Bankruptcy Regulations
| Court | Commodity Futures Trading Commission |
| Citation | 86 FR 19324 |
| Published date | 13 April 2021 |
| Section | Rules and Regulations |
| Record Number | 2020-28300 |
Federal Register, Volume 86 Issue 69 (Tuesday, April 13, 2021)
[Federal Register Volume 86, Number 69 (Tuesday, April 13, 2021)]
[Rules and Regulations]
[Pages 19324-19477]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-28300]
[[Page 19323]]
Vol. 86
Tuesday,
No. 69
April 13, 2021
Part IICommodity Futures Trading Commission-----------------------------------------------------------------------17 CFR Parts 1, 4, 41, and 190Bankruptcy Regulations; Final Rule
Federal Register / Vol. 86 , No. 69 / Tuesday, April 13, 2021 / Rules
and Regulations
[[Page 19324]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 4, 41, and 190
RIN 3038-AE67
Bankruptcy Regulations
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (the ``Commission'')
is amending its regulations governing bankruptcy proceedings of
commodity brokers. The amendments are meant comprehensively to update
those regulations to reflect current market practices and lessons
learned from past commodity broker bankruptcies.
DATES:
Effective date: The effective date for this final rule is May 13,
2021.
Compliance date: The compliance date for Sec. 1.43 is April 13,
2022, for all letters of credit accepted, and customer agreements
entered into, by a futures commission merchant prior to May 13, 2021.
FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Chief Counsel and
Senior Advisor, 202-418-5092, [email protected], Ward P. Griffin,
Senior Special Counsel, 202-418-5425, [email protected], Jocelyn
Partridge, 202-418-5926, [email protected], Abigail S. Knauff, 202-
418-5123, [email protected], Division of Clearing and Risk; Commodity
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street
NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Background of the Notice of Proposed Rulemaking
B. Major Themes in the Revisions to Part 190
II. Finalized Regulations
A. Subpart A--General Provisions
1. Regulation Sec. 190.00: Statutory Authority, Organization,
Core Concepts, Scope, and Construction
2. Regulation Sec. 190.01: Definitions
3. Regulation Sec. 190.02: General
B. Subpart B--Futures Commission Merchant (FCM) as Debtor
1. Regulation Sec. 190.03: Notices and Proofs of Claims
2. Regulation Sec. 190.04: Operation of the Debtor's Estate--
Customer Property
3. Regulation Sec. 190.05: Operation of the Debtor's Estate--
General
4. Regulation Sec. 190.06: Making and Taking Delivery Under
Commodity Contracts
5. Regulation Sec. 190.07: Transfers
6. Regulation Sec. 190.08: Calculation of Funded Net Equity
7. Regulation Sec. 190.09: Allocation of Property and Allowance
of Claims
8. Regulation Sec. 190.10: Provisions Applicable to Futures
Commission Merchants During Business as Usual
C. Subpart C--Clearing Organization as Debtor
1. Regulation Sec. 190.11: Scope and Purpose of Subpart C
2. Regulation Sec. 190.12: Required Reports and Records
3. Regulation Sec. 190.13: Prohibition on Avoidance of
Transfers
4. Regulation Sec. 190.14: Operation of the Estate of the
Debtor Subsequent to the Filing Date
5. Regulation Sec. 190.15: Recovery and Wind-Down Plans;
Default Rules and Procedures
6. Regulation Sec. 190.16: Delivery
7. Regulation Sec. 190.17: Calculation of Net Equity
8. Regulation Sec. 190.18: Treatment of Property
9. Regulation Sec. 190.19: Support of Daily Settlement
D. Appendix A Forms
E. Appendix B Forms
F. Technical Corrections to Other Parts
1. Part 1
2. Part 4
3. Part 41
G. Additional Comments
H. Supplemental Proposal
III. Cost-Benefit Considerations
A. Introduction
1. Baseline
2. Overarching Concepts
a. Changes to Structure of Industry
b. Trustee Discretion
c. Cost Effectiveness and Promptness Versus Precision
d. Unique Nature of Bankruptcy Events
e. Administrative Costs Are Costs to the Estate, and Often to
the Customers
f. Preference for Public Customers Over Non-Public Customers and
for Both Over General Creditors
B. Subpart A--General Provisions
1. Regulation Sec. 190.00: Statutory Authority, Organization,
Core Concepts, Scope, and Construction: Consideration of Costs and
Benefits
2. Regulation Sec. 190.01: Definitions: Consideration of Costs
and Benefits
3. Regulation Sec. 190.02: General: Consideration of Costs and
Benefits
4. Section 15(a) Factors--Subpart A
C. Subpart B--Futures Commission Merchant as Debtor
1. Regulation Sec. 190.03: Notices and Proofs of Claims:
Consideration of Costs and Benefits
2. Regulation Sec. 190.04: Operation of the Debtor's Estate--
Customer Property: Consideration of Costs and Benefits
3. Regulation Sec. 190.05: Operation of the Debtor's Estate--
General: Consideration of Costs and Benefits
4. Regulation Sec. 190.06: Making and Taking Delivery Under
Commodity Contracts: Consideration of Costs and Benefits
5. Regulation Sec. 190.07: Transfers: Consideration of Costs
and Benefits
6. Regulation Sec. 190.08: Calculation of Funded Net Equity:
Consideration of Costs and Benefits
7. Regulation Sec. 190.09: Allocation of Property and Allowance
of Claims: Consideration of Costs and Benefits
8. Regulation Sec. 190.10: Provisions Applicable to Futures
Commission Merchants During Business as Usual: Consideration of
Costs and Benefits
9. Section 15(a) Factors--Subpart B
D. Subpart C--Clearing Organization as Debtor
1. Regulation Sec. 190.11: Scope and Purpose of Subpart C:
Consideration of Costs and Benefits
2. Regulation Sec. 190.12: Required Reports and Records:
Consideration of Costs and Benefits
3. Regulation Sec. 190.13: Prohibitions on Avoidance of
Transfers: Consideration of Costs and Benefits
4. Regulation Sec. 190.14: Operation of the Estate of the
Debtor Subsequent to the Filing Date: Consideration of Costs and
Benefits
5. Regulation Sec. 190.15: Recovery and Wind-Down Plans;
Default Rules and Procedures: Consideration of Costs and Benefits
6. Regulation Sec. 190.16: Delivery: Consideration of Costs and
Benefits
7. Regulation Sec. 190.17: Calculation of Net Equity:
Consideration of Costs and Benefits
8. Regulation Sec. 190.18: Treatment of Property: Consideration
of Costs and Benefits
9. Regulation Sec. 190.19: Support of Daily Settlement:
Consideration of Costs and Benefits
10. Section 15(a) Factors--Subpart C
E. Changes to Appendices A and B
F. Technical Corrections to Parts 1, 4, and 41
IV. Related Matters
A. Antitrust Considerations
B. Regulatory Flexibility Act
C. Paperwork Reduction Act
1. Reporting Requirements in an FCM Bankruptcy
2. Recordkeeping Requirements in an FCM Bankruptcy
3. Third-Party Disclosure Requirements Applicable to a Single
Respondent in an FCM Bankruptcy
4. Reporting Requirements in a Derivatives Clearing Organization
(DCO) Bankruptcy
5. Recordkeeping Requirements in a DCO Bankruptcy
6. Third-Party Disclosure Requirements Applicable to a Single
Respondent in a DCO Bankruptcy
7. Third-Party Disclosure Requirements Applicable to Multiple
Respondents During Business as Usual
I. Background
A. Background of the Notice of Proposed Rulemaking
The basic structure of the Commission's bankruptcy regulations,
part 190 of title 17 of the Code of Federal Regulations, was proposed
in 1981 and finalized in 1983. In April of
[[Page 19325]]
this year, the Commission proposed a comprehensive revision of part 190
(the ``Proposal''),\1\ and in September of this year, the Commission
issued a supplemental proposal (the ``Supplemental Proposal'') \2\
addressing a particular issue involving the interaction between
bankruptcy and resolution of a clearing organization pursuant to Title
II of the Dodd-Frank Wall Street Reform and Consumer Protection Act \3\
(hereinafter, ``Title II'' and ``Dodd-Frank'').
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\1\ 85 FR 36000 (June 12, 2020).
\2\ 85 FR 60110 (Sept. 24, 2020).
\3\ Public Law 111-203 (July 21, 2010).
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The Commission is revising part 190 comprehensively in light of
several major changes to the industry over the 37 years since part 190
was first finalized. These changes include exponential growth in the
speed of transactions and trade processing, important lessons learned
over prior bankruptcies, and the increased importance of derivatives
clearing organizations (``DCOs'') to the financial system.
In promulgating these rules, the Commission is exercising its broad
power under the Commodity Exchange Act (``CEA'' or ``Act'') to make
regulations with respect to commodity broker debtors. Specifically,
section 20(a) states that notwithstanding title 11, the Commission may
provide, with respect to a commodity broker that is a debtor under
chapter 7 of title 11, by rule or regulation (1) that certain cash,
securities, other property, or commodity contracts are to be included
in or excluded from customer property or member property; (2) that
certain cash, securities, other property, or commodity contracts are to
be specifically identifiable to a particular customer in a specific
capacity; (3) the method by which the business of such commodity broker
is to be conducted or liquidated after the date of the filing of the
petition under such chapter, including the payment and allocation of
margin with respect to commodity contracts not specifically
identifiable to a particular customer pending their orderly
liquidation; (4) any persons to which customer property and commodity
contracts may be transferred under section 766 of title 11; and (5) how
the net equity of a customer is to be determined.\4\
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\4\ See CEA section 20(a), 7 U.S.C. 24(a).
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In developing this rulemaking, the Commission benefited from
outside contributions. In particular, the Proposal benefited from a
thoughtful and detailed model set of part 190 rules submitted by the
Part 190 Subcommittee of the Business Law Section of the American Bar
Association (``ABA Subcommittee'').\5\ In addition, and as discussed
further below, the Commission benefited from thoughtful, analytical,
and detailed public comments submitted in response to the Proposal and
Supplemental Proposal.
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\5\ The submission by the ABA Subcommittee cautioned that
``[t]he views expressed in this letter, and the proposed Model Part
190 Rules, are presented on behalf of the [ABA Subcommittee]. They
have not been approved by the House of Delegates or Board of
Governors of the ABA and, accordingly, should not be construed as
representing the policy of the ABA. In addition, they do not
represent the position of the ABA Business Law Section, nor do they
necessarily reflect the views of all members of the Committee.''
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B. Major Themes in the Revisions to Part 190
The major themes in the revisions to part 190 include the
following:
(1) The Commission is adding Sec. 190.00, which sets out the
statutory authority, organization, core concepts, scope, and rules of
construction for part 190. More generally, this section sets out, after
notice and comment rulemaking, the Commission's thinking and intent
regarding part 190 in order to benefit and to enhance the understanding
of DCOs, FCMs, their customers, trustees,\6\ and the public at large.
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\6\ Including bankruptcy and SIPA trustees, as well as the FDIC
in its role as a receiver.
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(2) Some of the provisions support the implementation of the
requirements, established consistent with section 4d of the CEA, that
shortfalls in segregated property should be made up from the FCM's
general assets, while others further the preferences, arising from both
title 11 of the United States Code (i.e., the ``Bankruptcy Code''),
section 766(h), and Commission policy, that with respect to customer
property, public customers are favored over non-public customers, and
that public customers are entitled inter se to a pro rata distribution
based on their respective claims.
(3) Other provisions foster the longstanding and continuing policy
preference for transferring (as opposed to liquidating) positions of
public customers and those customers' proportionate share of associated
collateral.\7\
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\7\ This policy preference is manifest in section 764(b) of the
Bankruptcy Code, 11 U.S.C. 764(b) (protecting from avoidance
transfers approved by the Commission up to seven days after the
order for relief), and in current Sec. 190.02(e).
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(4) The Commission is promulgating a new subpart C to part 190,
governing the bankruptcy of a clearing organization. In doing so, the
Commission is establishing ex ante the approach to be taken in
addressing such a bankruptcy, in order to foster prompt action in the
event such a bankruptcy occurs, and in order to establish a more clear
counterfactual (i.e., ``what would creditors receive in a liquidation
in bankruptcy?'') in the event of a resolution of a clearing
organization pursuant to Title II of Dodd-Frank.\8\ The Commission's
approach toward a DCO bankruptcy is characterized by three overarching
concepts:
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\8\ Section 210(d)(2), 12 U.S.C. 5390(d)(2), provides that the
maximum liability of the FDIC, acting as a receiver for a covered
financial company in a resolution under Title II, is the amount the
claimant would have received if the FDIC had not been appointed
receiver and the covered financial company had instead been
liquidated under chapter 7 of the Bankruptcy Code. Thus, in
developing resolution strategies for a DCO while mitigating claims
against the FDIC as receiver, it is important to understand what
would happen if the DCO was instead liquidated pursuant to chapter 7
of the Bankruptcy Code (and this part 190), and such a liquidation
is the counterfactual to resolution of that DCO under Title II.
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a. First, the trustee should follow, to the extent practicable and
appropriate, the DCO's pre-existing default management rules and
procedures and recovery and wind-down plans that have been submitted to
the Commission. These rules, procedures, and plans will, in most
cases,\9\ have been developed pursuant to the Commission's regulations
in part 39, and subject to staff oversight. This approach relieves the
trustee of the burden of developing, in the moment, models to address
an extraordinarily complex situation. It would also enhance the clarity
of the counterfactual for purposes of resolution under Title II.
However, as discussed further below, such plans are not rigid formulae.
Moreover, the Commission's approach gives the trustee discretion in
following those plans. Accordingly, the approach seeks to balance
advance planning with flexibility to tailor the implementation to the
specific circumstances.
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\9\ Only those DCOs that are subject to subpart C of part 39
(i.e., those that have been designated as systemically important by
the Financial Stability Oversight Council (FSOC) or that have
elected to be subject to subpart C of part 39) are subject to Sec.
39.35 (default rules and procedures) and Sec. 39.39 (recovery and
wind-down plans).
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b. Second, resources that are intended to flow through to members
as part of daily settlement (including both daily variation payments
and default resources) are devoted to that purpose, rather than to the
general estate.\10\
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\10\ See generally Sec. 190.19.
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c. Third, other provisions draw, with appropriate adaptations, from
provisions applicable to FCMs.\11\
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\11\ See, e.g., Sec. Sec. 190.16, 190.17(c).
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(5) The Commission is noting the applicability of part 190 in the
context
[[Page 19326]]
of proceedings under the Securities Investors Protection Act (``SIPA'')
in the case of FCMs subject to a SIPA proceeding,\12\ and Title II of
Dodd-Frank in the case of a commodity broker where the Federal Deposit
Insurance Corporation (``FDIC'') is acting as a receiver.
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\12\ Those would be FCMs that are also registered as broker-
dealers with the Securities and Exchange Commission. See generally
SIPA, 15 U.S.C. 78aaa et seq.
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(6) The Commission is enacting changes to the treatment of letters
of credit as collateral, both during business as usual and during
bankruptcy, in order to ensure that, consistent with the pro rata
distribution principle, customers who post letters of credit as
collateral suffer the same proportional loss as customers who post
other types of collateral.
(7) The Commission is granting trustees enhanced discretion, based
on both practical necessity and positive experience.
a. Recent commodity broker bankruptcies have involved many
thousands of customers, with as many as hundreds of thousands of
commodity contracts. Trustees must make decisions as to how to handle
such customers and contracts in the days--in some cases, the hours--
after being appointed. Moreover, each commodity broker bankruptcy has
unique characteristics, and bankruptcy trustees need to adapt
correspondingly quickly to those unique characteristics.
i. In order to foster the ability of the trustee to operate
effectively, some of the changes would permit the trustee enhanced
discretion generally.
ii. Others, recognizing the difficulty in treating large numbers of
public customers on a bespoke basis, would permit the trustee to treat
public customers on an aggregate basis. These changes represent a move
from a model where the trustee receives and complies with instructions
from individual public customers, to a model--reflecting actual
practice in commodity broker bankruptcies in recent decades--where the
trustee transfers as many open commodity contracts as possible on an
omnibus basis.
b. These grants of discretion are also supported by the
Commission's positive experience working in cooperation and
consultation with bankruptcy and SIPA trustees.
c. On a related note, and as discussed further as the third
overarching concept in the section below on cost-benefit
considerations,\13\ part 190 favors cost effectiveness and promptness
over precision in certain respects, particularly with respect to the
concept of pro rata treatment. Following the policy choice made by
Congress in section 766(h) of the Bankruptcy Code, the Commission's
policy is that it is more important to be cost effective and prompt in
the distribution of customer property (i.e., in terms of being able to
treat customers as part of a class) than it is to value each customer's
entitlements on an individual basis. The Commission believes that this
approach would lead to (1) in general, a faster administration of the
proceeding, (2) customers receiving their share of the debtor's
customer property more quickly, and (3) a decrease in administrative
costs (and thus, in case of a shortfall in customer property, a greater
return to customers).
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\13\ See the overarching concept discussed in section III.A.2.c
below.
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(8) Many of the changes are intended to update part 190 in light of
changes to the regulatory framework over the past three decades,
including cross-references to other Commission regulations. Some of
these codify actual practice in prior bankruptcies, such as a
requirement that an FCM notify the Commission of its imminent intention
to file for voluntary bankruptcy. In another case, the Commission is
addressing for the first time the interaction between part 190 and
recent revisions to the Commission's customer protection rules.\14\
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\14\ 78 FR 68506 (Nov. 14, 2013). This refers to Sec. 190.05(f)
in section II.B.3 below.
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(9) Other changes follow from changes to the technological
ecosystem, in particular changes from paper-based to electronic-based
means of communication and recording, (for example, the use of
communication to customers' electronic addresses rather than by paper
mail, as well as the use of websites as a means for the trustee to
communicate with customers on a regular basis). The proposal would also
recognize the change from paper-based to electronic recording of
``documents of title.'' Many of these changes also recognize the actual
practice in prior bankruptcies.
(10) Finally, many of the changes are intended to clarify language
in existing regulations, without any intent to change substantive
results. While some of these changes will, as discussed below, address
ambiguities that have complicated past bankruptcies, this comprehensive
revision of part 190 has also provided opportunities to clarify
language in order to avoid future ambiguities, and to add provisions to
address circumstances that have not yet arisen, in order to accomplish
better and more reliably the goals of promptly and cost-effectively
resolving commodity broker bankruptcies while mitigating systemic risk
and protecting the commodity broker's customers.
The Commission invited comments on all aspects of the proposed
rulemaking and received a total of 16 substantive comment letters in
response.\15\ The comments generally supported the adoption of
revisions to part 190, though several provided suggestions as to
particular elements of the proposal that should be modified, clarified,
deleted, or otherwise improved. The Commission has adopted many, though
not all, of these suggestions, and in some cases has sought to address
the concerns raised through alternative drafting.\16\
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\15\ The Commission received comment letters submitted by the
following: American Council of Life Insurers (ACLI); Better Markets,
Inc. (Better Markets); Cboe Global Markets, Inc. (CBOE); CME Group
Inc. (CME); Commodity Markets Council (CMC); Futures Industry
Association (FIA); Investment Company Institute (ICI);
Intercontinental Exchange Inc. (ICE); International Swaps and
Derivatives, Inc. (ISDA); LCH Group (LCH); National Grain and Feed
Association (NGFA); Options Clearing Corporation (OCC); Part 190
Subcommittee of the Business Law Section of the American Bar
Association (ABA Subcommittee); Securities Industry and Financial
Markets Asset Management Group and Managed Funds Association (SIFMA
AMG/MFA);); Kathryn Trkla; Geoffrey Goodman; and Vincent Lazar, as
individuals (Subcommittee Members), and Vanguard Group, Inc.
(Vanguard).
\16\ The Commission also issued the Supplemental Proposal, which
withdrew proposed Sec. 190.14(b)(2) and (3), and proposed an
alternative. The Commission received 5 substantive comment letters
in response, each of which was from an entity that had also
submitted a comment letter on the Proposal. For the reasons
discussed in section II.H below, the Commission is not adopting the
Supplemental Proposal.
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II. Finalized Regulations
In the discussion below, the Commission highlights topics of
interest to commenters and discusses comment letters that are
representative of the views expressed on those topics. The discussion
does not explicitly respond to every comment submitted; rather, it
addresses important issues raised by the proposed rulemaking and
analyzes those issues in the context of specific comments.
A. Subpart A--General Provisions \17\
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\17\ The Commission is adopting the proposed technical
corrections and updates to parts 1, 4, and 41, which are discussed
in section II.F. below. Moreover, as discussed in section II.B.8,
parts of proposed Sec. 190.10 are being adopted, but codified in
part 1.
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The Commission is adopting as subpart A (Sec. Sec. 190.00-190.02)
general provisions to address both debtors that are both FCMs and
debtors that are DCOs.
[[Page 19327]]
1. Regulation Sec. 190.00: Statutory Authority, Organization, Core
Concepts, Scope, and Construction
The Commission is adopting Sec. 190.00 as proposed with the
addition of Sec. 190.00(c)(3)(i)(C) and the modification to Sec.
190.00(d)(3)(v), as set forth below. The Commission is adopting Sec.
190.00 to set forth general provisions that state facts and concepts
that exist in the Commission's bankruptcy regulations. It is applicable
to all of part 190. The Commission's intent is to assist trustees,
bankruptcy courts, customers, clearing members, clearing organizations,
and other interested parties in understanding the Commission's
rationale for, and intent in promulgating, the specific provisions of
part 190. The Commission also believes that the regulation may be
particularly useful in a time of crisis for those individuals who may
not have extensive experience with the CEA or Commission regulations.
The Commission requested comment with respect to all aspects of
proposed Sec. 190.00. The Commission also raised specific questions as
to whether a regulation setting forth core concepts would be useful;
whether the core concepts were under or over inclusive; and whether the
definitions and discussions for each core concept would be helpful. The
Commission received several comments expressing support for various
aspects of proposed Sec. 190.00, including comments from SIFMA AMG/
MFA, CME, and the ABA Subcommittee. CME noted in particular that it
believed that the regulation ``may prove particularly useful to a
trustee who has little experience with the CEA or the Commission's
customer funds segregation rules, as they try to get `up to speed' in
the critical early hours and days following the trustee's appointment
when the trustee is expected to act quickly on various matters.''
The Commission is adopting Sec. 190.00(a) to set forth the
Commission's statutory authority to adopt the proposed part 190
regulations under section 8a(5) of the CEA, which empowers the
Commission to make and promulgate such rules and regulations as are
necessary to effectuate any of the provisions or to accomplish any of
the purposes of the CEA, and section 20 of the CEA, which provides that
the Commission may, notwithstanding the Bankruptcy Code, adopt certain
rules or regulations governing a proceeding involving a commodity
broker that is a debtor under subchapter IV of chapter 7 of the
Bankruptcy Code. The Commission received comments from CME and the ABA
Subcommittee specifically supporting the inclusion of an explanation of
the Commission's authority to adopt the part 190 regulations in Sec.
190.00.
The Commission is adopting Sec. 190.00(b) to explain that the part
190 regulations are organized into three subparts. Subpart A contains
general provisions applicable in all cases. Subpart B contains
provisions that apply when the debtor is an FCM, the definition of
which includes acting as a foreign FCM.\18\ Subpart C contains
provisions that apply when the debtor is a DCO, as defined by the CEA.
The Commission received comments from the ABA Subcommittee, CME, and
ICI in support of the reorganization of part 190.
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\18\ See CEA section 1a(28), 7 U.S.C. 1a(28). The definition of
foreign FCM involves soliciting or accepting orders for the purchase
or sale of a commodity for future delivery executed on a foreign
board of trade, or by accepting property or extending credit to
margin, guarantee or secure any trade or contract that results from
such a solicitation or acceptance. See section 761(12) of the
Bankruptcy Code, 11 U.S.C. 761(12).
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The Commission is adopting Sec. 190.00(c) to set forth the core
concepts \19\ of part 190 that are central to understanding how a
commodity broker bankruptcy works. These include concepts related to
commodity brokers and commodity contracts, account classes, public
customers and non-public customers, Commission segregation
requirements, member property,\20\ porting of public customer commodity
contract positions, pro rata distribution, and deliveries.
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\19\ The Commission is using to use the term ``core concepts''
to avoid confusion with the core principles applicable to registered
entities. Cf. CEA section 5b(c)(2), 7 U.S.C. 7a-1(c)(2).
\20\ ``Member property'' is defined in Sec. 190.01 and will be
used to identify cash, securities, or property available to pay the
net equity claims of clearing members based on their house account
at the clearing organization. Cf. 11 U.S.C. 761(16).
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The Commission is adopting Sec. 190.00(c)(1) to explain that
subchapter IV of chapter 7 of the Bankruptcy Code applies to a debtor
that is a ``commodity broker,'' the definition of which requires a
``customer.'' \21\ Section 190.00(c)(1) states that the regulations in
part 190 apply to commodity brokers that are FCMs as defined by the
Act, or DCOs as defined by the Act.
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\21\ See 11 U.S.C. 101(6) (definition of ``commodity broker''),
761(9) (definition of ``customer'' referred to in 101(6)).
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The Commission is adopting Sec. 190.00(c)(2) to explain that the
CEA and Commission regulations provide separate treatment and
protections for different types of cleared commodity contracts or
account classes. The four account classes include the (domestic)
futures account class (including options on futures),\22\ the foreign
futures account class (including options on foreign futures),\23\ the
cleared swaps account class for swaps cleared by a registered DCO
(including cleared options other than options on futures or foreign
futures),\24\ and the delivery account class for property held in an
account designated as a delivery account. Delivery accounts are used
for effecting delivery under commodity contracts that provide for
settlement via delivery of the underlying when a commodity contract is
held to expiration or, in the case of an option on a commodity, is
exercised.\25\
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\22\ This corresponds to segregation pursuant to section 4d(a)
of the CEA, 7 U.S.C. 6d(a).
\23\ This corresponds to segregation pursuant to Sec. 30.7
(enacted pursuant to section 4(b)(2)(A) of the CEA, 7 U.S.C.
6(b)(2)(A).
\24\ This corresponds to segregation pursuant to section 4d(f)
of the CEA, 7 U.S.C. 6d(f).
\25\ Delivery accounts are discussed further below in, e.g.,
Sec. Sec. 190.00(c)(6), 190.01 (definition of delivery account,
cash delivery property, physical delivery property) and 190.06.
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The Commission is adopting Sec. 190.00(c)(3)(i) to prescribe the
separate treatment of ``public customers'' and ``non-public
customers,'' as defined in Sec. 190.01, within each account class in
the event of a proceeding in which the debtor is an FCM. It explains
that, in a bankruptcy, public customers are generally entitled to a
priority distribution of cash, securities, or other customer property
over ``non-public customers,'' and both are given a priority over all
other claimants (except for claims relating to the administration of
customer property) pursuant to section 766(h) of the Bankruptcy
Code.\26\ The Commission is adopting Sec. 190.00(c)(3)(ii) to address
the division of customer property and member property in proceedings in
which the debtor is a clearing organization. In such a proceeding,
customer property consists of member property, which is distributed to
pay member claims based on members' house accounts, and
[[Page 19328]]
customer property other than member property, which is reserved for
payment of claims for the benefit of members' public customers. The
Commission is adopting Sec. 190.00(c)(3)(iii) to address the
preferential assignment of property among customer classes and account
classes in clearing organization bankruptcies. Certain customer
property, as specified in Sec. 190.18(c), will be preferentially
assigned to ``customer property other than member property'' (i.e.,
property for the public customers of members) instead of ``member
property'' to the extent that there is a shortfall in funded balances
for members' public customer claims. To the extent that there are
excess funded balances for members' claims in any customer class/
account class combination, that excess will also be assigned
preferentially to ``customer property other than member property'' for
other account classes to the extent of any shortfall in funded balances
for members' public customer claims in such account classes. Where
property will be assigned to a particular customer class with more than
one account class, it will be assigned on a least funded to most funded
basis among the account classes.
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\26\ Section 766(h) of the Bankruptcy Code explicitly states
that the trustee shall distribute property ratably to customers in
priority to all other claims, except claims that are attributable to
the administration of customer property. Notwithstanding any other
provision of this subsection, a customer net equity claim based on a
proprietary account may not be paid either in whole or in part,
directly or indirectly, out of customer property unless all other
customer net equity claims have been paid in full. Thus, all
customer property will be allocated to public customers so long as
the funded balance in any account class for public customers is less
than one hundred percent of public customer net equity claims. Once
all account classes for public customers are fully funded (i.e., at
one hundred percent of net equity claims), any excess will be
allocated to non-public customers' net equity claims until all of
those are fully funded.
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The Commission is adopting Sec. 190.00(c)(4) to explain that, in a
proceeding in which the debtor is an FCM, part 190 details the policy
preference for transferring to another FCM (commonly known as
``porting''), the open commodity contract positions of the debtor's
customers along with all or a portion of such customers' account
equity.\27\
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\27\ Transfer or porting of customer positions mitigates risks
to both the customers of the debtor FCM and to the markets.
Specifically, porting (rather than the alternative, liquidation) of
customer positions protects customers' hedges from changes in value
between the time they are liquidated and the time, if any, that the
customer may be able to re-establish them (and thus mitigates the
market risk that some customers use the futures markets to
counteract), and similarly protects customers' directional
positions. Moreover, not all customers may be able to re-establish
positions with the same speed--in particular, smaller customers may
be subject to longer delays in re-establishing their positions. In
addition, liquidation of an FCM's book of positions can increase
volatility in the markets, to the detriment of all market
participants (and also contribute to making it more expensive for
customers to re-establish their hedges and other positions).
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The Commission is adopting Sec. 190.00(c)(5) to address pro rata
distribution. It explains that, if the aggregate value of customer
property in a particular account class is less than the amount needed
to satisfy the net equity claims of public customers in that account
class (i.e., there is a ``shortfall''), customer property in that
account class will be distributed pro rata to those public customers.
The pro rata distribution principle carries forth the statutory
direction in section 766(h) of the Bankruptcy Code. It ensures that all
public customers within an account class will suffer the same
proportional loss, including those public customers that post as
collateral letters of credit or specifically identifiable property.\28\
Any customer property that is not attributable to any particular
account class or which is in excess of public customer net equity
claims for the account class to which it is attributed, will be
distributed to public customers in respect of net equity claims in
other account classes where there is a shortfall. Thus, as noted in
Sec. 190.00(c)(3), all public customer net equity claims would receive
priority over non-public customer claims.
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\28\ In prior bankruptcies, some customers posting letters of
credit or specifically identifiable property as collateral sought to
escape pro rata treatment for these categories of collateral,
contrary to the Commission's intent. See discussion of Sec.
190.04(d)(3) in section II.B.2 below.
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The Commission is adopting Sec. 190.00(c)(6) to address
deliveries. It explains that the delivery provisions of part 190 apply
to any commodity that is subject to delivery under a commodity
contract, including agricultural commodities, other non-financial
commodities (such as metals or energy), and commodities that are
financial in nature (including virtual currencies). In the ordinary
course of business, commodity contracts with delivery obligations are
offset before reaching the delivery stage (i.e., prior to triggering
bilateral delivery obligations). Nonetheless, when delivery obligations
do arise, a delivery default could have a disruptive effect on the cash
market for the commodity and could adversely impact the parties to the
transaction. In a proceeding in which the debtor is an FCM, the
delivery provisions in part 190 reflect the policy preferences (A) to
liquidate commodity contracts that settle via delivery before they move
into a delivery position and (B) when contracts do move into a delivery
position, to allow the delivery to occur, where practicable, outside
the administration of the debtor's estate (i.e., directly between the
debtor's customer and the delivery counterparty assigned by the
clearing organization).
The Commission received several comments expressing support for
certain provisions in Sec. 190.00(c) and two comments expressing
concerns. CME expressed support for ``limiting the scope of part 190 to
the bankruptcy of a commodity broker that is an FCM or a DCO and to
commodity contracts that are cleared'' as set forth Sec. 190.00(c)(1).
CME, OCC, Vanguard, and NGFA supported the concept of preferring the
claims of public customers over non-public customers in a bankruptcy
proceeding. CME agreed with the inclusion of the core concept set forth
Sec. 190.00(c)(3)(ii), noting that ``it aids understanding to explain
how the distinction between the public customer class and the non-
public customer class is reflected at the DCO-level in the distinctions
made between customer accounts and house accounts and between the two
categories of customer property--customer property and member
property--that are available to satisfy the net equity claims of
each.'' Better Markets supported the clarification in Sec.
190.00(c)(5)(ii) that customers relying on letters of credit must carry
the same proportional losses as customers posting other forms of
acceptable collateral.
NGFA supported the core concept of prioritizing the prompt transfer
of customer accounts and positions to another FCM as opposed to
liquidating customer accounts. OCC, however, disagreed with this policy
preference. OCC supported ``the Commission's objective to mitigate risk
to an FCM's customers and limit market volatility,'' noting that
``[p]orting positions and associated collateral in an FCM bankruptcy
proceeding can be an effective way to achieve these objectives in some
instances.'' OCC believed, however, that the trustee should retain
broad discretion to decide, on a case-by-case basis and in
consideration of certain factors (e.g., the defaulting FCM's total book
of positions and market conditions) whether porting or liquidating
positions will achieve the best result for customers involved in an
FCM's bankruptcy. OCC further commented that the market risk associated
with closing out and reopening positions for certain customers that may
be introduced with liquidation should be weighed against potential
drawbacks of porting, including that ``(i) a trustee (or DCO) must
first identify a transferee to accept the open position[s] and
collateral, which depending on market conditions could be a difficult
and time consuming process; (ii) until the transfer is complete, the
customer may face uncertainty as to how its position and associated
collateral will be resolved and may not be able to exit the position in
a timely and efficient manner; and (iii) a customer may be required to
post additional collateral at a new FCM prior to or immediately after a
transfer.''
In response to the concerns raised by OCC, the Commission notes
first that, as OCC forthrightly acknowledges,
[[Page 19329]]
liquidating customer positions may introduce market risk associated
with closing out and reopening positions for certain customers.
Additionally, liquidating a mass of customer positions may roil the
markets, if any, where those positions are concentrated. For these
reasons, the policy preference in favor of transfer is both supported
by statute and quite longstanding. It is supported by Sec. 764(b) of
the Bankruptcy Code, which explicitly permits transfers of commodity
contracts that are authorized by the Commission up to seven calendar
days after the order for relief. It is also embodied in current Sec.
190.02(e), which requires the trustee to immediately use its best
efforts to effect a transfer, and is continued in proposed (and
adopted) Sec. 190.04(a)(1).
Furthermore, Sec. 190.00(c)(4) establishes, consistent with Sec.
764(b), a policy preference for porting, rather than a mandate for
porting. This recognizes that finding willing and able transferees for
all customer positions may or may not be practicable. Moreover, Sec.
190.04(a)(1) requires the trustee to use its best efforts to effect a
transfer no later than the seventh calendar day after the order for
relief,\29\ and Sec. 190.04(d) requires the trustee promptly to
liquidate most remaining contracts after than time. Indeed, as a
practical matter, there is cause for doubt that a DCO will permit the
trustee of a debtor that is a clearing member to hold open contracts
quite that long.\30\ Thus, despite the preference for porting, there
are practical limits to how long contracts will be held open before
being liquidated. This also imposes temporal limits on the uncertainty
customers will face as to how their positions will be resolved.
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\29\ Indeed, the preference contained Sec. 190.00(c)(4) does
not represent a departure from the existing standards under current
part 190. It merely highlights the requirement in Sec. 190.04(a)(1)
that the trustee use its best efforts to effect a transfer no later
than the seventh calendar day after the order for relief; that
requirement is substantially identical to the requirement in current
Sec. 190.02(e).
\30\ For example, OCC Rule 1102(a) provides that OCC may
summarily suspend any Clearing Member which is in such financial or
operating difficulty that OCC determines and so notifies the
Securities and Exchange Commission or the Commodity Futures Trading
Commission that suspension is necessary for the protection of the
Corporation, other Clearing Members, or the general public. OCC Rule
1106 permits OCC to close out the positions of a suspended clearing
member.
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Finally, while a customer may indeed be called for additional
collateral at a transferee FCM (particularly if less than 100% of the
collateral is transferred along with the positions), a customer that is
unwilling to meet such a call will at the least be permitted to have
their positions liquidated. That would entitle the customer to prompt
return by the transferee FCM of the remaining collateral that was
transferred--which may well be more prompt than a distribution in the
bankruptcy proceeding of the debtor.
ICI expressed concerns with respect to the discretion granted to
the trustee under the part 190 regulations. ICI agreed with the
Commission ``that trustees need flexibility given the myriad of
decisions they must make in a short period of time and the unique
circumstances that each commodity broker insolvency may present,'' and
that ``trustees to date have exercised their discretion in a manner
that has generally promoted customer protection.'' ICI cautioned,
however, that the Commission should take steps to help ensure that the
trustee prioritizes the protection of public customers. ICI urged the
Commission to make clear in Sec. 190.00 ``that the trustee must
exercise [its] discretion in a manner that it determines will result in
the greatest recovery for, and the least disruption to, public
customers.'' With respect to part 190 regulations that are
``specifically aimed at protecting customers,'' ICI asserted the
trustee's discretion should be more limited. While ICI acknowledged
that, at times, compliance with such provisions ``may be impractical or
impossible or may cause harm to customers,'' ICI was concerned that a
``reasonable efforts'' standard ``could signal that the trustee has
wider latitude to depart from the requirement at issue.'' ICI asked the
Commission to impose a ``best efforts'' standard in certain cases.
The Commission agrees with ICI that the trustee should exercise its
discretion in a manner that best achieves the overarching goal of
protecting the interests of public customers as a class, and
specifically should act in the manner that it determines will result in
the greatest recovery for, and the least disruption to, public
customers. The Commission notes that, at times, those two sub-goals may
be in tension. Because the Commission does not believe that there is a
universally optimal means to reconcile the two sub-goals in aid of best
achieving the overarching goal of protecting the interests of public
customers, the Commission concludes that it is best to leave the
balancing of the two sub-goals to the discretion of the trustee. It is
in that context that the Commission has decided to direct the trustee
to exercise ``reasonable efforts'' rather than ``best efforts'' to
achieve certain standards. In determining what efforts are
``reasonable,'' the trustee should act to achieve the overarching goal.
In light of the foregoing and to provide clarity with respect to
the scope of the trustee's discretion, the Commission is adopting new
Sec. 190.00(c)(3)(i)(C) which provides that where a provision in part
190 affords the trustee discretion, that discretion should be exercised
in a manner that the trustee determines will best achieve the
overarching goal of protecting public customers as a class by enhancing
recoveries for, and mitigating disruptions to, public customers as a
class. In seeking to achieve that overarching goal, the trustee has
discretion to balance those two subgoals when they are in tension.
Where the trustee is directed to exercise ``reasonable efforts'' to
meet a standard, those efforts should only be less than ``best
efforts'' to the extent that the trustee determines that such an
approach would support the foregoing goals.\31\
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\31\ While `` `[b]est efforts' is a term which necessarily takes
its meaning from the circumstances,'' the trustee in exerting best
efforts to meet a standard must diligently exert efforts to meet
that standard ``to the extent of its own total capabilities.'' See
generally Bloor v. Falstaff Brewing Corp, 454 F.Supp. 258, 266-67
aff'd 601 F.2d 609 (2nd. Cir. 1979). By contrast, in exerting
``reasonable efforts'' to meet a standard, the Commission expects
that the trustee will work in good faith to meet the standard, but
will also take into account other considerations, including the
impact of the effort necessary to meet the standard on the
overarching goal of protecting public customers as a class.
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The Commission is adopting Sec. 190.00(d)(1) to describe the scope
of commodity broker proceedings under subchapter IV of chapter 7 of the
Bankruptcy Code,\32\ and the relationship between part 190 to SIPA
proceedings (where the debtor is a commodity broker) and to resolution
of commodity brokers under Title II of the Dodd-Frank Act.''
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\32\ 12 U.S.C. 5381 et seq.
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Section 190.00(d)(1)(i) acknowledges that, while section 101(6) of
the Bankruptcy Code recognizes ``commodity options dealers'' and
``leverage transaction merchants'' (as defined in sections 761(6) and
(13) of the Bankruptcy Code), as separate categories of commodity
brokers, there are no commodity options dealers or leverage transaction
merchants currently registered as such. As set forth in the Note to
paragraph (d)(1)(i)(B), the Commission is declaring its intent to adopt
regulations with respect to commodity options dealers and leverage
transaction merchants, respectively, at such time as an entity
registers as such.
Section 190.00(d)(1)(ii) explains that, pursuant to section 7(b) of
SIPA,\33\ the
[[Page 19330]]
trustee in a SIPA proceeding where the debtor is also a commodity
broker has the same duties as a trustee in a proceeding under
subchapter IV of chapter 7 of the Bankruptcy Code, to the extent
consistent with SIPA or as ordered by the court.\34\ This part
implements subchapter IV of chapter 7 by establishing the trustee's
duties thereunder, consistent with the broad authority granted to the
Commission pursuant to section 20 of the CEA. Therefore, this part also
applies to a proceeding commenced under SIPA with respect to a debtor
that is registered as a broker or dealer under section 15 of the
Securities Exchange Act of 1934 \35\ when the debtor also is an FCM.
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\33\ 15 U.S.C. 78aaa et seq.
\34\ See SIPA section 7(b), 15 U.S.C. 78fff-1(b) (To the extent
consistent with the provisions of [SIPA] or as otherwise ordered by
the court, a trustee shall be subject to the same duties as a
trustee in a case under chapter 7 of title 11, including, if the
debtor is a commodity broker, as defined under section 101 of such
title, the duties specified in subchapter IV of such chapter 7).
\35\ 15 U.S.C. 78o.
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Moreover, in the context of a resolution proceeding under Title II
of Dodd-Frank, section 210(m)(1)(B) \36\ provides that the FDIC (in its
role as resolution authority) must apply the provisions of subchapter
IV of chapter 7 of the Bankruptcy Code in respect of the distribution
of customer property and member property of a resolution entity \37\
that is a commodity broker as if the resolution entity were a debtor
for purposes of subchapter IV. Accordingly, Sec. 190.00(d)(1)(iii)
explains that this part shall serve as guidance with respect to the
distribution of property in a proceeding in which the FDIC acts as a
receiver for an FCM or DCO pursuant to Title II of Dodd-Frank.\38\
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\36\ 12 U.S.C. 5390(m)(1)(B).
\37\ That is, the entity being resolved under Title II. Section
210(m)(1)(b) refers to ``any covered financial company or bridge
financial company.''
\38\ 12 U.S.C. 5390(m)(1)(B) provides that the FDIC must apply
the provisions of subchapter IV of chapter 7 of the Code with
respect to the distribution of customer property and member property
in connection with the liquidation of a commodity broker that is a
``covered financial company'' or ``bridge financial company'' (terms
defined in 12 U.S.C. 5381(a)).
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The Commission is adopting Sec. 190.00(d)(2)(i) to clarify that a
trustee may not recognize any account classes not explicitly provided
for in part 190. Section 190.00(d)(2)(ii) provides that no property
that would otherwise be included in customer property, as defined in
Sec. 190.01, shall be excluded from customer property because it is
considered to be held in a constructive trust, resulting trust, or
other trust that is implied in equity.
Generally, in a commodity broker bankruptcy, the basis for
distributing segregated customer property is pro rata treatment. To
achieve this goal, the FCM's segregation records (including account
statements) and reporting to the Commission and self-regulatory
organizations (``SROs'') and DCOs must reflect what is actually
available for customers. This is necessary to enable FCMs, SROs, DCOs,
and the Commission to ensure, during business as usual, that (a)
customer property is being properly protected pursuant to the
segregation requirements of section 4d of the CEA and the regulations
thereunder, and (b) customer property is not subject to hidden
arrangements that cannot be accounted for transparently and reliably.
Through Sec. 190.00(d)(2)(ii), the Commission is making clear that
customer property cannot be burdened by equitable trusts. Attempting to
account for such equitable trusts in a bankruptcy proceeding under part
190 would undermine the Commission's implementation and enforcement of
the statutory scheme under the CEA.
Section 190.00(d)(3) provides that certain transactions, contracts,
or agreements are excluded from the term ``commodity contract.'' \39\
The excluded agreements and transactions traditionally have not been
considered to be commodity contracts for purposes of segregation and
customer protection, while those that are excepted from these
exclusions are so considered, and thus are covered by part 190.
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\39\ The contracts that would be excluded include: Options on
commodities unless cleared by a DCO (or, in the context of a foreign
futures clearing member, a foreign clearing organization); forwards
(defined as such pursuant to the exclusions in sections 1a(27) or
1a(47)(B)(ii) of the CEA), unless they are cleared by a DCO (or, in
the context of a foreign futures clearing member, a foreign clearing
organization); security futures products when they are carried in a
securities account; retail foreign currency transactions described
in sections 2(c)(2)(B) or (C) of the CEA; security-based swaps or
other securities carried in a securities account (other than
security futures products carried in an enumerated account class);
and retail commodity transactions described in section (2)(c)(2)(D)
of the CEA (other than transactions executed on or subject to the
rules of a designated contract market (``DCM'') or foreign board of
trade (``FBOT'') as if they were futures).
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The Commission received four comments supportive of specific
provisions of proposed Sec. 190.00(d) and one comment requesting a
modification of the regulation. CME agreed that removing provisions
relating to commodity option dealers and leverage transaction merchants
would ``improve the rules' clarity.'' CME and Cboe expressed support
for the clarification in Sec. 190.00(d)(1)(ii) of the applicability of
SIPA in the bankruptcy proceeding of a firm that is dually registered
as an FCM and a broker-dealer where the bankruptcy must be handled
pursuant to SIPA rather than by the FCM rules. Cboe noted that such
clarity will be ``beneficial to the entire ecosystem, including
customers of FCMs and broker-dealers'' and will ``further the ability
of market participants to utilize portfolio margining and the
associated efficiencies.'' CME expressed support for Sec.
190.00(d)(1)(iii). CME specifically supported ``setting out that Part
190 `shall serve as guidance' to the FDIC as receiver for an FCM or DCO
in a proceeding under Title II of Dodd Frank, with respect to the
distribution of customer property and member property.'' Noting that
``Title II [of the Dodd-Frank Act] directs the FDIC to apply the
provisions of subchapter IV of chapter 7 of the [Bankruptcy] Code with
respect to such distributions,'' CME stated its belief that ``it is
reasonable to read Title II's cross-reference to subchapter IV of
chapter 7 ``as indirectly bringing [p]art 190 into the scope of that
provision given the need for Commission regulations to give specificity
and meaning to the general principles set out in subchapter IV.'' SIFMA
AMG/MFA supported the principle of excluding property held in a
constructive trust from customer property as set forth in Sec.
190.00(d)(2)(ii), noting that this principle ``serves to preserve the
integrity of customer property.'' ICI strongly supported setting forth
the prohibition on excluding property from ``customer property''
because it is considered to be held in a trust implied in equity in
Sec. 190.00(d)(2)(ii), and the exclusion from the term ``commodity
contract'' of off-exchange retail foreign currency transactions in
Sec. 190.00(d)(3)(iv).
The ABA Subcommittee recommended one modification to this
regulation. It asked the Commission to amend proposed Sec.
190.00(d)(3)(v) to clarify that mixed swaps could be commodity
contracts subject to part 190. In support of its position, the ABA
Subcommittee asserted that a DCO could theoretically provide clearing
services to FCMs and their customers with respect to mixed swaps, where
the mixed swap positions are carried in accounts subject to part 22 and
customers are part of the cleared swap account class under part 190.
The ABA Subcommittee analogized the inclusion of mixed swaps within the
``commodity contract'' definition to the Commission's proposal to not
exclude security futures products from the commodity contract
definition when the security futures product is carried in an account
for which there is a corresponding account class under part 190. The
Commission agrees with the
[[Page 19331]]
ABA Subcommittee's reasoning with respect to proposed Sec.
190.00(d)(3)(v) and is amending Sec. 190.00(d)(3)(v) to read in
pertinent part, that ``. . . a security futures product or mixed swap
(as defined in 1a(47)(D) of the Act) that is, in either case, carried
in an account for which there is a corresponding account class under
part 190 is not excluded.''
The Commission is adopting Sec. 190.00(e) to explain the context
in which part 190 should be interpreted. It states that any references
to other federal rules and regulations refer to the most current
versions of these rules and regulations (i.e., ``as the same may be
amended, superseded or renumbered'') and that, where they differ, the
definitions set forth in Sec. 190.01 shall be used instead of the
defined terms set forth in section 761 of the Bankruptcy Code. The
Commission notes that other regulations in part 190 are designed to be
consistent with subchapter IV of chapter 7 of the Bankruptcy Code.
Section 190.00(e) addresses account classes in the context of
portfolio margining and cross margining programs. Where commodity
contracts (and associated collateral) that would be attributable to one
account class are, instead, commingled with the commodity contracts
(and associated collateral) in a second account class (the ``home
field''), then the trustee must treat all such commodity contracts and
associated collateral as being held in, and consistent with the
regulations applicable to, an account of the second account class. The
approach of following the rules of the ``home field'' also pertains to
securities positions held in a commodity account class (and thus
treated in accord with the relevant commodity account class) and
commodity contract positions (and associated collateral) held in the
securities account, in which case the rules applicable to the
securities account will apply, consistent with section 16(2)(b)(ii) of
SIPA, 15 U.S.C. 78lll(2)(b)(ii).
The Commission received two comments on proposed Sec. 190.00(e).
ICI and Cboe expressed support for the clarity provided by Sec.
190.00(e) with respect to portfolio margining and cross margining
programs. ICI strongly supported the ``home field'' rule in proposed
Sec. 190.00(e), noting that providing ``clarity regarding how
transactions and margin that are portfolio margined in the same account
will be treated in the event that an FCM or broker-dealer becomes
insolvent is a ``prerequisite for an effective portfolio margining
regime.''
Accordingly, after consideration of the comments and for the
reasons stated above, the Commission is adopting Sec. 190.00 as
proposed with the addition of Sec. 190.00(c)(3)(i)(C) and the
modification to Sec. 190.00(d)(3)(v), as set forth above.
2. Regulation Sec. 190.01: Definitions
The Commission is adopting Sec. 190.01 as proposed with
modifications set forth below, to update the definitions for revised
part 190. Most of the changes in Sec. 190.01 are conforming changes,
such as correcting cross-references and deleting definitions of certain
terms that are not used in part 190, as amended. Other changes tie the
definitions in Sec. 190.01 more closely to the definitions in Sec.
1.3 and other Commission regulations, to reflect changes in Commission
regulations. In some cases, the Commission is adopting more substantive
changes to the definitions, such as amending or adding definitions to
further clarify and provide additional details where the current
definitions are silent or unclear, or to reflect concepts that are new
to part 190. In particular, the Commission is separating the delivery
account class into two subclasses, a physical delivery account class
and a cash delivery account class; the relevant terms are defined
below. The definitions of commodity contract and physical delivery
property codify positions that the Commission has taken in recent
commodity broker bankruptcies.\40\
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\40\ Respectively, In Re Peregrine Financial Group, Inc., No.
12-B27488 (Bankr. N.D. Ill.), and MF Global, Inc.
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The Commission is also amending Sec. 190.01 to replace the
paragraphs identified with an alphabetic designation for each defined
term (e.g., ``Sec. 190.01(ll)'') with a simple alphabetized list, as
is recommended by the Office of the Federal Register, and as recently
implemented by the Commission with respect to, e.g., Sec. 1.3.\41\
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\41\ See generally 83 FR 7979, 7979 & n.6 (Feb. 23, 2018).
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The Commission requested comment with respect to all aspects of
proposed Sec. 190.01, including the usefulness and any unintended
consequences of the revised definitions. The Commission received a
number of comments on the proposed definitions in Sec. 190.01. As
further detailed below, the Commission is modifying some of the
definitions in response to comments. Unless stated otherwise below, the
Commission did not receive any comments on a proposed definition in
Sec. 190.01 and is adopting each definition as proposed.\42\
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\42\ The Commission did not receive comments with respect to the
following part 190 definitions as proposed in Sec. 190.00: Act,
Bankruptcy code, Business day, Calendar day, Cash delivery account
class, Cash equivalents, Clearing organization, Commodity broker,
Commodity contract account, Court, Cover, Customer, Customer claim
of record, Customer class, Dealer option, Debtor, Distribution,
Equity, Exchange Act, FDIC, Filing Date, Final net equity
determination date, Foreign board of trade, Foreign clearing
organization, Foreign future, Foreign futures commission merchant,
Foreign futures intermediary, Funded balance, Futures and futures
contract, In-the-money amount, Joint account, Leverage contract,
Leverage transaction merchant, Member property, Net equity, Open
commodity contract, Order for relief, Person, Premium, Primary
liquidation date, Principal contract, Securities Account, SIPA,
Security, Short term obligation, Specifically identifiable property,
Strike price, Substitute customer property, Swap, Trustee, and
Undermargined. Accordingly, the Commission is adopting those
definitions as proposed, as discussed later in section II.A.2.
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The Commission is adopting the definition of ``account class'' as
proposed with the modifications described below. The current definition
of the term ``account class'' specifies that it includes certain types
of customer accounts, each of which is to be recognized as a separate
class of account. The types are ``futures account,'' ``foreign futures
accounts,'' ``leverage accounts,'' ``delivery accounts,'' and ``cleared
swap accounts.'' The Commission is adding detail to the definition of
``account class'' by including therein definitions of ``futures
account,'' ``foreign futures accounts,'' ``cleared swaps accounts,''
and ``delivery accounts.'' However, as discussed above with respect to
Sec. 190.00(d)(1)(i), the Commission is removing, at least
temporarily, the ``commodity options'' and ``leverage account'' account
classes.\43\
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\43\ The Commission is adopting paragraph (2) of the definition
of account class to address commingling orders and rules.
Specifically, there are cases where commodity contracts (and
associated collateral) that would be attributable to one account
class are held separately from contracts and collateral associated
with that first account class, and instead are allocated to a
different account class and commingled with contracts and collateral
in that latter account class. This would take place because the
contracts in question are risk-offsetting to contracts in the latter
account class. For example, this could involve portfolio margining
within a DCO or cross-margining between a DCO and another central
counterparty, which may or may not be a DCO. This commingling may be
authorized pursuant to a Commission regulation or order, or pursuant
to a clearing organization rule that is approved in accordance with
Sec. 39.15(b)(2). The Commission is adopting paragraph (2) to
confirm that the trustee must treat the commodity contracts in
question (and the associated collateral) as being held in an account
of the latter account class. The Commission is also adopting
paragraph (3) of the definition of account class to address cases
where the commodity broker establishes internal books and records in
which it records a customer's commodity contracts and collateral,
and related activity. It confirms that the commodity broker is
considered to maintain such an account for the customer regardless
of whether it has kept such books and records current or accurate.
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[[Page 19332]]
The Commission is adopting the definition of ``futures account'' to
cross-reference the definition of the same term in Sec. 1.3 of the
Act, while the definition of ``cleared swaps account'' cross-references
the definition of ``cleared swaps customer account'' in Sec. 22.1.
These definitions apply to both FCMs and DCOs. The definition of
``foreign futures account'' cross-references the definition of ``30.7
account'' in Sec. 30.1(g). As that latter definition is limited to
FCMs, the Commission is adopting a corresponding reference to such
accounts at a clearing organization, in the event that a clearing
organization clears foreign futures transactions for members that are
FCMs, where those accounts are maintained on behalf of those FCM
members' 30.7 customers (as that latter term is defined in Sec.
30.1(f)). The Commission clarifies that this would not apply if a
foreign clearing organization is clearing foreign futures for clearing
members that are not subject to the requirements of Sec. 30.7.
The ABA Subcommittee and CME recommended that the Commission expand
the definitions of ``futures account,'' ``foreign futures account,''
and ``cleared swaps account'' within the Sec. 190.01 definition of
``account class'' to cover the accounts of non-public customers. The
ABA Subcommittee and CME stated that as proposed, the cross-references
to Sec. 1.3, the ``30.7 account'' in 30.1, and the ``cleared swaps
customer account'' in Sec. 22.1 within the account class definitions,
limited the scope of those definitions to only segregated accounts of
public customers despite the Commission's intention to use those same
account class distinctions for non-public customers elsewhere in the
part 190 rules. The ABA Subcommittee and CME suggested that those
account class distinctions are also relevant for the non-public
customer class (i.e., the holders of proprietary accounts carried by
FCMs and for clearing members' house accounts carried by DCOs).
The Commission is persuaded by the comments that there are, in at
least some cases, account class distinctions within the customer class
for non-public customers,\44\ and thus agrees that the revised
definitions of ``futures account,'' ``foreign futures account,'' and
``cleared swaps account'' within the Sec. 190.01 definition of
``account class'' should address separately non-public customers, and
has amended the definitions to do so.
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\44\ See, e.g., Sec. 190.09(c)(2)(iv) (allocating residual
property to the non-public customer estate for each account class in
the same order as is prescribed in paragraphs (c)(2)(i) through
(iii) of this section for the allocation of the customer estate
among account classes.)
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Accordingly, after consideration of the comments and for the
reasons stated above, the Commission is adopting the ``account class,''
``futures account,'' foreign futures account,'' and ``cleared swaps
account'' definitions in Sec. 190.01 as proposed with the
modifications referred to above.
The ``delivery account'' class is the fourth type of account class.
It is the relevant account through which an FCM or DCO accounts for the
making or taking of physical delivery under commodity contracts whose
terms require settlement by delivery of a commodity. The FCM or DCO
designates such account as a delivery account on its books and records.
The Commission is adopting the definition of ``delivery account'' as
proposed within paragraph (1)(iv) of the definition of account class,
with a modification to conform to the issue addressed in the preceding
paragraph: The delivery account applies to ``both public and non-public
customers, considered separately.'' \45\
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\45\ This separate consideration is a consequence of the fact
that, pursuant to Bankruptcy Code section 766(h), public customer
claims must be paid in full before non-public customer claims.
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The current definition of ``delivery account'' in Sec.
190.05(a)(2) refers to an account that contains only property described
in three of the nine categories of property in the current definition
of ``specifically identifiable property.'' The Commission has
determined to adopt a more functional definition of ``delivery
account'' in Sec. 190.01. This revised definition will focus on an
account maintained on the books and records of an FCM or DCO for the
purpose of accounting for the making or taking of delivery under
commodity contracts whose terms require settlement by delivery of a
commodity.\46\
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\46\ See Sec. 190.01.
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The Commission is thus adopting paragraph (1)(iv)(A)(1) to define
delivery accounts for FCMs. The Commission is adopting paragraph
(1)(iv)(A)(2) to incorporate the same concepts for clearing
organizations, and also permit a clearing organization to act as a
central depository for physical delivery property represented by
electronic title documents, or otherwise in electronic (dematerialized)
form.
As set forth in paragraph (1)(iv)(B), the delivery account class is
being subdivided into separate physical and cash delivery account
classes, as provided in Sec. 190.06(b), for purposes of pro rata
distributions to customers for their delivery claims. The definitions
of the terms ``physical delivery property'' and ``cash delivery
property'' are addressed in detail later in this section.
As customer property held in a delivery account is not subject to
the Commission's segregation requirements, the Commission believes it
may be more challenging and time-consuming to identify customer
property for the cash delivery account class,\47\ (and such cash would
thus be commingled with the FCM's own cash intended for operations).
Consequently, the Commission believes separating (1) most cash delivery
property and customer claims from (2) most physical delivery property
and customer claims should promote more efficient and prompter
distribution of the latter to customers. For these reasons, the
Commission is adopting the delivery account definition to be further
divided into physical delivery and cash delivery account classes, for
purposes of pro rata distributions to customers for their delivery
claims.
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\47\ The Commission agrees with a point previously made by the
ABA Committee: ``Based on lessons learned from the MF Global
Bankruptcy, those challenges are likely greater for tracing cash.
Physical delivery property, in particular when held in the form of
electronic documents of title as is prevalent today, is more readily
identifiable and less vulnerable to loss, compared to cash delivery
property that an FCM may hold in an operating bank account.'' See
Transmittal Letter from The Part 190 Subcommittee of the Business
Law Section of the American Bar Association accompanying Model Part
190 Rules (``ABA Cover Note''), available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61330&SearchText at 14. See also In re MF Global
Inc., 2012 WL 1424670 (noting how physical delivery property was
traceable).
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The claims with respect to the physical delivery and cash delivery
subclasses are fixed on the ``filing date.'' \48\ Thus, the physical
delivery account class includes, in addition to certain physical
delivery property, cash delivery property received post-filing date in
exchange for physical delivery property held on the filing date that
has been delivered under a commodity contract. Conversely, the cash
delivery account class includes, in addition to certain cash delivery
property, physical delivery property that has been received post-filing
date in exchange for cash delivery property held on the filing date.
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\48\ ``Filing date'' means the date that a petition under the
Bankruptcy Code or application under SIPA commencing a proceeding is
filed or on which the FDIC is appointed as a receiver pursuant to 12
U.S.C. 5382(a).
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CME and ICE supported separate subaccounts of the delivery account
for physical property (the property being delivered) and cash property
(cash used
[[Page 19333]]
to pay for delivery). CME agreed with the proposed definition of the
delivery account class and supported the proposed separation of the
delivery account class into the cash delivery account and physical
delivery account classes, as they delineate the customer property that
is available to distribute to customers in each account class on a pro
rata basis. CME agreed that cash delivery property should include cash
or cash equivalents recorded in a customer's delivery account as of the
filing date, along with any physical delivery property subsequently
received in accepting a delivery, and likewise that physical delivery
property should include any cash delivery property received subsequent
to the filing date in exchange for making a delivery. CME also had
specific comments on each of the two subaccount definitions as
discussed below.
CME noted that the Commission does not impose segregation
requirements on FCMs with respect to the cash or physical delivery
property that an FCM holds on behalf of its customers and records in a
delivery account. As learned from the In re MF Global, Inc. bankruptcy
(hereinafter ``MF Global''),\49\ CME agreed that it can be more
challenging for a trustee to trace the cash recorded in delivery
accounts than to trace physical delivery property. For example, the MF
Global trustee could more readily identify physical delivery property
in the form of electronic title documents, compared to identifying non-
segregated cash belonging to the delivery account class given the
fungible nature of cash.
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\49\ In re MF Global, No. 11-2790 (MG) (SIPA) (Bankr. S.D.N.Y.).
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CME recommended that the Commission address through a separate
rulemaking the broader issues around whether customer property carried
in delivery accounts should be subject to any special customer
protections, such as requirements that FCMs should hold such property
in custody accounts or limitations on how long cash or cash equivalents
should be held in delivery accounts that are not subject to custody
requirements.\50\
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\50\ This recommendation is addressed in section II.G below.
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At this time, after consideration of the comments and for the
reasons stated above the Commission is adopting the definition of
``delivery account'' as proposed, with the modification to note that it
applies to each of public and non-public customers, considered
separately.
The Commission is adopting the definition of ``cash delivery
property'' as proposed with the modifications described below. The
Commission proposed to define cash delivery property to carry through
the concepts from current Sec. 190.01(ll)(4) and (5) that the cash or
cash equivalents, or the commodity must be identified on the books and
records of the debtor as having been received, from or for the account
of a particular customer, on or after three calendar days before the
relevant (i) first delivery notice date in the case of a futures
contract or (ii) exercise date in the case of an option.
The Commission is adopting the cash delivery property definition to
mean any cash or cash equivalents recorded in a delivery account that
is, as of the filing date: (1) Credited to such account to pay for
receipt of delivery of a commodity under a commodity contract; (2)
credited to such account to collateralize or guarantee an obligation to
make or take delivery of a commodity under a commodity contract, or (3)
has been credited to such account as payment received in exchange for
making delivery of a commodity under a commodity contract. It includes
property in the form of commodities that have been delivered after the
filing date in exchange for cash or cash equivalents held in a delivery
account as of the filing date. The definition also requires that the
cash or cash equivalents, or the commodity, must be identified on the
books and the records of the debtor as having been received, from or
for the account of a particular customer, on or after seven calendar
days before the relevant (i) first delivery notice date in the case of
a futures contract or (ii) exercise date in the case of a cleared
option.\51\ In response to comments discussed below, the Commission is
adopting the definition of cash delivery property to also include any
cash transferred by a customer to the trustee on or after the filing
date for the purpose of paying for delivery, consistent with Sec.
190.06(a)(3)(ii)(B)(1). The Commission is also adopting the definition
in response to comments that requested that the Commission provide that
in the case of a contract where one fiat currency is to be exchanged
for another fiat currency, each currency will be considered cash
delivery property to the extent that it is recorded in a delivery
account.
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\51\ As discussed below, the proposal had specified a period of
three calendar days; after consideration of the comments, that
period has been changed to seven calendar days.
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Commenters generally supported separate subaccounts of the delivery
account, and that cash delivery property should include cash or cash
equivalents recorded in a customer's delivery accounts as of the filing
date, along with any delivery property subsequently received in
accepting a delivery. However, the Commission also received several
comments on three aspects of the proposed definition of cash delivery
property.
First, the ABA Subcommittee, CME, ICE, FIA, and CMC recommended
that the Commission remove the three-calendar day restriction proposed
in the definition of cash delivery property in Sec. 190.01. While
several of these commenters recognized the Commission's intention to
encourage customers and their FCMs to hold cash in a segregated account
where it is better protected until needed to pay for a delivery that is
effected in the delivery account, the commenters were concerned that
cash or cash equivalents might be posted to delivery accounts sooner
than three days before the first notice date or exercise date, and
therefore this property might be denied the cash delivery property
protection.
FIA stated that the Federal Register release did not explain why
the Commission proposed to restrict cash delivery property to cash and
cash equivalents received no earlier than three calendar days before
the relevant first notice day or exercise date. FIA and ICE could not
identify any justification as to why cash or cash equivalents that may
be received by a debtor FCM and properly deposited in a cash delivery
account prior to this period should receive different protections under
part 190 than cash and cash equivalents received within the three-
calendar day time frame. The ABA Subcommittee noted that their
Committee eliminated this provision in the Model Part 190 Rules to
avoid unintended consequences.
CME recognized that the three-day limitation is based on the
limitation in current part 190, but stated that it does not make sense
and if not eliminated from the definition, it could be detrimental to
customers, which is contrary to the goal of enhancing customer
protections. CME further explained that if a customer posts cash or
cash equivalents to its delivery account in anticipation of paying for
an upcoming delivery or to guarantee its obligation to take delivery,
the timing of the payment should not matter. If the parties intend to
make and take delivery, CME believed the trustee should be able to
follow the customers' intention. CME explained that a customer is
unlikely to leave cash in an unsegregated delivery account with an FCM
for any extended time, without reason, when it would be better
[[Page 19334]]
protected by holding the cash in a segregated account or withdrawing
the cash if not needed to meet upcoming delivery obligations. CME noted
that there can be times, though, when a customer will legitimately post
cash to its delivery account sooner than the definition would allow,
for example, out of caution to assure that the necessary funds are
available to pay for a delivery when the first notice date or exercise
date immediately follows a weekend or holiday, or to meet payment
deadlines imposed by the FCM, or based on market convention. CME noted
that some FCMs may require customers to post cash sooner than three
days prior to the relevant notice or exercise date, as applicable, to
satisfy a delivery-related obligation. CME believed it could be
potentially disruptive to the delivery process to deny the customer the
protection of having its funds classified as cash delivery property
because it posted the cash or cash equivalents needed to complete an
upcoming delivery too soon.
CME also believed the three-day timing element does not make sense
with respect to cash recorded in a customer's delivery account as of
the filing date, which the customer had previously received as payment
for delivering a commodity under an expired or exercised contract. CME
believed the Commission intended for the timing limitation to apply to
this situation, but the proposed definition does not exclude such cash
from the requirement.
CME understood that the Commission proposed to keep the timing
limitation to encourage FCMs and their delivery customers to hold cash
intended to pay for a delivery in a segregated account until bilateral
delivery obligations are near at hand. However, CME questioned whether
the limitation was effective in encouraging the desired behavior, in
particular when it is contained in bankruptcy regulations and parties
with delivery obligations may not necessarily be aware of it. As a
result, CME recommended that the Commission address the protection of
customer property held in delivery accounts in a more direct and
transparent matter, through a separate rulemaking. Specifically, CME
recommended that the Commission revise the ``cash delivery property''
definition to remove the limitation that cash delivery property must be
recorded in the delivery account no sooner than three calendar days
before the first notice date or exercise date.
The Commission notes that part 190 currently contains the three-day
limitation, which serves to limit delivery property to property that is
transferred into a delivery account shortly before the notice or
exercise date.\52\ Thus, the Commission considered whether a change in
the current standard is warranted. As discussed further below, the
Commission concludes that while the case has been made to extend the
limitation from three calendar days to seven calendar days, the case
has not been made to remove the limitation in its entirety at this
time.
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\52\ See current Sec. 190.05(a)(2) (tying delivery account to
portions of the definition of specifically identifiable property in
Sec. 190.01); Sec. 190.01(ll)(4) and (5) (limiting recognition of
cash as specifically identifiable property to cases where it is
identified on the books and records of the FCM as being received
from or for the account of a particular customer on or after three
calendar days before the first notice date or exercise date
specifically for the purpose of a delivery or exercise).
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While delivery accounts provide some customer protection, in that
they benefit from favorable treatment in bankruptcy, they lack the
protection of segregation requirements, in contrast to futures account,
foreign futures account, and cleared swaps accounts. In the case of the
latter types of accounts, the FCM must maintain in accounts, protected
from the claims of creditors of the FCM other than the customers for
whom they are segregated, sufficient funds to repay the claims of such
customers in full, at all times. Such segregation protections are a
very important means of ensuring that sufficient funds are in fact
available to pay customers in full in the (highly unlikely) event of
the insolvency of an FCM.
Accordingly, the Commission is of the view that changing current
part 190 to completely remove any time limitation for protecting
property transferred into a delivery account would, in light of this
lack of segregation protection, carry the risk of significant
unintended consequences, e.g., customers being encouraged to transfer
funds prematurely into an account without such protection, and thus a
bankruptcy where a greater number of customers receive less than the
full amount of their claims, and greater total shortfalls in repayment
of such claims.
CME, while noting their preference for simply deleting the three-
day limitation, observed that protection of customer property held in
delivery accounts should be addressed in a direct and transparent
manner through a separate rulemaking. The Commission concludes that
deleting entirely the time limitation on posting cash delivery property
should only be undertaken, if at all, in the context of a separate,
dedicated, and explicit rulemaking, in which moving property more
quickly to a delivery account is considered in conjunction with
segregation protection for property in such an account.
However, the Commission believes CME's concerns about long weekends
raise important issues. For example, in the context of an FCM's global
business, there could be a bank holiday on a Friday in the jurisdiction
where a customer is based, a Federal holiday on the following Monday in
the U.S., and the exercise or notice date might be on a Tuesday; in
which event three calendar days may be too short. Similarly, in the
vein of CME's comment, there may be legitimate reasons to transfer the
funds a day or two in advance of when they are needed, to account for
the possibility of a failure in the transfer process.
Weighing the concerns of having funds for an extended time in an
account that is not protected by segregation against the need to
provide a modest amount of flexibility in the process, the Commission
has determined that a reasonable balance can be achieved by changing
the three-day (before notice or exercise date) period to a seven-day
period. The Commission believes this extended time period will address
completely the concern that a delivery date may come after a holiday
weekend, and should mitigate concerns about FCM funding requirements
that extend beyond three days. If and when a separate rulemaking
results in additional protection for delivery accounts, it will be
appropriate to revisit this aspect of part 190 as part of such a
rulemaking.
Second, the ABA Subcommittee, CME, and CMC recommended that the
Committee revise the definition of cash delivery property to allow for
the possibility that cash or cash equivalents could be posted after the
filing date for the purpose of paying for a delivery, and to provide
protection for such deposits. The commenters requested that the
Commission expand the definition to allow for the rare possibility that
a customer may be unable to post funds needed to pay for a delivery in
advance of the filing date so that the definition should also cover
cash delivery property received after the filing date in anticipation
of taking delivery of a commodity. CME noted that as has been seen with
other FCM bankruptcies, the days prior to actual filing can be chaotic
and customers may not have had the opportunity to meet such a deadline.
To allow the delivery to be completed reduces a potential disruptive
situation to commodities markets during an otherwise tumultuous time.
This issue is illuminated by considering the interplay of other
[[Page 19335]]
regulations that affect delivery. The Commission notes that while Sec.
190.04(c) continues the preference for the trustee to liquidate
contracts moving into delivery position before they do so, and Sec.
190.06(a)(2) continues the preference, in cases where the trustee is
unable to do so, for the trustee to arrange for delivery to occur
outside the estate, Sec. 190.06(a)(3) acknowledges that there may be
cases where the trustee will need to facilitate the making or taking of
delivery. Regulation Sec. 190.06(a)(3)(ii)(B)(1) refers to cases where
the trustee pays for delivery (in whole or in part) with cash
transferred by the customer to the trustee on or after the filing date
for the purpose of paying for delivery.
Thus, the Commission agrees with the arguments made by the
commenters who suggested that the Commission expand the definition of
``cash delivery property'' in this context, and consequently is adding
an explicit reference to the cash transferred from a customer to the
trustee after the filing date, consistent with Sec.
190.06(a)(3)(ii)(B)(1). Moreover, for consistency, the Commission will
amend Sec. 190.08(c)(1)(ii) as proposed to explicitly give such post-
petition transfers treatment as 100% funded.
Finally, the ABA Subcommittee suggested that the Commission clarify
that the delivery of two different fiat currencies for foreign currency
commodity contract constitutes cash delivery property. CME suggested a
similar technical change to clarify in the definition that for a
commodity contract that settles by delivery of a foreign currency as
the underlying commodity or by an exchange of a pair of currencies, the
USD or foreign currency recorded to a delivery account in connection
with either side of the delivery constitutes cash delivery property.
In response to the ABA Subcommittee comment regarding the delivery
of two fiat currencies, ``[g]iven the fungible nature of cash,
regardless of currency denomination,'' the Commission has determined to
amend further the definition of ``cash delivery property'' to clarify
that for foreign exchange contracts, i.e., contracts where one fiat
currency is exchanged for another fiat currency, both fiat currencies
will be treated as cash delivery property, and neither currency will be
considered physical delivery property.
Accordingly, in consideration of the comments and the reasons
discussed above, the Commission will adopt the definition of ``cash
delivery property'' in Sec. 190.01 as modified, with the additions
referred to above.
The Commission is adopting the definition of ``physical delivery
property'' in Sec. 190.01 as proposed with modifications, as described
below. The Commission is adopting the definition of ``physical delivery
property'' to include, under the four specified sets of circumstances
discussed below, a commodity, whether tangible or intangible, held in a
form that can be delivered to meet and fulfill delivery obligations
under a commodity contract that settles via delivery if held to a
delivery position.\53\ The Commission is adopting the definition to
include warehouse receipts, other documents of title, or shipping
certificates (including electronic versions of the forgoing), for the
commodity, or the commodity itself.
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\53\ The current definition is found in Sec. 190.01(ll)(3), and
focuses on documents of title and physical commodities.
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The Commission is amending the physical deliver property definition
to address changes in delivery practices since the 1980s. The reference
to electronic versions of warehouse receipts, other documents of title,
or shipping certificates explicitly recognizes that title documents for
commodities are now commonly held in dematerialized, electronic form,
in lieu of paper. Moreover, the types of commodities that might be
physically delivered would extend beyond tangible commodities to those
that are intangible, including Treasury securities, foreign currencies,
or virtual currencies.\54\
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\54\ See ABA Cover Note at 10, 12-13.
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For purposes of analytical clarity, the Commission is adopting the
definition of physical delivery property as subdivided into four
categories:
First, the commodities or warehouse receipts, other documents of
title, or shipping certificates (including electronic versions of any
of the foregoing) for the commodity that the debtor holds for the
account of a customer for purposes of making delivery of such property
and which, as of the filing date or thereafter, can be identified as
held in a delivery account for the benefit of such customer on the
books and records of the debtor.\55\
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\55\ These first two categories together correspond to current
Sec. 190.01(ll)(3), with the first category corresponding to
physical delivery property held for the purpose of making delivery
and the second category corresponding to physical delivery property
held as a result of taking delivery. The property that is (or should
be) within these two categories, as of the filing date, comprises
the property that will be distributed as part of the physical
delivery class.
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Second, the commodities or warehouse receipts, other documents of
title, or shipping certificates (including electronic versions of any
of the foregoing) for the commodity that the debtor holds for the
account of the customer, where the customer received or acquired such
property by taking delivery under an expired or exercised commodity
contract, and which, as of the filing date or thereafter, can be
identified as held in a delivery account for the benefit of such
customer on the books and records of the debtor.\56\
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\56\ The current definition does not prescribe or imply a limit
to how long such received property can be held in a delivery
account, because there is no principled basis to draw a bright line
delineating how long is too long. The definition the Commission is
adopting explicitly codifies that position.
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The third category addresses property that (a) is in fact being
used, or has in fact been used, for the purpose of making or taking
delivery, but (b) is held in a futures, foreign futures, cleared swaps,
or (if the commodity is a security) securities account.\57\ This
property would be considered physical delivery property solely for the
purpose of the obligations, pursuant to Sec. 190.06, to make or take
delivery of physical delivery property. The property in this category
would be distributed as part of the account class in which it is held
(futures, foreign futures, or cleared swaps, or, in the case of a
securities account, as part of a SIPA proceeding).
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\57\ As the ABA Cover Note explained at 13, ``[w]hen the FCM has
a role in facilitating delivery, deliveries may occur via title
transfer in a futures account, foreign futures account, cleared
swaps account, delivery account, or, if the commodity is a security
. . . in a securities account.''
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Fourth, where such commodities or documents of title are not held
by the debtor, but are delivered or received by a customer in
accordance with Sec. 190.06(a)(2) (either by itself in the case of an
FCM bankruptcy or in conjunction with Sec. 190.16(a) in the case of a
clearing organization bankruptcy), they will be considered physical
delivery property, but, again, solely for purposes of obligations to
make or take delivery of physical delivery property pursuant to Sec.
190.06. As this property is held outside of the debtor's estate (and
there was no obligation to transmit it to the debtor's customer
accounts), it is not subject to pro rata distribution.
The Commission is also adding a special case to correspond with the
special case for cash delivery property, which states that where one
fiat currency is exchanged for another, neither such currency, to the
extent that it is recorded in the delivery account, will be considered
physical delivery property. The Commission is also, as discussed
further below, additionally amending the physical delivery property
definition to address the possibility of a negative delivery price
[[Page 19336]]
where the party obliged to delivery physical delivery property under an
expiring contract or an expired options contract is also obliged to
make a cash payment to the buyer, as such cash or cash equivalents
constitute physical delivery property.
CME and CMC agreed that physical delivery property should include
any cash delivery property received subsequent to the filing date in
exchange for making a delivery.
