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

Federal RegisterJan 22, 2025

Ask Donna

What actually matters in this document.

Text

COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 22, and 30

RIN 3038-AF24

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

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Final rule.

SUMMARY:

The Commodity Futures Trading Commission (“Commission” or “CFTC”) is amending its regulations governing the types of investments that futures commission merchants and derivatives clearing organizations may make with funds held for the benefit of customers engaging in futures, foreign futures, and cleared swaps transactions. The Commission is also revising asset-based and issuer-based concentration limits for the investment of customer funds. The Commission is also specifying market risk capital charges that a futures commission merchant must take on new investments added to the list of permitted investments in computing the firm's adjusted net capital. The amendments also revise regulations that require each futures commission merchant to report to the Commission, and to the firm's designated self-regulatory organization, the name, location, and amount of customer funds held by each depository, including any investments of customer funds held by the depository. Lastly, the Commission is eliminating the requirement that each depository holding customer funds must provide the Commission with read-only electronic access to such accounts for the futures commission merchant to treat the funds as customer segregated funds.

DATES:

Effective date:

This rule is effective February 21, 2025.

Compliance dates:

The compliance dates for the rule amendments are discussed in section VI of

SUPPLEMENTARY INFORMATION

in the preamble to this rule.

FOR FURTHER INFORMATION CONTACT:

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

aolear@cftc.gov;

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

tsmith@cftc.gov;

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

wgorlick@cftc.gov;

Liliya Bozhanova, Associate Director, 202-418-6232,

lbozhanova@cftc.gov;

Jennifer M. Narvaez, Attorney Advisor, 202-418-5742,

jnarvaez@cftc.gov,

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

lmcphail@cftc.gov,

Office of the Chief Economist, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581; Theodore Z. Polley, Associate Director, 312-596-0551,

tpolley@cftc.gov;

Division of Clearing and Risk, Commodity Futures Trading Commission, 77 West Jackson Boulevard, Suite 800, Chicago, Illinois 60604.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction

A. Background and Statutory Authority

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

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

II. Requests for Amendments to the List of Permitted Investments

III. Summary of the Proposal

IV. Final Rule

A. Investment of Customer Funds

1. Interests in Money Market Funds

2. Foreign Sovereign Debt

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

4. Investments in Commercial Paper and Corporate Notes or Corporate Bonds

5. Investments in Permitted Investments With Adjustable Rates of Interest

6. Investments in Certificates of Deposit Issued by Banks

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

C. Futures Commission Merchant Capital Charges on Permitted Investments

D. Segregation Investment Detail Report

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

F. Revisions to the Customer Risk Disclosure Statement

V. Section 4(c) of the Act

VI. Compliance Dates

VII. Administrative Compliance

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

C. Cost-Benefit Considerations

1. Specified Foreign Sovereign Debt, Interests in Qualified Exchange-Traded Funds, and Associated Capital Charges

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

3. SOFR as a Permitted Benchmark

4. Revision of the Read-Only Access Provisions

D. Antitrust Considerations

I. Introduction

A. Background and Statutory Authority

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

The Commodity Exchange Act (“Act” or “CEA”)

and the Commission's regulations thereunder

establish a framework to safeguard funds of customers engaged in CFTC-regulated derivative transactions. Core elements of this framework are requirements for a futures commission merchant (“FCM”) or a derivatives clearing organization (“DCO”) to treat customer funds as belonging to customers and not as the property of the FCM or DCO, and for the FCM or DCO to segregate customer funds from its own funds in designated customer accounts maintained at banks, trust companies, FCMs, or DCOs, as applicable.

The segregation of customer funds from an FCM's or DCO's own funds is intended to ensure that customer funds are used only to support customer trading and transactions and to facilitate the return of the funds to customers in the event of the insolvency of the FCM or DCO.

7 U.S.C. 1

et seq.

The Commission's regulations are found in chapter I of title 17 of the Code of Federal Regulations, 17 CFR parts 1 through 199.

7 U.S.C. 6d.

Segregated customer funds are classified as either: (i) “futures customer funds;” (ii) “Cleared Swaps Customer Collateral;” or (iii) “30.7 customer funds.”

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

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

customer.

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

See generally

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

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

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

Id.

Section 4d(b) of the Act establishes obligations for DCOs and other depositories receiving futures customer funds from FCMs pursuant to section 4d(a)(2) of the Act.

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

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

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

Id.

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

With respect to cleared swap transactions, Commission regulations 1.3 and 22.1

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

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

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

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

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

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

17 CFR 22.1.

Commission regulation 22.1 defines the term “Cleared Swaps Customer” to mean, in relevant part, any customer entering into a Cleared Swap. The Act and Commission regulation 22.1 further define the term “Cleared Swap” to mean any swap that is, directly or indirectly, submitted to, and cleared by, a DCO registered with the Commission. 7 U.S.C. 1a(7) and 17 CFR 22.1.

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

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

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

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

17 CFR 22.2 through 22.13, and 17 CFR 22.15 through 22.17, respectively. Protection of Cleared Swaps Customer Contracts and Collateral; Conforming Amendments to the Commodity Broker Bankruptcy Provisions, 77 FR 6336 (Feb. 7, 2012) (“Protection of Cleared Swaps Customer Contracts and Collateral”).

Part 30 of the Commission's regulations govern the requirements imposed on FCMs that carry futures positions for customers trading on foreign markets.

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

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

Section 4(b)(2)(A) of the Act authorizes the Commission to adopt regulations requiring FCMs to safeguard 30.7 customer funds deposited by 30.7 customers for trading on foreign boards of trade,

which the Commission did by adopting Commission regulation 30.7.

As part of the safeguarding requirements, Commission regulation 30.7(e)(2) requires an FCM to segregate 30.7 customer funds from the FCM's own funds, and Commission regulation 30.7(b) provides that an FCM may hold 30.7 customer funds only with certain specified depositories, including banks, trust companies, DCOs, foreign brokers, and clearing organizations of foreign boards of trade.

17 CFR part 30.

Commission regulation 30.1 defines the term “30.7 customer” to mean any person located in the U.S., its territories or possessions, as well as any foreign-domiciled person, who trades in foreign futures or foreign options through an FCM. 17 CFR 30.1.

17 CFR 30.1.

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

17 CFR 30.7.

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

In order to simplify the discussion in this preamble, the terms “futures customer funds,” “Cleared Swaps Customer Collateral,” and “30.7 customer funds,” are used when referring to regulations applicable specifically to futures customers, Cleared Swaps Customers, and 30.7 customers, respectively. In addition, the term “Customer Funds” is used when referring collectively to “futures customer funds,” “Cleared Swaps Customer Collateral,” and “30.7 customer funds.”

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

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

The Commission's predecessor agency, the Commodity Exchange Authority of the U.S. Department of Agriculture, adopted Commission regulation 1.25 to implement section 4d(a)(2) of the Act, and authorized FCMs and DCOs to invest futures customer funds in the instruments enumerated in section 4d(a)(2) (the “Permitted Investments”).

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

See generally

Title 17—Commodity and Securities Exchanges, 33 FR 14454 (Sept. 26, 1968), amending Commission regulation 1.25 and providing that FCMs and clearing organizations may invest futures customer funds in obligations of the U.S., in general obligations of any State or of any political subdivision of any State, or in obligations fully guaranteed as to principal and interest by the U.S.

The Commission subsequently expanded the Permitted Investments in 2000 to include certificates of deposit, commercial paper, corporate notes, foreign sovereign debt, and interests in money market funds.

The Commission

also authorized FCMs and DCOs to buy the Permitted Investments under agreements to resell the securities (“reverse repurchase agreements”) and to sell the Permitted Investments under agreements to repurchase the securities (“repurchase agreements”).

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

More generally, Commission regulation 1.25 contains an overarching requirement that all Permitted Investments must be “consistent with the objectives of preserving principal and maintaining liquidity.”

In adopting the 2000 Permitted Investments Amendment, the Commission stated that it was expanding the range of instruments in which FCMs may invest customer funds beyond those listed in section 4d(a)(2) of the Act to enhance the yield available to FCMs, clearing organizations, and their customers without compromising the safety of futures customer funds.

See generally

Rules Relating to Intermediaries of Commodity Interest Transactions, 65 FR 77993 (Dec. 13, 2000) (amending Commission regulation 1.25 to permit FCMs and DCOs to invest customer funds in certificates of deposit, commercial paper, corporate notes, foreign sovereign debt, and interest in money market funds); and Investment of Customer Funds, 65 FR 82270 (Dec. 28, 2000) (making technical corrections and accelerating the effective date of the final rules from February 12, 2001 to December 28, 2000) (collectively, the “2000 Permitted Investments Amendment”). The 2000 Permitted Investments Amendment was adopted pursuant to section 4(c) of the Act, which empowers the Commission to “promote responsible economic or financial innovation and fair competition” by exempting any transaction or class of transactions (including any person or class of persons offering, entering into, rendering advice or rendering other services with respect to, the agreement, contract, or transaction) from any of the

provisions of the Act, subject to certain exceptions. The Commission may grant an exemption by rule, regulation, or order, after notice and opportunity for hearing, and may do so on application of any person or on its own initiative. 7 U.S.C. 6(c)(1). A further discussion of section 4(c)(1) of the Act is set forth in section V of this preamble.

2000 Permitted Investments Amendment at 78001-78004. Reverse repurchase agreements and repurchase agreements are collectively referred to as “Repurchase Transactions” in this preamble.

17 CFR 1.25(b).

Id.

2000 Permitted Investments Amendment at 78007.

The list of investments that qualify as Permitted Investments has undergone several revisions following the 2000 Permitted Investments Amendment.

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

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

E.g.,

Investment of Customer Funds and Record of Investments, 70 FR 28190 (May 17, 2005) (“2005 Permitted Investments Amendment”), and Investment of Customer Funds and Funds Held in an Account for Foreign Futures and Foreign Options Transactions, 76 FR 78776 (Dec. 19, 2011) (“2011 Permitted Investments Amendment”).

17 CFR 1.25(a)(1).

17 CFR 1.25(a)(2).

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

Prior to 2011, an FCM was not subject to a specific regulation defining the investments that the firm could enter into with 30.7 customer funds.

In 2011, the Commission determined that the terms of Commission regulation 1.25 should also apply to an FCM's investment of 30.7 customer funds, and amended Commission regulation 30.7 to provide that to the extent an FCM invests 30.7 customer funds, the firm must invest such funds subject to, and in compliance with, the terms and conditions of Commission regulation 1.25.

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

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

17 CFR 30.7. The Commission stated that it was appropriate to align the investment standards of Commission regulation 30.7 with those of Commission regulation 1.25 because many of the same prudential concerns arise with respect to both segregated customer funds and 30.7 customer funds. 2011 Permitted Investment Amendment at 78791.

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

The Commission adopted Commission regulations 22.2 and 22.3 in 2012

pursuant to its authority under section 4d(f)(4) of the Act, which provides that Cleared Swaps Customer Collateral may be invested by an FCM or DCO in: (i) obligations of the U.S.; (ii) general obligations of any State or of any political subdivision of a State; (iii) obligations fully guaranteed as to principal and interest by the U.S.; and (iv) any other investment that the Commission may by rule or regulation prescribe.

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

See

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

See generally

Protection of Cleared Swaps Customer Contracts and Collateral.

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

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

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

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

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

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

To limit risk to customers from the investment of Customer Funds, Commission regulations provide that FCMs and DCOs are financially responsible for any losses resulting from Permitted Investments and explicitly prohibit the allocation of investment losses to customers or clearing FCMs, respectively.

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

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

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

In addition, Commission regulation 22.3(d) provides that DCOs may invest Cleared Swaps Customer Collateral in Permitted Investments set forth in Commission regulation 1.25. The regulation, however, does not provide that a DCO is responsible for investment losses. The Commission proposed to amend Commission regulation 22.3(d) to explicitly provide that a DCO shall bear sole responsibility for any losses resulting

from the investment of Cleared Swaps Customer Collateral and may not allocate such losses to Cleared Swaps Customers. Investment of Customer Funds by Futures Commission Merchants and Derivatives Clearing Organizations, 88 FR 81236 at 81238-81239, 81259 (Nov. 21, 2023).

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

In furtherance of these objectives, and in consideration of the requests for amendments to Commission regulation 1.25 discussed in section II of this preamble, the Commission published a notice of proposed rulemaking to amend the list of Permitted Investments in Commission regulation 1.25 and to adopt several related amendments to its rules governing the investment of Customer Funds by FCMs and DCOs.

2011 Permitted Investments Amendment at 78777.

Investment of Customer Funds by Futures Commission Merchants and Derivatives Clearing Organizations, 88 FR 81236 (Nov. 21, 2023) (“Proposal”).

II. Requests for Amendments to the List of Permitted Investments

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

The Petitioners requested an extension of the Permitted Investments to include the foreign sovereign debt of Canada, France, Germany, Japan, and the United Kingdom (“Specified Foreign Sovereign Debt”), subject to the condition that any investment is limited to balances owed by FCMs and DCOs to customers and FCM clearing members, respectively, denominated in the applicable currency of Canada, France, Germany, Japan, or the United Kingdom.

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

Petition for Order under section 4(c) of the Commodity Exchange Act, dated May 24, 2023 (the “Joint Petition”). On September 22, 2023, the Petitioners submitted updated data in support of the Joint Petition and corrected an inadvertent transposition of data items in the Joint Petition. Supplement to Petition for Order under section 4(c) of the Commodity Exchange Act (“Supplement to Joint Petition”). The Joint Petition and the Supplement to Joint Petition are available on the Commission's website,

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

and

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

Joint Petition at p. 4. The currencies of Canada, France, Germany, Japan, and the United Kingdom are the Canadian dollar, the euro (France and Germany), the yen (Japan), and the British pound (United Kingdom).

Joint Petition at p. 5.

