Regulations To Address Margin Adequacy and To Account for the Treatment of Separate Accounts by Futures Commission Merchants

Federal RegisterJan 22, 2025

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 22, 30, and 39

RIN 3038-AF21

Regulations To Address Margin Adequacy and To Account for the Treatment of Separate Accounts by Futures Commission Merchants

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Final rule.

SUMMARY:

The Commodity Futures Trading Commission (Commission or CFTC) is amending its regulations, adopted under the Commodity Exchange Act (CEA), to require a futures commission merchant (FCM) to ensure a customer does not withdraw funds from its account with the FCM if the balance in the account after the withdrawal would be insufficient to meet the customer's initial margin requirements; and relatedly, to permit an FCM, subject to certain requirements, to treat the separate accounts of a single customer as accounts of separate entities for purposes of certain Commission regulations.

DATES:

Effective date:

This rule is effective March 24, 2025.

Compliance dates:

The compliance date for FCMs that are clearing members of a derivatives clearing organization (DCO) as of the date of publication of this rule in the

Federal Register

shall be July 21, 2025. The compliance date for all other FCMs shall be January 22, 2026.

FOR FURTHER INFORMATION CONTACT:

Robert B. Wasserman, Chief Counsel, 202-418-5092,

rwasserman@cftc.gov;

Daniel O'Connell, Special Counsel, 202-418-5583,

doconnell@cftc.gov,

Division of Clearing and Risk; Thomas Smith, Deputy Director, 202-418-5495,

tsmith@cftc.gov;

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

lbozhanova@cftc.gov;

Jennifer Bauer, Special Counsel, 202-418-5472,

jbauer@cftc.gov,

Market Participants Division; Jasmine Lee, Special Counsel, 202-418-5226,

jlee@cftc.gov,

Division of Market Oversight, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. The Commission's Customer Funds Protection Regulations

B. The Divisions' No-Action Position

C. The Commission's First Proposal

D. The Commission's Second Proposal

II. Regulations

A. Amendments to Regulation § 1.3

B. Amendments to Regulation § 1.17

C. Amendments to Regulations §§ 1.20, 1.32, 22.2, and 30.7

D. Regulation § 1.44(a)

E. Regulation § 1.44(b)

F. Regulation § 1.44(c)

G. Regulation § 1.44(d)

H. Regulation § 1.44(e)

I. Regulation § 1.44(f)

J. Regulation § 1.44(g)

K. Regulation § 1.44(h)

L. Appendix A to Part 1

M. Amendments to Regulation § 1.58

N. Amendments to Regulation § 1.73

O. Amendments to Regulation § 30.2

P. Amendments to Regulation § 39.13

III. Cost Benefit Considerations

A. Introduction

B. Consideration of the Costs and Benefits of the Commission's Action

C. Costs and Benefits of the Commission's Action as Compared to Alternatives

D. Section 15(a) Factors

IV. Related Matters

A. Antitrust Considerations

B. Regulatory Flexibility Act

C. Paperwork Reduction Act

D. Congressional Review Act

I. Background

A. The Commission's Customer Funds Protection Regulations

Protection of market participants from misuses of customer assets and avoidance of systemic risk are two of the fundamental purposes of the CEA.

The Commission has promulgated regulations designed to protect customer assets, including regulations designed to ensure that FCMs appropriately margin customer accounts and are not induced to cover one customer's margin shortfall with another customer's funds. The Commission has also promulgated regulations designed to diminish the risk that a customer default in its obligations to an FCM that is a clearing member of a DCO (clearing FCM) results in the clearing FCM in turn defaulting on its obligations to a DCO, which could adversely affect the stability of the broader financial system.

Section 3(b) of the CEA, 7 U.S.C. 5(b).

Section 4d(a)(2) of the CEA and regulation § 1.20(a) require an FCM to separately account for, and segregate from its own funds, all money, securities, and property it has received to margin, guarantee, or secure the trades or contracts of its commodity customers.

Additionally, section 4d(a)(2) of the CEA and regulation § 1.22(a) prohibit an FCM from using the money, securities, or property of one customer to margin or settle the trades or contracts of another customer.

This requirement is designed to prevent an FCM from treating customers disparately and to mitigate the risk that the FCM will not maintain sufficient funds in segregation to pay all customer claims if the FCM becomes insolvent.

Section 4d(a)(2) of the CEA and regulations §§ 1.20 and 1.22 effectively require an FCM to add its own funds into segregation in an amount equal to the sum of all customer undermargined amounts, including customer account deficits, to prevent the FCM from being induced to use one customer's funds to margin or carry another customer's trades or contracts.

7 U.S.C. 6d(a)(2); 17 CFR 1.20(a).

7 U.S.C. 6d(a)(2); 17 CFR 1.22(a).

Prohibition of Guarantees Against Loss, 46 FR 11668, 11669 (Feb. 10, 1981).

7 U.S.C. 6d(a)(2); 17 CFR 1.20; 17 CFR 1.22; Prohibition of Guarantees Against Loss, 46 FR at 11669.

Section 5b of the CEA,

as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010,

sets forth eighteen core principles with which DCOs must comply to register and maintain registration as DCOs with the Commission. In 2011, the Commission adopted regulations for DCOs to implement Core Principle D, which concerns risk management.

These regulations include a number of provisions that require a DCO to in turn require that its clearing members take certain steps to support their own risk management to mitigate the risk that such clearing members pose to the DCO.

7 U.S.C. 7a-1.

Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010).

Section 5b(c)(2)(D) of the CEA, 7 U.S.C. 7a-1(c)(2)(D); Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 69334, 69335 (Nov. 8, 2011).

One such regulation, § 39.13(g)(8)(iii), provides that a DCO shall require a clearing member to ensure that a customer does not withdraw funds from its account with the clearing member unless the net liquidating value plus the margin deposits remaining in the customer's account after the withdrawal would be sufficient to meet the customer initial margin requirements with respect to all products and swap portfolios held in the customer's account that are cleared by the DCO.

Regulation § 39.13(g)(8)(iii) thus establishes a “Margin Adequacy Requirement” designed to mitigate the risk that a clearing FCM fails to hold customer funds sufficient to cover the required initial margin for the customer's cleared positions.

In light

of the use of omnibus margin accounts, in which the funds of multiple customers are held together, this safeguard is necessary to avoid the misuse of customer funds by mitigating the likelihood that the clearing FCM will effectively cover one customer's margin shortfall using another customer's funds.

17 CFR 39.13(g)(8)(iii).

For purposes of this final rule, the Commission uses the term “Margin Adequacy Requirement” to

refer to this requirement, which applies indirectly to clearing FCMs via the operation of DCO rules, and the analogous requirement set forth in regulation § 1.44(b) which will apply directly to all FCMs.

Section 3(b) of the CEA, 7 U.S.C. 5(b).

In adopting the Margin Adequacy Requirement of regulation § 39.13(g)(8)(iii), the Commission stated

that the regulation was consistent with the definition of “Margin Funds Available for Disbursement” in the Margins Handbook

prepared by the Joint Audit Committee (JAC), a representative committee of U.S. futures exchanges and the National Futures Association (NFA).

The Commission noted that although designated self-regulatory organizations (DSROs) reviewed FCMs to determine whether they appropriately prohibited their customers from withdrawing funds from their futures accounts, it was unclear to what extent that requirement applied to cleared swap accounts when such swaps were executed on a designated contract market (DCM) that participated in the JAC.

The Commission also noted that clearing members that cleared only swaps that were executed on a swap execution facility were not subject to the requirements of the JAC Margins Handbook or review by a DSRO.

Derivatives Clearing Organization General Provisions and Core Principles, 76 FR at 69379.

Joint Audit Committee Margins Handbook, available at

http://www.jacfutures.com/jac/MarginHandBookWord.aspx.

JAC, JAC Members, available at

http://www.jacfutures.com/jac/Members.aspx.

Self-regulatory organizations, such as commodity exchanges and registered futures associations (

e.g.,

NFA), enforce minimum financial and reporting requirements, among other responsibilities, for their members.

See

regulation § 1.3, 17 CFR 1.3. Pursuant to regulation § 1.52(d), when an FCM is a member of more than one self-regulatory organization, the self-regulatory organizations may decide among themselves which of them will assume primary responsibility for these regulatory duties and, upon approval of such a plan by the Commission, the self-regulatory organization assuming such primary responsibility will be appointed the designated self-regulatory organization for the FCM. 17 CFR 1.52(d).

Derivatives Clearing Organization General Provisions and Core Principles, 76 FR at 69379.

Id.

Thus, although regulation § 39.13(g)(8)(iii) was also designed to apply these risk mitigation and customer protection standards to futures and swap positions carried in customer accounts by clearing FCMs, Commission regulations do not apply a Margin Adequacy Requirement to non-clearing FCMs. Furthermore, regulation § 39.13(g)(8)(iii) does not require DCOs to apply a Margin Adequacy Requirement to the positions carried by a clearing FCM that are not cleared at a registered DCO (

e.g.,

most foreign futures and foreign option positions).

The term “foreign futures” means any contract for the purchase or sale of any commodity for future delivery made, or to be made, on or subject to the rules of any foreign board of trade. Regulation § 30.1(a), 17 CFR 30.1(a). The term “foreign option” means any transaction or agreement which is or is held out to be of the character of, or is commonly known to the trade as, an “option,” “privilege,” “indemnity,” “bid,” “offer,” “put,” “call,” “advance guaranty” or “decline guaranty,” made or to be made on or subject to the rules of any foreign board of trade. 17 CFR 30.1(b).

B. The Divisions' No-Action Position

On July 10, 2019, the Division of Swap Dealer and Intermediary Oversight (DSIO) (now Market Participants Division (MPD)) and the Division of Clearing and Risk (DCR) (collectively, the Divisions) published CFTC Letter No. 19-17, which, among other things, provides staff guidance with respect to the processing of margin withdrawals under regulation § 39.13(g)(8)(iii) and announced a conditional and time-limited no-action position for certain such withdrawals.

The advisory followed discussions with, and written representations from, the Asset Management Group of the Securities Industry and Financial Markets Association (SIFMA-AMG), the Chicago Mercantile Exchange (CME), the Futures Industry Association (FIA), the JAC, and several FCMs, regarding practices among FCMs and their customers related to the handling of separate accounts of the same customer.

CFTC Letter No. 19-17, July 10, 2019, available at

https://www.cftc.gov/csl/19-17/download

as extended by CFTC Letter No. 20-28, Sept. 15, 2020, available at

https://www.cftc.gov/csl/20-28/download;

CFTC Letter No. 21-29, Dec. 21, 2021, available at

https://www.cftc.gov/csl/21-29/download;

CFTC Letter No. 22-11, Sept. 15, 2022, available at

https://www.cftc.gov/csl/22-11/download;

CFTC Letter No. 23-13, Sept. 11, 2023, available at

https://www.cftc.gov/csl/23-13/download;

and CFTC Letter No. 24-07, June 24, 2024, available at

https://www.cftc.gov/csl/24-07/download.

