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Rule2024-30927

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

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Published

January 22, 2025

Effective

February 21, 2025

Issuing agencies

Commodity Futures Trading Commission

Abstract

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

Full Text

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<title>Federal Register, Volume 90 Issue 13 (Wednesday, January 22, 2025)</title>
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[Federal Register Volume 90, Number 13 (Wednesday, January 22, 2025)]
[Rules and Regulations]
[Pages 7810-7877]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-30927]

[[Page 7809]]

Vol. 90

Wednesday,

No. 13

January 22, 2025

Part II

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; Final Rule

Federal Register / Vol. 90 , No. 13 / Wednesday, January 22, 2025 /
Rules and Regulations

[[Page 7810]]

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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: Final rule.

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

DATES:
Effective date: This rule is effective February 21, 2025.
Compliance dates: The compliance dates for the rule amendments are
discussed in section VI of SUPPLEMENTARY INFORMATION in the preamble to
this rule.

FOR FURTHER INFORMATION CONTACT: Amanda L. Olear, Director, (202) 418-
5213, <a href="/cdn-cgi/l/email-protection#7c1d1310191d0e3c1f1a081f521b130a">[email&#160;protected]</a>; Thomas J. Smith, Deputy Director, 202-418-5495,
<a href="/cdn-cgi/l/email-protection#6216110f0b160a22010416014c050d14">[email&#160;protected]</a>; Warren Gorlick, Associate Director, 202-418-5195,
<a href="/cdn-cgi/l/email-protection#2255454d504e4b414962414456410c454d54">[email&#160;protected]</a>; Liliya Bozhanova, Associate Director, 202-418-6232,
<a href="/cdn-cgi/l/email-protection#3458565b4e5c555a5b425574575240571a535b42">[email&#160;protected]</a>; Jennifer M. Narvaez, Attorney Advisor, 202-418-
5742, <a href="/cdn-cgi/l/email-protection#016b6f60737760647b41626775622f666e77">[email&#160;protected]</a>, Market Participants Division, or Lihong
McPhail, Research Economist, (202) 418-5722, <a href="/cdn-cgi/l/email-protection#f09c9d93809891999cb093968493de979f86">[email&#160;protected]</a>, Office
of the Chief Economist, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street NW, Washington, DC 20581; Theodore
Z. Polley, Associate Director, 312-596-0551, <a href="/cdn-cgi/l/email-protection#1561657a7979706c55767361763b727a63">[email&#160;protected]</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. Summary of the Proposal
IV. Final Rule
A. Investment of Customer Funds
1. Interests in Money Market Funds
2. Foreign Sovereign Debt
3. Interests in U.S. Treasury Exchange-Traded Funds
4. Investments in Commercial Paper and Corporate Notes or
Corporate Bonds
5. Investments in Permitted Investments With Adjustable Rates of
Interest
6. Investments in Certificates of Deposit Issued by Banks
B. Asset-Based and Issuer-Based Concentration Limits for
Permitted Investments
C. Futures Commission Merchant Capital Charges on Permitted
Investments
D. Segregation Investment Detail Report
E. Read-Only Electronic Access to Customer Funds Accounts
Maintained by Futures Commission Merchants
F. Revisions to the Customer Risk Disclosure Statement
V. Section 4(c) of the Act
VI. Compliance Dates
VII. Administrative Compliance
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost-Benefit Considerations
1. Specified Foreign Sovereign Debt, Interests in Qualified
Exchange-Traded Funds, and Associated Capital Charges
2. Government Money Market Funds, Commercial Paper and Corporate
Notes or Bonds, and Certificates of Deposit Issued by Banks
3. SOFR as a Permitted Benchmark
4. Revision of the Read-Only Access Provisions
D. Antitrust Considerations

I. Introduction

A. Background and Statutory Authority

1. Segregation of Customer Funds by Futures Commission Merchants and
Derivatives Clearing Organizations
The Commodity Exchange Act (``Act'' or ``CEA'') \1\ and the
Commission's regulations thereunder \2\ establish a framework to
safeguard funds of customers engaged in CFTC-regulated derivative
transactions. Core elements of this framework are requirements for a
futures commission merchant (``FCM'') or a derivatives clearing
organization (``DCO'') to treat customer funds as belonging to
customers and not as the property of the FCM or DCO, and for the FCM or
DCO to segregate customer funds from its own funds in designated
customer accounts maintained at banks, trust companies, FCMs, or DCOs,
as applicable.\3\ The segregation of customer funds from an FCM's or
DCO's own funds is intended to ensure that customer funds are used only
to support customer trading and transactions and to facilitate the
return of the funds to customers in the event of the insolvency of the
FCM or DCO.
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\1\ 7 U.S.C. 1 et seq.
\2\ The Commission's regulations are found in chapter I of title
17 of the Code of Federal Regulations, 17 CFR parts 1 through 199.
\3\ 7 U.S.C. 6d.
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Segregated customer funds are classified as either: (i) ``futures
customer funds;'' (ii) ``Cleared Swaps Customer Collateral;'' or (iii)
``30.7 customer funds.'' \4\ The term ``futures customer funds'' is
defined by Commission regulation 1.3 to mean, in relevant part, all
money, securities, and property received by an FCM or DCO from, for, or
on behalf of ``futures customers'' \5\ to margin, guarantee, or secure
futures and options on futures transactions traded on CFTC-designated
contract markets, and all money accruing to futures customers resulting
from trading futures and options on futures. Section 4d(a)(2) of the
Act requires an FCM to treat and deal with futures customer funds
received to margin, guarantee, or secure trades or contracts of any
futures customer, or accruing to a futures customer as the result of
such trades or contracts, as belonging to the futures

[[Page 7811]]

customer.\6\ Section 4d(a)(2) further provides that an FCM may not
commingle futures customer funds with the FCM's own funds, provided,
however, that the FCM may commingle the futures customer funds of two
or more futures customers and deposit the funds with any bank, trust
company, DCO, or other FCM.\7\
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\4\ 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).
\5\ The term ``futures customer'' is defined by Commission
regulation 1.3 to mean, in relevant part, any person who uses an FCM
as an agent in connection with trading in any contract for the
purchase or sale of a commodity for future delivery or any option on
such contract. 17 CFR 1.3.
\6\ 7 U.S.C. 6d(a)(2).
\7\ Id.
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Section 4d(b) of the Act establishes obligations for DCOs and other
depositories receiving futures customer funds from FCMs pursuant to
section 4d(a)(2) of the Act.\8\ Specifically, section 4d(b) provides
that it is unlawful for any person, including a DCO, that has received
futures customer funds to hold, dispose of, or use the funds as
belonging to the depositing FCM or any person other than the futures
customers of the FCM.\9\ The Commission adopted Commission regulations
1.20 through 1.30, and Commission regulations 1.32 and 1.49, to
implement the segregation requirements for futures customer funds
mandated by sections 4d(a)(2) and 4d(b) of the Act.\10\
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\8\ 7 U.S.C. 6d(b).
\9\ Id.
\10\ 17 CFR 1.20 through 1.30, 17 CFR 1.32, and 17 CFR 1.49,
respectively.
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With respect to cleared swap transactions, Commission regulations
1.3 and 22.1 \11\ define the term ``Cleared Swaps Customer Collateral''
to mean, in relevant part, all money, securities, or other property
received by an FCM or DCO from, for, or on behalf of, a ``Cleared Swaps
Customer'' to margin, guarantee, or secure ``Cleared Swap''
positions.\12\ 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.\13\
Section 4d(f)(2)(B) of the Act further provides that an FCM may not
commingle Cleared Swaps Customer Collateral of a Cleared Swaps Customer
with the FCM's own funds.\14\ The FCM may, however, commingle Cleared
Swaps Customer Collateral of two or more Cleared Swaps Customers and
deposit the funds in any bank, trust company, DCO, or other FCM.\15\
Additionally, section 4d(f)(6) of the Act provides that it is unlawful
for any person, including a DCO and any depository institution, that
receives Cleared Swaps Customer Collateral to hold, dispose of, or use
the Cleared Swaps Customer Collateral as belonging to the depositing
FCM or any person other than the Cleared Swaps Customer of the FCM.\16\
The Commission adopted Commission regulations 22.2 through 22.13, and
Commission regulations 22.15 through 22.17, to implement the
segregation requirements for Cleared Swaps Customer Collateral mandated
by section 4d(f) of the Act.\17\
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\11\ 17 CFR 22.1.
\12\ Commission regulation 22.1 defines the term ``Cleared Swaps
Customer'' to mean, in relevant part, any customer entering into a
Cleared Swap. The Act and Commission regulation 22.1 further define
the term ``Cleared Swap'' to mean any swap that is, directly or
indirectly, submitted to, and cleared by, a DCO registered with the
Commission. 7 U.S.C. 1a(7) and 17 CFR 22.1.
\13\ 7 U.S.C. 6d(f)(2)(A).
\14\ 7 U.S.C. 6d(f)(2)(B).
\15\ 7 U.S.C. 6d(f)(3)(A)(i).
\16\ 7 U.S.C. 6d(f)(6).
\17\ 17 CFR 22.2 through 22.13, and 17 CFR 22.15 through 22.17,
respectively. Protection of Cleared Swaps Customer Contracts and
Collateral; Conforming Amendments to the Commodity Broker Bankruptcy
Provisions, 77 FR 6336 (Feb. 7, 2012) (``Protection of Cleared Swaps
Customer Contracts and Collateral'').
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Part 30 of the Commission's regulations govern the requirements
imposed on FCMs that carry futures positions for customers trading on
foreign markets.\18\ Commission regulation 30.1 defines the term ``30.7
customer funds'' to mean any money, securities, or other property
received by an FCM from, for, or on behalf of a U.S. person or foreign-
domiciled person (a ``30.7 customer'') \19\ to margin, guarantee, or
secure futures or options on futures positions executed on foreign
boards of trade (``foreign futures'').\20\ Section 4(b)(2)(A) of the
Act authorizes the Commission to adopt regulations requiring FCMs to
safeguard 30.7 customer funds deposited by 30.7 customers for trading
on foreign boards of trade,\21\ which the Commission did by adopting
Commission regulation 30.7.\22\ As part of the safeguarding
requirements, Commission regulation 30.7(e)(2) requires an FCM to
segregate 30.7 customer funds from the FCM's own funds, and Commission
regulation 30.7(b) provides that an FCM may hold 30.7 customer funds
only with certain specified depositories, including banks, trust
companies, DCOs, foreign brokers, and clearing organizations of foreign
boards of trade.\23\
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\18\ 17 CFR part 30.
\19\ Commission regulation 30.1 defines the term ``30.7
customer'' to mean any person located in the U.S., its territories
or possessions, as well as any foreign-domiciled person, who trades
in foreign futures or foreign options through an FCM. 17 CFR 30.1.
\20\ 17 CFR 30.1.
\21\ 7 U.S.C. 6(b)(2)(A).
\22\ 17 CFR 30.7.
\23\ 17 CFR 30.7(b) and 17 CFR 30.7(e)(2).
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In order to simplify the discussion in this preamble, the terms
``futures customer funds,'' ``Cleared Swaps Customer Collateral,'' and
``30.7 customer funds,'' are used when referring to regulations
applicable specifically to futures customers, Cleared Swaps Customers,
and 30.7 customers, respectively. In addition, the term ``Customer
Funds'' is used when referring collectively to ``futures customer
funds,'' ``Cleared Swaps Customer Collateral,'' and ``30.7 customer
funds.''
2. Authority for Futures Commission Merchants and Derivatives Clearing
Organizations To Invest Customer Funds
The Act establishes the authority for FCMs and DCOs to invest
Customer Funds. Section 4d(a)(2) of the Act authorizes FCMs to invest
futures customer funds in: (i) obligations of the U.S.; (ii)
obligations fully guaranteed as to principal and interest by the U.S.;
and (iii) general obligations of any State or of any political
subdivision of a State.\24\ The Commission's predecessor agency, the
Commodity Exchange Authority of the U.S. Department of Agriculture,
adopted Commission regulation 1.25 to implement section 4d(a)(2) of the
Act, and authorized FCMs and DCOs to invest futures customer funds in
the instruments enumerated in section 4d(a)(2) (the ``Permitted
Investments'').\25\
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\24\ 7 U.S.C. 6d(a)(2).
\25\ See generally Title 17--Commodity and Securities Exchanges,
33 FR 14454 (Sept. 26, 1968), amending Commission regulation 1.25
and providing that FCMs and clearing organizations may invest
futures customer funds in obligations of the U.S., in general
obligations of any State or of any political subdivision of any
State, or in obligations fully guaranteed as to principal and
interest by the U.S.
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The Commission subsequently expanded the Permitted Investments in
2000 to include certificates of deposit, commercial paper, corporate
notes, foreign sovereign debt, and interests in money market funds.\26\
The Commission

[[Page 7812]]

also authorized FCMs and DCOs to buy the Permitted Investments under
agreements to resell the securities (``reverse repurchase agreements'')
and to sell the Permitted Investments under agreements to repurchase
the securities (``repurchase agreements'').\27\ To minimize credit
risk, market risk, and liquidity risk to the Permitted Investments, the
Commission imposed conditions that are required to be met, including a
restriction on the dollar-weighted average of the time-to-maturity of
the securities held in segregated portfolios, asset-based and issuer-
based concentration limits, and prohibitions on certain investments
containing embedded derivatives.\28\ More generally, Commission
regulation 1.25 contains an overarching requirement that all Permitted
Investments must be ``consistent with the objectives of preserving
principal and maintaining liquidity.'' \29\ In adopting the 2000
Permitted Investments Amendment, the Commission stated that it was
expanding the range of instruments in which FCMs may invest customer
funds beyond those listed in section 4d(a)(2) of the Act to enhance the
yield available to FCMs, clearing organizations, and their customers
without compromising the safety of futures customer funds.\30\
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\26\ See generally Rules Relating to Intermediaries of Commodity
Interest Transactions, 65 FR 77993 (Dec. 13, 2000) (amending
Commission regulation 1.25 to permit FCMs and DCOs to invest
customer funds in certificates of deposit, commercial paper,
corporate notes, foreign sovereign debt, and interest in money
market funds); and Investment of Customer Funds, 65 FR 82270 (Dec.
28, 2000) (making technical corrections and accelerating the
effective date of the final rules from February 12, 2001 to December
28, 2000) (collectively, the ``2000 Permitted Investments
Amendment''). The 2000 Permitted Investments Amendment was adopted
pursuant to section 4(c) of the Act, which empowers the Commission
to ``promote responsible economic or financial innovation and fair
competition'' by exempting any transaction or class of transactions
(including any person or class of persons offering, entering into,
rendering advice or rendering other services with respect to, the
agreement, contract, or transaction) from any of the provisions of
the Act, subject to certain exceptions. The Commission may grant an
exemption by rule, regulation, or order, after notice and
opportunity for hearing, and may do so on application of any person
or on its own initiative. 7 U.S.C. 6(c)(1). A further discussion of
section 4(c)(1) of the Act is set forth in section V of this
preamble.
\27\ 2000 Permitted Investments Amendment at 78001-78004.
Reverse repurchase agreements and repurchase agreements are
collectively referred to as ``Repurchase Transactions'' in this
preamble.
\28\ 17 CFR 1.25(b).
\29\ Id.
\30\ 2000 Permitted Investments Amendment at 78007.
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The list of investments that qualify as Permitted Investments has
undergone several revisions following the 2000 Permitted Investments
Amendment.\31\ In its current form, Commission regulation 1.25 lists
seven categories of investments that qualify as Permitted Investments:
(i) obligations of the U.S. and obligations fully guaranteed as to
principal and interest by the U.S. (``U.S. government securities'');
(ii) general obligations of any State or political subdivision of a
State (``municipal securities''); (iii) obligations of any U.S.
government corporation or enterprise sponsored by the U.S. (``U.S.
agency obligations''); (iv) certificates of deposit issued by a bank;
(v) commercial paper fully guaranteed by the U.S. under the Temporary
Liquidity Guarantee Program (``TLGP'') as administered by the Federal
Deposit Insurance Corporation (``FDIC'') (``commercial paper''); (vi)
corporate notes and bonds fully guaranteed as to principal and interest
by the U.S. under the TLGP (``corporate notes and bonds''); and (vii)
interests in money market mutual funds.\32\ In addition, Commission
regulation 1.25(a)(2) permits FCMs and DCOs to buy and sell the
Permitted Investments under Repurchase Transactions.\33\
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\31\ E.g., Investment of Customer Funds and Record of
Investments, 70 FR 28190 (May 17, 2005) (``2005 Permitted
Investments Amendment''), and Investment of Customer Funds and Funds
Held in an Account for Foreign Futures and Foreign Options
Transactions, 76 FR 78776 (Dec. 19, 2011) (``2011 Permitted
Investments Amendment'').
\32\ 17 CFR 1.25(a)(1).
\33\ 17 CFR 1.25(a)(2).
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Section 4(b)(2)(A) of the Act grants the Commission authority to
adopt rules and regulations regarding an FCM's safeguarding of 30.7
customer funds.\34\ Prior to 2011, an FCM was not subject to a specific
regulation defining the investments that the firm could enter into with
30.7 customer funds.\35\ In 2011, the Commission determined that the
terms of Commission regulation 1.25 should also apply to an FCM's
investment of 30.7 customer funds, and amended Commission regulation
30.7 to provide that to the extent an FCM invests 30.7 customer funds,
the firm must invest such funds subject to, and in compliance with, the
terms and conditions of Commission regulation 1.25.\36\
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\34\ 7 U.S.C. 6(b)(2)(A).
\35\ 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.
\36\ 17 CFR 30.7. The Commission stated that it was appropriate
to align the investment standards of Commission regulation 30.7 with
those of Commission regulation 1.25 because many of the same
prudential concerns arise with respect to both segregated customer
funds and 30.7 customer funds. 2011 Permitted Investment Amendment
at 78791.
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The Commission also extended the requirements of Commission
regulation 1.25 to FCMs and DCOs investing Cleared Swaps Customer
Collateral.\37\ The Commission adopted Commission regulations 22.2 and
22.3 in 2012 \38\ pursuant to its authority under section 4d(f)(4) of
the Act, which provides that Cleared Swaps Customer Collateral may be
invested by an FCM or DCO in: (i) obligations of the U.S.; (ii) general
obligations of any State or of any political subdivision of a State;
(iii) obligations fully guaranteed as to principal and interest by the
U.S.; and (iv) any other investment that the Commission may by rule or
regulation prescribe.\39\ Section 4d(f)(4) of the Act further provides
that the investments must be made in accordance with the rules and
regulations, and subject to any conditions, that the Commission may
prescribe.\40\
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\37\ See 17 CFR 22.2(e)(1) and 17 CFR 22.3(d).
\38\ See generally Protection of Cleared Swaps Customer
Contracts and Collateral.
\39\ 7 U.S.C. 6d(f).
\40\ 7 U.S.C. 6d(f)(4).
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In addition to enumerating the Permitted Investments that FCMs and
DCOs may enter into with Customer Funds, Commission regulation 1.25
also imposes several conditions on the investment of Customer Funds.
Commission regulation 1.25(b)(3) contains both asset-based and issuer-
based concentration limits applicable to Permitted Investments. The
asset-based concentration limits restrict the total amount of Customer
Funds that an FCM or DCO may invest in any particular Permitted
Investment instrument or asset class to a defined percentage of the
total funds held in segregation by the FCM or DCO.\41\ The issuer-based
concentration limits cap the total amount of Customer Funds that may be
invested in Permitted Investment instruments offered, or managed, by a
particular issuer to a defined percentage of the total funds held in
segregation by the FCM or DCO.\42\
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\41\ 17 CFR 1.25(b)(3)(i).
\42\ 17 CFR 1.25(b)(3)(ii).
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To limit risk to customers from the investment of Customer Funds,
Commission regulations provide that FCMs and DCOs are financially
responsible for any losses resulting from Permitted Investments and
explicitly prohibit the allocation of investment losses to customers or
clearing FCMs, respectively.\43\
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\43\ Commission regulation 1.29 provides that FCMs or DCOs, as
applicable, shall bear sole responsibility for any losses resulting
from the investment of futures customer funds, and further provides
that no investment losses shall be borne or otherwise allocated to
FCM customers or to clearing FCMs and their customers. 17 CFR
1.29(b).
Commission regulation 22.2(e)(1) provides that an FCM shall bear
sole responsibility for any losses resulting from the investment of
Cleared Swaps Customer Collateral and may not allocate investment
losses to Cleared Swaps Customers of the FCM. 17 CFR 22(e)(1).
Commission regulation 30.7(i) provides that an FCM shall bear
sole financial responsibility for any losses resulting from the
investment of 30.7 customer funds, and further provides that no
investment losses may be allocated to the 30.7 customers of the FCM.
17 CFR 30.7(i).
In addition, Commission regulation 22.3(d) provides that DCOs
may invest Cleared Swaps Customer Collateral in Permitted
Investments set forth in Commission regulation 1.25. The regulation,
however, does not provide that a DCO is responsible for investment
losses. The Commission proposed to amend Commission regulation
22.3(d) to explicitly provide that a DCO shall bear sole
responsibility for any losses resulting from the investment of
Cleared Swaps Customer Collateral and may not allocate such losses
to Cleared Swaps Customers. Investment of Customer Funds by Futures
Commission Merchants and Derivatives Clearing Organizations, 88 FR
81236 at 81238-81239, 81259 (Nov. 21, 2023).

