On May 14, 2019, the Joint Audit Committee (JAC)1 issued two regulatory alerts calling for futures commission merchants (FCMs) to review policies and procedures and account agreements in situations where an FCM carries multiple accounts of the same beneficial owner, including accounts managed by different advisors. One regulatory alert directs FCMs to combine all accounts of the same beneficial owner within the same regulatory account classification for margin purposes, while the other regulatory alert makes clear that FCMs’ account agreements may not include limited recourse or nonrecourse clauses. The JAC’s alerts may conflict with contractual arrangements between market participants, investment advisers and the FCMs carrying their futures and cleared swap accounts.

In Regulatory Alert 19-02 (May 14, 2019), the JAC notes that FCMs must combine all accounts of the same beneficial owner within the same regulatory account classification (i.e., customer segregated, customer secured, cleared swaps, customer or noncustomer) (i) for margin purposes, and (ii) in determining an account’s margin funds available for disbursement, even if such accounts are under different control. FCMs may continue to treat individual accounts separately when calling for margin (the JAC notes that the margin calls must be conservative in relation to the aggregate margin call calculated for the combined account); however, before releasing excess margin funds from one account of a beneficial owner, the FCM must combine all accounts of the same beneficial owner within the same regulatory account classification, even if under different control.

In Regulatory Alert 19-03 (May 14, 2019), the JAC focuses on US Commodity Futures Trading Commission Regulation 1.56(b), which generally prohibits FCMs from (i) undertaking to guarantee customers against losses arising from commodity interest trading, (ii) limiting the amount of such losses or (iii) not calling for exchange-required margin. Pursuant to the alert, FCMs are not allowed to have limited recourse and nonrecourse clauses in any agreements with their customers and noncustomers. Further, the regulatory alert states that FCMs must have “the absolute right to look to funds in all accounts of the beneficial owner,” including accounts that are under the control of different asset managers. Moreover, FCMs have the right to call the beneficial owner for additional funds beyond the amount allocated to the asset managers.

The regulatory alerts require FCMs to review their policies and procedures as well as customer and noncustomer account agreements for noncompliant language. The regulatory alerts may affect a broad range of negotiated agreements, including:

  • Investment Management Agreements. Pension funds, retirement plans, investment funds and other institutional clients often enter into investment management agreements that contain limited recourse provisions, which provide that the asset manager will limit any liability arising from its investments to the assets in that portfolio. Investment management clients need to consider how the prohibition on limited recourse and nonrecourse clauses in FCM account agreements impacts limited recourse provisions in the investment management agreements. For example, they may consider placing limitations on their asset managers from opening accounts with FCMs that already carry other accounts on behalf of the customer.
  • Futures Agreements and Cleared Swap Addendums. Agreements between an asset manager and its FCM often contain provisions limiting the FCM’s recourse to only assets in a particular portfolio, meaning that the FCM cannot reach assets in the client’s other accounts with the FCM (whether controlled by the same or different asset manager). Such agreements would need to be amended to remove or revise the noncompliant provisions.

Market participants should review their policies and procedures as well as current account and trading documentation and determine whether such documentation may be affected by the new JAC regulatory alerts.