# Regulations To Address Margin Adequacy and To Account for the Treatment of Separate Accounts by Futures Commission Merchants > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2024-04107 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** March 1, 2024 - **Citation:** 89 FR 15312 ## Text COMMODITY FUTURES TRADING COMMISSION 17 CFR Parts 1, 22, 30, and 39 RIN 3038-AF21 Regulations To Address Margin Adequacy and To Account for the Treatment of Separate Accounts by Futures Commission Merchants AGENCY: Commodity Futures Trading Commission. ACTION: Notice of proposed rulemaking; withdrawal. SUMMARY: On April 14, 2023, the Commodity Futures Trading Commission (Commission or CFTC) published a notice of proposed rulemaking (First Proposal) that proposed to amend the derivatives clearing organization (DCO) risk management regulations adopted under the Commodity Exchange Act (CEA) to permit futures commission merchants (FCMs) that are clearing members of DCOs (clearing FCMs), subject to specified requirements, to treat separate accounts of a single customer as accounts of separate legal entities for purposes of certain Commission regulations. In light of comments received supporting direct application of separate account treatment requirements to FCMs in the Commission's regulations, the Commission has determined to withdraw the First Proposal. The Commission now proposes regulations to require an FCM to ensure that a customer does not withdraw funds from its account with the FCM if the balance in such account after such withdrawal would be insufficient to meet the customer's initial margin requirements, and relatedly, to permit an FCM, in certain circumstances and subject to certain conditions, to treat the separate accounts of a single customer as accounts of separate entities for purposes of certain Commission regulations (Second Proposal). The proposed amendments would establish the conditions under which an FCM may engage in such separate account treatment. DATES: Comments must be received on or before April 22, 2024. ADDRESSES: You may submit comments, identified by RIN 3038-AF21, by any of the following methods: • CFTC Comments Portal: https://comments.cftc.gov. Select the “Submit Comments” link for this rulemaking and follow the instructions on the Public Comment Form. • Mail: Send to Christopher Kirkpatrick, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581. • Hand Delivery/Courier: Follow the same instructions as for Mail, above. Please submit your comments using only one of these methods. Submissions through the CFTC Comments Portal are encouraged. All comments must be submitted in English, or if not, accompanied by an English translation. Comments will be 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, 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. 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 proposed determination and order 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: Robert B. Wasserman, Chief Counsel, 202-418-5092, rwasserman@cftc.gov; Daniel O'Connell, Special Counsel, 202-418-5583, doconnell@cftc.gov, Division of Clearing and Risk; Thomas Smith, Deputy Director, 202-418-5495, tsmith@cftc.gov; Joshua Beale, Associate Director, 202-418-5446, jbeale@cftc.gov; Jennifer Bauer, Special Counsel, 202-418-5472, jbauer@cftc.gov, Market Participants Division, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581. SUPPLEMENTARY INFORMATION: Table of Contents I. Background A. The Commission's Customer Funds Protection Regulations B. The Divisions' No-Action Position C. The Commission's First Proposal and It's Withdrawal D. The Commission's Second Proposal II. Proposed Regulations A. Proposed Amendments to Regulation § 1.3 B. Proposed Amendments to Regulation § 1.17 C. Proposed Amendments to Regulations §§ 1.20, 1.32, 22.2, and 30.7 D. Proposed Regulation § 1.44(a) E. Proposed Regulation § 1.44(b) F. Proposed Regulation § 1.44(c) G. Proposed Regulation § 1.44(d) H. Proposed Regulation § 1.44(e) I. Proposed Regulation § 1.44(f) J. Proposed Regulation § 1.44(g) K. Proposed Regulation § 1.44(h) L. Proposed Appendix A to Part 1 M. Proposed Amendments to Regulation § 1.58 N. Proposed Amendments to Regulation § 1.73 O. Proposed Amendments to Regulation § 30.2 P. Proposed Amendments to Regulation § 39.13(g)(8) III. Cost Benefit Considerations A. Introduction B. Consideration of the Costs and Benefits of the Commission's Action C. Costs and Benefits of the Commission's Action as Compared to Alternatives D. Section 15(a) Factors IV. Related Matters A. Antitrust Considerations B. Regulatory Flexibility Act C. Paperwork Reduction Act I. Background A. The Commission's Customer Funds Protection Regulations 1 1 For purposes of completeness and explanation of the basis for this Second Proposal, the Commission restates its explanation of its customer funds protection regulations, as stated in the First Proposal. See Derivatives Clearing Organization Risk Management Regulations to Account for the Treatment of Separate Accounts by Futures Commission Merchants, 88 FR 22934, 22935-22936 (Apr. 14, 2023) (First Proposal). Two of the fundamental purposes of the CEA are the avoidance of systemic risk and the protection of market participants from misuses of customer assets. 2 The Commission has promulgated a number of regulations in furtherance of those objectives, including regulations designed to ensure that FCMs appropriately margin customer accounts, and are not induced to cover one customer's margin shortfall with another customer's funds. In addition to protecting customer assets, the current regulations serve the purpose of avoidance of systemic risk by mitigating the risk that a customer default in its obligations to a clearing FCM results in the clearing FCM in turn defaulting on its obligations to a DCO, which could adversely affect the stability of the broader financial system. 2 Section 3(b) of the CEA, 7 U.S.C. 5(b). Section 4d(a)(2) of the CEA and Commission regulation § 1.20(a) require an FCM to separately account for and segregate from its own funds all money, securities, and property which it has received to margin, guarantee, or secure the trades or contracts of its commodity customers. 3 Additionally, section 4d(a)(2) of the CEA and Commission regulation § 1.22(a) prohibit an FCM from using the money, securities, or property of one customer to margin or settle the trades or contracts of another customer. 4 This requirement is designed to prevent disparate treatment of customers by an FCM and mitigate the risk that there will be insufficient funds in segregation to pay all customer claims if the FCM becomes insolvent. 5 Section 4d(a)(2) of the CEA and regulations §§ 1.20 and 1.22 effectively require an FCM to add its own funds into segregation in an amount equal to the sum of all customer undermargined amounts, including customer account deficits, to prevent the FCM from being induced to use one customer's funds to margin or carry another customer's trades or contracts. 6 3 7 U.S.C. 6d(a)(2); 17 CFR 1.20(a). 4 7 U.S.C. 6d(a)(2); 17 CFR 1.22(a). 5 Prohibition of Guarantees Against Loss, 46 FR 11668, 11669 (Feb. 10, 1981). 6 7 U.S.C. 6d(a)(2); 17 CFR 1.20; 17 CFR 1.22; Prohibition of Guarantees Against Loss, 46 FR at 11669. Section 5b of the CEA, 7 as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, 8 sets forth eighteen core principles with which DCOs must comply to register and maintain registration as DCOs with the Commission. In 2011, the Commission adopted regulations for DCOs to implement Core Principle D, which concerns risk management. 9 These regulations include a number of provisions that require a DCO to in turn require that its clearing members take certain steps to support their own risk management in order to mitigate the risk that such clearing members pose to the DCO. 7 7 U.S.C. 7a-1(b). 8 Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010). 9 Section 5b(c)(2)(D) of the CEA, 7 U.S.C. 7a-1(c)(2)(D); Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 69334, 69335 (Nov. 8, 2011). Specifically, Commission regulation § 39.13(g)(8)(iii) provides that a DCO shall require an FCM clearing member to ensure that a customer does not withdraw funds from its account with such clearing member unless the net liquidating value plus the margin deposits remaining in the customer's account after the withdrawal would be sufficient to meet the customer initial margin requirements with respect to the products or portfolios in the customer's account, which are cleared by the DCO. 10 Regulation § 39.13(g)(8)(iii) thus establishes a “Margin Adequacy Requirement,” designed to mitigate the risk that an FCM clearing member fails to hold, from a customer, funds sufficient to cover the required initial margin for the customer's cleared positions. 11 In light of the use of omnibus margin accounts, where the funds of multiple customers are held together, this safeguard is necessary to “avoid the misuse of customer funds” 12 by mitigating the likelihood that the clearing member will effectively cover one customer's margin shortfall using another customer's funds. 10 17 CFR 39.13(g)(8)(iii). 11 For purposes of this proposed rulemaking, the Commission uses the term “Margin Adequacy Requirement” to refer to this requirement, which applies indirectly to clearing FCMs via the operation of DCO rules, and the analogous requirement set forth in proposed regulation § 1.44(b) which would apply directly to all FCMs. 12 Section 3(b) of the CEA, 7 U.S.C. 5(b). In adopting the Margin Adequacy Requirement of regulation § 39.13(g)(8)(iii), the Commission stated 13 that the regulation was consistent with the definition of “Margin Funds Available for Disbursement” in the Margins Handbook 14 prepared by the Joint Audit Committee (JAC), a representative committee of U.S. futures exchanges and the National Futures Association (NFA). 15 The Commission noted that while designated self-regulatory organizations (DSROs) reviewed FCMs to determine whether they appropriately prohibited their customers from withdrawing funds from their futures accounts, it was unclear to what extent that requirement applied to cleared swap accounts when such swaps were executed on a designated contract market (DCM) that participated in the JAC. 16 The Commission also noted that clearing members that cleared only swaps that were executed on a swap execution facility were not subject to the requirements of the JAC Margins Handbook or review by a DSRO. 17 13 Derivatives Clearing Organization General Provisions and Core Principles, 76 FR at 69379. 14 JAC Margins Handbook, available at http://www.jacfutures.com/jac/MarginHandBookWord.aspx. 15 Joint Audit Committee, JAC Members, available at http://www.jacfutures.com/jac/Members.aspx. Self-regulatory organizations, such as commodity exchanges and registered futures associations ( e.g., NFA), enforce minimum financial and reporting requirements, among other responsibilities, for their members. See Commission regulation § 1.3, 17 CFR 1.3. Pursuant to Commission regulation § 1.52(d), when an FCM is a member of more than one self-regulatory organization, the self-regulatory organizations may decide among themselves which of them will assume primary responsibility for these regulatory duties and, upon approval of such a plan by the Commission, the self-regulatory organization assuming such primary responsibility will be appointed the designated self-regulatory organization for the FCM. 17 CFR 1.52(d). 16 Derivatives Clearing Organization General Provisions and Core Principles, 76 FR at 69379. 17 Id. Thus, regulation § 39.13(g)(8)(iii) was also designed to apply these risk mitigation and customer protection standards to futures and swap positions carried in customer accounts by clearing FCMs. However, Commission regulations do not apply a Margin Adequacy Requirement to non-clearing FCMs, and regulation § 39.13(g)(8)(iii) does not require DCOs to apply that requirement to the positions carried by a clearing FCM that are not cleared at a registered DCO ( e.g., most foreign futures and foreign option positions). 18 18 The term “foreign futures” means any contract for the purchase or sale of any commodity for future delivery made, or to be made, on or subject to the rules of any foreign board of trade. 17 CFR 30.1(a). The term “foreign option” means any transaction or agreement which is or is held out to be of the character of, or is commonly known to the trade as, an “option”, “privilege”, “indemnity”, “bid”, “offer”, “put”, “call”, “advance guaranty” or “decline guaranty”, made or to be made on or subject to the rules of any foreign board of trade. 17 CFR 30.1(b). B. The Divisions' No-Action Position 19 19 For purposes of completeness and explanation of the basis for this Second Proposal, the Commission restates its explanation of the no-action position contained in CFTC Letter No. 19-17, as stated in the First Proposal. See First Proposal, 88 FR 22936-22937. On July 10, 2019, the Division of Swap Dealer and Intermediary Oversight (DSIO) (now Market Participants Division (MPD)) and the Division of Clearing and Risk (DCR) (collectively, the Divisions) published CFTC Letter No. 19-17, which, among other things, provides guidance with respect to the processing of margin withdrawals under regulation § 39.13(g)(8)(iii) and announced a conditional and time-limited no-action position for certain such withdrawals. 20 The advisory followed discussions with and written representations from the Asset Management Group of the Securities Industry and Financial Markets Association (SIFMA-AMG), the Chicago Mercantile Exchange (CME), the Futures Industry Association (FIA), the JAC, and several FCMs, regarding practices among FCMs and their customers related to the handling of separate accounts of the same customer. 21 CFTC Letter No. 19-17 used the term “beneficial owner” synonymously with the term “customer,” as “beneficial owner” was, in this context, commonly used to refer to the customer that is financially responsible for an account. Additionally, as discussed further below, in the customer relationship context, FCMs often deal directly with a commodity trading advisor acting as an agent of the customer rather than the customer itself. For the avoidance of confusion ( e.g., with regard to the terms “owner” or “ownership,” as those terms are used in Forms 40 and 102, or parts 17-20, or with regard to the term “beneficial owner,” as that term may be used by other agencies), this proposed rulemaking uses only the term “customer,” except where directly quoting or paraphrasing a source that uses “beneficial owner.” 