CFTC Adopts Rules On Investment Of FCM Customer Funds, Registration Of Fbots, 'Made Available To Trade' Determination, And 'Actual Delivery' For Retail Commodity Transactions Such As Forex

Introduction

On December 5, 2011, the US Commodity Futures Trading Commission (the CFTC or Commission) held an open meeting where it approved two final rules and one proposed rule promulgated under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). This was the first meeting in nearly two months after the CFTC had canceled its last 2 scheduled meetings due to the retirement of Commissioner Michael Dunn and appointment of new Commissioner Mark Wetjen, as well as the intervening investigation and unwinding of customer positions related to the bankruptcy of a futures commission merchant (FCM).

Summary

The final rules adopted on December 5 will (i) amend CFTC Rule 1.25, which regulates the manner in which FCMs and derivatives clearing organizations (DCOs) may invest customer collateral (Rule 1.25)1 and (ii) create a registration regime for foreign boards of trade (the FBOT Rule).2 The proposed rule would create a process by which swap execution facilities (SEFs) and designated contract markets (DCMs) can determine that a swap is "made available to trade" (the MAT Rule).3 This determination triggers the trade execution requirement for swaps that are already subject to mandatory clearing. The Commission was also scheduled to vote on an interpretation regarding the meaning of the term "actual delivery" as it relates to retail commodity transactions, but the Commissioners voted on that proposal via seriatim on December 2, 2011.4 The rules have not yet been published in the Federal Register but are available on the Commission's website.5 Below is a description of the views expressed in the Commissioners' opening statements and each of the above-mentioned rules.

Opening Statements by Commissioners

At the meeting, Chairman Gary Gensler announced that he had directed staff to hold two roundtables on the mandatory clearing of swaps and the process by which SEFs and DCMs determine that swaps are made available to trade.

Commissioner Jill Sommers argued that the MAT Rule is deeply flawed for several reasons. First, she stated that it would allow a single SEF or DCM to bind the entire marketplace because, once a SEF or DCM determines that a given swap is made available to trade, all market participants engaging in such a swap must do so through regulated platforms instead of over-the-counter. Some have argued that this will create a race for SEFs and DCMs to determine that all conceivable swaps are made available to trade even though they may not be suitable for SEF or DCM trading. Second, once a single SEF or DCM determines that a given swap is made available to trade, all "economically equivalent" swaps must also trade on a SEF or DCM. According to Sommers, the term "economically equivalent" is ill-defined and confusing. Third, she stated that there was no reason why the Commission itself should not make this determination, noting that Dodd-Frank does not prohibit the CFTC from doing so. Separately, Sommers stated that she generally supports Rule 1.25 because it clarifies the scope of the ban on in-house transactions and distinguishes in-house transactions from (i) in-house sales of permitted investments and (ii) certain in-house exchanges of collateral. She also called for the Commission to gather more information on how FCMs and DCOs actually invest customer funds.

Commissioner Bart Chilton stressed that the penalties imposed on FCMs for misuse of customer segregated funds must be an appropriate deterrent to such misconduct, and suggested that the current penalties may not do so. Further, Chilton suggested that the CFTC should establish a retail futures customer protection regime similar to that established with respect to securities.

Commissioner Scott O'Malia largely agreed with Commissioner Sommers' criticisms of the MAT Rule, arguing that the rule would vest those with the greatest financial interest in forcing all trading onto platforms with the power to determine which swaps must be executed on such platforms. Although O'Malia stated that this would create an inherent conflict of interest, he voted in favor of the proposed rule. O'Malia also stated that he is pleased with Rule 1.25 because it clarifies the rules surrounding in-house transactions, permits greater utilization of money market mutual funds (MMMFs), and regulates investments in Fannie Mae and Freddie Mac.

The December 5 meeting was Commissioner Mark Wetjen's first appearance at a public meeting. With regard to Rule 1.25, he argued that the Commission should address the following issues which are not addressed in the final rule: (1) the sufficiency of penalties for misuse of customer funds, (2) how examinations of FCMs are conducted, and (3) rules requiring FCMs to provide their customers with information regarding their investments.

Final Rule 1.25: Investment of Customer Funds

This final rule will narrow the scope of instruments in which FCMs and DCOs may invest customer funds and will raise the standards imposed on certain permitted investments. This rule is also made to comply with the Dodd-Frank mandate to remove references to credit ratings. Notably, it will generally eliminate the ability of FCMs and DCOs to invest in foreign sovereign debt, but will permit them to petition the Commission for exemptive relief from this prohibition. The Commissioners voted unanimously in favor of the final rule.

Permitted Investments. Under amended Rule 1.25, FCMs and DCOs will be permitted to invest customer money in the following instruments: (i) US government securities that are fully guaranteed as to principal and interest; (ii) general obligations of any State or political subdivision thereof; (iii) obligations of any US government corporation or enterprise sponsored by the US government; (iv) certificates of deposit issued by a bank that carries deposits insured by the FDIC; (v) commercial paper fully guaranteed as to principal and interest by the US under the Temporary Liquidity Guarantee Program; (vi) corporate notes or bonds fully guaranteed by the US under the Temporary Liquidity Guarantee Program; and (vii)...