In light of the evolving nature of intangible assets, and of the
manner in which they may be held, custodied or transferred, ICE
suggested that the definition of physical delivery property include, as
examples (and not by way of limitation), other electronic
representations of commodities (whether or not technically ``an
electronic title document'') or any property entitlement to a commodity
(such as for a commodity held as a financial asset in a securities
account under Article 8 of the Uniform Commercial Code (whether or not
a security) or similar structure).
ICE strongly agreed with the Commission's proposal to clarify that
intangible property received or held for purposes of delivery is
appropriately regarded as subject to the delivery account, without
regard to whether it is ``physical'' as under the current rule. ICE
argued that any asset, tangible or intangible, that can be delivered in
settlement of a contract should be eligible to be treated as delivery
property, as set out in the proposed definition of ``physical delivery
property.'' ICE believed this proposed definition would avoid questions
that may otherwise arise in connection with the delivery of digital
currencies or other novel digital assets. CME also supported the
decision to expand the delivery account class to cover intangible
commodities.
Additionally, CME supported modernizing the definition of physical
delivery property to recognize the use of electronic delivery documents
in effecting deliveries under physical delivery commodity contracts.
CME recommended that the Commission further expand the physical
delivery property definition to cover within its scope any cash or cash
equivalents that a seller may deposit in its delivery account when its
obligation to deliver physical delivery property under an expiring
futures or exercised options contract also includes an obligation to
make a cash payment to the buyer, as could arise if the contract's
final settlement price is negative. CME acknowledged that this scenario
would be unprecedented and may never occur, but believed it prudent to
contemplate the possibility in light of events in April 2020 where
certain physical-delivery oil futures contracts traded below zero in
the days prior to establishment of the final settlement prices.
CME also recommended a technical correction to the definition
relating to the fact that shipping certificates are not electronic
title documents, and instead represent the contractual obligation of a
facility to deliver the underlying commodity to the buyer. Thus, for
clarity CME recommended that the Commission revise the phrase
``including warehouse receipts, shipping certificates or other
documents of title (including electronic title documents) for the
commodity'' to read ``including warehouse receipts, shipping
certificates or other similar documents (including electronic versions
thereof).'' The Commission is not amending the examples to explicitly
address additional ``electronic representations of commodities'' within
the definition of physical delivery property because the definition
already broadly covers ``a commodity, whether tangible or intangible,
held in a form that can be delivered to meet and fulfill delivery
obligations under a commodity contract. . . .''
The Commission is amending the definition of physical delivery
property to address the technical correction recommended by CME by
acknowledging that shipping certificates are not documents of title
while avoiding the phrase ``similar documents'' by instead amending the
last phrase to read ``including warehouse receipts, other documents of
title, or shipping certificates (including electronic versions of any
of the foregoing) for the commodity, or the commodity itself.''
The Commission is also adding a special case, corresponding to the
special case for cash delivery property, stating that where one fiat
currency is exchanged for another, neither such currency would be
considered physical delivery property.
The Commission is further amending the physical delivery property
definition with a second special case in response to CME's suggestion
to address the possibility of a negative delivery price. While negative
prices for deliverable commodities are rare, they are not unprecedented
(e.g., the price of crude oil briefly went negative in April 2020).
While a negative price for actual delivery may be even rarer, it is
theoretically possible. Thus, the Commission is amending the definition
of ``physical delivery property'' to address this special case by
adding the following: In a case where the final settlement price is
negative, i.e., where the party obliged to deliver physical delivery
property under an expiring futures contract or an expired options
contract is also obliged to make a cash payment to the buyer, such cash
or cash equivalents constitute physical delivery property.
Accordingly, after consideration of the comments and for the
reasons stated above, the Commission is adopting the definition of
``physical delivery property'' as proposed with the appropriate
modifications to the structure, as set forth above, to correspond to
``(1) In general.'' and to address two special cases in ``(2) Special
cases.'' The Commission is adopting the definition of ``allowed net
equity'' as proposed in Sec. 190.01 and as modified to become ``funded
net equity'' as described below. The Commission proposed ``allowed net
equity'' to update cross-references and allow for two definitions of
the term (as used in subparts B and C of part 190).
The ABA Subcommittee expressed concern in their comment letter that
the definition and the use of the term ``allowed net equity'' as
proposed in Sec. Sec. 190.01 and 190.08(a) could create
inconsistencies and confusion between part 190 and the settled
bankruptcy law terminology in which ``allowed'' typically refers to the
fixed amount of a creditor's claim rather than the amount distributable
on such claim. The ABA Subcommittee recommended three modifications to
address this potential confusion, including the deletion of the
definition of ``allowed net equity'' in proposed Sec. Sec. 190.01 and
190.08(a), as the ABA Subcommittee believes the remainder of proposed
Sec. 190.08 would address how to calculate a customer's net equity
claims and the funded balances for each such claims.\58\
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\58\ The ABA Subcommittee also recommended that the Commission
further amend Sec. 190.02 by adding new paragraph (g) to proposed
Sec. 190.02 to state that the term `allowed' in this part shall
have the meaning ascribed to it in the Bankruptcy Code. The ABA
Subcommittee believed that this would confirm that ``allowed'' under
part 190 equates with the use of ``allowed'' under the Bankruptcy
Code. The ABA Subcommittee also recommended that the Commission add
``funded balance of'' before ``such customer's allowed net equity
claim'' in proposed Sec. 190.09(d)(3). The Commission agrees that
these recommended amendments would avoid confusion with the meaning
of ``allowed'' in Sec. 190.02(g) and is therefore making these
suggested changes.
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The Commission agrees with the ABA Subcommittee that the inclusion
of ``allowed'' in the defined term ``allowed net equity'' could cause
confusion in the broader context of established bankruptcy law, where
``allowed'' refers to the trustee's measure of the proper amount of a
claim, rather than to the
[[Page 19337]]
portion of a claim that is funded (in pro rata distribution).
Accordingly, after consideration of the comments, including the ABA
Subcommittee's suggestion regarding the funded portion of a customer's
allowed claim throughout part 190, and for the reasons stated above,
the Commission is changing the defined term ``allowed net equity'' to
``funded net equity,'' and adopting the definition as so modified. The
Commission is also adding Sec. 190.02(g) (as discussed below) and
adding ``funded balance of'' before ``such customer's allowed net
equity claim'' in Sec. 190.09(d)(3) as suggested.
The Commission is adopting the definition of ``commodity contract''
in Sec. 190.01 as proposed, in order to amend the definition to
incorporate and extend in context (through references to current
Commission regulations) the definition in section 761(4) of the
Bankruptcy Code.\59\
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\59\ It should be noted that, consistent with Sec.
190.00(d)(3)(iv) and the decision In re Peregrine Financial Group,
Inc., 866 F.3d 775, 776 (7th Cir. 2017), adopting by reference
Secure Leverage Group, Inc. v. Bodenstein, 558 B.R. 226 (N.D. Ill.
2016), retail foreign exchange contracts do not fit within the
definition of commodity contracts.
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ICI strongly supported the proposed amendments to the definition of
``commodity contract'' to include any ``futures contract'' and any
``swap'' thereby permitting transactions carried in a futures or
cleared swaps account in accordance with the Commission's regulations
to be eligible for the protections that part 190 affords.
Accordingly, after consideration of the comment and for the reasons
stated above, the Commission is adopting the definition of ``commodity
contract'' as proposed.
The Commission is adopting the definition of ``customer property
and customer estate'' as proposed to update the definition to clarify
cross-references within part 190 and to note that customer property
distribution is addressed in section 766(i) of the Bankruptcy Code in
addition to section 766(h).
ICE supported the Commission's decision to include forward
contracts that are traded on a DCM and cleared by a DCO as customer
property.
Accordingly, after consideration of the comment, and for the
reasons stated above, the Commission is adopting the definition of
``Customer property, customer estate'' in Sec. 190.01 as proposed.
The Commission is adopting the definition of ``house account'' with
modifications, as set forth below to modify the existing definition to
(a) clarify the connection between the concept of a ``house account''
in part 190 and the concept of a proprietary account in Sec. 1.3, and
(b) separately define the term in relation to an FCM, a foreign futures
commission merchant, and a DCO.
The ABA Subcommittee and CME agreed with expanding the current
definition to cover the house accounts that DCOs maintain for clearing
members. However, the commenters noted that ``house account'' is used
in only three places for an FCM proceeding: (i) Proposed Sec.
190.06(a)(5), which addresses deliveries made or taken with respect to
the debtor FCM's house account under open commodity contracts; (ii)
proposed Sec. 190.07(c), which prohibits transfer of the debtor FCM's
house account after the filing date; and (iii) proposed Sec.
190.08(b)(2)(ix), which provides that when a non-debtor FCM maintains
an omnibus account and a house account with a debtor FCM, it holds the
accounts in a separate capacity for purposes of calculating its net
equity claims against the debtor FCM. Assuming the Commission intended
to expand the scope of these provisions in each case, the ABA
Subcommittee and CME suggested that the Commission modify the three
provisions to clarify that they apply to proprietary accounts of FCMs,
and to limit the defined term to house accounts maintained by a DCO for
clearing members. The ABA Subcommittee believed it was unnecessary,
potentially confusing, and could preclude porting of proprietary
accounts.
The Commission agrees with the commenters' recommendation to
streamline the ``house account'' definition and amend the respective
subpart B provisions to limit the use of ``house account'' to the
context of clearing organization bankruptcies to avoid any potential
confusion regarding the ability to port proprietary accounts.
Accordingly, after considering the comments, and for the reasons stated
above, the Commission is adopting the definition of ``house account''
in Sec. 190.01, as modified.
The Commission is adopting the definitions of ``non-public
customer'' and ``public customer'' as proposed to define who is
considered a public versus a non-public customer separately for FCMs
and for clearing organizations. These definitions are complements
(i.e., every customer is either a ``public customer'' or a ``non-public
customer,'' but never both).
In the case of a customer of an FCM, the Commission is adopting the
definition of ``public customer,'' \60\ which would be analyzed
separately for each of the relevant account classes (futures, foreign
futures, cleared swaps, and delivery) with the relevant cross-
references to other Commission regulations. For the ``futures account
class,'' this would be a futures customer as defined in Sec. 1.3,
whose futures account is subject to the segregation requirements of
section 4d(a) of the Act and the Commission regulations thereunder; for
the foreign futures account class, a 30.7 customer as defined in Sec.
30.1, whose foreign futures account is subject to the segregation
requirements of Sec. 30.7; for the cleared swaps account class, a
cleared swaps customer as defined in Sec. 22.1, whose cleared swaps
account is subject to the segregation requirements of part 22; and for
the delivery account class, a customer that would be classified as a
``public customer'' if the property held in the customer's delivery
account had been held in an account described in one of the prior three
categories. The Commission is tying the definition of public customer
for bankruptcy purposes to the definitions of ``customer'' (and
segregation requirements) that apply during business as usual. An FCM's
non-public customers are customers that are not public customers.
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\60\ This is in contrast to the current definition in Sec.
190.01(cc) and (ii), which explicitly define non-public customer,
and define public customer as a customer that is not a non-public
customer. This change is not substantive, but rather fosters closely
tying the account classes to business-as-usual segregation
requirements.
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As part of the process for introducing a bespoke regime for the
bankruptcy of a clearing organization, the Commission is
differentiating between public and non-public customers such that
customers of clearing members (whether such clearing members are FCMs
or foreign brokers) acting on behalf of their proprietary (i.e., house)
accounts, would be non-public customers, while all other customers of
clearing members would be public customers.
In the case of members of a DCO that are foreign brokers, the
determination as to whether a customer of such a member is a
proprietary member would be based on either the rules of the clearing
organization or the jurisdiction of incorporation of such member: If
either designates the customer as a proprietary member, then the
customer would be treated as a non-public customer.
Vanguard agreed that the proposed definition of public customer in
Sec. 190.01 included any customer of an FCM whose commodity contract
is subject to the Commission's segregation
[[Page 19338]]
requirements, and for a DCO, a person whose account with the FCM is not
classified as a proprietary account. CME also supported the proposed
definitions of public customer and non-public customer as it believed
they are more understandable than the prior part 190 definitions.
CME, however, asked the Commission to reconsider the recommendation
of the ABA Subcommittee to include non-U.S. customers of foreign broker
clearing members of a DCO within the public customer definition. CME
noted that it previously considered admitting foreign brokers as
clearing members to clear trades of their non-U.S. customers in futures
or options on futures listed on the CME or the other designated
contract markets (``DCMs'') owned by CME Group, which would be
analogous to a foreign clearing organization admitting FCMs as members
to clear trades of their public customers in futures or options on
futures listed by a foreign board of trade. While that model does not
currently exist for U.S. DCOs and the DCMs for which they provide
clearing services, CME believed it is appropriate to include that
flexibility in part 190 to accommodate that possibility. OCC also
requested clarification as to whether customers of foreign brokers that
access a DCO through an FCM clearing member affiliated with the foreign
broker would be treated as public customers.
The Commission is of the view that including non-U.S. customers of
foreign-broker clearing members as public customers should be
considered as part of a comprehensive review of the issues at such time
as the model of admitting foreign brokers as clearing members for U.S.
DCOs becomes empirical. Such a review of the issues, including issues
related to both bankruptcy and risk management, can be more reliably,
and more efficiently, be conducted in the context of empirical rather
than hypothetical circumstances.
In response to OCC's request for clarification, the Commission
notes that where a foreign broker clears the trades of its (foreign)
customers through an affiliated FCM that is a clearing member, those
trades would be cleared on an omnibus basis through the FCM's customer
account, and would be required to be kept separate from the proprietary
trades of the affiliated foreign broker. Thus, those customers would be
treated as public customers. If a foreign broker clears its own
proprietary trades through an unaffiliated FCM (i.e., there is no
proprietary relationship between the foreign broker and the FCM as set
forth in Sec. 1.3), those trades would be considered as public
customer trades at the FCM, but would not be part of the customer
omnibus account of the foreign broker at the FCM.
Accordingly, after consideration of the comments and for the
reasons stated above, the Commission is adopting the definitions of
``non-public customer'' and ``public customer'' as proposed in Sec.
190.01.
The Commission is adopting the definitions of ``variation
settlement'' as proposed to define the payments that a trustee may make
with respect to open commodity contracts. The definition of variation
settlement includes ``variation margin'' as defined in Sec. 1.3, and
also includes ``all other daily settlement amounts (such as price
alignment payments) that may be owed or owing on the commodity
contract'' to cover all of the potential obligations associated with an
open commodity contract.
CME supported defining variation settlement and generally agreed
with the substance of the definition, but recommended that the
Commission adopt one self-contained definition that does not rely on
cross-reference to another Commission definition. CME suggested that
the Commission adopt the ABA Subcommittee's variation settlement
definition which would cover ``any amount paid or collected (or to be
paid or collected) on an open commodity contract relating to changes in
the market value of the commodity contract since the trade was executed
or the previous time the commodity contract was marked to market along
with all other daily settlement amounts (such as price alignment
payments) that may be owed or owing on the commodity contract.''
The ABA Subcommittee believed that the definition of variation
settlement was not used consistently in the Proposal and identified two
places in proposed Sec. 190.14(b) where the term ``variation'' is used
instead of ``variation settlement.'' The ABA Committee recommended
using ``variation settlement'' in both places, to avoid any confusion
as to whether ``variation'' refers to the Commission's variation margin
definition or variation settlement definition.
The Commission notes that the cross-references in Sec. 190.01 to
definitions in other parts of the Commission's rules is intentional to
clarify the relationships with those other definitions, and thus the
Commission declines to make the change proposed by the commenters.\61\
Accordingly, after consideration of the comments and for the reasons
stated above, the Commission is adopting the definition of ``variation
settlement'' in Sec. 190.01 as proposed.
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\61\ The technical correction suggested by the ABA subcommittee
to Sec. 190.14(b) (change ``variation'' to ``variation
settlement'') will be adopted in one case; the subsection where the
second case was found has been removed entirely by the supplemental
notice of proposed rulemaking.
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The Commission did not receive comments on the remaining
definitions in Sec. 190.01 and is therefore adopting them as proposed.
The Commission is adopting the definition of ``Act'' in Sec.
190.01 to refer to the Commodity Exchange Act.
The Commission is amending the definition of ``Bankruptcy Code'' in
Sec. 190.01 to update cross-references.
The Commission is amending the definition of ``Business day'' to
define what constitutes a Federal holiday and clarify that the end of a
business day is one second before the beginning of the next business
day.
The Commission is amending the definition of ``Calendar day'' to
include a reference to Washington, DC as the reference location for the
Calendar day.
The Commission is adopting the definition of ``Cash delivery
account class'' to cross-reference it to the new definition in
``Account class.''
The Commission is adopting the definition of ``Cash equivalents''
to define assets that might be accepted as a substitute for United
States dollar cash.
The Commission is amending the definition of ``Cleared swaps
account'' in Sec. 190.01 to cross-reference it to the new definition
in ``Account class.''
The Commission is adopting the amended definition of ``Clearing
organization'' to update cross-references.
The Commission is amending the definition of ``Commodity broker''
to reflect the current definition of commodity broker in the Bankruptcy
Code and the relevant cross-references.
The Commission is adding the definition of ``Commodity contract
account'' to refer to accounts of a customer based on commodity
contracts in one of the four account classes, as well as, for purposes
of identifying customer property for the foreign futures account class
(subject to Sec. 190.09(a)(1)), accounts maintained by foreign
clearing organizations or foreign futures intermediaries reflecting
foreign futures or options on futures executed on or subject to the
rules of a foreign board of trade, including any account maintained on
behalf of the debtor's public customers.
The Commission is amending the definition of ``Court'' to clarify
that the court having jurisdiction over the
[[Page 19339]]
debtor's estate may not be a bankruptcy court (e.g., in the event of a
withdrawal of the reference).\62\
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\62\ Cf. 28 U.S.C. 157(d).
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The Commission is amending the definition of ``Cover'' to improve
clarity without any substantive change to the current definition.
The Commission is amending the definition of ``Customer'' to
reflect the revisions to part 190 through this rulemaking,
specifically, noting the different meanings of ``customer'' with
respect to an FCM in contrast to with respect to a DCO.
The Commission is amending the definition of ``Customer claim of
record'' to improve clarity without any substantive changes to the
current definition.
The Commission is amending the definition of ``Customer class'' to
reflect the revisions to part 190 through this rulemaking, specifically
emphasizing the difference between public customers and non-public
customers.
The Commission is deleting the definition of ``Dealer option'' as
this term is no longer used.
The Commission is amending the definition of ``Debtor'' to
explicitly refer to commodity brokers involved in a bankruptcy
proceeding, a proceeding under SIPA, or a proceeding under which the
FDIC is appointed as a receiver.
The Commission is newly adopting a definition of ``Distribution''
to include the transfer of property on a customer's behalf, return of
property to a customer, as well as distributions to a customer of
valuable property that is different than the property posted by that
customer.
The Commission is amending the definition of ``Equity'' to update a
cross-reference.
The Commission is adding definitions for ``Exchange Act'' and
``FDIC'' to incorporate the statute and regulator, respectively, in
part 190.
The Commission is revising the definition of ``Filing date'' to
include the commencement date for proceedings under SIPA or Title II of
the Dodd-Frank Act.\63\
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\63\ In SIPA, the term ``filing date'' is defined to occur
earlier than the filing of an application for a protective decree if
the debtor is the subject of a proceeding in which a receiver,
trustee, or liquidator for the debtor has been appointed and such
proceeding is commenced before the date on which the application for
a protective decree under SIPA is filed. In such case, the term
``filing date'' is defined to mean the date on which such proceeding
is commenced. By contrast, this rulemaking does not define the term
``filing date'' to occur earlier in such a case, although it would
(in Sec. 190.02(f) as discussed below) authorize such a to receiver
themselves file a voluntary petition for bankruptcy of the FCM.
This difference is due to the different uses of the ``filing
date'' in these rules and in SIPA. For purposes of part 190,
``filing date'' refers to the date on and after which a commodity
broker is treated as a debtor in bankruptcy. See, e.g., Sec. Sec.
190.00(c)(4), 190.06(a)(1) and (b)(1), 190.08(b)(4), and
190.09(a)(1)(ii)(A). For purposes of SIPA, by contrast, the ``filing
date'' is the date on which securities are valued. See, e.g., SIPA
sections 8(b), 8(c)(1), 8(d), 9 ff-2(b), (c)(1), (d), and 78fff-
3(a)(3).
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The Commission is revising the definition of ``Final net equity
determination date'' stylistically, to provide updated cross-
references, and to further clarify who the parties involved are
intended to be.
The Commission is adding the definition of ``Foreign board of
trade'' and adopting by reference the definition in Sec. 1.3 (which is
consistent with Sec. 48.2(a)).
The Commission is adding the definition of ``Foreign clearing
organization'' to refer to a clearing house, clearing association,
clearing corporation or similar entity, facility or organization that
clears and settles transactions in futures or options on futures
executed on or subject to the rules of a foreign board of trade.
The Commission is retaining the definitions of ``Foreign future''
and ``Foreign futures commission merchant'' as proposed to be
unchanged.
The Commission is adopting the definition of ``Foreign futures
intermediary'' to refer to a foreign futures or options broker, as
defined in Sec. 30.1, acting as an intermediary for foreign futures
contracts between a foreign futures commission merchant and a foreign
clearing organization.
The Commission is revising the definition of ``Funded balance'' to
the definition in Sec. 190.08(c). That definition is discussed further
below in section II.B.6.
The Commission is adding a definition for ``Futures'' and ``Futures
contract,'' used interchangeably, to clarify what these terms mean for
purposes of part 190.
The Commission is deleting the definition of ``In-the-money
amount'' as the term will no longer be used and replacing it with ``in-
the-money,'' a term that is Boolean, and is used in Sec. 190.04(c).
The Commission is amending the definition of ``Joint account'' to
reflect that a commodity pool must be a legal entity.\64\ Thus, the
Commission is removing the reference to a commodity pool that is not a
legal entity.
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\64\ See Sec. 4.20(a)(1).
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The Commission is deleting the definitions of ``Leverage contract''
and ``Leverage transaction merchant'' consistent with the discussion
above with respect to Sec. 190.00(d)(1)(i)(B).
The Commission is removing the definition of ``Member property''
from current Sec. 190.09(a) and addressing it in Sec. 190.01, and
clarifying that member property is the property that may be used to pay
net equity claims based on both the members' house account as well as
claims on behalf of non-public customers of the member.
The Commission is revising the definition of ``Net equity'' to
update cross-references, including the difference between bankruptcy of
an FCM and of a clearing organization.
The Commission is revising the definition of ``Open commodity
contract'' to improve clarity without any substantive changes to the
definition.
The Commission is revising the definition of ``Order for relief''
to update cross-references and incorporate stylistic, non-substantive
changes.
The Commission is adding the definition of ``Person'' to clarify
what this term means in the context of part 190.
The Commission is adding the definition of ``Physical delivery
account class'' to be cross-referenced to the new definition in
``Account class.''
The Commission is deleting the definition of ``Premium'' as that
term is no longer used.
The Commission is revising the definition of ``Primary liquidation
date'' to reflect the removal of the concept of accounts being held
open for later transfer. As a result of such removal, the Commission is
also deleting current Sec. 190.03(a), which set forth provisions
regarding the operation of accounts held open for later transfer, since
there will no longer be any such accounts.
The Commission is deleting the definition of ``Principal contract''
as that term is no longer used. This term was previously used to refer
to contracts that are not traded on designated contract markets, but
the definition excluded cleared swaps.
The Commission is adding the definition of the ``Securities
account'' and ``SIPA'' to address the bankruptcy of an FCM that is also
subject to the Securities Investor Protection Act. These are based on
appropriate cross-references to the Exchange Act and SIPA.
The Commission is amending the definition of ``Security'' to update
the cross-reference to the Bankruptcy Code without any substantive
changes to the definition.
The Commission is removing the definition of ``Short term
obligation'' from Sec. 190.01 as the term is no longer used within the
definition of ``specifically identifiable property.'' The Commission is
instead amending the ``specifically identifiable property''
[[Page 19340]]
definition with respect to securities, as discussed immediately below.
The Commission is amending the definition of ``Specifically
identifiable property'' to update and streamline the definition in
current Sec. 190.01(ll). Paragraph (1)(i) focuses on ``futures
accounts,'' ``foreign futures accounts,'' and ``cleared swaps
accounts.'' Paragraph (1)(i)(A) corresponds in major part to paragraphs
(ll)(1) and (6) of the current definition. For securities, paragraph
(1)(i)(A)(1) substantially copies current paragraph (ll)(1)(i), but
clarifies that a security, to be included as specifically identifiable
property, must have ``a duration or maturity date of more than 180
days.'' Paragraph (1)(i)(A)(2) reformats current paragraph (ll)(6). For
warehouse receipts, bills of lading, or other documents of title
(paragraph (i)(B), corresponding to current paragraph (ll)(1)(ii)), the
definition restates the corresponding portion of the current
definition.
Paragraph (1)(ii) of the definition furthers the approach of
providing discretion to the trustee. It includes as specifically
identifiable property commodity contracts that are treated as such in
accordance with Sec. 190.03(c)(2). As discussed further below,\65\ the
latter provision permits (but does not require) the trustee, following
consultation with the Commission, to treat open commodity contracts of
public customers as specifically identifiable property if they are held
in a futures account, foreign futures account, or cleared swaps account
that is designated as a hedging account in the debtor's books and
records, and if the trustee determines that treating the commodity
contracts as specifically identifiable property is reasonably
practicable under the circumstances of the case. In contrast, paragraph
(ll)(2) of the current definition is more prescriptive.
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\65\ See section II.B.1.c.
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The Commission is amending the definition of ``Strike price'' for
brevity without any substantive change.
The Commission is adding the definition of ``Substitute customer
property'' to refer to the property (in the form of cash or cash
equivalents) delivered to the trustee by or on behalf of a customer in
order to redeem either specifically identifiable property or a letter
of credit.
The Commission is adopting the definition of ``Swap'' to replace
the current definition of ``Cleared swap'' \66\ in part 190. The
definition of reflects the current definition and meaning of the term
``swap'' in section 1a(47) of the CEA and Commission regulation Sec.
1.3. The Commission is also adopting the definition to add as a swap,
for purposes of this part, ``any other contract, agreement or
transaction that is carried in a cleared swaps account pursuant to a
rule, regulation or order of the Commission, provided, in each case,
that it is cleared by a clearing organization [i.e., a DCO] as, or the
same as if it were, a swap.'' \67\
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\66\ See current Sec. 190.01(pp).
\67\ Cf. 11 U.S.C. 761(4)(F)(ii) (including as a commodity
contract ``with respect to a futures commission merchant or clearing
organization, any other contract, option, agreement, or transaction,
in each case, that is cleared by a clearing organization'').
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The Commission is amending the definition of ``Trustee'' to include
the trustee in a SIPA proceeding.
The Commission is adopting a definition of ``Undermargined'' for
purposes of part 190 to mean when the funded balance of a debtor's
futures account, foreign futures account, or cleared swaps account is
below the minimum amount that the debtor is required to collect and
maintain for the open commodity contracts in such account under the
rules of the relevant clearing organization, foreign clearing
organization, DCM, Swap Execution Facility (``SEF''), or FBOT. If any
such rules establish both an initial margin requirement and a lower
maintenance margin \68\ requirement applicable to any commodity
contracts (or to the entire portfolio of commodity contracts or any
subset thereof) in a particular commodity contract account of the
customer, the trustee will use the lower maintenance margin level to
determine the customer's minimum margin requirement for such account.
An undermargined account may or may not be in deficit.\69\
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\68\ For further discussion of maintenance margin and its
relationship to initial margin, see, e.g., https://www.cmegroup.com/education/courses/introduction-to-futures/margin-know-what-isneeded.html.
\69\ An account is in deficit if the balance is negative (i.e.,
the customer owes the debtor instead of the reverse). An account can
be undermargined but not in deficit (if the balance is positive, but
less than the required margin). See discussion of Sec.
190.04(b)(f). For example, if the margin requirement is $100 and the
account balance is $20, the account is undermargined by $80, but is
not in deficit. If the account loses a further $35, the balance
would be ($15). The account would be in deficit by $15, and would be
undermargined by $115.
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Accordingly, after consideration of the comments, and for the
reasons discussed above, the Commission will adopt Sec. 190.01 as
proposed, with the amendments discussed above.
3. Regulation Sec. 190.02: General
Regulation Sec. 190.02 is being adopted as proposed, with the
addition of paragraph (g) as described below. The Commission is
adopting Sec. 190.02(a)(1) based on current Sec. 190.10(b)(1) with
one substantive change to permit a trustee to request an exemption from
the Commission from any procedural provision (rather than limiting such
requests to exemptions from, or extension of, a time limit). Such an
exemption may be subject to conditions, and must be consistent with the
purposes of this part and of subchapter IV of the Bankruptcy Code. The
Commission is adopting Sec. 190.02(a)(1) consistent with major theme
7, discussed in section I.B. above regarding enhanced trustee
discretion. Section 190.02(a)(1) allows the trustee to request to be
permitted to extend a deadline or to amend a form.
The Commission is also adopting Sec. 190.02(a)(2)(i) and (ii),
(a)(3), and (b), as derived from current Sec. Sec. 190.10(b)(2), (3),
and (4) and 190.10(d), respectively, with minor editorial and
conforming changes.
The Commission is adopting Sec. 190.02(b) to delegate the
functions of the Commission set forth in part 190, other than the
authority to disapprove pre-relief transfers pursuant to Sec.
190.07(e)(1), to the Director of the Division of Clearing and Risk,
after consultation with the Director of the Market Participants
Division \70\ (with the possibility of further delegations to members
of the respective Directors' staffs).
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\70\ The Market Participants Division is the successor to the
Division of Swap Dealer and Intermediary Oversight, the title of
that division at the time of the Proposal.
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The Commission is adopting Sec. 190.02(c) to exclude from the
definition of ``customer'' entities who hold claims against a debtor
solely on account of uncleared forward contracts. The Commission is
adopting Sec. 190.02(d) to provide that the Bankruptcy Code will not
be construed to prohibit a commodity broker from doing certain
combinations of business, or to permit any otherwise prohibited
operation, trade or business. The Commission is adopting Sec.
190.02(e) to provide that security futures products held in a
securities account shall not be considered to be part of commodity
futures or options accounts as those terms are used in section 761(9)
of the Bankruptcy Code. The Commission is adopting Sec. 190.02(c)
(forward contracts), (d) (other), and (e) (rule of construction) as
transposed from current Sec. 190.10(e), (g), and (h), respectively.
The Commission continues to believe, as stated in the proposal,
that Sec. 190.02(f) should enhance customer protection in cases where
a receiver has been
[[Page 19341]]
appointed (pursuant to e.g., section 6c of the CEA) for an FCM due to a
violation or imminent violation \71\ of the customer property
protection requirements of section 4d of the CEA or of the regulations
thereunder, or of the Commission's capital rule (Sec. 1.17). Section
190.02(f) explicitly permits such a receiver to file a voluntary
petition for bankruptcy of such FCM in appropriate cases. For example,
the receiver may determine that, due to a deficiency in property in
segregation, bankruptcy is necessary to protect customers' interests in
customer property.
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\71\ Section 6c of the CEA provides in relevant part that
whenever it shall appear to the Commission that any person has
engaged, is engaging, or is about to engage in any act or practice
constituting a violation of any provision of this Act or any rule,
regulation, or order thereunder the Commission may bring an action
in the proper district court to enjoin such act or practice, or to
enforce compliance with this Act (emphasis supplied). Section 6c
also refers to an order appointing a temporary receiver to
administer such restraining order and to perform such other duties
as the court may consider appropriate. 7 U.S.C. 13a-1.
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The Commission requested comment with respect to all aspects of
proposed Sec. 190.02. In particular, the Commission requested comment
as to whether it would be appropriate to permit trustees to request
relief from procedural provisions such as requirements as to forms, in
addition to requesting relief from deadlines; whether it would be
appropriate to permit receivers for FCMs to file voluntary petitions in
bankruptcy; and whether any portion of proposed Sec. 190.02 would
likely to lead to unintended consequences, and, if so, how may these be
mitigated.
The Commission received two comments on proposed Sec. 190.02. CME
generally supported proposed Sec. 190.02, including adding a provision
that would allow the trustee to request an exemption from the
procedural requirements of the rules. CME also favored adding the
proposed provision to clarify that a receiver appointed for an FCM due
to segregation or net capital violations may, in an appropriate case,
file a petition for bankruptcy of the FCM pursuant to section 301 of
the Bankruptcy Code. In contrast, FIA recommended that the Commission
require a receiver to obtain the Commission's consent before the
receiver may file a voluntary petition in bankruptcy on behalf of an
FCM. FIA believed that any receiver that may be appointed by a court
would be in response to a proceeding initiated by the Commission
pursuant to section 6c of the Act, which authorizes the Commission to
file an action in the appropriate U.S. District Court when it appears
that a person has engaged, is engaging, or is about to engage in any
act or practice constituting a violation of any provision of this Act
or any rule, regulation, or order thereunder. FIA noted that there may
be circumstances in which a receiver may determine that a voluntary
petition under the Bankruptcy Code is warranted. However, in light of
the fact that such a petition would effectively close the FCM, FIA
believed that Sec. 190.02(f) should provide that the receiver may file
a voluntary petition only with the prior consent of the Commission.
The Commission notes that Sec. 190.02(f) is limited to cases where
the receiver was appointed due to concerns about either protection of
customer property, or of capital inadequacy, and the appointment would
be in response to a proceeding initiated by the Commission. In such a
case, the Commission believes that it would be appropriate and most
effective to defer to the judgment of the appointed receiver as to the
necessity of the filing of a petition in bankruptcy.
As a technical point, the ABA Subcommittee recommended (consistent
with their recommendation in the definitions section, Sec. 190.01, to
more precisely use the term ``allowed net equity'') \72\ that the
Commission further amend Sec. 190.02 by adding new paragraph (g) to
proposed Sec. 190.02 to state that the term ``allowed'' in this part
shall have the meaning ascribed to it in the Bankruptcy Code. The ABA
Subcommittee believed that this would confirm that ``allowed'' under
part 190 equates with the use of ``allowed'' under the Bankruptcy Code.
The Commission agrees, and is making the change.
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\72\ See section II.A.2. (recommending that the Commission
instead use ``funded net equity'' as the defined term in the Sec.
190.01 definitions.)
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Accordingly, after consideration of the comments, and for the
reasons stated above, the Commission is adopting Sec. 190.02 as
proposed, with the addition of paragraph (g).
B. Subpart B--Futures Commission Merchant (FCM) as Debtor
The Commission is adopting subpart B (Sec. Sec. 190.03-190.10) to
address debtors that are FCMs.
1. Regulation Sec. 190.03: Notices and Proofs of Claims
The Commission is adopting Sec. 190.03 as proposed with
modifications to Sec. 190.03(c)(2), as set forth below.
The Commission is adopting Sec. 190.03 to set forth requirements
for the notices and proofs of claim that are applicable to subpart B of
part 190. It reorganizes and revises much of current Sec. 190.02, and
incorporates some portions of current Sec. 190.10.
a. Regulation Sec. 190.03(a): Notices--Means of Providing
The Commission is adopting Sec. 190.03(a) to set forth the means
by which notices required under subpart B of part 190 are to be
provided. Section 190.03(a)(1) is substantially similar to current
Sec. 190.10(a), but, in an effort to modernize part 190, the
Commission is deleting the requirement that notices be given to it via
overnight mail (i.e., in hard copy). The Commission is retaining the
requirement that all such notices be sent via electronic mail. The
Commission believes that overnight hard copy delivery is unnecessary
and that removing the requirement to send notices to the Commission via
overnight mail will result in cost savings.
The Commission is adopting Sec. 190.03(a)(2) to provide a
generalized approach for giving notice to customers under part 190. In
light of evolving technology, Sec. 190.03(a)(2) replaces the specific
procedures for providing notice to customers that appear in current
Sec. 190.02(b) with the requirement that the trustee must establish
and follow procedures ``reasonably designed'' for giving notice to
customers under subpart B of part 190. Such notice procedures should
generally include the use of a website and customers' electronic
addresses. In the Commission's view, this new approach provides
trustees with the necessary flexibility to determine the best way to
provide notice and is consistent with the manner in which bankruptcy
trustees in recent FCM bankruptcy cases have provided notice to
customers. The Commission also believes that adopting a generalized
notice requirement in lieu of retaining more specific notice
obligations (e.g., newspaper publication) will result in both cost
savings for the debtor's estate, and more efficient and effective
notification of customers.
The Commission requested comment on the approach to the notice
requirements set forth in proposed Sec. 190.03(a). The Commission
specifically asked whether the proposed changes would be helpful; would
be likely to lead to unintended consequences; and how any unintended
consequences could be mitigated. CME supported providing trustees with
the flexibility, in consultation with the Commission, to establish
appropriate procedures for giving notice to customers and moving away
from outdated and impractical notice requirements. CME also agreed that
the changes align with how trustees in recent FCM cases have
communicated with the FCM's customers and are more customer-friendly.
[[Page 19342]]
b. Regulation Sec. 190.03(b): Notices to the Commission and Designated
Self-Regulatory Organizations
Section 190.03(b)(1) is derived from current Sec. 190.02(a)(1),
but includes revised notice requirements that are designed to ensure
that the Commission and the relevant designated self-regulatory
organization (``DSRO'') \73\ will be aware of a voluntary or
involuntary bankruptcy filing or SIPA application as soon as is
practicable and to codify the practices observed in recent bankruptcy
and SIPA cases.\74\ First, Sec. 190.03(b)(1) provides that, in the
event of a voluntary bankruptcy filing, the commodity broker must
notify the Commission and the appropriate DSRO as soon as practicable
before, and in any event no later than, the time of filing. Second,
Sec. 190.03(b)(1) provides that, in the event of an involuntary
bankruptcy filing or an application for a protective decree under
SIPA,\75\ the commodity broker must notify the Commission and the
appropriate DSRO immediately upon the filing of such petition or
application. The Commission notes that, as a practical matter, a
decision to file for bankruptcy takes measurable time, as does the
preparation of the necessary papers. In previous FCM voluntary
bankruptcy filings, the commodity broker has provided the Commission
and its DSRO with notice ahead of the bankruptcy filing. Section
190.03(b)(1) merely codifies the expectation that such advance notice
should, in fact, occur to the extent practicable. Section 190.03(b)(1)
allows the commodity broker to provide the relevant docket number of
the bankruptcy or SIPA proceeding to the Commission and the DSRO ``as
soon as known,'' in order to account for the fact that there may be a
time lag between the filing of a proceeding and the assignment of a
docket number.
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\73\ For further detail regarding SROs and DSROs see generally
Sec. 1.52.
\74\ A voluntary case under a chapter of the Bankruptcy Code is
commenced by the debtor by filing a petition under that chapter.
Section 301(a) of the Bankruptcy Code, 11 U.S.C. 301(a). Under
certain circumstances, creditors of a person may file an involuntary
case against that person pursuant to section 303 of the Bankruptcy
Code, 11 U.S.C. 303. In such cases, the order for relief will be
granted only if the petition is not timely controverted or if the
court makes specific findings. Id. There is no historical precedent
for an involuntary petition in bankruptcy being filed against a
commodity broker.
\75\ A SIPA proceeding is commenced when the Securities
Investors Protection Corporation (``SIPC'') files a petition for a
protective order. See generally SIPA section 5, 15 U.S.C. 78eee.
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Section 190.03(b)(2) sets forth the requirements for the provision
of notice to the Commission of an intent to transfer or to apply to
transfer open commodity contracts in accordance with section 764(b) of
the Bankruptcy Code and relevant provisions of part 190. It is derived
from current Sec. 190.02(a)(2). While Sec. 190.03(b)(2) retains the
requirement that such notice be provided ``[a]s soon as possible,'' it
removes the requirement that such notice be provided no later than
three days after the order for relief. The Commission believes that the
three-day deadline set forth in current Sec. 190.02(a)(2) is likely in
many cases to be too long, but may, in some cases, be too short.
The Commission expects that the bankruptcy trustee would begin
working on transferring any open commodity contracts as soon as the
trustee is appointed and that, by the end of three days following entry
of the order for relief, any such transfers likely will be either
completed, actively in process, or determined not to be possible.
Indeed, the Commission expects that a DCO would, in most cases, be
reluctant to hold a position open for more than three days following
the entry of the order for relief unless a transfer is actively in
process and imminent. Thus, while the Commission recognizes that the
``[a]s soon as possible'' language is somewhat vague, given past
experience, the Commission views the current timeframe of three days
after the entry of the order for relief as generally too long, and it
is not clear what precise shorter period of time would be generally
appropriate, given the uniqueness of each case. Under different
circumstances, that is, where transfer arrangements cannot be made
within three days after the order for relief, a specified deadline for
notification may in fact be harmful, in that it could be interpreted to
prohibit notification after the expiration of such deadline (and thus,
impliedly prohibit the trustee from forming the intent to transfer
after that time).
In the event of an FCM bankruptcy, the Commission anticipates that
there will be frequent contact between the trustee, the relevant DSRO,
any relevant clearing organization(s), and Commission staff. Thus, a
specified deadline for such notification would not appear to be
helpful. Section 190.03(b)(2) also clarifies that notification should
be made with respect to a transfer of customer property.
The Commission requested comment on proposed Sec. 190.03(b).
Specifically, the Commission asked whether proposed Sec. 190.03 would
meet the objective of ensuring that the Commission and the relevant
DSRO will be aware of a bankruptcy filing or SIPA proceeding as soon as
is practicable. LCH expressed support for the requirement that FCMs
notify DSROs, in addition to the CFTC, of involuntary bankruptcy
filings. LCH also requested that the Commission consider ways in which
this information could be quickly transmitted to the DCOs that may be
impacted, given the interconnectedness of the derivatives market.
While, as noted above, staff would be in contact with DCOs that might
be impacted by a bankruptcy proceeding involving an FCM as a matter of
supervisory practice, this practice does not need to be incorporated
into regulation. Moreover, the Commission notes that many DCOs,
including LCH, require as part of their own rules and procedures that
their clearing members provide prompt notice of a bankruptcy filing
affecting the clearing member.\76\
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\76\ See, e.g., LCH Ltd.: FCM Procedures of the Clearing House
1.6(b)(G) (``All FCM Clearing Members must provide the Clearing
House in a prompt and timely manner with: . . . notice if the FCM
Clearing Member becomes the subject of a bankruptcy petition.'').
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c. Regulation Sec. 190.03(c): Notices to Customers; Treatment of
Hedging Accounts and Treatment of Specifically Identifiable Property
The Commission is adopting Sec. 190.03(c) to address notices to
customers and the treatment of hedging accounts and specifically
identifiable property.
Section 190.03(c)(1) requires the trustee to use all reasonable
efforts to notify promptly any customer whose futures account, foreign
futures account, or cleared swaps account includes specifically
identifiable property, other than open commodity contracts, which has
not been liquidated, that such property may be liquidated on and after
the seventh day after the order for relief if the customer has not
instructed the trustee in writing before the deadline specified in the
notice to return such property pursuant to the terms for distribution
of customer property contained in part 190. It also requires that the
trustee's notice to customers with specifically identifiable property
include, where applicable, a reference to substitute property.
Section 190.03(c)(1) is derived from current Sec. 190.02(b)(1),
but replaces the requirement that the trustee publish such notice to
customers in a newspaper for two consecutive days prior to liquidating
the specifically identifiable property with the requirement that the
trustee notify customers in accordance with Sec. 190.03(a)(2). This
change is intended to provide the trustee with flexibility in notifying
customers regarding specifically identifiable
[[Page 19343]]
property and to modernize part 190 to allow the trustee to provide
notice to customers in a way that will maximize the number of customers
reached. The timeframe in which the Commission would allow the trustee
to commence liquidation of specifically identifiable property has been
modified to reflect the revised notice requirements. Because Sec.
190.03(c)(1) does not require newspaper publication of customer notice,
the Commission is allowing the trustee to commence liquidation of
specifically identifiable property on the seventh day after the order
for relief (or such other date as specified by the trustee with the
approval of the Commission or the court), so long as the trustee has
used all reasonable efforts promptly to notify the customer under Sec.
190.03(a)(2) and the customer has not instructed the trustee in writing
to return such specifically identifiable property.
The Commission is adopting Sec. 190.03(c)(2) to address how a
bankruptcy trustee may treat open commodity contracts carried in
hedging accounts. This regulation moves from the bespoke approach of
current Sec. 190.02(b)(2) to a categorical approach, in light of the
practical difficulties of treating large numbers of customers with
similar open contracts on a bespoke basis.\77\ The Commission notes
that recent commodity broker bankruptcies have involved thousands of
customers, with as many as hundreds of thousands of commodity
contracts. Trustees must make decisions as to how to handle such
customers and contracts within days--in some cases, hours--after being
appointed. Therefore, the Commission is giving the trustee the
authority (i.e., an option, but not an obligation) to treat open
commodity contracts of public customers held in hedging accounts
designated as such in the debtor's records as specifically identifiable
property, after consulting with the Commission and when practical under
the circumstances. To the extent the trustee exercises such authority,
the trustee is required to notify each relevant public customer in
accordance with Sec. 190.03(a)(2). As proposed, Sec. 190.03(c)(2)
would have required the trustee, in all cases, to request that the
customer provide instructions as to whether to transfer or liquidate
the relevant open commodity contracts.\78\ As discussed further below,
in response to a comment, the Commission is modifying this proposal to
address cases where, in the judgment of the trustee, the books and
records of the debtor reveal a clear preference by the public customer
with respect to transfer or liquidation of open commodity contracts.
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\77\ See major theme 7 in section I.B. above.
\78\ The Commission is also making other changes that are
intended to make it simpler for the trustee to identify hedging
positions and allow an FCM to designate an account as a hedging
account by relying on explicit customer representations that the
account contains a hedging position. See Sec. 1.41. This would
simplify the existing requirement that FCMs provide a hedging
instructions form when a customer first opens up a hedging account.
For commodity contract accounts opened prior to the effective date
of the part 190 revisions, the Commission is proposing that FCMs may
rely on written hedging instructions received from the customer in
accordance with current Sec. 190.06(d). See Sec. 1.41(c).
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Section 190.03(c)(2) also delineates certain information that the
trustee must include in the notice. As proposed, the notice must inform
the customer that (1) if the customer does not provide instructions in
the prescribed manner and by the prescribed deadline, the customer's
open commodity contracts will not be treated as specifically
identifiable property; (2) any transfer of the open commodity contracts
is subject to the terms for distribution contained in Sec.
190.09(d)(2); (3) absent compliance with any terms imposed by the
trustee or the court, the trustee may liquidate the open commodity
contracts; and (4) providing instructions may not prevent the open
commodity contracts from being liquidated. The Commission is making
conforming changes to this portion of proposed Sec. 190.03(c)(2) to
reflect the modification referenced above. To the extent the trustee
does not exercise its authority to treat public customer positions
carried in a hedging account as specifically identifiable property, the
trustee must endeavor to, as the baseline expectation, treat open
commodity contracts of public customers carried in hedging accounts the
same as other customer property and effect a transfer of such contracts
to the extent possible.\79\ The Commission is making these changes to
reflect the policy preference to port all positions of public
customers. Requiring a trustee to identify hedging accounts and provide
hedging account holders the opportunity to keep their positions open
may be a resource and time intensive process, which the Commission
believes could interfere with the trustee's ability to take prudent and
timely action to manage the debtor FCM's estate to protect all of the
FCM's customers. The Commission believes that allowing the FCM to rely
on representations made by customers during business-as-usual will
alleviate this concern. In cases where it may be practical, the trustee
may elect to provide special hedging account treatment.
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\79\ See Sec. 190.00(c)(4).
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The Commission is adopting Sec. 190.03(c)(3) to make minor
modifications to the notice of the commencement of an involuntary
proceeding that the trustee may provide to customers prior to entry of
an order for relief, and upon leave of the court. Such modifications
include clarifying that such notice must be in accordance with the
notice provisions set forth Sec. 190.03(a)(2), amending certain
terminology, and removing unnecessary references.
Section 190.03(c)(4) requires the bankruptcy trustee to notify
customers that an order for relief has been entered and instruct
customers to file a proof of customer claim. The regulation is derived
from current Sec. 190.02(b)(4), but adds that the notice must be
provided in accordance with Sec. 190.03(a)(2). Section 190.03(c)(4)
replaces the term ``customer of record'' with the term ``customer,'' as
``customer of record'' is not a defined term in part 190 and all
customers should receive notice that an order of relief has been
entered. Section 190.03(c)(4) also provides that the trustee shall
cause the proof of customer claim form to set forth the bar date for
its filing consistent with the current Sec. 190.03(a)(2).
The Commission requested comment on proposed Sec. 190.03(c). It
specifically asked whether the proposed changes to the notice
requirements would be helpful; whether the discretion granted to the
trustee concerning the treatment of hedging accounts as specifically
identifiable property is appropriately tailored; whether the proposed
revisions appeared likely to lead to unintended consequences; and how
such consequences; if any, could be mitigated.
The Commission received three comments on proposed Sec. 190.03.
CME fully endorsed the policy preference that the trustee should use
their best efforts to transfer all public customer positions and
related customer property from the debtor FCM to one or more other
FCMs. Accordingly, CME supported the provisions in Sec. 190.03(c) that
grant the trustee the discretion to not treat customer positions
carried in hedge accounts as specifically identifiable property, unless
the trustee determines that doing so would be practicable under the
circumstances, following consultation with the Commission. CME asserted
that this discretion will allow the trustee to devote their attention
to transferring open positions of all public customers, along with
their proportionate share of the customer property, in the aggregate.
[[Page 19344]]
SIFMA AMG/MFA also generally agreed with Sec. 190.03(c)(2) in that it
grants to the trustee the authority (that is, the option but not the
obligation) to treat open commodity contracts of public customers held
in hedging accounts designated as such in the debtor's record as
specifically identifiable property. SIFMA AMG/MFA stated that
permitting the trustee this flexibility would serve the interest of
customers as a whole by facilitating a more rapid transfer of customer
positions and property. SIFMA AMG/MFA recommended, however, that the
Commission explicitly clarify that Sec. 190.03(c)(2) is not intended
to affect the treatment of hedging accounts under part 39 of the
Commission's regulations and that, to the extent reasonably
practicable, the trustee's goal will be to maximize value to the public
customer.\80\ Additionally, in the context of the treatment of hedging
accounts, SIFMA AMG/MFA recommended that, if the trustee exercises the
authority as granted in this provision, the trustee should be first
required to consult the instructions (regarding preferences with
respect to transfer or liquidation of open commodity contracts)
provided by a public customer to the debtor at the time of opening the
relevant hedging account, and only if such instructions are missing or
unclear should the trustee require such customer to provide it with
written instructions as contemplated by proposed Sec. 190.03(c)(2).
SIFMA AMG/MFA noted that the notice sent by the trustee to the customer
can still provide that existing or previously provided instructions may
not prevent the open commodity contracts from being liquidated. SIFMA
AMG/MFA asserted that adding this first step would further the goal of
expediency.
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\80\ This last point is addressed with the addition of Sec.
190.00(c)(3)(i)(C).
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The Commission agrees with the suggestion by SIFMA AMG/MFA that it
is more efficient to endeavor to follow clear instructions previously
provided rather than to request new instructions. Moreover, this
approach mitigates the risk that a customer who has already made their
preference patent will fail to reply to the request and thus be treated
in a manner contrary to that previously expressed preference.
Accordingly, the Commission is amending and reorganizing Sec.
190.03(c)(2) to implement that suggestion. Specifically, Sec.
190.03(c)(2)(ii)(B) is being amended to provide, in pertinent part
that: (1) Where, in the judgment of the trustee, the books and records
of the debtor reveal a clear preference by a relevant public customer
with respect to transfer or liquidation of open commodity contracts,
the trustee shall endeavor, to the extent reasonably practicable, to
comply with that preference; and (2) Where, in the judgment of the
trustee, the books and records of the debtor do not reveal a clear
preference by a relevant public customer with respect to transfer or
liquidation of open commodity contracts, the trustee will request the
customer to provide written instructions whether to transfer or
liquidate such open commodity contracts. Such notice must specify the
manner for providing such instructions and the deadline by which the
customer must provide instructions.
Other conforming changes are being made to Sec. 190.03(c)(2). With
respect to SIFMA AMG/MFA's request that the Commission explicitly
clarify that proposed Sec. 190.03(c)(2) is not intended to affect the
treatment of hedging accounts under part 39, the Commission notes that
Sec. 190.03(c)(2) governs the trustee's actions, and does not govern
the actions a DCO may take under its default rules or otherwise.
ACLI recommended that the Commission amend proposed Sec.
190.03(c)(2) to require a trustee to transfer a public customer's hedge
positions where the customer has requested the transfer and met the
required terms unless, in consultation with the Commission, it is
determined that it would be unreasonable to transfer such positions.
ACLI further recommended that the Commission add a threshold such as
``impossibility'' or ``exigent circumstances'' to limit a trustee's
ability to liquidate a customer's hedge position in lieu of a requested
transfer. ACLI asserted that the Commission's oversight should be
specifically mandated. In response to ACLI's comment, the Commission
notes that Sec. 190.00(c)(4) sets forth a preference for the porting
of all open commodity contract positions of public customers, along
with all or a portion of such customers' account equity, and Sec.
190.04(a)(1) instructs the trustee promptly to use its best efforts to
effect a transfer of such positions and property in accordance with
Sec. 190.07(c) and (d) not later than seven calendar days after the
order for relief. The discretion granted to the trustee in Sec.
190.03(c)(2) is based on the reality that, in light of limited time and
administrative resources, achieving porting to the maximum extent is
fostered by treating customers on an omnibus, rather than an
individualized, basis. For these reasons, the Commission declines to
adopt ACLI's specific suggestions.
d. Regulation Sec. 190.03(d): Notice of Court Filings
Section 190.03(d) addresses notices of court filings. It is derived
from current Sec. 190.10(f), but makes modernizing changes to the
terminology and method of providing notice to the Commission. The
Commission requested comment on proposed Sec. 190.03(d). The
Commission specifically asked whether the proposed revisions appeared
likely to lead to unintended consequences, and, if so, how such
consequences could be mitigated. The Commission did not receive any
comments on proposed Sec. 190.03(d).
e. Regulation Sec. 190.03(e): Proof of Customer Claim
The Commission is adopting Sec. 190.03(e) to require a trustee to
request that customers provide information sufficient to determine a
customer's claim in accordance with the regulations contained in part
190. Section 190.03(e) lists certain information that customers shall
be requested to provide, to the extent reasonably practicable, but
grants the trustee discretion to adapt the request to the facts of the
particular case. Such discretion is being granted to the trustee in
order to enable the trustee to tailor the proof of claim form to the
information that is most appropriate in light of the specifics of the
types of business that the debtor did (and did not do), the way in
which such types of business were organized, and the available records
of the debtor (as well as the reliability of those records). Section
190.03(e) is generally derived from current Sec. 190.02(d), although
certain items on the list of information to be requested of customers
have been revised and reorganized to: Inter alia, improve clarity; tie
the questions to definitions of terms in part 190; give the claimant an
opportunity to provide a more complete picture of its claims; and
provide its own view as to the value of such open positions,
unliquidated securities or other unliquidated property in order to
support its claim against the debtor.
The Commission requested comment on proposed Sec. 190.03(e).
Specifically, the Commission asked whether the proposed changes would
be helpful; whether the discretion granted to the trustee was
appropriately tailored; whether the proposed revisions appeared likely
to lead to unintended consequences; and how such consequences, if any,
could be mitigated. The Commission received one comment on proposed
Sec. 190.03(e). CME noted that the proposed regulation
[[Page 19345]]
is a major improvement over the current regulation.
f. Regulation Sec. 190.03(f): Proof of Claim Form
Regulation Sec. 190.03(f) provides that a template proof of claim
form is included as appendix A to part 190.\81\ The Commission
substantially revised the customer proof of claim form in order to
streamline it and better map it to the information listed in Sec.
190.03(e). The revised customer proof of claim form now includes, in
each section, citations to the location in the text of Sec. 190.03(e)
where such information is listed.
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\81\ Appendix A is discussed in section II.D below.
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Section 190.03(f)(1) provides that, to the extent there are no open
commodity contracts that are being treated as specifically identifiable
property, the bankruptcy trustee should modify the proof of claim form
to delete any references to open commodity contracts as specifically
identifiable property. For example, this would be the case if all open
commodity contracts had been transferred or liquidated before the proof
of claim form is sent. Section 190.03(f)(2) makes clear that the
trustee has discretion as to whether to use the template proof of claim
form, and that the proof of claim form should be modified to reflect
the specific facts and circumstances of the case. The provisions of
Sec. 190.03(f), taken together, are meant to provide bankruptcy
trustees with appropriate flexibility to determine the best and most
efficient way to compose the customer proof of claim.
The Commission requested comment on proposed Sec. 190.03(f).
Specifically, the Commission asked whether the proposed changes to the
treatment of the proof of customer claim form would be helpful; whether
they would lead to unintended consequences; and how such consequences,
if any, could be mitigated. The Commission also asked whether the
discretion granted to the trustee was appropriately tailored and, if
not, what changes should be made. CME commented that the proof of claim
form had been improved and supported the flexibility provided to the
trustee.
Accordingly, after consideration of the comments and for the
reasons stated above, the Commission is adopting Sec. 190.03 as
proposed, with modifications to Sec. 190.03(c)(2), as set forth above.
2. Regulation Sec. 190.04: Operation of the Debtor's Estate--Customer
Property
The Commission is adopting Sec. 190.04 as proposed with
modifications, as set forth below to address the collection of margin
and variation settlement, as well as the liquidation and valuation of
positions. The Commission is adopting Sec. 190.04 to clarify and
update portions of Sec. Sec. 190.02, 190.03, and 190.04.
The Commission requested comment with respect to all aspects of
proposed Sec. 190.04 including: Whether the revisions create any
unintended conflicts with customer protection regulations set forth in
parts 1, 22, and 30; how any such conflicts may be resolved; whether
there are any proposed clarification changes that are likely to create
unintended consequences; and, if so, how might those be avoided or
mitigated.
a. Regulation Sec. 190.04(a): Transfers
The Commission is adopting Sec. 190.04(a) as proposed. Section
190.04(a) largely retains the current provisions in current Sec.
190.02(e) regarding transfers for customers in a bankruptcy proceeding.
It also retains the policy preference \82\ that the trustee should use
its best efforts to transfer open commodity contracts and property held
by the failed FCM for or on behalf of its public customers to one or
more solvent FCMs.\83\ Regulation Sec. 190.04(a)(1) provides that the
trustee ``shall promptly'' use its best efforts to effect such
transfers, while current Sec. 190.02(e)(1) states that the trustee
must ``must immediately'' do so. This revision signals that the trustee
must take action to transfer open commodity contracts as soon as
practicable, while avoiding potential pressure of the term
``immediately'' in light of the challenges presented in an FCM
bankruptcy. Regulation Sec. 190.04(a)(2) replaces the term ``equity''
with ``property'' to clarify that the trustee should endeavor to
transfer all types of property that the commodity broker is holding on
behalf of customers; the transfer is not limited to equity. The
Commission is also adding the word ``public'' before ``customers'' to
clarify that the transfers discussed in Sec. 190.04(a)(1) relate to
the open commodity contracts and property of the debtor's public
customers.\84\
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\82\ The Commission discussed the rationale for this policy
preference in the discussion of Sec. 190.00(c)(4). See section
II.A.1. See also ABA Cover Note at 14 (recommending explicitly
identifying in Sec. 190.04(a) a clear policy that the trustee
should use best efforts to transfer open commodity contracts and
property held by the failed FCM for or on behalf of its public
customers to one or more solvent FCMs).
\83\ The Commission is also adopting cross-references in Sec.
190.04(a) to other provisions within proposed part 190 that discuss
transfers of customer property.
\84\ The Commission is adopting the same change--addition of the
word ``public'' before ``customers''--to Sec. 190.04(a)(2), as
discussed below.
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The Commission is adopting Sec. 190.04(a)(2), as derived from
Sec. 190.02(e)(2), to remove the liquidation-only trading limitations
on an FCM that is subject to an involuntary bankruptcy petition unless
otherwise directed by the Commission, by any applicable self-regulatory
organization, or by court. The Commission is instead adopting
limitations on the business of an FCM in bankruptcy in Sec. 190.04(g)
to more generally address involuntary proceedings.\85\
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\85\ The Commission is deleting the reference to ``liquidation''
in Sec. 190.02(e)(4) accordingly since the limitation to trading
for liquidation only is being deleted from Sec. 190.04(a)(2).
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The Commission is adopting Sec. 190.04(a)(2), as derived from
current Sec. 190.02(e)(2), to provide that if such commodity broker
demonstrates to the Commission within a specified period of time that
it is in compliance with the Commission's segregation and financial
requirements on the filing date, the Commission may determine to allow
the commodity broker to continue in business. The Commission is
retaining this provision because any requirement to transfer customers
is properly addressed pursuant to Sec. 1.17(a)(4), which deals with
FCMs that do not meet minimum financial requirements. The Commission is
of the view that an FCM that does meet such requirements should not be
compelled to cease business and transfer its customers absent an
appropriate finding by a court or the Commission.
In addition, similar to Sec. 190.04(a)(1), as discussed above, the
Commission is replacing the term ``equity'' with ``property'' to
clarify that the transfers discussed in Sec. 190.04(a)(2) are for all
types of property that the commodity broker is holding on behalf of
customers, rather than limited to only equity. Also, the Commission is
adding the word ``public'' before ``customers'' to clarify in Sec.
190.04(a)(2) that the transfers discussed in Sec. 190.04(a)(1) relate
to the open commodity contracts and property of the debtor's public
customers.
The Commission did not receive any comments on this aspect of the
Proposal. Accordingly, for the reasons stated above, the Commission is
adopting Sec. 190.04(a) as proposed.
b. Regulation Sec. 190.04(b): Treatment of Open Commodity Contracts
The Commission is adopting Sec. 190.04(b) as proposed to clarify
and update the provisions in current Sec. 190.02(g)(1), which allow a
trustee to make ``variation and maintenance margin payments'' on behalf
of the
[[Page 19346]]
debtor FCM's customers. The Commission is adopting Sec. 190.04(b) to
be generally consistent with the current regulation but with a number
of substantive changes.
First, the Commission is adopting Sec. 190.04(b) to permit the
trustee to make margin payments pending transfer or liquidation; not
just pending liquidation as required by current Sec. 190.02(g)(1). The
amendment is consistent with the Commission's longstanding policy for
the trustee to endeavor to transfer open commodity contracts. The
trustee has two paths for the treatment of such contracts: Transfer
and, if transfer is not possible, liquidation.
Second, the Commission is adopting Sec. 190.04(b)(1) to delete the
phrase ``required to be liquidated under paragraph (f)(1) of this
section'' in current Sec. 190.02(g)(1) to eliminate a complete
prohibition against paying margin on open contracts. While holding
contracts open may or may not be practicable given the particular
circumstances of the bankruptcy, a complete prohibition against paying
margin on such open contracts would undermine the point of having the
possibility to hold those contracts open. Accordingly, the Commission
is deleting the phrase ``required to be liquidated under paragraph
(f)(1) of this section'' and thus will instead apply more broadly to
any open commodity contracts.
The Commission is also adopting several technical amendments.
Third, the Commission is replacing the phrase ``variation and
maintenance margin payments'' with ``payments of initial margin and
variation settlement'' which, in the Commission's view, more accurately
describes the types of payments being reflected in this provision.
Fourth, the Commission is replacing the phrase ``to a commodity
broker'' with ``to a clearing organization, commodity broker, foreign
clearing organization or foreign futures intermediary'' to account for
the various types of entities to which a margin payment described in
this provision may be made. Lastly, the Commission is replacing the
phrase ``specifically identifiable to a particular customer'' with
``specifically identifiable property of a particular customer'' in
order to be consistent with the definitions in part 190, which includes
as a defined term ``specifically identifiable property.''
The Commission is adopting Sec. 190.04(b)(1)(i), as derived from
current Sec. 190.02(g)(1)(i), to prevent the trustee from making any
payments on behalf of any commodity contract account that is in
deficit, to the extent within the trustee's control. The Commission is
including the phrase ``to the extent within the trustee's control'' to
recognize that certain commodity contract accounts may be held on an
omnibus basis (i.e., on behalf of several customers), so to the extent
the trustee is making a margin payment on behalf of the omnibus
account, it may be out of the trustee's control to identify and only
pay on behalf of those underlying customer accounts (within the omnibus
account) that are not in deficit. The Commission is including a proviso
to note that Sec. 190.04(b)(1)(i) shall not be construed to prevent a
clearing organization, foreign clearing organization, FCM, or foreign
futures intermediary from exercising its rights to the extent permitted
under applicable law. This proviso is intended to remove any doubt that
the right of these ``upstream'' entities to use collateral posted by
the FCM on an omnibus basis is not affected by the prohibition on
making margin payments on behalf of accounts that are in deficit.
The Commission is adopting Sec. 190.04(b)(1)(ii) as a new
provision to prohibit the trustee from making an upstream margin
payment with respect to a specific customer account that would exceed
the funded balance of that account. This restriction is consistent with
the pro rata distribution principle discussed in Sec. 190.00(c)(5), in
that any payment in excess of a customer's funded balance would be to
the detriment of other customers.
The Commission is adopting some non-substantive clarifications in
Sec. 190.04(b)(1)(iii), as derived from current Sec.
190.02(g)(1)(ii), to retain the limitation that the trustee may not
make payments on behalf of non-public customers of the debtor from
funds that are segregated for the benefit of public customers.
The Commission is adopting Sec. 190.04(b)(1)(iv)-(v) to clarify
and expand upon current Sec. 190.02(g)(1)(iii),\86\ to require that
margin is used consistent with the requirements of section 4d of the
CEA.\87\ First, the Commission is adopting Sec. 190.04(b)(1)(iv) to
provide that, if the trustee receives payments from a customer in
response to a margin call, then to the extent within the trustee's
control,\88\ the trustee must use such payments to make margin payments
for the open commodity contract positions of such customer. Second, the
Commission is adopting Sec. 190.04(b)(1)(v) to provide that the
trustee may not use payments received from one public customer to meet
the margin (or any other) obligations of any other customer. Given the
restriction in paragraph (b)(1)(v), the Commission believes it may in
some cases be impracticable for a trustee to follow paragraph
(b)(1)(iv). In such a situation, therefore the trustee would hold onto
the funds received in response to a margin payment and such funds would
be credited to the account of the customer that made the payment.\89\
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\86\ Current Sec. 190.02(g)(1)(iii) provides that the trustee
must make margin payments if payments of margin are received from
customers after bankruptcy in response to margin calls.
\87\ See 7 U.S.C. 6d.
\88\ The phrase ``to the extent within the trustee's control''
recognizes the reality that certain accounts are held on an omnibus
basis. See discussion of Sec. 190.04(b)(1)(i) above.
\89\ See Sec. 190.08(c)(1)(ii).
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Regulation Sec. 190.04(b)(1)(vi) builds upon current Sec.
190.02(g)(1)(iv), which provides that no payments need to be made to
restore initial margin, thus noting that such payments are not required
but implicitly allowed to be made. Revised Sec. 190.04(b)(1)(vi)
explains in this in more detail and provides more comprehensive
guidance to the trustee about when such payments may be made.
Specifically, Sec. 190.04(b)(1)(vi) provides that, in the event that
the funds segregated for the benefit of public customers in a
particular account class exceed the aggregate net equity claims for all
customers in that account class, the trustee is permitted to use such
funds to meet the margin obligations for any public customer in such
account class whose account is undermargined, but not in deficit, and
sets conditions around such use.
Regulation Sec. 190.04(b)(2) updates current Sec. 190.02(g)(2),
which concerns margin calls made by trustee with respect to
undermargined accounts of public customers. The Commission is removing
the current requirement in Sec. 190.02(g)(2) that the trustee issue
margin calls, by replacing the term ``must issue margin calls'' with
``may issue a margin call,'' in light of the possibility that the
trustee will determine it impracticable or inefficient to do so.
Current Sec. 190.02(g)(2), which sets up a retail-level analysis on
issuing mandatory margin calls based on the funded balance of the
account, is based on a model of the FCM continuing in business. Revised
Sec. 190.04(b)(d) recognizes that an FCM in bankruptcy will be
operated in crisis mode, and may be pending wholesale transfer or
liquidation of open positions.\90\ Therefore, the Commission is
allowing for the possibility that the trustee may issue margin calls.
The specification of
[[Page 19347]]
highly prescriptive conditions for issuing such calls is no longer
appropriate, given the Commission whether or not to make a margin call
is now based on the trustee's discretion.
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\90\ See generally major theme 7 discussed in section I.B.
above.
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Regulation Sec. 190.04(b)(3), as derived from current Sec.
190.02(g)(3) with updated cross-references, retains the important
concept that margin payments made by a customer in response to a
trustee's margin call are fully credited to the customer's funded
balance. As these post-petition payments made by the customer are fully
counted toward the customer's funded net equity claims under Sec.
190.04(b)(3), they are not subject to pro rata distribution (in
contrast to the treatment of the debtor commodity broker's pre-petition
obligations to customers).
Regulation Sec. 190.04(b)(4) is derived from a combination of
current Sec. Sec. 190.03(b)(1) and (2) and 190.04(e)(4), and addresses
the trustee's obligation to liquidate certain open commodity contracts;
in particular, those in deficit and those where the customer has failed
to promptly meet a margin call. During business-as-usual, an FCM is
required to cover, at all times, any customer accounts in deficit
(i.e., those with debit balances) with its own capital.\91\ The FCM is
also required to cover with its own capital any undermargined amounts
in customer accounts each day by no later than the Residual Interest
Deadline.\92\ These ongoing requirements are intended to protect other
customers with positive account balances.
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\91\ See, e.g., Sec. Sec. 1.22(i)(4), 1.23(a)(2).
\92\ See, e.g., Sec. 1.22(c)(3).
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An FCM in bankruptcy will generally not have capital available to
protect other customers by covering these obligations; rather, any loss
suffered by customers whose accounts are in deficit will be at the risk
of those other customers.\93\ The Commission intends for Sec.
190.04(b)(4) to mitigate the risk to those other customers by directing
the trustee to liquidate such accounts.
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\93\ While the trustee may seek to recover any debit balance
from a customer, see Sec. 190.09(a)(1)(ii)(E), Sec. 190.04(b)(4)
proceeds from the conservative assumption that such efforts will be
unsuccessful.
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In light of the importance of mitigating this fellow-customer risk,
Sec. 190.04(b)(4), in contrast to many of the other proposed changes
to part 190, curtails the trustee's discretion. Specifically, Sec.
190.04(b)(4), as derived from current Sec. 190.03(b)(1) and (2),
provides that the trustee shall, as soon as practicable, liquidate all
open commodity contract accounts in any commodity contract account (i)
that is in deficit; (ii) for which any mark-to-market calculation would
result in a deficit; or (iii) for which the customer fails to meet a
margin call made by the trustee within a reasonable time. Pursuant to
current Sec. 190.03(b)(1), a trustee must liquidate open commodity
contracts if any payment of margin would result in a deficit in the
account in which they are held.\94\ Revised Sec. 190.04(b)(4) adds a
requirement to liquidate all open commodity contracts in any commodity
contract account that is in deficit. The existing language applies to
an account that is on the threshold of deficit; the Commission is
revising the language to clarify that the provision also applies to an
account that is already in deficit. Moreover, the change from ``payment
of margin'' to ``mark-to-market'' calculations addresses the case where
the trustee is aware, based on mark-to-market calculations, that the
account is in deficit. In order to protect other customers more
effectively, the trustee should begin the liquidation process
immediately upon gaining that awareness, rather than delaying until the
time when a margin payment is due.
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\94\ An account is in deficit if the balance is negative (i.e.,
the customer owes the debtor instead of the reverse). An account can
be undermargined but not in deficit (if the balance is positive, but
less than the amount of required margin). For example, a customer
may have a margin requirement of $100 and an equity balance of $80.
Such customer is undermargined by $20, but is not in deficit,
because the liquidation value of the commodity contracts is
positive.
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Regulation Sec. 190.04(b)(4) also provides that, absent exigent
circumstances or unless otherwise provided, a reasonable time for
meeting margin calls made by a trustee shall be one hour or such
greater period not to exceed one business day, as determined by the
trustee.\95\ This language is largely reflective of current Sec.
190.04(e)(4), but adds the concept of ``exigent circumstances'' as a
new exception to the general and long-established rule that a minimum
of one hour is sufficient notice for a trustee to liquidate an
undermargined account. The Commission intends this revision to provide
the trustee with the discretion to deem a period of less than one hour
as sufficient notice to liquidate an undermargined account if the
``exigent circumstances'' so require.
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\95\ See Morgan Stanley & Co. Inc. v. Peak Ridge Master SPC
Ltd., 930 F.Supp.2d 532, 539-540 (S.D.N.Y. 2013)(Morgan Stanley, in
its business discretion, determined Peak Ridge's account had assumed
overly risky positions, necessitating an increase in the margin
requirement and giving Peak Ridge a limited amount of time to bring
the account into compliance. ``Courts have held that as little as
one hour is sufficient notice under similar circumstances.''). See
also Capital Options Invs., Inc. v. Goldberg Bros. Commodities,
Inc., 958 F.2d 186, 190 (7th Cir. 1992) (``One-hour notice to post
additional margin . . . is reasonable where a contract specifically
provides for margin calls on options at any time and without
notice.''); Prudential-Bache Sec., Inc. v. Stricklin, 890 F.2d 704,
706-07 (4th Cir. 1989) (rejecting a claim that 24-hour notice, which
the broker normally gave to customers, was necessary before broker
could liquidate an under-margined account and upholding notice of
one hour as in accordance with the customer agreement); Modern
Settings, Inc. v. Prudential-Bache Sec. Inc., 936 F.2d 640, 645 (2d
Cir. 1991) (upholding a provision of a customer agreement allowing
Defendant-broker to liquidate an under-margined account without
notice).
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The Commission is deleting current Sec. 190.03(b)(3) to permit the
trustee to liquidate open commodity contracts where the trustee has
received no customer instructions with respect to such contracts by the
sixth calendar day following the entry of the order for relief. The
Commission is adopting this change as part of a model where the trustee
receives and complies with instructions from individual customers to a
model--that reflects actual practice in commodity broker bankruptcies
in recent decades--where the trustee transfers as many open commodity
contracts as possible.\96\
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\96\ Cf. major theme 7 in section I.B above.
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The Commission is adopting new Sec. 190.04(b)(5) to provide
guidance to the trustee in assigning liquidating positions \97\ to the
debtor FCM's customers when only a portion of the open commodity
contracts in an omnibus account are liquidated. The new guidance is
designed to protect the customer account as a whole, in light of the
fact that any losses which cause a customer account to go into deficit
are, as discussed in connection with Sec. 190.04(b)(4), at the risk of
other customers. To mitigate the risk of such losses, Sec.
190.04(b)(5) establishes a preference, subject to the trustee's
exercise of reasonable business judgment, for assigning liquidating
transactions to individual customer accounts in a risk-reducing manner.
Specifically, the trustee should endeavor to assign such liquidating
transactions first, in a risk-reducing manner, to commodity contract
accounts that are in deficit; second, in a risk-reducing manner, to
commodity contract accounts that are undermargined; \98\ and finally to
liquidate any remaining open commodity contracts. Where there are
multiple accounts in any of these groups, the trustee is instructed to,
as practicable, to allocate such liquidating transactions pro rata. The
term ``risk-reducing manner'' is measured by the margin methodology and
parameters
[[Page 19348]]
followed by the DCO at which such contracts are cleared. Specifically,
where allocating a transaction to a particular customer account reduces
the margin requirement for that account, such an allocation is ``risk-
reducing.''
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\97\ A liquidating position or transaction is one that offsets a
position held by the debtor, in whole or in part. Thus, if the
debtor has three long March '21 corn contracts, then three (or two,
or one) short March '21 corn contracts would be a liquidating
transaction.
\98\ And thus are next at risk of going into deficit.
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The Commission requested comment on whether the revised approach in
proposed Sec. 190.04(b)(4) regarding the required liquidation of
certain open commodity contract accounts would provide the trustee with
an appropriate amount of discretion and is practicable; whether
customers, who believe they did not benefit from those decisions, would
likely challenge the trustee's choices given the level of discretion
provided; whether such challenges could materially slow down the
distribution of customer property relative to a context where the
trustee was granted less discretion; and whether the proposed approach
in Sec. 190.04(b)(5) for the assignment of liquidating positions to
debtor FCM customers in a ``risk-reducing manner'' is practicable when
only a portion of the open commodity contracts in an omnibus account
are liquidated.
SIFMA AMG/MFA supported most of the substantive amendments in
subpart B of part 190 and believed such changes are generally helpful
for purposes of reducing risk for market participants and allowing the
trustee to act as efficiently as possible. SIFMA AMG/MFA approved of
the inclusion of transfers in addition to liquidation, and the
clarification to apply the proposed regulation to any open commodity
contracts in proposed Sec. 190.04(b).
CME agreed with the general concept of providing the trustee for a
debtor FCM with significant flexibility to operate the FCM and favored
any provision that encourages the transfer of customer positions and
property and continuation of margin payments on behalf of the debtor
FCM pending transfer or liquidation of positions. ICE suggested that
the Commission should clarify that any trustee discretion proposed in
Sec. 190.04 for managing a failed FCM should be subject to the
obligations of the defaulting clearing member and the rights of the DCO
as provided by the DCO's rules.
ICE supported the Commission's proposal in Sec. 190.04(b)(1) to
clarify that a trustee may make variation margin payments on open
contracts, pending their liquidation or transfer. ICI agreed with
proposed Sec. 190.04(b)(1)(ii), which prohibits a trustee from making
any margin payments with respect to a customer account that would
exceed the funded balance for that account.
ICI and Vanguard agreed with the preservation of the existing
requirement within proposed Sec. 190.04(b)(3) that the trustee fully
credit the customer's funded balance for any margin payment made by a
customer in response to trustee's margin call. Vanguard noted that any
customer concerns as to the ability to fully recover margin would
surely de-incentivize customers to post additional margin in critical
times.
SIFMA AMG/MFA generally supported proposed Sec. 190.04(b), but had
concerns regarding the calculation of whether a customer is
undermargined, and the timing of margin calls. SIFMA AMG/MFA questioned
whether the trustee would be able to calculate accurately whether a
customer is undermargined, particularly if the FCM's books and records
do not accurately reflect margin amounts transferred by such customer
to the FCM. SIFMA AMG/MFA requested that the Commission clarify how the
trustee will try to protect customers from being called upon to provide
duplicate margin amounts. SIFMA AMG/MFA recommended that the Commission
amend proposed Sec. 190.04(b) to provide customers with the
opportunity to demonstrate that a margin payment was made even if the
FCM's books and records do not yet reflect its receipt.