Commission regulation 1.25(d)(2) provides that an FCM or DCO may enter into Repurchase Transactions only with the following counterparties: (i) a bank as defined in section 3(a)(6) of the Securities Exchange Act of 1934; (ii) a domestic branch of a foreign bank insured by the FDIC; (iii) an SEC-registered securities broker or dealer; or (iv) an SEC-registered government securities broker or dealer. Section 3(a)(6) of the Securities Exchange Act of 1934 defines the term “bank” to mean: (i) a banking institution organized under the laws of the U.S. or a Federal savings association; (ii) a member bank of the Federal Reserve System; (iii) any other banking institution or savings association doing business under the laws of any State or the U.S., a substantial portion of the business of which consists of receiving deposits or exercising fiduciary powers similar to those permitted to national banks under the authority of the Comptroller of the Currency, and which is supervised and examined by a State or Federal authority having supervision over banks or savings associations; and (iv) a receiver, conservator, or other liquidating agent of any institution or firm included in clauses (i), (ii), or (iii) above (“Section 3(a)(6) bank”). 15 U.S.C. 78c(a)(6). Foreign-domiciled banks and foreign securities brokers or dealers are not authorized counterparties for Repurchase Transactions under Commission regulation 1.25(d)(2).

In addition, Commission regulation 1.25(d)(7) provides that securities transferred to an FCM or DCO under Repurchase Transactions must be held in safekeeping accounts with certain U.S.-domiciled banks, a Federal Reserve Bank, a DCO, or the Depository Trust Company in an account that complies with the requirements of Commission regulation 1.26.

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

The Petitioners also asserted that the Commission's stated rationale for issuing the 2018 Order and providing an exemption to DCOs also applies to investments made by FCMs and extends to the sovereign debt of Canada, Japan, and the United Kingdom, in addition to France and Germany.

Order Granting Exemption from Certain Provisions of the Commodity Exchange Act Regarding Investment of Customer Funds and from Certain Related Commission Regulations, 83 FR 35241 (Jul. 25, 2018) (“2018 Order”). The 2018 Order provides an exemption only to DCOs. FCMs are not subject to the 2018 Order.

The 2018 Order's section 4(c) exemption for DCOs is subject to conditions, including that: (i) investment in French or German sovereign debt is limited to investments made with euro-denominated balances owed to the futures customers and Cleared Swaps Customers of FCM clearing members; (ii) the dollar-weighted average of the remaining time-to-maturity of a DCO's portfolio of investments in each of French and German sovereign debt may not exceed 60 days; and (iii) a DCO may not make a direct investment in any sovereign debt instrument of France or Germany that has a remaining time-to-maturity in excess of 180 calendar days.

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

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

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

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

A DCO may enter into Repurchase Transactions with a foreign bank or foreign securities broker or dealer provided that the firm qualifies as a permitted depository under Commission regulation 1.49(d)(3) and is located in a “money center country”

or in another jurisdiction that has adopted the euro as its currency.

The 2018 Order further grants an exemption from the requirement in Commission regulation 1.25(d)(7) that securities transferred to an FCM or DCO under reverse repurchase agreements must be held in

safekeeping accounts with certain U.S.-domiciled banks, a Federal Reserve Bank, a DCO, or the Depository Trust Company, to permit DCOs to hold French or German sovereign debt received under reverse repurchase agreements in a safekeeping account with foreign banks that qualify as depositories for Customer Funds under Commission regulation 1.49(d)(3).

Condition 2(a) of the 2018 Order at 35245.

Commission regulation 1.49(a) defines the term “money center country” as Canada, France, Italy, Germany, Japan, and the United Kingdom.

Conditions 2(b) and 3(e) of the 2018 Order at 35245. Commission regulation 1.49(d)(3) provides that to qualify as a depository for Customer Funds, a foreign depository must be a bank or trust company that has in excess of $1 billion in regulatory capital, a registered FCM, or a DCO. 17 CFR 1.49(d)(3).

Condition 2(b) of the 2018 Order at 35245. Commission regulation 1.25(d)(7) provides that securities transferred to an FCM or DCO under a reverse repurchase agreement must be held in a safekeeping account only with the following depositories: (i) a section 3(a)(6) bank; (ii) a domestic branch of a foreign bank insured by the FDIC; (iii) a Federal Reserve Bank; (iv) a DCO; or (v) the Depository Trust Company. 17 CFR 1.25(d)(7). A foreign-domiciled bank is currently not an authorized depository for securities transferred to an FCM or DCO under Commission regulation 1.25(d)(7).

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

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

Joint Petition at pp. 8-9.

Id.

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

Invesco stated that U.S. Treasury ETFs would provide FCMs and DCOs with additional investment choices for Customer Funds, promote operational efficiencies, and offer potentially better investment returns for FCMs, DCOs, and their customers, and facilitate financial market innovation.

Invesco further stated that listing U.S. Treasury ETFs as Permitted Investments would be consistent with the public interest and the customer protection regime under the Act and Commission regulations as U.S. Treasury ETFs may only invest in instruments that are otherwise eligible as Permitted Investments for Customer Funds.

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

i.e.,

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

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

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

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

Invesco Petition at p. 1.

Id.

at p. 9.

Id.

at p. 2.

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

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

CFTC Staff Letter 21-02, CFTC Regulation 1.25—Investment of Customer Funds—Time-Limited No-Action Position for Investments in Securities with an Adjustable Rate of Interest Benchmarked to the Secured Overnight Financing Rate (Jan. 4, 2021) (“Staff Letter 21-02”) available at the Commission's website:

https://www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=21-02&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All; CFTC Staff Letter 22-21,

CFTC Regulation 1.25—Investment of Customer Funds in Securities with an Adjustable Rate of Interest Benchmarked to the Secured Overnight Financing Rate—Extension of Time-Limited No-Action Position Concerning Investments by Futures Commission Merchants and No-Action Position Concerning Investments by Derivatives Clearing Organizations (Dec. 23, 2022) (“Staff Letter 22-21”) available at the Commission's website:

www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=22-21&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All.

Joint Petition at p. 4.

III. Summary of the Proposal

In order to revise Commission regulation 1.25 to address outdated provisions, and in consideration of the Joint Petition and the Invesco Petition, the Commission proposed to amend the list of Permitted Investments to: (i) add two new asset classes (

i.e.,

Specified Foreign Sovereign Debt instruments and U.S. Treasury ETFs), subject to certain conditions; (ii) limit the scope of money market funds (“MMFs”) whose interests qualify as Permitted Investments; and (iii) remove corporate notes, corporate bonds, and commercial paper. The Commission also proposed amendments to FCM financial reporting requirements to reflect the proposed amendments to the list of Permitted Investments. The Commission further proposed changes to the counterparty and depository requirements of Commission regulation 1.25(d)(2) and (7), and revisions to the concentration limits for Permitted Investments set forth in Commission regulation 1.25(b)(3). The Commission also specified proposed capital charges that FCMs would have to apply to the proposed new Permitted Investment instruments and proposed a clarifying amendment to Commission regulation 22.3(d) to specify that DCOs bear the financial responsibility for losses resulting from investment of Customer Funds in Permitted Investments. The Commission further proposed to replace LIBOR with SOFR as a permitted benchmark for the interest rate of adjustable rate securities that qualify as Permitted Investments. Lastly, the Commission proposed to amend its regulations to eliminate the requirement that a depository holding customer funds must provide the Commission with read-only electronic access to such accounts for the FCM to treat the accounts as customer segregated fund accounts.

Each of these proposed amendments are discussed in section IV. of this preamble.

See generally

Proposal.

The comment period for the Proposal closed on January 17, 2024. The Commission received 17 comment letters from various interested parties, including investor advocacy groups, trade associations, and financial services companies.

The majority of commenters expressed support for the Proposal, generally noting that the proposed amendments represent appropriate updates to the list of Permitted Investments. Several commenters specifically supported the inclusion of foreign sovereign debt and U.S. Treasury ETFs as Permitted Investments.

Conversely, two

commenters opposed allowing FCMs and DCOs to invest Customer Funds in foreign sovereign debt.

Many commenters also recommended revisions to the proposed conditions underlying the Proposal, including the conditions proposed for investment in certain short-term U.S. Treasury ETFs.

The following entities submitted comments: Alternative Investment Management Association (“AIMA”); Americans for Financial Reform Education Fund, Consumer Federation of America, Food & Water Watch, Institute for Agriculture and Trade Policy, and Public Citizen (collectively, the “Investor Advocacy Group” and the “Investor Advocacy Group Joint Letter”); Better Markets; BlackRock, Inc. (“BlackRock”); Eurex Clearing AG (“Eurex”); Federated Hermes, Inc. (“Federated Hermes”); Futures Industry Association and CME Group Inc. (“FIA/CME Joint Letter”); The Global Association of Central Counterparties (“CCP Global”); Intercontinental Exchange Inc. (“ICE”); Invesco Capital Management LLC (“Invesco”); Investment Company Institute (“ICI”); Managed Funds Association (“MFA”); National Futures Association (“NFA”); Nodal Clear, LLC (“Nodal”); the Asset Management Group of the Securities Industry and Financial Markets Association (“SIFMA AMG”); State Street Global Advisors (“SSGA”); and World Federation of Exchanges (“WFE”). The comment letters are available at

https://comments.cftc.gov/PublicComments/CommentList.aspx?id=7453.

Invesco at pp. 2-3; ICI at p. 2; AIMA at pp. 2-3; FIA/CME Joint Letter at pp. 2, 4-15; MFA at pp.

2-6; Nodal at pp. 1-2; SIFMA AMG at pp. 2-8, 12; CCP Global at pp. 2-4 WFE at pp. 3-6.

Better Markets at pp. 3-7; Investor Advocacy Group Joint Letter at pp. 1-2.

AIMA at pp. 2-3; MFA at pp. 5-6; FIA/CME Joint Letter at pp. 11-16; CCP Global at pp. 3-4; BlackRock at pp. 2-6; Invesco at pp. 3-5; ICI at pp. 2-6 SIFMA AMG at pp. 4-6; SSGA at pp. 2-3; WFE at pp. 5-6.

In consideration of the broad public input expressed in the public comments and the Commission's experience administering the rules that govern investments of Customer Funds by FCMs and DCOs, the Commission is adopting the proposed amendments, subject to the changes discussed below.

The final rulemaking is referred to as the “Final Rule” in this preamble.

IV. Final Rule

A. Investment of Customer Funds

1. Interests in Money Market Funds

a. Proposal

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

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

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

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

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

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

17 CFR 1.25(a)(vii).

15 U.S.C. 80a-1—80a-64.

17 CFR 270.2a-7 (“SEC Rule 2a-7”).

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

see supra

note 52.

15 U.S.C. 80b-1—80b-21.

17 CFR 1.25(c).

As further described below, the Commission proposed to amend Commission regulation 1.25(a)(1)(vii) to limit the scope of MMFs whose interests qualify as Permitted Investments in response to two sets of rule amendments adopted by the SEC regarding MMFs, which rendered, in the Commission's view, certain MMFs incompatible with the liquidity requirements of Commission regulation 1.25.

Specifically, the Commission proposed to limit Permitted Investments in MMFs to interests in certain “government money market funds,” as defined in SEC Rule 2a-7.

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

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

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

Proposal at 81240-81243.

Id.

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

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

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

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

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

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

The 2014 SEC Redemption Provisions were mandatory for Prime MMFs, and Government MMFs could voluntarily elect to impose the 2014 SEC Redemption Provisions (“Electing Government MMFs”).

Money Market Fund Reform; Amendments to Form PF, 79 FR 47736 (Aug. 14, 2014) (“2014 SEC MMF Final Rule”).

See

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

2014 SEC MMF Final Rule at 47747.

See also

Proposal at 81241-81243. The liquidity fees and suspension of redemptions provisions introduced by the 2014 SEC MMF Final Rule are referred to as the “2014 SEC Redemption Provisions” in this document.

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

Commission staff subsequently received inquiries from market participants concerning the permissibility of investing Customer Funds in MMF interests under Commission regulation 1.25 in light of the 2014 SEC Redemption Provisions. In response, Commission staff issued CFTC Staff Letter 16-68

and CFTC Staff Letter 16-69

addressing the 2014 SEC Redemption Provisions and the investment of Customer Funds in MMFs by FCMs and DCOs, respectively. Staff Letter 16-68

expresses DSIO's view that the 2014 SEC Redemption Provisions conflict with paragraphs (b)(1)

and (c)(5)(i)

of Commission regulation 1.25, as the Redemption Provisions have the effect of potentially reducing the liquidity of Prime MMFs and Electing Government MMFs through the imposition of fees and suspension of redemptions. Therefore, DSIO stated that FCMs may no longer

invest Customer Funds in Prime MMFs and Electing Government MMFs.

CFTC Letter No. 16-68, No-Action Relief with Respect to CFTC Regulation 1.25 Regarding Money Market Funds (Aug. 8, 2016) (“Staff Letter 16-68”) available at the Commission's website:

www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=16-68&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All.

Staff Letter 16-68 was issued by the Commission's Division of Swap Dealer and Intermediary Oversight (“DSIO”) (subsequently renamed the Market Participants Division (“MPD”)).

CFTC Letter No. 16-69, Staff Interpretation Regarding CFTC Part 39 In Light Of Revised SEC Rule 2a-7 (Aug. 8, 2016) (“Staff Letter 16-69”). Staff Letter 16-69 was issued by the Commission's Division of Clearing and Risk (“DCR”) and is available at the Commission's website:

www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=16-69&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All.

See also

CFTC Staff Advisory No. 16-75, Practical Application of No-Action Letter No. 16-68 Regarding the Investments in Money Market Mutual Funds (Oct. 18, 2016) (“Staff Letter 16-75”) (discussing the practical applicability and effect of Staff Letter 16-68) available at the Commission's website:

https://www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=16-75&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All.

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

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

Staff Letter 16-68 at p. 2. However, DSIO also states in Staff Letter 16-68 that it would not recommend an enforcement action to the Commission if an FCM invested Customer Funds held in segregation that represents an excess over the firm's targeted residual interest in Prime and Electing Government MMFs. Staff Letter 16-68 at pp. 3-4.

Staff Letter 16-69 set forth DCR's interpretation that Commission regulations 39.15(c) and (e)

prohibit a DCO from holding funds belonging to clearing members or their customers in Prime MMFs or Electing Government MMFs. Staff Letter 16-69 also states that the 2014 SEC Redemption Provisions are not consistent with Commission regulation 39.15(c), which requires a DCO to hold funds and assets belonging to clearing members and their customers in a manner that minimizes the risk of loss or of delay in the access by the DCO to such funds and assets. Staff Letter 16-69 further provides that the 2014 SEC Redemption Provisions are inconsistent with Commission regulation 39.15(e), which limits a DCO to investing funds and assets belonging to clearing members and their customer in instruments with minimal credit, market, and liquidity risk. FCMs and DCOs have not invested Customer Funds in Prime MMFs or Electing Government MMFs since the issuance of Staff Letters 16-68 and 16-69 in 2016.

