[Federal Register Volume 75, Number 212 (Wednesday, November 3, 2010)]
[Proposed Rules]
[Pages 67642-67657]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-27657]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1 and 30

RIN 3038-AC15


Investment of Customer Funds and Funds Held in an Account for 
Foreign Futures and Foreign Options Transactions

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rule.

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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC) 
is proposing to amend its regulations regarding the investment of 
customer segregated funds and funds held in an account subject to 
Commission Regulation 30.7 (30.7 funds). Certain amendments reflect the 
implementation of new statutory provisions enacted under Title IX of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act. The 
proposed rules address: Certain changes to the list of permitted 
investments, a clarification of the liquidity requirement, the removal 
of rating requirements, an expansion of concentration limits including 
asset-based, issuer-based, and counterparty concentration restrictions. 
It also addresses revisions to the acknowledgment letter requirement 
for investment in a money market mutual fund (MMMF), revisions to the 
list of exceptions to the next-day redemption requirement for MMMFs, 
the application of customer segregated funds investment limitations to 
30.7 funds, the removal of ratings requirements for depositories of 
30.7 funds, and the elimination of the option to designate a depository 
for 30.7 funds.

DATES: Comments must be received on or before December 3, 2010.

ADDRESSES: You may submit comments, identified by RIN number, by any of 
the following methods:
     Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments 
through the Web site.
     Mail: David A. Stawick, Secretary of the Commission, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, NW., Washington, DC 20581.
     Hand Delivery/Courier: Same as mail above.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
    All comments must be submitted in English, or if not, accompanied 
by an English translation. Comments will be posted as received to 
http://www.cftc.gov. You should submit only information that you wish 
to make available publicly. If you wish the Commission to consider 
information that may be exempt from disclosure under the Freedom of 
Information Act, a petition for confidential treatment of the exempt 
information may be submitted according to the established procedures in 
CFTC Regulation 145.9.\1\
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    \1\ Commission regulations referred to herein are found at 17 
CFR Ch. 1.

FOR FURTHER INFORMATION CONTACT: Phyllis P. Dietz, Associate Director, 
202-418-5449, pdietz@cftc.gov, or Jon DeBord, Attorney-Advisor, 202-
418-5478, jdebord@cftc.gov, or Division of Clearing and Intermediary 
Oversight, Commodity Futures Trading Commission, Three Lafayette 
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Centre, 1151 21st Street, NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background
    A. Regulation 1.25
    B. Regulation 30.7
    C. Advance Notice of Proposed Rulemaking
    D. The Dodd-Frank Act
II. Discussion of the Proposed Rules
    A. Permitted Investments
    1. Government Sponsored Enterprise Securities
    2. Commercial Paper and Corporate Notes or Bonds
    3. Foreign Sovereign Debt
    4. In-House Transactions
    B. General Terms and Conditions
    1. Marketability
    2. Ratings
    3. Restrictions on Instrument Features
    4. Concentration Limits
    (a) Asset-Based Concentration Limits
    (b) Issuer-Based Concentration Limits
    (c) Counterparty Concentration Limits
    C. Money Market Mutual Funds
    1. Acknowledgment Letters
    2. Next-Day Redemption Requirement
    D. Repurchase and Reverse Repurchase Agreements
    E. Regulation 30.7
    1. Harmonization
    2. Ratings
    3. Designation as a Depository for 30.7 Funds
III. Related Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act
    C. Costs and Benefits of the Proposed Rules
Text of Rules

I. Background

A. Regulation 1.25

    Under Section 4d(a)(2) of the Commodity Exchange Act (Act),\2\ the 
investment of customer segregated funds is limited to obligations of 
the United States and obligations fully guaranteed as to principal and 
interest by the United States (U.S. government securities), and general 
obligations of any State or of any political subdivision thereof 
(municipal securities). Pursuant to authority under Section 4(c) of the 
Act,\3\ the Commission substantially expanded the list of permitted 
investments by amending Commission Regulation 1.25 \4\ in December 2000 
to permit investments in general obligations issued by any enterprise 
sponsored by the United States (government sponsored enterprise 
securities or GSE securities), bank certificates of deposit (CDs), 
commercial paper, corporate notes,\5\ general obligations of a 
sovereign nation, and interests in MMMFs.\6\ In connection

[[Page 67643]]

with that expansion, the Commission included several provisions 
intended to control exposure to credit, liquidity, and market risks 
associated with the additional investments, e.g., requirements that the 
investments satisfy specified rating standards and concentration 
limits, and be readily marketable and subject to prompt liquidation.\7\
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    \2\ 7 U.S.C. 6d(a)(2).
    \3\ 7 U.S.C. 6(c).
    \4\ 17 CFR 1.25.
    \5\ This category of permitted investment was later amended to 
read ``corporate notes or bonds.'' See 70 FR 28190, 28197 (May 17, 
2005).
    \6\ See 65 FR 77993 (Dec. 13, 2000) (publishing final rules); 
and 65 FR 82270 (Dec. 28, 2000) (making technical corrections and 
accelerating effective date of final rules from February 12, 2001 to 
December 28, 2000).
    \7\ Id.
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    The Commission further modified Regulation 1.25 in 2004 and 2005. 
In February 2004, the Commission adopted amendments regarding 
repurchase agreements using customer-deposited securities and time-to-
maturity requirements for securities deposited in connection with 
certain collateral management programs of derivatives clearing 
organizations (DCOs).\8\ In May 2005, the Commission adopted amendments 
related to standards for investing in instruments with embedded 
derivatives, requirements for adjustable rate securities, concentration 
limits on reverse repurchase agreements, transactions by futures 
commission merchants (FCMs) that are also registered as securities 
brokers or dealers (in-house transactions), rating standards and 
registration requirements for MMMFs, an auditability standard for 
investment records, and certain technical changes.\9\
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    \8\ 69 FR 6140 (Feb. 10, 2004).
    \9\ 70 FR 28190.
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    The Commission has been, and continues to be, mindful that customer 
segregated funds must be invested in a manner that minimizes their 
exposure to credit, liquidity, and market risks both to preserve their 
availability to customers and DCOs and to enable investments to be 
quickly converted to cash at a predictable value in order to avoid 
systemic risk. Toward these ends, Regulation 1.25 establishes a general 
prudential standard by requiring that all permitted investments be 
``consistent with the objectives of preserving principal and 
maintaining liquidity.'' \10\
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    \10\ 17 CFR 1.25(b).
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    In 2007, the Commission's Division of Clearing and Intermediary 
Oversight (Division) launched a review of the nature and extent of 
investments of customer segregated funds and 30.7 funds (2007 Review) 
in order to further its understanding of investment strategies and 
practices and to assess whether any changes to the Commission's 
regulations would be appropriate. As part of this review, all 
registered DCOs and FCMs carrying customer accounts provided responses 
to a series of questions. As the Division was conducting follow-up 
interviews with respondents, the market events of September 2008 
occurred and changed the financial landscape such that much of the data 
previously gathered no longer reflected current market conditions. 
However, much of that data remains useful as an indication of how 
Regulation 1.25 was implemented in a more stable financial environment, 
and recent events in the economy have underscored the importance of 
conducting periodic reassessments and, as necessary, revising 
regulatory policies to strengthen safeguards designed to minimize risk.

B. Regulation 30.7

    Regulation 30.7 \11\ governs an FCM's treatment of customer money, 
securities, and property associated with positions in foreign futures 
and foreign options. Regulation 30.7 was issued pursuant to the 
Commission's plenary authority under Section 4(b) of the Act.\12\ 
Because Congress did not expressly apply the limitations of Section 4d 
of the Act to 30.7 funds, the Commission historically has not subjected 
those funds to the investment limitations applicable to customer 
segregated funds.
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    \11\ 17 CFR 30.7.
    \12\ 7 U.S.C. 6(b).
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    The investment guidelines for 30.7 funds are general in nature.\13\ 
Although Regulation 1.25 investments offer a safe harbor, the 
Commission does not currently limit investments of 30.7 funds to 
permitted investments under Regulation 1.25. Appropriate depositories 
for 30.7 funds currently include certain financial institutions in the 
United States, financial institutions in a foreign jurisdiction meeting 
certain capital and credit rating requirements, and any institution not 
otherwise meeting the foregoing criteria, but which is designated as a 
depository upon the request of a customer and the approval of the 
Commission.
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    \13\ See Commission Form 1-FR-FCM Instructions at 12-9 (Mar. 
2010) (``In investing funds required to be maintained in separate 
section 30.7 account(s), FCMs are bound by their fiduciary 
obligations to customers and the requirement that the secured amount 
required to be set aside be at all times liquid and sufficient to 
cover all obligations to such customers. Regulation 1.25 investments 
would be appropriate, as would investments in any other readily 
marketable securities.'').
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C. Advance Notice of Proposed Rulemaking

    In May 2009, the Commission issued an advance notice of proposed 
rulemaking (ANPR) \14\ to solicit public comment prior to proposing 
amendments to Regulations 1.25 and 30.7. The Commission stated that it 
was considering significantly revising the scope and character of 
permitted investments for customer segregated funds and 30.7 funds. In 
this regard, the Commission sought comments, information, research, and 
data regarding regulatory requirements that might better safeguard 
customer segregated funds. It also sought comments, information, 
research, and data regarding the impact of applying the requirements of 
Regulation 1.25 to investments of 30.7 funds.
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    \14\ 74 FR 23962 (May 22, 2009).
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    The Commission received twelve comment letters in response to the 
ANPR, and it has considered those comments in formulating its 
proposal.\15\ Eleven of the 12 letters supported maintaining the 
current list of permitted investments and/or specifically ensuring that 
MMMFs remain a permitted investment. Five of the letters were dedicated 
solely to the topic of MMMFs, providing detailed discussions of their 
usefulness to FCMs. Several letters addressed issues regarding ratings, 
liquidity, concentration, and portfolio weighted average time to 
maturity. The alignment of Regulation 30.7 with Regulation 1.25 was 
viewed as non-controversial.
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    \15\ The Commission received comment letters from CME Group Inc. 
(CME), Crane Data LLC (Crane), The Dreyfus Corporation (Dreyfus), 
FCStone Group Inc. (FCStone), Federated Investors, Inc. (Federated), 
Futures Industry Association (FIA), Investment Company Institute 
(ICI), MF Global Inc. (MF Global), National Futures Association 
(NFA), Newedge USA, LLC (Newedge), and Treasury Strategies, Inc. 
(TSI). Two letters were received from Federated: A July 10, 2009 
letter (Federated letter I) and an August 24, 2009 letter.
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    The FIA's comment letter expressed its view that ``all of the 
permitted investments described in Rule 1.25(a) are compatible with the 
Commission's objectives of preserving principal and maintaining 
liquidity.'' This opinion was echoed by MF Global, Newedge and FC 
Stone. CME asserted that only ``a small subset of the complete list of 
Regulation 1.25 permitted investments are actually used by the 
industry. * * *'' NFA also wrote that investments in instruments other 
than U.S. government securities and MMMFs are ``negligible'' and 
recommended that the Commission eliminate asset classes not ``utilized 
to any material extent.''

D. The Dodd-Frank Act

    On July 21, 2010, President Obama signed the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (Dodd-Frank Act).\16\ Title IX of 
the

[[Page 67644]]

Dodd-Frank Act \17\ was promulgated in order to increase investor 
protection, promote transparency and improve disclosure.
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    \16\ See Dodd-Frank Wall Street Reform and Consumer Protection 
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the 
Dodd-Frank Act may be accessed at http://www.cftc.gov./
LawRegulation/OTCDERIVATIVES/index.htm.
    \17\ Pursuant to Section 901 of the Dodd-Frank Act, Title IX may 
be cited as the ``Investor Protection and Securities Reform Act of 
2010.''
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    Section 939A of the Dodd-Frank Act obligates federal agencies to 
review their respective regulations and make appropriate amendments in 
order to decrease reliance on credit ratings. The Dodd-Frank Act 
requires the Commission to conduct this review within one year after 
the date of enactment.\18\ The Commission is proposing amendments to 
Regulations 1.25 and 30.7 that include removal of provisions setting 
forth credit rating requirements. Separate rulemakings proposed today 
address the elimination of credit ratings from Regulations 1.49 and 
4.24 and the removal of Appendix A to Part 40 (which contains a 
reference to credit ratings).
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    \18\ See Section 939A(a) of the Dodd-Frank Act.
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    The Commission is now proposing amendments to Regulations 1.25 and 
30.7 and requests comment on all aspects of the proposed rules, as well 
as comment on the specific provisions and issues highlighted in the 
discussion below. In addition, commenters are welcome to offer their 
views regarding any other related matters that are raised by the 
proposed amendments.

