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

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/fr%3A2023-24774

## Record

- **Collection:** Federal Register
- **Document type:** Proposed Rule
- **Published:** November 21, 2023
- **Citation:** 88 FR 81236

## Text

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.
1

1
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”)
2

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.

2
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.”
3

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”
4

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.
5

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.
6

3

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).

4
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.

5
7 U.S.C. 6d(a)(2).

6

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.
7

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.
8

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.
9

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

8

Id.

9
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
10

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.
11

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.
12

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,
13

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.
14

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.
15

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.
16

10
17 CFR 22.1.

11
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.

12
7 U.S.C. 6d(f)(2)(A).

13
7 U.S.C. 6d(f)(2)(B).

14
7 U.S.C. 6d(f)(3)(A)(i).

15
7 U.S.C. 6d(f)(6).

16
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”)
17

to margin, guarantee, or secure futures or options on futures positions executed on foreign boards of trade (“foreign futures”).
18

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.
19

The Commission adopted Regulation 30.7 pursuant to Section 4(b)(2)(A) of the Act.
20

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.
21

17
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.

18
17 CFR 30.1.

19
7 U.S.C. 6(b)(2)(A).

20
17 CFR 30.7.

21
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.
22

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”).
23

22
7 U.S.C. 6d(a)(2).

23

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.
24

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”).
25

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.
26

More generally, Regulation 1.25 requires all Permitted Investments to be “consistent with the objectives of preserving principal and maintaining liquidity.”
27

The 2000 Permitted Investments Amendment was adopted under the authority of Section 4(c) of the Act.
28

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.
29

24

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”).

25

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

26
17 CFR 1.25(b).

27

Id.

28
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.

29

See
2000 Permitted Investments Amendment at 78007.

Following the 2000 Permitted Investments Amendment, the list of Permitted Investments has undergone several revisions.
30

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.
31

In addition, Regulation 1.25(a)(2) permits FCMs and DCOs to buy and sell the Permitted Investments under Repurchase Transactions.
32

30

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”).

31
17 CFR 1.25(a)(1).

32
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.
33

Prior to 2011, an FCM was not subject to restrictions on the investments that it could enter into with 30.7 customer funds.
34

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.
35

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

33
7 U.S.C. 6(b)(2)(A).

34
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.

35

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.
36

Regulations 22.2 and 22.3 were adopted in 2012 under the authority of Section 4d(f)(4) of the Act,
37

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.
38

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.
39

36

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

37
7 U.S.C. 6d(f).

38

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).

39

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.
40

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.
41

40
17 CFR 1.25(b)(3)(i).

41
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.
42

42
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.”
43

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.
44

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.

43
2011 Permitted Investments Amendment at 78777.

44

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.
45

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.
46

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.
47

45

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.

46
Joint Petition at p. 4.

47
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.
48

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.
49

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.
50

48

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.

49
Conditions (3)(a), 3(c), and 3(d) of the 2018 Order at 35245.

50
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.
51

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.
52

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,
53

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).

51
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).

52
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.

53
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”).
54

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.
55

54
Joint Petition at pp. 8-9.

55

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.
56

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.
57

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.
58

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.
59

56
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.

57
Invesco Petition at p. 1.

58

Id.

59

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,
60

to permit FCMs and DCOs to invest Customer Funds in qualifying Permitted Investments that have adjustable rates of interest that correlate closely to SOFR.
61

60
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”).

61

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.
62

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
63

and hold itself out to investors as a MMF in accordance with SEC Rule 2a-7;
64

(ii) be sponsored by a federally-regulated financial institution, a Section 3(a)(6) bank,
65

an investment adviser registered under the Investment Advisers Act of 1940,
66

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.
67

62
17 CFR 1.25(a)(vii).

63
15 U.S.C. 80a-1—80a-64.

64
17 CFR 270.2a-7.

65
For a definition of Section 3(a)(6) bank,
see supra
note 51.

66
15 U.S.C. 80b-1—80b-21.

67
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.
68

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.”
69

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.”
70

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.
71

68
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.

69
17 CFR 270.2a-7(a)(14).

70
15 U.S.C. 80a-2(a)(16).

71
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.
72

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.
73

72

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).

73
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”
74

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.
75

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.
76

The SEC Redemption Provisions are directly applicable to Prime MMFs, and Government MMFs may voluntarily elect to impose such provisions (“Electing Government MMFs”).
77

74
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).

75
17 CFR 270.2a-7(c)(2)(i).

76
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.)

77
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
78

and the Commission's Division of Clearing and Risk (“DCR”) issued CFTC Staff Letter 16-69
79

addressing the SEC Redemption Provisions and the investment of Customer Funds in MMFs by FCMs and DCOs, respectively. Staff Letter 16-68
80

expressed DSIO staff's view that the SEC Redemption Provisions conflict with paragraphs (b)(1)
81

and (c)(5)(i)
82

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.
83

78
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.

79
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”).

80

See also
CFTC Staff Advisory No. 16-75,
Practical Application of No-Action Letter No. 16-68 Regarding the Investments in Money Market Mutual Funds
(Oct. 18, 2016) (“Staff Letter 16-75”) (discussing the practical applicability and effect of Staff Letter 16-68).

81
17 CFR 1.25(b)(1) (providing that investments of customer funds must be highly liquid such that the investments must have the ability to be liquidated and converted into cash within one business day without material discount in value).

82
17 CFR 1.25(c)(5)(i) (providing that to qualify as a Permitted Investment an MMF must be legally obligated to pay a fund investor (including an FCM) by the close of business on the day following a redemption request).

83
Staff Letter 16-68 at p. 2.

Staff Letter 16-69 set forth DCR staff's interpretation that Regulations 39.15(c) and (e)
84

prohibit a DCO from holding funds belonging to clearing members or their customers in Prime MMFs or Electing Government MMFs. DCR staff stated that the SEC Redemption Provisions were not consistent with Regulation 39.15(c), which requires a DCO to hold funds and assets belonging to clearing members and their customers in a manner that minimizes the risk of loss or of delay in the access by the DCO to such funds and assets. DCR staff further stated that the SEC Redemption Provisions were inconsistent with Regulation 39.15(e), which limits a DCO to investing funds and assets belonging to clearing members and their customer in instruments with minimal credit, market, and liquidity risk. Therefore, FCMs and DCOs have not invested customer funds in Prime MMFs or Electing Government MMFs since the issuance of the aforementioned Staff Letters in 2016.

84
17 CFR 39.15(c) and (e).

The SEC has recently adopted additional amendments to its MMF rules, including amendments revising the SEC Redemption Provisions discussed above.
85

The SEC MMF Reforms are intended to address issues observed by the SEC with MMFs in connection with the economic shock from the onset of the COVID-19 pandemic. Specifically, the SEC stated in March 2020, that concerns about the impact of COVID-19 pandemic led

investors to reallocate their assets into cash and short-term government securities. Certain Prime MMFs, in particular, experienced significant outflows, contributing to stress on short-term funding markets that resulted in government intervention to enhance the liquidity of such markets.
86

The events of March 2020 led the SEC to re-evaluate certain aspects of the regulatory framework applicable to MMFs. In considering the potential factors that caused the increased redemption activity in March 2020, the SEC noted that, among other concerns, fears about the potential imposition of redemption gates and liquidity fees based on observed declines in some funds' weekly liquid assets appear to have incentivized investors to redeem from certain MMFs.
87

Further, according to the SEC, the presence of a liquidity threshold for consideration of fees and gates appears to have affected fund managers' behavior, encouraging the sale of long-term portfolio assets to maintain weekly liquid assets above the 30 percent threshold. The SEC also cited to evidence suggesting that investors are particularly sensitive to the potential imposition of redemption gates, which fully inhibit the redeemability of MMF shares for the duration of the gate.
88

In the SEC's view, generally supported by commenters' feedback, the gates and liquidity fees associated with predictable weekly liquid asset triggers proved counterproductive in stemming heavy redemptions from certain MMFs.
89

As such, the SEC concluded that MMFs needed better functioning tools for managing through stress while mitigating harm to shareholders.
90

85

Money Market Fund Reforms; Form PF Reporting Requirements for Large Liquidity Fund Advisers, Technical Amendments to Form N-CSR and Form N-1A,
88 FR 51404 (Aug. 3, 2023) (“SEC MMF Reforms”). The SEC MMF Reforms have an effective date of October 2, 2023.

86
As noted in the SEC MMF Reforms' adopting release, to support the short-term funding markets, on March 18, 2020, the Federal Reserve, with the approval of the Department of the Treasury, established the Money Market Mutual Fund Liquidity Facility. The facility provided loans to financial institutions on advantageous terms to purchase securities from MMFs that were raising liquidity.
See
SEC MMF Reforms at 51408.

