(8)(iii).

In order to add the interests of Qualified ETFs to the list of Permitted Investments under Regulation 1.25, the Commission is proposing to add paragraph (vi) to Regulation 1.25(a)(1), as redesignated to accommodate other amendments to the list of Permitted Investments pursuant to this Proposal. Paragraph (vi) would identify interests in U.S. Treasury exchange-traded funds as a Permitted Investment. The Commission also proposes further conforming changes throughout Regulation 1.25. Section III.A.2. above provides for the replacement of “money market mutual fund” or “money market mutual funds” with “government money market fund” or “government money market funds” throughout Regulation 1.25. The Commission proposes, unless otherwise discussed below, to insert next to the term

“government money market fund” or “government money market funds,” the term “U.S. Treasury exchange-traded fund” or “U.S. Treasury exchange-traded funds,” as appropriate, preceded by an appropriate conjunction (

i.e.,

“or” or “and”), as necessary.

To incorporate the condition that a Qualified ETF must be an investment company that is registered under the Investment Company Act of 1940 with the SEC and holds itself out to investors as an ETF under SEC Rule 6c-11, the Commission proposes to revise Regulation 1.25(c)(1) to provide that, “The fund must be an investment company that is registered under the Investment Company Act of 1940 with the Securities and Exchange Commission and that holds itself out to investors as a government money market fund, in accordance with 270.2a-7 of this title, or an exchange-traded fund, in accordance with 270.6c-11 of this title.”

Moreover, to incorporate the requirement that an FCM or a DCO investing in a Qualified ETF must be an authorized participant, the Commission proposes to revise Regulation 1.25(c) to add paragraph (8), which would provide, “Interests in U.S. Treasury exchange-traded funds will qualify as a Permitted Investment under Regulation 1.25(a) if the interests are redeemable in cash by a futures commission merchant or derivatives clearing organization in its capacity as an authorized participant pursuant to an authorized participant agreement, as defined in § 270.6c-11, at a price based on the net asset value in accordance with the Investment Company Act of 1940 and regulations thereunder, and on a delivery versus payment basis.”

To account for the possibility that, as part of their investment strategy and within the limits of applicable SEC rules, Qualified ETFs may engage in derivatives transactions, the Commission is also proposing to amend Regulation 1.25(b)(2)(i) to indicate that the prohibition of investments containing embedded derivatives would not apply to Qualified ETFs.

Finally, the Commission is proposing to amend Regulation 1.25(b)(4)(i), which provides that except for investments in MMFs, the dollar-weighted average time-to-maturity of an FCM's or a DCO's portfolio of Permitted Investments, as computed under SEC Rule 2a-7, may not exceed 24 months. The proposed amendment would revise Regulation 1.25(b)(4)(i) to exclude Qualified ETFs from the calculation of the dollar-weighted average time-to-maturity of the portfolio of Permitted Investments.

198

The Commission is proposing this amendment as interests in Qualified ETFs do not have maturity dates, as the Qualified ETF manages the rolling of maturing U.S. Treasury securities into new investments.

198

Proposed revised Regulation 1.25(b)(4)(i).

Request for Comment:

The Commission seeks comment on all aspects of the Proposal relating to the expansion of the list of Permitted Investments to include interests in ETFs subject to the specified conditions discussed above, including:

6. For the interests of ETFs to be deemed a Permitted Investment, the ETFs would have to satisfy requirements similar to the requirements that apply to Government MMFs whose interests qualify as Permitted Investments. Is it appropriate to apply the regulatory framework that applies to Government MMFs to ETFs for determining whether an ETF would be deemed a Qualified ETF and interests in the ETF be deemed a Permitted Investment? To the extent some aspects of the regulatory framework applicable to MMFs is not appropriate for ETFs, please specify and explain why.

