An Overview of the CFTC Customer Protection Rules: What Customers of FCMs Should Know February 2014

Transcription

1 An Overview of the CFTC Customer Protection Rules: What Customers of FCMs Should Know February 2014

2 New Rules, New Information Published 11/14/2013 at 78 FR Effective Date was January 13, 2014, except as noted in respect of specific sections Why should a futures customer care about these new rules? Because information will be made available to your firm that will allow you to better assess the credit profile of your FCM.

3 Six Principles 1) Amend and enhance customer protection regime 2) Impose risk management requirements on FCMs 3) Provide CFTC with "Early Warning" notices, if an FCM has material operational or financial change 4) Impose additional liquidity requirements on FCMs 5) Revise FCM examination process by SROs and auditors 6) Enhanced risk disclosures to customers

4 Background - Segregated and Secured Accounts Section 4d(a)(2) - FCM must segregate property deposited by futures customers ("Segregated Account") Section 4d(f) - FCM must segregate property deposited by cleared swap customers ("Cleared Swap Segregated Account") Rule FCM must keep property deposited by foreign futures customers in a secure account at qualified depository ("Secured Account") In each case, customer property must be kept separate from FCM's own property

5 FCM Financial Reports (68513) CFTC Rule FCM Financial Reports Monthly unaudited Annual certified within 60 days of year end Report on Form 1-FR-FCM or, if b/d dual registrant, FOCUS Report Schedules to financial reports cover minimum capital and customer funds segregation requirements 1) Segregation, 2) Secured Amount, 3) Cleared Swaps Segregation (New) New Info in Schedules: Targeted Residual Interest -RI = Cushion of FCM's own funds deposited into seg/sec accounts to protect against shortfall -Target allows CFTC to see if actual RI is in line with targeted RI...and, if not, ask questions Monitor FCM as part of your firm's risk management process Market Reports tab - Financial Data for FCMs

6 FCM Risk Management Programs (68517) Rule Establish 1) a RMP with written P's + P's furnished to CFTC; and 2) RM unit separate from part of business that solicits orders and handles customer money Rule contains non-exclusive list of elements that must be part of RMP 1) Risk of affiliates to FCM and FCM's other trading activity, 2) Provision of periodic reports to mgmt., 3) Operational risk controls, 4) Capital controls, and 5) Risks of safekeeping & segregation of customer property Risks of safekeeping & segregation of customer property -Evaluate & monitor depositories, including required documentation and title of customer property account -Establish & maintain targeted residual interest (quarterly assessment) -Controls for withdrawal of customer property from segregated accounts -Investment of customer funds -Valuation and liquidity of customer funds -Timely recording of transactions -Annual compliance training Initial RMPs must be filed within 180 days of January 13, 2014 Effective Date

7 Early Warning Notices (68521) Rule Immediate notice to CFTC and SRO of financial events, but prompt (within 24 hours) of operational events Notices not publicly available (ICI had asked for these to be made publicly available) Reportable financial events -Undercapitalization -Insufficient segregation of customer funds -Investment of customer funds in non-compliant manner -Residual interest falls below targeted RI -Change in creditworthiness of FCM or material affiliate, credit rating downgrade, FCM placed on credit watch -Certain notices from other agencies or SROs: formal investigation; examination report; or issues relating to liquidity, adequacy of capital, business operations, internal controls Reportable operational events Change in management Establishment or termination of material line of business

8 Minimum Financial Requirements (68529) Section 4f(b) requires registered FCM to meet minimum financial requirements Rule 1.17 contains minimum capital requirements Upon request of CFTC, an FCM must now 1) certify that it has sufficient liquidity to continue operating as a going concern; and 2) demonstrate adequate access to liquidity with verifiable evidence FCM must transfer all customer accounts and immediately cease doing business, if it cannot do this FCM incurs a capital charge, if a customer account is undermargined one day after margin call issued Monday COB, Customer account undermargined --> Tuesday, margin call --> Wednesday COB, FCM takes capital charge No exceptions for offshore customers, smaller margin calls, etc. Standalone FCMs and FCM/BDs can have written P's & P's to assess credit risk of CP and convertible debt, and readily marketable non-convertible debt and, if minimal credit risk, take a lower haircut

9 Segregation and Accounting of Customer Funds (68533) Rule 1.20 imposes obligations on FCMs and DCOs for holding, and accounting for, futures customer funds Part 22 imposes obligations on cleared swaps customers Part 30 imposes obligations on foreign futures customers Rule 1.22 prohibits FCM from using one customer's funds to secure, extend credit, or cover losses of any other person FCM and DCO must account for funds and segregate customer funds from its own property Deposit funds with qualifying ("permitted") depository in account clearly identified as customer funds Depository institution (other than a Federal Reserve Bank) must provide FCM with a template "acknowledgment letter" in form published by CFTC Depository must provide CFTC with read-only electronic access to accounts maintained by FCM (does not apply to DCO omnibus account) Depository has no affirmative obligation to police FCM or DCO's compliance with law, but depository cannot ignore signs of wrongdoing and CFTC expects to be notified immediately of such signs

10 Segregated Funds Computation Requirement (68543) Amount of segregated/separate funds in account must be sufficient to meet total account equities of all futures and cleared swaps customers (the so-called, "Net Liquidating Equities") FCM must maintain a residual interest in segregated accounts in amount that exceeds the sum of all customer deficits (the so-called, "Residual Interest Requirement") FCM to determine undermargined amount of customer account once per day at COB by looking at amount, if any, by which collateral required for a customer's account positions exceeds value of net liquidating equity for the account Prior to "Residual Interest Deadline" (6:00 p.m. on day of settlement, but not beginning until November 2014 and through 12/31/2018) assets must be in account to cover the undermargined amount Changes were made to timing to alleviate pressure on costs of new requirements