II. Discussion of the Proposed Rules

A. Permitted Investments

    In proposing amendments to Regulation 1.25, the Commission seeks to 
simplify the regulation and impose requirements that can better ensure 
the preservation of principal and maintenance of liquidity. The 
Commission has endeavored to tailor its proposal to achieve these goals 
while retaining an appropriate degree of investment flexibility and 
opportunities for attaining capital efficiency for DCOs and FCMs 
investing customer segregated funds.
    The Commission seeks to simplify Regulation 1.25 by narrowing the 
scope of investment choices in order to eliminate the potential use of 
instruments that may pose an unacceptable level of risk. In their July 
2009 comment letters, both NFA and CME suggested contracting the scope 
of permitted investments by eliminating asset classes used negligibly 
as investment vehicles.
    The Commission seeks to increase the safety of Regulation 1.25 
investments by promoting diversification. For example, issuer-specific 
concentration limits control how much exposure an FCM or DCO has to the 
credit risk of any one investment. The Commission believes that greater 
diversification can be achieved through instituting two additional 
types of concentration limits. First, asset-based concentration limits, 
suggested by the FIA, MF Global and Newedge in their comment letters, 
reduce market risk by limiting how much of any one class of instrument 
an FCM or DCO can have in its portfolio at any one time. Second, 
repurchase agreement counterparty concentration limits serve to cap an 
FCM or DCO's exposure to the credit risk of a counterparty.
    Below, the Commission details its proposal to remove government 
sponsored enterprise (GSE) securities that are not backed by the full 
faith and credit of the United States, corporate debt obligations not 
guaranteed by the United States, general obligations of a sovereign 
nation (foreign sovereign debt), and in-house transactions from the 
list of permitted investments. These proposed changes reflect the 
position of the Commission that the safety of a particular instrument 
or transaction must be viewed through the lens of its likely 
performance during a period of market volatility and financial 
instability.
1. Government Sponsored Enterprise Securities
    The Commission proposes to amend paragraph (a)(1)(iii) to expressly 
add U.S. government corporation obligations \19\ to GSE securities 
(together, U.S. agency obligations) and to add the requirement that the 
U.S. agency obligations must be fully guaranteed as to principal and 
interest by the United States. GSEs are chartered by Congress but are 
privately owned and operated. Securities issued by GSEs do not have an 
explicit federal guarantee although they are considered by some to have 
an ``implicit'' guarantee due to their federal affiliation.\20\ 
Obligations of U.S. government corporations, such as the Government 
National Mortgage Association (known as Ginnie Mae), are explicitly 
backed by the full faith and credit of the United States. Although the 
Commission is not aware of any GSE securities that have an explicit 
federal guarantee, it believes that GSE securities should remain on the 
list of permitted investments in the event this status changes in the 
future.
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    \19\ See 31 U.S.C. 9101 (defining ``government corporation'').
    \20\ Frank J. Fabozzi with Steven V. Mann, The Handbook of Fixed 
Income Securities, 242-245 (McGraw Hill 7th ed. 2005).
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    The failure of two GSEs during the financial crisis has moved the 
Commission to view the securities of such GSEs as inappropriate for 
investments of customer funds. In 2008, the Federal National Mortgage 
Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation 
(Freddie Mac) failed due to problems in the subprime mortgage market. 
While Fannie Mae and Freddie Mac were bailed out in 2008, the U.S. 
government had no obligation to do so and investors cannot rely on 
another bailout should a GSE fail in the future.
    In consideration of the above, the Commission proposes to amend 
paragraph (a)(1)(iii) of Regulation 1.25 by permitting investments in 
only those U.S. agency obligations that are fully guaranteed as to 
principal and interest by the United States.\21\ The Commission 
requests comment on whether GSE securities should remain as permitted 
investments under Regulation 1.25, either subject to a Federal 
guarantee requirement or not.
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    \21\ Although U.S. Government corporation obligations backed by 
the full faith and credit of the United States could also be 
categorized as U.S. Government securities under Regulation 
1.25(a)(1)(i), the Commission is distinguishing them from other 
government securities, such as Treasury securities, because they 
cannot be expected to have the same liquidity even if they satisfy 
the ``highly liquid'' requirement under proposed. Regulation 
1.25(b)(1). See also discussion of concentration limits in Section 
II.B.4. of this notice.
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2. Commercial Paper and Corporate Notes or Bonds
    In order to simplify the regulation by eliminating rarely-used 
instruments, and in light of the credit, liquidity, and market risks 
posed by corporate debt securities, the Commission proposes to limit 
investments in ``commercial paper'' \22\ and ``corporate notes or 
bonds'' \23\ to commercial paper and corporate notes or bonds that are 
federally guaranteed as to principal and interest under the Temporary 
Liquidity Guarantee Program (TLGP) and meet certain other prudential 
standards.\24\
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    \22\ Regulation 1.25(a)(1)(v).
    \23\ Regulation 1.25(a)(1)(vi).
    \24\ Commercial paper would remain available as a direct 
investment for MMMFs and corporate notes or bonds would remain 
available as indirect investments for MMMFs by means of a repurchase 
agreement. Additionally, it should be noted that two commenters 
suggested expanding the list of permitted investments to include 
commercial paper and corporate notes or bonds guaranteed by foreign 
sovereign governments. However, as the Commission has determined 
that foreign sovereign debt is itself unsuitable as a permitted 
investment, going forward (explained in more detail below), it 
follows that corporate debt guaranteed by a foreign sovereign 
government would also not be permissible.

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[[Page 67645]]

    Information obtained during the 2007 Review indicated that 
commercial paper and corporate notes or bonds were not widely used by 
FCMs or DCOs.\25\ Consistent with this, the NFA states in its comment 
letter that most firms invest about 33 percent of their customer funds 
in government securities, 10 percent in MMMFs, and the balance 
maintained in bank accounts or on deposit with a carrying broker.
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    \25\ The 2007 Review indicated that out of 87 FCM respondents, 
only nine held commercial paper and seven held corporate notes/bonds 
as direct investments during the November 30, 2006-December 1, 2007 
period. Further, 26 FCM respondents engaged in reverse repurchase 
agreements as of December 1, 2007 and none received commercial paper 
or corporate notes or bonds in those transactions.
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    In the fall of 2008, the Federal Deposit Insurance Corporation 
(FDIC) created the TLGP, which guarantees principal and interest on 
certain types of corporate debt. Although the TLGP debt securities are 
backed by the full faith and credit of the U.S. Government and 
therefore pose minimal credit risk to the buyer for the period during 
which the guarantee is effective, initially there was concern as to 
whether the securities were readily marketable and sufficiently liquid 
so that the holders of such securities would be able to liquidate them 
quickly and easily without having to incur a substantial discount.
    In February 2010, having evaluated the growing market for TLGP debt 
securities, the Division issued an interpretative letter concluding 
that TLGP debt securities are sufficiently liquid, and might therefore 
qualify as permitted investments under Regulation 1.25 if they meet the 
following criteria in addition to satisfying the pre-existing 
requirements imposed by Regulation 1.25: (1) The size of the issuance 
is greater than $1 billion; (2) the debt security is denominated in 
U.S. dollars; and (3) the debt security is guaranteed for its entire 
term.\26\
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    \26\ Letter from Ananda Radhakrishnan, Director, Division of 
Clearing and Intermediary Oversight, CFTC, to Debra Kokal, Chairman 
of the Joint Audit Committee (Jan. 15, 2010) (TLGP Letter).
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    Although the TLGP expires in 2012, the Commission believes it is 
useful to include commercial paper and corporate notes or bonds that 
are fully guaranteed as to principal and interest by the United States 
as permitted investments because this would permit continuing 
investment in TLGP debt securities, even though the Commission has 
proposed to otherwise eliminate commercial paper and corporate notes or 
bonds. Therefore, the Commission proposes to limit the commercial paper 
and corporate notes or bonds that can qualify as permitted investments 
to only those guaranteed as to principal and interest under the TLGP 
and that meet the criteria set forth in the Division's interpretation. 
As a result of this limitation, paragraph (b)(3)(iv), which relates to 
adjustable rate securities, is no longer necessary.\27\ The Commission 
proposes to delete current paragraph (b)(3)(iv) and replace it with 
language codifying the criteria for federally backed commercial paper 
and corporate notes or bonds. Accordingly, the Commission proposes to 
delete paragraph (b)(3)(i)(B) and amend paragraph (b)(3)(iii) to remove 
references to paragraph (b)(3)(iv). The Commission requests comment on 
the proscription of commercial paper and corporate notes or bonds that 
are not federally guaranteed under the TLGP, the liquidity of TLGP 
debt, and whether the removal of the requirements for adjustable rate 
securities will have any unintended or detrimental effects on 
Regulation 1.25 investments.
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    \27\ The original purpose of this paragraph was to set 
parameters for adjustable rate securities issued by corporations 
and, to a lesser extent, GSEs. As proposed, Regulation 1.25 would 
only permit corporate and GSE securities that had explicit U.S. 
Government guarantees. Therefore, the mechanics of an adjustable 
rate component for these instruments would no longer require 
oversight for Regulation 1.25 purposes.
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3. Foreign Sovereign Debt
    The Commission proposes to remove foreign sovereign debt as a 
permitted investment in the interests of both simplifying the 
regulation and safeguarding customer funds. The 2007 Review revealed 
negligible investment in foreign sovereign debt \28\ and that fact, in 
combination with recent events undermining confidence in the solvency 
of a number of foreign countries, supports the Commission's proposed 
action. Removal of foreign sovereign debt from the list of permitted 
investments is not expected to significantly impact FCM and DCO 
investment strategies for customer funds. The Commission notes that, 
aside from general appeals to maintain the current list of permitted 
investments, only one commenter specifically addressed foreign 
sovereign debt.\29\
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    \28\ The 2007 Review indicated that out of 87 FCM respondents, 
only three held an investment in foreign sovereign debt at any time 
during that year. It should also be noted that only one FCM invested 
in such debt under Regulation 30.7.
    \29\ FIA, in its comment letter, recommended expanding 
investment in foreign sovereign debt beyond the current rule, which 
limits an FCM's investment in foreign sovereign debt to the amount 
of its liabilities to its clients in that foreign country's currency 
(FIA letter at 5). As the Commission is prepared to remove foreign 
sovereign debt entirely, a more detailed analysis of this 
recommendation is unnecessary.
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    Currently, an FCM or DCO can invest customer funds in foreign 
sovereign debt subject to two limitations: (1) The debt must be rated 
in the highest category by at least one nationally recognized 
statistical rating organization (NRSRO) and (2) the FCM or DCO may 
invest in such debt only to the extent it has balances in segregated 
accounts owed to its customers or its clearing member FCMs, 
respectively, denominated in that country's currency. The purpose of 
permitting investments in foreign sovereign debt is to facilitate 
investments of customer funds in the form of foreign currency without 
the need to convert that foreign currency to a U.S. dollar denominated 
asset, which would increase the FCM or DCO's exposure to currency risk. 
An investment in the sovereign debt of the same country that issues the 
foreign currency would limit the FCM or DCO's exposure to sovereign 
risk, i.e., the risk of the sovereign's default.
    Both the lack of investment in foreign sovereign debt and the 
recent global financial volatility have caused the Commission to 
reevaluate this provision. First, as noted above, it appears that 
foreign sovereign debt is rarely used as an investment tool by FCMs. 
Second, the financial crisis has highlighted the fact that certain 
countries' debt can exceed an acceptable level of risk.
    In consideration of the above, the Commission proposes to remove 
foreign sovereign debt as a permitted investment under Regulation 1.25 
and renumber paragraph (a)(1) accordingly. The Commission requests 
comment on whether foreign sovereign debt should remain, to any extent, 
as a permitted investment and, if so, what requirements or limitations 
might be imposed in order to minimize sovereign risk.
4. In-House Transactions
    The Commission proposes to eliminate in-house transactions 
permitted under paragraph (a)(3) and subject to the requirements of 
paragraph (e) of Regulation 1.25. This proposal is consistent with the 
Commission's proposed prohibition on an FCM or DCO entering into a 
repurchase or reverse repurchase agreement with a counterparty that is 
an affiliate of the FCM or DCO.\30\
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    \30\ See discussion infra at Section II.D, regarding proposed 
Regulation 1.25(d)(3).
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    In 2005, two commenters recommended that the Commission permit FCMs 
that are dually registered as securities brokers or dealers to engage