7. The Proposal to add interests in Qualified ETFs to the list of Permitted Investments provides that only the interests of ETFs that are passively managed and seek to replicate the performance of a published short-term U.S. Treasury security index by investing in a limited set of instruments would qualify as Permitted Investments. The Commission notes that the types of investments in which Qualified ETFs and Permitted Government MMFs would be permitted to invest under the Proposal would differ in that Qualified ETFs' investments would be determined by its investment strategy seeking to replicate the performance of a public short-term U.S. Treasury index and a requirement that the Qualified ETFs invest 95 percent or more of their assets in U.S. Treasury securities that are components of the index, whereas government MMFs would be required to invest 99.5 percent or more of their assets in cash, government securities (defined in 15 U.S.C. 80a-2(a)(16) to broadly include U.S. Treasury securities and U.S. agency securities), and/or Repurchase Transactions that must be collateralized fully, consistent with the definition of government money market funds under SEC Rule 2a-7. Should the Commission further limit the types of underlying instruments in which a Qualified ETF would be permitted to invest? If so, what criteria should be applied to determine the appropriate limitations? Should the Commission permit Qualified ETFs to invest a lower or higher percentage of their assets in short-term U.S. Treasury securities that are components of the index than the proposed 95 percent? If so, what percentage should the Commission consider and why? Also, should the Commission reconcile the types of investments in which Qualified ETFs and Permitted Government MMFs would be permitted to invest by allowing Qualified ETFs to invest in the same investments as Permitted Government MMFs?

8. Under the Proposal, Qualified ETFs would not be precluded from undertaking Repurchase Transactions. Does an ETF engaging in Repurchase Transactions with fund assets have the potential to adversely impact an authorized participant's ability to redeem interest in the fund in exchange for cash? Does an ETF engaging in Repurchase Transactions present other issues that would delay the ability of an authorized participant to redeem interest in the fund in cash? Could the potential delay prevent completing redemptions and liquidation of the ETF shares within one business day, as required by Regulation 1.25? Should Qualified ETFs be prohibited from undertaking Repurchase Transactions given the possible risk of delay in redemptions?

9. The Proposal would require that FCMs or DCOs that invest Customer Funds in interests of Qualified ETFs be authorized participants in order to address concerns that during purchase or redemption of ETF shares, Customer Funds might be moved to an account not held by an appropriate depository of customer segregated funds (

i.e.,

a bank, trust company, DCO or FCM) without a contemporaneous deposit of ETF shares or cash in customer segregated accounts, resulting in the FCM or DCO being undersegregated. Are there alternative approaches other than requiring FCMs or DCOs to be authorized participants that could address or mitigate the Commission's concerns? Can DCOs be authorized participants of Qualified ETFs? If not, are there alternatives that would permit DCOs to invest Customer Funds in Qualified ETFs consistent with the requirements of Regulation 1.25 and the Commission's segregation requirements?

10. The Commission understands that interests in short-term U.S. Treasury ETFs may be redeemed in cash or in kind. The Commission is proposing to require that the shares of a Qualified ETF be redeemable only in cash given the concern that in-kind redemptions may not permit the liquidation of the

ETF shares within one business day, as required by Regulation 1.25(b)(1). If the Commission were to allow shares of Qualified ETFs to be redeemable in kind, would the Qualified ETF's interests have the ability to be liquidated within one business day as required by Regulation 1.25(b)(1)? What mechanisms or arrangements exist that may allow FCMs and DCOs to convert Qualified ETF shares into cash within one business day without material discount in value if redemptions occur in kind? Are there any potential risks associated with such mechanisms and arrangements that the Commission should consider? Is there an alternative approach to address the Commission's concerns that would permit the use of in-kind redemptions and also provide FCMs and DCOs with access to cash for the redemptions within one business day? Does the proposed requirement that the Qualified ETF invest 95 percent or more of its total assets in short-term U.S. Treasury securities help ensure that FCMs and DCOs will be able to liquidate securities received from an in-kind redemption within one business day? Does the proposed requirement that an FCM or a DCO must be an authorized participant help ensure that the FCM or DCO has the internal operational capability and resources to liquidate in-kind redemptions in a manner and time-frame compliant with Regulation 1.25 requirements?