See, e.g.,

SIFMA-AMG letter dated June 7, 2019 to Brian A. Bussey and Matthew B. Kulkin (SIFMA-AMG Letter); CME letter dated June 14, 2019 to Brian A. Bussey and Matthew B. Kulkin (CME Letter); and FIA letter dated June 26, 2019 to Brian A. Bussey and Matthew B. Kulkin (First FIA Letter).

CFTC Letter No. 19-17 used the term “beneficial owner” synonymously with the term “customer,” as “beneficial owner” was, in this context, commonly used to refer to the customer that is financially responsible for an account. Additionally, as discussed further below, in the customer relationship context, FCMs often deal directly with a commodity trading advisor acting as an agent of the customer rather than with the customer itself. For the avoidance of confusion (

e.g.,

with regard to the terms “owner” or “ownership,” as those terms are used in Forms 40 and 102,

or parts 17-20,

or with regard to the term “beneficial owner,” as that term may be used by other agencies), this final rule uses only the term “customer,” except where directly quoting or paraphrasing a source that uses the term “beneficial owner.”

See

CFTC, CFTC Form 40, Statement of a Reporting Trader, available at

https://www.cftc.gov/sites/default/files/idc/groups/public/@forms/documents/file/cftcform40.pdf; see also

CFTC, Ownership & Control Reporting, available at

https://www.cftc.gov/Forms/OCR/index.htm

(discussing Ownership and Control Reporting under Form 102).

See

17 CFR parts 17 (covering reports by reporting markets, FCMs, clearing members, and foreign brokers), 18 (reports by traders), 19 (reports by persons holding reportable positions in excess of position limits and by merchants and dealers in cotton), and 20 (large trader reporting for physical commodity swaps).

The written representations preceding the issuance of CFTC Letter No. 19-17 included letters filed separately by SIFMA-AMG, CME, and FIA (collectively, the “Industry Letters”). Citing regulation § 39.13(g)(8)(iii)'s requirements related to the withdrawal of customer initial margin, and JAC Regulatory Alert #19-02 reminding FCMs of those requirements,

SIFMA-AMG and FIA explained that provisions in certain FCM customer agreements provide that certain accounts carried by the FCM that have the same customer are treated as accounts for different legal entities (

i.e.,

“separate accounts”).

JAC, Regulatory Alert #19-02, May 14, 2019, available at

http://www.jacfutures.com/jac/jacupdates/2019/jac1902.pdf.

SIFMA-AMG Letter; First FIA Letter.

As FIA explained, there are a variety of reasons why a customer may want separate treatment for its accounts under such an agreement.

For instance, an institutional customer, such as an investment or pension fund, may allocate assets to investment managers

under investment management agreements that require each investment manager to invest a specified portion of the customer's assets under management in accordance with an agreed trading strategy, independent of the trading that may be undertaken for the customer by the same or other investment manager(s) acting on behalf of other accounts of the

customer.

Under such a circumstances, an investment manager, in order to implement its trading strategy effectively, may want assurance that the portion of funds it has been allocated to manage is entirely available to the investment manager, and will not be affected by the activities of other investment managers who manage other portions of the customer's assets and maintain separate accounts at the same FCM.

First FIA Letter.

The Industry Letters sometimes used the terms “investment manager” and “asset manager” interchangeably.

Id.

Additionally, as FIA explained, a commercial enterprise may establish separate agreements to leverage specific broker expertise on products or to diversify risk management strategies.

In such cases, each separate account may be subject to a separate customer agreement, which the FCM in many cases negotiates directly with the customer's agent, which is often an investment manager.

Id.

SIFMA-AMG and FIA asserted that, subject to appropriate FCM internal controls and procedures, separate accounts should be treated as separate legal entities for purposes of regulation § 39.13(g)(8)(iii);

i.e.,

separate accounts should not be combined when determining an account's margin funds available for disbursement.

SIFMA-AMG and FIA maintained that such separate account treatment should not be expected to expose an FCM to any greater regulatory or financial risk, and asserted that an FCM's internal controls and procedures could be designed to assure that the FCM does not undertake any additional risk as to the separate account.

The Industry Letters included a number of examples of such controls and procedures.

SIFMA-AMG Letter; First FIA Letter.

SIFMA-AMG Letter; First FIA Letter; CME Letter.

In its letter, SIFMA-AMG suggested that it would be possible to allow for separate account treatment without undermining the risk mitigation and customer protection goals of regulation § 39.13(g)(8)(iii).

SIFMA-AMG recognized that there may be some instances, such as a customer default, in which separate account margining would no longer be prudent.

SIFMA-AMG stated that an FCM could agree to first satisfy any amounts owed from agreed assets related to a separate account, and continue to release funds until the FCM provided the separate account with a notice of an event of default under the applicable clearing account agreement, and determined that it is no longer prudent to continue to separately margin the customer's accounts, provided that such actions are consistent with the FCM's written internal controls and procedures.

SIFMA-AMG further stated that, in such instance, the FCM would retain the ability to ultimately look to funds in other accounts of the customer, including accounts under different control, and the right to call the customer for funds.

CME similarly asserted that disbursements on a separate account basis should not be permitted in certain circumstances, such as financial distress, that fall outside the “ordinary course of business.”

Although CME asserted that the plain language of regulation § 39.13(g)(8)(iii) unambiguously forbids disbursements on a separate account basis, CME noted that it would be amenable to the Commission amending the regulation to permit such disbursements, subject to certain such risk-mitigating conditions.

SIFMA-AMG Letter.

Id.

CME Letter.

Id.

SIFMA-AMG and FIA requested that DCR confirm that it would not recommend that the Commission initiate an enforcement action against a DCO that permits its clearing FCMs to treat certain separate accounts of a customer as accounts of separate entities for purposes of regulation § 39.13(g)(8)(iii),

and confirm that a clearing FCM may release excess funds from a separate customer account notwithstanding an outstanding margin call in another account of the same customer.

FIA specifically noted that such a no-action position could be conditioned on the FCM maintaining certain internal controls and procedures. First FIA Letter.

SIFMA-AMG Letter; First FIA Letter;

See also, e.g.,

CFTC, Guidebook for Part 17.00: Reports by Reporting Markets, Futures Commission Merchants, Clearing Members, and Foreign Brokers, at 18, May 30, 2023 (noting that for purposes of part 17.00 reports, “reporting entities may elect to not consider Saturdays to be a business day, as Saturday is not commonly known as such”).

B. Amendments to Regulation § 1.17

Regulation § 1.17 establishes minimum financial requirements for FCMs. Regulation § 1.17(a)(1)(i) provides that each person registered as an FCM must maintain adjusted net capital equal to, or in excess of, the greatest of: (1) $1 million (or $20 million if the FCM is also registered as a swap dealer); (2) eight percent of the total “risk margin” required on the positions in customer and noncustomer accounts

carried by the FCM; (3) the amount of adjusted net capital required by NFA as a registered futures association; or (4) for an FCM registered as a securities broker or dealer with the Securities and Exchange Commission (SEC), the amount of net capital required by SEC rule § 15c3-1.

For purposes of regulation § 1.17(a)(1)(i), the term “risk margin” is defined by paragraph (b)(8) of that regulation to generally mean the level of maintenance margin or performance bond required for customer and noncustomer positions established by the applicable exchanges or clearing organizations.

The term “noncustomer account” generally means the accounts of affiliates of an FCM or employees of an FCM.

See

17 CFR 1.17(b)(4).

17 CFR 240.15c3-1.

The Commission proposed several amendments to regulation § 1.17 to reflect the regulatory capital treatment of separate accounts that would result from the implementation of proposed regulation § 1.44, including the requirements contained in regulation § 1.44(g)(3), discussed below. As a general matter, the proposed amendments to regulation § 1.17 were designed to ensure that FCMs manage risk with respect to separate accounts consistently, and cannot revert to calculating minimum financial requirements on a combined account basis where such calculations would tend to reflect less risk and reduced financial requirements for a customer than if each of the customer's separate accounts were treated as an account of a distinct customer without regard to the same customer's other separate accounts.

Consistent with that intent, the Commission proposed to expand the list of modifiers to the definition of the term “risk margin” for an account by adding proposed paragraph (b)(8)(v) to regulation § 1.17, providing that if an FCM carries separate accounts for separate account customers pursuant to regulation § 1.44, then the FCM shall calculate the risk margin pursuant to regulation § 1.17(a)(1)(i)(B)(

) as if each separate account is owned by a separate entity.

The Commission notes that, under the amendments as proposed, risk margin would be calculated on an individual basis for each separate account. Calculating risk margin separately for each separate account would eliminate the potential for portfolio margining offsets based on positions between separate accounts of the same separate account customer,

which would either increase, or leave unchanged, the total risk margin requirement, and thus the minimum adjusted net capital requirement, for an FCM providing separate account treatment.

The proposed addition of paragraph (b)(8)(v) to regulation § 1.17 was intended to further clarify that, pursuant to the Commission's FCM capital rule, an FCM that elects to permit separate account treatment must compute the risk margin amount for separate accounts as if each account is an account of a separate entity.

As noted in regulation § 39.13(g)(4), a DCO may allow reductions in initial margin requirements for related positions if the price risks with respect to such positions are significantly and reliably correlated. This includes cases where (A) The products on which the positions are based are complements of, or substitutes for, each other. An example might be long versus short positions in oil and natural gas, both of which may be used for generating energy. However, portfolio margining is applicable only to accounts for the same customer.

See

regulation § 39.13(g)(8)(i) (requiring collection of initial margin on a gross basis for each clearing member's customer accounts). So, if a customer has, in a single account, both long oil positions and short natural gas positions, then the customer may benefit from a reduction in initial margin requirements for the two risk-offsetting positions. However, if those positions are in different separate accounts of the customer under this this final rule, then the positions would not lead to an initial margin reduction as the positions would not be margined on a combined or portfolio basis.

As noted above, per regulation § 1.17(a)(1)(i), the adjusted net capital requirement for an FCM is the greatest of several calculations, one of which is eight percent of the total risk margin requirement as defined in regulation § 1.17(b)(8). Thus, a calculation that would increase, or leave unchanged, the risk margin requirement would correspondingly increase, or leave unchanged, the adjusted net capital requirement.

In proposing to amend the definition of the term “risk margin” in regulation § 1.17(b)(8) to reflect separate accounts, the Commission noted that such amendment, and the resulting potential increase in an FCM's minimum adjusted net capital requirement under regulation § 1.17(a)(1)(i), would also affect other regulations that impose obligations on FCMs based on their level of adjusted net capital.

The Commission also

noted that the proposed amendments to the minimum capital requirements would affect an FCM's obligation to provide certain notices to the Commission and to the FCM's DSRO under regulation § 1.12.

