Securities Regulation Daily CFTC votes on bankruptcy, Form CPO-PQR, and EU margin rules
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Wednesday, April 15, 2020

CFTC votes on bankruptcy, Form CPO-PQR, and EU margin rules

By Jay Fishman, J.D.

The CFTC approved significant updates to its long-standing bankruptcy regime and commodity pool operator form while tweaking its swap clearing requirement and margin rule for the European Union, along with protecting its consumers’ financial privacy.

CFTC Chairman Heath Tarbert and Commissioners Rostin Behnam, Dan Berkovitz, Brian Quintenz, and Dawn Stump, on Tuesday April 14, 2020, held an opening meeting virtually in light of the COVID-19 pandemic to discuss and vote on proposed rules pertaining to commodity broker-dealer bankruptcies; Form CPO-PQR revisions; and swap clearing requirement exemptions, along with voting on final rules permitting margin relief for the European Stability Mechanism and protecting consumer financial privacy information. The commissioners unanimously approved all five rules and set a 90-day public comment period for the three proposals. The commissioners emphasized that comments submitted after the deadline would most likely be considered because of current coronavirus disruptions.

Chairman Tarbert and commissioners Behnam, Berkovitz, Quintenz, and Stump each acknowledged in their opening statements the hard work and number of hours their staff has devoted amid the coronavirus, as well as wished this meeting’s virtual attendees, market participants, and their families around the world good health during this difficult time. They also emphasized that they would devote the rest of 2020 to simply following through on the commodities matters undertaken in 2019, which include the three proposed rules discussed and voted on at this meeting. The commissioners also remarked upon their ongoing intentions to: (1) monitor the financial markets and their market participants’ activities; (2) clarify rules (even rules that are substantively okay) to remove ambiguous language to avoid future complications; and (3) continue to work as a team not only with each other but with other U.S. and international financial regulators, as well as with Congress, the importance of which has been brought to light by the COVID-19 pandemic.

Final rules. Margin relief for the European Stability Mechanism. This approved final rule relieves the European Stability Mechanism (ESM) from having to comply with the Commodity Exchange Act’s (CEA) Regulation 23.151 (the Margin Rule), which requires the posting of initial and variation margin for uncleared swaps that certain swap dealers, major swap participants, and financial end users enter into. The approved rule amends the definition of a "financial end user" to exclude the ESM.

While the five Commissioners had approved the final rule, Commissioner Quintenz said that his support came only after COVID-19. Before the coronavirus, Quintenz was against the Margin Rule revision because the European Union (EU) failed to honor the international Central Counterparty (CCP), which allowed each individual country member to oversee and regulate its respective market participants’ activities that occurred in a foreign country. But while he found the EU to have, in the past, overreached its authority by interfering with the CFTC’s ability to regulate its U.S. participants’ oversees commodity operations, he voted for the amendment out of faith that COVID-19 would bring out each financial regulator’s desire to cooperate with each other for the greater good.

Consumer financial privacy regulation. The commissioners, without any discussion, voted to approve this proposed regulation because of its importance in today’s world, to help protect consumers confidential personal and account information from cybersecurity incidents and identity theft. The final rule specifically restores certain requirements regarding the privacy of consumer financial information that were inadvertently deleted in a 2011 rulemaking. According to the 2019 rule proposal, CFTC regulation §160.30 requires every futures commission merchant (FCM), registered foreign exchange dealer (RFED), commodity trading advisor (CTA), commodity pool operator (CPO), introducing broker (IB), major swap participant (MSP), or swap dealer (SD) subject to the jurisdiction of the Commission to have policies and procedures to safeguard customer records and information. However, when the regulation was revised in 2011 to add SDs and MSPs to the list of covered entities, some requirements were inadvertently deleted. The final rule amends §160.30 to restore the deleted requirements. A statement of support for the final rule was issued by Chairman Tarbert.

Proposed rules. Updates to CFTC’s bankruptcy regime. Chairman Tarbert and Commissioners Behnam, Berkovitz, Quintenz, and Stump unanimously voted in favor of the proposed amendments to the bankruptcy regime but admitted that CFTC’s Part 190 was pretty much fine as initially adopted in 1983. Specifically, during Part 190’s 37-year history, very few CFTC bankruptcies occurred because market participants abided by the rules. There were, of course, some large bankruptcies in more recent times, namely MF Global’s in 2011 and Peregrine’s in 2012. But overall, presenter Bob Wasserman from the Division of Clearing and Risk said that amending the initially well-written rules at this juncture would clarify ambiguous language and replace outdated cross references to help resolve matters quickly in bankruptcy court that might otherwise result in a long, expensive court process. But, moreover, he said that the new rules are necessary to stem systemic disruptions that can arise much faster because of persistent market fluctuations in today’s global economy.