SIFMA AMG/MFA disagreed that absent exigent circumstances, a
reasonable time for meeting margin calls made by the trustee shall be
deemed to be one hour, or such greater period not to exceed one
business day, as the trustee may determine in its sole discretion.
SIFMA AMG/MFA stated that the necessary assets may not be readily
available to customers and urged the Commission to require the trustee
to defer to the margin call timings present in the applicable
underlying agreements entered into by the customer pursuant to Sec.
39.13 when determining a reasonable time for meeting margin calls.
SIFMA AMG/MFA opined that this is a reasonable level of deference,
since the trustee will have access to these agreements, which are
already in place with the Commission regulations, and will allow for
customers to satisfy margin calls without causing needless market
panic.
ICI and Vanguard agreed with proposed Sec. 190.04(b)(4), which
would require the trustee to liquidate any customer account in deficit.
ICI supported maintaining the existing requirement that the trustee
promptly liquidate any customer account when a customer fails to meet a
margin call in a reasonable time or where any payment of margin from
the account would result in an account deficit. ICI agreed with the
proposal that a debtor FCM will generally not have capital available to
protect other customers by covering account deficits, so any loss
suffered by customers whose accounts are in deficit will be at risk of
those other non-defaulting customers. As a result, ICI noted that it is
vital that the trustee be required to swiftly crystallize, and
therefore cap the losses resulting from, such deficits by promptly
liquidating accounts in deficit or for which a customer has failed to
meet a margin call. ICI cautioned that if the accounts were allowed to
remain open, additional losses on the delinquent customers'
transactions would be borne by the FCM's non-defaulting customers,
which could dissuade non-defaulting customers from continuing to meet
their margin obligations post-petition.
OCC was concerned that the proposed definition of ``undermargined''
in Sec. Sec. 190.01 and 190.04(b)(2) and (4) could create a situation
in which a trustee offers one public customer an opportunity to deposit
additional margin that ultimately prevents an account deficit and
resulting liquidation of the public customer's account, but exercises
discretion not to offer another public customer the same opportunity to
deposit margin and subsequently must liquidate the account because it
is in deficit, notwithstanding the customer's willingness to post
additional margin to keep its positions open. OCC was concerned that
the use of such trustee discretion would expose a trustee to challenge
by a public customer that asserts, though it was similarly situated to
a public customer that was given this opportunity, it was not given
this opportunity and received inequitable treatment.
In response to SIFMA AMG/MFA's comment, the Commission notes that,
in the case of an FCM in bankruptcy, any deficit in the account of one
customer may come at the expense of distributions to other customers.
As ICI noted, the normal buffer of the capital of an FCM in continuing
operation cannot be relied upon. Accordingly, where a trustee believes,
based on the records and limited time available to them, that a
customer is undermargined, it is important that they act on that belief
in order to protect other customers. Similarly, in a case where a
customer fails to meet a margin call within what the trustee
determines, in their sole discretion, is a reasonable time, the trustee
should liquidate the contracts of that customer to protect other
customers. Forcing the trustee to defer to margin call timings in pre-
bankruptcy agreements, or to give the customer an opportunity to
demonstrate that a margin payment was made, as requested by the
comment, may
[[Page 19349]]
increase: (1) The risk that such customer would default; (2) the risk
that delaying liquidation of such a customer's positions increases the
potential for and likelihood that they would do so with a debit
balance; and (3) the risk that the size of that debit balance would
increase as a result of that delay, thereby reducing the funded
balances of other customers. The Commission is of the view that
timeframes that may have been acceptable during business-as-usual
cannot bind the trustee in addressing the context of an FCM in
bankruptcy, because any post-petition losses incurred by a customer
will be at the cost of other customers (without the normal buffer of
the capital of a going-concern FCM). Moreover, the Commission agrees
with the view championed by ICI and Vanguard that the trustee should be
required to swiftly crystallize and therefore cap the losses resulting
from deficit balances by promptly liquidating accounts in deficit and
those for which a customer has failed to meet a margin call. OCC's
concerns about treating customers equitably inter se are
understandable, but, in the Commission's view, ensuring complete equity
may not be practicable. A trustee must make decisions within a severely
limited timeframe in a situation that is likely to be chaotic and with
information that is limited and may be imperfect. In these
circumstances, the Commission is of the view that it is appropriate to
defer to the trustee's discretion to make the best decisions they can
under the circumstances. Accordingly, the Commission believes that,
where a trustee makes in good faith decisions with regard to margin and
liquidation of accounts, that are, in retrospect, inequitable, the
Commission's regulations should discourage challenges to such a
decision (and, if such a challenge is made, should reduce the
likelihood that it is successful).
While the trustee retains discretion, as specified in, inter alia,
proposed Sec. 190.04, to manage the affairs of the debtor FCM, the
Commission can confirm, as requested by ICE, that a DCO of which that
FCM is a member retains its rights to act under its rules.\99\
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\99\ See, e.g., Sec. 190.04(b)(1) (while trustee shall, to the
extent within its control, not make payments on behalf of an account
in deficit, this shall not be construed to prevent a clearing
organization from exercising its rights to the extent permitted
under applicable law).
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SIFMA AMG/MFA recommended that the Commission amend proposed Sec.
190.04(b) to clearly state that, to the extent gains-based haircutting
has been utilized by a DCO in respect of customer positions, the
trustee should give customers of an FCM credit for any gains that were
haircut during such gains-based haircutting. With respect to this
suggestion, the Commission notes that, where a DCO at which a debtor
FCM is a member applies gains-based haircutting under that DCO's rules,
the measure of the claim of a customer whose account at the debtor FCM
contains contracts cleared on that DCO will be based on the customer
agreement between that customer and the debtor FCM. If, outside of the
FCM's bankruptcy and pursuant to that customer agreement, the
customer's gains would have been reduced by X% or $Y, then the amount
of the customer's claim in bankruptcy would be adjusted
accordingly.\100\ Accordingly, the Commission does not accept that
suggestion.
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\100\ Moreover, there are other reasons to forego an approach
that would reverse the effects of gains-based haircutting. As
discussed in more detail in section II.C.7 below, there is a limited
amount of customer property available. Any increase in some
customers claims (and thus their distributions) due to the reversal
of gains-based haircutting would thus come at the expense of a
reduced share of that limited customer property, and thus reduced
distributions, to other customers.
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ICI and Vanguard agreed with proposed Sec. 190.04(b)(5) which
prohibits a trustee from making margin payments that would exceed the
customer's funded account balance or transfer a customer's transactions
or property and thereby increase the exposure of other customers.
Vanguard supported addressing situations where the trustee could allow
certain customers to avoid the core customer protection of pro rata
treatment at the expense of other customers.
Accordingly, after consideration of the comments, and for the
reasons stated above, Sec. 190.04(b) will be adopted as proposed.
c. Regulation Sec. 190.04(c): Contracts Moving Into Delivery
The Commission is adopting Sec. 190.04(c), as proposed, to direct
the trustee to use its best efforts to avoid delivery obligations
concerning contracts held through the debtor FCM by transferring or
liquidating such contracts before they move into delivery position. The
Commission is adopting Sec. 190.04(c) based on its analog in current
Sec. 190.03(b)(5) and is incorporating a portion of current Sec.
190.02(f)(1)(ii). Current Sec. 190.03(b)(5) instructs the trustee to
liquidate promptly, and in an orderly manner, commodity contracts that
are not settled in cash (implicitly, those that settle via physical
delivery of a commodity) where the contract would remain open beyond
the earlier of (i) the last day of trading or (ii) the first day on
which notice of delivery may be tendered--that is, where the contract
would move into delivery position. The Commission intends Sec.
190.04(c) to have the same purpose as its predecessors, but uses more
explicit language regarding physical delivery to refer to ``any open
commodity contract that settles upon expiration or exercise via the
making or taking of delivery of a commodity,'' and that is moving into
the delivery position. The Commission also intends Sec. 190.04(c) to
expand current Sec. 190.03(b)(5), with the incorporation of some
aspects of current Sec. 190.02(f)(1)(ii), to include an explicit
reference to how options on commodities move into delivery position.
CME supported proposed Sec. 190.04(c), which directs the trustee
to use their best efforts to liquidate open physical delivery commodity
contracts that have not been transferred before the contracts move into
a delivery position as CME believed this would avoid unnecessary
disruptions to the delivery process by customers that did not intend to
participate in making or taking delivery. ICI supported adding
provisions that clarify the standards applicable to an FCM's
liquidation of a debtor FCM's transactions and the way a trustee must
assign liquidating transactions in the context of a partial
liquidation.
According, after consideration of the comments, and for the reasons
stated above, the Commission is adopting Sec. 190.04(c) as proposed.
d. Regulation Sec. 190.04(d): Liquidation or Offset
The Commission is adopting Sec. 190.04(d) as proposed with
modifications, as set forth below. Regulation Sec. 190.04(d), as
derived from current Sec. Sec. 190.02(f) and 190.04(d), sets forth the
categories of commodity contracts and other property held by or for the
account of a debtor that must be liquidated by the trustee in the
market or by book entry offset, promptly, and in an orderly
manner.\101\
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\101\ The Commission is also adopting three non-substantive
changes in the header language to proposed Sec. 190.04(d) from that
in current Sec. 190.02(f): (1) The addition of the phrase ``except
as otherwise set forth in this paragraph (d)'' to account for any
exceptions that are included in the paragraphs under the header
language; (2) the addition of cross-references to proposed Sec.
190.04(e) when discussing liquidation, as that provision contains
instructions on how to effect liquidation; and (3) the deletion of
the phrase ``subject to limit moves and to applicable procedures
under the Bankruptcy Code.''
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Importantly, the Commission is retaining the requirement, present
in the header language to current Sec. 190.02(f), that the trustee
must effect such
[[Page 19350]]
liquidation ``in an orderly manner.'' Regulation Sec. 190.04(d)
recognizes that any factor which, in the trustee's discretion, makes it
imprudent to liquidate a position at a particular point in time would
contribute to the trustee's judgment as to what constitutes liquidation
``in an orderly manner.''
Section 190.04(d)(1), as derived from Sec. 190.02(f)(1), requires
that all open commodity contracts must be liquidated, subject to two
exceptions: (1) Commodity contracts that are specifically identifiable
property and are subject to customer instructions to transfer as
provided in proposed Sec. 190.03(c)(2); and (2) open commodity
contract positions that are in a delivery position.\102\ In the former
case (specifically identifiable property), the Commission is adopting
Sec. 190.04(d)(1) to revise the language of current Sec.
190.02(f)(1)(ii) to add references to the provisions of Sec.
190.03(c)(2) (concerning the trustee's option to treat hedging accounts
as specifically identifiable property) and Sec. 190.09(d)(2)
(concerning the payments that customers on whose behalf specifically
identifiable commodity contracts will be transferred must make to
ensure that they do not receive property in excess of their pro rata
share).\103\ The latter exception, for open commodity contract
positions that are in a delivery position is new, and provides that
such positions should be treated in accordance with Sec. 190.06, which
concerns delivery.\104\
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\102\ Regulation Sec. 190.04(d)(1) deletes the reference in
current Sec. 190.02(f)(1)(i) to dealer option contracts since such
term is no longer used.
\103\ The Commission is incorporating part of current Sec.
190.02(f)(1)(ii) into Sec. 190.04(c), and therefore that will not
appear in Sec. 190.04(d)(1).
\104\ As noted in section II.A.1 above in the discussion of
Sec. 190.00(c)(6), a delivery default could have a disruptive
effect on the cash market for the commodity and could adversely
impact the parties to the transaction.
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Regulation Sec. 190.04(d)(2) describes when specifically
identifiable property, other than open commodity contracts or physical
delivery property, must be liquidated. The Commission derived Sec.
190.04(d)(2) from current Sec. 190.02(f)(2), with a number of
revisions.
First, the provision applies to specifically identifiable property,
other than open commodity contracts or physical delivery property,
while the current regulation applies only to specifically identifiable
property other than open commodity contracts. The Commission intends
for this change to provide the trustee with discretion to avoid
interfering with the physical delivery process.
Second, while the current regulation would require liquidation of
such property if the fair market value of the property drops below 90%
of its value on the date of the entry of the order for relief,\105\
Sec. 190.04(d)(2)(i) changes that standard to 75% of the fair market
value, in order to provide greater discretion to the trustee to forego
or postpone liquidation in appropriate cases.
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\105\ See current Sec. 190.02(f)(2)(i).
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Third, revised Sec. 190.04(d)(2)(ii) adds an additional condition
that will require liquidation where failure to liquidate the
specifically identifiable property may result in a deficit balance in
the applicable customer account, which corresponds to the general
policy of liquidating any accounts that are in deficit.
Lastly, Sec. 190.04(d)(2)(iii), which is similar to current Sec.
190.02(f)(2)(ii), includes updated cross-references to the provisions
in proposed part 190 that discuss the return of specifically
identifiable property.
Regulation Sec. 190.04(d)(3) is a new provision that codifies the
Commission's longstanding policies of pro rata distribution and
equitable treatment of customers in bankruptcy, as described in Sec.
190.00(c)(5) above, as applied to letters of credit posted as
margin.\106\ Accordingly, customers who post letters of credit as
margin will be treated no differently than other customers and thus
would suffer the same pro rata loss.
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\106\ See, e.g., 48 FR 8716, 8718-19 (March 1, 1983) (Commission
intends to assure that customers using a letter of credit to meet
original margin obligations would be treated no differently than
customers depositing other forms of non-cash margin or customers
with excess cash margin deposits. If letters of credit are treated
differently than Treasury bills or other non-cash deposits, there
would be a substantial incentive to use and accept such letters of
credit as margin as they would be a means of avoiding the pro rata
distribution of margin funds, contrary to the intent of the
Bankruptcy Code (11 U.S.C. 766).)
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The implementation of this policy in current Sec.
190.08(a)(1)(i)(E) was challenged in an adversary proceeding in the MF
Global bankruptcy; \107\ the codification of this policy in Sec. Sec.
190.00(c)(5) (clarifying policy), 190.04(d)(3) (treatment in
bankruptcy), and 1.43 (treatment during business-as-usual) are intended
to implement the policy effectively and to forestall any future
challenge.
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\107\ See ConocoPhillips v. Giddens, No. 12 Civ. 6014, 2012 WL
4757866 (S.D.N.Y. 2012).
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Regulation Sec. 190.04(d)(3) provides that the trustee may request
that such a customer deliver substitute customer property with respect
to any letter of credit received, acquired or held to margin,
guarantee, secure, purchase, or sell a commodity contract. This applies
whether the letter of credit is held by the trustee on behalf of the
debtor's estate, a DCO, a foreign broker, or foreign clearing
organization, and whether it is held on a pass-through or other basis.
The amount of the substitute customer property to be posted may be less
than the full-face amount of the letter of credit, in the trustee's
discretion, if such lesser amount is sufficient to ensure pro rata
treatment consistent with proposed Sec. Sec. 190.08 and 190.09. If
required, the trustee may require the customer to post property equal
to the full-face amount of the letter of credit to ensure pro rata
treatment. Regulation Sec. 190.04(d)(3)(i) provides that, if such a
customer fails to provide substitute customer property within a
reasonable time specified by the trustee, the trustee may draw upon the
full amount of the letter of credit or any portion thereof.
Regulation Sec. 190.04(d)(3)(ii) addresses cases where a letter of
credit received, acquired or held to margin, guarantee, secure,
purchase, or sell a commodity contract is not fully drawn upon. The
trustee is instructed to treat any portion of the letter of credit that
is not fully drawn upon as having been distributed to the customer.
However, the amount treated as having been distributed will be reduced
by the value of any substitute customer property delivered by the
customer to the trustee. For example, if the face amount of the letter
of credit is $1,000,000, the customer delivers $250,000 in substitute
customer property, and no portion of the letter of credit is drawn
upon, then the trustee will treat the customer as having received a
distribution of $750,000. In order to avoid an effective transfer of
value, due to an expiration of the letter of credit on or after the
date of the order for relief, to the customer who posted the letter of
credit, this calculation will not be changed due to such an expiration.
Regulation Sec. 190.04(d)(3)(iii) confirms that any proceeds of a
letter of credit drawn by the trustee, or substitute customer property
posted by a customer, shall be considered customer property in the
account class applicable to the original letter of credit.
Regulation Sec. 190.04(d)(4), as derived from current Sec.
190.02(f)(3), provides for the liquidation of all other property not
required to be transferred or returned pursuant to customer
instructions and which has not been liquidated. Regulation Sec.
190.04(d)(4) excepts from the liquidation requirement any ``physical
delivery property held for delivery in accordance with the provision
of'' Sec. 190.06, in order to avoid interfering with the physical
delivery process.
[[Page 19351]]
Several commenters supported proposed Sec. 190.04(d)(3). SIFMA
AMG/MFA, ICI, and Vanguard strongly supported proposed Sec.
190.04(d)(3) because it permits a trustee to demand substitute margin
so that other customers' margin need not be accessed to meet any
shortfall occasioned by the inability to draw on the letters of credit.
SIFMA AMG/MFA noted that the addition of proposed Sec. 190.04(d)(3)
would ensure that customers using letters of credit to meet original
margin obligations will be treated no differently from customers
depositing other forms of non-cash margin or excess cash margin
deposits. SIFMA AMG/MFA ``agree[d] that most letters of credit
currently in use by the industry follow the Joint Audit Committee forms
[and believed] that the impact of these additional requirements
concerning letters of credit will result in clearer guidance for more
equitable treatment of customers within each account class.'' However,
SIFMA AMG/MFA ``questione[d] the one-year transition period and urge[d]
the Commission to shorten it in the interest of investor protection.
For example, if an FCM were to enter bankruptcy proceedings during the
one-year transition period,'' SIFMA AMG/MFA inquired as to how the
letters of credit would be treated in such proceeding.
OCC also supported proposed Sec. 190.04(d)(3) and the pro rata
loss policy objective. OCC stated that it ``expects that it would
generally, to the extent permitted by OCC's rules and default
management arrangements, draw on a defaulted member's letter of credit
collateral as soon as practicable after a declaration of default. OCC
would attempt to do so, whether or not it has immediately identified a
need to draw on a letter of credit to meet the defaulted member's
settlement obligations, as a protective action in anticipation of any
potential increase in the credit risk associated with the letter of
credit. In such cases, a trustee would obtain any remaining proceeds
from the drawn-down letter to distribute pro rata among the FCM's
customers as appropriate.''
However, several commenters including CME, FIA, and CMC believed
the policy reasons for the trustee's general right to demand substitute
collateral do not exist with respect in the narrow context of a
delivery letter of credit.
CME agreed ``that a letter of credit posted to secure obligations
under open commodity contracts (whether drawn upon or not) must be
deemed as part of the customer's property, in addition to any
additional collateral posted by the customer, for purposes of
distribution calculations. [CME agreed] that it is prudent to make
clear that the trustee in either an FCM or DCO bankruptcy can draw upon
posted letters of credit.'' CME supported ``granting the trustee the
power to require a customer to deliver substitute customer property to
the estate and allowing the trustee to draw on the letter of credit if
the customer does not post additional collateral, provided that those
conditions apply only to letters of credit letter that are received,
acquired, or held to guarantee or secure a customer's obligations under
open commodity contracts, and do not apply to delivery letters of
credit.''
With respect to a delivery letter of credit posted as collateral to
secure the customer's obligation to pay for delivery of a commodity it
will receive, CME and CMC believed it was ``critically important that
the letter of credit be available to draw upon if the customer defaults
or is expected to default on its obligation to pay the seller.''
However, CME, CMC, and FIA recommended that the Commission revise
proposed Sec. 190.04(d)(3) to confirm that the authority of the
trustee to require a customer that posts a letter of credit to deliver
substitute customer property does not extend to letters of credit
posted to a delivery account.
CME argued that ``[c]ustomers routinely post letters of credit in
connection with delivery obligations under certain physical delivery
futures contracts held to maturity.'' CME noted that this is the case
for deliveries under certain oil futures listed on the New York
Mercantile Exchange. ``The buyers are required to post collateral for
the full payment amount owed because actual delivery is effected via
physical transfer of oil and thus is typically completed 30 days or so
after buyers and sellers are matched for bilateral delivery
obligations. Given the substantial dollar amounts involved, often
hundreds of millions, letters of credit are often posted as
collateral.'' CMC emphasized that ``unlike other situations, a delivery
[letter of credit] simply serves as collateral for delivery of a
futures contract after expiry but before delivery is taken and while
the seller still has possession of the commodity for delivery.'' CME
stated that ``[t]he value available to CME under such a letter of
credit is wholly independent from the solvency of an FCM, unlike a
letter of credit posted as performance bond, which decays when utilized
to meet margin or variation calls post-FCM bankruptcy.'' CME posited
that the delivery letter of credit does not pose the same issues that
the Commission encountered in the MF Global bankruptcy. FIA argued that
``[a] purchaser that takes delivery under a commodity contract
frequently is not required to take delivery for a significant period of
time after the purchaser and seller have been matched. In these
circumstances, the purchaser may be required to post a letter of credit
as security for full payment when delivery is made.''
CME, CMC, and FIA warned that a trustee's decision to request
substitute collateral of cash or cash equivalents for a delivery letter
of credit or risk having the letter of credit drawn down prior to the
time that delivery is made would create a sudden and unexpected
liquidity need for the delivery participant and introduce unnecessary
strain into physical and derivatives markets. The commenters were
concerned that because the parties' obligations under the delivery
account arise from a commodity account, a trustee's authority under
proposed Sec. 190.04(d)(3) could be interpreted to apply to letters of
credit held in a delivery account. Accordingly, CME and CMC recommended
``that the Commission limit or eliminate the trustee's powers to
request that a market participant substitute other forms of collateral
for a delivery letter of credit upon which the DCO is a beneficiary.''
Specifically, CME and FIA recommended that the Commission revise
proposed Sec. 190.04(d)(3) to exclude delivery letters of credit,
i.e., letters of credit posted by buyers to guarantee their payment for
commodities that they are contractually obligated to purchase under an
expired futures or exercised commodity option contract.
CME also requested clarity in the context of Sec. 190.06 ``that
when a customer posts a delivery letter of credit directly with the DCO
or with its delivery counterparty, and not with or through the FCM, the
letter of credit is outside the delivery account class, i.e., it does
not constitute cash delivery property (or property of the debtor's
estate), and the provisions in other parts of the proposed revisions
regarding treatment of letters of credit posted with or through the
debtor FCM do not apply.''
The Commission notes that, despite the comments of CME, CMC, and
FIA, there are reasons to forego excluding delivery letters of credit
as a class from the application of Sec. 190.04(d)(3), and to adopt
Sec. 190.04(d)(3) as proposed, as supported by ICI, SIFMA AMG/MFA, and
Vanguard: If, at the end of the bankruptcy proceeding, there are
shortfalls in customer property in the cash delivery account class,
those
[[Page 19352]]
shortfalls will necessarily be borne by public customers. If public
customers posting letters of credit (including in the delivery account)
are shielded from such losses, they will be borne in greater proportion
by other public customers. That result would be inconsistent with the
Commission's longstanding policy, embodied in section 766(h) of the
Bankruptcy Code, to treat all customers on a pro rata basis.\108\
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\108\ Pursuant to Sec. 190.08(c)(1)(ii), the customer's funded
balance includes 100% of margin posted after the order for relief.
Accordingly, this principle would not apply to a delivery letter of
credit posted after the order for relief (unless the letter of
credit was delivered in substitution for a pre-bankruptcy letter of
credit).
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However, the concerns raised by commenters regarding sudden and
unexpected liquidity needs are important ones. They are important both
in the context of delivery letters of credit, as discussed by some
commenters, and more broadly as well.\109\ The Commission agrees that
these concerns can and should be mitigated. Specifically, the trustee
has discretion in managing this process with respect to letters of
credit, and should exercise that discretion with the goal of achieving
pro rata treatment among customers in a manner that mitigates, to the
extent practicable, the adverse effects upon customers that have posted
letters of credit.
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\109\ Moreover, and for the avoidance of doubt, as delivery is
simply a stage in the life of a commodity contract, Sec.
190.04(d)(3) applies to letters of credit in connection with
delivery obligations under a commodity contract.
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First, with regard to timing, the commenters expressed concern that
requests for substitute property would cause ``sudden'' liquidity
needs. Regulation Sec. 190.04(d)(3)(i) states that the trustee may
draw upon the letter of credit if the customer fails to provide
substitute customer property within a reasonable time specified by the
trustee. If the expiry date of the letter of credit is not imminent,
the Commission expects that a ``reasonable time'' would be sufficiently
long to enable the customer to mitigate liquidity concerns (consistent
with the trustee's plans to make distributions). If the expiry date of
the letter of credit is imminent, and the customer can and does arrange
to have that expiry date extended, the parties could work in the
context of that extended expiry date. However, if the expiry date is
imminent, and cannot be extended, then the trustee will need to take
promptly whatever steps are, in their discretion, necessary to ensure
pro rata treatment among customers.
Second, with regard to the amount requested, Sec. 190.04(d)(3)
provides that the trustee may request that a customer deliver
substitute customer property with respect to a letter of credit, and
that the amount of the request may equal the full face amount of the
letter of credit or any portion thereof, to the extent required or may
be required, in the trustee's discretion to ensure pro rata treatment
among customer claims within each account class, consistent with
Sec. Sec. 190.08 and 190.09. Thus, the amount of the substitute
customer property requested (or, if substitute customer property is not
provided, the amount of the letter of credit drawn upon (if partial
draws are permitted)) should be proportionate to the amount required or
may be required, in the trustee's discretion, to ensure pro rata
treatment among customer claims. If the amount of the shortfall in the
relevant account class (whether cash delivery property or otherwise) is
estimated to be a small percentage, the amount of substitute customer
property requested would also be a small percentage (subject to the
trustee adding an appropriate buffer for later corrections in
estimates, and taking into account any need to use the letter of credit
as ongoing performance bond for the customer's obligations).
To re-enforce these concepts, the Commission is adding a new Sec.
190.04(d)(3)(iv), which provides that the trustee shall, in exercising
their discretion with regard to addressing letters of credit, including
as to the timing and amount of a request for substitute customer
property, endeavor to mitigate, to the extent practicable, the adverse
effects upon customers that have posted letters of credit in a manner
that achieves pro rata treatment among customer claims. The Commission
intends that this new paragraph will confirm to trustees that they
should steer their discretion in the specified manner, and will provide
assurance to customers that have posted letters of credit that the
trustees will exercise their discretion in that manner. The Commission
believes that this provision will appropriately address concerns
regarding the manner in which the trustee ensures that customers that
have posted letters of credit are treated economically in the same
manner as customers who have posted other forms of collateral
Moreover, in the context of Sec. 190.06, CME requested that the
Commission confirm that ``when a customer posts a delivery letter of
credit directly with the DCO or with its delivery counterparty, and not
with or through the FCM, the letter of credit is outside the delivery
account class, i.e., it does not constitute cash delivery property (or
property of the debtor's estate), and the provisions in other parts of
the proposed revisions regarding treatment of letters of credit posted
with or through the debtor FCM do not apply.''
For example, the Commission understands that upon expiry of certain
deliverable contracts and assignment of delivery obligation, the long/
buyer of the contract must post collateral to the DCO against its final
payment obligation on the delivery. In certain cases, collateral in the
form of a delivery letter of credit collateral is posted by the
customer directly to the DCO. The delivery letters of credit in these
cases are subject to uniform terms that name the DCO as the sole
beneficiary on the instrument. These delivery letters of credit do not
create an obligation of or to a customer's FCM as they are posted
directly to the DCO and the FCM is not a named beneficiary on the
instrument.\110\
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\110\ Similarly, CMC's concerns focus on ``a delivery LOC upon
which the DCO is beneficiary.''
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In the context of a delivery letter of credit that is posted
directly with the DCO or with the delivery counterparty, rather than
with or through the FCM, and for which the FCM is not a named
beneficiary, the Commission confirms that the letter of credit is
outside the delivery account class, i.e., it does not constitute cash
delivery property (or property of the debtor's estate), and the
provisions in other parts of the proposed revisions regarding treatment
of letters of credit posted with or through the debtor FCM do not
apply.\111\
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\111\ The Commission was not requested to opine on whether this
approach vis-[agrave]-vis letters of credit is permissible outside
of the context of the delivery account class, and expresses no view
on that question.
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The Commission believes that this clarification, in combination
with the new provision directing the trustee's discretion in the
context of letters of credit, will ameliorate the commenters concerns
regarding delivery letters of credit.
The foregoing applies to the trustee. DCOs remain free to exercise
any of the rights and powers in their rules vis-[agrave]-vis their
clearing members, in particular with respect to risk management,
limited only by requirements within the Commission's regulations.\112\
However, in this context, the Commission would encourage DCOs holding
letters of credit posted by customers of FCMs in bankruptcy to exercise
their rights under such letters of credit in a
[[Page 19353]]
measured fashion, in order to achieve risk management goals fully but
in a manner that mitigates, to the extent practicable, adverse effects
upon customers that have posted letters of credit.\113\
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\112\ See, e.g., Sec. 190.04(e) (Rules providing for
liquidation other than on the open market shall be designed to
achieve, to the extent feasible under market conditions at the time
of liquidation, a process for liquidating open commodity contracts
that results in competitive pricing.)
\113\ In this connection, the Commission notes that OCC Rule
1104(a)(ii) permits OCC, if the issuer of a letter of credit agrees
to extend the irrevocability of its commitment thereunder in a
manner satisfactory to OCC, to ``demand only such amounts as it may
from time to time deem necessary to meet anticipated
disbursements.''
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Accordingly, after consideration of the comments and for the
reasons stated above, the Commission is adopting Sec. 190.04(d) as
proposed, with the addition of new Sec. 190.04(d)(3)(iv) as set forth
above.
e. Regulation Sec. 190.04(e): Liquidation of Open Commodity Contracts
The Commission is adopting Sec. 190.04(e) as proposed to provide
details regarding the liquidation and valuation of open positions.\114\
Paragraph (e) is derived from current Sec. 190.04(d), subject to a
number of changes.
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\114\ The Commission is amending Sec. 190.08(d) to also clarify
the process by which customer positions and other customer property
are valued for purposes of determining the amount of a customer's
claim.
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The Commission is adopting Sec. 190.04(e)(1)(i), as derived from
current Sec. 190.04(d)(1)(ii), to describe the process of liquidating
open commodity contracts when the debtor is a member of a clearing
organization. Regulation Sec. 190.04(e)(1)(i), like its predecessor,
emphasizes the goal of competitive pricing to the extent feasible under
market conditions at the time of liquidation. Treatment under the CEA
of clearing organization rules has evolved from a pre-approval regime
to a primarily self-certification regime. The Commission is of the view
that the various processes set forth in part 40 of the Commission's
regulations (including self-certifications under Sec. 40.6, voluntary
submission for rule approval under Sec. 40.5, and Commission review of
certain rules of systemically important DCOs under Sec. 40.10) are
sufficient, and that a separate rule approval process for rules
regarding settlement price in the context of a bankruptcy is no longer
necessary. The Commission is accordingly adopting Sec. 190.04(e)(1)(i)
to delete the requirement contained in current Sec. 190.04(d)(1)(i)
that a clearing organization must obtain approval pursuant to section
5c(c) of the CEA for its rules regarding liquidation of open commodity
contracts.
Section 190.04(e)(1)(i) also adds a provision regarding open
commodity contracts that are futures or options on futures that were
established on or subject to the rules of a foreign board of trade and
cleared by the debtor as a member of a foreign clearing organization,
providing that such contracts shall by liquidated pursuant to the rules
of the foreign clearing organization or foreign board of trade or, in
the absence of such rules, in the manner the trustee deems appropriate.
This the new provision is analogous to the existing provision but would
extend to cases where the debtor FCM is a member of a foreign clearing
organization.
Section 190.04(e)(1)(ii) provides instructions to the trustee
regarding the liquidation of open commodity contracts where the debtor
is not a member of a DCO or foreign clearing organization, but instead
clears through one or more accounts established with an FCM or a
foreign futures intermediary. In such a case, Sec. 190.04(e)(1)(ii)
provides that the trustee shall use commercially reasonable efforts to
liquidate the open commodity contracts to achieve competitive pricing,
to the extent feasible under market conditions at the time of
liquidation. The Commission is adding this provision to account for
those circumstances where the trustee must liquidate open commodity
contracts for a debtor that is not a clearing member.
As with Sec. 190.04(e)(1)(i), the Commission is adopting Sec.
190.04(e)(2) to delete the rule approval requirement, for the same
reasons stated above. Regulation Sec. 190.04(e)(2) is derived from
current Sec. 190.04(d)(1)(ii) which requires a trustee or clearing
organization to apply to the Commission for permission to liquidate
open commodity contracts by book entry. In such a case, the settlement
price for such commodity contracts shall be determined by the clearing
organization in accordance with its rules, which shall be designed to
establish, to the extent feasible under market conditions at the time
of liquidation, such settlement prices in a competitive manner.
The Commission is adopting Sec. 190.04(e)(3) to recognize that an
FCM or foreign futures intermediary through which a debtor FCM carries
open commodity contracts will generally have enforceable contractual
rights to liquidate such commodity contracts. New Sec. 190.04(e)(3)
confirms that the upstream intermediary may exercise such rights.
However, the liquidating FCM or foreign futures intermediary shall use
commercially reasonable efforts to liquidate the open commodity
contracts to achieve competitive pricing, to the extent feasible under
market conditions at the time of liquidation and subject to any rules
or orders of the relevant clearing organization, foreign clearing
organization, DCM, SEF or foreign board of trade governing its
liquidation of such open commodity contracts.
If the liquidating FCM or foreign futures intermediary fails to do
so, the trustee may seek damages reflecting the difference in price(s)
resulting from such failure. However, such damages would be the
trustee's sole available remedy as the regulation makes clear that
``[i]n no event shall any such liquidation be voided.''
The Commission is adopting Sec. 190.04(e)(4)(i) and (ii) based on
current Sec. 190.04(d)(2) and (3), respectively, with some minor non-
substantive language changes and updated cross-references.
The Commission requested comment in particular on the treatment of
letters of credit in bankruptcy, as set forth in proposed Sec.
190.04(e). The Commission did not receive any comments on this aspect
of the Proposal. Accordingly, for the reasons stated above, the
Commission is adopting Sec. 190.04(e) as proposed.
f. Regulation Sec. 190.04(f): Long Option Contracts
The Commission is adopting Sec. 190.04(f) as proposed to contain
only minor non-substantive changes from the current Sec. 190.04(e)(5),
including (1) a cross-reference to the liquidation provisions in
proposed Sec. 190.04(d) and (e), and (2) a clarification that the
provision is referring to commodity contracts that are long option
contracts, rather than to long option contracts more generally.
The Commission did not receive any comments on this aspect of the
Proposal. Accordingly, for the reasons stated above, the Commission is
adopting Sec. 190.04(f) as proposed.
3. Regulation Sec. 190.05: Operation of the Debtor's Estate--General
The Commission is adopting Sec. 190.05 to revise parts of current
Sec. 190.04 and add new provisions to (1) require a trustee to use all
reasonable efforts to continue to issue account statements for customer
accounts holding open commodity contracts or other property and (2)
clarify the trustee's obligation with respect to residual interest. The
Commission requested comment with respect to all aspects of proposed
Sec. 190.05.
The Commission is adopting Sec. 190.05(a) to amend the requirement
in current Sec. 190.04(a) that the trustee ``shall'' comply with all
provisions of
[[Page 19354]]
the CEA and of the regulations thereunder as if it were the debtor, to
state that the trustee ``shall use reasonable efforts to comply'' with
all provisions of the CEA and of the regulations thereunder as if it
were the debtor. This change is intended to provide the trustee with
some flexibility in making decisions in an emergency bankruptcy
situation, subject to the requirements of the Bankruptcy Code. Given
that an FCM bankruptcy will likely be a fast-paced situation requiring
the trustee to make decisions with little time for consideration, the
Commission recognizes that there may be circumstances under which
strict compliance with the CEA and the regulations thereunder may not
be practicable. The Commission did not receive any comments on proposed
Sec. 190.05(a).\115\
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\115\ To the extent that ICI's comment raising concerns about
trustee discretion applies here, the Commission notes that the
addition of Sec. 190.00(c)(3)(i)(C), which directs the trustee to
use their discretion with the overarching goal of protecting public
customers, should mitigate that concern.
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The Commission is adopting Sec. 190.05(b) to address the
computation of funded balances. It is derived from, and makes several
revisions to, Sec. 190.04(b). The Commission's objective in making
such revisions is to provide the bankruptcy trustee with the latitude
to act reasonably given the circumstances with which the trustee is
confronted, recognizing that information may be more reliable and/or
accurate in some insolvency situations than in others and permitting an
approach that, to an appropriate extent, favors cost effectiveness and
promptness over precision.\116\ First, whereas current Sec. 190.04(b)
provides that a trustee ``must'' compute a daily funded balance for the
relevant customer accounts, Sec. 190.05(b) requires the trustee to use
``reasonable efforts'' to make such computations. Such computations are
required to be ``as accurate as reasonably practicable under the
circumstances, including the reliability and availability of
information.'' Second, Sec. 190.05(b) increases the scope of customer
accounts for which the bankruptcy trustee is obligated to compute a
funded balance from accounts that contain open commodity contracts to
accounts that contain open commodity contracts or other property. In
the Commission's view, there is no reason to exclude customer accounts
that contain only property (the value of which may change) from the
scope of those for which bankruptcy trustees must compute a daily
funded balance. Third, Sec. 190.05(b) revises the length of time that
the trustee is obligated to compute the funded balance of customer
accounts from ``until the final liquidation date'' to until the open
commodity contracts and other property in the account have been
transferred or liquidated. This change ties the computation requirement
to each specific account, such that a bankruptcy trustee is not
required to continue to compute the funded balance of customer accounts
that do not contain any open commodity contracts or other property.
Lastly, the specific deadline by which the computation must be
completed is being removed. The Commission does not believe that the
deadline in current Sec. 190.04(b) (by noon the next business day) is
crucial in a bankruptcy context (as it is with respect to an FCM
conducting ongoing daily business).\117\ Such computation would,
however, inherently need to be accomplished prior to performing any
action where knowledge of funded balances is essential, such as
transfers of accounts or property.
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\116\ See major theme 7 discussed in section I.B above.
\117\ See, e.g., Sec. 1.32(d).
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The Commission received one comment regarding proposed Sec.
190.05(b). CME agreed that allowing the trustee to compute the funded
balance for customers' accounts before transferring or liquidating
customer positions or property using ``reasonable efforts'' to be ``as
accurate as reasonably practicable under the circumstances, including
the reliability and availability of information'' ``should allow the
trustee to act more promptly to transfer the positions of public
customers and their pro rata share of the customer property than if the
trustee were held to a strict standard of precision in calculating
funded balances before it could undertake such transfers.'' This is
consistent with the Commission's view. The Commission is adopting Sec.
190.05(c)(1) to amend the record retention requirements in current
Sec. 190.04(c) to be more comprehensive. Section 190.05(c)(1) expands
the referenced records from ``computations required by this [p]art'' to
``records required under this chapter to be maintained by the debtor,
including records of the computations required by this part.'' To
enable the trustee to mitigate the expenses of record retention,
however, it reduces the time that records are required to be retained
from ``the greater of the period required by Sec. 1.31 of this chapter
or for a period of one year after the close of the bankruptcy
proceeding for which they were compiled'' to ``until such time as the
debtor's case is closed.'' Section 190.05(c)(2) simplifies the
corresponding portion of current Sec. 190.04(c)(2) by omitting the
requirement that the records required in Sec. 190.05(c)(1) be
available to the Court and parties in interest. The requirement that
such records be available to the Commission and the United States
Department of Justice is being retained. A court generally will not
itself look at records, and any parties in interest should have access
to records under the discovery provisions of the Federal Rules of
Bankruptcy Procedure and the Federal Rules of Civil Procedure, as
applicable. The Commission did not receive any comments on proposed
Sec. 190.05(c).
The Commission is adopting new Sec. 190.05(d) to facilitate the
ability of customers of the bankrupt FCM with open commodity contracts
or property to keep track of such open commodity contracts or property
even during insolvency, and promptly to make them aware of the
specifics of the liquidation or transfer of such contracts or property.
Section 190.05(d) requires the trustee to use all reasonable efforts to
continue to issue account statements with respect to any customer for
whose account open commodity contracts or other property is held that
has not been liquidated or transferred. Section 190.05(d) also requires
the trustee to issue an account statement reflecting any liquidation or
transfer that has taken place with respect to a customer account
promptly after such liquidation or transfer has occurred.
The Commission sought comment on the practicability of the proposed
requirements regarding the issuance of account statements. ICI
commented in support of the account statement requirements.
The Commission is adopting Sec. 190.05(e)(1) to amend the
requirement in current Sec. 190.04(e)(2) that a trustee must obtain
court approval to make disbursements to customers, to specifically
carve out transfers of customer property made in accordance with Sec.
190.07. The Commission is making this change to reflect the policy
preference to transfer as many public customer positions as practicable
in the event of an FCM insolvency.\118\ The Commission notes, however,
that this
[[Page 19355]]
carve out does not detract from the trustee's ability to, in their
discretion, nonetheless seek and obtain court approval for certain
transfers of property. The Commission recognizes that there is an
inherent tension between distributing to public customers as much
customer property as possible from the debtor's estate, as quickly as
possible, and ensuring accuracy in distribution, and believes that
Sec. 190.05(e)(1) strikes the right balance between these competing
objectives.\119\
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\118\ The Commission notes that current Sec. 190.08(d) provides
for the return of specifically identifiable property other than
commodity contracts under certain circumstances (namely, where the
customer makes good any pro rata loss related to that property)
without court approval; however, the Commission is deleting this
provision in favor of allowing transfers without court approval for
the reasons stated above.
\119\ The concept of prioritizing cost effectiveness and
promptness over precision is discussed in detail in major theme 7 in
section I.B above and in overarching concept three in the cost-
benefit considerations, section III.A.2.iii below.
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Section 190.05(e)(2) addresses how a bankruptcy trustee may invest
the proceeds \120\ from the liquidation of open commodity contracts and
specifically identifiable property, and other customer property. It is
derived from, and retains much of, current Sec. 190.04(e)(3), but it
expands the provision permitting the bankruptcy trustee to ``invest any
customer equity in accounts which remain open in accordance with Sec.
190.03'' to permit the investment of ``any other customer property.''
It continues to limit the permissible investments to obligations of, or
fully guaranteed by, the United States, and to limit the location of
permissible depositories to those located in the United States or its
territories or possessions. The Commission did not receive any comments
on proposed Sec. 190.05(e).
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\120\ Section 190.05(e)(2) uses the term ``proceeds'' rather
than the term ``equity,'' which is used in current Sec.
190.04(e)(3). This change in wording is not meant to be a
substantive.
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The Commission is adopting new Sec. 190.05(f) to require a
bankruptcy trustee to apply the residual interest provisions contained
in Sec. 1.11 ``in a manner appropriate to the context of their
responsibilities as a bankruptcy trustee'' and ``in light of the
existence of a surplus or deficit in customer property available to pay
customer claims.'' The purpose of the residual interest provisions is
to have the FCM maintain a sufficient buffer in segregated funds ``to
reasonably ensure that the [FCM] . . . remains in compliance with the
segregated funds requirements at all times.'' \121\ The Commission
requested comment with respect to all aspects of proposed Sec. 190.05.
Specifically, the Commission sought comment on the practicability and
appropriateness of proposed Sec. 190.05(f).
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\121\ Section 1.11(e)(3)(i)(D).
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The Commission received supportive comments from CME, SIFMA AMG/
MFA, ICI, and Vanguard. CME supported adding clarity that the trustee
should use reasonable efforts to operate the debtor FCM's estate in
compliance with the CEA and CFTC regulations governing FCMs, including
to apply the residual interest provisions in Sec. 1.11, in a manner
appropriate to the context of their responsibilities and in light of
the existence of a surplus or deficit in customer property available to
pay customer claims. ICI and Vanguard supported the clarification in
proposed Sec. 190.05(f) that an FCM's residual interest is to be
applied to public customer claims. Vanguard noted its belief that ``FCM
residual interest is a valuable buffer to insulate FCM customers from
the risk of delayed or failed margin transfers from other customers.''
Vanguard was ``pleased that the Commission has confirmed that, while
residual interest is fronted by FCMs, it must be used to support
customers through an FCM insolvency,'' noting that its ``purpose is to
enhance core customer protections.'' SIFMA AMG/MFA also believed that
``the proposed use of residual interest as contemplated by proposed
Sec. Sec. 190.05(f) and 190.09 is appropriate,'' and agreed with the
Commission that ``the residual interest provisions contained in Sec.
1.11 remain important.''
Accordingly, after consideration of the comments and for the
reasons stated above, the Commission is adopting Sec. 190.05 as
proposed.
4. Regulation Sec. 190.06: Making and Taking Delivery Under Commodity
Contracts
The Commission is adopting Sec. 190.06 as proposed. The Commission
is adopting Sec. 190.06 to provide more specificity regarding making
and taking deliveries on commodity contracts in the context of an FCM
bankruptcy and to reflect current delivery practices. Section 190.06 is
derived from current Sec. 190.05, but implements new concepts (with
respect to delivery practices, intangible commodities, and separation
of physical and cash delivery property), as discussed further below.
Generally, open positions may enter a delivery position where the
parties incur bilateral contractual delivery obligations.\122\ It is
important to address deliveries to avoid disruption to the cash market
for the commodity and to avoid adverse consequences to parties that may
be relying on delivery taking place in connection with their business
operations.
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\122\ The timing of the entry of the order for relief in a
subchapter IV proceeding relative to when physical delivery
contracts move into a delivery positions will generally influence
whether a delivery issue may arise. Additionally, during business as
usual, market participants typically offset contracts before
incurring delivery obligations.
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The delivery provisions in the current regulations largely reflect
the delivery practices at the time current part 190 was adopted in
1983. At that time, delivery was effected largely by tendering paper
warehouse receipts or certificates. In contrast, most deliverable title
documents today are held and transferred in electronic form, typically
with the clearing organization serving as the central depository for
such instruments. Under the terms of some contracts (such as oil or gas
futures) the party with the contractual obligation to make delivery
will physically transfer a tangible commodity to meet its obligations.
In other cases, intangible commodities may be delivered, including
virtual currencies. As noted previously, in the definitions section
(Sec. 190.01), the Commission is dividing the delivery account class
into physical delivery and cash delivery account subclasses to
recognize the differing issues that apply to physical delivery property
versus cash delivery property. The Commission is also recognizing that,
consistent with current practice, physical deliveries \123\ may be
effected in different types of accounts.\124\ For example, when an FCM
has a role in facilitating delivery, deliveries may occur via title
transfer in a futures account, foreign futures account, cleared swaps
account, delivery account, or, if the commodity is a security, in a
securities account. \125\
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\123\ Current Sec. 190.05 applies to the delivery of a physical
commodity, or of documents of title to physical commodities. Section
190.06 applies to any type of commodity that is subject to delivery,
whether tangible or intangible. This is captured in the definition
of physical property. Given the different ways in which delivery may
take place, physical delivery property is not limited to property
that an FCM holds for or on behalf of a customer in a delivery
account. For a discussion of those different ways, see the third and
fourth categories under the definition of physical delivery property
in Sec. 190.01 in section II.A.2 above.
\124\ See also Sec. 1.42.
\125\ See also Sec. 1.42.
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Section 190.06(a) applies to commodity contracts that settle upon
expiration or exercise by making or taking delivery of physical
delivery property, if such commodity contracts are in a delivery
position on the filing date or the trustee is unable to liquidate such
commodity contracts in accordance with Sec. 190.04(c) to prevent them
from moving into a delivery position.\126\ The Commission is
[[Page 19356]]
adopting Sec. 190.06(a)(2) to address delivery made or taken on behalf
of a customer outside of the administration of the debtor's estate,
(i.e., directly between the debtor's customer and the delivery
counterparty assigned by the clearing organization). It replaces
current Sec. 190.05(b). Current Sec. 190.05(b) requires a DCO, DCM,
or SEF to enact rules that permit parties to make or take delivery
under a commodity contract outside the debtor's estate, through
substitution of the customer for the commodity broker. The Commission
believes that deliveries should occur in this manner only where
feasible. Deliveries may not always happen in this manner, as customers
largely rely on their FCMs to hold physical delivery property on their
behalf in electronic form.\127\
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\126\ As discussed above, Sec. 190.04(c) directs the trustee to
use its best efforts to avoid delivery obligations concerning
contracts held through the debtor FCM by transferring or liquidating
such contracts before they move into delivery position.
\127\ The requirement for registered entity rules to be
submitted for approval in accordance with section 5c(c) of the Act
has been deleted for reasons discussed in section II.B.2 above with
respect to Sec. 190.04(e)(1) and (2).
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Section 190.06(a)(2)(i) \128\ directs the trustee to use
``reasonable efforts'' to allow a customer to deliver physical delivery
property that is held directly by the customer in settlement of a
commodity contract, and to allow payment in exchange for such delivery,
to occur outside the debtor's estate, where the rules of the exchange
or clearing organization prescribe a process for delivery that allows
delivery to be fulfilled either (A) in the ordinary course by the
customer, (B) by substitution of the customer for the commodity broker,
or (C) through agreement of the buyer and seller to alternative
delivery procedures. In adopting a ``reasonable efforts'' standard
rather than (as in current Sec. 190.05(a)(1)) ``best efforts,'' the
Commission is recognizing that, in the event that the trustee is unable
to transfer or earlier liquidate the positions, delivery involves a
significant degree of bespoke administration. Moreover, requiring the
trustee's ``best efforts'' for delivery might require the trustee to
spend an inordinate amount of time focusing on the needs of a few
customers and detract from the trustee's ability to manage the short
term challenges of the administration of the estate in the days
immediately following the filing date.
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\128\ The Commission notes that Sec. 190.04(c) directs the
trustee to use its best efforts to avoid delivery obligations
concerning contracts held through the debtor FCM by transferring or
liquidating such contracts before they move into delivery position.
Section 190.06(a)(2) applies where the trustee is unable to do so.
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Section 190.06(a)(2)(ii) addresses the circumstance where, while
the customer makes physical delivery in satisfaction of a commodity
contract using property that is outside the administration of the
estate of the debtor, the customer nonetheless has property held in
connection with that contract at the debtor (i.e., collateral posted in
connection with that contract pre-petition). Consistent with current
Sec. 190.05(b)(2), Sec. 190.06(a)(2)(ii) provides that the property
held at the debtor becomes part of the customer's claim and can only be
distributed pro rata, despite the customer fulfilling the delivery
obligation outside the administration of the debtor's estate.
Section 190.06(a)(3) applies when it is not practicable to effect
delivery outside the estate. Section 190.06(a)(3) clarifies that which
was implied, but was not addressed, in current Sec. 190.05(c)(1)-(2),
by providing additional details for when delivery is made or taken
within the debtor's estate. It contains provisions for the trustee to
deliver physical or cash delivery property on a customer's behalf, or
return such property to the customer so that the customer may fulfill
its delivery obligation. The regulation also includes restrictions
designed to assure that a customer does not receive (or otherwise
benefit from) a distribution of customer property (or other use of such
property that benefits the customer) that exceeds the customer's pro
rata share of the relevant customer property pool.
The Commission is adopting new Sec. 190.06(a)(4) to recognize that
delivery may need to be made in a securities account if an open
commodity contract held in a futures account, foreign futures account,
or cleared swaps account requires the delivery of securities, and
property from any of these accounts is transferred to the securities
account for the purpose of effecting delivery. The value of the
property transferred to the securities account must be limited to the
customer's funded balance for a commodity contract account, and only to
the extent that funded balance exceeds (i.e., the surplus over) the
customer's minimum margin requirements for that account. Such a
transfer may not be made if the customer is undermargined or has a
deficit balance in any other commodity contract accounts.
Section 190.06(a)(5), as proposed, addressed deliveries made or
taken on behalf of ``a house account of the debtor.'' It was derived
from current Sec. 190.05(c)(3), with some clarifying wording.
Consistent with the suggestion from the ABA Subcommittee, as discussed
in section II.A.2 above, the Commission is deleting in this final rule
the definition of house account as it applies to FCMs. The reference in
the provision as proposed to ``a house account of the debtor'' is being
replaced in the final rule with a reference to ``the debtor's own
account or the account of any non-public customer of the debtor.'' No
substantive change vis-[agrave]-vis either the current regulation or
the regulation as proposed is intended.
The Commission is adopting new Sec. 190.06(b) to divide the
delivery account class into separate physical delivery and cash
delivery account subclasses, for purposes of pro rata distributions to
customers in the delivery account class on their net equity claims.
Because claims in each subclass are fixed as of the filing date, Sec.
190.06(b)(1)(i) provides that the physical delivery account class
includes physical delivery property held in delivery accounts as of the
filing date, and the proceeds of any such physical delivery property
received subsequently (i.e., cash received after the filing date, in
exchange for physical delivery property on which delivery was made),
and Sec. 190.06(b)(ii) provides the cash delivery account class
includes cash delivery property in delivery accounts as of the filing
date, along with physical delivery property for which delivery is
subsequently taken (i.e., in exchange for cash delivery property paid
after the filing date) on behalf of a customer in accordance with Sec.
190.06(a)(3).
Section 190.06(b)(2) describes the customer property included in
the cash delivery account class and in the physical delivery account
class. Section 190.06(b)(2) provides that customer property in the cash
delivery account class includes cash or cash equivalents that are held
in an account under a name, or in a manner, that clearly indicates that
the account holds property for the purpose of making payment for taking
delivery of a commodity under commodity contracts. Customer property in
the cash delivery account class also includes any other property that
is (A) not segregated for the benefit of customers in the futures,
foreign futures, or cleared swaps account classes) and (B) traceable
(through, e.g., account statements) as having been received after the
filing date as part of taking delivery.
Section 190.06(b)(2) also provides, conversely, that customer
property in the physical delivery account class includes cash or cash
equivalents that are held in an account under a name, or in a manner,
that clearly indicates that the account holds property received in
payment for making delivery of a commodity under a commodity contract.
Customer property in the
[[Page 19357]]
physical delivery account class also includes any other property that
is (A) not segregated for the benefit of customers in the futures,
foreign futures, or cleared swaps account classes) and (B) traceable
(through, e.g., account statements) as having been held for the purpose
of making delivery of a commodity under a commodity contract, or held
as of the filing date as a result of taking delivery.
The Commission requested comment on all aspects of proposed Sec.
190.06. In particular, the Commission sought comment on the
implications of subdividing the delivery account class into separate
physical delivery and cash delivery account subclasses, including any
additional challenges or benefits that the Commission did not consider.
CME expressed support for specific aspects of proposed Sec. 190.06,
such as: (1) The proposed enhancements to the delivery account class,
including separating the account class into physical and cash delivery
account classes; (2) the additional detail provided to the trustee on
how to facilitate the completion of deliveries including, in
particular, the requirement for the trustee to use reasonable efforts
to allow delivery to occur outside administration of the debtor FCM's
estate when the rules of the relevant exchange or DCO prescribe a
process for allowing deliveries to be accomplished as set forth in the
proposal; and (3) the clarification that cash or cash equivalents held
by the debtor FCM in an account maintained at a bank, DCO, foreign
clearing organization or elsewhere constitutes customer property when
it is held under a name or in a manner clearly indicating the property
in the account relates to deliveries. As to the latter, CME believes
that this will facilitate identifying cash delivery property available
to distribute to customers in the cash delivery account class.\129\
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\129\ CME noted that its support was ``subject to CME's comments
which request changes to the cash delivery property and physical
delivery property definitions.'' Specifically, CME requested that
the Commission adopt more formal requirements with respect to
delivery accounts through a separate rulemaking. That request is
addressed in section II.G below.
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Accordingly, after consideration of the comments and for the
reasons stated above, the Commission is adopting Sec. 190.06 as
proposed, with modifications to Sec. 190.06(a)(5) as set forth above.
5. Regulation Sec. 190.07: Transfers
Regulation Sec. 190.07 was proposed to set forth detailed
provisions governing transfers, consistent with the policy preference,
explained in Sec. 190.00(c)(4), for transferring (or ``porting'')
public customer commodity contract positions, as well as all or a
portion of such customers' account equity. It is being adopted as
proposed with modifications to Sec. 190.07(b), (d), and (e), as set
forth below.
The Commission requested comment with respect to all aspects of
proposed Sec. 190.07, and raised particular questions with respect to
the proposed six-month post-transfer period to complete customer
diligence, partial transfers, and estimates of customer claims.
Section 190.07(a) addresses rules that clearing organizations and
SROs may ``adopt, maintain in effect, or enforce'' that may affect
transfers.
In Sec. 190.07, paragraphs (a)(1) and (2) states that these
organizations may not have such rules that, respectively, ``are
inconsistent with the provisions of'' part 190 or that interfere with
the acceptance by their members of commodity contracts and collateral
from FCMs that are required to transfer accounts pursuant to Sec.
1.17(a)(4). These provisions are derived from current Sec.
190.06(a)(1) and (2), with technical changes. No comments were received
with respect to these provisions.
Section 190.07(a)(3) is intended to promote transfers, to the
extent consistent with good risk management. It provides that no
clearing organization or other SRO may adopt, maintain in effect, or
enforce rules that ``interfere with the acceptance by its members of
transfers of commodity contracts, and the property margining or
securing such contracts, from [an FCM that is a debtor] if such
transfers have been approved by the Commission . . .'' Paragraph (a)(3)
includes a proviso, however, that it shall not (i) ``[l]imit the
exercise of any contractual right of a clearing organization or other
registered entity to liquidate or transfer open commodity contracts'';
or (ii) ``[b]e interpreted to limit a clearing organization's ability
adequately to manage risk.''
FIA supported the proviso, and CME ``agree[ed] that transfers
should be made consistent with sound risk management principles, and in
that regard welcome[d] the proposed clarification that the requirements
under the proposed rule do not limit the rights of a DCO (or a DCM or
swap execution facility as ``registered entities'' as defined in the
CEA) to liquidate or transfer open commodity contracts.'' ICE, by
contrast, was concerned that the term ``interfere with'' is overly
broad, and requested that the Commission ``clarify that a clearing
organization is not precluded from managing the risks presented by any
such transfer, including through bona fide changes in margin
requirements and guarantee fund contributions for transferee clearing
members.''
As discussed immediately above, the provision already states that
``this paragraph (a)(3) shall not . . . be interpreted to limit a
clearing organization's ability adequately to manage risk.'' Moreover,
recognizing the different or additional margin requirements or
guarantee fund contribution requirements resulting from the additional
positions carried by a transferee clearing member is not a rule that
interferes with the acceptance of a transfer of commodity
contracts.\130\ Accordingly, the Commission concludes that Sec.
190.07(a)(3) appropriately meets the goal of promoting transfers to the
extent consistent with good risk management.
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\130\ The Commission understands ICE's reference to ``bona fide
changes in margin requirements and guarantee fund contributions'' to
mean changes that are not based on the fact that positions were
acquired by transfer.
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Regulation Sec. 190.07(b) concerns requirements for transferees.
Paragraph (b)(1) clarifies that it is the duty of the transferee--not
of anyone else--to assure that the transfer will not cause the
transferee to be in violation of the minimum financial requirements.
Paragraph (b)(2) notes that the transferee accepts the transfer subject
to any loss arising from deficit balances that cannot be recovered from
the customer, and, in the case of customer accounts, must keep such
counts open for at least one business day (unless the customer fails to
respond to a margin call within a reasonable time) and may not collect
commissions with respect to the transfer.
As stated in the proposal, the Commission understands that customer
diligence processes would have already been required to have been
completed by the debtor FCM with respect to each of its customers as
part of opening their accounts. Regulation Sec. 190.07(b)(3) thus
provides that a transferee may accept open commodity contracts and
property, and may open accounts on its records prior to completing
customer diligence, provided that account opening diligence as required
is performed as soon as practicable but no later than six months after
transfer, unless the time is extended, by the Commission, for a
particular account, transfer, or debtor. This provision is consistent
with past practice in FCM bankruptcies.
CME supported this provision as a ``practical change'' that should
assist in finding willing transferees, while ICI believed that it will
help mitigate or
[[Page 19358]]
eliminate ``speed bumps'' to porting. Vanguard supported the
flexibility advanced by the Commission here, but urged the Commission
to work to harmonize that flexibility across other regulatory regimes
applicable at FCMs, particularly for those dually registered as broker-
dealers.
FIA supported the policy underlying paragraph (b)(3), and noted
that it is essential to realize the policy of favoring porting over
liquidation of customer accounts. FIA also agreed that six months is a
reasonable period of time for this process, subject to the Commission's
authority to grant additional time in particular circumstances. FIA
was, however, of the view that this regulation should ``provide
transferee FCMs more specific relief from applicable law relating to
`customer diligence.' ''
FIA encouraged the Commission to specify the customer diligence
rules from which transferee FCMs will have temporary relief. FIA stated
that
``such rules may include, but not be limited to: (i) rules relating
to anti-money laundering requirements (including rules requiring
FCMs to implement customer identification programs and know your
customer requirements and all corresponding self-regulatory
organization (``SRO'') requirements); (ii) rules relating to risk
and other disclosures (Sec. Sec. 1.55, 30.6, 33.7 and similar SRO
disclosure requirements); (iii) rules relating to capital and
residual interest requirements (Sec. Sec. 1.11, 1.17, 1.22, 1.23,
22.2, 22.17, 30.7 and 41.48 and related SRO requirements); (iv)
rules relating to account statements required under Sec. 1.33 in
the event positions transfer with inadequate contact information
(Sec. 1.33 and related SRO requirements); and [(v)] rules relating
to margin in the event accounts transfer without adequate margin
(Sec. Sec. 1.17, 39.13, 41.42-41.49 and related SRO
requirements).''
The Commission has considered each of the five types of
requirements discussed by FIA:
With respect to anti-money laundering requirements, the Commission
notes that, for purposes of the Customer Identification Program
(``CIP'') requirements applicable to futures commission merchants
pursuant to 31 CFR 1026.220, the term ``account'' is defined to exclude
``[a]n account that the futures commission merchant acquires through
any acquisition, merger, purchase of assets, or assumption of
liabilities.'' 31 CFR 1026.100(a)(2)(i). Thus, transferred accounts are
not subject to the CIP requirements.
However, the Customer Due Diligence (``CDD'') requirements of 31
CFR 1026.210(b)(5) do appear to apply. These include a requirement for
``[a]ppropriate risk-based procedures for conducting ongoing customer
due diligence, to include . . . [u]nderstanding the nature and purpose
of customer relationships for the purpose of developing a customer risk
profile . . . .'' 31 CFR 1026.210(b)(5)(i). The Commission is of the
view that Sec. 190.07(b)(3) would inform the determination of what
constitutes appropriate risk-based procedures in the exigent context of
an FCM accepting a transfer of accounts from an FCM that is a debtor in
bankruptcy.
While FIA appears to request a reference to the account opening
disclosure requirements in Sec. Sec. 1.55, 30.6, and 33.7, these would
appear to be addressed by the bulk transfer provisions of Sec. 1.65.
The Commission is amending Sec. 190.07(b)(3) to include a
parenthetical statement that explicitly refers to ``the risk
disclosures referred to in Sec. 1.65(a)(3).'' This will modify the
sixty-day requirement of that paragraph.
The Commission declines to amend the regulation to extend the time
to comply with capital and residual interest requirements. To do so
would risk permitting a transfer of accounts to result in contagion of
financial weakness. The Commission reiterates the importance of Sec.
190.07(b)(1), which provides that ``it is the duty of each transferee
to assure that it will not accept a transfer that would cause the
transferee to be in violation of the minimum financial requirements set
forth in this chapter.''
However, to the extent that shortfalls in compliance with these
requirements are due to errors or shortfalls in the data received by
the transferee from the transferor FCM, and the transferee acts with
reasonable and appropriate diligence in seeking to detect such errors
or shortfalls in data, and, where detected, in investigating and
correcting them, such shortfalls in compliance would not be considered
violations of such requirements.
Similarly, where account statements required by Sec. 1.33 do not
reach the customer due to errors or shortfalls in the contact
information provided to the transferee, there would be no violation so
long as the transferee takes reasonable steps to detect such errors or
shortfalls (e.g., by reacting promptly to rejected email or returned
postal mail, or to complaints by a transferred customer that they are
not receiving such statements) and to correct the situation once
detected. The proposed regulation does not need to be amended to
achieve this result.
Finally, with respect to FIA's request for relief with respect to
regulations ``relating to margin in the event accounts transfer without
adequate margin,'' the Commission believes that the determination of
whether a transferee FCM is promptly collecting such margin should be
informed by the exigencies of the situation. There is, however, no
basis for a general exemption for transferee accounts from the
requirements of Sec. 39.13(g)(8)(iii), providing that a DCO shall
require that its members do not permit customers to withdraw funds from
their accounts unless the accounts would be fully margined after such
withdrawal. If the transferee FCM is not confident of the information
it has regarding the transferred account, it would seem appropriate to
risk manage with caution. Once the transferee FCM is confident that it
fully understands the situation, the transferee can act in accordance
with its normal procedures.\131\ Similarly, there is no basis to
provide a general exemption from undermargined account capital charges
in accordance with Sec. 1.17.
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\131\ Such normal procedures would include the ``ordinary course
of business'' referred to in Letter 19-17, or any successor letter
or regulation. See CFTC Letter 19-17, https://www.cftc.gov/node/217076.
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In all of these cases, the Commission encourages DCOs and SROs to
take similar approaches.
While the Commission has declined, in many of the above cases, to
provide general relief by regulation, this is without prejudice to the
possibility that more targeted relief may be appropriate in particular
cases. Specifically, any further relief that might be appropriate in a
particular situation could be requested by, e.g., the transferee, in
light of the relevant facts and circumstances.
The Commission observes that its staff have traditionally responded
to requests for relief in emergency situations with great dispatch, and
expects, and thus instructs staff, to continue to do so in this context
in the future.\132\
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\132\ For the avoidance of doubt, the nature of the expectation
and the instruction is that staff will provide a response to such
requests with great dispatch. The nature of the response, whether
affirmative, affirmative in part, or negative, will depend on the
relevant facts and circumstances.
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OCC recommended that ``the Commission adopt a parallel regulation
permitting a DCO to postpone any due diligence the DCO would typically
have to perform on an FCM member accepting transferred positions from a
bankrupt FCM.'' This would include the requirements of, e.g., Sec.
39.12, requiring a DCO to have ``continuing participation requirements
for clearing members of the [DCO] that are objective, publicly
available, and risk-based.''
The Commission does not agree that the situations are parallel: An
FCM is required to perform individualized due
[[Page 19359]]
diligence on each of its customers, which in the case of a transfer
such as was seen in historical situations such as MF Global, would
amount to hundreds or even thousands of customers. By contrast, the
focus of a DCO is on the financial and operational capability of each
of its clearing members that is a transferee to manage, in the
aggregate, the customer portfolios of which it accepts transfer. The
number of transferee FCM clearing members is likely to be no more than
a dozen.
In any event, the Commission expects that a DCO would, and would be
permitted to, conduct its due diligence procedures in a manner
consistent with balancing risk management requirements (see, e.g.,
Sec. 190.07(a)(3)(ii) (restrictions on a DCO interfering with the
acceptance of transfers from a debtor FCM ``shall not be interpreted to
limit a clearing organization's ability adequately to manage risk'')
with the exigencies of the situation.
Section 190.07(b)(4) is designed to clarify what the account
agreement between the transferred customer and the transferee is at and
after the time the transfer becomes effective. This includes situations
where an account is partially transferred. As proposed, it provides
that any account agreements governing a transferred account shall be
deemed assigned to the transferee and shall govern the customer's
relationship unless and until a new agreement is reached. It also
provides that a breach of the agreement prior to a transfer does not
constitute a breach on the part of the transferee. CME, ICI, and
Vanguard supported this provision.
FIA appreciated the need for legal certainty as to the terms of the
relationship between a transferee FCM and each transferred customer,
but was concerned that the transferee FCM might be disadvantaged by
being subject to an account agreement between the transferred customer
and the transferor (debtor) FCM. There are two possible situations with
respect to each customer: Either the customer does, or does not, have a
pre-existing account agreement with the transferee FCM.
FIA noted that many large customers, in particular, may maintain
accounts at more than one FCM, and thus it may be the case that the
customer already has an account agreement in place with the transferee
FCM. FIA asked the Commission to confirm their view that, in this
context, the transferee would not be required to manage the ported
account(s) in accordance with the agreement with the transferor FCM.
The Commission agrees with this view, and is modifying proposed Sec.
190.07(b)(4) to state this explicitly: The proposed text will be
renumbered as Sec. 190.07(b)(4)(i), and paragraph (b)(4)(ii) will be
added to provide that paragraph (b)(4)(i) shall not apply where the
customer has a pre-existing account agreement with the transferee
futures commission merchant. In such a case, the transferred account
will be governed by that pre-existing account agreement.
However, where the transferred customer does not have a pre-
existing account agreement with the transferee FCM, FIA conceded that
``the account agreement [between the transferor and the customer]
should stay in place for a short defined interim period during which
the parties may renegotiate. . . .'' FIA did not specify how long that
``short defined interim period'' should last, nor what should happen at
the end of that period if the parties fail to reach agreement. The
Commission notes that nothing prevents either the transferee FCM or
customer from negotiating at any time to change the (in this case,
assigned) account agreement between them, and that, aside from Sec.
190.07(b)(2)(ii)(A) (requiring the transferee to keep the customer's
commodity contracts open at least one business day after their receipt
unless the customer fails to meet promptly a margin call), nothing in
the Commission's regulations prevents either the transferee or customer
from terminating their relationship if they cannot reach agreement as
to the terms under which that relationship should continue, on what
either party believes is a timely basis. Accordingly, the Commission
declines to modify Sec. 190.07(b)(4) in this context.
Lastly, FIA observed that a customer's account may not always be
able to be physically transferred from the debtor FCM to the transferee
FCM. The Commission notes that the reference in Sec. 190.07(b)(4) to
assignment of account agreements does not refer to the movement of
physical documents.\133\ As requested by FIA, the Commission can thus
confirm that assignment of the agreement does not depend upon such
movement.
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\133\ To be sure, a transfer agreement would likely include
transfers of records or at least copies of records as a matter of
good practice.
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Regulation Sec. 190.07(b)(5) provides that customer instructions
received by the debtor with respect to open commodity contracts or
specifically identifiable property that has been, or will be,
transferred in accordance with section 764(b) of the Bankruptcy Code,
should be transmitted to any transferee, which shall comply therewith
to the extent practicable (if the transferee subsequently enters
insolvency).
Regulation Sec. 190.07(c) addresses eligibility of accounts for
transfer under section 764(b) of the Bankruptcy Code. This provision
states that ``[a]ll commodity contract accounts (including accounts
with no open commodity contract positions) are eligible for transfer. .
. .'' This language recognizes that accounts can be transferred even if
they are intended for trading commodities but do not include any open
commodity contracts at the time of the order for relief.\134\
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\134\ Cf. 11 U.S.C. 761(9)(A)(ii)(II) (customer means, with
respect to an FCM, an entity that holds a claim against the FCM
arising out of ``a deposit or payment of cash, security, or other
property with such [FCM] for the purpose of making or margining [a]
commodity contract'') (emphasis added).
Thus, where a person opens a customer account and deposits
collateral on day 1, intending to trade on day 3 (or some subsequent
day when the customer determines that it is propitious to trade) and
the FCM becomes a debtor on day 2 (or some other day when the
customer has no positions open) such person nonetheless qualifies as
a customer, and their claim would be a customer claim.
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Regulation Sec. 190.07(d) addresses special rules for transfers
under section 764(b) of the Bankruptcy Code. Paragraph (d)(1) instructs
the trustee to ``use its best efforts to effect a transfer to one or
more other commodity brokers of all eligible commodity contract
accounts, open commodity contracts and property held by the debtor for
or on behalf of its customers, based on customer claims of record, no
later than the seventh calendar day after the order for relief.'' The
Commission will correct a typographical error in the proposal, and
refer to ``customer claims of record'' rather than ``customer claims or
record.''
Regulation Sec. 190.07(d)(2) addresses cases of partial transfers
and multiple transferees. It includes a requirement that ``a partial
transfer of contracts and property may be made so long as such transfer
would not result in an increase in the amount of any customer's net
equity claim.'' The added language is intended to caution against
partial transfers that would break netting sets and make the customer
worse off. The Commission has also decided to state that one way to
accomplish a partial transfer is ``by liquidating a portion of the open
commodity contracts held by a customer such that sufficient value is
realized, or margin requirements are reduced to an extent sufficient,
to permit the transfer of some or all of the remaining open commodity
contracts and property.'' This language is intended to clarify that the
liquidation may either crystalize gains or have the effect of reducing
the required margin. Finally, with regards to the transfer of part of a
spread or a straddle,
[[Page 19360]]
Sec. 190.07(d)(2)(ii) states that ``to the extent practicable under
the circumstances,'' each side of the spread or straddle must be
transferred or none of the open commodity contracts comprising the
spread or straddle may be transferred. This language is intended to
clarify that the trustee is required to protect customers holding
spread or straddle positions from the breaking of netting sets, but
only to the extent practicable given the circumstances.
Regulation Sec. 190.07(d)(3) provides details regarding the
treatment and transfer of letters of credit used as margin, consistent
with other proposed provisions related to letters of credit. In
particular, this provision states that a transfer of a letter of credit
cannot be made if it would result in a recovery that exceeds the amount
to which the customer is entitled in Sec. Sec. 190.08 and 190.09. If
the letter of credit cannot be transferred and the customer does not
deliver substitute property, the trustee may draw upon a portion or
upon all of the letter of credit, the proceeds of which will be treated
as customer property in the applicable account class. The Commission
believes a regulation detailing how letters of credit are to be treated
in a transfer will provide more certainty, as there is currently no
such regulation, and that the proposed treatment is both practical and
consistent with the policy of pro rata distribution.\135\
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\135\ See also discussion of treatment of letters of credit in
bankruptcy under Sec. 190.04(d)(3) in section II.B.2.
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Regulation Sec. 190.07(d)(4) requires a trustee to use reasonable
efforts to prevent physical delivery property from being separated from
commodity contract positions under which the property is deliverable.
The Commission is proposing this regulation to clarify its expectations
in such situations, specifically, to promote the delivery process.
Regulation Sec. 190.07(d)(5) is intended to prevent prejudice to
customers generally by prohibiting the trustee from making a transfer
that would result in insufficient customer property being available to
make equivalent percentage distributions to all equity claim holders in
the applicable account class. It clarifies that the trustee should make
determinations in this context based on customer claims reflected in
the FCM's records, and, for customer claims that are not consistent
with those records, should make estimates using reasonable discretion
based in each case on available information as of the calendar day
immediately preceding transfer.
Regulation Sec. 190.07(e) addresses the prohibition on avoidance
of transfers under section 764(b) of the Bankruptcy Code. It explicitly
approves specific types of transfers, unless such transfers are
disapproved by the Commission.
Section 190.07(e)(1) approves (i) transfers that were made before
the order for relief in compliance with Sec. 1.17(a)(4) (FCM fails to
meet capital requirements); (ii) pre-relief transfers, withdrawals or
settlements at the request of public customers, unless the customer
acted in collusion with the debtor to obtain a greater share than it
would otherwise be entitled to; and (iii) pre-relief transfers of
customer accounts or commodity contracts and other related property,
either by a clearing organization or a receiver that has been appointed
for the FCM that is now a debtor. In this context, ``public customers''
would include a lower-level (i.e., downstream) FCM acting on behalf of
its own public customers (e.g., cleared at the debtor on an omnibus
basis).
Regulation Sec. 190.07(e)(2) pertains to post-relief transfers.
Section 764(b) of the bankruptcy code permits the Commission to
approve, and thus protect from avoidance, transfers that occur up to
seven days after the order for relief. Section 190.07(e)(2)(i) approves
transfers of eligible commodity contract accounts or customer property
made by the trustee or any clearing organization. Section
190.07(e)(2)(ii) approves transfers made at the direction of the
Commission upon such terms and conditions as the Commission may deem
appropriate and in the public interest.
Regulation Sec. 190.07(e)(3) was referred to in preamble to the
proposal as derived from current Sec. 190.06(g)(3). It was
inadvertently omitted from the rule text in the proposal.
Section 190.07(e)(3) pertains to pre-relief withdrawals by
customers (in contrast to the transfers dealt with previously in Sec.
190.07(e)(1)(ii)). It states (in terms analogous to Sec.
190.07(e)(1)(ii)) that notwithstanding the provisions of paragraphs (c)
and (d) of this section, the following transfers are approved and may
not be avoided under sections 544, 546, 547, 548, 549 or 724(a) of the
Bankruptcy Code: The withdrawal or settlement of a commodity contract
account by a public customer, including a public customer which is a
commodity broker, prior to the filing date unless: (i) The customer
making the withdrawal or settlement acted in collusion with the debtor
or its principals to obtain a greater share of the bankruptcy estate
than that to which such customer would be entitled in a bankruptcy
distribution; or (ii) The withdrawal or settlement is disapproved by
the Commission.
Regulation Sec. 190.07(f) provides that, notwithstanding the other
provisions of this section (with exceptions discussed below), the
Commission may prohibit the transfer of a particular set or sets of the
commodity contract accounts and customer property, or permit the
transfer of a particular set or sets of commodity contract accounts and
customer property that do not comply with the requirements of the
section. The exceptions are the policy in favor of avoiding the
breaking of netting sets in Sec. 190.07(d)(2)(ii), and the avoidance
of prejudice to other customers in Sec. 190.07(d)(5).
Accordingly, after consideration of the comments and for the
reasons stated above, the Commission is adopting Sec. 190.07 as
proposed with modifications to Sec. 190.07(b), (d), and (e), as set
forth above.
6. Regulation Sec. 190.08: Calculation of Funded Net Equity
Section 190.08 is being adopted as proposed with a number of
technical modifications, as set forth below.
The Commission requested comment with respect to all aspects of
proposed Sec. 190.08, and raised particular questions with respect to
the revisions to the calculation of the equity balance of a commodity
contract set forth in proposed Sec. 190.08(b)(1), and the
appropriateness of the proposal to determine the value of an open
commodity contract at the end of the last settlement cycle on the day
preceding the transfer rather than at the end of the day of the
transfer, as set forth in Sec. 190.08(d)(1)-(2).
As proposed, Sec. 190.08(a) stated that the ``allowed net equity
claim of a customer shall be equal to the aggregate of the funded
balances of such customer's net equity claim for each account class.''
As discussed above, the ABA Subcommittee urged that there should be
more precise use of the term ``allowed claim.'' \136\ The Commission
agrees with this recommendation. Accordingly, the Commission is
amending the language in the proposal to replace the term ``allowed net
equity'' with the term ``funded net equity'' in the final rule in both
Sec. 190.08(a) and in the title of Sec. 190.08.\137\
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\136\ See discussion of ``funded claim'' in section II.A.2
above.