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[[Page 7813]]

The Commission has previously noted the importance of conducting
periodic assessments of Commission regulation 1.25 and, as necessary,
revising regulatory policies to strengthen safeguards designed to
minimize risk while retaining an appropriate degree of investment
flexibility and opportunities for capital efficiency for DCOs and FCMs
investing customer segregated funds.\44\ In furtherance of these
objectives, and in consideration of the requests for amendments to
Commission regulation 1.25 discussed in section II of this preamble,
the Commission published a notice of proposed rulemaking to amend the
list of Permitted Investments in Commission regulation 1.25 and to
adopt several related amendments to its rules governing the investment
of Customer Funds by FCMs and DCOs.\45\
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\44\ 2011 Permitted Investments Amendment at 78777.
\45\ Investment of Customer Funds by Futures Commission
Merchants and Derivatives Clearing Organizations, 88 FR 81236 (Nov.
21, 2023) (``Proposal'').
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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 that the Commission issue an order under section
4(c) of the Act, or take such other action as the Commission deems
appropriate, to expand the list of Permitted Investments that FCMs and
DCOs may enter into with Customer Funds.\46\ The Petitioners requested
an extension of the Permitted Investments to include the foreign
sovereign debt of Canada, France, Germany, Japan, and the United
Kingdom (``Specified Foreign Sovereign Debt''), subject to the
condition that any investment is limited to balances owed by FCMs and
DCOs to customers and FCM clearing members, respectively, denominated
in the applicable currency of Canada, France, Germany, Japan, or the
United Kingdom.\47\ The Petitioners further requested that the
Commission exempt FCMs and DCOs from the provisions of Commission
regulation 1.25(d)(2) to authorize FCMs and DCOs to enter into
Repurchase Transactions involving Specified Foreign Sovereign Debt with
foreign banks and foreign securities brokers or dealers, and to deposit
Specified Foreign Sovereign Debt in safekeeping accounts at foreign
banks.\48\
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\46\ 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>.
\47\ Joint Petition at p. 4. The currencies of Canada, France,
Germany, Japan, and the United Kingdom are the Canadian dollar, the
euro (France and Germany), the yen (Japan), and the British pound
(United Kingdom).
\48\ Joint Petition at p. 5.
Commission regulation 1.25(d)(2) provides that an FCM or DCO may
enter into Repurchase Transactions only with the following
counterparties: (i) a bank as defined in section 3(a)(6) of the
Securities Exchange Act of 1934; (ii) a domestic branch of a foreign
bank insured by the FDIC; (iii) an SEC-registered securities broker
or dealer; or (iv) an SEC-registered government securities broker or
dealer. Section 3(a)(6) of the Securities Exchange Act of 1934
defines the term ``bank'' to mean: (i) a banking institution
organized under the laws of the U.S. or a Federal savings
association; (ii) a member bank of the Federal Reserve System; (iii)
any other banking institution or savings association doing business
under the laws of any State or the U.S., a substantial portion of
the business of which consists of receiving deposits or exercising
fiduciary powers similar to those permitted to national banks under
the authority of the Comptroller of the Currency, and which is
supervised and examined by a State or Federal authority having
supervision over banks or savings associations; and (iv) a receiver,
conservator, or other liquidating agent of any institution or firm
included in clauses (i), (ii), or (iii) above (``Section 3(a)(6)
bank''). 15 U.S.C. 78c(a)(6). Foreign-domiciled banks and foreign
securities brokers or dealers are not authorized counterparties for
Repurchase Transactions under Commission regulation 1.25(d)(2).
In addition, Commission regulation 1.25(d)(7) provides that
securities transferred to an FCM or DCO under Repurchase
Transactions must be held in safekeeping accounts with certain U.S.-
domiciled banks, a Federal Reserve Bank, a DCO, or the Depository
Trust Company in an account that complies with the requirements of
Commission regulation 1.26.
---------------------------------------------------------------------------

In support of the request, the Petitioners stated that the
Commission issued an order in 2018 pursuant to section 4(c) of the Act
providing a limited exemption to section 4d of the Act and Commission
regulation 1.25 to permit DCOs to invest futures customer funds and
Cleared Swaps Customer Collateral in the foreign sovereign debt of
France and Germany.\49\ The Petitioners also asserted that the
Commission's stated rationale for issuing the 2018 Order and providing
an exemption to DCOs also applies to investments made by FCMs and
extends to the sovereign debt of Canada, Japan, and the United Kingdom,
in addition to France and Germany.
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\49\ Order Granting Exemption from Certain Provisions of the
Commodity Exchange Act Regarding Investment of Customer Funds and
from Certain Related Commission Regulations, 83 FR 35241 (Jul. 25,
2018) (``2018 Order''). The 2018 Order provides an exemption only to
DCOs. FCMs are not subject to the 2018 Order.
---------------------------------------------------------------------------

The 2018 Order's section 4(c) exemption for DCOs is subject to
conditions, including that: (i) investment in French or German
sovereign debt is limited to investments made with euro-denominated
balances owed to the futures customers and Cleared Swaps Customers of
FCM clearing members; (ii) the dollar-weighted average of the remaining
time-to-maturity of a DCO's portfolio of investments in each of French
and German sovereign debt may not exceed 60 days; and (iii) a DCO may
not make a direct investment in any sovereign debt instrument of France
or Germany that has a remaining time-to-maturity in excess of 180
calendar days.\50\ 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.\51\
---------------------------------------------------------------------------

\50\ Conditions (3)(a), 3(c), and 3(d) of the 2018 Order at
35245.
\51\ Condition (3)(b) of the 2018 Order at 35245.
---------------------------------------------------------------------------

The 2018 Order also grants an exemption from Commission regulation
1.25(d)(2) to permit DCOs to enter into Repurchase Transactions
involving French or German sovereign debt with foreign banks and
foreign securities brokers or dealers as counterparties.\52\ A DCO may
enter into Repurchase Transactions with a foreign bank or foreign
securities broker or dealer provided that the firm qualifies as a
permitted depository under Commission regulation 1.49(d)(3) and is
located in a ``money center country'' \53\ or in another jurisdiction
that has adopted the euro as its currency.\54\ The 2018 Order further
grants an exemption from the requirement in Commission regulation
1.25(d)(7) that securities transferred to an FCM or DCO under reverse
repurchase agreements must be held in

[[Page 7814]]

safekeeping accounts with certain U.S.-domiciled banks, a Federal
Reserve Bank, a DCO, or the Depository Trust Company, to permit DCOs to
hold French or German sovereign debt received under reverse repurchase
agreements in a safekeeping account with foreign banks that qualify as
depositories for Customer Funds under Commission regulation
1.49(d)(3).\55\
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\52\ Condition 2(a) of the 2018 Order at 35245.
\53\ Commission regulation 1.49(a) defines the term ``money
center country'' as Canada, France, Italy, Germany, Japan, and the
United Kingdom.
\54\ Conditions 2(b) and 3(e) of the 2018 Order at 35245.
Commission regulation 1.49(d)(3) provides that to qualify as a
depository for Customer Funds, a foreign depository must be a bank
or trust company that has in excess of $1 billion in regulatory
capital, a registered FCM, or a DCO. 17 CFR 1.49(d)(3).
\55\ Condition 2(b) of the 2018 Order at 35245. Commission
regulation 1.25(d)(7) provides that securities transferred to an FCM
or DCO under a reverse repurchase agreement must be held in a
safekeeping account only with the following depositories: (i) a
section 3(a)(6) bank; (ii) a domestic branch of a foreign bank
insured by the FDIC; (iii) a Federal Reserve Bank; (iv) a DCO; or
(v) the Depository Trust Company. 17 CFR 1.25(d)(7). A foreign-
domiciled bank is currently not an authorized depository for
securities transferred to an FCM or DCO under Commission regulation
1.25(d)(7).
---------------------------------------------------------------------------

The Petitioners further requested that FCMs and DCOs be permitted
to invest Customer Funds in certain exchange-traded funds (``ETFs'')
that invest primarily in short-term U.S. Treasury securities (``U.S.
Treasury ETFs'').\56\ In support of their request, the Petitioners
stated that U.S. Treasury ETFs have characteristics that may be
consistent with those of other Permitted Investments and may provide
FCMs and DCOs with an opportunity to diversify further their
investments of customer funds.\57\
---------------------------------------------------------------------------

\56\ Joint Petition at pp. 8-9.
\57\ Id.
---------------------------------------------------------------------------

The Commission also received a petition from Invesco Capital
Management LLC (``Invesco''), which serves as a sponsor of various
ETFs, advocating for the addition of U.S. Treasury ETF securities to
the list of Permitted Investments.\58\ Invesco stated that U.S.
Treasury ETFs would provide FCMs and DCOs with additional investment
choices for Customer Funds, promote operational efficiencies, and offer
potentially better investment returns for FCMs, DCOs, and their
customers, and facilitate financial market innovation.\59\ Invesco
further stated that listing U.S. Treasury ETFs as Permitted Investments
would be consistent with the public interest and the customer
protection regime under the Act and Commission regulations as U.S.
Treasury ETFs may only invest in instruments that are otherwise
eligible as Permitted Investments for Customer Funds.\60\ Invesco
further noted that because U.S. Treasury ETFs invest in a sub-set of
the same high-quality liquid instruments that are Permitted Investments
under Commission regulation 1.25 (i.e., U.S. government securities),
the ETFs offer an indirect, possibly simpler, and more cost-efficient
way for FCMs and DCOs to invest Customer Funds in U.S. Treasury
securities and obligations fully guaranteed as to principal and
interest by the U.S. by eliminating the need for FCMs and DCOs to
administer direct investments in individual U.S. government
securities.\61\
---------------------------------------------------------------------------

\58\ Letter from Anna Paglia, Chief Executive Officer, Invesco
Capital Management LLC, dated September 28, 2023 (``Invesco
Petition''), available at <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
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.
\59\ Invesco Petition at p. 1.
\60\ Id. at p. 9.
\61\ Id. at p. 2.
---------------------------------------------------------------------------

Lastly, the Petitioners also requested that the Commission amend
its regulations consistent with CFTC Staff Letter 21-02 and CFTC Staff
Letter 22-21 \62\ to permit FCMs and DCOs to invest Customer Funds in
qualifying Permitted Investments that have adjustable rates of interest
that correlate closely to SOFR.\63\
---------------------------------------------------------------------------

\62\ CFTC Staff Letter 21-02, CFTC Regulation 1.25--Investment
of Customer Funds--Time-Limited No-Action Position for Investments
in Securities with an Adjustable Rate of Interest Benchmarked to the
Secured Overnight Financing Rate (Jan. 4, 2021) (``Staff Letter 21-
02'') available at the Commission's website: <a href="https://www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=21-02&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All">https://www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=21-02&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All</a>
; CFTC Staff Letter 22-21, CFTC Regulation 1.25--Investment of
Customer Funds in Securities with an Adjustable Rate of Interest
Benchmarked to the Secured Overnight Financing Rate--Extension of
Time-Limited No-Action Position Concerning Investments by Futures
Commission Merchants and No-Action Position Concerning Investments
by Derivatives Clearing Organizations (Dec. 23, 2022) (``Staff
Letter 22-21'') available at the Commission's website: <a href="http://www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=22-21&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All">www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=22-21&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All</a>
.
\63\ Joint Petition at p. 4.
---------------------------------------------------------------------------

III. Summary of the Proposal

In order to revise Commission regulation 1.25 to address outdated
provisions, and in consideration of the Joint Petition and the Invesco
Petition, the Commission proposed to amend the list of Permitted
Investments to: (i) add two new asset classes (i.e., Specified Foreign
Sovereign Debt instruments and U.S. Treasury ETFs), subject to certain
conditions; (ii) limit the scope of money market funds (``MMFs'') whose
interests qualify as Permitted Investments; and (iii) remove corporate
notes, corporate bonds, and commercial paper. The Commission also
proposed amendments to FCM financial reporting requirements to reflect
the proposed amendments to the list of Permitted Investments. The
Commission further proposed changes to the counterparty and depository
requirements of Commission regulation 1.25(d)(2) and (7), and revisions
to the concentration limits for Permitted Investments set forth in
Commission regulation 1.25(b)(3). The Commission also specified
proposed capital charges that FCMs would have to apply to the proposed
new Permitted Investment instruments and proposed a clarifying
amendment to Commission regulation 22.3(d) to specify that DCOs bear
the financial responsibility for losses resulting from investment of
Customer Funds in Permitted Investments. The Commission further
proposed to replace LIBOR with SOFR as a permitted benchmark for the
interest rate of adjustable rate securities that qualify as Permitted
Investments. Lastly, the Commission proposed to amend its regulations
to eliminate the requirement that a depository holding customer funds
must provide the Commission with read-only electronic access to such
accounts for the FCM to treat the accounts as customer segregated fund
accounts.\64\ Each of these proposed amendments are discussed in
section IV. of this preamble.
---------------------------------------------------------------------------

\64\ See generally Proposal.
---------------------------------------------------------------------------

The comment period for the Proposal closed on January 17, 2024. The
Commission received 17 comment letters from various interested parties,
including investor advocacy groups, trade associations, and financial
services companies.\65\ The majority of commenters expressed support
for the Proposal, generally noting that the proposed amendments
represent appropriate updates to the list of Permitted Investments.
Several commenters specifically supported the inclusion of foreign
sovereign debt and U.S. Treasury ETFs as Permitted Investments.\66\
Conversely, two

[[Page 7815]]

commenters opposed allowing FCMs and DCOs to invest Customer Funds in
foreign sovereign debt.\67\ Many commenters also recommended revisions
to the proposed conditions underlying the Proposal, including the
conditions proposed for investment in certain short-term U.S. Treasury
ETFs.\68\
---------------------------------------------------------------------------

\65\ The following entities submitted comments: Alternative
Investment Management Association (``AIMA''); Americans for
Financial Reform Education Fund, Consumer Federation of America,
Food & Water Watch, Institute for Agriculture and Trade Policy, and
Public Citizen (collectively, the ``Investor Advocacy Group'' and
the ``Investor Advocacy Group Joint Letter''); Better Markets;
BlackRock, Inc. (``BlackRock''); Eurex Clearing AG (``Eurex'');
Federated Hermes, Inc. (``Federated Hermes''); Futures Industry
Association and CME Group Inc. (``FIA/CME Joint Letter''); The
Global Association of Central Counterparties (``CCP Global'');
Intercontinental Exchange Inc. (``ICE''); Invesco Capital Management
LLC (``Invesco''); Investment Company Institute (``ICI''); Managed
Funds Association (``MFA''); National Futures Association (``NFA'');
Nodal Clear, LLC (``Nodal''); the Asset Management Group of the
Securities Industry and Financial Markets Association (``SIFMA
AMG''); State Street Global Advisors (``SSGA''); and World
Federation of Exchanges (``WFE''). The comment letters are available
at <a href="https://comments.cftc.gov/PublicComments/CommentList.aspx?id=7453">https://comments.cftc.gov/PublicComments/CommentList.aspx?id=7453</a>.
\66\ Invesco at pp. 2-3; ICI at p. 2; AIMA at pp. 2-3; FIA/CME
Joint Letter at pp. 2, 4-15; MFA at pp. 2-6; Nodal at pp. 1-2; SIFMA
AMG at pp. 2-8, 12; CCP Global at pp. 2-4 WFE at pp. 3-6.
\67\ Better Markets at pp. 3-7; Investor Advocacy Group Joint
Letter at pp. 1-2.
\68\ AIMA at pp. 2-3; MFA at pp. 5-6; FIA/CME Joint Letter at
pp. 11-16; CCP Global at pp. 3-4; BlackRock at pp. 2-6; Invesco at
pp. 3-5; ICI at pp. 2-6 SIFMA AMG at pp. 4-6; SSGA at pp. 2-3; WFE
at pp. 5-6.
---------------------------------------------------------------------------

In consideration of the broad public input expressed in the public
comments and the Commission's experience administering the rules that
govern investments of Customer Funds by FCMs and DCOs, the Commission
is adopting the proposed amendments, subject to the changes discussed
below.\69\
---------------------------------------------------------------------------

\69\ The final rulemaking is referred to as the ``Final Rule''
in this preamble.
---------------------------------------------------------------------------

IV. Final Rule

A. Investment of Customer Funds

1. Interests in Money Market Funds
a. Proposal
Commission regulation 1.25(a)(1)(vii) currently provides that FCMs
and DCOs may invest Customer Funds in interests in MMFs, subject to
specified terms and conditions.\70\ To qualify as a Permitted
Investment, an MMF must: (i) be an investment company registered with
the SEC under the Investment Company Act of 1940 \71\ and hold itself
out to investors as an MMF in accordance with SEC Rule 2a-7; \72\ (ii)
be sponsored by a federally-regulated financial institution, a section
3(a)(6) bank,\73\ an investment adviser registered under the Investment
Advisers Act of 1940,\74\ or a domestic branch of a foreign bank
insured by the FDIC; and (iii) compute, and make available to MMF
shareholders, the net asset value (``NAV'') of the fund by 9 a.m. of
the business day following each business day.\75\
---------------------------------------------------------------------------

\70\ 17 CFR 1.25(a)(vii).
\71\ 15 U.S.C. 80a-1--80a-64.
\72\ 17 CFR 270.2a-7 (``SEC Rule 2a-7'').
\73\ For a definition of section 3(a)(6) bank, see supra note
52.
\74\ 15 U.S.C. 80b-1--80b-21.
\75\ 17 CFR 1.25(c).
---------------------------------------------------------------------------

As further described below, the Commission proposed to amend
Commission regulation 1.25(a)(1)(vii) to limit the scope of MMFs whose
interests qualify as Permitted Investments in response to two sets of
rule amendments adopted by the SEC regarding MMFs, which rendered, in
the Commission's view, certain MMFs incompatible with the liquidity
requirements of Commission regulation 1.25.\76\ Specifically, the
Commission proposed to limit Permitted Investments in MMFs to interests
in certain ``government money market funds,'' as defined in SEC Rule
2a-7.\77\ 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.'' \78\ 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.\79\ Therefore, a ``government security'' encompasses ``U.S.
government securities'' and ``U.S. agency obligations'' as defined
under Commission regulation 1.25(a)(1)(i) and (iii), respectively.\80\
---------------------------------------------------------------------------