87
SEC MMF Reforms at 51407.

88

Id.
at 51409.

89

Id.

90

Id.
at 51408.

Accordingly, in an effort to improve the resilience of MMFs and address the issue of preemptive investor redemption behavior, particularly in times of stress, the SEC adopted changes to the fee and gate provisions in SEC Rule 2a-7. The SEC MMF Reforms, among other things, amend the SEC Redemption Provisions by removing a Prime MMF's ability to temporarily suspend participant redemptions and by removing an Electing Government MMF's ability to voluntarily retain authority to suspend participant redemptions. The SEC MMF Reforms will also require Prime MMFs to impose a liquidity fee when the fund experiences net redemptions that exceed 5 percent of the fund's net assets, and will permit Prime MMFs to impose a discretionary liquidity fee if the fund's board of directors determines that a fee is in the best interest of the fund.
91

Government MMFs will not be required to implement the mandatory liquidity fee but, consistent with the current SEC Redemption Provisions, may choose to rely on the ability to impose discretionary liquidity fees.
92

Such fees, however, are no longer tied to the weekly liquid asset threshold.
93

91
17 CFR 270.2a-7(c)(2)(i) and (ii) (as amended by the SEC MMF Reforms). In describing the different types of MMFs, the SEC distinguishes between Prime MMFs, Government MMFs, and tax-exempt (or municipal) MMFs.
See
SEC MMF Reforms at 51406. Tax-exempt MMFs primarily hold obligations of state and local governments and their instrumentalities, and pay interest that is generally exempt from Federal income tax for individual taxpayers. Within the category of Prime and tax-exempt MMFs, the SEC also treats retail and institutional funds separately. The new mandatory liquidity fee framework will apply to institutional Prime and institutional tax-exempt MMFs. Tax-exempt MMFs are not specifically discussed in this Proposal, though the Commission notes that these funds would be subject to the same restrictions as those proposed with respect to Prime MMFs. Retail MMFs are held only by natural persons, and as such, are not discussed in this Proposal either.

92
17 CFR 270.2a-7(c)(2)(i)(B) (as amended by the SEC MMF Reforms).

93
17 CFR 270.2a-7(c)(2)(i) (as amended by the SEC MMF Reforms).

The SEC's liquidity fee mechanism is designated to address shareholder dilution and the potential for first-mover advantage by allocating liquidity costs to redeeming investors. Although the mechanism may contribute to decreasing outflows from certain MMFs, the Commission preliminarily believes that the potential imposition of a fee will nonetheless have the effect of reducing the liquidity of such funds and will reduce the principal of an FCM's or DCO's investment in MMF shares. Therefore, consistent with the positions taken in Staff Letter 16-68 and Staff Letter 16-69, the Commission is preliminarily of the view that FCMs and DCOs should be allowed to invest Customer Funds only in MMFs that will not be subject to a liquidity fee (
i.e.,
Government MMFs that do not elect to apply a discretionary liquidity fee). Thus, the proposed amendments would remove Prime MMFs and Electing Government MMFs, as participants in such funds may be subject to liquidity fees in certain circumstances. Therefore, the Commission is proposing amendments to Regulation 1.25(a)(1)(vii) that would limit the scope of MMFs whose interests qualify as Permitted Investments to Government MMFs that are not Electing Government MMFs (“Permitted Government MMFs”).
94

To qualify as a Permitted Government MMF, at least 99.5 percent of the fund's investment portfolio must be comprised of cash, government securities (
i.e.,
U.S. Treasury securities, securities fully-guaranteed as to principal and interest by the U.S. Government, and U.S. agency obligations), and/or Repurchase Transactions that are fully collateralized by government securities as set forth in SEC Rule 2a-7. The Commission preliminarily believes that the proposed amendment would ensure that FCMs and DCOs invest Customer Funds in instruments that are consistent with the objectives of Regulation 1.25 of preserving principal and maintaining liquidity of the investments.

94

See
proposed paragraph (a)(1)(iv) of Regulation 1.25. As discussed in Section III.A, the Commission is proposing to renumber paragraph (a)(1) of Regulation 1.25 to reflect proposed revisions to the list of Permitted Investments. The proposed revisions would result in the renumbering of current paragraph (a)(1)(vii) to paragraph (a)(1)(v) of Regulation 1.25.

The Commission also notes that the proposed amendments to remove from the scope of Permitted Investments the interests in MMFs whose redemptions may be subject to a liquidity fee would prohibit an FCM from depositing proprietary interests in such MMFs into Customer Funds accounts. Regulations 1.23(a)(1), 22.2(e)(3)(i), and 30.7(g)(1) permit FCMs to deposit proprietary cash and unencumbered securities into the accounts of futures customers, Cleared Swaps Customers, and 30.7 customers, respectively, to help ensure that at all times the accounts maintain sufficient funds to cover the amounts due to all customers and prevent the accounts from becoming undersegregated.
95

The securities deposited by FCMs, however, must be Permitted Investments as set forth in Regulation 1.25.
96

Therefore, with respect to MMFs, FCMs would only be permitted to deposit proprietary interest in Permitted Government MMFs in the accounts of futures customers, Cleared Swaps Customers, and 30.7 customers under the Proposal.

95
17 CFR 1.23(a)(1), 22.2(e)(3)(i), and 30.7(g)(1).

96

Id.

To eliminate MMFs whose redemptions may be subject to a liquidity fee from the scope of Permitted Investments under Regulation 1.25, the Commission proposes to revise Regulation 1.25(a)(1)(vii), which would be redesignated Regulation 1.25(a)(1)(v) to accommodate other amendments to Regulation 1.25(a) discussed in this Proposal, by replacing the term “money

market mutual fund” with the term “government money market funds as defined in § 270.2a-7 of this title, provided that the funds do not elect to be subject to liquidity fees in accordance with § 270.2a-7 of this title (government money market fund).” The Commission also proposes to make further conforming changes throughout Regulation 1.25 and the Appendix to Regulation 1.25 by replacing all references to “money market mutual fund” with “government money market fund.” In addition, the Appendix to Regulation 1.25 would be redesignated as Appendix E to Part 1 to address a change in the rules of the Office of the Federal Register regarding the structure of regulatory text to be codified in the Code of Federal Regulations.

Request for comment:
The Commission seeks comment on all aspects of the Proposal to limit the scope of MMFs whose interests qualify as Permitted Investments to certain Government MMFs to address changes to SEC rules governing MMFs as described above, including:

1. Other than concentration limits that are discussed further below, should any other safeguards be considered for Government MMFs whose interests qualify as Permitted Investments under the Proposal to ensure that the credit, liquidity, and market risk of those investments is maintained at an acceptable level, particularly in light of the history of runs in the Prime MMF markets and the potential for contagion?

2. 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?

2. Foreign Sovereign Debt

Regulation 1.25(a)(1) currently permits FCMs and DCOs to invest in the sovereign debt of the U.S. only. Regulation 1.25 previously permitted FCMs and DCOs to invest Customer Funds in the foreign sovereign debt of any country, provided that the investments were limited to balances owed by FCMs or DCOs to customers denominated in the currency of the applicable foreign sovereign debt.
97

The Commission subsequently eliminated all foreign sovereign debt as a Permitted Investment in 2011, citing an interest in both simplifying the regulation and safeguarding Customer Funds in light of economic crises experienced by a number of foreign sovereigns.
98

The Commission, however, also stated that it recognized that the safety of sovereign debt issuances of one country may vary greatly from the sovereign debt issuances of another country, and that investment in certain sovereign debt may be consistent with Regulation 1.25's objective of preserving principal and maintaining liquidity of investments.
99

The Commission further stated that it was amenable to considering requests for Section 4(c) exemptions to permit FCMs and DCOs to invest Customer Funds in foreign sovereign debt. Specifically, the Commission stated that it would consider permitting Customer Funds to be invested in the foreign sovereign debt of a country to the extent that: (i) FCMs or DCOs held balances in segregated accounts owed to customers denominated in that country's currency; and (ii) the foreign sovereign debt serves to preserve principal and maintain liquidity of Customer Funds as required for all other investments of Customer Funds under Regulation 1.25.
100

97
Regulation 1.25(a)(1) (2005).

98
2011 Permitted Investments Amendment at 78781.

99

Id.
at 78782.

100

Id.