\137\ Proposed Sec. 190.08(a) is derived from current Sec.
190.07(a), but reflects the fact that, under the revised definition
of the term ``primary liquidation date,'' all commodity contracts
will be liquidated or transferred prior to the primary liquidation
date. Since no (relevant) operations will occur subsequent to the
liquidation date, provisions that address how to deal with commodity
contracts after that time are moot.
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[[Page 19361]]
Section 190.08(b) sets forth the steps for a trustee to follow when
calculating each customer's net equity.\138\ Section 190.08(b)(1),
equity determination, sets forth the steps for a trustee to follow when
calculating the equity balance of each commodity contract account of a
customer. When calculating the customer's claim against the debtor, the
basis for calculating such claim is the data that appears in the
debtor's records. Once the customer's claim based on the debtor's
records is calculated, the customer will have the opportunity to
dispute such claim based on their own records, and the trustee may
adjust the debtor's records if it is persuaded by the customer. There
were no comments directed specifically to this provision.
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\138\ Pursuant to section 20(a)(5) of the CEA, 7 U.S.C.
24(a)(5), the Commission has the power to provide how the net equity
of a customer is to be determined.
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Section 190.08(b)(2), customer determination (aggregation),
provides instructions to the trustee regarding how to aggregate the
credit and debit equity balances of all accounts of the same class held
by a customer. Specifically, the regulation sets forth how to determine
whether accounts are held in the same capacity or in separate
capacities. There were two comments applicable to this provision.
As proposed, Sec. 190.08(b)(2)(ix) referred to the fact that an
omnibus customer accounts is held in a separate capacity from the
``house account.'' As noted above,\139\ the ABA Subcommittee has
suggested the deletion of the term ``house account'' in the context of
FCM bankruptcies, and the Commission has accepted this suggestion.
Consistent with that approach, the Commission is accepting the ABA
Subcommittee's revised drafting for this provision: An omnibus customer
account for public customers of a futures commission merchant
maintained with a debtor shall be deemed to be held in a separate
capacity from any omnibus customer account for non-public customers of
such futures commission merchant and from any account maintained with
the debtor on its own behalf or on behalf of any non-public customer
(emphasis added only for illustration).
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\139\ See section II.A.2 above.
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As proposed, Sec. 190.08(b)(2)(xii) provided that except as
otherwise provided in this section, an account maintained with a debtor
by an agent or nominee for a principal or a beneficial owner shall be
deemed to be an account held in the individual capacity of such
principal or beneficial owner.
SIFMA AMG/MFA urged the Commission to amend this provision to
``treat accounts of the same principal or beneficial owner maintained
by different agents or nominees as separate accounts,'' noting that
this approach would ``reduce the administrative difficulties the
trustee would face in consolidating all accounts of the same principal
or beneficial owner'' and would ``avoid[] any confusion as to the
treatment of separate accounts that could arise with the overlay of the
time-limited relief provided by Letter 19-17.'' \140\ SIFMA AMG/MFA
asserted that this change would be similar to the approach taken by the
Commission in proposed Sec. 190.08(b)(2)(xiv), which provides that
accounts held by a customer in separate capacities shall be deemed to
be accounts of different customers.
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\140\ See CFTC Letter 19-17, https://www.cftc.gov/node/217076.
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The Commission notes that CFTC Letter 19-17 conditioned such relief
on the FCM performing ``stress testing and credit limits . . . on a
combined account basis'' and ``provid[ing] each beneficial owner using
separate accounts with a disclosure that under CFTC [p]art 190 rules
all separate accounts of the beneficial owner will be combined in the
event of an FCM bankruptcy.'' \141\ Thus, treating separate accounts of
the same beneficial owner on a combined basis is entirely consistent
with the approach taken in Letter 19-17. Nor is the situation of
separate accounts for the same beneficial owner analogous to a customer
holding accounts in separate capacities, as referred to in Sec.
190.08(b)(2)(xiv) (e.g., in their personal capacity versus in their
capacity as trustee for X, or in their capacity as trustee for Y versus
their capacity as trustee for Z.). In those latter cases, the same
legal owner is acting for separate beneficial owners. Accordingly, the
Commission is declining to amend Sec. 190.08(b)(2)(xii).
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\141\ Id. at 5 (emphasis supplied).
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Section 190.08(b)(3), setoffs, sets forth instructions regarding
how and when to set off positive and negative equity balances.
Section 190.08(b)(4), correction for distributions, provides that
the value of property that has been transferred or distributed must be
added to the net equity amount calculated for that customer after
performing the steps contained in Sec. 190.08(b)(1) through (3).
Section 190.08(b)(4) also includes a proviso that clarifies that the
calculation of net equity for any late-filed claims (in cases where all
accounts for which there are customer claims of record as of the filing
date are transferred with all of the equity pertaining thereto) will be
based on the allowed amount of such claims.
Section 190.08(b)(5), correction for ongoing events, provides that
the calculation of net equity will be adjusted to correct for
misestimates or errors, including corrections for the liquidation of
claims or specifically identifiable property at a value different from
the estimate value previously used in computing net equity.
As proposed, Sec. 190.08(c) set forth the method for calculation
of a customer's funded balance, i.e., ``a customer's pro rata share of
the customer estate with respect to each account class available for
distribution to customers of the same customer class.'' Section
190.08(c)(1) sets forth instructions for calculating the funded balance
of any customer claim, while Sec. 190.08(c)(2) requires the funded
balance to be adjusted to correct for ongoing events.
One change is being made to paragraph (c)(1), as a result of
addressing a comment that affected a prior section. As proposed, Sec.
190.08(c)(1)(ii) addressed giving customers credit for 100% of margin
payments made after the order for relief.
As discussed above,\142\ a number of commenters (ABA Subcommittee,
CME, CMC), suggested that the definition of cash delivery property be
expanded to address the possibility of post-filing-date payments made
by customers to the FCM to pay for delivery. Such payments should be
credited in full to the customer's funded balance. Indeed, Sec.
190.06(a)(3)(ii)(B)(2) provides that the trustee could issue payment
calls in this context and that ``the full amount of any payment made by
the customer in response to a payment call must be credited to the
funded balance of the particular account for which such payment is
made.''
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\142\ See discussion of cash delivery property in section
II.A.2, above.
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In order to be consistent with the principle that 100% of post-
filing-date payments are credited to a customer's funded balance,
proposed Sec. 190.08(c)(1)(ii) is being amended, with the proposed
language addressing post-filing-date margin payments to be codified as
Sec. 190.08(c)(1)(ii)(A), and the addition of Sec.
190.08(c)(1)(ii)(B) to address post-filing-date payments for
deliveries, to read as follows: ``[then adding 100% of] . . . [f]or
cash delivery property, any cash transferred to the trustee on or after
the filing date for the purpose of paying for delivery.''
Section 190.08(d), valuation, sets forth instructions about how to
value
[[Page 19362]]
commodity contracts and other property for purposes of calculating net
equity as set forth in the rest of Sec. 190.08.
Section 190.08(d)(1) sets forth instructions regarding how to value
commodity contracts, separately addressing: (i) Open commodity
contracts, and (ii) liquidated commodity contracts.
As proposed, Sec. 190.08(d)(1)(i), regarding the valuation of open
commodity contracts, states that ``if an open commodity contract is
transferred to another commodity broker, its value on the debtor's
books and records shall be determined as of the end of the last
settlement cycle on the day preceding such transfer.'' The Commission
noted in the proposal that ``[t]his would allow the value of the open
commodity contract to be known prior to the transfer,'' \143\ and, as
discussed above, specifically sought comments on this issue.
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\143\ 85 FR 36028.
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The Commission received contrasting comments on this provision. ICE
``d[id] not believe that valuation is the right one, particularly
because the market may move significantly on the date of transfer.'' By
contrast, CME ``agree[d]'' with valuation as of the end the last
settlement cycle on the day preceding transfer, because it aligns with
calculations of funded balances under proposed Sec. 190.08(c), and
noted that ``any mark-to-market gains or losses on the date of the
transfer should be reflected by the receiving FCM(s) in the customer
account statements as a result of that day's settlement cycle.'' The
Commission is persuaded by the latter comment, and will adopt the
provision as proposed, both for the reasons stated by the latter
commenter, and because of concerns regarding practicability. Markets
move on a continuous basis so long as they are open and, considering
markets around the world, some markets on which futures, foreign
futures, or cleared swaps are traded are moving at all times other than
over a weekend.
Section 190.08(d)(1)(ii)(A) allows the trustee to use the weighted
average of liquidation prices for identical commodity contracts that
are liquidated within a 24-hour period or business day, but not at the
same price.
Section 190.08(d)(1)(ii)(B) provides instructions on how to value
commodity contracts that are liquidated as part of a bulk auction by a
clearing organization or similarly outside of the open market. As
proposed, this provision would value a commodity contract that is
liquidated as part of a bulk auction at the settlement price calculated
by the clearing organization as of the end of the settlement cycle
during which the commodity contract was liquidated. ICE disagreed with
this approach, stating that ``the price achieved in the auction should
be used.'' However, as the Commission noted in the proposing release,
the units being auctioned will often be a heterogenous (though risk-
related) set of products, tenors (e.g., contract months), and
directions (e.g., long or short). Different auctioned portfolios may
contain the same or similar contracts. In this context, setting the
price of a particular contract based on the auction price for a
portfolio would require considerable interpretation. Accordingly, the
Commission will implement the approach from the proposal.
Section 190.08(d)(2) sets forth the approach for valuing listed
securities, and incorporates the same weighted average concept
discussed above with respect to Sec. 190.08(d)(1)(ii)(A).
Section 190.08(d)(3) sets forth the approach for valuing
commodities held in inventory, directing the trustee to use fair market
value. If such fair market value is not readily ascertainable from
public sources of prices, the trustee is directed to use the approach
in Sec. 190.08(d)(5), discussed below.
Section 190.08(d)(4) addresses the valuation of letters of credit.
The trustee is directed to use the face amount (less amounts, if any,
drawn and outstanding). However, if the trustee makes a determination
in good faith that a draw is unlikely to be honored on either a
temporary or permanent basis, they are directed to use the approach in
paragraph (d)(5).
Section 190.08(d)(5) provides the trustee with pragmatic
flexibility in determining the value of customer property by allowing
the trustee, in their sole discretion, to enlist the use of
professional assistance to value all other customer property.\144\ This
provision further notes that, if such property is sold, its value for
purposes of the calculations required by this part is equal to the
actual value realized on sale of such property (the trustee, of course,
retains discretion to engage professional assistance to allocate such
value among a heterogenous set of items sold as a unit). Finally, the
provision notes that any such sale shall be made in compliance with all
applicable statutes, rules, and orders of any court or governmental
entity with jurisdiction thereover.
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\144\ The trustee's employment of professionals remains subject
to the requirements of section 327 of the Bankruptcy Code.
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Accordingly, after consideration of the comments and for the
reasons stated above, Sec. 190.08 is being adopted as proposed, with
modifications to the title and to Sec. 190.08(a), (b), and (c), as set
forth above.
7. Regulation Sec. 190.09: Allocation of Property and Allowance of
Claims
Section 190.09 is being adopted to set forth rules governing the
scope of customer property, the allocation of customer property between
customer and account classes, and distribution of customer property. It
was derived from current Sec. 190.08. It is being adopted as proposed
with modifications to Sec. 190.09(d)(3), as set forth below.
The Commission requested comment with respect to all aspects of
proposed Sec. 190.09. The Commission also raised particular questions
with respect to: Whether the proposed revisions to Sec. 190.09(a)(1)
would appropriately preserve customer property for the benefit of
customers; whether proposed Sec. 190.09(a)(1)(ii)(G), concerning
property that other regulations require to be placed into segregation,
and Sec. 190.09(a)(1)(ii)(L), concerning remaining shortfalls, are
appropriately crafted; whether it is advisable to permit customers to
post ``substitute customer property'' rather than ``cash'' in proposed
Sec. 190.09(d); and whether it is appropriate to clarify the term
``like-kind securities'' by reference to the concept, derived from
SIPA, of ``securities of the same class and series of an issuer?''
There are three substantive changes in new Sec. 190.09, as
compared to current regulations:
Section 190.09(a)(1)(ii)(G) and (L) are two categories of property
that are defined to be included in customer property in order better to
protect customers from shortfalls in customer property (i.e., cases
where customer property is insufficient to cover claims for customer
property).
Section 190.09(a)(1)(ii)(G) is a new category of property that
constitutes customer property. It includes any cash, securities, or
other property which constitutes current assets of the debtor,
including the debtor's trading or operating accounts and commodities of
the debtor held in inventory, in the greater of (i) the amount of the
debtor's targeted residual interest amount pursuant to Sec. 1.11 with
respect to each account class, or (ii) the debtor's obligations to
cover debit balances or undermargined amounts as provided in Sec. Sec.
1.20, 1.22, 22.2 and, 30.7. Each of the sets of regulations referred to
in proposed Sec. 190.09(a)(1)(ii)(G) requires an FCM to put certain
funds into
[[Page 19363]]
segregation on behalf of customers. To the extent the FCM has failed to
comply with those regulatory requirements prior to the filing of the
bankruptcy, this provision requires the bankruptcy trustee to fulfill
that requirement, and allows the trustee to use the current assets of
the debtor to do that.
CME stated that this new provision is a ``substantial improvement
over the current rule,'' and it was also supported by ICI and Vanguard.
Section 190.09(a)(1)(ii)(L) is the analog to current Sec.
190.08(a)(1)(ii)(J) but with updated cross-references (and a new second
sentence, discussed in the next paragraph). It states that customer
property includes any cash, securities, or other property in the
debtor's estate, but only to the extent that the customer property
under the other definitional elements is insufficient to satisfy in
full all claims of the FCM's public customers.\145\
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\145\ ICE notes that the issues with respect to this provision
may be complicated, and that it may warrant further consideration,
but ultimately expresses no view on it.
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A new second sentence of Sec. 190.09(a)(1)(ii)(L) notes explicitly
that customer property for purposes of these regulations includes any
``customer property,'' as that term is defined in SIPA, that remains
after satisfaction of the provisions in SIPA regarding allocation of
(securities) customer property. SIPA provides that such remaining
customer property would be allocated to the general estate of the
debtor.\146\ Any securities customer property that remains after
satisfaction in full of securities claims provided for in that section
of SIPA proceeding and would accordingly become property of the general
estate should, to the extent otherwise provided in proposed Sec.
190.09(a)(1)(ii)(L), and for the same reasons, become customer property
in the FCM bankruptcy proceeding.
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\146\ See generally SIPA section 8(c)(1), 15 U.S.C. 78fff-
2(c)(1).
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Section 190.09(d) governs the distribution of customer property,
and has its analog in current Sec. 190.08(d). Section 190.09(d)(1)(i)
and (ii) and (d)(2) require customers to deposit ``substitute customer
property,'' to obtain the return or transfer of specifically
identifiable property. ``Substitute customer property'' is defined in
Sec. 190.01 to mean (in relevant part) ``cash or cash equivalents.''
``Cash equivalents,'' in turn, are defined as ``assets, other than
United States dollar cash, that are highly liquid such that they may be
converted into United States dollar cash within one business day
without material discount in value.''
The purpose of requiring customers to, in essence, ``buy back''
specifically identifiable property is to implement the pro rata
distribution principle set forth in section 766(h) of the Bankruptcy
Code, and discussed in Sec. 190.00(d)(5). Permitting customers to
redeem specifically identifiable property with either cash or cash
equivalents, rather than requiring cash, may mitigate the difficulty
(and costs) such customers face in obtaining redemption, but will in
any event fully implement the pro rata distribution principle.
As a technical point, the ABA Subcommittee recommended (consistent
with their recommendation in the definitions section, Sec. 190.01, to
more precisely use the term ``allowed net equity'') that the reference
in proposed Sec. 190.09(d)(3) to the amount distributable on a
customer's claim be amended to add ``[the] funded balance of'' before
the phrase ``such customers allowed net equity claim.'' The Commission
agrees, and is making the change.
The remaining provisions of revised Sec. 190.09 include only
technical changes to the current regulations.
Accordingly, after consideration of the comments, and for the
reasons stated above, Sec. 190.09 will be adopted as proposed, with
the modification to Sec. 190.09(d)(3) referred to above.
8. Regulation Sec. 190.10: Provisions Applicable to Futures Commission
Merchants During Business as Usual
The Commission proposed Sec. 190.10 to contain new and relocated
provisions that set forth an FCM's obligations during business as
usual. The Commission requested comment with respect to all aspects of
proposed Sec. 190.10, and specifically with respect to (1) the impact
of proposed Sec. 190.10(b) regarding the designation of hedging
accounts, (2) the impact of proposed Sec. 190.10(c) regarding the
establishment of delivery accounts during business as usual, (3) the
changes in proposed Sec. 190.10(d) to the business as usual
requirements for acceptance of letters of credit, and in particular (a)
whether its understanding is correct that most letters of credit
currently in use by the industry follow the JAC forms, (b) the impact
of additional requirements concerning letters of credit (as well as any
alternative methods of achieving the goal of treating customers posting
letters of credit consistent with the treatment of other customers),
and (c) whether the proposed one year transition period is reasonable,
and (4) the disclosure statement for non-cash margin set out in
proposed Sec. 190.10(e) (whether the statement is helpful, legally or
practically, whether it should be changed, or whether it should be
deleted).
Section 190.10 will be adopted as proposed with modifications. In
particular, the ABA Subcommittee and CME suggested that the provisions
in proposed Sec. 190.10 be codified in part 1, along with other
regulations that pertain to an FCM's business as usual. The ABA
Subcommittee stated that, while they had originally suggested that
these provisions belong in Sec. 190.10, ``[u]pon further reflection,
the Committee believes that such a rule more logically belongs in the
Commission's Part 1 Regulations, along with other rules that apply to
FCMs during business as usual. Compliance and legal personnel could
inadvertently overlook obligations that are not located in the
Commission rule set where they would expect to find them.''
The Commission agrees with the commenters that transparency would
be fostered by putting the ``business as usual'' requirements proposed
for Sec. 190.10 into part 1 of the Commission's regulations.
Accordingly, as discussed further below, most of the paragraphs of the
regulation that was proposed as Sec. 190.10 are being renumbered and
will be codified in specified places in part 1. The provisions of
proposed Sec. 190.10 will otherwise be adopted as proposed.
The provision proposed as Sec. 190.10(a) notes that an FCM is
required to maintain current records relating to its customer accounts,
pursuant to Sec. Sec. 1.31, 1.35, 1.36, and 1.37, and in a manner that
would permit them to be provided to another FCM in connection with the
transfer of open customer contracts of other customer property. This
provision recognizes that current and accurate records are imperative
in arranging for the transfer of customer contracts and other property,
both for the trustee of the estate of the defaulter and for an FCM that
is accepting the transfer. Nonetheless, it does not add to an FCM's
obligations under the specified regulations, but rather is useful as a
reference for the trustee. Accordingly, this provision will not be
moved to part 1.
No comments were received with respect to the substance of proposed
Sec. 190.10(a). As the remaining paragraphs of proposed Sec. 190.10
will be moved to part 1, this provision will be codified as Sec.
190.10.
The provision proposed as Sec. 190.10(b) concerns the designation
of hedging accounts. It incorporates concepts contained in current
Sec. Sec. 190.04(e) and 190.06(d) and the current Bankruptcy appendix
form 3 instructions. As it sets
[[Page 19364]]
forth obligations for an FCM during business as usual, it will be moved
to part 1. As it does not fit under any existing part 1 regulation, it
will be moved under the miscellaneous heading of part 1, and codified
as Sec. 1.41.
For purposes of Sec. 1.41, a customer will not need to provide,
and an FCM will not be required to judge, evidence of hedging intent
for purposes of bankruptcy treatment. Rather, Sec. 1.41 will permit
the FCM to treat the account as a hedging account for such purposes
based solely upon the written record of the customer's representation.
Hedging treatment for these bankruptcy purposes will not be
determinative for any other purpose.
Section 1.41(a) will require an FCM to provide a customer an
opportunity to designate an account as a hedging account when the
customer first opens the account, rather than when the customer
undertakes its first hedging contract, as specified in current Sec.
190.06(d)(1). This provision will also require that the FCM indicate
prominently in its accounting records for each customer account whether
the account is designated as a hedging account.
Section 1.41(b) will set forth the requirements for an FCM to treat
an account as a hedging account: If, but only if, the FCM obtains the
customer's written representation that the customer's trading in the
account will constitute hedging as defined under any relevant
Commission regulation or rule of a DCO, DCM, SEF, or FBOT. CME
supported this approach, and the clarity it adds.
In order to avoid the significant burden that would be associated
with requiring FCMs to re-obtain hedging instructions for existing
accounts, Sec. 1.41(c) will provide that the requirements of Sec.
1.41(a) and (b) do not apply to commodity contract accounts opened
prior to the effective date of these revisions. Rather, the provision
will recognize expressly that an FCM may continue to designate existing
accounts as hedging accounts based on written hedging instructions
obtained under former Sec. 190.06(d).
Finally, Sec. 1.41(d) will permit an FCM to designate an existing
futures, foreign futures or cleared swaps account of a particular
customer as a hedging account, provided that the FCM obtains the
representation required under Sec. 1.41(b).
The provision proposed as Sec. 190.10(c) addresses the
establishment of delivery accounts during business as usual.\147\ As it
sets forth obligations for an FCM during business as usual, it will be
moved to part 1. As it does not fit under any existing part 1
regulation, it will be moved under the miscellaneous heading, and
codified as Sec. 1.42.
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\147\ See Sec. 190.06 regarding the making and taking of
deliveries during bankruptcy.
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When a commodity contract is in the delivery phase, or when a
customer has taken delivery of commodities that are physically
delivered, associated property may be held in a ``delivery account''
rather than in the segregated accounts pursuant to, e.g., Sec. 1.20 or
Sec. 22.2. Section 1.42 recognizes that when an FCM facilitates
delivery under a customer's physical delivery contract, and such
delivery is effected outside of a futures account, foreign futures
account, or cleared swaps account, it must be effected through (and the
associated property held in) a delivery account. If, however, the
commodity that is subject to delivery is a security, the FCM may effect
delivery through (and the property may be held in) a securities
account. The regulation clarifies that the property must be held in one
of these types of accounts. ICE and CME generally support this
provision.\148\
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\148\ CME again recommended that the Commission consider
adopting customer protection requirements with respect to delivery
accounts via a separate rulemaking.
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The provision proposed as Sec. 190.10(d) addresses letters of
credit that an FCM accepts as collateral. As it sets forth obligations
for an FCM during business as usual, it will be moved to part 1. As it
does not fit under any existing part 1 regulation, it will be moved
under the miscellaneous heading, and codified as Sec. 1.43.
Section 1.43 will prohibit an FCM from accepting a letter of credit
as collateral unless certain conditions (1) are met at the time of
acceptance and (2) remain true through its date of expiration.
First, pursuant to Sec. 1.43(a), the trustee must be able to draw
upon the letter of credit, in full or in part, in the event of a
bankruptcy proceeding, the entry of a protective decree under SIPA, or
the appointment of FDIC as receiver pursuant to Title II of the Dodd-
Frank Act. Second, pursuant to Sec. 1.43(b), if the letter of credit
is permitted to be and is passed through to a clearing organization,
the bankruptcy trustee for such clearing organization or (if
applicable) FDIC must be able to draw upon the letter of credit, in
full or in part, in the event of a bankruptcy proceeding, or where the
FDIC is appointed as receiver pursuant to Title II.
The Commission has considered the impact that implementation of
this regulation would have on FCMs and their customers, since letters
of credit are currently in use by the industry.\149\ The Commission
proposed that, upon the effective date of the regulation, what is now
codified as Sec. 1.43 would apply only to new letters of credit and
customer agreements. In order to mitigate the impact of implementing
this regulation with respect to existing letters of credit and customer
agreements, the Commission proposed a transition period of one year
from the effective date until Sec. 1.43 will apply to existing letters
of credit and customer agreements.
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\149\ The Joint Audit Committee (``JAC'') forms for an
Irrevocable Standby Letter of Credit (both Pass-Through and Non
Pass-Through) appear to be consistent with the requirements of Sec.
1.43.
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CME supported this one-year transition period. By contrast, SIFMA
AMG/MFA urged the Commission to shorten it in the interest of investor
protection. They asked how letters of credit would be treated if an FCM
were to go into bankruptcy during the transition period?
The provisions in this rulemaking regarding letters of credit are
intended to codify the Commission's longstanding policy that
``customers using a letter of credit to meet original margin
obligations [sh]ould be treated no differently than customers
depositing other forms of non-cash margin or customers with excess cash
margin deposits.'' \150\ This is the policy that has been advanced by
the Commission, including in litigation,\151\ under the current rules.
Moreover, this policy is supported by the provision in revised Sec.
190.04(d)(3)(ii) that, for a letter of credit posted as collateral,
``the trustee shall treat any portion that is not drawn upon (less the
value of any substitute customer property delivered by the customer) as
having been distributed to the customer for purposes of calculating
entitlements to distribution or transfer.'' That provision is not
subject to the one-year transition period.
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\150\ See, e.g., 48 FR 8716, 8718 (March 1, 1983) (Adopting
release for part 190); Proposal, 86 FR at 36019 & n. 103.
\151\ See, e.g. Brief of the Commodity Futures Trading
Commission In Support Of The Trustee's Motion To Confirm in
ConocoPhillips v. Giddens, Case No. 1:12-cv-06014-KBF, Document 33.
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While the Commission will decline to shorten the one-year
transition period for existing letters of credit, trustees will be
expected to treat such letters of credit in accordance with the
Commission's policy.
The provision proposed as Sec. 190.10(e) concerns the disclosure
statement for non-cash margin. No comments were received specific to
this provision.
[[Page 19365]]
As it sets forth obligations for an FCM during business as usual,
it will be moved to part 1. This provision does fit under existing
Sec. 1.55 (Public disclosures by futures commission merchants), and
will be added at the end, codified as Sec. 1.55(p).
Accordingly, after consideration of the comments, and for the
reasons stated above, Sec. 190.10 will be adopted as proposed, with
modifications: Proposed Sec. 190.10(a) will be codified as Sec.
190.10, proposed Sec. 190.10(b) will be codified as Sec. 1.41,
proposed Sec. 190.10(c) will be codified as Sec. 1.42, proposed Sec.
190.10(d) will be codified as Sec. 1.43, and proposed Sec. 190.10(e)
will be codified as Sec. 1.55(p).
C. Subpart C--Clearing Organization as Debtor
The Commission is adopting a new subpart C of part 190 (proposed
Sec. Sec. 190.11-190.19), with certain modifications discussed below,
to address the currently unprecedented scenario of a clearing
organization as debtor.\152\
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\152\ After considering comments that were received on the
original Proposal, the Commission subsequently issued a Supplemental
Proposal that withdrew Sec. 190.14(b)(2) and (3), and proposed
other revisions to Sec. 190.14. Bankruptcy Regulations, 85 FR 60110
(Sept. 24, 2020).
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The customers of a clearing organization are its members,
considered separately in two roles: (1) Each member may have a
proprietary (also known as ``house'') account at the clearing
organization, on behalf of itself and its non-public customers (i.e.,
affiliates). The property that the clearing organization holds in
respect of these accounts is referred to as ``member property.'' (2)
Each member may have one or more accounts (e.g., futures, cleared
swaps) for that members' public customers. The property that the
clearing organization holds in respect of these accounts is referred to
as ``customer property other than member property.'' Many clearing
members will have both such types of accounts, although some may have
only one or the other.
1. Regulation Sec. 190.11: Scope and Purpose of Subpart C
The Commission is adopting Sec. 190.11 as proposed, but designated
as new paragraph (a), and adding a new paragraph (b), as set forth
below. The Commission is adopting Sec. 190.11 to establish that
subpart C of part 190 will apply to proceedings under subchapter IV to
chapter 7 of the Bankruptcy Code where the debtor is a clearing
organization.
When originally proposing part 190 in 1981, the Commission proposed
to (and ultimately did) forego providing generally applicable rules for
the bankruptcy of a clearing organization.\153\ The Commission
explained that it had proposed no other rules with respect to the
operation of clearing organization debtors--other than proposing that
all open commodity contracts, even those in a deliverable position, be
liquidated in the event of a clearing organization bankruptcy--because
the Commission viewed it as highly unlikely that an exchange could
maintain a properly functioning futures market in the event of the
collapse of its clearing organization. The Commission noted that, under
section 764(b)(2) of the Bankruptcy Code, it had the power to permit a
distribution of the proceeds of a clearing organization liquidation
free from the avoidance powers of the trustee. The Commission further
explained that it was not proposing a general rule, because the
bankruptcy of a clearing organization would be unique. Instead, the
Commission was inclined to take a case-by-case approach with respect to
clearing organizations, given the potential for market disruption and
disruption of the nation's economy as a whole, in the case of a
clearing organization bankruptcy, as well as the desirability of the
Commission's active participation in developing a means of meeting such
an emergency.\154\
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\153\ At the time, the definition of clearing organization in
section 761(2) of the Bankruptcy Code was an ``organization that
clears commodity contracts on, or subject to the rules of, a
contract market or board of trade.'' See Public Law 95-598 (1978),
92 Stat 2549.
\154\ 46 FR 57535, 57545 (Nov. 24, 1981).
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Much has changed in the intervening 39 years. Markets move much
more quickly, and thus the importance of quick action in respect to the
bankruptcy of a clearing organization has increased. The Commodity
Futures Modernization Act established DCOs as a separate registration
category.\155\ The bankruptcy of a clearing organization would remain
unique--it remains the case that no clearing organization registered
with the Commission has ever entered bankruptcy--and thus the need for
significant flexibility remains, but the balance has shifted towards
establishing ex ante the approach that would be taken.
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\155\ Commodity Futures Modernization Act of 2000 Public Law
106-554 section 1(a)(5); Appendix E, section 112(f).
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Two clearing organizations for which the Commission has been
designated the agency with primary jurisdiction have been designated as
systemically important to the United States financial system pursuant
to Title VIII of Dodd-Frank.\156\ If any clearing organization were to
approach insolvency, it is possible, though not certain, that such an
entity would be resolved pursuant to Title II of Dodd-Frank.\157\
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\156\ See Dodd-Frank section 804 (designation of systemic
importance), section 803(8) (definition of ``supervisory agency''),
12 U.S.C. 5463, 5462(8). These are CME and ICE Clear Credit. A third
clearing organization (Options Clearing Corporation) has also been
so designated, but the SEC is the supervisory agency in that case.
\157\ Resolution under Title II would require a recommendation
concerning factors specified in section 203(a)(2) of Dodd-Frank, 12
U.S.C. 5383(a)(2), by a \2/3\ majority of the members then serving
of each of the Board of Governors of the Federal Reserve System and
of the FDIC, followed by a determination concerning a related set of
factors specified in section 203(b), 12 U.S.C. 5383(b), by the
Secretary of the Treasury in consultation with the President. Thus,
the choice of resolution versus bankruptcy for a DCO that is, in the
terminology of Dodd-Frank, ``in default or in danger of default,''
see Dodd-Frank section 203(c)(4), 12 U.S.C. 5383(c)(4), cannot be
considered certain.
It is, however, clear that Title II applies to clearing
organizations. See, e.g., Dodd-Frank section 210(m), 12 U.S.C.
5390(m) (applying ``the provisions of subchapter IV of chapter 7 of
the bankruptcy code'' to ``member property'' of ``commodity
brokers''). Pursuant to section 761(16) of the Bankruptcy Code,
``member property'' applies only to a debtor that is a ``clearing
organization.'' 11 U.S.C. 761(16).
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Administration of a resolution under Title II of Dodd-Frank
depends, in part, on clarity as to entitlements under chapter 7 of the
Bankruptcy Code. Specifically, section 210(a)(7)(B) of Dodd-Frank \158\
provides with respect to claims against the covered financial agency in
resolution, that ``a creditor shall, in no event, receive less than the
amount that the creditor is entitled to under paragraphs (2) and (3) of
subsection (d), as applicable.'' Tracing to the cross-referenced
subsection, section 210(d)(2) \159\ provides that the maximum liability
of the FDIC to a claimant is the amount that the claimant would have
received if the FDIC had not been appointed receiver, and (instead),
the covered financial company had been liquidated under chapter 7 of
the Bankruptcy Code.\160\ Thus, it is important to have a clear
``counterfactual'' that establishes what creditors would be entitled to
in the case of the liquidation of a clearing
[[Page 19366]]
organization under chapter 7 (subchapter IV) of the Bankruptcy Code.
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\158\ 12 U.S.C. 5390(a)(7)(B).
\159\ 12 U.S.C. 5390(d)(2).
\160\ For the sake of completeness, it should be noted that
section 210(d)(2), 12 U.S.C. 5390(d)(2), provides, as an additional
comparator, ``any similar provision of State insolvency law
applicable to the covered financial company.'' Given Federal
regulation of DCOs, it would appear that this phrase is
inapplicable. Similarly, section 210(d)(3), 12 U.S.C. 5390(d)(3),
which refers to covered financial companies that are brokers or
dealers resolved by SIPC, is also inapplicable here, given the
inconsistency in being both a DCO and a broker-dealer.
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Although the Commission believes that the potential--albeit
unprecedented--scenario of a clearing organization as debtor would
require significant flexibility, the Commission also believes it
necessary and appropriate to establish an ex ante set of regulations
for such a scenario.
The Commission requested comment regarding the proposed scope of
subpart C, as set forth in proposed Sec. 190.11. The Commission also
specifically asked commenters whether they supported or opposed the
establishment of an explicit, bespoke set of regulations for the
bankruptcy of a clearing organization.
The Commission received two comments that raised concerns about how
the proposed subpart C regulations would apply in the case of a debtor
clearing organization that is organized and/or domiciled in a foreign
country. SIFMA AMG/MFA commented that ``Part 190 should include a clear
statement of public policy . . . that if an insolvency proceeding is
commenced in respect of a DCO located outside the United States, such
home country proceeding should take precedence over any case under the
[U.S.] Bankruptcy Code.''
ICE commented that such a clearing organization, if insolvent, ``is
likely to be subject to an insolvency proceeding in its home
jurisdiction.'' ICE also commented that many such DCOs ``have
significant assets (including for this purpose, the assets of clearing
members and their customers.'' In particular, ICE stated that ``a
foreign DCO may have, in addition to the customer account classes
contemplated by the CEA and CFTC regulations (and the Part 190
regulations), one or more classes of customer accounts that are
required to be segregated or separately accounted for under applicable
foreign law, generally for the protection of foreign clearing members
and their customers.'' ICE further commented that, ``[t]o the extent
the Part 190 rules mandate a distribution scheme for property of the
[DCO in bankruptcy] that would be inconsistent with foreign law
applicable to the DCO, and that could disadvantage foreign members or
their customers, significant conflicts may arise . . . .'' ICE
suggested two alternative approaches for the Commission to consider:
(1) The ``Commission could provide that the new Part 190 regulations
would not apply to a foreign DCO;'' or (2) ``[a]lternatively, the
Commission could provide that the new Part 190 regulations, including
the distributional regime, would apply only to the separate customer
account class structure provided for under U.S. law (futures, cleared
swaps and foreign futures), to the extent carried through FCM clearing
members.''
After considering the comments, the Commission is adopting Sec.
190.11 with modifications. With respect to the protection of customer
property in connection with foreign DCOs, the Commission has
traditionally focused its efforts on the protection of the public
customers of FCM members of such foreign DCOs. While protecting public
customers of FCM members of foreign DCOs would not be well served by
disapplying part 190 in the case of foreign DCOs, as suggested in ICE's
first approach, as well as in the comment by SIFMA AMG/MFA, balancing
the goal of protecting public customers of FCM members with the goal of
mitigating conflict with foreign proceedings would appear to be
supported by following ICE's second approach, and limiting the
applicability of part 190, in the case of a foreign DCO subject to a
proceeding in its home jurisdiction, to focus on the contracts and
property of public customers of FCM members.
In order to balance the goal of protecting public customers of FCM
members with the goal of mitigating conflict with foreign proceedings,
the Commission believes it to be appropriate that, in a situation where
a debtor clearing organization is organized outside the United States
and is subject to a foreign bankruptcy proceeding, part 190 should
apply as follows. First, the Commission believes it to be appropriate
that subpart A should apply to such proceedings, given that those
provisions set forth core concepts, definitions and general provisions.
Second, the Commission believes it to be appropriate that Sec. 190.12
should apply to such proceedings, given that the regulation sets forth
requirements for records and reporting, which are critical in such
proceedings. And third, the Commission believes it to be appropriate
that three regulations should be applicable in a limited fashion, to
focus on the contracts and property of public customers of FCM members:
\161\ (1) Sec. 190.13, setting forth the prohibition on avoidance of
transfers, but only with respect to futures and cleared swaps contracts
cleared by FCM clearing members on behalf of their public customers;
(2) Sec. 190.17, setting forth the calculation of net equity; and (3)
Sec. 190.18, setting forth the treatment of property. In such a
scenario, Sec. Sec. 190.13, 190.17, and 190.18 would only apply with
respect to: (1) Claims of FCM clearing members on behalf of their
public customers; and (2) property that is or should have been
segregated for the benefit of FCM clearing members' public customers,
or that has been recovered for the benefit of FCM clearing members'
public customers.
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\161\ As noted above, the Commission has traditionally focused
its efforts on the protection of the public customers of FCM members
of such foreign DCOs. In a DCO bankruptcy, the Commission believes
that the application of these three regulations would be critical to
fulfilling the agency's mission to protect customers.
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Accordingly, after consideration of the comments and for the
reasons stated above, the Commission is: (1) Adopting the language of
Sec. 190.11 as proposed, but designated as new paragraph (a); and (2)
modifying proposed Sec. 190.11 by adding the following as new
paragraph (b): If the debtor clearing organization is organized outside
the United States, and is subject to a foreign proceeding, as defined
in 11 U.S.C. 101(23), in the jurisdiction in which it is organized,
then only the following provisions of part 190 shall apply: (1) Subpart
A; (2) Sec. 190.12; (3) Sec. 190.13, but only with respect to futures
contracts and cleared swaps contracts cleared by FCM clearing members
on behalf of their public customers and the property margining or
securing such contracts; and (4) Sec. Sec. 190.17 and 190.18, but only
with respect to claims of FCM clearing members on behalf of their
public customers, as well as property that is or should have been
segregated for the benefit of FCM clearing members' public customers,
or that has been recovered for the benefit of FCM clearing members'
public customers.''
2. Regulation Sec. 190.12: Required Reports and Records
The Commission is adopting Sec. 190.12 to establish the
recordkeeping and reporting obligations of a debtor clearing
organization and/or trustee in a bankruptcy proceeding under subpart C.
The operations of a clearing organization are extremely time-
sensitive. For example, Sec. 39.14 requires that a clearing
organization complete settlement with each clearing member at least
once every business day. It is thus critical that the Commission
receive notice of a DCO bankruptcy in an extraordinarily rapid manner.
Similarly, the trustee that is appointed (as well as the Commission)
must receive critical documents rapidly, and proper notice should be
provided to the DCO's members.
Regulation Sec. 190.12 sets forth the timing and content of
notices that must be provided to the Commission and the DCO's members,
as well as the timing and content of reports and records that
[[Page 19367]]
must be provided to the Commission and trustee.
Section 190.12(a)(1) is analogous to Sec. 190.03(a), as amended
herein, in that it would provide instructions regarding how to give
notice to the Commission and to a clearing organization's members,
where such notice would be required under subpart C of part 190.\162\
Section 190.12(a)(2) would require the clearing organization to notify
the Commission either in advance of, or at the time of, filing a
petition in bankruptcy (or within three hours of receiving notice of a
filing of an involuntary petition against it).\163\ Notice would need
to include the filing date and the court in which the proceeding has
been or will be filed. While the clearing organization would also need
to provide notice of the docket number, if the docket number is not
immediately assigned, that information would be provided separately as
soon as available.
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\162\ While Sec. 190.03(a)(2), as amended herein, applies to
notice to an FCM's customers, and Sec. 190.12(a)(1)(ii) applies to
notice to a clearing organization's members, the means of giving
notice are identical. For a discussion of how these notice
provisions differ from the prior iteration of part 190, please refer
to the discussion of Sec. 190.03(a) above.
\163\ Commodity broker bankruptcies are rare, and outside the
experience of most chapter 7 trustees, who are chosen from a panel
of private trustees eligible to serve as such for all chapter 7
cases. See generally 11 U.S.C. 701(a)(1), 28 U.S.C. 586(a)(1).
Historically, Commission staff, on being notified of an impending
commodity broker bankruptcy, have worked with the office of the
relevant regional United States Trustee, see generally 28 U.S.C. 581
et seq., to identify, and have then briefed, the chapter 7 trustee
that would then be appointed. This would be even more important in
the context of a clearing organization bankruptcy.
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It is also important to permit the trustee to begin to understand
the business of the clearing organization as soon as practicable, and
within hours. Accordingly, Sec. 190.12(b)(1) requires the clearing
organization to provide to the trustee copies of each of the most
recent reports filed with the Commission under Sec. 39.19(c), which
includes Sec. 39.19(c)(1) (daily reports, including initial margin
required and on deposit by clearing member, daily variation and end-of-
day positions (by member, by house and customer origin), and other
daily cash flows), Sec. 39.19(c)(2) (quarterly reports, including of
financial resources), Sec. 39.19(c)(3) (annual reporting, including
audited financial statements and a report of the chief compliance
officer), Sec. 39.14(c)(4) (event-specific reporting, which would
include the most up-to-date version of any recovery and wind-down plans
the debtor maintained pursuant to Sec. 39.39(b),\164\ and which may
well include events that contributed to the clearing organization's
bankruptcy), and Sec. 39.19(c)(5) (reporting specially requested by
the Commission or, by delegated authority, staff). In order to provide
the trustee with an initial overview of the business and status of the
clearing organization, with respect to quarterly, annual, or event-
specific reports, the clearing organization would be required to
provide any such reports filed during the preceding 12 months. These
reports would need to be provided to the trustee as soon as
practicable, but in any event no later than three hours following the
later of the commencement of the proceeding or the appointment of the
trustee. It is the Commission's expectation that in the event of an
impending bankruptcy event, staff at the DCO would, as soon as
practicable, be preparing these materials for transmission to the
trustee.
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\164\ See Sec. 39.19(c)(4)(xxiv).
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Similarly, Sec. 190.12(b)(2) requires the debtor clearing
organization, in the same time-frame, to provide the trustee and the
Commission with copies of the default management plan and default rules
and procedures maintained by the debtor pursuant to Sec. 39.16 and, as
applicable, Sec. 39.35. While some of this information may have
previously been filed with the Commission pursuant to Sec. 39.19, it
is important that the Commission have readily available what the
clearing organization believes are the most up-to-date versions of
these documents. Moreover, given that these documents must be provided
to the trustee, providing copies to the Commission should impose
minimal additional burden (particularly if the documents are provided
in electronic form).
Regulation Sec. 39.20(a) requires a DCO to maintain records of all
activities related to its business as such, and sets forth a non-
exclusive list of the records that are included in that term. To enable
the trustee and the Commission further to understand the business of
the clearing organization, Sec. 190.12(c) requires the debtor clearing
organization to make copies of such records available to the trustee
and to the Commission no later than the business day after the
commencement of the proceeding. In order to inform the trustee and the
Commission better concerning the enforceability in bankruptcy of the
clearing organization's rules and procedures, the clearing organization
is similarly required to make available any opinions of counsel or
other legal memoranda provided to the debtor, by inside or outside
counsel, in the five years preceding the commencement of the
proceeding, relating to the enforceability of those arrangements in the
event of an insolvency proceeding involving the debtor.\165\
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\165\ The trustee of a corporation in bankruptcy controls the
corporation's attorney-client privilege for pre-bankruptcy
communications. Commodity Futures Trading Comm'n v. Weintraub, 471
U.S. 343 (1985). Production to the Commission pursuant to the
proposed regulation would not waive that privilege (although
voluntary production would). See, e.g., U.S. v. de la Jara, 973 F.2d
746, 749 (9th Cir. 1992) (``a party does not waive the attorney-
client privilege for documents which he is compelled to produce'')
(emphasis in original); Office of Comptroller of the Currency
Interpretative Letter, 1991 WL 338409 (with respect to ``internal
Bank documents'' that are ``subject to the attorney-client
privilege'' and are ``requested by OCC examiners for their use
during examinations of the Bank,'' OCC ``has the power to request
and receive materials from national banks in carrying out its
supervisory duties. It follows that national banks must comply with
such requests. That being the case, it is our position that when
national banks furnish documents to us at our request they are not
acting voluntarily and do not waive any attorney-client privilege
that may attach to such documents.'').
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The Commission requested comment with respect to all aspects of
proposed Sec. 190.12. The Commission raised specific questions as to
whether the reports and records identified in proposed Sec. 190.12 to
be provided to the Commission are useful and appropriate, and whether
additional reports and records should be included. The Commission also
asked if the proposed time deadlines are appropriate.
The Commission received two comments on proposed Sec. 190.12.
CME expressed support for proposed Sec. 190.12, and agreed with
the Commission that ``the reports and records identified in [the
proposed regulation] would be useful for the trustee and the
Commission.'' CME also agreed with the Commission that certain items,
such as the DCO's default rules and recovery and wind-down plans,
should be furnished as soon as possible.
OCC ``generally support[ed] a requirement for a DCO to provide a
trustee and the Commission with information they need for efficient
resolution of the DCO,'' recognizing that ``time would be of the
essence in such a proceeding.'' OCC also noted that, because the
``information is periodically reported to, or filed with, the
Commission,'' OCC did not ``foresee any challenge in identifying and
providing this information without delay.'' However, OCC requested that
proposed Sec. 190.12(b) be amended to require a DCO to provide the
information delineated therein ``as soon as practicable.'' OCC
``believe[d] that a specific deadline of three hours is overly
prescriptive.''
After considering the comments, the Commission is adopting Sec.
190.12 as proposed. As the commenters observed, the information
specified in Sec. 190.12 is
[[Page 19368]]
important for the trustee and the Commission, and time would be of the
essence in a DCO bankruptcy. Moreover, the prescribed task in Sec.
190.12 is to gather and transmit documents that already exist, rather
than to generate new information. The documents to be sent to the
trustee are documents that were recently sent to the Commission, and
the documents to be sent to the trustee and to the Commission are
documents that one would expect, as the commenter noted, to be readily
accessible. In this context, the Commission believes that a deadline of
``as soon as practicable and in any event no later than three hours
following the commencement of the proceeding'' (or, where appropriate,
the appointment of the trustee) is reasonable and will set clear
expectations for relevant parties that will facilitate DCOs'
contingency planning.
Accordingly, after consideration of the comments, and for the
reasons stated above, the Commission is adopting Sec. 190.12 as
proposed.
3. Regulation Sec. 190.13: Prohibition on Avoidance of Transfers
The Commission is adopting Sec. 190.13 as proposed, to implement
section 764(b) of the U.S. Bankruptcy Code, protecting certain
transfers from avoidance (sometimes referred to as ``claw-back'') with
respect to a debtor clearing organization. Regulation Sec. 190.13 is
analogous to new Sec. 190.07(e) (and current Sec. 190.06(g)), with
certain changes. Specifically, while Sec. 190.07(e) allows FCM
transfers unless they are explicitly disapproved by the Commission,
Sec. 190.13 requires explicit Commission approval for DCO transfers.
The difference in approach is rooted in the inherent difference between
FCM transfers and DCO transfers: Whereas an FCM is capable of
transferring only a portion of its customer positions, a DCO would be
expected to transfer all of its customer positions (or at least all
positions in a given product set) simultaneously in order to maintain a
balanced book. Given the importance of transferring all open commodity
contracts--and the property margining such contracts--in the event of a
DCO bankruptcy, the Commission believes that any such transfer should
require explicit Commission approval, either before or after such
transfer.
Thus, whereas Sec. 190.07(e)(1) provides that a pre-relief
transfer by a clearing organization cannot be avoided as long as it is
not disapproved by the Commission, Sec. 190.13(a) instead provides
that a pre-relief transfer of open commodity contracts and the property
margining or securing such contracts cannot be avoided as long as it
was approved by the Commission, either before or after such transfer.
Similarly, whereas Sec. 190.07(e)(2)(i) provides (for all commodity
brokers, including clearing organizations) that a post-relief transfer
of a customer account cannot be avoided as long as it is not
disapproved by the Commission, Sec. 190.13(b) instead provides that a
post-relief transfer of open commodity contracts and the property
margining or securing such contracts made to another clearing
organization cannot be avoided as long as it was approved by the
Commission, either before or after such transfer.
The Commission requested comment with respect to all aspects of
proposed Sec. 190.13, and in particular, the Commission asked whether
commenters agreed with the proposed approach of requiring explicit
Commission approval of transfers by debtor DCOs.
The Commission received one comment on proposed Sec. 190.13. CME
expressed support for proposed Sec. 190.13, particularly the allowance
for Commission approval of transfers after such transfers have
occurred. CME noted that porting customer positions to a DCO would be
the preferred course of action in a bankruptcy, and a DCO may need to
act quickly.
Accordingly, after consideration of the comments and for the
reasons stated above, the Commission is adopting Sec. 190.13 as
proposed.
4. Regulation Sec. 190.14: Operation of the Estate of the Debtor
Subsequent to the Filing Date
The Commission is adopting Sec. 190.14 as proposed, with certain
modifications discussed below.
Section 190.14(a) provides discretion to the trustee to design the
proof of claim form and to specify the information that is required.
The Commission believes that broad discretion is appropriate in this
context, given the bespoke nature of a clearing organization
bankruptcy.
Section 190.14(b) addresses the operation of a debtor clearing
organization in bankruptcy and provides that, after the order for
relief, the DCO shall cease making calls for either variation or
initial margin.
As originally proposed, Sec. 190.14(b) included additional
provisions that were intended to provide a brief opportunity, after the
order for relief, to enable paths alternative to liquidation--that is,
resolution under Title II of the Dodd-Frank Act, or transfer of
clearing operations to another DCO--in cases where a short delay (i.e.,
less than or equal to six days) might facilitate such an alternative
path. Subsequent to the issuance of the Proposal, the Commission
received several comments on proposed Sec. 190.14(b), and based on its
consideration of those comments, the Commission determined it to be
appropriate to issue the Supplemental Proposal. The Supplemental
Proposal modified proposed Sec. 190.14(b) in several respects,
including the withdrawal of proposed Sec. 190.14(b)(2) and (3) and the
new proposal of an alternative approach.\166\ Further discussion of the
Supplemental Proposal, including the Commission's consideration of
comments received in response to the Supplemental Proposal, is set
forth in section II.H below.
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\166\ In withdrawing proposed Sec. 190.14(b)(2) and (3), the
Commission determined, after considering the comments, that those
provisions would not be a practicable and effective way to foster
the transfer of clearing operations--to the extent that such an
opportunity presents itself--at an acceptable cost. The Commission
also endeavored to propose (in the Supplemental Proposal) a more
cost-effective alternative to foster the resolution of a DCO--in
particular, a systemically important DCO--under Title II of the
Dodd-Frank Act. Specifically, as set forth in the Supplemental
Proposal, the Commission proposed ``a limited revision to the
Proposal that would (1) stay the termination of SIDCO contracts for
a brief time after bankruptcy in order to foster the success of a
Title II Resolution, if the FDIC is appointed receiver in such a
Resolution within that time, but (2) do so in a manner that does not
undermine the QMNA status of SIDCO rules.''
The Commission sought comment on the Supplemental Proposal, and
in particular, whether the new approach could reasonably be expected
to achieve the Commission's stated goals, would be feasible, would
be the best design for such a solution, and appropriately reflected
consideration of benefits and costs.
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Section 190.14(c)(1) requires the trustee to liquidate, no later
than seven calendar days after the order for relief, all open commodity
contracts that had not earlier been terminated, liquidated or
transferred. However, in the Proposal, paragraph (c)(1) also provided
that such liquidation would not be required if the Commission (whether
at the request of the trustee or sua sponte) determined that such
liquidation would be inconsistent with the avoidance of systemic risk
\167\ or, in the expert judgment of the Commission, would not be in the
best interests of the debtor clearing organization's estate.\168\ In
such a situation, the trustee would be directed to carry out such
liquidation in accordance with the rules and procedures of the debtor
clearing
[[Page 19369]]
organization, to the extent applicable and practicable.\169\
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\167\ See section 3(b) of the CEA, 7 U.S.C. 5(b) (``It is the
purpose of [the CEA] . . . to ensure . . . the avoidance of systemic
risk . . . .'').
\168\ See section 20(a)(3) of the CEA, 7 U.S.C. 24(a)(3)
(``Notwithstanding title 11 . . . , the Commission may provide, with
respect to a commodity broker that is a debtor . . . [,] the method
by which the business of such commodity broker is to be conducted or
liquidated after the date of the filing of the petition . . . .'').
\169\ As discussed below, Sec. 190.14(c)(1) is being modified
to remove language that commenters stated would raise uncertainties
concerning the enforceability of close-out netting provisions in a
DCO bankruptcy.
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Section 190.14(c)(2) permits the trustee to make distributions to
members in the form of securities that are equivalent (i.e., securities
of the same class and series of an issuer) to those that were
originally delivered to the debtor by the clearing member or such
member's customer, rather than liquidating securities and making
distributions in the form of cash. Section 190.14(c)(2) is analogous to
Sec. 190.09(d)(3), discussed above in section II.B.7.
Section 190.14(d) requires the trustee to use reasonable efforts to
compute the funded balance of each customer account immediately prior
to the distribution of any property in the account, ``which shall be as
accurate as reasonably practicable under the circumstances, including
the reliability and availability of information.'' Section 190.14(d) is
analogous to Sec. 190.05(b), discussed above in section II.B.3, but is
modified for the context of a DCO bankruptcy. Similar to Sec.
190.05(b), the Commission's objective in Sec. 190.14(d) is to provide
the bankruptcy trustee with the latitude to act reasonably, given the
circumstances they are confronted with, recognizing that information
may be more reliable and/or accurate in some insolvency situations than
in others. However, at a minimum, the trustee is required to calculate
each customer's funded balance prior to distributing property, to
achieve an appropriate allocation of property between customers.
The Commission requested comment with respect to all aspects of
proposed Sec. 190.14. The Commission also raised specific questions
regarding Sec. 190.14(b)(2).\170\ The comments received in response to
those specific questions on Sec. 190.14(b)(2) have already been
considered by the Commission in the Supplemental Proposal, wherein the
Commission ultimately withdrew Sec. 190.14(b)(2) and (3). Although
such comments on the Proposal relate to proposed paragraphs that were
withdrawn in the Supplemental Proposal, the comments relating to
proposed Sec. 190.14(b)(2) and (3) nonetheless are noted below.\171\
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\170\ In particular, the Commission asked about the framing of
the concepts of usefulness and practicability in the context of
permitting the trustee to continue to operate a DCO in insolvency,
in accordance with proposed Sec. 190.14(b)(2), in order to
facilitate the transfer of clearing operations to another DCO or
placing the debtor DCO into resolution pursuant to Title II of the
Dodd-Frank Act. The Commission also asked whether there is a better
way to frame either of those terms, and whether it is appropriate to
provide for the possibility that the trustee may be permitted to
delay liquidating contracts.
\171\ For further discussion of the Supplemental Proposal and
the Commission's consideration of comments received thereto, see
section II.H below.
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The Commission received some comments that related to Sec. 190.14
generally. ICI commented in favor of the requirement proposed in Sec.
190.14 that ``any decision to continue operating a DCO in liquidation
must be made with [the Commission's] input and consent.'' ICI asserted,
however, that the Commission should only approve an application from a
trustee to continue operating a DCO in liquidation if the Commission
determines that the trustee ``has the knowledge and experience to
manage such operations.'' Noting that the continued operation of a DCO
has the potential to result in significant continued losses for
customers and exacerbate stress, ICI further asserted that, ``[i]n
considering whether to grant a request to allow a failed DCO to
continue operating, the Commission should consider the potential harm
to customers and should request input from both DCO members and
customers.'' OCC commented that additional considerations should be
considered in determining ``whether continued operation of a DCO in
bankruptcy would be practical.'' Specifically, OCC stated that ``a DCO
may . . . maintain contractual arrangements with various counterparties
. . . that are necessary for the DCO's continued operation,'' such as
contract markets and other trade sources, other DCOs, banking and
liquidity providers, and information technology vendors). OCC asserted
that ``a trustee would need to review the DCO's recovery and wind-down
plan[s] and/or consult with a DCO to determine whether such
arrangements necessary for the DCO's continued operation would--or
could--be terminated [by the counterparties] upon the DCO's entry into
bankruptcy and, if so, determine whether the counterparties . . . would
continue to provide those necessary services for a period of time.''
The Commission also received comments on Sec. 190.14(a). CME
commented in support of paragraph (a). ICE commented that Sec.
190.14(a) did not clearly account for ``non-CFTC-regulated clearing or
other activity occurring at a DCO, including security-based swaps and
other securities, cleared forward contracts or spot contracts to the
extent such instruments are not carried in a CFTC regulated futures or
swap account.'' ICE recommended that while ``such activity may be
outside the scope of the Part 190 regulations, claims of members with
respect to such activity, whether for their proprietary or customer
accounts, need to be properly accounted for in a DCO's bankruptcy and
should not be disadvantaged.''
Several commenters expressed concern that proposed Sec. 190.14(b)
would inadvertently create legal uncertainty with respect to the
enforceability of a DCO's close-out netting rules and related issues,
and requested that the Commission address these concerns in varying
ways.
ICE did not object to proposed Sec. 190.14(b), but believed that
the Commission ``should clarify that the rule does not interfere with
either the automatic termination of contracts upon insolvency or
clearing member rights to terminate contracts upon insolvency.'' Noting
``that clearing member capital and accounting often take into account
the ability of a clearing member to terminate, or the automatic
termination of, its cleared positions in the event of a clearinghouse
insolvency,'' ICE asserted that it would be important that the final
rules ``not upset settled expectations of clearing members'' in this
regard. ICE further noted that ``automatic termination is common,'' and
thus, continuing the operations of a clearinghouse after insolvency
would likely be infeasible, in practice.
CME requested that the Commission add a provision to Sec. 190.14
stating that: ``if the Commission permits the trustee to continue to
operate the DCO, that the action is not in derogation of, and clearing
members fully retain and may exercise, their right under the DCO's
rules and procedures with respect to close-out netting.'' CME stated
that ``[s]ome have expressed concern that proposed Regulation 190.14
creates uncertainty around the enforceability of close-out netting
rules if the trustee is allowed to continue the DCO's operations under
the conditions as drafted.'' CME asserted that it would be ``critical
that any decision to continue to operate the DCO not be contrary to the
DCO's rules or be construed in any way to abrogate clearing members'
close-out netting rights under the rules.'' CME noted that the
enforceability of close-out rights is of ``paramount importance'' to
clearing members as part of their contract with the DCO, and that CME
and other DCOs have obtained detailed legal analyses on the
enforceability of their close-out netting rules and other features of
their default rules to assure clearing members of their rights. CME
commented that it did not believe that
[[Page 19370]]
proposed Sec. 190.14 would create an issue with respect to its own
close-out netting rules or netting opinions, because its own rules
``would compel termination of open contracts upon a CME bankruptcy
event and, thus the conditions of Regulation 190.14(b) would not be
satisfied and the trustee could not continue CME's DCO operations.''
Nonetheless, CME speculated that other DCOs ``could potentially have
rules that permit a clearing member to terminate open positions at
their discretion without compelling termination.''
ISDA supported the provision in proposed Sec. 190.14(b) that would
``prevent the trustee from continuing operation of the DCO subsequent
to the order for relief if the DCO's rules contain closeout netting
provisions.'' However, ISDA also recommended that the Commission modify
proposed Sec. 190.14(c)(1) to delete the second sentence and amend the
first sentence to affirmatively provide that: ``notwithstanding
anything else to the contrary in Subpart C, the trustee shall liquidate
all open contracts in accordance with the close-out needing provisions
in the DCO's rules (or bylaws) and, in any event, no later than seven
calendar days after the entry of the order for relief.'' ISDA commented
that it is ``critical'' that ``all aspects of [the] Part 190
regulations . . . support, and in no event be inconsistent with, . . .
exposure netting.'' ISDA noted that ``[e]nforceable close-out netting
rights provide the legal basis for netting of exposures between
derivative counterparties, which reduces costs, increases market
liquidity and reduces credit and systemic risks.'' ISDA stated that a
``firm's right to terminate outstanding transactions with a
counterparty following an event of default and calculate the net amount
due to one party by another is the primary means of mitigating credit
risks associated with financial contracts.'' ISDA further argued that,
[w]ithout enforceable close-out netting rights, firms would need to
manage their credit risk on a gross basis, dramatically reducing
liquidity and credit capacity.''
OCC commented that ``the Commission should continue to consult with
DCOs and market participants who rely on closeout netting opinions to
ensure that the proposed rules[, including proposed Sec.
190.14(b)(2),] do not raise uncertainty related to the enforceability
of DCOs' closeout netting rules or have other unintended
consequences.''
FIA commented that proposed Sec. 190.14(b)(2) and proposed Sec.
190.14(c) are ``fundamentally flawed and should not be adopted.'' FIA
raised concerns that those provisions may inadvertently create ``an
unacceptable level of legal uncertainty related to the enforcement of
closeout netting provisions'' set out in DCO rulebooks, which all but
four DCOs maintain. FIA asserted that, if proposed Sec.
190.14(b)(2)(ii)(A) ``could be read to provide the trustee some level
of discretion to determine whether or when DCO rules may `compel' the
termination of contracts, such discretion, in turn, may call into
question whether the DCO's rules constitute a `qualifying master
netting agreement' as described in the rules of the several bank
regulatory authorities.'' FIA also commented that the ``continued
operation of a DCO after an order for relief would be ill-advised'' and
impracticable. FIA stated that a trustee with no familiarity or
understanding of central clearing would be highly unlikely to be able
to manage effectively the operation of a bankrupt DCO. In the case of
SIDCOs, FIA noted that ``the prospect of a bankruptcy trustee operating
the DCO for even a brief interim period prior to commencement of Title
II [resolution] proceedings could result in a loss of market confidence
and a destabilizing rush to exit by clearing members and their clients,
[thereby] potentially frustrat[ing] the successful resolution of the
DCO.'' In the case of other DCOs, FIA commented that ``the post-filing
transfer of . . . clearing operations to another DCO would be difficult
at best,'' and ``clearing members and their clients should not be
expected to take the execution risk of being forced to continue
clearing through a bankrupt DCO when successful completion of a
transfer to a new DCO in bankruptcy is not certain.'' FIA also stated
its belief that ``non-defaulting clearing members or their clients
would be [unwilling] to continue to pay margin to the estate of a
bankrupt DCO.''
The ABA Subcommittee requested that the Commission revise proposed
Sec. 190.14(b) ``to clarify that the DCO's close-out netting rules
remain in effect and are enforceable as written, notwithstanding any
decision under [proposed Sec. ] 190.14(b) by the Commission to allow
the trustee to continue making calls for variation settlement and
margin.'' The ABA Subcommittee raised a concern that proposed Sec.
190.14(b) ``may create unintended ambiguity'' regarding the
enforceability of such rules.
After considering the comments, the Commission is adopting Sec.
190.14(a) as proposed. The Commission notes that Sec. 190.14(a)
provides that the trustee shall ``instruct each customer [a term that,
in the context of a debtor DCO, includes members] to file a proof of
claim containing such information as is deemed appropriate by the
trustee.'' To the extent that the DCO is conducting non-CFTC-regulated
activity that is outside the scope of the part 190 regulations, the
proof of claim form should include an opportunity to claim for debts of
the DCO related to activity that is not regulated by the CFTC. These
would be payable from the general estate (outside of customer property)
or, if secured, from the property securing the debts. Thus, such
activity will be properly accounted for in the DCO bankruptcy, and
members will not be disadvantaged. For those reasons, the Commission
does not believe that Sec. 190.14(a) should be modified in the manner
recommended by ICE.
The Commission is adopting Sec. 190.14(b)(1) as proposed, with two
modifications that reflect the Commission's previous withdrawal of
paragraphs (b)(2) and (3) in the Supplemental Proposal: (1) Proposed
paragraph (b)(1) is re-designated as paragraph (b); and (2) new
paragraph (b) is modified to remove the phrase: ``except as otherwise
explicitly provided in this paragraph (b).'' \172\
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\172\ See 85 FR at 60112 n.12 (``The Commission will make
appropriate edits to the language in proposed Sec. 190.14(b)(1) as
part of the process of finalizing the [p]art 190 rule proposal.'').
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Several commenters expressed concern that proposed Sec. 190.14(b)
inadvertently creates legal uncertainty with respect to the
enforceability of a DCO's close-out netting rules and requested that
the Commission address this concern in varying ways.\173\ The
Commission considered those comments in advance of issuing the
Supplemental Proposal, and determined that Sec. 190.14(b)(2) and (3)
would not be a practicable and effective way to foster the transfer of
clearing operations--to the extent that such an opportunity presents
itself--at an acceptable cost. Consequently, the Commission withdrew
Sec. 190.14(b)(2) and (3) in the Supplemental Proposal and instead
proposed an alternative approach. The Supplemental Proposal, including
the Commission's consideration of comments thereto, is discussed below
in section II.H of this adopting release.
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\173\ See comment letters from ICE, CME.
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Commenters' concerns regarding the legal uncertainty of close-out
netting rules in the context of Sec. 190.14(b) also apply to Sec.
190.14(c), as proposed, specifically the language that states that the
trustee shall liquidate all open positions no later than seven calendar
days after the order for relief ``unless the
[[Page 19371]]
Commission determines that liquidation would be inconsistent with the
avoidance of systemic risk or would not be in the best interests of the
debtor's estate'' (the ``Unless Clause''). Some commenters--including
FIA and ISDA--explicitly raised this issue in the context of Sec.
190.14(c), to the extent that the proposed language would afford the
trustee with some level of discretion to determine whether or when a
DCO rule may ``compel'' the termination of contracts. Although the
Commission believes that commenters' concerns were largely addressed in
the Supplemental Proposal through the withdrawal of Sec. 190.14(b)(2)
and (3), the Commission agrees that the Unless Clause raises similar
concerns, in that it suggests that the Commission may decide that a
DCO's contracts should not be terminated in bankruptcy, and accordingly
that paragraph (c)(1) should be modified by removing the Unless Clause.
Thus, after considering the comments, the Commission is adopting Sec.
190.14(c) as proposed, with a modification to paragraph (c)(1) by
deleting the phrase: ``unless the Commission determines that
liquidation would be inconsistent with the avoidance of systemic risk
or would not be in the best interests of the debtor's estate.'' This
modification--when taken in conjunction with the Commission's prior
withdrawal of Sec. 190.14(b)(2) and (3)--should remove any lingering
uncertainties in Sec. 190.14 concerning the enforceability of close-
out netting provisions in a DCO bankruptcy.
The Commission received no specific comments on the proposed
language of Sec. 190.14(d) and, thus, is adopting that paragraph as
proposed.
Accordingly, after consideration of the comments and for the
reasons stated above, the Commission is adopting Sec. 190.14 as
proposed, with the deletion of paragraphs (b)(2) and (3) and
modifications to paragraphs (b)(1) and (c)(1), as set forth above.\174\
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\174\ The modifications to paragraph (b)(1) include both the
addition of the language described above and the re-designation of
proposed paragraph (b)(1) as new paragraph (b), in light of the
withdrawal of proposed paragraphs (b)(2) and (3) in the Supplemental
Proposal.
For further discussion of the Supplemental Proposal and the
Commission's consideration of comments thereto, see section II.H
below.
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5. Regulation Sec. 190.15: Recovery and Wind-Down Plans; Default Rules
and Procedures
The Commission is adopting Sec. 190.15 substantially as proposed
(with a modification, as discussed below), to favor the implementation
of a debtor clearing organization's default rules and procedures
maintained pursuant to Sec. 39.16 and, as applicable, Sec. 39.35, and
any recovery and wind-down plans maintained by the debtor and filed
with the Commission, pursuant to Sec. Sec. 39.39 and 39.19,
respectively. Section 39.16 requires each DCO to, among other things,
``adopt rules and procedures designed to allow for the efficient, fair,
and safe management of events during which clearing members become
insolvent or default on the obligations of such clearing members to
the'' DCO. In adopting Sec. 39.35, the Commission explained that it
``was designed to protect SIDCOs, [s]ubpart C DCOs, their clearing
members, customers of clearing members, and the financial system more
broadly by requiring SIDCOs and [s]ubpart C DCOs to have plans and
procedures to address credit losses and liquidity shortfalls beyond
their prefunded resources.'' \175\ Similarly, in adopting Sec. 39.39,
the Commission explained that it was ``designed to protect the members
of such DCOs and their customers, as well as the financial system more
broadly, from the consequences of a disorderly failure of such a DCO.''
\176\
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\175\ 78 FR 72476, 72492 (Dec. 2, 2013).
\176\ Id. at 72494.
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Section 190.15(a) states that the trustee shall not avoid or
prohibit any action taken by the debtor DCO that was reasonably within
the scope of, and was provided for, in any recovery and wind-down plans
maintained by the debtor and filed with the Commission, subject to
section 766 of the Bankruptcy Code. The Commission's intent is to
provide finality and legal certainty to actions taken by a DCO to
implement its recovery and wind-down plans, which are developed subject
to Commission regulations.
Section 190.15(b) instructs the trustee to implement, in
consultation with the Commission, the debtor DCO's default rules and
procedures maintained pursuant to Sec. 39.16, and, as applicable,
Sec. 39.35, as well as any termination, close-out and liquidation
provisions included in the rules of the debtor, subject to the
trustee's reasonable discretion and to the extent that implementation
of such default rules and procedures is practicable.
Similarly, Sec. 190.15(c), as proposed, instructs the trustee, in
consultation with the Commission, to take actions in accordance with
any recovery and wind-down plans maintained by the debtor and filed
with the Commission, to the extent reasonable and practicable. The
Commission's intent is to provide the trustee, who will need to take
prompt action to manage the DCO (and any member default), with a
roadmap to manage such action. The Commission further intends that the
roadmap be based on the rules, procedures, and plans that the DCO has
developed in advance, and that are subject to the requirements of the
Commission's regulations.
The Commission requested comment with respect to all aspects of
proposed Sec. 190.15. The Commission also raised specific questions as
to whether it is appropriate to steer the trustee towards
implementation of the debtor DCO's default rules and procedures and
recovery and wind-down plans, and whether the proposed language
concerning discretion, reasonability, and practicability is appropriate
and sufficient.
The Commission received several comments on proposed Sec. 190.15.
CME and ICE generally supported the proposal, although ICE raised
concerns about the discretion afforded to the trustee. In contrast,
Vanguard, FIA, ACLI, SIFMA AMG/MFA, and ICI expressed concerns with the
proposed rule, in whole or in part.
ICE, while generally supporting the proposal, objected to the
language in Sec. 190.15 that a ``trustee's obligation to [follow a
DCO's default rules and recovery and wind-down plans] is `subject to
the reasonable discretion' of the trustee or is limited `to the extent
reasonable and practicable.' '' While ICE acknowledged ``the need for
some degree of flexibility in the conduct of a bankruptcy proceeding,''
it contended that ``the Commission should make clear that the trustee
cannot override the DCO rules . . . [or] deviate from an approved
recovery or wind-down plan.''
Vanguard requested that proposed Sec. 190.15(a) be removed,
arguing that it would be ``imprudent to give deference'' to a DCO's
rules because such rules ``do not set forth a comprehensive roadmap to
dealing with DCO insolvency.'' Vanguard noted that ``DCO rulebooks set
forth a variety of powers the DCO may employ'' (e.g., ``assessments,
variation margin gains haircutting, and tear-ups''), and that such
rules ``lack [the] necessary specificity and detail to provide
certainty to FCMs and customers, or to the trustee,'' with respect to
what would follow in DCO insolvency. Vanguard was concerned that such
uncertainty may ``contribute to further market stresses during a
critical time,'' and that expressly instructing the trustee to
implement a DCO's default rules and procedures ``where practicable,''
permits a DCO to ``override the fundamental customer protections
intended by Part 190.''
[[Page 19372]]
FIA did not support the adoption of proposed Sec. 190.15(b) and
(c), commenting that the proposal's post-bankruptcy implementation of
all DCO default rules and procedures and recovery and wind-down plans
is ``inappropriate.'' FIA was concerned that the proposal's ``concept
of `default rules and procedures' could encompass a number of different
tools or actions, some of which would be inappropriate and risky for a
bankruptcy trustee to attempt to execute.'' In addition, ``to the
extent that the Commission would select some but not other default
rules and procedures for a trustee to implement,'' uncertainty with
respect to possible bankruptcy scenarios would increase. FIA stated
that a DCO's default rules and procedures should not be used ``for any
purpose other than to ensure enforcement of a DCO's closeout netting
provisions,'' and that, ``[b]y their terms, the default rules and
procedures . . . represent contractual arrangements between a DCO and
its members whose purpose is to provide resources and tools to the DCO
to prevent its bankruptcy.'' FIA argued that ``a fundamental term'' of
these arrangements is that ``such resources and tools are only
available prior to bankruptcy,'' and that instructing a trustee in
bankruptcy to implement, with discretion, the DCO's default rules and
procedures would ``undermine the long-standing and settled expectations
of DCOs and their members.'' In the alternative, FIA recommended that
the Commission revise proposed Sec. 190.15(b) ``to confirm that, in
administering a proceeding under Subpart C, the trustee must implement
any termination, close-out and liquidation provisions included in the
rules (or bylaws) of the debtor'' (including loss allocation
provisions). FIA raised further concerns about the treatment of a DCO's
recovery plans in proposed Sec. 190.15. FIA asserted that such plans
are intended to address ``actions to be taken prior to the DCO's
bankruptcy and [are] not relevant post-filing.'' FIA also stated that
such plans ``would provide no meaningful guidance to a trustee''
because they ``do not prescribe a particular course of action.''
Rather, they ``present a menu of options that a DCO might consider.''
FIA asserted that reliance on a DCO's recovery and wind-down plans is
``particularly inappropriate'' because some of them ``have been
developed with no input or opportunity for comment by clearing members
and other market participants.''
ACLI also expressed concern with the deference that a trustee in
bankruptcy would be required to afford a DCO's rules and procedures and
recovery and wind-down plans under proposed Sec. 190.15(a) and (c).
ACLI claimed that ``DCO recovery and wind-down plans include such
drastic measures as Variation Margin Gains Haircutting . . . and
Partial Tear-Up . . . [that] are not subject to routine public input at
the DCO level or at the Commission.'' ACLI identified several
circumstances in which deference to the DCO's rules or recovery and
wind-down plans should be reduced. ACLI asserted that: (a) A trustee
should not be expected to defer to recovery and wind-down measures
unless they were originally adopted with public input at the DCO level
and made public for a reasonable period before the bankruptcy
proceeding; (b) the trustee should ``have discretion to override a
DCO's recovery or wind-down actions if they violate proposed [p]art
190's goal of protecting customer property on no worse than a pro rata
basis''; and (c) consistent with proposed Sec. 190.15(b), the trustee
should be able to avoid or prohibit any DCO action that it determines,
in consultation with the Commission, is not ``reasonable and
practicable.''
SIFMA AMG/MFA commented that requiring a trustee to defer to a
DCO's recovery and wind-down plans as set forth in proposed Sec.
190.15(a) and (c) is ``inadvisable'' and, in some cases,
``unworkable,'' and recommended that the provisions be deleted. SIFMA
AMG/MFA recommend that, if the Commission retains proposed Sec.
190.15(a), the provision be amended to remove the words ``was
reasonably in the scope of'' and replace references to the DCO's
recovery and wind-down plans with references to the DCO's default rules
and procedures. In support of their position, SIFMA AMG/MFA asserted
that recovery and wind-down plans are insufficiently prescriptive, and
that because they tend to be drafted as a menu of options, such plans
are not likely to provide the trustee with clear direction, effectively
causing the trustee to defer to the judgment of the debtor itself.
SIFMA AMG/MFA also asserted that recovery and wind-down plans do not
require Commission approval or reflect significant input from
customers, and because DCOs are not required to make such plans public,
the plans are not a fair reflection of the ex ante expectations of a
DCO's stakeholders. SIFMA AMG/MFA further asserted that ``requiring the
trustee . . . to defer to the debtor's resolution plans would be
inconsistent with other regimes for the resolution of systemically
important financial institutions.'' SIFMA AMG/MFA requested that the
Commission add a new clause to proposed Sec. 190.15 requiring the
trustee and Commission, in implementing Sec. 190.15, to ``consider
whether implementation of the debtor's default rules and procedures
[and recovery and wind-down plans] may undermine the core principles
set forth in Sec. 190.00 or may pose additional systemic risk.'' \177\
If the trustee and Commission determine that such implementation would
have that effect, SIFMA AMG/MFA suggested that the provision permit the
trustee to override the rules, procedures, and plans. SIFMA AMG/MFA
further commented that, in the event that deference to a DCO's default
management rules and procedures and recovery and wind-down plans is
mandated in subpart C of the proposal, the Commission should amend
parts 39 and 40 of the Commission's regulations ``to ensure that
customers have the opportunity to provide meaningful input during the
development and application of such rules, procedures, and plans.''
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\177\ Alteration in original.
---------------------------------------------------------------------------
ICI did not support the proposal's deference to a DCO's loss
allocation, recovery, and wind-down rules in a DCO liquidation. ICI
asserted that such rules are neither ``clear'' nor ``well-vetted.'' ICI
stated that DCO rules ``do not provide the level of specificity and
detail that is required to give certainty to market participants,'' but
rather, they ``enumerate a wide variety of tools that a DCO may deploy
to recover losses,'' some of which ``have the capacity to alter the
entitlements of customers'' under part 190 (e.g., ``a customer would
only be entitled to such a pro rata share of customer property to the
extent the DCO rules did not modify the distribution of the DCO's
assets'' through variation margin gains haircutting or partial tear-
up). ICI recommended that, ``[b]efore the Commission gives effect to
any DCO loss allocation, recovery, and wind-down rules in a [p]art 190
proceeding, . . . the Commission should develop and codify minimum
principles that must be reflected in [those rules,] . . . review both
existing DCO rules and proposed rule changes to ensure that they are
consistent with the Commission's minimum principles . . . [, and]
require DCOs to change their governance process for rule changes to
give stakeholders greater opportunity for input.''
As an initial matter, the Commission notes that some commenters,
including ACLI, FIA, ICI, and SIFMA AMG/MFA, objected to the
application of DCO recovery and wind-down plans and rules, in
particular the application of
[[Page 19373]]
variation margin gains haircutting, because they believed that changes
should be made to the process by which parts 39 and 40 permit DCOs to
adopt such plans and rules.
Amendments to parts 39 and 40 are beyond the scope of this
rulemaking, and the Commission does not believe that these concerns
with the content and operation of parts 39 and 40 should inhibit the
use of such plans and rules in the context of part 190. However, the
Commission continues actively to review these issues, in particular
with respect to governance, as they relate to parts 39 and 40.
