AMENDMENTS TO RULE 1.25
Changes to the Types of Permitted Investments
Corporate Obligations Not Guaranteed by the U.S.
Corporate obligations not guaranteed by the U.S. are no longer permissible investments because of the “credit, liquidity, and market risks posed by corporate debt securities.”5 Corporate debt securities guaranteed as to principal and interest by the Temporary Liquidity Guarantee Program (TLGP)6 are allowed if such security is part of an issuance larger than $1 billion, denominated in U.S. dollars and fully guaranteed by the U.S. for its entire term.7
Investments in Foreign Sovereign Debt Securities
Investments in foreign sovereign debt securities are no longer permitted. Prior to the amendment, such investments were permitted to the extent an FCM or DCO held balances owed to customers denominated in that country’s currency. The CFTC rejected comments that argued that investments in foreign sovereign debt securities are necessary to manage currency risk and increase diversification and liquidity, citing the volatility, risk and lack of liquidity of many foreign sovereign debt securities as reasons for prohibiting investments in foreign sovereign debt securities.8 The CFTC will consider permitting investments in foreign sovereign debt on a case-by-case basis to the extent an FCM or DCO can demonstrate that (1) it is has balances owed to customers in that country’s currency and (2) such sovereign debt services would preserve principal and maintain liquidity of customer funds.9
In-house transactions between an FCM or DCO and an affiliate involving customer funds are no longer permitted.10 This includes a prohibition on repurchase and reverse repurchase agreements with affiliates.11 Responding to several comments arguing in favor of permitting repurchase and reverse repurchase transactions with affiliates, the CFTC stated that “the concentration of credit risk and the potential for conflicts of interest during times of crisis” are too great in in-house transactions.12 The CFTC also distinguished in-house transactions from third-party repurchase and reverse repurchase transactions, which contain market-based safeguards such as being “transacted at arms-length (often by means of a tri-party repo mechanism), on a delivery versus payment basis, and [are] memorialized by a legally binding contract.”13
Fannie Mae and Freddie Mac Obligations
Last, the CFTC added a restriction that only permits investments in obligations issued by Fannie Mae and Freddie Mac so long as those “entities operate under the conservatorship or receivership of the Federal Housing Finance Agency with capital support from the United States.”14 This new limit is significantly less restrictive than the CFTC’s proposal, which would have prohibited all investments in obligations of U.S. government corporations or government sponsored enterprises (U.S. agency obligations).15 The CFTC agreed with numerous comments that investments in U.S. agency obligations should be permitted because those obligations generally performed well in the recent financial crises and are fully guaranteed by the U.S. government.
Other Changes – Liquidity, Credit Ratings, Restrictions on CDs, Concentration Limits
Investments Must Be “Highly Liquid”
Investments of customer funds now must be “‘highly liquid’ such that they have the ability to be converted into cash within one business day without material discount in value.”16 This standard is “to ensure that investments can be promptly liquidated in order to meet a margin call, pay variation settlement, or return funds to the customer upon demand.”17
References to Credit Ratings Are Removed
As required by Dodd-Frank § 939A, the CFTC also removed all references to credit ratings from Rule 1.25. This means that high credit ratings are no longer required for investments and will not provide a safe harbor for investments. One commenter noted that complete removal of ratings criteria may hinder an FCM’s or DCO’s ability to complete a thorough risk assessment of every issuer. The CFTC responded “that the removal of references to ratings does not prohibit a DCO or FCM from taking into account credit ratings as one of many factors to be considered in making an investment decision.”18