Proposed Rule2023-24774
Investment of Customer Funds by Futures Commission Merchants and Derivatives Clearing Organizations
Primary source
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Published
November 21, 2023
Issuing agencies
Commodity Futures Trading Commission
Abstract
The Commodity Futures Trading Commission ("Commission" or "CFTC") is proposing to amend its regulations governing the types of investments that futures commission merchants ("FCMs") and derivatives clearing organizations may make with funds held for the benefit of customers trading futures, foreign futures, and cleared swap transactions. The Commission is also specifying market risk capital charges that an FCM would be required to take on the revised permitted investments in computing the firm's adjusted net capital. The proposed amendments would also amend regulations that require each FCM to report to the Commission and to the firm's designated self-regulatory organization the name, location, and amount of customer funds held by each depository, including any investments of customer funds held by the depository. Lastly, the Commission is proposing to revise its regulations to eliminate the requirement that a depository holding customer funds must provide the Commission with read-only electronic access to such accounts for the FCM to treat the funds held in the accounts as customer segregated fund accounts.
Full Text
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<title>Federal Register, Volume 88 Issue 223 (Tuesday, November 21, 2023)</title>
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[Federal Register Volume 88, Number 223 (Tuesday, November 21, 2023)]
[Proposed Rules]
[Pages 81236-81292]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-24774]
[[Page 81235]]
Vol. 88
Tuesday,
No. 223
November 21, 2023
Part III
Commodity Futures Trading Commission
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17 CFR Parts 1, 22, and 30
Investment of Customer Funds by Futures Commission Merchants and
Derivatives Clearing Organizations; Proposed Rule
Federal Register / Vol. 88 , No. 223 / Tuesday, November 21, 2023 /
Proposed Rules
[[Page 81236]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 22, and 30
RIN 3038-AF24
Investment of Customer Funds by Futures Commission Merchants and
Derivatives Clearing Organizations
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing to amend its regulations governing the types of
investments that futures commission merchants (``FCMs'') and
derivatives clearing organizations may make with funds held for the
benefit of customers trading futures, foreign futures, and cleared swap
transactions. The Commission is also specifying market risk capital
charges that an FCM would be required to take on the revised permitted
investments in computing the firm's adjusted net capital. The proposed
amendments would also amend regulations that require each FCM to report
to the Commission and to the firm's designated self-regulatory
organization the name, location, and amount of customer funds held by
each depository, including any investments of customer funds held by
the depository. Lastly, the Commission is proposing to revise its
regulations to eliminate the requirement that a depository holding
customer funds must provide the Commission with read-only electronic
access to such accounts for the FCM to treat the funds held in the
accounts as customer segregated fund accounts.
DATES: Comments must be received on or before January 17, 2024.
ADDRESSES: You may submit comments, identified by RIN 3038-AF24, by any
of the following methods:
<bullet> CFTC Comments Portal: <a href="https://comments.cftc.gov">https://comments.cftc.gov</a>. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
<bullet> Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Center, 1155 21st Street NW, Washington, DC 20581.
<bullet> Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods.
Submissions through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
<a href="https://comments.cftc.gov">https://comments.cftc.gov</a>. You should submit only information that you
wish to make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act (``FOIA''), a petition for confidential
treatment of the exempt information may be submitted according to the
procedures established in Sec. 145.9 of the Commission's
regulations.\1\
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\1\ 17 CFR 145.9. Commission Regulations referred to herein are
found at 17 CFR Chapter I, and are accessible on the Commission's
website: <a href="https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm">https://www.cftc.gov/LawRegulation/CommodityExchangeAct/index.htm</a>.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from <a href="https://comments.cftc.gov">https://comments.cftc.gov</a> that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
the FOIA.
FOR FURTHER INFORMATION CONTACT: Amanda L. Olear, Director, (202) 418-
5213, <a href="/cdn-cgi/l/email-protection#7617191a131704361510021558111900"><span class="__cf_email__" data-cfemail="1677797a737764567570627538717960">[email protected]</span></a>; Thomas J. Smith, Deputy Director, 202-418-5495,
<a href="/cdn-cgi/l/email-protection#3a4e4957534e527a595c4e59145d554c"><span class="__cf_email__" data-cfemail="196d6a74706d71597a7f6d7a377e766f">[email protected]</span></a>; Warren Gorlick, Associate Director, 202-418-5195,
<a href="/cdn-cgi/l/email-protection#95e2f2fae7f9fcf6fed5f6f3e1f6bbf2fae3"><span class="__cf_email__" data-cfemail="2552424a57494c464e65464351460b424a53">[email protected]</span></a>; Liliya Bozhanova, Special Counsel, 202-418-6232,
<a href="/cdn-cgi/l/email-protection#e38f818c998b828d8c9582a380859780cd848c95"><span class="__cf_email__" data-cfemail="472b25283d2f2629283126072421332469202831">[email protected]</span></a>; Joo Hong, Risk Analyst, (202) 418-6221,
<a href="/cdn-cgi/l/email-protection#e8828087868fa88b8e9c8bc68f879e"><span class="__cf_email__" data-cfemail="43292b2c2d2403202537206d242c35">[email protected]</span></a>, Market Participants Division, or Lihong McPhail,
Research Economist, (202) 418-5722, <a href="/cdn-cgi/l/email-protection#ed81808e9d858c8481ad8e8b998ec38a829b"><span class="__cf_email__" data-cfemail="adc1c0ceddc5ccc4c1edcecbd9ce83cac2db">[email protected]</span></a>, Office of the
Chief Economist, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581; Scott Sloan, Special
Counsel, 312-596-0708, <a href="/cdn-cgi/l/email-protection#4330302f2c222d03202537206d242c35"><span class="__cf_email__" data-cfemail="3645455a595758765550425518515940">[email protected]</span></a>, Division of Clearing and Risk,
Commodity Futures Trading Commission, 77 West Jackson Boulevard, Suite
800, Chicago, Illinois 60604.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Background and Statutory Authority
1. Segregation of Customer Funds by Futures Commission Merchants
and Derivatives Clearing Organizations
2. Authority for Futures Commission Merchants and Derivatives
Clearing Organizations To Invest Customer Funds
II. Requests for Amendments to the List of Permitted Investments
III. Proposal
A. Investment of Customer Funds
1. Interests in Money Market Funds
2. Foreign Sovereign Debt
3. Interests in U.S. Treasury Exchange-Traded Funds
4. Investments in Commercial Paper and Corporate Notes or Bonds
5. Investments in Permitted Investments With Adjustable Rates of
Interest
6. Investments in Certificates of Deposit Issued by Banks
B. Asset-Based and Issuer-Based Concentration Limits for
Permitted Investments
C. Futures Commission Merchant Capital Charges on Permitted
Investments
D. Segregation Investment Detail Report
E. Read-Only Electronic Access to Customer Funds Accounts
Maintained by Futures Commission Merchants
F. Proposed Conforming Amendments
IV. Section 4(c) of the Act
V. Administrative Compliance
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost-Benefit Considerations
a. Foreign Sovereign Debt, Interests in Exchange-Traded Funds,
and Associated Capital Charges
b. Government Money Market Funds, Commercial Paper and Corporate
Notes or Bonds, and Certificates of Deposit Issued by Banks
c. SOFR as a Permitted Benchmark
d. Revision of the Read-Only Access Provisions
D. Antitrust Laws
I. Introduction
A. Background and Statutory Authority
1. Segregation of Customer Funds by Futures Commission Merchants and
Derivatives Clearing Organizations
A primary objective of the Commodity Exchange Act (``Act'') \2\ and
Commission regulations is the establishment of a framework to safeguard
funds of customers engaging in CFTC-regulated derivative transactions.
A core component of the framework is the requirement for a futures
commission merchant (``FCM'') or a derivatives clearing organization
(``DCO'') to treat customer funds as belonging to the customers and not
as the property of the FCM or DCO, and for the FCM or DCO to segregate
customer funds from its own funds by holding the funds in specially
designated customer accounts maintained at banks, trust companies,
FCMs, or DCOs, as applicable. The segregation of customer funds from an
FCM's or DCO's own funds is intended to ensure that customer funds are
used
[[Page 81237]]
only to support customer trading and transactions, and to facilitate
the return of the funds to customers in the event of the insolvency of
the FCM or DCO.
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\2\ 7 U.S.C. 1 et seq.
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Customer funds are classified into one of three distinct regulatory
frameworks that are based on the derivatives markets on which the
customers are transacting. Specifically, customer funds are classified
as either: (i) ``futures customer funds;'' (ii) ``Cleared Swaps
Customer Collateral;'' or (iii) ``30.7 customer funds.'' \3\ The term
``futures customer funds'' is defined by Regulation 1.3 to mean, in
relevant part, all money, securities, and property received by an FCM
or a DCO from, for, or on behalf of ``futures customers'' \4\ to
margin, guarantee, or secure futures and options on futures
transactions traded on a CFTC-designated contract market, and all money
accruing to futures customers as a result of trading futures and
options on futures. Section 4d(a)(2) of the Act requires an FCM to
treat and deal with futures customer funds received to margin,
guarantee, or secure trades or contracts of any futures customer, or
accruing to a futures customer as the result of such trades or
contracts, as belonging to the futures customer.\5\ Section 4d(a)(2)
further provides that an FCM may not commingle futures customer funds
of a futures customer with the FCM's own funds, provided, however, that
the FCM may commingle the futures customer funds of two or more futures
customers and deposit the funds with any bank, trust company, DCO, or
other FCM.\6\
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\3\ See generally, 17 CFR 1.20 (segregation framework for
futures customer funds); 17 CFR 22.2 and 22.3 (segregation framework
for Cleared Swaps Customer Collateral); and 17 CFR 30.7 (segregation
framework for 30.7 customer funds).
\4\ The term ``futures customer'' is defined by Regulation 1.3
to mean, in relevant part, any person who uses an FCM as an agent in
connection with trading in any contract for the purchase or sale of
a commodity for future delivery or any option on such contract. 17
CFR 1.3.
\5\ 7 U.S.C. 6d(a)(2).
\6\ Id.
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Section 4d(b) of the Act addresses the duties imposed on DCOs and
other depositories receiving futures customer funds from FCMs pursuant
to Section 4d(a)(2) of the Act.\7\ Section 4d(b) provides that it is
unlawful for any person, including a DCO, that has received futures
customer funds to hold, dispose of, or use the funds as belonging to
the depositing FCM or any person other than the futures customers of
the FCM.\8\ The Commission adopted Regulations 1.20 through 1.30, and
Regulations 1.32 and 1.49, to implement the segregation requirements
for futures customer funds mandated by Sections 4d(a)(2) and 4d(b) of
the Act.\9\
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\7\ 7 U.S.C. 6d(b).
\8\ Id.
\9\ 17 CFR 1.20 through 17 CFR 1.30, 17 CFR 1.32, and 17 CFR
1.49.
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The term ``Cleared Swaps Customer Collateral'' is defined by
Regulations 1.3 and 22.1 \10\ to mean, in relevant part, all money,
securities, or other property received by an FCM or a DCO from, for, or
on behalf of, a ``Cleared Swaps Customer'' to margin, guarantee, or
secure ``Cleared Swap'' positions.\11\ Section 4d(f)(2)(A) of the Act
requires an FCM to treat Cleared Swaps Customer Collateral received
from a Cleared Swaps Customer, or accruing to a Cleared Swaps Customer
as a result of Cleared Swap positions, as belonging to the Cleared
Swaps Customer.\12\ Section 4d(f)(2)(B) of the Act provides that an FCM
may not commingle Cleared Swaps Customer Collateral of a Cleared Swaps
Customer with the FCM's own funds,\13\ provided, however, that the FCM
may commingle Cleared Swaps Customer Collateral of two or more Cleared
Swap Customers and deposit the funds in any bank, trust company, DCO,
or other FCM.\14\ Section 4d(f)(6) of the Act provides that it is
unlawful for any person, including a DCO and any depository
institution, that has received Cleared Swaps Customer Collateral to
hold, dispose of, or use the Cleared Swaps Customer Collateral as
belonging to the depositing FCM or any person other than the Cleared
Swaps Customer of the FCM.\15\ The Commission adopted Regulations 22.2
through 22.13, and Regulations 22.15 through 22.17, to implement the
segregation requirements for Cleared Swaps Customer Collateral mandated
by Section 4d(f) of the Act.\16\
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\10\ 17 CFR 22.1.
\11\ The term ``Cleared Swaps Customer'' is defined by
Regulation 22.1 to mean, in relevant part, any customer entering
into a Cleared Swap. The term ``Cleared Swap'' is defined to mean
any swap that is, directly or indirectly, submitted to and cleared
by a DCO registered with the Commission. See 7 U.S.C. 1a(7) and 17
CFR 22.1.
\12\ 7 U.S.C. 6d(f)(2)(A).
\13\ 7 U.S.C. 6d(f)(2)(B).
\14\ 7 U.S.C. 6d(f)(3)(A)(i).
\15\ 7 U.S.C. 6d(f)(6).
\16\ 17 CFR 22.2 through 17 CFR 22.13, 17 CFR 22.15 through 17
CFR 22.17.
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The term ``30.7 customer funds'' is defined by Regulation 30.1 to
mean any money, securities, or other property received by an FCM from,
for, or on behalf of a U.S. person or foreign-domiciled person (a
``30.7 customer'') \17\ to margin, guarantee, or secure futures or
options on futures positions executed on foreign boards of trade
(``foreign futures'').\18\ Section 4(b)(2)(A) of the Act authorizes the
Commission to adopt regulations imposing requirements on FCMs regarding
the safeguarding of 30.7 customer funds deposited by 30.7 customers for
trading on foreign boards of trade.\19\ The Commission adopted
Regulation 30.7 pursuant to Section 4(b)(2)(A) of the Act.\20\
Regulation 30.7(e)(2) requires an FCM to segregate 30.7 customer funds
from the FCM's own funds, and Regulation 30.7(b) provides that an FCM
may hold 30.7 customer funds with designated depositories, including
banks, trust companies, DCOs, foreign brokers, and clearing
organizations of foreign boards of trade.\21\
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\17\ The term ``30.7 customer'' is defined by Regulation 30.1 to
mean any person located in the U.S., its territories or possessions,
as well as any foreign-domiciled person, who trades in foreign
futures or foreign options. 17 CFR 30.1.
\18\ 17 CFR 30.1.
\19\ 7 U.S.C. 6(b)(2)(A).
\20\ 17 CFR 30.7.
\21\ 17 CFR 30.7(b) and 17 CFR 30.7(e)(2).
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Throughout this release, the terms ``futures customer funds,''
``Cleared Swaps Customer Collateral,'' and ``30.7 customer funds'' are
collectively referred to as ``Customer Funds,'' unless otherwise
stated.
2. Authority for Futures Commission Merchants and Derivatives Clearing
Organizations To Invest Customer Funds
Section 4d(a)(2) of the Act authorizes FCMs to invest futures
customer funds in: (i) obligations of the U.S.; (ii) obligations fully
guaranteed as to principal and interest by the U.S.; and (iii) general
obligations of any State or of any political subdivision of a
State.\22\ Regulation 1.25 was initially adopted to implement Section
4d(a)(2), and authorized FCMs and DCOs to invest futures customer funds
in the instruments set forth in Section 4d(a)(2) of the Act (the
``Permitted Investments'').\23\
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\22\ 7 U.S.C. 6d(a)(2).
\23\ See Title 17--Commodity and Securities Exchanges, 33 FR
14454 (Sept. 26, 1968), amending Regulation 1.25 and providing that
FCMs and clearing organizations may invest customer funds in
obligations of the U.S., in general obligations of any State or of
any political subdivision of any State, or in obligations fully
guaranteed as to principal and interest by the U.S.
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The Commission, in 2000, expanded the Permitted Investments beyond
the investments specifically stated in Section 4d(a)(2) of the Act to
include certificates of deposit, commercial paper, corporate notes,
foreign sovereign debt, and interests in money market funds.\24\ In
addition, the Commission
[[Page 81238]]
authorized an FCM or a DCO to buy the Permitted Investments under
agreements to resell the securities (``reverse repurchase agreements'')
and to sell the Permitted Investments under agreements to repurchase
the securities (``repurchase agreements'').\25\ To minimize credit
risk, market risk, and liquidity risk, the Commission also imposed
conditions that Permitted Investments were required to meet, including
a restriction on the dollar-weighted average of the time-to-maturity of
securities held in the segregated portfolio, asset-based and issuer-
based concentration limits, and prohibitions on certain investments
containing embedded derivatives.\26\ More generally, Regulation 1.25
requires all Permitted Investments to be ``consistent with the
objectives of preserving principal and maintaining liquidity.'' \27\
The 2000 Permitted Investments Amendment was adopted under the
authority of Section 4(c) of the Act.\28\ In adopting the amendment,
the Commission stated that the expanded list of Permitted Investments
would enhance the yield available to FCMs, DCOs, and their customers
without compromising the safety of futures customer funds.\29\
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\24\ See Rules Relating to Intermediaries of Commodity Interest
Transactions, 65 FR 77993 (Dec. 13, 2000) (publishing final rules);
and Investment of Customer Funds, 65 FR 82270 (Dec. 28, 2000)
(making technical corrections and accelerating the effective date of
the final rules from February 12, 2001 to December 28, 2000)
(collectively, the ``2000 Permitted Investments Amendment'').
\25\ Id. Reverse repurchase agreements and repurchase agreements
are collectively referred to as ``Repurchase Transactions'' in the
Proposal.
\26\ 17 CFR 1.25(b).
\27\ Id.
\28\ Section 4(c)(1) of the Act empowers the Commission to
``promote responsible economic or financial innovation and fair
competition'' by exempting any transaction or class of transactions
(including any person or class of persons offering, entering into,
rendering advice or rendering other services with respect to, the
agreement, contract, or transaction), from any of the provisions of
the Act, subject to certain exceptions. The Commission may grant
such an exemption by rule, regulation, or order, after notice and
opportunity for hearing, and may do so on application of any person
or on its own initiative. See 7 U.S.C. 6(c). A further discussion of
Section 4(c)(1) of the Act is set forth in Section IV of this
Federal Register release.
\29\ See 2000 Permitted Investments Amendment at 78007.
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Following the 2000 Permitted Investments Amendment, the list of
Permitted Investments has undergone several revisions.\30\ In its
current form, Regulation 1.25 lists seven categories of investments
that qualify as Permitted Investments: (i) obligations of the U.S. and
obligations fully guaranteed as to principal and interest by the U.S.
(``U.S. government securities''); (ii) general obligations of any State
or political subdivision of a State (``municipal securities''); (iii)
obligations of any U.S. government corporation or enterprise sponsored
by the U.S. (``U.S. agency obligations''); (iv) certificates of deposit
issued by a bank; (v) commercial paper fully guaranteed by the U.S.
under the Temporary Liquidity Guarantee Program (``TLGP'') as
administered by the Federal Deposit Insurance Corporation (``FDIC'')
(``commercial paper''); (vi) corporate notes and bonds fully guaranteed
as to principal and interest by the U.S. under the TLGP (``corporate
notes and bonds''); and (vii) interests in money market mutual
funds.\31\ In addition, Regulation 1.25(a)(2) permits FCMs and DCOs to
buy and sell the Permitted Investments under Repurchase
Transactions.\32\
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\30\ See Investment of Customer Funds and Record of Investments,
70 FR 28190 (May 17, 2005) (``2005 Permitted Investments
Amendment''), and Investment of Customer Funds and Funds Held in an
Account for Foreign Futures and Foreign Options Transactions, 76 FR
78776 (Dec. 19, 2011) (``2011 Permitted Investments Amendment'').
\31\ 17 CFR 1.25(a)(1).
\32\ 17 CFR 1.25(a)(2).
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Section 4(b)(2)(A) of the Act grants the Commission the plenary
authority to adopt rules and regulations regarding an FCM's
safeguarding of 30.7 customer funds.\33\ Prior to 2011, an FCM was not
subject to restrictions on the investments that it could enter into
with 30.7 customer funds.\34\ In 2011, the Commission extended the
requirements of Regulation 1.25 to an FCM's investment of 30.7 customer
funds for trading foreign futures positions. Specifically, the
Commission amended Regulation 30.7 to provide that to the extent an FCM
invested 30.7 customer funds, it must invest such funds subject to, and
in compliance with, the terms and conditions of Regulation 1.25.\35\
The Commission exercised its plenary authority under Section 4(b) of
the Act to adopt Regulation 30.7.
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\33\ 7 U.S.C. 6(b)(2)(A).
\34\ 2011 Permitted Investments Amendment at 78777, providing
that because Congress did not expressly apply the investment
limitations set forth in Section 4d of the Act to 30.7 customer
funds, the Commission historically has not subjected such funds to
the investment limitations applicable to futures customer funds.