As discussed in Section II above, the Commission subsequently issued the 2018 Order pursuant to Section 4(c) of the Act granting DCOs a limited exemption from the provisions of Regulation 1.25(a) to authorize the investment of euro-denominated futures customer funds and Cleared Swaps Customer Collateral in euro-denominated sovereign debt issued by France or Germany subject to specified terms and conditions.
101

The 2018 Order also provides an exemption from Regulation 1.25(d) to permit DCOs to enter into Repurchase Transactions involving French or German sovereign debt with: (i) the European Central Bank; (ii) the Deutsche Bundesbank; (iii) the Banque de France; (iv) a foreign bank located in a country that has adopted the euro as its currency and maintains in excess of $1 billion in regulatory capital; and (v) a foreign dealer located in a country that has adopted the euro as its currency and is subject to regulation by a national financial regulator.
102

The 2018 Order also permits DCOs to hold German or French foreign sovereign debt purchased under reverse repurchase agreements with depositories located in a country that has adopted the euro as its currency and that maintain in excess of $1 billion in regulatory capital, provided that the DCOs separately account for the securities purchased as futures customer funds or Cleared Swaps Customer Collateral, as applicable.
103

101
2018 Order at 35244-35245. The 2018 Order does not address 30.7 customer funds.

102
Condition 3(e) of the 2018 Order at 35245.

103
Condition 3(f) of the 2018 Order at 35245.

The 2018 Order also contains certain conditions regarding the investment of futures customer funds or Cleared Swaps Customer Collateral in French or German sovereign debt. Specifically, the 2018 Order provides that the dollar-weighted average time-to-maturity of a DCO's portfolio of investments in either French or German sovereign debt may not exceed 60 days.
104

In addition, the 2018 Order provides that a DCO may not make a direct investment in any French or German debt instrument with a remaining time-to-maturity of greater than 180 calendar days.
105

104
Condition 3(c) of the 2018 Order at 35245.

105
Condition 3(d) of the 2018 Order at 35245.

For the reasons stated below, the Commission is proposing to amend Regulation 1.25 to add Specified Foreign Sovereign Debt to the list of Permitted Investments. The proposed addition of Specified Foreign Sovereign Debt would be subject to certain conditions that are consistent with the criteria specified in the 2011 Permitted Investments Amendment
106

and the conditions specified in the 2018 Order discussed above. The proposed conditions are also consistent with the general objectives set forth in Regulation 1.25 of preserving principal and maintaining liquidity of Permitted Investments.
107

106

See
2011 Permitted Investments Amendment at 78782 (stating that the Commission would consider permitting foreign sovereign debt investments to the extent that: (i) the petitioner has balances in segregated accounts owed to customers or clearing member FCMs in that country's currency; and (ii) the sovereign debt serves to preserve principal and maintain liquidity of customer funds as required for all other investments of customer funds under Regulation 1.25).

107
17 CFR 1.25(b).

The proposed amendments would expand the exemptive relief provided in the 2018 Order by adding the debt of Canada, Japan, and the United Kingdom, in addition to that of France and Germany, to the list of Permitted Investments under Regulation 1.25, and by allowing FCMs, in addition to DCOs, to invest in the foreign sovereign debt.
108

FCMs collectively held an aggregate of a U.S. dollar equivalent of $51 billion of Customer Funds denominated in Canadian dollars

(“CAD”), euros (“EUR”), Japanese yen (“JPY”), and Great British pounds (“GBP”) on August 15, 2023. The $51 billion represented approximately 10 percent of the total $490 billion of Customer Funds held by FCMs in segregated accounts on August 15, 2023.
109

108
Proposed Regulation 1.25(a)(1)(vi).

109
The $490 billion represents the U.S. dollar equivalent of the total value of margin assets held by FCMs for futures customers, Cleared Swaps Customers, and 30.7 customers as reported to CME as of August 15, 2023. The breakdown by currency was as follows: CAD 14 billion; EUR 18 billion; GBP 3 billion; and JPY 16 billion. Some of these funds may have been posted by the FCMs to DCOs as margin collateral.

Having considered the Joint Petition and analyzing the instruments' characteristics, the Commission believes that including Specified Foreign Sovereign Debt as a Permitted Investment would be consistent with the overall objectives set forth in Regulation 1.25 of preserving principal and maintaining liquidity of Customer Funds. The Joint Petition states that the Specified Foreign Sovereign Debt has credit and liquidity characteristics that are comparable to the credit and liquidity characteristics of U.S. Treasury securities. Specifically, the Joint Petition states that the credit default swaps of Canada, France, Germany, Japan, and the United Kingdom have relatively narrow spreads similar to the credit default spread of the United States.
110

With respect to liquidity, the Joint Petition states that there were substantial amounts of outstanding marketable Canadian, French, German, Japanese, and United Kingdom debt and provided data on the amount of outstanding debt in instruments with time-to-maturity of two years or less issued by each relevant jurisdiction.
111

110

See
Joint Petition at pp. 6-7.

111

See
Appendix A to Joint Petition and Supplement to Joint Petition at p. 1 (indicating that the outstanding debt in instruments with time-to-maturity of two years or less issued by Canada, France, Germany, Japan, and the United Kingdom, based on information available on Bloomberg as of July 11, 2023, was equal to the USD equivalence of $447 billion, $594 billion, $557 billion, $2.6 trillion, and $534 billion, respectively).
See also
Bank of International Settlements' Debt Securities Statistics (including data as of the end of 2021), available here:
https://www.bis.org/statistics/secstats.htm?m=2615
and 2021 Survey on Liquidity in Government Bond Secondary Markets, Organization for Economic Co-operation and Development, available here:
https://www.oecd-ilibrary.org/sites/b2d85ea7-en/1/4/2/index.html?itemId=/content/publication/b2d85ea7-en&_csp_=e3b7b0a57d02c41c597306342c85c8b6&itemIGO=oecd&itemContentType=book
(confirming that Specified Foreign Sovereign Debt instruments presented good liquidity characteristics in 2021).

The Commission also analyzed the volatility of the Specified Foreign Sovereign Debt and observed, based on the available data, that the price risk of the relevant foreign sovereign debt is comparable to that of U.S. Treasury securities. Specifically, using one-year sovereign debt instruments yield data for the period September 21, 2018 to September 20, 2023, the Commission notes that the standard deviation of daily yield change for one-year U.S. Treasury bills was 9 BPS, whereas the same measure for Canadian, French, German, Japanese, and United Kingdom one-year debt instruments ranged from 1 to 7 BPS.
112

The Commission also notes that holding high-quality foreign sovereign debt may pose less risk to Customer Funds than the credit risk of commercial banks through unsecured bank demand deposit accounts.
113

112
The Commission reviewed yield data available through Bloomberg, a proprietary financial data provider, for 1-year sovereign debt instruments issued by Canada, France, Germany, Japan, the United Kingdom, and the U.S.

113
The Commission discussed the preferability from a risk management perspective of investing foreign currency in high quality foreign sovereign debt relative to the credit risk posed by unsecured demand deposit accounts at commercial banks in issuing the 2018 Order permitting DCOs to invest futures customer funds and Cleared Swaps Customer Collateral in French and German sovereign debt.
See
2018 Order at 35245-35246.

Furthermore, the Commission believes that the proposed amendments would provide FCMs and DCOs with an investment option to manage the potential foreign exchange risk that may arise in their administration and investment of Customer Funds. Specifically, the Commission notes that absent the ability to invest Customer Funds in identically-denominated sovereign debt securities, an FCM or a DCO seeking to invest customer foreign currency deposits would need to convert the currencies to a U.S. dollar-denominated asset, which would introduce potential foreign currency fluctuation risk to the FCMs and DCOs.
114

114
To reach this conclusion, the Commission considered, among other factors, the daily volatility of exchange rates of the relevant currency pairs. Specifically, based on data from the Federal Reserve Bank of St. Louis' FRED database, the Commission notes that for the period from September 2018 to September 2023, the standard deviation of the daily percentage change of exchange rate between the relevant currency pairs was 0.45 percent for the CAD/USD pair, 0.46 percent for the EUR/USD pair, 0.61 percent for the GBP/USD pair, and 0.55 percent for the JPY/USD pair, indicating a currency fluctuation that is an additional risk factor with respect to the return on investment of customer foreign currency deposits in U.S. dollar-denominated assets. The Commission also recognized foreign currency fluctuation risk in the 2000 Permitted Investments Amendment, which added foreign sovereign debt to the list of Permitted Investments for the first time.
See
2000 Permitted Investments Amendment at 78003.

