CFTC Approves New Rule on Investment of Customer Funds
NFA IBs
Compliance Operations
December 31, 2024
The Case
At the heart of the statutory and regulatory framework governing transactions in derivatives in the United States is a customer asset protection regime that requires futures commission merchants (FCM) and derivatives clearing organizations (DCO) to hold customer funds in segregation. The Commodity Exchange Act (CEA), and the regulations of the Commodity Futures Trading Commission (CFTC) promulgated thereunder, create what courts have termed a "special statutory trust" over funds deposited by customers to secure futures, foreign futures and cleared swaps held by FCMs and cleared by DCOs (customer funds).
This means that the rights and duties of FCMs and DCOs with respect to segregated assets are determined by statute and regulation, rather than by general principles of trust law. Last week, the CFTC approved a final rule substantially granting the CME/FIA petition (Final Rule).
Regulatory Implications
The final rule reflects the CFTC’s focus on preserving customer funds while allowing FCMs and DCOs flexibility to generate yield within defined parameters.
Key regulatory changes include:
Expanded Investment Options
The inclusion of specific foreign sovereign debt, U.S. Treasury ETFs, and government money market funds broadens the scope of permissible low-risk investments.Stricter Limits and Conditions
Conditions for investments in foreign sovereign debt and ETFs include limits on maturity, concentration, and creditworthiness to mitigate risks.Removal of Certain Instruments
The exclusion of commercial paper, corporate notes, and corporate bonds highlights the CFTC’s shift toward more conservative investment options.Updated Benchmarks
The replacement of LIBOR with SOFR aligns with current market standards for adjustable-rate investments.DCO Financial Accountability
DCOs are explicitly held financially responsible for any losses from investment of customer funds in permitted categories.
Practical Guidance for Firms
To prepare for compliance with the final rule, FCMs and DCOs should take the following steps:
Review Investment Portfolios
Assess current investment portfolios and make necessary adjustments to align with the updated list of permitted investments and concentration limits.Enhance Risk Monitoring
Implement or refine monitoring processes to track compliance with maturity, creditworthiness, and concentration thresholds for investments.Understand ETF Guidelines
Familiarize relevant teams with the expanded transactional alternatives and specific requirements for U.S. Treasury ETFs.Address Compliance Deadlines
Prepare to meet the compliance date for the final rule, 30 days after publication in the Federal Register, and for SIDR Reports by March 31, 2025.
RIAs
The SEC recently brought settled enforcement actions against two registered investment advisers for failing to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material nonpublic information (MNPI), in violation of Section 204A of the Investment Advisers Act of 1940 (Advisers Act) and the Compliance Rule.
RIAs
On Sep. 4, 2024, FinCEN published a final rule (Final Rule) adding certain RIAs and ERAs (collectively, Covered Advisers) to the definition of “financial institution” under the regulations implementing the BSA, and imposing on Covered Advisers broad AML and CFT program requirements, as well as other BSA recordkeeping and reporting requirements.
Broker-Dealers
On November 22, the SEC announced (here) that broker-dealers Webull Financial LLC, Lightspeed Financial Services Group LLC, and Paulson Investment Company, LLC agreed to settle charges that they filed with law enforcement SARs that failed to include required information.