\35\ See 17 CFR 30.7. The Commission stated that it was
appropriate to align the investment standards of Regulation 30.7
with those of Regulation 1.25 as many of the same prudential
concerns arise with respect to both futures customer funds and 30.7
customer funds. See 2011 Permitted Investment Amendment at 78791.
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The Commission also extended the requirements of Regulation 1.25 to
FCMs and DCOs investing Cleared Swaps Customer Collateral.\36\
Regulations 22.2 and 22.3 were adopted in 2012 under the authority of
Section 4d(f)(4) of the Act,\37\ which provides that Cleared Swaps
Customer Collateral may be invested by an FCM or a DCO in: (i)
obligations of the U.S.; (ii) general obligations of any State or of
any political subdivision of a State; (iii) obligations fully
guaranteed as to principal and interest by the U.S.; and, (iv) any
other investment that the Commission may by rule or regulation
prescribe.\38\ Section 4d(f)(4) of the Act further provides that the
investments must be made in accordance with the rules and regulations,
and subject to any conditions, as the Commission prescribes.\39\
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\36\ See 17 CFR 22.2(e)(1) and 17 CFR 22.3(d).
\37\ 7 U.S.C. 6d(f).
\38\ See Protection of Cleared Swaps Customer Contracts and
Collateral; Conforming Amendments to the Commodity Amendments to the
Commodity Broker Bankruptcy Provisions, 77 FR 6336 (Feb. 7, 2012).
\39\ See 7 U.S.C. 6d(f)(4).
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In addition to setting forth the Permitted Investments that FCMs
and DCOs may enter into with Customer Funds, Regulation 1.25 also
includes several conditions on the investment of Customer Funds.
Regulation 1.25(b)(3) contains both asset-based and issuer-based
concentration limits applicable to Permitted Investments. The asset-
based concentration limit restricts the total amount of Customer Funds
that an FCM or a DCO may invest in a particular Permitted Investment to
a defined percentage of the total funds held in segregation by the FCM
or DCO.\40\ The issuer-based concentration limit caps the total amount
of Customer Funds that may be invested in instruments offered by, or
managed by, a particular issuer to a defined percentage of the total
funds held in segregation by the FCM or DCO.\41\
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\40\ 17 CFR 1.25(b)(3)(i).
\41\ 17 CFR 1.25(b)(3)(ii).
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Consistent with the objective of limiting customer risk, Commission
regulations also provide that FCMs and DCOs are financially responsible
for any losses resulting from Permitted Investments, and are explicitly
prohibited from allocating investment losses to customers or clearing
FCMs, respectively.\42\
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\42\ Regulation 1.29 provides that FCMs or DCOs, as applicable,
shall bear sole responsibility for any losses resulting from the
investment of futures customer funds, and further provides that no
investment losses shall be borne or otherwise allocated to FCM
customers or to FCMs clearing customer accounts at DCOs. 17 CFR
1.29(b).
Regulation 22.2(e)(1) provides that an FCM shall bear sole
responsibility for any losses resulting from the investment of
Cleared Swaps Customer Collateral and may not allocate investment
losses to Cleared Swaps Customers of the FCM. 17 CFR 22(e)(1).
Regulation 30.7(i) provides that an FCM shall bear sole
financial responsibility for any losses resulting from the
investment of 30.7 customer funds, and further provides that no
investment losses may be allocated to the 30.7 customers of the FCM.
17 CFR 30.7(i).
In addition, Regulation 22.3(d) provides that DCOs may invest
Cleared Swaps Customer Collateral in Permitted Investments set forth
in Regulation 1.25. The regulation, however, does not provide that a
DCO is responsible for investment losses. The Commission is
proposing to amend Regulation 22.3(d) to explicitly provide that a
DCO shall bear sole responsibility for any losses resulting from the
investment of Cleared Swaps Customer Collateral, and may not
allocate such losses to Cleared Swaps Customers. See Section III.C.
below. 17 CFR 22.3(d).
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[[Page 81239]]
The Commission has previously noted the importance of conducting
periodic reassessments of Regulation 1.25 ``and, as necessary, revising
regulatory policies to strengthen safeguards designed to minimize risk
while retaining an appropriate degree of investment flexibility and
opportunities for capital efficiency for DCOs and FCMs investing
customer segregated funds.'' \43\ In furtherance of these objectives
and in consideration of the requests for amendments to Regulation 1.25
discussed in Section II below, the Commission is proposing to amend the
list of Permitted Investments in Regulation 1.25 to: (i) add two new
asset classes (i.e., specified foreign sovereign debt instruments and
certain exchange-traded funds (``ETFs'')), subject to certain
conditions, (ii) limit the scope of money market funds (``MMFs'') whose
interests qualify as Permitted Investments, and (iii) remove corporate
notes, corporate bonds, and commercial paper. In connection with the
proposed amendments to the list of Permitted Investments, the
Commission is further proposing changes to the counterparty and
depository requirements of Regulation 1.25(d)(2) and (7) and revisions
to the concentration limits for Permitted Investments set forth in
Regulation 1.25(b)(3), and is specifying the capital charges that would
apply to the proposed new categories of Permitted Investments.
Additionally, the Commission is proposing an amendment to Regulation
22.3(d) to clarify that DCOs are financially responsible for any losses
resulting from investments of Cleared Swap Customer Collateral in
Permitted Investments, consistent with Regulation 1.29, which addresses
financial responsibility for losses resulting from investment of
futures customer funds. The proposed amendment reflects the
Commission's original intent to permit investments of Cleared Swaps
Customer Collateral within the parameters applicable to investments of
futures customer funds.\44\ The Commission is also proposing to replace
the London Interbank Offered Rate (``LIBOR'') with the Secured
Overnight Financing Rate (``SOFR'') as a permitted benchmark for
variable and floating interest rates for securities that qualify as
Permitted Investments. Each of the proposed amendments is discussed
below.
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\43\ 2011 Permitted Investments Amendment at 78777.
\44\ See Enhancing Protections Afforded Customers and Customer
Funds Held by Futures Commission Merchants and Derivatives Clearing
Organizations, 78 FR 68506 (Nov. 14, 2013) (``2013 Protections of
Customer Funds'') at 68556.
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II. Requests for Amendments to the List of Permitted Investments
The Futures Industry Association (``FIA) and CME Group Inc.
(``CME'') (collectively, the ``Petitioners'') submitted a joint
petition requesting the Commission to issue an order under Section 4(c)
of the Act, or to take such other action as the Commission deems
appropriate, to expand investments that FCMs and DCOs may enter into
with Customer Funds.\45\ The Petitioners request that the Commission
take action to permit FCMs and DCOs to invest Customer Funds in the
foreign sovereign debt of Canada, France, Germany, Japan, and the
United Kingdom (``Specified Foreign Sovereign Debt''), subject to the
condition that the investment in the foreign sovereign debt is limited
to balances owed by FCMs and DCOs to customers and FCM clearing firms,
respectively, denominated in the applicable currency of Canada, France,
Germany, Japan, or the United Kingdom.\46\ The Petitioners further
request that the Commission exempt FCMs and DCOs from the provisions of
Regulation 1.25(d)(2) to authorize FCMs and DCOs to enter into
Repurchase Transactions involving Specified Foreign Sovereign Debt with
foreign banks and foreign securities brokers or dealers and to hold
Specified Foreign Sovereign Debt in safekeeping accounts at foreign
banks.\47\
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\45\ Petition for Order under Section 4(c) of the Commodity
Exchange Act, dated May 24, 2023 (the ``Joint Petition''). On
September 22, 2023, the Petitioners submitted updated data in
support of the Joint Petition and corrected an inadvertent
transposition of data items in the Joint Petition. Supplement to
Petition for Order under Section 4(c) of the Commodity Exchange Act
(``Supplement to Joint Petition''). The Joint Petition and the
Supplement to Joint Petition are available on the Commission's
website, <a href="https://www.cftc.gov/media/9531/FIA_CMEPetition_Regulation125_052423/download">https://www.cftc.gov/media/9531/FIA_CMEPetition_Regulation125_052423/download</a> and <a href="https://www.cftc.gov/media/9536/FIALetterSupplementing_Regulation125_092223/download">https://www.cftc.gov/media/9536/FIALetterSupplementing_Regulation125_092223/download</a>.
\46\ Joint Petition at p. 4.
\47\ Joint Petition at p. 5.
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In support of the request, the Petitioners note that the Commission
issued an order in 2018 pursuant to Section 4(c) of the Act providing a
limited exemption to Section 4d of the Act and Regulation 1.25 to
permit DCOs to invest futures customer funds and Cleared Swaps Customer
Collateral in the foreign sovereign debt of France and Germany.\48\ The
exemption for DCOs to invest in French and German sovereign debt is
subject to conditions, including that: (i) investment in French or
German sovereign debt is limited to investments made with euro-
denominated balances owed to the futures customers and Cleared Swaps
Customers of FCM clearing members; (ii) the dollar-weighted average of
the remaining time-to-maturity of a DCO's portfolio of investments in
each of French and German sovereign debt may not exceed 60 days; and
(iii) a DCO may not make a direct investment in any sovereign debt
instrument of France or Germany that has a remaining time-to-maturity
in excess of 180 calendar days.\49\ The 2018 Order also provides that
if the two-year credit default spread of the French or German sovereign
debt exceeds 45 basis points (``BPS''), the DCO may not make any new
direct investments in the relevant sovereign debt using futures
customer funds or Cleared Swaps Customer Collateral, and must
discontinue investing futures customer funds and Cleared Swaps Customer
Collateral in the relevant debt through Repurchase Transactions as soon
as practicable under the circumstances.\50\
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\48\ Order Granting Exemption from Certain Provisions of the
Commodity Exchange Act Regarding Investment of Customer Funds and
from Certain Related Commission Regulations, 83 FR 35241 (Jul. 25,
2018) (``2018 Order''). The 2018 Order provides an exemption only to
DCOs. FCMs are not subject to the 2018 Order, and currently may not
invest Customer Funds in any foreign sovereign debt.
\49\ Conditions (3)(a), 3(c), and 3(d) of the 2018 Order at
35245.
\50\ Condition (3)(b) of the 2018 Order at 35245.
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The 2018 Order also grants an exemption from Regulation 1.25(d)(2)
to permit DCOs to enter into Repurchase Transactions involving French
or German sovereign debt with foreign banks and foreign securities
brokers or dealers as counterparties.\51\ A DCO may
[[Page 81240]]
enter into Repurchase Transactions with a foreign bank or foreign
securities broker or dealer provided that the such firm qualifies as a
permitted depository under Regulation 1.49(d)(3) and is located in a
money center country or in another jurisdiction that has adopted the
euro as its currency.\52\ The 2018 Order further grants an exemption
from the requirement in Regulation 1.25(d)(7) that securities
transferred to an FCM or a DCO under reverse repurchase agreements must
be held in safekeeping accounts with certain U.S.-domiciled banks, a
Federal Reserve Bank, a DCO, or the Depository Trust Company,\53\ to
permit DCOs to hold French or German sovereign debt received under
reverse repurchase agreements in a safekeeping account with foreign
banks that qualify as depositories for Customer Funds under Regulation
1.49(d)(3).
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\51\ As noted above, Regulation 1.25(d)(2) provides that an FCM
or a DCO may enter into Repurchase Transactions only with the
following counterparties: (i) a bank as defined in Section 3(a)(6)
of the Securities Exchange Act of 1934; (ii) a domestic branch of a
foreign bank insured by the FDIC; (iii) an SEC-registered securities
broker or dealer; or (iv) an SEC-registered government securities
broker or dealer. Section 3(a)(6) of the Securities Exchange Act of
1934 defines the term ``bank'' to mean: (i) a banking institution
organized under the laws of the U.S. or a Federal savings
association; (ii) a member bank of the Federal Reserve System; (iii)
any other banking institution or savings association doing business
under the laws of any State or the U.S., a substantial portion of
the business of which consists of receiving deposits or exercising
fiduciary powers similar to those permitted to national banks under
the authority of the Comptroller of the Currency, and which is
supervised and examined by a State or Federal authority having
supervision over banks or savings associations; and (iv) a receiver,
conservator, or other liquidating agent of any institution or firm
included in clauses (i), (ii), or (iii) above (``Section 3(a)(6)
bank''). 15 U.S.C. 78 et seq. Foreign-domiciled banks and foreign
securities brokers or dealers are not authorized counterparties for
Repurchase Transactions under Regulation 1.25(d)(2).
\52\ Regulation 1.49(d)(3) provides that a foreign depository
must be a bank or trust company that has in excess of $1 billion in
regulatory capital, a registered FCM, or a DCO in order to be a
qualified counterparty to Repurchase Transactions.
\53\ Specifically, Regulation 1.25(d)(7) provides that
securities transferred to an FCM or a DCO under a reverse repurchase
agreement must be held in a safekeeping account only with the
following depositories: (i) a Section 3(a)(6) bank; (ii) a domestic
branch of a foreign bank insured by the FDIC; (iii) a Federal
Reserve Bank; (iv) a DCO; or (v) the Depository Trust Company. A
foreign-domiciled bank is currently not an authorized depository for
securities transferred to an FCM or a DCO under Regulation
1.25(d)(7).
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The Petitioners further request that FCMs and DCOs be permitted to
invest Customer Funds in certain ETFs that invest primarily in short-
term U.S. Treasury securities (``U.S. Treasury ETFs'').\54\ In support
of their request, the Petitioners state that U.S. Treasury ETFs have
characteristics that may be consistent with those of other Permitted
Investments and may provide FCMs and DCOs with an opportunity to
diversify further their investments of customer funds.\55\
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\54\ Joint Petition at pp. 8-9.
\55\ Id.
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The Commission also received a petition from Invesco Capital
Management LLC (``Invesco''), which serves as a sponsor of various
ETFs, advocating for the addition of U.S. Treasury ETF securities to
the list of Permitted Investments.\56\ Invesco states that U.S.
Treasury ETFs will provide FCMs and DCOs with additional investment
choices for customer funds, promote operational efficiencies and offer
potentially better investment returns for FCMs, DCOs, and their
customers, and facilitate financial market innovation.\57\ Invesco
further states that permitting investments of U.S. Treasury ETFs would
be consistent with, and promote, the public interest goals enumerated
in the Act.\58\ Invesco further notes that U.S. Treasury ETFs invest in
a sub-set of the same high-quality liquid instruments that are
Permitted Investments under Regulation 1.25 (i.e., U.S. government
securities), and as such, the ETFs offer an indirect, possibly simpler,
and more cost-efficient way for FCMs and DCOs to invest Customer Funds
in U.S. Treasury securities and obligations fully guaranteed as to
principal and interest by the U.S. as the ETFs eliminate the need for
FCMs and DCOs to administer investments in individual U.S. government
securities.\59\
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\56\ Letter from Anna Paglia, Chief Executive Officer, Invesco
Capital Management LLC, dated September 28, 2023 (``Invesco
Petition''). See <a href="https://www.cftc.gov/media/9541/Invesco_CFTCPetition_Regulation125_092823/download">https://www.cftc.gov/media/9541/Invesco_CFTCPetition_Regulation125_092823/download</a>. Invesco is a
registered with the Commission as a commodity pool operator and
commodity trading advisor, and is registered with the Securities and
Exchange Commission (``SEC'') as an investment adviser.
\57\ Invesco Petition at p. 1.
\58\ Id.
\59\ See Invesco Petition at p. 2.
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Finally, the Petitioners also request that the Commission amend its
regulations consistent with CFTC Staff Letter 21-02 and CFTC Staff
Letter 22-21,\60\ to permit FCMs and DCOs to invest Customer Funds in
qualifying Permitted Investments that have adjustable rates of interest
that correlate closely to SOFR.\61\
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\60\ CFTC Staff Letter 21-02--CFTC Regulation 1.25--Investment
of Customer Funds--Time-Limited No-Action Position for Investments
in Securities with an Adjustable Rate of Interest Benchmarked to the
Secured Overnight Financing Rate, issued January 4, 2021 (``Staff
Letter 21-02''); CFTC Staff Letter 22-21--CFTC Regulation 1.25--
Investment of Customer Funds in Securities with an Adjustable Rate
of Interest Benchmarked to the Secured Overnight Financing Rate--
Extension of Time-Limited No-Action Position Concerning Investments
by Futures Commission Merchants and No-Action Position Concerning
Investments by Derivatives Clearing Organizations, issued December
23, 2022 (``Staff Letter 22-21'').
\61\ See Joint Petition at p. 4.
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III. Proposal
As part of its periodic assessment of Regulation 1.25 and in
consideration of the information set forth in the Joint Petition and
the Invesco Petition, the Commission is proposing to amend the list of
Permitted Investments, subject to certain terms and conditions, as
discussed in detail below. In connection with the proposed amendments
to the list of Permitted Investments, the Commission is further
proposing changes to the counterparty and depository requirements of
Regulation 1.25(d)(2) and (7), and revisions to the concentration
limits for Permitted Investments set forth in Regulation 1.25(b)(3).
Separately, the Commission is specifying capital charges that FCMs
would apply to the revised list of Permitted Investments as proposed,
and is proposing a clarifying amendment to Regulation 22.3(d) to
specify that DCOs bear the financial responsibility for losses
resulting from Permitted Investments. The Commission is also proposing
to replace LIBOR with SOFR as a permitted benchmark for the interest
rate of adjustable rate securities that qualify as Permitted
Investments. Lastly, the Commission is proposing to revise its
regulations to eliminate the requirement that a depository holding
customer funds must provide the Commission with read-only electronic
access to such accounts for the FCM to treat the accounts as customer
segregated fund accounts. Collectively, the proposed revisions and
amendments are referred to as the ``Proposal.''
A. Investment of Customer Funds
1. Interests in Money Market Funds
Regulation 1.25(a)(1)(vii) currently provides that FCMs and DCOs
may invest Customer Funds in interests in MMFs, subject to specified
terms and conditions.\62\ To qualify as a Permitted Investment, a MMF
must: (i) be an investment company that is registered with the SEC
under the Investment Company Act of 1940 \63\ and hold itself out to
investors as a MMF in accordance with SEC Rule 2a-7; \64\ (ii) be
sponsored by a federally-regulated financial institution, a Section
3(a)(6) bank,\65\ an investment adviser registered under the Investment
Advisers Act of 1940,\66\ or a domestic branch of a foreign bank
insured by the FDIC; and (iii) compute the net asset value (``NAV'') of
the fund by 9 a.m. of the business day following each business day and
make the NAV available to MMF shareholders by that time.\67\
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\62\ 17 CFR 1.25(a)(vii).
\63\ 15 U.S.C. 80a-1--80a-64.
\64\ 17 CFR 270.2a-7.
\65\ For a definition of Section 3(a)(6) bank, see supra note
51.
\66\ 15 U.S.C. 80b-1--80b-21.
\67\ 17 CFR 1.25(c).
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The Commission is proposing to amend Regulation 1.25(a)(1)(vii) to
limit the scope of MMFs whose interests qualify as Permitted
Investments to ``government money market funds,'' as defined in SEC
Rule 2a-7, in response to two sets of amendments that the SEC adopted
to its rules governing MMFs
[[Page 81241]]
discussed below.\68\ A Government MMF is defined in SEC Rule 2a-7 as a
fund that invests 99.5 percent or more of its total assets in cash,
``government securities,'' and/or Repurchase Transactions that are
collateralized fully by cash or ``government securities.'' \69\ A
``government security'' is defined as ``any security issued or
guaranteed as to principal or interest by the United States, or by a
person controlled or supervised by and acting as instrumentality of the
Government of the United States pursuant to authority granted by the
Congress of the United States; or any certificate of deposit of any of
the foregoing.'' \70\ Therefore, a ``government security'' encompasses
``U.S. government securities'' and ``U.S. agency obligations'' as
defined under Regulation 1.25(a)(1)(i) and (iii), respectively.\71\
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\68\ SEC Rule 2a-7 addresses MMFs that primarily invest in
securities issued or guaranteed by the U.S. government (``government
money market funds'' or ``Government MMFs''), MMFs that primarily
invest in short-term corporate debt securities (``Prime MMFs''), and
other types of MMFs that are not relevant to this Proposal, such as
tax-exempt funds. 17 CFR 270.2a-7.
\69\ 17 CFR 270.2a-7(a)(14).
\70\ 15 U.S.C. 80a-2(a)(16).
\71\ Regulation 1.25(a)(1)(i) and (iii) defines ``U.S.
government securities'' as obligations of the U.S. and obligations
fully guaranteed as to principal and interest by the U.S. and ``U.S.
agency obligations'' as obligations of any U.S. government
corporation or enterprise sponsored by the U.S. government,
respectively.
