Customer Protection Regulation - Comment Letters

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Gavel.png FINAL RULE: This page refers to the proposed rule on enhanced customer protections. The final rule was approved October 30, 2013
Timeline, Enhanced Customer Protections, CFTC
Proposal Date Comment Deadline Final Rule Approved Effective Date
November 14, 2012 February 15, 2012 October 30, 2013 January 13, 2014

On October 22, 2012, the CFTC released a proposal and request for public comment on a list of changes to its rules in order to enhance protections for futures customers. The amendments are designed to strengthen the safeguards surrounding the holding of money, securities and other property deposited by customers with futures commission merchants (FCMs) and derivatives clearing organizations (DCOs).[1]

The rulemaking appeared in the Federal Register on November 14, 2012. The original deadline for public comments was January 14, 2013. However, on January 11, 2013, the deadline was extended until February 15, 2013. Because of the substantial number of items in the proposal, several market participants, including DCOs, FCMs DCMs had requested additional time to address the issues in the proposal.

Also See

The October 22, 2012 proposal builds upon other finalized rulemakings related to the Dodd-Frank Act. Links to associated comment letters can be found here:

Futures Industry Association - February 15, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
February 15, 2013

In this 59-page comment letter, the FIA offers its perspective on numerous provisions in the proposed rule, including:

  • Calculation of residual interest,which FIA says will "impose a tremendous operational and financial burden on the industry, requiring the development and implementation of entirely new systems to assure compliance and"adversely affect the ability of many FCMs to operate effectively."
  • Undermargined capital charge, in which the FIA recommends an alternative approach for certain customers, particularly members agricultural community that depend on financing from banks to fund margin requirements.
  • Residual Interest of FCM in Customer Funds Accounts; Additions and Withdrawals, in which FIA says, "Under the proposed rules, an FCM that conservatively manages its residual interest may be required to file frequent notices with the Commission, even if it never falls below its targeted residual interest.
  • Disclosure requirements, FIA believes that "neither (i) an FCM’s targeted residual interest, nor (ii) the sum of margin deficits in the customer funds account should be made public," as such disclosure without context serves "no meaningful purpose." For the same reasons, FIA believes that the daily segregation, secured amount or cleared swaps customer account calculations should not be made available.
  • FIA does support several of the proposed provisions, including the risk management program, early warning requirements, template acknowledgement letters, prohibition of commingling of customer funds, limitations on foreign futures and foreign options secured amount outside of the US, and location and investment of customer funds provisions.


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CME Group - February 15, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
February 15, 2013

From the comment letter:

"In this comment letter, CME also offers comment on proposed changes to CFTC Regulation 1.52. CME supports the Commission’s goal of evaluating whether any changes should be made to the risk-based examinations currently performed on FCMs. Indeed, CME, in conjunction with the Joint Audit Committee (“JAC”) and the CFTC, regularly reviews its procedures and makes changes to those procedures so that they are continually evolving and improving. We are concerned, however, that instead of proposing changes narrowly designed to address perceived weaknesses in the current regulations, the Commission proposes to fundamentally overhaul the nature of the reviews performed by self-regulatory organizations (“SROs”) and designated self-regulatory organizations (“DSROs”) and, in so doing, threaten the viability of the current regulatory structure. This is a drastic measure that is not supported by an adequate cost benefit analysis. Our specific concerns regarding the proposed changes to Regulation 1.52 are detailed below in Section V."

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TD Ameritrade - February 15, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
February 15, 2013

From the comment letter:

"...TD Ameritrade opposes certain aspects of the CFTC’s Rule Proposal as they would impose new requirements on member firms that greatly exceed the intended benefits. As noted below, the Firm believes the Rule Proposal should be revised so as the costs imposed are more in line with the benefits that the CFTC seeks to achieve. In addition, the Firm believes the proposal to require firms to take capital charges for undermargined customers should not be reduced to one business day nor should residual interest target be made available to the public. Additionally, the Firm does not believe that the significant additional costs of requiring each FCM to maintain at all times a residual interest in each class of customer funds account sufficient to exceed the sum of all customer margin deficits outweigh the potential benefits."