Based on these considerations, the Commission proposes to expand the list of Permitted Investments to include Specified Foreign Sovereign Debt. To ensure that investments in Specified Foreign Sovereign Debt remain consistent with Regulation 1.25's general objectives of preserving principal and maintaining liquidity, and with the criteria specified in the 2011 Permitted Investments Amendment for adding foreign sovereign debt as a Permitted Investment, the Commission is proposing to permit the investment of Customer Funds in such debt subject to specified conditions, which are discussed below.

First, under the Proposal, an FCM or a DCO would be permitted to invest in the foreign sovereign debt of only Canada, France, Germany, Japan, and the United Kingdom.
115

The five jurisdictions are among the seven largest economies in the International Monetary Fund's classification of advanced economies.
116

Each country is also a member of the Group of 7 (“G7”), which represents the world's largest industrial democracies, and qualifies as a “money center country” as the term is defined in Regulation 1.49(a)(1).
117

Additionally, the currencies of the five jurisdictions represent a material portion of the total amount of non-U.S. dollar-denominated obligations that FCMs owe to customers, and amount to approximately 10 percent of the total Customer Funds held by FCMs and DCOs.
118

115
Proposed Regulation 1.25(a)(1)(vii).

116

See
Statistical Appendix to the World Economic Outlook, April 2023, International Monetary Fund, available here:
https://www.imf.org/en/Publications/WEO/Issues/2023/04/11/world-economic-outlook-april-2023.

117
17 CFR 1.49(a). In the absence of customer instructions to the contrary, Regulation 1.49(c) limits permissible locations of depositories of Customer Funds to the U.S., the country of origin of the currency, and a “money center country.” The concept of “money center country” is defined to mean Canada, France, Italy, Germany, Japan, and the United Kingdom, and is intended to correspond, together with the U.S., to the list of G7 countries.
See Denomination of Customer Funds and Location of Depositories,
68 FR 5551 (Feb. 4, 2003) at 5546.

118
Based on data contained in the Segregation Investment Detail Reports filed by FCMs with the Commission as of August 15, 2023. The reports contain detailed listings of the Permitted Investments held by each FCM.
See
17 CFR 1.32(f), 17 CFR 22.2(g)(5), and 17 CFR 30.7(l)(5).

Second, an FCM or a DCO would be permitted to invest in the Specified Foreign Sovereign Debt of a country only to the extent that the FCM or a DCO has balances in accounts owed to customers denominated in the country's currency.
119

Prior to the 2011 Permitted Investments Amendment, when Regulation 1.25 permitted the investment of Customer Funds in foreign sovereign debt, the regulation

included a similar restriction.
120

As noted above, the Commission explained that an FCM or a DCO seeking to invest deposits of foreign currencies, absent the ability to invest in identically-denominated sovereign debt securities, would need to convert the foreign currencies to a U.S. dollar-denominated asset, which would increase the FCM's or DCO's exposure to foreign currency fluctuation risk.
121

The Commission believes the restriction is appropriate as it balances the need to ensure the safety of Customer Funds with the Commission's desire to provide a degree of investment flexibility to FCMs and DCOs.
122

119
Proposed Regulation 1.25(a)(1)(vii)(A) and (B).

120

See
2000 Permitted Investments Amendment at 65 FR 78010, which provided in paragraph (a)(1)(vii) of Regulation 1.25 that an FCM or a DCO could invest in debt of a foreign sovereign subject to certain conditions, including that the FCM or DCO had balances owed to customers denominated in that country's currency.

121

Id.
at 78003.

122
As discussed
supra,
prior to 2011, the Commission permitted an FCM or a DCO to invest Customer Funds in foreign sovereign debt subject to the condition that the FCM or DCO held balances owed to customers denominated in the currency of the foreign country. In the wake of the 2008 financial crisis, the Commission eliminated foreign sovereign debt from the list of permitted investments noting at the time that “in many cases, the potential volatility of foreign sovereign debt in the current economic environment and the varying degrees of financial stability of different issuers make foreign sovereign debt inappropriate for hedging foreign currency risk.” 2011 Permitted Investments Amendment at 78781. Yet it recognized that “the safety of sovereign debt issuances of one country may vary greatly from those of another, and that investment in certain sovereign debt might be consistent with the objectives of preserving principal and maintaining liquidity, as required by Regulation 1.25.”
Id.
at 78782. For the reasons discussed above, the Commission is proposing to reinstate certain foreign sovereign debt consistent with the Commission's expressed statement in the 2011 Permitted Investments Amendment that it would consider permitting such investments provided that the investments: (i) are limited to balances owed to customers denominated in the currency of the applicable foreign sovereign, and (ii) serve to preserve the principal and maintain the liquidity of Customer Funds.
See id.
at 78782. The Proposal is also consistent with the Commission's approach in the 2018 Order of permitting DCOs to invest in the sovereign debt of France and Germany to the extent such foreign sovereign debt satisfies specific criteria demonstrating consistency with the credit, liquidity, and volatility of short-term U.S. Treasury securities.

Third, the Commission is proposing to permit FCMs and DCOs to invest in Specified Foreign Sovereign Debt provided that the two-year credit default spread of the issuing sovereign is 45 BPS or less.
123

This condition is consistent with the 45 BPS two-year credit default spread limit specified by the Commission in the 2018 Order permitting DCOs to invest futures customer funds and Cleared Swaps Customer Collateral in French and German sovereign debt.
124

The Commission set the cap of 45 BPS in the 2018 Order based on a historical analysis of the two-year credit default spread of the U.S. (“U.S. Spread”).
125

Forty-five BPS was, at the time, approximately two standard deviations above the mean U.S. Spread over the preceding eight years.
126

123
Proposed Regulation 1.25(f)(3).

124
Condition 3(b) of the 2018 Order at 35245.

125

See
2018 Order at 35243.

126
In 2018, the Commission reviewed the daily U.S. Spread from July 3, 2009 to July 3, 2017. Over that time period, the U.S. Spread had a mean of approximately 26.5 BPS and a standard deviation of approximately 9.72 BPS. Forty-five BPS were approximately two standard deviations above the 26.5 mean.

The Commission observed that over that eight-year period of July 3, 2009 to July 3, 2017, the U.S. Spread was 45 BPS or less approximately 95 percent of the time and exceeded 45 BPS approximately 5 percent of the time. During the same period, the two-year German spread exceeded 45 BPS approximately 6 percent of the time and the two-year French spread exceeded 45 BPS approximately 25 percent of the time, with all exceedances occurring between July 2009 and September 2012, in the aftermath of the 2008 financial crisis and the European sovereign debt crisis.
127

127

See
2018 Order at 35243.

During the more recent period of September 21, 2018 to September 20, 2023, the U.S. Spread had a mean of approximately 16.4 BPS,
128

which was lower than the mean spread of 26.5 BPS for the July 3, 2009 to July 3, 2017 period. In that same time period, the two-year credit default swap spread of the sovereigns issuing the Specified Foreign Sovereign Debt did not exceed 45 BPS. Based on these more recent U.S. Spread and Foreign Sovereign Debt data, the Commission preliminarily believes that the cap of 45 BPS established in the 2018 Order continues to be set at an appropriate level.
129

128
Based on an assessment conducted by CFTC staff on September 20, 2023.

129
Using the daily U.S. Spread data from July 3, 2009 to July 3, 2017 and assuming the two-year credit default spread follows a normal distribution, the Commission estimated that there was less than 2.5 percent likelihood that the U.S. credit default spread would exceed 45 BPS over a two-year period. In addition, the Commission's estimate, based on the daily U.S. Spread data from September 21, 2018 to September 20, 2023, indicates that there is less than 1 percent likelihood, under both normal and empirical distributions, that the two-year credit default swap spread of the sovereigns issuing Specified Foreign Sovereign Debt would exceed 45 BPS. Therefore, the Commission preliminarily believes that 45 BPS represents an appropriate threshold for countries whose debt may qualify as a Permitted Investment under Regulation 1.25.

Under the Proposal, if the credit default spread of a subject country were to exceed the 45 BPS cap, FCMs and DCOs would not be permitted to make new investments in the country's Specified Foreign Sovereign Debt.
130

In addition, if the credit default spread exceeded the 45 BPS cap, FCMs and DCOs would be required to discontinue investing Customer Funds in that sovereign's debt through Repurchase Transactions as soon as practicable under the circumstances.
131

The FCMs or DCOs would not, however, be required to immediately divest their current investments in Specified Foreign Sovereign Debt, given the risks associated with selling assets into a potentially volatile market or having to immediately locate depositories for funds that had been invested in a Repurchase Transaction with limited notice. The prohibition on new investments would reduce the exposure to Customer Funds by avoiding the risk of default on the Specified Foreign Sovereign Debt. In situations where the 45 BPS cap is exceeded, the Commission preliminarily believes that it would be more appropriate for FCMs and DCOs to hold Customer Funds denominated in foreign currency in cash or invest the foreign currency in U.S. dollar-denominated Permitted Investments instead of Specified Foreign Sovereign Debt. In addition, the length to maturity condition discussed immediately below would mitigate price risks to the Customer Funds that might arise from a country's two-year credit default spread exceeding the 45 BPS limit.