For example, regulation § 1.17(h) conditions an FCM's ability to repay or prepay subordinated debt obligations on the FCM maintaining an amount of adjusted net capital that, after taking into effect the

amount of the subordinated debt payment and other subordinate debt payments maturing within a set time period, exceeds the FCM's minimum adjusted net capital requirement by 120 percent to 125 percent, as specified in the applicable provision of regulation § 1.17(h).

See, e.g.,

17 CFR 1.17(h)(2)(vii) which generally provides, subject to certain conditions, that an FCM may not make a prepayment on an outstanding subordinated debt obligation if such payment would result in the FCM maintaining less than 120 percent of its minimum adjusted net capital requirement.

See, e.g.,

17 CFR 1.12(a), which requires an FCM to provide notice to the Commission and the FCM's DSRO if the FCM's adjusted net capital at any time is less than the minimum required by regulation § 1.17.

The Commission additionally proposed to amend regulation § 1.58 to provide that, where a clearing FCM carries an omnibus customer account for a non-clearing FCM, and the non-clearing FCM applies separate account treatment, then such non-clearing FCM must calculate initial and maintenance margin for purposes of regulation § 1.58(a) separately for each separate account. These proposed amendments to regulation § 1.58 are discussed further below.

Second, the Commission proposed to amend regulation § 1.17(c)(2), which defines “current assets” that an FCM may recognize and include in computing its net capital. Regulation § 1.17(c)(2) currently defines “current assets” to include cash and other assets or resources commonly identified as those that are reasonably expected to be realized in cash or sold during the next 12 months. However, regulation § 1.17(c)(2)(i) provides that an FCM must exclude from current assets any unsecured receivables resulting from futures, Cleared Swaps, or 30.7 accounts that liquidate to a deficit or contain a debit ledger balance only, provided, however, that the FCM may include a deficit or debit ledger balance in current assets until the close of business on the business day following the date on which the deficit or debit ledger balance originated (provided, in turn, that the account had timely satisfied the previous day's deficits or debit ledger balances).

The Commission proposed to amend regulation § 1.17(c)(2)(i) to provide explicitly that if an FCM carries separate accounts for separate account customers pursuant to proposed regulation § 1.44, then the FCM must treat each separate account as an account of a separate entity for the calculation of net capital, with certain limitations if deficits or debit ledger balances were not satisfied across the separate accounts of one separate account customer in accordance with the one business day requirements. As proposed, amended regulation § 1.17(c)(2)(i) would provide that the FCM must exclude each unsecured separate account that liquidates to a deficit or contains a debit ledger balance only from current assets in its calculation of net capital, provided, however, that if the separate account is subject to a call for margin by the FCM, it may be included in current assets until the close of business on the business day following the date on which the deficit or debit ledger balance originated, provided that the separate account timely satisfied a previous day's deficit or debit ledger balance in its entirety. As proposed, amended regulation § 1.17(c)(2)(i) further provides that, if the separate account does not satisfy a previous day's deficit or debit ledger balance in its entirety, then the deficit or debit ledger balance for the separate account, and any other deficits or debit ledger balances of the separate account customer in other separate accounts carried by the FCM, shall not be included in current assets until all such calls are satisfied in their entirety. The Commission's proposed amendments were intended to provide the same capital treatment to separate accounts as is currently provided customer accounts that liquidate to deficits or contain debit ledger balances, and to be consistent with corresponding conditions to the no-action position in CFTC Letter No. 19-17.

CFTC Letter No. 19-17. The letter provides that an “FCM shall record each separate account independently in the FCM's books and records,

i.e.,

the FCM shall record separate accounts as a receivable (debit/deficit) or payable with no offsets between the other separate accounts of the same customer.”

Id.

(Condition 6). The letter also provides that “the receivable from a separate account shall only be considered secured (a current/allowable asset) based on the assets of that separate account, not on the assets held in another separate account of the same customer.”

Id.

(Condition 7).

Third, the Commission proposed to amend regulation § 1.17(c)(4), which defines the term “liabilities” for purposes of an FCM calculating its net capital. Regulation § 1.17(c)(4) generally defines the term “liabilities” to mean the total money liabilities of an FCM arising in connection with any transaction whatsoever, including economic obligations of an FCM that are recognized and measured in conformity with generally accepted accounting principles. Regulation § 1.17(c)(4) also provides that for purposes of computing net capital, an FCM may exclude from its liabilities funds held in segregation for futures customers, Cleared Swaps Customers, and 30.7 customers, provided that such segregated funds are also excluded from the FCM's current assets in computing the firm's net capital.

The Commission proposed to amend regulation § 1.17(c)(4)(ii) to explicitly provide that an FCM that carries the separate accounts of separate account customers pursuant to proposed regulation § 1.44 must compute the amount of money, securities, and property due to a separate account customer as if each separate account of the separate account customer is a distinct customer. The Commission further proposed to amend regulation § 1.17(c)(4)(ii) to provide that an FCM, in computing its net capital, may exclude funds held in segregation for separate account customers from the FCM's liabilities, provided that funds held in segregation for separate account customers are also excluded from the FCM's current assets. The purpose of the proposed amendment is to ensure that an FCM, in computing its net capital, reflects separate accounts in a consistent manner in determining its total current assets and liabilities.

Fourth, the Commission proposed to amend regulation § 1.17(c)(5), which defines the term “adjusted net capital.” Regulation § 1.17(c)(5)(viii) provides, in relevant part, that adjusted net capital means net capital minus, among other items detailed in regulation § 1.17(c)(5), the amount of funds required in each customer account to meet maintenance margin requirements of the applicable board of trade or, if there are no such maintenance margin requirements, clearing organization margin requirements applicable to the account's positions. FCMs are allowed to apply (that is, to reduce the amount of this deduction from capital by) “calls for margin or other required deposits which are outstanding no more than one business day.”

However, once a customer fails to meet a margin call within one business day, the FCM loses that one business day period for receiving any of that customer's future margin calls, until the point in time at which the customer is no longer undermargined.

17 CFR 1.17(c)(5)(viii).

Thus, if, due to activity on Monday, Customer A is undermargined by $150, and the FCM calls Customer A for that margin on Tuesday, then the FCM does not need to deduct that $150 from its net capital in computing its adjusted net capital, so long as the margin call is met by the close of business on Wednesday. Moreover, if Customer A, due to activity on Tuesday, is undermargined by an additional $100, and the FCM calls for that additional $100 on Wednesday, then the FCM does not need to deduct that additional $100 on

Wednesday. If Customer A meets the $150 call by close of business Wednesday, and the $100 call by close of business on Thursday, then no deduction need be taken for either the $150 or the $100 margin calls. However, if Customer A fails to meet Tuesday's $150 call by close of business on Wednesday, then the FCM must deduct

both

the $150 from Tuesday

and

the $100 from Wednesday (thus a total of $250), as well as any future undermargined amounts

until

Customer A cures its entire undermargined amount. Again, once a customer fails to meet a margin call within one business day, the FCM loses the one business day period for that customer to meet any of its future margin calls, until the point in time at which the customer is no longer undermargined.

The Commission proposed to amend regulation § 1.17(c)(5)(viii) to provide that an FCM that carries separate accounts for a separate account customer pursuant to proposed regulation § 1.44 must compute the amount of funds required to meet maintenance margin requirements for each separate account as if the account was owned by a distinct customer. However, if a margin call for any separate account of a separate account customer is outstanding for more than one business day, then (consistent with the treatment of multiple margin calls for a single customer described in the previous paragraph), no margin call for that separate account customer will benefit from the one business day period until the point in time at which all margin calls for the separate accounts of that separate account customer have been met in full.

As discussed further below in the context of proposed regulation § 1.44(f), the concepts of margin calls that are outstanding no more than one business day (for purposes of § 1.17(c)(5)(viii)) and meeting a one business day margin call (for purposes of § 1.44(f)) are separate and distinct. It is possible that a separate account customer may meet the test for the first, but not the second, or may meet the test for the second, but not the first.

The proposed amendments to regulation § 1.17 also include certain technical changes designed to improve clarity and promote consistency with other Commission regulations.

E.g.,

changes to punctuation and substitution of “level of maintenance margin or performance bond required for the customer

and

noncustomer positions” for “level of maintenance margin or performance bond required for the customer

noncustomer positions” with respect to the meaning of risk margin for an account.

See, e.g.,

regulation § 1.17(b)(8). The Commission is further replacing the term “FCM” in regulation § 1.17(b)(8) with “futures commission merchant.” The Commission is also reorganizing paragraph § 1.17(c)(5)(viii) into sub-paragraphs (A), (B), (C), and (D) to enhance clarity. The Commission is also reorganizing the wording of the definition of the term “business day” in regulation § 1.17(b)(6) to read “any day other than a Saturday, Sunday, or holiday” rather than “any day other than a Sunday, Saturday, or holiday.” This change would align the wording in this provision with the wording of the term “business day” in regulation § 1.3.

Commenters did not object to the Commission's proposed addition of paragraph (b)(8)(v) to regulation § 1.17, the Commission's proposed amendments to regulation § 1.17(c)(4)(ii), or the technical amendments that the Commission proposed to regulation § 1.17. FIA welcomed the Commission's proposal to amend regulation § 1.17 to require FCMs that carry separate accounts to calculate the risk margin component of the FCM's regulatory capital requirement as if the separate accounts are owned by separate entities.

The JAC did not object to the proposed amendments to regulation § 1.17(c)(2)(i), but contended that the amendments would introduce a change from the current requirements related to the treatment of separate account debits and deficits in CFTC Letter No. 19-17 by requiring FCMs to look across all separate accounts of a separate account customer when determining one day debits or deficits to be considered current assets for net capital, rather than making that determination solely on the basis of each of the separate account customer's separate accounts individually.

The JAC noted that FCMs may require time to update their regulatory systems and records to comply with the amendments as proposed.

FIA Comment Letter.

JAC Comment Letter.

Id.

The JAC also recommended that the Commission clarify how an FCM should consider whether a separate account timely satisfied the previous day's debit or deficits in its entirety, noting that, if margin calls are only considered satisfied when receipts are settled for purposes of proposed regulation § 1.17(c)(2)(i), then margin calls met in non-USD in one separate account may affect the current or noncurrent classification of a debit or deficits in all separate accounts of a separate account customer.

As discussed further below, JAC guidance provides that FCMs, subject to certain conditions, may apply margin equity credit to an account for certain pending non-USD transactions. The JAC noted that, depending on how margin calls are considered satisfied, the proposed amendments may require FCMs permitting separate account treatment to consider additional capital needs.

Id.