20 CFTC Letter No. 19-17, July 10, 2019, available at https://www.cftc.gov/csl/19-17/download as extended by CFTC Letter No. 20-28, Sept. 15, 2020, available at https://www.cftc.gov/csl/20-28/download; CFTC Letter No. 21-29, Dec. 21, 2021, available at https://www.cftc.gov/csl/21-29/download; and CFTC Letter No. 22-11, Sept. 15, 2022, available at https://www.cftc.gov/csl/22-11/download; CFTC Letter No. 23-13, Sept. 11, 2023, available at https://www.cftc.gov/csl/23-13/download. 21 SIFMA-AMG letter dated June 7, 2019 to Brian A. Bussey and Matthew B. Kulkin (SIFMA-AMG Letter); CME letter dated June 14, 2019 to Brian A. Bussey and Matthew B. Kulkin (CME Letter); and FIA letter dated June 26, 2019 to Brian A. Bussey and Matthew B. Kulkin (First FIA Letter). The written representations preceding the issuance of CFTC Letter No. 19-17 included letters filed separately by SIFMA-AMG, CME, and FIA (collectively, the “Industry Letters”). 22 Citing regulation § 39.13(g)(8)(iii)'s requirements related to the withdrawal of customer initial margin, and JAC Regulatory Alert #19-02 reminding FCMs of those requirements, 23 SIFMA-AMG and FIA explained that provisions in certain FCM customer agreements provide that certain accounts carried by the FCM that have the same customer are treated as accounts for different legal entities ( i.e., “separate accounts”). 24 22 The Commission notes that while CME disagreed with certain aspects of FIA's letter that fall beyond the scope of this rulemaking, CME's letter noted that CME was “amenable to the Commission amending Rule 39.13(g)(8)(iii) to allow a DCO to permit a[n] FCM to release excess funds from a customer's separate account notwithstanding an outstanding margin call in another account of the same customer provided that certain specified risk-mitigating conditions . . . are satisfied.” CME Letter. 23 JAC, Regulatory Alert #19-02, May 14, 2019, available at http://www.jacfutures.com/jac/jacupdates/2019/jac1902.pdf. 24 SIFMA-AMG Letter; First FIA Letter. As FIA explained, there are a variety of reasons why a customer may want separate treatment for its accounts under such an agreement. 25 For instance, an institutional customer, such as an investment or pension fund, may allocate assets to investment managers under investment management agreements that require each investment manager to invest a specified portion of the customer's assets under management in accordance with an agreed trading strategy, independent of the trading that may be undertaken for the customer by the same or other investment managers acting on behalf of other accounts of the customer. 26 In such a situation, an investment manager may, in order to implement its trading strategy effectively, want assurance that the portion of funds it has been allocated to manage is entirely available to the investment manager, and will not be affected by the activities of other investment managers who manage other portions of the customer's assets and maintain separate accounts at the same FCM. Additionally, a commercial enterprise may establish separate agreements to leverage specific broker expertise on products or to diversify risk management strategies. 27 In such cases, each separate account may be subject to a separate customer agreement, which the FCM negotiates directly with, in many cases, the customer's agent, which often will be an investment manager. 28 25 First FIA Letter. 26 See id. 27 Id. 28 Cf. id. SIFMA-AMG and FIA asserted that, subject to appropriate FCM internal controls and procedures, separate accounts should be treated as separate legal entities for purposes of regulation § 39.13(g)(8)(iii); i.e., separate accounts should not be combined when determining an account's margin funds available for disbursement. 29 SIFMA-AMG and FIA maintained that such separate account treatment should not be expected to expose an FCM to any greater regulatory or financial risk, and asserted that an FCM's internal controls and procedures could be designed to assure that the FCM does not undertake any additional risk as to the separate account. 30 The Industry Letters included a number of examples of such controls and procedures. 31 29 SIFMA-AMG Letter; First FIA Letter. 30 SIFMA-AMG Letter; First FIA Letter. 31 SIFMA-AMG Letter; First FIA Letter; CME Letter. In its letter, SIFMA-AMG suggested that it would be possible to allow for separate account treatment without undermining the risk mitigation and customer protection goals of regulation § 39.13(g)(8)(iii). 32 SIFMA-AMG recognized that there may be some instances, such as a customer default, in which separate account treatment would no longer be appropriate. 33 SIFMA-AMG stated that an FCM could agree to first satisfy any amounts owed from agreed assets related to a separate account, and continue to release funds until the FCM provided the separate account with a notice of an event of default under the applicable clearing account agreement, and determined that it is no longer prudent to continue to separately margin the separate accounts, provided that such actions are consistent with the FCM's written internal controls and procedures. 34 SIFMA-AMG further stated that, in such instance, the FCM would retain the ability to ultimately look to funds in other accounts of the customer, including accounts under different control, and the right to call the customer for funds. 35 CME similarly asserted that disbursements on a separate account basis should not be permitted in certain circumstances, such as financial distress, that fall outside the “ordinary course of business.” 36 While CME asserted that the plain language of regulation § 39.13(g)(8)(iii) unambiguously forbids disbursements on a separate account basis, CME noted that it would be amenable to the Commission amending the regulation to permit such disbursements, subject to certain such risk-mitigating conditions. 37 32 SIFMA-AMG Letter. 33 Id. 34 Id. 35 Id. 36 CME Letter. 37 Id. SIFMA-AMG and FIA requested that DCR confirm that it would not recommend that the Commission initiate an enforcement action against a DCO that permits its clearing FCMs to treat certain separate accounts of a customer as accounts of separate entities for purposes of regulation § 39.13(g)(8)(iii), 38 and confirm that a clearing FCM may release excess funds from a separate customer account notwithstanding an outstanding margin call in another account of the same customer. 39 38 FIA specifically noted that such a no-action position could be conditioned on the FCM maintaining certain internal controls and procedures. 39 SIFMA-AMG Letter; First FIA Letter; see also CME Letter. In CFTC Letter No. 19-17, DCR stated that, in the context of separate accounts, the risk management goals of regulation § 39.13(g)(8)(iii) may effectively be addressed if a clearing FCM carrying a customer with separate accounts meets certain conditions, which were derived from the Industry Letters and specified in CFTC Letter No. 19-17. 40 DCR stated that it would not recommend that the Commission take enforcement action against a DCO if the DCO permits its clearing FCMs to treat certain separate accounts as accounts of separate entities for purposes of regulation § 39.13(g)(8)(iii) subject to these conditions. 41 The no-action position extended until June 30, 2021, in order to provide staff with time to recommend, and the Commission with time to determine whether to conduct and, if so, conduct, a rulemaking to implement a permanent solution. 42 CFTC Letter No. 20-28, published on September 15, 2020, extended the no-action position until December 31, 2021 due to challenges presented by the COVID-19 pandemic. 43 CFTC Letter No. 20-28 stated that if the process to consider codifying the no-action position provided for by CFTC Letter No. 19-17 was not completed by that date, DSIO and DCR would consider further extending the no-action position. 44 The Divisions published CFTC Letter No. 21-29, further extending the no-action position until September 30, 2022. 45 On September 15, 2022, the Divisions published CFTC Letter No. 22-11, which further extended the no-action position until the earlier of September 30, 2023 or the effective date of any final Commission action relating to regulation § 39.13(g). 46 As with CFTC Letter No. 21-29, this extension was issued in order to provide additional time for the Commission to consider a rulemaking. As discussed further below, while the Commission proposed a rulemaking to codify the no-action position in CFTC Letter No. 19-17, the Commission has determined to withdraw that proposed rulemaking in light of comments received and propose a new rulemaking in part 1 of its regulations to both impose a Margin Adequacy Requirement (as discussed herein) and simultaneously provide for separate account treatment. On September 11, 2023, the Divisions published CFTC Letter No. 23-13, extending the no-action position until the earlier of June 30, 2024 or the effective date of any final Commission action relating to regulation § 39.13(g), 47 to provide further time for staff to develop and for the Commission to consider the Second Proposal, and to receive and consider comments thereon and consider and adopt a final rule. 40 CFTC Letter No. 19-17. 41 Id. 42 Id. 43 CFTC Letter No. 20-28. 44 Id. 45 CFTC Letter No. 21-29. 46 CFTC Letter No. 22-11. 47 The Commission notes that this Second Proposal amends § 39.13(g) to refer to proposed regulation § 1.44. C. The Commission's First Proposal and its Withdrawal On April 14, 2023, the Commission published in the Federal Register a notice of proposed rulemaking—the First Proposal—designed to codify the no-action position in CFTC Letter No. 19-17. 48 The First Proposal proposed to amend regulation § 39.13 to add new paragraph (j) allowing a DCO to permit a clearing FCM to treat the separate accounts of customers as accounts of separate entities for purposes of regulation § 39.13(g)(8)(iii), if such clearing member's written internal controls and procedures permitted it to do so, and the DCO required its clearing members to comply with conditions specified in proposed regulation § 39.13(j). 48 First Proposal. The conditions for separate account treatment in proposed regulation § 39.13(j) were substantially similar to the conditions specified in CFTC Letter No. 19-17. However, certain conditions in proposed regulation § 39.13(j) reflected modification of the conditions in CFTC Letter No. 19-17 on which they were based. Such modifications included adding further reporting requirements for clearing members required to cease separate account treatment, an explicit process for clearing members to resume separate account treatment, and provisions designed to further clarify the requirement that separate accounts be on a one business day margin call. The comment period for the First Proposal was extended once at the request of a commenter and closed on June 30, 2023. 49 The Commission received comments from twelve commenters. 50 While commenters generally supported codifying the no-action position in CFTC Letter No. 19-17, six commenters 51 contended that the Commission should codify the no-action position in its part 1 FCM regulations (where it would apply directly to all FCMs) rather than its part 39 DCO regulations (where it applies only to clearing FCMs, through the instrumentality of DCOs). Other commenters did not opine on whether the proposed codification should be in part 1 versus part 39. 49 Derivatives Clearing Organization Risk Management Regulations to Account for the Treatment of Separate Accounts by Futures Commission Merchants, 88 FR 39205 (June 15, 2023). 50 American Council of Life Insurers (ACLI), CME, FIA, Intercontinental Exchange, Inc. (ICE), JAC, Managed Funds Association (MFA), NFA, SIFMA-AMG, Symphony Communications Services, LLC, and three individuals. 51 CME, FIA, ICE, JAC, NFA, and SIFMA-AMG. The Commission originally proposed to codify the no-action position in CFTC Letter No. 19-17 in part 39 in order to hew closely to the operation of the no-action position: DCOs could choose to permit clearing FCMs to engage in separate account treatment, provided such clearing FCMs complied with certain conditions. In its comment responding to the First Proposal, CME recommended codification in part 1 to extend the benefits of separate account treatment to all FCMs equally, whether or not they are clearing members of one or more DCOs. 52 CME asserted that codification in part 1 would eliminate the risk that a current or future DCO chooses not to permit separate account treatment, noting that CME's own clearing members have invested significant time and effort in conforming their policies, systems, and practices to comply with the no-action conditions and related JAC advisory notices. 53 As CME further contended, under the First Proposal, if one DCO chose not to permit separate account treatment, then an FCM would have to exclude contracts cleared through that DCO from its customers' separate accounts. 54 CME argued that this would likely make separate margining operationally infeasible, noting that the First Proposal acknowledged that an FCM's futures account for a customer includes all futures products that the FCM clears for the customer, and the initial margin requirement for the account would be the total of the initial margin the FCM charges the customer for each contract in the account, in each case regardless of the DCO at which the contracts are cleared. 55 52 CME Comment Letter. 53 Id. (citing regulations §§ 1.17, 1.20 and 22.2). 54 Id. 55 Id. CME also asserted that the First Proposal would effectively create two sets of reporting requirements applicable only to those FCM clearing members who choose to implement separate account margining at one or more DCOs, with new reporting requirements that conflict with regulations in part 1 that require calculation of deficits across all accounts of a single beneficial owner. 56 56 Id. CME further asserted that codification in part 39 would create new burdens for DCOs related to conducting examinations for compliance and the composition of DCO Chief Compliance Officer (CCO) reports, and would allow for disparate implementation by DCOs. 57 CME additionally opined that certain proposed requirements in the First Proposal were outside the scope of DCOs' risk management responsibilities and instead should be applied directly to FCMs. 58 57 Id. 58 Id. In its comment, FIA contended that rules that affect the obligations of FCMs should be set out in part 1, and, similar to CME, argued that, if the no-action position is codified in part 1, then non-clearing FCMs and FCMs that maintain 30.7 accounts for 30.7 customers pursuant to part 30 of the Commission's regulations would be able to provide consistent treatment to customers with the same enhanced risk management standards set forth in the no-action position. 