17 CFR 39.15(c) and (e).

While Staff Letter 16-68 provides that DSIO would not recommend an enforcement action against an FCM that invested Customer Funds in Prime and Electing Government MMFs, provided that the amount invested represents an amount held in customer segregated accounts that exceeds the firm's targeted residual interest amount, staff is not aware of FCMs investing Customer Funds in such MMFs.

In August 2023, the SEC adopted additional amendments to its MMF rules, including amendments revising the 2014 SEC Redemption Provisions discussed above.

The 2023 SEC MMF Reforms address issues observed by the SEC with MMFs in connection with the economic shock from the onset of the COVID-19 pandemic. Specifically, the SEC stated in March 2020, that concerns about the impact of COVID-19 pandemic led investors to reallocate their assets into cash and short-term government securities. Certain Prime MMFs, in particular, experienced significant outflows, contributing to stress on short-term funding markets that resulted in government intervention to enhance the liquidity of such markets.

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

Further, according to the SEC, the presence of a liquidity threshold for consideration of fees and gates appears to have affected fund managers' behavior, encouraging the sale of long-term portfolio assets to maintain weekly liquid assets above the 30 percent threshold.

The SEC also cited evidence suggesting that investors are particularly sensitive to the potential imposition of redemption gates, which restricts MMF share redemption for the duration of the gate.

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

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

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

As noted in the 2023 SEC MMF Reforms' adopting release, to support the short-term funding markets, on March 18, 2020, the Federal Reserve, with the approval of the Department of the Treasury, established the Money Market Mutual Fund Liquidity Facility. The facility provided loans to financial institutions on advantageous terms to purchase securities from MMFs that were raising liquidity. 2023 SEC MMF Reforms at 51408.

2023 SEC MMF Reforms at 51407. The term “weekly liquid assets” is generally defined as: (i) cash; (ii) direct obligations of the U.S. Government; (iii) U.S. Agency securities that are issued at a discount to the principal amount to be repaid at maturity and have a remaining time to maturity of 60 days or less; (iv) securities that mature, or are subject to a demand feature that is exercisable and payable, within 5 business days; or (v) amounts receivable and due unconditionally within 5 business days on pending sales of portfolio securities. 17 CFR 270-2a-7(c)(a)(28).

2023 SEC MMF Reforms at 51407.

Id.

at 51409.

Id.

at 51408.

Accordingly, in an effort to improve the resilience of MMFs and address the issue of preemptive investor redemption behavior, particularly in times of stress, the SEC adopted changes to the fee and gate provisions in SEC Rule 2a-7. The 2023 SEC MMF Reforms, among other things, amended the 2014 SEC Redemption Provisions by removing a Prime MMF's ability to temporarily suspend participant redemptions and by removing an Electing Government MMF's ability to voluntarily retain authority to suspend participant redemptions.

The 2023 SEC MMF Reforms also require Prime MMFs to impose a liquidity fee when the fund experiences net redemptions that exceed 5 percent of the fund's net assets, and permit Prime MMFs to impose a discretionary liquidity fee if the fund's board of directors determines that a fee is in the best interest of the fund.

100

Government MMFs are not required to implement the mandatory liquidity fee but may choose to rely on the ability to impose discretionary liquidity fees.

101

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

102

Id.

at 51410.

100

17 CFR 270.2a-7(c)(2)(i) and (ii) (as amended by the 2023 SEC MMF Reforms). SEC Rule 2a-7(c)(2)(i) provides, in relevant part, that if a Prime MMF's board of directors, including a majority of the directors who are not interested persons of the fund, determines that a liquidity fee is in the best interest of the fund, the fund must institute a liquidity fee that does not exceed two percent of the value of the shares redeemed. In addition, SEC Rule 2a-7(c)(2)(ii) provides, in relevant part, that a Prime MMF must apply a liquidity fee to all shares that are redeemed if the fund experiences total daily net redemptions that exceed 5 percent of the fund's net asset value, or such smaller amount of net redemptions as the board of directors of the fund determines.

101

17 CFR 270.2a-7(c)(2)(i)(B) (as amended by the 2023 SEC MMF Reforms). SEC Rule 2a-7(c)(2)(i)(B) permits Government MMFs to elect to impose the discretionary liquidity fees on shareholder redemptions.

102

17 CFR 270.2a-7(c)(2)(i) (as amended by the 2023 SEC MMF Reforms).

The SEC's liquidity fee mechanism is designed to address shareholder dilution and the potential for first-mover advantage by allocating liquidity costs to redeeming investors. Although the mechanism may contribute to decreasing outflows from certain MMFs, the Commission preliminarily considered that the potential imposition of a fee would nonetheless potentially reduce the principal of an FCM's or DCO's investment in MMF shares, particularly during periods of market stress and high shareholder redemptions. Such potential loss of principal could have an adverse impact on the ability of an FCM or DCO to fully repay customers, who may need liquidity in their accounts to meet trading losses and/or margin calls. Therefore, consistent with the positions taken in Staff Letter 16-68 and Staff Letter 16-69, the Commission proposed to limit the scope of MMFs whose interests qualify as Permitted Investments to funds that are not subject to a liquidity fee (

i.e.,

Government MMFs that are not Electing Government MMFs (referred to in this release as

“Permitted Government MMFs”)).

103

As discussed in the Proposal, to qualify as a Permitted Government MMF, at least 99.5 percent of the fund's investment portfolio must be comprised of cash, government securities (

i.e.,

U.S. Treasury securities, securities fully-guaranteed as to principal and interest by the U.S. Government, and U.S. agency obligations), and/or Repurchase Transactions that are fully collateralized by government securities as set forth in SEC Rule 2a-7.

104

The Commission's goal in proposing the amendment was to ensure that FCMs and DCOs invest Customer Funds in instruments that are consistent with the objectives of Commission regulation 1.25 of preserving principal and maintaining liquidity of the investments.

103

See

Proposal at 81240-81243 and proposed paragraph (a)(1)(v) of Commission regulation 1.25.

104

See

Proposal at 81240-81241.

To eliminate MMFs whose redemptions may be subject to a liquidity fee from the scope of Permitted Investments under Commission regulation 1.25, the Commission proposed revising Commission regulation 1.25(a)(1)(vii), which would be redesignated as Commission regulation 1.25(a)(1)(iv) to accommodate other amendments to Commission regulation 1.25(a) discussed in the Proposal, by replacing the term “money market mutual fund” with the term “government money market funds as defined in § 270.2a-7 of this title, provided that the funds do not elect to be subject to liquidity fees in accordance with § 270.2a-7 of this title (government money market fund).”

105

The Commission also proposed further conforming changes throughout Commission regulation 1.25, and the appendix to Commission regulation 1.25, by replacing all references to “money market mutual fund” with “government money market fund.”

106

In addition, the appendix to Commission regulation 1.25 was proposed to be redesignated as appendix E to part 1 to address a change in the rules of the Office of the Federal Register regarding the structure of regulatory text to be codified in the Code of Federal Regulations.

107

Further, the Commission proposed conforming amendments to Commission regulations 1.26 and 30.7(d), which require an FCM and/or DCO, as applicable, that invests Customer Funds in Permitted Investments, including qualifying MMFs, to obtain and retain in its files a written acknowledgement letter from the depository holding the instruments stating that the depository was informed that the instruments belong to customers and are being held in accordance with the provisions of the Act and Commission regulations.

108

The Commission also proposed conforming amendments to the appendices setting forth the template acknowledgment letters.

109

Specifically, the Commission proposed to replace the references to “money market mutual fund” with “government money market fund” in Commission regulation 1.26, appendix A and appendix B to Commission regulation 1.26 (to be redesignated appendix F and appendix G to part 1), Commission regulation 30.7(d), and appendix F to part 30 of the Commission's regulations.

110

105

Proposal at 81240-81243, proposed Commission regulation 1.25(a)(1)(v).

106

Proposal at 81243.

107

Id.

108

Id.

at 81263.

109

Id.

110

Id.

The Commission also noted that the proposed amendments removing interests in MMFs whose redemptions may be subject to a liquidity fee from the scope of Permitted Investments would prohibit an FCM from depositing proprietary interests in such MMFs into Customer Funds accounts.

111

The Commission stated that Commission regulations 1.23(a)(1), 22.2(e)(3)(i), and 30.7(g)(1) permit FCMs to deposit proprietary cash and unencumbered securities into the accounts of futures customers, Cleared Swaps Customers, and 30.7 customers, respectively, to help ensure that at all times the accounts maintain sufficient funds to cover the amounts due to all customers.

112

The proprietary securities deposited by FCMs into customer accounts, however, must satisfy the criteria of a Permitted Investment as specified in Commission regulation 1.25.

113

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

111

Proposal at 81242.

112

17 CFR 1.23(a)(1), 22.2(e)(3)(i), and 30.7(g)(1). A customer account is “undersegregated” if an FCM holds less funds in the account than is necessary to cover the total amount due to the customer at any given point in time.

113

Id.

b. Comments

The Commission received six comments on the proposed limit of the scope of MMFs whose interests qualify as Permitted Investments to Permitted Government MMFs.

114

Each of the commenters supported the proposed limitation.

115

AIMA noted that the amendments would appropriately update the list of Permitted Investments in line with sound risk management practices.

116

ICI stated that the proposed amendments are consistent with the regulatory objective of limiting Permitted Investments to safe, short-term instruments.

117

Though supportive of the proposed amendments, BlackRock raised concerns about the Proposal's rationale, asserting that in discussing investor behavior during the March 2020 events, the Commission failed to acknowledge that there was a broader “dash for cash” occurring across asset classes, not just MMFs, at that time period.

118

114

See

AIMA at p. 3; BlackRock at pp. 2, 6; Federated Hermes at pp. 1-2; FIA/CME Joint Letter at p. 21; ICI at p. 2; MFA at p. 6.

115

Id.

116

AIMA at p. 3.

117

ICI at p. 2.

118

BlackRock at p. 6.

In addition to supporting the proposed revisions to the scope of the MMFs, FIA and CME recommended an amendment to the template acknowledgement letters for Government MMFs set forth in appendices A and B to Commission regulation 1.26 for direct investments by FCMs and DCOs of futures customer funds and Cleared Swaps Customer Collateral in MMFs, and appendix F to part 30 for direct investments by FCMs of 30.7 customer funds in MMFs.

119

Specifically, FIA and CME recommended that each template acknowledgment letter include a representation from the Government MMF that the fund does not elect to impose discretionary liquidity fees.

120

119

FIA/CME Joint Letter at p. 21. As discussed in the Proposal, Commission regulations 1.26 and 30.7(d) require an FCM or DCO, as applicable, to obtain, and retain in its files, a written acknowledgment from each depository holding Permitted Investments. Proposal at 81263.

120

Id.

The FIA/CME Joint Letter included the following suggested language: “Furthermore, you acknowledge and agree that the Shares are in a fund that holds itself out to investors as a government money market fund, in accordance with 17 CFR 270.2a-7. In addition, the Shares are in a fund that does not choose to rely on the ability to impose discretionary liquidity fees consistent with the requirements of 17 CFR 270.2a-7(c)(2)(i).” FIA/CME Joint Letter at p. 21.

Finally, in response to the Commission's request for comment on whether the Commission should revise Commission regulation 1.25(b)(5)(ii) to prohibit FCMs and DCOs from investing Customer Funds in a fund affiliated with the FCM or DCO, commenters asserted that no changes were

necessary.

121

These commenters noted that “risk posed by affiliates” is a component of the risk management program that FCMs are required to adopt pursuant to Commission regulation 1.11.

122

The commenters further asserted that because Permitted Investments involving FCM affiliates are already subject to the policies, procedures, and controls of consolidated risk management programs, as well as existing statutory and regulatory requirements, there is no reason to revisit the Commission's previous consideration of this issue.

123

121

Proposal at 81243, Question 2. Commission regulation 1.25(b)(5)(ii) provides, in relevant part, that an FCM or DCO may not invest Customer Funds in obligations of an affiliated entity, but permits investments by FCMs and DCOs in interest in funds affiliated with the applicable FCM or DCO.

122

FIA/CME Joint Letter at p. 19; MFA at p. 6.

123

Id.

(referencing the Commission's final rule Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations, 78 FR 68506 at 68520 Nov. 14, 2013) (“2013 Protections of Customer Funds Release”), which notes that an FCM's risk management policies and procedures under Commission regulation 1.11 must include procedures for assessing the appropriateness of investing customer funds in accordance with Commission regulation 1.25, and “must take into consideration the market, credit, counterparty, operational, and liquidity risks associated with the investments.”)

c. Discussion

The Commission has considered the comments received, and is adopting as proposed the amendments to Commission regulation 1.25 to limit the scope of MMFs that qualify as Permitted Investments for Customer Funds to Permitted Government MMFs. As stated in the Proposal, the Commission's intent in eliminating Prime MMFs and Electing Government MMFs from the list of Permitted Investments is to ensure that Customer Funds are managed with the objectives of preserving principal of the investments, consistent with the general requirements of Commission regulation 1.25(b).

124

The SEC requirement for Prime MMFs to impose a liquidity fee on shareholder redemptions when the fund experiences net redemptions that exceed 5 percent of the fund's net assets and the separate authority granted by the SEC that permits funds to impose discretionary liquidity fees of up to 2 percent on shareholder redemptions if the board of directors determines that such a fee is in the best interest of the fund are not consistent with the obligation imposed under Commission regulation 1.25(b) on FCMs and DCOs to preserve the principal of Customer Funds invested in Permitted Investments. The imposition of mandatory or discretionary liquidity fees on an FCM's or DCO's redemption request from a Prime MMF or an Electing Government MMF may result in an FCM or DCO not realizing the full principal value of its investment upon its redemption request. The inability of the FCM or DCO to receive the full principal value of its investment of Customer Funds presents potential financial risk to the FCM or DCO as it may not have sufficient funds to fully repay the account balances of each customer. Thus, the Commission is revising the list of Permitted Investments to remove Prime MMFs and Electing Government MMFs.

124

Proposal at 81242. Commission regulation 1.25(b) provides, in relevant part, that an FCM or DCO is required to manage its Permitted Investments consistent with the objectives of preserving principal and maintaining liquidity of the Customer Funds. 17 CFR 1.25(b).