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Managed Funds Association - February 15, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
February 15, 2013

Recommendations from the comment letter:

  • require each FCM to make publicly available each month its Segregation Schedule, Secured Amount Schedule, Cleared Swaps Segregation Schedule, summary balance sheet and income statement information for the most recent twelve months, to the extent the FCM’s DSRO or the National Futures Association (“NFA”) does not otherwise make this information public available;
  • confirm that the FCM capital charge for undermargined accounts in §§1.17(c)(5)(viii) and (ix) and the FCM residual interest requirement in §1.20(i)(4) offset, such that the two obligations would not be duplicative;
  • not amend §§1.17(c)(5)(viii) and (ix) to reduce the time period by when an FCM must incur a capital charge for undermargined accounts, but rather retain the existing respective two business and three business day requirements;
  • modify the FCM residual interest requirement in §1.20(i)(4) so that it is not a continuous obligation, but instead a “point of time” obligation that requires FCMs to ensure they maintain sufficient residual interest as of the close of business Eastern Time on the business day after the FCM issues a customer’s margin call, given that FCM’s compliance with the “Net Liquidating Equity Method”10 ensures that FCMs hold sufficient funds at all times to cover any customer shortfalls;
  • reevaluate annually the Proposed Rules’ efficacy and the need for additional enhancements to the customer protection regime;
  • continue to evaluate the viability of a full physical segregation option for Cleared Swaps Customer Collateral; and
  • ensure that the Proposed Rules facilitate portfolio margining and are consistent with existing Commission guidance in that area.
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Commodity Customer Coalition - February 15, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
February 15, 2013

From the comment letter:

"While we applaud the efforts and intent behind the Proposed Rules, many of them would increase the risk of FCM insolvency, increase the magnitude of FCM insolvency by vastly increasing concentration risk and require commodity customers to greatly increase the capital they tender to their FCM to margin their positions. The malfeasance of some FCMs should not be corrected by asking commodity customers to provide more money to every FCM with which they do business.

Therefore the CCC respectfully requests that the CFTC refrain from implementing the Proposed Rules so that it can work more closely with industry constituents on their revision, as well as other means to achieve the goals of the Proposed Rules."

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Newedge - February 15, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
February 15, 2013

From the comment letter:

"The CFTC itself observes that adoption of its proposed rules will be costly. For example, the CFTC notes that the proposals are likely to cost individual FCMs between $193,000 and $1.85 million initially and $287,000 and $2.3 million annually to implement them. Newedge believes these numbers only partially reflect the expense to implement the CFTC's proposed rules, and ignore other material costssuch as the increased capital and liquidity necessary to enact many of the proposals...As a result, Newedge agrees with the FIA and urges the CFTC to refine its cost-benefit analysis and carefully consider the impact before it adopts any final rules."

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American Farm Bureau Federation - February 15, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
February 15, 2013

Points from the comment letter:

"Farm Bureau urges the CFTC to maintain the current three-day standard for capital charges in order to prevent adverse financial impacts on customers and to prevent increased risk with regard to the magnitude of funds potentially at risk in the event of future FCM insolvencies. The standard has worked well for decades and we see no compelling reason to change it now."

"As written, the proposal seems to mandate that an FCM cannot be undersegregated at any point in time during the day. Current interpretation affords an FCM time to “top up” the customer segregated account prior to the time a payment must be made to the DCO. Continual 100 percent compliance on segregation at all points during the day seems to be an unrealistic standard that could lead to many of the same outcomes described above."

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INTL FCStone - February 15, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
February 15, 2013

In the comment letter, INTL FCStone highlights negative impacts from several aspects of the proposed rule, including:

  • Capital charges for one day outstanding margin calls
  • Residual interest and margin deficit reporting
  • FCM representations regarding ability to continue as a going concern
  • Standardized acknowledgement letters
  • Amendments to public disclosures by FCMs
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R.J. O'Brien - February 15, 2013 - February 15, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
February 15, 2013

From the comment letter:

"Although RJO strongly supports the goal of improving client protections, we believe that certain aspects of the Proposed Rules may produce unintended negative consequences for key participants in the futures markets. Certain proposals would dramatically alter the way that FCMs and their customers have done business for decades and would substantially impact some customers' ability to hedge their commercial risks and severely challenge small and medium-sized FCMs' ability to remain competitive.