11. As noted, the Commission is proposing to require that interests in Qualified ETFs be redeemable in cash within one business day. Are there any extraordinary circumstances, similar to the events listed in Regulation 1.25(c)(5)(ii) with respect to MMFs, that may justify an exception to the proposed next-day redemption requirement? If so, please specify what redemption exceptions are necessary, and explain why the exceptions are necessary. Also address potential impacts to customers if Qualified ETFs do not redeem within one business if exceptions were provided.

12. Does the Proposal to add Qualified ETFs to the list of Permitted Investments under Regulation 1.25, along with the continued inclusion of MMFs, have the potential to reduce the availability of funds from the banking system in a manner that would raise any financial stability concerns? Could the use of Repurchase Transactions by MMFs and ETFs exacerbate any financial stability issues that may exist?

13. The Proposal would require that a Qualified ETF must be a passively managed fund that seeks to replicate the performance of a published short-term U.S. Treasury security index composed of bonds, notes, and bills with a remaining maturity of 12 months or less, issued by, or unconditionally guaranteed as to the timely payment of principal and interest by, the U.S. Department of the Treasury. Should the Commission impose conditions or requirements that a publisher of an ETF index must meet or satisfy in order for the ETF to be a Qualified ETF? If so, what conditions or requirements should the Commission impose, and why?

14. Regulation 1.25(b)(5)(ii) currently provides that an FCM or a DCO may invest Customer Funds in a fund affiliated with that FCM or DCO. Should the Commission revise Regulation 1.25(b)(5)(ii) to prohibit an FCM or a DCO from investing Customer Funds in affiliated funds? Are there other Commission or SEC rules that mitigate any potential conflicts of interest that may arise from an FCM or a DCO investing Customer Funds in affiliated funds?

4. Investments in Commercial Paper and Corporate Notes or Bonds

The Commission originally approved commercial paper and corporate notes as Permitted Investments for FCMs and DCOs in 2000.

199

The Commission subsequently revised the list of Permitted Investments in 2005 to include corporate bonds.

200

199

See

2000 Permitted Investments Amendment at 78010.

200

See

2005 Permitted Investments Amendment at 28200.

In 2007, the Commission's Division of Clearing and Intermediary Oversight conducted a review of the use of Permitted Investments by FCMs and DCOs.

201

The review indicated that commercial paper and corporate notes and bonds were not widely used by FCMs and DCOs. In 2011, in an effort to simplify Regulation 1.25 by eliminating rarely-used instruments and in consideration of the Commission's concerns that corporate debt securities posed credit, liquidity and market risks, the Commission revised Regulation 1.25 to provide that an FCM or a DCO may invest Customer Funds in commercial paper and corporate notes and corporate bonds only if the debt instruments were guaranteed by the TLGP.

202

201

2011 Permitted Investments Amendment at 78776.

202

Id.

at 78779.

The TLGP expired in 2012, and, therefore, commercial paper, corporate notes, and corporate bonds are no longer Permitted Investments under the terms of Regulation 1.25.

203

Accordingly, the Commission is proposing to remove commercial paper, corporate notes, and corporate bonds from the list of Permitted Investments.

203

Temporary Liquidity Guarantee Program,

available at

https://www.fdic.gov/Regulations/resources/tlgp/index.html

(“Under the [Debt Guarantee Program], the FDIC guaranteed in full, through maturity or June 30, 2012, whichever came first, the senior unsecured debt issued by a participating entity between October 14, 2008, and June 30, 2009. In 2009, the issuance period was extended through October 31, 2009. The FDIC's guarantee on each debt instrument was also extended in 2009 to the earlier of the stated maturity date of the debt or December 31, 2012.”).

5. Investments in Permitted Investments With Adjustable Rates of Interest

Regulation 1.25(b)(2)(iv)(A) provides that Permitted Investments may contain variable or floating rates of interest provided, among other things, that: (i) the interest payments on variable rate securities correlate closely, and on an unleveraged basis, to a benchmark of either the Federal Funds target or effective rate, the prime rate, the three-month Treasury Bill rate, the one-month or three-month LIBOR, or the interest rate of any fixed rate instrument that is a listed Permitted Investment under Regulation 1.25(a);

204

and (ii) the interest rate, in any period, on floating rate securities is determined solely by reference, on an unleveraged basis, to a benchmark of either the Federal Funds target or effective rate, the prime rate, the three-month Treasury Bill rate, the one-month or three-month LIBOR,

205

or the interest rate of any fixed rate instrument that is a listed Permitted Investment under Regulation 1.25(a).

