Staff of the Commodity Futures Trading Commission issued both an Interpretation and No-Action Relief prohibiting future commission merchants and derivatives clearing organizations from investing customer funds in money market funds that reserve the right to suspend redemptions for up to 10 business days and/or impose liquidity fees under certain circumstances. This action follows the adoption by the Securities and Exchange Commission in August 2014 of new rules that require a money market fund to retain authority to suspend investor redemptions under enumerated circumstances and/or to impose liquidity fees if a fund’s liquidity drops below a threshold amount. Money market funds investing in corporate debt securities (Prime MMFs) must mandatorily adopt these conditions while MMFs investing in government securities (Government MMFs) may elect (but are not mandated) to adopt these requirements. According to staff, when the SEC’s rules become effective on October 14, FCMs may no longer invest customer funds in Government MMFs electing to impose the new requirements (electing Government MMFs) or in any Prime MMFs as FCMs will not be able to ensure that they can redeem 100 percent of their investment in such funds by the business day following a redemption request, as required by applicable regulation (click here to access CFTC rule 1.25(c)). Similarly, staff said that DCOs would likewise be precluded, beginning on October 14, from accepting as initial margin from FCMs on behalf of their customers, or investing funds from FCMs for the benefit of their customers in, Prime MMFs or electing Government MMFs because such investments would pose “more than minimal liquidity risks,” among other reasons. However, staff expressly authorized FCMs to invest their own funds maintained in customer-segregated accounts in excess of their targeted residual amount (i.e., the buffer of a firm’s own capital an FCM is required to maintain in its customer-segregated accounts to help ensure customer safety) in Prime MMFs or electing Government MMFs. CFTC Commissioner Sharon Bowen blasted this carve-out permission for FCMs as creating a “window dressing” of customer protection, claiming that “[i]f the funds are not suitable investments for customer funds then they are not suitable for the additional capital that the FCMs put in those accounts to protect against potential shortfalls.” Under both staff's Interpretation and No Action Relief, FCMs and DCOs can continue to handle non-electing Government MMFs mostly as they do now. Contemporaneously with staff issuing its guidance, the CFTC also issued an order and proposed an amendment to an existing rule to facilitate the holding by the Board of Governors of the Federal Reserve System of segregated customer funds’ accounts on behalf of certain DCOs.
My View: Although it appears that CFTC staff has clear authority to restrict investment of customer funds by FCMs in Prime or electing Government MMFs because of the express language of the relevant CFTC regulation, this authority is less evident for the action CFTC staff took regarding DCOs last week. In restricting the ability of DCOs to accept from FCMs on behalf of their customers as initial margin, or invest customer funds in, Prime or electing Government MMFs, CFTC staff applied definitions of the words “minimal” and “minimize” to interpret existing CFTC rules that broadly enumerate DCOs’ risk management, financial resources and customer protection obligations. (Click here to access CFTC Regulation 39.13(g)(10); here for CFTC Regulation 39.11(e)(1)(i); here for CFTC Regulations 39.15(c) and 39.15(e); and here for CFTC Regulation 39.36(f).) Although the outcome of the staff's guidance seems reasonable in light of the new SEC requirements, staff’s actions might have been more appropriately implemented through CFTC rulemaking – including considering public comment and conducting a cost/benefit analysis – given the widespread impact of staff's interpretation. On the other hand, it is not clear why Commissioner Bowen is so outraged by staff’s granting permission to FCMs to continue to invest their own funds in Prime and electing Government MMFs in their customer-segregated accounts in excess of their targeted residual amount (i.e., not changing the status quo). Whatever the potential limitations on FCMs recovering the full value of their MMF investment on the next business day following a request for redemption, having any FCM’s excess capital in customer-segregated accounts is preferable to having no FCM excess capital in such protected accounts. As Chairman Timothy Massad wrote in supporting staff’s initiative, “the system as a whole [is] better off if [an FCM’s] excess funds are on deposit, and we do not wish to incentivize FCMs to withdraw such excess funds from the segregated account.”