The Commission also notes that other commenters, including FIA,
believed that default rules and procedures and recovery plans are
designed to avoid bankruptcy, and should not be applied if they fail in
achieving that goal. However, the DCO's rules, procedures, and plans
set forth ex ante the manner in which losses are allocated--that is,
who is exposed to them, and to what extent. In the event that losses
must be borne in bankruptcy, the Commission believes, as was noted in
the preamble to the proposal, that ``allocation of losses should not
depend on the happenstance of when default management or recovery tools
were used--e.g., when assessments were called for, or when such
assessments were met.'' The Commission does not believe that the
comments offer a persuasive reason why the allocation of losses--who
wins, who loses, and how much--should change on the basis of when a
bankruptcy is filed.
The Commission further notes that a number of commenters, including
ACLI and Vanguard, were concerned with the application in bankruptcy of
recovery tools such as variation margin gains haircutting and partial
tear-up. Variation margin gains haircutting, to the extent set forth in
DCO rules, will be applied in bankruptcy, in that it represents the ex
ante manner in which losses are allocated.\178\ By contrast, partial
tear-up of contracts will not be applied; rather, pursuant to Sec.
190.14(c)(1), ``the trustee shall liquidate all open commodity
contracts that have not been terminated, liquidated or transferred no
later than seven calendar days after entry of the order for relief''
(emphasis added).
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\178\ Moreover, as discussed in more detail in section II.C.7
below, there is a limited amount of customer property available. Any
increase in some customers claims (and thus, their distributions)
due to the disapplication of gains-based haircutting would come at
the expense of a reduced share of that limited customer property
(i.e., reduced distributions) to other customers, which could total
less than the amount of their claim arising from initial margin.
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Turning to SIFMA AMG/MFA's suggestion that ``the trustee and the
Commission should explicitly be required to consider the core concepts
set forth in proposed Sec. 190.00 and systemic risk in implementing a
debtor DCO's rules procedures and plans'': With respect to the core
concepts, Sec. 190.00(c) states that ``the specific requirements in
[part 190] should be interpreted and applied consistently with these
core concepts.'' In short, that requirement is already present.
Moreover, the Commission has added Sec. 190.00(c)(3)(i)(C) to provide
that where a provision in part 190 affords the trustee discretion, that
discretion should be exercised in a manner that the trustee determines
will best achieve the overarching goal of protecting public customers
by enhancing recoveries for, and mitigating disruptions to, public
customers as a class. Thus, in exercising their discretion to determine
what is ``reasonable'' for purposes of Sec. 190.15, the trustee is
already directed to focus on the ``core concepts'' in Sec. 190.00(c),
and, in particular, the ``overarching goal of protecting public
customers.''
However, while a DCO's default rules and procedures are required to
be made public, posted on the DCO's website,\179\ the same is not true
for the DCO's recovery and wind-down plans. Thus, in implementing the
DCO's default rules and procedures, the trustee would be implementing
rules and procedures that, prior to the bankruptcy, were both subject
to the supervision of the Commission and transparently available to
both clearing members and their customers. By contrast, in implementing
the DCO's recovery and wind-down plans, the trustee would be
implementing plans that, prior to the bankruptcy, were subject to the
supervision of the Commission,\180\ but may not have been transparently
available to clearing members or their customers. In light of this
distinction, a more customer-protective approach seems appropriate in
the latter context.
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\179\ See Sec. 39.21(c)(6).
\180\ Note that Sec. 190.15(c) only applies to recovery and
wind-down plans that were ``filed with the Commission pursuant to
Sec. 39.39 of this chapter.''
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Accordingly, the Commission is modifying proposed Sec. 190.15(c),
which reads that in administering a proceeding under this subpart, the
trustee shall, in consultation with the Commission, take actions in
accordance with any recovery and wind-down plans maintained by the
debtor and filed with the Commission pursuant to Sec. 39.39, to the
extent reasonable and practicable--to add at the end the qualifier that
these actions should also only be taken to the extent consistent with
the protection of customers.\181\
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\181\ The ``customers'' of a DCO are, as noted at the top of
this section II.C, the clearing members with respect to their public
customers, as well as the clearing members with respect to their
proprietary or ``house'' accounts.
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With respect to systemic risk, while the Commission, as a
governmental agency, is attentive to considerations of mitigating
systemic risk in all that it does,\182\ it may be difficult for a
trustee to make meaningful determinations as to how to do so. Moreover,
the trustee is the representative of the bankruptcy estate, see 11
U.S.C. 323(a), with fiduciary duties to estate beneficiaries,\183\
rather than to the financial system as a whole. Accordingly, the
Commission does not believe it appropriate to add an explicit
requirement concerning considerations of systemic risk, as suggested by
SIFMA AMG/MFA.
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\182\ See CEA section 3(b), 7 U.S.C. 5(b) (purposes of the CEA
include ``the avoidance of systemic risk'').
\183\ See U.S. Department of Justice, Executive Office for
United States Trustees, Handbook for Chapter 7 Trustees Section 4.B,
at 4-2.
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The Commission does not agree that FIA's observation that DCO
recovery and wind-down plans may ``not prescribe a particular course of
action but, rather, present a menu of options that a DCO may consider''
supports FIA's conclusion that ``these plans would appear to provide no
meaningful guidance to a trustee.'' To the contrary, the Commission
believes that providing a ``menu of options'' among which the trustee
may select (and adapt) in a manner that is ``reasonable and
practicable'' would provide the trustee--who would be stepping into a
complex and difficult situation with little preparation--with a helpful
roadmap to determine strategy and tactics, in order to act in a prompt
and cost-effective manner.
The Commission also declines to provide that the trustee cannot
override the DCO's rules or deviate from an approved recovery or wind-
down plan. Even if part 39 were to require that such plans be
``approved''--and it does not--they are designed in the context of
operation of the DCO outside of bankruptcy. Thus, the Commission
believes it to be appropriate for the trustee to apply them with
flexibility to the extent reasonable and practicable.
Accordingly, after consideration of the comments and for the
reasons stated above, the Commission is adopting Sec. 190.15 as
proposed, with the modification to Sec. 190.15(c) discussed above.
[[Page 19374]]
6. Regulation Sec. 190.16: Delivery
The Commission is adopting Sec. 190.16 as proposed with a
modification to paragraph (a), as set forth below.
Regulation Sec. 190.16(a) instructs the trustee to use reasonable
efforts to facilitate and cooperate with completion of delivery in a
manner consistent with Sec. 190.06(a) (which instructs trustees of
FCMs in bankruptcy to foster delivery where a contract has entered
delivery phase before the filing date or where it is not practicable
for the trustee to liquidate a contract moving into delivery position
after the filing date) and the pro rata distribution principle in Sec.
190.00(c)(5). The Commission believes that it is important to address
deliveries to avoid disruption to the cash market for the commodity and
to avoid adverse consequences to parties that may be relying on
delivery taking place in connection with their business operations.
However, given the potential for competing demands on the trustee's
resources, including time, this instruction is limited to requiring
``reasonable efforts.''
Regulation Sec. 190.16(b) carries forward, to the context of a DCO
in bankruptcy, the delineation between the physical delivery property
account class and the cash delivery property account class in Sec.
190.06(b), as discussed above. Specifically, physical delivery property
that is held in delivery accounts for the purpose of making delivery
shall be treated as physical delivery property, as will the proceeds
from any sale of such property. By contrast, cash delivery property
that is held in delivery accounts for the purpose of paying for
delivery shall be treated as cash delivery property, as would any
physical delivery property for which delivery is subsequently taken.
The Commission requested comment with respect to all aspects of
proposed Sec. 190.16. The Commission raised specific questions as to
whether it is appropriate, in the context of a clearing organization
bankruptcy, to separate the physical delivery account class from the
cash delivery account class, and if so, whether the physical delivery
account class should be further sub-divided. The Commission also asked
whether the delivery account class should be treated as a single,
undivided account class.
CME supported the requirement in proposed Sec. 190.16 that the
trustee use reasonable efforts to facilitate deliveries of commodity
contracts that have moved into delivery prior to the date and time of
relief on behalf of a clearing member or customer, but asked that the
Commission ``expand the rule to require the trustee to facilitate
deliveries'' under contracts that move into delivery position after the
filing and that the trustee is unable to liquidate. CME stated that
``[i]t is equally important to protect deliveries under [such]
contracts . . . to protect against disruption to commercial markets and
operations,'' and that the trustee may not be able to terminate them.
The ABA Subcommittee similarly expressed concern that proposed
Sec. 190.16(a) ``does not address contracts that are unable to be
liquidated and that then move into delivery position,'' noting that
``it may be impossible or impracticable for a trustee to liquidate
every'' physical-delivery commodity contract that is open at the date
and time of the order for relief before the contract moves into
delivery position. The ABA Subcommittee recommended that the Commission
``remove the timing limitation in Proposed Rule 190.16(a),'' and add
language stating that ``the trustee should use reasonable efforts to
liquidate open physical delivery commodity contracts before they move
into a delivery position.''
The Commission agrees with comments raised by CME and the ABA
Subcommittee that deliveries should be facilitated after the order for
relief for contracts that are not otherwise terminated, liquidated, or
transferred. The Commission believes that modifying the proposal to
address that scenario is appropriate to avoid disruption to the cash
market and to avoid adverse consequences to parties that may be relying
on delivery taking place in connection with their business operations.
Accordingly, after consideration of the comments, and for the
reasons stated above, the Commission is adopting Sec. 190.16 with a
modification to apply paragraph (a) to any contract that ``moves into
delivery after [the date and time of the order for relief], but before
being terminated, liquidated, or transferred.''
7. Regulation Sec. 190.17: Calculation of Net Equity
The Commission is adopting Sec. 190.17 as proposed, with a
modification to Sec. 190.17(b)(2), as discussed below. Section 190.17
establishes net equity calculations to be used in determining the
claims against the debtor DCO (and the allocation of losses) among
members and their accounts.
Section 190.17(a) with respect to net equity is parallel to Sec.
190.18(a) with respect to the treatment of customer property. Section
190.17(a)(1) confirms that a member of a clearing organization may have
claims in separate capacities. Specifically, a member may have claims
on behalf of its public customers (customer account) and claims on
behalf of itself and its non-public customers (i.e., affiliates) (house
account), and, within those separate customer classes, the claims may
be further separated by account class. The member shall be treated as
part of the public customer class with respect to claims based on
commodity customer accounts carried as ``customer accounts'' by the
clearing organization for the benefit of the member's public customers,
and as part of the non-public customer class with respect to claims
based on its house account. Section 190.17(a)(2) directs that net
equity shall be calculated separately with respect to each customer
capacity and, within such customer capacity, by account class.
Section 190.17(b) sets forth how a debtor DCO's pre-existing rules
and procedures governing the allocation of losses--including the
default rules and procedures--should be applied in a DCO bankruptcy.
Section 190.17(b)(1) confirms that the calculation of members' net
equity claims--and, thus, the allocation of losses among members and
their accounts--shall be based on the full application of the debtors'
loss allocation rules and procedures, including the default rules and
procedures referred to in Sec. Sec. 39.16 and 39.35. These pre-
existing loss allocation rules and procedures are the contract between
and among the members and the DCO, and the Commission believes that it
is appropriate to give them effect regardless of the bankruptcy of the
DCO or the timing of any such bankruptcy. In other words, the pre-
existing loss allocation rules and procedures (such as member
assessments) should be given the same effect in a bankruptcy,
regardless of whether default management or recovery tools were fully
applied prior to the order for relief. While certain DCOs may have
discretion, consistent with governance procedures, as to precisely when
they call for members to meet assessment obligations, the Commission
believes that allocation of losses should not depend on the
happenstance of when default management or recovery tools were used--
e.g., when assessments were called for, or when such assessments were
met.
Section 190.17(b) also addresses DCO rules that govern how
recoveries on claims against defaulting members are allocated to non-
defaulting members' accounts,\184\ which effectively ``reverse
[[Page 19375]]
the waterfall'' by allocating recovered assets to member accounts in
reverse order of the allocation of the losses to those member
accounts.\185\ Section 190.17(b)(2) implements such DCO rules in
bankruptcy, thereby adjusting members' net equity claims (and the basis
for distributing any such recoveries) in light of such recoveries. The
provision similarly implements DCO loss allocation rules in other
contexts, for example, (i) rights to portions of mutualized default
resources that are either prefunded or assessed and collected, and, in
either event, not used, as well as (ii) rules that would allocate to
members recoveries against third parties for non-default losses that
are, under the DCO's rules, originally borne by members.
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\184\ These recoveries might be based on prosecution of such
claims in an insolvency or receivership proceeding, or, in the
reasonable commercial judgment of the DCO, the settlement or sale of
such claims.
\185\ For example, if the DCO rules allocate losses in excess of
the defaulters' available resources first to the DCO's own
contributions, second to the mutualized default fund contributions
of members other than the defaulter, third to assessments, and
fourth to gains-based haircutting (pro rata), all of which tools
were in fact used in a particular case, then recoveries on claims
against the defaulting members would be allocated (to the extent
available) first to those member accounts for which gains were
haircut, pro rata based on the aggregate amount of such haircuts per
member account, until all such haircuts have been reversed, second
to those members who paid assessments, pro rata based on the amount
of such assessments paid, until all such assessments have been
repaid, third to members whose mutualized default-fund contributions
were consumed, pro rata based on such default-fund contributions,
until all such contributions have been repaid, and fourth to the DCO
to the extent of its own contribution.
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Section 190.17(c) adopts by reference the equity calculations set
forth in proposed Sec. 190.08, to the extent applicable.
Finally, Sec. 190.17(d) implements section 766(i) of the
Bankruptcy Code, which: (1) Allocates a debtor DCO's customer property
(other than member property) to the DCO's customers (i.e., clearing
members) ratably based on the clearing members' net equity claims based
on their (public) customer accounts; and (2) allocates a debtor DCO's
member property to the DCO's clearing members ratably based on the
clearing members' net equity claims based on their proprietary (i.e.,
house) accounts. To implement section 766(i), Sec. 190.17(d) defines
``funded balance'' as a clearing member's pro rata share of member
property (for a clearing member's house accounts) or customer property
other than member property (for accounts for a clearing member's public
customers). The pro rata amount shall be calculated with respect to
each account class available for distribution to customers of the same
customer class. Moreover, given that the calculation of funded balance
for FCMs is an analogous exercise, the Commission intends that such
calculations under Sec. 190.17(d) will be made in the manner provided
in Sec. 190.08(c), to the extent applicable.
The Commission requested comment with respect to all aspects of
proposed Sec. 190.17. The Commission raised a specific question as to
whether it is appropriate to base the calculations proposed Sec.
190.17 on the full application of the debtors' loss allocation rules
and procedures, including the DCO's default rules and procedures.
Commenters addressed the proposed language of paragraph (b), or of
Sec. 190.17 generally, but did not offer specific comments on the
proposed language of paragraph (a), (c), or (d).
CME commented in support of Sec. 190.17(b)(1)'s application of
``the DCO's loss allocation rules and procedures, including the DCO's
default rules and procedures, to the calculation of clearing members'
net equity claims,'' but suggested a clarification to the proposed
rule. Specifically, CME suggested that the Commission ``clarify that
`full application' of the DCO's loss allocation rules and procedures to
the calculation of clearing members' house net equity claims means that
assessments or similar loss allocation arrangements thereunder are part
of the calculation only if and to the extent that the DCO's rules and
procedures provide for post-filing assessments and payments.'' CME
noted that a ``DCO's rules are the contract between and among the
members and the DCO,'' and that, ``[i]f the calculation of net equity
claims deviates from the DCO's loss allocation under its rules,
including determination of amounts owned under close-out netting rules,
that could adversely affect CME's netting opinion as to the
enforceability of its netting rules.'' CME also commented in support of
``giving effect to provisions in the debtor DCO's loss allocation rules
that entitle clearing members to return of guaranty fund deposits or
other mutualized default resources that are not used, or to payments
out of amounts that the DCO recovers on claims against a defaulting
clearing member, through adjustments to clearing member's net equity
claims against member property to reflect their entitlement to such
payments.'' CME also commented in support of Sec. 190.17(b)(2).
The ABA Subcommittee expressed concern with respect to perceived
ambiguity in Sec. 190.17(b)(1) regarding ``how assessments that were
not called for, or that were called for but not paid before the filing
date, would impact the calculation of a clearing member's net equity
claim with respect to its house account.'' The ABA Subcommittee
requested that the Commission modify the proposed regulation to clarify
that ``house account net equity claims would be adjusted to reflect
post-filing obligations only if and to the extent that the DCO's rules
and procedures impose obligations on clearing members to continue
making such payments following the DCO's bankruptcy.'' Specifically,
the ABA Subcommittee suggested that the following phrase be added to
the end of Sec. 190.17(b)(1): If and to the extent that the debtor's
loss allocation rules and procedures impose obligations on clearing
members to make such payments on or after the filing date.
FIA did not support the adoption of Sec. 190.17(b)(1). FIA stated
that it would be ``inappropriate to require a clearing member to reduce
the value of its net equity claim by the amount of an assessment that,
under the rules of the relevant DCO, either may no longer be made or
are not required to be paid.'' FIA asserted that a DCO's default fund
is ``a multilateral indemnification arrangement between the DCO and its
members pursuant to which members' contributions are used to cover the
DCO's losses resulting from member default(s) and thereby prevent the
DCO's bankruptcy.'' FIA stated that a ``DCO has no authority under its
rules to request or to apply these funds for any other purpose, nor do
we believe that a trustee would have any authority under the
[Bankruptcy] Code to do so.'' FIA noted further that, ``by requiring
that a clearing member's net equity claim must include the full
application of the DCO's loss allocation rules and procedures, proposed
Rule 190.17(b)(1) appears to have the effect of reducing a clearing
member's potential recovery, even when the full application of the
DCO's loss allocation rules is not necessary to meet the DCO's
obligations to non-defaulting clearing members,'' thereby impermissibly
benefitting the DCO's general creditors and shareholders to the
detriment of clearing members.
ICE commented that the Commission should refrain from adopting
Sec. 190.17(b) or providing ``specific guidance as to what assumptions
the CFTC would make and how the net equity claim is to be calculated
hypothetically.'' ICE stated that, in determining a clearing member's
net equity claim, it is neither appropriate nor feasible to consider a
potential assessment that could have been called for before a
bankruptcy filing but was not. ICE asserted that a DCO's determination
of whether ``to call
[[Page 19376]]
for an assessment and/or implement other loss allocation arrangements''
accounts for many considerations that would not be appropriate to
revisit in an insolvency. ICE also asserted that calculating the full
application of loss allocation rules, or determining what would have
happened in any full allocation, may not be possible. ICE noted, for
example: (a) Because a DCO is not obligated to impose assessments
against its clearing members, it is unclear how the CFTC or the trustee
would determine how many assessments the DCO should have made; (b) in
the event that ``clearing members have the right to cap their liability
by terminating their membership in a DCO,'' it is unclear how the CFTC
or the trustee would determine whether a clearing member should have
terminated its membership; \186\ and (c) it ``may not be possible to
determine definitively what the [DCO's] losses . . . would have been if
additional loss allocation steps, such as variation margin gains
haircutting or tear-up, had been taken.''
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\186\ But see ICE Clear Credit Rules 806, 807. To mitigate the
risk that their members will ``rush to the exits'' after a default,
DCOs generally hold departing members liable for assessments due to
the defaults that occurred before they withdrew from membership, as
well as during a ``cooling-off'' period that extends past the date
the member gives notice of intent to withdraw. The ICE Clear Credit
rules cited, which include a ``cooling-off period'' of at least 30
days, are examples of this phenomenon. Thus, the possibility that
clearing members would withdraw is not likely to affect their
liability for assessments in this context.
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SIFMA AMG/MFA commented that Sec. Sec. 190.17 and 190.18(b)(1)
should be modified to explicitly state that any gains that were haircut
during gains-based haircutting will be treated as customer property and
included in the net equity claims of the clearing members and customers
whose gains were haircut. SIFMA AMG/MFA further commented in support of
Sec. 190.17(b) but suggested that the proposal be modified to provide
that, if a debtor DCO either (i) does not have ``reverse the
waterfall'' rules or (ii) has ``reverse the waterfall'' rules that do
not address each level of the debtor DCO's waterfall, the net equity
clams of the debtor DCO's clearing members and customers will be
calculated as though the debtor DCO, in fact, ``has `reverse the
waterfall' rules that address each level of the DCO's waterfall.
Vanguard commented on Sec. 190.17(b)(1)'s requirement that a
trustee's calculation of DCO members' net equity claims include the
full application of DCO loss allocation rules and procedures. Vanguard
expressed concern that the requirement would result in a customer being
entitled to only ``a pro rata share to the extent the DCO rules did not
modify the distribution of the DCO's asset, whether pre- or post-
petition, through measures such as variation margin gains haircutting
or partial tear-up of transactions.'' Vanguard noted the possibility
that, ``as the DCO begins to fail,'' the DCO's rules ``could be changed
without the appropriate vetting by FCMs and customers who presently
bear an inordinate share of the risk.'' Vanguard believed that ``any
application of non-defaulting customer gains haircutting, or any other
margin haircutting, should be prohibited as being fundamentally at odds
with normal insolvency practice and highly counterproductive to
incentivizing customers not to abandon a failing DCO.'' Vanguard
asserted that, if haircutting is to be allowed, customers should
``receive full compensation in the form of a credit or equity claim
against the DCO [that is] superior to that of other creditors.''
Vanguard also suggested that Sec. 190.17(b)(2) be modified in the same
manner as suggested by SIFMA AMG/MFA, with respect to situations in
which a debtor DCO does not have ``reverse the waterfall'' rules, or
has ``reverse the waterfall'' rules that do not address each level of
the debtor DCO's waterfall.
ICI expressed concern that Sec. 190.17(b)(1) would permit a DCO's
loss allocation, recovery, and wind-down rules ``to override the
fundamental customer protections that Part 190 and Subchapter IV [of
the Bankruptcy Code] are meant to safeguard,'' because they would ``no
longer guarantee to a customer a pro rata share of customer property
based on its transactions and margin in accordance with Subchapter
IV.'' In that scenario, ICI commented that ``a customer would only be
entitled to such a pro rata share to the extent the DCO rules did not
modify the distribution of the DCO's assets, whether pre- or post-
petition, through measures such as variation gains haircutting or
partial tear-up of transactions.''
Having received no specific comments on the proposed language of
paragraphs (a), (c), and (d) of Sec. 190.17, the Commission is
adopting those paragraphs as proposed.
As described above, the Commission received several comments on
paragraph (b). After considering the comments, the Commission notes
that DCO default rules and procedures (also referred to as ``default
waterfalls''), as a general matter, first use the resources of the
defaulter (i.e., the defaulter's initial margin and contribution to the
default fund) to cover a shortfall. Should those resources be
insufficient to cover the shortfall, such default waterfalls generally
proceed to use the DCO's own capital contribution, and only after those
resources are extinguished is the remaining shortfall mutualized among
the clearing members: (1) First, through the prefunded default fund
contributions of non-defaulting clearing members; (2) then, through
limited assessment powers against those non-defaulting clearing
members, which are generally set as a multiple of each clearing
member's prior contributions to the default fund; and (3) finally,
through gains-based haircuts that affect both clearing members and
(through customer agreements) the customers of clearing members (i.e.,
public customers).
The Commission notes two important takeaways from the general
structure of default waterfalls. First, each clearing member knows, in
advance of a default, the maximum amount of its exposure to contribute
to mutualized loss through the guarantee fund and the DCO's assessment
powers. Second, should there be any reduction in the amount of funds
collected through such assessments, then any losses in excess of the
waterfall (i.e., up through the assessments) would instead be allocated
to both clearing members and their public customers. In other words, if
the losses are large enough, a reduced allocation of losses to clearing
members would necessarily mean that their public customers would bear
an increased allocation of losses.
The Commission remains of the view that, as discussed in the
proposal, ``[w]hile certain DCOs may have discretion, consistent with
governance procedures, as to precisely when they call for members to
meet assessment obligations, . . . allocation of losses should not
depend on the happenstance of when default management or recovery tools
were used--e.g., when assessments were called for, or when such
assessments were met.'' \187\ As discussed above, the losses in a DCO
bankruptcy ultimately would be allocated between clearing members and
customers, and clearing members' exposure to this allocation of losses
is already capped by the ex ante limits on assessment powers. If the
Commission were to modify the language of paragraph (b) in the manner
suggested by multiple commenters, the modification would effectively
decrease the allocation of losses that would be borne by clearing
members--below the ex ante limits of which they are on
[[Page 19377]]
notice--and correspondingly increase the allocation of losses that
would be borne by customers. In other words, in such a scenario, the
Commission believes that the suggested language could harm customers
and run counter to the Commission's policy that, with respect to
customer property, public customers be favored over non-public
customers. For those reasons, the Commission declines to adopt
commenters' suggestions to modify the net equity calculations in Sec.
190.17(b) by limiting (or eliminating) the allocation of assessments
that were not exercised prior to a bankruptcy filing.
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\187\ 85 FR at 36038.
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By contrast, gains-based haircuts are also part of the pre-
bankruptcy arrangements for allocating losses. If that part of the
``waterfall'' is reached, then that ex ante arrangement should be
followed. Moreover, there is a limited amount of customer property
available. Thus, to the extent the application of gains-based haircuts
was to be reversed, and some customers would realize increases in the
allowed amounts of their claims (and thus a greater share of customer
property), other customers would suffer a decreased share of customer
property; indeed, the latter customers may, as a result, receive less
than the amount of their claims for initial margin. This could have the
effect of reducing those customers' recoveries below the initial margin
they have posted. The Commission stands firmly against initial margin
haircutting as inimical to the principles of segregation. Thus, the
Commission declines to adopt the suggestion by SIFMA AMG/MFA and
Vanguard to reverse the application of gains-based haircutting in a DCO
bankruptcy.
FIA's comment letter raised two points that should be further
addressed. First, FIA stated that a DCO, under its rules, lacks the
authority to apply the DCO's default fund for any purpose other than
preventing the DCO's bankruptcy, and a trustee would similarly lack the
authority to do so under the Bankruptcy Code.\188\ FIA further argued
that, as a result of that limitation, the DCO's authority to make new
assessments or otherwise require that members contribute additional
funds to a DCO's default fund would not continue into bankruptcy.
Consequently, FIA argued that a clearing member's net equity claim
should not be reduced in bankruptcy by the amount of an assessment that
would no longer be required to be paid under the DCO's rules. However,
the Commission notes that Sec. 190.17(b)(1) does not instruct the
trustee to call any clearing member to pay in additional funds; rather,
paragraph (b)(1) reduces the clearing member's net equity claim against
the estate of the DCO, to account for uncalled or uncollected
assessments. Pursuant to section 20(a)(5) of the CEA, the Commission
has the power to provide, with respect to a commodity broker in
bankruptcy, ``how the net equity of a customer is to be determined,''
\189\ and the Commission believes that by setting the net equity
calculation as proposed, the rule would appropriately set such
calculations in a manner that does ``not depend on the happenstance of
when default management or recovery tools were used,'' as discussed
more fully above.
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\188\ FIA at 9.
\189\ In the bankruptcy of a clearing organization, clearing
members are a species of customer.
---------------------------------------------------------------------------
Second, FIA noted that, ``by requiring that a clearing member's net
equity claim must include the full application of the DCO's loss
allocation rules and procedures, proposed [Sec. ] 190.17(b)(1) appears
to have the effect of reducing a clearing member's potential recovery,
even when the full application of the DCO's loss allocation rules is
not necessary to meet the DCO's obligations to non-defaulting clearing
members'' and that ``[s]uch a result would impermissibly benefit the
DCO's general creditors and shareholders to the detriment of clearing
members.'' The Commission did not intend for the potential outcome
suggested by FIA; rather, in proposed Sec. 190.17(b)(2)(i), the
Commission intended to provide that, where the full amount of
assessment powers is not needed to cover a default, an appropriate
adjustment shall be made to the net equity claims of clearing members.
The Commission believes that the rule text should be modified in order
to communicate its intent more clearly, and avoid the possibility of
the unintended outcome raised by FIA. Accordingly, the Commission is
modifying Sec. 190.17(b)(1) to clarify that the DCO's ``loss
allocation arrangements shall be applied to the extent necessary to
address losses arising from default by clearing members.''
This modification separates paragraph (b)(1) into two separate
parts. First, paragraph (b)(1)(i) will provide that the calculation of
a clearing member's net equity claim shall include the full application
of the debtor's loss allocation rules and procedures, including the
default rules and procedures referred to in Sec. 39.16 and, if
applicable, Sec. 39.35. Second, paragraph (b)(1)(ii) will provide that
the calculation in paragraph (b)(1)(i) will include, with respect to
the clearing member's house account, any assessments or similar loss
allocation arrangements provided for under those rules and procedures
that were not called for before the filing date, or, if called for,
have not been paid. Such loss allocation arrangements shall be applied
to the extent necessary to address losses arising from default by
clearing members.
The ABA Subcommittee, in its comment letter, was concerned that the
proposed rule is ambiguous on whether assessments or similar loss
allocation arrangements would be included in the calculation where the
clearing organization's rules do not impose obligations on clearing
members to make such payments on or after the filing date. The modified
structure of paragraph (b)(1), as described above, should remove that
ambiguity, albeit not in the direction that the ABA Subcommittee would
prefer: The calculation ``will include, with respect to the clearing
member's house account, any assessments or similar loss allocation
arrangements that were not called for before the filing date . . . to
the extent necessary to address losses arising from default . . .''
(emphasis added).
CME's comment letter also raises a concern that should be
addressed. In particular, CME is concerned that deviating from the
DCO's rules with respect to loss allocation in this context could
adversely affect the DCO's netting opinion as to the enforceability of
its netting rules. The Commission notes that this argument conflates
bank capital charge calculations for cleared transactions with capital
charge calculations for default fund contributions. Pursuant to, e.g.,
12 CFR 217.133(a)(2), a clearing member that is (or is part of) a bank
holding company regulated by the Federal Reserve Board and that uses
the internal ratings and advanced measurement approaches to bank
capital requirements is required to use the methodologies described in
the applicable paragraph of 12 CFR 217.133 to calculate its risk-
weighted assets for a cleared transaction (that is, paragraph (c) of
that section) and the methodologies described in a different paragraph
to calculate its risk-weighted assets for its default fund contribution
to a CCP (that is, paragraph (d) of that section).\190\ Netting
opinions are necessary to treat cleared transactions
[[Page 19378]]
on a net basis,\191\ while assessments are related to default fund
contributions. Thus, the treatment of assessment obligations is
irrelevant to netting opinions for cleared transactions.
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\190\ There are analogous provisions for bank holding companies
regulated by the Federal Reserve Board that use the standardized
approach for calculating bank capital requirements (12 CFR 217.35)
as well as banks regulated by the FDIC and the Office of the
Comptroller of the Currency.
\191\ See 12 CFR 217.3(d).
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The Commission also received comments on proposed Sec.
190.17(b)(2) concerning the treatment of ``reverse the waterfall''
rules in the context of a DCO bankruptcy. After considering the
comments, the Commission continues to believe that it is useful and
appropriate to use ``reverse the waterfall'' rules for recoveries made
by a clearing organization (including a debtor clearing organization).
Some commenters suggested that proposed Sec. 190.17(b)(2) be modified
to address situations where the debtor DCO lacks ``reverse the
waterfall'' rules, or where such rules do not address each level of the
debtor clearing organization's waterfall. Although the commenters did
not provide specific language that could be used to apply to such
situations, the Commission believes that such a complicated
modification is beyond the bounds of what was proposed, and thus, the
Commission declines to make the modification here. Nonetheless, the
commenters' suggestion is well taken, and the Commission may consider
further work on that issue in the future.
Accordingly, after consideration of the comments, and for the
reasons stated above, the Commission is: (1) Adopting Sec. 190.17(a),
(b)(1), (c), and (d) as proposed; and (2) adopting Sec. 190.17(b)(2)
with the modification discussed above.
8. Regulation Sec. 190.18: Treatment of Property
The Commission is adopting Sec. 190.18 to establish the allocation
of the debtor DCO's estate in order to satisfy claims of clearing
members, as customers of the debtor. The Commission is adopting Sec.
190.18 as proposed, with the following modifications: (1) Adding new
paragraph (b)(1)(iv), as described below; and (2) removing paragraph
(c)(1) and renumbering the remaining paragraphs of paragraph (c).
Section 190.18(a) with respect to customer property is parallel to
Sec. 190.17(a) with respect to net equity. Paragraph (a) provides that
property of the debtor clearing organization's estate is allocated
between member property, and customer property other than member
property, in order to satisfy claims of clearing members as customers
of the debtor. Such property would constitute a separate estate of the
customer class (i.e., member property, and customer property other than
member property) and the account class to which it is allocated, and
would be designated by reference to such customer class and account
class.
Section 190.18(b) sets out the scope of customer property for a
clearing organization,\192\ and is based in large part on Sec.
190.09(a). Specifically, in Sec. 190.18, paragraphs (b)(1)(i)(A)
through (G) are based on Sec. 190.09(a)(1)(i)(A) through (G). Section
190.18(b)(1)(i) does not include a provision that is parallel to Sec.
190.09(a)(1)(i)(H), because loans of margin are not applicable to DCOs.
In Sec. 190.18, paragraphs (b)(1)(ii)(A) through (D) are based on
Sec. 190.09(a)(1)(ii)(A), (D), (E), and (F), while Sec.
190.18(b)(1)(ii)(E) adopts by reference Sec. 190.09(a)(1)(ii)(H)
through (K) as if the term debtor used therein refers to a clearing
organization as debtor. Section 190.18(b)(1)(ii) does not include
provisions that are parallel to Sec. 190.09(a)(1)(ii)(B), (C), (G),
and (L), because they would not be applicable due to the differences in
business models, structures, and activities of DCOs and FCMs,
respectively. Section 190.18(b)(1)(iii) is unique to clearing
organizations, and includes as customer property any guarantee fund
deposit, assessment, or similar payment or deposit made by a member, to
the extent any remains following administration of the debtor's default
rules and procedures. Section 190.18(b)(1)(iii) also includes any other
property of a member that, pursuant to the debtor's rules and
procedures, is available to satisfy claims made by or on behalf of
public customers of a member. Finally, Sec. 190.18(b)(2), which
identifies property that is not included in customer property, adopts
by reference Sec. 190.09(a)(2) as if the term debtor used therein
refers to a clearing organization as debtor and to the extent relevant
to a clearing organization.
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\192\ This is another provision prescribed pursuant to the
Commission's authority under section 20(a)(1) of the CEA, 7 U.S.C.
24(a)(1).
---------------------------------------------------------------------------
Section 190.18(c) allocates customer property between customer
classes, favoring allocation to customer property other than member
property over allocation to member property, so long as the funded
balance in any account class for members' public customers is less than
one hundred percent of net equity claims. Once all account classes for
customer property other than member property are fully funded (i.e., at
one hundred percent of net equity claims), any excess could be
allocated to member property. Section 190.18(c)(1), as proposed (but
not adopted herein, as discussed below), would allocate any property
referred to in Sec. 190.18(b)(1)(iii) (guarantee deposits,
assessments, etc.) first to customer property other than member
property, to the extent that any account class therein is not fully
funded, and then to member property. In proposing this provision, the
Commission intended such treatment of property to favor public
customers over non-public customers. Section 190.18(c)(2) allocates any
excess funds in any account class for members' house accounts first to
customer property other than member property to the extent that any
account class therein is not fully funded, and then any remaining
excess to house accounts to the extent that any account class therein
is not fully funded. Finally, Sec. 190.18(c)(3) allocates any excess
funds in any account for members' customer accounts first to customer
property other than member property to the extent that any account
class therein is not fully funded, and then any remaining excess to
house accounts, to the extent that any account class therein is not
fully funded.
Section 190.18(d) allocates customer property among account classes
within customer classes. Section 190.18(d)(1) confirms that, where
customer property is tied to a specific account class--that is, where
it is segregated on behalf of, readily traceable on the filing date to,
or recovered by the trustee on behalf of or for the benefit of an
account class within a customer class--the property must be allocated
to the customer estate of that account class (that is, the account
class for which it is segregated, to which it is readily traceable, or
for which it is recovered). Section 190.18(d)(2) provides that customer
property that cannot be allocated in accordance with paragraph (d)(1)
shall be allocated in a manner that promotes equality of percentage
distribution among account classes within a customer class. Thus, in
such a scenario, such property would be allocated first to the account
class for which funded balance--that is, the percentage that each
member's net equity claim is funded--is the lowest. This would continue
until the funded balance percentage of that account class equals the
funded balance percentage of the account class with the next lowest
percentage of funded claims. The remaining customer property would be
allocated to those two account classes so that the funded balance for
each such account class remains equal. This would continue until the
funded balance percentage of those two account classes is equal to the
funded balance of the account class with the next lowest percentage of
funded claims, and so
[[Page 19379]]
forth, until all account classes within the customer class are fully
funded.
Section 190.18(e) confirms, however, that where the debtor DCO has,
prior to the order for relief, kept initial margin for house accounts
in accounts without separation by account class, then member property
will be considered to be in a single account class.
Section 190.18(f) reserves the right of the trustee to assert
claims against any person to recover the shortfall of property
enumerated in Sec. 190.18(b)(1)(i)(E) and (b)(1)(ii) and (iii).
Paragraph (f) is analogous in the DCO context to Sec. 190.09(a)(3) in
the context of FCMs. The purpose of paragraph (f), as with Sec.
190.09(a)(3), is to clarify that any claims that the trustee may have
against a person to recover customer property will not be undermined or
reduced by the fact that the trustee may have been able to satisfy
customer claims by other means.
The Commission requested comment with respect to all aspects of
proposed Sec. 190.18. The Commission raised a specific question about
the comprehensiveness of the scope of customer property for a clearing
organization in proposed Sec. 190.18(b). The Commission also asked
specifically about the appropriateness of the proposed allocation of
customer property between customer classes in proposed Sec. 190.18(c)
and within customer classes in proposed Sec. 190.18(d).
The Commission received several comments on the proposal. Whereas
some commenters supported the proposal, in whole or in part, others
raised concerns particularly with respect to the scope of customer
property in proposed Sec. 190.18(b) and the treatment of guarantee
fund deposits and other payments in proposed Sec. 190.18(c)(1), among
other issues.
ICI commented in support of the proposal and agreed with the
Commission that the proposal is necessary to further the policy in
section 766(h) of the Bankruptcy Code of prioritizing the claims of
public customers over the claims of non-public customers. ICI stated
that public customers need the proposed protections because they
``typically have no direct participation in the DCO's risk management
and no insight into the transactions other customers have with the
DCO.'' ICI also stated that public customers may have less access to
information concerning the DCO's financial health, and may have fewer
tools available to protect themselves against losses, when compared to
DCO members.
The ABA Subcommittee commented that the treatment of clearing
members' guaranty fund deposits and similar payments in proposed Sec.
190.18(c)(1) represents a ``significant policy change'' with
``significant competing policy considerations and complex issues'' that
warrant consideration outside of the Proposal. The ABA Subcommittee
contended, for example, that such payments ``may be exposed to risk in
asset classes in which [the clearing member] does not trade, and which
the clearing member does not expect to assume based on the DCO's
rules.'' Without taking a formal position on the proposal, the ABA
Subcommittee identified issues that it believed warrant further
attention by the Commission and market participants, including whether
the language in paragraph (c)(1): (a) Should be implemented ``through a
Part 190 rule that would have the effect of overruling inconsistent DCO
rules,'' or through an amendment to part 39 to require DCOs ``to have
loss allocation rules that align with [the] policy change''; (b) would
place U.S. DCOs ''at a competitive disadvantage to non-U.S. DCOs''; (c)
would ``discourage firms from becoming or remaining direct clearing
members of a DCO for the purpose of clearing trades solely for their
own account or for non-public customers''; and/or (d) would ``create a
risk that U.S. banking regulators will want to revisit the methodology
for determining the amount of regulatory capital that bank and bank-
affiliated clearing members must hold with respect to cleared
derivatives.'' The ABA Subcommittee therefore recommended that the
Commission maintain the status quo by revising proposed Sec.
190.18(c)(1) ``to confirm that customer property described in Rule
190.09(b)(1) will be allocated to member property after such property
is applied to cover losses in accordance with the DCO's rules . . .
[until] the Commission separately considers the merits of the
[proposed] policy change.''
SIFMA AMG/MFA requested that the Commission amend proposed Sec.
190.18(b)(1) to provide explicitly ``that customer property includes
property a debtor DCO contributes to its default waterfall,'' as
seemingly was intended by proposed Sec. 190.18(b)(1)(ii)(E).
Consistent with its comments on proposed Sec. 190.17(b), FIA
commented that customer property should not include guaranty fund
deposits as set forth in proposed Sec. 190.18(b)(1)(iii) and
recommended that the Commission remove that provision. FIA stated that
a ``default fund represents a multilateral indemnification arrangement
between the DCO and its members pursuant to which members'
contributions are used to cover the DCO's losses resulting from member
default(s) and thereby prevent the DCO's bankruptcy.'' FIA contended
that a DCO has no authority under its rules, and a trustee has no
authority under the Bankruptcy Code, ``to request or to apply these
funds for any other purpose.''
CME commented in support of the decision to set forth the elements
that comprise customer property in proposed Sec. 190.18(b)(1). CME
specifically agreed that the scope of customer property should include
any guaranty fund deposit, assessment or similar deposit made by a
clearing member or recovered by the trustee, to the extent any remains
following administration of the debtor's default rules and procedures,
and any other property of a member available under the debtor's default
rules and procedures to satisfy claims made by or on behalf of pubic
customers of a member. For clarity and transparency, CME encouraged the
Commission to expand the scope of customer property to explicitly
include the amounts that the DCO commits to the financial resources in
the waterfall under its rules, to the extent that those resources have
not already been applied under the DCO's default rules. CME stated,
however, that the Commission should eliminate the requirement set forth
in proposed Sec. 190.18(c)(1) that the payments described in proposed
Sec. 190.18(b)(1) be allocated to customer property other than member
property for use ``to cover a shortfall in the funded balances for
clearing members' customer accounts in any account class'' and,
instead, ``reaffirm that guaranty fund deposits are to be applied to
cover losses in accordance with the DCO's rules, with any remaining
funds allocated to member property.'' In support of its view, CME
stated that such requirement set forth in proposed Sec. 190.18(c)(1):
(1) Would materially change ``the definition of member property in
current Regulation 190.10, under which any guaranty funds remaining
after payments in accordance with the DCO's rules would be returned to
clearing members as member property''; (2) ``may significantly alter
how clearing members assess the risks they have assumed in joining
CME,'' by undermining CME's ``rules limiting use of clearing members'
guaranty fund deposits to cover losses in the relevant product class to
which they have contributed to the guaranty fund and in which they
participate''; and (3) would ``compromise CME's ability under
Regulation 39.27 to `operate pursuant to
[[Page 19380]]
a well-founded, transparent, and enforceable legal framework that
addresses each aspect' of CME's obligations as a DCO, including netting
arrangements and `other significant aspects' of CME's `operations, risk
management procedures, and related requirements' as a DCO.'' \193\ CME
also asserted that: (a) Proposed Sec. 190.18(c)(1) ``is vulnerable to
legal challenge as exceeding the Commission's authority'' in section 20
of the CEA, because such authority is not being exercised consistent
with the Bankruptcy Code and other provisions of the CEA; \194\ (b) the
Commission does not have the authority under the CEA ``to adopt rules
that have the effect of directly rewriting a DCO's rules,'' and that
doing so would be contrary to the reasonable discretion afforded to
DCOs under section 5b of the CEA to comply with DCO core principles and
Commission regulations; (c) the Commission may not alter or supplement
the rules of a registered entity until it satisfies the requirement
under section 8a(7) of the CEA to request that the registered entity
amend its rules and provide the registered entity with notice and an
opportunity for a hearing if it does not do so; (d) amending the
contract between and among clearing members and the DCO through a
Commission regulation ``would call into question . . . the
enforceability of the DCO's rules''; and (e) ``a proposed rule
impacting the manner in which bank or bank-affiliated clearing members'
guaranty fund deposits and assessment obligations can be utilized may
drive subsequent changes to the methodology and resulting amount of
capital such members must hold for those exposures under the Cleared
Transactions Framework in the Regulatory Capital Rules.''
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\193\ Emphasis in original.
\194\ CME commented that the proposal would be contrary to the
Bankruptcy Code's definition of ``member property'' as ``customer
property received, acquired, or held by or for the account of a
debtor that is a clearing organization, from or for the proprietary
account of a customer that is a clearing member of the debtor.''
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ICE agreed with the Commission's approach not to propose ``that
property in an insolvent DCO's general estate can be treated as
customer property where customer property is otherwise insufficient to
pay customer claims.'' ICE suggested that the Commission clarify ``that
any ability to use residual assets should be only to the extent such
assets are not required to be used for any other purpose under other
applicable law (e.g.[,] for other classes of customers or for other
products).'' ICE suggested that ``[t]he definition of customer property
should also respect any express limitations on recourse that have been
implemented under DCO rules.'' ICE did not believe that the
distributional preference for public customers over clearing members
and any non-public customers of clearing members, as established by
proposed Sec. 190.18, is appropriate in the context of a DCO failure,
because it could ``impose losses, or greater losses, on non-defaulting
clearing members in a manner that overrides the negotiated and approved
frameworks in the DCO's rules.'' ICE asserted that this ``change could
require fundamental restructuring of DCO operations,'' and should be
``part of a separate rulemaking that addresses the interaction [of the
proposal] with the Part 39 requirements.'' ICE also noted that the
liability caps that limit the overall amount of a clearing member's
contributions and assessments--and the manner in which they may be used
for a particular default--are important for the clearing members' risk
management and are often necessary under such clearing members' capital
requirements. ICE stated that requiring the use of contributions or
assessments for purposes other than what is set forth in the DCO's
rules ``would render such caps and limitations ineffective.'' ICE
further posited that proposed Sec. 190.18 is ``unworkable for clearing
houses that have separate guaranty funds for separate products, or
other limited recourse provisions in their rulebooks [that are used] to
designate particular default resources for particular products, and to
ring-fence the liability of clearing members from particular products
that they may choose not to clear.'' ICE also raised a concern that
proposed Sec. 190.18's potential subordination of the claims of the
self-clearing members of a defaulting DCO to customers of other
clearing members could serve as a ``significant disincentive'' to self-
clearing, sponsored clearing, or direct clearing. ICE commented that
proposed Sec. 190.18 ``should not be applied to require the use of
clearing member guarantee fund, margin, or other resources in the
context of a non-default loss where the rules of the DCO specifically
do not contemplate (or expressly forbid) the use of such assets for
such purposes.'' On that issue, ICE noted that many DCOs have sought to
address separately the allocation of non-default losses through rules
that ``may allocate certain losses, and not others, to clearing members
and/or to the clearing organization itself, and/or provide for the
sharing of certain losses in certain amounts.''
After considering the comments, the Commission is adopting Sec.
190.18 with modifications, specifically with respect to paragraphs
(b)(1) and (c)(1).
Multiple commenters suggested that the Commission modify Sec.
190.18(b)(1) to make explicit that customer property includes the
amounts of its own funds that a debtor DCO had committed as part of its
loss allocation rules. Given that the DCO's commitment, in DCO rules,
of a specified amount of its own funds to loss allocation sets a
market-wide understanding and expectation that such an amount will be
used for such a purpose, the Commission agrees that this clarification
is warranted. Therefore, the Commission is modifying Sec. 190.18(b)(1)
by adding a new paragraph (b)(1)(iv), which will explicitly include in
customer property: ``Amounts of its own funds that the debtor had
committed as part of its loss allocation rules, to the extent that such
amounts have not already been applied under such rules.''
Multiple commenters addressed proposed Sec. 190.18(c)(1)(i), which
assigned guarantee funds to customer property other than member
property (i.e., to the benefit of members' public customers) if and to
the extent that a shortfall existed in the funded balance for such
customers. The proposal was supported by ICI, but opposed by CME, FIA,
and ICE, while the ABA Subcommittee also noted potential issues.
The Commission separately considered each of the arguments raised
by the commenters in opposition to proposed Sec. 190.18(c)(1). In the
discussion below, the Commission reviews the arguments raised by the
commenters and explains why it is modifying the proposal by not
adopting proposed Sec. 190.18(c)(1), and renumbering the remaining
paragraphs of proposed Sec. 190.18(c).
In response to concerns that the Commission lacks the authority to
implement this provision, the Commission notes that it has the
authority under section 20(a)(1) of the CEA to determine,
``[n]otwithstanding title 11 of the United States Code'' (i.e., the
Bankruptcy Code) both ``(1) that certain . . . property [including,
e.g., guarantee fund deposits] [is] to be included in or excluded from
. . . member property'' and ``(5) how the net equity of a customer is
to be determined.'' Thus, Sec. 190.18(c)(1) is legally sound because
of the ``notwithstanding title 11'' clause in section 20 of the CEA.
Moreover, proposed Sec. 190.18(c)(1) would allocate guarantee fund
deposits to customer property other than member
[[Page 19381]]
property only where the funded balance is less than one hundred percent
of net equity claims for members' public customers in an account class,
i.e., where the DCO had failed to maintain in segregation sufficient
funds to pay members' public customer account balances in full. In
other words, in that scenario, the debtor DCO would be non-compliant
with Commission regulations. This is not a re-writing of the DCO's
rules,\195\ nor a re-writing of the contract between the DCO and its
members, nor an undermining of the DCO's ``well-founded, transparent,
and enforceable legal framework,'' but an allocation of shortfall in a
bankruptcy case where the DCO is non-compliant with Commission
regulations.
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\195\ And, thus, does not require the Commission to invoke or
follow the procedures of CEA section 8(a)(7).
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The use of guarantee funds in the manner specified in proposed
Sec. 190.18(c)(1) would not be an ``unexpected loss'' to non-
defaulting clearing members, given that the regulation would be
transparently available to all. To the extent that the consequences of
the application of the regulation (re-allocation of their default fund
contributions to cover a shortfall in customer property for members'
public customers) would be unexpected by clearing members, and
unpredicted by their risk management systems, it is equally the case
that the public customers of clearing members would be surprised by a
shortfall in customer property, which their risk management systems
would also see as unexpected.\196\ Thus, the choice is not simply
whether to impose an unexpected loss to clearing members or not, but
rather a choice of who should bear that unexpected loss, clearing
members (as a group) or their customers (as a group). To that point, in
addition to the statutory authority that is provided in the CEA, the
Commission agrees with the comment from ICI that Sec. 190.18(c)(1)
would further the policy goal--stated in section 766(h) of the
Bankruptcy Code, but also running throughout the Commission's approach
to part 190--of prioritizing the claims of public customers over the
claims of non-public customers.
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\196\ Indeed, the risk would be even more unexpected by public
customers: Clearing members are entirely aware that their default
fund contributions are at risk of use to cover a mutualized default.
Their customers, on the other hand, expect that their customer funds
are fully protected by the CEA's and the Commission's segregation
requirements.
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However, despite the foregoing analysis supporting adoption of
Sec. 190.18(c)(1), the Commission is concerned about bank regulators'
potential analysis of Sec. 190.08(c)(1). In particular, the Commission
has considered that bank regulators may conclude that, because Sec.
190.08(c)(1) directs the use of DCO default funds for reasons other
than addressing mutualized member defaults, member contributions to DCO
default funds do not fit within the definition (in bank capital
regulations) of ``default fund contribution,'' see, e.g., 12 CFR 217.2.
Specifically, such member contributions may not constitute ``funds
contributed or commitments made by a clearing member to a CCP's
mutualized loss sharing arrangement,'' see, e.g., id. If this were the
case, members' default fund contributions would be subject to more
onerous capital treatment than they would receive if such contributions
did fit within the definition of ``default fund contributions.'' \197\
That more onerous capital treatment would have a direct, negative
impact on normal day-to-day activities for bank-affiliated clearing
members, and not merely in the uncertain future event of a DCO
bankruptcy. In other words, as discussed further below in section
III.D.8, while the benefits to public customers of Sec. 190.18(c)(1)
in case of bankruptcy would be balanced by the costs to clearing
members, the present-day costs to (bank-affiliated) clearing members of
more onerous capital treatment would not be offset by significant
benefits to public customers.
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\197\ That treatment could be significantly more onerous: For
example, under the FDIC's regulations, the capital requirement for a
clearing member's prefunded default fund contribution to a
qualifying CCP can be as low as 0.16% of that default fund
contribution. See 12 CFR 324.133(d)(4). By contrast, the capital
requirement for a clearing member's prefunded default fund
contribution to a non-qualifying CCP is 100% of that default fund
contribution. See 12 CFR 324.10(a)(1)(iii), (b)(3) (requiring
capital of 8% of risk-weighted asset amount, 324.133(d)(2) (setting
risk-weighted asset amount for default fund contributions to non-
qualifying CCP at 1,250% of the contribution). (1,250% * 8% = 100%).
The Federal Reserve and Office of the Comptroller of the Currency
have similar regulations.
Default fund contributions to DCOs total many billions of
dollars. While not all default fund contributions to DCOs come from
bank-affiliated clearing members, the majority of them do.
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The Commission acknowledges that the decision not to adopt proposed
Sec. 190.18(c)(1) differs from the Commission's approach to Sec.
190.17(b)(1). In Sec. 190.17(b)(1), uncalled or unmet assessments
would be applied to address default losses, with the only difference
being the timing of the bankruptcy relative to the timing of the calls
for, or payment of, the assessments. In short, the Commission concludes
in that context that the default fund contributions would be treated as
such for bank capital purposes, and thus would not be subject to more
onerous capital treatment. In contrast, proposed Sec. 190.18(c)(1)
would apply guarantee funds to cases that are distinct from a member
default. As discussed above, it seems entirely plausible that doing so
would take such contributions outside of the definition (in bank
capital regulations) of ``default fund contribution,'' and thus subject
them to more onerous capital treatment. The Commission believes that
this distinction is significant and forms the basis for the difference
in the Commission's respective approaches to Sec. 190.17(b)(1) and
proposed Sec. 190.18(c)(1).
Accordingly, after consideration of the comments, and for the
reasons stated above, the Commission is adopting Sec. 190.18 as
proposed, with the following modifications, as set forth above: (1)
Adding new paragraph (b)(1)(iv), as described above; and (2) by
removing paragraph (c)(1) and renumbering the remaining paragraphs of
paragraph (c).
9. Regulation Sec. 190.19: Support of Daily Settlement
The Commission is adopting Sec. 190.19 as proposed, with a
modification to paragraph (b)(1), as discussed below.
As the Commission noted in proposing Sec. 39.14(b), ``[t]he daily
settlement of financial obligations arising from the addition of new
positions and price changes with respect to all open positions is an
essential element of the clearing process at a DCO.'' \198\ Indeed,
Congress confirmed this by requiring that each DCO complete money
settlements not less frequently than once each business day.\199\
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\198\ 76 FR 3608, 3708 (Jan. 11, 2011).
\199\ See Core Principle E(i), 7 U.S.C. 7a-1(c)(2)(E)(i).
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In the ordinary course of business, variation settlement payments
are, at a set time or times each day,\200\ sent to the DCO from the
customer and proprietary accounts of each clearing member with net
losses in such accounts (since the last point of computation of
settlement obligations for that member), and then sent from the DCO to
the customer and proprietary accounts of each clearing member with net
gains in such accounts over that time period.
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\200\ DCOs are required to effect settlement with each clearing
member at least once each business day. They are additionally
required to have the capability to effect a settlement with each
clearing member on an intraday basis. See Sec. 39.14(b).
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There is no necessary relationship between the aggregate amount of
payments to the DCO from all clearing
[[Page 19382]]
member customer accounts with net losses and the aggregate amount of
payments from the DCO to clearing members' customer accounts with net
gains. On the other hand, it is the case that, for each business day,
the sum of variation settlement payments to the clearinghouse from
clearing members' customer and house accounts with net losses will
equal the sum of variation settlement payments from the clearinghouse
to clearing members' customer and house accounts with net gains.\201\
Those variation settlement payments will be received into the DCO's
accounts at one or more settlement banks from the accounts of the
clearing members with net losses and subsequently be disbursed from the
DCO's accounts at settlement banks to the accounts of the clearing
members with net gains.\202\ Depending on the settlement bank and
operational arrangements of the particular DCO, the variation
settlement funds will remain in the DCO's accounts between receipt and
disbursement for a time period of between several minutes and several
hours.
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\201\ Thus, while (for each settlement cycle), customer account
losses (x) plus house account losses (y) will equal customer account
gains (p) plus house account gains (q) (that is, x + y = p + q), x
would only equal p by random chance.
\202\ In some cases, the DCO will use one settlement bank, and
all settlement funds will flow into and out of that bank. In other
cases, the DCO may use a system of settlement banks, and the DCO
may, after receiving payments from members with payment obligations,
move funds between and among the settlement banks (possibly through
a ``concentration bank'') to match the settlement funds at each bank
to the DCO's settlement obligations to members who are entitled to
settlement payments.
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The Commission believes that it is crucial to the settlement
process that the variation settlement payments that flow into the DCO
from accounts with net losses are available promptly to flow out of the
DCO as variation settlement to accounts with net gains.
The Commission is adopting Sec. 190.19(a), pursuant to section
20(a)(1) of the CEA,\203\ to provide that, upon and after an order for
relief, variation settlement funds shall be included in the customer
property of the DCO, and that they shall be considered traceable to--
and shall promptly be distributed to--member and customer accounts
entitled to payment with respect to the same daily settlement.\204\
This customer property would be allocated to (i) member property and
(ii) customer property other than member property, in proportion to the
ratio of total gains in member accounts with net gains, and total gains
in customer accounts with net gains, respectively.
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\203\ 7 U.S.C. 24(a)(1) (``Notwithstanding title 11 of the
United States Code, the Commission may provide, with respect to a
commodity broker that is a debtor under chapter 7 of title 11 of the
United States Code, by rule or regulation . . . that certain cash,
securities, other property, or commodity contracts are to be
included in or excluded from customer property or member
property.'').
\204\ Because deposits of initial margin described in Sec.
39.14(a)(1)(iii) are separate from the variation settlement process,
they are treated separately in Sec. 190.19(a). Such funds would be
member property to the extent that they are deposited on behalf of
members' house accounts, and customer property other than member
property to the extent that they are deposited on behalf of members'
customer accounts.
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The Commission is adopting Sec. 190.19(b) to address cases where
there is a shortfall in funds received pursuant to paragraph (a) (i.e.,
settlement payments received by the DCO), such as in the case of a
member default. Paragraph (b)(1) sets forth how such a shortfall shall
be supplemented, to the extent necessary, and further states that such
funds shall be allocated in the same proportion as referred to in
paragraph (a). Paragraph (b)(1) provides that four types of property
shall be included as customer property: (i) Initial margin held for the
account of a member that has defaulted on a daily settlement, including
initial margin segregated for the customers of such member; \205\ (ii)
Assets of the debtor to the extent dedicated to such use as part of the
debtor's default rules and procedures, or as part of any recovery and
wind-down plans described in the paragraph (a) (i.e., the debtor DCO's
``skin in the game''); (iii) Prefunded guarantee or default funds
maintained pursuant to the DCO debtor's default rules and procedures;
and (iv) Payments made by members pursuant to assessment powers
maintained pursuant to the debtor DCO's default rules and procedures.
Paragraph (b)(2) provides that, to the extent that the funds that are
included as customer property pursuant to paragraph (a), supplemented
as described in paragraph (b)(1), such funds would be allocated between
(i) member property; and (ii) customer property other than member
property, in proportion to the ratio of total gains in member accounts
with net gains, and total gains in customer accounts with net gains,
respectively.
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\205\ This is restricted to the extent that such margin may only
be used to the extent that such use is permitted pursuant to parts
1, 22, and 30 of the Commission's regulations, which include
provisions restricting the use of customer margin.
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The Commission requested comment with respect to all aspects of
proposed Sec. 190.19.
CME expressed support for proposed Sec. 190.19, commenting that
the provisions in the proposal ``are appropriate to support the daily
settlement cycle when the trustee obtains the Commission's approval to
continue operating the DCO.'' FIA commented that it did not support
proposed Sec. 190.19(b), stating that the provision's reliance on a
debtor DCO's recovery and wind-down plans post-bankruptcy would be
inappropriate.\206\ SIFMA AMG/MFA requested that the Commission modify
proposed Sec. 190.19(b)(1) to clarify the Commission's presumed intent
that ``the debtor's recovery and wind-down plans shall only apply with
respect to proposed Sec. 190.19(b)(1)(ii)--the debtor's ``skin in the
game'' [(i.e., its own capital contributions)]--and not with respect to
the other'' categories of customer property that are enumerated in
Sec. 190.19(b)(1). The Commission agrees that its intent should be
clarified to reflect the comment from SIFMA AMG/MFA,\207\ and is
modifying the language of Sec. 190.19 to reflect that clarification.
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\206\ FIA's concerns with the language in Sec. 190.19(b) are
the same as its concerns with Sec. 190.15(b) and (c), discussed in
greater detail above. See supra section II.C.5. However, for the
reasons noted in section II.C.5, the Commission believes that
providing a ``menu of options'' among which a trustee may select
(and adapt) in a manner that is ``reasonable and practicable'' would
provide the trustee with a helpful roadmap to determine strategy and
tactics, given that the trustee will likely face a complex and
difficult situation with little preparation.
\207\ As SIFMA AMG/MFA correctly suggested, the Commission
intends for the debtor DCO's recovery and wind-down plans to apply
to the property described in Sec. 190.19(b)(1)(ii), and not to the
property described in paragraph (b)(1)(i), (iii) or (iv), in the
manner and to the extent described in paragraph (b)(1). As noted in
the preamble to the proposal, and as found in the regulation itself,
Sec. 190.19(b)(1)(ii) contains an explicit reference to ``recovery
and wind-down plans,'' whereas Sec. 190.19(b)(1)(i), (iii) and (iv)
do not contain such references.
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Accordingly, after consideration of the comments, and for the
reasons stated above, the Commission is adopting Sec. 190.19 as
proposed, with a modification to clarify that the reference to the
debtor's recovery and wind-down plans in paragraph (b)(1) applies only
to paragraph (b)(1)(ii), as set forth above.
D. Appendix A Forms
The Commission is deleting forms 1 through 3 contained in appendix
A and is replacing form 4 with a streamlined proof of claim form.
Current forms 1 through 3 contain outdated provisions that require
unnecessary information to be collected. The Commission believes these
changes will provide a trustee with flexibility to act based on the
specific circumstances of the case, while still acting consistently
with the rules.
As noted in Sec. 190.03(f), the trustee will be permitted, but not
required, to use the revised template proof of claim form included as
new appendix A. That
[[Page 19383]]
template is intended to implement Sec. 190.03(e), and includes cross-
references to the detailed paragraphs of that section. Similarly, the
instructions for this template form that are included in appendix A are
also designed to aid customers in providing information and
documentation to the trustee that will enable the trustee to decide
whether, and in what amount, to allow each customer's claim consistent
with part 190.
The Commission received one comment with respect to appendix A,
from CME, which opined that ``the proposed template proof of claim form
included as Appendix A [is a] major improvement[ ] over the current . .
. proof of claim template. CME also support[ed] giving the trustee the
flexibility to tailor the proof of claim form to request information of
customers as appropriate under the circumstances.''
Accordingly, after consideration of this comment, and for the
reasons stated above, appendix A to part 190 will be adopted as
proposed.
E. Appendix B Forms
Appendix B to part 190 contains special bankruptcy distribution
rules. These rules are broken into two frameworks. Framework 1 provides
special rules for distributing customer funds when the debtor FCM
participated in a futures-securities cross-margining program that
refers to that framework. Framework 2 provides special rules for
allocating as shortfall in customer funds to customers when the
shortfall is incurred with respect to funds held in a depository
outside the U.S. or in a foreign currency.
The Commission proposed clarifying changes to framework 1. No
comments were received with respect to framework 1. Accordingly, and
for the reasons stated above, the Commission is adopting appendix B,
framework 1 as proposed.
The Commission proposed to retain framework 2 with some clarifying
changes to the opening paragraph, but without proposing any substantive
change. It proposed to retain the current instructions and examples
following the first paragraph in appendix B, framework 2 entirely
unchanged. It requested comment with respect to framework 2. The
Commission received two comments on framework 2: From the ABA
Subcommittee, and from a number of individual members of that
subcommittee writing on their own behalf.
The ABA Subcommittee expressed the concern that ``[f]ramework 2
creates some ambiguity on when and how the special distribution
framework it prescribes should apply.'' First, the ABA Subcommittee
stated that ``framework 2 could be read to apply whenever there is a
loss resulting from a sovereign action, even if there is sufficient
customer property to otherwise pay all customer net equity claims in
full.'' The ABA Subcommittee suggested that an additional sentence be
added to the opening paragraph of framework 2 clarifying that it
applies only when there is a loss due to sovereign action and there is
insufficient customer property to pay all customer net equity claims in
full. Second, the ABA Subcommittee (in conjunction with a clarifying
comment from the Subcommittee Members) noted that framework 2 uses the
term ``reduction in claims'' in a potentially confusing manner--
framework 2 is intended to reduce distributions allocated to those
customers who are allocated losses due to sovereign risk; those
customers claims are not reduced. If the sovereign action is later
reversed or modified, those customers whose distributions were reduced
will receive increased distributions on their claims.
Third, the existing instructions to framework 2 ``establish the
`Final Net Equity Determination Date' as the date for both converting
customer claims to U.S. dollars and determining the amount of the
Sovereign Loss.'' However, in prior bankruptcies of FCM/commodity
brokers, ``claims stated in foreign currencies were either valued on
the date of transfer (where porting was available), or converted to
U.S. dollars as of either as of the petition date or the date on which
the foreign currency reflected in the customer's account was liquidated
(and thus the customer bore the risk of interim currency
fluctuations).'' Furthermore, ``a sovereign action could take place at
any time after the petition date, and the trustee is required to make
funded balance calculations throughout the course of the bankruptcy
case for purposes of porting and/or making interim distributions.''
The Commission finds the comments on framework 2 of the ABA
Subcommittee, as clarified by the comment of the Subcommittee Members,
persuasive. First, framework 2 is indeed only intended to address cases
where there is insufficient customer property to pay all customer net
equity claims in the relevant account class in full (if there is no
shortfall, then there is no need to allocate losses), and that point
should be made clear. Second, it is correct that framework 2 is
intended to reduce distributions, it is not intended to reduce claims,
and it is indeed appropriate to change the language used in framework 2
to clarify this fact.\208\ Third, the relevant date is the date of the
calculation, not the ``Final Net Equity Determination Date,'' and this
should be clarified as well.
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\208\ The fact that sovereign action reduces distributions
rather than claims means that, if the sovereign action is later
reversed or modified (e.g., by appeal in the foreign courts, or due
to recovery of assets in the foreign insolvency proceeding)
resulting in reduced losses due to sovereign action in a particular
jurisdiction, those customers whose distributions have been reduced
due to sovereign action in that jurisdiction will receive increased
distributions on their claims (with those distributions adjusted to
reflect the revised amount of losses due to sovereign action). Thus,
in this case, the claims remain constant, while the distributions
increase.
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Accordingly, the Commission is:
(1) Modifying the first paragraph of framework 2 to include the
statement that: ``If a futures commission merchant enters into
bankruptcy and maintains futures customer funds or Cleared Swaps
Customer Collateral in a depository outside the U.S. or in a depository
located in the U.S. in a currency other than U.S. dollars, and a
sovereign action of a foreign government or court has occurred that
contributes to shortfalls in the amounts of futures customer funds or
Cleared Swaps Customer Collateral, the trustee shall use the following
allocation procedures'' (emphasis added solely for illustration).
(2) Amending the instructions and examples within the whole of
framework 2 to replace references to ``reduction in claims'' with
references to ``reduction in distributions,'' and with conforming
changes to other text.
(3) Deleting the phrase ``Final Net Equity Determination Date''
from current section II.B.2.b of framework 2, and replacing it with the
phrase ``date of the calculation.''
Accordingly, after consideration of the comments, and for the
reasons stated above, the Commission is adopting appendix B, framework
2 as proposed, with the modifications described above.
F. Technical Corrections to Other Parts
1. Part 1
The Commission is making as proposed several technical corrections
and updates to part 1 in order to update cross-references. These are as
follows:
In Sec. 1.25(a)(2)(ii)(B) the Commission will revise the
cross-reference to specifically identifiable property, since the
definition will be updated in Sec. 190.01.
In Sec. 1.55(d) introductory text and (d)(1) and (2),
references to current Sec. 190.06 will be removed consistent
[[Page 19384]]
with the revisions to new Sec. 1.41 (which was proposed as Sec.
190.10(b) and renumbered).
In Sec. Sec. 1.55(f) and 1.65(a)(3) introductory text and
(a)(3)(iii) the Commission will update references to the customer
acknowledgment in Sec. 1.55(p) (which was proposed as Sec. 190.10(e)
and renumbered).
2. Part 4
In part 4, the Commission is making as proposed minor technical
corrections: In Sec. Sec. 4.5(c)(2)(iii)(A), 4.12(b)(1)(i)(C), and
4.13(a)(3)(ii)(A), the Commission will change the cross-references to
the defined term for ``in-the-money-amount.''
3. Part 41
In part 41, the Commission is making as proposed one technical
correction. In Sec. 41.41(d), the Commission will delete the cross-
reference to the recordkeeping obligations in current Sec. 190.06,
pursuant to the revisions to Sec. 1.41 (which was proposed as Sec.
190.10(b) and renumbered).
No comments were received with any of these technical corrections
and accordingly, for the reasons stated above, they are being adopted
as proposed.
G. Additional Comments
In addition to the comments discussed above, the Commission
received several general comments that addressed matters outside the
scope of the Proposal. The Commission appreciates the additional
feedback. Because these comments do not address proposed changes and
are therefore outside the scope of this rulemaking, the Commission may
take the comments under advisement for future rulemakings.
ISDA encouraged the Commission to continue working on DCO recovery
and resolution issues alongside the Federal Deposit Insurance
Corporation (FDIC) in the United States, and with global standard
setters such as CPMI-IOSCO and the Financial Stability Board and other
CCP supervisors and resolution authorities internationally. The
Commission notes that staff are actively doing each of those things.
ISDA also noted that it would be advisable to engage in workshops
with both market participants (including DCOs, FCMs and other clearing
members and customers) and the FDIC prior to finalizing the Proposal to
develop examples that illustrate both how net equity claims would be
calculated in a hypothetical DCO insolvency under various loss
scenarios and how the claims of creditors and equity would be treated
in a resolution of the DCO under Title II of the Dodd-Frank Act. ISDA
observed that the Proposal's treatment of a DCO's insolvency contains
significant subtleties and nuances that could have implications for the
counterfactual in a DCO resolution. ISDA suggested that further
engagement could help ensure that these subtleties and nuances would
not result in any unintended consequences, and that they are broadly
understood by all entities that could be impacted by a DCO's insolvency
or resolution.
While the Commission is finalizing the Proposal, it agrees that
workshops and similar interactions between staff and other agencies, as
well as with industry participants, are an excellent way to expose
subtleties and nuances, build common understanding, and enhance
planning.
CME and CMC commented on various issues relating to delivery, and
requested that ``the Commission consider, in a separate rulemaking, the
merits of imposing custody requirements or other customer protection
requirements with respect to delivery accounts, along with the
possibility of further subdividing delivery accounts and delivery
account classes by underlying asset class or delivery mechanism, e.g.,
electronic transfer versus physical load-out.'' \209\ CME recommended
that the separate rulemaking consider requirements such as whether FCMs
should hold such property in custody accounts or limitations on how
long cash or cash equivalents should be held in delivery accounts that
are not subject to custody requirements.\210\ CME believed that any
such rules would fit best in the Commission's part 1 regulations and
not in part 190 as parties with delivery obligations may not
necessarily be aware of requirements in the bankruptcy regulations. CME
recommended that the part 190 provisions relating to the delivery
account class should be consistent with any such rules the Commission
may ultimately adopt. Thus, CME believed that the Commission may have
to revisit the delivery account class definition, and any appropriate
subdivisions within the account class, along with the definitions of
cash delivery property and physical delivery property definitions,
based on the outcome of such a rulemaking.
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\209\ See CMC, CME.
\210\ See CME. CME believed that the Commission has authority to
adopt such a rule pursuant to its anti-fraud authority under CEA
section 4b and its plenary authority to regulate commodity options
under CEA section 4c(b).
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As noted above, the Commission recognizes the importance of
addressing deliveries and delivery accounts, in order to protect
customer funds in delivery accounts, to avoid disruptions to cash
markets for delivered commodities, and to avoid adverse consequences to
parties that may be relying on delivery taking place in connection with
their business operations. The Commission notes that there potentially
would be benefits to requiring segregation for delivery accounts, but
there would be corresponding costs as well. The Commission expects to
continue its consideration of such delivery and delivery account issues
in the future.
SIMFA AMG/MFA understood the Commission's decision, due to limited
resources, not to amend certain key definitions and concepts outside
part 190, as proposed by the ABA Subcommittee in its model set of part
190 rules, within this rulemaking. These amendments include, e.g., the
definitions of foreign option and variation margin, as well as
regulations concerning non-swap and non-futures over-the-counter
transactions cleared by a DCO and concerning leverage transaction
merchants. However, SIFMA AMG/MFA recommended that the Commission make
these amendments as soon as possible, given the beneficial impact such
changes will have on the administration of an FCM or DCO insolvency.
The Commission may consider these proposed changes in the future.
ICI and Vanguard encouraged the Commission to work with other
regulators to minimize existing barriers to porting, particularly for
FCMs dually registered as broker-dealers, FCMs within consolidated
groups that are subject to certain due diligence requirements, and FCMs
that are subject to the FDIC's Orderly Liquidation Authority
proceedings. The commenters encouraged the Commission to work with
regulators to permit similar six-month grace periods and remove the
requirement to port ``all or none'' of the positions instead of
allowing partial transfers of customer positions, including those of
separately managed accounts.
ICI also recommended that the Commission engage with SIPC or the
relevant bankruptcy court to ensure that any selected trustee has the
experience and knowledge to act in accordance with the duties contained
in part 190 and Subchapter IV of the Bankruptcy Code.
Commission staff have and will continue to work with staff of other
regulators to minimize barriers to
[[Page 19385]]
porting, and have worked and will, if and when necessary in future,
work with SIPC and the office of the U.S. Trustee, to promote the
appointment of the most knowledgeable trustees available in the context
of SIPA or Chapter 7 proceedings, respectively, involving a commodity
broker.
ICI recommended that the Commission continue its portfolio
margining harmonization efforts with the SEC to further facilitate
portfolio margining, including with respect to security-based swaps and
swaps. The Commission notes that the two Commissions are actively
engaging in such efforts, and, on October 22, 2020, held a joint
meeting during which they jointly approved a ``Request for Comment:
Portfolio Margining of Uncleared Swaps and Non-Cleared Security-Based
Swaps.'' \211\
---------------------------------------------------------------------------
\211\ 85 FR 70536 (November 5, 2020).
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ICI and Vanguard recommended that the Commission extend the
``legally segregated operationally commingled'' (``LSOC'') model
applied to cleared swaps contracts (and associated collateral) within
part 22 to also apply to futures, foreign futures, and options thereon
(and associated collateral) to limit non-defaulting customer exposure
to defaulting customers.
ICI also requested that the Commission or Commission staff provide
guidance, such as an interpretive letter, that interprets part 22 to
require that OTC transactions cleared by DCOs and carried in a cleared
swaps account be treated as cleared swaps subject to part 22.\212\
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\212\ Such an interpretation may be superfluous. Previously, the
Commission issued an ``Interpretative Statement Regarding Funds
Related to Cleared-Only Contracts Determined To Be Included in a
Customer's Net Equity.'' 73 FR 57235 (October 2, 2008). At the time,
prior to Dodd-Frank, there were questions as to whether cleared-only
transactions were commodity contracts. The Commission noted that, in
cases where such contracts are held in a futures account at an FCM
and margined as a portfolio with exchange-traded futures, assets
margining that portfolio are likely to be includable within ``net
equity'' even if such contracts were found not to be commodity
contracts: Where the assets in an entity's account collateralize a
portfolio containing both commodity contracts and other contracts,
the entirety of those serves as performance bond for each type of
contracts. See id. at 57236. See also 17 CFR 22.1 (defining
``Cleared Swaps Customer Collateral,'' in relevant part, as all
property that ``[i]s intended to or does margin, guarantee, or
secure a Cleared Swap . . . .'').
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ICI and Vanguard recommended that the Commission prohibit non-
defaulting customer gains haircutting, or any other margin haircutting,
and if such gains haircutting is allowed at all, it should be limited
in scope and duration, overseen by the DCO's resolution authority and/
or the systemic risk authority, and the customer must receive full
compensation in the form of a credit or equity claim against the DCO,
superior to that of other creditors.
ICI and Vanguard also requested that the Commission require DCOs to
increase their ``skin-in-the-game'' as a foundational incentive for the
DCO to set appropriate margin levels and avoid clearing illiquid or
highly volatile products. Vanguard also recommended that a DCO's
capital should be required to backstop clearing risk, should the assets
available for DCO recovery prove inadequate.
FIA requested that the Commission confirm that amendments to part
190, including to appendix B, framework 2, would not prohibit the
Commission from amending Sec. 1.49 at a later date to expand the
definition of ``money center currency.''
The Commission confirms that the amendments to part 190 that are
being made herein will not prohibit the Commission from amending any
other regulation, including Sec. 1.49, in the future. If future
amendments to other parts of the Commission's regulations lead to a
situation where it would be advisable to make conforming changes to
part 190, the Commission will consider such conforming changes along
with those amendments.
H. Supplemental Proposal
In the Supplemental Proposal, the Commission noted a problem to be
solved: There is a possibility that a SIDCO could file for bankruptcy
before the process for placing that SIDCO into Title II resolution is
complete. Due to closeout netting rules adopted by many DCOs, including
the SIDCOs, that filing could have the consequence of terminating all
of the SIDCO's cleared contracts. Terminating those contracts could
undermine the success of any subsequent Title II resolution.
The Supplemental Proposal suggested one approach to solve the
problem, and requested comment, inter alia, on better ways to do so. In
light of concerns raised in the comments received in response to the
Supplemental Proposal, and for reasons discussed below, the Commission
has determined not to finalize the alternative that was proposed in the
Supplemental Proposal.
The process for placing a financial company into Title II
Resolution is deliberate and intricate.\213\ By contrast, a voluntary
petition in bankruptcy commences the case, which in turn constitutes an
order for relief. Accordingly, there exists a possibility that, in the
highly unlikely event that a SIDCO would consider bankruptcy, the SIDCO
could file for bankruptcy before a process to place that SIDCO into a
Title II Resolution would have completed. While the appointment of the
FDIC as receiver under Title II would automatically result in the
dismissal of the prior bankruptcy, if the bankruptcy filing were to
necessarily result in the termination of the SIDCO's derivatives
contracts with its members, that would undermine the potential success
of any subsequent Title II Resolution.