206

204

17 CFR 1.25(b)(2)(iv)(A)(

205

For simplicity, subsequent references to “one-month or three-month LIBOR rate” will be referred to as LIBOR unless otherwise required by the context of the discussion.

206

17 CFR 1.25(b)(2)(iv)(A)(

LIBOR has been used extensively as a reference rate in various commercial and financial contracts, including corporate and municipal bonds, commercial loans, floating rate mortgages, asset-backed securities, consumer loans, and interest rate swaps and other derivatives.

207

The U.K. Financial Conduct Authority, however, announced on March 5, 2021 that LIBOR would cease to be published and would effectively be discontinued.

208

This announcement had been anticipated given the loss of confidence in LIBOR as a reliable benchmark following a number of enforcement actions concerning attempts to manipulate the benchmark.

209

207

Staff Statement on LIBOR Transition,

SEC Division of Corporation Finance, Division of Investment Management, Division of Trading and Markets, and Office of the Chief Accountant (July 12, 2019), available at

https://www.sec.gov/news/public-statement/libor-transition.

208

See

CFTC Staff Letter No. 21-26,

Revised No-Action Positions to Facilitate an Orderly Transition of Swaps from Inter-Bank Offered Rates to Alternative Benchmarks

(Dec. 20, 2021) (“Staff Letter 21-26”), (More specifically, the U.K. Financial Conduct Authority, which regulates ICE Benchmark Administration Limited, the administrator of ICE LIBOR, confirmed that LIBOR

would either cease to be provided by any administrator or would no longer be representative for the 1-week and 2-month USD LIBOR settings, immediately after December 31, 2021, and for all other USD LIBOR settings immediately after June 30, 2023). As noted

supra,

CFTC Staff Letters are available at the Commission's website,

www.cftc.gov.

209

See e.g., In re Barclays PLC,

CFTC Docket No. 12-25 (June 27 2012);

In re UBS AG,

CFTC Docket No. 13-09 (Dec. 19, 2012).

The Federal Reserve Bank of New York convened the Alternative Reference Rate Committee (“ARRC”) in 2014 to identify best practices for U.S. alternative reference rates and best practices for contract robustness, to develop an adoption plan, and to create an implementation plan with metrics of success and a timeline.

210

In June 2017, the ARRC identified SOFR, a broad Treasury repurchase agreements financing rate, as the preferred alternative benchmark to USD LIBOR for certain new USD derivatives and financial contracts.

211

SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities in the Repurchase Transaction market used by financial institutions, governments, and corporations.

212

SOFR is calculated as a volume-weighted median of transaction-level triparty repo data collected from the Bank of New York Mellon as well as data on bilateral U.S. Treasury Repurchase Transactions cleared through the Fixed Income Clearing Corporation.

213

The Federal Reserve Bank of New York, in cooperation with the U.S. Office of Financial Research, publishes SOFR by 8:00 a.m. each business day.

214

210

Staff Letter 21-26 at p. 3.

211

ARRC,

“The ARRC Selects a Broad Repo Rate as its Preferred Alternative Reference Rate,”

June 22, 2017, available at

https://www.newyorkfed.org/medialibrary/microsites/arrc/files/2017/ARRC-press-release-Jun-22-2017.pdf.

212

See

Secured Overnight Financing Rate Data, published by the Federal Reserve Bank of New York (“FRBNY”) and available at

https://apps.newyorkfed.org/markets/autorates/sof.

213

Id.

214

See

Additional Information about the Treasury Repo Reference Rates, published by the FRBNY and available at

https://www.newyorkfed.org/markets/treasury-repo-reference-rates-information.

