[Federal Register: June 30, 2003 (Volume 68, Number 125)]
[Proposed Rules]
[Page 38654-38657]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr30jn03-31]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
RIN 3038-AC01
Investment of Customer Funds
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rule.
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SUMMARY: The Commodity Futures Trading Commission (Commission) proposes
to amend its regulations to allow futures commission merchants (FCMs)
and derivatives clearing organizations (DCO) to engage in repurchase
agreements with securities
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deposited by customers subject to certain conditions and to modify the
portfolio time-to-maturity requirements for securities deposited in
connection with certain collateral management programs of DCOs pursuant
to certain conditions. The Commission also is requesting comment on
several other provisions of the rule: Whether the portfolio time-to-
maturity requirement should be modified for portfolios consisting
exclusively of Treasury securities; whether the restriction on embedded
derivatives should be modified; whether the list of permitted
benchmarks for variable rate securities should be expanded; and whether
the concentration limitations on reverse repurchase agreements should
be changed. The Commission is proposing these rule amendments and
requesting comment as part of its continuing efforts to facilitate the
safe and efficient handling of customer funds, and in response to
inquiries received as firms gain experience implementing the revisions
adopted in December 2000.
DATES: Comments must be received on or before July 30, 2003.
ADDRESSES: Comments on the proposed amendments should be sent to Jean
A. Webb, Secretary, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581. Comments
may be sent by facsimile transmission to (202) 418-5521, or by e-mail
to secretary@cftc.gov. Reference should be made to ``Proposed
Amendments to Regulation 1.25.''
FOR FURTHER INFORMATION CONTACT: John C. Lawton, Deputy Director and
Chief Counsel, or Lois Gregory, Special Counsel, Division of Clearing
and Intermediary Oversight, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.
Telephone (202) 418-5450.
SUPPLEMENTARY INFORMATION:
I. Background
Commission Regulation 1.25 (17 CFR 1.25) sets forth the types of
instruments in which FCMs and DCOs are permitted to invest customer
segregated funds. Regulation 1.25 was substantially amended in December
2000 to expand the list of permitted investments.\1\ In connection with
the expansion, the Commission added several provisions intended to
minimize the credit, liquidity, and volatility risk associated with the
additional investments. The Commission is proposing to modify some of
those provisions. The Commission is also requesting comment on several
other provisions of the rule.
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\1\ 65 FR 77993 (December 13, 2000).
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II. Proposed Amendments
A. Repurchase Agreements Involving Collateral Deposited by Customers
CFTC Interpretative Letter 84-24 (``84-24'') permits FCMs to engage
in repurchase agreements (``repos'') with collateral deposited by
customers (``customer collateral'') subject to certain terms and
conditions.\2\ When the Commission adopted the amendments to Regulation
1.25 in December 2000, it included provisions governing repos and
reverse repos involving investments purchased with customer funds
(``permitted investments'') subject to terms and conditions that differ
in a number of ways from those in 84-24.\3\ The Commission did not
address 84-24 at that time.
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\2\ CFTC Staff Letter No. 84-24, [1984-1986 Transfer Binder]
Comm. Fut. L. Rep. (CCH) ]22,449 (Dec. 5, 1984).
\3\ Regulation 1.25(a)(2) and 1.25(d).
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Various market participants have suggested that repos involving
customer collateral should be permitted under the terms and conditions
applicable to permitted investments. They believe that increased use of
repos could enhance yield. They also note that certain types of
collateral, while permissible as margin at the FCM level, are not
acceptable at the clearinghouse level. Permitting repos of such
collateral could ease cash flow problems that sometimes arise from this
circumstance.
The Commission is proposing to amend Regulation 1.25(a)(2) to
permit FCMs and DCOs to engage in repos of customer-deposited
securities subject to certain terms and conditions. The proposal would
eliminate the requirement currently set forth in 84-24 that the FCM
provide written disclosure of the mechanics of the transaction and
obtain written authorization from the customer. If the Commission
adopted the proposal, 84-24 would be superseded.