With respect to the proposed amendments to regulation § 1.17(c)(5)(viii), the JAC agreed that proposed regulation § 1.17(c)(5)(viii)(A) (requiring that if one margin call is noncurrent, then all margin calls are noncurrent), is consistent with how, pursuant to the JAC's guidance, FCMs currently calculate noncurrent margin calls and account for noncurrent margin calls for purposes of determining capital charges. The JAC did not take a position with respect to the proposed amendments to regulation § 1.17(c)(5)(viii)(B), but urged the Commission (if adopting the amendments as proposed) to highlight in its final rulemaking that the amendments would require that, if a margin call for any separate account of a separate account customer is outstanding for more than one business day, then the calculation of current calls used in computing the separate account's undermargined capital charge must account for the age of

all

margin calls in

all

separate accounts of the separate account customer. The JAC noted that the resulting look-across to all margin calls in all separate accounts of a separate account customer could result in significant capital charges for FCMs even where each separate account is meeting its calls on a one business day basis as required by proposed regulation § 1.44(f), due to the additional time for compliance with the one business day margin requirement provided for holidays and foreign currency wires as proposed in accordance with the practices followed under CFTC Letter No. 19-17.

Id.

Additionally, as the JAC noted in its comments with respect to the proposed amendments to regulation § 1.17(c)(2)(i), JAC Regulatory Alert #14-06 provides that, when calculating the undermargined capital charge and consistent with the treatment for residual interest, an FCM may consider pending non-USD deposits, ACH payments, and checks as received, subject to certain conditions.

The JAC requested that the Commission confirm

that pending non-USD deposits would be permitted to be considered as received in computing the undermargined capital charge for all customers under proposed regulation § 1.17(c)(5)(viii)(A) and (B).

Id.

Specifically, JAC Alert #14-06 provides that, at an FCM's discretion, it may consider a non-USD deposit as pending in a customer's account and included in the account's margin equity if “(i) the FCM assesses that it is prudent to do so based on the account's past history of satisfying margin calls and the operational and credit risk profile of the account owner, (ii) the account is on a 1-day wire transfer basis (

i.e.,

the wire is initiated on Day 2), (iii) the FCM has a sufficient basis that the wire was actually initiated, (iv) the FCM continues to age the pending non-U.S. Dollar receipts and retains the ability to recognize a failed deposit immediately upon occurrence, and (v) the FCM treats unsettled non-U.S. Dollar disbursements from the account in the same manner.” JAC Regulatory Alert #14-06, Nov. 4, 2014, available at

http://www.jacfutures.com/jac/jacupdates/2014/jac1406.pdf.

JAC Comment Letter.

The JAC also noted that, as the Commission has not proposed to modify regulation § 1.17(c)(5)(ix), requiring undermargined capital charges for noncustomer and omnibus accounts, the JAC will assume that FCMs will still be able to apply treatment for pending deposits as set forth in JAC Regulatory Alert #14-06 to noncustomers and omnibus accounts, unless the Commission amends the provision or confirms otherwise.

Id.

Additionally, the JAC requested that the Commission confirm that for purposes of the undermargined capital charge for a customer account under regulation § 1.17(c)(5), maintenance margin requirements include the risk component only, and non-cash collateral should be valued at market value less applicable haircuts, including for separate account customers.

The JAC stated that performing such margin calculations differently in order to comply with different regulatory reporting requirements may prove burdensome for FCMs that permit separate account treatment.

Id.

FIA contended that the proposed amendments to regulation § 1.17(c)(2)(i) and regulation § 1.17(c)(5)(viii) are inconsistent with the principle of separate account margining and how clearing FCMs have understood the conditions of CFTC Letter No. 19-17.

FIA argued that, for purposes of calculating both current assets under regulation § 1.17(c)(2)(i) and charges against net capital for undermargined accounts under regulation § 1.17(c)(5)(viii), the Second Proposal would effectively require FCMs to suspend the ordinary course of business for purposes of both calculations in the event that any separate account fails to satisfy its previous day's deficit or debit ledger balance in its entirety within one business day (for purposes of the calculation of current assets) or within the close of business at the end of the second business day following the call (for purposes of the undermargined capital charge).

FIA noted that, on the basis of the conditions of the no-action position in CFTC Letter No. 19-17,

FCMs calculate current assets and undermargined capital charges for each separate account as if each such account were owned by a separate entity, and do not look across to other separate accounts of the same customer for purposes of either calculation, unless the FCM is suspending the ordinary course of business for any such account.

FIA Comment Letter.

Id.

Specifically, requirements that FCMs electing separate account treatment (i) record each separate account independently in the FCM's books and records, including by recording each separate account as a receivable (debit/deficit) or payable with no offsets between the other separate accounts of the same customer; and (ii) reflect the receivable from a separate account as secured (as a current/allowable asset) based on the assets of that separate account rather than on the assets held in another separate account of the same customer.

FIA Comment Letter.

FIA asserted that these proposed revisions to regulation § 1.17 would be costly for FCMs, which would be required to rebuild operational and reporting systems, and to rewrite underlying programming code, to perform the necessary look-across of all of the separately margined accounts for the same separate account customer whenever the separate account customer fails to timely satisfy the previous day's deficit/debit ledger balance in its entirety for the current asset calculation, or fails to settle a margin call by the end of the day after the call for the undermargined capital charge calculation.

Id.

FIA also argued that these proposed revisions to regulation § 1.17 would be punitive for FCMs, because they would impose capital costs on FCMs without regard to any related financial or operational risk. FIA included in its comment letter an example illustrating how an FCM could be required to take a significant capital charge due to a failure to meet a margin call timely in one separate account, even if the separate account customer's other separate accounts, managed by other investment managers, have margin calls that have not yet aged to a point that the FCM would be required to take a capital charge under existing regulation § 1.17.

FIA noted that a recent survey of its members showed that, although the percentage of required margin for separate accounts to total customer margin requirements varied from less than one percent to over 20%, members uniformly reported material potential capital implications measured by amount of margin required for a single beneficial owner across its separate accounts.

Id.

FIA recommended that the Commission modify its proposed amendments to regulation § 1.17 to require a look-across of all of a separate account customer's separate accounts only where the ordinary course of business has been suspended for the separate account customer.

FIA further recommended that such look-across be made subject to the requirements defining the Commission's proposed one business day margin call requirement in proposed regulation § 1.44(f) so that FCMs can continue taking the benefit of current assets and avoiding charges against capital while client settlement in non-USD for separate accounts is pending.

Id.

Like the JAC, FIA discussed the application of margin equity credit to accounts for pending non-USD margin deposits under JAC guidance.

FIA noted this practice appears to be in tension with the Commission's proposed amendments to regulation § 1.17 and urged the Commission to clarify that the Second Proposal was not adopted with the intention of prohibiting such current treatment of pending non-USD transfers for purposes of computing undermargined capital charges.

Id.

In proposing to codify the no-action position of CFTC Letter No. 19-17 in part 1 of its regulations, the Commission considered the way in which it would need to modify existing provisions of part 1 to facilitate separate account treatment for FCMs. With respect to the calculation of current assets as set forth in regulation § 1.17(c)(2)(i) and the undermargined capital charge as set forth in regulation § 1.17(c)(5)(viii), the Commission proposed a more conservative approach to risk management that would trigger inclusion of debits or deficits (with respect to proposed regulation § 1.17(c)(2)(i)) or outstanding margin calls (with respect to proposed regulation § 1.17(c)(5)(viii)) across a separate account customer's separate accounts when a margin call made of such separate account customer for purposes of either regulation is not satisfied timely. Although CFTC Letter No. 19-17, which applied directly to DCOs, did not speak explicitly to how FCMs should treat separate accounts for purposes of these regulations, its provisions call for DCOs to require FCMs to subject accounts receiving separate treatment to heightened scrutiny and enhanced risk management practices, particularly with respect to timely receipt of margin.

The Commission has considered the JAC's and FIA's assertions that the proposed amendments to regulation § 1.17(c)(2)(i) and regulation § 1.17(c)(5)(viii) would represent a deviation from how FCMs have generally understood and applied the conditions of CFTC Letter No. 19-17. The Commission further acknowledges that a separate account customer's untimely payment of margin with respect to a separate account for purposes of regulation § 1.17(c)(2)(i) or regulation § 1.17(c)(5)(viii) does not necessarily indicate that the separate account customer is out of the ordinary course of business, as set forth in proposed regulation § 1.44(a), with respect to that separate account or any other separate account of such customer. It follows that a separate account for which payment of margin is untimely for purposes of regulation § 1.17(c)(2)(i) or regulation § 1.17(c)(5)(viii) may not be indicative of financial or operational distress in the same manner as would untimely payment of margin for purposes of regulation § 1.44. Unlike regulations § 1.17(c)(2)(i) and § 1.17(c)(5)(iii), which require an FCM to reserve capital when the aggregate of a customer's accounts are, respectively, in debit/deficit or undermargined beyond a defined period of time to protect the FCM against potential losses or price exposure if the liquidation of the customer's positions is required, regulation § 1.44 is designed to build in allowances to account for delays resulting from differences in time zones as well as international banking conventions in establishing requirements for meeting a one business day margin call. The Commission accordingly appreciates, and finds persuasive, FIA's comments to the effect that the proposed look-across of separate accounts of a separate account customer who does not timely meet a margin call for purposes of regulation § 1.17(c)(2)(i) or § 1.17(c)(5)(viii) may prove costly to implement and operationally disruptive to deploy. The Commission also appreciates the JAC's comments regarding the potential implementation and compliance burden that the proposed requirements would pose for FCMs.

Accordingly, the Commission is adopting the amendments to regulation § 1.17 as proposed, but with two modifications. First, the Commission is removing language from the proposed amendments to regulation § 1.17(c)(2)(i) that would have provided that, if a separate account does not meet a previous day's margin call for a deficit or debit balance, the FCM shall exclude all separate accounts of that separate account customer carried by the FCM that have a deficit or debit ledger balance from current assets under regulation § 1.17(c)(2)(i). Second, the Commission is modifying the language of proposed regulation § 1.17(c)(5)(viii)(B) to provide that, if a call for margin or other required deposits for any separate account of a particular separate account customer is outstanding for more than one business day, then all outstanding margin calls for

that separate account

shall be treated as if the margin calls are outstanding for more than one business day, and shall be deducted from net capital until all such calls have been met in full. In this manner, where a separate account customer's separate account does not meet a previous day's margin call for a deficit or debit balance under regulation § 1.17(c)(2)(i), or has a margin call or other required deposits outstanding for more than one business day under regulation § 1.17(c)(5)(viii), then the FCM shall treat the separate account on a standalone basis in determining current assets or the undermargined capital charge, and need not look across to debits or deficits, or outstanding margin calls, in the separate account customer's other separate accounts.