In response to the anticipated termination of the publication of LIBOR and the increasing acceptance and use of SOFR as a benchmark interest rate, MPD issued Staff Letter 21-02 on January 4, 2021.

215

Staff Letter 21-02 provides that MPD would not recommend enforcement action to the Commission if an FCM invested Customer Funds in Permitted Investments that contain adjustable rates of interest benchmarked to SOFR. Staff Letter 21-02 was a time-limited no-action position that was to expire on December 31, 2022. MPD and DCR, however, subsequently issued a joint letter, Staff Letter 22-21, extending the effective date of the no-action position to December 31, 2024, and expanding the scope of the no-action position to include Permitted Investments made by DCOs.

216

215

See supra

note 60.

216

See id.

Given the discontinuation of the publishing of LIBOR and the increasing use of SOFR, the Commission is proposing to amend Regulation 1.25(b)(2)(iv)(A) by replacing LIBOR with SOFR as a permitted benchmark for Permitted Investments that contain an adjustable rate of interest. To give effect to this revision, paragraphs (b)(2)(iv)(A)(1) and (2) of Regulation 1.25 would be amended to replace the phrase “one-month or three-month LIBOR rate” with the phrase “SOFR rate.” These proposed amendments would be consistent with the Commission's intent of providing FCMs and DCOs with a certain degree of flexibility in selecting Permitted Investments with adjustable rates of interest, while also recognizing changes in the market.

217

The Commission preliminarily believes that the replacement of LIBOR with SOFR advances the objective of Regulation 1.25 of preserving principal and maintaining liquidity by requiring the use of reliable benchmarks in the qualification as Permitted Investments.

217

See

2005 Permitted Investments Amendment at 28192, where the Commission stated that it is appropriate to afford latitude in establishing benchmarks for Permitted Investments to enable FCMs and DCOs to more readily respond to changes in the market.

Request for Comment:

The Commission seeks comment on all aspects of the Proposal to eliminate LIBOR as a permitted benchmark, including:

15. The ARRC has identified SOFR as a preferred alternative reference interest rate to LIBOR. Should the Commission consider other additional interest rates beyond SOFR as permitted benchmarks for adjustable rate securities under Regulation 1.25? If so, please explain why such interest rates would be appropriate benchmarks.

16. The Commission is proposing to amend Regulation 1.25(b)(2)(iv) to permit SOFR as a benchmark for interest payments on variable rate securities or floating rate securities that are otherwise Permitted Investments under Regulation 1.25. Should the Commission reference a particular SOFR rate to provide greater certainty and clarity as to the acceptable benchmark? For instance, should the reference be to the overnight SOFR rate published by the Federal Reserve Bank of New York, to a CME Term SOFR Rate, or to another published SOFR rate? Please explain your answer.

6. Investments in Certificates of Deposit Issued by Banks

Regulation 1.25(a)(1)(iv) permits FCMs and DCOs to invest Customer Funds in certificates of deposit (“CDs”) issued by a Section 3(a)(6) bank or a domestic branch of a foreign bank that carries deposits insured by the FDIC (“bank CDs”). To qualify as a Permitted Investment under Regulation 1.25, a bank CD must be redeemable at the issuing bank within one business day, with any penalty for early withdrawal limited to accrued interest earned according to the written terms of the CD agreement.

218

Regulation 1.25(b)(2)(v); 17 CFR 1.25(b)(2)(v).

The Commission's experience has been, however, that FCMs and DCOs do not select bank CDs as an investment option. In addition to the Commission's general experience in overseeing DCOs and FCMs, Commission staff also reviewed Segregation Investment Detail Reports (“SIDR Reports”) filed by FCMs for the period September 15, 2022 through February 15, 2023 and noted no FCMs reporting investment of Customer Funds in bank CDs.

