Staff of the Commodity Futures Trading Commission (CFTC) has issued an Interpretation permitting futures commission merchants (FCMs) to deposit US customer funds margining foreign futures and options positions with UK investment firms that are licensed deposit-taking banks as bank deposits.
CFTC customer protection rules
Part 30 of the CFTC’s regulations governs the offer and sale of futures and options executed on a foreign exchange to persons located in the United States. Rule 30.7 addresses how FCMs may hold funds deposited by US customers for trading on foreign markets (referred to as “30.7 customer funds”).
In November 2013, the CFTC issued enhanced customer protection rules based on lessons learned in the recent failures of two FCMs, MF Global and Peregrine. As part of that effort, CFTC Rule 30.7(c) was revised to provide in part that an FCM:
must deposit 30.7 customer funds under the laws and regulations of the foreign jurisdiction that provide the greatest degree of protection to such funds. [An FCM] may not contract or otherwise waive any of the protections afforded to customer funds under the laws of the foreign jurisdiction.
The UK has different rules for holding customer cash collateral deposited to margin futures and options positions on UK and other foreign futures markets depending on whether the investment firm holding the customer funds is, or is not, a UK-licensed bank.
Generally, customer cash collateral deposited with an investment firm that is not a licensed bank must be held as “client money” pursuant to UK Financial Conduct Authority (FCA) regulations. An investment firm that also is a licensed deposit-taking bank (a “banking investment firm”), though, may hold cash collateral as a deposit subject to UK Prudential Conduct Authority (PRA) regulations rather than treating such funds as client money.
The FCA’s client money rules create a statutory trust, whereby the UK investment firm that receives customer funds places those funds with a third-party bank and acts as trustee. But, it is the investment firm as trustee, and not the FCM, that has a direct claim against a third-party bank depository over 30.7 customer funds. By contrast, if a banking investment firm elects the bank exemption, it holds 30.7 customer funds as a bank deposit, and not as trustee under the client money rules. But, the FCM retains a direct contractual claim against the banking investment firm for repayment of those funds.
CFTC staff interpretation
The CFTC’s Division of Swap Dealer and Intermediary Oversight (DSIO) on August 28, 2014, issued an Interpretation that an FCM does not waive protections under UK law if it deposits 30.7 customer funds at a banking investment firm that elects the bank exemption. Staff therefore will allow an FCM to maintain customer omnibus accounts with a UK investment firm that is a licensed deposit-taking bank, elects the bank exemption, and qualifies as a depository for holding 30.7 customer funds.
Caution to FCMs
DSIO’s Interpretation reminded FCMs that they remain subject to the requirement in CFTC Rule 1.11 to monitor the segregation risks associated with holding customer funds with a particular depository. Rule 1.11 requires an FCM to formulate criteria with respect to choosing a depository, including criteria that address the depository’s supervision, capitalization, creditworthiness, operational reliability, and access to liquidity, the availability of deposit insurance, and the extent to which segregated funds are concentrated with any depository.
The Interpretation noted that an FCM must consider how those factors would inform its choice of a depository including, if applicable, whether it would ask the depository to act as a trustee and follow the FCA’s client money rules or whether, if the bank exemption were available, the depository could rely on the bank exemption to directly hold customer funds as deposits subject to PRA regulations.