[[Page 67646]]

in in-house transactions.\31\ At the time, the Commission concluded 
that in-house transactions would allow FCMs to realize ``greater 
capital efficiency'' and further reasoned that ``the substitution of 
one permitted investment for another in an in-house transaction [would] 
not present an unacceptable level of risk to the customer segregated 
account.'' \32\ The Commission therefore amended Regulation 1.25 to 
allow an FCM/broker-dealer to enter into transactions that are the 
economic equivalent of a repurchase or reverse repurchase agreement, 
subject to certain requirements.\33\ More specifically, an FCM may 
exchange customer money for permitted investments held in its capacity 
as a broker-dealer, it may exchange customer securities for permitted 
investments held in its capacity as a broker-dealer, and it may 
exchange customer securities for cash held in its capacity as a broker-
dealer.\34\
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    \31\ See 70 FR at 28193 (FIA and Lehman Brothers supporting in-
house transactions).
    \32\ 70 FR 5577, 5581 (Feb. 3, 2005).
    \33\ See Regulation 1.25(a)(3) and (e).
    \34\ Regulation 1.25(a)(3)(i)-(iii).
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    Recent market events have, however, increased concerns about the 
concentration of credit risk within the FCM/broker-dealer corporate 
entity in connection with in-house transactions. Therefore, consistent 
with the Commission's proposal to prohibit FCMs from entering into 
repurchase and reverse repurchase agreements with affiliates, the 
Commission is proposing to eliminate in-house transactions as permitted 
investments for customer funds under paragraph (a)(3) of Regulation 
1.25 and rescind paragraph (e), which sets forth the requirements for 
in-house transactions. Accordingly, paragraph (f) will be redesignated 
as new paragraph (e).
    The Commission requests comment on the impact of this proposal on 
the business practices of FCMs and DCOs. Specifically, the Commission 
requests that commenters present scenarios in which a repurchase or 
reverse repurchase agreement with a third party could not be 
satisfactorily substituted for an in-house transaction.
    The Commission requests comment on any other aspect of the proposed 
changes to paragraph (a) of Regulation 1.25. In particular, the 
Commission solicits comment on whether MMMFs should be eliminated as a 
permitted investment.\35\ In discussing whether MMMF investments 
satisfy the overall objective of preserving principal and maintaining 
liquidity, the Commission specifically requests comment on whether 
changes in the settlement mechanisms for the tri-party repo market 
might impact a MMMF's ability to meet the requirements of Regulation 
1.25.\36\
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    \35\ MMMFs are discussed in greater detail infra, in Sections 
II.B.4 and II.C of this notice.
    \36\ An industry task force recently concluded an extensive 
review of the tri-party repo market to identify ways in which it 
could be improved. See Payments Risk Committee, Task Force on Tri-
Party Repo Infrastructure, http://www.newyorkfed.org/tripartyrepo/task_force_report.html (May 17, 2010). In contrast to current 
practice, under which funds from maturing repos are available early 
in the day, modifications to the settlement arrangements for tri-
party repo transactions may result in payments occurring later in 
the day. To the extent that MMMFs invest in tri-party repos, this 
change could impact their ability to pay out large amounts of cash 
early in the day.
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B. General Terms and Conditions

    FCMs and DCOs may invest customer funds only in enumerated 
permitted investments ``consistent with the objectives of preserving 
principal and maintaining liquidity * * *.'' \37\ In furtherance of 
this general standard, paragraph (b) of Regulation 1.25 establishes 
various specific requirements designed to minimize credit, market, and 
liquidity risk. Among them are a requirement that the investment be 
``readily marketable,'' that it meet specified rating requirements, and 
that it not exceed specified issuer concentration limits. The 
Commission is proposing to amend these standards to facilitate the 
preservation of principal and maintenance of liquidity by establishing 
clear, prudential standards that further investment quality and 
portfolio diversification. The Commission notes that an investment that 
meets the technical requirements of Regulation 1.25 but does not meet 
the overarching prudential standard cannot qualify as a permitted 
investment.
---------------------------------------------------------------------------

    \37\ Regulation 1.25(b).
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1. Marketability
    Regulation 1.25(b)(1) states that ``[e]xcept for interests in money 
market mutual funds, investments must be `readily marketable' as 
defined in Sec.  240.15c3-1 of this title.'' \38\ The Commission 
proposes to remove the ``readily marketable'' requirement from 
paragraph (b)(1) and substitute in its place a ``highly liquid'' 
standard.\39\ The Commission did not receive any comment letters 
specifically discussing the meaning and application of the ``readily 
marketable'' requirement.\40\
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    \38\ See 17 CFR 240.15c3-1(c)(11)(i) (SEC regulation defining 
``ready market'').
    \39\ Related to this proposed new standard, the provision in 
paragraph (a)(2)(ii)(A) that requires securities subject to 
repurchase agreements to be `` `readily marketable' as defined in 
Sec.  240.15c-1 of this title'' also would be amended to provide 
that securities subject to repurchase agreements must be `` `highly 
liquid' as defined in paragraph (b)(2) of this section.''
    \40\ FIA, MF Global and Newedge mentioned marketability in their 
letters but no significant changes were recommended.
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    The term ``ready market'' is borrowed from the Securities and 
Exchange Commission (SEC) capital rules and is interpreted by the 
SEC.\41\ That standard is used in setting appropriate haircuts for the 
purpose of calculating capital. Although its inclusion in Regulation 
1.25 was intended to be a proxy for the concept of liquidity, it is not 
a concept that is otherwise easily applied as a prudential standard in 
determining the appropriateness of a debt instrument for investment of 
customer funds.
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    \41\ The term ``ready market'' is defined, in relevant part, to 
``include a recognized established securities market in which there 
exists independent bona fide offers to buy and sell so that a price 
reasonably related to the last sales price or current bona fide 
competitive bid and offer quotations can be determined for a 
particular security almost instantaneously and where payment will be 
received in settlement of a sale at such price within a relatively 
short time conforming to trade custom.'' 17 CFR 240.15c3-
1(c)(11)(i).
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    It is the Commission's view that the ``readily marketable'' 
language should be eliminated as it creates an overlapping and 
confusing standard when applied in the context of the express objective 
of ``maintaining liquidity.'' While ``liquidity'' and ``ready market'' 
appear to be interchangeable concepts, they have distinctly different 
origins and uses: The objective of ``maintaining liquidity'' is to 
ensure that investments can be promptly liquidated in order to meet a 
margin call, pay variation settlement, or return funds to the customer 
upon demand. As noted above, the SEC's ``ready market'' standard is 
intended for a different purpose and is easier to apply to exchange 
traded equity securities than debt securities.
    Although Regulation 1.25 requires that investments be consistent 
with the objective of maintaining liquidity, the Commission has not 
articulated an explanation or a definition of the concept of 
``liquidity.'' The Commission therefore proposes to define ``highly 
liquid'' functionally, as having the ability to be converted into cash 
within one business day, without a material discount in value. This 
approach focuses on outcome rather than process, and the Commission 
believes it will be easier to apply to debt securities than the current 
``readily marketable'' standard.
    An alternative to using a materiality standard in the definition of 
highly liquid is to employ a more formulaic and measurable approach. An 
example of a calculable standard would be one that provides that an 
instrument is

[[Page 67647]]

highly liquid if there is a reasonable basis to conclude that, under 
stable financial conditions, the instrument has the ability to be 
converted into cash within one business day, without greater than a 1 
percent haircut off of its book value.
    The Commission proposes to amend paragraph (b)(1) to eliminate the 
marketability standard and in its place establish a requirement that 
permitted investments be highly liquid. The Commission requests comment 
on whether the proposed definition of ``highly liquid'' accurately 
reflects the industry's understanding of that term, and whether the 
term ``material'' might be replaced with a more precise or, perhaps, 
even calculable standard. The Commission welcomes comment on the ease 
or difficulty in applying the proposed or alternative ``highly liquid'' 
standards.
2. Ratings
    The Commission proposes to remove all rating requirements from 
Regulation 1.25. This proposal is mandated by Section 939A of the Dodd-
Frank Act. Further, the proposal reflects the Commission's views that 
ratings are not sufficiently reliable as currently administered, that 
there is reduced need for a measure of credit risk given the proposed 
elimination of certain permitted investments, and that FCMs and DCOs 
should bear greater responsibility for understanding and evaluating 
their investments.\42\
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    \42\ The Commission received three letters regarding rating 
requirements, but none focused on the question of whether or not to 
retain ratings.
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    The original purpose of imposing rating requirements was to 
mitigate credit risk associated with permitted investments which 
included commercial paper and corporate notes. Recent events in the 
financial markets, however, revealed significant weaknesses in the 
ratings industry.
    Eliminating or restricting rating requirements has been considered 
by Congress and regulators with some frequency during the past two 
years. This has been motivated, at least in part, by public sentiment 
that credit rating agencies did not accurately rate debt in the months 
and years leading up to the financial crisis, worsening the financial 
crisis and increasing investors' losses. The SEC, in September 2009, 
adopted rule amendments that removed references to NRSROs from a 
variety of SEC rules and forms promulgated under the Securities 
Exchange Act of 1934 and from certain rules promulgated under the 
Investment Company Act of 1940 (Investment Company Act).\43\ In 
November 2009, the SEC adopted rules imposing enhanced disclosure and 
conflict of interest requirements for NRSROs.\44\ The SEC also has 
opened comment periods on other proposed amendments, including one that 
would remove references to NRSROs from its net capital rule.\45\
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    \43\ See 74 FR 52358 (Oct. 9, 2009) (publishing final rules and 
proposing additional rule amendments).
    \44\ See 74 FR 63832 (Dec. 4, 2009) (publishing final rules and 
proposing additional rule amendments).
    \45\ 74 FR at 52377-78 (proposing removal of certain references 
to NRSROs in the SEC's net capital rules for broker-dealers).
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    The Dodd-Frank Act contains several measures that focus both on 
decreasing reliance on NRSROs and improving the performance of NRSROs 
when they must be relied upon. Section 939 of the Dodd-Frank Act 
mandates the removal of certain references to NRSROs in several 
statutes,\46\ and Section 939A requires all Federal agencies to review 
references to NRSROs in their regulations, to remove reliance on credit 
ratings and, if appropriate, to replace such reliance with other 
standards of credit-worthiness.
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    \46\ Sections 7(b)(1)(E)(i), 28(d) and 28(e) of the Federal 
Deposit Insurance Act (12 U.S.C. 1811 et seq.), Section 1319 of the 
Federal Housing Enterprises Financial Safety and Soundness Act of 
1992 (12 U.S.C. 4519), Section 6(a)(5)(A)(iv)(I) of the Investment 
Company Act of 1940 (15 U.S.C. 80a-6(a)(5)(A)(iv)(I)), Section 5136A 
of title LXII of the Revised Statutes of the United States (12 
U.S.C. 24a), and Section 3(a) of the Securities Exchange Act of 1934 
(15 U.S.C. 78a(3)(a)).
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    The Commission, therefore, intends to remove credit rating 
requirements from Regulation 1.25.\47\ Alternative standards of credit-
worthiness are not being proposed. Evidence that rating agencies have 
not reliably gauged the safety of debt instruments in the past and the 
fact that other Regulation 1.25 proposed amendments published in this 
notice obviate much of the need for credit ratings, have helped to 
shape the Commission's decision.
---------------------------------------------------------------------------