219

Regulations 1.32(f), 22.2(g)(5), and 30.7(l)(5) require each FCM to submit a SIDR Report to the Commission and the FCM's designated self-regulatory organization (“DSRO”) listing the names of all banks, trust companies, FCMs, DCOs, and any other depositories or custodians holding futures customer funds, Cleared Swaps Customer Collateral, or 30.7 customer funds, respectively. FCMs are required to submit the SIDR Report as of the 15th day of each month (or the next business day if the 15th day of the month is not a business day) and the last business day of the month. 17 CFR 1.32(f), 17 CFR 22.2(g)(5), and 17 CFR 30.7(l)(5). Proposed amendments to the SIDR Report to reflect the proposed revisions to the list of Permitted Investments discussed in this Proposal are discussed in Section III.D. below.

With respect to an FCM, a DSRO is the self-regulatory organization that has been delegated the responsibility under a formal plan approved by the Commission pursuant to Regulation 1.52 to monitor and examine the FCM for compliance with Commission and self-regulatory organization minimum financial and related financial reporting requirements. 17 CFR 1.52.

The Commission believes that bank CDs are consistent with the overall objective of Regulation 1.25 that all Permitted Investments must preserve principal and maintain liquidity of the Customer Funds. In this regard, and as noted above, Regulation 1.25(b)(2)(v) provides that in order to qualify as a

Permitted Investment, a CD must be redeemable at the issuing bank within one business day, with any penalty for early withdrawal limited to any accrued interest earned according to its written terms.

220

17 CFR 1.25(b)(2)(v).

Request for Comment:

Notwithstanding that bank CDs currently qualify as Permitted Investments, the Commission is seeking comment on whether Regulation 1.25 should be amended to remove bank CDs from the list of Permitted Investments. As noted above, the Commission's experience and the staff's review of the SIDR reports indicate that FCMs and DCOs generally have not invested Customer Funds in bank CDs. Specifically, the Commission seeks comment on the following issues:

17. Notwithstanding the Commission's experience and staff's review of the SIDR Reports discussed above, do FCMs and/or DCOs invest Customer Funds in bank CDs? If so, would the elimination of bank CDs as a Permitted Investment have a material adverse impact on FCMs' and DCOs' ability to invest Customer Funds pursuant to the proposed revisions to Regulation 1.25?

18. Are there provisions contained in current Regulation 1.25 or other regulations of the Commission that hinder or prevent FCMs or DCOs from investing Customer Funds in bank CDs? If so, please identify which provisions of Regulation 1.25 are at issue and explain why.

19. Are there legal or operational issues associated with bank CDs that hinder or prevent FCMs or DCOs from investing Customer Funds in such instruments? If so, please identify the legal or operational issues, and explain how such issues hinder or prevent the investment in bank CDs.

20. Would FCMs or DCOs elect to invest Customer Funds in bank CDs with the current rising interest rate environment? Are there other factors that may lead FCMs or DCOs to increase their use of bank CDs as Permitted Investments?

21. What factors should the Commission consider before removing bank CDs from the list of Permitted Investments?

Based on comments received and the Commission's further consideration of this issue, the Commission may determine to revise the Permitted Investments by removing bank CDs in the final rulemaking. If the Commission were to remove bank CDs from the list of Permitted Investments, the Commission would delete paragraph (a)(1)(iv) of Regulation 1.25 and redesignate the paragraphs of Regulation 1.25(a)(1) as appropriate to reflect the revised list of Permitted Investments. In addition, the Commission would delete paragraph (b)(2)(v) of Regulation 1.25, which sets forth restrictions on the features of permitted bank CDs, and revise and/or delete, as appropriate in light of other amendments, paragraphs (b)(3)(i)(C) and (b)(3)(ii)(B) of Regulation 1.25, which set forth asset-based and issuer-based concentration limits for certain instruments currently included in the list of Permitted Investments, to reflect the elimination of bank CDs from that list. The Commission would also make conforming amendments to Regulations 1.32(f), 22.2(g)(5), and 30.7(l)(5), which define the content of the SIDR Reports described in Section III.D. below, to reflect the removal of bank CDs from the list of Permitted Investments in Regulation 1.25. Specifically, the Commission would delete the requirement for an FCM to report the balances invested in bank CDs in the SIDR Report.

B. Asset-Based and Issuer-Based Concentration Limits for P

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