The CFTC issued a final rule and separate interpretive and no-action letters designed to enhance the protection of customer funds.
The CFTC actions include a staff interpretation letter (CFTC Staff Letter 16-39) prohibiting derivatives clearing organizations (“DCOs”) from investing customer funds, or funds that belong to clearing members in money market funds (“MMFs”) and that reserve the right to suspend redemptions in the funds or to impose liquidity fees under certain conditions. Such redemption restrictions are permitted under SEC Rule 2a-7, which will take effect on October 14, 2016, because they allow MMFs to manage periods of high levels of redemptions. However, they also conflict with CFTC rules that require DCOs to invest such funds in ways that allow them to be liquidated promptly. The CFTC specified that government MMFs without the retained authority to impose redemption restrictions will be considered acceptable margin collateral and investments.
The CFTC also issued a staff no-action letter (CFTC Staff Letter 16-38) allowing futures commission merchants (“FCMs”) to invest their own funds in excess of their targeted residual interest in MMFs that retain the authority to impose redemption restrictions. Additionally, the CFTC approved a final rule permitting Federal Reserve Banks to hold DCO customer funds without being subject to liability under the CEA’s private action provision as long as such funds are subject to strict segregation.
In a separate statement, CFTC Commissioner Sharon Y. Bowen “concur[red] with the two Commission actions” but criticized the provision concerning the investment of an FCM’s excess residual interest into MMFs that retain the authority to suspend participant redemptions. If such MMFs “are not suitable investments for customer funds,” she argued, “then they are not suitable for the additional capital that the FCMs put in those accounts to protect against potential shortfalls.”
Commissioner Bowen is right to assert that Staff No-Action Letter 16-68, which allows FCMs to invest their own funds in excess of their residual interest requirement into whatever MMFs they choose, does not constitute a consumer protection initiative. Even so, the purpose of the letter is not to protect consumers, nor should it be. Residual interest represents excess funds that are taken by an FCM from its own capital and deposited into a customer segregated account in order comply with the CEA’s segregation requirements. An FCM must use its own funds to make up for any deficiency in a customer’s account, if that customer lacks sufficient funds on deposit with the FCM to meet CFTC obligations. However, under CFTC Rule 1.23, an FCM may withdraw funds in excess of the “targeted residual interest” amount so long as the withdrawal does not cause the FCM to violate its obligation to comply continuously with the customer segregated funds requirement. Allowing FCMs to invest such excess funds as they see fit is not only fair but necessary in a world in which the number of FCMs has declined by 50% since the adoption of Dodd-Frank. After all, the funds belong to the FCMs and not to any customer. It is unfortunate when regulators bemoan the possibility of “too big to fail,” but adopt or support measures that make it impossible for midsize firms, let alone smaller ones, to survive.