As previously discussed, the Commission believes that separate account treatment results in a conservative capital treatment due to the impact of removing portfolio margining across separate accounts, including in the calculation of the required capital based on risk margin separately for each separate account. Even during a period outside the ordinary course of business when disbursements on a separate account basis are suspended, the Commission believes that net capital treatment may in most instances continue to be more conservative by maintaining separate treatment of separate accounts for net capital calculation purposes. In consideration of the comments received regarding the operational difficulties which FCMs may face from being required to consolidate the treatment of separate accounts for net capital calculations and the likely conservative effect of maintaining separate treatment, the Commission is adopting the final rules as modified, and further clarifies that even during a period of a suspension of disbursements on a separate account basis, an FCM must continue separate treatment for net capital calculations. However, should an FCM itself cease treating the separate accounts separately, such as by initiating any cross-default remedies across the separate accounts of a separate account customer (thus indicating the FCM is exercising legal remedies to collapse separate accounts for the purpose of collection against the separate account customer), then continued separate net capital treatment by the FCM of such accounts would no longer be appropriate, as an FCM's exercise of cross-default remedies that combine separate accounts would be inconsistent with an FCM's continued election of separate account treatment.

The Commission additionally considered the JAC's and FIA's comments with respect to the treatment of pending non-USD transfers. As the JAC and FIA noted, JAC Regulatory Alerts #14-03 and #14-06 permit FCMs to apply margin equity credit to an account for pending non-USD transfers for certain purposes and subject to certain conditions. As the JAC noted, the guidance provided by JAC Regulatory Alert #14-03 and #14-06 provides that, due to the inherent delays in the settlement of certain foreign currency transfers, in determining a customer's or noncustomer's margin status (under JAC Regulatory Alert #14-03) or residual interest requirement (under JAC Regulatory Alert #14-06), an FCM may, at its discretion, consider unsettled non-USD transactions as pending in a customer's or noncustomer's account and include in the account's margin equity if: (i) the FCM assesses that it is prudent to do so based on the account's past history of satisfying margin calls and the operational and credit risk profile of the account owner; (ii) the account is on a one-day wire transfer basis (

i.e.,

the wire is initiated on the day the margin call is issued); (iii) the FCM has a sufficient basis to believe that the wire was actually initiated; (iv) the FCM continues to age the pending non-USD receipts and retains the ability to recognize a failed deposit immediately upon occurrence; and (v) the FCM treats unsettled non-USD disbursements from the account in the same manner.

Although the Commission did not discuss treatment of pending non-USD transfers in the First Proposal, in the Second Proposal, or in CFTC Letter No. 19-17, as discussed below, commenters raised questions related to the treatment of pending non-USD transfers in several

contexts, which the Commission has focused on in developing this final rule.

See

JAC, JAC Regulatory Alert #14-03, May 21, 2014, available at

http://www.jacfutures.com/jac/jacupdates/2014/jac1403.pdf;

JAC, JAC Regulatory Alert #14-06, Nov. 4, 2014, available at

http://www.jacfutures.com/jac/jacupdates/2014/jac1406.pdf.

In the Second Proposal, the Commission noted that it sought to enact a narrow codification, with respect to all FCMs, of the no-action conditions of CFTC Letter No. 19-17.

100

In particular, the Commission does not seek to disrupt current, established margining practices at FCMs, except where explicitly stated in this final rule. In considering the JAC's and FIA's comments with respect to the treatment of pending non-USD transfers, the Commission considers, in light of this objective, that currently, and for the past ten years, subject to JAC guidance, a number of FCMs have treated as received certain pending non-USD transfers (

i.e.,

those that are consistent with that guidance) for certain purposes.

100

Second Proposal, 89 FR at 15317.

As the third condition, the FCM must also have a sufficient basis to believe that the transfer was actually initiated for immediate settlement (including, as the Commission understands, that the transfer was actually initiated on the required one-day basis). The Commission notes that, as each condition for the treatment of pending non-USD transfers is a separate condition, the Commission expects that in order to meet this third condition, an FCM would rely on evidence beyond the factors identified in the first condition (

i.e.,

the account's past history of satisfying margin calls and the operational and credit risk profile of the account owner). Further to this point, the requirement that the FCM have a sufficient basis to believe that the transfer was

actually

initiated indicates that an FCM would be expected to identify a sufficient, factual basis to support its conclusion that a

specific

transfer was initiated for immediate settlement consistent with the banking practices relative to the jurisdiction from which the transfer originated. The Commission expects that such sufficient factual support would include at minimum an affirmative, written representation from the customer that the specific transfer had actually been initiated.

101

The fourth condition requires the FCM to continue aging pending non-USD receipts and have the ability to recognize a deposit failure immediately when it occurs, both of which are critical to complying with the requirements of regulation § 1.17 (among other Commission regulations) that require an FCM to be able to accurately age outstanding margin calls. In particular, a transfer that does not arrive by the day it is expected (consistent with banking practices relative to the jurisdiction from which the transfer originated) should be considered to have failed. The fifth condition requires consistent treatment of pending non-USD transfers in an account: to the extent an FCM treats pending non-USD deposits as received for certain purposes, it must similarly treat pending non-USD disbursements as disbursed.

101

The Commission notes that a pattern wherein funds are not timely received despite such representations would undermine the satisfaction of the first condition;

i.e.,

the account's past history of satisfying margin calls.

The Commission has considered the history of FCMs' treatment of pending non-USD transfers under the JAC guidance. Among other information, the Commission has considered, with respect to separate accounts under the terms of the no-action position, the criteria applied to such treatment under the JAC guidance, the potential risks and benefits of such treatment for FCMs and customers, and the Commission's objectives in codifying the no-action position of CFTC Letter No. 19-17. The Commission confirms that it does not intend for the final rule to preclude FCMs from considering pending non-USD transfers as received for purposes of computing the undermargined capital charge pursuant to regulation § 1.17(c)(5), consistent with the JAC guidance as described above.

102

In doing so, however, the Commission notes that it expects that DSROs will diligently monitor their FCMs to ensure compliance with the criteria for such treatment, and will take appropriate supervisory steps where they find failures to comply with such criteria, with particular focus on the requirement that an FCM have a sufficient basis to believe that a non-USD transfer classified as pending was

in fact

initiated, and the requirement that an FCM treat pending non-USD disbursements in a manner consistent with its treatment of pending non-USD receipts.

102

The Commission additionally confirms that the final rule is not intended to preclude FCMs from treating as received pending non-USD transfers, subject to the same five conditions listed in JAC Regulatory Alerts #14-03 and #14-06 discussed above, for purposes of calculating undermargined capital charges for noncustomer and omnibus accounts under regulation § 1.17(c)(5)(ix). As the JAC noted in its comment letter, the Commission did not propose to amend this provision.

Lastly, to respond to the JAC's request for clarification on the subject, the Commission confirms that, for purposes of the undermargined capital charge for a customer account under regulation § 1.17(c)(5), maintenance margin requirements include the risk component only. The Commission further confirms that in computing the value of the margin deposits of an account, including accounts of separate account customers, non-cash collateral should be valued at market value less applicable haircuts.

C. Amendments to Regulations §§ 1.20, 1.32, 22.2, and 30.7

As previously stated, protecting market participants from misuses of customer assets is one of the fundamental purposes of the CEA.

103

Regulations §§ 1.32, 22.2(g), and 30.7(l) are designed in part to further this purpose by requiring each FCM carrying accounts for futures customers, Cleared Swaps Customers, or 30.7 customers, respectively, to perform a daily computation of, and to prepare a daily record demonstrating compliance with, the FCM's obligation to hold a sufficient amount of funds in designated customer segregated accounts to meet the aggregate credit balances of all of the FCM's futures customers, Cleared Swaps Customers, and 30.7 customers.

104

An FCM is required to prepare the daily segregation calculations reflecting customer account balances as of the close of business each day, and to submit the applicable segregation statements electronically to the Commission and to the FCM's DSRO by noon the next business day.

103

Section 3(b) of the CEA, 7 U.S.C. 5(b);

see also, e.g.,

CEA section 4d(a)(2), 7 U.S.C. 6d(a)(2); CEA section 4d(f)(2), 7 U.S.C. 6d(f)(2); CEA section 4b(2)(A), 7 U.S.C. 6b(2)(A).

104

Each FCM that carries accounts for futures customers, Cleared Swaps Customers, and 30.7 customers is required to prepare daily statements demonstrating compliance with the applicable segregation requirements. For futures customers, the FCM must prepare a daily Statement of Segregation Requirements and Funds in Segregation for Customers Trading on U.S. Commodity Exchanges (17 CFR 1.32(a)) (“Futures Segregation Statement”); for Cleared Swaps Customers, the FCM must prepare a daily Statement of Cleared Swaps Customer Segregation Requirements and Funds in Cleared Swaps Customer Accounts under section 4d(f) of the CEA (17 CFR 22.2(g)(1)-(4)) (“Cleared Swaps Segregation Statement”); and for 30.7 customers, the FCM must prepare a daily Statement of Secured Amounts and Funds Held in Separate Accounts for 30.7 Customers pursuant to regulation 30.7 (17 CFR 30.7(l)(1)). The statements listed above are part of the Commission's Form 1-FR-FCM, which contains the financial reporting templates required to be filed by FCMs.

The Commission proposed to amend regulations §§ 1.32, 22.2, and 30.7 to provide that an FCM that permits separate accounts pursuant to regulation § 1.44 must perform its daily segregation calculations, and prepare its daily segregation statements, by treating the accounts of separate account customers as accounts of separate entities. The amendments add new paragraph (l) to regulation § 1.32, new paragraph (g)(11) to regulation § 22.2, and new paragraph

(l)(11) to regulation § 30.7. The purpose of the amendments is to establish the manner in which these existing segregation and reporting obligations apply to FCMs that permit separate accounts pursuant to regulation § 1.44. Regulations §§ 1.32, 22.2, and 30.7 require an FCM to prepare one daily segregation computation, and submit one segregation schedule, for the funds of its futures customers, Cleared Swaps Customers, and 30.7 customers, respectively. The amendments to regulations §§ 1.32, 22.2(g), and 30.7(l) provide that an FCM that permits separate accounts, in preparing such computation and segregation schedule, is required to record each separate account as if it were an account of a separate entity, and include all separate accounts with other futures accounts, Cleared Swaps Customer Accounts, and 30.7 accounts, as applicable, carried by the FCM that are not separate accounts.

In addition, the amendments provide that an FCM, in computing its segregation obligations, may offset a net deficit in a particular separate account customer's separate account against the current value, net of specified haircuts, of any readily marketable securities held by the FCM for the separate account customer, provided that the readily marketable securities are held as margin collateral for the specific separate account that is in deficit. Readily marketable securities held for other separate accounts of the separate account customer may not be used to offset the separate account that is in deficit.

105

The amendments to regulations §§ 1.32, 22.2(g), and 30.7(l) with respect to the offsetting of a net deficit in a customer's account by the value of readily marketable securities, less applicable haircuts, held in the customer's account are consistent with how an FCM currently offsets a net deficit in a customer's account that is margined by securities. In addition, the amendments are consistent with the separate account conditions to the no-action position in CFTC Letter No. 19-17.

