June 21, 2021

Volume XI, Number 172


June 18, 2021

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Bridging the Week: April 17 to 21 and 24, 2017 (Direct Funding Participants; Chatting About FX Trades; You Trade, You Submit) [VIDEO]

CME Group revised its July 2016 proposal to permit current customers of futures commission merchants to become direct clearing members of its clearinghouse without potentially incurring liability for the default of other clearing members. In addition, a major international bank agreed to pay the Federal Reserve Bank US $156.6 million related to alleged deficiencies in the bank’s oversight of its forex trading activities a few years ago, as well as its current Volcker Rule compliance program. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • CME Group Revises July 2016 Proposal Authorizing End Customers to Become Direct Clearing Members Without Incurring Liability for Default of Other Members (includes My View);

  • Major International Bank and Affiliates Settle With Federal Reserve for Alleged Deficiencies in FX Trading Practices and Volcker Rule Compliance;

  • Trade With Us, Submit to Our Jurisdiction Reminds CME Group to All Traders (includes Compliance Weeds); and more.

CME Group Revises July 2016 Proposal Authorizing End Customers to Become Direct Clearing Members Without Incurring Liability for Default of Other Members

CME Group submitted amendments to its proposed rule changes previously provided to the Commodity Futures Trading Commission authorizing a new category of clearing membership, termed a “Direct Funding Participant.” 

Under CME Group’s proposal, a DFP could clear all of its own CME Group trades directly with the CME clearinghouse but would not be obligated to contribute to CME Group’s guaranty fund or otherwise be responsible in case of a default by another clearing member. Instead, all of a DFP’s obligations (except for obligations arising from disciplinary actions against a DFP) to CME Group would be guaranteed by at least one other CME Group clearing member – termed a “DFP Guarantor” – that was registered with the CFTC as a futures commission merchant. 

DFPs would respond to all collateral calls by paying the CME clearinghouse directly, but their performance bond requirements would typically be 104 percent of ordinary amounts.

To serve as a DFP Guarantor, an FCM clearing member would be subject to the higher of various minimum financial requirements, including potentially maintaining regulatory capital equal to the applicable CFTC requirements for positions carried in customer and non-customer accounts plus 4 percent of the total risk margin requirement for each DFP’s open positions that the DFP Guarantor guarantees. Additionally, a DFP Guarantor’s guaranty fund deposit would be increased to account for the activity of each DFP it guarantees, and a DFP Guarantor would have to serve as the exchange’s liquidating agent if a DFP defaulted.

According to CME Group, the intent of the DFP model is to enable a customer of an FCM to escape the risk of a pro rata loss allocation it might otherwise incur in the event of a customer-led or other default where there was a shortfall in any of the types of customer accounts at the FCM (segregated funds, foreign futures funds and cleared swaps) – avoiding so-called “fellow customer risk.” Moreover, even if there were no shortfall, a DFP would avoid potential delays in recovering its collateral as opposed to if it maintained an account at a failed FCM.

CME Group claimed that the DFP model would benefit US bank‑owned FCMs, as they could avoid having cash posted with them that might increase their leverage capital requirements. DFP Guarantors are authorized to provide back-office services and regulatory reporting for DFPs.

CME Group amended its earlier proposal submitted to the CFTC during July 2016, to permit a DFP Guarantor to have a second lien over collateral of a DFP it guarantees; to require DFP Guarantors to employ pre-trade risk controls for DFPs they guarantee consistent with CFTC requirements (click here to access CFTC Rule 1.73); to clarify a DFP’s financial reporting obligations (e.g., a DFP would not have to produce financial statements to the clearinghouse); and to address certain concerns previously expressed by the Futures Industry Association regarding CME Group’s DFP proposal. Among other things, FIA expressed a concern regarding the obligation of a DFP Guarantor to serve as the exchange’s liquidation agent in the event of a DFP default. However, CME Group said its view is “the DFP Guarantor is in the best position to know how to manage its designated DFP through a default as the DFP Guarantor guarantees the DFP’s financial obligation to the clearinghouse and risk manages the DFP’s portfolio.”

In response to another FIA concern, CME Group obtained a legal memorandum that concluded DFPs should not be considered customers of DFP guarantor FCMs and would not be subject to fellow customer risk at such FCMs.

Other commentators suggested that DFPs alone should fully incur any increased capital requirements prompted by their positions, by imposing on them a minimum margin of 108 percent of ordinary requirements. CME Group rejected this recommendation, positing, “whether the DFP program does in fact create heightened capital requirements on the DFP Guarantor as compared to the capital requirements set out for FCM clearing members with respect to customers under Commission Regulations.”

CME Group anticipates its amended rules authorizing DFP Memberships will be effective the earlier of June 19 or upon CFTC approval.

(Click here for background on CME Group’s earlier proposal. Click here for a very helpful Q&A on its DFP clearing membership proposal prepared by CME Group.)

My View: Once CME Group’s DFP proposal is implemented, CME Group will become the third clearinghouse in the United States and Europe to offer direct clearing membership programs. The others are at Eurex and ICE Clear Europe. (Click here for insight into Eurex’s direct clearing model, and here for background on ICE Clear Europe’s direct clearing model.) Although each model is different – mostly due to the application of different customer funds requirements and insolvency regimes in Europe and the United States, each attempts to exclude customers through direct clearinghouse membership from various risks associated with the insolvency of FCMs. However, whether FCMs will be willing to provide necessary guarantees will be seen. Ultimately, these models may evolve to provide greater flexibility by perhaps transferring all heightened capital requirements from guarantor FCMs to customers through a greater premium margin. This would enable more FCMs to become essentially introducing brokers only, reduce capital requirements, and generate more revenue solely through the provision of expert outsourcing, risk management and other services. Time will tell. But in conjunction with the introduction of distributed ledger technology, the direct clearing membership model may be a harkening of major changes coming in the way customers trading exchange-traded derivatives are serviced going forward. Stay tuned!