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As noted above, the Commission is proposing to amend Regulation
1.25 to limit the scope of MMFs that qualify as Permitted Investments
in response to SEC revisions to its MMF rules. In that regard, in 2014,
the SEC amended Rule 2a-7 to permit an MMF to impose liquidity fees on
participant redemptions or to temporarily suspend participant
redemptions if the MMF's investment portfolio triggered certain
liquidity thresholds.\72\ The 2014 SEC MMF Final Rule was adopted to
mitigate the adverse effects on fund liquidity resulting from increased
participant redemptions during times of financial stress.\73\
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\72\ Money Market Fund Reform; Amendments to Form PF, 79 FR
47736 (Aug. 14, 2014) (``2014 SEC MMF Final Rule''). See 17 CFR
270.2a-7(c)(2).
\73\ 2014 SEC MMF Final Rule at 47747.
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The 2014 SEC MMF Final Rule provides that a MMF that invests less
than 30 percent of its total assets in instruments defined as ``weekly
liquid assets'' \74\ may impose a liquidity fee of up to two percent of
the value of any shares redeemed, or may temporarily suspend
participants' redemptions for up to 10 business days in a 90-day
period, if the MMF's board of directors determines that imposing the
liquidity fee or suspending redemptions is in the best interest of the
MMF.\75\ In addition, if a MMF invests less than 10 percent of its
total assets in weekly liquid assets, the MMF must impose a liquidity
fee of at least one percent, and not more than two percent, on the
value of any shares redeemed, unless the MMF's board of directors
determines that the fee is not in the best interest of the MMF.\76\ The
SEC Redemption Provisions are directly applicable to Prime MMFs, and
Government MMFs may voluntarily elect to impose such provisions
(``Electing Government MMFs'').\77\
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\74\ The term ``weekly liquid assets'' is generally defined as:
(i) cash; (ii) direct obligations of the U.S. Government; (iii) U.S.
Agency securities that are issued at a discount to the principal
amount to be repaid at maturity and have a remaining time to
maturity of 60 days or less; (iv) securities that mature, or are
subject to a demand feature that is exercisable and payable, within
5 business days; or (v) amounts receivable and due unconditionally
within 5 business days on pending sales of portfolio securities. 17
CFR 270-2a-7(c)(a)(28).
\75\ 17 CFR 270.2a-7(c)(2)(i).
\76\ 17 CFR 270.2a-7(c)(2)(ii). (The liquidity fees and
suspension of redemptions provisions of SEC Rule 2a-7(c)(2) are
referred to as the ``SEC Redemption Provisions'' in this document.)
\77\ 17 CFR 270.2a-7(c)(2)(iii).
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Commission staff subsequently received inquiries from market
participants concerning the permissibility of investing Customer Funds
in MMF interests under Regulation 1.25 in light of the SEC Redemption
Provisions. The Commission's Division of Swap Dealer and Intermediary
Oversight (``DSIO''), currently known as the Market Participants
Division (``MPD'') issued CFTC Staff Letter 16-68 \78\ and the
Commission's Division of Clearing and Risk (``DCR'') issued CFTC Staff
Letter 16-69 \79\ addressing the SEC Redemption Provisions and the
investment of Customer Funds in MMFs by FCMs and DCOs, respectively.
Staff Letter 16-68 \80\ expressed DSIO staff's view that the SEC
Redemption Provisions conflict with paragraphs (b)(1) \81\ and
(c)(5)(i) \82\ of Regulation 1.25, as the Redemption Provisions have
the effect of potentially reducing the liquidity of Prime MMFs and
Electing Government MMFs. Therefore, in connection with the no-action
position taken in the staff letter, DSIO indicated that FCMs may no
longer invest Customer Funds in such MMFs.\83\
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\78\ CFTC Letter No. 16-68, No-Action Relief with Respect to
CFTC Regulation 1.25 Regarding Money Market Funds (Aug. 8, 2016)
(``Staff Letter 16-68''). CFTC Staff Letters are available at the
Commission's website, <a href="http://www.cftc.gov">www.cftc.gov</a>.
As noted above, Staff Letter 16-68 was issued by DSIO, which was
subsequently renamed MPD. For purposes of clarity, the Commission
notes that the formal division name change is not reflected in the
proposed amendments to existing Commission regulations and
appendices discussed in this Proposal, as the Commission plans to
address the name change in a separate Commission rulemaking. The new
division name, however, appears in the newly introduced proposed
appendices H and I to Part 1 and Appendix G to Part 30, as these
appendices do not currently exist in Commission's regulations and
would not be addressed in the above-referenced separate rulemaking.
\79\ CFTC Letter No. 16-69, Staff Interpretation Regarding CFTC
Part 39 In Light Of Revised SEC Rule 2a-7 (Aug. 8, 2016) (``Staff
Letter 16-69'').
\80\ See also CFTC Staff Advisory No. 16-75, Practical
Application of No-Action Letter No. 16-68 Regarding the Investments
in Money Market Mutual Funds (Oct. 18, 2016) (``Staff Letter 16-
75'') (discussing the practical applicability and effect of Staff
Letter 16-68).
\81\ 17 CFR 1.25(b)(1) (providing that investments of customer
funds must be highly liquid such that the investments must have the
ability to be liquidated and converted into cash within one business
day without material discount in value).
\82\ 17 CFR 1.25(c)(5)(i) (providing that to qualify as a
Permitted Investment an MMF must be legally obligated to pay a fund
investor (including an FCM) by the close of business on the day
following a redemption request).
\83\ Staff Letter 16-68 at p. 2.
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Staff Letter 16-69 set forth DCR staff's interpretation that
Regulations 39.15(c) and (e) \84\ prohibit a DCO from holding funds
belonging to clearing members or their customers in Prime MMFs or
Electing Government MMFs. DCR staff stated that the SEC Redemption
Provisions were not consistent with Regulation 39.15(c), which requires
a DCO to hold funds and assets belonging to clearing members and their
customers in a manner that minimizes the risk of loss or of delay in
the access by the DCO to such funds and assets. DCR staff further
stated that the SEC Redemption Provisions were inconsistent with
Regulation 39.15(e), which limits a DCO to investing funds and assets
belonging to clearing members and their customer in instruments with
minimal credit, market, and liquidity risk. Therefore, FCMs and DCOs
have not invested customer funds in Prime MMFs or Electing Government
MMFs since the issuance of the aforementioned Staff Letters in 2016.
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\84\ 17 CFR 39.15(c) and (e).
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The SEC has recently adopted additional amendments to its MMF
rules, including amendments revising the SEC Redemption Provisions
discussed above.\85\ The SEC MMF Reforms are intended to address issues
observed by the SEC with MMFs in connection with the economic shock
from the onset of the COVID-19 pandemic. Specifically, the SEC stated
in March 2020, that concerns about the impact of COVID-19 pandemic led
[[Page 81242]]
investors to reallocate their assets into cash and short-term
government securities. Certain Prime MMFs, in particular, experienced
significant outflows, contributing to stress on short-term funding
markets that resulted in government intervention to enhance the
liquidity of such markets.\86\ The events of March 2020 led the SEC to
re-evaluate certain aspects of the regulatory framework applicable to
MMFs. In considering the potential factors that caused the increased
redemption activity in March 2020, the SEC noted that, among other
concerns, fears about the potential imposition of redemption gates and
liquidity fees based on observed declines in some funds' weekly liquid
assets appear to have incentivized investors to redeem from certain
MMFs.\87\ Further, according to the SEC, the presence of a liquidity
threshold for consideration of fees and gates appears to have affected
fund managers' behavior, encouraging the sale of long-term portfolio
assets to maintain weekly liquid assets above the 30 percent threshold.
The SEC also cited to evidence suggesting that investors are
particularly sensitive to the potential imposition of redemption gates,
which fully inhibit the redeemability of MMF shares for the duration of
the gate.\88\ In the SEC's view, generally supported by commenters'
feedback, the gates and liquidity fees associated with predictable
weekly liquid asset triggers proved counterproductive in stemming heavy
redemptions from certain MMFs.\89\ As such, the SEC concluded that MMFs
needed better functioning tools for managing through stress while
mitigating harm to shareholders.\90\
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\85\ Money Market Fund Reforms; Form PF Reporting Requirements
for Large Liquidity Fund Advisers, Technical Amendments to Form N-
CSR and Form N-1A, 88 FR 51404 (Aug. 3, 2023) (``SEC MMF Reforms'').
The SEC MMF Reforms have an effective date of October 2, 2023.
\86\ As noted in the SEC MMF Reforms' adopting release, to
support the short-term funding markets, on March 18, 2020, the
Federal Reserve, with the approval of the Department of the
Treasury, established the Money Market Mutual Fund Liquidity
Facility. The facility provided loans to financial institutions on
advantageous terms to purchase securities from MMFs that were
raising liquidity. See SEC MMF Reforms at 51408.
\87\ SEC MMF Reforms at 51407.
\88\ Id. at 51409.
\89\ Id.
\90\ Id. at 51408.
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Accordingly, in an effort to improve the resilience of MMFs and
address the issue of preemptive investor redemption behavior,
particularly in times of stress, the SEC adopted changes to the fee and
gate provisions in SEC Rule 2a-7. The SEC MMF Reforms, among other
things, amend the SEC Redemption Provisions by removing a Prime MMF's
ability to temporarily suspend participant redemptions and by removing
an Electing Government MMF's ability to voluntarily retain authority to
suspend participant redemptions. The SEC MMF Reforms will also require
Prime MMFs to impose a liquidity fee when the fund experiences net
redemptions that exceed 5 percent of the fund's net assets, and will
permit Prime MMFs to impose a discretionary liquidity fee if the fund's
board of directors determines that a fee is in the best interest of the
fund.\91\ Government MMFs will not be required to implement the
mandatory liquidity fee but, consistent with the current SEC Redemption
Provisions, may choose to rely on the ability to impose discretionary
liquidity fees.\92\ Such fees, however, are no longer tied to the
weekly liquid asset threshold.\93\
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\91\ 17 CFR 270.2a-7(c)(2)(i) and (ii) (as amended by the SEC
MMF Reforms). In describing the different types of MMFs, the SEC
distinguishes between Prime MMFs, Government MMFs, and tax-exempt
(or municipal) MMFs. See SEC MMF Reforms at 51406. Tax-exempt MMFs
primarily hold obligations of state and local governments and their
instrumentalities, and pay interest that is generally exempt from
Federal income tax for individual taxpayers. Within the category of
Prime and tax-exempt MMFs, the SEC also treats retail and
institutional funds separately. The new mandatory liquidity fee
framework will apply to institutional Prime and institutional tax-
exempt MMFs. Tax-exempt MMFs are not specifically discussed in this
Proposal, though the Commission notes that these funds would be
subject to the same restrictions as those proposed with respect to
Prime MMFs. Retail MMFs are held only by natural persons, and as
such, are not discussed in this Proposal either.
\92\ 17 CFR 270.2a-7(c)(2)(i)(B) (as amended by the SEC MMF
Reforms).
\93\ 17 CFR 270.2a-7(c)(2)(i) (as amended by the SEC MMF
Reforms).
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The SEC's liquidity fee mechanism is designated to address
shareholder dilution and the potential for first-mover advantage by
allocating liquidity costs to redeeming investors. Although the
mechanism may contribute to decreasing outflows from certain MMFs, the
Commission preliminarily believes that the potential imposition of a
fee will nonetheless have the effect of reducing the liquidity of such
funds and will reduce the principal of an FCM's or DCO's investment in
MMF shares. Therefore, consistent with the positions taken in Staff
Letter 16-68 and Staff Letter 16-69, the Commission is preliminarily of
the view that FCMs and DCOs should be allowed to invest Customer Funds
only in MMFs that will not be subject to a liquidity fee (i.e.,
Government MMFs that do not elect to apply a discretionary liquidity
fee). Thus, the proposed amendments would remove Prime MMFs and
Electing Government MMFs, as participants in such funds may be subject
to liquidity fees in certain circumstances. Therefore, the Commission
is proposing amendments to Regulation 1.25(a)(1)(vii) that would limit
the scope of MMFs whose interests qualify as Permitted Investments to
Government MMFs that are not Electing Government MMFs (``Permitted
Government MMFs'').\94\ To qualify as a Permitted Government MMF, at
least 99.5 percent of the fund's investment portfolio must be comprised
of cash, government securities (i.e., U.S. Treasury securities,
securities fully-guaranteed as to principal and interest by the U.S.
Government, and U.S. agency obligations), and/or Repurchase
Transactions that are fully collateralized by government securities as
set forth in SEC Rule 2a-7. The Commission preliminarily believes that
the proposed amendment would ensure that FCMs and DCOs invest Customer
Funds in instruments that are consistent with the objectives of
Regulation 1.25 of preserving principal and maintaining liquidity of
the investments.
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\94\ See proposed paragraph (a)(1)(iv) of Regulation 1.25. As
discussed in Section III.A, the Commission is proposing to renumber
paragraph (a)(1) of Regulation 1.25 to reflect proposed revisions to
the list of Permitted Investments. The proposed revisions would
result in the renumbering of current paragraph (a)(1)(vii) to
paragraph (a)(1)(v) of Regulation 1.25.
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The Commission also notes that the proposed amendments to remove
from the scope of Permitted Investments the interests in MMFs whose
redemptions may be subject to a liquidity fee would prohibit an FCM
from depositing proprietary interests in such MMFs into Customer Funds
accounts. Regulations 1.23(a)(1), 22.2(e)(3)(i), and 30.7(g)(1) permit
FCMs to deposit proprietary cash and unencumbered securities into the
accounts of futures customers, Cleared Swaps Customers, and 30.7
customers, respectively, to help ensure that at all times the accounts
maintain sufficient funds to cover the amounts due to all customers and
prevent the accounts from becoming undersegregated.\95\ The securities
deposited by FCMs, however, must be Permitted Investments as set forth
in Regulation 1.25.\96\ Therefore, with respect to MMFs, FCMs would
only be permitted to deposit proprietary interest in Permitted
Government MMFs in the accounts of futures customers, Cleared Swaps
Customers, and 30.7 customers under the Proposal.
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\95\ 17 CFR 1.23(a)(1), 22.2(e)(3)(i), and 30.7(g)(1).
\96\ Id.
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To eliminate MMFs whose redemptions may be subject to a liquidity
fee from the scope of Permitted Investments under Regulation 1.25, the
Commission proposes to revise Regulation 1.25(a)(1)(vii), which would
be redesignated Regulation 1.25(a)(1)(v) to accommodate other
amendments to Regulation 1.25(a) discussed in this Proposal, by
replacing the term ``money
[[Page 81243]]
market mutual fund'' with the term ``government money market funds as
defined in Sec. 270.2a-7 of this title, provided that the funds do not
elect to be subject to liquidity fees in accordance with Sec. 270.2a-7
of this title (government money market fund).'' The Commission also
proposes to make further conforming changes throughout Regulation 1.25
and the Appendix to Regulation 1.25 by replacing all references to
``money market mutual fund'' with ``government money market fund.'' In
addition, the Appendix to Regulation 1.25 would be redesignated as
Appendix E to Part 1 to address a change in the rules of the Office of
the Federal Register regarding the structure of regulatory text to be
codified in the Code of Federal Regulations.
Request for comment: The Commission seeks comment on all aspects of
the Proposal to limit the scope of MMFs whose interests qualify as
Permitted Investments to certain Government MMFs to address changes to
SEC rules governing MMFs as described above, including:
1. Other than concentration limits that are discussed further
below, should any other safeguards be considered for Government MMFs
whose interests qualify as Permitted Investments under the Proposal to
ensure that the credit, liquidity, and market risk of those investments
is maintained at an acceptable level, particularly in light of the
history of runs in the Prime MMF markets and the potential for
contagion?
2. Regulation 1.25(b)(5)(ii) currently provides that an FCM or a
DCO may invest Customer Funds in a fund affiliated with that FCM or
DCO. Should the Commission revise Regulation 1.25(b)(5)(ii) to prohibit
an FCM or a DCO from investing Customer Funds in affiliated funds? Are
there other Commission or SEC rules that mitigate any potential
conflicts of interest that may arise from an FCM or a DCO investing
Customer Funds in affiliated funds?
2. Foreign Sovereign Debt
Regulation 1.25(a)(1) currently permits FCMs and DCOs to invest in
the sovereign debt of the U.S. only. Regulation 1.25 previously
permitted FCMs and DCOs to invest Customer Funds in the foreign
sovereign debt of any country, provided that the investments were
limited to balances owed by FCMs or DCOs to customers denominated in
the currency of the applicable foreign sovereign debt.\97\ The
Commission subsequently eliminated all foreign sovereign debt as a
Permitted Investment in 2011, citing an interest in both simplifying
the regulation and safeguarding Customer Funds in light of economic
crises experienced by a number of foreign sovereigns.\98\ The
Commission, however, also stated that it recognized that the safety of
sovereign debt issuances of one country may vary greatly from the
sovereign debt issuances of another country, and that investment in
certain sovereign debt may be consistent with Regulation 1.25's
objective of preserving principal and maintaining liquidity of
investments.\99\ The Commission further stated that it was amenable to
considering requests for Section 4(c) exemptions to permit FCMs and
DCOs to invest Customer Funds in foreign sovereign debt. Specifically,
the Commission stated that it would consider permitting Customer Funds
to be invested in the foreign sovereign debt of a country to the extent
that: (i) FCMs or DCOs held balances in segregated accounts owed to
customers denominated in that country's currency; and (ii) the foreign
sovereign debt serves to preserve principal and maintain liquidity of
Customer Funds as required for all other investments of Customer Funds
under Regulation 1.25.\100\
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\97\ Regulation 1.25(a)(1) (2005).
\98\ 2011 Permitted Investments Amendment at 78781.
\99\ Id. at 78782.
\100\ Id.
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As discussed in Section II above, the Commission subsequently
issued the 2018 Order pursuant to Section 4(c) of the Act granting DCOs
a limited exemption from the provisions of Regulation 1.25(a) to
authorize the investment of euro-denominated futures customer funds and
Cleared Swaps Customer Collateral in euro-denominated sovereign debt
issued by France or Germany subject to specified terms and
conditions.\101\ The 2018 Order also provides an exemption from
Regulation 1.25(d) to permit DCOs to enter into Repurchase Transactions
involving French or German sovereign debt with: (i) the European
Central Bank; (ii) the Deutsche Bundesbank; (iii) the Banque de France;
(iv) a foreign bank located in a country that has adopted the euro as
its currency and maintains in excess of $1 billion in regulatory
capital; and (v) a foreign dealer located in a country that has adopted
the euro as its currency and is subject to regulation by a national
financial regulator.\102\ The 2018 Order also permits DCOs to hold
German or French foreign sovereign debt purchased under reverse
repurchase agreements with depositories located in a country that has
adopted the euro as its currency and that maintain in excess of $1
billion in regulatory capital, provided that the DCOs separately
account for the securities purchased as futures customer funds or
Cleared Swaps Customer Collateral, as applicable.\103\
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\101\ 2018 Order at 35244-35245. The 2018 Order does not address
30.7 customer funds.
\102\ Condition 3(e) of the 2018 Order at 35245.
\103\ Condition 3(f) of the 2018 Order at 35245.
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The 2018 Order also contains certain conditions regarding the
investment of futures customer funds or Cleared Swaps Customer
Collateral in French or German sovereign debt. Specifically, the 2018
Order provides that the dollar-weighted average time-to-maturity of a
DCO's portfolio of investments in either French or German sovereign
debt may not exceed 60 days.\104\ In addition, the 2018 Order provides
that a DCO may not make a direct investment in any French or German
debt instrument with a remaining time-to-maturity of greater than 180
calendar days.\105\
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\104\ Condition 3(c) of the 2018 Order at 35245.
\105\ Condition 3(d) of the 2018 Order at 35245.
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For the reasons stated below, the Commission is proposing to amend
Regulation 1.25 to add Specified Foreign Sovereign Debt to the list of
Permitted Investments. The proposed addition of Specified Foreign
Sovereign Debt would be subject to certain conditions that are
consistent with the criteria specified in the 2011 Permitted
Investments Amendment \106\ and the conditions specified in the 2018
Order discussed above. The proposed conditions are also consistent with
the general objectives set forth in Regulation 1.25 of preserving
principal and maintaining liquidity of Permitted Investments.\107\
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\106\ See 2011 Permitted Investments Amendment at 78782 (stating
that the Commission would consider permitting foreign sovereign debt
investments to the extent that: (i) the petitioner has balances in
segregated accounts owed to customers or clearing member FCMs in
that country's currency; and (ii) the sovereign debt serves to
preserve principal and maintain liquidity of customer funds as
required for all other investments of customer funds under
Regulation 1.25).
\107\ 17 CFR 1.25(b).