106

105

I.e.,

if separate account customer

has separate accounts

and

then readily marketable securities held for separate account

could not be used to offset a deficit in separate account

and vice versa.

106

See

CFTC Letter No. 19-17 (providing, among other conditions for separate account treatment, that “[e]ach receivable from a separate account shall be `grossed up' on the applicable segregation, secured or cleared swaps customer statement; thus, an FCM shall use its own funds to cover the debit/deficit of each separate account.”).

The Commission also proposed to amend regulation § 22.2(f) to revise the regulatory description of the stated calculation of the total amount of funds that an FCM is required to hold in segregation for Cleared Swaps Customers. The amendment: (i) corrects an error included in the drafting of the description of the calculation when the regulation was originally adopted in 2012; and (ii) aligns the regulatory text describing the segregation calculation set forth in regulation § 22.2(f) with the calculation performed on the Cleared Swaps Segregation Statement that is submitted to the Commission each day by FCMs with Cleared Swaps Customers pursuant to regulation § 22.2(g). The amendment applies across FCMs with Cleared Swaps Customers, whether or not such FCMs maintain separate accounts.

The segregation calculation required by regulation § 22.2(f) is intended to ensure that an FCM holds, at all times, a sufficient amount of funds in segregation to cover its total financial obligation to all Cleared Swaps Customers. Compliance with the segregation requirements helps ensure that an FCM is not using the funds of one Cleared Swaps Customer to cover a deficit in the Cleared Swaps Customer Account of another Cleared Swaps Customer, and further helps ensure that an FCM holds sufficient funds in segregation to transfer the Cleared Swaps Customer Accounts, including the Cleared Swaps and the Cleared Swaps Customer Collateral, to a transferee FCM if the transferor FCM becomes insolvent.

To achieve the regulatory objective noted above, regulation § 22.2(f)(2) currently requires an FCM to calculate its minimum segregation requirement as the sum of the net liquidating equities of each Cleared Swaps Customer Account with a positive account balance carried by the FCM. The net liquidating equity of a Cleared Swaps Customer Account is explicitly calculated as the sum of the market value of any funds held in the Cleared Swaps Customer Account of a Cleared Swaps Customer (including readily marketable securities), as adjusted positively or negatively by, among other things, any unrealized gains or losses on open Cleared Swaps positions, the value of open long option positions and short option positions, fees charged to the account, and authorized withdrawals. To the extent that the calculation results in a net liquidating equity that is positive, the Cleared Swaps Customer Account has a credit balance.

107

To the extent that the calculation results in a net liquidating equity that is negative, the Cleared Swaps Customer Account has a debit balance.

108

Regulation § 22.2(f)(4) provides that an FCM must hold, at all times, a sufficient amount of funds in segregation to meet the total net liquidating equities of all Cleared Swaps Customer Accounts with credit balances, and further provides that the FCM may not offset this total by any Cleared Swaps Customer Accounts with debit balances.

107

17 CFR 22.2(f)(3).

108

Id.

With respect to Cleared Swaps Customer Accounts with debit balances, regulation § 22.2(f)(5) further requires the FCM to include in the total funds required to be held in segregation all debit balances to the extent secured by readily marketable securities held for the particular Cleared Swaps Customers that have debit balances. The required addition of debit balance accounts in regulation § 22.2(f)(5) was intended to be consistent with the long-standing Futures Segregation Statement contained in the Form 1-FR-FCM and the Form 1-FR-FCM Instructions Manual.

109

An error, however, was made in drafting the description of the details of the segregation calculation in current regulation § 22.2(f)(5). Specifically, as noted above, regulation § 22.2(f)(5) requires an FCM to include in the total segregation requirement any Cleared Swaps Customer Accounts with debit balances that are secured by readily marketable securities. However, the full value of the readily marketable collateral is part of the calculation of the net liquidating equity of the account. Therefore, a Cleared Swaps Customer Account with a debit balance would never have additional readily marketable securities available to offset a debit balance.

110

109

In adopting the final regulation § 22.2(f), the Commission stated that proposed regulation § 22.2(f) set forth an explicit calculation for the amount of Cleared Swaps Customer Collateral that an FCM must maintain in segregation that did not materially differ from the calculation of the amount of funds an FCM is required to hold in segregation under the Form 1-FR-FCM for futures customers. The Commission adopted final regulation § 22.2(f) as proposed. Protection of Cleared Swaps Customer Contracts and Collateral; Conforming Amendments to the Commodity Broker Bankruptcy Provisions; Final Rule, 77 FR 6336, at 6352-6353 (Feb. 7, 2012).

110

For example, if a Cleared Swaps Customer Account was comprised of cash of $300, securities of $200, and an unrealized loss on open Cleared Swaps of $600, the account would have a net equity debit balance of $100 under regulation § 22.2(f). There are no additional securities that the FCM may use to secure the $100 debit balance and, therefore, the FCM is required to increase its segregation requirement by $100 to ensure that there are sufficient funds in segregation to cover the FCM's obligation to all Cleared Swaps Customers with a credit balance.

The segregation calculation required under regulation § 1.32 for futures accounts, and the Commission's Form 1-FR-FCM and related Form 1-FR-

FCM Instructions Manual, differs from the description as currently written in regulation § 22.2(f)(4) and (5) with respect to the offsetting of debit balances by readily marketable securities. Specifically, an FCM is required to calculate the net equity of each futures customer excluding the value of any noncash collateral held in the account.

111

If the calculation results in a debit balance, the FCM is permitted to offset the debit balance by the fair market value of any readily marketable securities (after application of applicable securities haircuts set forth in the regulation).

112

111

The Form 1-FR-FCM Instructions Manual provides that a customer account is in deficit when the combination of the account's cash ledger balance, unrealized gain or loss on open futures contracts, and the value of open option contracts liquidates to an amount less than zero. The manual explicitly provides that “[a]ny securities used to margin the account are not included in determining a customer's deficit.” 1-FR-FCM Instructions Manual, p. 10-2. Accordingly, an FCM would exclude the value of any readily marketable securities from the calculation of the customer's account balance. The 1-FR-FCM Instructions Manual is available on the Commission's website at:

www.cftc.gov/sites/default/files/idc/groups/public/@iointermediaries/documents/file/1fr-fcminstructions.pdf.

112

17 CFR 1.32(b). Applying the calculation in regulation § 1.32 to Cleared Swaps, if a Cleared Swaps Customer Account was comprised of cash of $300, securities of $200, and an unrealized loss on open Cleared Swaps of $600, the account would have a net equity debit balance of $300, as the value of the securities is not included in the calculation ($300 cash less $600 in unrealized losses, results in a $300 debit balance). The FCM may offset the $300 debit balance by $170, which represents the value of the readily marketable securities held in the account as collateral ($200 fair market value of the securities, less a $30 haircut). The FCM is then required to include $130 in its segregation requirement, which represents the amount of the unsecured debit balance remaining in the customer's account (

i.e.,

$300 debit balance, less $170 value of the securities after haircuts).

As noted above, the amendments to regulation § 22.2(f)(4) and (5) are intended to correct the description of the segregation calculation and to make it consistent with: (i) how FCMs calculate their total Cleared Swaps segregation obligations under regulation § 22.2(g), (ii) how FCMs report their total segregation requirements on the Cleared Swaps Segregation Statement, and (iii) the segregation calculation requirements for futures accounts under regulation § 1.32. Thus, the amendments are not expected to have any effect on FCMs and their current practices.

In addition, the Commission proposed to amend regulations §§ 1.20(i) and 30.7(f), which require an FCM carrying futures accounts and 30.7 accounts, respectively, to calculate its total segregation requirements in a manner that is consistent with current regulation § 22.2(f). As with the amendment to regulation § 22.2(f), the amendments to regulations §§ 1.20(i) and 30.7(f) apply across FCMs that maintain futures customer accounts or 30.7 customer accounts, respectively, whether or not such FCMs maintain separate accounts. The Commission adopted current regulations §§ 1.20(i) and 30.7(f) in 2013. The final regulations, however, did not include the provision set forth in regulation § 22.2(f)(5) requiring an FCM to include any secured debit balances in its segregation requirement. This omission was unintentional, as the Commission expressed its intent to “mirror” the requirements of regulation § 22.2(f) in regulation § 1.20(i) (and effectively regulation § 30.7(f)).

113

Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations, 78 FR 68506, 68543 (Nov. 14, 2013) (discussing the Commission's intent to adopt regulation § 1.20(i) consistent with the corresponding requirements in regulation § 22.2(f));

id.

at 68576 (discussing the Commission's intent for the daily segregation calculation for 30.7 accounts to be consistent with the requirements for the daily segregation calculations for futures customer funds in regulation § 1.32).

To address the omission, the Commission proposed to amend regulations §§ 1.20(i) and 30.7(f) to reflect the requirement that an FCM include any unsecured customer debit balances, calculated consistent with the amendments to regulation § 22.2(f)(4) and (5) that are discussed above, in the calculation of its futures and foreign futures and foreign options segregation requirement. The amendments to regulations §§ 1.20(i) and 30.7(f) accurately describe and reflect the existing segregation calculations for futures, foreign futures, and Cleared Swaps as originally intended. The amendments to regulations §§ 1.20(i) and 30.7(f) are not expected to have any impact on FCMs as the firms currently calculate their segregation requirements by including customer unsecured debit balances.

The Commission did not receive any comments with respect to the proposed amendments to regulations §§ 1.20, 1.32, 22.2, and 30.7. Accordingly, the Commission is adopting the amendments to regulations §§ 1.20, 1.32, 22.2, and 30.7 as proposed.

114

The Commission is making technical changes in the final amendments with respect to regulations §§ 1.20(i)(5)(ii), 1.32(b), 22.2(f)(5)(ii), and 30.7(f)(2)(v)(B) to correct the citation to the SEC regulation defining “ready market” (§ 240.15c3-1(c)(11) rather than § 241.15c3-1(c)(11)).

D. Regulation § 1.44(a)

The Commission structured proposed regulation § 1.44 so that FCMs would be required to avoid returning margin to customers when doing so would create or exacerbate a margin deficiency in the customer's account; however, the proposed regulation then would allow FCMs to provide for separate account treatment within the Commission's broader regulatory framework for FCMs. As such, regulation § 1.44, as proposed, contains certain terms that are designed to operate in a specific manner with respect to regulation § 1.44, but that do not apply, or do not apply in the same way, with respect to other of the Commission's FCM regulations. The Commission therefore proposed to add new regulation § 1.44(a) to define certain terms only for purposes of regulation § 1.44. The Commission believes that regulation § 1.44(a) is reasonably necessary to accomplishing the goals of protecting customer funds and mitigating systemic risk because it defines key terms in requirements that FCMs will need to apply to ensure margin adequacy, and in requirements that FCMs will need to apply when treating customer accounts separately for purposes of margin adequacy.