    \47\ See infra Section II.E.2 regarding the corresponding change 
in Regulation 30.7.
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    While some might argue that imperfect information is better than 
none at all, several factors outweigh the possible risks associated 
with removing rating requirements. First, eliminating commercial paper 
and corporate notes or bonds as permitted investments would take away a 
large class of potentially risky investments for which ratings would be 
relevant. Second, the issuer concentration limits and proposed asset-
based concentration limits should reduce the likelihood that one 
problem investment would destabilize an entire investment portfolio. 
Finally, removing rating requirements would not absolve FCMs and DCOs 
from investing in safe, highly liquid investments; rather it would 
shift to FCMs and DCOs more of the responsibility to diligently 
research their investments.
    In light of the above analysis, the Commission proposes to 
eliminate paragraph (b)(2) of Regulation 1.25 and renumber the 
subsequent provisions of paragraph (b) accordingly.
3. Restrictions on Instrument Features
    Currently, both non-negotiable and negotiable CDs are permitted 
under Regulation 1.25. Paragraph (b)(3)(v) details the required 
redemption features of both types of CDs.
    Non-negotiable CDs represent a direct obligation of the issuing 
bank to the purchaser. The CD is wholly owned by the purchaser until 
early redemption or the final maturity of the CD. To be permitted under 
Regulation 1.25, the terms of the CD must allow the purchaser to redeem 
the CD at the issuing bank within one business day, with any penalty 
for early withdrawal limited to any accrued interest earned. Therefore, 
other than in the event of a bank default, an investor is assured of 
the return of its principal.
    Negotiable CDs are considerably different than non-negotiable CDs 
in that they are typically purchased by a broker on behalf of a large 
number of investors. The large size of the purchase by the broker 
results in a more favorable interest rate for the purchasers, who 
essentially own shares of the negotiable CD. Unlike a non-negotiable 
CD, the purchaser of a negotiable CD cannot redeem its interest from 
the issuing bank. Rather, an investor seeking redemption prior to a 
CD's maturity date must liquidate the CD in the secondary market. 
Depending on the negotiated CD terms (interest rate and duration) and 
the current economic conditions, the market for a given CD can be 
illiquid and can result in the inability to redeem within one business 
day and/or a significant loss of principal.
    Therefore, the Commission proposes to amend paragraph (b)(3)(v) by 
restricting CDs to only those instruments which can be redeemed at the 
issuing bank within one business day, with any penalty for early 
withdrawal limited to accrued interest earned according to its written 
terms.\48\
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    \48\ While it proposes to eliminate negotiable CDs as an 
interest bearing vehicle for purposes of Regulation 1.25, the 
Commission notes that Section 627 of the Dodd-Frank Act removes the 
prohibition on payments of interest on demand deposits. Demand 
deposits which meet Regulation 1.25 standards of liquidity may, 
therefore, be a source of interest income to DCOs and FCMs.

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[[Page 67648]]

4. Concentration Limits
    Paragraph (b)(4) of Regulation 1.25 currently sets forth issuer-
based concentration limits for direct investments, securities subject 
to repurchase or reverse repurchase agreements, and in-house 
transactions. The Commission proposes to adopt asset-based 
concentration limits for direct investments and a counterparty 
concentration limit for reverse repurchase agreements in addition to 
amending its issuer-based concentration limits and rescinding 
concentration limits applied to in-house transactions.\49\
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    \49\ The Commission is aware that other diversification methods 
exist or could be devised (such as the diversification requirements 
for MMMF investments in CME's IEF2 collateral management program) 
and believes that such methods can coexist with the proposed 
concentration limits.
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    (a) Asset-based concentration limits. Asset-based concentration 
limits would dictate the amount of funds an FCM or DCO could hold in 
any one class of investments, expressed as a percentage of total assets 
held in segregation. In their comment letters, the FIA, MF Global and 
Newedge specifically suggested the incorporation of asset-based 
concentration limits. The Commission agrees that such limits could 
increase the safety of customer funds by promoting diversification.
    Specifically, the Commission proposes the following asset-based 
limits in light of its evaluation of credit, liquidity, and market 
risk:
     No concentration limit (100 percent) for U.S. government 
securities;
     A 50 percent concentration limit for U.S. agency 
obligations fully guaranteed as to principal and interest by the United 
States;
     A 25 percent concentration limit for TLGP guaranteed 
commercial paper and corporate notes or bonds;
     A 25 percent concentration limit for non-negotiable CDs;
     A 10 percent concentration limit for municipal securities; 
and
     A 10 percent concentration limit for interests in MMMFs.
    Asset-based concentration limits are consistent with the 
Commission's historical view that not all permitted investments have 
identical risk profiles.\50\ In its efforts to increase the safety of 
permitted investments on a portfolio basis, the Commission has decided 
to assign to each permitted investment an asset-based concentration 
limit that correlates to its level of risk and liquidity relative to 
other permitted investments.\51\
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    \50\ See 70 FR at 5581 (discussing the relative risk profiles of 
permitted investments in the context of repurchase agreements).
    \51\ The Commission notes that paragraphs (b)(4)(ii)-(iii) of 
Regulation 1.25 would apply to both asset-based and issuer-based 
concentration limits. Therefore, for the purpose of calculating 
asset-based concentration limits, instruments purchased by an FCM or 
DCO as a result of a reverse repurchase agreement under paragraph 
(b)(4)(iii) would be combined with instruments held by the FCM or 
DCO as direct investments.
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    U.S. government securities are backed by the full faith and credit 
of the U.S. government, are highly liquid, and are the safest of the 
permitted investments. As such, the Commission proposes a 100 percent 
concentration limit, allowing an FCM or DCO to invest all of its 
segregated funds in U.S. government securities.\52\
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    \52\ FIA, MF Global and Newedge each assigned a 100 percent 
concentration limit to U.S. government securities. See FIA letter at 
3, MF Global letter at 2, and Newedge letter at 5.
---------------------------------------------------------------------------

    U.S. agency obligations, as proposed, must be fully guaranteed as 
to principal and interest by the United States. The Commission views 
these as sufficiently safe but potentially not as liquid as a Treasury 
security. Because of this concern, and in the interest of promoting 
diversification, the Commission proposes a 50 percent concentration 
limit.\53\
---------------------------------------------------------------------------

    \53\ FIA, MF Global and Newedge each assigned a 75 percent 
concentration limit to GSE securities. See FIA letter at 3, MF 
Global letter at 2, and Newedge letter at 5.
---------------------------------------------------------------------------

    The Commission categorizes TLGP debt securities as corporate 
securities,\54\ which are riskier than U.S. government securities. 
While TLGP debt securities have an explicit FDIC guarantee, which 
provides confidence for TLGP debt investors that they will receive the 
full amount of principal and interest in the event of an issuer 
default, the timing of such a payment is uncertain. Additionally, while 
TLGP debt securities that meet the Commission's requirements have a 
liquid secondary market, that might not always be the case. The 
Commission therefore proposes to apply a 25 percent concentration limit 
for TLGP debt securities as well.
---------------------------------------------------------------------------

    \54\ See TLGP Letter.
---------------------------------------------------------------------------

    CDs are safe for relatively small amounts, but the risk increases 
for larger sums. The rise in bank failures since 2008 is a cause for 
concern with regard to CDs because they are FDIC insured to a maximum 
of only $250,000. As a result, the Commission proposes to apply a 25 
percent concentration limit to CDs.
    In evaluating possible asset-based concentration limits for TLGP 
debt securities and CDs, the Commission determined that the same 
concentration limit should apply to both, even though the risk profiles 
of the asset classes are different. The Commission recognizes that TLGP 
debt securities pose no risk to principal, unlike bank CDs which are 
subject to the possible default of the issuing bank. However, a CD 
which must be redeemable within one business day under Regulation 
1.25(b)(3)(v) could prove to be more liquid than TLGP debt securities 
during a time of market stress. The Commission requests comment on 
whether there should be differentiation between asset-based 
concentration limits for TLGP debt securities and CDs and, if so, what 
those different concentration limits should be.
    Municipal securities are backed by the state or local government 
that issues them, and they have traditionally been viewed as a safe 
investment. However, municipal securities have been volatile and, in 
some cases, increasingly illiquid over the past two years. Therefore, 
the Commission proposes to apply a 10 percent concentration limit to 
municipal securities.\55\
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    \55\ FIA, MF Global and Newedge each assigned a 25 percent 
concentration limit to all assets that were not U.S. government 
securities, GSE securities or MMMFs. See FIA letter at 3, MF Global 
letter at 2, and Newedge letter at 5.
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    MMMFs have been widely used as an investment for customer 
segregated funds.\56\ As discussed in the next section, their portfolio 
diversification, administrative ease, and heightened prudential 
standards recently imposed by the SEC, continue to make MMMFs an 
attractive investment option. However, their volatility during the 2008 
financial crisis, which culminated in one fund ``breaking the buck'' 
and many more funds requiring infusions of capital, underscores the 
fact that investments in MMMFs are not without risk.\57\ To mitigate 
these risks, the Commission proposes to assign a 10 percent 
concentration limit for MMMFs.\58\ The Commission believes that this 
concentration limit is commensurate with the risks posed by MMMFs. The 
Commission solicits comment regarding whether 10 percent is an 
appropriate asset-based concentration limit for MMMFs. The Commission 
welcomes opinions on what alternative asset-based concentration limit 
might be appropriate for MMMFs and, if such

[[Page 67649]]

asset-based concentration limit is higher than 10 percent, what 
corresponding issuer-based concentration limit should be adopted.
---------------------------------------------------------------------------

    \56\ The 2007 Review indicated that out of 87 FCM respondents, 
46 had invested customer funds in MMMFs at some point during the 
November 30, 2006-December 1, 2007 period.
    \57\ See 75 FR 10060, 10078 n.234 (Mar. 4, 2010).
    \58\ FIA recommended a 100 percent concentration limit, Newedge 
recommended a 50 percent concentration limit, and MF Global 
recommended a 25 percent concentration limit for MMMFs. See FIA 
letter at 3, Newedge letter at 5, and MF Global letter at 2.
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    (b) Issuer-based concentration limits. The Commission has 
considered the current concentration limits and proposes to amend its 
issuer-based limits for direct investments to include a 2 percent limit 
for an MMMF family of funds, expressed as a percentage of total assets 
held in segregation. Currently, there is no concentration limit applied 
to MMMFs and the Commission believes that it is prudent to require FCMs 
and DCOs to diversify their MMMF portfolios. The 25 percent issuer-
based limitation for GSEs (now U.S. agency obligations) and the 5 
percent issuer-based limitation for municipal securities, commercial 
paper, corporate notes or bonds, and CDs will remain in place.
    (c) Counterparty concentration limits. Finally, the Commission 
proposes a counterparty concentration limit of 5 percent of total 
assets held in segregation for securities subject to reverse repurchase 
agreements. Under Regulation 1.25(b)(4)(iii), concentration limits for 
reverse repurchase agreements are derived from the concentration limits 
that would have been assigned to the underlying securities had the FCM 
or DCO made a direct investment. Therefore, under current rules, an FCM 
or DCO could have 100 percent of its segregated funds subject to one 
reverse repurchase agreement. The obvious concern in such a scenario is 
the credit risk of the counterparty. This credit risk, while 
concentrated, is significantly mitigated by the fact that in exchange 
for cash, the FCM or DCO is holding Regulation 1.25-permissible 
securities of equivalent or greater value. However, a default by the 
counterparty would put pressure on the FCM or DCO to convert such 
securities into cash immediately and would exacerbate the market risk 
to the FCM or DCO, given that a decrease in the value of the security 
or an increase in interest rates could result in the FCM or DCO 
realizing a loss. Even though the market risk would be mitigated by 
asset-based and issuer-based concentration limits, a situation of this 
type could seriously jeopardize an FCM or DCO's overall ability to 
preserve principal and maintain liquidity with respect to customer 
funds.
    In accordance with the above discussion, the Commission proposes to 
amend paragraph (b)(4) to add a new paragraph (i) setting forth asset-
based concentration limits for direct investments; amend and renumber 
as new paragraph (ii) issuer-based concentration limits for direct 
investments; amend and renumber as new paragraph (iii) concentration 
limits for reverse repurchase agreements; delete the existing paragraph 
(iv) due to the Commission's proposed elimination of in-house 
transactions; renumber as a new paragraph (iv) the provision regarding 
treatment of customer-owned securities; and add a new paragraph (v) 
setting forth counterparty concentration limits for reverse repurchase 
agreements.
    The Commission requests comment on any and all aspects of the 
proposed concentration limits, including whether asset-based 
concentration limits are an effective means for facilitating investment 
portfolio diversification and whether there are other methods that 
should be considered. In addition, the Commission requests comment on 
whether the proposed concentration levels are appropriate for the 
categories of investments to which they are assigned and whether there 
should be different standards for FCMs and DCOs.

