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CFTC Adds More Rules to Restructuring Effort

A series of new regulations issued recently by the Commodity Futures Trading Commission (CFTC) are aimed at increasing the protections of customers and customer funds held by companies designated by the CFTC as futures commission merchants (FCM) and derivative clearing organizations. They bring to 65 the number of rules, orders and guidances issued by the agency in carrying out the financial reform mandated by the Congress following the financial market’s 2008 collapse and passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The latest measures, part of the regulatory overhaul of the derivatives market, require FCMs to adopt stricter risk management programs, which would ensure that customer funds are separately accounted for and segregated or secured as belonging to customers. Under the new rules, FCMs also are required to provide more disclosures to customers about their business, operations and the general risks involved when dealing with an FCM. The final rules predominantly apply to FCMs but also cover requirements for self-regulatory organizations, designated self-regulatory organizations and derivatives clearing organizations.

"Residual-interest provisions have been the most discussed part of the [proposed rules]," said CFTC Commissioner Mark Wetjen. "The Commission received a significant number of comment letters in response to that proposal, which would have required FCMs to maintain 'at all times' enough residual interest in their segregated accounts to cover all customer margin deficits," he said.

“Many suggested that the 'at all times' requirement under the proposal...would have imposed significant capital costs on FCMs, which could have led to the unintended effect of limiting access to the derivatives markets...[As a result] the Commission has...taken a different approach" in its final rule.

Starting one year after the publication of the final rule, an FCM must hold the requisite residual interest by 6 p.m. eastern time on the next business day after the trade date. And within 30 months after the publication of the rule, CFTC staff will publish a report on the practicability of moving the deadline.

Wetjen said he supported the improvements to the residual-interest requirements. "First, they will better protect the excess segregation funds of a customer in the event of an FCM bankruptcy. Second, they will encourage FCMs to more actively monitor customer accounts [in] instances when those accounts are under-margined. And third, they will incentivize FCMs to address those circumstances when an account is under-margined."

Commissioner Scott O'Malia expressed concern with the residual interest deadline. "My main concern with the draft final rules is their radical reinterpretation of the longstanding residual interest deadline. This reinterpretation decreases the time in which customers' margin calls must arrive to their FCM from the current three days to just one day," he said.

"Such a change would mean a drastic increase in pre-funding of margin, perhaps nearly double the amounts currently required. As a result, many agribusiness hedgers will have to consider alternative risk management tools, or, even worse, will be forced out of the market," O'Malia said.

Despite O'Malia's dissent, the final rule addressing residual interest requirements and other customer protections cleared the Commission.

The new rules also require swap dealers and major swap participants to notify their uncleared swaps counterparties of their right to have any initial margin segregated in a separate account, and to clarify that the securities in a portfolio margining account that is a futures account or cleared swaps customer account will constitute customer property in a commodity broker bankruptcy.

The Commission approved final rules on ownership and control reports (OCR), which are aimed at providing the agency with "enhanced visibility" of participants in the futures and swaps markets and their positions and trading. "By expanding the Commission's identification of futures and swap market participants, the OCR will enable Commission staff to more easily identify relationships between trading accounts, special accounts, reportable positions and market activity.

"In addition, by requiring identification of trading accounts based on their trading volume, the Commission will acquire better information regarding market participants who may not be identified through the Commission's position-based reporting programs. These improvements will enable the Commission to better deter and prevent market manipulation, deter and detect abusive or disruptive practices (such as marking the close, wash trading, or money passing) and better perform monitoring and surveillance between related accounts," the CFTC said.

"In the wake of the global financial crisis, it is extremely important to intensify regulatory efforts to strengthen customers protection policies in order to promote the financial stability of the derivatives market. There is no dispute customer protection must be the cornerstone of the Commission's oversight," O'Malia said.

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