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The proposed amendments would expand the exemptive relief provided
in the 2018 Order by adding the debt of Canada, Japan, and the United
Kingdom, in addition to that of France and Germany, to the list of
Permitted Investments under Regulation 1.25, and by allowing FCMs, in
addition to DCOs, to invest in the foreign sovereign debt.\108\ FCMs
collectively held an aggregate of a U.S. dollar equivalent of $51
billion of Customer Funds denominated in Canadian dollars
[[Page 81244]]
(``CAD''), euros (``EUR''), Japanese yen (``JPY''), and Great British
pounds (``GBP'') on August 15, 2023. The $51 billion represented
approximately 10 percent of the total $490 billion of Customer Funds
held by FCMs in segregated accounts on August 15, 2023.\109\
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\108\ Proposed Regulation 1.25(a)(1)(vi).
\109\ The $490 billion represents the U.S. dollar equivalent of
the total value of margin assets held by FCMs for futures customers,
Cleared Swaps Customers, and 30.7 customers as reported to CME as of
August 15, 2023. The breakdown by currency was as follows: CAD 14
billion; EUR 18 billion; GBP 3 billion; and JPY 16 billion. Some of
these funds may have been posted by the FCMs to DCOs as margin
collateral.
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Having considered the Joint Petition and analyzing the instruments'
characteristics, the Commission believes that including Specified
Foreign Sovereign Debt as a Permitted Investment would be consistent
with the overall objectives set forth in Regulation 1.25 of preserving
principal and maintaining liquidity of Customer Funds. The Joint
Petition states that the Specified Foreign Sovereign Debt has credit
and liquidity characteristics that are comparable to the credit and
liquidity characteristics of U.S. Treasury securities. Specifically,
the Joint Petition states that the credit default swaps of Canada,
France, Germany, Japan, and the United Kingdom have relatively narrow
spreads similar to the credit default spread of the United States.\110\
With respect to liquidity, the Joint Petition states that there were
substantial amounts of outstanding marketable Canadian, French, German,
Japanese, and United Kingdom debt and provided data on the amount of
outstanding debt in instruments with time-to-maturity of two years or
less issued by each relevant jurisdiction.\111\
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\110\ See Joint Petition at pp. 6-7.
\111\ See Appendix A to Joint Petition and Supplement to Joint
Petition at p. 1 (indicating that the outstanding debt in
instruments with time-to-maturity of two years or less issued by
Canada, France, Germany, Japan, and the United Kingdom, based on
information available on Bloomberg as of July 11, 2023, was equal to
the USD equivalence of $447 billion, $594 billion, $557 billion,
$2.6 trillion, and $534 billion, respectively). See also Bank of
International Settlements' Debt Securities Statistics (including
data as of the end of 2021), available here: <a href="https://www.bis.org/statistics/secstats.htm?m=2615">https://www.bis.org/statistics/secstats.htm?m=2615</a> and 2021 Survey on Liquidity in
Government Bond Secondary Markets, Organization for Economic Co-
operation and Development, available here: <a href="https://www.oecd-ilibrary.org/sites/b2d85ea7-en/1/4/2/index.html?itemId=/content/publication/b2d85ea7-en&_csp_=e3b7b0a57d02c41c597306342c85c8b6&itemIGO=oecd&itemContentType=book">https://www.oecd-ilibrary.org/sites/b2d85ea7-en/1/4/2/index.html?itemId=/content/publication/b2d85ea7-en&_csp_=e3b7b0a57d02c41c597306342c85c8b6&itemIGO=oecd&itemContentType=book</a> (confirming that Specified Foreign Sovereign Debt instruments
presented good liquidity characteristics in 2021).
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The Commission also analyzed the volatility of the Specified
Foreign Sovereign Debt and observed, based on the available data, that
the price risk of the relevant foreign sovereign debt is comparable to
that of U.S. Treasury securities. Specifically, using one-year
sovereign debt instruments yield data for the period September 21, 2018
to September 20, 2023, the Commission notes that the standard deviation
of daily yield change for one-year U.S. Treasury bills was 9 BPS,
whereas the same measure for Canadian, French, German, Japanese, and
United Kingdom one-year debt instruments ranged from 1 to 7 BPS.\112\
The Commission also notes that holding high-quality foreign sovereign
debt may pose less risk to Customer Funds than the credit risk of
commercial banks through unsecured bank demand deposit accounts.\113\
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\112\ The Commission reviewed yield data available through
Bloomberg, a proprietary financial data provider, for 1-year
sovereign debt instruments issued by Canada, France, Germany, Japan,
the United Kingdom, and the U.S.
\113\ The Commission discussed the preferability from a risk
management perspective of investing foreign currency in high quality
foreign sovereign debt relative to the credit risk posed by
unsecured demand deposit accounts at commercial banks in issuing the
2018 Order permitting DCOs to invest futures customer funds and
Cleared Swaps Customer Collateral in French and German sovereign
debt. See 2018 Order at 35245-35246.
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Furthermore, the Commission believes that the proposed amendments
would provide FCMs and DCOs with an investment option to manage the
potential foreign exchange risk that may arise in their administration
and investment of Customer Funds. Specifically, the Commission notes
that absent the ability to invest Customer Funds in identically-
denominated sovereign debt securities, an FCM or a DCO seeking to
invest customer foreign currency deposits would need to convert the
currencies to a U.S. dollar-denominated asset, which would introduce
potential foreign currency fluctuation risk to the FCMs and DCOs.\114\
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\114\ To reach this conclusion, the Commission considered, among
other factors, the daily volatility of exchange rates of the
relevant currency pairs. Specifically, based on data from the
Federal Reserve Bank of St. Louis' FRED database, the Commission
notes that for the period from September 2018 to September 2023, the
standard deviation of the daily percentage change of exchange rate
between the relevant currency pairs was 0.45 percent for the CAD/USD
pair, 0.46 percent for the EUR/USD pair, 0.61 percent for the GBP/
USD pair, and 0.55 percent for the JPY/USD pair, indicating a
currency fluctuation that is an additional risk factor with respect
to the return on investment of customer foreign currency deposits in
U.S. dollar-denominated assets. The Commission also recognized
foreign currency fluctuation risk in the 2000 Permitted Investments
Amendment, which added foreign sovereign debt to the list of
Permitted Investments for the first time. See 2000 Permitted
Investments Amendment at 78003.
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Based on these considerations, the Commission proposes to expand
the list of Permitted Investments to include Specified Foreign
Sovereign Debt. To ensure that investments in Specified Foreign
Sovereign Debt remain consistent with Regulation 1.25's general
objectives of preserving principal and maintaining liquidity, and with
the criteria specified in the 2011 Permitted Investments Amendment for
adding foreign sovereign debt as a Permitted Investment, the Commission
is proposing to permit the investment of Customer Funds in such debt
subject to specified conditions, which are discussed below.
First, under the Proposal, an FCM or a DCO would be permitted to
invest in the foreign sovereign debt of only Canada, France, Germany,
Japan, and the United Kingdom.\115\ The five jurisdictions are among
the seven largest economies in the International Monetary Fund's
classification of advanced economies.\116\ Each country is also a
member of the Group of 7 (``G7''), which represents the world's largest
industrial democracies, and qualifies as a ``money center country'' as
the term is defined in Regulation 1.49(a)(1).\117\ Additionally, the
currencies of the five jurisdictions represent a material portion of
the total amount of non-U.S. dollar-denominated obligations that FCMs
owe to customers, and amount to approximately 10 percent of the total
Customer Funds held by FCMs and DCOs.\118\
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\115\ Proposed Regulation 1.25(a)(1)(vii).
\116\ See Statistical Appendix to the World Economic Outlook,
April 2023, International Monetary Fund, available here: <a href="https://www.imf.org/en/Publications/WEO/Issues/2023/04/11/world-economic-outlook-april-2023">https://www.imf.org/en/Publications/WEO/Issues/2023/04/11/world-economic-outlook-april-2023</a>.
\117\ 17 CFR 1.49(a). In the absence of customer instructions to
the contrary, Regulation 1.49(c) limits permissible locations of
depositories of Customer Funds to the U.S., the country of origin of
the currency, and a ``money center country.'' The concept of ``money
center country'' is defined to mean Canada, France, Italy, Germany,
Japan, and the United Kingdom, and is intended to correspond,
together with the U.S., to the list of G7 countries. See
Denomination of Customer Funds and Location of Depositories, 68 FR
5551 (Feb. 4, 2003) at 5546.
\118\ Based on data contained in the Segregation Investment
Detail Reports filed by FCMs with the Commission as of August 15,
2023. The reports contain detailed listings of the Permitted
Investments held by each FCM. See 17 CFR 1.32(f), 17 CFR 22.2(g)(5),
and 17 CFR 30.7(l)(5).
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Second, an FCM or a DCO would be permitted to invest in the
Specified Foreign Sovereign Debt of a country only to the extent that
the FCM or a DCO has balances in accounts owed to customers denominated
in the country's currency.\119\ Prior to the 2011 Permitted Investments
Amendment, when Regulation 1.25 permitted the investment of Customer
Funds in foreign sovereign debt, the regulation
[[Page 81245]]
included a similar restriction.\120\ As noted above, the Commission
explained that an FCM or a DCO seeking to invest deposits of foreign
currencies, absent the ability to invest in identically-denominated
sovereign debt securities, would need to convert the foreign currencies
to a U.S. dollar-denominated asset, which would increase the FCM's or
DCO's exposure to foreign currency fluctuation risk.\121\ The
Commission believes the restriction is appropriate as it balances the
need to ensure the safety of Customer Funds with the Commission's
desire to provide a degree of investment flexibility to FCMs and
DCOs.\122\
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\119\ Proposed Regulation 1.25(a)(1)(vii)(A) and (B).
\120\ See 2000 Permitted Investments Amendment at 65 FR 78010,
which provided in paragraph (a)(1)(vii) of Regulation 1.25 that an
FCM or a DCO could invest in debt of a foreign sovereign subject to
certain conditions, including that the FCM or DCO had balances owed
to customers denominated in that country's currency.
\121\ Id. at 78003.
\122\ As discussed supra, prior to 2011, the Commission
permitted an FCM or a DCO to invest Customer Funds in foreign
sovereign debt subject to the condition that the FCM or DCO held
balances owed to customers denominated in the currency of the
foreign country. In the wake of the 2008 financial crisis, the
Commission eliminated foreign sovereign debt from the list of
permitted investments noting at the time that ``in many cases, the
potential volatility of foreign sovereign debt in the current
economic environment and the varying degrees of financial stability
of different issuers make foreign sovereign debt inappropriate for
hedging foreign currency risk.'' 2011 Permitted Investments
Amendment at 78781. Yet it recognized that ``the safety of sovereign
debt issuances of one country may vary greatly from those of
another, and that investment in certain sovereign debt might be
consistent with the objectives of preserving principal and
maintaining liquidity, as required by Regulation 1.25.'' Id. at
78782. For the reasons discussed above, the Commission is proposing
to reinstate certain foreign sovereign debt consistent with the
Commission's expressed statement in the 2011 Permitted Investments
Amendment that it would consider permitting such investments
provided that the investments: (i) are limited to balances owed to
customers denominated in the currency of the applicable foreign
sovereign, and (ii) serve to preserve the principal and maintain the
liquidity of Customer Funds. See id. at 78782. The Proposal is also
consistent with the Commission's approach in the 2018 Order of
permitting DCOs to invest in the sovereign debt of France and
Germany to the extent such foreign sovereign debt satisfies specific
criteria demonstrating consistency with the credit, liquidity, and
volatility of short-term U.S. Treasury securities.
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Third, the Commission is proposing to permit FCMs and DCOs to
invest in Specified Foreign Sovereign Debt provided that the two-year
credit default spread of the issuing sovereign is 45 BPS or less.\123\
This condition is consistent with the 45 BPS two-year credit default
spread limit specified by the Commission in the 2018 Order permitting
DCOs to invest futures customer funds and Cleared Swaps Customer
Collateral in French and German sovereign debt.\124\ The Commission set
the cap of 45 BPS in the 2018 Order based on a historical analysis of
the two-year credit default spread of the U.S. (``U.S. Spread'').\125\
Forty-five BPS was, at the time, approximately two standard deviations
above the mean U.S. Spread over the preceding eight years.\126\
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\123\ Proposed Regulation 1.25(f)(3).
\124\ Condition 3(b) of the 2018 Order at 35245.
\125\ See 2018 Order at 35243.
\126\ In 2018, the Commission reviewed the daily U.S. Spread
from July 3, 2009 to July 3, 2017. Over that time period, the U.S.
Spread had a mean of approximately 26.5 BPS and a standard deviation
of approximately 9.72 BPS. Forty-five BPS were approximately two
standard deviations above the 26.5 mean.
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The Commission observed that over that eight-year period of July 3,
2009 to July 3, 2017, the U.S. Spread was 45 BPS or less approximately
95 percent of the time and exceeded 45 BPS approximately 5 percent of
the time. During the same period, the two-year German spread exceeded
45 BPS approximately 6 percent of the time and the two-year French
spread exceeded 45 BPS approximately 25 percent of the time, with all
exceedances occurring between July 2009 and September 2012, in the
aftermath of the 2008 financial crisis and the European sovereign debt
crisis.\127\
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\127\ See 2018 Order at 35243.
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During the more recent period of September 21, 2018 to September
20, 2023, the U.S. Spread had a mean of approximately 16.4 BPS,\128\
which was lower than the mean spread of 26.5 BPS for the July 3, 2009
to July 3, 2017 period. In that same time period, the two-year credit
default swap spread of the sovereigns issuing the Specified Foreign
Sovereign Debt did not exceed 45 BPS. Based on these more recent U.S.
Spread and Foreign Sovereign Debt data, the Commission preliminarily
believes that the cap of 45 BPS established in the 2018 Order continues
to be set at an appropriate level.\129\
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\128\ Based on an assessment conducted by CFTC staff on
September 20, 2023.
\129\ Using the daily U.S. Spread data from July 3, 2009 to July
3, 2017 and assuming the two-year credit default spread follows a
normal distribution, the Commission estimated that there was less
than 2.5 percent likelihood that the U.S. credit default spread
would exceed 45 BPS over a two-year period. In addition, the
Commission's estimate, based on the daily U.S. Spread data from
September 21, 2018 to September 20, 2023, indicates that there is
less than 1 percent likelihood, under both normal and empirical
distributions, that the two-year credit default swap spread of the
sovereigns issuing Specified Foreign Sovereign Debt would exceed 45
BPS. Therefore, the Commission preliminarily believes that 45 BPS
represents an appropriate threshold for countries whose debt may
qualify as a Permitted Investment under Regulation 1.25.
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Under the Proposal, if the credit default spread of a subject
country were to exceed the 45 BPS cap, FCMs and DCOs would not be
permitted to make new investments in the country's Specified Foreign
Sovereign Debt.\130\ In addition, if the credit default spread exceeded
the 45 BPS cap, FCMs and DCOs would be required to discontinue
investing Customer Funds in that sovereign's debt through Repurchase
Transactions as soon as practicable under the circumstances.\131\ The
FCMs or DCOs would not, however, be required to immediately divest
their current investments in Specified Foreign Sovereign Debt, given
the risks associated with selling assets into a potentially volatile
market or having to immediately locate depositories for funds that had
been invested in a Repurchase Transaction with limited notice. The
prohibition on new investments would reduce the exposure to Customer
Funds by avoiding the risk of default on the Specified Foreign
Sovereign Debt. In situations where the 45 BPS cap is exceeded, the
Commission preliminarily believes that it would be more appropriate for
FCMs and DCOs to hold Customer Funds denominated in foreign currency in
cash or invest the foreign currency in U.S. dollar-denominated
Permitted Investments instead of Specified Foreign Sovereign Debt. In
addition, the length to maturity condition discussed immediately below
would mitigate price risks to the Customer Funds that might arise from
a country's two-year credit default spread exceeding the 45 BPS limit.
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\130\ Proposed Regulation 1.25(f)(3)(i).
\131\ Proposed Regulation 1.25(f)(3)(ii).
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Fourth, the Commission is proposing to limit the time-to-maturity
of investments in Specified Foreign Sovereign Debt. Specifically, under
the Proposal, an FCM or a DCO would be required to ensure that the
dollar-weighted average time-to-maturity of its portfolio of
investments in the Specified Foreign Sovereign Debt, as the average is
computed under Rule 2a-7 under the Investment Company Act of 1940
(``SEC Rule 2a-7'') \132\ on a country-by-country basis, does not
exceed 60 calendar days.\133\ Consistent with the position taken in the
2018 Order,\134\ if the portfolio includes Specified Foreign Sovereign
Debt instruments that have been acquired under a reverse repurchase
agreement, the FCM or DCO would be permitted to use the maturity
[[Page 81246]]
of the reverse repurchase agreement to compute the dollar-weighted
average time-to-maturity of the portfolio.\135\ This approach takes
into account the expected resale of the instruments, which would be
scheduled to occur within one business day or on demand as required by
Regulation 1.25(d)(6).\136\ Conversely, if the FCM or DCO sells
Specified Foreign Sovereign Debt instruments under a repurchase
agreement, the FCM or DCO would be required to include the instruments
in the calculation of the dollar-weighted average based on the
remaining time-to-maturity of each instrument sold, to account for the
expected repurchase of such instruments.\137\ In addition, an FCM or a
DCO would not be permitted to make direct investments in any Specified
Foreign Sovereign Debt instrument that had a remaining maturity greater
than 180 calendar days.\138\
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\132\ 17 CFR 270.2a-7.
\133\ Proposed Regulation 1.25(f)(1). Under the Proposal, the
dollar-weighted average of the time-to-maturity would be computed
pursuant to SEC Rule 2a-7 (17 CFR 270.2a-7), consistent with the
general time-to-maturity provision in Regulation 1.25(b)(4)(i).
\134\ 2018 Order at 35244.
\135\ Consistent with SEC Rule 2a-7(i)(6), the reverse
repurchase agreement would be deemed to have a maturity equal to the
period remaining until the date on which the resale of the
underlying instruments is scheduled to occur, or, where the
agreement is subject to demand, the notice period applicable to a
demand for the resale of the instruments. See proposed Regulation
1.25(f)(1).
\136\ 17 CFR 1.25(d)(6).
\137\ Proposed Regulation 1.25(f)(1).
\138\ Proposed Regulation 1.25(f)(2).
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Arguing that these restrictions, which are analogous to the
restrictions in the 2018 Order, would be too limiting, the Petitioners
requested that the Commission revise the regulations to provide a six-
month dollar-weighted average time-to-maturity for the portfolio of
foreign sovereign debt, and a maximum two-year remaining time-to-
maturity for each foreign sovereign debt instrument.\139\ The
Commission, however, notes that the proposed restrictions are intended
to ensure that an FCM's or DCO's portfolio of Specified Foreign
Sovereign Debt is comprised of sovereign debt instruments that mature
within a relatively short period of time. The short time-to-maturity
requirement is expected to assist FCMs and DCOs in managing and
mitigating potential market and/or credit risk by providing FCMs and
DCOs with the option of holding the debt instruments to maturity during
periods of market stress and price volatility rather than selling the
debt instruments at potentially significant discounts. This option may
be particularly valuable in periods of significant interest rate
movements, which could exacerbate market risk in sovereign debt
markets. In that regard, the Commission preliminarily views the
relatively short time-to-maturity as an essential risk-managing feature
in the context of investments in Specified Foreign Sovereign Debt and
preliminarily believes that the 60-day dollar-weighted average time-to-
maturity restriction and the 180-day remaining maturity restriction are
more appropriate than the six months and two years respective limits
requested in the Joint Petition.
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\139\ Joint Petition at pp. 5-6 (asserting that the new issuance
supply of the Specified Foreign Sovereign Debt meeting the
restrictions is limited and would be thinly traded/quoted).
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The Commission also believes that the proposed time-to-maturity
requirements would not be as limiting as asserted in the Joint Petition
given that the new issuance supply of the Specified Foreign Sovereign
Debt meeting the proposed restrictions appears adequate to satisfy the
demand for the investment of Customer Funds in the relevant
instruments.\140\ In addition, the use of the maturity of reverse
repurchase agreements in the calculation of the dollar-weighted average
of the portfolio of investments in Specified Foreign Sovereign Debt
would reduce the average time-to-maturity of the portfolio as a whole.
As noted in the request for comment below, the Commission is explicitly
seeking comment on its preliminary analysis.
