This post is the next installment in a multi-part series on CFTC Regulation §1.44, as proposed by the U.S. Commodity Futures Trading Commission (the “CFTC”) on February 20, 2024 (the “Proposed Rule”).

The previous installment explained that a futures commission merchant (an “FCM”) can elect to treat separate accounts of a separate account customer as separate entities for purposes of the Margin Adequacy Requirement (the “Separate Account Election”) if three conditions are met.

This post will focus on one of those conditions—the requirement that the Separate Account Election can only be made during the “ordinary course of business.”

The Ordinary Course of Business: Understanding What It IS by Understanding What It Is NOT

Under paragraph (a) of proposed CFTC Regulation §1.44, “ordinary course of business”means the standard day-to-day operation of the FCM’s business relationship with its separate account customer. “Events specified in paragraph (e) of [the Proposed Rule] are inconsistent with the ordinary course of business.” In effect, understanding what is not the ordinary course of business affords insight into what the ordinary course of business is.

Conditions That Are Not Consistent with the Ordinary Course of Business

Paragraph (e) of CFTC Regulation §1.44 lists nine events that relate to the financial resiliency of the FCM or the separate account customer that would be inconsistent with the ordinary course of business.

In the proposing release, the CFTC explained that these events “would raise important concerns about the financial resiliency of the FCM or one or more of its separate account customers, and provided the following additional commentary in respect of these events:

These events are divided into two categories: (i) those that concern the separate accounts of a particular separate account customer, and the occurrence of any one of which would require the FCM to cease permitting disbursements on a separate account basis with respect to all accounts of that customer; and (ii) those that concern the financial status of the FCM itself, and the occurrence of any one of which would require the FCM to cease permitting disbursements on a separate account basis with respect to all of its separate account customers.

We next consider these events in turn.

Events Relating to the Resiliency of the FCM

1. The FCM receives notice from a board of trade (a “BoT”), a derivatives clearing organization (a “DCO”), a self-regulatory organization (an “SRO”), the CFTC, or other regulator, that the notifying party believes the FCM is in financial or other distress;
2. The chief compliance officer (“CCO”), senior risk managers, or other senior management of the FCM determine in good faith that the FCM is under financial or other distress;
3. The FCM or its parent company becomes insolvent or bankrupt;

Events Relating to the Separate Account Customer

4. Either the separate account customer or any separate account of that separate account customer fails to deposit initial margin or maintain maintenance margin or make a payment of variation margin or option premium, in each case, according to the “one business day margin call standard” set forth in paragraph (f) of CFTC Regulation §1.44 (which standard will be the subject of a subsequent post in this series);
5. The occurrence and declaration by the FCM of an event of default under the futures customer agreement or other account documentation executed between the FCM and the separate account customer;
6. After following the FCM’s internal escalation procedures, the CCO, senior risk managers, or other senior management of the FCM determine in good faith that either (i) the separate account customer is in financial distress or (ii) there is a significant and bona fide risk that the separate account customer will be unable to promptly perform its financial obligations to the FCM, for operational or other reasons;
7. The separate account customer or its parent company becomes insolvent or bankrupt;
8. The FCM receives notice from a BoT, a DCO, an SRO (including any securities market SRO subject to the oversight of the U.S. Securities and Exchange Commission), the CFTC, or another regulator with jurisdiction over the separate account customer, that the notifying party has initiated an action with respect to that customer on an allegation that the customer is in financial distress; and
9. A BoT, a DCO, an SRO, the CFTC, or another regulator with jurisdiction over the FCM directs the FCM to cease permitting disbursements on a separate account basis, with respect to the separate account customer.

An FCM must notify its designated SRO and the CFTC of the occurrence of any of the events suspending or terminating separate account treatment for one or more customers. The FCM must provide the notice promptly in writing no later than the next business day following the date on which it has identified or been informed of the relevant event, and otherwise provide the notice in the manner required by CFTC Regulation §1.12(n)(3).

Paragraph (e)(4) of Regulation §1.44 permits an FCM to return to the ordinary course of business and resume separate account treatment for itself or a customer if the FCM reasonably believes that the circumstances triggering a non-ordinary course of business event have been cured.

Read Part 1, Part 2, Part 3, Part 4, Part 5, Part 6