In Short
The Situation: In a December 13, 2023, Open Meeting, the Commodity Futures Trading Commission proposed amendments to the Commission's regulations concerning clearing member funds held by a derivatives clearing organization (DCO).
The Result: The proposed changes would revise 17 C.F.R. § 39.15 and § 39.19 to provide protections for clearing member funds held by DCOs comparable to protections currently in place for customer funds of futures commission merchant (FCM) customers. The proposed changes address: (i) the treatment of funds in the event of a DCO bankruptcy; (ii) segregation and commingling of funds; (iii) written depository acknowledgements; (iv) naming of customer fund accounts; (v) limits on the use of clearing member "proprietary funds" and investments DCOs can make with such funds; and (vi) daily reconciliations and reporting requirements. The proposed rule would also codify no-action exemptions for certain foreign DCOs and facilitate DCOs holding customer and proprietary funds with certain foreign central banks.
Looking Ahead: One of the animating concerns of the proposal was the view that the current rule fails to protect clearing member "proprietary funds." For example, in the event of a DCO bankruptcy, the current regulatory regime would protect customer funds but not clearing member funds. The proposed rule attempts to close this gap, but two Commissioners agreed at the Open Meeting that further regulation is likely needed for disintermediated clearing models.
Summary of Proposed Changes
The proposed rule is focused on providing new protections for clearing member "proprietary funds." The term "proprietary funds" is defined as all money, securities, and property held in a proprietary account on behalf of clearing members used to margin, guarantee, or secure futures, foreign futures and swaps contracts, as well as option premiums and other funds held in relation to options contracts, plus clearing member contributions to a guaranty fund.
- Proposed Regulation 39.15(f)(1) would require a DCO to segregate proprietary funds from its own funds such that proprietary fund accounts clearly identify the funds as belonging to clearing members.
- Proposed Regulation 39.15(f)(2) would require DCOs to obtain written acknowledgement letters from any depositories used to hold proprietary funds. The proposed rule would include a template form identical to that found in Regulation 1.20.
- Proposed Regulation 39.15(f)(3) would permit DCOs to commingle the proprietary funds of multiple clearing members in an omnibus account so long as they are not held with customer funds or the DCO's own funds.
- Proposed Regulation 39.15(f)(4) would only permit DCOs and depositories to use proprietary funds as belonging to clearing members, provided that DCOs can use proprietary funds as part of DCO default waterfalls, subject to DCOs' rules and agreements with clearing members.
Further, the proposed rule would add Regulation 39.15(g) to require DCOs to reconcile funds daily. Accordingly, DCOs would need to confirm (a) the amount of proprietary and customer funds owed to customers and clearing members and (b) their ability to cover such amounts with their segregated accounts. The proposed rule would add to Regulation 39.19 a requirement that DCOs report to the Commission any discrepancies noticed in the daily reconciliations of proprietary and customer funds.
The proposed rule would also amend existing Regulation 39.15(e), which sets out those investments that DCOs may make with proprietary funds. Consistent with the notion that the proposed rule is designed to align DCO and FCM regulations, 39.15(e) as proposed would limit a DCO's permitted investments with proprietary funds to those permitted for customer funds under current Regulation 1.25.
The reconciliation and segregation protections are meant to ensure that funds are available and plainly identified to enable distribution to different groups in the event of a bankruptcy.
In keeping with the Commission's efforts to harmonize with foreign regulatory regimes when necessary or desirable, proposed Regulation 39.15(h) would provide exemptive relief for foreign DCOs—those operating with primary places of business outside the United States—as to many of the proposed rule's requirements. The Commission explained that in doing so it seeks to avoid conflict with the bankruptcy regimes of foreign jurisdictions.
Proposed Regulations 39.15(b)(3) and (f)(2)(vi) would codify no-action exemptive relief for DCOs seeking to hold customer and proprietary funds with certain central banks. The codified relief applies with respect to the central banks of each non-U.S. G7 nation. If the rule is enacted, then DCOs holding customer or proprietary funds with such a central bank will still need to obtain written acknowledgement from the institution. However, the proposed rule provides a written acknowledgement form—modified from that in Regulation 1.20—to account for modifications various central banks requested.
Two Key Takeaways
- The Commission proposed to close a perceived gap in its regulations to provide protection for clearing member funds held at DCOs comparable to Commission protections for customer funds.
- Certain Commissioners expressed concern that the proposed rules would not protect the funds of retail self-clearing members trading on markets cleared by DCOs that do not use FCM clearing members.
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