\76\ Proposal at 81240-81243.
\77\ Id. SEC Rule 2a-7 addresses MMFs that primarily invest in
securities issued or guaranteed by the U.S. government (``government
money market funds'' or ``Government MMFs''), MMFs that primarily
invest in short-term corporate debt securities (``Prime MMFs''), and
other types of MMFs that are not relevant to this Proposal, such as
tax-exempt funds. 17 CFR 270.2a-7.
\78\ 17 CFR 270.2a-7(a)(14).
\79\ 15 U.S.C. 80a-2(a)(16).
\80\ Commission regulation 1.25(a)(1)(i) and (iii) defines
``U.S. government securities'' as obligations of the U.S. and
obligations fully guaranteed as to principal and interest by the
U.S. and ``U.S. agency obligations'' as obligations of any U.S.
government corporation or enterprise sponsored by the U.S.
government, respectively.
---------------------------------------------------------------------------

As noted above, the Commission proposed to amend Commission
regulation 1.25 to limit the scope of MMFs that qualify as Permitted
Investments in response to SEC revisions to its MMF rules.
Specifically, in 2014, the SEC amended SEC Rule 2a-7 to authorize an
MMF to impose liquidity fees on participant redemptions, or to
temporarily suspend participant redemptions, if the MMF's investment
portfolio triggered certain liquidity thresholds.\81\ 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.\82\ The 2014 SEC Redemption Provisions were
mandatory for Prime MMFs, and Government MMFs could voluntarily elect
to impose the 2014 SEC Redemption Provisions (``Electing Government
MMFs'').\83\
---------------------------------------------------------------------------

\81\ 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).
\82\ 2014 SEC MMF Final Rule at 47747. See also Proposal at
81241-81243. The liquidity fees and suspension of redemptions
provisions introduced by the 2014 SEC MMF Final Rule are referred to
as the ``2014 SEC Redemption Provisions'' in this document.
\83\ 17 CFR 270.2a-7(c)(2)(iii).
---------------------------------------------------------------------------

Commission staff subsequently received inquiries from market
participants concerning the permissibility of investing Customer Funds
in MMF interests under Commission regulation 1.25 in light of the 2014
SEC Redemption Provisions. In response, Commission staff issued CFTC
Staff Letter 16-68 \84\ and CFTC Staff Letter 16-69 \85\ addressing the
2014 SEC Redemption Provisions and the investment of Customer Funds in
MMFs by FCMs and DCOs, respectively. Staff Letter 16-68 \86\ expresses
DSIO's view that the 2014 SEC Redemption Provisions conflict with
paragraphs (b)(1) \87\ and (c)(5)(i) \88\ of Commission regulation
1.25, as the Redemption Provisions have the effect of potentially
reducing the liquidity of Prime MMFs and Electing Government MMFs
through the imposition of fees and suspension of redemptions.
Therefore, DSIO stated that FCMs may no longer

[[Page 7816]]

invest Customer Funds in Prime MMFs and Electing Government MMFs.\89\
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\84\ CFTC Letter No. 16-68, No-Action Relief with Respect to
CFTC Regulation 1.25 Regarding Money Market Funds (Aug. 8, 2016)
(``Staff Letter 16-68'') available at the Commission's website:
<a href="http://www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=16-68&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All">www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=16-68&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All</a>
.
Staff Letter 16-68 was issued by the Commission's Division of
Swap Dealer and Intermediary Oversight (``DSIO'') (subsequently
renamed the Market Participants Division (``MPD'')).
\85\ CFTC Letter No. 16-69, Staff Interpretation Regarding CFTC
Part 39 In Light Of Revised SEC Rule 2a-7 (Aug. 8, 2016) (``Staff
Letter 16-69''). Staff Letter 16-69 was issued by the Commission's
Division of Clearing and Risk (``DCR'') and is available at the
Commission's website: <a href="http://www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=16-69&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All">www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=16-69&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All</a>
.
\86\ See also CFTC Staff Advisory No. 16-75, Practical
Application of No-Action Letter No. 16-68 Regarding the Investments
in Money Market Mutual Funds (Oct. 18, 2016) (``Staff Letter 16-
75'') (discussing the practical applicability and effect of Staff
Letter 16-68) available at the Commission's website: <a href="https://www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=16-75&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All">https://www.cftc.gov/LawRegulation/CFTCStaffLetters/letters.htm?title=16-75&field_csl_letter_year_value=&field_csl_dodd_frank_exists_value=All</a>
.
\87\ 17 CFR 1.25(b)(1) (investments of customer funds must be
highly liquid such that the investments must have the ability to be
liquidated and converted into cash within one business day without
material discount in value).
\88\ 17 CFR 1.25(c)(5)(i) (to qualify as a Permitted Investment
an MMF must be legally obligated to pay a fund investor (including
an FCM) by the close of business on the day following a redemption
request).
\89\ Staff Letter 16-68 at p. 2. However, DSIO also states in
Staff Letter 16-68 that it would not recommend an enforcement action
to the Commission if an FCM invested Customer Funds held in
segregation that represents an excess over the firm's targeted
residual interest in Prime and Electing Government MMFs. Staff
Letter 16-68 at pp. 3-4.
---------------------------------------------------------------------------

Staff Letter 16-69 set forth DCR's interpretation that Commission
regulations 39.15(c) and (e) \90\ prohibit a DCO from holding funds
belonging to clearing members or their customers in Prime MMFs or
Electing Government MMFs. Staff Letter 16-69 also states that the 2014
SEC Redemption Provisions are not consistent with Commission regulation
39.15(c), which requires a DCO to hold funds and assets belonging to
clearing members and their customers in a manner that minimizes the
risk of loss or of delay in the access by the DCO to such funds and
assets. Staff Letter 16-69 further provides that the 2014 SEC
Redemption Provisions are inconsistent with Commission regulation
39.15(e), which limits a DCO to investing funds and assets belonging to
clearing members and their customer in instruments with minimal credit,
market, and liquidity risk. FCMs and DCOs have not invested Customer
Funds in Prime MMFs or Electing Government MMFs since the issuance of
Staff Letters 16-68 and 16-69 in 2016.\91\
---------------------------------------------------------------------------

\90\ 17 CFR 39.15(c) and (e).
\91\ While Staff Letter 16-68 provides that DSIO would not
recommend an enforcement action against an FCM that invested
Customer Funds in Prime and Electing Government MMFs, provided that
the amount invested represents an amount held in customer segregated
accounts that exceeds the firm's targeted residual interest amount,
staff is not aware of FCMs investing Customer Funds in such MMFs.
---------------------------------------------------------------------------

In August 2023, the SEC adopted additional amendments to its MMF
rules, including amendments revising the 2014 SEC Redemption Provisions
discussed above.\92\ The 2023 SEC MMF Reforms address issues observed
by the SEC with MMFs in connection with the economic shock from the
onset of the COVID-19 pandemic. Specifically, the SEC stated in March
2020, that concerns about the impact of COVID-19 pandemic led investors
to reallocate their assets into cash and short-term government
securities. Certain Prime MMFs, in particular, experienced significant
outflows, contributing to stress on short-term funding markets that
resulted in government intervention to enhance the liquidity of such
markets.\93\ 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.\94\
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.\95\
The SEC also cited evidence suggesting that investors are particularly
sensitive to the potential imposition of redemption gates, which
restricts MMF share redemption for the duration of the gate.\96\ 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.\97\ Thus, the SEC concluded that MMFs needed better functioning
tools for managing through stress while mitigating harm to
shareholders.\98\
---------------------------------------------------------------------------

\92\ Money Market Fund Reforms; Form PF Reporting Requirements
for Large Liquidity Fund Advisers, Technical Amendments to Form N-
CSR and Form N-1A, 88 FR 51404 (Aug. 3, 2023) (``2023 SEC MMF
Reforms''). The 2023 SEC MMF Reforms became effective on October 2,
2023.
\93\ As noted in the 2023 SEC MMF Reforms' adopting release, to
support the short-term funding markets, on March 18, 2020, the
Federal Reserve, with the approval of the Department of the
Treasury, established the Money Market Mutual Fund Liquidity
Facility. The facility provided loans to financial institutions on
advantageous terms to purchase securities from MMFs that were
raising liquidity. 2023 SEC MMF Reforms at 51408.
\94\ 2023 SEC MMF Reforms at 51407. The term ``weekly liquid
assets'' is generally defined as: (i) cash; (ii) direct obligations
of the U.S. Government; (iii) U.S. Agency securities that are issued
at a discount to the principal amount to be repaid at maturity and
have a remaining time to maturity of 60 days or less; (iv)
securities that mature, or are subject to a demand feature that is
exercisable and payable, within 5 business days; or (v) amounts
receivable and due unconditionally within 5 business days on pending
sales of portfolio securities. 17 CFR 270-2a-7(c)(a)(28).
\95\ 2023 SEC MMF Reforms at 51407.
\96\ Id. at 51409.
\97\ Id.
\98\ 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 2023 SEC MMF Reforms, among other
things, amended the 2014 SEC Redemption Provisions by removing a Prime
MMF's ability to temporarily suspend participant redemptions and by
removing an Electing Government MMF's ability to voluntarily retain
authority to suspend participant redemptions.\99\ The 2023 SEC MMF
Reforms also require Prime MMFs to impose a liquidity fee when the fund
experiences net redemptions that exceed 5 percent of the fund's net
assets, and permit Prime MMFs to impose a discretionary liquidity fee
if the fund's board of directors determines that a fee is in the best
interest of the fund.\100\ Government MMFs are not required to
implement the mandatory liquidity fee but may choose to rely on the
ability to impose discretionary liquidity fees.\101\ Such fees,
however, are no longer tied to the weekly liquid asset threshold.\102\
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\99\ Id. at 51410.
\100\ 17 CFR 270.2a-7(c)(2)(i) and (ii) (as amended by the 2023
SEC MMF Reforms). SEC Rule 2a-7(c)(2)(i) provides, in relevant part,
that if a Prime MMF's board of directors, including a majority of
the directors who are not interested persons of the fund, determines
that a liquidity fee is in the best interest of the fund, the fund
must institute a liquidity fee that does not exceed two percent of
the value of the shares redeemed. In addition, SEC Rule 2a-
7(c)(2)(ii) provides, in relevant part, that a Prime MMF must apply
a liquidity fee to all shares that are redeemed if the fund
experiences total daily net redemptions that exceed 5 percent of the
fund's net asset value, or such smaller amount of net redemptions as
the board of directors of the fund determines.
\101\ 17 CFR 270.2a-7(c)(2)(i)(B) (as amended by the 2023 SEC
MMF Reforms). SEC Rule 2a-7(c)(2)(i)(B) permits Government MMFs to
elect to impose the discretionary liquidity fees on shareholder
redemptions.
\102\ 17 CFR 270.2a-7(c)(2)(i) (as amended by the 2023 SEC MMF
Reforms).
---------------------------------------------------------------------------

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

[[Page 7817]]

``Permitted Government MMFs'')).\103\ As discussed in the Proposal, to
qualify as a Permitted Government MMF, at least 99.5 percent of the
fund's investment portfolio must be comprised of cash, government
securities (i.e., U.S. Treasury securities, securities fully-guaranteed
as to principal and interest by the U.S. Government, and U.S. agency
obligations), and/or Repurchase Transactions that are fully
collateralized by government securities as set forth in SEC Rule 2a-
7.\104\ The Commission's goal in proposing the amendment was to ensure
that FCMs and DCOs invest Customer Funds in instruments that are
consistent with the objectives of Commission regulation 1.25 of
preserving principal and maintaining liquidity of the investments.
---------------------------------------------------------------------------

\103\ See Proposal at 81240-81243 and proposed paragraph
(a)(1)(v) of Commission regulation 1.25.
\104\ See Proposal at 81240-81241.
---------------------------------------------------------------------------

To eliminate MMFs whose redemptions may be subject to a liquidity
fee from the scope of Permitted Investments under Commission regulation
1.25, the Commission proposed revising Commission regulation
1.25(a)(1)(vii), which would be redesignated as Commission regulation
1.25(a)(1)(iv) to accommodate other amendments to Commission regulation
1.25(a) discussed in the Proposal, by replacing the term ``money market
mutual fund'' with the term ``government money market funds as defined
in 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).'' \105\ The Commission also
proposed further conforming changes throughout Commission regulation
1.25, and the appendix to Commission regulation 1.25, by replacing all
references to ``money market mutual fund'' with ``government money
market fund.'' \106\ In addition, the appendix to Commission regulation
1.25 was proposed to be redesignated as appendix E to part 1 to address
a change in the rules of the Office of the Federal Register regarding
the structure of regulatory text to be codified in the Code of Federal
Regulations.\107\ Further, the Commission proposed conforming
amendments to Commission regulations 1.26 and 30.7(d), which require an
FCM and/or DCO, as applicable, that invests Customer Funds in Permitted
Investments, including qualifying MMFs, to obtain and retain in its
files a written acknowledgement letter from the depository holding the
instruments stating that the depository was informed that the
instruments belong to customers and are being held in accordance with
the provisions of the Act and Commission regulations.\108\ The
Commission also proposed conforming amendments to the appendices
setting forth the template acknowledgment letters.\109\ Specifically,
the Commission proposed to replace the references to ``money market
mutual fund'' with ``government money market fund'' in Commission
regulation 1.26, appendix A and appendix B to Commission regulation
1.26 (to be redesignated appendix F and appendix G to part 1),
Commission regulation 30.7(d), and appendix F to part 30 of the
Commission's regulations.\110\
---------------------------------------------------------------------------

\105\ Proposal at 81240-81243, proposed Commission regulation
1.25(a)(1)(v).
\106\ Proposal at 81243.
\107\ Id.
\108\ Id. at 81263.
\109\ Id.
\110\ Id.
---------------------------------------------------------------------------

The Commission also noted that the proposed amendments removing
interests in MMFs whose redemptions may be subject to a liquidity fee
from the scope of Permitted Investments would prohibit an FCM from
depositing proprietary interests in such MMFs into Customer Funds
accounts.\111\ The Commission stated that Commission regulations
1.23(a)(1), 22.2(e)(3)(i), and 30.7(g)(1) permit FCMs to deposit
proprietary cash and unencumbered securities into the accounts of
futures customers, Cleared Swaps Customers, and 30.7 customers,
respectively, to help ensure that at all times the accounts maintain
sufficient funds to cover the amounts due to all customers.\112\ The
proprietary securities deposited by FCMs into customer accounts,
however, must satisfy the criteria of a Permitted Investment as
specified in Commission regulation 1.25.\113\ Therefore, with respect
to MMFs, FCMs would only be permitted to deposit proprietary interest
in Permitted Government MMFs in the accounts of futures customers,
Cleared Swaps Customers, and 30.7 customers under the Proposal.
---------------------------------------------------------------------------

\111\ Proposal at 81242.
\112\ 17 CFR 1.23(a)(1), 22.2(e)(3)(i), and 30.7(g)(1). A
customer account is ``undersegregated'' if an FCM holds less funds
in the account than is necessary to cover the total amount due to
the customer at any given point in time.
\113\ Id.
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b. Comments
The Commission received six comments on the proposed limit of the
scope of MMFs whose interests qualify as Permitted Investments to
Permitted Government MMFs.\114\ Each of the commenters supported the
proposed limitation.\115\ AIMA noted that the amendments would
appropriately update the list of Permitted Investments in line with
sound risk management practices.\116\ ICI stated that the proposed
amendments are consistent with the regulatory objective of limiting
Permitted Investments to safe, short-term instruments.\117\ Though
supportive of the proposed amendments, BlackRock raised concerns about
the Proposal's rationale, asserting that in discussing investor
behavior during the March 2020 events, the Commission failed to
acknowledge that there was a broader ``dash for cash'' occurring across
asset classes, not just MMFs, at that time period.\118\
---------------------------------------------------------------------------

\114\ See AIMA at p. 3; BlackRock at pp. 2, 6; Federated Hermes
at pp. 1-2; FIA/CME Joint Letter at p. 21; ICI at p. 2; MFA at p. 6.
\115\ Id.
\116\ AIMA at p. 3.
\117\ ICI at p. 2.
\118\ BlackRock at p. 6.
---------------------------------------------------------------------------

In addition to supporting the proposed revisions to the scope of
the MMFs, FIA and CME recommended an amendment to the template
acknowledgement letters for Government MMFs set forth in appendices A
and B to Commission regulation 1.26 for direct investments by FCMs and
DCOs of futures customer funds and Cleared Swaps Customer Collateral in
MMFs, and appendix F to part 30 for direct investments by FCMs of 30.7
customer funds in MMFs.\119\ Specifically, FIA and CME recommended that
each template acknowledgment letter include a representation from the
Government MMF that the fund does not elect to impose discretionary
liquidity fees.\120\
---------------------------------------------------------------------------

\119\ FIA/CME Joint Letter at p. 21. As discussed in the
Proposal, Commission regulations 1.26 and 30.7(d) require an FCM or
DCO, as applicable, to obtain, and retain in its files, a written
acknowledgment from each depository holding Permitted Investments.
Proposal at 81263.
\120\ Id. The FIA/CME Joint Letter included the following
suggested language: ``Furthermore, you acknowledge and agree that
the Shares are in a fund that holds itself out to investors as a
government money market fund, in accordance with 17 CFR 270.2a-7. In
addition, the Shares are in a fund that does not choose to rely on
the ability to impose discretionary liquidity fees consistent with
the requirements of 17 CFR 270.2a-7(c)(2)(i).'' FIA/CME Joint Letter
at p. 21.
---------------------------------------------------------------------------

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

[[Page 7818]]

necessary.\121\ These commenters noted that ``risk posed by
affiliates'' is a component of the risk management program that FCMs
are required to adopt pursuant to Commission regulation 1.11.\122\ The
commenters further asserted that because Permitted Investments
involving FCM affiliates are already subject to the policies,
procedures, and controls of consolidated risk management programs, as
well as existing statutory and regulatory requirements, there is no
reason to revisit the Commission's previous consideration of this
issue.\123\
---------------------------------------------------------------------------

\121\ Proposal at 81243, Question 2. Commission regulation
1.25(b)(5)(ii) provides, in relevant part, that an FCM or DCO may
not invest Customer Funds in obligations of an affiliated entity,
but permits investments by FCMs and DCOs in interest in funds
affiliated with the applicable FCM or DCO.
\122\ FIA/CME Joint Letter at p. 19; MFA at p. 6.
\123\ Id. (referencing the Commission's final rule Enhancing
Protections Afforded Customers and Customer Funds Held by Futures
Commission Merchants and Derivatives Clearing Organizations, 78 FR
68506 at 68520 Nov. 14, 2013) (``2013 Protections of Customer Funds
Release''), which notes that an FCM's risk management policies and
procedures under Commission regulation 1.11 must include procedures
for assessing the appropriateness of investing customer funds in
accordance with Commission regulation 1.25, and ``must take into
consideration the market, credit, counterparty, operational, and
liquidity risks associated with the investments.'')
---------------------------------------------------------------------------

c. Discussion
The Commission has considered the comments received, and is
adopting as proposed the amendments to Commission regulation 1.25 to
limit the scope of MMFs that qualify as Permitted Investments for
Customer Funds to Permitted Government MMFs. As stated in the Proposal,
the Commission's intent in eliminating Prime MMFs and Electing
Government MMFs from the list of Permitted Investments is to ensure
that Customer Funds are managed with the objectives of preserving
principal of the investments, consistent with the general requirements
of Commission regulation 1.25(b).\124\ The SEC requirement for Prime
MMFs to impose a liquidity fee on shareholder redemptions when the fund
experiences net redemptions that exceed 5 percent of the fund's net
assets and the separate authority granted by the SEC that permits funds
to impose discretionary liquidity fees of up to 2 percent on
shareholder redemptions if the board of directors determines that such
a fee is in the best interest of the fund are not consistent with the
obligation imposed under Commission regulation 1.25(b) on FCMs and DCOs
to preserve the principal of Customer Funds invested in Permitted
Investments. The imposition of mandatory or discretionary liquidity
fees on an FCM's or DCO's redemption request from a Prime MMF or an
Electing Government MMF may result in an FCM or DCO not realizing the
full principal value of its investment upon its redemption request. The
inability of the FCM or DCO to receive the full principal value of its
investment of Customer Funds presents potential financial risk to the
FCM or DCO as it may not have sufficient funds to fully repay the
account balances of each customer. Thus, the Commission is revising the
list of Permitted Investments to remove Prime MMFs and Electing
Government MMFs.
---------------------------------------------------------------------------

