FIA urged the CFTC to clarify rules regarding the margin treatment of separate customer accounts.
In separate petitions (see here and here), FIA proposed amendments to CFTC Rule 1.56 ("Prohibition of guarantees against loss") and Rule 1.11 ("Risk Management Program for futures commission merchants") that are intended to: (i) provide clarity on allocated asset recourse for separate accounts (that is, allow for limited recourse accounts); and (ii) codify, in significant part, CFTC No-Action Letter No. 19-17, which allows an FCM to treat separate accounts of a single legal entity as belonging to separate persons in limited circumstances.
In the petition to amend Rules 1.11 and 1.56, FIA proposed, among other things, to:
- clarify that certain types of limited recourse provisions do not violate Rule 1.56; and
- require an FCM, under Rule 1.11, that is seeking to enter into limited recourse agreements to supplement its risk management policies and procedures by, among other things, (i) evaluating customers' credit risk, (ii) implementing risk limits and margin requirements for each customer, and (iii) monitor allocation levels applicable to institutional customers.
In the petition that seeks to codify Letter 19-17, FIA proposed, among other things:
- adding a new paragraph (f) to Rule 1.56 that recognizes the right of an FCM to enter into a customer agreement that (i) allows "a customer to withdraw excess funds from a separate account while there is an outstanding margin call in another separate account," and (ii) prevents the FCM from using excess funds from one account in order to meet the obligation in another account without the customer's consent, "provided the FCM has in place the enhanced risk management requirements set out in the Proposed Amendment;" and
- incorporate the bulk of the terms and conditions in the no-action letter into amended Rule 1.11.
FIA emphasized the direct interest that its FCM member firms have in implementing the requirements of the no-action letter in order to be able to offer separate margining to customers beyond the June 30, 2021 expiration date. Additionally, FIA noted that a rulemaking would minimize interpretive questioning and allow for cost-benefit consideration.
The treatment of separate accounts is a very significant issue for asset managers and their clients that transact in futures or cleared swaps, including pension plans. If FCMs are not permitted to enter into limited recourse agreements with customers, any entity that uses multiple advisers will be putting itself at material risk in connection with the trades of each of those advisers.
The CFTC has made a bit of a mess of this issue. As noted before, Letter 19-17 is unnecessarily burdensome and at odds with longstanding market practice. The CFTC staff compounded the problems by issuing a statement in which it said it "expects" compliance by FCMs by a specified date. If CFTC does not reverse course, separate account customers would have incentives to materially reduce their transactions through registered FCMs, and/or establish additional legal entities to avoid the impact of the CFTC's approach to separate accounts.