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\213\ In the case of a SIDCO, this would include a written
recommendation by each of the FDIC and the Federal Reserve covering
eight statutory factors. Following that recommendation, the
Secretary of the Treasury would then need to make a determination,
in consultation with the President, that each of seven statutory
factors is met. (The FDIC, Federal Reserve, and Secretary of the
Treasury are often referred to as the ``key turners'' for Title II
resolution). Following such a determination, the board of directors
of the financial company may acquiesce or consent to the appointment
of the FDIC as receiver, or there may be a period of judicial review
which may extend to 24 hours.
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To address the problem, the Commission proposed, in the
Supplemental Proposal, to adopt a provision that would stay the
termination of SIDCO contracts for a brief time after bankruptcy in
order to provide advance notice to the Commission (and, thus, to enable
the Commission to notify the key turners) of the point at which the
SIDCO's contracts could be terminated, in order to foster the success
of a Title II resolution by avoiding that termination, if the FDIC is
appointed receiver in such a Resolution within that time. During this
stay, variation margin would neither be collected nor paid. Due to
concerns raised by commenters to the original Proposal regarding the
effect of any restriction on termination of DCO contracts on treatment,
under the capital regulations of Prudential Regulators of the banks
that many clearing members are affiliated with, of SIDCO rules, the
proposal provided that this provision would become effective only if
the Commission were to find that the Prudential Regulators (i.e., the
Federal Reserve, the FDIC, and the Office of the Comptroller of the
Currency) have taken steps to make such a stay consistent with SIDCO
rules retaining status as QMNAs.\214\
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\214\ Any stay (in bankruptcy) on the termination of the SIDCO's
derivatives contracts would--under the regulations of the Prudential
Regulators of the banks and bank holding companies that SIDCO
clearing members may be affiliated with or part of--be inconsistent
with the status of a DCO's rules as a qualifying master netting
agreement (``QMNA''). Qualification of DCO rules as a QMNA is
necessary in order for the banks and bank holding companies that
clearing members are affiliated with or part of to net the exposures
of their contracts cleared with the DCO in calculating bank capital
requirements. If they cannot net such exposures, there would be
significantly increased bank capital requirements associated with
such contracts. Such an increase in bank capital requirements would
disrupt both proprietary and customer clearing. See generally
Supplemental Proposal, 85 FR 60110, 60112 (Sept. 24, 2020).
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[[Page 19386]]
The Commission requested comment on all aspects of the Supplemental
Proposal, including as to whether the approach proposed ``is the best
design for such a solution.''
The Commission received five comments on the Supplemental Proposal,
each of which was from an entity that commented on the Proposal.\215\
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\215\ Comments on the Supplemental Proposal were submitted by:
CME Group Inc. (``CME (2)''); Futures Industry Association (``FIA
(2)''); Intercontinental Exchange Inc. (``ICE (2)''); Investment
Company Institute (``ICI (2)''), and Securities Industry and
Financial Markets Asset Management Group and Managed Funds
Association (``SIFMA AMG/MFA (2)'').
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Many of the commenters argued that the proposed stay is
unnecessary, because the Commission would inevitably have received
notice of the impending bankruptcy. For instance, ICI (2) commented
that:
Although it may indeed take some time for the relevant agencies
to ``turn the three keys,'' a DCO's recovery tools should give the
agencies more than enough time. DCOs have clearing fund provisions,
operational default provisions, and a variety of other risk
management tools at their disposal. In practice, these tools may not
be completely effective to preclude an insolvency. However, it seems
extraordinarily unlikely that they would be so ineffective as to
fail to give the FDIC, Federal Reserve Board, and Secretary of the
Treasury enough time to decide whether to trigger OLA proceedings.
Similarly, SIFMA AMG/MFA (2) stated that ``the possibility of a
surprise bankruptcy filing [is] implausible given the regulatory
oversight framework.''
FIA (2) agreed, stating that:
A determination with regard to invoking Title II will almost
certainly be made before a SIDCO is subject to an order for relief.
. . . [W]e fully anticipate that the Commission, the FRB, the FDIC,
and the Department of the Treasury will be making an assessment
regarding the necessity and feasibility of recommending that the
President invoke Title II and taking appropriate action before the
SIDCO concludes that it must file a petition for bankruptcy.
CME (2) argued that:
under the CEA oversight framework, including a SIDCO's reporting
obligations, surely it is reasonable to expect that the Commission,
FDIC, FRB and Treasury will be well aware of any circumstances that
could portend a SIDCO's failure, whatever the cause, and will be
closely monitoring the situation. If the relevant parties are
contemplating placing the SIDCO into a Title II resolution
proceeding, and doing so is feasible, it is hard to imagine that a
SIDCO could file a voluntary petition for relief under subchapter IV
of Chapter 7 of the Bankruptcy Code without their prior knowledge.
* * *
In the highly unlike event a SIDCO were to face a decision
whether to file for bankruptcy, it would be one of last resort,
taken only after careful deliberation. The decision to file a
voluntary petition for relief is certainly not one that CME, or any
DCO, would take lightly.
The Commission agrees that, pursuant to the DCO oversight
framework, including a SIDCO's reporting obligations under Sec. 39.19,
the Commission would promptly be notified of a DCO's financial
distress. Upon learning of such distress--whether through notification
by the DCO or by risk surveillance by Commission staff--the Commission
and staff would monitor the situation closely, and, in appropriate
cases, promptly contact and act in coordination with fellow regulators,
including the Federal Reserve and FDIC (and, as appropriate, the
Department of the Treasury). Moreover, DCOs have strong and effective
``clearing fund provisions, operational default provisions, and other
risk management tools at their disposal,'' as noted in the comment
letter from ICI (2). The Commission believes it to be ``extraordinarily
unlikely'' that these tools would fail, let alone fail before the ``key
turners'' have time to act.
It is also true that, given prior experience with discussions with
DCOs concerning defaults of clearing members (none of which resulted in
financial distress to the DCOs), the Commission fully expects that any
DCO that is in financial distress would be in close contact with
Commission staff. The Commission also appreciates the sentiment
expressed by CME and quoted above, implying that ``it is hard to
imagine'' that a SIDCO would not provide the Commission with prior
knowledge of a voluntary bankruptcy filing. Finally, the Commission is
confident that the decision to file a voluntary petition for relief in
bankruptcy is ``not one that . . . any DCO would take lightly.''
Nevertheless, given the destructive impact that termination of the
derivatives contracts of a SIDCO would cause, the Commission remains
concerned about the effects that a bankruptcy filing would have on the
ability to resolve the SIDCO pursuant to Title II successfully. In this
context, it is not enough that such an event is ``implausible,'' ``hard
to imagine,'' or ``extraordinarily unlikely.'' Knowledge of the SIDCO's
financial distress is distinct from knowledge of the timing of a
potential bankruptcy filing. While the Commission would most likely be
aware of the SIDCO's distress, it is at this point not certain that
there would be clear communication of the SIDCO's intention to file for
bankruptcy sufficiently in advance that the key turners would have time
to act.
As noted in the Supplemental Proposal, the destructive impact of a
full tear-up of a SIDCO's contracts would be significant. The FSOC has
found that a significant disruption or failure of either SIDCO could
have a major adverse impact on the U.S. financial markets, the impact
of which would be exacerbated by the limited number of clearing
alternatives currently available for the products cleared by each
SIDCO. A failure or disruption of either SIDCO would likely have a
significant detrimental effect on the liquidity of the futures and
options markets (for CME) or swaps markets (for ICC), and on clearing
members, which include large financial institutions, and other market
participants. These significant effects would, in turn, likely threaten
the stability of the broader U.S. financial system.\216\ For those
reasons, inter alia, the Commission continues to be concerned about
avoiding a circumstance where the derivatives contracts of a SIDCO are
irrevocably terminated because the SIDCO files for bankruptcy before a
process to place that SIDCO into a Title II Resolution.
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\216\ See 2012 FSOC Annual Report, Appendix A, at 163, 178.
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However, the comments expressed strong concerns about achieving
those goals through the use of a bankruptcy stay, especially in light
of the fact that variation margin would neither be collected nor paid
during that period.
The Supplemental Proposal acknowledged that risk levels would
increase during the stay period. Commenters argued that such increase
in risk exposures during the stay period would pose unacceptable risks.
For example, CME (2) stated that ``permitting the accumulation of
uncovered risk for 48 hours during an extremely volatile time would
pose a risk to financial stability.'' Similarly, SIFMA AMG/MFA (2)
warned that the proposed part 190 stay, in conjunction with the Title
II stay, ``would result in extraordinary market exposures to market
participants during highly volatile market conditions. The non-payment
of margin could also result in a multiple day liquidity problem for
[[Page 19387]]
market participants clearing at the SIDCO.''
The Supplemental Proposal also acknowledged that there is a
significant cost to the proposed stay, in that ``[f]or the duration of
the stay period, clearing members and clients will be uncertain whether
their contracts will continue (as part of a Resolution) or be
terminated (and thus would need to be replaced). That uncertainty would
mean that clearing members and clients would be disadvantaged in
determining how best to protect their positions.'' Again, commenters
agreed that this cost would ensue, and argued that it would be
unacceptable. For example, ICI (2) observed that during the stay:
the price of the relevant underlying assets could (and if a SIDCO is
insolvent, likely would) move dramatically. However, customers would
be precluded from entering into risk-reducing or replacement
transactions to stem potential losses, since they will not know
whether their contracts will be terminated or reinstated. Such a
freeze not only threatens to cause public customers significant
losses that they cannot mitigate; it would also create a liquidity
event because customers will need to preserve as much liquidity as
possible during the pendency of the stay in order to meet potential
margin calls.
Commenters also raised issues relating to legal uncertainty. For
instance, FIA (2) acknowledged that section 20 ``authorizes the
Commission to adopt rules `[n]otwithstanding title 11 of the United
States Code' '' (i.e., the Bankruptcy Code). However, FIA observed that
``[w]hether a stay contemplated under the Supplemental Proposal would
conflict with section 404(a) of FDICIA . . . is unclear.''
In light of the persuasive arguments of the commenters, the
Commission concludes that a bankruptcy stay is not an appropriate means
of achieving the goal of fostering the success of a Title II Resolution
by avoiding the possibility that the SIDCO could file for bankruptcy
before a process to place that SIDCO into a Title II Resolution would
have completed with the result that all of the SIDCO's contracts were
terminated. This would be true even if action was taken by the
Prudential Regulators to avoid having such a stay undermine the QMNA
status of SIDCO rules. Thus, while the goal remains important, the
Commission will not adopt such a stay.
A number of the comments answered the Commission's call for a
better way of achieving that goal. SIFMA AMG/MFA(II) stated that ``[a]s
an alternative to the proposed stay, the Commission could require, as
part of its Part 39 or Part 190 rules, that a SIDCO provide a 1 or 2
day notice to the Commission of any bankruptcy petition by a SIDCO. We
believe this notice requirement would achieve the same goal in a
materially less detrimental manner.''
CME (2) suggested the same alternative approach to achieve the same
regulatory goal, in somewhat more detail. CME (2) urged that the
Commission should address the problem:
in a more direct manner, consistent with its rulemaking authority.
For example, the Commission could require a DCO to notify the CFTC
in advance of its plan to file a voluntary petition for relief under
subchapter IV of Chapter 7 of the Code, to allow Treasury time to
determine whether to appoint the FDIC as receiver before the SIDCO
files its petition. We note that before a commodity broker may file
a voluntary petition for relief under subchapter IV, its board of
directors must approve a resolution authorizing the debtor to take
that step.
The Commission agrees that the alternative suggested by the
commenters in response to the Commission's request--providing the
advance notice sought by the Commission, but before a bankruptcy filing
rather than thereafter--is one that, as FIA (2) observed, ``deserves
the Commission's strong consideration.'' It appears that it may achieve
the regulatory goals specified in the Supplemental Proposal while
avoiding the concerns raised by the commenters: By providing advance
notice to the Commission, it appears that it may allow the Commission,
which will be coordinating with the ``key-turners,'' to advise those
agencies of the imminence of a bankruptcy filing, and to provide them
with warning at a time that may be sufficient to enable them to act
with dispatch to complete the process.
Because the alternative approach would not involve a post-
bankruptcy stay, it would appear to avoid affecting the QMNA status of
SIDCO rules (and, thus, would appear not to require any action by the
Prudential Regulators).\217\ Moreover, because this notice would occur
in advance of a bankruptcy filing, the suspension of payments and
collections of variation margin would not occur, and there would appear
to be no ambiguity concerning the status of the cleared contracts of
market participants. By avoiding the mechanism of a bankruptcy stay,
the Commission would also appear to avoid the legal uncertainty issues
raised by the commenters with respect to that mechanism. Instead, this
notice approach would appear to be, as noted by CME, well within the
Commission's rulemaking authority.\218\
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\217\ This also avoids the issue, raised by ICE (2), that action
by the Prudential Regulators with respect to QMNA status may not be
sufficient to address netting issues for non-U.S. clearing members.
\218\ See, e.g., CEA section 5b(c)(2)(J), 7 U.S.C. 7a-1(c)(2)(J)
(reporting core principle); CEA section 3(b), 7 U.S.C. 5(b) (purpose
of the CEA is to ensure the financial integrity of transactions
subject to the CEA and the avoidance of systemic risk); CEA section
8a(5), 7 U.S.C. 12a(5) (general rule-making authority).
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However, in light of the concerns raised with the previous
approaches to addressing this problem, both the one advanced in the
Supplemental Proposal as well as one advanced in the Proposal, the
Commission concludes that, at this point, it should engage in further
analysis and development before proposing this, or any other,
alternative approach. Such further analysis and development might
better enable the Commission to propose, in detail, a solution that is
effective, and that mitigates any attendant costs. Thus, the Commission
will, at present, keep this issue under advisement.
III. Cost-Benefit Considerations
A. Introduction
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders.\219\ Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
the following five broad areas of market and public concern: (1)
Protection of market participants and the public; (2) efficiency,
competitiveness, and financial integrity of futures markets; (3) price
discovery; (4) sound risk management practices; and (5) other public
interest considerations. The Commission considers the costs and
benefits resulting from its discretionary determinations with respect
to the section 15(a) factors (collectively referred to herein as
``Section 15(a) Factors'') below.
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\219\ CEA section 15(a), 7 U.S.C. 19(a).
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In the Proposal, the Commission endeavored to assess the expected
costs and benefits of the proposed rulemaking in quantitative terms,
including costs related to matters addressed in the Paperwork Reduction
Act \220\ (``PRA-related costs''), where possible. In situations where
the Commission was unable to quantify the costs and benefits, the
Commission identified and considered the costs and benefits of the
applicable proposed rules in qualitative terms. The lack of data and
information to estimate those costs was attributable in part to the
nature of the proposed
[[Page 19388]]
rules. None of the comments identified quantifiable costs or benefits.
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\220\ 44 U.S.C. 3501 et seq.
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In a number of cases, commenters suggested alternative approaches
or modifications to the proposed provisions. The Commission has
carefully considered these alternatives and modifications and in a
number of instances, for reasons discussed in detail above, has adopted
such alternative approaches or modifications where, in the Commission's
judgment, the alternative or modified approach is more appropriate to
accomplish the regulatory objectives. The rationale in these cases was
discussed in detail above.
1. Baseline
The baselines for the Commission's consideration of the costs and
benefits of this rulemaking are: (1) The Commission's current
regulations in part 190, which establish bankruptcy rules in the event
of an FCM bankruptcy; (2) current appendix A to part 190, which
contains four bankruptcy forms (form 1--Operation of the Debtor's
Estate--Schedule of Trustee's Duties; form 2--Request for Instructions
Concerning Non-Cash property Deposited with (Commodity Broker); form
3--Request for Instructions Concerning Transfer of Your Hedging
Contracts Held by (Commodity Broker); and form 4--Proof of Claim); and
(3) current appendix B to part 190, which contains two frameworks
setting forth rules concerning distribution of customer funds or
allocation of shortfall to customer claims in specific circumstances.
2. Overarching Concepts
a. Changes to Structure of Industry
The Commission is making several revisions to part 190 in order to
reflect the changes to the structure of the industry since part 190 was
originally published in 1983. In particular, FCMs and DCOs now operate
in a different world, where matters such as market moves, transactions,
and movements of funds tend to happen much more quickly, in part due to
the advances in technology and the global nature of underlying markets.
These changes include major structural changes in the financial
markets, including regulatory reforms following the 2008 financial
crisis and consequent changes to the structure of the derivatives
markets, changes in the governance of the market utilities, such as
DCOs, from non-profit organizations to public companies, and major
reforms in the banking sector, followed by the creation of large,
publicly held financial holding companies with different attitudes
towards risk.
As a result, several of the changes to part 190 will address these
changed circumstances. The Commission believes that the revisions in
proposed part 190 that address the computerized and fast-paced nature
of the industry will benefit all parties involved in a bankruptcy
proceeding, since the rules would reflect how the industry actually
works today and will avoid unnecessary delay to the administration of a
bankruptcy proceeding.
b. Trustee Discretion
In several places in revised part 190, the Commission provides
additional flexibility and discretion to the bankruptcy trustee in
taking certain actions.\221\ This principles-based approach is in
contrast to the customer notice procedures in current part 190, which
are more prescribed and depend on the type of notice being given.
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\221\ The alternative, to forego providing such flexibility or
discretion, would invert the benefits and costs discussed below.
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The Commission has concluded that, in general, affording more
discretion to the bankruptcy trustee in appropriate circumstances is
beneficial, and indeed necessary, where matters are unique and fast-
paced, as they often are in commodity broker bankruptcy proceedings. In
many areas, it is unlikely that a prescriptive approach can be designed
that will reliably be ``fit for purpose'' in all plausible future
circumstances.
Granting the trustee discretion is expected to decrease, though it
certainly does not eliminate, the number and extent of cases in which
the trustee will petition the bankruptcy court for formal approval of
an action. Each formal approval the trustee is required to obtain--
i.e., each time the trustee moves for an order from the bankruptcy
court authorizing the trustee to take a particular action in a
particular way--takes significant time and involves significant
administrative costs--in particular, the time of professionals such as
attorneys and financial experts to draft legal pleadings and analyses.
These professionals charge significant hourly fees, and thus their time
leads to significant administrative costs. As discussed further below,
administrative costs can be charged against customer property, leading
to reduced recoveries by public customers.
Therefore, increased discretion of the trustee will benefit the
estate by allowing the trustee to make principles-based decisions that
are uniquely tailored to the facts and circumstances of the particular
case, rather than compelling the trustee to follow a procrustean
framework, or requiring the trustee to request formal approval from the
bankruptcy court or the Commission before implementing those decisions.
This approach leads to approaches that are better tailored to the
specifics of the circumstances, reductions in administrative costs
(leaving more funds available for distribution to public customers and/
or other creditors) and faster distributions of customer property (to
the benefit of public customers). It is also intended to mitigate the
negative externalities arising from the distressed circumstances that
tend to result in further reduction in the value of customer
assets.\222\
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\222\ As discussed above, see section II.B.2, while the trustee
has discretion as to how they administer the affairs of the
bankruptcy estate, a DCO of which that FCM is a member retains its
rights to act under its rules.
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The Commission recognizes, however, that with increased discretion
comes a risk of trustee mistake or misfeasance; in other words, a
trustee making decisions that turn out not to be in the best interests
of public customers as a class, or other creditors.\223\ While this is
certainly a potential cost in situations where the trustee is given
increased discretion or flexibility, the Commission believes that this
potential cost will be mitigated by (1) the high degree of informal
(and, where necessary, formal) involvement of Commission staff in FCM
and DCO bankruptcy matters,\224\ and (2) the fact that such discretion
would not be unbounded and would apply only in particular
circumstances, as discussed below.
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\223\ Certain discretionary decisions a trustee may take, for
example, the frequency with which the trustee provides information.
\224\ As a formal matter, the Commission has the right to appear
and be heard on any issue in any such case. See 11 U.S.C. 762(b). As
a practical matter, trustees and their counsel have, in previous
commodity broker bankruptcies, consulted with Commission staff
frequently and on an ongoing basis, particularly in making and
implementing important decisions.
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Moreover, in response to a comment by ICI, and as discussed further
below, the Commission is adding a clarification in Sec. 190.00 that
where a provision in part 190 affords the trustee discretion, that
discretion should be exercised in a manner that the trustee determines
will best achieve the overarching goal of protecting public customers
as a class by enhancing recoveries for, and mitigating disruptions to,
public customers as a class. The Commission is of the view that adding
this principles-based provision will further clarify the duty of
trustees in commodity broker bankruptcy proceedings to act in a
[[Page 19389]]
manner that adds benefits, and reduces costs, to public customers as a
class by, respectively, enhancing their recoveries and mitigating
disruptions to them.
However, channeling the trustee's discretion towards protecting
public customers as a class may well work to the detriment of (and thus
impose costs upon) individual public customers, or classes of public
customers, whose interests differ from that of the class in general.
For example, certain customers may have a particular need for current
and precise information about their account balances and
positions.\225\ It is possible (though unlikely) that the trustee might
determine that it is inordinately costly to do so for a particular
time, looking at the interests of public customers as a class. Such a
decision would not be a mistake or malfeasance, though one would expect
the trustee to endeavor to avoid the necessity for doing so.
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\225\ See ICI at 22 (failure of trustee to provide account
statements or information about funded balances could ``hinder the
ability of a regulated fund to confirm the existence and value of
its transactions and associated margin.'')
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An additional risk related to increased discretion is the
possibility that parties that are dissatisfied with the trustee's
exercise of discretion may challenge it in court, potentially leading
to increased litigation costs. The Commission believes that this risk
is mitigated by (1) the fact that certain of these decisions would be
made in contexts where the trustee would be seeking an order of the
bankruptcy court approving the trustee's approach (and thus the
trustee's discretion would be subject to judicial review within a
proceeding in which interested parties already have an opportunity to
object) and (2) the likelihood that bankruptcy courts would respect the
Commission's rules granting the trustee discretion, rendering such
litigation less likely to succeed, and quicker to resolve. Litigation
that is less likely to succeed is less likely to be brought, and
litigation that is quicker to resolve is likely to cost less. Thus, by
granting the trustee discretion, the Commission mitigates the cost of
such litigation.
Instances where the revisions to proposed part 190 will afford more
flexibility or discretion to the bankruptcy trustee are discussed in
further detail where they appear in each provision below.
c. Cost Effectiveness and Promptness Versus Precision
In revising part 190, the Commission has endeavored to effect a
proper balance between cost effectiveness and promptness, on the one
hand, and precision, on the other hand. Current part 190 favors cost
effectiveness and promptness over precision in certain respects,
particularly with respect to the concept of pro rata treatment. As a
result of the policy choice made by Congress in section 766(h) of the
Bankruptcy Code, part 190 proceeds from the principle that it is more
important to be cost effective and prompt in the distribution of
customer property (i.e., in terms of being able to treat public
customers as part of a class) than it is to value each customer's
entitlements on an individual basis. The revisions to part 190 take
this concept further, recognizing that there are additional
circumstances where cost effectiveness and promptness in the
administration of a bankruptcy proceeding should have higher priority
than precision. However, in response to ICI's comment, the Commission
has clarified that where the trustee is directed to exercise
``reasonable efforts'' to meet a standard, those efforts should only be
less than ``best efforts'' to the extent that the trustee determines
that such an approach would support the goal of protecting public
customers by enhancing recoveries for, and mitigating disruptions to,
public customers as a class.\226\ Thus, the Commission recognizes that
there are limits to the extent to which cost effectiveness and
promptness will be favored over precision as discretion must be
exercised in furtherance of the overarching goal of protecting the
interests of public customers as a class.
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\226\ See comparison of best efforts to reasonable efforts in
section II.A.1 above.
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The Commission believes that these revisions favoring cost
effectiveness and promptness over precision further the policy embodied
in section 766(h) of the Bankruptcy Code and benefit parties involved
in a bankruptcy proceeding overall, in that they will in general lead
to: (1) A faster administration of the proceeding; (2) public customers
receiving their share of the debtor's customer property more quickly;
and (3) a decrease in administrative costs.
There could, however, be corresponding costs to this approach for
some public customers in that they may lose out on being treated
precisely in terms of their individual circumstances (and, for example,
may receive a smaller distribution of customer property than
otherwise).
d. Unique Nature of Bankruptcy Events
The Commission recognizes in revised part 190 that there is no one-
size-fits-all approach to the administration of the bankruptcy of an
FCM or a DCO, and that it is important that the rules allow the
trustee, in conducting that administration, to take into account the
unique nature of each of these events. The revisions to proposed part
190, therefore, address the uniqueness of these bankruptcy events and
allow for the bankruptcy trustee to tailor their approach in the way
that most makes sense given the individual circumstances of the case at
hand.\227\ History has shown that FCM bankruptcies play out in very
different ways, and several of the Commission's revisions to part 190
address that reality. These new provisions reflect the fact that each
FCM and DCO bankruptcy presents individual circumstances, and that the
proof of claim form will likely have to be modified to fit the unique
facts and circumstances of each case. The Commission believes that the
revisions of this type will benefit all parties involved in a
bankruptcy proceeding by better tailoring such a proceeding to the
unique needs of the particular case.
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\227\ Circumstances that may vary include: The accuracy of the
commodity broker's records at the time of bankruptcy; whether the
bulk of an FCM's customer accounts were transferred in the days
after the filing date (or otherwise migrated in the days before);
the number of customer accounts; the existence and extent of a
shortfall in customer funds; and the complexity of the positions
carried by the commodity broker.
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However, by providing for a bespoke tailoring of the approach to
commodity broker bankruptcy, the Commission inherently provides less
transparency, and thus less certainty, of the particulars of the
approach that will be followed.
e. Administrative Costs are Costs to the Estate, and Often to the
Customers
In many instances in this adopting release, the Commission is
noting that a certain provision will impose or reduce administrative
costs, that is, the actual and necessary costs of preserving the
bankruptcy estate and administering the case. In each of these cases,
administrative costs will be a cost to the estate of the debtor, since
administrative expenses that the bankruptcy trustee incurs in
administering the estate (including for the time of the trustee,
accountants, counsel, consultants, etc.) \228\ will be passed onto the
estate
[[Page 19390]]
itself. This means that, in the event of a shortfall, such costs will
ultimately be borne by the public customers of the debtor, who will
receive smaller dividends on their claims as the value of the debtor's
estate decreases.\229\ By a parity of reasoning, reducing such
administrative costs will reduce the shortfall, and increase recoveries
by public customers.
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\228\ Pursuant to section 503(b)(1) of the Code, administrative
costs include the actual, necessary costs and expenses of preserving
the estate; and pursuant to section 330(a)(1)(A) of the Code, the
Court may award ``reasonable compensation for actual, necessary
services rendered by the trustee . . . professional person, or
attorney . . . .'' Factors that are considered in determining
``reasonable compensation'' include the time spent on the services,
the rates charged, the customary compensation charged by comparably
skilled practitioners, and whether the services were necessary to
the administration of the case. See generally 11 U.S.C. 330(a)(3).
\229\ While such costs may in certain cases be borne instead by
general creditors, section 766(h) permits customer property to be
used to meet ``claims of a kind specified in section 507(a)(2)'' of
the Bankruptcy Code (which in turn include claims for the expenses
of administering the estate) ``that are attributable to the
administration of customer property.''
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To be sure, the actions taken to achieve these cost efficiencies
that enhance the value of the estate for public customers as a whole
may impose costs on individual public customers.
f. Preference for Public Customers Over Non-Public Customers and for
Both Over General Creditors
As noted repeatedly above, and consistent with the requirements of
section 766(h) of the Bankruptcy Code and longstanding Commission
policy, many provisions in part 190 favor public customers over non-
public customers, and both over general creditors, whenever there is a
shortfall in customer property in any account class for public
customers (or, with reference to general creditors, for non-public
customers).
The preference for public customers benefits them, and provides
them with incentives to participate in transactions protected by part
190, and to post collateral willingly. However, this preference
correspondingly disfavors non-public customers. Accordingly, it
arguably provides them with incentives to participate less in
transactions protected by part 190--or, perhaps, to clear through
unaffiliated FCMs (and thus, to do so as public customers of those
FCMs).
Similarly, the preference for both public and non-public customers
over general creditors may incentivize general creditors to be less
willing to extend credit to commodity brokers. However, in light of the
fact that commodity brokers are highly regulated entities subject to
stringent capital or resource requirements, this incentive effect with
respect to general creditors is not likely to be strong.
B. Subpart A--General Provisions
1. Regulation Sec. 190.00: Statutory Authority, Organization, Core
Concepts, Scope, and Construction: Consideration of Costs and Benefits
Section 190.00 contains general provisions applicable to all of
part 190. These provisions set forth the concepts that guide the
Commission's bankruptcy regulations. All of Sec. 190.00 is new, in
that current part 190 does not contain an analogous regulation.
However, only certain provisions within Sec. 190.00 have cost-benefit
implications, since the bulk of Sec. 190.00 is designed to explain
concepts that are either (1) not different from those contained in
current part 190, but are simply stated more explicitly in the revised
rules, or (2) new, in that they are not contained in current part 190,
but are concepts that are meant to clarify how revised substantive
provisions operate. In the latter case, cost and benefit considerations
are addressed with respect to the substantive provisions.
The Commission requested comment on all aspects of its cost and
benefit considerations with respect to proposed Sec. 190.00.
There are potential costs associated with Sec. 190.00(c)(4) which
promotes the transfer or porting of the open commodity contract
positions of a bankrupt FCM's public customers rather than the
liquidation of these positions. For example, OCC commented that while
liquidating customer positions may introduce market risk associated
with closing out and reopening positions for certain customers, those
risks should be weighed against the potential drawbacks of porting,
especially if an FCM to accept the transfer is not immediately
identified. Specifically, OCC identified three potential drawbacks with
the proposed Sec. 190.00(c)(4). First, that it could be difficult for
a trustee (or DCO) to identify a transferee to accept the open
positions and collateral, which depending on the market conditions
could be a difficult and time-consuming process. Second, a customer
could face uncertainty as to how its position and associated collateral
will be resolved until a transfer is complete and also may be unable to
exit a position in a timely and efficient manner. Third, a customer
might need to post additional collateral at a new FCM prior to or
immediately after a transfer.
In considering the costs and benefits of the preference for
transfer versus liquidation, the Commission notes first that, as OCC
forthrightly acknowledged, liquidating customer positions may introduce
market risk associated with closing out and reopening positions for
certain customers. Additionally, liquidating a mass of customer
positions may roil the markets, if any, where those positions are
concentrated.
Furthermore, Sec. 190.00(c)(4) establishes a preference for
transfer rather than a mandate. Thus, if after exerting their best
efforts, the trustee finds that the process of transfer is indeed too
``difficult and time-consuming,'' the trustee is not obligated to
implement a transfer. Moreover, as a practical matter, there are narrow
limits to how long a trustee will have to endeavor to transfer before
being compelled to liquidate positions by the DCO at which they are
held, or, if applicable, an FCM through which they are held. (Either
the DCO or the FCM, whichever is applicable, will have the discretion
to liquidate positions that are being cleared/carried for an FCM that
is in bankruptcy).\230\ Pursuant to Sec. 190.04(d), if the trustee is
not successful in transferring an open contract by the seventh calendar
day after the order for relief consistent with Sec. 190.04(a), the
trustee is directed to liquidate such contract promptly and in an
orderly manner. Thus, while a customer could face uncertainty as to how
its position and associated collateral will be resolved until a
transfer is complete (or until the customer's positions are otherwise
liquidated), the time of that uncertainty is both practically and
legally limited. Finally, a customer who does not wish to post
additional collateral at a new FCM would be entitled to have the new
FCM liquidate their positions, and promptly receive any remaining
transferred collateral. In this light, the Commission believes that the
benefits of continuing the preference for transfer remain significant,
while the costs of this preference are mitigated.
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\230\ For example, as noted above in section II.A.1, OCC's own
rules would appear to permit it to liquidate such positions.
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There are potential benefits arising from reduced uncertainty as a
result of clarifications provided in several provisions. For example,
Sec. 190.00(d)(1)(ii), clearly expresses that part 190 applies to a
proceeding commenced under SIPA with respect to a debtor that is
registered as a broker or dealer under the CEA when the debtor also is
an FCM. Similarly, Sec. 190.00(e) clarifies how transactions and
collateral that are portfolio margined are treated as an important
prerequisite to an effective portfolio margining program. Cboe's
comment letter expressed the view that the clarity provided in Sec.
190.00(d)(1)(ii) will be beneficial to the entire
[[Page 19391]]
ecosystem, including customers of FCMs and broker-dealers, as it
furthers the ability of market participants to utilize portfolio
margining and the associated efficiencies. CME also saw benefits to
``remov[ing] any doubt'' that part 190 applies to a SIPA proceeding
involving an FCM that is also registered with the SEC as a broker-
dealer.
Similarly, ICI's comment letter considered that the ``home field''
rule in Sec. 190.00(e) is highly beneficial.
With respect to the remaining provisions within proposed Sec.
190.00, the Commission has not received comment letters that identify
costs or benefits explicitly attributed to these provisions, and does
not believe that there are material cost-benefit implications with
respect to them:
Proposed Sec. 190.00(a), which sets forth the statutory
authority pursuant to which the Commission is proposing to adopt
proposed part 190.
Proposed Sec. 190.00(b), which describes how the proposed
rules are organized into three subparts. While the addition of DCO-
specific rules in this proposal is new, the cost-benefit implications
of the DCO-specific provisions (Sec. Sec. 190.11 through 190.18) are
discussed separately below.
Section 190.00(c)(2), which provides that part 190
establishes four separate account classes, each of which is treated
differently under the regulations. In the Commission's view, this
provision is a mere clarification, as current part 190 also establishes
different account classes for different types of cleared commodity
contracts, and treats each account class differently.
Section 190.00(c)(5), which explains that part 190 applies
the concept of pro rata distribution when it comes to shortfalls of
property in a particular account class. This provision is merely
explanatory.
Section 190.00(d)(1)(i)(A), which provides that the
definition of ``commodity broker'' in proposed part 190 covers both
``futures commission merchants'' and ``foreign futures commission
merchants'' because both are required to register as FCMs under the CEA
and Commission regulations.
Section 190.00(d)(2)(i), which states that the bankruptcy
trustee may not recognize any account class that is not one of the
account classes enumerated in proposed Sec. 190.01.
Section 190.00(d)(3), which sets forth the transactions
that are excluded from the definition of ``commodity contract.'' This
provision explains and carries over concepts that are already embedded
in current part 190.
While the Commission has not received comment letters that identify
costs or benefits explicitly attributed to the following provisions in
Sec. 190.00, it believes that there will be cost-benefit implications
to these provisions:
Section 190.00(c)(1) states that part 190 is limited to a
commodity broker that is (1) an FCM as defined by the CEA and
Commission regulations, or (2) a DCO under the CEA and Commission
regulations. Current part 190 applies to a broader set of ``commodity
brokers,'' including FCMs, clearing organizations, commodity options
dealers, and leverage transaction merchants. This narrowing of the
application of part 190 (by excluding the empty categories of commodity
options dealers and leverage transaction merchants) benefits the
bankruptcy estate, and the customers, by allowing the Commission to
promulgate regulations that are less complex and better tailored to the
narrower, set of commodity brokers that are covered by the revised
regulations.\231\
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\231\ Moreover, prescribing regulations that are intended to be
applicable to entities that, at some unknown point in the future,
enter these empty categories risks poor tailoring due to lack of
data concerning the characteristics of those unknown future
entrants.
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Section 190.00(c)(3) explains the distinction between
``public customers'' and ``non-public customers,'' and the priority
that public customers (and, after them, non-public customers) enjoy
over all other claimants with respect to distributions of customer
property. Both of these concepts exist in current part 190 and are
clarified and explained further in Sec. 190.00(c)(3). In its comment,
ICI urged the Commission to take steps ``to help ensure that the
trustee prioritizes the protection of [public] customers.'' In
response, Commission has added a provision, Sec. 190.00(c)(3)(i)(C),
directing the trustee to exercise its discretion (where it has such
discretion) in a manner that will best achieve the overarching goal of
protecting public customers by enhancing recoveries for, and mitigating
disruptions to, public customers as a class.\232\ This approach has the
benefit of guiding the trustee's discretion in a manner consistent with
the Commission's regulatory and statutory goals. However, it has the
limitation of still leaving the trustee with discretion. As noted above
in section III.A.2 above, with discretion comes a risk of trustee
mistake or misfeasance.
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\232\ As noted above in section III.A.2.vi, the preference for
public customers over non-public customers creates incentives for
both groups.
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Section 190.00(c)(6) addresses the treatment of commodity
contracts that require delivery performance. The revised regulations,
in allowing the trustee more flexibility in how a customer could effect
delivery outside of the debtor's estate, will benefit customers by
allowing for a more bespoke approach to effecting delivery when
customers incur delivery obligations under their open commodity
contracts. There will, however, be costs in acting in such a bespoke
fashion in contrast to following standards established during business
as usual.
Section 190.00(d)(1)(i)(B) notes that while there are
currently no registered leverage transaction merchants or commodity
options dealers, the Commission intends to adopt rules with respect to
leverage transaction merchants or commodity options dealers at such
time as an entity registers as one of those categories of commodity
brokers. This forward-looking flexibility will generate benefits by
fostering bankruptcy rules specifically tailored to leverage
transaction merchants or commodity options dealers when and if an
entity registers as such.
Section 190.00(d)(1)(iii), provides that part 190 shall
serve as guidance as to the distribution of customer property and
member property in a proceeding in which the FDIC is acting as receiver
pursuant to Title II of Dodd-Frank.\233\ This provision has the
benefits associated with transparently providing to FDIC during
business-as-usual the expertise and guidance of the agency with
regulatory and supervisory responsibility for commodity brokers (i.e.,
FCMs and DCOs).\234\
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\233\ Section 210(m)(1)(B) of title II,12 U.S.C. 5390(m)(1)(B),
requires the FDIC, where the covered financial company or bridge
financial company is a commodity broker, to apply the provisions of
subchapter IV as if the financial company were a debtor for purposes
of such subchapter.
\234\ DCOs operate nearly 24-hours a day, between Sunday
afternoon and Friday evening. Moreover, the risks that a DCO is
required to manage are based on market movements and events
(including in OTC markets) that may occur whether or not the DCO is
able to operate. Accordingly, Commission staff (in cooperation with
FDIC staff) have engaged, and will continue to engage, in
significant efforts to plan for the unlikely event that resolution
under Title II would be necessary for a DCO.
Thus, there is a public benefit to facilitating FDIC's efforts
in resolution planning for DCOs by setting forth clear guidance as
to the distribution of customer property and member property in a
DCO resolution proceeding.
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Section 190.00(d)(2)(ii) provides that no property that
would otherwise be included in customer property shall be excluded from
customer property because it is considered to be held in a
constructive, resulting, or other trust that is implied in equity. It
prevents public customers from evading pro rata exposure to shortfalls
in customer property by keeping their collateral in a trust structure.
This provision has the
[[Page 19392]]
benefit of supporting the statutory policy of pro rata distribution for
the pool of customers, by ensuring that all property that properly
belongs in the category of ``customer property'' would be considered
such customer property. It should mitigate costs in cases where
particular customers might structure their relationships with their
FCMs in order to establish such a trust for the purpose of thwarting
their exposure to pro rata distribution, rather than structuring those
relationships in ways that otherwise make sense for their business. It
would also reduce those customers' incentives to do so, and would
mitigate the costs of litigation within the bankruptcy proceeding over
the effectiveness of such structures in achieving that goal. It also
benefits the remaining customers, since if such litigation were
successful, it would spread the pro rata shortfall over a smaller
volume of customer claims.
However, this approach will impose costs on those
customers, if any there be, who would otherwise endeavor to rely on the
trust concept to shield certain of their property from entering the
pool of customer property. Such customers might (despite opposition
from the Commission and the trustee) otherwise be successful in
litigation over the effectiveness of such arrangements, or may obtain
settlements that would benefit their individual claims (albeit to the
detriment of other customers, and to the policy of pro rata
distribution). Such customers may view the inability to protect their
collateral under a trust concept as an incentive to reduce their use of
transactions subject to part 190.
2. Regulation Sec. 190.01: Definitions: Consideration of Costs and
Benefits
Section 190.01 sets forth definitions as they are used for purposes
of part 190. In the Commission's view, only certain of the definitions
in proposed Sec. 190.01 will have cost-benefit implications, and these
are discussed in more detail below, as are any definitions concerning
which there were comments. The remainder of the definitions set forth
in revised Sec. 190.01 do not, in the Commission's view, impose any
costs or benefits, as the changes to the definitions are minor (in the
vein of, for example, updating cross-references or updating language to
reflect the changes in the rest of revised part 190) or merely clarify
the current definition.
Where, in the Commission's view, a definition in revised Sec.
190.01 has cost-benefit implications, and/or where comments have
identified costs or benefits concerning such a definition, those
implications are discussed in more detail below:
``Account class,'' ``cash delivery property,'' and
``physical delivery property'': The definition of the term ``account
class'' is expanded to include definitions of each type of account
class set forth in proposed part 190: Futures account, foreign futures
account, cleared swaps account, and delivery account. The ABA
Subcommittee recommended that the Commission clarify that these types
of account classes apply to non-public customers in addition to public
customers. The Commission agrees that it is appropriate to clarify this
point, and to include a specific definition for each type of account
class. Doing so will benefit all parties involved in a bankruptcy
proceeding by ensuring that all have a common understanding of how
these various types of accounts are defined for purposes of part 190.
Accordingly, the Commission is adopting the ABA Subcommittee's
recommendation.
The definition of ``account class'' also removes the
category in current part 190 of ``leverage account'' because, as noted
above, there are currently no registered leverage transaction
merchants. Rather, the Commission intends to adopt rules with respect
to leverage transaction merchants (and, accordingly, with respect to
leverage accounts) at such time as an entity registers as such. Removal
of the category of ``leverage account'' from the ``account class''
definition benefits market participants by allowing the Commission to
promulgate bankruptcy rules specifically tailored to leverage
transaction merchants (and, accordingly, to leverage accounts) in the
event an entity registers as such.
The definition of ``account class'' also splits ``delivery
accounts'' into separate physical and cash delivery account classes.
Because cash delivery property is, in some cases, more difficult to
trace to specific customers and more vulnerable to loss,\235\ this
separate treatment of physical delivery property and cash delivery
property should benefit customers with physical delivery property by
allowing for more prompt distribution of such physical delivery
property. This separation should also benefit the estate, because the
trustee will not have to wait to distribute physical delivery property
to customers while attempting to trace cash delivery property, which
could result in a more prompt resolution of the bankruptcy as a whole.
However, there may be costs as a result of complications, since the
trustee will have to deal with two delivery account subclasses rather
than one delivery account class. Moreover, in the event of a shortfall,
some customers could ultimately obtain larger recoveries than they
would have if the delivery account had not been split into two
subclasses, while others could obtain smaller recoveries.
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\235\ These reasons for this difficulty and vulnerability are
discussed above in section II.B.4 in the explanation of the changes
to proposed Sec. 190.06(b).
---------------------------------------------------------------------------
The ABA Subcommittee and CME suggested changes to the definition of
``cash delivery property.'' Under the current definition, cash falls
within the delivery class if, inter alia, it is received on or after
three calendar days before the first notice date or exercise date. The
definition of cash delivery property in the Proposal continued that
limitation. CME suggested that the three-day limitation should be
removed to address cases where
``a customer will legitimately post cash to its delivery account
sooner than the definition would allow, for example, out of caution
to assure that the necessary funds are available to pay for a
delivery when the first notice date or exercise date immediately
follows a weekend or holiday, or to meet payment deadlines imposed
by the FCM, or based on market convention.''
The comments acknowledged that the Commission's policy objective is
to ``encourage FCMs and their delivery customers to hold cash intended
to pay for delivery in a segregated account until bilateral delivery
obligations are near at hand'' (the segregation obligations that apply
to futures, foreign futures, and cleared swaps accounts do not apply to
delivery accounts), but express some doubt that the limitation is
effective in encouraging the desired behavior, because parties with
delivery obligations may not be aware of it.
Thus, the benefit of retaining the three-calendar day limitation is
mitigating the time during which cash delivery property is held in an
account that is not subject to the protection of segregation
requirements, and in encouraging business models that take that
approach. The cost of doing so is the risk that funds may nonetheless
be transferred earlier into a delivery account, and would then be
denied protection as delivery property in an FCM bankruptcy.\236\
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\236\ The Commission also notes CME's suggestion that it
``consider adopting more formal requirements with respect to
delivery accounts through separate rulemaking.''
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As discussed above,\237\ the Commission has determined to take a
middle-ground approach by expanding the three-calendar day limitation
to a
[[Page 19393]]
seven-calendar day limitation. This approach has the benefit of
addressing fully the possibility that delivery property is transferred
slightly early because of, e.g., a holiday weekend (and especially
cases where FCMs and their customers or contracts span across
jurisdictions with different holidays). By expanding the period by four
days, it should address most of the cases where there are legitimate
reasons to transfer the funds in advance of when they are needed, to
account for the possibility of a failure in the transfer process.\238\
Significantly, it avoids the cost of encouraging the use of the
delivery account (that is not subject to segregation requirements) as a
long-term place to hold cash.
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\237\ See section II.A.2 above.
\238\ The commenters have not identified any legitimate reason
for an FCM to impose a payment deadline of more than seven days
before first notice or exercise date, or any relevant market
convention that would require earlier payment, which in either case
would require that the funds be held in a delivery account.
---------------------------------------------------------------------------
Commenters also suggested technical additions to the definitions of
cash delivery property (to address cash provided post-petition to
facilitate taking deliveries in cases where necessary) to physical
delivery property (to address the possibility of a negative final
settlement price), and (in the case of both cash delivery property and
physical delivery property) to provide that, for contracts exchanging
one fiat currency for another, both ends of the transaction would be
considered cash delivery property. The Commission incorporated these
suggestions in the definitions as adopted. The benefit of these
approaches is to deal properly with these scenarios; there are no
discernable material costs.
Pursuant to section 4d of the CEA, certain contracts and
associated collateral that would be associated with one account class
may instead (pursuant to Commission regulation \239\ or order) be
commingled with a different account class.\240\ The purpose of these
arrangements, referred to as portfolio-margining, is to associate such
contracts with an account class in which they are risk-reducing related
to other contracts in that latter account class.
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\239\ See Sec. 39.15(b)(2), which provides a mechanism for
these arrangements to be implemented pursuant to clearing
organization rules.
\240\ Securities positions may also be commingled in an account
class subject to section 4d of the CEA. 7 U.S.C. 6d.
---------------------------------------------------------------------------
Paragraph (2) of the definition of account class confirms that
these portfolio-margining arrangements will be respected in bankruptcy,
that is, such contracts and associated collateral will be treated as
being part of the account class into which they are commingled. The
benefit of this treatment in bankruptcy is to foster and incentivize
such risk-reducing (and capital-efficient) arrangements during business
as usual; there should be no associated costs in bankruptcy.
Finally, paragraph (3) of the definition of account class addresses
cases where a commodity broker's account for a customer is non-current,
or otherwise inaccurate. These are situations over which public
customers have, at best, limited control, and thus it is ineffective to
endeavor to create incentives for public customers to police the
behavior of their FCM. Paragraph (3) confirms that a commodity broker
is considered to maintain an account for a customer where it
establishes internal books and records for the customer's contracts and
collateral and related activity, regardless of whether the commodity
broker has kept those internal books or records current or accurate.
The benefit of this treatment will be to treat customers in accordance
with their entitlements, regardless of whether the commodity broker has
maintained its books and records current or accurate.
``Customer,'' ``Customer class,'' ``public customer,'' and
``non-public customer:'' The definitions of the terms ``public
customer'' and ``non-public customer'' are being revised to include
separate definitions of those terms for FCMs and DCOs. This change
reflects the new organization of part 190, which includes separate
provisions for when the debtor is (1) an FCM (subpart B) and (2) a DCO
(subpart C). The ``public customer'' definition for FCMs is also being
revised to define that term with respect to each of the relevant
account classes.\241\
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\241\ CME suggested that the Commission should include non-U.S.
customers of foreign broker clearing members of a DCO within the
public customer definition. As discussed above, the Commission has
determined to consider this suggestion as part of a comprehensive
review of the issues, to be conducted at such time as the model of
admitting foreign brokers as clearing members for U.S. DCOs becomes
empirical.
---------------------------------------------------------------------------
These changes will generate benefits as they bring clarity to the
question of who qualifies as a ``public'' versus a ``non-public''
customer, and transparency to the distribution of property to which
each customer is entitled. Furthermore, this clarity and transparency
is likely to reduce the administrative costs to the estate, and the
costs to claimants, associated with the claims allowance process, as
well as the likelihood of litigation by dissatisfied claimants (and
associated costs). These changes could, however, impose costs on
customers for whom, under current part 190, it will not be clear which
category they fall into. The pool of customer property would be
different for public and non-public customers under the new policy
regime. Thus, a hypothetical customer who could have been considered
``public'' under current part 190 but will be categorized as ``non-
public'' under revised part 190 could receive less in the distribution
of customer property (with other customers receiving more).
``Futures, futures contract:'' The Commission is adding a
definition for the terms ``futures'' and ``futures contract'' to
clarify what those terms mean for purposes of part 190. This
clarification will lower administrative costs by providing clarity and
transparency to the types of transactions that are considered
``futures'' for purposes of proposed part 190 and therefore form part
of the futures account or foreign futures account.
``House account:'' The definition of the term ``house
account'' will be revised to include a definition of that term solely
for DCOs. This change will reflect the new organization of part 190,
which is revised to include separate provisions for when the debtor is
(1) an FCM (subpart B) or (2) a DCO (subpart C). CME and the ABA
Subcommittee urged that the term ``house account'' be deleted in the
few cases where it was proposed to be used in subpart B in order to
avoid the implication that the accounts of non-public customers could
not be ported. This change would enhance clarity and transparency (and,
thus, would reduce administrative costs) by (1) avoiding that incorrect
implication, while (2) clarifying what precisely constitutes a house
account for a DCO bankruptcy proceeding.
``Primary liquidation date:'' The definition of the term
``primary liquidation date'' is being revised to delete references to
holding accounts open for later transfer. This is consistent with the
policy of transferring as many open commodity contracts as possible
within seven calendar days after entry of an order for relief or, if
that is not possible, liquidating such commodity contracts. \242\ This
change in policy should benefit some customers, who will more quickly
have clarity as to how their positions and associated collaterals will
be resolved.\243\ There may, however, be costs to customers who might
have preferred having their open commodity contracts held open for
transfer after the primary liquidation
[[Page 19394]]
date. \244\ In the event that a larger number of contracts is
liquidated rather than transferred, there will be costs resulting from
additional downward pressure on prices.
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\242\ See Sec. 190.04(a)(1).
\243\ See discussion of Sec. 190.00(c)(4) in section II.B.1
above for concerns about customers lacking such clarity for an
extended time.
\244\ Given that the clearing organization for such contracts
may not be willing to permit such contracts to be held open for an
extended period of time, the existence of such customers is quite
hypothetical.
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``Specifically identifiable property:'' The Commission is
revising the definition of the term ``specifically identifiable
property'' to clarify and streamline the current definition of that
term. The use of definitions that are clearer should reduce
administrative costs. Of course, increasing clarity may be to the
detriment of those customers for whom such clarity results in
assignment to a category that they view as less favorable.
``Substitute customer property:'' The definition of the
term ``substitute customer property'' is being added to refer to cash
or cash equivalents delivered to the trustee by or on behalf of a
customer in order to redeem specifically identifiable property or a
letter of credit. This provision will benefit customers who, in a
bankruptcy event, seek to redeem their specifically identifiable
property or letters of credit.\245\ Introducing the concept of
substitute customer property may impose administrative costs, however,
because the trustee may have to expend time and resources on tracking
the substitute customer property and ensuring that such property ends
up in the proper pool of customer property once received.
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\245\ Benefits and costs associated with the use of substitute
customer property are addressed further below in connection with
Sec. 190.04(d)(3) in section III.C.2.
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``Swap:'' The Commission is amending the definition of
``cleared swap'' that appears in the current rules in order to clarify
what this term means for purposes of proposed part 190. This
clarification should serve the goals of clarity and transparency (and,
consequently, reducing administrative costs).
3. Regulation Sec. 190.02: General: Consideration of Costs and
Benefits
Section 190.02(a)(1) is revised to provide that the bankruptcy
trustee may, for good cause shown, request from the Commission an
exemption from the requirements of any procedural provision in proposed
part 190. This is in contrast to current Sec. 190.10(b)(1), which
provides only that a bankruptcy trustee may request an exemption from,
or extension of, any time limit prescribed in current part 190. This
expanded mechanism for a trustee to request exemptions should benefit
the estate and customers by allowing the trustee to request an
exemption that lowers administrative costs and increases timeliness.
This change, however, may impose administrative costs if the trustee's
request is ill-founded and the Commission were nonetheless to grant the
request.
The Commission does not believe that there will be any cost-benefit
implications to Sec. 190.02(a)(2) and (3), (b), (c), (d), and (e), as
those provisions largely align with the provisions in current part 190
from which they are derived.
Regulation Sec. 190.02(f) is a new provision which addresses the
context of a receiver for an FCM appointed due to a violation or
imminent violation of the customer property protection requirements of
section 4d of the CEA or of the regulations thereunder, or of the FCM's
minimum capital requirements in Sec. 1.17. In this context, the FCM
has been found to be in precarious financial condition. This provision
will permit the receiver to file a petition for bankruptcy of such an
FCM in appropriate cases. This provision may benefit public customers,
in that a bankruptcy proceeding may be necessary to protect those
customers' interests in customer property from losses in value.
However, this provision may have distributional effects as there may be
some customers who do not receive as much in bankruptcy as they
otherwise would have under the receivership. In addition, there could
be additional administrative costs that result from this provision, as
the bankruptcy trustee would have to spend time and resources
overseeing a bankruptcy proceeding that might not be entered into
absent the power granted to the receiver under this regulation. These
costs could possibly be greater than the costs of continuing to
administer the FCM under receivership.
Indeed, FIA suggested that the Commission should require that the
receiver must receive permission from the Commission before filing a
voluntary petition, given that this action ``would effectively close
the FCM.'' Closing the FCM would impose significant costs on the FCM
and, in a case where the Commission would have denied permission, those
costs could be unnecessary.
In considering the costs (discussed above) of what could be an
unnecessary voluntary filing for bankruptcy in contrast to the benefits
of avoiding delay in filing a necessary filing for bankruptcy, the
Commission determines that the context where this rule would be
applicable--only cases where a receiver has been appointed due to
violation or imminent violation of customer property protection
requirements, or of the FCM's minimum capital requirements--minimizes
the likelihood that a filing would turn out to be unnecessary, and
counsels in favor of avoiding delay.
4. Section 15(a) Factors--Subpart A
No comments were received on the application of the section 15(a)
factors to subpart A.
i. Protection of Market Participants and the Public
Subpart A of the proposed rules should increase the protection of
market participants and the public by clearly setting forth how
customers of FCMs and DCOs will be classified and treated, and how
their accounts will be categorized and treated, in the event of an FCM
or DCO insolvency. The goal of subpart A of the proposed rules is to
promote an orderly and cost-effective resolution of the insolvency of
an FCM or DCO, and to increase transparency to the customers of FCMs
and DCOs as to how their property would be treated in the event of such
an insolvency. However, as noted above, some of the provisions of
subpart A provide discretion to the trustee. While enhanced discretion
for the trustee has the benefit of permitting a more tailored approach,
it also has the cost of increasing the possibility of trustee mistake
or misfeasance.
ii. Efficiency, Competitiveness, and Financial Integrity
Subpart A of the proposed rules should promote efficiency (in the
sense of both cost effectiveness and timeliness) in the administration
of insolvency proceedings of FCMs and DCOs and the financial integrity
of derivatives transactions carried by FCMs and/or cleared by DCOs by
clearly communicating the goals and core concepts involved in such
insolvencies, and by setting forth clear definitions that have been
updated to account for current market practices. These effects should,
in turn, enhance the competitiveness and financial integrity of U.S.
FCMs and DCOs, by enhancing market confidence in the protection of
public customer funds and positions entrusted to U.S. FCMs and DCOs,
even if such an entity were to become insolvent.
iii. Price Discovery
Price discovery is the process of determining the price level for
an asset
[[Page 19395]]
through the interaction of buyers and sellers and based on supply and
demand conditions. To the extent that the revised regulations should
mitigate the need for liquidations in conditions of distress, they will
help avoid negative impacts on price discovery.
iv. Sound Risk Management Practices
Subpart A of the proposed rules should generally promote sound risk
management practices by setting forth the core concepts to which the
bankruptcy trustee must adhere in administering an FCM or DCO
bankruptcy.
v. Other Public Interest Considerations
Some of the FCMs or DCOs that might enter bankruptcy are very large
financial institutions, and some are (or are part of larger groups that
are) considered to be systematically important. A bankruptcy process
that effectively facilitates the proceedings is likely to help to
attenuate the detrimental effects of the bankruptcy on the financial
marketplace and thus benefit the financial system and thus the public
interest.
C. Subpart B--Futures Commission Merchant as Debtor
1. Regulation Sec. 190.03: Notices and Proofs of Claims: Consideration
of Costs and Benefits
Section 190.03(a)(1) replaces the requirement in current Sec.
190.10(a) that all mandatory or discretionary notices be sent to the
Commission via overnight mail with the requirement of sending the
notices by electronic mail.\246\ This change is expected to result in a
benefit to all parties required to provide notices to the Commission
because they will be able to avoid the costs of sending such notice in
hardcopy form via overnight mail. These revisions will also allow the
Commission to receive such notices--and thus, to act--much more
expeditiously.
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\246\ See also Sec. 190.03(d), which is adopting this new
method of providing notice to the Commission for any court filings
filed in a bankruptcy.
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Section 190.03(a)(2) is a new, principles-based provision that
replaces the more specific procedures for providing notice to customers
that appear in current Sec. 190.02(b) by allowing the trustee to
establish and follow procedures ``reasonably designed'' for giving
adequate notice to customers. Paragraph (a)(2) also provides that the
trustee's procedures for providing notice to customers should include
``the use of a prominent website as well as communication to customers'
electronic addresses that are available in the debtor's books and
records.'' A generalized and more modernized approach to notifying
customers will benefit the debtor's estate, as the process allows the
trustee to choose cost effective means of providing notice to customers
within the more flexible bounds of the proposed regulation, resulting
in savings of administrative costs. Similarly, it will benefit parties
interested in the proceedings, by permitting the trustee flexibly to
choose methods of notification that are more prompt and effective. On
the other hand, affording the trustee increased discretion in how to
provide notice to customers will carry the potential cost of trustee
misfeasance and abuse of such discretion, as discussed above in section
III.A.2.ii.
Section 190.03(b)(1) will revise the time in which a commodity
broker must notify the Commission of a bankruptcy filing. These
revisions codify procedures whereby (1) in a voluntary bankruptcy
proceeding, the commodity broker will provide advance notice to the
Commission ahead of the filing to the extent practicable, and (2) in an
involuntary bankruptcy proceeding, the commodity broker will notify the
Commission immediately upon the filing. These revisions will foster the
ability of the Commission and its staff to perform their duties to
protect customers by providing the Commission with notice of any
bankruptcy proceeding as soon as possible.
Section 190.03(b)(2) removes the current deadline of three days
after the order for relief by which the trustee, the relevant DSRO or a
clearing organization must notify the Commission of an intent to
transfer or to apply to transfer open commodity contracts in accordance
with section 764(b) of the Bankruptcy Code. It instead instructs such
parties to give such notice of an intent to transfer ``[a]s soon as
possible.'' To the extent that the three-day deadline was limiting
transfer arrangements, this revision will benefit the estate and some
customers by removing time constraints that could be construed to
prohibit notification after expiration of the deadline (and thus, allow
the trustee to form the intent to transfer after such time).
The revision will also enhance the orderly functioning of the
marketplace at a time of severe market disruption by facilitating
prompt notice of intent to transfer. On the other hand, by giving the
trustee, DSRO, or clearing organization more latitude for providing
notice of an intent to transfer, there will be the potential cost of
misfeasance in waiting an unreasonable amount of time to provide such
notice (or to form such intent), which could ultimately impose
additional costs on customers who would have benefited from an earlier
transfer.\247\
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\247\ See discussion of Sec. 190.00(c)(4) in section III.b.1
above.
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Section 190.03(c)(1) removes the requirement that the trustee must
publish notice to customers with specifically identifiable property in
a newspaper of general circulation serving the location of each branch
office of the debtor prior to liquidating such property and instead
establishes a requirement to notify the customers with specifically
identifiable property in accordance with Sec. 190.03(a)(2). The
Commission believes that this change will result in lower
administrative costs, as the trustee will be relieved of the cost of
identifying, and publishing notice in, such newspapers. Moreover, the
trustee will no longer be required to wait seven days after the second
publication date to commence liquidation of specifically identifiable
property. Rather, the trustee will be free to commence liquidation of
specifically identifiable property starting on the seventh day after
entry of the order for relief. This will benefit the estate, and
potentially the affected customers, by allowing the trustee more
freedom (from the time constraints set forth in the current
regulations) in liquidating the specifically identifiable property,
which, in turn, is expected ultimately to result in a better price.
Moreover, the provisions in Sec. 190.03(a)(2) that describe the
notification of customers with specifically identifiable property will
benefit public customers by allowing them to receive notice on a
``prominent website'' and, more specifically, at their electronic
addresses (to the extent such addresses are in the debtor's books and
records), thereby enhancing their ability to request the return of
their specifically identifiable property within the specified
timeframe.
Section 190.03(c)(2) provides the bankruptcy trustee with authority
to treat open commodity contracts of public customers held in hedging
accounts designated as such in the debtor's records as specifically
identifiable property.\248\ This is a change from the current
framework, under which the trustee treats customers with specifically
identifiable property on a bespoke basis. Specifically, to the extent
the trustee does not receive transfer instructions regarding a
customer's specifically identifiable open commodity contracts, the
trustee will be required to liquidate
[[Page 19396]]
such contracts within a certain time period. To the extent the trustee
exercises the authority derived from revised Sec. 190.03(c)(2), they
will (subject to the revision discussed in the next paragraph) be
required to notify each relevant customer and request instructions
whether to transfer or liquidate the open commodity contracts. To the
extent the trustee would not exercise such authority, the trustee will
treat these open commodity contracts the same as other customer
property and effect a transfer of such contracts. This new framework
should reduce administrative costs and benefit the bankruptcy estate by
allowing the trustee to rely on hedging designations made during
business as usual, thereby allowing the trustee to make swift and cost
effective decisions regarding the treatment of open commodity contracts
during a bankruptcy situation.
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\248\ See proposed Sec. 190.10(b)(2) for the process of
designating an account as a ``hedging account.''
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ACLI suggested that Sec. 190.03(c)(2) should express a preference
for transfer over liquidation with respect to specifically identifiable
property in the form of positions that are identified as hedging
positions, and consult (on an individual basis) each customer's
expressed preferences. However, Sec. 190.00(c)(4) sets forth a
preference for porting (transfer) of all open commodity contract
positions of public customers. Thus, while treating customers with
hedging positions on a bespoke basis may benefit some of them, it may
be at the cost of effectively transferring a larger group of customer
positions. Some of those may be customers with hedging positions whose
positions are not transferred due to limited time and resources
available to be devoted to bespoke treatment. Indeed, SIFMA AMG/MFA
noted that ``permitting the trustee this flexibility (subject to the
additional customer protections [of consulting existing instructions,
as described immediately below]) serves the interest of customers as a
whole by facilitating a more rapid transfer of customer positions and
property.''
SIFMA AMG/MFA suggested that it would ``further the goal of
expediency'' if the regulation would require the trustee to ``first
consult the instructions (regarding preferences with respect to
transfer or liquidation of open commodity contracts) provided by a
public customer to the debtor at the time of opening the relevant
hedging account, and only if such instructions are missing or unclear,
to then require such customer to provide the trustee with written
instructions as contemplated by proposed Sec. 190.03(c)(2).'' The
Commission agrees, and has made corresponding changes to the
regulation. While there is a cost involved in scanning to determine if
there are instructions, there is a significant benefit in avoiding
duplication, and in avoiding cases where the customer, having already
provided instructions, does not reply to a duplicative request in time
for that reply to be acted upon.
The Commission does not believe that there are any cost-benefit
implications to Sec. 190.03(c)(3) or (4) (other than those discussed
above with respect to the new notice provision referenced in each) or
to Sec. 190.03(d).
Section 190.03(e), sets forth the information required from
customers regarding their claims against the debtor. As revised, Sec.
190.03(e), reorganizes and adds certain information items to those
listed in the current regulation. The Commission anticipates that,
while customers are likely to have this information at their disposal,
there could be costs associated with gathering it all in one place.
However, this additional and more detailed information should benefit
the estate, the bankruptcy court and customers alike by allowing all
parties to have a fuller, more detailed and more transparent picture of
the customer claims against the debtor. It should foster the reduction
of administrative costs and the prompt administration of the estate.
Moreover, the Commission is of the view that clarifying several of the
information items listed in proposed Sec. 190.03(e) and revising the
proof of claim form to match more closely the text of the regulation
should result in benefits to all parties involved in an FCM
bankruptcy--the estate, the bankruptcy court, and the customers--by
making the bankruptcy claims process more prompt and cost effective.
CME sees Sec. 190.03(e) and (f), and the revised proof of claim form,
as ``major improvements over the current rules and proof of claim
template.''
This regulation also provides that the specific items referred to
are to be included ``in the discretion of the trustee.'' This
discretion will permit the trustee to tailor the information requested
to the specifics of the debtor's prior business, as well as the
already-available records. This will permit the trustee to limit or to
increase the information requested, in appropriate cases, with a
corresponding increase in cost effectiveness. To be sure, there may be
corresponding costs (both in administrative expense and time) if the
set of information requested by the trustee in the exercise of their
discretion turns out, in retrospect, to be overly narrow (or broad).
Proposed Sec. 190.03(f) is new and provides the trustee with
flexibility to modify the customer proof of claim form set forth in
appendix A to part 190. Specifically, Sec. 190.03(f) allows the
trustee to modify the proof of claim form to take into account the
particular facts and circumstances of the case. This provision should
benefit the estate because the trustee will be able to modify the proof
of claim form in a way that gathers the information necessary in a
manner that is both effective and cost effective based on the specific
facts of the case, and the trustee no longer will be required to get an
order from the bankruptcy court to make such modifications, thereby
saving time and resources. This new provision should also benefit
customers, who will be able to take advantage of the more streamlined
and tailored proof of claim forms developed by the trustee, and should,
therefore, spend less time filling out such forms. It should also
benefit the estate, which should bear less administrative cost in
evaluating such forms. Again, there may be corresponding administrative
costs if the set of information in a modified proof of claim form turns
out, in retrospect, to be overly narrow (or broad).
2. Regulation Sec. 190.04: Operation of the Debtor's Estate--Customer
Property: Consideration of Costs and Benefits
Regulation Sec. 190.04(a) explicitly provides a policy and a
direction by which the trustee should use best efforts to transfer open
commodity contracts and property held by the failed FCM for or on
behalf of its public customers. This policy and direction is
substantially similar to the policy and direction under current
regulations.\249\ The changes set forth a clear policy for trustees to
follow, which should benefit customers of the failed FCM in a
streamlined description of the transfer process that is consistent with
the core concepts set forth in this part. The costs and benefits of the
preference for transfer are discussed in section III.B.1 above, in the
context of Sec. 190.00(c)(4).
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\249\ See current Sec. 190.02(e).
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In Sec. 190.04(a)(1), the Commission is clarifying language; these
clarifications should benefit customers of the failed FCM by minimizing
the likelihood of future disputes concerning qualification of property
for transfer. The Commission is also changing the direction in current
Sec. 190.02(e) that the trustee ``must immediately use its best
efforts to effect a transfer'' to a direction that the trustee ``shall
promptly use its best efforts to effect a transfer.'' This modest
change in focus will benefit public customers by recognizing that,
[[Page 19397]]
while effecting transfer is an extraordinarily high priority, it is
possible that there may be higher priorities at the inception of the
bankruptcy proceeding, e.g., it may be necessary to preserve some
portion of customer property from an immediate threat.\250\ Once again,
by enhancing the trustee's discretion as to how to manage the
liquidation, there is the cost that the trustee will make a mistake.
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\250\ The Commission is implementing the same change--the
addition of the word ``public'' before ``customers''--to Sec.
190.04(a)(2). The anticipated cost and benefit analysis of the
change is the same as in Sec. 190.04(a)(1).
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Section 190.04(a)(2) directs the FCM (or a trustee, if one has been
appointed) in a case where an involuntary petition for bankruptcy is
filed against the FCM to use best efforts to effect a transfer within
seven calendar days. The current regulation limits the commodity broker
to trading for liquidation unless otherwise directed by the Commission,
by any applicable self-regulatory organization or by the court. Revised
Sec. 190.04(a)(2) removes this limitation. Rather, revised Sec.
190.04(e)(4) more generally covers limitations on the business of an
FCM in bankruptcy. Similarly, any requirement to transfer customer
positions would more properly be addressed by Sec. 1.17(a)(4). The
Commission believes that these changes will benefit the estate and the
public customers by mitigating the administrative costs by removing a
redundant regulation. The Commission does not anticipate any resulting
increase in cost.
In Sec. 190.04(b)(1), the Commission is clarifying and updating
conditions under which the trustee may make payments of variation
settlement and initial margin. In sum, the revisions clarify that
payments can be made prior to pending transfers or liquidation, not
just pending liquidation. The revision should benefit the customers of
the FCM debtor in clarifying that the trustee has two paths in treating
open commodity contracts--transfer, and if transfer is not possible,
liquidation. The changes describe more accurately the types of payments
that the trustee will be permitted to make and account specifically for
the types of entities to which the trustee is permitted to make the
types of payments referred to in this section. The revisions clarify
the current regulatory text, which should benefit stakeholders. The
Commission does not anticipate any increased cost from these changes.
Section 190.04(b)(1)(i) prevents the trustee from making any
payments of behalf of any commodity contract account that is in
deficit, to the extent within the trustee's control. The revised
provision recognizes that certain accounts may be held on an omnibus
basis on behalf of many customers. To the extent the trustee is making
a margin payment with respect to such an omnibus account, it may be out
of the trustee's control to only make payment with respect to those
customer accounts that are not in deficit. The proviso similarly will
clarify that this prohibition on making margin payments on behalf of
accounts in deficit is not intended to prohibit ``upstream'' entities
(e.g., a CCP or an intermediary through which the debtor clears) from
exercising legal rights to margin under applicable law. Due to the
structure of omnibus accounts and the explicit requirement of lack of
trustee control, any payments that are made under the revised provision
would have been made pursuant to Commission authorization under the
current regulation. Thus, neither provision should add any new
regulatory burden and the Commission does not estimate that there will
be any additional cost associated with the proposed changes.
Section 190.04(b)(1)(ii) is a new regulation that adds an explicit
restriction, that the trustee cannot make a margin payment with respect
to a specific customer account that would exceed the funded balance of
that account. ICI agrees that this restriction supports the pro rata
distribution principle, and should benefit the other customers of the
FCM debtor--any payment of customer property in excess of a particular
customer's funded balance is to the detriment of other customers.\251\
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\251\ While there will be a corresponding detriment to the
customers who may have benefited from such excess payments, those
customers would only be losing something that runs counter to the
statutory goal of pro rata distribution. Moreover, there are no
likely incentive effects because, on this issue, customers stand
behind the ``veil of ignorance''--it is difficult to identify, ex
ante, which customers would be in the group of gaining customers (or
in the group of losing customers).
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Section 190.04(b)(1)(iii) is a minor, non-substantive clarification
of current Sec. 190.02(g)(1)(ii), that should not create any changes
from the status quo with regards to costs and benefits.
In Sec. 190.04(b)(1)(iv)-(v), the Commission is clarifying that
margin must only be used (i.e., paid to a clearing organization or
upstream intermediary) consistent with section 4d of the CEA. Section
190.04(b)(1)(vi) states explicitly the conditions under which the
trustee may make payments to meet margin obligations.
Together, these changes protect customers who make payments after
the order for relief by ensuring that they fully benefit from those
payments (and thus incentivize customers to make such payments in
appropriate circumstances). Moreover, more clearly permitting the
trustee, for the purpose of curing customer margin deficiencies, to use
funds in an account class that exceed the sum of all of the net equity
claims for that account class, should facilitate the orderly transfer
of positions and contracts following the default, lessening the
potential for further roiling markets. Finally, these changes taken
together also benefit the broader group of customers of the FCM debtor
by clarifying the treatment of funds in segregated accounts, and thus
mitigating administrative costs.
These changes are designed to clarify the statutory requirements
applicable to funds in the customer account. While there may be
accounting requirements associated with funds in segregated accounts,
substantially all of the costs of such accounting are already incurred
pursuant to the segregation rules. Thus, the Commission does not
anticipate that there should be any material additional costs
associated with this change.
Section 190.04(b)(2) allows the trustee discretion as to whether to
issue margin calls to customers who are undermargined, deleting highly
prescriptive conditions from the current rule. The revision should
benefit public customers of the FCM debtor by giving the trustee the
flexibility to recognize that there may be situations in which issuing
a margin call is impracticable because the trustee is operating the FCM
in ``crisis mode'' and may be pending wholesale transfer of liquidation
of open positions.
It is, however, possible that the trustee would exercise their
discretion poorly, or in a manner that, in retrospect, would be seen to
be to the detriment of the estate, and that the trustee would have
failed to issue a margin call in a situation in which a public customer
would have paid the call (and in which the balance of administrative
cost and amount recovered would mean that, in retrospect, it would have
profited the estate if the call was made). Such failure could result in
a cost to the estate of the FCM debtor to the extent that such funds
are not available.
The balance of the revisions to Sec. 190.04(b) should cause no
change to the related costs and benefits.
Section 190.04(b)(3) retains the concept in current Sec.
190.02(g)(3), with updated cross-references. The Commission does not
anticipate that there will be any costs or benefits to the proposed
minor revisions.
[[Page 19398]]
Section 190.04(b)(4) addresses the trustee's obligation to
liquidate accounts in deficit, or where a mark-to-market calculation
would result in a deficit, or where the customer fails to meet a margin
call within a reasonable time. The revision will clarify the
applicability of current authority to a situation that is already
implicit in the current rule. The regulation does not require the
trustee to make additional calculations but, if a calculation made by
the trustee reveals that the mark-to-market value of the account is a
deficit, the trustee is instructed to liquidate the account as soon as
practicable rather than to wait for the time that payment would be due.
The benefit of this change should be to liquidate accounts in deficit
more promptly (thus mitigating potential further losses); the cost will
be the cost of engaging in such liquidation, as well as the possibility
that, absent prompt liquidation, the deficit would have been mitigated
due to favorable intervening changes in market value (or, potentially,
an intervening deposit of additional collateral by the customer).\252\
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\252\ This change may also provide incentives for a customer
whose account is in, or is approaching, deficit to make such
payments promptly to avoid liquidation of their positions.
---------------------------------------------------------------------------
Second, the Commission is adding the concept of ``exigent
circumstances'' as a new exception to the general and long-established
rule that a minimum of one hour is sufficient notice for a trustee to
liquidate an undermargined account.
SIFMA AMG/MFA urged the Commission to curtail the trustee's
discretion in Sec. 190.04(b)(4) in a number of ways: By requiring the
trustee to defer to the margin call timings present in applicable
underlying agreements between the customer and the (pre-bankruptcy)
debtor, and by providing customers with the opportunity to demonstrate
that a margin payment was made even if the FCM's books and records do
not yet reflect its receipt. By contrast, ICI noted that it is vital
that the trustee be required to swiftly crystallize, and therefore cap
the losses resulting from, such deficits by promptly liquidating
accounts in deficit or for which a customer has failed to meet a margin
call. ICI further stated that if the accounts were allowed to remain
open, additional losses on the delinquent customers' transactions would
be borne by the FCM's non-defaulting customers.
The Commission has determined not to make the requested changes.
While making those changes would benefit those customers who are
treated on a more bespoke it would be to the detriment of the FCM's
other customers. Enhancing the trustee's discretion to determine how
long a customer has to meet a margin call, and to rely on the FCM's
books and records in doing--and refusing to curtail that discretion (by
forcing the trustee to defer to margin call timings in pre-bankruptcy
agreements, or to give the customer an opportunity to demonstrate that
the a margin payment was made) as requested by the comment--will
benefit other customers of the debtor FCM by giving the trustee
flexibility to respond to market conditions following an FCM default.
It is important to recognize that in stressed markets or in situations
where communication protocols cannot practicably be followed,
permitting a customer time to post margin in accordance with a pre-
bankruptcy agreement--or, in some cases, even notice of one hour--may
be insufficiently prompt to mitigate appropriately (1) the risk that
such customers would default, (2) the risk that delaying liquidation of
such a customer's positions increases the potential for and likelihood
that they would do so with a debit balance, and (3) the risk that the
size of that debit balance would increase as a result of that delay,
thereby reducing the funded balances of those other customers. However,
customers who are required to make payments more promptly would bear
associated costs, from making such payments in a reduced time frame,
from having to make duplicate payments (while these would ultimately be
returned in full, this would be without interest) or from having
contracts liquidated that would otherwise not have been liquidated if
the customer had more time to make payment.\253\
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\253\ SIFMA AMG and MFA also suggested that the regulation
should be amended to give customers credit for any gains that were
haircut due to gains-based haircutting by a DCO. Any such
haircutting of a customer's gains is due to application of the
customer's agreement with the FCM. Moreover, giving some customers
credit despite such agreements would increase their recovery, but at
the expense of other customers, as discussed in detail in section
II.C.7 above.
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The Commission is adding Sec. 190.04(b)(5) to guide the trustee in
assigning liquidating positions to the FCM debtor's customers when only
a portion of the open contracts are liquidated. The benefit of this new
provision is that it presents a clear and transparent mechanism by
which the trustee is to allocate the positions. This mechanism will
protect the customer account as a whole, by establishing a preference
for assigning liquidating transactions to individual customer accounts
in a risk-reducing manner. The allocation mechanism will, however, be
subject to the trustee's exercise of reasonable business judgement. It
is possible that such judgment could be exercised in a poor manner (or
in a manner that, in retrospect, turns out to be regrettable), with
resultant cost to the FCM debtor estate.
