iThis post is the next in our multi-part series on CFTC Regulation §1.44, as proposed by the U.S. Commodity Futures Trading Commission (the “CFTC”) on February 20, 2024 (the “Proposed Rule”).
The previous post in this series focused on the relationship between international payment systems and timing considerations in the “one business day margin call requirement” that applies to separate account customers under the Proposed Rule.
This post explores four miscellaneous considerations related to this requirement. They are:
- Administrative and operational errors;
- Failure by a futures commission merchant (“FCM”) to comply with the timing requirements under paragraph (f) of proposed CFTC Regulation §1.44;
- Unique holiday scenarios involving a designated contract market (“DCM”); and
- Updates to the list of foreign currencies designated on Appendix A to Part 1 of the CFTC Regulations.
Sub-paragraphs (5) through (8) of proposed CFTC Regulation §1.44, respectively, relate to these four considerations.
Administrative and Operational Errors
As part of an investment manager’s ordinary course of business, administrative and operational errors will occasionally prevent a separate account customer from meeting the margin call obligations owed to an FCM. These errors could occur due to an issue at the investment manager, such as a data entry error, or at a point in the payment chain beyond the money manager, as described in greater detail in footnote 172 to the proposing release.
The Proposed Rule clarifies that an unforeseen error will not equate to a failure to timely deposit margin that would result in a separate account being treated as out of the ordinary course of business. Rather, the Proposed Rule seeks to strike what the CFTC describes as, “A reasonable balance in ensuring that FCMs and customers are not forced to cease separate account treatment as a result of unusual and unexpected, one-off errors.”
Specifically, proposed CFTC Regulation §1.44(f)(5) provides that a failure with respect to a specific separate account to meet its obligation to pay margin or option premium will not constitute a failure by that separate account to comply with the Proposed Rule, if the failure is due to an unusual administrative error or operational constraint that the specific separate account customer or investment manager acting diligently and in good faith could not have reasonably foreseen.
The rule proposal tasks an FCM with the responsibility to determine whether the failure to pay margin or option premium was due to an administrative error or operational constraint. An FCM must make such a determination on the basis of its reasonable belief in light of the information known to the FCM at the time that it learns of the relevant error or constraint.
Finally, the CFTC emphasized that the proposal relating to an unusual administrative error or operational constraint applies to a specific separate account, and “not to the FCM’s business with respect to separate accounts as a whole.” So, a particular error may be unusual for a particular customer, notwithstanding the fact that multiple customers of an FCM have had exposure to that particular error. For detail on this point, see footnote 174 in the proposing release.
Failure by an FCM to Comply with Timing Requirements
The Proposed Rule establishes a maximum period of time in which a margin call must be met by a separate account customer for purposes of CFTC Regulation §1.44(f), rather than establishing a minimum period of time that an FCM must allow.
Accordingly, sub-paragraph (6) of CFTC Regulation §1.44(f) makes it clear that an FCM would not be in compliance with the Proposed Rule if it provided a separate account customer with a grace or cure period for a margin payment failure.
Further, in its commentary, the CFTC clarified that the Proposed Rule is not intended to supplant risk management standards of a designated contract organization (e.g., margin timing requirements that apply to clearing member FCMs) that may be more stringent than the requirements of the Proposed Rule.
Unique Holiday Scenarios Involving DCMs
An FCM must make a margin call when market movements or position changes on the previous business day cause a separate account to be unmargined. For example, if market movements on a Friday resulted in an account being undermargined, then the FCM would have to issue a margin call on Monday.
The previous post discussed the timing of when the customer has to make that payment, which varies by currency. If margin is paid in United States dollars, then separate account customer must make the payment on the same day as the margin call.
Sub-paragraph (7) of CFTC Regulation §1.44(f) deals with a holiday on which a DCM may be open for trading, but on which the scheduled closure of banks makes margin payments impracticable or difficult. For purposes of this post, this type of a holiday is called a “DCM-only holiday.”
Specifically, the Proposed Rule provides that an FCM may make margin calls on a DCM-only holiday with the required margin transfer due by the close of the Fedwire Funds Services (“Fedwire”) on the next business day after the DCM-only holiday.
Further, the Proposed Rule deals with the scenario in which mark-to-market movements or position changes on the DCM-holiday result in an incremental increase in undermargined amount of the separate account, relative to the prior business day. The CFTC provided the following examples of how the Proposed Rule works in respect of an incremental undermargined amount:
The following uses Veterans Day (November 11) as an example, and assumes that no relevant day falls on a weekend. If, as a result of market movements on November 10, a separate account is undermargined by $100, the FCM would issue a margin call of at least $100 and, payment of that $100 would be due by the close of Fedwire on November 12.
If that separate account were to be undermargined by a total of $160 as a result of market movements on November 11, the FCM would issue a margin call for at least the incremental amount ($160 – $100 = $60) on November 12, and that incremental $60 would also be due by the close of Fedwire on November 12. If, instead, the separate account gained $60 on November 11, the original margin call for $100 (issued on November 11) would still need to be met by the close of Fedwire on November 12.
By contrast, if the separate account were not undermargined as a result of market movements on November 10, but then became undermargined by $60 as a result of market movements on November 11, the FCM would issue a margin call in the amount of at least $60 on November 12, and payment would be due by the close of Fedwire on November 12.
Updates to Appendix A to Part 1 of the CFTC Regulations
As explained in Part 8 of this series, a separate account customer using one of the currencies listed in Appendix A to Part 1 of the CFTC’s Regulations (the “Appendix A Currencies”) as margin must meet an FCM’s margin call by 12:00 p.m. ET on the second United States business day after the business day on which the FCM issued the margin call.
Sub-paragraph (8) of CFTC Regulation §1.44(f) establishes a procedure that would allow members of the public or the CFTC itself to update the list of Appendix A Currencies by adding or removing a currency listed on Appendix A, subject to approval by the CFTC. Generally, the party proposing the update must provide supporting information to the CFTC, which will consider that information and make a determination as to the update through notice and comment rulemaking process, including a minimum public comment period of 30 days.
The next post in this series will consider requirements related to calculations for capital, risk management, and segregation of customer funds in the separate account customer context.
Read Part 1, Part 2, Part 3, Part 4, Part 5, Part 6, Part 7, and Part 8