59 FIA also asserted that codification in part 1 would allow an FCM to control whether enhanced standards and separate account treatment are offered to a specific customer, rather than requiring each DCO to manage and control whether separate account treatment is permitted. 60 FIA additionally contended that the terms and conditions under which separate account treatment should be permitted or prohibited is a decision that the Commission, rather than individual DCOs, should make. 61 59 FIA Comment letter. As set forth in Commission regulations, the term “30.7 account” means any account maintained by an FCM for or on behalf of 30.7 customers to hold money, securities, or other property to margin, guarantee, or secure foreign futures or foreign option positions. 17 CFR 30.1(g). The term “30.7 customer” means any person who trades foreign futures or foreign options through an FCM, except for the owner or holder of a proprietary account as defined in regulation § 1.3. 17 CFR 30.1(f). 60 Id. 61 Id. FIA noted that FCMs collect customer margin across DCOs and, if a DCO was to deny its clearing FCMs the right to provide separate account treatment, or establish different standards, such FCMs would effectively be denied the right to provide separate account treatment for their customers. Id. In its comment, ICE supported part 1 codification on the basis that the no-action conditions are mainly relevant to the operation of an FCM and its relationship with its customers, rather than the operation of a DCO. 62 ICE also argued that supervision of FCM compliance with requirements related to separate accounts would be more consistently applied if not done at the individual DCO level. 63 ICE noted that functions of supervision, examination, and surveillance of the relationship between FCMs and customers are typically performed by an FCM's DSRO under Commission regulation § 1.52, rather than by DCOs. 64 ICE further contended that it would be more efficient for an FCM to address issues related to separate account treatment with a single DSRO rather than each DCO of which it is a member, and that imposing on DCOs additional burden and costs of supervising separate account treatment conditions may disincentivize DCOs from permitting FCMs to engage in separate account treatment. 65 62 ICE Comment Letter. For instance, ICE contended that DCOs would not be well-placed to administer or enforce ensuring FCMs verify the identity of authorized representatives of clients, and recommended that if the Commission believes it necessary to establish steps clearing FCMs must take to identify such representatives, that it applies those requirements directly to such FCMs. Id. ICE also contended that a DSRO would be better placed than a DCO to readily assess whether an FCM is applying separate account treatment consistently. Id. 63 Id. 64 Id. 65 Id. In its comment, the JAC opined that conditions for separate account treatment should be stringent enough to mitigate to the maximum extent possible the additional risks to other customers of an FCM that separate account treatment presents, but noted that, in any case, part 39 DCO regulations do not fall under the JAC's self-regulatory organization surveillance authority. 66 Similar to CME, the JAC also asserted that the First Proposal lacked clarity regarding whether it contemplated bifurcated reporting requirements, because the First Proposal provided that a clearing FCM would need to calculate certain separate account customer balances for capital and segregation differently than under parts 1, 22, or 30, but did not include amendments to those regulations. 67 Thus, the JAC argued, it was unclear whether the JAC would continue to review and monitor an FCM's financial statements prepared in accordance with those regulations, while a DCO would monitor the FCM's different computations prepared in accordance with proposed regulation § 39.13(j). 68 The JAC also noted that the First Proposal did not provide for separate account treatment for non-clearing FCMs and Commission regulation § 30.7 customers. 69 66 JAC Comment Letter. 67 Id. 68 Id. 69 Id. Like other commenters, NFA argued that codification in part 1 would provide a clear path for an FCM's DSRO to examine it for compliance with separate account treatment requirements, and would provide greater clarity to non-clearing FCMs regarding whether they are permitted to engage in separate account treatment. 70 70 NFA Comment Letter. SIFMA-AMG recommended incorporating the First Proposal's conditions, with modifications, in Commission regulations §§ 1.11 and 1.56, and argued that codification in part 1 would directly establish obligations for the FCM, rather than indirect obligations applied through the DCO, with respect to separate treatment of customer accounts within the CFTC's regulatory framework. 71 SIFMA-AMG also argued that codification in part 1 would clarify that the regulatory obligations of the proposed regulation are the FCM's, and not the DCO's obligation to evaluate and determine if the FCM's behavior was appropriate. 72 71 SIFMA-AMG Comment Letter. 72 Id. In light of these comments, the Commission has determined to propose codification of the underlying Margin Adequacy Requirement ( i.e., that an FCM should not permit a customer to withdraw margin funds from that customer's accounts with the FCM if the net liquidating value plus the margin deposits remaining in such accounts after such withdrawal would be insufficient to meet the customer's initial margin requirements) 73 along with the conditional modification of that requirement embodied in CFTC Letter No. 19-17, in part 1 of its regulations. The Commission believes codification in part 1 can be effectuated in a manner that provides appropriate flexibility for market participants, enhanced risk management and protection of customer funds along with appropriate flexibility for a larger number of FCMs, and more efficient supervision of compliance with the no-action conditions proposed to be codified, while maintaining the effectiveness of those conditions. Therefore, the Commission formally withdraws its First Proposal, and proposes this new rulemaking to provide for separate account treatment through part 1 of its regulations. 73 As discussed further below, this requirement, which currently is effectively applied only to clearing FCMs, and predominately to part 1 (futures customer) and part 22 (Cleared Swaps Customer) accounts, would through codification in part 1 effectively apply to all FCMs, including those that are not members of a DCO, and would apply to all FCMs' 30.7 accounts. Separate from the question of whether the proposed codification should be in part 1 versus part 39, commenters provided feedback related to the proposed codification of individual no-action conditions. These comments are discussed below. The Commission notes that, with some exceptions that it believes are helpful to understanding differences between the First Proposal and this Second Proposal, certain comments that appear to be premised specifically on the First Proposal's proposed codification in part 39 in contrast to part 1 are not discussed, as the Commission no longer proposes to codify the no-action position in part 39. In addition to the comments noted above, FIA supported amending regulation § 1.56 to add a new paragraph recognizing (i) the right of an FCM to allow a customer to withdraw excess funds from a separate account while there is an outstanding margin call in another separate account, and (ii) that an FCM may agree that, in the absence of certain conditions, it will not use excess funds from one account to meet an obligation in another account without the customer's consent. 74 ACLI, MFA, and SIFMA-AMG additionally supported codification of interpretation of regulation § 1.56. 75 74 FIA Comment Letter. The Commission also received comments from two individuals generally supportive of the First Proposal. Additionally, the Commission received a comment from Symphony Communication Services, LLC, describing ways in which the commenter's technological capabilities could facilitate compliance with certain components of the First Proposal. Lastly, the Commission received a comment from an individual requesting that the Commission provide a chart explaining to what extent and subject to what conditions portfolio-based margining is available across specific products and scenarios. The Commission considers this request outside the scope of this Second Proposal. 75 ACLI Comment Letter; MFA Comment Letter; SIFMA-AMG Comment Letter. While appreciating those comments, the Commission seeks in this Second Proposal to engage in a narrower task: to directly apply the Margin Adequacy Requirement to all FCMs, while enacting a narrow codification (with respect to all FCMs) of the no-action position in CFTC Letter No. 19-17 with respect to the current Margin Adequacy Requirement embodied in regulation § 39.13(g)(8)(iii). Amendments to regulation § 1.56 are outside the scope of the proposed rulemaking. As such, where an FCM elects to apply separate account treatment, such treatment shall apply only for purposes of proposed regulation § 1.44 (inclusive of the Margin Adequacy Requirement of proposed regulation § 1.44(b)), including requirements that flow through to, e.g., Commission regulations §§ 1.17, 1.20, 1.32, 1.58, 1.73, 22.2, 30.7, the gross margining requirement of regulation § 39.13(g)(8)(i), and the Margin Adequacy Requirement of proposed regulation § 39.13(g)(8)(iii). Nothing in this rulemaking is intended to affect the requirements of regulation § 1.56 or, unless otherwise expressly indicated, any other Commission regulation. D. The Commission's Second Proposal For the reasons discussed above, the Commission proposes to codify the Margin Adequacy Requirement, along with the no-action position in CFTC Letter No. 19-17, in part 1. The bulk of the proposed regulation will be contained in new Commission regulation § 1.44, which is presently reserved. However, as explained below, the Commission also proposes supporting amendments in Commission regulations §§ 1.3, 1.17, 1.20, 1.32, 1.58, 1.73, 22.2, 30.2, 30.7, and 39.13 to facilitate implementation of proposed regulation § 1.44. The Commission is also proposing a number of amendments to address inadvertent inconsistencies in existing regulations. 76 76 These are proposed changes to regulation § 1.3 (to clarify that Saturday is not a business day), regulation § 1.17(b) (to reorganize the wording of the definition of the term “business day” for capital purposes to be consistent with the wording in the proposed amendments to regulation § 1.3, to clarify that the definition of the term “risk margin” includes both customer and noncustomer accounts, and to change the term “FCM” to read “futures commission merchant”), regulations §§ 1.20(i), 30.7(f)(2), and 22.2(f) to revise the regulatory description of the calculation of the total amount of funds that an FCM must hold in segregation for futures customers, Cleared Swaps Customers, and 30.7 customers, respectively, to align such description with the Commission's financial forms and the instructions to such forms, reorganizing regulations § 22.2(f)), § 1.58(a) and (b) (to clarify that gross margining requirements for omnibus accounts carried for one FCM at another FCM apply to cleared swaps as well as to futures and options and futures), and § 30.2(b) (to clarify, in the context of the exclusion for applying certain regulations to persons and transactions subject to the requirements of part 30, existing regulations §§ 1.41, 1.42, and 1.43 (which were added in the 2021 part 190 bankruptcy rulemaking) are not excluded). These proposed changes are discussed in more detail in the relevant sections below. The Commission's Second Proposal represents in part a reorganization of the First Proposal. The First Proposal largely mirrored the organization of the no-action position in CFTC Letter No. 19-17, first providing that a DCO could allow a clearing FCM to engage in separate account treatment (so long as such clearing FCM complied with certain conditions), then explaining specific circumstances that would disqualify a clearing FCM from engaging in separate account treatment, and finally providing the specific risk-mitigating conditions with which the clearing FCM would be required to comply in order to provide separate account treatment. Proposed regulation § 1.44 is comprised of eight paragraphs. First, proposed regulation § 1.44(a) defines key terms solely for purposes of proposed regulation § 1.44. Second, proposed regulation § 1.44(b) incorporates for all FCMs, and for all accounts, 77 the same Margin Adequacy Requirement that DCOs are obligated in regulation § 39.13(g)(8)(iii) to require their clearing FCMs to apply. Third, proposed regulation § 1.44(c) makes clear that an FCM can engage in separate account treatment only during the “ordinary course of business,” a term that is defined in proposed regulation § 1.44. Fourth, proposed regulation § 1.44(d) explains how FCMs may elect to engage in separate account treatment for one or more customers. Fifth, proposed regulation § 1.44(e) enumerates events inconsistent with the ordinary course of business and contains requirements for FCMs related to cessation of separate account treatment upon the occurrence of such events, and resumption of separate account treatment upon the cure of such events. Sixth, proposed regulation § 1.44(f) contains the requirement that each separate account be on a “one business day margin call” and sets out regulations designed to explain the meaning of a one business day margin call for purposes of proposed regulation § 1.44. Seventh, proposed regulation § 1.44(g) sets forth capital, risk management, and segregation calculation requirements with which FCMs would be required to comply with respect to accounts for which the FCM has elected separate treatment. Eighth, proposed regulation § 1.44(h) sets out information and disclosure requirements for FCMs that engage in separate account treatment. 77 Proposed regulation § 1.44(a) defines “account” to include futures accounts and Cleared Swaps Customer Accounts, both of which terms are defined in regulation § 1.3, and 30.7 accounts. A 30.7 account means any account maintained by an FCM for or on behalf of 30.7 customers to hold money, securities, or other property to margin, guarantee, or secure foreign futures or foreign options. 17 CFR 30.1(g). In its comment responding to the First Proposal, the JAC recommended adding two additional conditions for separate account treatment. First, the JAC supported adding a condition requiring a clearing FCM's risk-based capital requirement to be adjusted to capture the risk of accounts receiving separate treatment. 