Most importantly, we believe that the CFTC's proposal to require FCMs to take a capital charge for margin deficiencies that are outstanding for more than one day, together with the proposal to require residual interest to exceed margin deficiencies at all times, would result in very substantial costs to both FCMs and their customers."

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BlackRock - February 15, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
February 15, 2013

From the comment letter:

"As the voice of and a fiduciary for our clients, BlackRock has a vested interest in the development of a sustainable and fair regulatory regime that minimizes overall risk to the financial system and provides appropriate customer protection for those financial products such as futures, foreign futures, swaps and other derivatives that the Commission oversees and regulates."

"While we support the Commission’s stated goals to adopt new regulations and amend existing regulations in the Proposed Rule...we do not believe that these changes are sufficient to provide the necessary protection for customer collateral needed after the failures of MF Global and Peregrine.

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LCH.Clearnet - January 25, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
January 25, 2013

In the comment letter, LCH.Clearnet recommends the consideration of alternative approaches for routine access to account balances. LCH suggests following the lead of the NFA in utilizing third party audit confirmation.

Also, LCH is concerned that certain residual interest rules will have unintended consequences, such as giving FCMs an incentive to hold less of a capital buffer at the DCO in favor of holding excess capital at the FCM level.

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Rosenthal Collins Group - February 12, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
February 12, 2013

In the comment letter, Rosenthal Collins Group (RCG) expresses concern with an aspect of the rule known as "residual interest," which would require substantial capital contribution by FCMs and could result in unintended consequences for FCMs and, ultimately, farmers, ranchers and other commercial end users. Key points include:

  • FCMs should not nave to maintain residual interest exceeding the sum of all margin deficiencies and, practically speaking, it would be impossible to do so.
  • Requiring FCMs to take a capital charge for any margin calls outstanding for more than one day is unreasonable.
  • Requiring FCMs to separate the risk management function from the "business unit" is unnecessary, counterproductive, and will likely result in increased risk to the FCM and its customers.
  • Public disclosure of FCMs' target residual interest would pose substantial risks to FCMs, their customers and the markets.
  • Final rules should not be published until a cost-benefit analysis can be completedand the FCM community has had an opportunity to engage in a productive dialog with Commission staff.
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Commercial Energy Working Group - February 13, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
February 13, 2013

The working group supports the proposed disclosure requirements of FCMs and would add further measures including:

  • require FCMs to each month post on their Web site, as part of their Disclosure Documents, the Segregation Schedule, the Secured Account Schedule and the Cleared Swaps Segregation Schedule. The Web site should include the schedules for the most recent twelve months; and
  • require FCMs to each month post on their Web site, as part of their Disclosure Documents, summary balance sheet and income statement information. The Web site should include such information for the most recent twelve months.
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CFA Institute - February 13, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
February 13, 2013

Key points from the comment letter:

  • "Given the proven problems and conflicts banks have had using internal models for determination of capital in recent years, we strongly oppose letting FCMs use internal models for calculating their own capital requirements.
  • While we recognize that the events surrounding MF Global’s illegal confiscation of client funds is a rare breach of Commodity Exchange Act rules, we believe these events highlight a significant weakness that, unless closed could lead to further customer losses and loss of investor trust. Therefore, we support requirements that customer accounts remain segregated from FCM proprietary accounts, and that individuals illegally engaged in violation of these laws are held criminally accountable.
  • FCMs should be held responsible for covering losses occurring from their investment of customer accounts.
  • FCMs should have to disclose critical information about such matters as the ability of FCMs to commingle customer funds in one or more accounts, including accounts provided by affiliates of the FCM, and that in the event of an FCM’s bankruptcy that such funds are not guaranteed by a clearing entity.
  • Protections and requirements for foreign customers of FCMs should be as strong as those for domestic customers."
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State Street - January 16, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
January 16, 2013