130
Proposed Regulation 1.25(f)(3)(i).

131
Proposed Regulation 1.25(f)(3)(ii).

Fourth, the Commission is proposing to limit the time-to-maturity of investments in Specified Foreign Sovereign Debt. Specifically, under the Proposal, an FCM or a DCO would be required to ensure that the dollar-weighted average time-to-maturity of its portfolio of investments in the Specified Foreign Sovereign Debt, as the average is computed under Rule 2a-7 under the Investment Company Act of 1940 (“SEC Rule 2a-7”)
132

on a country-by-country basis, does not exceed 60 calendar days.
133

Consistent with the position taken in the 2018 Order,
134

if the portfolio includes Specified Foreign Sovereign Debt instruments that have been acquired under a reverse repurchase agreement, the FCM or DCO would be permitted to use the maturity

of the reverse repurchase agreement to compute the dollar-weighted average time-to-maturity of the portfolio.
135

This approach takes into account the expected resale of the instruments, which would be scheduled to occur within one business day or on demand as required by Regulation 1.25(d)(6).
136

Conversely, if the FCM or DCO sells Specified Foreign Sovereign Debt instruments under a repurchase agreement, the FCM or DCO would be required to include the instruments in the calculation of the dollar-weighted average based on the remaining time-to-maturity of each instrument sold, to account for the expected repurchase of such instruments.
137

In addition, an FCM or a DCO would not be permitted to make direct investments in any Specified Foreign Sovereign Debt instrument that had a remaining maturity greater than 180 calendar days.
138

132
17 CFR 270.2a-7.

133
Proposed Regulation 1.25(f)(1). Under the Proposal, the dollar-weighted average of the time-to-maturity would be computed pursuant to SEC Rule 2a-7 (17 CFR 270.2a-7), consistent with the general time-to-maturity provision in Regulation 1.25(b)(4)(i).

134
2018 Order at 35244.

135
Consistent with SEC Rule 2a-7(i)(6), the reverse repurchase agreement would be deemed to have a maturity equal to the period remaining until the date on which the resale of the underlying instruments is scheduled to occur, or, where the agreement is subject to demand, the notice period applicable to a demand for the resale of the instruments.
See
proposed Regulation 1.25(f)(1).

136
17 CFR 1.25(d)(6).

137
Proposed Regulation 1.25(f)(1).

138
Proposed Regulation 1.25(f)(2).

Arguing that these restrictions, which are analogous to the restrictions in the 2018 Order, would be too limiting, the Petitioners requested that the Commission revise the regulations to provide a six-month dollar-weighted average time-to-maturity for the portfolio of foreign sovereign debt, and a maximum two-year remaining time-to-maturity for each foreign sovereign debt instrument.
139

The Commission, however, notes that the proposed restrictions are intended to ensure that an FCM's or DCO's portfolio of Specified Foreign Sovereign Debt is comprised of sovereign debt instruments that mature within a relatively short period of time. The short time-to-maturity requirement is expected to assist FCMs and DCOs in managing and mitigating potential market and/or credit risk by providing FCMs and DCOs with the option of holding the debt instruments to maturity during periods of market stress and price volatility rather than selling the debt instruments at potentially significant discounts. This option may be particularly valuable in periods of significant interest rate movements, which could exacerbate market risk in sovereign debt markets. In that regard, the Commission preliminarily views the relatively short time-to-maturity as an essential risk-managing feature in the context of investments in Specified Foreign Sovereign Debt and preliminarily believes that the 60-day dollar-weighted average time-to-maturity restriction and the 180-day remaining maturity restriction are more appropriate than the six months and two years respective limits requested in the Joint Petition.

139
Joint Petition at pp. 5-6 (asserting that the new issuance supply of the Specified Foreign Sovereign Debt meeting the restrictions is limited and would be thinly traded/quoted).

The Commission also believes that the proposed time-to-maturity requirements would not be as limiting as asserted in the Joint Petition given that the new issuance supply of the Specified Foreign Sovereign Debt meeting the proposed restrictions appears adequate to satisfy the demand for the investment of Customer Funds in the relevant instruments.
140

In addition, the use of the maturity of reverse repurchase agreements in the calculation of the dollar-weighted average of the portfolio of investments in Specified Foreign Sovereign Debt would reduce the average time-to-maturity of the portfolio as a whole. As noted in the request for comment below, the Commission is explicitly seeking comment on its preliminary analysis.

140
Data made available by the Bank of Canada, l'Agence France Trésor (the French Finance Agency), the Bundesrepublik Deutschland Finanzagentur (the German Finance Agency), the Japan Ministry of Finance, and the United Kingdom Debt Management Office indicate that the five jurisdictions issue a sizable amount of debt securities with time-to-maturity of less than 180 days on a frequent basis. Specifically, in July 2023, Canada auctioned approximately USD 22 billion, France auctioned approximately USD 18 billion, Germany auctioned approximately USD 10 billion, Japan auctioned approximately USD 15 billion, and the United Kingdom auctioned approximately USD 34 billion in debt instruments with time-to-maturity of six months or less (
see
Canadian Treasury bills auction results at
https://www.bankofcanada.ca/markets/government-securities-auctions/calls-for-tenders-and-results/regular-treasury-bills/;
French BTF auction history at
https://www.aft.gouv.fr/en/dernieres-adjudications
); German Bubills issuance results at
https://www.deutsche-finanzagentur.de/en/federal-securities/issuances/issuance-results
(refer to reopening of 12-month Bubills with residual maturities between three and six months); Japanese T-bills auction results at
https://www.mof.go.jp/english/policy/jgbs/auction/past_auction_results/index.html;
and United Kingdom Treasury Bill tender results at
https://www.dmo.gov.uk/data/treasury-bills/tender-results/
).

The Commission is also 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 Specified Foreign Sovereign Debt from the calculation of the dollar-weighted average time-to-maturity of the portfolio.
141

The Commission is proposing this amendment as Specified Foreign Sovereign Debt would be subject to its own dollar-weighted average time-to-maturity limit of 60 calendar days, which is substantially shorter than the two-year dollar-weighted average time-to-maturity requirement for the overall portfolio required by Regulation 1.25(b)(4)(i).

141
Proposed revised Regulation 1.25(b)(4)(i).

To allow Regulation 1.25(a)(2) to effectively incorporate Specified Foreign Sovereign Debt as a Permitted Investment that FCMs and DCOs would be able to buy or sell pursuant to Repurchase Transactions, the Commission also proposes to expand the permissible counterparties and depositories under Regulation 1.25(d)(2) and (7) to include certain foreign entities. Regulation 1.25(d)(2) limits counterparties with which an FCM or a DCO may enter into a Repurchase Transaction to a Section 3(a)(6)
142

bank, a domestic branch of a foreign bank insured by the FDIC, a securities broker or dealer, or a government securities dealer registered with the SEC or which has filed a notice pursuant to Section 15C(a) of the Government Securities Act of 1986.
143

Regulation 1.25(d)(7) further requires an FCM and a DCO to hold the securities transferred to the FCM or DCO under a reverse repurchase agreement, in a safekeeping account held with a bank as referred to in Regulation 1.25(d)(2), a Federal Reserve Bank, a DCO, or the Depository Trust Company.

142
For a definition of Section 3(a)(6) bank,
see supra
note 51.

143
Public Law 99-571, 100 Stat. 3208 (Oct. 28, 1986).

As a practical matter, absent amendment to these counterparty and depository provisions, an FCMs' and DCOs' ability to buy and sell Specified Foreign Sovereign Debt pursuant to Repurchase Transactions would be restricted given that participants in the foreign sovereign debt Repurchase Transactions market are predominantly non-U.S. entities. The Commission therefore proposes to add foreign banks and foreign brokers or dealers meeting certain requirements, as well as the European Central Bank and the central banks of Canada, France, Germany, Japan, and the United Kingdom, to the list of permitted counterparties.
144

To be deemed a permitted counterparty, a foreign bank would have to qualify as a depository under Regulation 1.49(d)(3)

by holding regulatory capital in excess of $1 billion, and would also have to be located in a money center country as defined in Regulation 1.49(a)(1) (
i.e.,
Canada, France, Italy, Germany, Japan, and the United Kingdom) or in another jurisdiction that has adopted the currency of the permitted foreign sovereign debt. Similarly, a foreign broker or dealer would have to be located in a money center country and be regulated by a foreign financial regulator. The proposed provisions are designed to ensure that the counterparties would be regulated entities comparable to those counterparties already permitted under Regulation 1.25(d)(2), and are consistent with the counterparty conditions set forth in the 2018 Order.
145

144
Proposed Regulation 1.25(d)(2).

145

See
2018 Order, Condition (e) at 35245.