Proposed paragraph (a)(2)(ii)(A) would provide that, to be
eligible, securities must meet the marketability requirements of
Regulation 1.25(b)(1). This is intended to ensure that, if a repo
counterparty should default, the FCM or DCO could use the cash proceeds
from the repo to buy the securities elsewhere.
Proposed paragraph (a)(2)(ii)(B) would provide that securities
subject to repurchase agreements must not be ``specifically
identifiable property'' as defined in section 190.01(kk) of the
Commission's rules. Such property is generally not eligible for repo.
Proposed paragraph (a)(2)(ii)(C) would provide that the terms and
conditions of such a repo must be in accordance with the requirements
of Rule 1.25(d). The Commission believes that these safeguards,
currently applicable to repos for permitted investments, are
appropriate to apply to customer-deposited securities as well.
Proposed paragraph (a)(2)(ii)(D) would provide that, in the
unlikely event of a default by a counterparty to a repurchase
agreement, the FCM must take steps to ensure that the default does not
result in any cost or expense to the customer. The Commission believes
that this requirement is appropriate in light of the proposal to
eliminate the disclosure and consent requirements of 84-24. Given this
lack of express authorization, any risk of loss created by the
transaction should be borne by the FCM. The Commission believes that
although the standards set forth in paragraph (a)(2)(ii)(C) should
minimize the risk of default, nonetheless, if there is such a default,
the FCM must make the customer whole.
The Commission requests comment on all aspects of this proposal. In
particular, the Commission requests comment on whether it is
appropriate to permit repos of customer collateral without prior
written consent, and, if so, whether the limitations set forth in the
proposal are appropriate. In this regard, the Commission specifically
requests comment on whether a one-way notice disclosure to the customer
should be required and whether a mechanism should be provided under
which a customer could instruct the FCM that repos of its collateral
would not be permitted. The Commission also requests comment on how an
FCM may fulfill its obligations to its customer in the event a repo
counterparty fails to perform. Is it sufficient if the FCM gives the
customer the cash equivalent of the securities plus any transaction
costs that might be incurred in replacing the securities? Or, should
the FCM replace the securities? Would cash compensation be
insufficient, for example, if a customer needed the particular security
to maintain the risk profile of its portfolio?
The Commission further requests comment on whether the terms and
conditions applicable to DCOs engaging in repos should differ in any
way from those applicable to FCMs. The Commission also requests comment
on whether customer collateral that is subject to repo should be
treated for concentration purposes like permitted investments under
paragraph (b)(4)(ii) or continue to be treated under paragraph
(b)(4)(v). Finally, the
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Commission requests comment on whether there are tax implications that
should be considered in connection with this proposal.
B. Time-to-Maturity Requirements for Certain Collateral
Rule 1.25(b)(5) establishes a time-to-maturity requirement for the
portfolio of permitted investments. Certain industry participants have
requested limited relief from this provision. In particular, a DCO is
developing a program whereby FCMs could deposit certain collateral on
an overnight basis to meet certain special margin charges. Absent
amendment of the rule, the deposit of such collateral could cause the
FCM's portfolio to exceed the time-to-maturity limits of Rule
1.25(b)(5).
In order to encourage development of such innovative collateral
management programs, and thereby facilitate the efficient use of
capital, the Commission is proposing to amend Rule 1.25(b)(5). Under
the proposal, certain instruments may be treated as if they had a time-
to-maturity of one day if certain terms and conditions are satisfied.
First, the instrument must be deposited with a DCO solely on an
overnight basis. Second, the instrument must be one that the FCM owns
or has the unqualified right to pledge, and free of any lien.\4\ Third,
the instrument must be used for the purpose of meeting concentration
margin or other similar charges that are in addition to the basic
margin requirement established by the DCO. Fourth, the DCO must price
the instrument each day based on a current mark-to-market value. Fifth,
the DCO must haircut the instrument by at least 2 percent. The
Commission understands that 2 percent is the standard haircut generally
used in the repo market.
