CFTC Issues Relief to FCMs From Residual Interest Requirement | Practical Law

CFTC Issues Relief to FCMs From Residual Interest Requirement | Practical Law

The CFTC issued no-action relief to futures commission merchants (FCMs) from the requirement to hold excess residual interest in cleared swaps customer accounts in accordance with CFTC Regulation 22.17(b).

CFTC Issues Relief to FCMs From Residual Interest Requirement

Practical Law Legal Update w-005-6474 (Approx. 4 pages)

CFTC Issues Relief to FCMs From Residual Interest Requirement

by Practical Law Finance
Published on 31 Jan 2017 • USA (National/Federal)
The CFTC issued no-action relief to futures commission merchants (FCMs) from the requirement to hold excess residual interest in cleared swaps customer accounts in accordance with CFTC Regulation 22.17(b).
On January 26, 2017, the CFTC issued No-Action Letter 17-03 (No-Action 17-03), providing relief to futures commission merchants (FCMs) from the requirement to hold excess residual interest in cleared swaps customer accounts in accordance with CFTC Regulation 22.17(b).
FCMs are required to maintain an amount of "residual interest" (in the FCM's own funds), in cleared swaps customer accounts. This amount must be equal to or exceed the aggregate amount by which all cleared swaps customer accounts are undermargined before the time of settlement with a derivatives clearing organization (DCO) (see Legal Update, Final Rules on Protection of FCM Customer Funds Adopted by CFTC). An undermargined account is one in which the value of the positions under all cleared swaps in the account exceeds the value of customer collateral in the account. (This amount may be reduced by payments by cleared swaps customers prior to the time of settlement.)
CFTC Regulation 22.17(b) prevents an FCM from withdrawing any excess residual interest from the cleared swaps customer account prior to preparing the cleared swaps segregation calculation, which is conducted at the close of business on the prior day. This prohibition exists even when payments from cleared swaps customers are received, reducing the undermargined amount.
For FCMs, maintaining residual interest for a cleared swaps customer account even as the cleared swaps customer makes payments to reduce the undermargined amounts can result in "significant gaps in liquid capital" as the FCM's funds are held in cleared swaps customer accounts for the requisite time period.
No-Action 17-03 provides relief to FCMs from CFTC Regulation 22.17(b), allowing for the withdrawal of residual interest from cleared swaps customer accounts prior to requisite daily cleared swaps segregation calculations and in connection with the cleared swaps customer posting additional collateral to reduce the undermargined amount.
The relief granted under No-Action 17-03 is subject to the following conditions:
  • FCMs must maintain a minimum of 110% of the current targeted residual interest balance in cleared swaps customer accounts. The targeted residual interest balance is an amount that is established by the FCM as part of its risk management program under CFTC Regulation 1.11.
  • The withdrawal of excess residual interest must be in conjunction with corresponding payments made by the cleared swaps customer, and the FCM must be able to demonstrate that the amounts deposited by the cleared swaps customer satisfy the undermargined amounts.
  • FCMs must maintain "robust" risk-management processes and controls in order to ensure that any withdrawals of residual interest do not result in any intraday undersegregation risk for cleared swaps customer accounts. In the event that a self-regulatory organization (SRO) or the CFTC identifies a deficiency in an FCM's risk-management controls, the FCM would be disqualified from relying on the relief provided by No-Action 17-03.
  • In consideration of the above point, and as a substitute for the requisite segregation computations, FCMs must, prior to the withdrawal of the residual interest, document considerations given to the impact on cleared swaps segregation of any other disbursements made for:
    • the benefit of cleared swaps customers;
    • intraday margin calls;
    • intraday volatility and expected cleared swaps customer debit deficits; and
    • any other activity which the FCM reasonably expects would impact the FCM's residual interest in cleared swaps customer accounts through the day.
Further, for withdrawals that exceed 25% of the FCM's cleared swaps customer account residual interest as calculated from the prior trade date that are made pursuant to No-Action 17-03 and in compliance with the above conditions, the CFTC will also not recommend enforcement action under CFTC Regulation 22.17(c) for failure of the FCM to provide notice to the CFTC and designated SROs of such withdrawals.
The relief granted by No-Action 17-03 is effective immediately and indefinitely, as it does not include a sunset provision.