With respect to permitted depositories, the Commission proposes to permit Specified Foreign Sovereign Debt instruments transferred to an FCM or a DCO under a reverse repurchase agreement to be held with a foreign bank that qualifies as a permitted depository under Regulation 1.49.
146

The proposed provision is designed to ensure that any additional depositories would be comparable to those already permitted under Regulation 1.25(d)(7), and subject to the conditions for depositories in the 2018 Order.
147

The Commission notes that mandating the safekeeping of foreign securities purchased through reverse repurchase agreements with a U.S. custodian as required under the current regulation may be inefficient or impractical.

146
Proposed Regulation 1.25(d)(7).

147

See
2018 Order, Condition (f) at 35245.

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 Specified Foreign Sovereign Debt, including:

3. Under the Proposal, the list of Permitted Investments set forth in Regulation 1.25(a) would be expanded to include sovereign debt issued by Canada, France, Germany, Japan, and the United Kingdom, subject to specified conditions. Although these Specified Foreign Sovereign Debt instruments present credit and liquidity characteristics that are similar to those of currently Permitted Investments, such debt may also be less liquid than U.S. government securities. Do investments in Specified Foreign Sovereign Debt raise any liquidity issues or concerns? If so, please explain your responses and provide data if possible.

4. The Proposal would prohibit investments of Customer Funds in Specified Foreign Sovereign Debt if the two-year credit default swap spread of the issuing sovereign exceeds 45 BPS. Should the Commission consider a higher or lower credit default spread limit? If so, please specify the appropriate credit default spread and explain why it is necessary and appropriate. Should the investment prohibition be contingent on the breach of the 45 BPS threshold occurring a certain number of times within a specified time period or for a particular duration within a specified time period? Should there be a “cooling-off” period before the Specified Foreign Sovereign Debt may be used again as a Permitted Investment under Regulation 1.25? For instance, should the Specified Foreign Sovereign Debt be subject to a requirement that the CDS spread be below 45 BPS for a minimum period of time (
e.g.,
3 months) before it could be reinstated as an eligible Permitted Investment?

5. The Proposal would limit the time-to-maturity of investments in Specified Foreign Sovereign Debt to a 60-day maximum dollar-weighted average time-to-maturity of the portfolio of investments and a 180-day maximum remaining time-to-maturity of individual direct investments. The Petitioners requested that the limits be set at six months and two years, respectively. Should the Commission consider extending the time-to-maturity limits as requested? If yes, please provide analysis and appropriate market data supporting the extension.

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

ETFs are collective investment vehicles that issue redeemable securities that are also traded at the market price on national securities exchanges.
148

The Commission proposes to add interests in ETFs to the list of Permitted Investments under Regulation 1.25, subject to specified proposed conditions discussed below.

148
Invesco Petition at p. 5.
See also, Exchange-Traded Funds,
84 FR 57162 (Oct. 24, 2019) (“SEC ETFs Release”) at 57164.

The SEC adopted Rule 6c-11
149

under the Investment Company Act of 1940 in 2019, creating a regulatory framework that allows ETFs meeting certain requirements to operate as investment companies under the Investment Company Act of 1940 without having to obtain an exemptive order from the SEC as previously required.
150

Like other investment companies, an ETF pools the assets of multiple investors and invests those assets according to a set investment objective and principal investment strategies.
151

Each share of an ETF represents an undivided fractional interest in the underlying assets of the ETF.
152

Similar to indexed mutual funds, many ETFs are designed to passively track a particular market index, investing in all or a representative sample of the instruments included in the index and aiming to achieve the same return as the tracked index.
153

Other ETFs are actively managed, with portfolio managers buying and selling stocks in accordance with an investment strategy rather than passively tracking an index.
154

149
17 CFR 270.6c-11 (“SEC Rule 6c-11”).

150

See generally
SEC ETFs Release.

151
Invesco Petition at p. 5.
See also,
SEC ETFs Release at 57164.

152

Id.

153

See
“
Exchange-Traded Funds,
” publication by FINRA, available at:
https://www.finra.org/investors/learn-to-invest/types-investments/investment-funds/exchange-traded-fund.

154

Id.

As an open-end management company,
155

similar to a mutual fund,
156

an ETF continuously offers its shares for sale. Unlike mutual funds, however, ETFs do not sell shares to, or redeem shares from, investors directly. Instead, ETFs issue (and redeem) shares to (and from) “authorized participants”—market intermediaries that have a contractual arrangement with the ETF (or its distributor) and are members or participants of a clearing agency registered with the SEC—in blocks called “creation units.”
157

Authorized participants play a key role for ETF shares as they are the only investors that are allowed to transact directly with the ETF.
158

Authorized participants must: (i) be an SEC-registered broker or dealer or other securities market participant (such as a bank or other financial institution that is not required to register as a broker or dealer to engage in securities transactions); (ii) be a full participating member of the National Securities Clearing Corporation and the Depository Trust Company; and (iii) have entered

into an authorized participant agreement with the ETF (and potentially other parties, such as the ETF's sponsor, distributor or transfer agent).
159

155
Some ETFs may also be structured as unit-investment trusts.
See e.g.,
SPDR® S&P 500® ETF Trust and SPDR® Dow Jones Industrial Average ETF Trust. The regulatory framework set forth by SEC Rule 6c-11, however, applies only to ETFs that are organized as open-end management investment companies.
See
17 CFR 270.6c-11.

156
A “mutual fund” is a type of open-end management company, meaning that investors can purchase and redeem shares in the fund on a daily basis based on the NAV of their shares. Mutual funds pool the money of many investors to purchase a range of securities to meet specified investment objectives.

157

See
17 CFR 270.6c-11 (defining “exchange-traded fund”).

158
Invesco Petition at p. 5.

159

Id.

An authorized participant may act as a principal for its own account or as an agent for others when purchasing or redeeming creation units.
160

Purchases and redemptions of ETF shares by an authorized participant are referred to as “primary market transactions” and occur at the next-calculated NAV. As noted above, ETF shares can also be purchased and sold in the secondary market at market prices that may reflect a discount or premium to the ETF's NAV.

160

See
SEC ETFs Release at 57164;
see also
David Abner,
The ETF Handbook: How to Value and Trade Exchange-Traded Funds,
2nd ed. (2016).

As part of its periodic reassessment of the list of Permitted Investments of Customer Funds and in consideration of industry input provided by the Joint Petition and the Invesco Petition, the Commission is proposing to include shares in U.S. Treasury ETFs to the list of Permitted Investments under Regulation 1.25. More specifically, in assessing the potential expansion of the list of Permitted Investments, the Commission has considered statements emphasizing the liquidity of U.S. Treasury ETF shares and the diversification opportunity that such ETFs provide for Customer Funds. In particular, as discussed in other parts of the Proposal, the Petitioners note that U.S. Treasury ETFs have characteristics that may be consistent with those of Permitted Investments and may provide FCMs and DCOs with an opportunity to further diversify their investments of Customer Funds.
161

Similarly, the Invesco Petition focused on the fact 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).
162

The Invesco Petition also notes that ETFs, as registered investment companies whose shares are registered under the Securities Act and Exchange Act, must comply with a number of SEC financial reporting requirements and liquidity risk management program requirements.
163

Finally, the Invesco Petition asserts that the design and characteristics such as price and investment transparency, and intra-day trading and liquidity, are additional features that help make interests in U.S. Treasury ETFs a safe and efficient vehicle for investment of Customer Funds.
164

161

See
Joint Petition at pp. 8-9.

162
Invesco Petition at p. 2.

163

Id.
at pp. 6-7. Financial requirements include: (i) annual shareholder report, including audited financial statements (17 CFR 270.30e-1); (ii) semi-annual shareholder report, including unaudited financial statements (17 CFR 270.30e-1); (iii) monthly portfolio statistics and holdings filed quarterly (17 CFR 270.30b1-9); (iv) annual census report containing financial-related information (17 CFR 270.30a-1); and (v) periodic reports with respect to portfolio liquidity and derivatives use (17 CFR 270.30b1-10). With respect to liquidity risk management, SEC regulations require open-ended management investment companies, including ETFs, to adopt and implement a liquidity risk management program that is reasonably designed to assess and manage liquidity risk, which is defined to mean the risk that the fund could not meet redemption requests to redeem shares issued by the fund without significant dilution of remaining investors' interests in the fund (17 CFR 270.22e-4).