11 Investment and Responsibility for Customer Funds (68556) Rule FCM or DCO is responsible for losses incurred on investment of customer funds Interest payable to customer, but only if negotiated FCM's Obligation in Event of Bank Default 1971 CFTC Administrative Determination - FCM not liable if it used due care in selecting the bank, had not otherwise breached its fiduciary duty, and fully complied with CEA requirements in respect of handling customer funds CFTC directed its staff to inquire into several legal and policy issues NOT address by 1971 AD, so more to come

12 Loans by FCMs (68557) Rule FCM may make secured loans to customers Allows customers to deposit non-cash collateral and for FCM to make a loan, if customer does not have other assets available to meet margin call In absence of provision, FCM would have to sell customer property in that instance This rule now prohibits FCM from making an unsecured loan or a loan secured only by customer's trading account

13 Daily Computation and Reporting of Segregated Accounts (68557) Daily computation and electronic reporting of Segregated Account information Compute prior to noon on next BD Report to CFTC (new), NFA and CME by COB each BD Info same as month-end filings on Form 1-FR-FCM / FOCUS Report Haircuts on investments same as Exchange Act Rule 15c-31(c)(2)(vi), so 15% unless "minimal credit risk" Public disclosure - CFTC working with NFA to determine most efficient and effective method of disclosure Bi-monthly reporting of depositories and investment of customer funds under Rule 1.25 File by 11:59 p.m. on 15th calendar day (or next BD) and last BD of each month Detailed list of investments - cash, "Govvies", Agencies, munis, CDs, MMFs, corporate notes By depository, including whether it is an affiliate of FCM Whether held by reverse repo Public disclosure - CFTC working with NFA and futures exchanges to determine most efficient and effective method of disclosure

14 Public Disclosures by FCMs (68562) Rule Disclosure requirements provide customers with information; amendments in final rules intended to enhance disclosures General risk disclosures effective 90 days after January 13, 2014 FCM specific risk disclosures effective 180 days after January 13, 2014 FCM disclosures about segregated accounts effective 180 days after January 13, 2014

15 Generic Risk Disclosure Statements (68562) Previously Required Disclosures 1) Losses may exceed amounts contributed to trading; 2) Risks of price limits causing trading illiquidity; 3) Stop limits and other contingent orders may not limit losses; 4) Risks of losses from leverage; and 5) Risks of trading foreign futures and options in non-u.s. markets. New Disclosures About Customer Funds 1) No insurance protection if misappropriated; 2) No SIPC protections, even if FCM/BD; 3) Not guaranteed or insured by DCO; 4) Can be commingled with property of other customers (not held in separate account for each customer); 5) Can be invested in permitted types of investments with returns retained by FCM; and 6) Can be deposited by FCM with its affiliates, which may present customer with additional risks. Beginning on effective date, FCM must: 1) obtain signed acknowledgment from each new customer; and 2) provide existing customers with revised disclosures.

16 FCM Specific Disclosure Document (68564) Objective - Enable customers to make informed decisions about FCMs Disclosures made at least once every 12 months (more frequently, as needed) 1) Firm's name and contact information; 2) Firm's principals; 3) FCM's significant activities and product lines, and amount of capital and assets contributed to each; 4) Business engaged in on behalf of customers, such as types of customers, markets, Ps & Ps for choosing depositories, and the other counterparties to its rule 1.25 permitted investment transactions; 5) Material risks of its operations, such as portfolio of permitted investments (credit quality, weighted average maturity and coupon), liquidity, leverage, etc.; 6) Name of self-regulatory organization;

17 FCM Specific Disclosure Document (68564) - Continued 7) Material administrative, civil, or criminal actions pending, and any enforcement actions taken in past 3 years; 8) Basic information about segregated accounts (Futures, Foreign Futures, Cleared Swaps), collateral management, and investments, as well as risks posed by trading in non-u.s. markets in the event of an FCM failure; 9) How a customer can obtain information about filing a complaint against the FCM with its SRO; 10) Monthly financial information - HELPFUL TO YOUR CREDIT ANALYSIS, SO NOTE RULE 1.55(k)(10)(i) to (vii); and 11) Current risk practices, controls and procedures.

18 Public Availability of FCM Financial Disclosures (68569) Financial information must be available on an FCM's public website 1) Daily Segregation Schedules (Futures, Cleared Swaps, Foreign Futures) for past 12 months 2) Summary month-end schedule of capital, adjusted net capital and excess capital for 12 most recent months 3) Info from recent certified annual report - Statement of Financial Condition and Segregation Schedules 4) Info from most recent 12 months of FOCUS Reports - Statement of Financial Condition and Segregation Schedules 5) A link to NFA's information about the FCM's current permitted investments 6) A link to CFTC's information about the FCM's financial information

19 Foreign Futures and Options - Select Issues (68572) FCM must set aside in a segregated account sufficient amount of funds to cover FULL account balances of BOTH U.S. and foreign-domiciled customers -Change from Alternative Method (margin only) to Net Liquidating Equities Method -Puts Non-U.S. customers on parity with U.S. customers -FCM may use internal credit risk model to compute haircuts on securities deposited by customers -FCM must hold residual interest for benefit of foreign futures customers = to sum of undermargined amounts FCM may transfer funds to non-u.s. depository in amount sufficient to cover margin obligations under foreign exchange PLUS a 20% additional cushion Variation margin does not count against the 20% cushion FCM may NOT commingle customer funds from futures (regulated) with customer funds from OTC transactions (unregulated), in order to ensure availability of U.S. bankruptcy code for the funds related to regulated futures

20 Questions or Comments Please contact: Andrew Cross Or the Reed Smith lawyer with whom you regularly work