This is the third of a multi-part series (Introduction; Part 1) on a February 20 proposal by the U.S. Commodity Futures Trading Commission (“CFTC”) to implement CFTC Regulation §1.44 (the “Proposed Rule”) and related amendments to other CFTC regulations.

This part will provide background information about the nature of the relationship between institutional investors and their investment managers, since that relationship is one of the primary reasons for the Proposed Rule in the first instance.

It is common for futures customer agreements between a futures commission merchant (“FCM”) and certain of its customers to include provisions clarifying that different accounts of the same customer at the FCM will be treated independently of one another—in effect, like assets of separate legal entities. The Proposed Rule refers to such accounts as “separate accounts.”

Typically, an investment manager is an agent of its client and opens a derivative trading account at an FCM on behalf of its client, the FCM’s customer. In other words, the FCM deals with the agent of the customer instead of the customer (i.e., the principal) itself.

An institutional investor, such as investment fund or a pension plan, may retain multiple investment advisers to manage the investor’s assets. And, a single institutional investor may retain the same investment adviser to manage multiple accounts of the same investor according to different investment strategies (e.g., an equity mandate and a fixed-income mandate).

In these situations, the same beneficial owner (i.e., the institutional investor) may have multiple accounts at the same FCM opened by one or more agents (i.e., the investment manager) with each account managed independently of one another.

From the perspective of institutional investors and their investment managers, each account has its own risk-return profile and the assets and liabilities of the account are, in effect, independent of those in any other account. Further, each account is usually governed by a unique investment strategy, inclusive of restrictions on the permitted amount and type of derivatives.

In short, notwithstanding common beneficial ownership, the assets of one account are not considered to be available to meet the liabilities of another account, since the intention of the investor in having separate accounts is to segregate one account from the other account.

To be clear, an institutional investor does not necessarily segregate investment mandates at the “account level” to prevent intermediaries, like FCMs, from accessing a customer’s assets in a default, but rather such segregation is a reflection of the fact that each account is truly a separate investment strategy with its own unique risk profile and limitations.

Accordingly, investment managers take risk positions on behalf of a client on the basis of assets available solely at the account level.

And, importantly, FCMs undertake their risk management analysis of each account on the basis of the assets that are in that account, rather than on an aggregated or multi-account basis.

In the next part of the series, we will consider different views that flow from the relationship between an institutional investor and its investment manager, particularly in the context of the Proposed Rule.