\124\ Proposal at 81242. Commission regulation 1.25(b) provides,
in relevant part, that an FCM or DCO is required to manage its
Permitted Investments consistent with the objectives of preserving
principal and maintaining liquidity of the Customer Funds. 17 CFR
1.25(b).
---------------------------------------------------------------------------

The Commission is also maintaining current Commission regulation
1.25(b)(5)(ii), which provides that an FCM or DCO may invest Customer
Funds in a fund affiliated with that FCM or DCO. Consistent with its
views expressed in connection with the risk management program mandated
by Commission regulation 1.11,\125\ the Commission expects that FCMs
will assess the appropriateness of investing Customer Funds in
affiliated funds in accordance with this program.\126\ Similarly,
because DCO Core Principle F and Commission regulation 39.15(e) require
a DCO to hold Customer Funds only in instruments with minimal credit,
market, and liquidity risks, the Commission expects that DCOs will
assess the risk of investing Customer Funds in affiliated funds before
doing so. In addition, investment advisers that act as investment
managers of a fund have fiduciary duties to their client, the fund,
under the Investment Adviser Act of 1940.\127\ In this context, the
investment adviser has a duty to eliminate, or disclose and mitigate,
conflicts of interest that may impact the advisory relationship.\128\
Therefore, as investors in a fund that qualifies as a Permitted
Investment, FCMs and DCOs should not receive either preferential or
disadvantageous treatment compared to other investors in the fund.
---------------------------------------------------------------------------

\125\ 2013 Protections of Customer Funds Release at 68519-68520.
\126\ Commission regulation 1.11(e)(1)(ii) provides that an
FCM's risk management program must consider risks posed by
affiliates, all lines of business of the FCM, and all other trading
activity engaged in by the FCM. 17 CFR 1.11(e)(1)(ii).
\127\ See Commission Interpretation Regarding Standard of
Conduct for Investment Adviser, SEC, 84 FR 33669 (July 12, 2019) at
33670.
\128\ Id. at 33677.
---------------------------------------------------------------------------

Lastly, in response to the comment asserting that the Commission
failed to acknowledge the broader ``dash for cash'' that occurred
across assets classes in March 2020,\129\ the Commission was recounting
the SEC's rationale for adopting the 2023 SEC MMF Reforms. The
Commission's own rationale for revising the scope of MMFs whose
interests qualify as Permitted Investments is the potential reduced
liquidity of Prime MMFs and Electing Government MMFs resulting from the
implementation of liquidity fees by such funds under the SEC's
regulatory framework.
---------------------------------------------------------------------------

\129\ Blackrock at p. 6.
---------------------------------------------------------------------------

To eliminate MMFs whose redemptions may be subject to a liquidity
fee from the scope of Permitted Investments under Commission regulation
1.25, the Commission is revising Commission regulation 1.25(a)(1)(vii),
which is redesignated Commission regulation 1.25(a)(1)(iv) to
accommodate other amendments to Commission regulation 1.25(a) discussed
in this Final Rule, by replacing the term ``money market mutual fund''
with the term ``government money market funds as defined in 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 is also adopting
further conforming changes throughout Commission regulation 1.25 and
the appendix to Commission regulation 1.25 by replacing all references
to ``money market mutual fund'' with ``government money market fund.''
In addition, the appendix to Commission regulation 1.25 is redesignated
as appendix E to part 1 to address a change in the rules of the Office
of the Federal Register regarding the structure of regulatory text to
be codified in the Code of Federal Regulations.
To reflect the Final Rule's amendments to the scope of MMFs that
qualify as Permitted Investments, the Commission is also adopting
conforming amendments to Commission regulation 1.26, appendices A and B
to Commission regulation 1.26, Commission regulation 30.7(d), and
appendix F to part 30 of the Commission's regulations, as proposed.
Specifically, the Commission is adopting conforming amendments to
paragraphs (a) and (b) of Commission regulation 1.26 to replace the
term ``money market mutual fund'' with the term ``government money
market fund.'' Paragraph (b) of Commission regulation 1.26 is further
revised to reflect the redesignation of appendices A and B to
Commission regulation 1.26 as

[[Page 7819]]

``appendices F and G to part 1 of the Commission's regulations'' and to
reflect the redesignation of appendices A and B to Commission
regulation 1.20 as ``appendices C and D to part 1.'' \130\ The
Commission is also amending appendices A and B to Commission regulation
1.26 (redesignated appendices F and G to part 1) to replace the term
``Money Market Mutual Fund'' with ``Government Money Market Fund.''
---------------------------------------------------------------------------

\130\ Commission regulation 1.26 currently refers to ``appendix
A or B to this section'' and ``appendix A or B to Sec. 1.20.''
Appendix A and appendix B to Commission regulation 1.26 are being
redesignated appendix F and appendix G to part 1, and appendix A and
B to Commission regulation 1.20 are being redesignated appendix C
and D to part 1, to address a change in the rules of the Office of
the Federal Register regarding the structure of regulatory text to
be codified in the Code of Federal Regulations.
---------------------------------------------------------------------------

In addition, the Commission is making conforming changes to
Commission regulation 30.7(d)(2) and 30.7(l)(5)(iii)(G) (redesignated
Commission regulation 30.7(l)(5)(iii)(F)) to replace the term ``money
market mutual fund'' with ``government money market fund.'' The
Commission is also implementing changes to appendix F to part 30, to
replace the term ``money market mutual fund'' with ``government money
market fund.''
In response to FIA/CME Joint Letter, the Commission is also
adopting additional conforming changes to the template acknowledgement
letters set forth in appendices A and B to Commission regulation 1.26
(redesignated as appendices F and G to part 1) and in appendix F to
part 30 to reflect the changes to the scope of MMFs that qualify as
Permitted Investments.\131\ Specifically, the Commission is including a
template representation that the Government MMF does not elect to
impose discretionary liquidity fees. The Commission understands that
including language to memorialize the representation in the template
acknowledgement letter may create efficiencies for registrants seeking
to ascertain that the MMF meets the eligibility conditions of
Commission regulation 1.25. Thus, the Commission is including the
following statement after the second full paragraph of the template
acknowledgment letters in appendices A and B to Commission regulation
1.26 (redesignated appendices F and G to part 1 for FCMs and DCOs,
respectively) and appendix F to part 30: Furthermore, you acknowledge
and agree that the Shares are in a fund that holds itself out to
investors as a government money market fund, in accordance with 17 CFR
270.2a-7. In addition, you acknowledge and agree that the Shares are in
a fund that does not choose to rely on the ability to impose
discretionary liquidity fees consistent with the requirements of 17 CFR
270.2a-7(c)(2)(i).
---------------------------------------------------------------------------

\131\ FIA/CME Joint Letter at p. 21.
---------------------------------------------------------------------------

As discussed in section IV.E. of this preamble regarding the
removal of read-only electronic access, FCMs do not need to obtain new
acknowledgment letters for existing accounts at depositories holding
Customer Funds reflecting this new language regarding government money
market funds. Instead, revised acknowledgment letters must be obtained
only for accounts opened after the effective date of this Final Rule or
if the FCM is required to obtain a new acknowledgment letter for
reasons unrelated to the addition of the government money market fund
language after the effective date of this Final Rule.
2. Foreign Sovereign Debt
a. Proposal
The Commission authorized FCMs and DCOs to invest futures customer
funds in foreign sovereign debt as part of the 2000 Permitted
Investments Amendment.\132\ The investments were subject to specified
conditions, including that investments in the debt of a particular
foreign sovereign were limited to balances owed by FCMs or DCOs to
customers denominated in the currency of the applicable sovereign
debt.\133\
---------------------------------------------------------------------------

\132\ 2000 Permitted Investments Amendment at 78003.
\133\ Id.
---------------------------------------------------------------------------

The Commission subsequently proposed to eliminate foreign sovereign
debt as a Permitted Investment in 2010 citing an interest in
simplifying the regulation and safeguarding futures customer funds in
light of economic crises experienced by a number of foreign
sovereigns.\134\ Specifically, the 2010 Proposed Permitted Investments
Amendment cited a Division of Clearing and Intermediary Oversight
(``DCIO'') 2007 review of the investment of futures customer funds and
30.7 customer funds.\135\ The 2007 Review revealed that only three of
the total 87 active FCMs invested futures customer funds in foreign
sovereign debt at any time during that year, and that only one FCM
invested 30.7 customer funds in foreign sovereign debt.\136\
---------------------------------------------------------------------------

\134\ Investment of Customer Funds and Funds Held in Account for
Foreign Futures and Foreign Options Transactions, 75 FR 67645 (Nov.
3, 2010) at 67645 (``2010 Proposed Permitted Investments
Amendment'').
\135\ Id. at 67643 (``2007 Review''). MPD is a successor
division to DCIO. The 2007 Review was conducted to further staff's
understanding of FCM investment strategies and practices for
customer funds and to assess whether any changes to the Commission's
regulations would be appropriate.
\136\ Id. at 67645.
---------------------------------------------------------------------------

The Commission subsequently eliminated foreign sovereign debt as a
Permitted Investment in 2011.\137\ In eliminating foreign sovereign
debt as a Permitted Investment, the Commission stated that it
recognized that the safety of sovereign debt issuances of one country
may vary greatly from the sovereign debt issuances of another country
and that investments in certain sovereign debt may be consistent with
the objective of preserving principal and maintaining liquidity of
investments entered into with Customer Funds specified in Commission
regulation 1.25.\138\ The Commission expanded on this view by stating
that it was amenable to considering requests for section 4(c)
exemptions to permit FCMs and DCOs to invest futures customer funds in
foreign sovereign debt upon a demonstration that the investment is
appropriate in light of the objectives of Commission regulation 1.25,
and the issuance of the exemption satisfies the criteria set forth in
section 4(c).\139\ Specifically, the Commission stated that it would
consider permitting futures customer funds to be invested in the
foreign sovereign debt of a country to the extent that: (i) FCMs or
DCOs held balances in segregated accounts owed to customers denominated
in that country's currency; and (ii) the foreign sovereign debt serves
to preserve principal and maintain liquidity of futures customer funds
as required for all other investments of Customer Funds under
Commission regulation 1.25.\140\
---------------------------------------------------------------------------

\137\ 2011 Permitted Investments Amendment at 78780-78782.
\138\ Id. at 78782.
\139\ Id.
\140\ Id.
---------------------------------------------------------------------------

As discussed in section II. of this preamble, the Commission issued
an order in 2018 pursuant to section 4(c) granting DCOs a limited
exemption from the prohibition on the investment of customer funds in
foreign sovereign debt consistent with its views and the criteria
expressed in the 2011 Permitted Investments Amendment.\141\
Specifically, the 2018 Order authorizes DCOs to invest euro-denominated
futures customer funds and Cleared Swaps Customer Collateral in euro-
denominated sovereign debt issued by France or Germany.\142\ The 2018
Order

[[Page 7820]]

also contains conditions designed to ensure that the investments
preserve the principal and maintain the liquidity of customer funds.
Specifically, the conditions provide that: (i) investments of futures
customer funds and Cleared Swaps Customer Collateral in the sovereign
debt of France and Germany is limited to investments made with euro
customer cash; (ii) if the two-year credit default spread of France or
Germany, as applicable, exceeds 45 BPS, a DCO must not make any new
direct investments in the relevant debt using futures customer funds or
Cleared Swaps Customer Collateral, and a DCO must discontinue investing
futures customer funds and Cleared Swaps Customer Collateral in the
relevant debt instruments through Repurchase Transactions as soon as
practicable under the circumstances; (iii) the dollar-weighted average
of the time-to-maturity of a DCO's portfolio of investments in each of
France or Germany's sovereign debt may not exceed 60 days; (iv) a DCO
may not make a direct investment in the sovereign debt instruments of
France or Germany that have a remaining time-to-maturity of greater
than 180 calendar days; (v) a DCO may use futures customer funds or
Cleared Swaps Customer Collateral to enter into Repurchase Transactions
for French or German sovereign debt with a counterparty that is a
foreign bank that qualifies as a permitted depository under Commission
regulation 1.49(d)(3) and that is located in a money center country (as
defined in Commission regulation 1.49(a)(1)) or in another jurisdiction
that has adopted the euro as it currency, a securities dealer located
in a money center country as defined in Commission regulation
1.49(a)(1) that is regulated by a national financial regulator, or the
European Central Bank, The Deutsche Bundesbank, or the Banque de
France; and (vi) a DCO may hold the sovereign debt of France or Germany
purchased under Repurchase Transactions with a foreign depository only
if the depository meets the location and qualification requirements
contained in Commission regulation 1.49(c) and (d) and if the account
complies with the requirements of Commission regulation 1.26.\143\
---------------------------------------------------------------------------

\141\ 2018 Order.
\142\ 2018 Order at 35244-35245. The petitioners of the 2018
Order did not request any relief with respect to the investment of
30.7 customer funds, which are held by FCMs for 30.7 customers are
trading on foreign contract markets that are not Commission
designated contract markets.
\143\ Conditions 3(a)-(f) of the 2018 Order at 35245.
---------------------------------------------------------------------------

As stated in section II. of this preamble, the FIA and CME
submitted a joint petition requesting that the Commission expand the
scope of the 2018 Order by permitting both DCOs and FCMs to invest
Customer Funds (i.e., futures customer funds, Cleared Swaps Customer
Collateral, and 30.7 customer funds, as applicable) in the sovereign
debt of Canada, France, Germany, Japan, and the United Kingdom (i.e.,
the Specified Foreign Sovereign Debt).\144\ In support of the Joint
Petition, the Petitioners asserted that the Commission's justification
for issuing the 2018 Order to permit DCOs to invest futures customer
funds and Cleared Swaps Customer Collateral in French and German
sovereign debt is also applicable to FCMs. Specifically, the
Petitioners stated that FCMs face the same challenges in assuring the
protection of foreign currencies received from customers to margin
cleared transactions as DCOs.\145\ In this regard, the Petitioners
noted that, in issuing the 2018 Order, the Commission stated that cash
held in unsecured deposit accounts at commercial banks is exposed to
the credit risk of the banks.\146\ The Petitioners asserted that this
credit risk can be effectively eliminated if an FCM or DCO is permitted
to invest Customer Funds denominated in Canadian dollars (``CAD''),
euros (``EUR''), Japanese yen (``JPY''), or Great Britain pounds
(``GBP'') in the sovereign debt of Canada, France, Germany, Japan, or
the UK (i.e., Specified Foreign Sovereign Debt).\147\ The Petitioners
further stated that although investments through Repurchase
Transactions involve exposure to a commercial counterparty, an FCM or
DCO would receive the additional added benefit of receiving securities
as collateral against that counterparty's credit risk.\148\
---------------------------------------------------------------------------

\144\ See generally Joint Petition.
\145\ Joint Petition at p. 2.
\146\ Id.
\147\ Id.
\148\ Id. Consistent with arguments presented in connection with
the 2018 Order, the Petitioners further argued that ``in the event a
securities custodian enters insolvency proceedings, [a DCO or FCM]
would have a claim to specific securities rather than a general
claim against the assets of the custodian.'' Id. See also 2018 Order
at 35242.
---------------------------------------------------------------------------

After considering the Joint Petition and assessing changes to the
holding of non-U.S. dollar currencies by FCMs and DCOs since the 2007
Review, the Commission proposed to permit both FCMs and DCOs to invest
Customer Funds in Specified Foreign Sovereign Debt securities.\149\
Specifically, the Commission proposed revising Commission regulation
1.25 to include Specified Foreign Sovereign Debt instruments as
Permitted Investments, subject to conditions that are consistent with
the conditions specified in the Commission's 2018 Order. As detailed in
the Proposal, an FCM or DCO: (i) would be permitted to invest Customer
Funds in the sovereign debt of Canada, France, Germany, Japan, and the
United Kingdom (i.e., the Specified Foreign Sovereign Debt); \150\ (ii)
may only invest Customer Funds in the Specified Foreign Sovereign Debt
of a particular country to the extent that the FCM or DCO has balances
in accounts owed to customers denominated in such country's currency;
\151\ (iii) would not be permitted to make new investments of Customer
Funds in the Specified Foreign Sovereign Debt of a particular country
if such country's two-year credit default spread exceeded 45 BPS; and,
(iv) would be required to discontinue investing Customer Funds in the
Specified Foreign Sovereign Debt of a particular country through
Repurchase Transactions as soon as practicable under the circumstances
if such country's two-year credit default spread exceeded 45 BPS.\152\
---------------------------------------------------------------------------

\149\ Proposal at 81243-81248.
\150\ Proposal at 81244 and proposed Commission regulation
1.25(a)(1)(vii). The proposed condition defining the Specified
Foreign Sovereign Debt is consistent with clause (1) of the 2018
Order, which provides that the Commission's order is limited to the
sovereign debt of France and Germany.
\151\ Proposal at 81244-81245 and proposed Commission regulation
1.25(a)(1)(vii)(A) and (B). The proposed condition is consistent
with condition 3(a) of the 2018 Order, which limits a DCO's
investment in French or German sovereign debt to the extent the DCO
owes balances owed to customers denominated in euros.
\152\ Proposal at 81245 and proposed Commission regulations
1.25(f)(3). The proposed conditions are consistent with condition
3(b) of the 2018 Order.
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The Commission also proposed to limit the time-to-maturity of
investments in Specified Foreign Sovereign Debt.\153\ Specifically, the
Commission proposed that an FCM or DCO would be required to ensure that
the dollar-weighted average time-to-maturity of its portfolio of
investments in the Specified Foreign Sovereign Debt, as the average is
computed under SEC Rule 2a-7 under the Investment Company Act of 1940
(``SEC Rule 2a-7'') \154\ on a country-by-country basis, does not
exceed 60 calendar days.\155\ The Proposal further provided that if the
portfolio includes Specified Foreign Sovereign Debt securities acquired
under a reverse repurchase agreement, the FCM or DCO shall use the
maturity of the reverse repurchase agreement to compute the dollar-
weighted average time-to-maturity of the portfolio as opposed to the
remaining time-to-maturity of the securities.\156\ This