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\140\ Data made available by the Bank of Canada, l'Agence France
Tr[eacute]sor (the French Finance Agency), the Bundesrepublik
Deutschland Finanzagentur (the German Finance Agency), the Japan
Ministry of Finance, and the United Kingdom Debt Management Office
indicate that the five jurisdictions issue a sizable amount of debt
securities with time-to-maturity of less than 180 days on a frequent
basis. Specifically, in July 2023, Canada auctioned approximately
USD 22 billion, France auctioned approximately USD 18 billion,
Germany auctioned approximately USD 10 billion, Japan auctioned
approximately USD 15 billion, and the United Kingdom auctioned
approximately USD 34 billion in debt instruments with time-to-
maturity of six months or less (see Canadian Treasury bills auction
results at <a href="https://www.bankofcanada.ca/markets/government-securities-auctions/calls-for-tenders-and-results/regular-treasury-bills/">https://www.bankofcanada.ca/markets/government-securities-auctions/calls-for-tenders-and-results/regular-treasury-bills/</a>; French BTF auction history at <a href="https://www.aft.gouv.fr/en/dernieres-adjudications">https://www.aft.gouv.fr/en/dernieres-adjudications</a>); German Bubills issuance results at <a href="https://www.deutsche-finanzagentur.de/en/federal-securities/issuances/issuance-results">https://www.deutsche-finanzagentur.de/en/federal-securities/issuances/issuance-results</a> (refer to reopening of 12-month Bubills with
residual maturities between three and six months); Japanese T-bills
auction results at <a href="https://www.mof.go.jp/english/policy/jgbs/auction/past_auction_results/index.html">https://www.mof.go.jp/english/policy/jgbs/auction/past_auction_results/index.html</a>; and United Kingdom Treasury
Bill tender results at <a href="https://www.dmo.gov.uk/data/treasury-bills/tender-results/">https://www.dmo.gov.uk/data/treasury-bills/tender-results/</a>).
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The Commission is also proposing to amend Regulation 1.25(b)(4)(i),
which provides that except for investments in MMFs, the dollar-weighted
average time-to-maturity of an FCM's or a DCO's portfolio of Permitted
Investments, as computed under SEC Rule 2a-7, may not exceed 24 months.
The proposed amendment would revise Regulation 1.25(b)(4)(i) to exclude
Specified Foreign Sovereign Debt from the calculation of the dollar-
weighted average time-to-maturity of the portfolio.\141\ The Commission
is proposing this amendment as Specified Foreign Sovereign Debt would
be subject to its own dollar-weighted average time-to-maturity limit of
60 calendar days, which is substantially shorter than the two-year
dollar-weighted average time-to-maturity requirement for the overall
portfolio required by Regulation 1.25(b)(4)(i).
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\141\ Proposed revised Regulation 1.25(b)(4)(i).
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To allow Regulation 1.25(a)(2) to effectively incorporate Specified
Foreign Sovereign Debt as a Permitted Investment that FCMs and DCOs
would be able to buy or sell pursuant to Repurchase Transactions, the
Commission also proposes to expand the permissible counterparties and
depositories under Regulation 1.25(d)(2) and (7) to include certain
foreign entities. Regulation 1.25(d)(2) limits counterparties with
which an FCM or a DCO may enter into a Repurchase Transaction to a
Section 3(a)(6) \142\ bank, a domestic branch of a foreign bank insured
by the FDIC, a securities broker or dealer, or a government securities
dealer registered with the SEC or which has filed a notice pursuant to
Section 15C(a) of the Government Securities Act of 1986.\143\
Regulation 1.25(d)(7) further requires an FCM and a DCO to hold the
securities transferred to the FCM or DCO under a reverse repurchase
agreement, in a safekeeping account held with a bank as referred to in
Regulation 1.25(d)(2), a Federal Reserve Bank, a DCO, or the Depository
Trust Company.
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\142\ For a definition of Section 3(a)(6) bank, see supra note
51.
\143\ Public Law 99-571, 100 Stat. 3208 (Oct. 28, 1986).
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As a practical matter, absent amendment to these counterparty and
depository provisions, an FCMs' and DCOs' ability to buy and sell
Specified Foreign Sovereign Debt pursuant to Repurchase Transactions
would be restricted given that participants in the foreign sovereign
debt Repurchase Transactions market are predominantly non-U.S.
entities. The Commission therefore proposes to add foreign banks and
foreign brokers or dealers meeting certain requirements, as well as the
European Central Bank and the central banks of Canada, France, Germany,
Japan, and the United Kingdom, to the list of permitted
counterparties.\144\ To be deemed a permitted counterparty, a foreign
bank would have to qualify as a depository under Regulation 1.49(d)(3)
[[Page 81247]]
by holding regulatory capital in excess of $1 billion, and would also
have to be located in a money center country as defined in Regulation
1.49(a)(1) (i.e., Canada, France, Italy, Germany, Japan, and the United
Kingdom) or in another jurisdiction that has adopted the currency of
the permitted foreign sovereign debt. Similarly, a foreign broker or
dealer would have to be located in a money center country and be
regulated by a foreign financial regulator. The proposed provisions are
designed to ensure that the counterparties would be regulated entities
comparable to those counterparties already permitted under Regulation
1.25(d)(2), and are consistent with the counterparty conditions set
forth in the 2018 Order.\145\
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\144\ Proposed Regulation 1.25(d)(2).
\145\ See 2018 Order, Condition (e) at 35245.
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With respect to permitted depositories, the Commission proposes to
permit Specified Foreign Sovereign Debt instruments transferred to an
FCM or a DCO under a reverse repurchase agreement to be held with a
foreign bank that qualifies as a permitted depository under Regulation
1.49.\146\ The proposed provision is designed to ensure that any
additional depositories would be comparable to those already permitted
under Regulation 1.25(d)(7), and subject to the conditions for
depositories in the 2018 Order.\147\ The Commission notes that
mandating the safekeeping of foreign securities purchased through
reverse repurchase agreements with a U.S. custodian as required under
the current regulation may be inefficient or impractical.
---------------------------------------------------------------------------
\146\ Proposed Regulation 1.25(d)(7).
\147\ See 2018 Order, Condition (f) at 35245.
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Request for Comment. The Commission seeks comment on all aspects of
the Proposal relating to the expansion of the list of Permitted
Investments to include Specified Foreign Sovereign Debt, including:
3. Under the Proposal, the list of Permitted Investments set forth
in Regulation 1.25(a) would be expanded to include sovereign debt
issued by Canada, France, Germany, Japan, and the United Kingdom,
subject to specified conditions. Although these Specified Foreign
Sovereign Debt instruments present credit and liquidity characteristics
that are similar to those of currently Permitted Investments, such debt
may also be less liquid than U.S. government securities. Do investments
in Specified Foreign Sovereign Debt raise any liquidity issues or
concerns? If so, please explain your responses and provide data if
possible.
4. The Proposal would prohibit investments of Customer Funds in
Specified Foreign Sovereign Debt if the two-year credit default swap
spread of the issuing sovereign exceeds 45 BPS. Should the Commission
consider a higher or lower credit default spread limit? If so, please
specify the appropriate credit default spread and explain why it is
necessary and appropriate. Should the investment prohibition be
contingent on the breach of the 45 BPS threshold occurring a certain
number of times within a specified time period or for a particular
duration within a specified time period? Should there be a ``cooling-
off'' period before the Specified Foreign Sovereign Debt may be used
again as a Permitted Investment under Regulation 1.25? For instance,
should the Specified Foreign Sovereign Debt be subject to a requirement
that the CDS spread be below 45 BPS for a minimum period of time (e.g.,
3 months) before it could be reinstated as an eligible Permitted
Investment?
5. The Proposal would limit the time-to-maturity of investments in
Specified Foreign Sovereign Debt to a 60-day maximum dollar-weighted
average time-to-maturity of the portfolio of investments and a 180-day
maximum remaining time-to-maturity of individual direct investments.
The Petitioners requested that the limits be set at six months and two
years, respectively. Should the Commission consider extending the time-
to-maturity limits as requested? If yes, please provide analysis and
appropriate market data supporting the extension.
3. Interests in U.S. Treasury Exchange-Traded Funds
ETFs are collective investment vehicles that issue redeemable
securities that are also traded at the market price on national
securities exchanges.\148\ The Commission proposes to add interests in
ETFs to the list of Permitted Investments under Regulation 1.25,
subject to specified proposed conditions discussed below.
---------------------------------------------------------------------------
\148\ Invesco Petition at p. 5. See also, Exchange-Traded Funds,
84 FR 57162 (Oct. 24, 2019) (``SEC ETFs Release'') at 57164.
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The SEC adopted Rule 6c-11 \149\ under the Investment Company Act
of 1940 in 2019, creating a regulatory framework that allows ETFs
meeting certain requirements to operate as investment companies under
the Investment Company Act of 1940 without having to obtain an
exemptive order from the SEC as previously required.\150\ Like other
investment companies, an ETF pools the assets of multiple investors and
invests those assets according to a set investment objective and
principal investment strategies.\151\ Each share of an ETF represents
an undivided fractional interest in the underlying assets of the
ETF.\152\ Similar to indexed mutual funds, many ETFs are designed to
passively track a particular market index, investing in all or a
representative sample of the instruments included in the index and
aiming to achieve the same return as the tracked index.\153\ Other ETFs
are actively managed, with portfolio managers buying and selling stocks
in accordance with an investment strategy rather than passively
tracking an index.\154\
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\149\ 17 CFR 270.6c-11 (``SEC Rule 6c-11'').
\150\ See generally SEC ETFs Release.
\151\ Invesco Petition at p. 5. See also, SEC ETFs Release at
57164.
\152\ Id.
\153\ See ``Exchange-Traded Funds,'' publication by FINRA,
available at: <a href="https://www.finra.org/investors/learn-to-invest/types-investments/investment-funds/exchange-traded-fund">https://www.finra.org/investors/learn-to-invest/types-investments/investment-funds/exchange-traded-fund</a>.
\154\ Id.
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As an open-end management company,\155\ similar to a mutual
fund,\156\ an ETF continuously offers its shares for sale. Unlike
mutual funds, however, ETFs do not sell shares to, or redeem shares
from, investors directly. Instead, ETFs issue (and redeem) shares to
(and from) ``authorized participants''--market intermediaries that have
a contractual arrangement with the ETF (or its distributor) and are
members or participants of a clearing agency registered with the SEC--
in blocks called ``creation units.'' \157\ Authorized participants play
a key role for ETF shares as they are the only investors that are
allowed to transact directly with the ETF.\158\ Authorized participants
must: (i) be an SEC-registered broker or dealer or other securities
market participant (such as a bank or other financial institution that
is not required to register as a broker or dealer to engage in
securities transactions); (ii) be a full participating member of the
National Securities Clearing Corporation and the Depository Trust
Company; and (iii) have entered
[[Page 81248]]
into an authorized participant agreement with the ETF (and potentially
other parties, such as the ETF's sponsor, distributor or transfer
agent).\159\
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\155\ Some ETFs may also be structured as unit-investment
trusts. See e.g., SPDR[supreg] S&P 500[supreg] ETF Trust and
SPDR[supreg] Dow Jones Industrial Average ETF Trust. The regulatory
framework set forth by SEC Rule 6c-11, however, applies only to ETFs
that are organized as open-end management investment companies. See
17 CFR 270.6c-11.
\156\ A ``mutual fund'' is a type of open-end management
company, meaning that investors can purchase and redeem shares in
the fund on a daily basis based on the NAV of their shares. Mutual
funds pool the money of many investors to purchase a range of
securities to meet specified investment objectives.
\157\ See 17 CFR 270.6c-11 (defining ``exchange-traded fund'').
\158\ Invesco Petition at p. 5.
\159\ Id.
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An authorized participant may act as a principal for its own
account or as an agent for others when purchasing or redeeming creation
units.\160\ Purchases and redemptions of ETF shares by an authorized
participant are referred to as ``primary market transactions'' and
occur at the next-calculated NAV. As noted above, ETF shares can also
be purchased and sold in the secondary market at market prices that may
reflect a discount or premium to the ETF's NAV.
---------------------------------------------------------------------------
\160\ See SEC ETFs Release at 57164; see also David Abner, The
ETF Handbook: How to Value and Trade Exchange-Traded Funds, 2nd ed.
(2016).
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As part of its periodic reassessment of the list of Permitted
Investments of Customer Funds and in consideration of industry input
provided by the Joint Petition and the Invesco Petition, the Commission
is proposing to include shares in U.S. Treasury ETFs to the list of
Permitted Investments under Regulation 1.25. More specifically, in
assessing the potential expansion of the list of Permitted Investments,
the Commission has considered statements emphasizing the liquidity of
U.S. Treasury ETF shares and the diversification opportunity that such
ETFs provide for Customer Funds. In particular, as discussed in other
parts of the Proposal, the Petitioners note that U.S. Treasury ETFs
have characteristics that may be consistent with those of Permitted
Investments and may provide FCMs and DCOs with an opportunity to
further diversify their investments of Customer Funds.\161\ Similarly,
the Invesco Petition focused on the fact that U.S. Treasury ETFs invest
in a sub-set of the same high-quality liquid instruments that are
Permitted Investments under Regulation 1.25 (i.e., U.S. government
securities).\162\ The Invesco Petition also notes that ETFs, as
registered investment companies whose shares are registered under the
Securities Act and Exchange Act, must comply with a number of SEC
financial reporting requirements and liquidity risk management program
requirements.\163\ Finally, the Invesco Petition asserts that the
design and characteristics such as price and investment transparency,
and intra-day trading and liquidity, are additional features that help
make interests in U.S. Treasury ETFs a safe and efficient vehicle for
investment of Customer Funds.\164\
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\161\ See Joint Petition at pp. 8-9.
\162\ Invesco Petition at p. 2.
\163\ Id. at pp. 6-7. Financial requirements include: (i) annual
shareholder report, including audited financial statements (17 CFR
270.30e-1); (ii) semi-annual shareholder report, including unaudited
financial statements (17 CFR 270.30e-1); (iii) monthly portfolio
statistics and holdings filed quarterly (17 CFR 270.30b1-9); (iv)
annual census report containing financial-related information (17
CFR 270.30a-1); and (v) periodic reports with respect to portfolio
liquidity and derivatives use (17 CFR 270.30b1-10). With respect to
liquidity risk management, SEC regulations require open-ended
management investment companies, including ETFs, to adopt and
implement a liquidity risk management program that is reasonably
designed to assess and manage liquidity risk, which is defined to
mean the risk that the fund could not meet redemption requests to
redeem shares issued by the fund without significant dilution of
remaining investors' interests in the fund (17 CFR 270.22e-4).
\164\ Invesco Petition at p. 2.
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Further, the Commission has taken into consideration the limited
range of investments that meet the requirements of Regulation 1.25. In
that regard, the Commission notes that as a result of various
regulatory reforms, discussed in this Federal Register release, several
asset classes included in Regulation 1.25 no longer qualify as
Permitted Investments. In particular, as discussed in Section III.A.2.
above, the range of MMFs whose securities qualify as Permitted
Investments has contracted, as only interests in Permitted Government
MMFs currently meet the eligibility criteria of Regulation 1.25. In
addition, as discussed in Section III.A.4. below, commercial paper and
corporate notes and bonds no longer qualify as Permitted Investments
with the expiration of the TLGP.
Also, due to certain regulatory reforms, there has been an
increased demand for high quality collateral, including for assets that
currently qualify as Permitted Investments under Regulation 1.25. For
example, in the aftermath of the 2008 financial crisis, Congress
enacted the Dodd-Frank Wall Street Reform and Consumer Protection
Act,\165\ which set forth a regulatory framework for swaps, requiring,
among other things, the clearing of certain swaps or the margining of
certain uncleared swaps. As a result, market participants dealing in
swaps may be required to post to clearinghouses, or post and collect
with swap counterparties, specified forms of liquid collateral, driving
increased demand for assets that currently qualify as Permitted
Investments.
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\165\ The Dodd-Frank Wall Street Reform and Consumer Protection
Act of 2010 (Pub. L. 111-203, H.R. 4173).
---------------------------------------------------------------------------
The Commission believes expanding the range of available Permitted
Investments to include interests in ETFs that meet specified
conditions, as discussed below, would provide FCMs and DCOs with
greater flexibility and opportunities for capital efficiency in the
investment of Customer Funds, without unacceptably increasing risk to
customers. Consistent with the existing regulations limiting customer
risk associated with the investment of Customer Funds by FCMs and DCOs,
under the terms of the Proposal, FCMs and DCOs would be financially
responsible for bearing any loss on an investment of Customer Funds in
an ETF in the same manner as FCMs and DCOs are financially responsible
for losses incurred from the investment of Customer Funds in Permitted
Investments.\166\
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\166\ See Regulation 1.29(b) (providing that an FCM or a DCO, as
applicable, shall bear sole responsibility for any losses resulting
from the investment of futures customer funds in Permitted
Investments) and Regulations 22.2(e)(1) and 30.7(i) (providing that
an FCM shall bear sole responsibility for any losses resulting from
the investment of Cleared Swaps Customer Collateral and 30.7 funds,
respectively, in Permitted Investments). As further discussed in
Section III.C. below, the Commission is also proposing an amendment
to Regulation 22.3(d) to clarify that DCOs are financially
responsible for investments of Cleared Swaps Customer Collateral in
Permitted Investments.
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The Commission also believes that the proposed addition of
interests in ETFs as Permitted Investments under Regulation 1.25(a)
would foster innovation and promote competition in the ETF market and
the financial services industry more generally, as the Proposal would
permit the flow of Customer Funds into a new type of financial
instrument that previously had been prohibited and, as discussed below,
would offer the possibility for market participants to purchase a type
of collateral that is already a Permitted Investment without having to
purchase the securities directly or through a MMF.
As noted above, industry representatives and other market
participants have also expressed interest in U.S. Treasury ETFs as
Permitted Investments.\167\ Both the Petitioners and Invesco highlight
the similarity in characteristics between U.S. Treasury ETF securities
and other instruments that qualify as Permitted Investments under
Regulation 1.25.\168\ Invesco further notes that ETFs investing in U.S.
Treasury securities offer an indirect, yet simpler and more cost-
efficient way, for FCMs to invest Customer Funds in such instruments,
eliminating the need to identify, invest in, and administer
[[Page 81249]]
investments in individual U.S. Treasury securities.\169\
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\167\ They generally refer to short-term U.S. Treasury ETFs that
invest at least 80 percent of their assets in U.S. Treasury
securities with a remaining term to final maturity of 12 months or
less.
\168\ See Joint Petition at pp. 8-9 and Invesco Petition at pp.
9-10.
\169\ Invesco Petition at p. 11. Invesco states that an ETF
would allow FCMs and DCOs to gain exposure to short-term U.S.
Treasury securities without buying and selling Treasury securities
on a periodic basis, such as each quarter, eliminating the costs
associated with trading Treasury securities.
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The Commission also notes that CME accepts shares of short-term
U.S. Treasury ETFs as performance bond from clearing members to margin
customer and house trades.\170\ The Commission believes that this
represents an important consideration in determining whether to add
interests of U.S. Treasury ETFs to the list of Permitted Investments
given that interests in U.S. Treasury ETFs that qualify as a Permitted
Investment under the Proposal could ultimately be accepted by DCOs,
such as CME, as performance bond, and pledged by FCMs as margin
collateral.
---------------------------------------------------------------------------
\170\ CME Advisory Notice, Modifications to Schedule of
Acceptable Performance Bond--Addition of Short-Term U.S. Treasury
ETFs (Aug. 2, 2022) (``2022 CME Advisory Notice''), available at
<a href="https://www.cmegroup.com/notices/clearing/2022/08/Chadv22-293.pdf">https://www.cmegroup.com/notices/clearing/2022/08/Chadv22-293.pdf</a>
(providing that acceptable ETFs must track a U.S. Treasury index and
must have a minimum 80 percent investment in U.S. Treasury
securities with a time to maturity of 1 year or less).
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To ensure consistency with the requirements applicable to other
Permitted Investments and the general objectives of Regulation 1.25 of
preserving principal and maintaining liquidity of Permitted
Investments, the Commission is proposing to impose the conditions
discussed below on ETFs for their interests to qualify as a Permitted
Investment. The Commission preliminarily believes that to the extent
ETFs meet the proposed conditions, the ETFs would be comparable to
Permitted Government MMFs whose interests currently qualify as
Permitted Investments under Regulation 1.25(a).\171\ The Commission
also notes that by allowing FCMs and DCOs to invest Customer Funds in
ETFs that meet the specified proposed conditions, it would provide FCMs
and DCOs with a means for investing indirectly in Permitted
Investments--U.S. Treasury securities, while allowing FCMs and DCOs to
dispense with the expense and resources required to manage individual
investments in such instruments.
