CFTC Issues Guidance on FCM Investment in Money Market Mutual Funds | Practical Law

CFTC Issues Guidance on FCM Investment in Money Market Mutual Funds | Practical Law

The CFTC issued an advisory providing clarification and instruction to futures commission merchants (FCMs) on complying with CFTC No-Action Letter 16-68, which provides relief from certain CFTC regulations to FCMs investing in money market mutual funds (MMFs).

CFTC Issues Guidance on FCM Investment in Money Market Mutual Funds

Practical Law Legal Update w-004-0351 (Approx. 3 pages)

CFTC Issues Guidance on FCM Investment in Money Market Mutual Funds

by Practical Law Finance
Published on 25 Oct 2016 • USA (National/Federal)
The CFTC issued an advisory providing clarification and instruction to futures commission merchants (FCMs) on complying with CFTC No-Action Letter 16-68, which provides relief from certain CFTC regulations to FCMs investing in money market mutual funds (MMFs).
The CFTC's Division of Swap Dealer and Intermediary Oversight (DSIO) issued Staff Advisory No. 16-75 (Advisory 16-75) providing clarification and instruction to futures commission merchants (FCMs) on complying with CFTC No-Action Letter 16-68 (No-Action 16-68), which provides relief from certain CFTC regulations to FCMs investing in money market mutual funds (MMFs) (see Legal Update, CFTC Grants Relief to FCMs on Investment of Customer Funds to Align with SEC Rule 2a-7). The advisory provides clarification and instruction to FCMs in complying with No-Action 16-68.
CFTC Regulation 1.25 governs the investment of customer funds by FCMs, including investments in MMFs, and requires that customer funds be held by FCMs in only highly liquid investments (see Practice Note, The Dodd-Frank Act: Derivatives Margin Collateral Rules: Investment of Customer Funds and Cleared Swaps Customer Collateral). However, SEC Rule 2a-7, which became effective on October 14, 2016, imposes liquidity fee and redemption restrictions that conflict with CFTC Regulation 1.25(b)(1) and (c)(5), preventing FCMs from investing customer funds in MMFs, particularly MMFs that invest primarily in corporate debt securities (Prime MMFs) or government MMFs that voluntarily elect to be subject to liquidity fees and redemption restrictions (Electing Government MMFs).
The CFTC temporarily addressed this conflict with No-Action 16-68, under which FCMs may invest funds held in the FCM's segregated accounts in MMFs despite the redemption restrictions, as long as the investments are limited to the amount of funds the FCM holds in excess of its targeted residual interest.
An FCM's "residual interest" is the amount of funds, as required under CFTC Regulation 1.22, that is comprised of the FCM's own capital held in segregated accounts to cover its customers' margin deficits (see Practice Note, The Dodd-Frank Act: Derivatives Margin Collateral Rules: Segregation of Futures Collateral (Customer Funds) by FCMs and DCOs). An FCM's “targeted residual interest” is the amount of residual interest that the FCM determines is necessary to maintain in order to ensure compliance with CFTC segregation requirements.
However, since the issuance of No-Action 16-68, the CFTC has received numerous requests for guidance regarding the practical implementation of the relief issued. The CFTC issued Advisory 16-75 in response to these requests, focuses on permitted investments in Prime MMFs and Electing Government MMFs.
Advisory 16-75 provides:
  • Clarification that if a FCM invests in a Prime MMF or Electing Government MMF, its buffer over the residual interest target is not reduced. These invested funds still qualify as a segregated asset and qualify as part of the FCM's excess above its targeted residual interest.
  • Clarification that a FCM's investment in a Prime MMF or an Electing Government MMF does not reduce the FCM's excess segregation for reporting purposes or any other calculation, but rather qualifies as a segregated asset in all respects.
  • Instruction for FCMs in reporting an investment in a Prime or Electing Government MMF that has suspended redemptions on its daily segregation calculation.
  • Instruction for a FCM if it performs its daily segregation calculation and determines that it has invested more than the excess above the targeted residual interest in Prime MMFs or Electing Government MMFs, assuming that the FCM has acted in good faith and the over-investment is inadvertent.
  • Explanation of how asset-based and issuer-based concentration limits are applied to SEC Rule 2a-7 Government MMFs.
  • Direction that an acknowledgement letter executed between a FCM and a Prime or Electing Government MMF or a prospectus of a Prime or Electing Government MMF may include provisions stating the authority of the fund to suspend redemptions or impose liquidity fees under SEC Rule 2a-7.