78 As discussed below, the Commission is proposing to amend regulation § 1.17 to revise an FCM's risk-based capital requirement to capture the risks of separate accounts. Second, the JAC supported adding a condition requiring accounts treated as separate accounts to be identified as such in an FCM's books and records, including on customer statements. 79 The Commission's proposed regulation § 1.44(d)(1), as discussed below, would provide that an FCM must include each separate account customer on a list of separate account customers maintained in its books and records. While an FCM may elect to specifically identify separate accounts as such in customer statements, the Commission expects that FCMs will be able to readily identify all of their customer accounts receiving separate treatment. 78 JAC Comment Letter. 79 Id. II. Proposed Regulations Section 8a(5) of the CEA 80 authorizes the Commission “to make and promulgate such rules and regulation as, in the judgment of the Commission, are reasonably necessary to effectuate any of the provisions, or to accomplish any of the purposes, of” the CEA. The Commission is proposing these rules pursuant to section 8a(5) as reasonably necessary to effectuate sections 4d(a)(2) and 4d(f)(2), 81 providing for the segregation and protection of, respectively, futures customer funds and Cleared Swaps Customer Collateral, and 4(b)(2)(A), 82 providing for the safeguarding of customers' funds in connection with foreign futures and foreign option transactions. As additional authority, the Commission is also proposing these rules as reasonably necessary to effectuate section 4f(b), which requires an FCM to meet minimum financial requirements prescribed by the Commission as necessary to ensure that the firm meets its obligations. 83 Moreover, as further additional authority, the Commission is also proposing these rules as reasonably necessary to accomplish the purposes of the CEA as set forth in section 3(b); 84 specifically, “the avoidance of systemic risk” and “protect[ing] all market participants from . . . misuses of customer assets.” 80 7 U.S.C. 12a(5). 81 7 U.S.C. 6d(a)(2) and (f)(2). 82 7 U.S.C. 6(b)(2)(A). 83 7 U.S.C. 6f(b). 84 7 U.S.C. 5(b). Accordingly, the Commission preliminarily believes that the amendments proposed herein relating to the Margin Adequacy Requirement, and the modification of this requirement to permit, subject to certain prescribed conditions, separate account treatment in connection with the withdrawal of customer initial margin, support the customer funds protection and risk management provisions and purposes of the CEA. As further described below, the Commission also preliminarily believes that preventing the under-margining of customer accounts and mitigating the risk of a clearing member default, or the default of a non-clearing FCM, and the potential for systemic risk in either scenario, is effectively addressed by the standards set forth in the proposed regulation. All FCMs are currently subject to a detailed set of requirements designed to provide effective protection for customer funds. These include, for futures accounts, regulations §§ 1.20 (requiring segregation), 1.22 (requiring, inter alia, residual interest to cover undermargined amounts), and 1.23 (requiring FCMs to maintain residual interest in segregated accounts up to a targeted amount that they determine based on specified considerations), as well as similar requirements with respect to Cleared Swaps Customer Accounts (respectively, regulations §§ 22.2(d) and (f), and 22.17), and 30.7 accounts (regulation § 30.7). Regulation § 39.13(g)(8)(iii) provides an additional layer of protection, but only with respect to FCMs that are clearing members of DCOs. There is no analogous Margin Adequacy Requirement applicable to FCMs that are not clearing members of DCOs. As discussed above, regulation § 39.13(g)(8)(iii) is designed to mitigate the risk that a clearing member fails to hold, from a customer, funds sufficient to cover the required initial margin for the customer's cleared positions and, in light of the use of omnibus margin accounts, “avoid the misuse of customer funds” by mitigating the likelihood that the clearing member will effectively cover one customer's margin shortfall using another customer's funds. 85 Regulation § 39.13(g)(8)(iii) provides a risk mitigation provision for DCOs, clearing FCMs, and customers. The effect of the staff no-action position is to allow DCOs to permit clearing FCMs to engage in separate account treatment for purposes of that provision, but subject to conditions designed to maintain the provision's risk mitigating effects. 85 Section 3(b) of the CEA, 7 U.S.C. 5(b). Where it is now proposing to establish requirements for separate account treatment for all FCMs by adding a similar Margin Adequacy Requirement to part 1, the Commission seeks to replicate the same regulatory structure on an all-FCM basis, and furthers the customer fund protection and risk mitigation purposes of the CEA 86 by implementing measures designed to further ensure that all FCMs, whether clearing or non-clearing, do not create or exacerbate an under-margining scenario. 86 Section 3(b) of the CEA, 7 U.S.C. 5(b) (It is the purpose of this Act to ensure the financial integrity of all transactions subject to this Act and the avoidance of systemic risk and to protect all market participants from misuses of customer assets) Similar to the First Proposal, the requirements for separate account treatment proposed herein are designed to ensure that FCMs carry out separate account treatment in a consistent and documented manner, monitor customer accounts on a separate and combined basis, identify and act upon instances of financial or operational distress that necessitate a cessation of separate account treatment, provide appropriate disclosures to customers 87 regarding separate account treatment, and apprise their DSROs when they apply separate account treatment or an event has occurred that would necessitate cessation of separate account treatment. 88 87 In this proposal, references to a “customer” are to a direct customer of the FCM in question. Thus, where non-clearing FCM N clears through clearing FCM C, a customer (including a separate account customer) of N is not considered a customer of C. 88 For the avoidance of doubt, the Second Proposal permits an FCM to elect to engage in separate account treatment. It neither requires an FCM to engage in such treatment nor requires a customer of an FCM that elects to engage in separate account treatment to elect to have its accounts with such FCM treated as separate accounts of separate entities. Thus, separate account treatment requires an affirmative election of both the FCM and the customer. The Second Proposal is designed to extend the customer protection and risk management benefits of regulation § 39.13(g)(8)(iii) to all FCMs and all of their customer accounts, and to provide an alternative means of achieving those risk management goals if the FCM elects to permit customers to maintain separate accounts under the proposal. 89 Additionally, as discussed further below in the cost benefit considerations, because a number of clearing FCMs have already implemented the conditions set forth in CFTC Letter No. 19-17, a number of FCMs will have already implemented, in significant part, the requirements proposed herein. 89 As a result, proposed regulation § 1.44 would prohibit the application of portfolio margining or cross-margining treatment between separate accounts of the same customer, but would not prohibit the application of such treatments within a particular separate account of a customer. Request for Comment Question 1: The Commission requests comment regarding whether, in light of changes made in this Second Proposal relative to the First Proposal, it should consider any conditions additional to those contained in proposed regulation § 1.44 below, or modify or remove any of the conditions proposed herein. Question 2: The Commission requests comment regarding whether the interaction between proposed regulation § 1.44(g) through (h) and other regulations under parts 1, 22, and 30 affected by the proposed requirements therein ( e.g., regulations §§ 1.17, 1.20, 1.22, 1.23, 1.32, 1.55, 1.58, 1.73, 22.2, 30.2, and 30.7) is sufficiently clear. A. Proposed Amendments to Regulation § 1.3 The definitions contained in Commission regulation § 1.3 are key to understanding and interpreting the Commission's regulations, including part 1 FCM regulations. The Commission believes the provisions of proposed regulation § 1.44 necessitate an amendment to regulation § 1.3. The Commission proposes to amend the definition of “business day” in regulation § 1.3. Current regulation § 1.3 provides, in relevant part, that “business day” means any day other than a Sunday or holiday. The Commission proposes to expand this definition to confirm that the term encompasses any day other than a Saturday, Sunday, or holiday. This term, which is applicable to proposed regulation § 1.44(f), setting forth the requirement that separate accounts be on a one business day margin call, is similar to the proposed definition of “United States business day,” which appeared in the First Proposal. 90 As in the First Proposal, however, the term is intended to encompass days on which banks and custodians are open in the United States to facilitate payment of margin. Thus, for the avoidance of doubt, “holiday” in this context refers to holidays in the United States. 90 Under the First Proposal, the term “United States business day” referred to weekdays not including federal holidays as established by 5 U.S.C. 6103. The Commission notes that, notwithstanding the current definition of the term in regulation § 1.3, which is used in a variety of regulations, in actual practice, Saturdays are generally not treated as business days in the markets, 91 by market participants, or for regulatory purposes. 92 The Commission is thus proposing to change the definition of “business day” in regulation § 1.3 to conform to that reality. 91 It is true that some markets are moving toward 24/7 operation. The Commission will continue to monitor these developments, and consider further rulemaking in this area as appropriate. Nonetheless, a definition of business days that includes Saturday, but not Sunday, does not reflect present or plausible future reality. 92 For instance, Saturdays are treated as non-business days for purposes of swaps reporting under parts 43 and 45 of the Commission's regulations, 17 CFR 43.1; 17 CFR 45.2, execution of confirmations by swap dealers, 17 CFR 23.501(c)(5)(ii), and under the Commission's part 39 DCO regulations, 17 CFR 39.2 (defining an intraday business day period). See also, e.g., CFTC, Guidebook for Part 17.00: Reports by Reporting Markets, Futures Commission Merchants, Clearing Members, and Foreign Brokers, at 18, May 30, 2023 (noting that for purposes of part 17.00 reports, “reporting entities may elect to not consider Saturdays to be a business day, as Saturday is not commonly known as such”). Request for Comment Question 3: The Commission requests comment regarding whether its proposal to revise the definition of “business day” in regulation § 1.3 would result in any adverse consequences for any market participants. B. Proposed Amendments to Regulation § 1.17 Regulation § 1.17 currently establishes minimum financial requirements for FCMs. In this regard, regulation § 1.17(a)(1)(i) provides that each person registered as an FCM must maintain adjusted net capital equal to, or in excess of, the greatest of: (1) $1 million (or $20 million if the FCM is also registered as a swap dealer); (2) eight percent of the total “risk margin” required on the positions in customer and noncustomer accounts 93 carried by the FCM; (3) the amount of adjusted net capital required by NFA as a registered futures association; or (4) for an FCM registered as a securities broker or dealer with the Securities and Exchange Commission (SEC), the amount of net capital required by SEC rule § 15c3-1. 94 For purposes of regulation § 1.17(a)(1)(i), the term “risk margin” is defined by paragraph (b)(8) of regulation § 1.17 to generally mean the level of maintenance margin or performance bond required for customer and noncustomer positions established by the applicable exchanges or clearing organizations. 93 The term “noncustomer account” generally means the accounts of affiliates of an FCM or employees of an FCM. See 17 CFR 1.17(b)(4). 94 17 CFR 240.15c3-1. The Commission is proposing several amendments to regulation § 1.17 to reflect the regulatory capital treatment of separate accounts that would result from the implementation of proposed regulation § 1.44, including the conditions contained in proposed regulation § 1.44(g)(3) discussed below. These proposed amendments were not part of the First Proposal. As a general matter, the proposed amendments to regulation § 1.17 are designed to ensure that FCMs risk manage separate accounts consistently, and cannot revert to calculating minimum financial requirements on a combined account basis where such calculations would tend to reflect less risk and reduced financial requirements for a customer than if each of the customer's separate accounts were treated as an account of a distinct customer without regard to the same customer's other separate accounts. Consistent with the above intent, the Commission is proposing to expand the list of modifiers to the definition of the term “risk margin” for an account by adding proposed paragraph (b)(8)(v) to regulation § 1.17, providing that if an FCM carries separate accounts for separate account customers pursuant to proposed regulation § 1.44, then the FCM shall calculate the risk margin pursuant to regulation § 1.17(a)(1)(i)(B)( 1 ) as if each separate account is owned by a separate entity. The Commission notes that, under the proposed regulation, risk margin would be calculated on an individual basis for each separate account. Calculating risk margin separately for each separate account would eliminate the potential for portfolio margining offsets based on positions between separate accounts of the same separate account customer. 95 Therefore, the proposal to treat separate accounts as accounts of separate entities would either increase, or leave unchanged, the total risk margin requirement, and thus the minimum adjusted net capital requirement, for an FCM providing separate account treatment. 96 The proposed addition of paragraph (b)(8)(v) to regulation § 1.17 is intended to further clarify that, pursuant to the Commission's FCM capital rule, an FCM that elects to permit separate account treatment must compute the risk margin amount for separate accounts as if each account is an account of a separate entity. 