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\171\ The Commission notes that SEC Rule 2a-7, which applies to
MMFs, restricts the types of investments in which MMFs can invest
their assets, limits the terms of the investments, and imposes
liquidity requirements with respect to the investments, among other
things. See 17 CFR 270.2a-7(d)(2) (providing that MMFs must limit
their portfolio investments to U.S. dollar-dominated securities that
at the time of acquisition are eligible securities), 17 CFR 270.2a-
7(d)(1) (limiting the terms of maturity of MMFs' investments), and
17 CFR 270.2a-7(d)(4) (providing that MMFs must hold securities that
are sufficiently liquid to meet reasonably foreseeable shareholder
redemptions and setting forth other liquidity requirements).
Although SEC Rule 2a-7 does not apply to ETFs, as described below,
this Proposal would admit as a Permitted Investment only ETFs
providing investors with substantial protections that are
comparable, though not identical, to those afforded to MMF
investors.
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One rationale for adding ETFs investing primarily in short-term
U.S. Treasury securities to the list of Permitted Investments is the
similarity of the ETFs to MMFs whose interests qualify as Permitted
Investments under Regulation 1.25(a). As such, the Commission
preliminarily believes that it is appropriate to propose to impose all
pertinent requirements applicable to MMFs under Regulation 1.25 to such
ETFs, subject to certain modification to address the unique
characteristics of the ETFs. Therefore, under the terms of the
Proposal, an ETF would be required to satisfy specified requirements,
as discussed below, to be a qualified ETF (``Qualified ETF'') whose
interests qualify as a Permitted Investment.
Consistent with Regulation 1.25(c), which sets forth provisions for
MMFs whose interests qualify as Permitted Investments, a Qualified ETF
would be required to be an investment company that is registered under
the Investment Company Act of 1940 with the SEC and that holds itself
out to investors as an ETF under SEC Rule 6c-11.\172\ The ETF would
also be required to be sponsored by a federally regulated financial
institution, a Section 3(a)(6) bank,\173\ an investment adviser
registered under the Investment Advisers Act of 1940, or a domestic
branch of a foreign bank insured by the FDIC.\174\
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\172\ Proposed Regulation 1.25(c)(1).
\173\ For a definition of Section 3(a)(6) bank, see supra note
51.
\174\ Proposed Regulation 1.25(c)(2), as applying to Qualified
ETFs per proposed revised introductory text of paragraph (c) of
Regulation 1.25.
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In addition, the Commission is proposing to limit Qualified ETFs to
funds that are passively managed and seek to replicate the performance
of a published short-term U.S. Treasury security index.\175\ For
purposes of the Proposal, short-term U.S. Treasury securities are
bonds, notes, and bills with a remaining maturity of 12 months or less,
issued by, or unconditionally guaranteed as to the timely payment of
principal and interest by, the U.S. Department of the Treasury.\176\
Consistent with this condition, the Commission is further proposing to
require that the eligible U.S. Treasury securities represent at least
95 percent of the ETF's investment portfolio. In that regard, the
Commission notes that pursuant to SEC requirements,\177\ certain
registered investment companies, including ETFs, must adopt a policy to
invest at least 80 percent of the value of their assets in accordance
with the investment focus suggested by the fund's name.\178\
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\175\ Proposed revised Regulation 1.25(a)(1)(vi).
\176\ Id.
\177\ SEC Rule 35d-1 under the Investment Company Act of 1940
(indicating that a fund name suggesting that the fund focuses its
investments in a particular type of investments or in investments in
a particular industry would be a materially deceptive and misleading
name unless the fund has adopted a policy to invest, under normal
circumstances, at least 80 percent of the value of its assets in the
particular type of investments or in investments in the particular
industry suggested by the fund's name). 17 CFR 270.35d-1.
\178\ Proposed Regulation 1.25(c)(8)(ii).
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The Commission, however, preliminarily believes that a stricter
standard is necessary to help ensure that FCMs and DCOs invest Customer
Funds in accordance with Regulation 1.25's general objectives of
preserving principal and maintaining liquidity. The Commission's
preliminary analysis indicates that short-term U.S. Treasury ETFs
generally invest at least 95 percent of their assets in securities
comprising the U.S. Treasury securities index whose performance the
funds seek to replicate. As such, the Commission preliminarily believes
that mandating that a Qualified ETF invest a minimum of 95 percent of
its assets in eligible U.S. Treasury securities would not be overly
restrictive. \179\ To ensure compliance with the proposed condition,
FCMs and DCOs would be required to monitor the Qualified ETF's
portfolio. If the portion of the ETF's assets invested in eligible U.S.
Treasury securities falls below 95 percent of the fund's total assets,
the FCM or DCO would not be permitted to make additional investments of
Customer Funds in the ETF. The FCM or DCO would also be expected to
take reasonable actions to divest interests in the fund, while managing
Customer Funds in a manner consistent with Regulation 1.25's general
objectives of preserving principal and maintaining liquidity. Depending
on the market conditions, such actions may include taking steps to
progressively reduce the
[[Page 81250]]
amount of Customer Funds invested in ETFs instead of immediately
divesting the investments in a potentially volatile market.
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\179\ The Commission considered proposing to require that
Qualified ETFs invest at least 99.5 percent of their assets in
eligible U.S. Treasury securities to reflect an analogous condition
in SEC Rule 2a-7 requiring that government MMFs invest at least 99.5
percent of their assets in government securities. The Commission,
however, preliminarily believes that such threshold would be more
restrictive in the context of Qualified ETFs, given that an eligible
U.S. Treasury security would be defined as a bond, note, or bill
with a remaining maturity of 12 months or less, issued or
unconditionally guaranteed by the U.S. Department of the Treasury,
whereas a government security is broadly defined in SEC Rule 2a-7
(by reference to 15 U.S.C. 80a-2(a)(16)) to include U.S. government
securities and U.S. agency obligations.
---------------------------------------------------------------------------
The Commission preliminarily believes that limiting the investments
of Qualified ETFs as proposed would increase the safety and resilience
of the ETFs \180\ and allow the funds to more closely match the risk
profile of Permitted Investments, including Permitted Government MMFs.
Also, Qualified ETFs that maintain portfolios primarily comprised of
high-quality and liquid investments are better able to redeem interests
without placing excessive downward pressure on the NAVs.
---------------------------------------------------------------------------
\180\ The Commission notes that a preliminary analysis of ETFs
investing primarily in short-term U.S. Treasury securities indicates
that the funds have a risk profile and volatility characteristics
that are comparable to that of the underlying U.S. Treasury security
investments. Specifically, using data available on Bloomberg, the
Commission notes that for the period June 2020-September 2023, the
Invesco Collateral Treasury ETF, as well as four other short-term
U.S. Treasury ETFs that CME accepts as performance bond--
SPDR[supreg] Bloomberg 1-3 Month T-Bill ETF, Goldman Sachs Access
Treasury 0-1 Year ETF, iShares 0-3 Month Treasury Bond ETF, and
iShares Short Treasury Bond ETF--had a standard deviation for a two-
day period of risk of approximately 6 BPS, whereas the one-year U.S.
Treasury securities had a standard deviation of 8 BPS for the same
period.
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In addition, the agreement pursuant to which an FCM or a DCO
acquires and holds its interest in the Qualified ETF would be
prohibited from containing provisions that would prevent the pledging
of the Qualified ETF's shares.\181\ FCMs and DCOs would be required to
maintain confirmations relating to their purchase of interests in a
Qualified ETF in their records in accordance with Regulation 1.31 and
note the ownership of the interests (by book-entry or otherwise) in the
FCMs' and DCOs' custody account in accordance with Regulation
1.26.\182\ FCMs and DCOs would be required to obtain the acknowledgment
letter required by Regulation 1.26 from an entity that has substantial
control over the ETF interests purchased with Customer Funds and that
has the knowledge and authority to facilitate redemption and payment or
transfer of the Customer Funds. Such entity may be the sponsor of the
Qualified ETF or a depository acting as custodian for the ETF
interests.
---------------------------------------------------------------------------
\181\ Paragraph (c)(6) of Regulation 1.25 as applying to
Qualified ETFs per proposed revised introductory text of paragraph
(c) of Regulation 1.25.
\182\ Paragraph (c)(3) of Regulation 1.25 as applying to
Qualified ETFs per proposed revised introductory text of paragraph
(c) of Regulation 1.25.
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Also, the NAV for the Qualified ETF would be required to be
computed by 9 a.m. of the business day following each business day and
made available to FCMs or DCOs, as applicable, by that time.\183\ The
Commission notes that this proposed requirement is intended to allow
for the valuation of the Qualified ETF's investment portfolio to be
available by 9 a.m. the business day following an investment in the
ETF, so that the valuation is available in time for FCMs to perform
their daily segregation calculations, which are required to be
completed by noon each business day, reflecting balances as of the
close of business on the previous business day.\184\
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\183\ Paragraph (c)(4) of Regulation 1.25 as applying to
Qualified ETFs per proposed revised introductory text of paragraph
(c) of Regulation 1.25.
\184\ 2000 Permitted Investments Amendment at 78003.
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Further, the Qualified ETF would be required to be legally
obligated to redeem its interests and make payment in satisfaction of
the interests by the business day following a redemption request.\185\
FCMs or DCOs, as applicable, would be required to retain documentation
demonstrating compliance with this requirement.\186\ Regulation
1.25(c)(5)(ii) currently provides an exception to the next-day
redemption obligation for MMFs for defined extraordinary circumstances,
such as the non-routine closures of the Fedwire or applicable Federal
Reserve Banks, and any period during which the SEC by order restricts
redemptions for the protection of security holders in the fund.
Regulation 1.25(c)(5)(ii) was adopted by the Commission to be
consistent with Section 22(e) of the Investment Company Act of 1940
\187\ and SEC Rule 22e-3,\188\ which provides exceptions to MMFs for
next-day redemptions.\189\ The Commission is not proposing to adopt
next-day redemption exceptions for Qualified ETFs as no comparable
provisions are provided under the rules of the SEC, and in recognition
that the redemption process for ETFs involves the exchange of ETF share
for cash by authorized participants. As noted below, the Commission is
seeking comment on the potential existence of extraordinary
circumstances that may warrant an exception to the proposed next-day
redemption requirement.
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\185\ Paragraph (c)(5)(i) of Regulation 1.25 as applying to
Qualified ETFs per proposed revised introductory text of paragraph
(c) of Regulation 1.25.
\186\ Id.
\187\ 15 U.S.C. 80a-22(e).
\188\ 17 CFR 270.22e-3.
\189\ Regulation 1.25(c)(5)(ii) was originally adopted in 2005.
See 2005 Permitted Investments Amendment at 28196. It codified a
2001 letter issued by the Commission's Division of Trading and
Markets in response to an industry inquiry, stating that the
division would raise no issue in connection with MMFs that provide
for certain exceptions to the next-day redemption requirement. Id.
As specified in the 2001 letter, the circumstances in which the
next-day redemption could be excused overlapped to a certain extent
with those contained in Section 22(e) of the Investment Company Act
of 1940. See CFTC Staff Letter No. 01-31, [2000-2002 Transfer
Binder] Comm. Fut. L. Rep. (CCH)] 28,521 (Apr. 2, 2001). In 2011,
the Commission revised Regulation 1.25(c)(5)(ii) to more closely
align the language of that regulation with Section 22(e) and to
expressly incorporate SEC Rule 22e-3. See 2011 Permitted Investments
Amendment at 78789.
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The Commission preliminarily believes that limiting, as discussed
above, Qualified ETFs to funds that track the performance of a
published short-term U.S. Treasury security index would contribute to
facilitating redemptions of Qualified ETFs' shares to be completed
within one business day consistent with Regulations 1.25(c)(5)(i) and
1.25(b)(1).\190\
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\190\ See 17 CFR 1.25(c)(5) (providing that MMFs must be legally
obligated to redeem their interests and to make payment in
satisfaction of the interests by the business day following a
redemption request) and 17 CFR 1.25(b)(1) (providing that Permitted
Investments must be ``highly liquid'' such that the investments have
the ability to be converted into cash within one business day
without material discount in value).
---------------------------------------------------------------------------
As previously discussed, ETFs issue and redeem their shares with
authorized participants in primary market transactions in blocks of
shares or ``creation units'' at the NAV per share. Redemptions may be
in cash or in kind. Authorized participants and the general public can
also purchase and sell ETF shares in the secondary market at the market
price per share. The Commission preliminarily believes that FCMs and
DCOs are likely to purchase and redeem the shares of a Qualified ETF
through primary market transactions intermediated by authorized
participants rather than purchasing and selling the ETF shares in the
secondary market, because the price of the shares in the secondary
market may differ from the NAV, and the sale of the shares in the
secondary market may delay the liquidation of the instruments.
The Commission notes that an FCM's or a DCO's purchase or
redemption of Qualified ETF shares through intermediated transactions
with authorized participants raises two concerns. First, if an FCM or a
DCO invests Customer Funds in shares of a Qualified ETF by purchasing
the shares through an authorized participant, the FCM or DCO would need
to take Customer Funds out of the segregated account maintained in
compliance with Section 4d of the Act and/or Part 30 of the
Commission's regulations to
[[Page 81251]]
purchase the ETF shares.\191\ As a result, customer segregated accounts
may not be fully funded, thus potentially violating Commission
regulations that require FCMs to maintain, at all times, in the
segregated account, money, securities and property in an amount that is
at least sufficient in the aggregate to cover their total obligations
to all customers.\192\ Also, the transfer of Customer Funds to the
authorized participant may be in contravention of Commission
regulations that provide that Customer Funds may only be deposited with
a bank or trust company, a DCO, or another FCM.\193\ Second, if an FCM
or a DCO uses an unaffiliated authorized participant to redeem its
Qualified ETF shares, the redemption of the ETF shares may be
protracted, preventing the redemption and liquidation of the shares to
occur within one business day, as required by Regulation 1.25.
---------------------------------------------------------------------------
\191\ See 7 U.S.C. 6d (setting forth segregation requirements
for FCMs' futures customer funds); see also 17 CFR 1.20(a)
(providing that FCMs must separately account for futures customer
funds and segregate such funds as belonging to their futures
customers) and 17 CFR 1.20(g) (providing that DCOs must separately
account for and segregate futures customer funds as belonging to
futures customers); 17 CFR 22.2 (providing that FCMs must segregate
Cleared Customer Collateral) and 17 CFR 22.3 (requiring that DCOs
segregate Cleared Customer Collateral); and 17 CFR 30.7(b)
(providing that FCMs must deposit 30.7 funds under an account name
that clearly identifies the funds as belonging to 30.7 customers).
\192\ 17 CFR 1.20(a), 17 CFR 22.2(f), and 17 CFR 30.7(a).
\193\ 17 CFR 1.20(b), 17 CFR 22.2(b) and 17 CFR 30.7(b). With
respect to 30.7 customer funds, Regulation 30.7(b) also permits
funds to be deposited with the clearing organization of any foreign
board of trade, a member of any foreign board of trade, or such
member's or clearing organization's designated depositories. 17 CFR
30.7(b).
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To address these two concerns, the Commission proposes to require
an FCM or a DCO that invests Customer Funds in the shares of a
Qualified ETF to be an authorized participant of the ETF.\194\ The
Commission believes that this approach would permit Customer Funds to
be maintained in a segregated account in accordance with Section 4d or
Part 30, as applicable, with a permitted depository (i.e., a bank,
trust company, DCO, or another FCM), given that the Customer Funds
would not need to be transferred to an authorized participant
unaffiliated with the FCM or DCO. In addition, because an FCM or a DCO
acting as an authorized participant would be able to redeem the shares
without relying on a separate authorized participant, the Commission
believes that the FCM or DCO would be able to better manage completing
the redemption and liquidation of the Qualified ETFs shares within one
business day, as required by Regulation 1.25.
---------------------------------------------------------------------------
\194\ Proposed paragraph (c)(8) of Regulation 1.25.
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The Commission, however, understands that FCMs and DCOs may have
access to other means of purchasing or liquidating interest in ETFs.
For instance, an FCM or a DCO may be able to acquire interests in an
ETF on a delivery-versus-payment basis through a securities broker or
dealer at price equal to the next calculated NAV amount per share or
another agreed-upon price that approximates the last calculated NAV.
Similarly, an FCM or a DCO may be able to sell Qualified ETF shares to
a broker or dealer willing to buy them at a price corresponding to the
NAV amount per share and later redeem them from the fund. To be able to
assess the feasibility of such arrangements and the potential
associated risks, the Commission requests additional information on the
availability and functioning of alternative mechanisms of purchasing
and liquidating Qualified ETF interests in a manner compliant with
Regulation 1.25 and compliant with the segregation requirements for
Customer Funds.
The Commission is also proposing that Qualified ETFs be required to
redeem their shares in cash.\195\ The Commission understands that ETFs
typically redeem interests in kind, although they may also redeem in
cash or both in kind and in cash. The Commission also notes that CME,
in announcing its acceptance of short-term U.S. Treasury ETFs as
performance bond, stated that it would accept short-term U.S. Treasury
ETFs that redeem their shares in cash or in kind.\196\ As discussed
above, the Commission is requiring that Qualified ETFs redeem their
shares within one business day following the submission of the
redemption request, consistent with the time limit for redemptions
applicable to MMFs under Regulation 1.25(c)(5). In addition, under
Regulation 1.25(c)(1), the shares of Qualified ETFs, as a Permitted
Investment, would be required to be convertible into cash within one
business day without material discount in value. As such, given these
time limits for the redemption and liquidation of Qualified ETF shares,
the Commission is proposing to require Qualified ETFs to redeem their
shares in cash because in-cash redemptions may allow for a more
expeditious liquidation of the shares than in-kind redemptions.
---------------------------------------------------------------------------
\195\ Proposed Regulation 1.25(c)(8)(i).
\196\ 2022 CME Advisory Notice at 1.
---------------------------------------------------------------------------
In this regard, the Commission notes that in-kind redemptions may
introduce a time lag between the redemption of the ETF shares and the
ultimate liquidation of the shares, as the assets received in in-kind
redemptions would need to be sold or otherwise converted into cash to
complete the liquidation of the ETF shares, hindering the ability to
liquidate the ETF shares within one business day, as required by
Regulation 1.25(b)(1). As such, the Commission is proposing to require
that Qualified ETFs redeem their shares only in cash. The Commission,
however, is requesting information on the availability and functioning
of potential mechanisms or arrangements that may allow FCMs and DCOs to
liquidate a Qualified ETF's shares in a manner compliant with
Regulation 1.25 and the segregation requirements if the fund's
interests were redeemed in kind.
The Commission is also proposing to require, as a condition for
qualification as a Permitted Investment, that Qualified ETFs be
acceptable by a DCO as performance bond from clearing members to margin
customer trades.\197\ Although qualification as acceptable collateral
by a DCO is not determinative of qualification as a Permitted
Investment, the Commission preliminarily believes that limiting
Qualified ETFs to funds that have met a DCO's criteria of eligibility
as performance bond represents an additional safeguard. In addition, as
noted above, the possibility that ETF shares could be pledged by an FCM
as margin collateral is an important consideration for the Commission
in determining whether to add the interests of ETFs to the list of
Permitted Investments.
---------------------------------------------------------------------------
\197\ Proposed Regulation 1.25(c)(8)(iii).
---------------------------------------------------------------------------
In order to add the interests of Qualified ETFs to the list of
Permitted Investments under Regulation 1.25, the Commission is
proposing to add paragraph (vi) to Regulation 1.25(a)(1), as
redesignated to accommodate other amendments to the list of Permitted
Investments pursuant to this Proposal. Paragraph (vi) would identify
interests in U.S. Treasury exchange-traded funds as a Permitted
Investment. The Commission also proposes further conforming changes
throughout Regulation 1.25. Section III.A.2. above provides for the
replacement of ``money market mutual fund'' or ``money market mutual
funds'' with ``government money market fund'' or ``government money
market funds'' throughout Regulation 1.25. The Commission proposes,
unless otherwise discussed below, to insert next to the term
[[Page 81252]]
``government money market fund'' or ``government money market funds,''
the term ``U.S. Treasury exchange-traded fund'' or ``U.S. Treasury
exchange-traded funds,'' as appropriate, preceded by an appropriate
conjunction (i.e., ``or'' or ``and''), as necessary.
To incorporate the condition that a Qualified ETF must be an
investment company that is registered under the Investment Company Act
of 1940 with the SEC and holds itself out to investors as an ETF under
SEC Rule 6c-11, the Commission proposes to revise Regulation 1.25(c)(1)
to provide that, ``The fund must be an investment company that is
registered under the Investment Company Act of 1940 with the Securities
and Exchange Commission and that holds itself out to investors as a
government money market fund, in accordance with 270.2a-7 of this
title, or an exchange-traded fund, in accordance with 270.6c-11 of this
title.''
