The Commodity Futures Trading Commission (the “CFTC” or “Commission”) is requesting public comment on possible amendments to Rule 1.25 which governs the investment of customer funds segregated for US futures and options transactions pursuant to Section 4d of the Commodity Exchange Act, as well as to Rule 30.7 which is applicable to the investment of funds held in an account for foreign futures and options transactions. 74 Fed. Reg. 23962 (May 22, 2009). Comments must be received on or before July 21, 2009.
The Commission is apparently considering significant revisions to the scope and character of permitted investments for customer segregated funds and Rule 30.7 funds and is requesting public comment before proposing any amendments to Rules 1.25 or 30.7. The Advance Notice of Proposed Rulemaking requests comments on all aspects of Rules 1.25 and 30.7, including which instruments should continue to be permitted investments of customer segregated funds under Rule 1.25 and whether the requirements of Rule 1.25 should be applied to investments of Rule 30.7 funds.
Discussion
Rule 1.25 permits a derivatives clearing organization (“DCO”) or a futures commission merchant (“FCM”) holding customer segregated funds to invest those funds in certain instruments specified therein, subject to various requirements that are designed to minimize exposure to credit, liquidity, and market risks. The permitted investments include, in addition to US government securities and municipal securities, obligations issued by US government sponsored enterprises, bank certificates of deposit, commercial paper, corporate notes, sovereign debt obligations, and interests in money market mutual funds. The risk-limiting provisions include requirements that the investments satisfy specified rating standards, concentration limits, be readily marketable and subject to prompt liquidation, and that the dollar-weighted average time-to-maturity of the portfolio of investments not exceed 24 months.
Rule 30.7 addresses an FCM’s investment of funds relating to foreign futures and options transactions, which is referred to as the “secured amount” or “secured amount funds.” Since the adoption of the Part 30 rules in 1987, the Commission has not limited investments of Rule 30.7 funds to permitted investments under Rule 1.25. Instead the Commission has required the secured amount to be at all times liquid and sufficient to cover the FCM’s obligations to its foreign futures and options customers. For this purpose, Rule 1.25 investments are permitted, as well as investments in other readily marketable securities. See 74 Fed. Reg. 23963 and n.10.
In the aftermath of the market events of the past year, including the failures of certain US government sponsored enterprises, difficulties experienced by certain money market mutual funds in honoring redemption requests, the illiquidity of certain adjustable rate securities, and the issues affecting the credit ratings industry, the Commission believes that it is appropriate to review permitted investments for customer segregated funds under Rule 1.25 and for Rule 30.7 funds. The Commission is requesting comments on which instruments may no longer merit inclusion as permitted investments, as well as comments in support of any new instruments that might qualify as permitted instruments, and also on appropriate limitations or safeguards that should be applied to permitted instruments.
Analysis
To obtain a better understanding of investment strategies and practices and to assess the need for any changes in the current rules, the CFTC’s Division of Clearing and Intermediary Oversight had begun a review of investments of customer segregated funds and Rule 30.7 funds in 2007, including surveying DCOs and FCMs. 74 Fed. Reg. 23963. Before the staff had finalized that review, the market events of September 2008 occurred, with a resulting need for reevaluation in light of those events and current market conditions.
It is likely that the Commission will propose at least some amendments to Rules 1.25 and 30.7 in the future. As noted, the CFTC is considering, among other things, imposing the investment requirements of Rule 1.25, as they may be amended, to investments of Rule 30.7 funds on the basis that the same prudential concerns that arise in the context of customer segregated funds are applicable in the context of Rule 30.7 funds. In that event, according to the Commission, there will be an opportunity for additional public comment before any regulatory changes are adopted.