164
Invesco Petition at p. 2.

Further, the Commission has taken into consideration the limited range of investments that meet the requirements of Regulation 1.25. In that regard, the Commission notes that as a result of various regulatory reforms, discussed in this
Federal Register
release, several asset classes included in Regulation 1.25 no longer qualify as Permitted Investments. In particular, as discussed in Section III.A.2. above, the range of MMFs whose securities qualify as Permitted Investments has contracted, as only interests in Permitted Government MMFs currently meet the eligibility criteria of Regulation 1.25. In addition, as discussed in Section III.A.4. below, commercial paper and corporate notes and bonds no longer qualify as Permitted Investments with the expiration of the TLGP.

Also, due to certain regulatory reforms, there has been an increased demand for high quality collateral, including for assets that currently qualify as Permitted Investments under Regulation 1.25. For example, in the aftermath of the 2008 financial crisis, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act,
165

which set forth a regulatory framework for swaps, requiring, among other things, the clearing of certain swaps or the margining of certain uncleared swaps. As a result, market participants dealing in swaps may be required to post to clearinghouses, or post and collect with swap counterparties, specified forms of liquid collateral, driving increased demand for assets that currently qualify as Permitted Investments.

165
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Pub. L. 111-203, H.R. 4173).

The Commission believes expanding the range of available Permitted Investments to include interests in ETFs that meet specified conditions, as discussed below, would provide FCMs and DCOs with greater flexibility and opportunities for capital efficiency in the investment of Customer Funds, without unacceptably increasing risk to customers. Consistent with the existing regulations limiting customer risk associated with the investment of Customer Funds by FCMs and DCOs, under the terms of the Proposal, FCMs and DCOs would be financially responsible for bearing any loss on an investment of Customer Funds in an ETF in the same manner as FCMs and DCOs are financially responsible for losses incurred from the investment of Customer Funds in Permitted Investments.
166

166

See
Regulation 1.29(b) (providing that an FCM or a DCO, as applicable, shall bear sole responsibility for any losses resulting from the investment of futures customer funds in Permitted Investments) and Regulations 22.2(e)(1) and 30.7(i) (providing that an FCM shall bear sole responsibility for any losses resulting from the investment of Cleared Swaps Customer Collateral and 30.7 funds, respectively, in Permitted Investments). As further discussed in Section III.C. below, the Commission is also proposing an amendment to Regulation 22.3(d) to clarify that DCOs are financially responsible for investments of Cleared Swaps Customer Collateral in Permitted Investments.

The Commission also believes that the proposed addition of interests in ETFs as Permitted Investments under Regulation 1.25(a) would foster innovation and promote competition in the ETF market and the financial services industry more generally, as the Proposal would permit the flow of Customer Funds into a new type of financial instrument that previously had been prohibited and, as discussed below, would offer the possibility for market participants to purchase a type of collateral that is already a Permitted Investment without having to purchase the securities directly or through a MMF.

As noted above, industry representatives and other market participants have also expressed interest in U.S. Treasury ETFs as Permitted Investments.
167

Both the Petitioners and Invesco highlight the similarity in characteristics between U.S. Treasury ETF securities and other instruments that qualify as Permitted Investments under Regulation 1.25.
168

Invesco further notes that ETFs investing in U.S. Treasury securities offer an indirect, yet simpler and more cost-efficient way, for FCMs to invest Customer Funds in such instruments, eliminating the need to identify, invest in, and administer

investments in individual U.S. Treasury securities.
169

167
They generally refer to short-term U.S. Treasury ETFs that invest at least 80 percent of their assets in U.S. Treasury securities with a remaining term to final maturity of 12 months or less.

168

See
Joint Petition at pp. 8-9 and Invesco Petition at pp. 9-10.

169
Invesco Petition at p. 11. Invesco states that an ETF would allow FCMs and DCOs to gain exposure to short-term U.S. Treasury securities without buying and selling Treasury securities on a periodic basis, such as each quarter, eliminating the costs associated with trading Treasury securities.

The Commission also notes that CME accepts shares of short-term U.S. Treasury ETFs as performance bond from clearing members to margin customer and house trades.
170

The Commission believes that this represents an important consideration in determining whether to add interests of U.S. Treasury ETFs to the list of Permitted Investments given that interests in U.S. Treasury ETFs that qualify as a Permitted Investment under the Proposal could ultimately be accepted by DCOs, such as CME, as performance bond, and pledged by FCMs as margin collateral.

170
CME Advisory Notice,
Modifications to Schedule of Acceptable Performance Bond—Addition of Short-Term U.S. Treasury ETFs
(Aug. 2, 2022) (“2022 CME Advisory Notice”), available at
https://www.cmegroup.com/notices/clearing/2022/08/Chadv22-293.pdf
(providing that acceptable ETFs must track a U.S. Treasury index and must have a minimum 80 percent investment in U.S. Treasury securities with a time to maturity of 1 year or less).

To ensure consistency with the requirements applicable to other Permitted Investments and the general objectives of Regulation 1.25 of preserving principal and maintaining liquidity of Permitted Investments, the Commission is proposing to impose the conditions discussed below on ETFs for their interests to qualify as a Permitted Investment. The Commission preliminarily believes that to the extent ETFs meet the proposed conditions, the ETFs would be comparable to Permitted Government MMFs whose interests currently qualify as Permitted Investments under Regulation 1.25(a).
171

The Commission also notes that by allowing FCMs and DCOs to invest Customer Funds in ETFs that meet the specified proposed conditions, it would provide FCMs and DCOs with a means for investing indirectly in Permitted Investments—U.S. Treasury securities, while allowing FCMs and DCOs to dispense with the expense and resources required to manage individual investments in such instruments.

171
The Commission notes that SEC Rule 2a-7, which applies to MMFs, restricts the types of investments in which MMFs can invest their assets, limits the terms of the investments, and imposes liquidity requirements with respect to the investments, among other things.
See
17 CFR 270.2a-7(d)(2) (providing that MMFs must limit their portfolio investments to U.S. dollar-dominated securities that at the time of acquisition are eligible securities), 17 CFR 270.2a-7(d)(1) (limiting the terms of maturity of MMFs' investments), and 17 CFR 270.2a-7(d)(4) (providing that MMFs must hold securities that are sufficiently liquid to meet reasonably foreseeable shareholder redemptions and setting forth other liquidity requirements). Although SEC Rule 2a-7 does not apply to ETFs, as described below, this Proposal would admit as a Permitted Investment only ETFs providing investors with substantial protections that are comparable, though not identical, to those afforded to MMF investors.

One rationale for adding ETFs investing primarily in short-term U.S. Treasury securities to the list of Permitted Investments is the similarity of the ETFs to MMFs whose interests qualify as Permitted Investments under Regulation 1.25(a). As such, the Commission preliminarily believes that it is appropriate to propose to impose all pertinent requirements applicable to MMFs under Regulation 1.25 to such ETFs, subject to certain modification to address the unique characteristics of the ETFs. Therefore, under the terms of the Proposal, an ETF would be required to satisfy specified requirements, as discussed below, to be a qualified ETF (“Qualified ETF”) whose interests qualify as a Permitted Investment.

Consistent with Regulation 1.25(c), which sets forth provisions for MMFs whose interests qualify as Permitted Investments, a Qualified ETF would be required to be an investment company that is registered under the Investment Company Act of 1940 with the SEC and that holds itself out to investors as an ETF under SEC Rule 6c-11.
172

The ETF would also be required to be sponsored by a federally regulated financial institution, a Section 3(a)(6) bank,
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an investment adviser registered under the Investment Advisers Act of 1940, or a domestic branch of a foreign bank insured by the FDIC.
174

172
Proposed Regulation 1.25(c)(1).

173
For a definition of Section 3(a)(6) bank,
see supra
note 51.

174
Proposed Regulation 1.25(c)(2), as applying to Qualified ETFs per proposed revised introductory text of paragraph (c) of Regulation 1.25.

