In a no-action letter, the CFTC Division of Swap Dealer and Intermediary Oversight ("SDIO") and Division of Clearing and Risk ("DCR") provided guidance on the treatment of separate accounts of a single beneficial owner by futures commission merchants ("FCMs").

The CFTC advisory on CFTC Rule 1.56 ("Prohibition of guarantees against loss") provided guidance on the appropriate documentation required within customer agreements and the processing of margin withdrawals. The letter states that FCMs must retain the ability to access funds in the other accounts of a beneficial owner (including those under different control) to meet margin requirements when the customer is in financial distress. The letter also clarifies that FCM customer agreements or other documents cannot (i) prevent an FCM from calling the beneficial owner of an account for required margin, (ii) obstruct the FCM from initiating legal proceedings to recover any losses should the beneficial owner fail to meet the margin call or (iii) guarantee a beneficial owner against or limit the beneficial owner's loss.

Concurrently, the letter provides no-action relief for derivatives clearing organizations ("DCOs") in order to permit FCM clearing members to treat the separate accounts of a customer as the accounts of separate entities if the FCM's written internal controls and procedures require it to comply with specific conditions. The DCR granted temporary no-action relief for DCOs from CFTC Rule 39.13 (g)(8)(iii) ("Withdrawal of customer initial margin"), subject to numerous conditions, including the following:

  • The FCM permits disbursements on a separate basis only during its "ordinary course of business" (defined in further detail in the letter).

  • The FCM receives "information sufficient . . . to assess the value of the assets dedicated to such separate account."

  • The FCM risk policies and procedures are updated by July 1, 2010 to include stress testing and credit limits, applied on both a separate account level and across accounts of the beneficial owner.

  • Margin is calculated for each separate account without offsets/spreads across accounts.

  • All separate accounts are on a one-business-day margin call, with exceptions permitted for administrative errors or operational constraints.

  • Receivables from a separate account are "grossed up" for the appropriate customer statements and segregation - i.e., an FCM must use its own funds to cover a debit/deficit of each separate account.

  • Information must be obtained as to an authorized representative at the beneficial owner even when an account is maintained by a third party (e.g., an adviser). (For existing accounts, an FCM has until January 1, 2010 to obtain the information.)

  • The FCM makes disclosures to each separate account client regarding bankruptcy treatment. Evidence must be obtained that the disclosure was made directly to the beneficial owner. The disclosure must be made "as soon as feasible," but no later than February 1, 2020.

The no-action relief will extend until June 30, 2021 in order for the CFTC to determine whether to conduct a rulemaking to make the relief a permanent rule.

Commentary /Nihal Patel

This letter could create a lot of work for a lot of people.

The letter follows on two recent regulatory alerts from the Joint Audit Committee ("JAC") (a committee with representatives from futures exchanges and the NFA). In JAC Regulatory Alert 19-02, the committee said that for all accounts, "the same beneficial owner with the same regulatory account classification" must be combined for margin purposes. Further, when determining funds available, even if accounts are controlled by different persons, accounts must be combined (although margin could be called for on an account basis). In essence, JAC said that if account 1 managed by Adviser X is in a margin deficit, then account 2 managed by Adviser Y cannot call for a return of collateral (no matter how over-margined) if account 1 and account 2 are, collectively, in a deficit. (JAC issued a regulatory alert in response to the new CFTC letter, saying that Regulatory Alert 19-02 is considered amended to reflect the application of the CFTC letter.)

Treatment of these situations raises many issues. However, the letter reflects a fairly skeptical view of how money managers conduct their business for separate account clients. For example, the letter requires that an FCM must have contact for an authorized representative of the beneficial owner and must obtain evidence that insolvency-related disclosures are directly delivered to the beneficial owner. More concretely, the letter creates a series of tasks for market participants either immediately or in a condensed time period. The letter provides no build time for many of the conditions in the no-action relief (including contractual changes), with only certain diligence matters and disclosures given explicit time periods for addressing existing accounts. As to compliance, generally, market participants should immediately consider the following tasks:

  • FCMs:

    • update policies and procedures and ensure operational capabilities;

    • review account information and reach out to all in-scope separate accounts;

    • amend contracts with separate accounts with terms that are not consistent with the no-action letter (e.g., 2 broker-dealer margin transfer or, potentially, cure periods);

    • engage in diligence on all relevant separate account clients;

    • draft and/or update existing disclosures; and

    • submit paperwork to DCOs.

  • Advisers Managing Separate Accounts:

    • respond to outreach from every FCM;

    • re-engage with clients for obtaining necessary information and delivering necessary disclosures;

    • diligence potential clients in respect of FCM arrangements and other managers involved in portfolio management; and

    • potentially amend existing investment management agreements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.