The Commission is also maintaining current Commission regulation 1.25(b)(5)(ii), which provides that an FCM or DCO may invest Customer Funds in a fund affiliated with that FCM or DCO. Consistent with its views expressed in connection with the risk management program mandated by Commission regulation 1.11,

125

the Commission expects that FCMs will assess the appropriateness of investing Customer Funds in affiliated funds in accordance with this program.

126

Similarly, because DCO Core Principle F and Commission regulation 39.15(e) require a DCO to hold Customer Funds only in instruments with minimal credit, market, and liquidity risks, the Commission expects that DCOs will assess the risk of investing Customer Funds in affiliated funds before doing so. In addition, investment advisers that act as investment managers of a fund have fiduciary duties to their client, the fund, under the Investment Adviser Act of 1940.

127

In this context, the investment adviser has a duty to eliminate, or disclose and mitigate, conflicts of interest that may impact the advisory relationship.

128

Therefore, as investors in a fund that qualifies as a Permitted Investment, FCMs and DCOs should not receive either preferential or disadvantageous treatment compared to other investors in the fund.

125

2013 Protections of Customer Funds Release at 68519-68520.

126

Commission regulation 1.11(e)(1)(ii) provides that an FCM's risk management program must consider risks posed by affiliates, all lines of business of the FCM, and all other trading activity engaged in by the FCM. 17 CFR 1.11(e)(1)(ii).

127

See

Commission Interpretation Regarding Standard of Conduct for Investment Adviser, SEC, 84 FR 33669 (July 12, 2019) at 33670.

128

Id.

at 33677.

Lastly, in response to the comment asserting that the Commission failed to acknowledge the broader “dash for cash” that occurred across assets classes in March 2020,

129

the Commission was recounting the SEC's rationale for adopting the 2023 SEC MMF Reforms. The Commission's own rationale for revising the scope of MMFs whose interests qualify as Permitted Investments is the potential reduced liquidity of Prime MMFs and Electing Government MMFs resulting from the implementation of liquidity fees by such funds under the SEC's regulatory framework.

129

Blackrock at p. 6.

To eliminate MMFs whose redemptions may be subject to a liquidity fee from the scope of Permitted Investments under Commission regulation 1.25, the Commission is revising Commission regulation 1.25(a)(1)(vii), which is redesignated Commission regulation 1.25(a)(1)(iv) to accommodate other amendments to Commission regulation 1.25(a) discussed in this Final Rule, by replacing the term “money market mutual fund” with the term “government money market funds as defined in § 270.2a-7 of this title, provided that the funds do not elect to be subject to liquidity fees in accordance with § 270.2a-7 of this title (government money market fund).” The Commission is also adopting further conforming changes throughout Commission regulation 1.25 and the appendix to Commission regulation 1.25 by replacing all references to “money market mutual fund” with “government money market fund.” In addition, the appendix to Commission regulation 1.25 is redesignated as appendix E to part 1 to address a change in the rules of the Office of the Federal Register regarding the structure of regulatory text to be codified in the Code of Federal Regulations.

To reflect the Final Rule's amendments to the scope of MMFs that qualify as Permitted Investments, the Commission is also adopting conforming amendments to Commission regulation 1.26, appendices A and B to Commission regulation 1.26, Commission regulation 30.7(d), and appendix F to part 30 of the Commission's regulations, as proposed. Specifically, the Commission is adopting conforming amendments to paragraphs (a) and (b) of Commission regulation 1.26 to replace the term “money market mutual fund” with the term “government money market fund.” Paragraph (b) of Commission regulation 1.26 is further revised to reflect the redesignation of appendices A and B to Commission regulation 1.26 as

“appendices F and G to part 1 of the Commission's regulations” and to reflect the redesignation of appendices A and B to Commission regulation 1.20 as “appendices C and D to part 1.”

130

The Commission is also amending appendices A and B to Commission regulation 1.26 (redesignated appendices F and G to part 1) to replace the term “Money Market Mutual Fund” with “Government Money Market Fund.”

130

Commission regulation 1.26 currently refers to “appendix A or B to this section” and “appendix A or B to § 1.20.” Appendix A and appendix B to Commission regulation 1.26 are being redesignated appendix F and appendix G to part 1, and appendix A and B to Commission regulation 1.20 are being redesignated appendix C and D to part 1, to address a change in the rules of the Office of the Federal Register regarding the structure of regulatory text to be codified in the Code of Federal Regulations.

In addition, the Commission is making conforming changes to Commission regulation 30.7(d)(2) and 30.7(l)(5)(iii)(G) (redesignated Commission regulation 30.7(l)(5)(iii)(F)) to replace the term “money market mutual fund” with “government money market fund.” The Commission is also implementing changes to appendix F to part 30, to replace the term “money market mutual fund” with “government money market fund.”

In response to FIA/CME Joint Letter, the Commission is also adopting additional conforming changes to the template acknowledgement letters set forth in appendices A and B to Commission regulation 1.26 (redesignated as appendices F and G to part 1) and in appendix F to part 30 to reflect the changes to the scope of MMFs that qualify as Permitted Investments.

131

Specifically, the Commission is including a template representation that the Government MMF does not elect to impose discretionary liquidity fees. The Commission understands that including language to memorialize the representation in the template acknowledgement letter may create efficiencies for registrants seeking to ascertain that the MMF meets the eligibility conditions of Commission regulation 1.25. Thus, the Commission is including the following statement after the second full paragraph of the template acknowledgment letters in appendices A and B to Commission regulation 1.26 (redesignated appendices F and G to part 1 for FCMs and DCOs, respectively) and appendix F to part 30: Furthermore, you acknowledge and agree that the Shares are in a fund that holds itself out to investors as a government money market fund, in accordance with 17 CFR 270.2a-7. In addition, you acknowledge and agree that the Shares are in a fund that does not choose to rely on the ability to impose discretionary liquidity fees consistent with the requirements of 17 CFR 270.2a-7(c)(2)(i).

131

FIA/CME Joint Letter at p. 21.

As discussed in section IV.E. of this preamble regarding the removal of read-only electronic access, FCMs do not need to obtain new acknowledgment letters for existing accounts at depositories holding Customer Funds reflecting this new language regarding government money market funds. Instead, revised acknowledgment letters must be obtained only for accounts opened after the effective date of this Final Rule or if the FCM is required to obtain a new acknowledgment letter for reasons unrelated to the addition of the government money market fund language after the effective date of this Final Rule.

2. Foreign Sovereign Debt

a. Proposal

The Commission authorized FCMs and DCOs to invest futures customer funds in foreign sovereign debt as part of the 2000 Permitted Investments Amendment.

132

The investments were subject to specified conditions, including that investments in the debt of a particular foreign sovereign were limited to balances owed by FCMs or DCOs to customers denominated in the currency of the applicable sovereign debt.

133

132

2000 Permitted Investments Amendment at 78003.

133

Id.

The Commission subsequently proposed to eliminate foreign sovereign debt as a Permitted Investment in 2010 citing an interest in simplifying the regulation and safeguarding futures customer funds in light of economic crises experienced by a number of foreign sovereigns.

134

Specifically, the 2010 Proposed Permitted Investments Amendment cited a Division of Clearing and Intermediary Oversight (“DCIO”) 2007 review of the investment of futures customer funds and 30.7 customer funds.

135

The 2007 Review revealed that only three of the total 87 active FCMs invested futures customer funds in foreign sovereign debt at any time during that year, and that only one FCM invested 30.7 customer funds in foreign sovereign debt.

136

134

Investment of Customer Funds and Funds Held in Account for Foreign Futures and Foreign Options Transactions, 75 FR 67645 (Nov. 3, 2010) at 67645 (“2010 Proposed Permitted Investments Amendment”).

135

Id.

at 67643 (“2007 Review”). MPD is a successor division to DCIO. The 2007 Review was conducted to further staff's understanding of FCM investment strategies and practices for customer funds and to assess whether any changes to the Commission's regulations would be appropriate.

136

Id.

at 67645.

The Commission subsequently eliminated foreign sovereign debt as a Permitted Investment in 2011.

137

In eliminating foreign sovereign debt as a Permitted Investment, the Commission stated that it recognized that the safety of sovereign debt issuances of one country may vary greatly from the sovereign debt issuances of another country and that investments in certain sovereign debt may be consistent with the objective of preserving principal and maintaining liquidity of investments entered into with Customer Funds specified in Commission regulation 1.25.

138

The Commission expanded on this view by stating that it was amenable to considering requests for section 4(c) exemptions to permit FCMs and DCOs to invest futures customer funds in foreign sovereign debt upon a demonstration that the investment is appropriate in light of the objectives of Commission regulation 1.25, and the issuance of the exemption satisfies the criteria set forth in section 4(c).

139

Specifically, the Commission stated that it would consider permitting futures customer funds to be invested in the foreign sovereign debt of a country to the extent that: (i) FCMs or DCOs held balances in segregated accounts owed to customers denominated in that country's currency; and (ii) the foreign sovereign debt serves to preserve principal and maintain liquidity of futures customer funds as required for all other investments of Customer Funds under Commission regulation 1.25.

140

137

2011 Permitted Investments Amendment at 78780-78782.

138

Id.

at 78782.

139

Id.

140

Id.

As discussed in section II. of this preamble, the Commission issued an order in 2018 pursuant to section 4(c) granting DCOs a limited exemption from the prohibition on the investment of customer funds in foreign sovereign debt consistent with its views and the criteria expressed in the 2011 Permitted Investments Amendment.

141

Specifically, the 2018 Order authorizes DCOs to invest euro-denominated futures customer funds and Cleared Swaps Customer Collateral in euro-denominated sovereign debt issued by France or Germany.

142

The 2018 Order

also contains conditions designed to ensure that the investments preserve the principal and maintain the liquidity of customer funds. Specifically, the conditions provide that: (i) investments of futures customer funds and Cleared Swaps Customer Collateral in the sovereign debt of France and Germany is limited to investments made with euro customer cash; (ii) if the two-year credit default spread of France or Germany, as applicable, exceeds 45 BPS, a DCO must not make any new direct investments in the relevant debt using futures customer funds or Cleared Swaps Customer Collateral, and a DCO must discontinue investing futures customer funds and Cleared Swaps Customer Collateral in the relevant debt instruments through Repurchase Transactions as soon as practicable under the circumstances; (iii) the dollar-weighted average of the time-to-maturity of a DCO's portfolio of investments in each of France or Germany's sovereign debt may not exceed 60 days; (iv) a DCO may not make a direct investment in the sovereign debt instruments of France or Germany that have a remaining time-to-maturity of greater than 180 calendar days; (v) a DCO may use futures customer funds or Cleared Swaps Customer Collateral to enter into Repurchase Transactions for French or German sovereign debt with a counterparty that is a foreign bank that qualifies as a permitted depository under Commission regulation 1.49(d)(3) and that is located in a money center country (as defined in Commission regulation 1.49(a)(1)) or in another jurisdiction that has adopted the euro as it currency, a securities dealer located in a money center country as defined in Commission regulation 1.49(a)(1) that is regulated by a national financial regulator, or the European Central Bank, The Deutsche Bundesbank, or the Banque de France; and (vi) a DCO may hold the sovereign debt of France or Germany purchased under Repurchase Transactions with a foreign depository only if the depository meets the location and qualification requirements contained in Commission regulation 1.49(c) and (d) and if the account complies with the requirements of Commission regulation 1.26.

143

141

2018 Order.

142

2018 Order at 35244-35245. The petitioners of the 2018 Order did not request any relief with respect to the investment of 30.7 customer funds, which are held by FCMs for 30.7 customers are trading on foreign contract markets that are not Commission designated contract markets.

143

Conditions 3(a)-(f) of the 2018 Order at 35245.

As stated in section II. of this preamble, the FIA and CME submitted a joint petition requesting that the Commission expand the scope of the 2018 Order by permitting both DCOs and FCMs to invest Customer Funds (

i.e.,

futures customer funds, Cleared Swaps Customer Collateral, and 30.7 customer funds, as applicable) in the sovereign debt of Canada, France, Germany, Japan, and the United Kingdom (

i.e.,

the Specified Foreign Sovereign Debt).

144

In support of the Joint Petition, the Petitioners asserted that the Commission's justification for issuing the 2018 Order to permit DCOs to invest futures customer funds and Cleared Swaps Customer Collateral in French and German sovereign debt is also applicable to FCMs. Specifically, the Petitioners stated that FCMs face the same challenges in assuring the protection of foreign currencies received from customers to margin cleared transactions as DCOs.

145

In this regard, the Petitioners noted that, in issuing the 2018 Order, the Commission stated that cash held in unsecured deposit accounts at commercial banks is exposed to the credit risk of the banks.

146

The Petitioners asserted that this credit risk can be effectively eliminated if an FCM or DCO is permitted to invest Customer Funds denominated in Canadian dollars (“CAD”), euros (“EUR”), Japanese yen (“JPY”), or Great Britain pounds (“GBP”) in the sovereign debt of Canada, France, Germany, Japan, or the UK (

i.e.,

Specified Foreign Sovereign Debt).

147

The Petitioners further stated that although investments through Repurchase Transactions involve exposure to a commercial counterparty, an FCM or DCO would receive the additional added benefit of receiving securities as collateral against that counterparty's credit risk.

148

144

See generally

Joint Petition.

145

Joint Petition at p. 2.

146

Id.

147

Id.

148

Id.

Consistent with arguments presented in connection with the 2018 Order, the Petitioners further argued that “in the event a securities custodian enters insolvency proceedings, [a DCO or FCM] would have a claim to specific securities rather than a general claim against the assets of the custodian.”

Id. See also

2018 Order at 35242.

After considering the Joint Petition and assessing changes to the holding of non-U.S. dollar currencies by FCMs and DCOs since the 2007 Review, the Commission proposed to permit both FCMs and DCOs to invest Customer Funds in Specified Foreign Sovereign Debt securities.