Moreover, to incorporate the requirement that an FCM or a DCO
investing in a Qualified ETF must be an authorized participant, the
Commission proposes to revise Regulation 1.25(c) to add paragraph (8),
which would provide, ``Interests in U.S. Treasury exchange-traded funds
will qualify as a Permitted Investment under Regulation 1.25(a) if the
interests are redeemable in cash by a futures commission merchant or
derivatives clearing organization in its capacity as an authorized
participant pursuant to an authorized participant agreement, as defined
in Sec. 270.6c-11, at a price based on the net asset value in
accordance with the Investment Company Act of 1940 and regulations
thereunder, and on a delivery versus payment basis.''
To account for the possibility that, as part of their investment
strategy and within the limits of applicable SEC rules, Qualified ETFs
may engage in derivatives transactions, the Commission is also
proposing to amend Regulation 1.25(b)(2)(i) to indicate that the
prohibition of investments containing embedded derivatives would not
apply to Qualified ETFs.
Finally, the Commission is proposing to amend Regulation
1.25(b)(4)(i), which provides that except for investments in MMFs, the
dollar-weighted average time-to-maturity of an FCM's or a DCO's
portfolio of Permitted Investments, as computed under SEC Rule 2a-7,
may not exceed 24 months. The proposed amendment would revise
Regulation 1.25(b)(4)(i) to exclude Qualified ETFs from the calculation
of the dollar-weighted average time-to-maturity of the portfolio of
Permitted Investments.\198\ The Commission is proposing this amendment
as interests in Qualified ETFs do not have maturity dates, as the
Qualified ETF manages the rolling of maturing U.S. Treasury securities
into new investments.
---------------------------------------------------------------------------
\198\ Proposed revised Regulation 1.25(b)(4)(i).
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Request for Comment: The Commission seeks comment on all aspects of
the Proposal relating to the expansion of the list of Permitted
Investments to include interests in ETFs subject to the specified
conditions discussed above, including:
6. For the interests of ETFs to be deemed a Permitted Investment,
the ETFs would have to satisfy requirements similar to the requirements
that apply to Government MMFs whose interests qualify as Permitted
Investments. Is it appropriate to apply the regulatory framework that
applies to Government MMFs to ETFs for determining whether an ETF would
be deemed a Qualified ETF and interests in the ETF be deemed a
Permitted Investment? To the extent some aspects of the regulatory
framework applicable to MMFs is not appropriate for ETFs, please
specify and explain why.
7. The Proposal to add interests in Qualified ETFs to the list of
Permitted Investments provides that only the interests of ETFs that are
passively managed and seek to replicate the performance of a published
short-term U.S. Treasury security index by investing in a limited set
of instruments would qualify as Permitted Investments. The Commission
notes that the types of investments in which Qualified ETFs and
Permitted Government MMFs would be permitted to invest under the
Proposal would differ in that Qualified ETFs' investments would be
determined by its investment strategy seeking to replicate the
performance of a public short-term U.S. Treasury index and a
requirement that the Qualified ETFs invest 95 percent or more of their
assets in U.S. Treasury securities that are components of the index,
whereas government MMFs would be required to invest 99.5 percent or
more of their assets in cash, government securities (defined in 15
U.S.C. 80a-2(a)(16) to broadly include U.S. Treasury securities and
U.S. agency securities), and/or Repurchase Transactions that must be
collateralized fully, consistent with the definition of government
money market funds under SEC Rule 2a-7. Should the Commission further
limit the types of underlying instruments in which a Qualified ETF
would be permitted to invest? If so, what criteria should be applied to
determine the appropriate limitations? Should the Commission permit
Qualified ETFs to invest a lower or higher percentage of their assets
in short-term U.S. Treasury securities that are components of the index
than the proposed 95 percent? If so, what percentage should the
Commission consider and why? Also, should the Commission reconcile the
types of investments in which Qualified ETFs and Permitted Government
MMFs would be permitted to invest by allowing Qualified ETFs to invest
in the same investments as Permitted Government MMFs?
8. Under the Proposal, Qualified ETFs would not be precluded from
undertaking Repurchase Transactions. Does an ETF engaging in Repurchase
Transactions with fund assets have the potential to adversely impact an
authorized participant's ability to redeem interest in the fund in
exchange for cash? Does an ETF engaging in Repurchase Transactions
present other issues that would delay the ability of an authorized
participant to redeem interest in the fund in cash? Could the potential
delay prevent completing redemptions and liquidation of the ETF shares
within one business day, as required by Regulation 1.25? Should
Qualified ETFs be prohibited from undertaking Repurchase Transactions
given the possible risk of delay in redemptions?
9. The Proposal would require that FCMs or DCOs that invest
Customer Funds in interests of Qualified ETFs be authorized
participants in order to address concerns that during purchase or
redemption of ETF shares, Customer Funds might be moved to an account
not held by an appropriate depository of customer segregated funds
(i.e., a bank, trust company, DCO or FCM) without a contemporaneous
deposit of ETF shares or cash in customer segregated accounts,
resulting in the FCM or DCO being undersegregated. Are there
alternative approaches other than requiring FCMs or DCOs to be
authorized participants that could address or mitigate the Commission's
concerns? Can DCOs be authorized participants of Qualified ETFs? If
not, are there alternatives that would permit DCOs to invest Customer
Funds in Qualified ETFs consistent with the requirements of Regulation
1.25 and the Commission's segregation requirements?
10. The Commission understands that interests in short-term U.S.
Treasury ETFs may be redeemed in cash or in kind. The Commission is
proposing to require that the shares of a Qualified ETF be redeemable
only in cash given the concern that in-kind redemptions may not permit
the liquidation of the
[[Page 81253]]
ETF shares within one business day, as required by Regulation
1.25(b)(1). If the Commission were to allow shares of Qualified ETFs to
be redeemable in kind, would the Qualified ETF's interests have the
ability to be liquidated within one business day as required by
Regulation 1.25(b)(1)? What mechanisms or arrangements exist that may
allow FCMs and DCOs to convert Qualified ETF shares into cash within
one business day without material discount in value if redemptions
occur in kind? Are there any potential risks associated with such
mechanisms and arrangements that the Commission should consider? Is
there an alternative approach to address the Commission's concerns that
would permit the use of in-kind redemptions and also provide FCMs and
DCOs with access to cash for the redemptions within one business day?
Does the proposed requirement that the Qualified ETF invest 95 percent
or more of its total assets in short-term U.S. Treasury securities help
ensure that FCMs and DCOs will be able to liquidate securities received
from an in-kind redemption within one business day? Does the proposed
requirement that an FCM or a DCO must be an authorized participant help
ensure that the FCM or DCO has the internal operational capability and
resources to liquidate in-kind redemptions in a manner and time-frame
compliant with Regulation 1.25 requirements?
11. As noted, the Commission is proposing to require that interests
in Qualified ETFs be redeemable in cash within one business day. Are
there any extraordinary circumstances, similar to the events listed in
Regulation 1.25(c)(5)(ii) with respect to MMFs, that may justify an
exception to the proposed next-day redemption requirement? If so,
please specify what redemption exceptions are necessary, and explain
why the exceptions are necessary. Also address potential impacts to
customers if Qualified ETFs do not redeem within one business if
exceptions were provided.
12. Does the Proposal to add Qualified ETFs to the list of
Permitted Investments under Regulation 1.25, along with the continued
inclusion of MMFs, have the potential to reduce the availability of
funds from the banking system in a manner that would raise any
financial stability concerns? Could the use of Repurchase Transactions
by MMFs and ETFs exacerbate any financial stability issues that may
exist?
13. The Proposal would require that a Qualified ETF must be a
passively managed fund that seeks to replicate the performance of a
published short-term U.S. Treasury security index composed of bonds,
notes, and bills with a remaining maturity of 12 months or less, issued
by, or unconditionally guaranteed as to the timely payment of principal
and interest by, the U.S. Department of the Treasury. Should the
Commission impose conditions or requirements that a publisher of an ETF
index must meet or satisfy in order for the ETF to be a Qualified ETF?
If so, what conditions or requirements should the Commission impose,
and why?
14. Regulation 1.25(b)(5)(ii) currently provides that an FCM or a
DCO may invest Customer Funds in a fund affiliated with that FCM or
DCO. Should the Commission revise Regulation 1.25(b)(5)(ii) to prohibit
an FCM or a DCO from investing Customer Funds in affiliated funds? Are
there other Commission or SEC rules that mitigate any potential
conflicts of interest that may arise from an FCM or a DCO investing
Customer Funds in affiliated funds?
4. Investments in Commercial Paper and Corporate Notes or Bonds
The Commission originally approved commercial paper and corporate
notes as Permitted Investments for FCMs and DCOs in 2000.\199\ The
Commission subsequently revised the list of Permitted Investments in
2005 to include corporate bonds.\200\
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\199\ See 2000 Permitted Investments Amendment at 78010.
\200\ See 2005 Permitted Investments Amendment at 28200.
---------------------------------------------------------------------------
In 2007, the Commission's Division of Clearing and Intermediary
Oversight conducted a review of the use of Permitted Investments by
FCMs and DCOs.\201\ The review indicated that commercial paper and
corporate notes and bonds were not widely used by FCMs and DCOs. In
2011, in an effort to simplify Regulation 1.25 by eliminating rarely-
used instruments and in consideration of the Commission's concerns that
corporate debt securities posed credit, liquidity and market risks, the
Commission revised Regulation 1.25 to provide that an FCM or a DCO may
invest Customer Funds in commercial paper and corporate notes and
corporate bonds only if the debt instruments were guaranteed by the
TLGP.\202\
---------------------------------------------------------------------------
\201\ 2011 Permitted Investments Amendment at 78776.
\202\ Id. at 78779.
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The TLGP expired in 2012, and, therefore, commercial paper,
corporate notes, and corporate bonds are no longer Permitted
Investments under the terms of Regulation 1.25.\203\ Accordingly, the
Commission is proposing to remove commercial paper, corporate notes,
and corporate bonds from the list of Permitted Investments.
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\203\ Temporary Liquidity Guarantee Program, available at
<a href="https://www.fdic.gov/Regulations/resources/tlgp/index.html">https://www.fdic.gov/Regulations/resources/tlgp/index.html</a> (``Under
the [Debt Guarantee Program], the FDIC guaranteed in full, through
maturity or June 30, 2012, whichever came first, the senior
unsecured debt issued by a participating entity between October 14,
2008, and June 30, 2009. In 2009, the issuance period was extended
through October 31, 2009. The FDIC's guarantee on each debt
instrument was also extended in 2009 to the earlier of the stated
maturity date of the debt or December 31, 2012.'').
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5. Investments in Permitted Investments With Adjustable Rates of
Interest
Regulation 1.25(b)(2)(iv)(A) provides that Permitted Investments
may contain variable or floating rates of interest provided, among
other things, that: (i) the interest payments on variable rate
securities correlate closely, and on an unleveraged basis, to a
benchmark of either the Federal Funds target or effective rate, the
prime rate, the three-month Treasury Bill rate, the one-month or three-
month LIBOR, or the interest rate of any fixed rate instrument that is
a listed Permitted Investment under Regulation 1.25(a); \204\ and (ii)
the interest rate, in any period, on floating rate securities is
determined solely by reference, on an unleveraged basis, to a benchmark
of either the Federal Funds target or effective rate, the prime rate,
the three-month Treasury Bill rate, the one-month or three-month
LIBOR,\205\ or the interest rate of any fixed rate instrument that is a
listed Permitted Investment under Regulation 1.25(a).\206\
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\204\ 17 CFR 1.25(b)(2)(iv)(A)(1).
\205\ For simplicity, subsequent references to ``one-month or
three-month LIBOR rate'' will be referred to as LIBOR unless
otherwise required by the context of the discussion.
\206\ 17 CFR 1.25(b)(2)(iv)(A)(2).
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LIBOR has been used extensively as a reference rate in various
commercial and financial contracts, including corporate and municipal
bonds, commercial loans, floating rate mortgages, asset-backed
securities, consumer loans, and interest rate swaps and other
derivatives.\207\ The U.K. Financial Conduct Authority, however,
announced on March 5, 2021 that LIBOR would cease to be published and
would effectively be discontinued.\208\
[[Page 81254]]
This announcement had been anticipated given the loss of confidence in
LIBOR as a reliable benchmark following a number of enforcement actions
concerning attempts to manipulate the benchmark.\209\
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\207\ Staff Statement on LIBOR Transition, SEC Division of
Corporation Finance, Division of Investment Management, Division of
Trading and Markets, and Office of the Chief Accountant (July 12,
2019), available at <a href="https://www.sec.gov/news/public-statement/libor-transition">https://www.sec.gov/news/public-statement/libor-transition</a>.
\208\ See CFTC Staff Letter No. 21-26, Revised No-Action
Positions to Facilitate an Orderly Transition of Swaps from Inter-
Bank Offered Rates to Alternative Benchmarks (Dec. 20, 2021)
(``Staff Letter 21-26''), (More specifically, the U.K. Financial
Conduct Authority, which regulates ICE Benchmark Administration
Limited, the administrator of ICE LIBOR, confirmed that LIBOR would
either cease to be provided by any administrator or would no longer
be representative for the 1-week and 2-month USD LIBOR settings,
immediately after December 31, 2021, and for all other USD LIBOR
settings immediately after June 30, 2023). As noted supra, CFTC
Staff Letters are available at the Commission's website,
<a href="http://www.cftc.gov">www.cftc.gov</a>.
\209\ See e.g., In re Barclays PLC, CFTC Docket No. 12-25 (June
27 2012); In re UBS AG, CFTC Docket No. 13-09 (Dec. 19, 2012).
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The Federal Reserve Bank of New York convened the Alternative
Reference Rate Committee (``ARRC'') in 2014 to identify best practices
for U.S. alternative reference rates and best practices for contract
robustness, to develop an adoption plan, and to create an
implementation plan with metrics of success and a timeline.\210\ In
June 2017, the ARRC identified SOFR, a broad Treasury repurchase
agreements financing rate, as the preferred alternative benchmark to
USD LIBOR for certain new USD derivatives and financial contracts.\211\
SOFR is a broad measure of the cost of borrowing cash overnight
collateralized by U.S. Treasury securities in the Repurchase
Transaction market used by financial institutions, governments, and
corporations.\212\ SOFR is calculated as a volume-weighted median of
transaction-level triparty repo data collected from the Bank of New
York Mellon as well as data on bilateral U.S. Treasury Repurchase
Transactions cleared through the Fixed Income Clearing
Corporation.\213\ The Federal Reserve Bank of New York, in cooperation
with the U.S. Office of Financial Research, publishes SOFR by 8:00 a.m.
each business day.\214\
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\210\ Staff Letter 21-26 at p. 3.
\211\ ARRC, ``The ARRC Selects a Broad Repo Rate as its
Preferred Alternative Reference Rate,'' June 22, 2017, available at
<a href="https://www.newyorkfed.org/medialibrary/microsites/arrc/files/2017/ARRC-press-release-Jun-22-2017.pdf">https://www.newyorkfed.org/medialibrary/microsites/arrc/files/2017/ARRC-press-release-Jun-22-2017.pdf</a>.
\212\ See Secured Overnight Financing Rate Data, published by
the Federal Reserve Bank of New York (``FRBNY'') and available at
<a href="https://apps.newyorkfed.org/markets/autorates/sof">https://apps.newyorkfed.org/markets/autorates/sof</a>.
\213\ Id.
\214\ See Additional Information about the Treasury Repo
Reference Rates, published by the FRBNY and available at <a href="https://www.newyorkfed.org/markets/treasury-repo-reference-rates-information">https://www.newyorkfed.org/markets/treasury-repo-reference-rates-information</a>.
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In response to the anticipated termination of the publication of
LIBOR and the increasing acceptance and use of SOFR as a benchmark
interest rate, MPD issued Staff Letter 21-02 on January 4, 2021.\215\
Staff Letter 21-02 provides that MPD would not recommend enforcement
action to the Commission if an FCM invested Customer Funds in Permitted
Investments that contain adjustable rates of interest benchmarked to
SOFR. Staff Letter 21-02 was a time-limited no-action position that was
to expire on December 31, 2022. MPD and DCR, however, subsequently
issued a joint letter, Staff Letter 22-21, extending the effective date
of the no-action position to December 31, 2024, and expanding the scope
of the no-action position to include Permitted Investments made by
DCOs.\216\
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\215\ See supra note 60.
\216\ See id.
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Given the discontinuation of the publishing of LIBOR and the
increasing use of SOFR, the Commission is proposing to amend Regulation
1.25(b)(2)(iv)(A) by replacing LIBOR with SOFR as a permitted benchmark
for Permitted Investments that contain an adjustable rate of interest.
To give effect to this revision, paragraphs (b)(2)(iv)(A)(1) and (2) of
Regulation 1.25 would be amended to replace the phrase ``one-month or
three-month LIBOR rate'' with the phrase ``SOFR rate.'' These proposed
amendments would be consistent with the Commission's intent of
providing FCMs and DCOs with a certain degree of flexibility in
selecting Permitted Investments with adjustable rates of interest,
while also recognizing changes in the market.\217\ The Commission
preliminarily believes that the replacement of LIBOR with SOFR advances
the objective of Regulation 1.25 of preserving principal and
maintaining liquidity by requiring the use of reliable benchmarks in
the qualification as Permitted Investments.
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\217\ See 2005 Permitted Investments Amendment at 28192, where
the Commission stated that it is appropriate to afford latitude in
establishing benchmarks for Permitted Investments to enable FCMs and
DCOs to more readily respond to changes in the market.
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Request for Comment: The Commission seeks comment on all aspects of
the Proposal to eliminate LIBOR as a permitted benchmark, including:
15. The ARRC has identified SOFR as a preferred alternative
reference interest rate to LIBOR. Should the Commission consider other
additional interest rates beyond SOFR as permitted benchmarks for
adjustable rate securities under Regulation 1.25? If so, please explain
why such interest rates would be appropriate benchmarks.
16. The Commission is proposing to amend Regulation 1.25(b)(2)(iv)
to permit SOFR as a benchmark for interest payments on variable rate
securities or floating rate securities that are otherwise Permitted
Investments under Regulation 1.25. Should the Commission reference a
particular SOFR rate to provide greater certainty and clarity as to the
acceptable benchmark? For instance, should the reference be to the
overnight SOFR rate published by the Federal Reserve Bank of New York,
to a CME Term SOFR Rate, or to another published SOFR rate? Please
explain your answer.
6. Investments in Certificates of Deposit Issued by Banks
Regulation 1.25(a)(1)(iv) permits FCMs and DCOs to invest Customer
Funds in certificates of deposit (``CDs'') issued by a Section 3(a)(6)
bank or a domestic branch of a foreign bank that carries deposits
insured by the FDIC (``bank CDs''). To qualify as a Permitted
Investment under Regulation 1.25, a bank CD must be redeemable at the
issuing bank within one business day, with any penalty for early
withdrawal limited to accrued interest earned according to the written
terms of the CD agreement.\218\
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\218\ Regulation 1.25(b)(2)(v); 17 CFR 1.25(b)(2)(v).
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The Commission's experience has been, however, that FCMs and DCOs
do not select bank CDs as an investment option. In addition to the
Commission's general experience in overseeing DCOs and FCMs, Commission
staff also reviewed Segregation Investment Detail Reports (``SIDR
Reports'') filed by FCMs for the period September 15, 2022 through
February 15, 2023 and noted no FCMs reporting investment of Customer
Funds in bank CDs.\219\
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\219\ Regulations 1.32(f), 22.2(g)(5), and 30.7(l)(5) require
each FCM to submit a SIDR Report to the Commission and the FCM's
designated self-regulatory organization (``DSRO'') listing the names
of all banks, trust companies, FCMs, DCOs, and any other
depositories or custodians holding futures customer funds, Cleared
Swaps Customer Collateral, or 30.7 customer funds, respectively.
FCMs are required to submit the SIDR Report as of the 15th day of
each month (or the next business day if the 15th day of the month is
not a business day) and the last business day of the month. 17 CFR
1.32(f), 17 CFR 22.2(g)(5), and 17 CFR 30.7(l)(5). Proposed
amendments to the SIDR Report to reflect the proposed revisions to
the list of Permitted Investments discussed in this Proposal are
discussed in Section III.D. below.
With respect to an FCM, a DSRO is the self-regulatory
organization that has been delegated the responsibility under a
formal plan approved by the Commission pursuant to Regulation 1.52
to monitor and examine the FCM for compliance with Commission and
self-regulatory organization minimum financial and related financial
reporting requirements. 17 CFR 1.52.
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The Commission believes that bank CDs are consistent with the
overall objective of Regulation 1.25 that all Permitted Investments
must preserve principal and maintain liquidity of the Customer Funds.
In this regard, and as noted above, Regulation 1.25(b)(2)(v) provides
that in order to qualify as a
[[Page 81255]]
Permitted Investment, a CD must be redeemable at the issuing bank
within one business day, with any penalty for early withdrawal limited
to any accrued interest earned according to its written terms.\220\
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\220\ 17 CFR 1.25(b)(2)(v).
