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Back to the Future: CFTC Proposes to Amend Customer Funds Investment Rule Including to Again Permit Investments in Certain Non-US Sovereign Debt
Wednesday, November 15, 2023

The Commodity Futures Trading Commission (CFTC) has proposed to lessen a blanket restriction on the investment of customer funds in all non-United States sovereign debt instruments that was imposed on future commission merchants (FCMs) and derivative clearing organizations (DCOs) following the dramatic collapse of MF Global in October 2011, in a newly issued Notice of Proposed Rulemaking (NPRM).

Specifically, in response to two public petitions for rulemaking, the CFTC proposed amendments to its longstanding regulations governing the safeguarding and investment of derivatives customer segregated, secured and cleared swap customer funds (collectively, “customer funds”) held by FCMs and DCOs on November 3, 2023. All five of the CFTC commissioners supported issuing the NPRM.

Promulgated under Commodity Exchange Act section 4d(2)(a) (which provides that customer money may be invested in US government securities and municipal securities, but further provides that the CFTC may prescribe rules and conditions on such investments), CFTC Rule 1.25 permits and limits the way in which FCMs and DCOs can invest customer funds held with respect to transactions in futures, foreign futures, and cleared swaps. The proposed amendments to CFTC Rule 1.25 would revise the list of permitted investments in CFTC Rule 1.25 and introduce certain related conditions, many of which were previously codified in CFTC staff no-action relief. 

Specifically, the proposed amendments would, among other things:

  • add the sovereign debt of Canada, Japan, the United Kingdom, France, and Germany to the list of permitted investments, subject to certain enumerated conditions. Investment of customer funds in all non-US sovereign debt instruments was banned by the CFTC in 2011;
  • limit the scope of money market funds whose interests qualify as permitted investments to “government money market funds,” as defined in SEC Investment Company Act Rule 2a-7 (i.e., funds that invest 99.5 percent or more of total assets in cash, government securities, repo transactions that are collateralized fully by cash or government securities);
  • add interests in exchange-traded funds to the list of permitted investments, subject to specified enumerated conditions;
  • remove commercial paper, corporate notes, and corporate bonds from the list of permitted investments;
  • replace the London Interbank Offered Rate (LIBOR) with the secured overnight financing rate (“SOFR”) as a permitted benchmark for permitted investments that contain an adjustable rate of interest;
  • amend certain counterparty and depository requirements set forth in CFTC Rule 1.25, and revise the concentration limits for permitted investments; 
  • specify regulatory capital charges that would apply to the proposed new categories of permitted investments; and
  • clarify that DCOs are financially responsible for any losses resulting from investment of cleared swap customer funds in permitted investments (as they and FCMs are for any such investments of segregated, secured or cleared swap customer funds, under CFTC Rule 1.29). 

The proposed amendments also would eliminate the requirement in the CFTC’s regulations that a depository holding customer funds must provide the CFTC with read-only electronic access to such accounts for the FCM to treat the funds held in the accounts as customer-segregated fund accounts. The National Futures Association and the Chicago Mercantile Exchange would be expected to continue to maintain rules requiring FCMs that hold customer funds to instruct their depositories to report balances to them on a daily basis, however.

The proposed amendments are a response to a joint petition of the Futures Industry Association and the CME requesting that the CFTC permit FCMs and DCOs to invest customer funds in the sovereign debt of Canada, France, Germany, Japan, and the United Kingdom, thereby effectively rescinding a general ban on permitted investments in all foreign sovereign debt, adopted by the CFTC in 2011 in response to the dramatic collapse of MF Global the same year and the European sovereign debt crises that roiled financial markets between 2009 and 2011. (MF Global was an FCM whose collapse and subsequent bankruptcy filing were attributed to an alleged misuse of customer funds to support margin calls on proprietary trading positions involving certain non-US sovereign debt instruments; click here for details.)

The CFTC also received a petition from Invesco Capital Management LLC advocating for the addition of US Treasury ETF securities to the list of permitted investments in CFTC Rule 1.25.

In his statement accompanying the NPRM, CFTC Chairman Rostin Behnam cited the potential of the proposed rule amendments to decrease FCMs’ foreign currency risks from holding customers’ non-US cash balances and to increase the profitability of FCMs as among the reasons he supported issuance of the NPRM. The Chairman noted the decline in the number of FCMs over the past few years, and the need to take measures to ensure the resiliency and continuity of clearing opportunities. Commissioners Kristin Johnson, Caroline Pham, and Christy Goldsmith Romero also issued separate statements supporting issuance of the NPRM.  Comments to the NPRM must be received by the CFTC by January 17, 2024.

The NPRM, the FIA/CME and Invesco petitions and statements of the four CFTC Commissioners are available here.

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