"New Restrictions on Investment of Customer Funds by Derivatives Clearing Organizations and Futures Commission Merchants"
The Commodity Futures Trading Commission (the CFTC) long has restricted how derivatives clearing organizations (DCOs) and futures commission merchants (FCMs) may invest customer funds through its Rule 1.25. By law for decades, customer funds must be kept separate from any other funds of FCMs and DCOs. Rule 1.25 does not address or affect segregation; it simply limits how FCMs and DCOs may invest segregated customer funds. On December 5, the CFTC voted unanimously to amend Rule 1.25 to place additional restrictions on permissible investments of customer funds deposited to support both futures and swap positions.1 The rules are effective on February 17, 2012.
The additional restrictions adopted by the CFTC now will prohibit investment of customer funds in:
• Corporate obligations not guaranteed by the U.S.;
• Foreign sovereign securities; and
• Transactions with an affiliate of the FCM or DCO.
The amendments also make changes to investment requirements, such as requiring investments to be highly liquid, removing conditions in the rule that depended on credit ratings, imposing additional restrictions to certificates of deposit (CDs), tightening concentration limits and making technical changes for investments in money market mutual funds (MMMFs).
CFTC Rule 1.25 prescribes rules for investing customer funds and applies equally to DCOs and FCMs.2 As originally promulgated, Rule 1.25 restricted investments of customer funds to obligations of the United States, any state (or subdivision thereof), or obligations fully guaranteed as to principal and interest by the United States. Between 2000 and 2005, the CFTC expanded the list of permitted investments to include obligations of government sponsored entities (e.g., Fannie Mae and Freddie Mac), bank certificates of deposit, commercial paper, corporate notes, foreign sovereign debt, interests in MMMFs and transactions with an affiliate of the FCM that is registered as a broker-dealer.3 The CFTC also included concentration limits on certain investments, marketability requirements and rating standards, among other requirements. The amendments to Rule 1.25 effectively roll back some of the changes made between 2000 and 2005.
Although the CFTC’s vote on amended Rule 1.25 followed on the heels of the collapse of MF Global, the CFTC initially raised the issue of proposing amendments to Rule 1.25 in 2009. While some claims have been made that the amendments to Rule 1.25 would have prevented the shortfall in customer segregated funds at MF Global, the amendments do not increase or decrease the strength of the longstanding statutory and regulatory prohibition on violating the sanctity of customer segregation. In any event, it is difficult to confirm how the amendments to Rule 1.25 might have affected the MF Global episode until a full public accounting of the pertinent facts has been made.4