The Commission proposed to define “account” for purposes of proposed regulation § 1.44 as meaning a futures account, a Cleared Swaps Customer Account (both of which are defined in regulation § 1.3, which definitions apply broadly to all CFTC regulations), or a § 30.7 account (as defined in regulation § 30.1

115

). The Commission proposed this definition to implement the proposed Margin Adequacy Requirement, including in the context of separate account treatment, with respect to accounts of all three types for all FCMs, consistent with comments received in response to the First Proposal.

115

17 CFR 30.1.

ICE's comment letter indirectly addressed the definition of “account” in proposed regulation § 1.44(a). ICE voiced support for the Commission's proposal to permit FCMs to provide separate account treatment for customers with regulation 30.7 accounts for futures and options transactions traded on exchanges outside the United States, but stated it does not believe it is necessary for the Commission to distinguish regulation 30.7 accounts from futures and Cleared Swap Customer accounts in connection with separate account treatment.

116

ICE also noted that there are references in proposed regulation § 1.44 to DCMs that should also include foreign exchanges

in connection with regulation 30.7 accounts.

117

116

ICE Comment Letter.

117

Including proposed regulation § 1.44(b)(2) and (f)(7).

Id.

The Commission proposed to codify the Second Proposal principally in part 1 (as opposed to in part 39) in light of comments received in response to the First Proposal. This is designed to ensure that the Margin Adequacy Requirement and requirements for separate account treatment will apply directly to all FCMs and all FCM customers, including futures customers, Cleared Swaps Customers, and 30.7 account customers. The Commission is distinguishing these accounts in regulation § 1.44 to ensure that the regulation encompasses each class of FCM customer.

The Commission agrees that certain references to DCMs that are included in regulation § 1.44 should be clarified to include explicitly foreign exchanges in connection with 30.7 accounts, as separate account customers may have foreign futures and foreign options positions traded on such exchanges. Accordingly, as noted further below in connection with regulation § 1.44(b)(2) and 1.44(f)(7), in adopting these provisions, the Commission is modifying them to refer to “any designated contract market

or other board of trade,”

in order to encompass such foreign exchanges. The Commission did not receive any other comments related to the definition of “account” in proposed regulation § 1.44(a) and is adopting that definition as proposed.

The Commission also proposed in proposed regulation § 1.44(a) to further define “business day” as having the same meaning as set forth in regulation § 1.3, but with the clarification that “holiday” refers to Federal holidays as established by 5 U.S.C. 6103. The Commission also proposed in proposed regulation § 1.44(a) to define “holiday” as meaning Federal holidays as established by 5 U.S.C. 6103.

In Question 4 of the Second Proposal, the Commission sought commenters' views on how the proposed definition of “business day” should address days when securities and other markets are closed. (

E.g.,

whether the Commission should address in the definition days when such other markets are open or create an exception for days when such markets are closed on a prescheduled basis.) The Commission sought information on potential liquidity challenges or other risks that could result from such an exception, as well as information on how FCMs and customers currently address days when securities and other markets are closed.

In its comment letter, FIA noted that neither the proposed definitions of “business day” nor “holiday” in proposed regulation § 1.44(a) address days on which banks are open but futures and securities markets are closed.

118

FIA stated that, on such days, transfers of non-cash collateral cannot settle, and separate account customers settling initial margin calls with such collateral will, under the proposed regulation, be deemed to have failed to meet a margin call.

119

In FIA's view, a separate account customer should not be deemed to have failed to settle a margin call because securities markets are closed.

120

FIA suggested the Commission revise the definition of “holiday” in proposed regulation § 1.44(a) to provide that holidays include “any business day that is not a securities settlement day in the United States.”

121

No other commenters responded specifically to this question.

118

FIA Comment Letter.

119

Id.

120

Id.

121

Id.

The Commission acknowledges that, on days on which banks are open but futures and securities markets are closed, customers, including separate account customers, may be unable to use non-cash collateral to aid in their meeting margin calls. However, FCMs and customers may arrange for a variety of methods to settle margin calls, including bank transfers. The Commission believes that, given the availability of such funding mechanisms on days when banks are open but securities and other markets are closed, introducing an exception that would allow for additional delays in the payment of margin on such days may introduce unnecessary additional risk of undermargining.

The Commission did not receive any other comments related to the definitions of “business day” or “holiday” in proposed regulation § 1.44(a) and is adopting those definitions as proposed.

Relatedly, the Commission proposed to define “one business day margin call” as a margin call that is issued and met in accordance with the requirements of proposed regulation § 1.44(f). The Commission did not receive any comments with respect to this proposed definition, but the Commission received comments related to the substantive requirements defining a one business day margin call in proposed regulation § 1.44(f). The Commission addresses those comments below in connection with that provision. The Commission is adopting the definition of “one business day margin call” in regulation § 1.44(a) as proposed.

Under regulation § 1.44, an FCM may provide disbursements on a separate account basis only when it, and its customer, are operating within the “ordinary course of business,” as that term is defined in the proposed regulation. The Commission proposed to define “ordinary course of business” as meaning the standard day-to-day operation of the FCM's business relationship with its separate account customer, a condition where there are no unusual circumstances that might indicate either a materially increased level of risk that the separate account customer may fail promptly to perform its financial obligations to the FCM, or a decrease in the FCM's financial resilience. The Commission proposed regulation § 1.44(e) to set forth the circumstances that would be inconsistent with the ordinary course of business, and the occurrence of which would require a cessation of disbursements on a separate account basis.

SIFMA-AMG contended that the definition of “ordinary course of business” in proposed regulation § 1.44(a) poses certain regulatory compliance challenges.

122

Specifically, SIFMA-AMG asserted that the proposed definition does not sufficiently clarify the meaning of “standard day-to-day operation.”

123

SIFMA-AMG argued that FCMs and DCOs would be required to continuously monitor for a series of events, some of which would not appear to rise to the level of significance to suggest that they are not within the ordinary course of business, such as the failure of a customer to make a single margin payment.

124

SIFMA-AMG urged the Commission to better define “ordinary course of business” and consider an approach that presumes operation in the ordinary course of business, with clearly delineated events such as default or bankruptcy as the only instances that would be considered outside the ordinary course of business.

125

122

SIFMA-AMG Comment Letter.

123

Id.

124

Id.

125

Id.

SIFMA-AMG further contended that the Commission's proposed definition of “ordinary course of business” fails to recognize that FCMs must, under Commission regulations, manage risk effectively, and that FCMs also have

commercial incentives to do so.

126

SIFMA-AMG argued the proposed definition of “ordinary course of business” is inconsistent with an FCM's obligations, noting that an FCM's obligations under its Risk Management Program (RMP) are intentionally fluid and are designed to allow FCMs to tailor their RMP to the specific activities of the FCM and its customers.

127

126

Id.

127

Id.

In adopting regulation § 1.44(a), the Commission has determined to modify the definition of “ordinary course of business” in consideration of SIFMA-AMG's comment. As an initial matter, the Commission notes that under regulation § 1.44 as proposed, events inconsistent with the ordinary course of business are generally those that the Commission would expect an FCM to become aware of through its existing compliance function and procedures (

e.g.,

with respect to cessation of disbursements on a separate account basis for a separate account customer, a failure to deposit margin timely; the occurrence and declaration

by the FCM

of an event of default

as defined in the account documentation executed between the FCM and the separate account customer;

a good faith determination by the FCM's chief compliance officer (CCO), one of its senior risk managers, or other senior manager,

following such FCM's own internal escalation procedures,

that the separate account customer is in financial distress; or the insolvency or bankruptcy of the separate account customer or a parent company of the customer; or, with respect to cessation of disbursements on a separate account basis for any of an FCM's customers, a determination in good faith by an FCM's CCO, senior risk managers, or other senior management, that

the FCM itself

is under financial or other distress; or the insolvency or bankruptcy of the FCM or a parent company of the FCM) and notifications or directives from third parties.

The Commission notes that the list of events inconsistent with the ordinary course of business proposed as part of regulation § 1.44(e) is substantially the same as the list of events discussed in CFTC Letter No. 19-17, which has been relied on by DCOs (and by extension their clearing FCMs) successfully since 2019. As SIFMA-AMG noted in its comment letter, FCMs have some discretion in managing risk with respect to their (and their customers') activities, and FCMs appear to have done so effectively under the conditions of CFTC Letter No.19-17 for over five years. The Commission expects FCMs will under regulation § 1.44 similarly exercise risk management discretion to identify when certain non-ordinary course of business events have occurred.

128

See, e.g.,

new regulation § 1.44(e)(1)(iii) (“A good faith determination by the futures commission merchant's chief compliance officer, one of its senior risk managers, or other senior manager, following such futures commission merchant's own internal escalation procedures, that the separate account customer is in financial distress, or there is significant and bona fide risk that the separate account customer will be unable promptly to perform its financial obligations to the futures commission merchant, whether due to operational reasons or otherwise.”).

Additionally, the Commission notes that although failure to make a single margin payment may not in itself represent a departure from the ordinary course of business (hence the Commission's proposal, consistent with the no-action conditions of CFTC Letter No. 19-17, to include an exception to non-ordinary course of business conditions for failure to pay margin due to certain unusual administrative errors or operational constraints), as a general matter, ensuring timely payment of margin is critical to the Commission's goal of providing for separate account treatment in a manner that ensures the safety of customer funds and effective risk mitigation.

Although the Commission believes default or bankruptcy of an FCM or customer are not the only events that could represent a departure from the ordinary course of business with respect to separate account margining, the Commission agrees that the standard for what constitutes the ordinary course of business can be more clearly defined.

Under the proposal, although the occurrence of any of the events described in regulation § 1.44(e) would be inconsistent with the “ordinary course of business,” it was also possible that some other, unspecified, events might also be inconsistent with the “ordinary course of business.” Accordingly, the Commission has modified regulation § 1.44(a) to close the set of such events by providing that the “ordinary course of business” means the operation of the FCM's business relationship with its separate account customer

absent the occurrence of one or more of the events specified in regulation § 1.44(e).

In such manner, the ordinary course of business continues, provided none of the events delineated in regulation § 1.44(e) have occurred.

The Commission proposed to define “separate account” as meaning any one of multiple accounts of the same separate account customer that are carried by the same FCM. The Commission did not receive any comments with respect to this proposed definition and is adopting it as proposed.

The Commission proposed to define “separate account customer” as meaning a customer for which the FCM has elected to engage in separate account treatment. The Commission also did not receive any comments with respect to this proposed definition and is adopting it as proposed.

Lastly, the Commission proposed to define “undermargined amount” for an account as meaning the amount, if any, by which the customer margin requirements with respect to all products held in that account, exceed the net liquidating value plus the margin deposits currently remaining in that account.