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Request for Comment: Notwithstanding that bank CDs currently
qualify as Permitted Investments, the Commission is seeking comment on
whether Regulation 1.25 should be amended to remove bank CDs from the
list of Permitted Investments. As noted above, the Commission's
experience and the staff's review of the SIDR reports indicate that
FCMs and DCOs generally have not invested Customer Funds in bank CDs.
Specifically, the Commission seeks comment on the following issues:
17. Notwithstanding the Commission's experience and staff's review
of the SIDR Reports discussed above, do FCMs and/or DCOs invest
Customer Funds in bank CDs? If so, would the elimination of bank CDs as
a Permitted Investment have a material adverse impact on FCMs' and
DCOs' ability to invest Customer Funds pursuant to the proposed
revisions to Regulation 1.25?
18. Are there provisions contained in current Regulation 1.25 or
other regulations of the Commission that hinder or prevent FCMs or DCOs
from investing Customer Funds in bank CDs? If so, please identify which
provisions of Regulation 1.25 are at issue and explain why.
19. Are there legal or operational issues associated with bank CDs
that hinder or prevent FCMs or DCOs from investing Customer Funds in
such instruments? If so, please identify the legal or operational
issues, and explain how such issues hinder or prevent the investment in
bank CDs.
20. Would FCMs or DCOs elect to invest Customer Funds in bank CDs
with the current rising interest rate environment? Are there other
factors that may lead FCMs or DCOs to increase their use of bank CDs as
Permitted Investments?
21. What factors should the Commission consider before removing
bank CDs from the list of Permitted Investments?
Based on comments received and the Commission's further
consideration of this issue, the Commission may determine to revise the
Permitted Investments by removing bank CDs in the final rulemaking. If
the Commission were to remove bank CDs from the list of Permitted
Investments, the Commission would delete paragraph (a)(1)(iv) of
Regulation 1.25 and redesignate the paragraphs of Regulation 1.25(a)(1)
as appropriate to reflect the revised list of Permitted Investments. In
addition, the Commission would delete paragraph (b)(2)(v) of Regulation
1.25, which sets forth restrictions on the features of permitted bank
CDs, and revise and/or delete, as appropriate in light of other
amendments, paragraphs (b)(3)(i)(C) and (b)(3)(ii)(B) of Regulation
1.25, which set forth asset-based and issuer-based concentration limits
for certain instruments currently included in the list of Permitted
Investments, to reflect the elimination of bank CDs from that list. The
Commission would also make conforming amendments to Regulations
1.32(f), 22.2(g)(5), and 30.7(l)(5), which define the content of the
SIDR Reports described in Section III.D. below, to reflect the removal
of bank CDs from the list of Permitted Investments in Regulation 1.25.
Specifically, the Commission would delete the requirement for an FCM to
report the balances invested in bank CDs in the SIDR Report.
B. Asset-Based and Issuer-Based Concentration Limits for Permitted
Investments
Regulation 1.25 establishes asset-based and issuer-based
concentration limits for an FCM's and a DCO's investment of Customer
Funds in Permitted Investments.\221\ The asset-based and issuer-based
concentration limits are set at the same levels for investments of
futures customer funds, Cleared Swaps Customer Collateral, and 30.7
customer funds.\222\ An FCM or a DCO is also required to calculate the
asset-based and issuer-based concentration limits separately for
futures customer funds, Cleared Swaps Customer Collateral, and 30.7
customer funds based on the total amount of funds held by the FCM or
DCO in each respective segregation classification.\223\
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\221\ 17 CFR 1.25(b)(3).
\222\ The asset-based and issuer-based concentration limits for
futures customer funds are set forth in Regulation 1.25(b)(3). 17
CFR 1.25(b)(3). With respect to 30.7 customer funds, Regulation
30.7(h)(1) provides that an FCM may invest 30.7 customer funds
subject to, and in compliance with the terms and conditions of
Regulation 1.25, which includes the asset-based and issuer-based
concentration limits. 17 CFR 30.7(h)(1). With respect to Cleared
Swaps Customer Collateral, Regulations 22.2(e)(1) and 22.3(d)
provide that an FCM or a DCO, respectively, may invest Cleared Swaps
Customer Collateral in accordance with Regulation 1.25, which
includes the asset-based and issuer-based concentration limits. 17
CFR 22.2(e)(1) and 17 CFR 22.3(d).
\223\ See 2011 Permitted Investments Amendment at 78787, where
the Commission stated that concentration limits are to be calculated
on a fund-by-fund basis (i.e., based on separate segregation
classifications).
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An FCM or a DCO is currently permitted to directly invest futures
customer funds, Cleared Swaps Customer Collateral, and 30.7 customer
funds in each of the Permitted Investments up to the following asset-
based limits: (i) U.S. government securities--100 percent; (ii) U.S.
agency obligations--50 percent; (iii) for each investment asset class
of bank CDs, commercial paper, and corporate notes and bonds--25
percent; and (iv) municipal securities--10 percent.\224\
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\224\ Regulation 1.25(b)(3)(i)(A)-(D); 17 CFR 1.25(b)(3)(i)(A)-
(D). U.S. government securities refers to general obligations of the
U.S. and obligations fully guaranteed as to principal and interest
by the U.S. See 17 CFR 1.25(a)(1)(i).
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With respect to MMFs, an FCM or a DCO may invest up to 100 percent
of the total futures customer funds, Cleared Swaps Customer Collateral,
and 30.7 customer funds that it holds in MMFs that invest only in U.S.
government securities, provided that the size of the funds' portfolio
is at least $1 billion and the funds' management company has at least
$25 billion of assets under management.\225\ If a fund has less than $1
billion of assets under management, or if the manager of the fund has
less than $25 billion of assets under management, the FCM or DCO may
invest up to 10 percent of its total futures customer funds, Cleared
Swaps Customer Collateral, and 30.7 customer funds in the fund.\226\
For Prime MMFs, an FCM or a DCO may invest up to 50 percent of the
total futures customer funds, Cleared Swaps Customer Collateral, and
30.7 customer funds in such MMFs; however, the asset-based
concentration is limited to 10 percent if a fund has less than $1
billion in assets under management or if the fund's manager has less
than $25 billion of assets under management.\227\
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\225\ 17 CFR 1.25(b)(3)(i)(E).
\226\ 17 CFR 1.25(b)(3)(i)(G).
\227\ 17 CFR 1.25(b)(3)(i)(F) and (G).
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With respect to issuer-based concentration limits, an FCM or a DCO
is permitted to invest up to 100 percent of the total futures customer
funds, Cleared Swaps Customer Collateral, and 30.7 customer funds that
it holds in U.S. government securities.\228\ An FCM or a DCO also may
invest futures customer funds, Cleared Swaps Customer Collateral, and
30.7 customer funds directly in qualifying Permitted Investments, other
than U.S. government securities, subject to the following issuer-based
concentration limits: (i) obligations of any single issuer of U.S.
agency obligations--25 percent;
[[Page 81256]]
(ii) obligations of any single issuer of municipal securities, bank
CDs, commercial paper, or corporate notes or bonds--5 percent.\229\
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\228\ See 17 CFR 1.25(b)(3)(ii), which excludes U.S. government
securities from the issuer-based concentration limits. See also,
2011 Permitted Investments Amendment at 78788.
\229\ 17 CFR 1.25(b)(3)(ii)(A) and (B).
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With respect to MMFs, an FCM or a DCO may invest up to 100 percent
of the total futures customer funds, Cleared Swaps Customer Collateral,
and 30.7 customer funds in a single MMF that invests only in U.S.
government securities.\230\ With respect to MMFs that maintain
investment portfolios that hold instruments other than U.S. government
securities, an FCM or a DCO is subject to the following issuer-based
concentration limits: (i) interest in any single MMF family may not
exceed 25 percent of customer funds held; and (ii) interest in any
individual MMF may not exceed 10 percent of customer funds held.\231\
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\230\ See 17 CFR 1.25(b)(3)(ii) which excludes MMFs that invest
only in U.S. government securities from the issuer-based
concentration limits.
\231\ 17 CFR 1.25(b)(3)(ii)(C) and (D).
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The Commission is proposing to amend the asset-based and issuer-
based concentration limits in Regulation 1.25(b)(3) to reflect the
proposed revisions to the list of Permitted Investments discussed in
this Proposal and to adjust the limits based on the Commission's
experience administering Regulation 1.25. In that regard, as discussed
in Section III.A.2. above, the Commission is proposing to limit the
scope of MMFs whose interests qualify as Permitted Investments to
Permitted Government MMFs. A Permitted Government MMF would be defined
by reference to SEC Rule 2a-7 as an MMF that invests at least 99.5
percent or more of its total assets in cash, government securities,
and/or Repurchase Transactions that are collateralized fully.\232\ The
Commission notes that the scope of underlying instruments in which a
Permitted Government MMF would be allowed to invest is broader than
that of the MMFs currently excluded from the concentration limits of
Regulation 1.25(c) (i.e., MMFs investing solely in U.S. government
securities). To account for the potential increase in risk associated
with such broader scope and in the interest of imposing a simple and
consistent approach to concentration limits, the Commission is
proposing to establish a single concentration limit of 50 percent for
all Permitted Government MMFs of a certain size, without distinguishing
between funds investing solely in U.S. government securities and those
whose portfolio may also include U.S. agencies securities and/or other
instruments within the limits of SEC Rule 2a-7.
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\232\ See supra notes 120 and 121.
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More precisely, under the Proposal, an FCM's or a DCO's investment
of Customer Funds in interests in Permitted Government MMFs with at
least $1 billion in assets and whose management company manages at
least $25 billion in assets would be limited to no more than 50 percent
of the total Customer Funds computed separately for each of the
segregated funds classifications of futures customer funds, Cleared
Swaps Customer Collateral, and 30.7 customer funds.\233\ The proposed
asset-based concentration limits are consistent with the concentration
limits applicable to U.S. agency obligations, which along with U.S.
Treasury securities, are a permitted underlying instrument for
Permitted Government MMFs.\234\
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\233\ Proposed revised Regulation 1.25(c)(3)(i)(E).
\234\ 17 CFR 1.25(b)(3)(i)(B).
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More generally, the Commission is proposing these asset-based
concentration limits for Permitted Government MMFs to ensure that
Customer Funds are invested in a manner that limits risks arising from
a high concentration in any particular Permitted Investment asset
class. In particular, based on its experience administering the CFTC's
customer protection rules, the Commission preliminarily believes that
it is not prudent to allow FCMs and DCOs to invest up to 100 percent of
segregated Customer Funds in any category of MMFs. For the reasons
discussed below in connection with the proposed issuer-based
concentration limits, the Commission is of the view that holding U.S.
government securities through an MMF gives rise to risks that are
different from those associated with holding U.S. government securities
directly, including operational and cybersecurity risks. As such, the
Commission preliminarily believes that even large MMFs that invest
solely in U.S. government securities should be subject to a
concentration limit. The Commission is also proposing to maintain the
current 10 percent asset-based concentration limit on investments in
MMFs that hold less than $1 billion in assets or have a management
company with less than $25 billion in assets under management.\235\ For
purposes of clarity, the Commission is proposing to delete the
conjunction ``and'' in that provision to indicate that the fund size
threshold and the management company size threshold are to be construed
as alternative prongs triggering the 10 percent limit.
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\235\ Proposed Regulation 1.25(c)(3)(i)(F).
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In addition, to mitigate the potential risks arising from
concentration in any particular fund or family of funds, the Commission
is proposing issuer-based concentration limits for investments in
Permitted Government MMFs. Specifically, the Commission is proposing to
limit investments of Customer Funds in any single family of Permitted
Government MMFs to 25 percent and investments of Customer Funds in any
single issuer of Permitted Government MMFs to 5 percent of the total
assets held in each of the segregated classifications of futures
customer funds, Cleared Swaps Customer Collateral, and 30.7 customer
funds.\236\
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\236\ Proposed Regulations 1.25(c)(3)(ii)(C) and (D),
respectively.
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In adopting the 2011 Permitted Investment Amendment, the Commission
decided not to introduce concentration limits for MMFs of a certain
size investing solely in U.S. government securities. This determination
was made in consideration of comments received from the public,
including in particular a comment asserting that if FCMs and DCOs are
permitted to invest all customer segregated funds in U.S. government
securities directly, an FCM or a DCO should be able to make the same
investment indirectly via an MMF.\237\ Based on its experience
administrating CFTC's customer protection rules and in consideration of
certain recent marketplace events, however, the Commission
preliminarily believes that introducing concentration limits for
Permitted Government MMFs is warranted. In particular, the Commission
is concerned that MMFs, like any institution relying on electronic
communications, are susceptible to cyber-attacks and operational
incidents that may adversely impact their normal operating
capabilities, including delaying or otherwise preventing them from
processing redemption requests of FCMs and DCOs in a timely
manner.\238\ FCMs and DCOs may need to redeem
[[Page 81257]]
their interest in Permitted Government MMFs to provide customers with
cash that is needed to meet, for example, margin calls at other FCMs or
DCOs, or variation or initial margin requirements for uncleared swap
transactions, or to cover cash market losses or purchases. More
generally, the concentration of Customer Funds in any single MMF
creates vulnerabilities that may affect FCMs' and DCOs' ability to meet
their regulatory obligations, including providing customers with prompt
access to their funds.\239\
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\237\ 2011 Permitted Investments Amendment at 78787.
\238\ The cyber-attack against ION Cleared Derivatives, a third-
party provider of cleared derivatives order management, order
execution, trading, and trade processing, demonstrated that an
incident affecting a single entity may disrupt the operations of
other market participants and have ripple effects across the
industry. The incident impacted certain FCMs' operations, including
by preventing such FCMs from submitting timely and accurate
positions data to the CFTC. See CFTC Statement on ION and the Impact
on the Derivatives Markets, available here: <a href="https://www.cftc.gov/PressRoom/SpeechesTestimony/cftcstatement020223">https://www.cftc.gov/PressRoom/SpeechesTestimony/cftcstatement020223</a>.
\239\ For instance, as discussed in the 2011 Permitted
Investments Amendment, the Reserve Primary Fund's ``breaking the
buck,'' in September 2008, called attention to the risk to principal
and potential lack of sufficient liquidity of Prime MMF investments.
See 2011 Permitted Investments Amendment at 78785. In connection
with the events affecting the Reserve Primary Fund, staff of the
CFTC's Division of Clearing and Intermediary Oversight, intervened
and issued guidance indicating that FCMs holding shares of the fund,
either as a proprietary investment or as an investment of customer
segregated funds, could include these investments in the
calculations required for purposes of compliance with capital,
segregation, and secured amount reporting requirements (with the
condition that the NAV be reduced appropriately) even though the
fund had suspended redemptions. See CFTC Staff Letter No. 08-17,
available here: <a href="https://www.cftc.gov/csl/08-17/download">https://www.cftc.gov/csl/08-17/download</a>.
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Although cyber-attacks and other operational incidents may impact
transactions in any Permitted Investment, including U.S. government
securities, the Commission believes that the potential risk of Customer
Funds becoming unavailable is elevated when access to such funds
depends on the operations of a third party such as an MMF. For
instance, to the extent a fund experiences an operational issue, such
incident may result in a redemption suspension for all participants in
the fund. Thus, by imposing issuer-based concentration limits, the
Commission intends to facilitate the preservation of principal and
maintenance of liquidity of Customer Funds through sound
diversification standards and to mitigate the potential risk of access
to a large portion of Customer Funds becoming unavailable due to
cybersecurity or operational incidents, among other events. Given the
large number of SEC-registered Government MMFs available on the market
and likely to meet the Permitted Investments' eligibility criteria, the
Commission preliminarily believes that diversifying an FCM's or DCO's
portfolio of MMF investments would not be burdensome.\240\
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\240\ As of August 17, 2023, there are 183 government MMFs
registered with the SEC (of which 49 are ``Treasury-only'' MMFs).
See U.S. Securities and Exchange Commission, Money Market Funds
Statistics, available here: <a href="https://www.sec.gov/divisions/investment/mmf-statistics">https://www.sec.gov/divisions/investment/mmf-statistics</a>. The government MMFs currently registered
with the SEC generally do not elect to apply liquidity fees and/or
redemption gates.
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In addition, as part of the proposed amendments to the
concentration limits in Regulation 1.25,\241\ the Commission is
proposing to revise the asset-based and issuer-based concentration
limits set forth in paragraphs (b)(3)(i)(F) and (b)(3)(ii)(C) and (D),
respectively, to reflect the removal of Prime MMFs from the list of
Permitted Investments.
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\241\ See discussion in Section III.A.2 above.
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As discussed in Section III.A.3 above, the Commission is also
proposing to permit FCMs and DCOs to invest Customer Funds in Qualified
ETFs.\242\ The Commission is proposing to impose conditions on
Qualified ETFs that are similar to the conditions that are imposed on
Permitted Government MMFs whose interests qualify as Permitted
Investments.\243\ Among other things, similar to Government MMFs, which
can invest in a limited set of instruments, including government
securities and cash, Qualified ETFs would be required to limit their
investments to instruments that are consistent with their investment
strategy of seeking to replicate the performance of a public short-term
U.S. Treasury security index.\244\ For purposes of the Proposal, short-
term U.S. Treasury securities are bonds, notes, and bills with a
remaining maturity of 12 months or less, issued by, or unconditionally
guaranteed as to the timely payment of principal and interest by, the
U.S. Department of the Treasury. Consistent with this condition, the
Commission is also proposing to require that the eligible U.S. Treasury
securities represent at least 95 percent of the ETF's investment
portfolio. Given the similarity of the terms that would apply to
Permitted Government MMFs and Qualified ETFs under the Proposal, and
the comparable credit, market, and liquidity risk associated with these
types of funds comprising instruments generally recognized as safe and
highly liquid, the Commission preliminarily believes that it is
appropriate for Qualified ETFs to have the same asset-based and issuer-
based concentration limits as those proposed for Permitted Government
MMFs. Specifically, under the Proposal, an FCM's or a DCO's investment
of Customer Funds in Qualified ETFs with at least $1 billion in assets
and whose management company manages at least $25 billion in assets
would be limited to an asset-based concentration limit of 50 percent of
total funds held in each of the segregated classifications of futures
customer funds, Cleared Swaps Customer Collateral, and 30.7 customer
funds.\245\ The current 10 percent asset-based concentration limit for
investments in MMFs that hold less than $1 billion in assets or whose
management company manages less than $25 billion in assets under
management would also be extended to Qualified ETFs. In addition, for
the reasons described supra in connection with Permitted Government
MMFs, the Commission is proposing to limit investments of Customer
Funds in any single family of Qualified ETFs to 25 percent and
investments of Customer Funds in any single issuer of Qualified ETFs to
5 percent of the total assets held in each of the segregated
classifications of futures customer funds, Cleared Swaps Customer
Collateral, and 30.7 customer funds.\246\ Given that there may be at
least five U.S. Treasury ETFs that could potentially qualify as
Permitted Investments, the Commission preliminarily believes that the
proposed issuer-based concentration limits would not be overly
restrictive.\247\
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\242\ Proposed Regulation 1.25(a)(1)(vi).
\243\ See Section III.A.3. above.
\244\ Proposed Regulation 1.25(a)(1)(vi).
\245\ Proposed Regulation 1.25(b)(3)(i)(E).
\246\ Proposed Regulations 1.25(b)(3)(ii)(C) and (D).
\247\ See 2022 CME Advisory Notice, supra note 170 (announcing
that CME has added five Short-Term U.S. Treasury ETFs to the list of
accepted margin collateral). The five ETFs would meet the proposed
condition of being accepted as performance bond by a DCO. For
purposes of clarity, the Commission notes, however, that should the
Commission proceed with adding Qualified ETFs to the list of
Permitted Investments, FCMs and DCOs would need to assess ETFs'
eligibility in light of all applicable conditions.
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The Commission is also proposing revisions to the asset-based and
issuer-based concentration limits to remove commercial paper, and
corporate notes and bonds from the limits.\248\ As noted in Section
III.A.4. above, the Commission is proposing to remove commercial paper
and corporate notes and bonds from the list of Permitted Investments
due to the termination of the TLGP by the FDIC in 2012, which resulted
in such investments no longer qualifying as Permitted Investments. In
addition, as discussed in Section III.A.6. above, the Commission is
requesting public comment on the elimination of bank CDs as a Permitted
Investment due to the apparent lack of interest by FCMs and DCOs in
such instruments. Therefore, if bank CDs are removed from the list of
Permitted Investments in a final rulemaking after considering
[[Page 81258]]
comments, specifying asset-based and issuer-based concentra
[…truncated; see source link]Indexed from Federal Register on November 21, 2023.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.