C. Money Market Mutual Funds

    The continued use of MMMFs was the sole focus of five comment 
letters,\59\ a substantial focus of one,\60\ and referenced positively 
by an additional four.\61\ Taken together, the letters conveyed a 
consensus that MMMFs are both safe and administratively efficient. In 
their respective comment letters, Federated noted that MMMFs are 
subject to the overlapping regulatory regimes overseen by the SEC, and 
ICI highlighted the quality, liquidity and diversity of an MMMF's 
holdings. Further, TSI noted that out of 700-800 MMMFs, only one failed 
during the September 2008 financial turmoil, a crisis which Dreyfus 
likened to a ``1,000 year flood.''
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    \59\ See Crane letter, Dreyfus letter, Federated letter I, ICI 
letter, and TSI letter.
    \60\ See CME letter at 5-6.
    \61\ See FCStone letter at 2, MF Global letter at 2, Newedge 
letter at 5, and NFA letter at 1.
---------------------------------------------------------------------------

    While the Commission appreciates the benefits of MMMFs, it also is 
cognizant of their risks. Reserve Primary Fund, the September 2008 
failure referenced by TSI, was an MMMF that satisfied the enumerated 
requirements of Regulation 1.25 and at one point was a $63 billion 
fund. The Reserve Primary Fund's breaking the buck called attention to 
the risk to principal and potential lack of sufficient liquidity of any 
MMMF investment. In the wake of the Reserve Primary Fund problem, the 
Commission has been forced to consider the possibility that any number 
of MMMFs that meet the technical requirements of Regulation 1.25(c) 
might not meet the Regulation 1.25 objective of preserving principal 
and maintaining liquidity, particularly during volatile market 
conditions.\62\ Lending credence to such concerns, the SEC has 
estimated that, in order to avoid breaking the buck, nearly 20 percent 
of all MMMFs received financial support from their money managers or 
affiliates from mid-2007 through the end of 2008.\63\
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    \62\ See 75 FR at 10078 n.234 (SEC final rulemaking adopting 
amendments to regulations governing MMMFs, describing the September 
2008 run on MMMFs: ``On September 17, 2008, approximately 25% of 
prime institutional money market funds experienced outflows greater 
than 5% of total assets; on September 18, 2008, approximately 30% of 
prime institutional money market funds experienced outflows greater 
than 5%; and on September 19, 2008, approximately 22% of prime 
institutional money market funds experienced outflows greater than 
5%'').
    \63\ See 74 FR 32688, 32693 (July 8, 2009).
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    In response to the potential risks posed by investments in MMMFs, 
the Commission is proposing to institute the concentration limits 
discussed above. However, the Commission has decided to refrain from 
further restricting investments in MMMFs at this time. The Commission 
is hopeful that the combination of its asset-based limitations, issuer-
based limitations applied to a single family of funds, and the SEC's 
recent MMMF reforms will adequately address the risks associated with 
MMMFs.\64\
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    \64\ See 75 FR 10060 (SEC final rulemaking decreasing the 
percentage of second tier securities (which are securities that do 
not receive the highest rating from an NRSRO or, if unrated, 
securities that are comparable in quality to securities that do not 
receive the highest rating from an NRSRO) from 5 percent to 3 
percent, reducing the dollar-weighted average portfolio maturity 
from 90 days to 60 days, introducing a dollar-weighted average life 
to maturity of 120 days, and imposing new daily and weekly liquidity 
requirements, among others).
---------------------------------------------------------------------------

    The Commission requests comment on whether MMMF investments should 
be limited to Treasury MMMFs,\65\ or to those MMMFs that have 
portfolios consisting only of permitted investments under Regulation 
1.25.
---------------------------------------------------------------------------

    \65\ A ``Treasuries fund'' must have at least 80 percent of its 
assets invested in U.S. treasuries at all times, as required by 17 
CFR 270.35d-1.
---------------------------------------------------------------------------

    The Commission is proposing two technical amendments to paragraph 
(c) of Regulation 1.25. First, the Commission is proposing to clarify 
the acknowledgment letter requirement under paragraph (c)(3); and 
second, the Commission is proposing to revise and clarify the 
exceptions to the next-day redemption requirement under paragraph 
(c)(5)(ii).
1. Acknowledgment Letters
    The Commission is proposing to amend Regulation 1.25(c)(3) to 
clarify

[[Page 67650]]

the appropriate party to provide an acknowledgment letter where 
customer funds are invested in MMMFs. Regulation 1.26 requires an FCM 
or DCO which invests customer funds in instruments permitted under 
Regulation 1.25 to create a segregated account at a depository for such 
instruments and to obtain an acknowledgment letter from the depository. 
Because interests in MMMFs generally are not held at a depository in 
the first instance, like other permitted investments, Regulation 
1.25(c)(3) currently provides an exception to the Regulation 1.26 
requirement that an acknowledgment letter be provided by a depository. 
Regulation 1.25(c)(3) requires the ``sponsor of the fund and the fund 
itself'' to provide an acknowledgment letter when the MMMF shares are 
held by a fund's shareholder servicing agent.
    The Commission has received a number of inquiries regarding the 
meaning of this provision and the definition of ``sponsor,'' a term 
that is not defined in the Investment Company Act. While the term is 
not defined, it is nonetheless used throughout the Investment Company 
Act and is generally understood to refer to the entity that organizes 
the fund. Such an entity typically provides seed capital to the 
investment company and may be an affiliated investment adviser or 
underwriter to the investment company.
    The Commission seeks to clarify that the intent of Regulation 
1.25(c)(3) is to require an acknowledgment letter from a party that has 
substantial control over the fund's assets and has the knowledge and 
authority to facilitate redemption and payment or transfer of the 
customer segregated funds invested in shares of an MMMF. The Commission 
has concluded that in many circumstances, the fund sponsor, the 
investment adviser, or fund manager would satisfy this requirement. To 
the extent there are circumstances where an entity such as the 
Administrator would be in this position, proposed Regulation 1.25(c)(3) 
encompasses such an entity. The Commission requests comment on whether 
the proposed standard is appropriate and whether there are other 
entities that could serve as examples.
    The Commission is also proposing to remove the current language in 
Regulation 1.25(c)(3) relating to the issuer of the acknowledgment 
letter when the shares of the fund are held by the fund's shareholder 
servicing agent. This revision is designed to eliminate any confusion 
as to whether the acknowledgment letter requirement is applied 
differently based on the presence or absence of a shareholder servicing 
agent. The Commission requests comment on whether removal of this 
language helps clarify the intent of Regulation 1.25(c)(3).
    The Commission is accordingly proposing to amend Regulation 
1.25(c)(3) to set forth a functional definition accompanied by specific 
examples. The proposed amendment would require an FCM or DCO to obtain 
the acknowledgment letter required by Regulation 1.26 \66\ from an 
entity that has substantial control over the fund's assets and has the 
knowledge and authority to facilitate redemption and payment or 
transfer of the customer segregated funds. The proposed language would 
specify that such an entity may include the fund sponsor or investment 
adviser.\67\
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    \66\ In a related proposed rulemaking, the Commission has 
proposed to add a new paragraph (c) to Regulation 1.26 which would 
specifically govern acknowledgment letters for MMMFs. The Commission 
also has proposed a mandatory form of acknowledgment letter in 
proposed Appendix A to Regulation 1.26. See 75 FR 47738 (Aug. 9, 
2010).
    \67\ A fund sponsor or investment adviser would be identified as 
appropriate entities to provide an acknowledgment letter, because 
they would typically be expected to satisfy the proposed standard. 
However, in any circumstance where the fund sponsor or investment 
adviser does not meet that standard, the acknowledgment letter would 
have to be obtained from another entity that can meet the regulatory 
requirement.
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2. Next-Day Redemption Requirement
    Regulation 1.25(c) requires that ``[a] fund shall be legally 
obligated to redeem an interest and to make payment in satisfaction 
thereof by the business day following a redemption request.'' \68\ This 
``next-day redemption'' requirement is a significant feature of 
Regulation 1.25 and is meant to ensure adequate liquidity.\69\ 
Regulation 1.25(c)(5)(ii) lists four exceptions to the next-day 
redemption requirement, and incorporates by reference the emergency 
conditions listed in Section 22(e) of the Investment Company Act 
(Section 22(e)).\70\ The Commission has received questions from FCMs 
regarding Regulation 1.25(c)(5), particularly because the exceptions 
listed in paragraph (c)(5)(ii) overlap with some of those appearing in 
Section 22(e).
---------------------------------------------------------------------------

    \68\ Regulation 1.25(c)(5)(i).
    \69\ See 70 FR 5585 (noting that ``[t]he Commission believes the 
one-day liquidity requirement for investments in MMMFs is necessary 
to ensure that the funding requirements of FCMs will not be impeded 
by a long liquidity time frame.'').
    \70\ 15 U.S.C. 80a-22(e).
---------------------------------------------------------------------------

    Recently, as part of its MMMF reform initiative, the SEC adopted a 
rule that provides the basis for another exception to the next-day 
redemption requirement.\71\ Promulgated under Section 22(e), Rule 22e-3 
\72\ permits MMMFs to suspend redemptions and postpone payment of 
redemption proceeds in order to facilitate an orderly liquidation of 
the fund.\73\ Before Rule 22e-3 may be invoked, the fund's board, 
including a majority of its disinterested directors, must determine 
that the extent of the deviation between the fund's amortized cost per 
share and its current net asset value per share may result in material 
dilution or other unfair results,\74\ and the board, including a 
majority of its disinterested directors, must irrevocably approve the 
liquidation of the fund.\75\ In addition, prior to suspending 
redemption, the fund must notify the SEC of its decision.\76\
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    \71\ See Letter from Ananda Radhakrishnan, Director, Division of 
Clearing and Intermediary Oversight, CFTC, to Debra Kokal, Chairman 
of the Joint Audit Committee (June 3, 2010) (stating that Rule 22e-3 
falls within the exceptions to the next-day redemption requirement 
under Regulation 1.25).
    \72\ 17 CFR 270.22e-3.
    \73\ See 75 FR at 10088.
    \74\ 17 CFR 270.22e-3(a)(1).
    \75\ 17 CFR 270.22e-3(a)(2).
    \76\ 17 CFT 270.22e-3(a)(3).
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    In order to expressly incorporate Rule 22e-3 into the permitted 
exceptions for purposes of clarity, and to otherwise clarify the 
existing exceptions to the next-day redemption requirement, the 
Commission has decided to amend paragraph (c)(5)(ii) of Regulation 1.25 
by more closely aligning the language of that paragraph with the 
language in Section 22(e) and specifically including Rule 22e-3. 
Section 22(e) will, however, continue to be incorporated by reference 
so as to provide for any future amendment or regulatory actions by the 
SEC.
    The Commission will include, as Appendix A to the rule text, safe 
harbor language that can be used by MMMFs to ensure that their 
prospectuses comply with Regulation 1.25(c)(5). The proposed language 
tracks the proposed paragraph (c)(5).
    The Commission requests comment on all aspects of its proposed 
amendments to paragraph (c). The Commission seeks comment specifically 
on any proposed regulatory language that commenters believe requires 
further clarification. In addition, commenters are invited to submit 
views on the usefulness and substance of the proposed safe harbor 
language contained in proposed Appendix A.