In addition, the Commission is proposing to limit Qualified ETFs to funds that are passively managed and seek to replicate the performance of a published short-term U.S. Treasury security index.
175

For purposes of the Proposal, short-term U.S. Treasury securities are 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.
176

Consistent with this condition, the Commission is further proposing to require that the eligible U.S. Treasury securities represent at least 95 percent of the ETF's investment portfolio. In that regard, the Commission notes that pursuant to SEC requirements,
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certain registered investment companies, including ETFs, must adopt a policy to invest at least 80 percent of the value of their assets in accordance with the investment focus suggested by the fund's name.
178

175
Proposed revised Regulation 1.25(a)(1)(vi).

176

Id.

177
SEC Rule 35d-1 under the Investment Company Act of 1940 (indicating that a fund name suggesting that the fund focuses its investments in a particular type of investments or in investments in a particular industry would be a materially deceptive and misleading name unless the fund has adopted a policy to invest, under normal circumstances, at least 80 percent of the value of its assets in the particular type of investments or in investments in the particular industry suggested by the fund's name). 17 CFR 270.35d-1.

178
Proposed Regulation 1.25(c)(8)(ii).

The Commission, however, preliminarily believes that a stricter standard is necessary to help ensure that FCMs and DCOs invest Customer Funds in accordance with Regulation 1.25's general objectives of preserving principal and maintaining liquidity. The Commission's preliminary analysis indicates that short-term U.S. Treasury ETFs generally invest at least 95 percent of their assets in securities comprising the U.S. Treasury securities index whose performance the funds seek to replicate. As such, the Commission preliminarily believes that mandating that a Qualified ETF invest a minimum of 95 percent of its assets in eligible U.S. Treasury securities would not be overly restrictive.
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To ensure compliance with the proposed condition, FCMs and DCOs would be required to monitor the Qualified ETF's portfolio. If the portion of the ETF's assets invested in eligible U.S. Treasury securities falls below 95 percent of the fund's total assets, the FCM or DCO would not be permitted to make additional investments of Customer Funds in the ETF. The FCM or DCO would also be expected to take reasonable actions to divest interests in the fund, while managing Customer Funds in a manner consistent with Regulation 1.25's general objectives of preserving principal and maintaining liquidity. Depending on the market conditions, such actions may include taking steps to progressively reduce the

amount of Customer Funds invested in ETFs instead of immediately divesting the investments in a potentially volatile market.

179
The Commission considered proposing to require that Qualified ETFs invest at least 99.5 percent of their assets in eligible U.S. Treasury securities to reflect an analogous condition in SEC Rule 2a-7 requiring that government MMFs invest at least 99.5 percent of their assets in government securities. The Commission, however, preliminarily believes that such threshold would be more restrictive in the context of Qualified ETFs, given that an eligible U.S. Treasury security would be defined as a bond, note, or bill with a remaining maturity of 12 months or less, issued or unconditionally guaranteed by the U.S. Department of the Treasury, whereas a government security is broadly defined in SEC Rule 2a-7 (by reference to 15 U.S.C. 80a-2(a)(16)) to include U.S. government securities and U.S. agency obligations.

The Commission preliminarily believes that limiting the investments of Qualified ETFs as proposed would increase the safety and resilience of the ETFs
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and allow the funds to more closely match the risk profile of Permitted Investments, including Permitted Government MMFs. Also, Qualified ETFs that maintain portfolios primarily comprised of high-quality and liquid investments are better able to redeem interests without placing excessive downward pressure on the NAVs.

180
The Commission notes that a preliminary analysis of ETFs investing primarily in short-term U.S. Treasury securities indicates that the funds have a risk profile and volatility characteristics that are comparable to that of the underlying U.S. Treasury security investments. Specifically, using data available on Bloomberg, the Commission notes that for the period June 2020-September 2023, the Invesco Collateral Treasury ETF, as well as four other short-term U.S. Treasury ETFs that CME accepts as performance bond—SPDR® Bloomberg 1-3 Month T-Bill ETF, Goldman Sachs Access Treasury 0-1 Year ETF, iShares 0-3 Month Treasury Bond ETF, and iShares Short Treasury Bond ETF—had a standard deviation for a two-day period of risk of approximately 6 BPS, whereas the one-year U.S. Treasury securities had a standard deviation of 8 BPS for the same period.

In addition, the agreement pursuant to which an FCM or a DCO acquires and holds its interest in the Qualified ETF would be prohibited from containing provisions that would prevent the pledging of the Qualified ETF's shares.
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FCMs and DCOs would be required to maintain confirmations relating to their purchase of interests in a Qualified ETF in their records in accordance with Regulation 1.31 and note the ownership of the interests (by book-entry or otherwise) in the FCMs' and DCOs' custody account in accordance with Regulation 1.26.
182

FCMs and DCOs would be required to obtain the acknowledgment letter required by Regulation 1.26 from an entity that has substantial control over the ETF interests purchased with Customer Funds and that has the knowledge and authority to facilitate redemption and payment or transfer of the Customer Funds. Such entity may be the sponsor of the Qualified ETF or a depository acting as custodian for the ETF interests.

181
Paragraph (c)(6) of Regulation 1.25 as applying to Qualified ETFs per proposed revised introductory text of paragraph (c) of Regulation 1.25.

182
Paragraph (c)(3) of Regulation 1.25 as applying to Qualified ETFs per proposed revised introductory text of paragraph (c) of Regulation 1.25.

Also, the NAV for the Qualified ETF would be required to be computed by 9 a.m. of the business day following each business day and made available to FCMs or DCOs, as applicable, by that time.
183

The Commission notes that this proposed requirement is intended to allow for the valuation of the Qualified ETF's investment portfolio to be available by 9 a.m. the business day following an investment in the ETF, so that the valuation is available in time for FCMs to perform their daily segregation calculations, which are required to be completed by noon each business day, reflecting balances as of the close of business on the previous business day.
184

183
Paragraph (c)(4) of Regulation 1.25 as applying to Qualified ETFs per proposed revised introductory text of paragraph (c) of Regulation 1.25.

184
2000 Permitted Investments Amendment at 78003.

Further, the Qualified ETF would be required to be legally obligated to redeem its interests and make payment in satisfaction of the interests by the business day following a redemption request.
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FCMs or DCOs, as applicable, would be required to retain documentation demonstrating compliance with this requirement.
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Regulation 1.25(c)(5)(ii) currently provides an exception to the next-day redemption obligation for MMFs for defined extraordinary circumstances, such as the non-routine closures of the Fedwire or applicable Federal Reserve Banks, and any period during which the SEC by order restricts redemptions for the protection of security holders in the fund. Regulation 1.25(c)(5)(ii) was adopted by the Commission to be consistent with Section 22(e) of the Investment Company Act of 1940
187

and SEC Rule 22e-3,
188

which provides exceptions to MMFs for next-day redemptions.
189

The Commission is not proposing to adopt next-day redemption exceptions for Qualified ETFs as no comparable provisions are provided under the rules of the SEC, and in recognition that the redemption process for ETFs involves the exchange of ETF share for cash by authorized participants. As noted below, the Commission is seeking comment on the potential existence of extraordinary circumstances that may warrant an exception to the proposed next-day redemption requirement.

185
Paragraph (c)(5)(i) of Regulation 1.25 as applying to Qualified ETFs per proposed revised introductory text of paragraph (c) of Regulation 1.25.

186

Id.

187
15 U.S.C. 80a-22(e).

188
17 CFR 270.22e-3.

189
Regulation 1.25(c)(5)(ii) was originally adopted in 2005.
See
2005 Permitted Investments Amendment at 28196. It codified a 2001 letter issued by the Commission's Division of Trading and Markets in response to an industry inquiry, stating that the division would raise no issue in connection with MMFs that provide for certain exceptions to the next-day redemption requirement.
Id.
As specified in the 2001 letter, the circumstances in which the next-day redemption could be excused overlapped to a certain extent with those contained in Section 22(e) of the Investment Company Act of 1940.
See
CFTC Staff Letter No. 01-31, [2000-2002 Transfer Binder] Comm. Fut. L. Rep. (CCH)] 28,521 (Apr. 2, 2001). In 2011, the Commission revised Regulation 1.25(c)(5)(ii) to more closely align the language of that regulation with Section 22(e) and to expressly incorporate SEC Rule 22e-3.
See
2011 Permitted Investments Amendment at 78789.

The Commission preliminarily believes that limiting, as discussed above, Qualified ETFs to funds that track the performance of a published short-term U.S. Treasury security index would contribute to facilitating redemptions of Qualified ETFs' shares to be completed within one business day consistent with Regulations 1.25(c)(5)(i) and 1.25(b)(1).
190

190

See
17 CFR 1.25(c)(5) (providing that MMFs must be legally obligated to redeem their interests and to make payment in satisfaction of t

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2023-24774. Public record. Not legal advice.