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\4\ Instruments that have been given to an FCM by a customer for
deposit in a segregated account currently are not subject to the
time-to-maturity provisions of Rule 1.25 and this would remain the
case under this proposal. Instruments that have been purchased by an
FCM with customer funds and are being held in a segregated account
currently are subject to those provisions and this generally would
remain the case under the proposal. The proposal would provide
relief with regard to instruments that had been held by an FCM in
its non-segregated inventory and that were deposited on an overnight
basis into a segregated account at a DCO. So long as an FCM had an
unqualified right to pledge the instruments, they could include
instruments obtained through reverse repurchase transactions, or
otherwise.
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The time-to-maturity requirement in 1.25(b)(5) is intended to limit
the market risk of permitted investments. The Commission believes that
it is appropriate to provide some additional flexibility under the
circumstances and with the safeguards described above. That is, when
instruments are held at a DCO solely on an overnight basis, subject to
a haircut, and for the purpose of satisfying a margin cushion over and
above the basic performance bond requirement, a modified treatment is
appropriate. This treatment could increase capital efficiency at the
FCM level by permitting additional instruments to be used for margin
while enhancing systemic security at the DCO level by increasing the
amount of collateral held to support positions.
The Commission requests comment on the appropriateness of the
proposed terms and conditions. In particular, the Commission requests
comment on whether the haircut is appropriate and whether the relief
should be limited to instruments deposited to meet concentration and
similar margin requirements, as proposed or whether the modified
treatment should be extended to apply to initial margin generally. If
the latter, should alternative safeguards be developed? For example,
would it be appropriate to apply the relief to the extent that an FCM
holds excess funds in segregation?
C. Time to Maturity--Treasury Portfolio
As noted above, current Rule 1.25(b)(5) limits the dollar weighted
average of the time-to-maturity for permitted investments to no longer
than 24 months. In expanding the range of permissible investments in
December 2000, the Commission added this requirement.
One FCM has informed a self-regulatory organization that the FCM
invests exclusively in obligations of the U.S. Treasury. This FCM
believes that because Treasury instruments do not pose the same risks
that other permitted investments pose, the time-to-maturity limitation
should not apply.
The Commission requests comment on whether an alternate safeguard
to limit risk, such as appropriate haircuts, would be more appropriate
than the time-to-maturity requirement of Rule 1.25(b)(5) with respect
to a portfolio consisting exclusively of U.S. Treasury securities.
D. Embedded Derivatives
Rule 1.25(b)(3)(i) prohibits instruments with embedded derivatives.
Some market participants have suggested that there are certain
instruments containing embedded derivatives that have a lower level of
risk than some of the other investments permitted under the rule. The
Commission requests comment on whether Rule 1.25(b)(3)(i) should be
amended to modify the prohibition on investments in securities that
contain an embedded derivative. In this regard, commenters are asked to
describe how the level of risk of such securities could be limited.
E. Variable Rate Securities--Permitted Benchmarks
Rule 1.25(b)(3)(iv) permits investment in variable rate securities
provided that they correlate to certain specified benchmarks. Industry
representatives have noted that the benchmarks used in the marketplace
evolve over time. They have suggested the rule should provide that the
interest rate on variable rate securities may be benchmarked to any
fixed rate instrument that is a permitted investment under the rule.
The Commission requests comment on whether the provision on permitted
benchmarks should be amended, and if so, what the applicable standard
should be.
F. Reverse Repos--Concentration Limits
Rule 1.25(b)(4)(iii) establishes concentration limits for reverse
repos. Industry representatives have indicated that because of the need
to engage in manual processing, this investment alternative has
generally proved not to be viable. They have expressed a desire to work
with Commission staff to develop a proposal that would continue to
address the risks of reverse repos. The Commission requests comment on
market participants' experience with the current provisions relating to
reverse repos and suggestions on how best to address the risks of these
transactions.
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq.