D. Repurchase and Reverse Repurchase Agreements

    The Commission proposes to eliminate repurchase and reverse 
repurchase transactions with affiliate counterparties. This amendment 
forwards the interests of both protecting

[[Page 67651]]

customer funds as well as establishing consistency within the 
regulation, which would no longer permit in-house transactions and 
currently prohibits investments in instruments issued by affiliates.
    Repurchase and reverse repurchase transactions were originally 
included as permitted investments to increase the liquidity in the 
portfolio of segregated funds.\77\ By entering into repurchase 
agreements with unaffiliated counterparties, FCMs can convert 
securities holdings into cash or alternatively supply cash to market 
participants in exchange for liquid securities. In the event that a 
counterparty receiving cash defaults, the other party is protected due 
to its holding of the counterparty's securities. Reverse repurchase and 
repurchase agreements contribute generally to increased market 
liquidity and are not inconsistent with the required safety of customer 
funds.
---------------------------------------------------------------------------

    \77\ 65 FR 39008, 39015 (June 22, 2000).
---------------------------------------------------------------------------

    The benefits of such an arrangement are diminished, however, when 
repurchase agreements are between affiliates. In particular, the 
concentration of credit risk increases the likelihood that the default 
of one party could exacerbate financial strains and lead to the default 
of its affiliate. While such a scenario would be unexpected in calm 
markets, during periods of financial turbulence such problems are 
considerably more likely to occur. It should be noted that the actions 
of market participants suggest that even possession and control of 
liquid securities may be insufficient to alleviate concerns relating to 
transactions with financially troubled counterparties.\78\
---------------------------------------------------------------------------

    \78\ See SEC Press Release No. 2008-46, ``Answers to Frequently 
Asked Investor Questions Regarding the Bear Stearns Companies, 
Inc.'' (Mar. 18, 2008), available at http://www.sec.gov/news/press/2008/2008-46.htm (noting that rumors of liquidity problems at Bear 
Stearns caused their counterparties to become concerned, creating a 
``crisis of confidence'' which led to the counterparties' 
``unwilling[ness] to make secured funding available to Bear Stearns 
on customary terms.'').
---------------------------------------------------------------------------

    Further, the interests of consistency of the regulation weigh in 
favor of disallowing repurchase agreements between affiliates. 
Currently, a repurchase agreement between affiliates is allowed under 
Regulation 1.25(d), while investments in debt instruments issued by an 
affiliate--effectively a collateralized loan between affiliates--is 
prohibited by paragraph (b)(6). A repurchase agreement is functionally 
equivalent to a short-term collateralized loan. In both transactions, 
one party provides cash to another party, secured by assets owned by 
the other party, and, in return, the other party repays the cash, plus 
interest, and its assets are returned. The similarity of the two 
transactions would seem to require similar treatment under Regulation 
1.25.
    Therefore, the Commission proposes to amend paragraph (d) by adding 
new paragraph (3) prohibiting repurchase and reverse repurchase 
agreements with affiliates. Current paragraphs (3) through (12) will be 
renumbered as (4) through (13), accordingly. The Commission seeks 
comment on its proposal to eliminate repurchase and reverse repurchase 
transactions with affiliate counterparties.

E. Regulation 30.7

1. Harmonization
    The Commission proposes to harmonize Regulation 30.7 with the 
investment limitations of Regulation 1.25. As noted above, the 
Commission has not previously restricted investments of 30.7 funds to 
the permitted investments under Regulation 1.25, although Regulation 
1.25 limitations can be used as a safe harbor for such investments.\79\ 
The Commission now believes that it is appropriate to align the 
investment standards of Regulation 30.7 with those of Regulation 1.25 
because many of the same prudential concerns arise with respect to both 
segregated customer funds and 30.7 funds. Such a limitation should 
increase the safety of 30.7 funds and provide clarity for the FCMs, 
DCOs, and designated self-regulatory organizations.
---------------------------------------------------------------------------

    \79\ See Commission Form 1-FR-FCM Instructions at 12-9 (Mar. 
2010) (``In investing funds required to be maintained in separate 
section 30.7 account(s), FCMs are bound by their fiduciary 
obligations to customers and the requirement that the secured amount 
required to be set aside be at all times liquid and sufficient to 
cover all obligations to such customers. Regulation 1.25 investments 
would be appropriate, as would investments in any other readily 
marketable securities.'').
---------------------------------------------------------------------------

    The Commission anticipates that the impact of this amendment will 
be slight, as it appears that using Regulation 1.25 standards in 30.7 
investments is a common industry practice. For example, Newedge 
commented that the harmonization of Regulations 1.25 and 30.7 ``would 
reflect current market practice * * *'' since, in its opinion, ``* * * 
many if not most FCMs currently invest Part 30.7 funds in the same 
products and transactions in which they invest Rule 1.25 funds.'' \80\ 
FIA also noted that its ``member firms generally follow the Rule 1.25 
investment guidelines'' when investing 30.7 funds.\81\ In addition to 
adding new paragraph (g) to Regulation 30.7 to reflect this amendment, 
the Form 1-FR-FCM instruction manual would be revised accordingly.\82\
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    \80\ Newedge letter at 4.
    \81\ FIA letter at 5.
    \82\ Pending adoption of final amendments to Regulation 30.7, 
the Commission will revise the section headed ``Permissible 
Investments of Part 30 Set-Aside Funds'' on page 12-9 to align with, 
and refer back to, the discussion of Regulation 1.25 investments on 
pages 10-7 and 10-8.
---------------------------------------------------------------------------

    The Commission solicits comment on applying the requirements of 
Regulation 1.25 to 30.7 funds. In this regard, the Commission seeks 
comment on any differences between customer segregated funds and 30.7 
funds that would warrant the continuing application of different 
standards.
2. Ratings
    The Commission proposes to remove all rating requirements from 
Regulation 30.7. This proposal is required by Section 939A of the Dodd-
Frank Act and further reflects the Commission's views on the 
unreliability of ratings as currently administered and its interest in 
aligning Regulation 30.7 with Regulation 1.25.\83\
---------------------------------------------------------------------------

    \83\ See discussion supra Section II.B.2 regarding the 
Commission's policy decision to remove references to credit ratings 
from Regulation 1.25 and other regulations.
---------------------------------------------------------------------------

    The only reference to credit ratings in Regulation 30.7 is in 
paragraph (c)(1)(ii)(B). Paragraph (c)(1)(ii) permits 30.7 funds to be 
kept in an account with a depository outside the United States if the 
depository meets any of three alternative standards: (1) The depository 
has in excess of $1 billion of regulatory capital, (2) the depository 
or its parent's ``commercial paper or long-term debt instrument * * * 
is rated in one of the two highest rating categories by at least one'' 
NRSRO, or (3) if it does not meet either of the first two criteria, the 
depository has been permitted to hold 30.7 funds upon the request of a 
customer.
    The use of the credit rating of the commercial paper or long-term 
debt of the depository institution is comparable to the standard used 
to gauge the safety of an issuer of a CD.\84\ The Commission has viewed 
credit ratings as unreliable to gauge the safety of an issuer of a CD 
and proposed, in Section II.B.2 of this notice, to remove this 
requirement from Regulation 1.25. The Commission now proposes to remove 
paragraph (c)(1)(ii)(B) in Regulation 30.7 as it views an NRSRO rating 
as similarly unreliable to gauge the safety of a depository institution 
for 30.7 funds. This proposal also serves to align

[[Page 67652]]

Regulation 30.7 with Regulation 1.25 on the topic of NRSROs.
---------------------------------------------------------------------------

    \84\ See Regulation 1.25(b)(2)(i)(E).
---------------------------------------------------------------------------

    The Commission requests comment on whether there is a standard or 
measure of solvency and credit-worthiness that can be used as an 
additional test of a bank's safety. Specifically, the Commission seeks 
comment on whether a leverage ratio or a capital adequacy ratio 
requirement consistent with or similar to those in the Basel III 
accords \85\ would be an appropriate additional safeguard for a bank or 
trust company located outside the United States.
---------------------------------------------------------------------------

    \85\ See Press Release, Basel Committee on Banking Supervision, 
Group of Governors and Heads of Supervision Announces Higher Global 
Minimum Capital Standards (Sept. 12, 2010), http://bis.org/press/p100912.pdf.
---------------------------------------------------------------------------

3. Designation as a Depository for 30.7 Funds
    Under Regulation 30.7(c)(1)(ii)(C), a bank or trust company that 
does not otherwise meet the requirements of paragraph (c)(1)(ii) may 
still be designated as an acceptable depository by request of its 
customer and with the approval of the Commission. The Commission 
proposes to no longer allow a customer to request that a bank or trust 
company located outside the United States be designated as a depository 
for 30.7 funds. The Commission has never allowed a bank or trust 
company located outside the United States to be a depository through 
these means, and believes that it is appropriate to require that all 
depositories meet the regulatory capital requirement under paragraph 
(c)(1)(ii)(A).
    Therefore, the Commission proposes to amend Regulation 30.7 by 
deleting paragraph (c)(1)(ii)(C). The Commission requests comment on 
whether an exception of any kind to Regulation 30.7(c)(1)(ii) is 
appropriate.

III. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) \86\ requires federal 
agencies, in promulgating rules, to consider the impact of those rules 
on small businesses. The rule amendments proposed herein will affect 
FCMs and DCOs. The Commission has previously established certain 
definitions of ``small entities'' to be used by the Commission in 
evaluating the impact of its rules on small entities in accordance with 
the RFA.\87\ The Commission has previously determined that registered 
FCMs \88\ and DCOs \89\ are not small entities for the purpose of the 
RFA. Accordingly, pursuant to 5 U.S.C. 605(b), the Chairman, on behalf 
of the Commission, certifies that the proposed rules will not have a 
significant economic impact on a substantial number of small entities.
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    \86\ 5 U.S.C. 601 et seq.
    \87\ 47 FR 18618 (Apr. 30, 1982).
    \88\ Id. at 18619.
    \89\ 66 FR 45604, 45609 (Aug. 29, 2001).
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B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (PRA) imposes certain 
requirements on federal agencies (including the Commission) in 
connection with their conducting or sponsoring any collection of 
information as defined by the PRA. The proposed rule amendments do not 
require a new collection of information on the part of any entities 
subject to the proposed rule amendments. Accordingly, for purposes of 
the PRA, the Commission certifies that these proposed rule amendments, 
if promulgated in final form, would not impose any new reporting or 
recordkeeping requirements.

C. Costs and Benefits of the Proposed Rules

    Section 15(a) of the CEA \90\ requires the Commission to consider 
the costs and benefits of its actions before issuing a rulemaking under 
the Act. By its terms, section 15(a) does not require the Commission to 
quantify the costs and benefits of a rule or to determine whether the 
benefits of the rulemaking outweigh its costs; rather, it requires that 
the Commission ``consider'' the costs and benefits of its actions. 
Section 15(a) further specifies that the costs and benefits shall be 
evaluated in light of five broad areas of market and public concern: 
(1) Protection of market participants and the public; (2) efficiency, 
competitiveness and financial integrity of futures markets; (3) price 
discovery; (4) sound risk management practices; and (5) other public 
interest considerations. The Commission may in its discretion give 
greater weight to any one of the five enumerated areas and could in its 
discretion determine that, notwithstanding its costs, a particular rule 
is necessary or appropriate to protect the public interest or to 
effectuate any of the provisions or accomplish any of the purposes of 
the Act.
---------------------------------------------------------------------------

    \90\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

    Summary of proposed requirements. The proposed rules would 
facilitate greater protection of customer funds and 30.7 funds and 
reduction of systemic risk by establishing stricter prudential 
standards for investment of such funds. The proposed amendments 
restrict the scope of permitted investments to reflect the current 
economic environment. During the prior ten-year period, starting with 
the December 2000 rulemaking, Regulation 1.25 was substantially revised 
and expanded. The more restrictive proposals contained herein are based 
on the Commission's experience over the course of the past decade and, 
in particular, since September 2008, during which certain permitted 
investments under Regulation 1.25 were shown to present potentially 
unacceptable levels of risk. In narrowing the scope of Regulation 1.25 
(as to both type and characteristics of permitted investments), the 
Commission's primary purpose is to safeguard the funds of customers 
and, in so doing, to help ease the chain reaction of negative effects 
that can come about during a financial crisis in the broader financial 
marketplace.
    Costs. With respect to costs, the Commission has determined that 
any costs associated with the proposal are outweighed by its benefits. 
The Commission recognizes that scaling back on the type and form of 
permitted investments could result in certain FCMs and DCOs earning 
less income from their investments of customer funds. This, in turn, 
could reduce an FCM or DCO's overall profits and create an incentive 
for them to charge higher fees to customers. The Commission believes, 
however, that the potential loss of income for those FCMs and DCOs 
whose investment strategies will be materially affected by the proposed 
amendments will be outweighed by the reduction in potential risk 
associated with the current regulatory standards for permitted 
investments. To the extent that customers may bear the cost of the 
proposed changes, the customers will nonetheless benefit from greater 
protection of their funds. Eliminating the option of a customer to 
designate, with the Commission's permission, a foreign depository for 
30.7 funds would potentially limit the choices of suitable 
depositories. However, the presence of alternative depositories would 
mitigate any adverse impact. The proposed amendments would not affect 
the efficiency or competitiveness of futures markets, and the proposed 
amendments will not affect price discovery.
    Benefits. With respect to benefits, the Commission has determined 
that the proposal will result in several benefits. First, the risk-
reducing nature of the proposed amendments would facilitate greater 
financial integrity of FCMs and DCOs and, as a result, futures markets 
more generally. Essential to the proper functioning of futures markets 
is the financial integrity of the clearing