Section 190.04(c) requires the trustee to use its best efforts to
liquidate open commodity contracts that are not settled in cash (i.e.,
those that settle via physical delivery of a commodity) where the
contract would move into delivery position. These clarifications are
likely to reduce administrative costs, to the benefit of the estate
(and, ultimately, customers). CME believed that this provision would
have the benefit of avoiding unnecessary disruptions to the delivery
process by customers that did not intend to participate in making or
taking delivery. There should be no cost associated with the revision
because, while there may be some customers who would prefer to hold
their contracts through delivery, the current regulations, just as the
revised regulations, direct the trustee to liquidate contracts coming
into delivery position.\254\
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\254\ See, e.g., current Sec. 190.03(b)(5).
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Section 190.04(d) will clarify requirements concerning the
liquidation and valuation of open positions. Section 190.04(d)(1) and
(2) clarify requirements for liquidating open commodity contracts and
specifically identifiable property other than commodity contracts.
Section 190.04(d)(3) codifies the Commission's longstanding
policies of pro rata distribution and equitable treatment of customers
in bankruptcy, as described in Sec. 190.00(c)(5) above, as applied to
letters of credit posted as margin. Under the new provision, the
trustee may request that a customer deliver substitute customer
property with respect to any letter of credit received, acquired or
held to margin, guarantee, secure, purchase, or sell a commodity
contract. The amount of the substitute customer property to be posted
may, in the trustee's discretion, be less than the full-face amount of
the letter of the credit, if such lesser amount is sufficient to ensure
pro rata treatment consistent with Sec. Sec. 190.08 and 190.09. If
necessary, the trustee may require the customer to post property equal
to the full-face amount of the letter of credit to ensure pro rata
treatment. Pursuant to paragraph (d)(3)(i), if such a customer fails to
provide substitute customer property within a reasonable time specified
by the trustee, the trustee may draw upon the full amount of the letter
of credit or any portion thereof (if the
[[Page 19399]]
letter of credit has not expired). Under paragraph (d)(3)(ii), the
trustee is instructed to treat any portion of the letter of credit that
is not fully drawn upon as having been distributed to the customer.
However, the amount treated as having been distributed will be reduced
by the value of any substitute customer property delivered by the
customer to the trustee. Any expiration of the letter of credit after
the date of the order for relief would not affect this calculation.
Pursuant to paragraph (d)(3)(iii), letters of credit drawn by the
trustee, or substitute customer property posted by a customer, are to
be considered customer property in the account class applicable to the
original letter of credit.
ICI, SIFMA AMG/MFA, and Vanguard supported Sec. 190.04(d)(3) on
the grounds that it has the benefit of treating customers equitably by
avoiding a more favorable treatment of customers who post letters of
credit than those who post cash and securities.
These proposed new provisions could impose costs on customers who
use letters of credit as collateral for their positions. Such customers
could be considered to have received distributions up to the full
amount of the letter of credit, or the trustee may draw upon a portion
or possibly the full amount of the letter of credit.
Moreover, a number of commenters,\255\ expressed the concern that
requests for substitute customer property in the special context of
delivery letters of credit could cause sudden liquidity needs, and
substantial hardship to customers. For example, CME noted that, while
they support Sec. 190.04(d)(3) outside the context of delivery letters
of credit, they see difficulties in that context, specifically in the
case of deliveries for certain energy contracts, often which take place
over 30 days. The delivery letters of credit for these contracts can
involve hundreds of millions of dollars in face amounts, and CME is of
the view that it would cause substantial liquidity hardship for buyers
to have to substitute cash in such amounts.
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\255\ CMC, CME, FIA.
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While the discussion above represents potentially important costs,
the Commission is noting factors that can alleviate these costs, and is
implementing provisions that it believes substantially mitigate these
costs: First, the Commission is adding a new Sec. 190.04(d)(3)(iv),
which provides that the trustee shall, in exercising their discretion
with regard to addressing letters of credit, including as to the timing
and amount of a request for substitute customer property, endeavor to
mitigate, to the extent practicable, the adverse effects upon customers
that have posted letters of credit, in a manner that achieves pro rata
treatment among customer claims. Second, the Commission notes the
likelihood that requests for substitute customer property may not apply
to the particular delivery letters of credit the commenters have
expressed concerns about: As requested by CME, the Commission confirms
that (1) a delivery letter of credit that is posted directly with the
DCO or with the delivery counterparty, rather than with or through the
FCM, and for which the FCM is not a named beneficiary, is outside the
delivery account class, i.e., it does not constitute cash delivery
property (or property of the debtor's estate), and (2) the provisions
in other parts of the part 190 regulations regarding treatment of
letters of credit posted with or through the debtor FCM do not apply
such a letter of credit.
The Commission's priority in this context is to ensure the
customers using letters of credit to meet margin obligations are
treated in an economically equivalent manner to those who have posted
other types of collateral, so that there is no incentive to use such
letters of credit to circumvent the pro rata distribution of margin
funds as set forth in section 766(h) of the Bankruptcy Code.\256\
Moreover, if there are shortfalls in customer property in a particular
account class, and public customers posting letters of credit are
protected from sharing in those shortfalls, those public customers
would benefit. However, the shortfalls would, inevitably, instead be
allocated to other public customers, who would suffer corresponding
losses. Regulation Sec. 190.04(d)(3) supports the policy of pro rata
treatment of public customers embodied in section 766(h) of the
Bankruptcy Code by clarifying that letters of credit cannot be used to
avoid pro rata distribution of margin funds. It therefore avoids
concentrating losses on those public customers (who are likely to be
smaller customers) that cannot qualify for, or cannot afford the cost
of, letters of credit, or otherwise do not use letters of credit as
collateral. Moreover, by directing the trustee to exercise their
discretion, including with respect to amounts and timing of requests
for customer property, in a manner that mitigates adverse effects on
those customers that have posted letters of credit, it will mitigate
the liquidity costs to such customers.
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\256\ See, e.g., 48 FR at 8718-19.
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Section 190.04(e)(1) concerns liquidation of open commodity
contracts in the market, while paragraph (e)(2) addresses liquidation
by book entry offset. Both of these revised regulations delete the
requirement in the current regulations that a clearing organization
must obtain approval for its rules regarding liquidation of open
commodity contracts, a requirement that is superfluous in light of the
regulatory framework set forth in part 40 of the Commission's
regulations, and in light of the notice-filing regime established by
Congress in section 5c(c) of the CEA.\257\ This has the benefit of
enabling clearing organizations to avoid the cost of filing a request
for rule approval, pursuant to CEA section 5c(c)(4) and Regulation
Sec. 40.5. There are potential costs, in that an ill-conceived rule
could be more readily identified, and addressed, in a rule approval
process. However, Commission staff, as a matter of practice, closely
reviews all notice-filed clearing organization rules.
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\257\ 7 U.S.C. 7a-2(c).
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Section 190.04(e)(3) is new, and confirms that an FCM or foreign
futures intermediary through which a debtor FCM carries open commodity
contracts may exercise any enforceable contractual rights that the FCM
or foreign futures intermediary has to liquidate such commodity
contracts. It provides that the liquidating FCM or foreign futures
intermediary must use ``commercially reasonable efforts'' in the
liquidation and provides the trustee a damages remedy if the FCM or
foreign futures intermediary fails to do so. Damages are the only
remedy; under no circumstance can the liquidation be voided.
This new provision will benefit carrying FCMs by confirming
explicitly that carrying FCMs are allowed to exercise enforceable
contractual rights to liquidate contracts, which reduces ambiguity and
thus will reduce administrative costs. At the same time, clarification
of the availability of the damages remedy will help to protect
creditors of the debtor FCM's estate in the event that the carrying FCM
does not use commercially reasonable efforts in liquidating the open
contracts (and thus will incentivize carrying FCMs to act in a
commercially reasonable manner). Thus, the regulation itself provides
the estate with a potential mitigant for the costs in the form of a
damages remedy.
The remainder of the revisions to Sec. 190.04(e)(4) and (f) are
non-substantive language changes and
[[Page 19400]]
clarifications and updated cross-references and should not have
associated costs or benefits.
3. Regulation Sec. 190.05: Operation of the Debtor's Estate--General:
Consideration of Costs and Benefits
In Sec. 190.05, the Commission is addressing general issues
regarding the operation of the debtor's estate. In both Sec. 190.05(a)
and (b), the Commission is making revisions providing the trustee with
more flexibility to act in a bankruptcy situation. Section 190.05(a),
for example, provides that the trustee ``shall use reasonable efforts''
to comply with the CEA and the Commission's regulations. Section
190.05(b) requires the trustee to ``use reasonable efforts'' to compute
a funded balance for each customer account that contains open commodity
contracts or other property as of the close of business each business
day until such open commodity contracts and other property in such
account have been transferred or liquidated, ``which shall be as
accurate as reasonably practicable under the circumstances, including
the reliability and availability of information.'' These two revisions
will benefit the estate by recognizing that a bankruptcy could be an
emergency event, that perfectly reliable information could be
unavailable or inordinately expensive to obtain, and that therefore the
trustee should be allowed some measure of flexibility to act reasonably
given the particular circumstances of the case. CME noted that Sec.
190.05(b) will have the benefit of allowing the trustee to transfer
more promptly public customers' positions and property than if the
trustee were held to a strict standard of precision. On the other hand,
affording the trustee increased discretion in complying with the CEA
and the Commission's regulations, and in computing a funded balance for
each customer account, may carry the potential cost of trustee mistake,
misfeasance, or abuse of such discretion, as discussed above.
Whereas current Sec. 190.04(b) requires a trustee to compute a
funded balance only for those customer accounts with open commodity
contracts, revised Sec. 190.05(b) expands the scope of customer
accounts for which a trustee is required to compute a funded balance to
those accounts with open commodity contracts or other property
(including, but not limited to, specifically identifiable property).
This expansion of the trustee's duties represents an administrative
cost, as the trustee will have to expend time and resources at the
close of business each business day to compute the funded balance of
all customer accounts. However, this revision should also result in a
benefit to those customers whose accounts hold property but no open
commodity contracts, in the form of enhanced information about their
financial position (including with regard to collateral, the value of
which may change on a daily basis, and with regard to the percentage
distribution currently available). These customers will, under the
revised provision, receive daily computations of the funded balance of
their accounts with the debtor.
However, revised Sec. 190.05(b) also narrows the trustee's duty
compared to current Sec. 190.04(b): While the current provision states
that the trustee ``must compute a funded balance for each customer
account . . . each day,'' the revised provision only requires the
trustee to ``use reasonable efforts'' to do so. Regulation Sec.
190.00(c)(3)(i)(C) provides that ``reasonable efforts'' should only be
less than ``best efforts'' to the extent that this would benefit public
customers as a class. Exercises of discretion by a trustee that, on a
net basis, benefit public customers as a class may, on a net basis,
impose costs on individuals or groups within that class. For example,
there theoretically may be cases where, because the administrative cost
of computing a funded balance would outweigh the benefit of doing so to
public customers as a class, the trustee, in exerting ``reasonable
efforts,'' determines not to do so on a particular day or for a
particular time. As ICI points out in their comment letter, that
decision would harm certain customers, i.e., regulated funds, who have
a particular need to confirm the existence and value of their
transactions and associated margin.
Section 190.05(c) requires the debtor to maintain ``records
required under this chapter to be maintained by the debtor, including
records of the computations required by this part'' ``until such time
as the debtor's case is closed.'' This revision expands the scope of
records that must be maintained, thereby imposing certain
administrative costs, but should benefit the estate, because it will
limit the amount of time the trustee will have to maintain the relevant
records.
Section 190.05(d) requires the bankruptcy trustee to use all
reasonable efforts to continue to issue account statements for customer
accounts that contain open commodity contracts or other property, and
to issue account statements reflecting any liquidation or transfer of
open commodity contracts or other property promptly after such
liquidation or transfer. This provision will likely result in
administrative costs, as the trustee will have to expend time and
resources issuing account statements to customers. It will benefit
customers because it should help them to keep track of their commodity
contracts (and the continued availability of hedges) and the property
in their accounts, including in particular when such contracts and
property are liquidated or transferred, even during a bankruptcy. ICI
noted that this is of particular benefit to regulated funds, providing
them with a basis to confirm the existence and value of their
transactions and associated margin.
Section 190.05(e)(1) allows a bankruptcy trustee to effect
transfers of customer property in accordance with Sec. 190.07, but
requires the trustee to obtain court approval prior to making any other
disbursements to customers. This provision should benefit the estate
and customers by allowing the trustee, without court approval, to port
customers' positions and associated property to a solvent FCM as
quickly as possible in a bankruptcy situation. In the event that too
much customer property (that is, an amount in excess of the ultimate
pro rata share) is transferred for those customers whose positions are
being ported, and cannot be offset or clawed back, it could result in
costs to other customers, for whom less than their pro rata share would
be available.
Section 190.05(e)(2) allows the bankruptcy trustee to invest the
proceeds from the liquidation of commodity contracts or specifically
identifiable property, and any other customer property, in obligations
of or guaranteed by the United States, so long as the obligations are
maintained in depositories located in the United States or its
territories or possessions. The revised regulation expands the scope of
customer property that the trustee is permitted to invest in such a
manner to include ``any other customer property.'' This change should
benefit customers, in that additional customer property could be
invested (in this limited manner).
Section 190.05(f) requires the trustee to apply the residual
interest provisions contained in Sec. 1.11 ``in a manner appropriate
to the context of their responsibilities as a bankruptcy trustee
pursuant to'' the Bankruptcy Code and ``in light of the existence of a
surplus or deficit in customer property available to pay customer
claims.'' This explicit requirement to continue to apply the residual
interest requirements set forth in Sec. 1.11 may result in
administrative costs, since the trustee would require resources to do
so. However, this provision should benefit customers by
[[Page 19401]]
making it more likely that they would receive what they are entitled to
receive from the debtor's estate. Indeed, Vanguard noted that the
residual interest requirement is a valuable buffer to protect
customers.
4. Regulation Sec. 190.06: Making and Taking Delivery Under Commodity
Contracts: Consideration of Costs and Benefits
Section 190.06 addresses the making and taking of deliveries under
commodity contracts.
Specifically, Sec. 190.06(a)(2) requires the trustee to use
``reasonable efforts'' (in contrast to the current ``best efforts'') to
allow a customer to deliver physical delivery property that is held
directly by the customer in settlement of a commodity contract, and to
allow payment in exchange for such delivery, and for both of these to
occur outside the debtor's estate, where the rules of the exchange or
clearing organization prescribe a process for delivery that allows
this.
Management of contracts in the delivery positions involves a
significant degree of tailored administration. Under the best efforts
standard, the trustee may spend more time (and thus incur higher costs)
focusing on the needs of a few customers, which could detract from the
trustee's ability to manage the estate more broadly. Accordingly, the
change from ``best efforts'' to ``reasonable efforts'' should benefit
creditors of the estate (as a whole) as the trustee should not need to
provide a disproportionate amount of individualized treatment to such
contracts.\258\ However, particular customers that would otherwise have
received the trustee's focused treatment under the ``best efforts''
standard could suffer a cost from the change.
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\258\ As discussed above in section II.A.1, the trustee in
exerting best efforts to meet a standard must diligently exert
efforts to meet that standard ``to the extent of its own total
capabilities.'' By contrast, in exerting ``reasonable efforts'' to
meet a standard, the Commission expects that the trustee will work
in good faith to meet the standard, but will also take into account
other considerations, including the impact of the effort necessary
to meet the standard on the overarching goal of protecting public
customers as a class.
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Section 190.06(a)(3) provides guidance to address situations when
the trustee determines that it is not practicable to effect delivery
outside the estate and therefore, delivery is made or taken within the
debtor's estate. The revisions provide the trustee with the flexibility
to act ``as it deems reasonable under the circumstances of the case,''
but set an outer bound to the trustee's discretion in requiring them to
act ``consistent with the pro rata distribution of customer property by
account class.'' This provision again will have the benefits and costs
of enhanced discretion discussed above, but includes an outer bound to
that discretion.
In Sec. 190.06(a)(4), the Commission adds a new provision to
reflect that delivery may need to be made in a securities account.\259\
The new provision should benefit customers who require the delivery of
securities, and the trustee, by permitting those securities to be
delivered to the proper type of account. By setting limits, the
provision should mitigate the risk of transferring too much value out
of the commodity contract account (and creating a risk of an
undermargin or deficit balance).
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\259\ This is only relevant for debtor FCMs that are also
broker-dealers.
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Section 190.06(b) is also new. It creates an account class for
physical delivery property held in delivery accounts and the proceeds
of such physical delivery property. This account class is further be
sub-divided into separate physical delivery and cash delivery account
subclasses. In general, creating the delivery account class should help
protect customers with property in delivery accounts following a
default, because delivery accounts are not subject to the Commission's
segregation requirements. The further sub-division into sub-classes
recognizes that cash is more vulnerable to loss, and more difficult to
trace, as compared to physical delivery property. This will likely
benefit those with physical delivery claims; customers in the cash
delivery sub-class would be likely get a pro rata distribution that is
less. The benefits and costs of creating these sub-classes were
discussed more fully above in reference to the definition of account
class in proposed Sec. 190.01.
5. Regulation Sec. 190.07: Transfers: Consideration of Costs and
Benefits
Section 190.07(a) works to promote transfers of commodity contracts
from a debtor FCM. It does so by prohibiting any clearing organization
or self-regulatory organization from adopting, maintaining in effect,
or enforcing rules that interfere with the acceptance by its members of
transfers of open commodity contracts and the equity margining or
securing of such contracts from FCMs with respect to which a petition
in bankruptcy has been filed, if the transfers have been approved by
the Commission.
The revised regulation includes the provisos that it (1) does not
limit the exercise of any contractual right of a clearing organization
or other registered entity to liquidate or transfer open commodity
contracts, and (2) should not be interpreted to limit a DCO's ability
adequately to manage risk. The revision modifies, in a balanced
fashion, the standard for clearing organization and SRO rules that are
adopted, maintained, in effect, and enforced and where transfers are
approved by the Commission. While clearing organizations and SROs will
need to comply with the revised standard, the compliance cost should
not be different than under the prior standard. The clarification that
the regulations do not limit contractual risk management rights should
provide a benefit to clearing organizations and their members in
clarifying that the regulation will not nullify the contracts in this
regard, and will not have an associated cost.
In Sec. 190.07(b)(1), the Commission clarifies that it is the
transferee FCM itself who has the responsibility to determine whether
it would be in violation of regulatory minimum financial requirements
upon accepting a transfer. It is not the trustee's duty. The Commission
does not anticipate any material cost from this revision.
Section 190.07(b)(3) permits a transferee to accept open commodity
contracts and associated property prior to completing customer
diligence requirements, provided that such diligence is completed as
soon as practicable thereafter, and no later than six months after
transfer. It is intended to incentivize potential transferees to accept
transfers by making it more practicable to do so. It recognizes that
customer diligence processes would have already been required to have
been completed by the debtor FCM with respect to each of its customers
as part of opening their accounts. CME, ICI and Vanguard agree that the
proposal would provide a benefit to customers and transferee clearing
members and trustees, by facilitating the transfer process.\260\ If
such flexibility were not provided, under the current regulations,
transfer might not be accomplished, or may not be accomplished
promptly. The provision recognizes the importance of the account
opening diligence
[[Page 19402]]
requirements and would mitigate the risk from delay by requiring the
diligence to be performed as soon as practicable and setting an outer
limit at six months, unless that time is extended by the Commission.
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\260\ The customer diligence requirements in question focus on
anti-money-laundering requirements and ensuring that risk
disclosures have been provided to customers and acknowledgements of
such disclosures have been received. The corresponding costs would
arise from the possibility that the transferee's diligence would
have revealed problems that had been missed by the debtor FCM's
customer diligence process, or arose subsequent to the time that the
original process was conducted, and that conducting the revised
diligence more promptly would sooner reveal the concerns, thus
permitting them to be addressed more expeditiously.
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FIA has requested that the Commission provide transferee FCMs with
more specific relief from applicable law relating to ``customer
diligence'' and to add specific references to certain rules, in order
to provide certainty, and to mitigate regulatory risk, to a transferee.
FIA requested various points of specific relief under five headings:
(i) Rules relating to anti-money laundering requirements; (ii) rules
relating to risk and other disclosures; (iii) rules relating to capital
and residual interest requirements; (iv) rules relating to account
statements; and (v) rules relating to margin.
As discussed in more detail in Section II.B.5 above, the Commission
has decided that, with respect to certain points of the requested
relief, providing the relief is warranted, and there are no material
associated costs from doing so. Thus, for example, Sec. 190.07(b)(3)
is being amended to refer explicitly to the risk disclosure
requirements in Sec. 1.65(a)(3).
With respect to the other points of requested relief, the comment
requests relief that the Commission has decided carries unacceptable
costs. Thus, the Commission is not providing a general exemption from
undermargined account capital charges in accordance with Sec. 1.17,
nor is the Commission extending the time to comply with capital or
residual interest requirements. While such relief might have the
advantage of further incentivizing FCMs to accept transferred accounts,
it would do so at the cost of potentially causing or accepting
financial weakness at transferee FCMs.
In a third group of points of requested relief, the Commission
notes that interpretations of existing regulations should adequately
address the concerns. Thus, transferred accounts are (based on the
terms of the regulations) excluded from the Customer Identification
Program requirements of 31 CFR 1026.220, while the provisions of Sec.
190.07(b)(3) adequately inform what constitutes ``appropriate risk-
based procedures for conducting ongoing customer due diligence''
(emphasis supplied) in the context of 31 CFR 1026.210(b)(5)(i). While
providing more specific regulatory provisions might enhance regulatory
certainty (and thus redound to the benefit of transferee FCMs, and
potentially incentivize FCMs to accept transferred accounts), it
carries the risk of being under-inclusive or over-inclusive, and thus
failing to achieve the regulatory goals.
Moreover, as to both the second and third categories, there may be
a more tailored approach to achieving the goal: As the Commission
explicitly notes above, any further relief that might be appropriate in
a particular situation can be requested by the transferee in light of
the relevant facts and circumstances. The Commission observed that its
staff have traditionally responded to requests for relief in emergency
situations with great dispatch, and expects, and has instructed staff,
to continue to do so in this context in the future.\261\ While this
approach provides less certainty in advance, it has the benefit of
making tailored relief available (and mitigating the possibility that
relief leads to unintended consequences).
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\261\ See discussion in Section II.B.5 above.
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Section 190.07(b)(4) clarifies that account agreements governing a
transferred account are deemed assigned to the transferee until and
unless a new agreement is reached. At the request of FIA, the
Commission is confirming that if there is a pre-existing account
agreement between a transferred customer and the transferee FCM, that
pre-existing agreement will govern the relationship rather than the
agreement between the customer and the transferor (debtor) FCM. The
provision also confirms that consequences for breaches pre-transfer are
borne by the transferor rather than the transferee. Section
190.07(b)(4) provides important transparency regarding the agreement
between a transferred customer and a transferee FCM pending the
negotiation of a new agreement between them, or, if such negotiation is
unsuccessful, until either party decides to terminate the relationship.
Section 190.07(b)(5) provides that in the event of transfer,
customer instructions that are received by the debtor with respect to
any open commodity contracts or specifically identifiable property
should be transmitted to the transferee, who should comply with such
instructions to the extent practicable. The slight revisions to current
Sec. 190.02(c) are merely clarifications, and there should be no costs
or benefits associated with such revisions.
Section 190.07(c) provides that ``all commodity contract accounts
(including accounts with no open commodity contract positions) are
eligible for transfer. . . .'' This recognizes explicitly that accounts
can be transferred if the accounts are intended for trading
commodities, but do not include any open commodity contracts at the
time of the order for relief. The revision clarifies the current
language and will not change the types of accounts that can be
transferred. Accordingly, the Commission does not anticipate that there
will be material added cost associated with the revision.
Section 190.07(d) revises special rules for transfers under section
764(b) of the Bankruptcy Code. The revision is being made to promote
transfer. Cost and benefit considerations related to transfer are as
discussed above.\262\ The revised regulation permits partial transfers,
but (to the extent practicable) not in cases where netting sets for
spreads or straddles would be broken or where customers' net equity
claims would increase. The revised regulation should provide a benefit
to customers by codifying this limitation. This recognizes that there
may be circumstances where partial transfer is not practicable and
implies that the trustee makes that decision. It is therefore possible
that certain customers holding spread or straddle positions could have
positions liquidated or not transferred under the revised provision, or
could have spreads or straddles broken because of the trustee's
exercise of discretion.
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\262\ See section III.B.1 above.
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The Commission has declined to adopt ICI's suggestion to provide
guidance to the effect that the trustee should not effectuate a
transfer that will result in a separately managed account having a
significant deficit following the porting, in order to avoid a
circumstance where ``the manager of that account would likely need to
liquidate the bulk of the account's portfolio and other positions in
order to eliminate or reduce the deficit.'' While adopting such a
suggestion might benefit the beneficial owner by enabling the account
manager to manage the separate account in accord with the account
manager's investment program, it may instead have the opposite effect,
in that it may prevent any transfer of the customer's positions before
the seventh calendar day after the order for relief, in which event the
trustee will be required to liquidate the entirety of the customer's
account, promptly and in an orderly manner, causing the very
disruptions that the transfer provisions (and ICI's suggestion) are
designed to avoid. Moreover, many FCMs carry hundreds or even thousands
of separately managed accounts. It may well not be practical for a
trustee, in addition to their numerous other responsibilities (and in a
context where they need to learn those responsibilities
[[Page 19403]]
in a compressed timeframe) to take ``due account'' of the particular
circumstances of each of these separately managed accounts in the
hours, or perhaps a small number of days, that the trustee may be
allowed by the clearing organizations carrying the FCMs accounts to
negotiate and effectuate a transfer. Endeavoring to do so might well
have the cost of diverting the trustee and their assistants from
carrying out more pressing tasks.
Section 190.07(d)(3) permits a letter of credit associated with a
commodity contract to be transferred with an eligible commodity
contract account. If the letter of credit cannot be transferred and the
customer does not deliver substitute property, the provision will
permit the trustee to draw upon all or a portion of the letter of
credit and treat the proceeds as customer property in the applicable
account class. The revised regulation ensures that letters of credit
are treated in an economically similar fashion to other types of
collateral and that customers using letters of credit will not receive
any differential economic advantages, thus serving the goal of pro rata
distribution. If the trustee does draw upon the letter of credit, there
may be administrative costs incurred by the estate, as well as costs to
the customer that posted the letter of credit as collateral. These
costs may be mitigated if the customer delivers substitute property, as
set forth in the proposed regulation. Moreover, consistent with Sec.
190.04(d)(3)(iv), the trustee is directed to ``endeavor to achieve pro
rata treatment among customer claims in a manner that mitigates, to the
extent practicable, the adverse effects upon customers that have posted
letters of credit.'' \263\
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\263\ The costs and benefits of allowing the trustee to draw
upon the letter of credit have been discussed above in section
III.C.2 with respect to Sec. 190.04(d)(3).
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Section 190.07(d)(4) will require a trustee to use reasonable
efforts to prevent physical delivery property from being separated from
commodity contract positions under which the property is deliverable.
While this provision will impose an administrative cost on the estate,
it is already a best practice for trustees; keeping delivery property
with the underlying contract positions is necessary for (and thus
should benefit) the delivery process. Therefore, the additional
administrative cost from the revised regulation should be minimal.
In Sec. 190.07(d)(5), the Commission prohibits the trustee from
making a transfer that would result in insufficient remaining customer
property to make an equivalent percentage distribution to all customers
in the applicable account class (taking into account all previous
transfers and distributions). The Commission is further clarifying that
the trustee should make determinations in this context based on
customer claims reflected in the FCM's records, and, for customer
claims that are not consistent with those records, should make
estimates using reasonable discretion based in each case on available
information as of the calendar day immediately preceding transfer. This
will support achieving the statutory policy of pro rata distribution
and give the trustee discretion to make decisions based on the
overarching principle set forth above, valuing cost effectiveness over
precise values of entitlement. However, this is designed to work to the
detriment of any customer who, absent the provision, would otherwise
benefit from a larger distribution. Moreover, in giving the trustee
discretion, it carries the risk of mistake or misfeasance.
Section 190.07(e) will add language to clarify that certain
transfers are approved by the Commission pursuant to the procedure set
forth in the Bankruptcy Code (and thus protected from avoidance) and
will prohibit the trustee from avoiding such transfers, unless the
transfer is disapproved by the Commission. These include a transfer
made by ``a receiver that has been appointed for the FCM that is now a
debtor.'' The new provision is being added in order to respect the
actions of a receiver that is acting to protect the property of the FCM
that has become the debtor in bankruptcy. It will provide certainty to
the actions of such a receiver, whose duties, among others, include
protecting the customer property of the FCM. However, to the extent
that the receiver takes actions that are, considered in retrospect,
mistaken or ill-advised, the revised provision will prevent the
correction of such actions unless the Commission acts affirmatively to
disapprove them.\264\
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\264\ Regulation Sec. 190.02(b)(1) explicitly excepts from the
delegation to the Director of the Division of Clearing and Risk the
authority to disapprove a pre-relief transfer pursuant to Sec.
190.07(e)(1).
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Section 190.07(f) will clarify that the Commission may prohibit the
transfer of a particular set or sets of the commodity contract
accounts, or permit the transfer of a particular set or sets of
commodity contract accounts that do not comply with the requirements of
the section. In addition, the Commission is clarifying that the
transfers of the commodity contract accounts include the associated
customer property. These revisions are clarifications and should not
have any associated costs.
6. Regulation Sec. 190.08: Calculation of Funded Net Equity:
Consideration of Costs and Benefits
In Sec. 190.08, the Commission addresses calculation of funded net
equity. Section 190.08(a) simply states that a customer's funded net
equity claim is equal to the aggregate of such customers funded net
equity claims for each account class.
Section 190.08(b) sets forth the steps for a trustee to follow when
calculating each customer's net equity. SIFMA AMG/MFA requested that
the Commission amend proposed Sec. 190.08(b)(2)(xii) to treat accounts
of the same principal or beneficial owner maintained by different
agents or nominees as separate accounts and not all held in the
individual capacity of such principal or beneficial owner, suggesting
that this would have the benefit of reducing the administrative
difficulties the trustee would face in consolidating all accounts of
the same principal or beneficial owner, and it would have the further
benefit of avoiding any confusion as to treatment of separate accounts
that could arise with the overlay of the time-limited relief provided
by Letter 19-17.
The Commission declined to make this change. The change would not
achieve those benefits and would have associated costs: First, the FCM,
to the extent it does treat such accounts separately pursuant to the
relief set forth in Letter 19-17, will already be consolidating (for
purposes of certain calculations) all accounts of the same principal or
beneficial owner, in that the Letter conditions its relief on the FCM
applying credit limits and stress testing on a combined account
basis.\265\ Second, given that Letter 19-17 also conditions relief on
the FCM disclosing that ``under CFTC [p]art 190 rules all separate
accounts of the beneficial owner will be combined in the event of an
FCM bankruptcy,'' amending Sec. 190.08(b)(2)(xii) to treat them
separately would be inconsistent with that disclosure, and would cause,
rather than relieve, inconsistency with the approach taken under the
Letter.
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\265\ See CFTC Letter 19-17, https://www.cftc.gov/node/217076 at
4.
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While the Commission is making certain revisions in Sec.
190.08(b)(3), (4), and (5), the Commission views such revisions as non-
substantive and merely clarifying the text in the current analogous
provisions. Thus, the Commission does not expect these
[[Page 19404]]
changes to result in any costs or benefits.
Section 190.08(c) sets forth instructions for calculating each
customer's funded balance, while in Sec. 190.08(d), the Commission is
in general implementing changes to provide more flexibility to the
trustee in valuing commodity contracts and other property held by or
for a commodity broker. For instance, in Sec. 190.08(d)(5), the
Commission is deleting the requirement that the trustee seek approval
of the court prior to enlisting professional assistance to value
customer property. These changes should benefit the estate by providing
the trustee with more flexibility to determine how to value certain
customer property, including whether or not to enlist professional
assistance in doing so. Likewise, these revisions should serve the goal
of a pro rata distribution to customers, as the accurate valuation of
customer property can benefit from the input of a professional. On the
other hand, affording the trustee increased discretion in how to value
commodity contracts and other property held by a debtor carries the
potential cost of mistake, misfeasance, or abuse of discretion by the
trustee, as discussed above, or possibly by the professional whose
service is retained.
With respect to commodity contracts that have been transferred,
Sec. 190.08(d)(1)(i) provides that such contracts be valued at the end
of the last settlement cycle on the day preceding such transfer, rather
than at the end of the settlement cycle in which it is transferred.
Again, this revision should benefit both the estate and customers by
making it practical to calculate the value of the transferred commodity
contracts prior to the transfer.
The Commission has declined to accept ICE's suggestion that it
adopt a ``more flexible approach'' because ``the market may move
significantly on the date of the transfer.'' While prices may move
intra-day during the period between opening and the time of auction,
they may also move between the time of auction and closing. Therefore,
there is no ex ante reason to expect that the previous day's price is
less reflective of the price at the time of the auction than the
closing price on the auction day. Moreover, an alternative approach,
using the price set in the auction as the price for individual
contracts, is unlikely to be practicable. Units auctioned will
frequently contain a heterogenous (though risk-related) set of
products, tenors (e.g., contract months), and directions (e.g., long or
short). Thus, it will often be impracticable to translate an auction
price for a portfolio to prices for individual contracts within that
portfolio.
7. Regulation Sec. 190.09: Allocation of Property and Allowance of
Claims: Consideration of Costs and Benefits
In Sec. 190.09, the Commission is addressing allocation of
property and allowance of claims. Section 190.09(a)(1) defines the
scope of ``customer property'' that is available to pay the claims of a
debtor FCM's customers, and Sec. 190.09(a)(1)(i) sets forth the
categories of ``cash, securities, or other property or the proceeds of
such cash, securities, or other property received, acquired, or held by
or for the account of the debtor, from or for the account of a
customer'' that are included in customer property. In Sec.
190.09(a)(1)(i), the Commission is making certain substantive changes
to the categories listed in current Sec. 190.08(a)(1)(i), as discussed
below:
First, Sec. 190.09(a)(1)(i)(D) is new and provides that
customer property includes any property ``received by the debtor as
payment for a commodity to be delivered to fulfill a commodity contract
from or for the commodity customer account of a customer.'' Clarifying
this point explicitly should benefit both the estate and customers by
avoiding confusion or potential litigation.
Second, Sec. 190.09(a)(1)(i)(F) provides that letters of
credit, including proceeds of letters of credit drawn by the trustee,
or substitute customer property, constitute ``customer property.'' This
section is being revised to be consistent with the other letters of
credit provisions that are being added throughout part 190. The
Commission does not anticipate that this provision will result in any
material costs or benefits, as current Sec. 190.08(a)(1)(i) already
includes a provision regarding letters of credit.\266\
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\266\ The costs and benefits of the underlying policy decision
to take steps to ensure that customers posting letters of credit are
treated (with respect to pro rata allocation of losses) in a manner
consistent with the manner in which customers posting other forms of
collateral are treated are discussed in connection with Sec.
190.04(d)(3) in section III.C.2 above.
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Section 190.09(a)(1)(ii) sets forth the categories of ``[a]ll cash,
securities, or other property'' that would be included in customer
property. In Sec. 190.09(a)(1)(ii), the Commission is making certain
substantive changes to the categories listed in current Sec.
190.08(a)(1)(ii), as discussed below:
First, Sec. 190.09(a)(1)(ii)(D) provides that any cash,
securities, or other property that was property received, acquired or
held to margin, guarantee, secure, purchase, or sell a commodity
contract and that is subsequently recovered by the avoidance powers of
the trustee or is otherwise recovered by the trustee on any other claim
or basis constitutes customer property. The current version of this
provision refers only to the trustee's avoidance powers (leaving out
the possibility for recovery other than through avoidance powers). The
Commission's revisions to this section will benefit the estate, by
assuring that any property they recover will be included in the pool of
customer property, rather than going to some other creditor (to be
sure, those other creditors will receive correspondingly less).
Second, Sec. 190.09(a)(1)(ii)(G) is new, and provides
that any current assets of the debtor in the greater of (i) the amount
that the debtor is obligated to be set aside as its targeted residual
interest amount, pursuant to Sec. 1.11, or (ii) the debtor's
obligations to cover debit balances or undermargined amounts, pursuant
to Sec. 1.20, Sec. 1.22, Sec. 22.2, or Sec. 30.7, constitute
customer property. This new provision will result in administrative
costs, because the trustee will need to take the extra step of
determining whether any current assets of the debtor need to be set
aside as customer property and, if so, how much. This provision should
benefit public customers (and serve the policy of protecting customer
collateral), however, because it will mitigate the risk of a shortfall
in customer funds by ensuring that the trustee fulfills the
Commission's regulations that require an FCM to put certain funds into
segregation on behalf of customers. ICI and Vanguard agreed that this
provision will benefit customers, while CME considered it a
``substantial improvement over the current rule.'' This approach will
result in such funds being included in the pool of customer property,
rather than going to some other creditor. It will, to the same extent,
operate to the detriment of general creditors.
Third, Sec. 190.09(a)(1)(ii)(K) is also new, and provides
that any cash, securities, or other property that is payment from an
insurer to the trustee arising from or related to a claim related to
the conversion or misuse of customer property constitutes customer
property. This provision should benefit customers (and, again, the
policy of protecting customer collateral), since any insurance payment
as described in this proposed section will enlarge the pool of customer
property, rather than going
[[Page 19405]]
to general creditors.\267\ It could result in administrative costs,
however, as the trustee will need to spend time and resources in order
to determine whether any such insurance payments exist, and in
prosecuting such insurance claims.
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\267\ It will, again, to the same extent, act to the detriment
of general creditors.
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Fourth, the second sentence of Sec. 190.09(a)(1)(ii)(L)
is new, and will provide that customer property for purposes of these
regulations includes any ``customer property,'' as that term is defined
in SIPA, that remains after satisfaction of the provisions in SIPA
regarding allocation of customer property constitutes customer
property. This provision should benefit commodity customers (and act to
the detriment of general creditors) because any securities customer
property remaining after full allocation to securities customers will
enlarge the pool of commodity customer property. It could result in
administrative costs, however, since the trustee could need to spend
time and resources determining the extent to which such property is
left over after allocation to customers in a SIPA proceeding.\268\
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\268\ The Commission further notes that the first sentence of
Sec. 190.09(a)(1)(ii)(L), which provides that customer property
includes any cash, securities, or other property in the debtor's
estate, but only to the extent that the customer property under the
other definitional elements is insufficient to satisfy in full all
claims of the debtor's public customers, will impose no new costs or
benefits because such provision already appears in current Sec.
190.08, and the only changes to the provision would be non-
substantive updates to cross-references.
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Section 190.09(a)(2) sets forth the categories of property that are
not included in customer property. In Sec. 190.09(a)(2), the
Commission has made certain substantive changes to the categories
listed in current Sec. 190.08(a)(2), as discussed below:
First, in Sec. 190.09(a)(2)(iii), the Commission is
adding explicit language to state that only those forward contracts
that are not cleared by a clearing organization are excluded from the
pool of customer property. This revision will benefit customers (and
act to the detriment of general creditors), since the pool of customer
property would increase by explicitly including any cleared forward
contracts.
Second, Sec. 190.09(a)(2)(v) provides that any property
deposited by a customer with a commodity broker after the entry of an
order for relief that is not necessary to meet the margin requirements
of such customer is not customer property. The deletion of the word
``maintenance'' before ``margin'' will eliminate any distinction
between initial and variation margin; this deletion will benefit
customers by ensuring that any amount deposited by a customer after the
entry of an order for relief that is necessary to meet that customer's
margin requirements will be included in the pool of customer property.
This provision would correspondingly act to the detriment of general
creditors.
Third, Sec. 190.09(a)(2)(viii), which is new, provides
that any money, securities, or other property held in a securities
account to fulfill delivery, under a commodity contract that is a
security futures product, from or for the account of a customer, is
excluded from customer property. This provision avoids conflict with
the resolution, under SIPA, of claims for securities and related
collateral.
Section 190.09(a)(3), which is new, gives the trustee the authority
to assert claims against any person to recover the shortfall of
customer property enumerated in certain paragraphs elsewhere in Sec.
190.09(a). This provision could impose administrative costs, since the
trustee could have to expend time and resources to assert and prosecute
such claims to make up for any shortfall in customer property. The
provision will, however, benefit customers, since it will ensure that
the trustee is in a position to recover any such shortfalls and gives
the trustee authority to act to do so. Moreover, since this provision
makes explicit what is implicit in current part 190, an additional
benefit of this provision may be reduced litigation costs over a
trustee's authority to engage in attempts to recover shortfalls in
customer property.\269\
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\269\ Of course, these recoveries are derived from persons
against whom such claims are successfully asserted. The transfer to
customers from these individuals advances the goal of pro-rata
distribution.
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Section 190.09(b) adds the phrase ``or attributable to'' to the
language that is in current Sec. 190.08(b), when describing how to
treat property segregated on behalf of or attributable to non-public
customers, namely, as part of the public customer estate; the addition
of this phrase, as described above, will clarify that Sec.
190.09(b)(1) applies both to property that is in the debtor's estate at
the time of the bankruptcy filing, as well as property that is later
recovered by the trustee and becomes part of the debtor's estate at the
time of recovery. This additional phrase would benefit public customers
and the statutory policy in favor of them (and correspondingly act to
the detriment of non-public customers and general creditors), since it
could increase the amount of property that is treated as part of the
public customer estate. It could impose administrative costs because it
could take time and resources to properly allocate any property that is
recovered after the time the bankruptcy is filed.\270\
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\270\ Section 190.09(c)(1) will have a similar change in the
addition of the phrase ``or recovered by the trustee on behalf of or
for the benefit of an account class,'' which is meant to clarify
that any property recovered by the trustee on behalf of or for the
benefit of a particular account class after the bankruptcy filing
must be allocated to the customer estate of that account class. This
revision will present similar costs and benefits to those discussed
above.
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Section 190.09(c)(1)(ii) is a new provision that instructs the
trustee, in the event there is property remaining allocated to a
particular account class after payment in full of all allowed customer
claims in that account class, to allocate the excess in accordance with
proposed Sec. 190.09(c)(2), which in turn sets forth the order of
allocation for any customer property that cannot be traced to a
specific customer account class. These provisions will benefit public
customers who would otherwise face shortfalls (and then, non-public
customers who would otherwise face shortfalls). Since these provisions
make explicit what is implicit in current part 190, an additional
benefit of these provisions will result from the increased clarity over
what to do with any excess customer property. However, the provisions
will act to the detriment of non-public customers (relative to public
customers) and general creditors (relative to both) who, under the
current regime, could have been more likely to receive any excess
customer property in the absence of an explicit provision providing
what to do with any such excess customer property.\271\
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\271\ The incentive effects of such preferences are discussed in
section III.A.2.vi, above.
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Section 190.09(d) governs the distribution of customer property.
The only substantive change in Sec. 190.09(d) from its analog in
current Sec. 190.08(d) is in Sec. 190.09(d)(1)(i) and (ii), which
import the concept of ``substitute customer property.'' Whereas current
Sec. 190.08(d)(1)(i) and (ii) require customers to deposit cash in
order to obtain the return of specifically identifiable property, Sec.
190.09(d)(1)(i) and (ii) allow the posting of ``substitute customer
property.'' This term, which is defined in Sec. 190.01, means cash or
cash equivalents. This revision will benefit customers because it makes
it easier for customers to redeem their specifically identifiable
property by no longer limiting customers to only using cash to do so.
It could, however, impose administrative costs in the form of time and
resources of the trustee, who, in the event a customer chooses to post
cash equivalents to redeem their specifically identifiable property,
will be required to
[[Page 19406]]
value (and potentially to liquidate) such cash equivalents. Moreover,
while ``cash equivalents'' are required to be assets ``that are highly
liquid such that they may be converted into United States dollar cash
within one business day without material discount in value,'' it is
possible that such assets could nonetheless decrease in value,
potentially to the detriment of other customers.
8. Regulation Sec. 190.10: Provisions Applicable to Futures Commission
Merchants During Business as Usual: Consideration of Costs and Benefits
As proposed, Sec. 190.10 addresses provisions applicable to FCMs
during business as usual. The ABA Subcommittee and CME recommended that
these ordinary course provisions should be codified in part 1 of the
Commission's regulations, to be more transparent to FCM compliance
personnel. As discussed further below, the Commission has accepted that
suggestion and is adopting in part 1 of its regulations the provisions
that were proposed as Sec. 190.10 (b), (c), (d), and (e).
In the regulation proposed as Sec. 190.10(a), the Commission notes
that an FCM is required to maintain current records related to its
customer accounts, consistent with current Commission regulations, and
in a manner that will permit them to be provided to another FCM in
connection with the transfer of open customer contracts and other
customer property. This regulation does not impose new obligations, but
rather informs the trustee regarding their duties by incorporating
references to the Commission's existing regulations. Thus, this
provision is remaining in part 190, and, as the sole remaining
paragraph, will be codified as Sec. 190.10.
The regulation proposed as Sec. 190.10(b) addresses designation of
accounts as intended for the purpose of hedging. It is being codified
as Sec. 1.41. An FCM will be permitted to rely upon a customer's
written representation of hedging intent regarding the designation of a
hedging account, without being required to look behind that
representation, thus mitigating administrative costs.
Section 1.41(a) requires an FCM to provide a customer an
opportunity to designate an account as a hedging account when the
customer first opens the account, allowing for clear instruction to
FCMs at the outset of the relationship. Clear instruction at the outset
will facilitate the ability properly to account for customer property.
There will be some disclosure and accounting costs associated with this
provision. For those customers that do engage in hedging, it will be
more cost effective to designate the account at opening than to monitor
the transactions for the first qualifying transaction to provide the
opportunity to make the designation, as applicable under the current
regulation. Thus, the regulation should reduce the probability that the
opportunity to designate the account as a hedging account will be
missed.
Section 1.41(b) sets forth the conditions for treating an account
as a hedging account, permitting such treatment upon the customer's
written representation that their trading would constitute hedging as
defined under any relevant Commission rule or the rule of a DCO, DCM,
SEF, or FBOT. There will be record-keeping costs for FCMs and customers
associated with the provision.
Section 1.41(c) provides that the foregoing requirements do not
apply to commodity contract accounts opened prior to the effective date
of this final rulemaking, and that an FCM can continue to designate
such existing accounts as hedging accounts based on written hedging
instructions obtained under current regulations. This provision should
mitigate the impact of the changes to current requirements in Sec.
1.41(a) and (b) by not applying those provisions to already opened
hedging accounts, instead relying upon the information collected and
maintained during the current regulatory framework.
Section 1.41(d) will permit an FCM to designate an existing
customer account as a hedging account for purposes of bankruptcy
treatment, provided that the FCM obtains the necessary customer
representation. This provision will give FCMs and customers flexibility
to apply the proposed regulations to existing accounts where the impact
would not be overly burdensome.
The regulation proposed as Sec. 190.10(c) addresses the
establishment of delivery accounts during business as usual. It is
being codified as Sec. 1.42, and recognizes that when an FCM
facilitates delivery under a customer's physical delivery contract and
such delivery is effected outside of a futures account, foreign futures
account, or cleared swaps account, it must be effected through (and the
associated property held in) a delivery account. While there are costs
associated with the opening and maintenance of delivery accounts, the
Commission views that the use of such accounts is cost effective in
facilitating delivery.\272\ The benefit of using such accounts is
twofold: To protect customer assets during the delivery process, and to
foster the well-functioning of the delivery process.
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\272\ The Commission further understands that it is already
industry practice to use such accounts, therefore, as a practical
matter, the cost associated with mandating the use of such accounts
should be mitigated.
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The regulation proposed as Sec. 190.10(d) addresses letters of
credit, and will prohibit an FCM from accepting a letter of credit as
collateral during business as usual unless certain conditions are met
at the time of acceptance and remain true through the date of
expiration. It is being codified as Sec. 1.43.
The first condition is that the trustee must be able to draw upon
the letter of credit in full or in part in the event of a bankruptcy
proceeding, the entry of a protective decree under SIPA, or the
appointment of FDIC as receiver pursuant to Title II of the Dodd-Frank
Act. Second, if the letter of credit is permitted to be and in fact is
passed through to a clearing organization, the trustee for such
clearing organization (or the FDIC) must be able to draw upon the
letter of credit in full or in part in the event of a bankruptcy
proceeding for such clearing organization (or where the FDIC is
appointed as receiver).
Section 1.43 will ensure that an FCM's treatment and acceptance of
letters of credit during business as usual is consistent with and does
not preclude the trustee's treatment of letters of credit in accordance
with Sec. Sec. 190.00(c)(5) and 190.04(d)(3). The Commission
understands that under industry practice, most existing letter of
credit arrangements are consistent with the Joint Audit Committee Forms
of Irrevocable Standby Letter of Credit, both Pass-Through and Non
Pass-Through,\273\ and that these forms are consistent with these new
requirements. Nevertheless, FCMs will need to review the existing
letters of credit for consistency with the regulation, and it is
plausible that some could need to be re-negotiated to be consistent
therewith.
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\273\ See section II.B.8 above.
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To mitigate the costs of this change, the Commission has considered
the extent of the use of letters of credit in the industry and has
determined that upon the effective date of the regulation, Sec. 1.43
will apply only to new letters of credit and customer agreements. The
Commission further is including a transition period of one year from
the effective date until Sec. 1.43 will apply to existing letters of
credit and customer agreements. The transition period is intended to
give FCMs an adequate opportunity to conduct the necessary review of
existing letters of credit and customer agreements, and to make any
[[Page 19407]]
necessary changes. SIFMA AMG/MFA have urged the Commission to shorten
that one-year transition period, questioning how a (non-conforming)
letter of credit would be treated if an FCM that is holding such a
letter of credit went into bankruptcy during that period. Nonetheless,
the Commission has concluded that the one-year time period
appropriately balances the goals of mitigating burden on FCMs who are
required to conduct such reviews, and make such changes, with the goal
of mitigating the risk that an FCM that has accepted one or more
letters of credit that do not conform to the new requirements becomes a
debtor during that transition period. Even if such a situation occurs,
the risk that the customer who posted that letter of credit would
obtain treatment that is not consistent with (i.e., better than) pro
rata treatment (at the expense of other public customers) is mitigated
by the provision in Sec. 190.04(d)(3)(ii)--which is not subject to the
one-year transition period--that, for a letter of credit posted as
collateral, ``the trustee shall treat any portion that is not drawn
upon (less the value of any substitute customer property delivered by
the customer) as having been distributed to the customer for purposes
of calculating entitlements to distribution or transfer.''
It is possible that some letters of credit could become more
expensive for customers to obtain, as there will be an increased
likelihood that the letter of credit will be drawn upon. (As discussed
above, this appears to not apply to the majority of existing
arrangements). As noted in the discussion of Sec. 190.04(d)(3), the
benefit of the regulation is ensuring that letters of credit are
treated in an economically consistent manner with other types of
collateral, thus promoting the goal of pro rata distribution. However,
it could create incentives for customers who had, or who would prefer
to, post letters of credit that could not be drawn upon unless the
customer defaulted, to reduce their participation in transactions
cleared through FCMs.
The provision proposed as Sec. 190.10(e) concerns the disclosure
statement for non-cash margin, and is being codified as Sec. 1.55(p).
It largely aligns with the provisions in current part 190 from which it
was derived; there will be no additional cost or benefit implications.
9. Section 15(a) Factors--Subpart B
a. Protection of Market Participants and the Public
Subpart B of the revised regulations will increase the protection
of market participants and the public by clarifying certain provisions
(thereby promoting transparency for customers, other claimholders, and
the general public), by providing, in certain other provisions,
discretion to the trustee in determining how best to achieve the goal
of protecting public customers as a class, by fostering transfer (and
therefore mitigating the market risk associated with closing out and
reopening positions for certain customers), by enhancing the likelihood
that customer net equity claims will be fully funded, and by promoting
fairness to customers as a class by achieving pro rata distribution.
b. Efficiency, Competitiveness, and Financial Integrity
Subpart B of the revised regulations will promote efficiency (in
the sense of both cost effectiveness and timeliness) in the
administration of insolvency proceedings of FCMs and the financial
integrity of derivatives transactions carried by FCMs by setting forth
clear and well-thought-out instructions for a bankruptcy trustee to
follow in the event of an FCM insolvency, and by ensuring that these
instructions are and remain consistent with current market practices.
Moreover, subpart B will provide the bankruptcy trustee with
discretion, in certain circumstances, to react flexibly to the
particulars of the insolvency proceeding, guided by the goal of
protecting public customers as a class, thereby promoting cost-
effective administration of the proceeding. These effects will, in
turn, enhance the competitiveness of U.S. FCMs, by enhancing market
confidence in the protection of customer funds and positions entrusted
to U.S. FCMs, even in the case of insolvency.
c. Price Discovery
Price discovery is the process of determining the price level for
an asset through the interaction of buyers and sellers and based on
supply and demand conditions. The revised regulations work to promote
the transfer, rather than liquidation, of customer positions. To the
extent that they therefore mitigate the likelihood of the need for
liquidations of customer positions, particularly in conditions of
market distress, they will mitigate the negative impacts of bankruptcy
proceedings on price discovery.
d. Sound Risk Management Practices
Subpart B of the revised regulations will promote sound risk
management practices by facilitating the bankruptcy trustee' effective
management of the risk of the debtor FCM. Subpart B will accomplish
this by revising the bankruptcy regulations for an FCM insolvency to
reflect current market practices and thereby make it easier for the
trustee to act effectively to protect customer property in the event of
such an insolvency.
e. Other Public Interest Considerations
Subpart B of the revised regulations supports the implementation of
statutory policy such as promoting protection of public customers and
ensuring pro rata distribution of customer funds. Moreover, some of the
FCMs that might enter bankruptcy are very large financial institutions,
and some are (or are part of larger groups that are) considered to be
systematically important. A well-structured and effective bankruptcy
process that efficiently facilitates the proceedings is likely to
benefit the financial system (and thus the public interest), as that
process will help to attenuate the detrimental effects of the
bankruptcy on the financial system and reduce the likelihood that
uncertainty as to the outcome of the insolvency could cause disruption
to financial markets.
D. Subpart C--Clearing Organization as Debtor
Subpart C to part 190 is intended to create a tailored set of
regulations to govern a proceeding under subchapter IV of chapter 7 of
the Bankruptcy Code in which the debtor is a clearing organization. As
discussed further below, while these regulations are fitted to the
context of a commodity broker that is a clearing organization, they are
principles-based rather than prescriptive, and flexible rather than
rigid.
The overarching benefits of this approach include the following.
First, uncertainty will be reduced during business-as-usual (thus
enhancing the ability of both clearing members and their customers
better to understand their exposures to the possible insolvency of a
clearing organization, and to tailor their risk management practices
(and use of clearing services) in light of this enhanced
understanding). This better understanding may well foster greater trust
in the cleared derivatives marketplace, and thus greater participation
therein. To be sure, it is also possible that some market participants,
upon achieving a greater understanding, may decide not to participate.
There are other limitations to these benefits, noted below. Second, by
developing a more detailed, yet flexible, framework and procedures for
the bankruptcy of a DCO, the costs (to the estate, to clearing members,
and to
[[Page 19408]]
public customers) of the case should be reduced.
Third, the resolution regime established under Title II of Dodd-
Frank provides that the maximum liability of FDIC as receiver of a
covered financial company to a claimant is the amount the claimant
would have received if the FDIC had not been appointed receiver and the
covered financial company had been liquidated under chapter 7 of the
Bankruptcy Code. By establishing a clearer counterfactual, subpart C
will: (a) Enhance the ability of FDIC to plan for and to execute its
responsibilities as receiver; (b) enhance the ability of market
participants to predict in advance their exposures in the unlikely
event of the resolution as a DCO; and (c) mitigate the cost of
litigation over the value of such claims. The Commission notes that
there can, to a certain extent, be costs imposed by proposed subpart C,
in that there may be a corresponding reduction in flexibility with the
addition of rules specifically tailored to address a DCO bankruptcy,
but the Commission has drafted these proposed rules with the intent of
maintaining significant flexibility, where warranted.
It is apposite to note an important issue that affects incentives:
A significant group of commenters have expressed strong concerns, both
in comments to this rulemaking \274\ and elsewhere,\275\ that clearing
members and their customers have no meaningful role in DCO risk
governance, and, most relevant here, that DCOs' default rules and
procedures and recovery and wind-down plans are developed without
sufficient input from members and their customers. As discussed in
detail in section II.C above and in this section II.D, subpart C is
based, in large part, on a debtor DCO's ex ante default rules and
procedures and recovery and wind-down plans, though applied flexibly by
the trustee--that is, only to the extent they determine is
``reasonable'' and ``practicable.''
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\274\ See ACLI, FIA, ICI, SIFMA AMG/MFA, and Vanguard.
\275\ See, e.g., A Path Forward for CCP Resilience, Recovery,
and Resolution (published by a group of prominent clearing members
and money managers).
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Most of those concerns transcend the topic of this rulemaking: As a
general matter, risk governance is intended to mitigate the possibility
of default and, where default does occur, to foster the result that it
is the defaulter that pays for all of the losses; skin-in-the-game
provides an additional layer of loss-absorbency that (i) comes before
mutualizing costs to non-defaulters and (ii) creates incentives for
DCOs to engage in successful risk management. Default rules and
procedures are intended to, inter alia, ensure that the DCO can take
timely action to contain losses and liquidity pressures and to continue
meeting its obligations in the event of a clearing member default.
Recovery plans address credit losses that exceed the DCO's available
resources, as well as the manifestation of other risks, as necessary to
maintain the derivatives clearing organization's viability as a going
concern, while wind-down involves the actions of the DCO to effect the
permanent cessation or sale or transfer of one or more services.
Commission regulations require DCOs to: Take steps to ensure their
resilience, have effective rules and procedures to manage defaults,
address fully any individual or combined default loss, and maintain
viable plans for recovery in the event that they suffer a default loss
or any other (non-default) loss.\276\
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\276\ See generally part 39 of the Commission's regulations.
Only SIDCOs, or other DCOs that have elected to become subject to
the provisions of subpart C of part 39, are required to address
fully any default loss, or to maintain recovery and wind-down plans.
However, among DCOs based in the United States, the vast majority of
activity is conducted on DCOs that fall within one of those two
categories.
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DCOs' rules and arrangements for default management and their
recovery plans work to allocate losses that are not covered by the
resources of the defaulter between the DCOs themselves, their clearing
members, and (in some cases such as gains-based haircutting), will have
the effect (along with clearing agreements between FCMs and their
public customers) of allocating certain losses to public customers.
These include default losses that are not covered by margin posted by
the defaulter (or the defaulter's own contribution to mutualized loss
arrangements) or by the DCO's ``skin-in-the-game,'' as well as certain
investment or custody losses. All of this would occur outside of
bankruptcy.\277\
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\277\ Moreover, among U.S. DCOs (and among all DCOs registered
with the Commission), no loss has ever been so large that it was
mutualized.
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Those rules, plans, and arrangements--and the extent to which they
are considered helpful or noxious--thus influence the incentives of
DCOs, their clearing members, and the customers of those clearing
members. Accordingly, the concerns that these clearing members and
money managers have raised with respect to their limited ability to
influence these rules, plans, and arrangements that have effects
outside of bankruptcy are likely to have important incentive effects on
how, and the extent to which, clearing members and their public
customers (including money managers) are willing to and do participate
in cleared markets.
To the extent that subpart C of part 190 applies those rules, plans
and arrangements, even if flexibly, then the incentive effects
described above may be felt more strongly by clearing members and their
public customers, albeit only marginally so.\278\ The level of that
enhanced incentive is difficult to measure, since it depends, in
significant part, on the perception of those entities as to the effect
of referring to those rules, plans, and procedures in bankruptcy under
part 190, subpart C: Those rules, plans, and procedures, which they
dislike, are and will be applicable in cases where the DCO engages in
either default management or recovery outside of bankruptcy. The
references to these rules, plans, and procedures in part 190 increases
the likelihood that they will be used (because bankruptcy represents an
additional circumstance in which they would be applicable). The
incentive effects also depend on the perception of clearing members and
their public customers on the effect of such use in bankruptcy.
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\278\ The effects of those rules on incentives for DCOs is even
more difficult to measure, since a chapter 7 liquidation (the only
bankruptcy available to a commodity broker, see 11 U.S.C. 109(d)) is
highly likely to reduce severely, if it does not eliminate, the
DCO's value to its shareholders.
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A note on terminology: As discussed above in section II.C, the
customers of a clearing organization are its members, considered
separately in two roles: (1) Each member may have a proprietary (also
known as ``house'') account at the clearing organization, on behalf of
itself and its non-public customers (i.e., affiliates). The property
that the clearing organization holds in respect of these accounts is
referred to as ``member property.'' (2) Each member may have an account
for that members' public customers. The property that the clearing
organization holds in respect of these accounts is referred to as
``customer property other than member property.'' Many clearing members
will have both such accounts, although some may have only one or the
other.
1. Regulation Sec. 190.11: Scope and Purpose of Subpart C:
Consideration of Costs and Benefits
Section 190.11(a) will simply state that the new subpart C of part
190 will apply to a proceeding commenced under subchapter IV of chapter
7 of the Bankruptcy Code in which the debtor is a clearing
organization. Therefore, the costs and benefits of Sec. 190.11(a) are
the overarching costs and benefits stated above.
[[Page 19409]]
ICE and SIFMA AMG/MFA noted that, in the case of the bankruptcy of
a DCO organized outside the United States, there may be conflicts with
a bankruptcy proceeding in the home jurisdiction unless the
applicability of part 190 is limited. For example, there may be
differing--and irreconcilable--rules for distributing property. Such
differing rules could incentivize, e.g. a customer of a non-FCM
clearing member to bring litigation seeking to apply part 190's
customer protection rules to what they might describe as the customer
claims of their non-FCM clearing member.\279\
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\279\ As noted immediately below, public customers of FCM
clearing members will benefit from protection under part 190.
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The Commission has determined to adopt a suggestion by ICE and, in
a newly created Sec. 190.11(b), to limit the applicability of part
190, in the case of a foreign DCO subject to a proceeding in its home
jurisdiction, to provisions that (a) focus on the contracts and
property of public customers of FCM members \280\ or (b) general
provisions, and those that provide notice and reports to the Commission
and a U.S. bankruptcy trustee.\281\ By limiting the applicability of
part 190 in this manner, the Commission will foster the goal of
mitigating such conflicts,\282\ while by including those provisions
(rather than disapplying part 190 entirely to the bankruptcy of a
foreign-based clearing organization), the Commission will foster the
goal of protecting customers of U.S. FCM members of such a foreign-
based DCO.
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\280\ I.e., Sec. Sec. 190.13, 190.17, and 190.18, but only with
respect to: (1) Claims of FCM clearing members on behalf of their
public customers; and (2) property that is or should have been
segregated for the benefit of FCM clearing members' public
customers, or that has been recovered for the benefit of FCM
clearing members' public customers.
\281\ I.e., subpart A, and Sec. 190.12.
\282\ The Commission notes that conflicts involving a DCO based
outside the United States with the insolvency law in that DCO's home
jurisdiction as applied to claims of FCM clearing members on behalf
of their public customers should be mitigated by the fact that,
pursuant to Sec. 39.27(c)(3) and Exhibit R to appendix A to part
39, the DCO is required to submit and to keep current a memorandum
demonstrating, inter alia, the basis for the conclusion that the
DCO's arrangements to ring-fence the customer funds of FCM clearing
member are effective under the relevant non-U.S. law in the event of
the insolvency of the DCO, and the basis for the conclusion that a
local court or insolvency official in the DCO's jurisdiction of
domicile would respect the choice of U.S. law in that context, and
the basis for the conclusion that the DCO would be able to comply
with relevant provisions of the Bankruptcy Code and Commission
regulations with respect to pro rata distribution and relevant
orders of a U.S. court regarding the distribution of customer funds.
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2. Regulation Sec. 190.12: Required Reports and Records: Consideration
of Costs and Benefits
Section 190.12(a)(1) is analogous to Sec. 190.03(a), in that it
provides instructions regarding how to give notice to the Commission
and to a clearing organization's members, where such notice is required
under subpart C. For a discussion of the costs and benefits of this
section, please refer to the discussion of the cost and benefit
implications of Sec. 190.03(a).
Section 190.12(a)(2) will revise the time in which a debtor
clearing organization must notify the Commission of a bankruptcy
filing. In particular: (1) In the event of a voluntary bankruptcy
filing, the debtor will be required to notify the Commission at or
before the time of filing, and (2) in the event of an involuntary
bankruptcy filing, the debtor must notify the Commission as soon as
possible, but in any event no later than three hours after the receipt
of the notice of such filing. These revisions codify expectations that
(1) in a voluntary bankruptcy proceeding, the debtor clearing
organization will provide advance notice to the Commission ahead of the
filing to the extent practicable, and (2) in an involuntary bankruptcy
proceeding, the debtor clearing organization will notify the Commission
immediately upon receiving notice of the filing, or within at the most
three hours thereafter.
With respect to a voluntary bankruptcy filing, the Commission
expects that the DCO will have reported its financial distress in the
lead-up to a bankruptcy filing in accordance with the mandatory
reporting requirements in Sec. 39.19(c)(4); the revision in proposed
Sec. 190.12(a) merely codifies the expectation that the clearing
organization will notify the Commission of an intent to file for
bankruptcy protection as soon as practicable before, and in no event
later than, the time of the filing. In addition, Sec. 190.12(a) also
will allow a debtor clearing organization to provide the relevant
docket number of the bankruptcy proceeding to the Commission ``as soon
as available,'' while not delaying notifying the Commission of the
filing itself, to account for the potential for a time lag between the
filing of a proceeding and the assignment by the relevant court of a
docket number. These revisions will enhance the ability of the
Commission to perform its responsibilities to support the interests of
clearing members, customers of clearing members, markets, and the
broader financial system, by providing the Commission with prompt
notice of any DCO bankruptcy proceeding.
Section 190.12(b) and (c) involve the provision of certain reports
and records to the trustee and/or the Commission by the debtor clearing
organization. In particular: Sec. 190.12(b) sets forth the reports and
records that the clearing organization will be required to provide to
the Commission and to the trustee within three hours following the
later of the commencement of the proceeding or the appointment of the
trustee, and Sec. 190.12(c) sets forth the records to be provided to
the Commission and to the trustee no later than the next business day
following commencement of a bankruptcy proceeding. These provisions
will impose administrative costs on the debtor clearing organization
and/or the trustee, which will be obligated to spend time and resources
transmitting copies of the required reports and records to the trustee
and/or Commission. However, these provisions should both benefit the
estate, and enhance the Commission's ability to fulfil its
responsibilities, by providing them with the most current information
about the clearing organization, and by allowing the trustee to begin
to understand the business of the clearing organization as soon as
possible following a bankruptcy filing, which is critically necessary
to the administration of the debtor clearing organization's estate.
This would in turn promote confidence in the clearing system in
particular, and financial markets more broadly.
OCC indicated that, while they ``maintain[ ] this information in a
readily accessible place and do[ ] not foresee any challenge in
identifying and providing this information without delay,'' they
believe that the three hour time period is ``overly prescriptive''
because of the possibility of ``unforeseen delays that could occur on
the day in which a DCO enters bankruptcy.'' The Commission has declined
to modify the proposal, because the Commission believes that setting
this specific deadline will result in significant benefits: Providing
this information to the trustee and the Commission with much-needed
expediency, and facilitating DCOs' contingency planning. By comparison,
the burden of providing the reports, which as the commenter notes, are
already in existence and are readily accessible, appears modest.
3. Regulation Sec. 190.13: Prohibitions on Avoidance of Transfers:
Consideration of Costs and Benefits
Section 190.13 implements section 764(b) of the Bankruptcy Code
with respect to DCOs, and prohibits the
[[Page 19410]]
avoidance of certain transfers made either before or shortly after
entry of the order for relief. While the prohibition of avoidance of
pre- and post-relief transfers in the context of FCM debtors in Sec.
190.07(e) applies so long as the transfer is not disapproved by
Commission, the same prohibition on avoidance of pre- and post-relief
transfers in Sec. 190.13(a) and (b) will require the affirmative
approval of the Commission (though such approval can be given either
before or after the transfer is made). This distinction will impose
administrative costs on the clearing organization or the trustee, who
will have to expend time and resources to seek affirmative approval
from the Commission for such a transfer in the context of administering
a DCO, respectively, either before or after bankruptcy. As noted
above,\283\ a clearing organization is mandated to maintain a
``balanced book.'' Thus, a transferee clearing organization may only
accept transfer of all of the transferor's customer positions (or at
least all positions in a given product set).\284\ Any such transfer
will have significant effects on the markets cleared, and on the
broader financial system. There are important benefits from requiring
the Commission's approval of such a significant transaction, and thus
permitting the administrative agency responsible for oversight of the
derivatives markets to maintain a level of discretion which will help
accomplish the goal of an orderly functioning of the marketplace.
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\283\ See section II.C.3 above.
\284\ If the transferor clearing organization does not have a
balanced book, e.g., because of a member default, it could
nonetheless only transfer a balanced book.
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4. Regulation Sec. 190.14: Operation of the Estate of the Debtor
Subsequent to the Filing Date: Consideration of Costs and Benefits
Section 190.14(a) provides that the trustee may, in their
discretion based upon the facts and circumstances of the case, instruct
each customer to file a proof of claim containing such information as
is deemed appropriate by the trustee. Allowing the bankruptcy trustee
to use their discretion in tailoring the proof of claim form to the
specific facts and circumstances of the case should benefit both the
trustee and customers by limiting the information requested to only
that which is necessary for purposes of administering the debtor's
estate and thereby increasing cost effectiveness, particularly given
the bespoke nature of a clearing organization bankruptcy. Thus, the
Commission has not proposed a prescribed proof of claim form. There
could, however, be corresponding administrative costs to both the
estate and the customers if the set of information requested by the
trustee in the exercise of their discretion turns out in retrospect to
be overly narrow or broad.
ICE believed that the proposal did not clearly take into account
non-CFTC-regulated clearing, and that claims of members with respect to
such activity should be properly accounted for in bankruptcy and should
not be disadvantaged. As the Commission noted above,\285\ to the extent
that the DCO is conducting non-CFTC-regulated activity, the Commission
expects that the proof of claim form will include the opportunity to
claim for debts of the DCO related to activity that is not regulated by
the CFTC. Thus, no change is necessary to address this concern.
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\285\ See section II.C.4.
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Section 190.14(b) provides that a debtor clearing organization will
cease making calls for variation settlement or initial margin.\286\
Under current regulations, it would not be possible to continue the
operations of a debtor clearing organization for any amount of time
after entry of the order for relief, as there is no clear and coherent
mechanism to do so. Thus, Sec. 190.14(b) affirms current legal
requirements and maintains the status quo. Section 190.14(c)(1)
provides that the trustee shall liquidate all open commodity contracts
that have not been terminated, liquidated or transferred no later than
seven calendar days after the entry of the order for relief. This
provision will impose administrative costs in that the trustee will
have a hard deadline for terminating, liquidating or transferring any
open commodity contracts within a certain timeframe, whereas under
current part 190 there was no specified timeframe for such termination,
liquidation or transfer. It could, however, benefit clearing members
and customers, who will have certainty that their open commodity
contracts would be liquidated within a particular timeframe rather than
being held open for an undetermined amount of time. A deadline for
liquidation or transfer of open contracts may benefit the broader
financial markets by mitigating uncertainty.
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\286\ As originally proposed, Sec. 190.14(b) also contained
provisions that were intended to provide a brief opportunity, after
the order for relief, to enable paths alternative to liquidation--
that is, resolution under Title II of the Dodd-Frank Act, or
transfer of clearing operations to another DCO--in cases where a
short delay (i.e., less than or equal to six days) might facilitate
such an alternative path. The Commission subsequently issued the
Supplemental Proposal, which withdrew those proposed provisions--
Sec. 190.14(b)(2) and (3)--and proposed a new alternative to
facilitate the potential resolution of a SIDCO pursuant to Title II
of the Dodd-Frank Act. As discussed in section II.C.4 above, the
Commission is not adopting the Supplemental Proposal.
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Section 190.14(c)(2), which is derived from current Sec.
190.08(d)(3), will provide that the trustee may, at their discretion,
make distributions in the form of securities that are equivalent to the
securities originally delivered to the debtor by a clearing member or
such clearing member's customer, rather than liquidating the securities
and making distributions in cash. Unlike current Sec. 190.08(d)(3),
Sec. 190.14(c)(2) will not allow the customer to request that the
trustee purchase like-kind securities and distribute those instead of
cash, but instead will leave it to the discretion of the trustee
whether to do so. This change could impose costs on customers who would
prefer to have a distribution of equivalent securities rather than
cash, since it will remove their option to request such a distribution.
However, it could benefit the estate by allowing the trustee to use
their discretion as to whether to purchase and distribute equivalent
securities, rather than being obligated to do so at the request of a
customer.
Section 190.14(d) will require the trustee to use reasonable
efforts to compute the funded balance of each customer account
immediately prior to the distribution of any property in the account,
``which shall be as accurate as reasonably practicable under the
circumstances, including the reliability and availability of
information.'' This requirement applies with respect to accounts of the
customers of the clearing organization: That is, its members,
separately in respect of each such member's (1) house account (on
behalf of the member and its non-public customers and (2) customer
account or accounts (on behalf of the member's public customers, one
such account for each account class, to the extent relevant).
This requirement will impose administrative costs due to the time
and effort involved in making such calculations. However, the
regulation gives the trustee a certain amount of discretion, and this
calculation will be necessary to achieve the goal of making
distributions that are consistent with each customer's proportionate
share.
5. Regulation Sec. 190.15: Recovery and Wind-Down Plans; Default Rules
and Procedures: Consideration of Costs and Benefits
Section 190.15 provides that (1) the trustee shall not avoid or
prohibit any
[[Page 19411]]
action taken by a debtor that was within the scope of and was provided
for in the debtor's recovery and wind-down plans; (2) in administering
a DCO bankruptcy, the trustee shall, subject to the reasonable
discretion of the trustee and to the extent practicable, implement the
default rules and procedures maintained by the debtor; and (3) in
administering a DCO bankruptcy, the trustee shall, to the extent
reasonable and practicable, and consistent with the protection of
customers, take actions in accordance with the debtor's recovery and
wind-down plans.
The Commission considered two alternatives to directing the trustee
to implement the debtor's own default rules and procedures and recovery
and wind-down plans: First, continuing to allow a bankruptcy trustee to
develop, in the moment, a plan for liquidating the debtor clearing
organization, and second, prescribing an across-the-board method for
liquidating a debtor clearing organization.
A number of commenters appeared to support the first alternative
approach. Some (e.g., ACLI, FIA, ICI, SIFMA AMG/MFA, Vanguard)
expressed concern that they lack transparency with regard to the DCO
risk management decisions and DCOs' default rules and procedures and
recovery and wind-down plans are developed without sufficient input
from clearing members and their customers. For example, Vanguard argued
that the existing DCO governance regime provides them with no
meaningful voice in critical DCO risk management practices and new
cleared product introductions; and since public customers have only a
very limited ability to mitigate clearing risks contractually, they
``rely heavily on the Commission to protect the interests of [their]
investors in the mandated cleared market.'' Commenters also expressed
the concern that there is a risk that, as a DCO begins to fail,
otherwise prudent DCO rules could be changed without the appropriate
vetting by clearing members and public customers who, given mutualized
allocation of losses, bear the risk of poor risk management choices
undertaken by the DCO.\287\
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\287\ With respect to DCO rules adopted as the DCO is on the
threshold of failure: DCO rules are subject to review by the
Commission. In all cases, they are subject to review for consistency
with the CEA and Commission regulations (see Sec. 40.6). In the
case of SIDCOs, they are additionally subject to review for
consistency with the purposes of the Dodd-Frank Act or any
applicable rules, orders, or standards prescribed under section
805(a) thereof. Moreover, to the extent commenters are concerned
that such late-enacted rules will be unfair to clearing members or
their customers, the Commission expects that such unfairness would
affect the trustee's judgment of the extent to which it is
``reasonable'' to apply those rules.
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The Commission has considered the potential interplay of the
amendments to part 190 with other Commission regulations and applicable
statutes. As noted above, these commenters' concerns predominantly
relate to the economic interests of clearing members and their
customers in contexts outside of bankruptcy.
A DCO's operations and rules outside of bankruptcy are governed by
parts 39 and 40 of the Commission's regulations. The Commission, in
particular through its Division of Clearing and Risk, applies these
regulations and conducts a rigorous program of oversight of DCOs
designed to protect the interests of market participants and of the
financial system, including through careful reviews of their rules
(including default rules) and their recovery and wind-down plans,
through detailed daily and periodic risk surveillance, and through in-
depth remote and on-site examinations addressing a wide spectrum of
risk management issues.
As noted by a commenter above, they ``rely heavily on the
Commission to protect the interests of our investors in the mandated
cleared market.'' Over the years, the Commission has taken seriously
its responsibilities in this regard, through its regulatory,
surveillance, and examinations programs.
As discussed above, there are important costs to addressing, in the
context of part 190, market participants' concerns regarding DCOs'
rules, procedures, and plans for allocating losses that apply outside
of a DCO bankruptcy: Establishing a bankruptcy regime where some market
participants would be allocated a smaller amount of losses in
bankruptcy than outside of bankruptcy would risk creating incentives
for those participants to act in a manner that promotes the likelihood
that the DCO will enter bankruptcy.
In view of these considerations, the Commission believes the
commenters' concerns are effectively mitigated by the existing
provisions of parts 39 and 40 of its regulations and by the
Commission's supervision of DCOs.\288\ Therefore, the adoption of part
190, subpart C, which is applicable to a DCO's potential bankruptcy,
appropriately complements parts 39 and 40 and the Commission's ongoing
supervision, which apply to a DCO's operations and rules outside of
bankruptcy.
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\288\ Nonetheless, the Commission is sensitive to the concerns
raised by commenters with respect to the development and maintenance
of DCO recovery and wind-down plans and default rules and
procedures, and is actively reviewing these issues, in particular
with respect to governance, as they relate to parts 39 and 40.
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Other commenters are concerned with the inclusion in those DCO
rules and plans of ``drastic measures as Variation Margin Gains
Haircutting (VMGH) and Partial Tear-Up (PTU) of open positions.'' Gains
haircutting, however, is part of the ex ante allocation of losses, and
thus is an inherent part of the way in which losses will be allocated
in bankruptcy. Moreover, there is a limited amount of customer property
available. Thus, to the extent the application of VMGH were to be
disallowed, and some customers would realize corresponding benefits
through increases in the allowed amounts of their claims (and thus a
greater share of customer property), other customers would suffer
corresponding costs, through a decreased share of customer property--
indeed, the latter customers may receive less than the amount of their
claims for initial margin.\289\ Accordingly, the Commission concludes
that it is inadvisable to prohibit VMGH, or to mandate that its effects
be reversed, in cases of DCO bankruptcy.
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\289\ Cf. ISDA: Safeguarding Clearing: The Need for a
Comprehensive CCP Recovery and Resolution Framework (2017) at 2
(``Initial margin haircutting should never be permitted.'')
