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The Division of Clearing and Risk and the Division of Swap Dealer and Intermediary Oversight (the "Divisions") provided further relief and guidance concerning the treatment of separate accounts of a single beneficial owner by futures commission merchants ("FCMs").
The new relief (CFTC Letter 20-28) comes in response to an inquiry from FIA requesting an extension of relief previously granted in CFTC Letter 19-17 (see previous coverage) and clarified in a further staff statement (see previous coverage). The prior relief was set to expire on September 15, 2020, but the new relief extends the expiration date to March 31, 2021, which the Divisions state is "due only to the extraordinary difficulties created by the COVID-19 Pandemic."
In addition to extending the previous relief, the new letter provides a further interpretation of CFTC Rule 1.56 ("Prohibition of guarantees against loss"):
- No specific language is necessary for an FCM to comply, but it must ensure that it does not (1) guarantee the account against loss, (2) limit the loss of the beneficial owner, or (3) prohibit the FCM from calling for margin as required by the applicable board of trade. The staff said that an FCM and its client can agree to a protocol to address "rare occasions" when a margin call in one account of a beneficial owner is not met - but, the FCM must at all times retain discretion to determine when a shortfall is "extraordinary" and necessitates accelerating the liquidation timeline. The staff also noted that a recognition by an FCM of any external law that limits the liability of an account owner would not violate Rule 1.56.
- Where a contractual statement in an agreement before March 31,
2021 could be construed as violating Rule 1.56:
- if the FCM believes other provisions (e.g., applicable law, severability) override or negate the violative provision, the staff indicated that an FCM should obtain written legal opinions or "well-reasoned" memoranda from outside counsel to confirm that analysis; and
- if the FCM provides specified written disclosure to the account owner no later than March 31, 2021 relating to its obligations under Rule 1.56, the staff provided no-action relief as to the potentially violative contractual provision.
Finally, the staff extended, through December 31, 2021, no-action relief under CFTC Rule 39.13(g)(8)(iii) ("Withdrawal of customer initial margin") to permit staff time to consider the experience of derivatives clearing organizations, FCMs and customers operating under the conditions of the no-action relief.
Commentary
Credit risk to an intermediary is a real concern. While the need to modify the previous relief and staff statement seemed inevitable, it is not an easy task. But the new policy (or at least, statement of policy) requires changes to longstanding market practice and is inconsistent with requirements for other types of financial products and intermediaries. The CFTC should address this issue through considered, formal action that gives all relevant stakeholders a meaningful opportunity to comment.
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