[[Page 7821]]

approach takes into account the contractual obligation to resell the
securities within one business day or on demand as required by
Commission regulation 1.25(d)(6).\157\ Conversely, if the FCM or DCO
sells Specified Foreign Sovereign Debt securities under a repurchase
agreement, the FCM or DCO shall include the debt securities in the
calculation of the dollar-weighted average based on the remaining time-
to-maturity of each security sold, to account for the contractual
obligation to repurchase such securities.\158\ In addition, an FCM or
DCO would not be permitted to make direct investments in Specified
Foreign Sovereign Debt securities with a remaining time-to-maturity
greater than 180 calendar days.\159\
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\153\ Proposal at 81245-81246.
\154\ 17 CFR 270.2a-7.
\155\ Proposed Commission regulation 1.25(f)(1). The proposed
condition is consistent with condition 3(c) of the 2018 Order.
\156\ Consistent with SEC Rule 2a-7(i)(6), the reverse
repurchase agreement would be deemed to have a maturity equal to the
period remaining until the date on which the resale of the
underlying instruments is scheduled to occur, or, where the
agreement is subject to demand, the notice period applicable to a
demand for the resale of the instruments. See proposed Commission
regulation 1.25(f)(1).
\157\ 17 CFR 1.25(d)(6).
\158\ Proposal at 81245-81246 and proposed Commission regulation
1.25(f)(1). In addition, under the Proposal, the dollar-weighted
average of the time-to-maturity of the portfolio would be computed
pursuant to SEC Rule 2a-7 (17 CFR 270.2a-7), consistent with the
general time-to-maturity provision in Commission regulation
1.25(b)(4)(i). Commission regulation 1.25(b)(4)(i) provides that
except for investments in MMFs, the dollar-weighted average time-to-
maturity of an FCM's or DCO's portfolio of Permitted Investments, as
computed under SEC Rule 2a-7, may not exceed 24 months. 17 CFR
1.25(b)(4)(i). The Commission also proposed to amend Commission
regulation 1.25(b)(4)(i) to exclude Specified Foreign Sovereign
Debt, which, as discussed, would be subject to its own dollar-
weighted average time-to-maturity limit.
\159\ Proposed Commission regulation 1.25(f)(2). The proposed
condition is consistent with condition 3(d) of the 2018 Order.
---------------------------------------------------------------------------

The Commission also proposed to expand the permissible Repurchase
Transaction counterparties and depositories under Commission
regulations 1.25(d)(2) and (7) to include certain foreign entities to
effectively permit FCMs and DCOs to engage in Repurchase Transactions
with Specified Foreign Sovereign Debt securities pursuant to Commission
regulation 1.25(a)(2).\160\ Currently Commission regulation 1.25(d)(2)
limits counterparties with whom an FCM or DCO may enter into Repurchase
Transactions involving Customer Funds or Permitted Investments to a
section 3(a)(6) \161\ bank, a domestic branch of a foreign bank insured
by the FDIC, a securities broker or dealer, or a government securities
dealer registered with the SEC or which has filed a notice pursuant to
section 15C(a) of the Government Securities Act of 1986.\162\
Additionally, Commission regulation 1.25(d)(7) further requires an FCM
or DCO to hold the securities transferred to the FCM or DCO under a
reverse repurchase agreement in a safekeeping account with a bank as
referred to in Commission regulation 1.25(d)(2), a Federal Reserve
Bank, a DCO, or the Depository Trust Company.\163\
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\160\ Proposal at 81246-81247. Commission regulation
1.25(a)(2)(i) provides that FCMs and DCOs may engage in Repurchase
Transactions with Permitted Investments provided the transactions
are in accordance with the provisions of Commission regulation
1.25(d). 17 CFR 1.25(a)(2)(i).
\161\ For a definition of section 3(a)(6) bank, see supra note
52.
\162\ Public Law 99-571, 100 Stat. 3208 (Oct. 28, 1986).
\163\ 17 CFR 1.25(d)(7).
---------------------------------------------------------------------------

The Commission noted in the Proposal that, absent amendment to the
counterparty and depository provisions of Commission regulations
1.25(d)(2) and (7), an FCM's and DCO's ability to buy and sell
Specified Foreign Sovereign Debt pursuant to Repurchase Transactions
would be restricted given that participants in such markets are
predominantly non-U.S. entities.\164\ The Commission, therefore,
proposed to add foreign banks and foreign securities brokers or dealers
meeting certain requirements discussed below, as well as the European
Central Bank and the central banks of Canada, France, Germany, Japan,
and the United Kingdom, to the list of permitted counterparties for
Repurchase Transactions.\165\ To be deemed a permitted counterparty,
the Proposal provided that a foreign bank would have to qualify as a
depository under Commission regulation 1.49(d)(3) by maintaining
regulatory capital in excess of $1 billion, and would also have to be
located in a money center country as defined in Commission regulation
1.49(a)(1) (i.e., Canada, France, Italy, Germany, Japan, or the United
Kingdom) or in another jurisdiction that adopted the currency of the
permitted foreign sovereign debt.\166\ Similarly, a foreign securities
broker or dealer would have to be located in a money center country and
be regulated by a national financial regulator.\167\ The proposed
provisions were designed to ensure that counterparties would be
regulated entities comparable to counterparties currently permitted
under Commission regulation 1.25(d)(2) and are consistent with the
Repurchase Transaction counterparty conditions specified in the 2018
Order.\168\
---------------------------------------------------------------------------

\164\ Proposal at 81246-81247.
\165\ Id., and proposed Commission regulation 1.25(d)(2).
\166\ Id.
\167\ Id.
\168\ Condition (e) of the 2018 Order.
---------------------------------------------------------------------------

The Commission also proposed to permit Specified Foreign Sovereign
Debt securities transferred to an FCM or DCO under a reverse repurchase
agreement to be held with a foreign bank that qualifies as a permitted
depository under Commission regulation 1.49 by maintaining in excess of
$1 billion in regulatory capital.\169\ The Commission noted that
mandating the safekeeping of foreign securities purchased through
reverse repurchase agreements with a U.S. custodian, as required under
the current regulation, may be inefficient or impractical.\170\ The
proposed amendment to permit a foreign bank that satisfies the
requirements of current Commission regulation 1.49 was designed to
ensure that any additional foreign depositories authorized to hold
Specified Foreign Sovereign Debt securities would be comparable to
those currently permitted under Commission regulation 1.25(d)(7), and
is consistent with the conditions of the 2018 Order.\171\
---------------------------------------------------------------------------

\169\ Proposed Commission regulation 1.25(d)(7).
\170\ Proposal at 81247.
\171\ Id. And Condition (f) of the 2018 Order.
---------------------------------------------------------------------------

Lastly, the Commission proposed to amend Commission regulation
1.25(b)(4)(i), which provides that except for investments in MMFs, the
dollar-weighted average time-to-maturity of an FCM's or DCO's portfolio
of Permitted Investments, as computed under SEC Rule 2a-7, may not
exceed 24 months.\172\ The proposed amendment would exclude Specified
Foreign Sovereign Debt from the calculation of the dollar-weighted
average time-to-maturity of the portfolio specified under Commission
regulation 1.25(b)(4)(i).\173\ The Commission proposed to exclude
Specified Foreign Sovereign Debt as such debt would be subject to a
separate dollar-weighted average time-to-maturity limit of 60 calendar
days, which is substantially shorter than the two-year dollar-weighted
average time-to-maturity requirement for the overall portfolio required
by Commission regulation 1.25(b)(4)(i).
---------------------------------------------------------------------------

\172\ Proposal at 81246.
\173\ Proposed Commission regulation 1.25(b)(4)(i).
---------------------------------------------------------------------------

b. Comments
The Commission received 12 comments in response to the proposed
addition of Specified Foreign Sovereign Debt to the list of Permitted
Investments for Customer Funds. Ten commenters supported the
Proposal.\174\ Two commenters opposed the Proposal.\175\
---------------------------------------------------------------------------

\174\ AIMA; CCP Global; Eurex; FIA/CME Joint Letter; ICE; MFA;
NFA; Nodal; SIMFA AMG; and WFE.
\175\ Investor Advocacy Group Joint Letter and Better Markets.
---------------------------------------------------------------------------

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

[[Page 7822]]

and DCOs with a risk management tool to effectively manage foreign
currency risk from holding Customer Funds denominated in non-U.S.
dollars.\176\ In this regard, MFA stated that Commission regulation
1.25 currently requires an FCM holding excess non-U.S. dollar Customer
Funds to first convert such currency to U.S. dollars before investing
the funds in Permitted Investments, thereby exposing the FCM and
customers to foreign currency risk.\177\ MFA further stated that a more
prudent risk management approach would be for an FCM to invest excess
CAD, EUR, GBP, and JPY in corresponding Specified Foreign Sovereign
Debt securities, which eliminates the foreign currency exposure to the
FCM and customers.\178\ Similarly, AIMA asserted that allowing FCMs and
DCOs to invest foreign-denominated Customer Funds in short-term
sovereign bonds of the same currency would reduce the currency risk
associated with investing those funds in U.S. dollar-denominated
investments.\179\ FIA and CME echoed these comments, stating that the
Proposal expands the risk management tools available to FCMs and DCOs
to manage risk associated with holding Customer Funds by mitigating
foreign currency risk resulting from converting foreign currencies into
U.S. dollars in order to invest in U.S. dollar-denominated Permitted
Investments.\180\
---------------------------------------------------------------------------

\176\ AIMA at p. 2; FIA/CME Joint Letter at p. 2; MFA at pp. 1-
2; CCP Global at p. 1; WFE at p. 4.
\177\ MFA at pp. 3-4.
\178\ Id.
\179\ AIMA at p. 2.
\180\ FIA/CME Joint Letter at pp. 2, 6-7.
---------------------------------------------------------------------------

Several commenters also observed that the ability to invest foreign
currency balances owed to customers in Specified Foreign Sovereign Debt
securities reduces potential credit risk that FCMs and DCOs would
otherwise be exposed to by depositing the foreign currencies in
unsecured commercial bank accounts.\181\ CCP Global stated that,
consistent with the Joint Petition, the ability of FCMs and DCOs to
invest customer foreign currencies in Specified Foreign Sovereign Debt
securities effectively eliminates the credit risk of commercial banks
that FCMs and DCOs are exposed to, while holding such funds in
unsecured deposit accounts.\182\ AIMA noted that investing foreign
currencies belonging to customers, particularly non-U.S. clients, in
Specified Foreign Sovereign Debt is a more prudent option than
depositing funds with a foreign depository institution that provides
less insolvency protection, as such deposits would be at greater risk
of being treated as unsecured claims compared to securities held in
custody.\183\ FIA and CME stated that in the event of a foreign
depository's insolvency, claims to uninsured cash balances are at
greater risk of being treated as unsecured claims against the
depository estate than claims to specific securities held in
custody.\184\ FIA and CME further stated that FCMs, DCOs, and customers
are in a better risk posture when FCMs and DCOs are able to diversify
non-U.S. dollar exposures by leveraging both permitted non-U.S.
depositories for cash as well as Permitted Investments in Specified
Foreign Sovereign Debt securities.\185\
---------------------------------------------------------------------------

\181\ AIMA at p. 2; Eurex at p. 2; WFE at p. 4; MFA at pp. 2-5;
FIA/CME Joint Letter at pp. 2-11; CCP Global at p.1; Nodal at p. 2;
NFA at p. 1.
\182\ CCP Global at p. 1.
\183\ AIMA at p. 2.
\184\ FIA/CME Joint Letter at p. 7.
\185\ Id.
---------------------------------------------------------------------------

FIA and CME further commented that the significant growth in the
holding of foreign currencies, particularly CAD, EUR, JPY, and GBP,
which comprise the currencies of the Specified Foreign Sovereign Debt
securities, provides compelling evidence demonstrating the risk
management rationale for expanding the list of Permitted Investments to
include Specified Foreign Sovereign Debt securities.\186\ Specifically,
FIA and CME referenced the Proposal, where the Commission stated that
as of August 15, 2023, FCMs collectively held an aggregate U.S. dollar
equivalent of $51 billion of Customer Funds denominated in the
currencies of the Specified Foreign Sovereign Debt, which represented
approximately 10 percent of the total $490 billion of Customer Funds
held in segregated accounts on that date.\187\ FIA and CME stated that
the increase in foreign currency-denominated Customer Funds is
attributable primarily to the growth in cleared swaps, which only
commenced when the Commission issued the 2011 Permitted Investments
Amendment eliminating foreign sovereign debt as a Permitted
Investment.\188\ In FIA and CME's view, it would be impractical--and
unfair to Cleared Swaps Customers--to continue incentivizing FCMs to
manage currency fluctuation risk by refusing margin deposits not
denominated in U.S. dollars or requiring customers depositing such
balances to assume the foreign currency risk.\189\
---------------------------------------------------------------------------

\186\ Id.
\187\ Id. See also Proposal at 81243-81244.
\188\ FIA/CME Joint Letter at p. 7. FIA and CME stated that
Cleared Swaps Customers deposit initial margin in foreign currency
to a much greater extent than do futures customers or 30.7
customers. Specifically, FIA and CME stated that based on a survey
of members, the growth of CAD, EUR, GBP and JPY customer balances
(measured by the total equity value of accounts holding cash,
securities, and positions denominated in those currencies, expressed
in U.S. dollar-equivalent basis) between November 30, 2018 and
November 30, 2023 has been most pronounced for the Cleared Swaps
origin. FIA and CME stated that for members surveyed, CAD/EUR/GBP/
JPY Cleared Swaps Customer Collateral balances totaled USD 1.6
billion in 2018 and USD 9.8 billion in 2023, a 600 percent increase.
FIA/CME Joint Letter at pp. 7-8, note 37.
\189\ FIA/CME Joint Letter at pp. 7-8.
---------------------------------------------------------------------------

FIA and CME also observed that as non-U.S. dollar customer funds
balances have increased, so has the customer demand for FCM flexibility
in servicing multi-currency accounts.\190\ The commenters explained
that many customers, particularly Cleared Swaps Customers, deposit non-
U.S. dollar cash and rely on FCMs to manage those deposits to satisfy
margin calls on their behalf denominated in one or more other
currencies. They further asserted that since several of the Commission-
registered DCOs clearing swaps are located in the United Kingdom and
the European Union, the complexity of single-currency margining
processes is compounded by the operational complexity of Cleared Swaps
Customer Collateral segregation and ``residual interest''
requirements.\191\ In particular, FIA and CME stated that to comply
with Commission regulation 22.2(f)(4), which requires that an FCM
maintain in segregation, at all times, ``an amount equal to the sum of
any credit balances that the Cleared Swaps Customers of the [FCM] have
in their accounts,'' FCMs may need to source non-U.S. dollar assets to
cover deficits in advance of settlement with DCOs outside of U.S.
banking hours.\192\ In this regard, FIA and CME asserted that having
the ability to convert non-cash balances into Specified Foreign
Sovereign Debt and to use Specified Foreign Sovereign Debt instruments
to cover deficits incurred outside of U.S. banking hours would assist
FCMs to control the higher level of operational risk associated with
single-currency margining and Cleared Customer Collateral-specific
segregation compliance processes.\193\
---------------------------------------------------------------------------

\190\ FIA/CME Joint Letter at p. 8.
\191\ Id.
\192\ Id. and 17 CFR 22.2(f)(4). Commission regulation
22.2(e)(3) further states that an FCM may deposit in the Cleared
Swaps Customer Accounts its own money, securities, or other property
to ensure that it is always in compliance with the segregation
requirements of Commission regulation 22.2(f), provided, that the
proprietary funds deposited are cash or unencumbered Permitted
Investments. 17 CFR 22.2.
\193\ FIA/CME Joint Letter at p. 8, citing as an example an FCM
transferring proprietary funds in the form of Specified Foreign
Sovereign Debt instruments to a Cleared Swaps Customer Collateral
Account to cover a deficit and ensure compliance with its
segregation requirements outside of U.S. banking hours.

---------------------------------------------------------------------------

[[Page 7823]]

Commenters also supported the Proposal by noting that the credit,
liquidity, and volatility characteristics of Specified Foreign
Sovereign Debt securities are comparable to those of U.S. Treasury
securities.\194\ Specifically, FIA and CME stated that if measuring
liquidity by the bid-ask spread, ``the short-term Specified Foreign
Sovereign Debt instruments in scope of the Proposed Regulation all
demonstrate abundant market liquidity; they are comparable to, if not
identical with, bid-ask spreads in U.S. government securities of the
same tenors.'' \195\ WFE further emphasized the low risk of default
associated with these instruments.\196\
---------------------------------------------------------------------------

\194\ E.g., Eurex at p. 2; ICE at p. 2. See also MFA at p. 3 and
FIA/CME Joint Letter at p. 5 (noting that if liquidity is measured
by bid-ask spread (i.e., the difference between the lowest ask price
and the highest bid price), the short-term Specified Foreign
Sovereign Debt instruments referenced in the Proposal are all highly
liquid and comparable from a liquidity perspective to U.S.
government securities with the same tenors).
\195\ FIA/CME Joint Letter at p. 5.
\196\ WFE at p. 4 (referencing available credit ratings for the
relevant foreign sovereign debt instruments).
---------------------------------------------------------------------------

Better Markets and the Investor Advocacy Group opposed the proposed
addition of Specified Foreign Sovereign Debt to the list of Permitted
Investments, stating that such investments could compromise the
protection of Customer Funds and put customers at undue financial
risk.\197\ Specifically, Better Markets stated that investments in
foreign sovereign debt can exhibit variable degrees of liquidity,
affected by factors such as market conditions, geopolitical stability,
and economic policies.\198\ Better Markets further stated that in times
of financial stress or market volatility, foreign sovereign debt
instruments may not be readily convertible to cash without significant
loss of value. Better Markets argued that the reduced liquidity could
hinder the ability of DCOs and FCMs to promptly meet withdrawal
requests or margin calls, potentially compromising their operational
efficiency and financial stability.\199\ Better Markets further stated
that the increased exposure to credit and market risks could lead to
situations where losses from investments in foreign sovereign debt
impact DCOs' and FCMs' financial health to the extent of potentially
limiting DCOs' and FCMs' ability to return Customer Funds. Better
Markets also asserted that the proposed conditions to investing in
Specified Foreign Sovereign Debt, such as the 45 BPS cap on the two-
year credit default swap spread and the limits on the time-to-maturity
of investments, may not be sufficient to mitigate the underlying
liquidity concerns.\200\ Better Markets also criticized the use of
credit default swap spreads as an indicator of the creditworthiness of
the issuing sovereign, noting that the reliability of credit default
swap spreads depends heavily on the health and liquidity of the credit
default swaps market.\201\
---------------------------------------------------------------------------

\197\ Better Markets at p. 3; Investor Advocacy Group Joint
Letter at p. 1.
\198\ Better Markets at pp. 5-6.
\199\ Id.
\200\ Id. at p. 6.
\201\ Id.
---------------------------------------------------------------------------

Better Markets also asserted that allowing investments of Customer
Funds in foreign sovereign debt would constitute a relaxation of
regulatory enhancements introduced following the failures of MF Global
Inc. (``MF Global'') and Peregrine Financial Group
(``Peregrine'').\202\ Specifically, Better Markets stated that the
failures of both MF Global and Peregrine resulted from misuse of
customer funds and fraud, which caused significant customer
losses.\203\ In addition, the Investor Advocacy Group noted that the
failure of MF Global resulted, at least in part, due to risky
investments in foreign sovereign debt.\204\
---------------------------------------------------------------------------

\202\ Id. at p. 2.
\203\ Id.
\204\ Investor Advocacy Group Joint Letter at p. 1 (the
expansion of Permitted Investments to include foreign debt
instruments of France, Germany, Canada, Japan, and the United
Kingdom could put customers at undue financial risk and asserting
that avoiding such risk was the rationale for prohibiting
investments in foreign sovereign debt in 2011 after the MF Global
meltdown).
---------------------------------------------------------------------------