---------------------------------------------------------------------------
Partial tear-up, on the other hand, is inapplicable in a clearing
organization bankruptcy: Sec. 190.14(b) prohibits further collection
of variation margin, while Sec. 190.14(c) requires the trustee to
liquidate all open commodity contracts. Together, they effectively
mandate full tear-up of open positions. Thus, the question of whether
partial tear-up should be prohibited is moot.
Other commenters were concerned that these plans do not prescribe a
specific course of action, but rather ``present a menu of options.''
See, e.g., FIA, Vanguard. The Commission is of the view that, given the
complexity of the operations of a DCO, and the need for extremely
prompt action, having the trustee develop an entire plan in the moment
would be likely to turn out to be impracticable. By contrast, being
presented with a ``menu of options'' among which the trustee may select
(and adapt) in a manner that is ``reasonable and practicable'' provides
the benefit of a helpful roadmap to determine strategy and tactics.
The commenters, and potentially other clearing members and public
customers who share the concerns of the commenters, appeared to view
DCO default rules and procedures and recovery and wind-down plans that
they believe have been adopted with
[[Page 19412]]
inadequate input from them as noxious, and thus they may already be
incentivized to reduce their exposure to such DCOs. Those incentives
may be (marginally) increased by the fact that the Commission is
establishing in Sec. 190.15 a model for the trustee that is based on
those rules, procedures, and plans.
Other commenters (CME and ICE) supported the second alternative,
specifically, a requirement that the trustee cannot override the DCO's
default rules or deviate from the DCO's recovery or wind-down plans.
However, given that these rules and plans are designed to operate
outside of bankruptcy, a requirement to follow them in procrustean
fashion would have the cost of compelling the trustee to adopt an
approach that may be poorly tailored to the situation, and the
Commission will accordingly not adopt such a requirement.
Finally, given the differences between DCOs (and potential
bankruptcy situations), a one-size-fits-all approach prescribed by the
Commission is likely to prove too rigid, and thus will not be adopted.
The Commission is accordingly of the view that, relative to these
alternatives, directing a trustee to implement the DCO's own default
rules and procedures, and recovery and wind-down plans, would benefit
the estate by providing the trustee with a menu of purpose-built rules,
procedures and plans to liquidate a DCO, which rules, procedures and
plans the DCO has developed subject to the requirements of the
Commission's regulations and supervision of the Commission. Adding
concepts of reasonability and practicability will give the trustee the
discretion to modify those rules, procedures, and plans where and to
the extent appropriate. Hence, the Commission believes that an approach
whereby the trustee would follow the DCO's own purpose-built default
rules and procedures and recovery and wind-down plans, but have the
discretion to vary them as appropriate, would be the most cost
effective.
6. Regulation Sec. 190.16: Delivery: Consideration of Costs and
Benefits
Regulation Sec. 190.16 addresses delivery in the context of a
clearing organization bankruptcy. Current part 190 does not contain any
regulations specific to delivery in that context.
Section 190.16(a) provides that a bankruptcy trustee is required to
use ``reasonable efforts'' to facilitate and cooperate with the
completion of the delivery on behalf of the clearing organization's
clearing member or the clearing member's customer. This has the benefit
of mitigating disruption to the cash market for the commodity and
mitigating adverse consequences to parties that may be relying on
delivery taking place in connection with their business operations.
While the exertion of such reasonable efforts will necessarily involve
administrative costs (predominantly, time of the trustee or their
agents), the Commission is of the view that this approach has important
benefits relative to the two alternatives. Given the importance of
reliable delivery to physical markets, it would be inappropriate to
relieve the trustee of the obligation to endeavor to facilitate and
cooperate with the members' or members' customers' efforts to
accomplish delivery. On the other hand, mandating that the trustee go
beyond reasonable efforts would risk compelling the trustee to expend
unwarranted amounts of resources in this endeavor.
While proposed Sec. 190.16(a) applied this approach only to
contracts that had moved into delivery position prior to the date and
time of the order for relief, the ABA Subcommittee and CME suggested
that this approach should be extended to contracts that move into
delivery position after that date and time, with CME noting that ``it
is equally important to protect deliveries under [such contracts] to
avoid disruption to commercial markets and operations.'' The Commission
has accepted this suggestion and notes that, if any contracts move into
delivery position after the order for relief, but before being
terminated, liquidated, or transferred, the benefits and costs of this
approach are analogous to those of contracts that move into delivery
position prior to the order for relief.
Section 190.16(b) clarifies which property will be part of the
physical delivery account class and which will be part of the cash
delivery account class. It is analogous to Sec. 190.06(b) in the FCM
context, and carries forward the concepts in that section, but has been
modified for the context of a DCO bankruptcy. Clearly delineating
between the physical delivery account class and the cash delivery
account class will benefit customers because it will increase
transparency in terms of which account class their property belongs in.
Section 190.16(b) will likely impose administrative costs, since
accounting separately for physical delivery property and cash delivery
property will take the trustee's time and resources. As noted
above,\290\ the sub-division of the delivery account class into the
physical and cash delivery account classes will recognize that cash is
more vulnerable to loss, and more difficult to trace, as compared to
physical delivery property. Therefore, this sub-division will likely
benefit those with physical delivery claims. Since cash is more
vulnerable to loss and more difficult to trace, then under this
approach, clearing members and customers with claims in the cash
delivery sub-class will be more likely to get a pro rata distribution
that would be less than those with claims in the physical delivery
property sub-class.\291\
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\290\ See discussion of Sec. 190.06(b) in section II.B.4 above.
\291\ Costs and benefits of the separation of the delivery
account class into physical delivery and cash delivery subclasses
were also addressed in respect to the costs and benefits section
addressing the definition of ``account class'' in Sec. 190.01,
section II.A.2 above.
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7. Regulation Sec. 190.17: Calculation of Net Equity: Consideration of
Costs and Benefits
Section 190.17(a) clarifies that a member of a debtor clearing
organization may have claims against the clearing organization in
separate capacities: On behalf of its public customers (customer
accounts) and on behalf of its non-public customers (house accounts).
It further states that net equity shall be calculated separately for
each customer capacity in which the clearing member has a claim against
the debtor. In the Commission's view, the provisions in Sec. 190.17(a)
are clarifications that reflect customer classifications set forth in
section 766(i) of the Bankruptcy Code, and account classifications that
have long been used in other contexts, and will not impose any costs or
benefits on any parties.
Section 190.17(b)(1) provides that the calculation of a clearing
member's net equity claim in the bankruptcy of a clearing organization
shall include the full application of the debtor's loss allocation
rules and procedures. It also provides that, with respect to a clearing
member's house account, this will include any assessments or similar
loss allocation arrangements provided for under those rules and
procedures that were not called for before the filing date, or, if
called for, have not been paid.
A number of commenters, including the ABA Subcommittee, CME, FIA,
and ICE, objected to including assessments that had not been called for
before the order for relief in the calculation of net equity claims
where the debtor clearing organization's rules provide that assessments
cannot be called for after bankruptcy. Taking these commenters'
preferred approach would benefit the clearing members in circumstances
where there are both uncalled
[[Page 19413]]
assessments, and remaining default losses. As FIA noted in its comment
letter, the inclusion of uncalled assessments ``appears to have the
effect of reducing a clearing member's potential recovery.'' However,
all losses will ultimately be allocated, and if uncalled assessments
are not taken into account, any remaining losses that haven't been
covered by other default resources will be allocated through gains-
based haircutting. Thus, the commenters' preferred approach would be at
the cost of the customers of clearing members, who would bear
additional losses even as the clearing members would benefit.
Relative to the alternative suggested by these commenters, the
direct effect of Sec. 190.17(b)(1) is to ensure that the uncalled
assessment will make up more of the default losses, and conversely that
haircutting of the gains (of both clearing members and customers) will
make up less of that loss. Hence, the rule could harm clearing members,
and correspondingly benefit their customers. In addition, there can be
indirect effects. While the maximum amount of assessments that clearing
members are exposed to will not increase, there is a marginally \292\
increased likelihood that those assessments will be used.\293\ Because
clearing members' potential assessments are more likely to be used,
they will have a marginally increased incentive to reduce their level
of exposure to assessments--for example, by reducing their clearing
activity for themselves or on behalf of their customers. While it is
conceivable that clearing members could work to influence DCOs to
reduce their own assessment powers as a result of these incentives,
there are mitigants in the Commission's regulations.\294\
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\292\ ``Marginal'' because this happens only if (a) there is a
DCO bankruptcy, (b) there is a default loss suffered by the DCO in
connection with the bankruptcy, and (c) not all of the assessments
necessary to address that default loss were called before that
bankruptcy.
\293\ While Sec. 190.17(b)(1) will not result in uncalled
assessments being ``called''--the clearing members will not have to
pay them to the estate--uncalled assessments will be ``used'' to
reduce the clearing member's net equity claim.
\294\ For example, Sec. 39.39(b)(1) requires SIDCOs and Subpart
C DCOs to have viable plans for recovery necessitated by uncovered
credit losses, and the extent of a DCO's assessment power
contributes to the viability of its recovery plan. Moreover, the two
SIDCOs, CME and ICE Clear Credit, already have significant
assessment powers, and any proposed rule change to reduce those
powers would need to withstand review under Sec. 40.10 for
consistency with inter alia, the purposes of the CEA and the Dodd-
Frank Act, which include the mitigation of systemic risk and the
promotion of financial stability.
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Section 190.17(b)(2) provides that where the debtor's loss
allocation rules and procedures provide that clearing members are
entitled to payments due to portions of mutualized default resources
that are either prefunded, or assessed and collected, but in either
case not used, or to the clearing organization's recoveries on claims
against others (including recoveries on claims against defaulting
clearing members), then ``appropriate adjustments shall be made to the
net equity claims of clearing members that are so entitled.'' These
provisions will benefit the estate by providing the trustee with tools
to act promptly and efficiently, with lower administration costs. The
trustee will have a clear roadmap to calculate net equity in the
bankruptcy of a clearing organization and will not be obligated to come
up with an ad hoc methodology for doing so. The provisions would also
benefit clearing members (and, therefore, their customers) by providing
transparency as to how their net equity will be calculated, as well as
facilitating the efficient administration of the estate.\295\
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\295\ See also 17 CFR 39.16 (requiring each DCO to, among other
things, ``adopt rules and procedures designed to allow for the
efficient, fair, and safe management of events during which clearing
members become insolvent or default on the obligations of such
clearing members to the'' DCO).
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In those cases where the debtor has excess mutualized default
funds, or recovers on claims against defaulters, application of the
debtor's ``reverse waterfall'' rules will benefit clearing members
(and, in certain cases, their customers) by increasing the net equity
claims of the entitled clearing members.
In addition to the potential for these transfers between general
creditors and clearing members and their customers, this rule can
create incentives for clearing members and their customers. In
particular, it makes clearing members' contributions to mutualized
resources (and the possibility that gains-based haircutting will affect
clearing members and their customers) less onerous, because they
enhance the possibility that if the clearing member's contribution to
mutualized default resources (or gains-based haircutting affecting
clearing members or their customers) is used to meet a default, it
ultimately will come back to the clearing member or their customers as
it is recovered by the DCO (or the DCO's trustee) from the (bankruptcy)
estate of the defaulter.
Section 190.17(c) adopts by reference the net equity calculations
set forth in proposed Sec. 190.08, to the extent applicable.\296\
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\296\ For a discussion of the cost and benefit considerations
for Sec. 190.08, please see section IV.C.6 above.
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Section 190.17(d) sets forth a definition of the term ``funded
balance'' that is taken directly from the relevant Bankruptcy Code
provisions. Clarifying the meaning of the term ``funded balance'' in
the context of a clearing organization bankruptcy will benefit clearing
members, in that they will know ex ante what is and is not included in
their funded balance and how that amount is calculated. In addition,
Sec. 190.17(d) adopts by reference the methodology for calculating
funded balance that is set forth in Sec. 190.08(c).\297\
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\297\ For a discussion of the cost and benefit considerations
for Sec. 190.08(c), please see section III.C.6 above.
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8. Regulation Sec. 190.18: Treatment of Property: Consideration of
Costs and Benefits
Section 190.18(a) is analogous to Sec. 190.17(a), in that it will
provide that property of the debtor clearing organization's estate will
be allocated between member property and customer property other than
member property in order to satisfy the proprietary and customer
claims, respectively, of clearing members. In the Commission's view,
the provisions in Sec. 190.18(a) are mere clarifications and do not
impose any costs or benefits on any parties.
Section 190.18(b)(1)(i) and (ii) set out the scope of customer
property for a clearing organization, and are largely based on Sec.
190.09(a).\298\
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\298\ For a discussion of the cost and benefit considerations
for Sec. 190.09(a), please see section III.C.7 above.
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Section 190.18(b)(1)(iii) provides that customer property for a
clearing organization includes any guaranty fund deposit, assessment or
similar payment or deposit made by a clearing member or recovered by a
trustee, to the extent any remains following administration of the
debtor's default rules and procedures, and any other property of a
member available under the debtor's rules and procedures to satisfy
claims made by or on behalf of public customers of a member. This
provision supports the goal of making customers of the clearing
organization whole, since it clarifies that any property described in
this section will be included in the scope of customer property, rather
than ultimately going to some other creditor of the debtor. It would
result in corresponding costs to non-customer creditors, and could
result in administrative costs, however, since the trustee could need
to spend time and resources in order to determine whether any such
property exists in order to properly allocate such property to
customers.
[[Page 19414]]
A number of commenters (CME, SIFMA AMG/MFA) have suggested that the
Commission make it explicit that customer property should include the
amounts of its own funds a debtor DCO had committed as part of its loss
allocation rules. The Commission has accepted this suggestion in the
final rule, incorporating this provision in Sec. 190.18(b)(1)(iv).
This will benefit customers, who will have additional funds allocated
to their claims, thereby increasing the payment that they receive on
their claims and/or increasing the likelihood of full payment of their
claims (due to an increase in customer property). However, this benefit
would accrue at the possible expense of general creditors, as there
will be an equivalent reduction in assets in the general estate. An
indirect consequence of this change might be to marginally incentivize
customers to retain open positions in contracts that are cleared by a
potentially-failing DCO, which might marginally contribute to
preserving liquidity in those markets.
Regulation Sec. 190.18(b)(2) adopts by reference, in the context
of a DCO as a debtor, the exclusions from customer property applied in
the context of debtor FCMs in Sec. 190.09(a)(2), as if the term debtor
used therein would refer to a clearing organization as debtor and to
the extent relevant to a clearing organization.\299\
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\299\ For a discussion of the cost and benefit considerations
for proposed Sec. 190.09(a)(2), please see section III.C.7 above.
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Regulation Sec. 190.18(c) sets forth the allocation of customer
property among customer classes (i.e., allocation between (1) customer
property other than member property, and (2) member property). This
provision, in general, applies the principle, consistent with the
Commission's policy to favor public customers over non-public
customers, that allocation to customer property other than member
property is favored over allocation to member property, so long as the
funded balance in any account class for members' public customers is
less than one hundred percent of net equity claims. This provision
would, in the event and at the time it applied, benefit the public
customers of the debtor's clearing members, since it makes clear that
allocation to such customers is preferred over allocation to the
clearing members' house accounts. It imposes corresponding costs on the
debtor's clearing members and affiliates to the extent that, under the
current regime, there is a possibility that more customer property
would be allocated to their house accounts. Overall, this provision
provides the benefit of ex ante transparency to the estate, the
debtor's clearing members, and their customers, who would know during
business-as-usual how customer property would be allocated in the event
of a bankruptcy.
However, the ABA Subcommittee, CME, FIA, and ICE objected to
proposed Sec. 190.18(c)(1), which would apply the debtor's mutualized
(and, in general, member-funded) default fund to customer property
other than member property, that is, to the customer class for members'
public customers, to the extent the funded balance is less than one
hundred percent for members' public customers in any account class. CME
raised a particularly trenchant point: Devoting member-funded guarantee
funds to purposes other than mutualizing member defaults may result in
more onerous capital treatment for the contributions of bank- or bank-
affiliated-members to such funds, increasing the capital charges for
such exposures manifold.\300\
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\300\ As discussed in detail in a footnote in section II.C.8,
those capital charges could increase by literally hundreds of times,
for a total impact of billions of dollars in increased capital
charges.
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As noted, the costs and benefits discussed above will only accrue
if there is both a clearing organization bankruptcy and a shortfall in
customer funds in one or more of the account classes for members'
public customers for that clearing organization in that bankruptcy. The
costs and benefits at that potential future time would be balanced, in
that the costs to clearing members (whose guarantee funds were devoted
to claims of the clearing members' customers) would be benefits to
those customers. By contrast, less favorable capital treatment would
have a present-day effect, in the form of higher capital costs for
clearing members. Moreover, those higher costs would not create any
direct benefit (present day or otherwise) for, e.g., customers. In
light of these factors, the Commission has decided not to adopt
proposed Sec. 190.18(c)(1) and to renumber the remaining paragraphs of
Sec. 190.18(c).
Section 190.18(d) sets forth the allocation of customer property
among account classes. This provision is similar in concept to Sec.
190.09(c). This provision will benefit clearing members and their
customers, who will have increased transparency, ex ante, into how
customer property will be allocated. Prescribing this allocation will,
however, impose administrative costs, because the trustee will lose
some amount of flexibility in terms of how to allocate customer
property between account classes.
Section 190.18(e) provides that, where the debtor has, prior to the
order for relief, kept initial margin for house accounts in accounts
without separation by account class, then member property will be
considered to be in a single account class.\301\ This provision will
benefit the estate in those cases, because the trustee will not be put
to the considerable task of separating in bankruptcy that which was
treated as a single account during business-as-usual. Paragraph (e)
will also benefit the debtor's clearing members, who will have
increased transparency as to how their member property will be treated.
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\301\ ``Account class'' is defined in Sec. 190.01 as meaning
one or more of each of the following types of accounts, as described
in greater detail in that provision: (1) Futures account; (2)
foreign futures account; (3) cleared swaps account; and (4) delivery
account.
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Section 190.18(f) gives the trustee the authority to assert claims
against any person to recover the shortfall of customer property
enumerated in certain paragraphs elsewhere in Sec. 190.18, analogous
to Sec. 190.09(a)(3). This provision could impose administrative
costs, since the trustee will need to expend time and resources to
assert claims to make up for any shortfall in customer property. The
provision will, however, benefit customers, since it will support the
trustee's efforts to recover any such shortfalls by giving the trustee
authority to act to do so. Moreover, since this provision will make
explicit what is implicit in current part 190, an additional benefit of
this provision is a reduction in potential litigation costs over a
trustee's attempts to recover shortfalls in customer property.\302\
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\302\ As discussed above in section III.C.7, while the persons
against whom claims are successfully asserted may perceive a
subjective cost, the Commission does not find these costs relevant
to the analysis.
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9. Regulation Sec. 190.19: Support of Daily Settlement: Consideration
of Costs and Benefits
Section 190.19 deals with the treatment of variation settlement in
a clearing organization bankruptcy, and sets forth the approach for the
trustee to follow when there is a shortfall in variation settlement
owed to a debtor clearing organization's clearing members and
customers. Specifically, Sec. 190.19(a) provides that any variation
settlement payments received by the clearing organization after entry
of an order for relief shall be included in customer property, and
shall promptly be distributed to the member and customer accounts
entitled to such payments. Section 190.19(b) deals with a situation
where there is a shortfall in
[[Page 19415]]
variation settlement received by the clearing organization, and
provides that such funds shall be supplemented with four specified
categories of funds (margin, to the extent permissible under parts 1,
22, and 30, assets of the debtor, to the extent dedicated to such
purpose, prefunded guarantee funds, and assessments) in accordance with
the clearing organization's default rules and procedures and (with
respect to assets of the debtor) any recovery and wind-down plans
maintained by the clearing organization.
Section 190.19 will benefit clearing members and their customers
because it will ensure that any variation settlement received by the
clearing organization will be sent to those member and customer
accounts that would be entitled to payment of variation settlement, and
that the trustee would be able to supplement any shortfall in variation
settlement amounts with the property listed in proposed Sec.
190.19(b). This approach will also benefit the financial system more
broadly, by mitigating the effect of the bankruptcy of the debtor on
settlement payments. There will be corresponding costs to general
creditors of the clearing organization since, under current part 190,
it is conceivable that, contrary to the Commission's interpretation of
the current rules, variation settlement received by the clearing
organization could be diverted to the pool of general creditors rather
than becoming customer property (even though such diversion would be
contrary to the expectations of both the Commission and the industry).
In clarifying how variation settlement received by the clearing
organization is to be treated by the bankruptcy trustee, Sec. 190.19
will also benefit clearing members and their customers by providing
enhanced transparency.
10. Section 15(a) Factors--Subpart C
i. Protection of Market Participants and the Public
Subpart C of the part 190 regulations will increase the protection
of market participants and the public by setting forth a bespoke
framework for how the bankruptcy trustee is expected to treat the
property of DCO clearing members and their customers in the event of a
DCO insolvency, thereby promoting ex ante transparency for such
clearing members and customers, and by providing, in certain
provisions, discretion to the trustee in determining how best to
address the bankruptcy of the DCO, and to achieve the goal of
protecting public customers as a class. Moreover, the addition in part
190 of bespoke bankruptcy rules for a DCO bankruptcy will provide
better protections to market participants by accounting for the unique
position of clearing members (and the customers of such clearing
member) of a DCO that is going through an insolvency proceeding.
Finally, provisions such as Sec. 190.18(c), which preferentially
allocate excess property in any account class to the customer class
that benefits public customers, to the extent there is a shortfall in
any account class in that customer class, will further protect public
customers.
ii. Efficiency, Competitiveness, and Financial Integrity
Subpart C of the part 190 regulations will promote efficiency (in
the sense of both cost effectiveness and timeliness) in the
administration of insolvency proceedings of DCOs, and the financial
integrity of transactions cleared by DCOs by setting forth clear
instructions for a bankruptcy trustee to follow in the event of a DCO
insolvency. Moreover, subpart C will provide the bankruptcy trustee
with discretion, in certain circumstances, to react flexibly to the
particulars of the insolvency proceeding, guided by the goal of
protecting public customers as a class, thereby promoting efficiency of
the administration of the proceeding. These effects will, in turn,
enhance the competitiveness of U.S. DCOs and their FCM clearing
members, by enhancing market confidence in the protection of customer
funds and positions entrusted to U.S. DCOs through their clearing
members, even in the case of insolvency.
iii. Price Discovery
Price discovery is the process of determining the price level for
an asset through the interaction of buyers and sellers and based on
supply and demand conditions. Because a DCO bankruptcy inevitably leads
to full close-out of the positions carried at the DCO, the part 190
regulations will not contribute to avoiding the resultant negative
impacts on price discovery.
iv. Sound Risk Management Practices
Subpart C of the part 190 regulations will promote sound risk
management practices by facilitating the bankruptcy trustee's efforts
to manage effectively the risk of the debtor DCO. Subpart C will
accomplish this by adding bankruptcy regulations to part 190 for a DCO
insolvency that reflect current market practices and thereby make it
easier for the trustee to act effectively to protect customer property
in the event of such an insolvency. Moreover, subpart C will promote
sound risk management practices by instructing a bankruptcy trustee to
implement the debtor DCO's default rules and procedures and to take
actions in accordance with the debtor DCO's recovery and wind-down
plans, which rules, procedures and plans are developed and overseen by
the Commission, though subject to the trustee's discretion. Some
portions of subpart C may make additional resources available to the
trustee. On the other hand, some commenters expressed concern about
changes (such as Sec. 190.15) that they believe might lead to
inappropriate risk management choices by DCOs.
v. Other Public Interest Considerations
By favoring the implementation of the clearing organization's
default rules, recovery plans, and procedures established ex ante under
the supervision of the Commission, and by supporting daily settlement,
the part 190 regulations will support financial stability. Moreover,
some of the DCOs that might enter bankruptcy are very large financial
institutions, and some are considered to be systematically important.
An effective bankruptcy process that efficiently facilitates the
proceedings is likely to benefit the financial system (and thus the
public interest), as that process will help to attenuate the
detrimental effects of the bankruptcy on the financial network.
E. Changes to Appendices A and B
The Commission is deleting forms 1 through 3 contained in appendix
A, which contain outdated provisions that require the collection of
unnecessary information, and is replacing form 4 with a streamlined
template proof of claim form, which the trustee can use in a flexible
manner. CME considered the template proof of claim ``a major
improvement'' over the current version. These changes have the benefit
of reducing administrative costs, and there are no obvious increased
costs.
Similarly, the Commission is making clarifying changes to framework
1 of appendix B, and making, consistent with the suggestions of the ABA
Subcommittee and the Subcommittee Members, a significant set of
clarifying changes to framework 2. These changes have the benefit of
having framework 2 work in a more accurate, and less confusing manner,
thus reducing administrative costs, and there are no obvious increased
costs.
F. Technical Corrections to Parts 1, 4, and 41
The Commission is making technical corrections to parts 1, 4, and
41 to
[[Page 19416]]
update cross-references. These corrections are clarifying and do not
have any impact on the substantive obligations related to these
sections. Thus, there are no increased costs associated with these
minor technical updates.
IV. Related Matters
A. Antitrust Considerations
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the CEA in issuing any order or adopting any Commission
rule or regulation.\303\
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\303\ Section 15(b) of the CEA, 7 U.S.C. 19(b).
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The Commission believes that the public interest to be protected by
the antitrust laws is the promotion of competition. The Commission has
considered this rulemaking to determine whether it might have
anticompetitive effects, and has not identified any effect this
rulemaking, which would apply only in the rare instance of an FCM or
DCO bankruptcy, would have on competition. Accordingly, the Commission
has not identified any less anticompetitive means of achieving the
purposes of the CEA.
B. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires that agencies
consider whether the regulations they propose will have a significant
economic impact on a substantial number of small entities and, if so,
provide a regulatory flexibility analysis on the impact.\304\ The
regulations being adopted by the Commission affect clearing
organizations, FCMs, bankruptcy trustees, and customers. The Commission
has previously established certain definitions of ``small entities'' to
be used in evaluating the impact of its regulations in accordance with
the RFA.\305\
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\304\ 5 U.S.C. 601 et seq.
\305\ 47 FR 18618 (Apr. 30, 1982).
---------------------------------------------------------------------------
The Commission has previously determined that clearing
organizations and FCMs are not small entities for purposes of the
RFA.\306\ In the event of a bankruptcy, a trustee is appointed as
receiver to manage the estate of the insolvent FCM or clearing
organization. Accordingly, since the trustee is representing the estate
of either an FCM or clearing organization, the trustee is not a small
entity for purposes of the RFA. The Commission recognizes that many
customers of an FCM or DCO in bankruptcy could be considered to be
small entities for purposes of the RFA. The Commission believes,
however, that the amendments to part 190 are designed so that they can
be implemented without imposing a significant economic burden on a
substantial number of small entities. These regulations take into
account existing trading practices and the logistical considerations of
implementing the regulations.
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\306\ See 66 FR 45604, 45609 (Aug. 29, 2001); 67 FR 53146, 53171
(Aug. 14, 2002).
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Accordingly, the Commission Chairman, on behalf of the Commission,
hereby certifies pursuant to 5 U.S.C. 605(b), that the rule adopted
herein will not have a significant economic impact on a substantial
number of small entities.
C. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (PRA) \307\ imposes certain
requirements on Federal agencies (including the Commission) in
connection with their conducting or sponsoring a collection of
information as defined by the PRA. The regulations adopted herein would
result in such a collection, as discussed below. A person is not
required to respond to a collection of information unless it displays a
currently valid control number issued by the Office of Management and
Budget (OMB). The regulations include a collection of information for
which the Commission has previously received control numbers from OMB.
The title of this collection of information is: OMB Control Number
3038-0021, ``Regulations Governing Bankruptcies of Commodity Brokers.''
---------------------------------------------------------------------------
\307\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
Information Collection 3038-0021 \308\ contains the reporting,
recordkeeping and third-party disclosure requirements in the
Commission's bankruptcy regulations for commodity broker liquidations
(17 CFR part 190). These regulations apply to liquidations under
chapter 7, subchapter IV of the Bankruptcy Code.\309\ The Commission
promulgated part 190 pursuant to the authority of 7 U.S.C. 24. The
Commission is amending Information Collection 3038-0021 as a result of
these final regulations to (1) accommodate new information collection
requirements for FCMs and DCOs, and (2) revise the existing information
collection requirements for FCMs and DCOs. The Commission did not
receive any comments regarding its PRA burden analysis in the preamble
to the proposal.
---------------------------------------------------------------------------
\308\ There are two information collections associated with OMB
Control No. 3038-0021. The first includes the reporting,
recordkeeping, and third-party disclosure requirements applicable to
a single respondent in a commodity broker liquidation (e.g., a
single FCM, DCO, or trustee) within the relevant time period. This
includes both (1) requirements on a single FCM or a single trustee
in an FCM bankruptcy which correspond to current requirements on a
single FCM or a single trustee in an FCM bankruptcy, as provided for
in Sec. Sec. 190.03(b)(1) and (2) and (c)(1), (2), and (4),
190.05(b) and (d), and 190.07(b)(5); and (2) new requirements on a
single DCO or a single trustee in a DCO bankruptcy as provided for
in Sec. Sec. 190.12(a)(2), (b)(1) and (2), and (c)(1) and (2) and
190.14(a) and (d). The second information collection includes the
third-party disclosure requirements that are applicable during
business as usual to multiple respondents (e.g., multiple FCMs).
These requirements were proposed as Sec. 190.10(b) and (e) (which
are analogs to current Sec. Sec. 190.06(d) and 190.10(c)), as well
as a new third-party disclosure requirement provided for in Sec.
190.10(d) (regarding letters of credit); however, the third-party
disclosure requirements are being adopted as Sec. Sec. 1.41, 1.43,
and 1.55(p).
\309\ 11 U.S.C. 761 et seq.
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1. Reporting Requirements in an FCM Bankruptcy
Regulation Sec. 190.03(b)(1) requires FCMs that file a petition in
bankruptcy to notify the Commission and the relevant DSRO, as soon as
practicable before and in any event no later than the time of such
filing, of the anticipated or actual filing date, the court in which
the proceeding will be or has been filed and, as soon as known, the
docket number assigned to that proceeding. It further requires an FCM
against which an involuntary bankruptcy petition or application for a
protective decree under SIPA is filed to notify the Commission and the
relevant DSRO immediately upon the filing of such petition or
application.
Regulation Sec. 190.03(b)(2) requires the trustee, the relevant
DSRO, or an applicable clearing organization to notify the Commission
if such person intends to transfer or apply to transfer open commodity
contracts or customer property on behalf of the public customers of the
debtor.
Based on its experience, the Commission anticipates that an FCM
bankruptcy would occur once every three years.\310\ The Commission has
estimated the burden hours for the reporting requirements in an FCM
bankruptcy as follows:
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\310\ These estimates express the burdens in terms of those that
would be imposed on one respondent during the three-year period.
---------------------------------------------------------------------------
Estimated number of respondents: 1.
Estimated annual number of responses per respondent: 1.\311\
---------------------------------------------------------------------------
\311\ The Commission estimates that (1) under Sec.
190.03(b)(1), an FCM would make two notifications per bankruptcy
(one to the Commission and one to its DSRO), and (2) under Sec.
190.03(b)(2), an FCM would make one notification per bankruptcy.
Dividing those numbers by three (since the Commission anticipates an
FCM bankruptcy occurring once every three years) results in 0.67
notifications annually pursuant to Sec. 190.03(b)(1), and 0.33
notifications annually pursuant to Sec. 190.03(b)(2), for a total
of one notification annually per respondent.
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[[Page 19417]]
Estimated total annual number of responses for all respondents: 1.
Estimated annual number of burden hours per respondent: 1.\312\
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\312\ The Commission estimates that (1) the notifications
required under Sec. 190.03(b)(1) would take 0.5 hours to make, and
(2) the notification required under Sec. 190.03(b)(2) would take 2
hours to make. In terms of burden hours, this amounts to (0.5*0.67
under Sec. 190.03(b)(1)) plus (2*0.33 under Sec. 190.03(b)(2)), or
a total of one burden hour annually per respondent.
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Estimated total annual burden hours for all respondents: 1.
2. Recordkeeping Requirements in an FCM Bankruptcy
Regulation Sec. 190.05(b) requires the trustee to use reasonable
efforts to compute a funded balance for each customer account that
contains open commodity contracts or other property as of the close of
business each business day subsequent to the order for relief until the
date all open commodity contracts and other property in such account
has been transferred or liquidated.
Regulation Sec. 190.05(d) requires the trustee to use reasonable
efforts to continue to issue account statements with respect to any
customer for whose account open commodity contracts or other property
is held that has not been liquidated or transferred.
Based on its experience, the Commission anticipates that an FCM
bankruptcy would occur once every three years.\313\ The Commission has
estimated the burden hours for the recordkeeping requirements in an FCM
bankruptcy as follows:
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\313\ These estimates express the burdens in terms of those that
would be imposed on one respondent during the three-year period.
---------------------------------------------------------------------------
Estimated number of respondents: 1.
Estimated annual number of responses per respondent:
26,666.67.\314\
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\314\ The Commission estimates that (1) under Sec. 190.05(b), a
trustee would compute a funded balance for customer accounts 40,000
times; and (2) under Sec. 190.05(d), a trustee would issue 40,000
account statements for customer accounts. Dividing those numbers by
three (since the Commission anticipates an FCM bankruptcy occurring
once every three years) results in 13,333.33 records annually
pursuant to Sec. 190.05(b), and 13,333.33 records annually pursuant
to Sec. 190.05(d), for a total of 26,666.67 records annually per
respondent.
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Estimated total annual number of responses for all respondents:
26,666.67.
Estimated annual number of burden hours per respondent:
266.67.\315\
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\315\ The Commission estimates that each record required under
Sec. 190.05(b) and 190.05(d) would take 0.01 hours to prepare. In
terms of burden hours, this amounts to (0.01*13,333.33 under Sec.
190.05(b)) plus (0.01*13,333.33 under Sec. 190.05(d)), or a total
of 266.67 burden hours annually per respondent.
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Estimated total annual burden hours for all respondents: 266.67.
3. Third-Party Disclosure Requirements Applicable to a Single
Respondent in an FCM Bankruptcy
Regulation Sec. 190.03(c)(1) requires the trustee to use all
reasonable efforts to promptly notify any customer whose futures
account, foreign futures account, or cleared swaps account includes
specifically identifiable property, and that such specifically
identifiable property may be liquidated on and after the seventh day
after the order for relief if the customer has not instructed the
trustee in writing before the deadline specified in the notice to
return such property pursuant to the terms for distribution of customer
property contained in part 190.
Regulation Sec. 190.03(c)(2) allows the trustee to treat open
commodity contracts of public customers identified on the books and
records of the debtor has held in an account designated as a hedging
account as specifically identifiable property of such customer.\316\
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\316\ The Commission no longer assigns burden hours to the
discretionary notice that a trustee may provide to customers in an
involuntary FCM bankruptcy proceeding pursuant to Sec.
190.03(c)(3). There have been no involuntary FCM liquidations and
none are anticipated. Accordingly, continuing to assign burden hours
to this voluntary requirement would inappropriately inflate the
burden hours of this information collection.
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Regulation Sec. 190.03(c)(4) requires the trustee to promptly
notify each customer that an order for relief has been entered and
instruct each customer to file a proof of customer claim containing the
information specified in Sec. 190.03(e).
Regulation Sec. 190.07(b)(5) requires the trustee, in the event
that specifically identifiable property has been or will be
transferred, to transmit any customer instructions previously received
by the trustee with respect to such specifically identifiable property
to the transferee of such property.
Based on its experience, the Commission anticipates that an FCM
bankruptcy would occur once every three years.\317\ The Commission has
estimated the burden hours for the third-party disclosure requirements
applicable to a single respondent in an FCM bankruptcy as follows:
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\317\ These estimates express the burdens in terms of those that
would be imposed on one respondent during the three-year period.
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Estimated number of respondents: 1.
Estimated annual number of responses per respondent:
10,003.32.\318\
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\318\ The Commission estimates that a trustee would make the
required disclosures under each of Sec. 190.03(c)(1), (2), and (4)
10,000 times per bankruptcy. Dividing those numbers by three (since
the Commission anticipates an FCM bankruptcy occurring once every
three years) results in 3,333.33 disclosures annually pursuant to
each of Sec. 190.03(c)(1), (2), and (4). The Commission further
estimates that a trustee would make the required disclosure under
Sec. 190.07(b)(5) 10 times per bankruptcy. Dividing this number by
three results in 3.33 disclosures annually pursuant to Sec.
190.07(b)(5). This amounts to a total of 10,003.32 disclosures
annually per respondent.
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Estimated total annual number of responses for all respondents:
10,003.32.
Estimated annual number of burden hours per respondent:
1,336.67.\319\
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\319\ The Commission estimates that (1) each disclosure required
under Sec. 190.03(c)(1) and (2) and (b) would take 0.1 hours to
prepare; (2) each disclosure required under Sec. 190.03(c)(4) would
take 0.2 hours to prepare; and (3) each disclosure required under
Sec. 190.07(b)(5) would take 1 hour to prepare. In terms of burden
hours, this amounts to (0.1*3,333.33 under Sec. 190.03(c)(1)) plus
(0.1*3,333.33 under Sec. 190.03(c)(2)) plus (0.2*3,333.33 under
Sec. 190.03(c)(4)) plus (1*3.33 under Sec. 190.07(b)(5)), or a
total of 1336.66 burden hours annually per respondent.
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Estimated total annual burden hours for all respondents: 1,336.67.
4. Reporting Requirements in a Derivatives Clearing Organization (DCO)
Bankruptcy
Regulation Sec. 190.12(a)(2) requires a clearing organization that
files a petition in bankruptcy to notify the Commission, at or before
the time of such filing, of the filing date, the court in which the
proceeding will be or has been filed and, as soon as known, the docket
number assigned to that proceeding. It further requires a clearing
organization against which an involuntary bankruptcy petition is filed
to similarly notify the Commission within three hours after the receipt
of notice of such filing.
Regulation Sec. 190.12(b)(1) requires the debtor clearing
organization to provide to the trustee, no later than three hours
following the later of the commencement of a bankruptcy proceeding or
the appointment of the trustee, copies of each of the most recent
reports that the debtor was required to file with the Commission under
Sec. 39.19(c).
Regulation Sec. 190.12(b)(2) requires the debtor clearing
organization to provide to the trustee and the Commission, no later
than three hours following the commencement of a bankruptcy proceeding,
copies of (1) the most recent recovery or wind-down plans of the debtor
maintained pursuant to Sec. 39.39(b), and (2) the most recent version
of the debtor's default management plan and default rules and
procedures maintained pursuant to Sec. 39.16 and, as applicable, Sec.
39.35.
Regulations Sec. 190.12(c)(1) and (2) require the debtor clearing
organization
[[Page 19418]]
to make available to the trustee and the Commission, no later than the
next business day following commencement of a bankruptcy proceeding,
copies of (1) all records maintained by the debtor pursuant to Sec.
39.20(a), and (2) any opinions of counsel or other legal memoranda
provided to the debtor in the five years preceding the bankruptcy
proceeding relating to the enforceability of the rules and procedures
of the debtor in the event of an insolvency proceeding involving the
debtor.
Based on its experience, the Commission anticipates that a clearing
organization bankruptcy would occur once every fifty years.\320\ The
Commission has estimated the burden hours for the reporting
requirements in a DCO bankruptcy as follows:
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\320\ No U.S. clearing organization has ever been the subject of
a bankruptcy proceeding, and none has come anywhere near insolvency.
While there have been less than a handful of central counterparties
worldwide that became functionally insolvent during the twentieth
century, none of those were subject to modern resiliency
requirements. Accordingly, the Commission believes that an estimate
of one DCO bankruptcy every fifty years is an appropriate estimate.
These burden estimates express the burdens in terms of those that
would be imposed on one respondent during the fifty-year period.
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Estimated number of respondents: 1.
Estimated annual number of responses per respondent: 2.98.\321\
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\321\ The Commission estimates that (1) under Sec.
190.12(a)(2), a clearing organization would make two notifications
per bankruptcy; (2) under Sec. 190.12(b)(1), a clearing
organization would provide 40 reports to the trustee; (3) under
Sec. 190.12(b)(2), a clearing organization would provide 5 reports
to the trustee and the Commission; (4) under Sec. 190.12(c)(1), a
clearing organization would provide 100 records to the trustee and
the Commission; and (5) under Sec. 190.12(c)(2), a clearing
organization would provide 2 records to the trustee and the
Commission. Dividing those numbers by 50 (since the Commission
anticipates a clearing organization bankruptcy occurring once every
50 years) results in (1) 0.04 reports annually pursuant to Sec.
190.12(a)(2); (2) 0.8 reports annually pursuant to Sec.
190.12(b)(1); (3) 0.1 reports annually pursuant to Sec.
190.12(b)(2); (4) 2 reports annually pursuant to Sec. 190.12(c)(1);
and (5) 0.04 reports annually pursuant to Sec. 190.12(c)(2), for a
total of 2.98 reports annually per respondent.
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Estimated total annual number of responses for all respondents:
2.98.
Estimated annual number of burden hours per respondent: 0.61.\322\
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\322\ The Commission estimates that (1) each notification
required under Sec. 190.12(a)(2) and (d)(2) would take 0.5 hours to
make; (2) gathering the reports required under Sec. 190.12(b)(1)
would take 0.2 hours; (3) gathering the reports required under Sec.
190.12(b)(2) would take 0.2 hours; (4) gathering the reports
required under Sec. 190.12(c)(1) would take 0.2 hours; and (5)
gathering the reports required under Sec. 190.12(c)(2) would take
0.2 hours. In terms of burden hours, this amounts to (0.5*0.04 under
Sec. 190.12(a)(2)) plus (0.2*0.8 under Sec. 190.12(b)(1)) plus
(0.2*0.1 under Sec. 190.12(b)(2)) plus (0.2*2 under Sec.
190.12(c)(1)) plus (0.2*0.04 under Sec. 190.12(c)(2)), or a total
of 0.61 burden hours annually per respondent.
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Estimated total annual burden hours for all respondents: 0.61.
5. Recordkeeping Requirements in a DCO Bankruptcy
Regulation Sec. 190.14(d) requires the trustee to use reasonable
efforts to compute a funded balance for each customer account that
contains open commodity contracts or other property as of the close of
business each business day subsequent to the order for relief on which
liquidation of property within the account has been completed or
immediately prior to any distribution of property within the account.
Based on its experience, the Commission anticipates that a clearing
organization bankruptcy would occur once every fifty years.\323\ The
Commission has estimated the burden hours for the recordkeeping
requirements in a DCO bankruptcy as follows:
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\323\ These estimates express the burdens in terms of those that
would be imposed on one respondent during the fifty-year period.
---------------------------------------------------------------------------
Estimated number of respondents: 1.
Estimated annual number of responses per respondent: 9.\324\
---------------------------------------------------------------------------
\324\ The Commission estimates that, under Sec. 190.14(d), a
clearing organization would compute a funded balance for customer
accounts 450 times during a bankruptcy. This number is based on an
average of 45 clearing members, each with two accounts (house and
customer). Dividing that number by 50 (since the Commission
anticipates a clearing organization bankruptcy occurring once every
50 years) results in 9 records annually per respondent.
---------------------------------------------------------------------------
Estimated total annual number of responses for all respondents: 9.
Estimated annual number of burden hours per respondent: 0.9.\325\
---------------------------------------------------------------------------
\325\ The Commission estimates that computing the funded balance
of customer accounts pursuant to Sec. 190.14(d) would take 0.1
hours per computation. In terms of burden hours, this amounts to
(0.1*9), or 0.9 burden hours annually per respondent.
---------------------------------------------------------------------------
Estimated total annual burden hours for all respondents: 0.9.
6. Third-Party Disclosure Requirements Applicable to a Single
Respondent in a DCO Bankruptcy
Regulation Sec. 190.14(a) allows the trustee, in their discretion
based upon the facts and circumstances of the case, to instruct each
customer to file a proof of claim containing such information as is
deemed appropriate by the trustee, and seek a court order establishing
a bar date for the filing of such proofs of claim.
Based on its experience, the Commission anticipates that a clearing
organization bankruptcy would occur once every fifty years.\326\ The
Commission has estimated the burden hours for the third-party
disclosure requirements applicable to a single respondent in a DCO
bankruptcy as follows:
---------------------------------------------------------------------------
\326\ These estimates express the burdens in terms of those that
would be imposed on one respondent during the fifty-year period.
---------------------------------------------------------------------------
Estimated number of respondents: 1.
Estimated annual number of responses per respondent: 0.9.\327\
---------------------------------------------------------------------------
\327\ The Commission estimates that, under Sec. 190.14(a), a
trustee would make the disclosure 45 times during a bankruptcy. This
number is based on an average of 45 clearing members. Dividing that
number by 50 (since the Commission anticipates a clearing
organization bankruptcy occurring once every 50 years) results in
0.9 records annually per respondent.
---------------------------------------------------------------------------
Estimated total annual number of responses for all respondents:
0.9.
Estimated annual number of burden hours per respondent: 0.18.\328\
---------------------------------------------------------------------------
\328\ The Commission estimates that instructing customers to
file a proof of claim pursuant to Sec. 190.14(a) would take 0.2
hours. In terms of burden hours, this amounts to (0.2*0.9), or 0.18
burden hours annually per respondent.
---------------------------------------------------------------------------
Estimated total annual burden hours for all respondents: 0.18.
7. Third-Party Disclosure Requirements Applicable to Multiple
Respondents During Business as Usual
As discussed in Section II.B.8 above, the Commission is codifying
the provisions proposed as Sec. 190.10(b), (d), and (e) in part 1,
along with other regulations that pertain to an FCM's business as
usual. Regulation Sec. 1.41, which was proposed as Sec. 190.10(b),
requires an FCM to provide an opportunity to each of its customers,
upon first opening a futures account or cleared swaps account with such
FCM, to designate such account as a hedging account.
Regulation Sec. 1.43, which was proposed as Sec. 190.10(d),
prohibits an FCM from accepting a letter of credit as collateral unless
such letter of credit may be exercised under certain conditions
specified in the regulation.
Regulation Sec. 1.55(p), which was proposed as Sec. 190.10(e),
requires an FCM to provide any customer with the disclosure statement
set forth in Sec. 1.55(p) prior to accepting property other than cash
from or for the account of a customer to margin, guarantee, or secure a
commodity contract.
The requirements described above are applicable on a regular basis
(i.e., during business as usual) to multiple respondents. The
Commission has estimated the burden hours for the third-party
disclosure requirements applicable to multiple respondents during
business as usual as follows:
Estimated number of respondents: 125.
Estimated annual number of responses per respondent: 3,000.\329\
---------------------------------------------------------------------------
\329\ The Commission estimates that under Sec. Sec. 1.41, 1.43,
and 1.55(p), an FCM would make the required disclosures 1,000 times
per year. This amounts to a total of 3,000 responses annually per
respondent.
---------------------------------------------------------------------------
[[Page 19419]]
Estimated total annual number of responses for all respondents:
375,000.
Estimated annual number of burden hours per respondent: 60.\330\
---------------------------------------------------------------------------
\330\ The Commission estimates that each disclosure required
under Sec. Sec. 1.41, 1.43, and 1.55(p) would take 0.02 hours to
make. In terms of burden hours, this amounts to (0.02*1,000 under
Sec. 1.41) plus (0.02*1,000 under Sec. 1.43 plus (0.02*1,000 under
Sec. 1.55(p)), or 60 burden hours annually per respondent.
---------------------------------------------------------------------------
Estimated total annual burden hours for all respondents: 7,500.
List of Subjects
17 CFR Part 1
Brokers, Commodity futures, Consumer protection, Reporting and
recordkeeping requirements.
17 CFR Part 4
Brokers, Commodity futures, Consumer protection, Reporting and
recordkeeping requirements.
17 CFR Part 41
Brokers, Reporting and recordkeeping requirements, Securities.
17 CFR Part 190
Bankruptcy, Brokers, Reporting and recordkeeping requirements.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission amends 17 CFR chapter I as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
0
1. The authority citation for part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g,
6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8,
9, 10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24
(2012).
0
2. In Sec. 1.25, revise paragraph (a)(2)(ii)(B) to read as follows:
Sec. 1.25 Investment of customer funds.
(a) * * *
(2) * * *
(ii) * * *
(B) Securities subject to such repurchase agreements must not be
``specifically identifiable property'' as defined in Sec. 190.01 of
this chapter.
* * * * *
0
3. Add Sec. 1.41 to read as follows:
Sec. 1.41 Designation of hedging accounts.
(a) A futures commission merchant must provide an opportunity to
each customer, when it first opens a futures account, foreign futures
account or cleared swaps account with such futures commission merchant,
to designate such account as a hedging account. The futures commission
merchant must indicate prominently in the accounting records in which
it maintains open trade balances whether, for each customer account,
the account is designated as a hedging account.
(b) A futures commission merchant may permit the customer to open
an account as a hedging account only if it obtains the customer's
written representation that the customer's trading of futures or
options on futures, foreign futures or options on foreign futures, or
cleared swaps (as applicable) in the account constitutes hedging as
such term may be defined under any relevant Commission regulation or
rule of any clearing organization, designated contract market, swap
execution facility or foreign board of trade.
(c) The requirements set forth in paragraphs (a) and (b) of this
section do not apply to a futures commission merchant with respect to
any commodity contract account that the futures commission merchant
opened prior to May 13, 2021. The futures commission merchant may
continue to designate as a hedging account any account with respect to
which the futures commission merchant received written hedging
instructions from the customer in accordance with former Sec.
190.06(d) of this chapter.
(d) A futures commission merchant may designate an existing futures
account, foreign futures account or cleared swaps account of a
particular customer as a hedging account, provided that it has obtained
the representation set out in paragraph (b) of this section from such
customer.
0
4. Add Sec. 1.42 to read as follows:
Sec. 1.42 Delivery accounts.
In connection with the making or taking of delivery of a commodity
under a commodity contract whose terms require settlement via physical
delivery, if a futures commission merchant facilitates or effects the
transfer of the physical delivery property and payment therefor on
behalf of the customer, and does so outside the futures account,
foreign futures account or cleared swaps account in which the commodity
contract was held, the futures commission merchant must do so in a
delivery account, provided, however, that when the commodity subject to
delivery is a security, a futures commission merchant may, consistent
with any applicable regulatory requirements, do so in a securities
account.
0
5. Add Sec. 1.43 to read as follows:
Sec. 1.43 Letters of credit as collateral.
A futures commission merchant shall not accept a letter of credit
as collateral unless such letter of credit may be exercised, through
its stated date of expiry, under the following conditions, regardless
of whether the customer posting that letter of credit is in default in
any obligation:
(a) In the event that an order for relief under chapter 7 of the
Bankruptcy Code or a protective decree pursuant to section 5(b)(1) of
SIPA is entered with respect to the futures commission merchant, or if
the FDIC is appointed as receiver for the futures commission merchant
pursuant to 12 U.S.C. 5382(a), the trustee for that futures commission
merchant (or, as applicable, FDIC) may draw upon such letter of credit,
in full or in part, in accordance with Sec. 190.04(d)(3) of this
chapter.
(b) If the letter of credit is passed through to a clearing
organization, then in the event that an order for relief under chapter
7 of the Bankruptcy Code is entered with respect to the clearing
organization, or if the FDIC is appointed as receiver for the clearing
organization pursuant to 12 U.S.C. 5382(a), the trustee for that
clearing organization (or, as applicable, FDIC) may draw upon such
letter of credit, in full or in part, in accordance with Sec.
190.04(d)(3) of this chapter.
(c) A futures commission merchant shall not accept a letter of
credit from a customer as collateral if it has any agreement with the
customer that is inconsistent with this section.
0
6. In Sec. 1.55:
0
a. Revise paragraphs (d) and (f);
0
b. Remove the parenthetical control number sentence and parenthetical
authority citation following paragraph (h);
0
c. Remove the paragraph (k) heading; and
0
d. Add paragraph (p).
The revision and addition read as follows:
Sec. 1.55 Public disclosures by futures commission merchants.
* * * * *
(d) Any futures commission merchant, or (in the case of an
introduced account) any introducing broker, may open a commodity
futures account for a customer without obtaining the separate
acknowledgments of disclosure and elections required by this section
and by Sec. Sec. 1.33(g) and 33.7 of this chapter, provided that:
(1) Prior to the opening of such account, the futures commission
merchant or introducing broker obtains an acknowledgement from the
customer, which may consist of a single signature
[[Page 19420]]
at the end of the futures commission merchant's or introducing broker's
customer account agreement, or on a separate page, of the disclosure
statements, consents, and elections specified in this section and Sec.
1.33(g), and in Sec. Sec. 33.7, 155.3(b)(2), and 155.4(b)(2) of this
chapter, and which may include authorization for the transfer of funds
from a segregated customer account to another account of such customer,
as listed directly above the signature line, provided the customer has
acknowledged by check or other indication next to a description of each
specified disclosure statement, consent, or election that the customer
has received and understood such disclosure statement or made such
consent or election; and
(2) The acknowledgment referred to in paragraph (d)(1) of this
section is accompanied by and executed contemporaneously with delivery
of the disclosures and elective provisions required by this section and
Sec. 1.33(g), and by Sec. 33.7 of this chapter.
* * * * *
(f) A futures commission merchant or, in the case of an introduced
account, an introducing broker, may open a commodity futures account
for an ``institutional customer'' as defined in Sec. 1.3 without
furnishing such institutional customer the disclosure statements or
obtaining the acknowledgments required under paragraph (a) of this
section, or Sec. Sec. 1.33(g), 1.55(p), and 1.65(a)(3), and Sec. Sec.
30.6(a), 33.7(a), 155.3(b)(2), and 155.4(b)(2) of this chapter.
* * * * *
(p)(1) Except as provided in Sec. 1.65, no commodity broker (other
than a clearing organization) may accept property other than cash from
or for the account of a customer, other than a customer specified in
paragraph (f) of this section, to margin, guarantee, or secure a
commodity contract unless the commodity broker first furnishes the
customer with the disclosure statement set forth in paragraph (p)(2) of
this section in boldface print in at least 10 point type which may be
provided as either a separate, written document or incorporated into
the customer agreement, or with another statement approved under
paragraph (c) of this section and set forth in appendix A to this
section which the Commission finds satisfies the requirement of this
paragraph (p)(1).
(2) The disclosure statement required by paragraph (p)(1) of this
section is as follows:
THIS STATEMENT IS FURNISHED TO YOU BECAUSE REGULATION 1.55(p) OF
THE COMMODITY FUTURES TRADING COMMISSION REQUIRES IT FOR REASONS OF
FAIR NOTICE UNRELATED TO THIS COMPANY'S CURRENT FINANCIAL CONDITION.
1. YOU SHOULD KNOW THAT IN THE UNLIKELY EVENT OF THIS COMPANY'S
BANKRUPTCY, PROPERTY, INCLUDING PROPERTY SPECIFICALLY TRACEABLE TO YOU,
WILL BE RETURNED, TRANSFERRED OR DISTRIBUTED TO YOU, OR ON YOUR BEHALF,
ONLY TO THE EXTENT OF YOUR PRO RATA SHARE OF ALL PROPERTY AVAILABLE FOR
DISTRIBUTION TO CUSTOMERS.
2. THE COMMISSION'S REGULATIONS CONCERNING BANKRUPTCIES OF
COMMODITY BROKERS CAN BE FOUND AT 17 CODE OF FEDERAL REGULATIONS PART
190.
(3) The statement contained in paragraph (p)(2) of this section
need be furnished only once to each customer to whom it is required to
be furnished by this section.
0
7. In Sec. 1.65, revise paragraphs (a)(3) introductory text and
(a)(3)(iii) to read as follows:
Sec. 1.65 Notice of bulk transfers and disclosure obligations to
customers.
(a) * * *
(3) Where customer accounts are transferred to a futures commission
merchant or introducing broker, other than at the customer's request,
the transferee introducing broker or futures commission merchant must
provide each customer whose account is transferred with the risk
disclosure statements and acknowledgments required by Sec. 1.55
(domestic futures and foreign futures and options trading) and Sec.
33.7 of this chapter (domestic exchange-traded commodity options) and
receive the required acknowledgments within sixty days of the transfer
of accounts. This paragraph (a)(3) shall not apply:
* * * * *
(iii) If the transfer of accounts is made from one introducing
broker to another introducing broker guaranteed by the same futures
commission merchant pursuant to a guarantee agreement in accordance
with the requirements of Sec. 1.10(j) and such futures commission
merchant maintains the relevant acknowledgments required by Sec. Sec.
1.55(a)(1)(ii) and 33.7(a)(1)(ii) of this chapter and can establish
compliance with Sec. 1.55(p).
* * * * *
PART 4--COMMODITY POOL OPERATORS AND COMMODITY TRADING ADVISORS
0
8. The authority citation for part 4 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6(c), 6b, 6c, 6l, 6m, 6n, 6o, 12a,
and 23.
0
9. In Sec. 4.5, revise paragraph (c)(2)(iii)(A) to read as follows:
Sec. 4.5 Exclusion for certain otherwise regulated persons from the
definition of the term ``commodity pool operator.''
* * * * *
(c) * * *
(2) * * *
(iii) * * *
(A) Will use commodity futures or commodity options contracts, or
swaps solely for bona fide hedging purposes within the meaning and
intent of the definition of bona fide hedging transactions and
positions for excluded commodities in Sec. Sec. 1.3 and 151.5 of this
chapter; Provided however, That, in addition, with respect to positions
in commodity futures or commodity options contracts, or swaps which do
not come within the meaning and intent of the definition of bona fide
hedging transactions and positions for excluded commodities in
Sec. Sec. 1.3 and 151.5 of this chapter, a qualifying entity may
represent that the aggregate initial margin and premiums required to
establish such positions will not exceed five percent of the
liquidation value of the qualifying entity's portfolio, after taking
into account unrealized profits and unrealized losses on any such
contracts it has entered into; and, Provided further, That in the case
of an option that is in-the-money at the time of the purchase, the in-
the-money amount as defined in Sec. 190.01of this chapter may be
excluded in computing such five percent; or
* * * * *
0
10. In Sec. 4.12, revise the section heading and paragraph
(b)(1)(i)(C) to read as follows:
Sec. 4.12 Exemption from provisions of this part.
* * * * *
(b) * * *
(1) * * *
(i) * * *
(C) Will not enter into commodity interest transactions for which
the aggregate initial margin and premiums, and required minimum
security deposit for retail forex transactions (as defined in Sec.
5.1(m) of this chapter) exceed 10 percent of the fair market value of
the pool's assets, after taking into account unrealized profits and
unrealized losses on any such contracts it has entered
[[Page 19421]]
into; Provided, however, That in the case of an option that is in-the-
money at the time of purchase, the in-the-money amount as defined in
Sec. 190.01 of this chapter may be excluded in computing such 10
percent; and
* * * * *
0
11. In Sec. 4.13, revise paragraph (a)(3)(ii)(A) to read as follows:
Sec. 4.13 Exemption from registration as a commodity pool operator.
* * * * *
(a) * * *
(3) * * *
(ii) * * *
(A) The aggregate initial margin, premiums, and required minimum
security deposit for retail forex transactions (as defined in Sec.
5.1(m) of this chapter) required to establish such positions,
determined at the time the most recent position was established, will
not exceed 5 percent of the liquidation value of the pool's portfolio,
after taking into account unrealized profits and unrealized losses on
any such positions it has entered into; Provided, That in the case of
an option that is in-the-money at the time of purchase, the in-the-
money amount as defined in Sec. 190.01 of this chapter may be excluded
in computing such 5 percent; or
* * * * *
PART 41--SECURITY FUTURES PRODUCTS
0
12. The authority citation for part 41 continues to read as follows:
Authority: Sections 206, 251 and 252, Pub. L. 106-554, 114
Stat. 2763, 7 U.S.C. 1a, 2, 6f, 6j, 7a-2, 12a; 15 U.S.C. 78g(c)(2).
0
13. In Sec. 41.41, revise paragraph (d) to read as follows:
Sec. 41.41 Security futures products accounts.
* * * * *
(d) Recordkeeping requirements. The Commission's recordkeeping
rules set forth in Sec. Sec. 1.31, 1.32, 1.35, 1.36, 1.37, 4.23, 4.33,
and 18.05 of this chapter shall apply to security futures product
transactions and positions in a futures account (as that term is
defined in Sec. 1.3 of this chapter). The rules in the preceding
sentence shall not apply to security futures product transactions and
positions in a securities account (as that term is defined in Sec. 1.3
of this chapter); provided, that the SEC's recordkeeping rules apply to
those transactions and positions.
* * * * *
0
14. Revise part 190 to read as follows:
PART 190--BANKRUPTCY RULES
Subpart A--General Provisions
Sec.
190.00 Statutory authority, organization, core concepts, scope, and
construction.
190.01 Definitions.
190.02 General.
Subpart B--Futures Commission Merchant as Debtor
190.03 Notices and proofs of claims.
190.04 Operation of the debtor's estate--customer property.
190.05 Operation of the debtor's estate--general.
190.06 Making and taking delivery under commodity contracts.
190.07 Transfers.
190.08 Calculation of funded net equity.
190.09 Allocation of property and allowance of claims.
190.10 Current records during business as usual.
Subpart C--Clearing Organization as Debtor
190.11 Scope and purpose of this subpart.
190.12 Required reports and records.
190.13 Prohibition on avoidance of transfers.
190.14 Operation of the estate of the debtor subsequent to the
filing date.
190.15 Recovery and wind-down plans; default rules and procedures.
190.16 Delivery.
190.17 Calculation of net equity.
190.18 Treatment of property.
190.19 Support of daily settlement.
Appendix A to Part 190--Customer Proof of Claim Form
Appendix B to Part 190--Special Bankruptcy Distributions
Authority: 7 U.S.C. 1a, 2, 6c, 6d, 6g, 7a-1, 12, 12a, 19, and
24; 11 U.S.C. 362, 546, 548, 556, and 761-767, unless otherwise
noted.
Subpart A--General Provisions
Sec. 190.00 Statutory authority, organization, core concepts, scope,
and construction.
(a) Statutory authority. The Commission has adopted the regulations
in this part pursuant to its authority under sections 8a(5) and 20 of
the Act. Section 8a(5) provides general rulemaking authority to
effectuate the provisions and accomplish the purposes of the Act.
Section 20 provides that the Commission may, notwithstanding title 11
of the United States Code, adopt certain rules or regulations governing
a proceeding involving a commodity broker that is a debtor under
subchapter IV of chapter 7 of the Bankruptcy Code. Specifically, the
Commission is authorized to adopt rules or regulations specifying:
(1) That certain cash, securities, or other property, or commodity
contracts, are to be included in or excluded from customer property or
member property;
(2) That certain cash, securities, or other property, or commodity
contracts, are to be specifically identifiable to a particular customer
in a particular capacity;
(3) The method by which the business of the commodity broker is to
be conducted or liquidated after the date of the filing of the petition
under chapter 7 of the Bankruptcy Code, including the payment and
allocation of margin with respect to commodity contracts not
specifically identifiable to a particular customer pending their
orderly liquidation;
(4) Any persons to which customer property and commodity contracts
may be transferred under section 766 of the Bankruptcy Code; and
(5) How a customer's net equity is to be determined.
(b) Organization. This part is organized into three subparts. This
subpart contains general provisions applicable in all cases. Subpart B
of this part contains provisions that apply when the debtor is a
futures commission merchant (as that term is defined in the Act or
Commission regulations). This includes acting as a foreign futures
commission merchant, as defined in section 761(12) of the Bankruptcy
Code, but excludes a person that is ``notice-registered'' as a futures
commission merchant pursuant to section 4f(a)(2) of the Act. Subpart C
contains provisions that apply when the debtor is registered as a
derivatives clearing organization under the Act.
(c) Core concepts. The regulations in this part reflect several
core concepts. The descriptions of core concepts in paragraphs (c)(1)
through (6) of this section are subject to the further specific
requirements set forth in this part, and the specific requirements in
this part should be interpreted and applied consistently with these
core concepts.
(1) Commodity brokers. Subchapter IV of chapter 7 of the Bankruptcy
Code applies to a debtor that is a commodity broker, against which a
customer holds a ``net equity'' claim relating to a commodity contract.
This part is limited to a commodity broker that is:
(i) A futures commission merchant; or
(ii) A derivatives clearing organization registered under the Act
and Sec. 39.3 of this chapter.
(2) Account classes. The Act and Commission regulations in parts 1,
22, and 30 of this chapter provide differing treatment and protections
for different types of cleared commodity contracts. This part
establishes three account classes that correspond to the different
types of accounts that futures
[[Page 19422]]
commission merchants and clearing organizations are required to
maintain under the regulations in the preceding sentence, specifically,
the futures account class (including options on futures), the foreign
futures account class (including options on foreign futures), and the
cleared swaps account class (including cleared options other than
options on futures or foreign futures). This part also establishes a
fourth account class, the delivery account class (which may be further
subdivided as provided in this part), for property held in an account
designated within the books and records of the debtor as a delivery
account, for effecting delivery under commodity contracts whose terms
require settlement via delivery when the commodity contract is held to
expiration or, in the case of a cleared option, is exercised.
(3) Public customers and non-public customers; Commission
segregation requirements; member property--(i) Public customers and
non-public customers. This part prescribes separate treatment of
``public customers'' and ``non-public customers'' (as these terms are
defined in Sec. 190.01) within each account class in the event of a
proceeding under this part in which the debtor is a futures commission
merchant. Public customers of a debtor futures commission merchant are
entitled to a priority in the distribution of cash, securities, or
other customer property over non-public customers, and both have
priority over all other claimants (except for claims relating to the
administration of customer property) pursuant to section 766(h) of the
Bankruptcy Code.
(A) The cash, securities, or other property held on behalf of the
public customers of a futures commission merchant in the futures,
foreign futures, or cleared swaps account classes are subject to
special segregation requirements imposed under parts 1, 22, and 30 of
this chapter for each account class. Although such segregation
requirements generally are not applicable to cash, securities, or other
property received from or reflected in the futures, foreign futures, or
cleared swaps accounts of non-public customers of a futures commission
merchant, such transactions and property are customer property within
the scope of this part.
(B) While parts 1, 22, and 30 of this chapter do not impose special
segregation requirements with respect to treatment of cash, securities,
or other property of public customers carried in a delivery account,
such property does constitute customer property. Thus, the distinction
between public and non-public customers is, given the priority for
public customers in section 766(h) of the Bankruptcy Code, relevant for
the purpose of making distributions to delivery account class customers
pursuant to this part.
(C) Where a provision in this part affords the trustee discretion,
that discretion should be exercised in a manner that the trustee
determines will best achieve the overarching goal of protecting public
customers as a class by enhancing recoveries for, and mitigating
disruptions to, public customers as a class. In seeking to achieve that
overarching goal, the trustee has discretion to balance those two sub-
goals when they are in tension. Where the trustee is directed to
exercise ``reasonable efforts'' to meet a standard, those efforts
should only be less than ``best efforts'' to the extent that the
trustee determines that such an approach would support the foregoing
goals.
(ii) Clearing organization bankruptcies: Member property and
customer property other than member property. For a clearing
organization, ``customer property'' is divided into ``member property''
and ``customer property other than member property.'' The term member
property is used to identify the cash, securities, or property
available to pay the net equity claims of clearing members based on
their house account at the clearing organization. Thus, in the event of
a proceeding under this part in which the debtor is a clearing
organization, the classification of customers as public customers or
non-public customers also is relevant, in that each member of the
clearing organization will have separate claims against the clearing
organization (by account class) with respect to:
(A) Commodity contract transactions cleared for its own account or
on behalf of any of its non-public customers (which are cleared in a
``house account'' at the clearing organization); and
(B) Commodity contract transactions cleared on behalf of any public
customers of the clearing member (which are cleared in accounts at the
clearing organization that is separate and distinct from house
accounts).
(iii) Preferential assignment among customer classes and account
classes for clearing organization bankruptcies. Section 190.18 is
designed to support the interests of public customers of members of a
debtor that is a clearing organization.
(A) Certain customer property is preferentially assigned to
``customer property other than member property'' instead of ``member
property'' to the extent that there is a shortfall in funded balances
for members' public customer claims. Moreover, to the extent that there
are excess funded balances for members' claims in any customer class/
account class combination, that excess is also preferentially assigned
to ``customer property other than member property'' to the extent of
any shortfall in funded balances for members' public customer claims.
(B) Where property is assigned to a particular customer class with
more than one account class, it is assigned to the account class for
which the funded balance percentage is the lowest until there are two
account classes with equal funded balance percentages, then to both
such account classes, keeping the funded balance percentage the same,
and so forth following the analogous approach if the debtor has more
than two account classes within the relevant customer class.
(4) Porting of public customer commodity contract positions. In a
proceeding in which the debtor is a futures commission merchant, this
part sets out a policy preference for transferring to another futures
commission merchant, or ``porting,'' open commodity contract positions
of the debtor's public customers along with all or a portion of such
customers' account equity. Porting mitigates risks to both the
customers of the debtor futures commission merchant and to the markets.
To facilitate porting, this part addresses the manner in which the
debtor's business is to be conducted on and after the filing date, with
specific provisions addressing the collection and payment of margin for
open commodity contract positions prior to porting.
(5) Pro rata distribution. (i) The commodity broker provisions of
the Bankruptcy Code, subchapter IV of chapter 7, in particular section
766(h), have long revolved around the principle of pro rata
distribution. If there is a shortfall in the cash, securities or other
property in a particular account class needed to satisfy the net equity
claims of public customers in that account class, the customer property
in that account class will be distributed pro rata to those public
customers (subject to appendix B of this part). Any customer property
not attributable to a specific account class, or that exceeds the
amount needed to pay allowed customer net equity claims in a particular
account class, will be distributed to public customers in other account
classes so long as there is a shortfall in those other classes. Non-
public customers will not receive any distribution of customer property
so long as there is any shortfall, in any account class, of customer
property
[[Page 19423]]
needed to satisfy public customer net equity claims.
(ii) The pro rata distribution principle means that, if there is a
shortfall of customer property in an account class, all customers
within that account class will suffer the same proportional loss
relative to their allowed net equity claims. The principle in this
paragraph (c)(5)(ii) applies to all customers, including those who post
as collateral specifically identifiable property or letters of credit.
The pro rata distribution principle is subject to the special
distribution provisions set forth in framework 1 in appendix B of this
part for cross-margin accounts and framework 2 in appendix B of this
part for funds held outside of the U.S. or held in non-U.S. currency.
(6) Deliveries. (i) Commodity contracts may have terms that require
a customer owning the contract:
(A) To make or take delivery of the underlying commodity if the
customer holds the contract to a delivery position; or
(B) In the case of an option on a commodity:
(1) To make delivery upon exercise (as the buyer of a put option or
seller of a call option); or
(2) To take delivery upon exercise (as seller of a put option or
buyer of a call option).
(ii) Depending upon the circumstances and relevant market, delivery
may be effected via a delivery account, a futures account, a foreign
futures account or a cleared swaps account, or, when the commodity
subject to delivery is a security, in a securities account (in which
case property associated with the delivery held in a securities account
is not part of any customer account class for purposes of this part).
(iii) Although commodity contracts with delivery obligations are
typically offset before reaching the delivery stage (i.e., prior to
triggering bilateral delivery obligations), when delivery obligations
do arise, a delivery default could have a disruptive effect on the cash
market for the commodity and adversely impact the parties to the
transaction. This part therefore sets out special provisions to address
open commodity contracts that are settled by delivery, when those
positions are nearing or have entered into a delivery position at the
time of or after the filing date. The delivery provisions in this part
are intended to allow deliveries to be completed in accordance with the
rules and established practices for the relevant commodity contract
market or clearing organization, as applicable and to the extent
permitted under this part.
(iv) In a proceeding in which the debtor is a futures commission
merchant, the delivery provisions in this part reflect policy
preferences to:
(A) Liquidate commodity contracts that settle via delivery before
they move into a delivery position; and
(B) When such contracts are in a delivery position, to allow
delivery to occur, where practicable, outside administration of the
debtor's estate.
(v) The delivery provisions in this part apply to any commodity
that is subject to delivery under a commodity contract, as the term
commodity is defined in section of 1a(9) of the Act, whether the
commodity itself is tangible or intangible, including agricultural
commodities as defined in Sec. 1.3 of this chapter, other non-
financial commodities (such as metals or energy commodities) covered by
the definition of exempt commodity in section 1a(20) of the Act, and
commodities that are financial in nature (such as foreign currencies)
covered by the definition of excluded commodity in section 1a(19) of
the Act. The delivery provisions also apply to virtual currencies that
are subject to delivery under a commodity contract.
(d) Scope--(1) Proceedings--(i) Certain commodity broker
proceedings under subchapter IV of chapter 7 of the Bankruptcy Code.
(A) Section 101(6) of the Bankruptcy Code recognizes ``futures
commission merchants'' and ``foreign futures commission merchants,'' as
those terms are defined in section 761(12) of the Bankruptcy Code, as
separate categories of commodity broker. The definition of commodity
broker in Sec. 190.01, as it applies to a commodity broker that is a
futures commission merchant under the Act, also covers foreign futures
commission merchants because a foreign futures commission merchant is
required to register as a futures commission merchant under the Act.
(B) Section 101(6) of the Bankruptcy Code recognizes ``commodity
options dealers,'' and ``leverage transaction merchants'' as defined in
sections 761(6) and (13) of the Bankruptcy Code, as separate categories
of commodity brokers. There are no commodity options dealers or
leverage transaction merchants as of December 8, 2020.
Note 1 to paragraph (b)(1)(i)(B). The Commission intends to adopt
rules with respect to commodity options dealers or leverage transaction
merchants, respectively, at such time as an entity registers as such.
(ii) Futures commission merchants subject to a SIPA proceeding.
Pursuant to section 7(b) of SIPA, 15 U.S.C. 78fff-1(b), the trustee in
a SIPA proceeding, where the debtor also is a commodity broker, has the
same duties as a trustee in a proceeding under subchapter IV of chapter
7 of the Bankruptcy Code, to the extent consistent with the provisions
of SIPA or as otherwise ordered by the court. This part therefore also
applies to a proceeding commenced under SIPA with respect to a debtor
that is registered as a broker or dealer under section 15 of the
Securities Exchange Act of 1934 when the debtor also is a futures
commission merchant.
(iii) Commodity brokers subject to an FDIC proceeding. Section
5390(m)(1)(B) of title 12 of the United States Code provides that the
FDIC must apply the provisions of subchapter IV of chapter 7 of the
Bankruptcy Code in respect of the distribution of customer property and
member property in connection with the liquidation of a covered
financial company or a bridge financial company (as those terms are
defined in section 5381(a) of title 12) that is a commodity broker as
if such person were a debtor for purposes of subchapter IV, except as
specifically provided in section 5390 of title 12. This part therefore
shall serve as guidance as to such distribution of property in a
proceeding in which the FDIC is acting as a receiver pursuant to title
II of the Dodd-Frank Wall Street Reform and Consumer Protection Act
with respect to a covered financial company or bridge financial company
that is a commodity broker whose liquidation otherwise would be
administered by a trustee under subchapter IV of chapter 7 of the
Bankruptcy Code.
(2) Account class and implied trust limitations. (i) The trustee
may not recognize any account class that is not one of the account
classes enumerated in Sec. 190.01.
(ii) No property that would otherwise be included in customer
property, as defined in Sec. 190.01, shall be excluded from customer
property because such property is considered to be held in a
constructive, resulting, or other trust that is implied in equity.
(3) Commodity contract exclusions. For purposes of this part, the
following are excluded from the term ``commodity contract'':
(i) Options on commodities (including swaps subject to regulation
under part 32 of this chapter) that are not centrally cleared by a
clearing organization or foreign clearing organization.
(ii) Transactions, contracts or agreements that are classified as
``forward contracts'' under the Act pursuant to the exclusion from the
term ``future delivery'' set out in section 1a(27) of the Act or the
exclusion from the definition of a ``swap'' under section
[[Page 19424]]
1a(47)(B)(ii) of the Act, in each case that are not centrally cleared
by a clearing organization or foreign clearing organization.
(iii) Security futures products as defined in section 1a(45) of the
Act when such products are held in a securities account.
(iv) Any off-exchange retail foreign currency transaction, contract
or agreement described in sections 2(c)(2)(B) or (C) of the Act.
(v) Any security-based swap or other security (as defined in
section 3 of the Exchange Act), but a security futures product or a
mixed swap (as defined in 1a(47)(D) of the Act) that is, in either
case, carried in an account for which there is a corresponding account
class under this part is not so excluded.
(vi) Any off-exchange retail commodity transaction, contract or
agreement described in section 2(c)(2)(D) of the Act, unless such
transaction, contract or agreement is traded on or subject to the rules
of a designated contract market or foreign board of trade as, or as if,
such transaction, contract, or agreement is a futures contract.
(e) Construction. (1) A reference in this part to a specific
section of a Federal statute or specific regulation refers to such
section or regulation as the same may be amended or superseded.
(2) Where they differ, the definitions set forth in Sec. 190.01
shall be used instead of defined terms set forth in section 761 of the
Bankruptcy Code. In many cases, these definitions are based on
definitions in parts 1, 22, and 30 of this chapter. Notwithstanding the
use of different defined terms, the regulations in this part are
intended to be consistent with the provisions and objectives of
subchapter IV of chapter 7 of the Bankruptcy Code.
(3) In the context of portfolio margining and cross margining
programs, commodity contracts and associated collateral will be treated
as part of the account class in which, consistent with part 1, 22, 30,
or 39 of this chapter, or Commission Order, they are held.
(i) Thus, as noted in paragraph (2) of the definition of account
class in Sec. 190.01, where open commodity contracts (and associated
collateral) that would be attributable to one account class are,
instead, commingled with the commodity contracts (and associated
collateral) in a second account class (the ``home field''), then the
trustee must treat all such commodity contracts and collateral as part
of, and consistent with the regulations applicable to, the second
account class.
(ii) The concept in paragraph (e)(3)(i) of this section, that the
rules of the ``home field'' will apply, also pertains to securities
positions that are, pursuant to an approved cross margining program,
held in a commodities account class (in which case the rules of that
commodities account class will apply) and to commodities positions that
are, pursuant to an approved cross-margining program, held in a
securities account (in which case, the rules of the securities account
will apply, consistent with section 16(2)(b)(ii) of SIPA, 15 U.S.C.
78lll(2)(b)(ii)).
Sec. 190.01 Definitions.
For purposes of this part:
Account class:
(1) Means one or more of each of the following types of accounts
maintained by a futures commission merchant or clearing organization
(as applicable), each type of which must be recognized as a separate
account class by the trustee:
(i) Futures account means:
(A) With respect to public customers, the same definition as set
forth in Sec. 1.3 of this chapter.
(B) With respect to non-public customers:
(1) With respect to a futures commission m