129

The proposed definition noted that “[f]or purposes of this definition, `margin requirements' shall mean the level of maintenance margin or performance bond (including, as appropriate, the equity component or premium for long or short option positions) required for the positions in the account by the applicable exchanges or clearing organizations.”

130

This clarification (which was drawn from the definition of risk margin in regulation § 1.17(b)(8)) is in recognition of the difference between exchange (or clearing organization) requirements for “initial margin” and “maintenance margin.” However, here, unlike risk margin, the Commission included the equity component or premium for long or short option positions, as those are part of the total required level of margin. “Initial margin” is the amount of margin (otherwise known as “performance bond”

131

in this context) required to establish a position. Some (though not all) contract markets and clearing houses establish “maintenance margin” requirements that are less than the corresponding initial margin

requirement. Where, due to adverse market movements, the amount of margin on deposit is less than the initial margin requirement, but greater than or equal to maintenance margin, the FCM is not required to (though it may) call additional margin from the customer. Once the amount of margin on deposit is less than the maintenance margin required, the FCM must call the customer for enough margin to meet the

initial

margin level.

129

The definition of “undermargined amount” in regulation § 1.44(a) is different from, and simpler than, the definitions of “undermargined amount” for the purpose of residual interest calculations in regulations §§ 1.22(c)(1), 22.2(f)(6)(i), and 30.7(f)(1)(ii). The calculations in the latter cases are required to take into account information at the close of business on day

T-1

that will be used to calculate a residual interest requirement on day

as well as payments that may be received on day

and the elimination of double counting of debit balances.

130

The definition of “undermargined amount” in regulation § 1.44(a) further provides that, with respect to positions for which maintenance margin is not specified, “margin requirements” shall refer to the initial margin required for such positions.

131

“Performance bond” secures the performance by a customer to meet its variation margin payment obligations to its FCM (or the performance of variation margin payment obligations of an FCM to the clearinghouse, or to an intermediary upstream FCM).

The Commission used the term “undermargined amount” in connection with proposed regulation § 1.44(f) in defining the requirements for making and meeting a one business day margin call, as well as in proposed regulation § 1.44(g) in setting legally segregated, operationally commingled (LSOC) compliance calculations for separate accounts.

In its comment letter, the JAC contended that the Commission's proposed definition of “undermargined amount” in proposed regulation § 1.44(a) is inconsistent with industry practice and methodologies for calculating the undermargined amount provided in the JAC Margins Handbook.

132

Specifically, proposed regulation § 1.44(a) defines “undermargined amount” for an account as, “the amount, if any, by which the customer margin requirements with respect to all products held in that account exceeds the net liquidating value plus the margin deposits currently remaining in that account.” Further, proposed regulation § 1.44(a) provides that, for purposes of such definition, “margin requirements” means the “level of maintenance margin or performance bond (including, as appropriate, the equity component or premium for long or short options positions) required for the positions in the account by the applicable exchanges or clearing organizations.”

132

JAC Comment Letter.

As the JAC explained, its Margins Handbook recognizes two methods for determining the undermargined amount: the Net Liquidating Value Method

133

and the Total Equity Method.

133

Also referred to as the “Risk Method” or “Pure SPAN Method.”

For purposes of the Net Liquidating Value Method, the JAC Margins Handbook defines the undermargined amount as: “The amount by which margin equity is less than the maintenance margin requirement.”

134

The JAC noted that, for purposes of this method, its Margins Handbook defines margin equity as “an account's net liquidating equity plus the collateral value of acceptable margin deposits”

135

and defines the maintenance margin requirement as: “The minimum amount of margin equity required to be maintained in an account.”

136

134

JAC Comment Letter (citing JAC Margins Handbook, Chapter 1, Definition of “Undermargined Amount”).

135

Id.

(citing JAC Margins Handbook, Chapter 1, Definition of “Margin Equity”).

136

Id.

(citing JAC Margins Handbook, Chapter 1, Definition of “Maintenance Margin Requirement (MMR)”). The definition further notes that the maintenance margin requirement is the actual risk margin calculated by the SPAN® margin system.

Id.

Under the alternative Total Equity Method, the undermargined amount is the amount by which total equity plus the collateral value of acceptable margin deposits is less than the risk maintenance margin requirement adjusted for the option value.

137

Id.

(citing JAC Margins Handbook, Chapter 4, “Margins Calls”). The JAC noted that net long option value reduces the risk margin requirement while net short option value increases it.

The JAC argued that, as proposed, the definition of “undermargined amount” in proposed regulation § 1.44(a) would require that, for all customer accounts (not just the separate accounts of separate account customers), an FCM include the equity component of long and short options in both the margin equity and the margin requirement.

138

However, the JAC asserted, under the JAC Margins Handbook, exchange rules, and industry practice, the equity component of long and short options is included only in either the margin equity (under the Net Liquidating Value Method) or margin requirement (under the Total Equity Method).

139

The JAC further asserted that currently, option premium is already included in margin equity and is not a component of the margin requirement.

140

138

Id.

139

Id.

140

Id.

The JAC noted that, depending on the composition of an account, the Second Proposal's definition of “undermargined amount” may result in different undermargined amounts than the Net Liquidating Value Method or Total Equity Method as those methods are applied today. The JAC requested the Commission provide the specific calculation for inclusion of the equity component of premium for long or short options positions and provide further clarification as to the rationale for the apparent proposed change in methodology.

FIA similarly commented that, although the proposed definition of “undermargined amount” in proposed regulation § 1.44(a) appeared to derive from the JAC Margins Handbook definition of the same term, the definition as proposed may give the impression that the Commission intends to codify a preference for the Net Liquidating Value Method to the exclusion of the Total Equity Method alternative in the JAC Margins Handbook. FIA recommended that the Commission amend the proposed definition of “undermargined amount” in proposed regulation § 1.44(a) to provide that “undermargined amount” for an account means the account's margin deficiency, if any, computed in accordance with applicable guidance of the JAC promulgated under regulation § 1.52(d).

The Commission's proposed definition of “undermargined amount” is based not on the Net Liquidating Value/Risk/Pure SPAN Method as set forth in the JAC Margins Handbook but rather on the Margin Adequacy Requirement in regulation § 39.13(g)(8)(iii), which provides that a DCO shall require its clearing members to ensure their customers do not withdraw funds from their accounts with such clearing members unless the net liquidating value plus the margin deposits remaining in a customer's account after such withdrawal are sufficient to meet the customer initial margin requirements with respect to all products and swap portfolios held in such customer's account which are cleared by the DCO. In that respect, it is not intended to evince a requirement to determine the undermargined amount of an account specifically using the Net Liquidating Value Method to the exclusion of the Total Equity Method as set forth in the JAC Margins Handbook. In proposing the definition of “undermargined amount,” the Commission sought to make clear that an FCM's determination of the undermargined amount for a separate account should account for the equity component or premium for long or short options positions in computing the required level of margin for an account. However, the Commission's intent was not to change FCMs' current practice with respect to the way in which they determine the undermargined amount for an account.

In its comment letter, the JAC noted that FCMs determine the undermargined amount using either the Net Liquidating Value method or the alternative Total Equity method set forth in the JAC Margins Handbook, both of which incorporate the equity component for long or short option positions (the former as part of margin equity and the latter as part of margin requirements), and that margin

premium is already included as part of margin equity under either method.

Having considered the JAC's and FIA's comments, relevant provisions of the JAC Margins Handbook, and the Commission's objectives in defining “undermargined amount,” the Commission is persuaded that utilizing either the Net Liquidating Value method or the alternative Total Equity method to determine an account's undermargined amount generally will produce an identical result (with the exception, as the JAC notes, of certain instances involving long options positions, in which the Total Equity method will produce a greater margin deficiency, resulting in a greater margin requirement, which would further serve to mitigate risk).

Accordingly, in adopting the definition of “undermargined amount” in regulation § 1.44(a), the Commission is removing the proposed language stating that, for purposes of the definition of “undermargined amount,” the term “margin requirements” shall “include[ ], as appropriate, the equity component or premium for long or short option positions,” based on the Commission's understanding, in light of comments received, that under current practice, the equity component is included as a matter of course in margin equity or margin requirements, and the option premium is factored into margin equity.

141

The Commission believes the resulting definition is consistent with the Net Liquidating Value method for determining an undermargined amount, as set forth in the JAC's Margins Handbook. Notwithstanding that definition, the Commission also believes an FCM's use of the Total Equity method, as set forth in the JAC's Margins Handbook, would also be consistent with that definition.

141

The Commission is also making a technical (grammatical) change to the definition of “undermargined amount” in regulation § 1.44(a) to change “by which the customer margin requirements . . .

exceeds

the net liquidating value . . .” to “by which the customer margin requirements . . .

exceed

the net liquidating value . . . .”

In Question 5 of the Second Proposal, the Commission invited commenters to provide feedback with respect to whether the definition of “undermargined amount” should apply haircuts to the value of customer collateral held by an FCM and, if so, whether the amount of such haircuts should be based on SEC rule 240.15c3-1 and Commission regulation § 1.17(c)(5)(ii), or on some other basis. A haircut is a reduction in the allowable value of an asset to account for market risk. In its comment letter, the JAC stated that non-cash collateral on deposit in a customer's account should be valued at market value less applicable SEC and CFTC haircuts for determining the margin value of collateral. No other commenters responded specifically to this question. The Commission has determined, in adopting the definition of “undermargined amount” in regulation § 1.44(a), to include in that definition a requirement that collateral haircuts based on Rule 15c3-1 of the Securities and Exchange Commission (17 CFR 240.15c3-1) and regulation § 1.17(c)(5) be applied to the value of the margin deposits held by an FCM to reflect potential market risk associated with the value of the collateral if and when such collateral was liquidated.

Accordingly, the Commission is adopting regulation § 1.44(a) as proposed, subject to the modifications discussed above with respect to the definitions of “ordinary course of business” and “undermargined amount.”

E. Proposed Regulation § 1.44(b)

The Commission proposed regulation § 1.44(b) to require all FCMs, whether clearing or non-clearing, to comply with the same Margin Adequacy Requirement that DCOs are required to apply to their clearing FCMs pursuant to regulation § 39.13(g)(8)(iii). As proposed, regulation § 1.44(b) provides that an FCM shall ensure that a customer does not withdraw funds from its accounts with such FCM unless the net liquidating value (calculated as of the close of business on the previous business day) plus the margin deposits remaining in the customer's account after such withdrawal are sufficient to meet the customer initial margin requirements with respect to all products held in such customer's account, except as provided in proposed regulation § 1.44(c), which allows an FCM to permit disbursements on a separate account basis under ordinary course of business conditions.

142

Consistent with the existing Margins Handbook, the Margin Adequacy Requirement is based on initial margin requirements rather than any lower maintenance margin requirement.

See

JAC Margins Handbook at 10-1 (“Margin Funds Available for Disbursement = Net Liquidating Value + Margin Deposits − Initial Margin Requirement > 0”);