More generally, Better Markets and the Investor Advocacy Group
contended that the Commission lacks a compelling, public interest-
focused rationale for expanding the list of Permitted Investments to
include Specified Foreign Sovereign Debt.\205\ In particular, these
commenters criticized the Commission's consideration of the potential
increase in profits for DCOs and FCMs as a benefit of the proposed
expansion of the list of Permitted Investments.\206\ Better Markets
also argued that higher profits for DCOs and FCMs do not inherently
guarantee reduced customer charges.\207\ Instead, Better Markets stated
that the current financial landscape, characterized with high interest
rates, has generated substantial additional revenue for FCMs,
reportedly amounting to hundreds of millions of dollars, and has led to
an expectation of an expansion of the number of FCMs entering the
market.\208\
---------------------------------------------------------------------------

\205\ Better Markets at p. 6; Investor Advocacy Group Joint
Letter at pp. 1-2.
\206\ Investor Advocacy Group Joint Letter at p. 1.
\207\ Better Markets at p. 4. Better Markets states that there
is substantial historical evidencing that benefits accruing at the
higher end of the economic spectrum (e.g., DCOs and FCMs) do not
``trickle down'' effectively to lower levels (e.g., customers),
citing 50 years of tax cuts for the rich failed to trickle down,
economics study says, CBS News Money Watch (December 17, 2020),
available at <a href="https://www.cbsnews.com/news/tax-cuts-rich-5-years-no-trickel-down/">https://www.cbsnews.com/news/tax-cuts-rich-5-years-no-trickel-down/</a>.
\208\ Id. Better Markets, citing Futures Commission Merchants
Target Expansion, Traders Magazine (June 26, 2023), available at
<a href="https://www.tradersmagazine.com/departments/clearing/fcms-target-expansion/">https://www.tradersmagazine.com/departments/clearing/fcms-target-expansion/</a>.
---------------------------------------------------------------------------

Separately, four commenters responded to the Commission's request
for comment on whether the Commission should impose a ``cooling-off ''
period, following an exceedance of the 45 BPS limit on the two-year
credit default swap spread of the issuing foreign sovereign, during
which investments in Specified Foreign Sovereign Debt would remain
prohibited.\209\ FIA and CME stated that a ``cooling-off'' period was
not necessary because, in their view, an exceedance of the 45 BPS limit
would most likely be related to broader market volatility conditions,
the improvement of which itself constitutes a cooling-off period.\210\
CCP Global agreed with the Commission that there should be a mechanism
to exclude a sovereign's debt in the event of an increased credit risk,
but advocated for a phased ``cooling-off'' period and flexibility in
terms of the number of breaches before investments are limited.\211\
CCP Global also warned against potential ``cliff-edge'' effects due to
the use of hard limits, which could aggravate volatility in the
underlying bond market.\212\ CCP Global further noted that given the
limited maturity of investments in reverse repurchase agreements (i.e.,
reverse repurchase agreements must be limited to an overnight maturity
or reversible upon demand), imposing an immediate limitation on new
investments would have the effect of requiring a large proportion of
all FCM and DCO investments in reverse repurchase agreements
collateralized by the relevant debt to be re-allocated within one
business day.\213\ WFE similarly recommended that the Commission
consider a minimum period of time or number of times that this limit is
breached before investment in the applicable Specified Foreign
Sovereign

[[Page 7824]]

Debt security is prohibited.\214\ ICE stated that requiring DCOs to
discontinue investment in Specified Foreign Sovereign Debt securities
due to fluctuations in credit default swap spreads could be
disruptive.\215\ In ICE's view, this restriction is not necessary given
the jurisdictions involved.\216\
---------------------------------------------------------------------------

\209\ Proposal at 81247, Question 4. Comments in response to
Question 4 were submitted by CCP Global at pp. 2-3; FIA/CME Joint
Letter at pp. 10-11; ICE at p. 3; and WFE at p. 4.
\210\ FIA/CME Joint Letter at p. 11.
\211\ CCP Global at p. 2.
\212\ Id.
\213\ Id.
\214\ WFE at p. 4.
\215\ ICE at p. 3.
\216\ ICE at p. 3. FIA and CME also noted that immediate
divestment should not be required after a change in credit default
spread. See FIA/CME Joint Letter at p. 10.
---------------------------------------------------------------------------

FIA and CME also observed that the Commission did not indicate
whether the calculation of the 45 BPS credit default spread condition
should be based on the bid, offer or mid-level.\217\ FIA and CME
proposed that the 45 BPS credit default spread condition be determined
using mid-level pricing.\218\ FIA and CME stated that mid-level pricing
is a widely accepted pricing convention, including for sovereign
debt.\219\
---------------------------------------------------------------------------

\217\ FIA/CME Joint Letter at p. 10.
\218\ Id.
\219\ Id.
---------------------------------------------------------------------------

In addition, FIA and CME reiterated their request, originally
expressed in the Joint Petition, that the Commission set a six-month
dollar-weighted average time-to-maturity limit for the portfolio of
Specified Foreign Sovereign Debt, and a maximum two-year remaining
time-to-maturity condition for individual instruments.\220\ Although
FIA and CME agreed with the Commission's observation in the Proposal
that the new issuance supply of Specified Foreign Sovereign Debt
meeting the proposed restrictions appears ``adequate to satisfy the
demand for investments of Customer Funds in the relevant instruments,''
FIA and CME asserted that the time-to-maturity restrictions ``may be
safely expanded, thereby enhancing liquidity (with the attendant
additional benefit of enhanced price stability and diversification
across currencies and tenors), without increasing credit risk.'' \221\
---------------------------------------------------------------------------

\220\ FIA/CME Joint Letter at pp. 9-10. Joint Petition at pp. 5-
6 (asserting that the new issuance supply of the Specified Foreign
Sovereign Debt meeting the restrictions is limited and would be
thinly traded/quoted).
\221\ FIA/CME Joint Letter at pp. 9-10.
---------------------------------------------------------------------------

Commenters also supported the Commission's proposal to revise
Commission regulations 1.25(d)(2) and (7) by expanding the eligible
counterparties for Repurchase Transactions for Specified Foreign
Sovereign Debt securities to include foreign banks, foreign securities
brokers and dealers, and the central banks of Canada, France, Germany,
Japan, and the United Kingdom, and by including foreign banks as
eligible custodians for securities received by FCMs and DCOs under
agreements to resell the securities.\222\ ICE stated that the principal
custodians for foreign sovereign debt securities are located outside of
the U.S., and that custody through a U.S. institution as required under
Commission regulation 1.25 would be impractical or involve an indirect
custodial relationship through a foreign bank or dealer in the relevant
jurisdiction. ICE also requested that the Commission revise Commission
regulation 1.25(d)(7) to explicitly include the central banks of
Canada, France, Germany, Japan, the United Kingdom, and the European
Central Bank as eligible custodians for Specified Foreign Sovereign
Debt securities.\223\
---------------------------------------------------------------------------

\222\ ICE at p. 3; FIA/CME Joint Letter at p. 9; WFE at p. 4.
See also Proposal at 81246-81247 and proposed Commission regulation
1.25(d)(2) and (7).
\223\ ICE at p. 3.
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Separately, three commenters asserted that the Proposal's goals of
increasing investment vehicles for DCOs, while minimizing credit risk,
market risk, and liquidity risk could be effectively met if DCOs were
allowed to deposit Customer Funds at the Federal Reserve Banks.\224\
The commenters thus recommended that the Commission advocate for
Federal Reserve deposit access for all DCOs.\225\
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\224\ Eurex at p. 2, CCP Global at p. 2, Nodal at p. 2.
\225\ Id.
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BlackRock also requested that the Commission amend Commission
regulation 1.25(d)(2) to allow FCMs and DCOs to invest Customer Funds
pursuant to Repurchase Transactions cleared by a covered clearing
agency registered with the SEC under section 17A of the Securities
Exchange Act.\226\
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\226\ BlackRock at p. 7-8 (referring to the recommendation made
by the Global Market Structure Subcommittee of the Commission's
Global Markets Advisory Committee on November 6, 2023). See Proposal
by FICC to add CCPs as Permitted Repo Counterparties under CFTC Rule
1.25 Recommendation, November 6, 2023, available at <a href="https://www.cftc.gov/PressRoom/Events/opaeventgmac110623">https://www.cftc.gov/PressRoom/Events/opaeventgmac110623</a>.
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c. Discussion
The Commission is amending Commission regulation 1.25 to add
Specified Foreign Sovereign Debt to the list of Permitted Investments
as proposed, subject to certain clarifications and revisions to address
comments. The amendments incorporate and expand upon the exemptive
relief provided by the Commission in the 2018 Order by authorizing DCOs
to invest Customer Funds in the sovereign debt of Canada, Japan, and
the United Kingdom in addition to the sovereign debt of France and
Germany. The amendments also expand upon the 2018 Order by authorizing
FCMs to invest Customer Funds in the Specified Foreign Sovereign
Debt.\227\
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\227\ Final Commission regulation 1.25(a)(1)(vi). The Final Rule
thus supersedes the 2018 Order.
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After considering the public comments, the Commission continues to
believe that adding Specified Foreign Sovereign Debt securities as a
Permitted Investment provides FCMs and DCOs with an option to manage
the potential foreign exchange risk that may arise in their
administration and investment of Customer Funds. Specifically, absent
the ability to invest Customer Funds in identically-denominated
sovereign debt securities, an FCM or DCO seeking to invest customer
foreign currency deposits would need to convert the currencies to a
U.S. dollar-denominated asset, which would introduce potential foreign
currency fluctuation risk to the FCMs and DCOs.\228\ If the U.S. dollar
decreases in value relative to the particular foreign currency, the FCM
or DCO may not receive sufficient foreign currency to cover the full
amount owed to its customers upon the conversion of the U.S. dollar-
denominated investment back to the applicable foreign currency. This
may further impact an FCM's or DCO's obligation under Commission
regulation 1.25(b)(1) to preserve the principal of Customer Funds
invested in Permitted Investments. Thus, to provide FCMs and DCOs with
an investment option that allows them to manage potential foreign
exchange risk, while staying consistent with the general objectives set
forth in Commission regulation 1.25 of preserving principal and
maintaining liquidity of Permitted Investments,\229\ the Commission is
adopting the conditions discussed above as proposed. These conditions
are consistent with the criteria specified in

[[Page 7825]]

the 2011 Permitted Investments Amendment \230\ and the conditions set
forth in the Commission's 2018 Order.\231\
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\228\ In reaching this conclusion, the Commission considered,
among other factors, the daily volatility of exchange rates of the
relevant currency pairs. Specifically, based on data from the
Federal Reserve Bank of St. Louis' FRED database, the Commission
noted that for the period from September 2018 to September 2023, the
standard deviation of the daily percentage change of exchange rate
between the relevant currency pairs was 0.45 percent for the CAD/USD
pair, 0.46 percent for the EUR/USD pair, 0.61 percent for the GBP/
USD pair, and 0.55 percent for the JPY/USD pair, indicating a
currency fluctuation that is an additional risk factor with respect
to the return on investment of customer foreign currency deposits in
U.S. dollar-denominated assets. The Commission also adopted foreign
sovereign debt as a Permitted Investment in 2000 to mitigate the
potential foreign currency fluctuation risk facing FCMs and DCOs in
converting foreign currencies to U.S. dollars for investment
purposes. 2000 Permitted Investments Amendment at 78003.
\229\ 17 CFR 1.25(b).
\230\ 2011 Permitted Investments Amendment at 78782 (stating
that the Commission would consider permitting foreign sovereign debt
investments to the extent that: (i) the petitioner has balances in
segregated accounts owed to customers or clearing member FCMs in
that country's currency; and (ii) the sovereign debt serves to
preserve principal and maintain liquidity of customer funds as
required for all other investments of customer funds under
Commission regulation 1.25).
\231\ 2018 Order at 35245.
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First, an FCM or DCO will be permitted to invest in the foreign
sovereign debt of only Canada, France, Germany, Japan, and the United
Kingdom. The Commission's determination to include the foreign
sovereign debt to these five countries is based on various factors. As
a preliminary matter, each of these countries, including the U.S., is a
member of the Group of 7 (``G7''), which represents the world's largest
industrial democracies, and qualifies as a ``money center country'' as
the term is defined in Commission regulation 1.49(a)(1).\232\
Additionally, the currencies of the five jurisdictions represent a
material portion of the total amount of non-U.S. dollar-denominated
obligations that FCMs owe to customers. FCMs collectively held an
aggregate of a U.S. dollar equivalent of $64 billion of Customer Funds
denominated in CAD, EUR, JPY, and GBP on August 13, 2024.\233\ The $64
billion represented approximately 12 percent of the total $511 billion
of Customer Funds held by FCMs in segregated accounts on August 13,
2024.\234\
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\232\ 17 CFR 1.49(a). In the absence of customer instructions to
the contrary, Commission regulation 1.49(c) limits permissible
locations of depositories of Customer Funds to the U.S., the country
of origin of the currency, and a ``money center country.'' The
concept of ``money center country'' is defined to mean Canada,
France, Italy, Germany, Japan, and the United Kingdom, and is
intended to correspond, together with the U.S., to the list of G7
countries. Denomination of Customer Funds and Location of
Depositories, 68 FR 5551 (Feb. 4, 2003) at 5546.
\233\ Based on data provided by CME. The amount has increased
compared to the amount the Commission considered in the Proposal
(i.e., $51 billion, representing approximately 10 percent of the
Customer Funds held in segregation, on August 15, 2023). Proposal at
81243-81244.
\234\ The $511 billion represents the U.S. dollar equivalent of
the total value of margin assets held by FCMs for futures customers,
Cleared Swaps Customers, and 30.7 customers as reported to CME as of
August 15, 2023. The breakdown by currency was as follows: CAD 17
billion; EUR 19 billion; GBP 7 billion; and JPY 21 billion. Some of
these funds may have also been posted by the FCMs to DCOs as
customer margin collateral.
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In addition, prior to proposing to allow FCMs and DCOs to invest in
the sovereign debt of the enumerated countries, the Commission analyzed
the credit, liquidity, and volatility characteristics of Specified
Foreign Sovereign Debt. In particular, the Commission considered data
provided by the Petitioners in support of the Joint Petition's
statement that the credit default swaps of Canada, France, Germany,
Japan, and the United Kingdom have relatively narrow spreads similar to
the credit default spread of the U.S.\235\ To assess the liquidity of
Specified Foreign Sovereign Debt, the Commission also considered the
amounts of outstanding marketable Canadian, French, German, Japanese,
and United Kingdom debt instruments with time-to-maturity of two years
or less.\236\
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\235\ Proposal at 81244, note 110 (referencing Joint Petition at
pp. 6-7). Data provided in the Joint Petition, subsequently
clarified by the Supplement to Joint Petition, indicates that in the
period between April 2018 and April 2023, the average 2-year credit
default swap spreads of Canada, France, Germany, Japan, and the UK
were 13.9 BPS, 9.6 BPS, 5.3 BPS, 7.4 BPS, and 12.2 BPS,
respectively, whereas the average 2-year credit default swap spread
of the U.S. was 15.1 BPS. Joint Petition at p. 7 and Supplement to
Joint Petition at p. 1.
\236\ Id. note 111 (referencing appendix A to Joint Petition and
Supplement to Joint Petition at p. 1, which indicate that the
outstanding debt in instruments with time-to-maturity of two years
or less issued by Canada, France, Germany, Japan, and the United
Kingdom, based on information available on Bloomberg as of July 11,
2023, was equal to the USD equivalence of $447 billion, $594
billion, $557 billion, $2.6 trillion, and $534 billion,
respectively; Bank of International Settlements' Debt Securities
Statistics, available here: <a href="https://www.bis.org/statistics/secstats_to180923.htm">https://www.bis.org/statistics/secstats_to180923.htm</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/governance/oecd-sovereign-borrowing-outlook-2022_3f4e2676-en">https://www.oecd-ilibrary.org/governance/oecd-sovereign-borrowing-outlook-2022_3f4e2676-en</a>, which
confirms that Specified Foreign Sovereign Debt instruments presented
good liquidity characteristics in 2021).
---------------------------------------------------------------------------

With regard to the volatility characteristics of Specified Foreign
Sovereign Debt, the Commission concluded that expanding the list of
Permitted Investments to include the sovereign debt of these five G7
countries is warranted based on available data that the price risk of
the relevant foreign sovereign debt is comparable to that of U.S.
Treasury securities that are already included in the list of Permitted
Investments. Specifically, using one-year sovereign debt instruments
yield data for the period September 21, 2018 to September 20, 2023, the
Commission observed that the standard deviation of daily yield change
for one-year U.S. Treasury bills was 9 BPS, whereas the same measure
for Canadian, French, German, Japanese, and United Kingdom one-year
debt instruments ranged from 1 to 7 BPS.\237\ The Commission's
determination that the price risk of Specified Foreign Sovereign Debt
instruments is comparable to that of U.S. Treasury securities, and
therefore merits inclusion in the list of Permitted Investments, is
based on data from an inquiry including the more recent period of
September 20, 2023 to September 5, 2024, using the standard deviation
of daily yield change for one-year debt instruments.\238\ Finally, in
proposing to add Specified Foreign Sovereign Debt to the list of
Permitted Investments, the Commission surmised that holding high-
quality foreign sovereign debt may pose less risk to Customer Funds
than the credit risk of commercial banks through unsecured bank demand
deposit accounts.\239\
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\237\ The Commission reviewed yield data available through
Bloomberg, a proprietary financial data provider, for 1-year
sovereign debt instruments issued by Canada, France, Germany, Japan,
the United Kingdom, and the U.S.
\238\ The Commission reviewed one-year sovereign debt
instruments yield data, available through Bloomberg, for the period
from September 21, 2018 to September 5, 2024. During this period,
the standard deviation of daily yield change for U.S. Treasury bills
was approximately 9 BPS, whereas the same measure for Canadian,
French, German, Japanese, and United Kingdom one-year debt
instruments ranged from approximately 1 to approximately 6 BPS.
\239\ The Commission discussed the preferability from a risk
management perspective of investing foreign currency in high quality
foreign sovereign debt relative to the credit risk posed by
unsecured demand deposit accounts at commercial banks in issuing the
2018 Order permitting DCOs to invest futures customer funds and
Cleared Swaps Customer Collateral in French and German sovereign
debt. 2018 Order at 35245-35246.
---------------------------------------------------------------------------

Second, an FCM or DCO is permitted to invest in the Specified
Foreign Sovereign Debt of a country only to the extent that the FCM or
DCO has balances in accounts owed to customers denominated in the
country's currency.\240\ This restriction takes into account both the
need to ensure the safety of Customer Funds and the Commission's desire
to provide a degree of investment flexibility to FCMs and DCOs.\241\ As
noted in the Proposal, an

[[Page 7826]]

