The 2024 US elections may signal a shift in the policy orientation of other federal financial regulators, but at the Commodity Futures Trading Commission (CFTC or Commission), at least in the short-term, the most significant Commission actions impacting the operations of futures commission merchants (FCMs) are likely to be the adoption of final rules proposed the CFTC within the last year.[1] Beyond the short-term, however, more impactful changes for FCMs are starting to come into view.

Short-Term Takeaways for FCMs 

The CFTC will seek to finalize three rulemaking proposals advanced in the last year that directly affect FCMs.

• Permitted Investments of Customer Funds: In November 2023, the CFTC proposed lifting a blanket restriction on the investment of customer funds in certain non-US sovereign debt instruments, which had been imposed on FCMs and derivative clearing organizations (DCO) following the collapse of MF Global in October 2011.[2]
• Operational Resilience Framework: Proposed rules, if adopted, would require FCMs and swap dealers to establish comprehensive operational resilience programs, holistically addressing cybersecurity, third-party relationships and business continuity and disaster recovery.[3]
• Margin Adequacy and Separate Accounts: Proposed rules would codify staff no-action relief permitting FCMs to maintain separately margined accounts for the same beneficial owner.[4]

If adopted, these rules would require FCMs to review and update policies and procedures. 

Permitted Investments of Customer Funds

The proposed revisions would revise CFTC Regulation 1.25 by:

• expanding the list of permitted investments to include sovereign debt of Canada, the UK, France, Germany and Japan;
• limiting 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);
• adding interests in exchange-traded funds to the list of permitted investments, subject to conditions;
• removing commercial paper, corporate notes and corporate bonds from the list of permitted investments; and
• updating benchmarks by replacing LIBOR with SOFR and revising acknowledgment letter templates.

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.

Operational Resilience Framework

The operational risk framework rulemaking would require FCMs and swap dealers to adopt policies and procedures reasonably designed to identify, monitor, manage and assess three types of operational risk:

• risks related to information and technology security;
• risks related to third-party relationships; and
• disruptions to normal business operations and recovery from such disruptions.

The proposal combines and expands requirements already applicable to FCMs and swap dealers in the form of CFTC Regulation 1.11 (relating to the requirement to adopt and establish a risk management program) and in several NFA Interpretive Notices (including Notice 9070 on Information Systems Security Programs, Notice 9079 on use of third-party service providers, and Notice 9052 on business continuity and disaster recovery).

In addition, annual reviews and audits, senior leadership approvals, staff training and notifications to the CFTC and self-regulatory organizations of cybersecurity and other risk incidents would be mandated.

Margin Adequacy and Separate Accounts

In 2019, CFTC staff issued no-action relief permitting DCOs to permit their clearing members to maintain separately margined accounts for the same customer, notwithstanding a longstanding DCO rule requiring clearing members to aggregate such accounts for the purpose of determining the amount of excess funds available for withdrawal to the customer.[5] Letter 19-17 affirms that the risk management goals of that rule may be addressed if the clearing FCM carrying a customer with separate accounts satisfies 16 conditions.

Letter 19-17 promised codification in due course, and that promise was redeemed in the form of a “margin adequacy” rule (first proposed by the CFTC in 2023 and then reproposed earlier this year). The reproposed rules also include amendments to Parts 22 and 30 of the CFTC Regulations (extending separate account margining risk management to the foreign futures and cleared swaps customer account origins), as well as to the regulatory capital rule for FCMs, CFTC Regulation 1.17 (making clear that calculations of assets, liabilities and capital charges by FCMs that elect to offer separate account margining to their customers must accurately reflect that separate account treatment).

The CFTC’s proposed codification departs most markedly from the framework of Letter 19-17 in the additional machinery around the condition that separately margined accounts of the same customer “must be on a one business day margin call.” The reproposal includes new definitions of “business day” and “holiday,” as well as detailed guidance on how this condition should apply to settlement in USD, Euros and 10 other foreign currencies, and on how FCMs should account for holidays, both US and non-US. Doubtless these reformulated proposals will receive careful attention from market participants.

Beyond the Short-Term: New Models of Clearing

Recent years have seen the emergence of new models for derivatives clearing: the CFTC has approved fully collateralized DCOs open to all comers, including retail investors, as direct participants, as well as fully collateralized DCOs offering access through FCM intermediaries.[6] Several DCOs now offer or are preparing to offer access to binary options listed on affiliated designated contract markets (DCM).[7] The CFTC has blessed vertically integrated structures in which access to the DCM and DCO is available through an affiliated FCM. What we have not seen to date is disintermediated clearing (i.e., offered directly to participants, including retail) that is margined (i.e., not fully collateralized). This was the model that FTX sought to offer in 2022, a few months before its collapse.[8] It has been widely touted as the ideal market structure for trading and clearing crypto derivatives (which trade in real time 24/7).

Will a new administration be inclined to give the green light to margined disintermediated trading and clearing of crypto derivatives?

Conclusion

Post-election, the winds of regulatory change are blowing. Firms should prepare for finalized rules on customer fund handling, operational resilience and separate account margining. Beyond that, new approaches to event contracts, and non-traditional clearing models may be in the offing. And, of course, with new blood at the top come new appointments in senior staff. Proactive compliance measures and close monitoring of regulatory updates will be essential to navigating this evolving landscape.

[1] This post is part of a series exploring changes expected under the new administration across various sectors of the derivatives markets. For analysis focused on swap dealers, see Katten's Passle post on this topic here.

[2]See Katten’s Passle post on this topic here.

[3]See Katten’s Passle post on this topic here.

[4]See Katten’s Passle post on this topic here.

[5] CFTC Letter No. 19-17 (July 10, 2019), https://www.cftc.gov/csl/19-17/download.

[6]See Press Release, CFTC, “CFTC Approves LedgerX, LLC to Clear Fully-Collateralized Futures and Options on Futures” (Sept. 2, 2020), https://www.cftc.gov/PressRoom/PressReleases/8230-20.

[7]See Investor Alert, SEC, “Binary Options and Fraud” (June 6, 2013), https://www.sec.gov/files/ia_binary.pdf.

[8] Aoyon Ashraf, “FTX Withdraws US CFTC Derivatives Clearing Plan,” CoinDesk (Nov. 11, 2022), https://www.coindesk.com/business/2022/11/11/ftx-withdraws-us-cftc-derivatives-clearing-plan-bloomberg/.