The Commodity Futures Trading Commission (“CFTC”) proposed changes to Regulation 1.25(a) late in 2023. These comments were required to be submitted no later than January 17, 2024.  For those unfamiliar regulation 1.25 grants Futures Commission Merchants (“FCMs”) and Derivatives Clearing Organizations (“DCOs”) the authority to invest customer funds in specified categories known as “permitted investments.”

Permitted investments include:

  • United States Treasury securities
  • obligations fully guaranteed by the U.S. government
  • general obligations of States or political subdivisions
  • S. agency obligations
  • certificates of deposit issued by banks
  • money market mutual funds.

The scope of these permissible investments encompasses “futures customer funds,” “cleared swaps customer collateral” held by an FCM or DCO, and “30.7 customer funds” held by an FCM. Additionally, according to Commission regulation 1.25(b)(2)(iv)(A), if an FCM or DCO chooses to invest customer funds in a permitted investment featuring an adjustable interest rate, the rate must closely align with or be determined solely by reference to specific benchmarks such as the Federal Funds target rate, prime rate, three-month Treasury Bill rate, one-month or three-month LIBOR, or the interest rate of any fixed rate instrument recognized as a permitted investment.

Proposed rulemaking

Recently the Futures Industry Association (“FIA”) and CME Group (“CME”) petitioned the CFTC to issue an order amending regulation 1.25. The CFTC considered this petition and has now proposed changes to regulations which:

  1. refine the range of investment choices available to FCMs and DCOs,
  2. Enhance specific standards on permitted investments both individually and within portfolios,
  3. Bolster safety by encouraging diversification.

While tailoring the proposal to accomplish these objectives, the Commission sought to maintain an appropriate level of investment flexibility, while also providing opportunities for DCOs and FCMs to achieve capital efficiency when investing customer segregated funds and secured amount funds.

Does the proposal impose restrictions on the collateral that customers of an FCM can use?

No, this proposal exclusively addresses the investment of customer funds by FCMs and DCOs and expands options. The Commission’s focus is on ensuring that customer funds are invested in instruments aligning with its overarching goals of preserving principal and maintaining liquidity. In Turnkey’s view the largest change is that the CFTC is proposing to allow DCOs and FCMs to invest customer funds in the foreign sovereign debt of Canada, France, Germany, Japan, and the United Kingdom. Investments in these nation’s sovereign debt would be limited to balances owed by FCMs and DCOs to customers and FCM clearing firms respectively denominated in the applicable currency of the nation where the investment is held. It is notable that the nations included on this list are nations that are home to some of the world’s largest financial institutions and commodity futures clearing exchanges. Allowing assets within these jurisdictions to remain invested in sovereign debt issued in a native currency rather than USD, at least in concept, makes sense.

NFA Comments on the CFTC’s proposed Updates

The National Futures Association has expressed support for the CFTC’s goal of strengthening the customer protection framework while maintaining flexibility for FCMs and DCOs. The NFA endorses the addition of specific sovereign debt instruments to the list of permitted investments, emphasizing that the proposed conditions align with previous regulatory criteria. In its comments, NFA underscored the importance of limitations, such as restricting investments to sovereign debt of Canada, France, Germany, Japan, and the United Kingdom, and believes these additions fulfill Regulation 1.25’s objectives of preserving principal, ensuring liquidity, and managing foreign exchange risk.

This proposal is not yet in place as of the date of publication of this article. Those FCMs and DCOs who may be reading should ensure that the CFTC has implemented this change prior to adjusting their unique customer funds investment strategies.