  • Major International Bank and Affiliates Settle With Federal Reserve for Alleged Deficiencies in FX Trading Practices and Volcker Rule Compliance: Deutsche Bank AG (“DB AG”), DB USA Corporation and Deutsche Bank AG New York Branch (collectively, “DB”) agreed to pay an aggregate fine of US $136.95 million pursuant to a consent order initiated by the Board of Governors of the Federal Reserve System for failing to have an “effective and comprehensive risk management framework” related to its foreign exchange trading activities from October 2008 through October 2013. During that time, claimed the FRB, DB traders engaged in communications with traders from other financial institutions through electronic chat rooms where they disclosed trading positions and coordinated trading strategies; discussed possible FX-benchmark price fixing; discussed bid/offer spreads offered to FX customers; and discussed trading overall in a manner to benefit DB’s trading positions. In addition to agreeing to pay a fine, DB consented to other undertakings, including, within 90 days, to submit a plan to improve DB’s compliance with applicable laws and regulations in connection with its FX trading, as well as its trading of commodities and interest rate products. In May 2015, five major international banks, not including DB, pleaded guilty to conspiring to manipulate the price of certain foreign exchange transactions, and agreed to pay fines totaling US $5.6 billion, as well as other sanctions, to resolve criminal proceedings by the US Department of Justice and disciplinary proceedings by other US regulators. (Click here for details.) Separately, DB also entered into a consent order with the FRB for not, since July 21, 2015, establishing a compliance program “reasonably designed” to ensure and monitor compliance with certain of its obligations regarding proprietary activities under the Dodd Frank Wall Street Reform and Consumer Protection Act and certain related rules enacted by the FRB (collectively, the “Volcker Rule”). Under this consent decree, DB agreed to pay a fine of US $19.71 million and agree to additional undertakings.

  • Trade With Us, Submit to Our Jurisdiction Reminds CME Group to All Traders: CME Group issued a reminder that all persons who trade on its exchanges agree to comply with all its rules and submit to its jurisdiction. This requires all traders, among other things, to fully cooperate with exchange staff during investigations, including producing requested documents and answering all questions by staff and to participate fully in disciplinary proceedings.

Compliance Weeds: CME Group’s guidance, which it issued in the form of a market regulation advisory notice, broke no new ground. Since August 2012, the Commodity Futures Trading Commission has required all designated contract markets, such as CME Group exchanges, to require all traders to submit to their jurisdiction (click here to access CFTC Rule 38.151). In response, CME Group adopted a rule effectuating this provision (click here to access CME Group Rule 418), as did ICE Futures U.S. (click here to access IFUS Rules 4.00). It often comes as a surprise to exchange non-members, particularly when located abroad, that they must cooperate fully during a DCM’s investigation or disciplinary proceeding, but it is ultimately a CFTC mandate. It is precisely because of the applicability of DCM rules to all traders on a DCM that I previously have argued that the CFTC could more effectively accomplish most of its objectives in proposed Regulation Automated Trading by better leveraging existing exchange requirements and plugging what it perceives to be gaps through amendments to core principles for DCMs rather than by inflicting a new regulatory behemoth on the industry.

More Briefly:

  • CFTC DSIO Extends Relief Preventing Double Margin Requirement for Swap Dealers Located in Europe: The Commodity Futures Trading Commission’s Division of Swap Dealer and Intermediary Oversight extended no-action relief previously granted that excludes Europe-based swap dealers from having to comply both with CFTC and European Union requirements related to margin for non-cleared swaps. Under the DSIO’s no action relief, EU-based SDs will only have to comply with EU obligations until November 7, 2017. During this time, the CFTC is determining whether the EU’s margin rules are comparable with respect to the CFTC’s rules; if the Commission determines they are, non-US SDs would only have to comply with EU requirements pursuant to the substituted compliance framework previously articulated in the CFTC’s cross-border margin rule. (Click here for background on the original-granted relief.)

  • NEX SEF Approved as a Swap Execution Facility by CFTC: Last week, the Commodity Futures Trading Commission designated NEX SEF as a swap execution facility. NEX SEF, located in the United Kingdom, proposes initially to offer non‑deliverable forwards in emerging market currencies. (Click here for background on NEX SEF.)

  • OFAC Updates Specially Designated Nationals and Blocked Persons Lists: The US Treasury Department’s Office of Foreign Assets Control has updated its list of so-called “Specially Designated Nationals and Blocked Persons List.” This list identifies persons with whom US financial institutions should not conduct business as their assets are blocked.

©2021 Katten Muchin Rosenman LLPNational Law Review, Volume VII, Number 114



About this Author

Gary DeWaal, Securities Attorney, Katten Law Firm, New York
Special Counsel

Gary DeWaal focuses his practice on financial services regulatory matters. He counsels clients on the application of evolving regulatory requirements to existing businesses and structuring more effective compliance programs, as well as assists in defending and resolving regulatory disciplinary actions and enforcement matters. Gary also advises buy-side and sell-side clients, as well as trading facilities and clearing houses, on the developing laws and regulations related to cryptocurrencies and digital tokens.

Previously, Gary was a senior...