149

Specifically, the Commission proposed revising Commission regulation 1.25 to include Specified Foreign Sovereign Debt instruments as Permitted Investments, subject to conditions that are consistent with the conditions specified in the Commission's 2018 Order. As detailed in the Proposal, an FCM or DCO: (i) would be permitted to invest Customer Funds in the sovereign debt of Canada, France, Germany, Japan, and the United Kingdom (

i.e.,

the Specified Foreign Sovereign Debt);

150

(ii) may only invest Customer Funds in the Specified Foreign Sovereign Debt of a particular country to the extent that the FCM or DCO has balances in accounts owed to customers denominated in such country's currency;

151

(iii) would not be permitted to make new investments of Customer Funds in the Specified Foreign Sovereign Debt of a particular country if such country's two-year credit default spread exceeded 45 BPS; and, (iv) would be required to discontinue investing Customer Funds in the Specified Foreign Sovereign Debt of a particular country through Repurchase Transactions as soon as practicable under the circumstances if such country's two-year credit default spread exceeded 45 BPS.

152

149

Proposal at 81243-81248.

150

Proposal at 81244 and proposed Commission regulation 1.25(a)(1)(vii). The proposed condition defining the Specified Foreign Sovereign Debt is consistent with clause (1) of the 2018 Order, which provides that the Commission's order is limited to the sovereign debt of France and Germany.

151

Proposal at 81244-81245 and proposed Commission regulation 1.25(a)(1)(vii)(A) and (B). The proposed condition is consistent with condition 3(a) of the 2018 Order, which limits a DCO's investment in French or German sovereign debt to the extent the DCO owes balances owed to customers denominated in euros.

152

Proposal at 81245 and proposed Commission regulations 1.25(f)(3). The proposed conditions are consistent with condition 3(b) of the 2018 Order.

The Commission also proposed to limit the time-to-maturity of investments in Specified Foreign Sovereign Debt.

153

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

154

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

155

The Proposal further provided that if the portfolio includes Specified Foreign Sovereign Debt securities acquired under a reverse repurchase agreement, the FCM or DCO shall use the maturity of the reverse repurchase agreement to compute the dollar-weighted average time-to-maturity of the portfolio as opposed to the remaining time-to-maturity of the securities.

156

This

approach takes into account the contractual obligation to resell the securities within one business day or on demand as required by Commission regulation 1.25(d)(6).

157

Conversely, if the FCM or DCO sells Specified Foreign Sovereign Debt securities under a repurchase agreement, the FCM or DCO shall include the debt securities in the calculation of the dollar-weighted average based on the remaining time-to-maturity of each security sold, to account for the contractual obligation to repurchase such securities.

158

In addition, an FCM or DCO would not be permitted to make direct investments in Specified Foreign Sovereign Debt securities with a remaining time-to-maturity greater than 180 calendar days.

159

153

Proposal at 81245-81246.

154

17 CFR 270.2a-7.

155

Proposed Commission regulation 1.25(f)(1). The proposed condition is consistent with condition 3(c) of the 2018 Order.

156

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

applicable to a demand for the resale of the instruments.

See

proposed Commission regulation 1.25(f)(1).

157

17 CFR 1.25(d)(6).

158

Proposal at 81245-81246 and proposed Commission regulation 1.25(f)(1). In addition, under the Proposal, the dollar-weighted average of the time-to-maturity of the portfolio would be computed pursuant to SEC Rule 2a-7 (17 CFR 270.2a-7), consistent with the general time-to-maturity provision in Commission regulation 1.25(b)(4)(i). Commission regulation 1.25(b)(4)(i) provides that except for investments in MMFs, the dollar-weighted average time-to-maturity of an FCM's or DCO's portfolio of Permitted Investments, as computed under SEC Rule 2a-7, may not exceed 24 months. 17 CFR 1.25(b)(4)(i). The Commission also proposed to amend Commission regulation 1.25(b)(4)(i) to exclude Specified Foreign Sovereign Debt, which, as discussed, would be subject to its own dollar-weighted average time-to-maturity limit.

159

Proposed Commission regulation 1.25(f)(2). The proposed condition is consistent with condition 3(d) of the 2018 Order.

The Commission also proposed to expand the permissible Repurchase Transaction counterparties and depositories under Commission regulations 1.25(d)(2) and (7) to include certain foreign entities to effectively permit FCMs and DCOs to engage in Repurchase Transactions with Specified Foreign Sovereign Debt securities pursuant to Commission regulation 1.25(a)(2).

160

Currently Commission regulation 1.25(d)(2) limits counterparties with whom an FCM or DCO may enter into Repurchase Transactions involving Customer Funds or Permitted Investments to a section 3(a)(6)

161

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

162

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

163

160

Proposal at 81246-81247. Commission regulation 1.25(a)(2)(i) provides that FCMs and DCOs may engage in Repurchase Transactions with Permitted Investments provided the transactions are in accordance with the provisions of Commission regulation 1.25(d). 17 CFR 1.25(a)(2)(i).

161

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

see supra

note 52.

162

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

163

17 CFR 1.25(d)(7).

The Commission noted in the Proposal that, absent amendment to the counterparty and depository provisions of Commission regulations 1.25(d)(2) and (7), an FCM's and DCO's ability to buy and sell Specified Foreign Sovereign Debt pursuant to Repurchase Transactions would be restricted given that participants in such markets are predominantly non-U.S. entities.

164

The Commission, therefore, proposed to add foreign banks and foreign securities brokers or dealers meeting certain requirements discussed below, as well as the European Central Bank and the central banks of Canada, France, Germany, Japan, and the United Kingdom, to the list of permitted counterparties for Repurchase Transactions.

165

To be deemed a permitted counterparty, the Proposal provided that a foreign bank would have to qualify as a depository under Commission regulation 1.49(d)(3) by maintaining regulatory capital in excess of $1 billion, and would also have to be located in a money center country as defined in Commission regulation 1.49(a)(1) (

i.e.,

Canada, France, Italy, Germany, Japan, or the United Kingdom) or in another jurisdiction that adopted the currency of the permitted foreign sovereign debt.

166

Similarly, a foreign securities broker or dealer would have to be located in a money center country and be regulated by a national financial regulator.

167

The proposed provisions were designed to ensure that counterparties would be regulated entities comparable to counterparties currently permitted under Commission regulation 1.25(d)(2) and are consistent with the Repurchase Transaction counterparty conditions specified in the 2018 Order.

168

164

Proposal at 81246-81247.

165

Id.,

and proposed Commission regulation 1.25(d)(2).

166

Id.

167

Id.

168

Condition (e) of the 2018 Order.

The Commission also proposed to permit Specified Foreign Sovereign Debt securities transferred to an FCM or DCO under a reverse repurchase agreement to be held with a foreign bank that qualifies as a permitted depository under Commission regulation 1.49 by maintaining in excess of $1 billion in regulatory capital.

169

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

170

The proposed amendment to permit a foreign bank that satisfies the requirements of current Commission regulation 1.49 was designed to ensure that any additional foreign depositories authorized to hold Specified Foreign Sovereign Debt securities would be comparable to those currently permitted under Commission regulation 1.25(d)(7), and is consistent with the conditions of the 2018 Order.

171

169

Proposed Commission regulation 1.25(d)(7).

170

Proposal at 81247.

171

Id.

And Condition (f) of the 2018 Order.

Lastly, the Commission proposed to amend Commission regulation 1.25(b)(4)(i), which provides that except for investments in MMFs, the dollar-weighted average time-to-maturity of an FCM's or DCO's portfolio of Permitted Investments, as computed under SEC Rule 2a-7, may not exceed 24 months.

172

The proposed amendment would exclude Specified Foreign Sovereign Debt from the calculation of the dollar-weighted average time-to-maturity of the portfolio specified under Commission regulation 1.25(b)(4)(i).

173

The Commission proposed to exclude Specified Foreign Sovereign Debt as such debt would be subject to a separate dollar-weighted average time-to-maturity limit of 60 calendar days, which is substantially shorter than the two-year dollar-weighted average time-to-maturity requirement for the overall portfolio required by Commission regulation 1.25(b)(4)(i).

172

Proposal at 81246.

173

Proposed Commission regulation 1.25(b)(4)(i).

b. Comments

The Commission received 12 comments in response to the proposed addition of Specified Foreign Sovereign Debt to the list of Permitted Investments for Customer Funds. Ten commenters supported the Proposal.

174

Two commenters opposed the Proposal.

175

174

AIMA; CCP Global; Eurex; FIA/CME Joint Letter; ICE; MFA; NFA; Nodal; SIMFA AMG; and WFE.

175

Investor Advocacy Group Joint Letter and Better Markets.

Several commenters expressing support for the Proposal stated that permitting investment in the Specified Foreign Sovereign Debt provides FCMs

and DCOs with a risk management tool to effectively manage foreign currency risk from holding Customer Funds denominated in non-U.S. dollars.

176

In this regard, MFA stated that Commission regulation 1.25 currently requires an FCM holding excess non-U.S. dollar Customer Funds to first convert such currency to U.S. dollars before investing the funds in Permitted Investments, thereby exposing the FCM and customers to foreign currency risk.

177

MFA further stated that a more prudent risk management approach would be for an FCM to invest excess CAD, EUR, GBP, and JPY in corresponding Specified Foreign Sovereign Debt securities, which eliminates the foreign currency exposure to the FCM and customers.

178

Similarly, AIMA asserted that allowing FCMs and DCOs to invest foreign-denominated Customer Funds in short-term sovereign bonds of the same currency would reduce the currency risk associated with investing those funds in U.S. dollar-denominated investments.

179

FIA and CME echoed these comments, stating that the Proposal expands the risk management tools available to FCMs and DCOs to manage risk associated with holding Customer Funds by mitigating foreign currency risk resulting from converting foreign currencies into U.S. dollars in order to invest in U.S. dollar-denominated Permitted Investments.

180

176

AIMA at p. 2; FIA/CME Joint Letter at p. 2; MFA at pp. 1-2; CCP Global at p. 1; WFE at p. 4.

177

MFA at pp. 3-4.

178

Id.

179

AIMA at p. 2.

180

FIA/CME Joint Letter at pp. 2, 6-7.

Several commenters also observed that the ability to invest foreign currency balances owed to customers in Specified Foreign Sovereign Debt securities reduces potential credit risk that FCMs and DCOs would otherwise be exposed to by depositing the foreign currencies in unsecured commercial bank accounts.

181

CCP Global stated that, consistent with the Joint Petition, the ability of FCMs and DCOs to invest customer foreign currencies in Specified Foreign Sovereign Debt securities effectively eliminates the credit risk of commercial banks that FCMs and DCOs are exposed to, while holding such funds in unsecured deposit accounts.

182

AIMA noted that investing foreign currencies belonging to customers, particularly non-U.S. clients, in Specified Foreign Sovereign Debt is a more prudent option than depositing funds with a foreign depository institution that provides less insolvency protection, as such deposits would be at greater risk of being treated as unsecured claims compared to securities held in custody.

183

FIA and CME stated that in the event of a foreign depository's insolvency, claims to uninsured cash balances are at greater risk of being treated as unsecured claims against the depository estate than claims to specific securities held in custody.

184

FIA and CME further stated that FCMs, DCOs, and customers are in a better risk posture when FCMs and DCOs are able to diversify non-U.S. dollar exposures by leveraging both permitted non-U.S. depositories for cash as well as Permitted Investments in Specified Foreign Sovereign Debt securities.

185

181

AIMA at p. 2; Eurex at p. 2; WFE at p. 4; MFA at pp. 2-5; FIA/CME Joint Letter at pp. 2-11; CCP Global at p.1; Nodal at p. 2; NFA at p. 1.

182

CCP Global at p. 1.

183

AIMA at p. 2.

184

FIA/CME Joint Letter at p. 7.

185

Id.

FIA and CME further commented that the significant growth in the holding of foreign currencies, particularly CAD, EUR, JPY, and GBP, which comprise the currencies of the Specified Foreign Sovereign Debt securities, provides compelling evidence demonstrating the risk management rationale for expanding the list of Permitted Investments to include Specified Foreign Sovereign Debt securities.

186

Specifically, FIA and CME referenced the Proposal, where the Commission stated that as of August 15, 2023, FCMs collectively held an aggregate U.S. dollar equivalent of $51 billion of Customer Funds denominated in the currencies of the Specified Foreign Sovereign Debt, which represented approximately 10 percent of the total $490 billion of Customer Funds held in segregated accounts on that date.

187

FIA and CME stated that the increase in foreign currency-denominated Customer Funds is attributable primarily to the growth in cleared swaps, which only commenced when the Commission issued the 2011 Permitted Investments Amendment eliminating foreign sovereign debt as a Permitted Investment.

188

In FIA and CME's view, it would be impractical—and unfair to Cleared Swaps Customers—to continue incentivizing FCMs to manage currency fluctuation risk by refusing margin deposits not denominated in U.S. dollars or requiring customers depositing such balances to assume the foreign currency risk.

189

186

Id.

187

Id. See also

Proposal at 81243-81244.

188

FIA/CME Joint Letter at p. 7. FIA and CME stated that Cleared Swaps Customers deposit initial margin in foreign currency to a much greater extent than do futures customers or 30.7 customers. Specifically, FIA and CME stated that based on a survey of members, the growth of CAD, EUR, GBP and JPY customer balances (measured by the total equity value of accounts holding cash, securities, and positions denominated in those currencies, expressed in U.S. dollar-equivalent basis) between November 30, 2018 and November 30, 2023 has been most pronounced for the Cleared Swaps origin. FIA and CME stated that for members surveyed, CAD/EUR/GBP/JPY Cleared Swaps Customer Collateral balances totaled USD 1.6 billion in 2018 and USD 9.8 billion in 2023, a 600 percent increase. FIA/CME Joint Letter at pp. 7-8, note 37.

189

FIA/CME Joint Letter at pp. 7-8.

FIA and CME also observed that as non-U.S. dollar customer funds balances have increased, so has the customer demand for FCM flexibility in servicing multi-currency accounts.

190

The commenters explained that many customers, particularly Cleared Swaps Customers, deposit non-U.S. dollar cash and rely on FCMs to manage those deposits to satisfy margin calls on their behalf denominated in one or more other currencies. They further asserted that since several of the Commission-registered DCOs clearing swaps are located in the United Kingdom and the European Union, the complexity of single-currency margining processes is compounded by the operational complexity of Cleared Swaps Customer Collateral segregation and “residual interest” requirements.

191

In particular, FIA and CME stated that to comply with Commission regulation 22.2(f)(4), which requires that an FCM maintain in segregation, at all times, “an amount equal to the sum of any credit balances that the Cleared Swaps Customers of the [FCM] have in their accounts,” FCMs may need to source non-U.S. dollar assets to cover deficits in advance of settlement with DCOs outside of U.S. banking hours.