95 As noted in regulation § 39.13(g)(4), a DCO may allow reduction in initial margin requirements for related positions if the price risks with respect to such positions are significantly and reliably correlated. This includes cases where (A) The products on which the positions are based are complements of, or substitutes for, each other. An example might be long versus short positions in oil and natural gas, both of which may be used for generating energy. However, portfolio margining is applicable only to accounts for the same customer. See regulation § 39.13(g)(8)(i) (requiring collection of initial margin on a gross basis for each clearing member's customer accounts). So, if a customer has, in a single account, both long oil positions and short natural gas positions, they may benefit from a reduction in initial margin requirements for the two risk-offsetting positions. However, if those positions are in different separate accounts of the customer under this proposal, the positions would not lead to an initial margin reduction as the positions would not be margined on a combined or portfolio basis. 96 As noted above, per regulation § 1.17(a)(1)(i), the adjusted net capital requirement for an FCM is the greatest of a number of calculations, one of which is eight percent of the total risk margin requirement as defined in regulation § 1.17(b)(8). Thus, a calculation that would increase, or leave the same, the risk margin requirement would correspondingly increase, or leave the same, the adjusted net capital requirement. The Commission further notes that the proposed amendment to the definition of the term “risk margin” in regulation § 1.17(b)(8) to reflect separate accounts, and the resulting potential increase in an FCM's minimum adjusted net capital requirement under regulation § 1.17(a)(1)(i), would also impact other regulations that impose obligations on FCMs based on their level of adjusted net capital. For example, regulation § 1.17(h) conditions an FCM's ability to repay or prepay subordinated debt obligations on the FCM maintaining an amount of adjusted net capital that, after taking into effect the amount of the subordinated debt payment and other subordinate debt payments maturing within a set time period, exceeds the FCM's minimum adjusted net capital requirement by 120 percent to 125 percent, as specified in the applicable provision of regulation § 1.17(h). 97 The proposed amendments to the minimum capital requirements would also impact an FCM's obligation to provide certain notices to the Commission and to the FCM's DSRO under Commission regulation § 1.12. 98 97 See, e.g., 17 CFR 1.17(h)(2)(vii) which generally provides, subject to certain conditions, that an FCM may not make a prepayment on an outstanding subordinated debt obligation if such payment would result in the FCM maintaining less than 120 percent of its minimum adjusted net capital requirement. 98 See, e.g., 17 CFR 1.12(a), which requires an FCM to provide notice to the Commission and the firm's DSRO if the FCM's adjusted net capital at any time is less than the minimum required by regulation § 1.17. The Commission additionally notes that, as discussed further below, it is additionally proposing to amend regulation § 1.58 to provide that, where a clearing FCM carries an omnibus customer account for a non-clearing FCM, and the non-clearing FCM applies separate account treatment, then such non-clearing FCM must calculate initial and maintenance margin for purposes of regulation § 1.58(a) separately for each separate account. These proposed amendments to regulation § 1.58 are discussed further below. Second, the Commission proposes to amend regulation § 1.17(c)(2), which defines “current assets” that an FCM may recognize and include in computing its net capital. Regulation § 1.17(c)(2) currently defines “current assets” to include cash and other assets or resources commonly identified as those that are reasonably expected to be realized in cash or sold during the next 12 months. Regulation § 1.17(c)(2)(i), however, provides that an FCM must exclude from current assets any unsecured receivables resulting from futures, Cleared Swaps, or 30.7 accounts that liquidate to a deficit or contain a debit ledger balance only, provided, however, that the FCM may include a deficit or debit ledger balance in current assets until the close of business on the business day following the date on which the deficit or debit ledger balance originated (provided, in turn, that the account had timely satisfied the previous day's deficits or debit ledger balances). The Commission is proposing to amend regulation § 1.17(c)(2)(i) to provide explicitly that if an FCM carries separate accounts for separate account customers pursuant to proposed regulation § 1.44, then the FCM must treat each separate account as an account of a separate entity. Accordingly, the FCM must exclude each unsecured separate account that liquidates to a deficit or contains a debit ledger balance only from current assets in its calculation of net capital, provided, however, that if the separate account is subject to a call for margin by the FCM it may be included in current assets until the close of business on the business day following the date on which the deficit or debit ledger balance originated, provided that the separate account timely satisfied previous day's debit or deficits in its entirety. If the separate account does not satisfy a previous day's deficit in its entirety, then the deficit for the separate account, and any other deficits of the separate account customer in other separate accounts carried by the FCM, shall not be included in current assets until all such calls are satisfied in their entirety. The proposed amendment to regulation § 1.17(c)(2)(i) would provide the same capital treatment to separate accounts as is currently provided customer accounts that liquidate to deficits or contain debit ledger balances, and is consistent with corresponding conditions to the no-action position in CFTC Letter No. 19-17. 99 99 CFTC Letter No. 19-17. CFTC Letter No. 19-17 provides that an “FCM shall record each separate account independently in the FCM's books and records, i.e., the FCM shall record separate accounts as a receivable (debit/deficit) or payable with no offsets between the other separate accounts of the same customer.” Id. (Condition 6.) CFTC Letter No. 19-17 also provides that “the receivable from a separate account shall only be considered secured (a current/allowable asset) based on the assets of that separate account, not on the assets held in another separate account of the same customer.” Id. (Condition 7.) Third, the Commission proposes to amend regulation § 1.17(c)(4), which defines the term “liabilities” for purposes of an FCM calculating its net capital. Regulation § 1.17(c)(4) generally defines the term “liabilities” to mean the total money liabilities of an FCM arising in connection with any transaction whatsoever, including economic obligations of an FCM that are recognized and measured in conformity with generally accepted accounting principles. Regulation § 1.17(c)(4) also provides that for purposes of computing net capital, an FCM may exclude from its liabilities funds held in segregation for futures customers, Cleared Swaps Customers, and 30.7 customers, provided that such segregated funds are also excluded from the FCM's current assets in computing the firm's net capital. The Commission is proposing to amend regulation § 1.17(c)(4)(ii) to explicitly provide that an FCM that carries the separate accounts of separate account customers pursuant to proposed regulation § 1.44 must compute the amount of money, securities, and property due to a separate account customer as if each separate account of the separate account customer is a distinct customer. The Commission is further proposing to amend regulation § 1.17(c)(4)(ii) to provide that an FCM, in computing its net capital, may exclude funds held in segregation for separate account customers from the FCM's liabilities, provided that funds held in segregation for separate account customers are also excluded from the FCM's current assets. The purpose of the proposed amendment is to ensure that an FCM, in computing its net capital, reflects separate accounts in a consistent manner in determining its total current assets and liabilities. Fourth, the Commission proposes to amend regulation § 1.17(c)(5), which defines the term “adjusted net capital.” Regulation § 1.17(c)(5)(viii) provides, in relevant part, that adjusted net capital means net capital minus, among other items detailed in regulation § 1.17(c)(5), the amount of funds required in each customer account to meet maintenance margin requirements of the applicable board of trade or, if there are no such maintenance margin requirements, clearing organization margin requirements applicable to the account's positions. FCMs are allowed to apply (that is, to reduce the amount of this deduction from capital by) “calls for margin or other required deposits which are outstanding no more than one business day.” However, once a customer fails to meet a margin call within one business day, the FCM loses the one business day “grace period” for receiving any of that customer's future margin calls, until the point in time at which the customer is no longer undermargined. Thus, if, due to activity on Monday, Customer A is undermargined by $150, and the FCM calls Customer A for that margin on Tuesday, the FCM does not need to deduct that $150 from its net capital in computing its adjusted net capital, so long as the margin call is met by the close of business on Wednesday. Moreover, if Customer A, due to activity on Tuesday, is undermargined by an additional $100, and the FCM calls for that additional $100 on Wednesday, the FCM does not need to deduct that additional $100 on Wednesday. If Customer A meets the $150 call by close of business Wednesday, and the $100 call by close of business on Thursday, then no deduction need be taken for either the $150 or the $100 margin calls. However, if Customer A fails to meet Tuesday's $150 call by close of business on Wednesday, then the FCM must deduct both the $150 from Tuesday and the $100 from Wednesday (thus a total of $250), as well as any future undermargined amounts until Customer A cures its entire undermargined amount. Again, once a customer fails to meet a margin call within one business day, the FCM loses the one business day “grace period” for that customer meeting any of its future margin calls, until the point in time at which the customer is no longer undermargined. The Commission proposes to amend regulation § 1.17(c)(5)(viii) to provide that an FCM that carries separate accounts for a separate account customer pursuant to proposed regulation § 1.44 must compute the amount of funds required to meet maintenance margin requirements for each separate account as if the account was owned by a distinct customer. However, if a margin call for any separate account of a separate account customer is outstanding for more than one business day, then (consistent with the treatment of multiple margin calls for a single customer described in the previous paragraph), no margin call for that separate account customer will benefit from the one business day grace period until the point in time at which all margin calls for the separate accounts of that separate account customer have been met in full. As discussed further below in the context of proposed regulation § 1.44(f), the concepts of margin calls that are outstanding no more than one business day (for purposes of § 1.17(c)(5)(viii)), and meeting a one business day margin call (for purposes of § 1.44(f)) are separate and distinct—it is possible that a separate account customer may meet the test for the first, but not the second, or may meet the test for the second, but not the first. The Commission notes that its proposed amendments to regulation § 1.17 also include a number of technical changes designed to improve clarity and promote consistency with other Commission regulations. 100 100 E.g., changes to punctuation and substitution of level of maintenance margin or performance bond required for the customer and noncustomer positions for level of maintenance margin or performance bond required for the customer or noncustomer positions with respect to the meaning of risk margin for an account. See, e.g., proposed regulation § 1.17(b)(8). The Commission is further proposing to replace the term “FCM” in regulation § 1.17(b)(8) with “futures commission merchant.” The Commission is also proposing to reorganize paragraph § 1.17(c)(5)(viii) into sub-paragraphs (A), (B), (C), and (D) to enhance clarity. The Commission is additionally proposing to reorganize the wording of the definition of the term “business day” in regulation § 1.17(b)(6) to read any day other than a Saturday, Sunday, or holiday rather than any day other than a Sunday, Saturday, or holiday. This change would align the wording with the wording of the term “business day” in proposed regulation § 1.3. C. Proposed Amendments to Regulations §§ 1.20, 1.32, 22.2, and 30.7 As previously stated, a fundamental purpose of the CEA is to provide for the protection of market participants from misuses of customer assets. 101 Regulations §§ 1.32, 22.2(g), and 30.7(l) are designed in part to further this purpose by requiring each FCM carrying accounts for futures customers, Cleared Swaps Customers, or 30.7 customers, respectively, to perform a daily computation of, and to prepare a daily record demonstrating compliance with, the FCM's obligation to hold a sufficient amount of funds in designated customer segregated accounts to meet the aggregate credit balances of all of the FCM's futures customers, Cleared Swaps Customers, and 30.7 customers. 102 An FCM is required to prepare the daily segregation calculations reflecting customer account balances as of the close of business each day, and to submit the applicable segregation statements electronically to the Commission and to the FCM's DSRO by noon the next business day. 101 Section 3(b) of the CEA, 7 U.S.C. 5(b). 