CFTC: Clearing Banks Must Hold Secured Customer Funds in Separate Account | Practical Law

CFTC: Clearing Banks Must Hold Secured Customer Funds in Separate Account | Practical Law

The CFTC issued guidance stating that secured customer funds collateralizing cleared derivatives transactions which are held by Futures Commissions Merchants (FCMs) must be held in separate accounts from segregated but unsecured customer funds. The CFTC also proposed amendments to existing regulations to increase protections for customer funds that are held by FCMs and Derivatives Clearing Organizations (DCOs), as well as other rules for FCMs.

CFTC: Clearing Banks Must Hold Secured Customer Funds in Separate Account

Practical Law Legal Update 2-522-0703 (Approx. 4 pages)

CFTC: Clearing Banks Must Hold Secured Customer Funds in Separate Account

by PLC Finance
Published on 01 Nov 2012 • USA (National/Federal)
The CFTC issued guidance stating that secured customer funds collateralizing cleared derivatives transactions which are held by Futures Commissions Merchants (FCMs) must be held in separate accounts from segregated but unsecured customer funds. The CFTC also proposed amendments to existing regulations to increase protections for customer funds that are held by FCMs and Derivatives Clearing Organizations (DCOs), as well as other rules for FCMs.
On October 4, 2012, the CFTC issued guidance stating that secured customer funds collateralizing cleared derivatives transactions such as futures and commodity options which are held by futures commissions merchants (FCMs) must be held in separate accounts from segregated but unsecured customer funds. FCMs are derivatives exchange members and clearing members of derivatives clearinghouses.
The guidance makes clear that current CFTC Regulations 1.20 and 30.7 require that an FCM deposit customer funds under an account name that clearly identifies the funds as secured or simply segregated. Therefore, a single account holding both segregated and secured funds, regardless of any memorandum notation on the allocation of assets (which amounts are secured and which are just segregated), does not provide the requisite delineation of assets (and could put customer funds at risk in the event of a bankruptcy or similar event involving the FCM).
FCMs must maintain separate omnibus accounts with a carrying FCM for segregated and secured customer trading and assets. These accounts must be clearly titled as segregated customer funds held for the benefit of customers under Regulation 1.20 or secured customer funds held for the benefit of customers under Regulation 30.7. Account acknowledgment letters must also be obtained for each account.
On November 14, 2012, the CFTC published in the Federal Register proposed rules that would increase protections for customers and customer funds that are held by FCMs and derivatives clearinghouses (DCOs) by modifying regulations that govern how FCMs hold and segregate customer funds for customers trading futures and options on futures that are listed on foreign exchanges (foreign boards of trade (FBOTs)), strengthening FCM risk management and disclosure policies and supplementing FCM audit requirements.
The proposed rules would govern how FCMs hold and segregate customer funds for customers trading futures and options on futures that are listed on FBOTs. The proposed rules would:
  • Require FCMs to set aside sufficient funds to meet the net liquidating equity in the trading accounts of each customer trading Part 30 funds.
  • Require FCMs to hold a sufficient amount of funds in secured accounts to cover the net liquidating equities of all US domiciled customers and foreign domiciled customers.
  • Prohibit FCMs from commingling funds set aside in Part 30 secured accounts with any funds from customer positions other than foreign futures or foreign options positions.
  • Subject FCMs to restrictions regarding the amount of customer funds that could be held in depositories outside of the US.
  • Prohibit FCMs from waiving any of the protections afforded under the laws or regulations of a foreign jurisdiction regarding the deposit of customer funds with a foreign broker or a foreign clearing organization for the purpose of margining foreign futures or foreign options.
The proposed rules would also require the implementation of risk management policies, procedures and controls around risks related to operations, capital, liquidity and customer fund segregation. With regard to risk management, the rules, among other things, would require FCMs to:
  • Evaluate the depositories of segregated funds.
  • Develop a process to establish control over segregated fund withdrawals.
  • Develop procedures regarding the appropriate separation of duties among individual responsible for compliance.
  • Develop policies that are designed to ensure that the FCM has sufficient capital and liquidity to meet reasonably foreseeable needs.
  • Provide firm specific risk disclosures to customers, including, but not limited to:
    • the significant types of business activities and product lines of the FCM and the percentage of assets and capital devoted to each;
    • the types of accounts the FCM holds on behalf of its customers; and
    • the material risks of trusting funds to the FCM.
  • Inform customers that funds are not covered by insurance in the event of an FCM bankruptcy.
  • Provide additional financial information to the public, such as daily statement of segregation requirements, secured amounts, and clear swaps customer segregation requirements, among other information.
In addition to increased requirements for FCMs, the proposal would heighten the standards of FCM auditors and supplement the orientation of audit programs to include an increased focus on quality control. Public accountants would need to be registered with the Public Company Accounting Oversight Board (PCAOB) and have undergone at least one examination by the PCAOB. The governing body of the FCM would also be required to ensure that the auditor is duly qualified to perform an audit of the FCM, considering factors such as the auditor's firm's size, experience, location and knowledge of the regulations. Additionally, SROs that regulate FCMs would be required to apply controls testing in addition to the currently required substantive testing.
The procedural requirements for reporting financial and regulatory notices would also be modified, and would require that FCMs:
  • File all financial data and regulatory notices electronically using the WinJammer system.
  • Use a new segregation schedule for cleared swaps, based on the existing segregation schedule for customers trading futures contracts on designated contracts markets.
  • Report targeted residual interest and balance sheet leverage ratios.
  • Electronically notify the CFTC on a change in the risk profile of the FCM.
  • Provide read-only direct-access to customer accounts holding customer funds for the CFTC and the governing SRO.
These proposed rules will be open for public comment for 60 days after publication in the Federal Register.