192

In this regard, FIA and CME asserted that having the ability to convert non-cash balances into Specified Foreign Sovereign Debt and to use Specified Foreign Sovereign Debt instruments to cover deficits incurred outside of U.S. banking hours would assist FCMs to control the higher level of operational risk associated with single-currency margining and Cleared Customer Collateral-specific segregation compliance processes.

193

190

FIA/CME Joint Letter at p. 8.

191

Id.

192

Id.

and 17 CFR 22.2(f)(4). Commission regulation 22.2(e)(3) further states that an FCM may deposit in the Cleared Swaps Customer Accounts its own money, securities, or other property to ensure that it is always in compliance with the segregation requirements of Commission regulation 22.2(f), provided, that the proprietary funds deposited are cash or unencumbered Permitted Investments. 17 CFR 22.2.

193

FIA/CME Joint Letter at p. 8, citing as an example an FCM transferring proprietary funds in the form of Specified Foreign Sovereign Debt instruments to a Cleared Swaps Customer Collateral Account to cover a deficit and ensure compliance

with its segregation requirements outside of U.S. banking hours.

Commenters also supported the Proposal by noting that the credit, liquidity, and volatility characteristics of Specified Foreign Sovereign Debt securities are comparable to those of U.S. Treasury securities.

194

Specifically, FIA and CME stated that if measuring liquidity by the bid-ask spread, “the short-term Specified Foreign Sovereign Debt instruments in scope of the Proposed Regulation all demonstrate abundant market liquidity; they are comparable to, if not identical with, bid-ask spreads in U.S. government securities of the same tenors.”

195

WFE further emphasized the low risk of default associated with these instruments.

196

194

E.g.,

Eurex at p. 2; ICE at p. 2.

See also

MFA at p. 3 and FIA/CME Joint Letter at p. 5 (noting that if liquidity is measured by bid-ask spread

(i.e.,

the difference between the lowest ask price and the highest bid price), the short-term Specified Foreign Sovereign Debt instruments referenced in the Proposal are all highly liquid and comparable from a liquidity perspective to U.S. government securities with the same tenors).

195

FIA/CME Joint Letter at p. 5.

196

WFE at p. 4 (referencing available credit ratings for the relevant foreign sovereign debt instruments).

Better Markets and the Investor Advocacy Group opposed the proposed addition of Specified Foreign Sovereign Debt to the list of Permitted Investments, stating that such investments could compromise the protection of Customer Funds and put customers at undue financial risk.

197

Specifically, Better Markets stated that investments in foreign sovereign debt can exhibit variable degrees of liquidity, affected by factors such as market conditions, geopolitical stability, and economic policies.

198

Better Markets further stated that in times of financial stress or market volatility, foreign sovereign debt instruments may not be readily convertible to cash without significant loss of value. Better Markets argued that the reduced liquidity could hinder the ability of DCOs and FCMs to promptly meet withdrawal requests or margin calls, potentially compromising their operational efficiency and financial stability.

199

Better Markets further stated that the increased exposure to credit and market risks could lead to situations where losses from investments in foreign sovereign debt impact DCOs' and FCMs' financial health to the extent of potentially limiting DCOs' and FCMs' ability to return Customer Funds. Better Markets also asserted that the proposed conditions to investing in Specified Foreign Sovereign Debt, such as the 45 BPS cap on the two-year credit default swap spread and the limits on the time-to-maturity of investments, may not be sufficient to mitigate the underlying liquidity concerns.

200

Better Markets also criticized the use of credit default swap spreads as an indicator of the creditworthiness of the issuing sovereign, noting that the reliability of credit default swap spreads depends heavily on the health and liquidity of the credit default swaps market.

201

197

Better Markets at p. 3; Investor Advocacy Group Joint Letter at p. 1.

198

Better Markets at pp. 5-6.

199

Id.

200

Id.

at p. 6.

201

Id.

Better Markets also asserted that allowing investments of Customer Funds in foreign sovereign debt would constitute a relaxation of regulatory enhancements introduced following the failures of MF Global Inc. (“MF Global”) and Peregrine Financial Group (“Peregrine”).

202

Specifically, Better Markets stated that the failures of both MF Global and Peregrine resulted from misuse of customer funds and fraud, which caused significant customer losses.

203

In addition, the Investor Advocacy Group noted that the failure of MF Global resulted, at least in part, due to risky investments in foreign sovereign debt.

204

202

Id.

at p. 2.

203

Id.

204

Investor Advocacy Group Joint Letter at p. 1 (the expansion of Permitted Investments to include foreign debt instruments of France, Germany, Canada, Japan, and the United Kingdom could put customers at undue financial risk and asserting that avoiding such risk was the rationale for prohibiting investments in foreign sovereign debt in 2011 after the MF Global meltdown).

More generally, Better Markets and the Investor Advocacy Group contended that the Commission lacks a compelling, public interest-focused rationale for expanding the list of Permitted Investments to include Specified Foreign Sovereign Debt.

205

In particular, these commenters criticized the Commission's consideration of the potential increase in profits for DCOs and FCMs as a benefit of the proposed expansion of the list of Permitted Investments.

206

Better Markets also argued that higher profits for DCOs and FCMs do not inherently guarantee reduced customer charges.

207

Instead, Better Markets stated that the current financial landscape, characterized with high interest rates, has generated substantial additional revenue for FCMs, reportedly amounting to hundreds of millions of dollars, and has led to an expectation of an expansion of the number of FCMs entering the market.

208

205

Better Markets at p. 6; Investor Advocacy Group Joint Letter at pp. 1-2.

206

Investor Advocacy Group Joint Letter at p. 1.

207

Better Markets at p. 4. Better Markets states that there is substantial historical evidencing that benefits accruing at the higher end of the economic spectrum (

e.g.,

DCOs and FCMs) do not “trickle down” effectively to lower levels (

e.g.,

customers), citing

50 years of tax cuts for the rich failed to trickle down, economics study says,

CBS News Money Watch (December 17, 2020), available at

https://www.cbsnews.com/news/tax-cuts-rich-5-years-no-trickel-down/.

208

Id.

Better Markets, citing

Futures Commission Merchants Target Expansion,

Traders Magazine (June 26, 2023), available at

https://www.tradersmagazine.com/departments/clearing/fcms-target-expansion/.

Separately, four commenters responded to the Commission's request for comment on whether the Commission should impose a “cooling-off ” period, following an exceedance of the 45 BPS limit on the two-year credit default swap spread of the issuing foreign sovereign, during which investments in Specified Foreign Sovereign Debt would remain prohibited.

209

FIA and CME stated that a “cooling-off” period was not necessary because, in their view, an exceedance of the 45 BPS limit would most likely be related to broader market volatility conditions, the improvement of which itself constitutes a cooling-off period.

210

CCP Global agreed with the Commission that there should be a mechanism to exclude a sovereign's debt in the event of an increased credit risk, but advocated for a phased “cooling-off” period and flexibility in terms of the number of breaches before investments are limited.

211

CCP Global also warned against potential “cliff-edge” effects due to the use of hard limits, which could aggravate volatility in the underlying bond market.

212

CCP Global further noted that given the limited maturity of investments in reverse repurchase agreements (

i.e.,

reverse repurchase agreements must be limited to an overnight maturity or reversible upon demand), imposing an immediate limitation on new investments would have the effect of requiring a large proportion of all FCM and DCO investments in reverse repurchase agreements collateralized by the relevant debt to be re-allocated within one business day.

213

WFE similarly recommended that the Commission consider a minimum period of time or number of times that this limit is breached before investment in the applicable Specified Foreign Sovereign

Debt security is prohibited.

214

ICE stated that requiring DCOs to discontinue investment in Specified Foreign Sovereign Debt securities due to fluctuations in credit default swap spreads could be disruptive.

215

In ICE's view, this restriction is not necessary given the jurisdictions involved.

216

209

Proposal at 81247, Question 4. Comments in response to Question 4 were submitted by CCP Global at pp. 2-3; FIA/CME Joint Letter at pp. 10-11; ICE at p. 3; and WFE at p. 4.

210

FIA/CME Joint Letter at p. 11.

211

CCP Global at p. 2.

212

Id.

213

Id.

214

WFE at p. 4.

215

ICE at p. 3.

216

ICE at p. 3. FIA and CME also noted that immediate divestment should not be required after a change in credit default spread.

See

FIA/CME Joint Letter at p. 10.

FIA and CME also observed that the Commission did not indicate whether the calculation of the 45 BPS credit default spread condition should be based on the bid, offer or mid-level.

217

FIA and CME proposed that the 45 BPS credit default spread condition be determined using mid-level pricing.

218

FIA and CME stated that mid-level pricing is a widely accepted pricing convention, including for sovereign debt.

219

217

FIA/CME Joint Letter at p. 10.

218

Id.

219

Id.

In addition, FIA and CME reiterated their request, originally expressed in the Joint Petition, that the Commission set a six-month dollar-weighted average time-to-maturity limit for the portfolio of Specified Foreign Sovereign Debt, and a maximum two-year remaining time-to-maturity condition for individual instruments.

220

Although FIA and CME agreed with the Commission's observation in the Proposal that the new issuance supply of Specified Foreign Sovereign Debt meeting the proposed restrictions appears “adequate to satisfy the demand for investments of Customer Funds in the relevant instruments,” FIA and CME asserted that the time-to-maturity restrictions “may be safely expanded, thereby enhancing liquidity (with the attendant additional benefit of enhanced price stability and diversification across currencies and tenors), without increasing credit risk.”

221

220

FIA/CME Joint Letter at pp. 9-10. Joint Petition at pp. 5-6 (asserting that the new issuance supply of the Specified Foreign Sovereign Debt meeting the restrictions is limited and would be thinly traded/quoted).

221

FIA/CME Joint Letter at pp. 9-10.

Commenters also supported the Commission's proposal to revise Commission regulations 1.25(d)(2) and (7) by expanding the eligible counterparties for Repurchase Transactions for Specified Foreign Sovereign Debt securities to include foreign banks, foreign securities brokers and dealers, and the central banks of Canada, France, Germany, Japan, and the United Kingdom, and by including foreign banks as eligible custodians for securities received by FCMs and DCOs under agreements to resell the securities.

222

ICE stated that the principal custodians for foreign sovereign debt securities are located outside of the U.S., and that custody through a U.S. institution as required under Commission regulation 1.25 would be impractical or involve an indirect custodial relationship through a foreign bank or dealer in the relevant jurisdiction. ICE also requested that the Commission revise Commission regulation 1.25(d)(7) to explicitly include the central banks of Canada, France, Germany, Japan, the United Kingdom, and the European Central Bank as eligible custodians for Specified Foreign Sovereign Debt securities.

223

222

ICE at p. 3; FIA/CME Joint Letter at p. 9; WFE at p. 4.

See also

Proposal at 81246-81247 and proposed Commission regulation 1.25(d)(2) and (7).

223

ICE at p. 3.

Separately, three commenters asserted that the Proposal's goals of increasing investment vehicles for DCOs, while minimizing credit risk, market risk, and liquidity risk could be effectively met if DCOs were allowed to deposit Customer Funds at the Federal Reserve Banks.

224

The commenters thus recommended that the Commission advocate for Federal Reserve deposit access for all DCOs.

225

224

Eurex at p. 2, CCP Global at p. 2, Nodal at p. 2.

225

Id.

BlackRock also requested that the Commission amend Commission regulation 1.25(d)(2) to allow FCMs and DCOs to invest Customer Funds pursuant to Repurchase Transactions cleared by a covered clearing agency registered with the SEC under section 17A of the Securities Exchange Act.

226

BlackRock at p. 7-8 (referring to the recommendation made by the Global Market Structure Subcommittee of the Commission's Global Markets Advisory Committee on November 6, 2023).

See

Proposal by FICC to add CCPs as Permitted Repo Counterparties under CFTC Rule 1.25 Recommendation, November 6, 2023, available at

https://www.cftc.gov/PressRoom/Events/opaeventgmac110623.

c. Discussion

The Commission is amending Commission regulation 1.25 to add Specified Foreign Sovereign Debt to the list of Permitted Investments as proposed, subject to certain clarifications and revisions to address comments. The amendments incorporate and expand upon the exemptive relief provided by the Commission in the 2018 Order by authorizing DCOs to invest Customer Funds in the sovereign debt of Canada, Japan, and the United Kingdom in addition to the sovereign debt of France and Germany. The amendments also expand upon the 2018 Order by authorizing FCMs to invest Customer Funds in the Specified Foreign Sovereign Debt.

227

Final Commission regulation 1.25(a)(1)(vi). The Final Rule thus supersedes the 2018 Order.

After considering the public comments, the Commission continues to believe that adding Specified Foreign Sovereign Debt securities as a Permitted Investment provides FCMs and DCOs with an option to manage the potential foreign exchange risk that may arise in their administration and investment of Customer Funds. Specifically, absent the ability to invest Customer Funds in identically-denominated sovereign debt securities, an FCM or DCO seeking to invest customer foreign currency deposits would need to convert the currencies to a U.S. dollar-denominated asset, which would introduce potential foreign currency fluctuation risk to the FCMs and DCOs.

228

If the U.S. dollar decreases in value relative to the particular foreign currency, the FCM or DCO may not receive sufficient foreign currency to cover the full amount owed to its customers upon the conversion of the U.S. dollar-denominated investment back to the applicable foreign currency. This may further impact an FCM's or DCO's obligation under Commission regulation 1.25(b)(1) to preserve the principal of Customer Funds invested in Permitted Investments. Thus, to provide FCMs and DCOs with an investment option that allows them to manage potential foreign exchange risk, while staying consistent with the general objectives set forth in Commission regulation 1.25 of preserving principal and maintaining liquidity of Permitted Investments,

229

the Commission is adopting the conditions discussed above as proposed. These conditions are consistent with the criteria specified in

the 2011 Permitted Investments Amendment

230

and the conditions set forth in the Commission's 2018 Order.