102 Each FCM that carries accounts for futures customers, Cleared Swaps Customers, and 30.7 customers is required to prepare daily statements demonstrating compliance with the applicable segregation requirements. For futures customers, the FCM must prepare a daily Statement of Segregation Requirements and Funds in Segregation for Customers Trading on U.S. Commodity Exchanges (17 CFR 1.32(a)) (“Futures Segregation Statement”); for Cleared Swaps Customers, the FCM must prepare a daily Statement of Cleared Swaps Customer Segregation Requirements and Funds in Cleared Swaps Customer Accounts under section 4d(f) of the CEA (17 CFR 22.2(g)(1) through (4)) (“Cleared Swaps Segregation Statement”); and for 30.7 customers, the FCM must prepare a daily Statement of Secured Amounts and Funds Held in Separate Accounts for 30.7 Customers pursuant to Commission Regulation 30.7 (17 CFR 30.7(l)(1)). The statements listed above are part of the Commission's Form 1-FR-FCM, which contains the financial reporting templates required to be filed by FCMs. The Commission is proposing to amend regulations §§ 1.32, 22.2, and 30.7 to provide that an FCM that permits separate accounts pursuant to proposed regulation § 1.44 must perform its daily segregation calculations, and prepare its daily segregation statements, by treating the accounts of separate account customers as accounts of separate entities. The proposed amendments would add new paragraph (l) to regulation § 1.32, new paragraph (g)(11) to regulation § 22.2, and new paragraph (l)(11) to regulation § 30.7. The purpose of the proposed amendments is to establish the manner in which these existing segregation and reporting obligations apply to FCMs that permit separate accounts pursuant to proposed regulation § 1.44. Regulations §§ 1.32, 22.2, and 30.7 require an FCM to prepare one daily segregation computation, and submit one segregation schedule, for each of its futures customer funds, Cleared Swaps Customer Collateral, and 30.7 customer funds, respectively. The proposed amendments to regulations §§ 1.32, 22.2(g), and 30.7(l) provide that an FCM that permits separate accounts, in preparing such computation and segregation schedule, would be required to record each separate account as if it was an account of a separate entity, and include all separate accounts with other futures accounts, Cleared Swaps Customer Accounts, and 30.7 accounts, as applicable, carried by the FCM that are not separate accounts. In addition, the proposed amendments would provide that an FCM, in computing its segregation obligations, may offset a net deficit in a particular separate account customer's separate account against the current value of any readily marketable securities held by the FCM for the separate account customer, provided that the readily marketable securities are held as margin collateral for the specific separate account that is in deficit. Readily marketable securities held for other separate accounts of the separate account customer may not be used to offset the separate accounts that is in deficit. 103 The proposed amendments to regulations §§ 1.32, 22.2(g), and 30.7(l) with respect to the offsetting of a net deficit in a customer's account by the value of readily marketable securities held in the customer's account are consistent with how an FCM currently offsets a net deficit in a customer's account that is margined by securities. In addition, the proposed amendments are consistent with the separate account conditions to the no-action position in CFTC Letter No. 19-17. 104 103 I.e., if separate account customer S has separate accounts A and B, then readily marketable securities held for separate account A could not be used to offset a deficit in separate account B, and vice versa. 104 See CFTC Letter No. 19-17 (providing, among other conditions for separate account treatment, that “[e]ach receivable from a separate account shall be `grossed up' on the applicable segregation, secured or cleared swaps customer statement; thus, an FCM shall use its own funds to cover the debit/deficit of each separate account.”). The Commission is also proposing to amend regulation § 22.2(f) to revise the regulatory description of the stated calculation of the total amount of funds that an FCM is required to hold in segregation for Cleared Swaps Customers. The proposed amendment would (i) correct an error included in the drafting of the description of the calculation when the regulation was originally adopted in 2012; and (ii) align the regulatory text describing the segregation calculation set forth in regulation § 22.2(f) with the calculation performed on the Cleared Swaps Segregation Statement that is submitted to the Commission each day by FCMs with Cleared Swaps Customers pursuant to regulation § 22.2(g). The proposed amendment would be applicable across FCMs with Cleared Swaps Customers, whether or not such FCMs maintain separate accounts. The segregation calculation required by regulation § 22.2(f) is intended to ensure that an FCM holds, at all times, a sufficient amount of funds in segregation to cover its total financial obligation to all Cleared Swaps Customers. Compliance with the segregation requirements helps ensure that an FCM is not using the funds of one Cleared Swaps Customer to cover a deficit in the Cleared Swaps Customer Account of another Cleared Swaps Customer, and further helps ensure that an FCM holds sufficient funds in segregation to transfer the Cleared Swaps Customer Accounts, including the Cleared Swaps and the Cleared Swaps Customer Collateral, to a transferee FCM if the transferor FCM becomes insolvent. To achieve the regulatory objective noted above, regulation § 22.2(f)(2) currently requires an FCM to calculate its minimum segregation requirement as the sum of the net liquidating equities of each Cleared Swaps Customer Account with a positive account balance carried by the firm. The net liquidating equity of a Cleared Swaps Customer Account is explicitly calculated as the sum of the market value of any funds held in the Cleared Swaps Customer Account of a Cleared Swaps Customer (including readily marketable securities), as adjusted positively or negatively by, among other things, any unrealized gains or losses on open Cleared Swaps positions, the value of open long option positions and short option positions, fees charged to the account, and authorized withdrawals. To the extent that the calculation results in a net liquidating equity that is positive, the Cleared Swaps Customer Account has a credit balance. 105 To the extent that the calculation results in a net liquidating equity that is negative, the Cleared Swaps Customer Account has a debit balance. 106 Regulation § 22.2(f)(4) provides that an FCM must hold, at all times, a sufficient amount of funds in segregation to meet the total net liquidating equities of all Cleared Swaps Customer Accounts with credit balances, and further provides that the FCM may not offset this total by any Cleared Swaps Customer Accounts with debit balances. 105 17 CFR 22.2(f)(3). 106 Id. With respect to Cleared Swaps Customer Accounts with debit balances, regulation § 22.2(f)(5) further requires the FCM to include in the total funds required to be held in segregation all debit balances to the extent secured by readily marketable securities held for the particular Cleared Swaps Customers that have debit balances. The required addition of debit balance accounts in regulation § 22.2(f)(5) was intended to be consistent with the long-standing Futures Segregation Statement contained in the Form 1-FR-FCM and the Form 1-FR-FCM Instructions Manual. 107 An error, however, was made in drafting the description of the details of the segregation calculation in regulation § 22.2(f)(5). Specifically, as noted above, regulation § 22.2(f)(5) requires an FCM to include in the total segregation requirement any Cleared Swaps Customer Accounts with debit balances that are secured by readily marketable securities. However, the full value of the readily marketable collateral is part of the calculation of the net liquidating equity of the account. Therefore, a Cleared Swaps Customer Account with a debit balance would never have additional readily marketable securities available to offset a debit balance. 108 107 In adopting the final regulation § 22.2(f), the Commission stated that proposed regulation § 22.2(f) set forth an explicit calculation for the amount of Cleared Swaps Customer Collateral that an FCM must maintain in segregation that did not materially differ from the calculation of the amount of funds an FCM is required to hold in segregation under the Form 1-FR-FCM for futures customers. The Commission adopted final regulation § 22.2(f) as proposed. Protection of Cleared Swaps Customer Contracts and Collateral; Conforming Amendments to the Commodity Broker Bankruptcy Provisions; Final Rule, 77 FR 6336, at 6352-6353 (Feb. 7, 2012). 108 For example, if a Cleared Swaps Customer Account was comprised of cash of $300, securities of $200, and an unrealized loss on open Cleared Swaps of $600, the account would have a net equity debit balance of $100 under regulation § 22.2(f). There are no additional securities that the FCM may use to secure the $100 debit balance and, therefore, the FCM is required to increase its segregation requirement by $100 to ensure that there are sufficient funds in segregation to cover the FCM's obligation to all Cleared Swaps Customers with a credit balance. The segregation calculation required under regulation § 1.32 for futures accounts, and the Commission's Form 1-FR-FCM and related Form 1-FR-FCM Instructions Manual, differs from the description as currently written in regulation § 22.2(f)(4) and (5) with respect to the offsetting of debit balances by readily marketable securities. Specifically, an FCM is required to calculate the net equity of each futures customer excluding the value of any noncash collateral held in the account. 109 If the calculation results in a debit balance, the FCM is permitted to offset the debit balance by the fair market value of any readily marketable securities (after application of applicable securities haircuts set forth in the regulation). 110 109 The Form 1-FR-FCM Instructions Manual provides that a customer account is in deficit when the combination of the account's cash ledger balance, unrealized gain or loss on open futures contracts, and the value of open option contracts liquidates to an amount less than zero. The manual explicitly provides that “[a]ny securities used to margin the account are not included in determining a customer's deficit.” 1-FR-FCM Instructions Manual, p. 10-2. Accordingly, an FCM would exclude the value of any readily marketable securities from the calculation of the customer's account balance. The 1-FR-FCM Instructions Manual is available on the Commission's website at: www.cftc.gov/sites/default/files/idc/groups/public/@iointermediaries/documents/file/1fr-fcminstructions.pdf. 110 17 CFR 1.32(b). Applying the calculation in regulation § 1.32 to Cleared Swaps, if a Cleared Swaps Customer Account was comprised of cash of $300, securities of $200, and an unrealized loss on open Cleared Swaps of $600, the account would have a net equity debit balance of $300, as the value of the securities is not included in the calculation ($300 cash less $600 in unrealized losses, results in a $300 debit balance). The FCM may offset the $300 debit balance by $170, which represents the value of the readily marketable securities held in the account as collateral ($200 fair market value of the securities, less a $30 haircut). The FCM is then required to include $130 in its segregation requirement, which represents the amount of the unsecured debit balance remaining in the customer's account ( i.e., $300 debit balance, less $170 value of the securities after haircuts). As noted above, the proposed amendments to regulation § 22.2(f)(4) and (5) are intended to correct the description of the segregation calculation and to make it consistent with how FCMs calculate their total Cleared Swaps segregation obligations under regulation § 22.2(g), with how FCMs report their total segregation requirements on the Cleared Swaps Segregation Statement, and with the segregation calculation requirements for futures accounts under regulation § 1.32. Thus, the proposed amendments are not expected to have any effect on FCMs. In addition, the Commission is proposing to amend regulations §§ 1.20(i) and 30.7(f), which require an FCM carrying futures accounts and 30.7 accounts, respectively, to calculate its total segregation requirements in a manner that is consistent with current regulation § 22.2(f). As with the proposed amendment to regulation § 22.2(f), the proposed amendments to regulations §§ 1.20(i) and 30.7(f) apply across FCMs that maintain futures customer accounts or 30.7 customer accounts, respectively, whether or not such FCMs maintain separate accounts. The Commission adopted current regulations §§ 1.20(i) and 30.7(f) in 2013. The final regulations, however, did not include the provision set forth in regulation § 22.2(f)(5) requiring an FCM to include any secured debit balances in its segregation requirement. This omission was unintentional, as the Commission expressed its intent to “mirror” the requirements of regulation § 22.2(f) in regulation § 1.20(i) (and effectively regulation § 30.7(f)). 111 111 Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations, 78 FR 68506, 68543 (Nov. 14, 2013) (discussing the Commission's intent to adopt regulation § 1.20(i) consistent with the corresponding requirements in regulation § 22.2(f)); id. at 68576 (discussing the Commission's intent for the daily segregation calculation for 30.7 accounts to be consistent with the requirements for the daily segregation calculations for futures customer funds in regulation § 1.32). To address the omission, the Commission is proposing to amend regulations §§ 1.20(i) and 30.7(f) to reflect the requirement for an FCM to include in the calculation of its futures and foreign futures segregation requirement any unsecured customer debit balances, calculated consistent with the proposed amendments to regulation § 22.2(f)(4) and (5) that are discussed above. The proposed amendments to regulations §§ 1.20(i) and 30.7(f) would accurately describe and reflect the existing segregation calculations for futures, foreign futures, and Cleared Swaps as originally intended. The proposed amendments to regulations §§ 1.20(i) and 30.7(f) are not expected to have any impact on FCMs as the firms currently calculate their segregation requirements by including customer unsecured debit balances. D. Proposed Regulation § 1.44(a) Proposed regulation § 1.44 will represent a discrete set of regulations, first directly requiring FCMs to avoid returning margin to customers where doing so would create or exacerbate a margin deficiency in the customer's account, but then allowing FCMs to provide for separate account treatment within the Commission's broader regulatory framework for FCMs. As such, proposed regulation § 1.44 contains a number of terms that are specific to proposed regulation § 1.44, but are not applicable, or are not applicable in the same manner, with respect to other of the Commission's FCM regulations. The Commission therefore proposes to add new regulation § 1.44(a) to define certain terms “only for purposes of this section” ( i.e., proposed regulation § 1.44). The Commission proposes to define “account” for purposes of proposed regulation § 1.44 as meaning a futures account, a Cleared Swaps Customer Account (both of which are defined in regulation § 1.3, which definitions apply broadly to all CFTC regulations) or a § 30.7 account (as defined in regulation § 30.1). This definition is intended to implement the proposed Margin Adequacy Requirement and requirements for separate account treatment subject to such Margin Adequacy Requirement, with respect to accounts of all three types. This definition was not included in the First Proposal. The Commission also proposes in proposed regulation § 1.44(a) to further define “business day,” as having the same meaning as set forth in regulation § 1.3, but with the clarification that “holiday” refers to Federal holidays as established by 5 U.S.C. 6103. As noted above, this definition is similar to the definition of “United States business day” included in the First Proposal. In its comment responding to the First Proposal, FIA noted that the term “United States business day” accounts for days that banks are open, but may not encompass days when other markets, such as securities markets, are closed, which could make it difficult to meet margin calls by liquidating certain instruments. 