FCM or DCO seeking to invest deposits or amounts owed to customers
denominated in foreign currencies, absent the ability to invest in
identically-denominated sovereign debt securities, would need to
convert the foreign currencies to a U.S. dollar-denominated asset,
which would increase the FCM's or DCO's exposure to foreign currency
fluctuation risk.\242\ Commenters did not raise concerns regarding this
condition, and as such, the Commission is adopting this requirement as
proposed.
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\240\ Final Commission regulation 1.25(a)(1)(vi).
\241\ As discussed above, prior to 2011, the Commission
permitted an FCM or DCO to invest Customer Funds in foreign
sovereign debt subject to the condition that the FCM or DCO held
balances owed to customers denominated in the currency of the
foreign country. In the wake of the 2008 financial crisis, the
Commission eliminated foreign sovereign debt from the list of
permitted investments noting at the time that ``in many cases, the
potential volatility of foreign sovereign debt in the current
economic environment and the varying degrees of financial stability
of different issuers make foreign sovereign debt inappropriate for
hedging foreign currency risk.'' 2011 Permitted Investments
Amendment at 78781. Yet the Commission recognized that ``the safety
of sovereign debt issuances of one country may vary greatly from
those of another, and that investment in certain sovereign debt
might be consistent with the objectives of preserving principal and
maintaining liquidity, as required by Regulation 1.25.'' Id. at
78782. For the reasons discussed above, the Commission is
reinstating certain foreign sovereign debt consistent with the
Commission's statement in the 2011 Permitted Investments Amendment
that it would consider permitting such investments provided that the
investments: (i) are limited to balances owed to customers
denominated in the currency of the applicable foreign sovereign, and
(ii) serve to preserve the principal and maintain the liquidity of
Customer Funds. Id. at 78782. The Final Rule is also consistent with
the Commission's approach in the 2018 Order of permitting DCOs to
invest in the sovereign debt of France and Germany to the extent
such foreign sovereign debt satisfies specific criteria
demonstrating consistency with the credit, liquidity, and volatility
of short-term U.S. Treasury securities.
\242\ 2011 Permitted Investments Amendment at 78003.
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Third, the Commission proposed to permit FCMs and DCOs to invest in
Specified Foreign Sovereign Debt provided that the two-year credit
default spread of the issuing sovereign is 45 BPS or less.\243\ As
discussed in the Proposal, the 45 BPS limit is consistent with the
conditions specified in the 2018 Order.\244\ The Commission set the cap
of 45 BPS in the 2018 Order based on a historical analysis of the two-
year credit default spread of the U.S. (``U.S. Spread'').\245\ Forty-
five BPS was, at the time, approximately two standard deviations above
the mean U.S. Spread over the preceding eight years.\246\ The
Commission observed that over that eight-year period of July 3, 2009 to
July 3, 2017, the U.S. Spread was 45 BPS or less approximately 95
percent of the time and exceeded 45 BPS approximately 5 percent of the
time. During the same period, the two-year German spread exceeded 45
BPS approximately 6 percent of the time and the two-year French spread
exceeded 45 BPS approximately 25 percent of the time, with all
exceedances occurring between July 2009 and September 2012, in the
aftermath of the 2008 financial crisis and the European sovereign debt
crisis.\247\
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\243\ Proposed Commission regulation 1.25(f)(3).
\244\ Proposal at 81245.
\245\ 2018 Order at 35243.
\246\ In 2018, the Commission reviewed the daily U.S. Spread
from July 3, 2009 to July 3, 2017. Over that time period, the U.S.
Spread had a mean of approximately 26.5 BPS and a standard deviation
of approximately 9.72 BPS. Forty-five BPS were approximately two
standard deviations above the 26.5 mean.
\247\ See 2018 Order at 35243.
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During the more recent period of September 21, 2018 to September
20, 2023 preceding the issuance of the Proposal, the U.S. Spread had a
mean of approximately 16.4 BPS,\248\ which was lower than the mean
spread of 26.5 BPS for the July 3, 2009 to July 3, 2017 period. In that
same time period, the two-year credit default swap spread of the
sovereigns issuing the Specified Foreign Sovereign Debt did not exceed
45 BPS. Thus, based on these U.S. Spread and Specified Foreign
Sovereign Debt data, the Commission is maintaining the cap of 45 BPS
established in the 2018 Order.\249\
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\248\ Based on an assessment conducted by CFTC staff on
September 20, 2023.
\249\ Using the daily U.S. Spread data from July 3, 2009 to July
3, 2017 and assuming the two-year credit default spread follows a
normal distribution, the Commission estimated that there was less
than 2.5 percent likelihood that the U.S. credit default spread
would exceed 45 BPS over a two-year period. In addition, the
Commission's estimate, based on the daily U.S. Spread data from
September 21, 2018 to September 5, 2024, indicates that there is
less than 1 percent likelihood, under both normal and empirical
distributions, that the two-year credit default swap spread of the
sovereigns issuing Specified Foreign Sovereign Debt would exceed 45
BPS. Therefore, the Commission has determined to adopt a threshold
of 45 BPS for countries whose debt may qualify as a Permitted
Investment under Commission regulation 1.25.
---------------------------------------------------------------------------

Consistent with the Proposal, if the credit default spread of the
issuing sovereign exceeds the 45 BPS cap, FCMs and DCOs will not be
permitted to make further investments, but neither will they be
required to immediately divest their current investments in Specified
Foreign Sovereign Debt. The prohibition on new investments will reduce
the exposure to Customer Funds by avoiding the risk of default on the
Specified Foreign Sovereign Debt. In situations where the 45 BPS cap is
exceeded, FCMs and DCOs will hold Customer Funds denominated in foreign
currency in cash or invest the foreign currency in U.S. dollar-
denominated Permitted Investments rather than Specified Foreign
Sovereign Debt. In addition, the requirement that the dollar-weighted
average time-to-maturity of the portfolio of Specified Foreign
Sovereign Debt not exceed 60 calendar days helps mitigate price risks
to the Customer Funds that might arise from a country's two-year credit
default spread exceeding the 45 BPS limit.
In addition, in response to a comment stating that the Commission
did not specify how the 45 BPS limit should be calculated, the
Commission is clarifying that the 45 BPS credit default spread must be
determined using mid-level pricing, rather than the bid or ask
price.\250\ The mid-price is the average of the bid and ask prices,
representing a midpoint between what buyers are willing to pay (bid)
and what sellers are asking for (ask). This mid-point price provides a
more balanced view of the security's credit risk, without the skew of
immediate buy or sell pressures.
---------------------------------------------------------------------------

\250\ FIA/CME Joint Letter at p. 10 (recommending that the
spread be determined using the mid-level and asserting that mid-
level pricing is a widely accepted pricing convention for a wide
range of asset classes including sovereign debt).
---------------------------------------------------------------------------

The Commission also requested comments as to whether it was
appropriate to impose a ``cooling-off'' period before an FCM or DCO
could invest Customer Funds in the Specified Foreign Sovereign Debt of
a particular country once the two-year credit default spread of the
country exceeded 45 BPS.\251\ As commenters noted, market conditions
based on broader volatility will self-resolve and result in a market
driven ``cooling-off'' period.\252\ Moreover, because FCMs and DCOs
will not be able to make new investments in Specified Foreign Sovereign
Debt until the credit default spread is back within the required
limits, any ``cooling-off'' period promulgated by the Commission could
potentially be arbitrary and inconsistent with the market's assessment
that the increased credit risk that resulted in the exceedance of the
45 BPS cap no longer exists. Thus, the Commission is not specifying a
``cooling-off'' period during which FCMs and DCOs may not engage in
investment in the applicable Specified Foreign Sovereign Debt.
---------------------------------------------------------------------------

\251\ Proposal at 81247, Question 4.
\252\ FIA/CME Joint Letter at pp. 10-11.
---------------------------------------------------------------------------

However, the Commission has determined to immediately halt the
purchase of additional Specified Foreign Sovereign Debt once the 45 BPS
cap is exceeded. Specifically, the Commission does not agree with
commenters who suggested that there should be ``flexibility'' with
respect to the number of breaches of the 45 BPS cap before investments
are limited,\253\ because the breach of the 45 BPS cap indicates the
market's assessment of an increased likelihood of credit risk. The
Commission acknowledges those comments cautioning that there is a
potential for unintended consequences such as ``cliff-edge effects,''
\254\ but it is for that reason that the Commission is taking a
measured and balanced approach to such situations where the 45 BPS
limit has been exceeded. Therefore, the Commission is not requiring
that FCMs and DCOs sell

[[Page 7827]]

Specified Foreign Sovereign Debt that has already been purchased
because it could increase volatility and the potential for procyclical
impacts. The Commission, however, maintains its position that FCMs and
DCOs must stop making direct investments in, or engaging in Repurchase
Transactions involving, Specified Foreign Sovereign Debt of a country
whose credit default swap spread on two-year debt instruments has
exceeded 45 BPS.
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\253\ See CCP Global at p. 2; WFE at p. 4-5.
\254\ See CCP Global at p. 2.
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The Commission is also adopting the 60-calendar-day dollar-weighted
average time-to-maturity of investments in Specified Foreign Sovereign
Debt, as proposed.\255\ As discussed in the Proposal, the restrictions
on time-to-maturity will ensure that an FCM's or DCO's portfolio of
Specified Foreign Sovereign Debt is comprised of sovereign debt
instruments that mature within a relatively short period of time.\256\
The short time-to-maturity requirement is intended to assist FCMs and
DCOs in managing and mitigating potential market and/or credit risk by
providing FCMs and DCOs with the option of holding the foreign
sovereign debt securities to maturity during periods of market stress
and price volatility rather than selling the securities at potentially
significant discounts. The option to hold the debt securities to
maturity may be particularly valuable to FCMs and DCOs from a risk
management perspective during periods of significant interest rate
movements, which could exacerbate market risk in sovereign debt
markets. Thus, the Commission has determined to adopt a 60-calendar-day
dollar-weighted average time-to-maturity requirement for Specified
Foreign Sovereign Debt securities, computed on a portfolio of
securities on a country-by-country basis, and a 180-calendar-day
maximum remaining time-to-maturity requirement for each individual
Specified Foreign Sovereign Debt security.
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\255\ Final Commission regulation 1.25(f)(1) and (2).
\256\ Proposal at 81245-81246.
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In addition, data regarding the new issuances of short-term
Specified Foreign Sovereign Debt supports the lower 60-day dollar-
weighted average time-to-maturity requirement and the 180-day maximum
remaining time-to-maturity requirement proposed.\257\ Therefore, the
proposed time-to-maturity conditions more effectively account for
liquidity needs with the market and credit risk management
considerations than the six-month dollar-weighted portfolio average and
two-year individual remaining time-to-maturity limits recommended by
FIA and CME. Furthermore, as discussed in the Proposal, using the
maturity of reverse repurchase agreements in calculating the dollar-
weighted average of the portfolio of investments in Specified Foreign
Sovereign Debt will reduce the average time-to-maturity of the
portfolio as a whole. This approach takes into account the expected
resale of the instruments, which must be contractually scheduled to
occur within one business day or on demand as required by Commission
regulation 1.25(d)(6).\258\ Conversely, if the FCM or DCO sells
Specified Foreign Sovereign Debt instruments under a repurchase
agreement, the FCM or DCO is required to include the instruments in the
calculation of the dollar-weighted average based on the remaining time-
to-maturity of each instrument sold, to account for the expected
repurchase of such instruments.\259\
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\257\ 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 2024, Canada auctioned approximately
USD 35 billion, France auctioned approximately $26.2 billion,
Germany auctioned approximately $8.2 billion, Japan auctioned
approximately $12.5 billion, and the United Kingdom auctioned
approximately $41 billion in debt instruments with time-to-maturity
of six months or less (see Canadian Treasury bills auction results
at <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>).
\258\ 17 CFR 1.25(d)(6).
\259\ Final Commission regulation 1.25(f)(1).
---------------------------------------------------------------------------

In addition, as discussed in the Proposal, with the adoption of the
60-day dollar-weighted portfolio average time-to-maturity requirement,
the Commission is also amending Commission regulation 1.25(b)(4)(i) to
exclude Specified Foreign Sovereign Debt from the calculation of the
dollar-weighted average time-to-maturity of the FCM's or DCO's full
portfolio of investment of Customer Funds.\260\ This amendment reflects
that Specified Foreign Sovereign Debt will be subject to its own
dollar-weighted average time-to-maturity limit.
---------------------------------------------------------------------------

\260\ Proposal at 81246.
---------------------------------------------------------------------------

The Commission acknowledges the request of Eurex, CCP Global, and
Nodal in their public comments \261\ that the Commission work with the
Federal Reserve Board to permit all DCOs to deposit Customer Funds at
the Federal Reserve Banks. The Commission supports DCOs having deposit
accounts at Federal Reserve Banks; \262\ however, granting access to
such accounts is not within the jurisdiction of the Commission.
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\261\ Eurex at p. 2, CCP Global at p. 2, Nodal at p. 2.
\262\ See, e.g., Behnam urges wider CCP access to Fed deposit
accounts, <a href="http://Risk.net">Risk.net</a> (Apr. 1, 2022), available at <a href="https://www.risk.net/regulation/7945026/behnam-urges-wider-ccp-access-to-fed-deposit-accounts">https://www.risk.net/regulation/7945026/behnam-urges-wider-ccp-access-to-fed-deposit-accounts</a>.
---------------------------------------------------------------------------

Consistent with the Proposal, the Commission is also amending
Commission regulations 1.25(d)(2) and (7) to expand permissible
counterparties and depositories that can be used in connection with
Repurchase Transactions to include certain foreign entities. Without
amendment to these counterparty and depository provisions, an FCM's and
DCO's ability to buy and sell Specified Foreign Sovereign Debt
securities pursuant to Repurchase Transactions would be restricted
because participants in the foreign market are predominantly non-U.S.
entities. The Commission is therefore adding foreign banks and foreign
brokers or dealers meeting certain requirements, as well as the
European Central Bank and the central banks of Canada, France, Germany,
Japan, and the United Kingdom, to the list of permitted
counterparties.\263\ To be deemed a permitted counterparty, a foreign
bank must qualify as a depository under Commission regulation
1.49(d)(3) by holding regulatory capital in excess of $1 billion, and
must be located in a money center country as defined in Commission
regulation 1.49(a)(1) (i.e., Canada, France, Italy, Germany, Japan, and
the United Kingdom) or in another jurisdiction that has adopted the
currency of the permitted foreign sovereign debt. Similarly, a foreign
broker or dealer must be located in a money center country and be
regulated by a foreign financial regulator or a provincial financial
regulator with respect to a Canadian securities broker or dealer.\264\
The newly adopted

[[Page 7828]]

provisions are designed to ensure that the counterparties to an FCM's
or DCO's Repurchase Transactions are regulated entities comparable to
those counterparties already permitted under Commission regulation
1.25(d)(2). The final revisions to Commission regulation 1.25(d)(2) are
also consistent with the counterparty conditions set forth in the 2018
Order.\265\
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\263\ Final Commission regulation 1.25(d)(2). ICE requested in
its comment letter that the Commission explicitly include the
central banks of Canada, France, Germany, Japan, the United Kingdom,
and the European Central Bank. See ICE at p. 3. The Commission is
including these recommendations in the terms of the Final Rule.
\264\ The Commission is revising the Final Rule to provide that
Canadian securities brokers or dealers may be subject to applicable
provincial financial regulators in recognition of the Canadian
regulatory structure vests supervisory authority with provincial
regulators. Final Commission regulation 1.25(d)(2).
\265\ 2018 Order, Condition (e) at 35245.
---------------------------------------------------------------------------

In response to Better Markets' assertion that allowing investments
in Specified Foreign Sovereign Debt is relaxing some of the stringent
requirements put in place after the collapse of MF Global,\266\ the
Commission notes that the impetus for eliminating foreign sovereign
debt from the list of Permitted Investments in 2011 was not the
bankruptcy of MF Global. Under the 2000 Permitted Investments
Amendment, FCMs and DCOs were permitted to invest in the foreign
sovereign debt of any foreign sovereign provided that the FCM or DCO
owed balances denominated in that currency to customers. The Commission
eliminated foreign sovereign debt in the 2011 Permitted Investments
Amendment primarily due to its concerns with the varying degree of
financial stability of different issuers as well as because it was not
persuaded that foreign sovereign debt was used with sufficient
frequency to justify commenters' claims that such debt assisted with
the diversification of Customer Funds.\267\ However, as previously
stated, with respect to concerns regarding the economic stability of
certain countries, the Commission recognized that the safety of
sovereign debt issuances of one country may vary greatly from those of
another. In this context, the Commission stated that it was amenable to
considering applications for exemptions with respect to investments in
certain foreign sovereign debt instruments upon a demonstration that
the investment in the sovereign debt of one or more countries is
appropriate in light of the objectives of Commission regulation 1.25
and that the issuance of the exemption satisfies the criteria set forth
in section 4(c) of the Act.\268\
---------------------------------------------------------------------------

\266\ Better Markets at p. 3.
\267\ 2011 Permitted Investments Amendment at 78781.
\268\ Id. at 78782.
---------------------------------------------------------------------------

The Commission continues to recognize that the safety of sovereign
debt issuances of one country may vary greatly from the sovereign debt
issuances of another country. Because of this, the Commission finds
that investment in Specified Foreign Sovereign Debt that meets the
tightly circumscribed risk characteristics set forth in the 2018 Order
and restated in the Final Rule is consistent with the objectives of
preserving principal and maintaining liquidity of investments specified
in Commission regulation 1.25.\269\ In light of the varying liquidity
and credit risk associated with foreign sovereign debt, the Commission
is recognizing jurisdictions whose short-term debt instruments meet the
general objectives set forth in Commission regulation 1.25 of
preserving principal and maintaining liquidity, subject to the
conditions discussed above that are consistent with the conditions
specified in the 2018 Order.
---------------------------------------------------------------------------

\269\ Id. at 78782.
---------------------------------------------------------------------------

In addition, MF Global's trading losses, which Better Markets
references in asserting that FCMs' and DCOs' investments in Specified
Foreign Sovereign Debt might compromise the protection of Customer
Funds,\270\ were undertaken as speculative proprietary investments and
not as investments of Customer Funds. MF Global engaged in, among other
speculative investments, proprietary repurchase-to-maturity
transactions collateralized with sovereign debt issued by various
European countries that were experiencing economic distress.\271\ As
the value of the European sovereign debt positions deteriorated in the
summer of 2011, and as MF Global's credit ratings were downgraded in
the fall of 2011, MF Global was required to pay additional variation
and initial margin on its proprietary transactions.\272\ To satisfy the
firm's liquidity needs and, more generally, to support the firm's
proprietary transactions and the operations of the firm's affiliates,
MF Global unlawfully used Customer Funds.\273\ The firm's misuse of
Customer Funds violated the Act and Commission regulations and would
have been impermissible regardless of the type of investments involved
in such malfeasance.\274\
---------------------------------------------------------------------------

\270\ Better Markets at p. 3.
\271\ Another MF Global affiliate was also involved in the
transactions, but MF Global held the economic risk of ownership.
First Report of Louis J. Freeh, Chapter 11 Trustee of MF Global
Holdings LTD., et al., for the Period of October 31, 2011 through
June 4, 2012 (``MF Global Trustee Report'') at p. 33, available at
<a href="https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/h0711reportoflouisjfreeh060412.pdf">https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/h0711reportoflouisjfreeh060412.pdf</a>.
\272\ Id. at pp. 36-37.
\273\ CFTC Release No. 7508-17, Consent Order: Jon S. Corzine
(Jan. 5, 2017) at p. 6.
\274\ Moreover, MF Global had invested not in the sovereign debt
of Canada, France, Germany, Japan and the United Kingdom, which meet
the liquidity, volatility, and credit characteristics that are
consistent with the overall objectives set forth in Commission
regulation 1.25 of preserving principal and maintaining liquidity of
Customer Funds, but rather, such Customer Funds were ultimately used
to support high-risk transactions involving the sovereign debt of
Belgium, Ireland, Italy, Portugal, and Spain. None of these
jurisdictions are on the list of allowable foreign sovereign debt
that is being added to the list of Permitted Investments. See MF
Global Trustee Report at p. 40.
---------------------------------------------------------------------------

Peregrine's failure was also the result of the misappropriation of
Customer Funds and violations of the Commission segregation
requirements for Customer Funds.\275\ Peregrine's owner and Chief
Executive Officer plead guilty to the embezzlement of customer funds
and making false statements to the Commission.\276\ These unlawful
actions have no bearing on the types of Permitted Investments
authorized by the Commission.
---------------------------------------------------------------------------