[[Page 67653]]

process, which is dependent upon the immediate availability of 
sufficient funds for daily pays and collects and default management.
    The proposed amendments would also raise the standards for risk 
management practices of FCMs and DCOs that invest customer funds. They 
balance the need for investment flexibility and capital efficiency with 
the need to preserve principal and maintain liquidity. In particular, 
the proposal both narrows the scope of permitted investments to only 
those that the Commission considers the safest, and mandates 
diversification well beyond previous requirements. The Commission 
believes that these structural safeguards will decrease the credit, 
market, and liquidity risk exposures of FCMs and DCOs. Moreover, the 
revised requirements will more closely align with the investment 
restrictions contained in Section 4d of the Act.
    Also, the Commission recognizes that many, if not most, FCMs and 
DCOs are already engaging in sound risk management practices and are 
pursuing responsible investment strategies under the existing 
regulatory regime. However, the Commission believes that in an 
environment where many of its previous economic assumptions are called 
into question, it becomes necessary to establish new bright line 
requirements to better ensure proper risk management in connection with 
the investment of customer segregated and 30.7 funds.
    The proposed amendments retain an appropriate degree of flexibility 
in making investments with customer segregated and 30.7 funds, while 
significantly strengthening the rules that protect the safety of such 
funds. In addition, eliminating the option of a customer to designate, 
with the Commission's permission, a foreign depository for 30.7 funds 
that otherwise would not meet the requirements of Regulation 30.7 both 
closes a loophole that might have allowed for a less financially sound 
depository to hold 30.7 funds and eliminates the need for the 
Commission to individually review the safety and soundness of foreign 
depositories.
    Public Comment. The Commission invites public comment on its cost-
benefit considerations. Commenters are also are invited to submit any 
data or other information that they may have quantifying or qualifying 
the costs and benefits of the Proposal with their comment letters.

Lists of Subjects

17 CFR Part 1

    Brokers, Commodity futures, Consumer protection, Reporting and 
recordkeeping requirements.

17 CFR Part 30

    Commodity futures, Consumer protection, Currency, Reporting and 
recordkeeping requirements.

    In consideration of the foregoing and pursuant to the authority 
contained in the Commodity Exchange Act, in particular, Sections 4d, 
4(c), and 8a(5) thereof, 7 U.S.C. 6d, 6(c) and 12a(5), respectively, 
the Commission hereby proposes to amend Chapter I of Title 17 of the 
Code of Federal Regulations as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

    1. The authority citation for Part 1 is revised to read as follows:

    Authority:  7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 
6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 
13a, 13a-1, 16, 16a, 19, 21, 23, and 24, as amended by the Dodd-
Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-
203, 124 Stat. 1376 (2010).

    2. Revise Sec.  1.25 to read as follows:


Sec.  1.25  Investment of customer funds.

    (a) Permitted investments. (1) Subject to the terms and conditions 
set forth in this section, a futures commission merchant or a 
derivatives clearing organization may invest customer money in the 
following instruments (permitted investments):
    (i) Obligations of the United States and obligations fully 
guaranteed as to principal and interest by the United States (U.S. 
government securities);
    (ii) General obligations of any State or of any political 
subdivision thereof (municipal securities);
    (iii) Obligations of any United States government corporation or 
enterprise sponsored by the United States government and fully 
guaranteed as to principal and interest by the United States (U.S. 
agency obligations);
    (iv) Certificates of deposit issued by a bank (certificates of 
deposit) as defined in section 3(a)(6) of the Securities Exchange Act 
of 1934, or a domestic branch of a foreign bank that carries deposits 
insured by the Federal Deposit Insurance Corporation;
    (v) Commercial paper fully guaranteed as to principal and interest 
by the United States under the Temporary Liquidity Guarantee Program as 
administered by the Federal Deposit Insurance Corporation (commercial 
paper);
    (vi) Corporate notes or bonds fully guaranteed as to principal and 
interest by the United States under the Temporary Liquidity Guarantee 
Program as administered by the Federal Deposit Insurance Corporation 
(corporate notes or bonds); and
    (vii) Interests in money market mutual funds.
    (2)(i) In addition, a futures commission merchant or derivatives 
clearing organization may buy and sell the permitted investments listed 
in paragraphs (a)(1)(i) through (vii) of this section pursuant to 
agreements for resale or repurchase of the instruments, in accordance 
with the provisions of paragraph (d) of this section.
    (ii) A futures commission merchant or a derivatives clearing 
organization may sell securities deposited by customers as margin 
pursuant to agreements to repurchase subject to the following:
    (A) Securities subject to such repurchase agreements must be 
``highly liquid'' as defined in paragraph (b)(1) of this section.
    (B) Securities subject to such repurchase agreements must not be 
``specifically identifiable property'' as defined in Sec.  190.01(kk) 
of this chapter.
    (C) The terms and conditions of such an agreement to repurchase 
must be in accordance with the provisions of paragraph (d) of this 
section.
    (D) Upon the default by a counterparty to a repurchase agreement, 
the futures commission merchant or derivatives clearing organization 
shall act promptly to ensure that the default does not result in any 
direct or indirect cost or expense to the customer.
    (b) General terms and conditions. A futures commission merchant or 
a derivatives clearing organization is required to manage the permitted 
investments consistent with the objectives of preserving principal and 
maintaining liquidity and according to the following specific 
requirements:
    (1) Liquidity. Investments must be ``highly liquid'' such that they 
have the ability to be converted into cash within one business day 
without material discount in value.
    (2) Restrictions on instrument features. (i) With the exception of 
money market mutual funds, no permitted investment may contain an 
embedded derivative of any kind, except that the issuer of an 
instrument otherwise permitted by this section may have an option to 
call, in whole or in part, at par, the principal amount of the 
instrument before its stated maturity date; provided, however, that the 
terms of such instrument obligate the issuer to

[[Page 67654]]

repay the principal amount of the instrument at not less than par value 
upon maturity.
    (ii) No instrument may contain interest-only payment features.
    (iii) No instrument may provide payments linked to a commodity, 
currency, reference instrument, index, or benchmark, and it may not 
otherwise constitute a derivative instrument.
    (iv) Commercial paper and corporate notes or bonds must meet the 
following criteria:
    (A) The size of the issuance must be greater than $1 billion;
    (B) The instrument must be denominated in U.S. dollars; and
    (C) The instrument must be fully guaranteed as to principal and 
interest by the United States for its entire term.
    (v) Certificates of deposit must be redeemable at the issuing bank 
within one business day, with any penalty for early withdrawal limited 
to any accrued interest earned according to its written terms.
    (3) Concentration. (i) Asset-based concentration limits for direct 
investments. (A) Investments in U.S. government securities shall not be 
subject to a concentration limit.
    (B) Investments in U.S. agency obligations may not exceed 50 
percent of the total assets held in segregation by the futures 
commission merchant or derivatives clearing organization.
    (C) Investments in each of commercial paper, corporate notes or 
bonds and certificates of deposit may not exceed 25 percent of the 
total assets held in segregation by the futures commission merchant or 
derivatives clearing organization.
    (D) Investments in each of municipal securities and money market 
mutual funds may not exceed 10 percent of the total assets held in 
segregation by the futures commission merchant or derivatives clearing 
organization.
    (ii) Issuer-based concentration limits for direct investments. (A) 
Securities of any single issuer of U.S. agency obligations held by a 
futures commission merchant of derivatives clearing organization may 
not exceed 25 percent of total assets held in segregation by the 
futures commission merchant or derivatives clearing organization.
    (B) Securities of any single issuer of municipal securities, 
certificates of deposit, commercial paper, or corporate notes or bonds 
held by a futures commission merchant or derivatives clearing 
organization may not exceed 5 percent of total assets held in 
segregation by the futures commission merchant or derivatives clearing 
organization.
    (C) Interests in any single family of money market mutual funds may 
not exceed 2 percent of total assets held in segregation by the futures 
commission merchant or derivatives clearing organization.
    (D) For purposes of determining compliance with the issuer-based 
concentration limits set forth in this section, securities issued by 
entities that are affiliated, as defined in paragraph (b)(5) of this 
section, shall be aggregated and deemed the securities of a single 
issuer. An interest in a permitted money market mutual fund is not 
deemed to be a security issued by its sponsoring entity.
    (iii) Concentration limits for agreements to repurchase. (A) 
Repurchase agreements. For purposes of determining compliance with the 
asset-based and issuer-based concentration limits set forth in this 
section, securities sold by a futures commission merchant or 
derivatives clearing organization subject to agreements to repurchase 
shall be combined with securities held by the futures commission 
merchant or derivatives clearing organization as direct investments.
    (B) Reverse repurchase agreements. For purposes of determining 
compliance with the asset-based and issuer-based concentration limits 
set forth in this section, securities purchased by a futures commission 
merchant or derivatives clearing organization subject to agreements to 
resell shall be combined with securities held by the futures commission 
merchant or derivatives clearing organization as direct investments.
    (iv) Treatment of customer-owned securities. For purposes of 
determining compliance with the asset-based and issuer-based 
concentration limits set forth in this section, securities owned by the 
customers of a futures commission merchant and posted as margin 
collateral are not included in total assets held in segregation by the 
futures commission merchant, and securities posted by a futures 
commission merchant with a derivatives clearing organization are not 
included in total assets held in segregation by the derivatives 
clearing organization.
    (v) Counterparty concentration limits. Securities purchased by a 
futures commission merchant or derivatives clearing organization from a 
single counterparty, subject to an agreement to resell to that 
counterparty, shall not exceed 5 percent of total assets held in 
segregation by the futures commission merchant or derivatives clearing 
organization.
    (4) Time-to-maturity. (i) Except for investments in money market 
mutual funds, the dollar-weighted average of the time-to-maturity of 
the portfolio, as that average is computed pursuant to Sec.  270.2a-7 
of this title, may not exceed 24 months.
    (ii) For purposes of determining the time-to-maturity of the 
portfolio, an instrument that is set forth in paragraphs (a)(1)(i) 
through (vii) of this section may be treated as having a one-day time-
to-maturity if the following terms and conditions are satisfied:
    (A) The instrument is deposited solely on an overnight basis with a 
derivatives clearing organization pursuant to the terms and conditions 
of a collateral management program that has become effective in 
accordance with Sec.  39.4 of this chapter;
    (B) The instrument is one that the futures commission merchant owns 
or has an unqualified right to pledge, is not subject to any lien, and 
is deposited by the futures commission merchant into a segregated 
account at a derivatives clearing organization;
    (C) The derivatives clearing organization prices the instrument 
each day based on the current mark-to-market value; and
    (D) The derivatives clearing organization reduces the assigned 
value of the instrument each day by a haircut of at least 2 percent.
    (5) Investments in instruments issued by affiliates. (i) A futures 
commission merchant shall not invest customer funds in obligations of 
an entity affiliated with the futures commission merchant, and a 
derivatives clearing organization shall not invest customer funds in 
obligations of an entity affiliated with the derivatives clearing 
organization. An affiliate includes parent companies, including all 
entities through the ultimate holding company, subsidiaries to the 
lowest level, and companies under common ownership of such parent 
company or affiliates.
    (ii) A futures commission merchant or derivatives clearing 
organization may invest customer funds in a fund affiliated with that 
futures commission merchant or derivatives clearing organization.
    (6) Recordkeeping. A futures commission merchant and a derivatives 
clearing organization shall prepare and maintain a record that will 
show for each business day with respect to each type of investment made 
pursuant to this section, the following information:
    (i) The type of instruments in which customer funds have been 
invested;
    (ii) The original cost of the instruments; and
    (iii) The current market value of the instruments.