112 The Commission requests further comment on this term, below. 112 FIA Comment Letter. Relatedly, the Commission proposes to define “one business day margin call” as a margin call that is issued and met in accordance with the requirements of proposed regulation § 1.44(f). The First Proposal did not include this definition, although it contained provisions that, similar to proposed regulation § 1.44(f), further explained when an FCM would be considered in compliance with a one business day margin call. As noted above, this definition (along with all of the definitions in proposed regulation § 1.44(a)) applies only for purposes of proposed regulation § 1.44, thus, this definition of “one business day margin call” is not intended to apply in any other context. Under proposed regulation § 1.44, an FCM may engage in separate account treatment only when it, and its customer, are operating within the “ordinary course of business,” as that term is defined in the proposed regulation. The Commission proposes to define “ordinary course of business” as meaning the standard day-to-day operation of the FCM's business relationship with its separate account customer, a condition where there are no unusual circumstances that might indicate a materially increased level of risk that the separate account customer may fail promptly to perform its financial obligations to the FCM, or decreased financial resilience on the part of the FCM. As noted in the proposed definition, proposed regulation § 1.44(e) sets out circumstances that are inconsistent with the ordinary course of business, and the occurrence of which would require a cessation of separate account treatment. This definition of “ordinary course of business” is unchanged from the First Proposal, except that it replaces the term “customer” with the term “separate account customer.” Comments received regarding the definition of “ordinary course of business” are addressed in connection with proposed regulation § 1.44(e) below, which enumerates events that are inconsistent with the ordinary course of business. The Commission also proposes to define “separate account” as meaning any one of multiple accounts of the same separate account customer that are carried by the same FCM. The definition of this term is the same as in the First Proposal, except that it replaces “customer” with “separate account customer” and excludes the criteria that the FCM be a clearing member of a DCO. The Commission did not receive comments on the definition of this term in the First Proposal. As noted above, the Commission proposes to define “separate account customer” as meaning a customer for which the FCM has elected to engage in separate account treatment. This definition was not included in the First Proposal. Lastly, the Commission proposes to define “undermargined amount” for an account as meaning the amount, if any, by which the customer margin requirements with respect to all products held in that account, exceeds the net liquidating value plus the margin deposits currently remaining in that account. 113 The definition notes that for purposes of this definition, “margin requirements” shall mean the level of maintenance margin or performance bond (including, as appropriate, the equity component or premium for long or short option positions) required for the positions in the account by the applicable exchanges or clearing organizations. 114 This clarification (which is drawn from the definition of risk margin in regulation § 1.17(b)(8)) is in recognition of the difference between exchange (or clearing organization) requirements for “initial margin” and “maintenance margin.” However, here, in distinction to risk margin, the equity component or premium for long or short option positions is included, since those are part of the total required level of margin. “Initial margin” is the amount of margin (otherwise known as “performance bond” 115 in this context) required to establish a position. Some (though not all) contract markets and clearing houses establish “maintenance margin” requirements that are less than the corresponding initial margin requirement.” Where, due to adverse market movements, the amount of margin on deposit is less than the initial margin requirement, but greater than or equal to maintenance margin, the FCM is not required to (though it may) call additional margin from the customer. Once the amount of margin on deposit is less than the maintenance margin required, the FCM must call the customer for enough margin to meet the initial margin level. 113 The definition of “undermargined amount” in proposed regulation § 1.44(a) is different from, and simpler than, the definitions of “undermargined amount” for the purpose of residual interest calculations in regulations §§ 1.22(c)(1), 22.2(f)(6)(i), and 30.7(f)(1)(ii). The calculations in the latter cases are required to take into account information at the close of business on day T-1 that will be used to calculate a residual interest requirement on day T, as well as payments that may be received on day T, and the elimination of double counting of debit balances. 114 The definition of “undermargined amount” in proposed regulation § 1.44(a) further provides that, with respect to positions for which maintenance margin is not specified, “margin requirements” shall refer to the initial margin required for such positions. 115 “Performance bond” secures the performance by a customer to meet its variation margin payment obligations to its FCM (or the performance of variation margin payment obligations of an FCM to the clearinghouse, or to an intermediary upstream FCM). The Commission uses this term in connection with proposed regulation § 1.44(f) in defining the requirements for making and meeting a one business day margin call, as well as in regulation § 1.44(g) in setting LSOC compliance calculations for separate accounts. This definition was not included in the First Proposal. Request for Comment Question 4: How should the proposed definition of “business day” address days when securities and other markets are closed? For instance, should the Commission address in the definition days when such other markets are open, or create an exception for days when such markets are closed on a prescheduled basis? ( E.g., a requirement rolls over to the next day that the market is open.) What liquidity challenges or other risks would result from such an exception? How do FCMs and customers currently address these cases? Question 5: In the proposed definition of “undermargined amount” in proposed regulation § 1.44(a), the term “margin deposits currently remaining” does not include a deduction for “haircuts” on non-cash collateral or collateral posted in alternate currencies. This is consistent with the approach taken with respect to calculating undermargined amounts for purposes of determining requirements for residual interest in regulations §§ 1.22(c)(1), 22.2(f)(6)(i), and 30.7(f)(1)(ii). By contrast, in a number of cases, Commission regulations require FCMs, in determining the amount of customer debit/deficit balances secured by readily marketable securities, to apply securities haircuts set forth in SEC Rule 15c3-1(c)(2). 116 Similarly, some exchanges require members, in determining the amount of margin they are required to collect from their customers, to apply haircuts to securities collateral in amounts consistent with SEC Rule 240.15c3-1, and to apply haircuts to commodities in amounts consistent with the inventory haircuts specified in Commission regulation § 1.17(c)(5)(ii). 117 116 See, e.g., regulations §§ 1.32(b) and 22.2(f)(5)(iii). 117 See, e.g., CME Rule 930.C, ICE Futures U.S. Rule 5.03(j). Should the definition of “undermargined amount” apply haircuts to the value of customer collateral held by the FCM? If so, should the amount of such haircuts be based on SEC rule 240.15c3-1 and Commission regulation § 1.17(c)(5)(ii), or some other basis? E. Proposed Regulation § 1.44(b) As discussed above, the Commission proposes regulation § 1.44(b) to apply directly to FCMs, whether clearing or non-clearing, the same Margin Adequacy Requirement that DCOs are required to apply to their clearing FCMs pursuant to regulation § 39.13(g)(8)(iii). Proposed regulation § 1.44(b) provides that an FCM shall ensure that a customer does not withdraw funds from its accounts with such FCM unless the net liquidating value plus the margin deposits remaining in the customer's account after such withdrawal are sufficient to meet the customer initial margin requirements with respect to all products held in such customer's account, except as provided in proposed regulation § 1.44(c), which allows for separate account treatment under ordinary course of business conditions. 118 118 Consistent with the existing Margins Handbook, the Margin Adequacy Requirement is based on initial margin requirements rather than any lower maintenance margin requirement. See JAC Margins Handbook at p. 10-1 (“Margin Funds Available for Disbursement = Net Liquidating Value + Margin Deposits−Initial Margin Requirement ≥0”); see also supra n. 14 and accompanying text. The Commission acknowledges that real-time calculation of margin adequacy with respect to a potential withdrawal may prove impracticable. Instead, the Commission seeks to articulate a standard for the time as of which such calculation shall be made that is consistent with the Commission's requirements for calculation of undermargined amounts for purposes of an FCM's residual interest calculations. Regulations §§ 1.22(c)(2), 22.2(f)(6)(ii), and 30.7(f)(ii)(B) require each FCM to compute such undermargined amounts based on the information available to the FCM as of the close of each business day for futures customer accounts, Cleared Swaps Customer Accounts, and 30.7 accounts, respectively. To ensure such consistency, proposed regulation § 1.44(b)(1) provides that the sufficiency of the amount in a customer's account to meet customer initial margin requirements following a potential withdrawal shall be calculated as of close of business on the previous business day. In order to address circumstances in which the previous day is a holiday on which markets, but not banks, may be open, proposed regulation § 1.44(b)(2) further provides that, for purposes of proposed regulation § 1.44(b)(1)'s margin adequacy calculation requirements, where the previous day (excluding Saturdays and Sundays) is a holiday, as defined in proposed regulation § 1.44(a), where any DCM on which the FCM trades is open for trading, and where an account of any of the FCM's customers includes positions traded on such a market, the margin adequacy calculation shall instead be made as of the close of business on such holiday. 119 119 Proposed regulation § 1.44(b)(2), and proposed regulation § 1.44(f)(7), discussed below, are consistent with JAC Regulatory Alert 22-02, which provides that an FCM must issue margin calls to customers on holidays where futures markets are open and U.S. banks are closed. The margin calls are calculated based on information as of the close of the previous business day ( i.e., the business day prior to the holiday) and the FCM does not count the holiday for purposes of aging the margin call. JAC Regulatory Alert 22-01, Mar. 30, 2022, available at www.jacfutures.com. The Commission notes that proposed regulation § 1.44(b)'s requirements related to the timing of the margin adequacy calculation required by the same section are intended to represent a minimum standard, and are not intended to prevent an FCM from exercising its judgment in connection with good risk management practice to prevent the disbursement of customer funds based on intervening intraday market movements resulting in losses to a customer account between the calculation benchmark set forth in proposed regulation § 1.44(b) and the time at which a customer requests to withdraw funds. Ensuring that customers do not withdraw funds from their accounts at FCMs if such withdrawal would create or exacerbate an initial margin shortfall is reasonably necessary from a risk management perspective, in that it reduces the likelihood and extent of the risk that the FCM must cover losses due to a default by the customer on obligations that exceed the margin actually held by the FCM. Similarly, because customer funds are held by an FCM in omnibus accounts, this prohibition will reduce the likelihood and extent of the risk that the FCM will effectively use the margin of other customers to “margin or guarantee the trades or contracts, or to secure or extend the credit of” a customer that was permitted to withdraw margin in a manner that created or exacerbated an undermargined condition, 120 whether the duty to prevent such withdrawals falls on DCOs acting on their member FCMs, or directly on FCMs. Because regulation § 39.13(g)(8)(iii) applies only to DCOs (which in turn can only apply regulation § 39.13(g)(8)(iii)'s Margin Adequacy Requirement to their clearing member FCMs), and given the strong trend of the comments in favor of addressing these issues in a manner uniform among all types of FCMs directly in part 1 rather than indirectly through part 39, the Commission now views it as reasonably necessary to extend to all FCMs the requirement to prevent such under-margining scenarios. 