(1994 & Supp. II 1996), requires federal agencies, in proposing rules,
to consider the impact of those rules on small businesses. The rule
amendments discussed herein would affect FCMs. The Commission has
previously established certain definitions of ``small entities'' to be
used by the Commission in evaluating the impact of its rules on small
entities in accordance with the RFA.\5\ The Commission has previously
determined that registered FCMs are not small entities for the purpose
of the RFA.\6\ The amendments proposed herein would not require any
registrant to change its current method of doing business. The proposed
amendments should reduce, rather than increase, the regulatory
requirements that apply to registered FCMs. Accordingly, pursuant to 5
U.S.C. 605(b), the Chairman, on behalf of the Commission, certifies
that
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these proposed amendments will not have a significant economic impact
on a substantial number of small entities.
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\5\ 47 FR 18618-18621 (April 30, 1982).
\6\ 47 FR 18619-18620.
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B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') imposes certain
requirements on federal agencies (including the Commission) in
connection with their conducting or sponsoring any collection of
information as defined by the PRA. The proposed rule amendments do not
require a new collection of information on the part of any entities
subject to the proposed rule amendments. Accordingly, for purposes of
the PRA, the Commission certifies that these proposed rule amendments,
if promulgated in final form, would not impose any new reporting or
recordkeeping requirements.
Lists of Subjects in 17 CFR Part 1
Brokers, Commodity futures, Consumer protection, Reporting and
recordkeeping requirements.
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for Part 1 continues to read as follows:
Authority: 7 U.S.C.
2. Section 1.25 is proposed to be amended by revising paragraphs
(a)(2) and (b)(5) to read as follows:
Sec. 1.25 Investment of customer funds.
(a) * * *
(2)(i) In addition, a futures commission merchant or clearing
organization may buy and sell the permitted investments listed in
paragraphs (a)(1)(i) through (viii) of this section pursuant to
agreements for resale or repurchase of the instruments, in accordance
with the provisions of paragraph (d) of this section.
(ii) A futures commission merchant or a clearing organization may
sell securities deposited by customers as margin pursuant to agreements
to repurchase subject to the following:
(A) Securities subject to such repurchase agreements must meet the
marketability requirement of paragraph (b)(1) of this section.
(B) Securities subject to such repurchase agreements must not be
``specifically identifiable property'' as defined in Sec. 190.01(kk)
of this chapter.
(C) The terms and conditions of such an agreement to repurchase
must be in accordance with the provisions of paragraph (d) of this
section.
(D) Upon the default by a counterparty to a repurchase agreement,
the futures commission merchant or clearing organization must take
steps to ensure that the default does not result in any cost or expense
to the customer.
(b) * * *
(5) Time-to-maturity. (i) Except for investments in money market
mutual funds, the dollar-weighted average of the time-to-maturity of
the portfolio, as that average is computed pursuant to Sec. 270.2a-7
of this title, may not exceed 24 months.
(ii) For purposes of determining the time-to-maturity of the
portfolio, an instrument that is set forth in paragraphs (a)(1)(i)
through (vii) of this section may be treated as having a one-day time-
to-maturity if the following terms and conditions are satisfied:
(A) The instrument is deposited solely on an overnight basis with a
derivatives clearing organization pursuant to the terms and conditions
of a collateral management program;
(B) The instrument is one that the futures commission merchant owns
or has an unqualified right to pledge, is not subject to any lien, and
is deposited by the futures commission merchant into a segregated
account at a registered derivatives clearing organization;
(C) The instrument is used only for the purpose of meeting
concentration margin or other similar charges assessed by a derivatives
clearing organization in addition to the basic margin requirement
established by the derivatives clearing organization;
(D) The derivatives clearing organization prices the instrument
each day based on the current mark-to-market value; and
(E) The derivatives clearing organization reduces the assigned
value of the instrument each day by a haircut of at least 2 percent.
* * * * *
Issued in Washington, DC on June 25, 2003, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 03-16473 Filed 6-27-03; 8:45 am]
BILLING CODE 6351-01-U