231

228

In reaching this conclusion, the Commission considered, among other factors, the daily volatility of exchange rates of the relevant currency pairs. Specifically, based on data from the Federal Reserve Bank of St. Louis' FRED database, the Commission noted that for the period from September 2018 to September 2023, the standard deviation of the daily percentage change of exchange rate between the relevant currency pairs was 0.45 percent for the CAD/USD pair, 0.46 percent for the EUR/USD pair, 0.61 percent for the GBP/USD pair, and 0.55 percent for the JPY/USD pair, indicating a currency fluctuation that is an additional risk factor with respect to the return on investment of customer foreign currency deposits in U.S. dollar-denominated assets. The Commission also adopted foreign sovereign debt as a Permitted Investment in 2000 to mitigate the potential foreign currency fluctuation risk facing FCMs and DCOs in converting foreign currencies to U.S. dollars for investment purposes. 2000 Permitted Investments Amendment at 78003.

229

17 CFR 1.25(b).

230

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

231

2018 Order at 35245.

First, an FCM or DCO will be permitted to invest in the foreign sovereign debt of only Canada, France, Germany, Japan, and the United Kingdom. The Commission's determination to include the foreign sovereign debt to these five countries is based on various factors. As a preliminary matter, each of these countries, including the U.S., is a member of the Group of 7 (“G7”), which represents the world's largest industrial democracies, and qualifies as a “money center country” as the term is defined in Commission regulation 1.49(a)(1).

232

Additionally, the currencies of the five jurisdictions represent a material portion of the total amount of non-U.S. dollar-denominated obligations that FCMs owe to customers. FCMs collectively held an aggregate of a U.S. dollar equivalent of $64 billion of Customer Funds denominated in CAD, EUR, JPY, and GBP on August 13, 2024.

233

The $64 billion represented approximately 12 percent of the total $511 billion of Customer Funds held by FCMs in segregated accounts on August 13, 2024.

234

232

17 CFR 1.49(a). In the absence of customer instructions to the contrary, Commission regulation 1.49(c) limits permissible locations of depositories of Customer Funds to the U.S., the country of origin of the currency, and a “money center country.” The concept of “money center country” is defined to mean Canada, France, Italy, Germany, Japan, and the United Kingdom, and is intended to correspond, together with the U.S., to the list of G7 countries.

Denomination of Customer Funds and Location of Depositories,

68 FR 5551 (Feb. 4, 2003) at 5546.

233

Based on data provided by CME. The amount has increased compared to the amount the Commission considered in the Proposal (

i.e.,

$51 billion, representing approximately 10 percent of the Customer Funds held in segregation, on August 15, 2023). Proposal at 81243-81244.

234

The $511 billion represents the U.S. dollar equivalent of the total value of margin assets held by FCMs for futures customers, Cleared Swaps Customers, and 30.7 customers as reported to CME as of August 15, 2023. The breakdown by currency was as follows: CAD 17 billion; EUR 19 billion; GBP 7 billion; and JPY 21 billion. Some of these funds may have also been posted by the FCMs to DCOs as customer margin collateral.

In addition, prior to proposing to allow FCMs and DCOs to invest in the sovereign debt of the enumerated countries, the Commission analyzed the credit, liquidity, and volatility characteristics of Specified Foreign Sovereign Debt. In particular, the Commission considered data provided by the Petitioners in support of the Joint Petition's statement that the credit default swaps of Canada, France, Germany, Japan, and the United Kingdom have relatively narrow spreads similar to the credit default spread of the U.S.

235

To assess the liquidity of Specified Foreign Sovereign Debt, the Commission also considered the amounts of outstanding marketable Canadian, French, German, Japanese, and United Kingdom debt instruments with time-to-maturity of two years or less.

236

235

Proposal at 81244, note 110 (referencing Joint Petition at pp. 6-7). Data provided in the Joint Petition, subsequently clarified by the Supplement to Joint Petition, indicates that in the period between April 2018 and April 2023, the average 2-year credit default swap spreads of Canada, France, Germany, Japan, and the UK were 13.9 BPS, 9.6 BPS, 5.3 BPS, 7.4 BPS, and 12.2 BPS, respectively, whereas the average 2-year credit default swap spread of the U.S. was 15.1 BPS. Joint Petition at p. 7 and Supplement to Joint Petition at p. 1.

236

Id.

note 111 (referencing appendix A to Joint Petition and Supplement to Joint Petition at p. 1, which indicate that the outstanding debt in instruments with time-to-maturity of two years or less issued by Canada, France, Germany, Japan, and the United Kingdom, based on information available on Bloomberg as of July 11, 2023, was equal to the USD equivalence of $447 billion, $594 billion, $557 billion, $2.6 trillion, and $534 billion, respectively; Bank of International Settlements' Debt Securities Statistics, available here:

https://www.bis.org/statistics/secstats_to180923.htm;

and 2021 Survey on Liquidity in Government Bond Secondary Markets, Organization for Economic Co-operation and Development, available here:

https://www.oecd-ilibrary.org/governance/oecd-sovereign-borrowing-outlook-2022_3f4e2676-en,

which confirms that Specified Foreign Sovereign Debt instruments presented good liquidity characteristics in 2021).

With regard to the volatility characteristics of Specified Foreign Sovereign Debt, the Commission concluded that expanding the list of Permitted Investments to include the sovereign debt of these five G7 countries is warranted based on available data that the price risk of the relevant foreign sovereign debt is comparable to that of U.S. Treasury securities that are already included in the list of Permitted Investments. Specifically, using one-year sovereign debt instruments yield data for the period September 21, 2018 to September 20, 2023, the Commission observed that the standard deviation of daily yield change for one-year U.S. Treasury bills was 9 BPS, whereas the same measure for Canadian, French, German, Japanese, and United Kingdom one-year debt instruments ranged from 1 to 7 BPS.

237

The Commission's determination that the price risk of Specified Foreign Sovereign Debt instruments is comparable to that of U.S. Treasury securities, and therefore merits inclusion in the list of Permitted Investments, is based on data from an inquiry including the more recent period of September 20, 2023 to September 5, 2024, using the standard deviation of daily yield change for one-year debt instruments.

238

Finally, in proposing to add Specified Foreign Sovereign Debt to the list of Permitted Investments, the Commission surmised that holding high-quality foreign sovereign debt may pose less risk to Customer Funds than the credit risk of commercial banks through unsecured bank demand deposit accounts.

239

237

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

238

The Commission reviewed one-year sovereign debt instruments yield data, available through Bloomberg, for the period from September 21, 2018 to September 5, 2024. During this period, the standard deviation of daily yield change for U.S. Treasury bills was approximately 9 BPS, whereas the same measure for Canadian, French, German, Japanese, and United Kingdom one-year debt instruments ranged from approximately 1 to approximately 6 BPS.

239

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

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

240

This restriction takes into account both the need to ensure the safety of Customer Funds and the Commission's desire to provide a degree of investment flexibility to FCMs and DCOs.

241

As noted in the Proposal, an

FCM or DCO seeking to invest deposits or amounts owed to customers denominated in foreign currencies, absent the ability to invest in identically-denominated sovereign debt securities, would need to convert the foreign currencies to a U.S. dollar-denominated asset, which would increase the FCM's or DCO's exposure to foreign currency fluctuation risk.

242

Commenters did not raise concerns regarding this condition, and as such, the Commission is adopting this requirement as proposed.

240

Final Commission regulation 1.25(a)(1)(vi).

241

As discussed above, prior to 2011, the Commission permitted an FCM or DCO to invest Customer Funds in foreign sovereign debt subject to the condition that the FCM or DCO held balances owed to customers denominated in the currency of the foreign country. In the wake of the 2008 financial crisis, the Commission eliminated foreign sovereign debt from the list of permitted investments noting at the time that “in many cases, the potential volatility of foreign sovereign debt in the current economic environment and the varying degrees of financial stability of different issuers make foreign sovereign debt inappropriate for hedging foreign currency risk.” 2011 Permitted Investments Amendment at 78781. Yet the Commission recognized that “the safety of sovereign debt issuances of one country may vary greatly from those of another, and that investment in certain sovereign debt might be consistent with the objectives of preserving principal and maintaining liquidity, as required by Regulation 1.25.”

Id.

at 78782. For the reasons discussed above, the Commission is reinstating certain foreign sovereign debt consistent with the Commission's

statement in the 2011 Permitted Investments Amendment that it would consider permitting such investments provided that the investments: (i) are limited to balances owed to customers denominated in the currency of the applicable foreign sovereign, and (ii) serve to preserve the principal and maintain the liquidity of Customer Funds.

Id.

at 78782. The Final Rule is also consistent with the Commission's approach in the 2018 Order of permitting DCOs to invest in the sovereign debt of France and Germany to the extent such foreign sovereign debt satisfies specific criteria demonstrating consistency with the credit, liquidity, and volatility of short-term U.S. Treasury securities.

242

2011 Permitted Investments Amendment at 78003.

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

243

As discussed in the Proposal, the 45 BPS limit is consistent with the conditions specified in the 2018 Order.

244

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

245

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

246

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

247

243

Proposed Commission regulation 1.25(f)(3).

244

Proposal at 81245.

245

2018 Order at 35243.

246

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

247

See

2018 Order at 35243.

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

248

which was lower than the mean spread of 26.5 BPS for the July 3, 2009 to July 3, 2017 period. In that same time period, the two-year credit default swap spread of the sovereigns issuing the Specified Foreign Sovereign Debt did not exceed 45 BPS. Thus, based on these U.S. Spread and Specified Foreign Sovereign Debt data, the Commission is maintaining the cap of 45 BPS established in the 2018 Order.

249

248

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

249

Using the daily U.S. Spread data from July 3, 2009 to July 3, 2017 and assuming the two-year credit default spread follows a normal distribution, the Commission estimated that there was less than 2.5 percent likelihood that the U.S. credit default spread would exceed 45 BPS over a two-year period. In addition, the Commission's estimate, based on the daily U.S. Spread data from September 21, 2018 to September 5, 2024, indicates that there is less than 1 percent likelihood, under both normal and empirical distributions, that the two-year credit default swap spread of the sovereigns issuing Specified Foreign Sovereign Debt would exceed 45 BPS. Therefore, the Commission has determined to adopt a threshold of 45 BPS for countries whose debt may qualify as a Permitted Investment under Commission regulation 1.25.

Consistent with the Proposal, if the credit default spread of the issuing sovereign exceeds the 45 BPS cap, FCMs and DCOs will not be permitted to make further investments, but neither will they be required to immediately divest their current investments in Specified Foreign Sovereign Debt. The prohibition on new investments will reduce the exposure to Customer Funds by avoiding the risk of default on the Specified Foreign Sovereign Debt. In situations where the 45 BPS cap is exceeded, FCMs and DCOs will hold Customer Funds denominated in foreign currency in cash or invest the foreign currency in U.S. dollar-denominated Permitted Investments rather than Specified Foreign Sovereign Debt. In addition, the requirement that the dollar-weighted average time-to-maturity of the portfolio of Specified Foreign Sovereign Debt not exceed 60 calendar days helps mitigate price risks to the Customer Funds that might arise from a country's two-year credit default spread exceeding the 45 BPS limit.

In addition, in response to a comment stating that the Commission did not specify how the 45 BPS limit should be calculated, the Commission is clarifying that the 45 BPS credit default spread must be determined using mid-level pricing, rather than the bid or ask price.

250

The mid-price is the average of the bid and ask prices, representing a midpoint between what buyers are willing to pay (bid) and what sellers are asking for (ask). This mid-point price provides a more balanced view of the security's credit risk, without the skew of immediate buy or sell pressures.

250

FIA/CME Joint Letter at p. 10 (recommending that the spread be determined using the mid-level and asserting that mid-level pricing is a widely accepted pricing convention for a wide range of asset classes including sovereign debt).

The Commission also requested comments as to whether it was appropriate to impose a “cooling-off” period before an FCM or DCO could invest Customer Funds in the Specified Foreign Sovereign Debt of a particular country once the two-year credit default spread of the country exceeded 45 BPS.

251

As commenters noted, market conditions based on broader volatility will self-resolve and result in a market driven “cooling-off” period.

252

Moreover, because FCMs and DCOs will not be able to make new investments in Specified Foreign Sovereign Debt until the credit default spread is back within the required limits, any “cooling-off” period promulgated by the Commission could potentially be arbitrary and inconsistent with the market's assessment that the increased credit risk that resulted in the exceedance of the 45 BPS cap no longer exists. Thus, the Commission is not specifying a “cooling-off” period during which FCMs and DCOs may not engage in investment in the applicable Specified Foreign Sovereign Debt.

251

Proposal at 81247, Question 4.

252

FIA/CME Joint Letter at pp. 10-11.

However, the Commission has determined to immediately halt the purchase of additional Specified Foreign Sovereign Debt once the 45 BPS cap is exceeded. Specifically, the Commission does not agree with commenters who suggested that there should be “flexibility” with respect to the number of breaches of the 45 BPS cap before investments are limited,

253

because the breach of the 45 BPS cap indicates the market's assessment of an increased likelihood of credit risk. The Commission acknowledges those comments cautioning that there is a potential for unintended consequences such as “cliff-edge effects,”

254

but it is for that reason that the Commission is taking a measured and balanced approach to such situations where the 45 BPS limit has been exceeded. Therefore, the Commission is not requiring that FCMs and DCOs sell

Specified Foreign Sovereign Debt that has already been purchased because it could increase volatility and the potential for procyclical impacts. The Commission, however, maintains its position that FCMs and DCOs must stop making direct investments in, or engaging in Repurchase Transactions involving, Specified Foreign Sovereign Debt of a country whose credit default swap spread on two-year debt instruments has exceeded 45 BPS.

253

See

CCP Global at p. 2; WFE at p. 4-5.

254

See

CCP Global at p. 2.

The Commission is also adopting the 60-calendar-day dollar-weighted average time-to-maturity of investments in Specified Foreign Sovereign Debt, as proposed.

255

As discussed in the Proposal, the restrictions on time-to-maturity will ensure that an FCM's or DCO's portfolio of Specified Foreign Sovereign Debt is comprised of sovereign debt instruments that mature within a relatively short period of time.

256

The short time-to-maturity requirement is intended to assist FCMs and DCOs in managing and mitigating potential market and/or credit risk by providing FCMs and DCOs with the option of holding the foreign sovereign debt securities to maturity during periods of market stress and price volatility rather than selling the securities at potentially significant discounts. The option to hold the debt securities to maturity may be particularly valuable to FCMs and DCOs from a risk management perspective during periods of significant interest rate movements, which could exacerbate market risk in sovereign debt markets. Thus, the Commission has determined to adopt a 60-calendar-day dollar-weighted average time-to-maturity requirement for Specified Foreign Sovereign Debt securities, computed on a portfolio of securities on a country-by-country basis, and a 180-calendar-day maximum remaining time-to-maturity requirement for each individual Specified Foreign Sovereign Debt security.

