CFTC makes changes to customer fund investment regulation

The Commodity Futures Trading Commission (CFTC) has recently made changes to its rules governing the types of investments allowed for customer funds held by futures commission merchants (FCMs) and derivatives clearing organizations (DCOs). Responding to requests from the derivatives industry, the CFTC has expanded the range of instruments in which customer assets can be invested. These adjustments were made in consideration of protecting customer assets, one of the core missions of the CFTC and a key purpose of the Commodity Exchange Act.

FCMs and DCOs are mandated to segregate customer assets from their own funds and only employ these funds to cover customer liabilities. This hurdle is set up to ensure that in case an FCM or DCO goes bankrupt, customer assets are promptly returned. The CFTC regulation 1.25 allows FCMs and DCOs to invest segregated customer funds in certain investments that meet the objectives of preserving capital and maintaining liquidity.

The list of permitted investments under CFTC regulation 1.25 has continuously evolved since its inception in 1968, typically in response to the failures of large FCMs or financial crises. The new amendments include limiting investments in money market funds, introducing specific foreign sovereign debt instruments and U.S. Treasury exchange-traded funds, and eliminating certificates of deposit, commercial paper, corporate notes, and corporate bonds. Additionally, conforming changes were made to modernize the regulation. Each amendment to the list of permitted investments brings about a different dynamic to the investment landscape.

Regarding money market funds, FCMs and DCOs are now constrained to a narrower range of MMFs. The exclusion of MMFs subject to liquidity fees is meant to prevent outflows during economic stress, ensuring liquidity for FCMs and DCOs to repay customers fully. As for U.S. Treasury ETFs, they have been newly introduced as allowable investments. These ETFs must align with certain conditions to qualify, which includes replicating a published short-term U.S. Treasury security index with bonds, notes, and bills.

The inclusion of certain foreign sovereign debt as an asset class is another amendment. FCMs and DCOs can now invest in specified sovereign debt, like Canada, Japan, France, Germany, and the United Kingdom, to manage foreign exchange risks. However, there are conditions such as a maximum 60-day average time-to-maturity for investments in sovereign debt and a 180-calendar day limit on remaining time-to-maturity for each security.

Overall, the amendments made by the CFTC underscore their commitment to ensuring customer asset protection and mitigating risks associated with investments made by FCMs and DCOs. The changes offer greater diversity in investment options while safeguarding against undue risks. By enhancing the permitted investments framework, the CFTC aims to promote efficiency and competition in the financial services industry.