120 Cf. CEA 4d(a)(2), 7 U.S.C. 6d(a)(2) (an FCM may not use the money or property of one customer “to margin or guarantee the trades or contracts, or to secure or extend the credit, of any customer or person other than the one for whom the same are held.”) Accordingly, the Commission preliminarily believes that proposed regulation § 1.44(b), which will apply a similar Margin Adequacy Requirement directly to FCMs, both clearing and non-clearing, would further serve to protect customer funds and mitigate systemic risk, thus effectuating CEA section 4d(a)(2), 4d(f)(2), and 4(b)(2)(A) 121 and accomplishing the purposes of “avoidance of systemic risk” and “protecting all market participants from . . . misuses of customer assets.” 122 121 7 U.S.C. 6d(a)(2), 6d(f)(2), and 6(b)(2)(A). 122 CEA 3(b), 7 U.S.C. 5(b). See, as discussed above, section 8a(5) of the CEA, 7 U.S.C. 12a(5), authorizing the Commission to make and promulgate such rules and regulation as in the Commission's judgment are reasonably necessary to effectuate any of the provisions, or to accomplish any of the purposes, of the CEA. F. Proposed Regulation § 1.44(c) Proposed regulation § 1.44(c) sets forth the fundamental terms and conditions for separate account treatment. As a general matter, those terms and conditions are substantially the same as in CFTC Letter No. 19-17, and in the First Proposal, except that the FCM may choose to engage in separate account treatment without a DCO specifically authorizing such treatment. Proposed regulation § 1.44(c) provides that an FCM may, only during the ordinary course of business, as that term is defined in proposed regulation § 1.44, treat the separate accounts of a separate account customer as accounts of separate entities for purposes of proposed regulation § 1.44(b), 123 if such FCM elects to do so as specified in proposed regulation § 1.44(d). Proposed regulation § 1.44(c) further provides that an FCM that has made such an election shall comply with the risk-mitigating conditions set forth further in proposed regulation § 1.44 and maintain written internal controls and procedures designed to ensure such compliance. 123 As noted above, proposed regulation § 1.44(b) is intended to serve as an analog to regulation § 39.13(g)(8)(iii) for FCMs. The Commission preliminarily believes that permitting FCMs to treat the separate accounts of separate account customers as accounts of separate entities for purposes of proposed regulation § 1.44(b), subject to the risk-mitigating conditions set forth further in proposed regulation § 1.44, accomplishes the CEA's purpose of promoting responsible innovation, while also maintaining continuity of robust customer fund protection and risk mitigation. 124 Compliance with those conditions can best be achieved if the FCM maintains written internal controls and procedures designed to ensure such compliance. 124 See CEA 3(b), 8a(5). G. Proposed Regulation § 1.44(d) Proposed regulation § 1.44(d) provides that an FCM may elect to treat the separate accounts of a customer as accounts of separate entities for purposes of proposed regulation § 1.44(b). In order to do so, an FCM shall include the customer on a list of separate account customers maintained in its books and records. Such list shall include the identity of each separate account customer, as well as the identity of each separate account of such customer. The FCM is required to keep such list current. Furthermore, the first time that an FCM chooses to include a customer on a list of separate account customers, the FCM is required to provide notification of the election to allow separate account treatment for customers in accordance with the process specified in regulation § 1.12(n)(3). 125 For the avoidance of doubt, the notification of such election would remain a one-time notification made the first time the FCM begins providing separate account notification for a customer. Successive notifications would not be required for each additional customer for which the FCM provides separate account treatment. Furthermore, the FCM would need only provide notification of the election, and would not be required to include the identity of the separate account customer. Proposed regulation § 1.44(d) is intended to ensure that DSROs are able effectively to monitor and regulate FCMs that engage in separate account treatment, and that FCMs have the records necessary to understand which accounts receive separate account treatment for purposes of monitoring compliance with the proposed regulation. 125 See 17 CFR 1.12(n)(3). Once an FCM provides notice in the first instance that it will apply separate account treatment to one or more customers, it would not be required to provide the same notification each time it applies separate account treatment to a new or additional customer. The First Proposal proposed to require a clearing FCM to (i) provide a one-time notification to its DSRO and any DCO of which it is a clearing member that it will apply such treatment; (ii) maintain and keep current a list of all separate accounts receiving such treatment; and (iii) conduct a review of such records of accounts receiving separate treatment no less than quarterly. With respect to the proposed one-time notice requirement for separate account treatment, the JAC in its comment contended that such notice (and other notices required under the First Proposal) should be made to any DCO permitting separate account treatment of which a clearing FCM is a member, but should not be required to be provided to the clearing FCM's DSRO, as monitoring for compliance with separate account treatment requirements would not fall under the oversight of the DSRO. 126 Because the Commission is no longer proposing to codify the no-action position in CFTC Letter No. 19-17 in part 39, it is no longer proposing to require that notifications made to DSROs additionally be made to every DCO of which the notifying FCM is a member. Furthermore, the Commission believes notice to the Commission, and to DSROs (who review FCMs' compliance with the Commission's part 1 regulations) pursuant to proposed regulation § 1.44(d)(2) is proper. 126 JAC Comment Letter. With respect to the proposed recordkeeping requirement, CME opined in its comment that clearing FCMs should be required to be able to produce, upon request of the relevant DCO or the Commission, a current list of accounts receiving separate treatment. 127 The Commission believes such requirement is already provided for by the requirement in proposed regulation § 1.44(d) to maintain and keep current such a list, combined with Commission regulation § 1.31(d)'s requirement for records entities to produce regulatory records promptly upon request by Commission representatives. 127 CME Comment Letter. The Commission notes that, in proposing the recordkeeping requirement in this Second Proposal, it has determined not to include the First Proposal's proposed requirement that an FCM review records of accounts receiving separate treatment no less than quarterly, as the Commission views the objective of such requirement—the keeping of accurate and current records—as being subsumed by this Second Proposal's proposed requirement to maintain and keep current a list of accounts receiving separate treatment. H. Proposed Regulation § 1.44(e) Proposed regulation § 1.44(e) enumerates events that would be inconsistent with the ordinary course of business, as that term is defined in proposed regulation § 1.44(a), and sets forth requirements related to the cessation and resumption of permitting disbursements on a separate account basis upon, respectively, the occurrence and cure of certain non-ordinary course of business events. Each of these events would raise important concerns about the financial resiliency of the FCM or one or more of its separate account customers. 128 128 For example, while the bankruptcy of an FCM or a separate account customer would have direct effects, the bankruptcy of an FCM or separate account customer's parent company would also portend financial challenges for, respectively, the FCM or separate account customer ( e.g., if the parent company decided to liquidate its subsidiaries in bankruptcy). Experience in the bankruptcies of, e.g., Refco and Lehman, demonstrates that when one member of an affiliate financial company structure files for bankruptcy, other affiliates soon follow. These events are divided into two categories: (i) those that concern the separate accounts of a particular separate account customer, and the occurrence of any one of which would require the FCM to cease permitting disbursements on a separate account basis with respect to all accounts of that customer; and (ii) those that concern the financial status of the FCM itself, and the occurrence of any one of which would require the FCM to cease permitting disbursements on a separate account basis with respect to all of its separate account customers. It is important to note, however, that under this proposal, while a separate account customer is outside the ordinary course of business as defined in proposed regulation § 1.44(a), it is only the privilege of permitting disbursements on a separate account basis, pursuant to proposed regulation § 1.44(c), with respect to that customer and that customer's separate accounts, that is terminated (or suspended). So long as a customer remains a separate account customer, whether or not within the ordinary course of business, then the FCM is required to comply with the requirements in proposed regulation §§ 1.44(g) and (h), including with respect to the relevant provisions addressed in regulations §§ 1.17, 1.20, 1.22, 1.23, 1.32, 1.55, 1.58, 1.73, 22.2, 30.7, and 39.13(g)(8)(i) with respect to that customer and all of that customer's separate accounts. Similarly, if it is the FCM that is outside the ordinary course of business, it is only the privilege of permitting disbursements on a separate account basis with respect to any of the FCM's separate account customers and their separate accounts that is terminated (or suspended). The FCM continues to be required to comply with the requirements in regulation §§ 1.44(g) and (h), including with respect to the relevant provisions described above, with respect to all of its separate account customers and their separate accounts. The first category of events is as follows: • (1)(i) The separate account customer, including any separate account of such customer, fails to deposit initial margin or maintain maintenance margin or make payment of variation margin or option premium as specified in proposed regulation § 1.44(f). 129 129 I.e., the one business day margin call requirement. • (ii) The occurrence and declaration by the FCM of an event of default as defined in the account documentation executed between the FCM and the separate account customer. • (iii) A good faith determination by the FCM's CCO, one of its senior risk managers, or other senior manager, following such FCM's own internal escalation procedures, that the separate account customer is in financial distress, or there is significant and bona fide risk that the separate account customer will be unable promptly to perform its financial obligations to the FCM, whether due to operational reasons or otherwise. • (iv) The insolvency or bankruptcy of the separate account customer or a parent company of such customer. • (v) The FCM receives notification that a board of trade, a DCO, a self-regulatory organization (SRO) as defined in regulation § 1.3 or section 3(a)(26) of the Securities Exchange Act of 1934, the Commission, or another regulator 130 with jurisdiction over the separate account customer, has initiated an action 131 with respect to such customer based on an allegation that the customer is in financial distress. 130 E.g., the SEC or a foreign regulator. 131 In this context, the term “initiate an action” is intended to include the filing of a complaint or a petition to take action against an entity, or an analogous process. The initiation or conduct of an investigation would not be sufficient to constitute “initiating an action” in this context. • (vi) The FCM is directed to cease permitting disbursements on a separate account basis, with respect to the separate account customer, by a board of trade, a DCO, an SRO, the Commission, or another regulator with jurisdiction over the FCM, pursuant to, as applicable, board of trade, DCO, or SRO rules, government regulations, or law. The second set of events is as follows: • (2)(i) The FCM is notified by a board of trade, a DCO, an SRO, the Commission, or another regulator with jurisdiction over the FCM, that the board of trade, the DCO, the SRO, the Commission, or other regulator, as applicable, believes the FCM is in financial or other distress. • (ii) The FCM is under financial or other distress as determined in good faith by its CCO, senior risk managers, or other senior management. • (iii) The insolvency or bankruptcy of the FCM or a parent company of the FCM. Proposed regulation § 1.44(e)(3) provides that the FCM must provide notice to its DSRO and to the Commission of the occurrence of any of the events suspending or terminating separate account treatment for one or more separate account customers. The notice must be provided to the DSRO and the Commission in accordance with the process specified in regulation § 1.12(n)(3). The notice also must identify the event and, if applicable, the customer. The FCM would be required to provide such notice promptly in writing no later than the next business day following the date on which the FCM identifies or has been informed that the relevant event has occurred. The notification required upon exiting the ordinary course of business is intended to ensure that the Commission and DSROs will be apprised of the occurrence of non-ordinary course of business events, and will actively communicate with and monitor an FCM with respect to the resolution of such events ( i.e., where an FCM attempts to reenter ordinary course of business conditions). Proposed regulation § 1.44(e)(4) provides an avenue for an FCM that has experienced a non-ordinary course of business event with respect to itself or a customer to return to the ordinary course of business and resume separate account treatment for itself or its customers, as may be the case. Proposed regulation § 1.44(e)(4) provides that an FCM that has ceased permitting disbursements on a separate account basis to a separate account customer due to the occurrence of a non-ordinary course of business event, with respect to that specific separate account customer, or with respect to all such customers, may resume permitting disbursements to such customer(s) on a separate account basis if such FCM reasonably believes, based on new information, that those circumstances triggering the event have been cured, and such FCM documents in writing the factual basis and rationale for it [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2024-04107. Public record. Not legal advice.