255

Final Commission regulation 1.25(f)(1) and (2).

256

Proposal at 81245-81246.

In addition, data regarding the new issuances of short-term Specified Foreign Sovereign Debt supports the lower 60-day dollar-weighted average time-to-maturity requirement and the 180-day maximum remaining time-to-maturity requirement proposed.

257

Therefore, the proposed time-to-maturity conditions more effectively account for liquidity needs with the market and credit risk management considerations than the six-month dollar-weighted portfolio average and two-year individual remaining time-to-maturity limits recommended by FIA and CME. Furthermore, as discussed in the Proposal, using the maturity of reverse repurchase agreements in calculating the dollar-weighted average of the portfolio of investments in Specified Foreign Sovereign Debt will reduce the average time-to-maturity of the portfolio as a whole. This approach takes into account the expected resale of the instruments, which must be contractually scheduled to occur within one business day or on demand as required by Commission regulation 1.25(d)(6).

258

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

259

257

Data made available by the Bank of Canada, l'Agence France Trésor (the French Finance Agency), the Bundesrepublik Deutschland Finanzagentur (the German Finance Agency), the Japan Ministry of Finance, and the United Kingdom Debt Management Office indicate that the five jurisdictions issue a sizable amount of debt securities with time-to-maturity of less than 180 days on a frequent basis. Specifically, in July 2024, Canada auctioned approximately USD 35 billion, France auctioned approximately $26.2 billion, Germany auctioned approximately $8.2 billion, Japan auctioned approximately $12.5 billion, and the United Kingdom auctioned approximately $41 billion in debt instruments with time-to-maturity of six months or less (

see

Canadian Treasury bills auction results at

https://www.bankofcanada.ca/markets/government-securities-auctions/calls-for-tenders-and-results/regular-treasury-bills/;

French BTF auction history at

https://www.aft.gouv.fr/en/dernieres-adjudications

); German Bubills issuance results at

https://www.deutsche-finanzagentur.de/en/federal-securities/issuances/issuance-results

(refer to reopening of 12-month Bubills with residual maturities between three and six months); Japanese T-bills auction results at

https://www.mof.go.jp/english/policy/jgbs/auction/past_auction_results/index.html;

and United Kingdom Treasury Bill tender results at

https://www.dmo.gov.uk/data/treasury-bills/tender-results/

258

17 CFR 1.25(d)(6).

259

Final Commission regulation 1.25(f)(1).

In addition, as discussed in the Proposal, with the adoption of the 60-day dollar-weighted portfolio average time-to-maturity requirement, the Commission is also amending Commission regulation 1.25(b)(4)(i) to exclude Specified Foreign Sovereign Debt from the calculation of the dollar-weighted average time-to-maturity of the FCM's or DCO's full portfolio of investment of Customer Funds.

260

This amendment reflects that Specified Foreign Sovereign Debt will be subject to its own dollar-weighted average time-to-maturity limit.

260

Proposal at 81246.

The Commission acknowledges the request of Eurex, CCP Global, and Nodal in their public comments

261

that the Commission work with the Federal Reserve Board to permit all DCOs to deposit Customer Funds at the Federal Reserve Banks. The Commission supports DCOs having deposit accounts at Federal Reserve Banks;

262

however, granting access to such accounts is not within the jurisdiction of the Commission.

261

Eurex at p. 2, CCP Global at p. 2, Nodal at p. 2.

262

See, e.g., Behnam urges wider CCP access to Fed deposit accounts,

Risk.net (Apr. 1, 2022), available at

https://www.risk.net/regulation/7945026/behnam-urges-wider-ccp-access-to-fed-deposit-accounts.

Consistent with the Proposal, the Commission is also amending Commission regulations 1.25(d)(2) and (7) to expand permissible counterparties and depositories that can be used in connection with Repurchase Transactions to include certain foreign entities. Without amendment to these counterparty and depository provisions, an FCM's and DCO's ability to buy and sell Specified Foreign Sovereign Debt securities pursuant to Repurchase Transactions would be restricted because participants in the foreign market are predominantly non-U.S. entities. The Commission is therefore adding foreign banks and foreign brokers or dealers meeting certain requirements, as well as the European Central Bank and the central banks of Canada, France, Germany, Japan, and the United Kingdom, to the list of permitted counterparties.

263

To be deemed a permitted counterparty, a foreign bank must qualify as a depository under Commission regulation 1.49(d)(3) by holding regulatory capital in excess of $1 billion, and must be located in a money center country as defined in Commission regulation 1.49(a)(1) (

i.e.,

Canada, France, Italy, Germany, Japan, and the United Kingdom) or in another jurisdiction that has adopted the currency of the permitted foreign sovereign debt. Similarly, a foreign broker or dealer must be located in a money center country and be regulated by a foreign financial regulator or a provincial financial regulator with respect to a Canadian securities broker or dealer.

264

The newly adopted

provisions are designed to ensure that the counterparties to an FCM's or DCO's Repurchase Transactions are regulated entities comparable to those counterparties already permitted under Commission regulation 1.25(d)(2). The final revisions to Commission regulation 1.25(d)(2) are also consistent with the counterparty conditions set forth in the 2018 Order.

265

263

Final Commission regulation 1.25(d)(2). ICE requested in its comment letter that the Commission explicitly include the central banks of Canada, France, Germany, Japan, the United Kingdom, and the European Central Bank.

See

ICE at p. 3. The Commission is including these recommendations in the terms of the Final Rule.

264

The Commission is revising the Final Rule to provide that Canadian securities brokers or dealers may be subject to applicable provincial financial regulators in recognition of the Canadian regulatory

structure vests supervisory authority with provincial regulators. Final Commission regulation 1.25(d)(2).

265

2018 Order, Condition (e) at 35245.

In response to Better Markets' assertion that allowing investments in Specified Foreign Sovereign Debt is relaxing some of the stringent requirements put in place after the collapse of MF Global,

266

the Commission notes that the impetus for eliminating foreign sovereign debt from the list of Permitted Investments in 2011 was not the bankruptcy of MF Global. Under the 2000 Permitted Investments Amendment, FCMs and DCOs were permitted to invest in the foreign sovereign debt of any foreign sovereign provided that the FCM or DCO owed balances denominated in that currency to customers. The Commission eliminated foreign sovereign debt in the 2011 Permitted Investments Amendment primarily due to its concerns with the varying degree of financial stability of different issuers as well as because it was not persuaded that foreign sovereign debt was used with sufficient frequency to justify commenters' claims that such debt assisted with the diversification of Customer Funds.

267

However, as previously stated, with respect to concerns regarding the economic stability of certain countries, the Commission recognized that the safety of sovereign debt issuances of one country may vary greatly from those of another. In this context, the Commission stated that it was amenable to considering applications for exemptions with respect to investments in certain foreign sovereign debt instruments upon a demonstration that the investment in the sovereign debt of one or more countries is appropriate in light of the objectives of Commission regulation 1.25 and that the issuance of the exemption satisfies the criteria set forth in section 4(c) of the Act.

268

266

Better Markets at p. 3.

267

2011 Permitted Investments Amendment at 78781.

268

Id.

at 78782.

The Commission continues to recognize that the safety of sovereign debt issuances of one country may vary greatly from the sovereign debt issuances of another country. Because of this, the Commission finds that investment in Specified Foreign Sovereign Debt that meets the tightly circumscribed risk characteristics set forth in the 2018 Order and restated in the Final Rule is consistent with the objectives of preserving principal and maintaining liquidity of investments specified in Commission regulation 1.25.

269

In light of the varying liquidity and credit risk associated with foreign sovereign debt, the Commission is recognizing jurisdictions whose short-term debt instruments meet the general objectives set forth in Commission regulation 1.25 of preserving principal and maintaining liquidity, subject to the conditions discussed above that are consistent with the conditions specified in the 2018 Order.

269

Id.

at 78782.

In addition, MF Global's trading losses, which Better Markets references in asserting that FCMs' and DCOs' investments in Specified Foreign Sovereign Debt might compromise the protection of Customer Funds,

270

were undertaken as speculative proprietary investments and not as investments of Customer Funds. MF Global engaged in, among other speculative investments, proprietary repurchase-to-maturity transactions collateralized with sovereign debt issued by various European countries that were experiencing economic distress.

271

As the value of the European sovereign debt positions deteriorated in the summer of 2011, and as MF Global's credit ratings were downgraded in the fall of 2011, MF Global was required to pay additional variation and initial margin on its proprietary transactions.

272

To satisfy the firm's liquidity needs and, more generally, to support the firm's proprietary transactions and the operations of the firm's affiliates, MF Global unlawfully used Customer Funds.

273

The firm's misuse of Customer Funds violated the Act and Commission regulations and would have been impermissible regardless of the type of investments involved in such malfeasance.

274

270

Better Markets at p. 3.

271

Another MF Global affiliate was also involved in the transactions, but MF Global held the economic risk of ownership. First Report of Louis J. Freeh, Chapter 11 Trustee of MF Global Holdings LTD.,

et al.,

for the Period of October 31, 2011 through June 4, 2012 (“MF Global Trustee Report”) at p. 33, available at

https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/h0711reportoflouisjfreeh060412.pdf.

272

Id.

at pp. 36-37.

273

CFTC Release No. 7508-17, Consent Order: Jon S. Corzine (Jan. 5, 2017) at p. 6.

274

Moreover, MF Global had invested not in the sovereign debt of Canada, France, Germany, Japan and the United Kingdom, which meet the liquidity, volatility, and credit characteristics that are consistent with the overall objectives set forth in Commission regulation 1.25 of preserving principal and maintaining liquidity of Customer Funds, but rather, such Customer Funds were ultimately used to support high-risk transactions involving the sovereign debt of Belgium, Ireland, Italy, Portugal, and Spain. None of these jurisdictions are on the list of allowable foreign sovereign debt that is being added to the list of Permitted Investments.

See

MF Global Trustee Report at p. 40.

Peregrine's failure was also the result of the misappropriation of Customer Funds and violations of the Commission segregation requirements for Customer Funds.

275

Peregrine's owner and Chief Executive Officer plead guilty to the embezzlement of customer funds and making false statements to the Commission.

276

These unlawful actions have no bearing on the types of Permitted Investments authorized by the Commission.

275

CFTC Release No. 7116-15.

276

U.S. Attorney's Office Northern District of Iowa, Press Release, Peregrine Financial Group CEO Sentenced To 50 Years For Fraud, Embezzlement, And Lying To Regulators [Court's Sentence Is The Maximum Allowed By Law]. January 31, 2013. Available at

https://www.justice.gov/usao-ndia/pr/peregrine-financial-group-ceo-sentenced-50-years-fraud-embezzlement-and-lying.

Moreover, the Commission adopted major revisions to its rules to enhance the protection of Customer Funds in response to the MF Global and Peregrine bankruptcies. Specifically, the Commission adopted Commission regulation 1.11,

277

which requires each FCM carrying customer accounts to establish a risk management program designed to monitor and manage risks associated with the activities of the FCM, including risks associated with the segregation of Customer Funds, FCM operations, and capital resources.

278

Commission regulation 1.11 requires an FCM to establish written policies and procedures that are reasonably designed to ensure that Customer Funds are separately accounted for and segregated as belonging to customers as required by the Act and Commission regulations. Furthermore, the written policies and procedures must, at a minimum, include or address: (i) a process for assessing the appropriateness of specific investments of Customer Funds in Permitted Investments, including the consideration of the market, credit, counterparty, operational, and liquidity risks associated with the investments, and an assessment of whether the investments are managed consistent with the objectives of preserving principal and maintaining liquidity of Customer Funds; (ii) a process for the evaluation of depositories of segregated

funds, including, at a minimum, documented criteria addressing the depository's capitalization, creditworthiness, operational reliability, and access to liquidity; (iii) an account opening process for depositories, including documented authorization requirements, procedures to ensure that customer segregated funds are not deposited with a depository prior to the FCM receiving a written acknowledgment letter, and procedures to ensure that the account is properly titled as a customer segregated account under the Act and Commission regulations; and (iv) a program to monitor an approved depository on an ongoing basis to assess its continued satisfaction of the FCM's established criteria, including a thorough due diligence review of each depository at least annually.

279

277

17 CFR 1.11.

278

2013 Protections of Customer Funds Release

at 68517-68521.

See also

17 CFR 1.11.

279

17 CFR 1.11(e)(3).

The Commission also revised Commission regulation 1.10 to require, among other things, an FCM to report and maintain a targeted amount of residual interest (

i.e.,

excess segregated funds above the full balance owed to customers) that the FCM seeks to hold in segregated accounts as a buffer to prevent the accounts from becoming undersegregated.

280

Additionally, the Commission amended Commission regulation 1.16 to ensure the high quality of annual audits of the FCM's financial statements by public accountants. The amendments to Commission regulation 1.16 require public accountants to be registered with, and examined by, the Public Company Accounting Oversight Board (“PCAOB”), and further require that the public accountant's audit report state whether the audit was conducted in accordance with auditing standards established or adopted by the PCAOB.

281

280

2013 Protections of Customer Funds Release at 68513-68516.

281

Id.

at 68577.

The Commission further revised Commission regulation 1.12 to enhance reporting by FCMs to the Commission. Specifically, Commission regulation 1.12 was amended to define several additional reportable events that require an FCM to file a notice with the Commission and with the FCM's designated self-regulatory organization.

282

Among other changes, the revisions included a requirement for FCMs to provide immediate notice whenever the FCM discovers or is informed that it has invested Customer Funds in investments that do not qualify as Permitted Investments, or if the FCM holds Permitted Investments in a manner that is not in compliance with the provisions of Commission regulation 1.25.

283

282

Id.

at 68521-68522.

283

Id.

at 68522.

The additional Customer Funds safeguards adopted in 2013 are not affected by the amendments adopted in this Final Rule.

284

In light of the enhanced safeguards that are now in place with respect to the segregation of Customer Funds,

285

and the limitation of investment in foreign sovereign debt to jurisdictions whose debt meets certain liquidity, volatility, and credit characteristics consistent with the overall objectives set forth in

This text is long and has been trimmed here. Open the source document for the complete record.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.