[[Page 67655]]

    (c) Money market mutual funds. The following provisions will apply 
to the investment of customer funds in money market mutual funds (the 
fund).
    (1) The fund must be an investment company that is registered under 
the Investment Company Act of 1940 with the Securities and Exchange 
Commission and that holds itself out to investors as a money market 
fund, in accordance with Sec.  270.2a-7 of this title.
    (2) The fund must be sponsored by a federally-regulated financial 
institution, a bank as defined in section 3(a)(6) of the Securities 
Exchange Act of 1934, an investment adviser registered under the 
Investment Advisers Act of 1940, or a domestic branch of a foreign bank 
insured by the Federal Deposit Insurance Corporation.
    (3) A futures commission merchant or derivatives clearing 
organization shall maintain the confirmation relating to the purchase 
in its records in accordance with Sec.  1.31 and note the ownership of 
fund shares (by book-entry or otherwise) in a custody account of the 
futures commission merchant or derivatives clearing organization in 
accordance with Sec.  1.26(c). The futures commission merchant or the 
derivatives clearing organization shall obtain the acknowledgment 
letter required by Sec.  1.26(c) from an entity that has substantial 
control over the fund's assets and has the knowledge and authority to 
facilitate redemption and payment or transfer of the customer 
segregated funds. Such entity may include the fund sponsor or 
investment adviser.
    (4) The net asset value of the fund must be computed by 9 a.m. of 
the business day following each business day and made available to the 
futures commission merchant or derivatives clearing organization by 
that time.
    (5)(i) General requirement for redemption of interests. A fund 
shall be legally obligated to redeem an interest and to make payment in 
satisfaction thereof by the business day following a redemption 
request, and the futures commission merchant or derivatives clearing 
organization shall retain documentation demonstrating compliance with 
this requirement.
    (ii) Exception. A fund may provide for the postponement of 
redemption and payment due to any of the following circumstances:
    (A) For any period during which there is a non-routine closure of 
the Fedwire or applicable Federal Reserve Banks;
    (B) For any period:
    (1) During which the New York Stock Exchange is closed other than 
customary week-end and holiday closings; or
    (2) During which trading on the New York Stock Exchange is 
restricted;
    (C) For any period during which an emergency exists as a result of 
which:
    (1) Disposal by the company of securities owned by it is not 
reasonably practicable; or
    (2) It is not reasonably practicable for such company fairly to 
determine the value of its net assets;
    (D) For any period as the Securities and Exchange Commission may by 
order permit for the protection of security holders of the company;
    (E) For any period during which the Securities and Exchange 
Commission has, by rule or regulation, deemed that:
    (1) Trading shall be restricted; or
    (2) An emergency exists; or
    (F) For any period during which each of the conditions of Sec.  
270.22e-3(a)(1) through (3) of this title are met.
    (6) The agreement pursuant to which the futures commission merchant 
or derivatives clearing organization has acquired and is holding its 
interest in a fund must contain no provision that would prevent the 
pledging or transferring of shares.
    (7) Appendix A to this section sets forth language that will 
satisfy the requirements of paragraph (c)(5) of this section.
    (d) Repurchase and reverse repurchase agreements. A futures 
commission merchant or derivatives clearing organization may buy and 
sell the permitted investments listed in paragraphs (a)(1)(i) through 
(vii) of this section pursuant to agreements for resale or repurchase 
of the securities (agreements to repurchase or resell), provided the 
agreements to repurchase or resell conform to the following 
requirements:
    (1) The securities are specifically identified by coupon rate, par 
amount, market value, maturity date, and CUSIP or ISIN number.
    (2) Permitted counterparties are limited to a bank as defined in 
section 3(a)(6) of the Securities Exchange Act of 1934, a domestic 
branch of a foreign bank insured by the Federal Deposit Insurance 
Corporation, a securities broker or dealer, or a government securities 
broker or government securities dealer registered with the Securities 
and Exchange Commission or which has filed notice pursuant to section 
15C(a) of the Government Securities Act of 1986.
    (3) A futures commission merchant or derivatives clearing 
organization shall not enter into an agreement to repurchase or resell 
with a counterparty that is an affiliate of the futures commission 
merchant or derivatives clearing organization, respectively. An 
affiliate includes parent companies, including all entities through the 
ultimate holding company, subsidiaries to the lowest level, and 
companies under common ownership of such parent company or affiliates.
    (4) The transaction is executed in compliance with the 
concentration limit requirements applicable to the securities 
transferred to the customer segregated custodial account in connection 
with the agreements to repurchase referred to in paragraphs 
(b)(3)(iii)(A) and (B) of this section.
    (5) The transaction is made pursuant to a written agreement signed 
by the parties to the agreement, which is consistent with the 
conditions set forth in paragraphs (d)(1) through (13) of this section 
and which states that the parties thereto intend the transaction to be 
treated as a purchase and sale of securities.
    (6) The term of the agreement is no more than one business day, or 
reversal of the transaction is possible on demand.
    (7) Securities transferred to the futures commission merchant or 
derivatives clearing organization under the agreement are held in a 
safekeeping account with a bank as referred to in paragraph (d)(2) of 
this section, a derivatives clearing organization, or the Depository 
Trust Company in an account that complies with the requirements of 
Sec.  1.26.
    (8) The futures commission merchant or the derivatives clearing 
organization may not use securities received under the agreement in 
another similar transaction and may not otherwise hypothecate or pledge 
such securities, except securities may be pledged on behalf of 
customers at another futures commission merchant or derivatives 
clearing organization. Substitution of securities is allowed, provided, 
however, that:
    (i) The qualifying securities being substituted and original 
securities are specifically identified by date of substitution, market 
values substituted, coupon rates, par amounts, maturity dates and CUSIP 
or ISIN numbers;
    (ii) Substitution is made on a ``delivery versus delivery'' basis; 
and
    (iii) The market value of the substituted securities is at least 
equal to that of the original securities.
    (9) The transfer of securities to the customer segregated custodial 
account is made on a delivery versus payment basis in immediately 
available funds. The transfer of funds to the customer segregated cash 
account is made on a payment versus delivery basis. The transfer is not 
recognized as accomplished until the funds and/or

[[Page 67656]]

securities are actually received by the custodian of the futures 
commission merchant's or derivatives clearing organization's customer 
funds or securities purchased on behalf of customers. The transfer or 
credit of securities covered by the agreement to the futures commission 
merchant's or derivatives clearing organization's customer segregated 
custodial account is made simultaneously with the disbursement of funds 
from the futures commission merchant's or derivatives clearing 
organization's customer segregated cash account at the custodian bank. 
On the sale or resale of securities, the futures commission merchant's 
or derivatives clearing organization's customer segregated cash account 
at the custodian bank must receive same-day funds credited to such 
segregated account simultaneously with the delivery or transfer of 
securities from the customer segregated custodial account.
    (10) A written confirmation to the futures commission merchant or 
derivatives clearing organization specifying the terms of the agreement 
and a safekeeping receipt are issued immediately upon entering into the 
transaction and a confirmation to the futures commission merchant or 
derivatives clearing organization is issued once the transaction is 
reversed.
    (11) The transactions effecting the agreement are recorded in the 
record required to be maintained under Sec.  1.27 of investments of 
customer funds, and the securities subject to such transactions are 
specifically identified in such record as described in paragraph (d)(1) 
of this section and further identified in such record as being subject 
to repurchase and reverse repurchase agreements.
    (12) An actual transfer of securities to the customer segregated 
custodial account by book entry is made consistent with Federal or 
State commercial law, as applicable. At all times, securities received 
subject to an agreement are reflected as ``customer property.''
    (13) The agreement makes clear that, in the event of the bankruptcy 
of the futures commission merchant or derivatives clearing 
organization, any securities purchased with customer funds that are 
subject to an agreement may be immediately transferred. The agreement 
also makes clear that, in the event of a futures commission merchant or 
derivatives clearing organization bankruptcy, the counterparty has no 
right to compel liquidation of securities subject to an agreement or to 
make a priority claim for the difference between current market value 
of the securities and the price agreed upon for resale of the 
securities to the counterparty, if the former exceeds the latter.
    (e) Deposit of firm-owned securities into segregation. A futures 
commission merchant shall not be prohibited from directly depositing 
unencumbered securities of the type specified in this section, which it 
owns for its own account, into a segregated safekeeping account or from 
transferring any such securities from a segregated account to its own 
account, up to the extent of its residual financial interest in 
customers' segregated funds; provided, however, that such investments, 
transfers of securities, and disposition of proceeds from the sale or 
maturity of such securities are recorded in the record of investments 
required to be maintained by Sec.  1.27. All such securities may be 
segregated in safekeeping only with a bank, trust company, derivatives 
clearing organization, or other registered futures commission merchant. 
Furthermore, for purposes of Sec. Sec.  1.25, 1.26, 1.27, 1.28 and 
1.29, investments permitted by Sec.  1.25 that are owned by the futures 
commission merchant and deposited into such a segregated account shall 
be considered customer funds until such investments are withdrawn from 
segregation.

Appendix to Sec.  1.25--Money Market Mutual Fund Prospectus Provisions 
Acceptable for Compliance With Paragraph (c)(5)

    Upon receipt of a proper redemption request submitted in a 
timely manner and otherwise in accordance with the redemption 
procedures set forth in this prospectus, the [Name of Fund] will 
redeem the requested shares and make a payment to you in 
satisfaction thereof no later than the business day following the 
redemption request. The [Name of Fund] may postpone and/or suspend 
redemption and payment beyond one business day only as follows:
    a. For any period during which there is a non-routine closure of 
the Fedwire or applicable Federal Reserve Banks;
    b. For any period (1) during which the New York Stock Exchange 
is closed other than customary week-end and holiday closings or (2) 
during which trading on the New York Stock Exchange is restricted;
    c. For any period during which an emergency exists as a result 
of which (1) disposal of securities owned by the [Name of Fund] is 
not reasonably practicable or (2) it is not reasonably practicable 
for the [Name of Fund] to fairly determine the net asset value of 
shares of the [Name of Fund];
    d. For any period during which the Securities and Exchange 
Commission has, by rule or regulation, deemed that (1) trading shall 
be restricted or (2) an emergency exists;
    e. For any period that the Securities and Exchange Commission, 
may by order permit for your protection; or
    f. For any period during which the [Name of Fund,] as part of a 
necessary liquidation of the fund, has properly postponed and/or 
suspended redemption of shares and payment in accordance with 
federal securities laws.

PART 30--FOREIGN FUTURES AND FOREIGN OPTIONS TRANSACTIONS

    3. The authority citation for part 30 continues to read as follows:

    Authority:  7 U.S.C. 1a, 2, 6, 6c, and 12a, unless otherwise 
noted.

    4. In Sec.  30.7, revise paragraph (c) and add paragraph (g) to 
read as follows:


Sec.  30.7  Treatment of foreign futures or foreign options secured 
amount.

* * * * *
    (c)(1) The separate account or accounts referred to in paragraph 
(a) of this section must be maintained under an account name that 
clearly identifies them as such, with any of the following 
depositories:
    (i) A bank or trust company located in the United States;
    (ii) A bank or trust company located outside the United States that 
has in excess of $1 billion of regulatory capital;
    (iii) A futures commission merchant registered as such with the 
Commission;
    (iv) A derivates clearing organization;
    (v) A member of any foreign board of trade; or
    (vi) Such member or clearing organization's designated 
depositories.
    (2) Each futures commission merchant must obtain and retain in its 
files for the period provided in Sec.  1.31 of this chapter an 
acknowledgment from such depository that it was informed that such 
money, securities or property are held for or on behalf of foreign 
futures and foreign options customers and are being held in accordance 
with the provisions of these regulations.
* * * * *
    (g) Each futures commission merchant that invests customer funds 
held in the account or accounts referred to in paragraph (a) of this 
section must invest such funds pursuant to the requirements of Sec.  
1.25 of this chapter.

    Issued in Washington, DC, on October 26, 2010, by the 
Commission.
David A. Stawick,
Secretary of the Commission.

    Note: The following statement will not appear in the Code of 
Federal Regulations.


[[Page 67657]]



Statement of Chairman Gary Gensler

Investment of Customer Funds and Funds Held in an Account for Foreign 
Futures and Foreign Options Transactions

October 26, 2010

    I support today's Commission vote on the proposed rulemaking 
regarding the investment of customer segregated and secured amount 
funds. This rulemaking fulfills part of the Dodd-Frank Act's 
requirement that the Commission remove all reliance on credit ratings 
from its regulations. In addition, the rule enhances protections 
regarding where derivatives clearing organizations (DCOs) and futures 
commission merchants (FCMs) can invest customer funds. The market 
events of the last two years have underscored the importance of prudent 
investment standards to ensure the financial integrity of DCOs and FCMs 
and of maximizing protection of customer funds.

[FR Doc. 2010-27657 Filed 11-2-10; 8:45 am]
BILLING CODE P