From the comment letter:
"Permitting a customer of an FCM, if it so elects, to post margin with a custodial bank in a third-party custodial account in lieu of posting futures margin with the FCM would enhance the protection of customer funds and boost customer confidence in the futures market. In State Street’s view, the concerns that the Commission expressed about custodial bank arrangements when adopting Interpretation 10-1 are no longer valid concerns today and in any event should be balanced by the legitimate concerns of FCM customers for transparency and the benefits of harmonization, taken together with other improvements to FCM and FCM customer protections."

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AICPA - February 11, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
February 11, 2013

In the comment letter, the American Institute of Certified Public Accountants (AICPA) highlights its concerns with three aspects of the proposed rule:

  • "First, we believe the Commission’s proposed amendment to §1.16(b)(1) to require the public accountant of FCMs to be registered with and have undergone an examination by the Public Company Accounting Oversight Board (PCAOB) is, in some cases, fundamentally unfair and should not be required."
  • "Second, the Commission is proposing to amend §1.16(b)(1) to require any deficiencies noted during a PCAOB examination to be remediated to the satisfaction of the PCAOB within three years. We are concerned with this aspect of the proposal for several reasons. It is unclear what is meant by [deficiencies are to be] “remediated to the satisfaction of the PCAOB” or how the registered FCM would be able to determine that its auditor had complied with such a requirement. Also, if a firm fails to remediate any deficiency on any of its PCAOB inspected audits (regardless of whether it was an audit of an FCM) to the PCAOB’s satisfaction, that firm would be forced to resign from the audits of its FCM clients."
  • "Third, the Commission is proposing to require a public accountant to state in the audit opinion 'whether the audit was conducted in accordance with U.S. GAAS after full consideration of the auditing standards adopted by the PCAOB'...We recommend that, in its final rule, the Commission clarify its expectations about which auditing standards framework would be required. Specifically, we recommend requiring the application of U.S. GAAS to audits of non-issuer FCMs and the application of PCAOB audit standards to audits of FCMs subject to a permanent PCAOB inspection program."

Note: several auditing/advisory firms such as PricewaterhouseCoopers, KPMG, Deloitte&Touche, and Ernst&Young expressed similar concerns in comment letters.

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Investment Company Institute - January 14, 2013

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
January 14, 2013

From the comment letter:

"We generally support the CFTC’s proposal to provide greater protection to customer funds. In particular, we support the following aspects of the proposal:

  • prohibitions on an FCM from commingling futures customer funds with the FCM’s proprietary funds and on an FCM from commingling funds deposited by futures customers with funds deposited by 30.7 Customers or cleared swap customers.
  • prohibition on an FCM from using one customer’s funds to margin or secure another customer’s positions and from using a customer’s funds to extend credit to any other person;
  • imposition of additional safeguards with respect to an FCM withdrawing customer funds from segregated accounts that are part of the FCM’s residual interest in such accounts.
  • requirement on an FCM to file its segregation calculation with the Commission and with its designated SRO (“DSRO”) each business day."

ICI also recommended strengthening the proposed requirements with respect to the public disclosure by FCMs "to ensure that customers are provided with more complete information regarding the FCMs, especially when FCMs are in a difficult financial condition."

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Forex Capital Markets - December 14, 2012

Enhancing Protections Afforded Customers and Customer Funds Held by FCMs and DCOs
December 14, 2012

In the comment letter, FXCM highlights industry trends that have challenged the FCM and retail foreign exchange dealer (RFED) community, such as the downward pressure on commissions and the inability of FCMs to earn interest income on deposits in a low interest rate environment. At the same time, trade volume has diminished.

FXCM suggests that all FCMs and RFEDs should be required to have audited financial statements certified by a top-tier accounting firm, and to publish consolidated balance sheets and income statements once per quarter.

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References

  1. CFTC Proposes New Regulations and to Amend Existing Regulations to Enhance Protections for Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations. CFTC. Retrieved on October 23, 2012.

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