\275\ CFTC Release No. 7116-15.
\276\ U.S. Attorney's Office Northern District of Iowa, Press
Release, Peregrine Financial Group CEO Sentenced To 50 Years For
Fraud, Embezzlement, And Lying To Regulators [Court's Sentence Is
The Maximum Allowed By Law]. January 31, 2013. Available at <a href="https://www.justice.gov/usao-ndia/pr/peregrine-financial-group-ceo-sentenced-50-years-fraud-embezzlement-and-lying">https://www.justice.gov/usao-ndia/pr/peregrine-financial-group-ceo-sentenced-50-years-fraud-embezzlement-and-lying</a>.
---------------------------------------------------------------------------

Moreover, the Commission adopted major revisions to its rules to
enhance the protection of Customer Funds in response to the MF Global
and Peregrine bankruptcies. Specifically, the Commission adopted
Commission regulation 1.11,\277\ which requires each FCM carrying
customer accounts to establish a risk management program designed to
monitor and manage risks associated with the activities of the FCM,
including risks associated with the segregation of Customer Funds, FCM
operations, and capital resources.\278\ Commission regulation 1.11
requires an FCM to establish written policies and procedures that are
reasonably designed to ensure that Customer Funds are separately
accounted for and segregated as belonging to customers as required by
the Act and Commission regulations. Furthermore, the written policies
and procedures must, at a minimum, include or address: (i) a process
for assessing the appropriateness of specific investments of Customer
Funds in Permitted Investments, including the consideration of the
market, credit, counterparty, operational, and liquidity risks
associated with the investments, and an assessment of whether the
investments are managed consistent with the objectives of preserving
principal and maintaining liquidity of Customer Funds; (ii) a process
for the evaluation of depositories of segregated

[[Page 7829]]

funds, including, at a minimum, documented criteria addressing the
depository's capitalization, creditworthiness, operational reliability,
and access to liquidity; (iii) an account opening process for
depositories, including documented authorization requirements,
procedures to ensure that customer segregated funds are not deposited
with a depository prior to the FCM receiving a written acknowledgment
letter, and procedures to ensure that the account is properly titled as
a customer segregated account under the Act and Commission regulations;
and (iv) a program to monitor an approved depository on an ongoing
basis to assess its continued satisfaction of the FCM's established
criteria, including a thorough due diligence review of each depository
at least annually.\279\
---------------------------------------------------------------------------

\277\ 17 CFR 1.11.
\278\ 2013 Protections of Customer Funds Release at 68517-68521.
See also 17 CFR 1.11.
\279\ 17 CFR 1.11(e)(3).
---------------------------------------------------------------------------

The Commission also revised Commission regulation 1.10 to require,
among other things, an FCM to report and maintain a targeted amount of
residual interest (i.e., excess segregated funds above the full balance
owed to customers) that the FCM seeks to hold in segregated accounts as
a buffer to prevent the accounts from becoming undersegregated.\280\
Additionally, the Commission amended Commission regulation 1.16 to
ensure the high quality of annual audits of the FCM's financial
statements by public accountants. The amendments to Commission
regulation 1.16 require public accountants to be registered with, and
examined by, the Public Company Accounting Oversight Board (``PCAOB''),
and further require that the public accountant's audit report state
whether the audit was conducted in accordance with auditing standards
established or adopted by the PCAOB.\281\
---------------------------------------------------------------------------

\280\ 2013 Protections of Customer Funds Release at 68513-68516.
\281\ Id. at 68577.
---------------------------------------------------------------------------

The Commission further revised Commission regulation 1.12 to
enhance reporting by FCMs to the Commission. Specifically, Commission
regulation 1.12 was amended to define several additional reportable
events that require an FCM to file a notice with the Commission and
with the FCM's designated self-regulatory organization.\282\ Among
other changes, the revisions included a requirement for FCMs to provide
immediate notice whenever the FCM discovers or is informed that it has
invested Customer Funds in investments that do not qualify as Permitted
Investments, or if the FCM holds Permitted Investments in a manner that
is not in compliance with the provisions of Commission regulation
1.25.\283\
---------------------------------------------------------------------------

\282\ Id. at 68521-68522.
\283\ Id. at 68522.
---------------------------------------------------------------------------

The additional Customer Funds safeguards adopted in 2013 are not
affected by the amendments adopted in this Final Rule.\284\ In light of
the enhanced safeguards that are now in place with respect to the
segregation of Customer Funds,\285\ and the limitation of investment in
foreign sovereign debt to jurisdictions whose debt meets certain
liquidity, volatility, and credit characteristics consistent with the
overall objectives set forth in Commission regulation 1.25 of
preserving principal and maintaining liquidity of Customer Funds,
concerns regarding the past failures of MF Global and Peregrine are
already addressed.
---------------------------------------------------------------------------

\284\ The Commission acknowledges, as discussed further in
section IV.E. of this preamble, that the read-only electronic access
to account information provisions are being removed. However, the
same information will be accessible through CME and NFA programs
that compare the daily balances reported by each of the depositories
with balances reported by the FCMs in their daily segregation
reports that are filed with CME and/or NFA. This will allow the same
information to be accessible to the Commission without the current
difficulties involved in the read-only access currently maintained.
\285\ See generally 2013 Protections of Customer Funds Release.
---------------------------------------------------------------------------

The Commission is not addressing BlackRock's request for amendments
to Commission regulation 1.25(d)(2) to allow FCMs and DCOs to invest
Customer Funds pursuant to Repurchase Transactions cleared by a covered
clearing agency registered with the SEC because this requested change
was not proposed and discussed as part of the Proposal.\286\ Any
potential amendment to effectuate such change would be addressed
separately from this Final Rule.
---------------------------------------------------------------------------

\286\ BlackRock at p. 7-8 (referring to the recommendation made
by the Global Market Structure Subcommittee of the Commission's
Global Markets Advisory Committee on November 6, 2023). See
generally Proposal by FICC to add CCPs as Permitted Repo
Counterparties under CFTC Rule 1.25 Recommendation, November 6,
2023, available at <a href="https://www.cftc.gov/PressRoom/Events/opaeventgmac110623">https://www.cftc.gov/PressRoom/Events/opaeventgmac110623</a>.
---------------------------------------------------------------------------

Finally, as discussed previously, some commenters raised concerns
about the profits of FCMs and DCOs and whether increased profits were
in line with the public interest language in the Act to justify these
changes to the list of Permitted Investments.\287\ In assessing the
public interest as part of its analysis of the conditions of section
4(c) of the Act, the Commission has considered more than just the
potential profits of FCMs and DCOs.\288\ As discussed above, the use of
foreign sovereign debt provides FCMs and DCOs with an effective risk
management tool for foreign currency exchange risk. By investing
customers' foreign currency deposits in the sovereign debt of the
applicable foreign currency, an FCM or DCO avoids the need to convert
the foreign currency deposits into U.S. dollar-denominated assets and
reduces potential foreign currency fluctuation risk associated with
such transactions. The ability to manage foreign currency fluctuation
risk benefits FCMs, DCOs, customers, and the markets. In addition, as
discussed above, holding Customer Funds in foreign sovereign debt
securities with custodians may provide enhanced protections to the
funds relative to holding the funds as unsecured deposits with
commercial banks.
---------------------------------------------------------------------------

\287\ See Investor Advocacy Group Joint Letter at p. 1 (arguing
that ``[t]he CFTC must not embed revenues and profits of exchanges
and brokers into the fabric of its definition of the public
interest.''); Better Markets at p. 4 (asserting that ``[i]n the
context of FCMs, higher profits do not inherently guarantee reduced
customer charges. The dynamics of profit allocation within
businesses, market competition, and economic realities often
complicate the direct correlation between increased profits and
reduced costs for customers.'').
\288\ 7 U.S.C. 6(c). With respect to investments of futures
customer funds, the Commission is changing the list of Permitted
Investments pursuant to authority under section 4(c) of the Act.
---------------------------------------------------------------------------

Furthermore, permitting investments in Specified Foreign Sovereign
Debt facilitates FCMs' and DCOs' overall risk management in recognition
of how the market has evolved since the 2007 Review.\289\ As previously
noted, the 2007 Review revealed that only three of the total 87 active
FCMs invested futures customer funds in foreign sovereign debt at any
time during that year, and that only one FCM invested 30.7 customer
funds in foreign sovereign debt.\290\ This contrasts sharply to the $64
billion U.S. dollar equivalent of Customer Funds held in CAD, EUR, GBP,
and JPY by FCMs today.
---------------------------------------------------------------------------

\289\ 2010 Proposed Permitted Investments Amendment at 67643.
\290\ Id. at 67645.
---------------------------------------------------------------------------

The Commission has also determined that it is in the public
interest to allow FCMs and DCOs to invest in foreign sovereign debt
because there will be increased resources for financial stability and
responsible innovation. Any increase in profits by FCMs and DCOs as a
result of these expanded investment options would generate income and
potentially increase their presence in the futures market and other
relevant markets to support greater competition. This is particularly
important because the futures industry has experienced considerable
consolidation, with the number of FCMs

[[Page 7830]]

declining from over 400 in the late 1970s,\291\ to 177 FCMs in January
2004,\292\ to just 64 as of May 2024.\293\ Over approximately the same
period, however, there has been a dramatic increase in Customer Funds
held at FCMs to support derivatives trading, with client margin
requirements increasing by about 700 percent in the past 20 years, from
approximately $60 billion to over $500 billion in 2023.\294\ Such a
significant reduction in the number of FCMs concentrates risk related
to Customer Funds in fewer firms, thereby increasing the possibility of
systemic risk, particularly as the decline in the number of FCMs
creates challenges in porting customer positions to another firm in the
event of an FCM failure. Therefore, the changes in this Final Rule that
could potentially increase revenue generated by FCMs could serve to
increase entrants to the FCM market by making entrance more attractive
and mitigate forces that would result in further consolidation of the
market, thereby supporting both institutional and retail customers'
access to FCMs and reducing concentration and potential systemic
risk.\295\
---------------------------------------------------------------------------

\291\ See Statement of CFTC Commissioner Giancarlo to the Market
Risk Advisory Committee (``MRAC''), June 1, 2015.
\292\ Selected FCM Financial Data as of January 31, 2004,
COMMODITY FUTURES TRADING COMM'N (2004), available at <a href="https://www.cftc.gov/sites/default/files/files/tm/fcm/tmfcmdata0401.pdf">https://www.cftc.gov/sites/default/files/files/tm/fcm/tmfcmdata0401.pdf</a>.
\293\ Emm, E., Gay, G., Shen, M., Futures commission merchants,
customer funds and capital requirements: An organizational analysis
of the futures industry, Journal of Commodity Markets 18 (2020)
100093; Financial Data on FCMs as of February 29, 2024, available at
<a href="https://www.cftc.gov/MarketReports/financialfcmdata/index.htm">https://www.cftc.gov/MarketReports/financialfcmdata/index.htm</a>.
\294\ Transcript, MRAC, April 9, 2024, p. 78, available at
<a href="https://www.cftc.gov/sites/default/files/2024/07/1721936529/mrac_transcript040924.pdf">https://www.cftc.gov/sites/default/files/2024/07/1721936529/mrac_transcript040924.pdf</a>.
\295\ Better Markets questioned the need for any ``regulatory
change aimed at further increasing profitability.'' Better Markets
at p. 4. In support of its assertion, Better Markets cited a Traders
Magazine article that references a 2023 study by Acuiti asserting
that rising interest rates and higher trading volumes could
potentially increase the number of FCM registrants. See A. Lyudvig,
Futures Commission Merchants Target Expansion (June 26, 2023)
available at <a href="https://www.tradersmagazine.com/departments/clearing/fcms-target-expansion/">https://www.tradersmagazine.com/departments/clearing/fcms-target-expansion/</a> (``Traders Magazine Article''); see also
Acuiti, The Growing Opportunity in Derivatives Clearing, (2023),
available at <a href="https://www.acuiti.io/wp-content/uploads/2023/06/The-Growing-Opportunities-in-Derivatives-Clearing.pdf">https://www.acuiti.io/wp-content/uploads/2023/06/The-Growing-Opportunities-in-Derivatives-Clearing.pdf</a> (``2023 Acuiti
Study''). However, the Acuiti study also found that ``[t]he market
needs more FCMs,'' and that for some firms, such as proprietary
trading and smaller hedge funds, the ``reliance on a smaller number
of providers presents a major risk to their operational models.''
2023 Acuiti Study at 13. In addition, the Acuiti study was nuanced
in its prediction of new entrants, finding that ``[o]pinion was more
mixed on whether increased interest rates were likely to attract new
FCMs to market.'' Id. at 6. In the Commission's view, the Acuiti
study shows further support for the Commission's interest in
providing additional avenues for FCMs to generate revenue to
potentially reduce costs to clients, rather than the alternative
perspective articulated by Better Markets that such regulatory
changes are not in the public interest.
---------------------------------------------------------------------------

There is no guarantee that the potential for additional profits
will benefit customers directly at all times; however, as described
above, the increased investment options may potentially reduce
concentration in the FCM industry, mitigate foreign currency risk, and
facilitate FCMs' ability to answer margin calls in foreign currency,
all of which directly benefit FCM customers.
In consideration of comments received, the Commission is amending
Commission regulation 1.25(a)(1) to add Specified Foreign Sovereign
Debt to the list of Permitted Investments, subject to the conditions as
described above. The Commission is adding Commission regulation
1.25(a)(vi), as redesignated to accommodate other amendments to the
list of Permitted Investments pursuant to this Final Rule. Paragraph
(vi) reflects the addition of general obligations of Canada, France,
Germany, Japan, and the United Kingdom as a Permitted Investment.
3. Interests in U.S. Treasury Exchange-Traded Funds
a. Proposal
As part of its periodic reassessment of the list of Permitted
Investments of Customer Funds, and as a result of its consideration of
industry input provided in the Joint Petition and the Invesco Petition,
the Commission proposed to include shares in certain U.S. Treasury ETFs
to the list of Permitted Investments under Commission regulation 1.25.
ETFs are collective investment vehicles that issue redeemable
securities that are also traded at the market price on national
securities exchanges.\296\ 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. Each share of an ETF represents an undivided fractional
interest in the underlying assets of the ETF.\297\ 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.\298\ Other ETFs are actively managed, with
portfolio managers buying and selling securities in accordance with an
investment strategy.\299\
---------------------------------------------------------------------------

\296\ See generally Exchange-Traded Funds, 84 FR 57162 (Oct. 24,
2019) (``SEC ETFs Release'').
\297\ Id. at 57164.
\298\ See generally ``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>.
\299\ Id.
---------------------------------------------------------------------------

As an open-end investment company,\300\ similar to a mutual
fund,\301\ 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.'' \302\ Authorized participants play
a key role for ETF shares as they are the only investors that are
allowed to transact directly with the ETF.\303\ An authorized
participant must: (i) be an SEC-registered broker or dealer or other
securities market participant (such as a bank or other financial
institution that is not required to register as a broker or dealer to
engage in securities transactions); (ii) be a full participating member
of the National Securities Clearing Corporation and the Depository
Trust Company; and (iii) have entered into an authorized participant
agreement with the ETF (and potentially other parties, such as the
ETF's sponsor, distributor, or transfer agent).\304\
---------------------------------------------------------------------------

\300\ An ``open-end company'' is defined as a ``management
company which is offering for sale or has outstanding any redeemable
security of which it is the issuer.'' 15 U.S.C. 80a-5. Some ETFs may
also be structured as unit-investment trusts (e.g., SPDR[supreg] S&P
500[supreg] ETF Trust and SPDR[supreg] Dow Jones Industrial Average
ETF Trust), which have characteristics of both open-end and closed-
end companies. 15 U.S.C. 80a-4 (defining unit investment trusts);
Unit Investment Trusts (UITs), Glossary, available at <a href="https://www.investor.gov/introduction-investing/investing-basics/glossary/unit-investment-trusts-uits">https://www.investor.gov/introduction-investing/investing-basics/glossary/unit-investment-trusts-uits</a>. The regulatory framework set forth by
SEC Rule 6c-11, however, applies only to ETFs that are organized as
open-end investment companies. 17 CFR 270.6c-11.
\301\ A ``mutual fund'' is a type of open-end investment
company, meaning that investors can purchase and redeem shares in
the fund on a continuous basis at the NAV of the shares. See
generally Securities and Exchange Commission, Mutual Funds and ETFs,
A Guide for Investors, available at <a href="https://www.sec.gov/investor/pubs/sec-guide-to-mutual-funds.pdf">https://www.sec.gov/investor/pubs/sec-guide-to-mutual-funds.pdf</a>. Mutual funds pool the money of
many investors to purchase a range of securities and other assets to
meet specified investment objectives. Id.
\302\ See 17 CFR 270.6c-11 (defining ``exchange-traded fund'').
\303\ Invesco Petition at p. 5.
\304\ Id.

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[[Page 7831]]

An authorized participant may act as a principal for its own
account or as an agent for others when purchasing or redeeming creation
units.\305\ 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.
---------------------------------------------------------------------------

\305\ SEC ETFs Release at 57164; see also David Abner, The ETF
Handbook: How to Value and Trade Exchange-Traded Funds, 2nd ed.
(2016).
---------------------------------------------------------------------------

In assessing the potential expansion of the list of Permitted
Investments, the Commission considered statements emphasizing the
liquidity of U.S. Treasury ETF shares and the diversification
opportunity that such ETFs provide for Customer Funds.\306\ In
particular, as discussed in the Proposal, the Petitioners stated that
U.S. Treasury ETFs have characteristics that they believe are
consistent with those of current Permitted Investments and may provide
FCMs and DCOs with an opportunity to diversify their investments of
Customer Funds.\307\ 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
Commission regulation 1.25 (i.e., U.S. government securities).\308\
Invesco also noted 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.\309\ Finally, Invesco
asserted 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.\310\
---------------------------------------------------------------------------

\306\ Proposal at 81248.
\307\ Id. and Joint Petition at pp. 8-9.
\308\ Proposal at 81248 and Invesco Petition at p. 2.
\309\ Proposal at 81248 and Invesco Petition 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-end 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
requests to redeem shares issued by the fund without significant
dilution of remaining investors' interests in the fund (17 CFR
270.22e-4).
\310\ Invesco Petition at p. 2.
---------------------------------------------------------------------------

The Commission also conducted an independent preliminary analysis
of the risk profile and volatility of ETFs investing primarily in
short-term U.S. Treasury securities and observed that during the period
covered by the analysis, the relevant ETFs presented characteristics
that were comparable to that of the underlying U.S. Treasury security
investments.\311\ Specifically, using data available on Bloomberg, the
Commission observed 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 one-year U.S. Treasury securities had a
standard deviation of 8 BPS for the same period.
---------------------------------------------------------------------------

\311\ Proposal at 81250.
---------------------------------------------------------------------------

Further, the Commission considered the limited types of investments
that meet the requirements of Commission regulation 1.25. As a result
of various regulatory reforms discussed in the Proposal, several asset
classes included in Commission regulation 1.25 no longer qualify as
Permitted Investments.\312\ In particular, as discussed in section
III.A.1. of the Proposal, 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 Commission
regulation 1.25.\313\ In addition, as discussed in section III.A.4. of
the Proposal, commercial paper and corporate notes and bonds no longer
qualify as Permitted Investments with the expiration of the TLGP.\314\
---------------------------------------------------------------------------

\312\ Proposal at 81248.
\313\ Proposal at 81241-81242.
\314\ Proposal at 81253.
---------------------------------------------------------------------------

The Commission also noted the increased demand for high quality
collateral, including for assets that currently qualify as Permitted
Investments under Commission regulation 1.25, resulting from certain
regulatory reforms.\315\ As an example, the Commission discussed the
regulatory framework for swaps, adopted in the aftermath of the 2008
financial crisis through the Dodd-Frank Wall Street Reform and Consumer
Protection Act. The Commission remarked that the framework requires,
among other things, the clearing of cer

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