It's DSRO Exam Time for FCMs: Be Letter 25-38 Prepared!

For futures commission merchants (FCMs) that are clearing members of the Chicago Mercantile Exchange, it’s that time of year: Time for the annual examination of the FCM’s operations and financial controls by their designated self-regulatory organization, the CME’s Financial and Regulatory Surveillance (FRS) Department. 

An FRS exam begins with a questionnaire addressed to the FCM, a key question being what has changed at the FCM since the last exam. Many FCMs will likely respond that they have begun using customer securities to collateralize their CFTC Rule 30.7 foreign futures customer exposures in accordance with the conditions set forth in CFTC Letter 25-38.  (We wrote recently about Letter 25-38, here.)

In Letter 25-38, the staff of the CFTC’s Market Participants Division confirmed that an FCM would not be in violation of CFTC Rule 30.7 if it transfers customer securities to a foreign broker pursuant to a title transfer arrangement or a “right of re-use,” provided certain conditions are met. These conditions include that: (i) the laws of the relevant jurisdiction “protect the value of” the securities over which title has been transferred in the event of an insolvency; (ii) such title transfer or right of re-use is “authorized or required” under the laws of the relevant jurisdiction or the rules of the relevant exchange or CCP; and (iii) the rules of the relevant exchange or CCP provide that such securities collateral may only be used for the purposes of securing client positions.

We anticipate that FRS will be looking to test FCM initiatives in response to Letter 25-38. In particular, we expect exam staff to ask how FCMs concluded that the Letter 25-38 conditions are satisfied for each jurisdiction where customer securities are being used pursuant to the new guidance. 

We recommend that any FCM intending to expand its use of customer securities in reliance on Letter 25-38 analyze whether there is a reasonable basis for the FCM to conclude that the three conditions are met in connection with any title transfer arrangements involved in the use of such customer securities to collateralize foreign futures customer transactions. That analysis should be in writing and ready for review by FRS staff.

It’s exam season — if you are anticipating exam attention on your FCM’s initiatives in scope of Letter 25-38, do not hesitate to reach out to your contact at Katten.