Once, many years ago, the Joint Audit Committee released a Regulatory Alert (RA 14-03) addressed to futures commission merchants that are clearing members of derivatives clearing organizations registered with the CFTC, which included the following passage:
“Additionally, all accounts of the same beneficial owner within the same regulatory account classification (i.e., customer segregated, customer secured, cleared swaps customer, or noncustomer) should be combined for margin purposes. FCMs should be reminded that when determining an account’s margin funds available for disbursement, all accounts of the same beneficial owner, even if under different control, within the same regulatory account classification must be combined” (emphasis in the original).
FCMs and institutional money managers received this deliverance with some consternation. Could it possibly be that if Money Manager A and Money Manager B each separately contracts with Municipal Pension Fund X and then both A and B establish futures clearing arrangements with FCM 1, FCM 1 would be required to combine the accounts of A and B for margin purposes – notwithstanding that A and B are not affiliated, are implementing different investment mandates from X, and would have no visibility into each other’s portfolios at FCM 1?
Over the course of the next five years, FCMs addressed this question, in various configurations and contexts, to the JAC. Finally, having tired of dialogue, the JAC released a Regulatory Alert (RA 19-02), reiterating RA 14-03’s separate account margining mandate (with the same emphasis on the “must”!) and ordering FCM clearing members to comply. On the same day, JAC released an interpretation of CFTC Rule 1.56 (RA 19-03) which purported to find any “limited recourse” arrangement entered into by an FCM inconsistent with the provision of that rule prohibiting FCMs from guaranteeing customers against loss. This was addressed to the FCM practice (which surfaced in the course of the preceding five years’ discussions), widespread at the time, of acceding to investment manager demands to limit FCM recourse against their clients to the assets made available to the manager under the related investment mandate.
In response, FCMs took their case to the Staff of the CFTC. In CFTC Letter 19-17, Solomon-like, Staff split the JAC-baby: they endorsed the JAC’s interpretation of Rule 1.56; but they opened a path to separate margining of separately managed accounts of the same customer, notwithstanding the unequivocal, twice-emphasized JAC prohibition of the practice. This path was time-limited (expiring in June 2021), by way of no-action relief, and in contemplation of time for Staff to recommend, and for the CFTC to “determine whether to conduct, and if so, to in fact conduct, a rulemaking to implement appropriate relief on a permanent basis.”
Letter 19-17 may have seemed a final settlement; but fresh antagonisms soon stirred between the JAC and the FCM clearing members, particularly over the deadline by which the FCMs would be expected to be in full compliance with the requirement to remediate documentation not in compliance with the new interpretation of Rule 1.56 and with the (16) new compliance conditions around separate account margining. Once again, Staff was prevailed upon to impose peace upon the fractious parties; the result was CFTC Letter 20-28, which gave the industry until March 31, 2021 to remediate and come into compliance. Letter 20-28 also deferred the expiration of Letter 19-17’s no-action relief from June 30, 2021 to December 31, 2021. In CFTC Letter 21-29, Staff extended that deadline again, to September 2022, citing, once more the CFTC’s need for more time “to consider whether, and if so, how, to codify that relief.”
And now Staff has extended the deadline, once more. Under CFTC Letter 22-11, the new deadline is the earlier of September 30, 2023 or the effective date of any final CFTC action relating to separate account margining.
Meanwhile, FCM clearing members continue to feel the heat from the members of the JAC responsible for conducting financial and operational audits of compliance with CFTC and exchange regulations governing their clearing activities. Most recently, reportedly, examiners are taking the position that FCM clearing members are prohibited from agreeing to a contractual grace or cure period overlying a customer’s failure to pay (that is not qualified by reference to administrative or operational reasons for the failure) – a position that might be sustained as another interpretive extension of Rule 1.56, or might be footed in exchange rules like CME Rule 930.K (which requires clearing members to “maintain full discretion to determine when and under what circumstances positions in any account shall be liquidated”). At any rate, space cleared since 2014 by industry discussion and dispute over separate accounts and limited recourse, and the whiplash many FCMs have experienced between the not-always-convergent views of the JAC and its members on the one side, and CFTC Staff on the other, show that the space remains unsettled. The need for proposed rulemaking, a full airing of public comments, and final rules clearly setting forth the regulators’ expectations concerning the constraints around customer futures and cleared swap documentation and the operational and compliance constraints around separate account margining remains as pressing as ever.