As Wasserman explained, the proposed amendments to Part 190 would comprise model rules pertaining to bankruptcy proceedings for commodity broker-dealers, composed of both FCMs and derivatives clearing organizations (DCOs). He proclaimed that the proposed model rules would substantively protect both customers and the financial system in the following ways:

  1. When an FCM or DCO is on the verge of bankruptcy, instead of liquidating the FCM, the customer funds’ would be ported (or transferred) to a stable FCM or DCO, thereby allowing the customers’ to quickly retrieve at least 60 or 70 percent of the money they would have otherwise lost in the bankrupt FCM’s or DCO’s liquidation.
  2. The FCM’s or DCO’s trustee would have much more discretion over the FCM’s or DCO’s liquidation, thereby permitting the trustee authority to administer the liquidation in a way better befitting the customers’ ability to recover their lost funds, as long as the trustee abides by the federal bankruptcy regulations while doing so. Also, Wasserman emphasized that while the trustee would be independent, the trustee would work closely with the CFTC in bankruptcy court.
  3. Treating customers as a class instead of individuals and distribution funds to them pro rata would allow each customer to retrieve at least lost money rather than certain individual customers receiving a lot of it while others receive nothing. Also, by treating the customers as a class for a pro rata distribution, the funds could be processed and distributed faster than if having to be processed separately for each victim. Lastly, pro rata distribution gives the money back first to the people who need it the most.

Commissioner Quintenz asked whether the above distributions would include virtual currencies, to which Wasserman answered "yes" because the FCM’s or DCO’s assets and property would be separately classified as physical or nonphysical deliverables, with nonphysical deliverables comprising virtual currencies.

Commissioner Stump asked how DCOs particularly would be treated under the model rules, to which Wasserman declared that the trustee would take action under the DCO bankruptcy rules to the extent practical but subject to the trustee’s discretion.

Commissioner Berkovitz asked whether the proposal’s objectives would be contradictory, to which Wasserman replied "no," specifically stating the objectives: (1) to protect customers; (2) protect financial systems; and (3) protect the confidence in the markets so that customers do not panic or fear a run on the bank before investing. And the model rules would "make the creditor no worse off than the credit would be in liquidation." Wasserman further asserted that ensuring these objectives would bolster U.S. markets’ competitiveness in the current global economy.

Amendments to compliance requirements for commodity pool operators on Form CPO-PQR. Chairman Tarbert expressed support for the proposed Form CPO-PQR revisions, along with Commissioners Behnam and Quintenz. Joshua Sterling and Amanda Olear from the Division of Swap Dealer and Intermediary Oversight (DSIO) presented on the proposed amendments to Form CPO-PQR, declaring that the proposal’s dual purpose is to eliminate duplicative and non-useful information requirements from the form but add requirements for information that would be useful to the CFTC. Commissioners Berkovitz and Stump were glad that all of Schedule C and most of Schedule B (except for providing a CPO’s investment-type such as gold or platinum) would be eliminated.

The item that particularly caught the commissioners’ attention was the proposed requirement for CPOs to provide legal entity identifier (LEI) information on the form. Sterling said that LEIs would help regulators to better oversee CPO transactions and track the exposure and risk from the CPO to the swap dealer, namely both sides of the transaction. He also did not believe that providing LEI information on the form would have a negative effect on consumers. Regarding Sterling’s major point that LEIs apply only to swap transactions, Commissioner Berkovitz requested that a future requirement be for the form to mandate LEIs for non-swaps, i.e., exchange-traded commodities. Olear said that it’s too late for mid- and small-size CPOs to extend their filings due in March but that because of COVID-19, these CPOs will get a 90-day extension on their next quarterly filing.

The other important points made during this discussion included the following:

  • Commissioner Quintenz proclaimed the difficulty of aggregating Form CPO-PQR information in real time so that by the time the CFTC obtains it for review, the information is already 60 days old. Sterling acknowledged that the information provided on the form is just a snapshot in time, and also that it is difficult to aggregate the submitted form information because that information varies so much by CPO type and size.
  • The Financial Stability Oversight Council (FSOC) created from the Dodd-Frank Act did not mandate that Form CPO-PQR be revised. Furthermore, Olear stated that the FSOC has never requested information about a particular CPO’s activities.
  • Mention was made about CPOs having to quarterly file Form NAF-PQR. But Sterling and Olear pointed out that there would be no duplicative filing burden because CPOs could file either Form NAF-PQR or the proposed amended Form CPO-PQR.
  • Mention was also made about the need to file Form PF with the SEC. Sterling and Olear said that before proposing the Form CPO-PQR revisions, they asked SEC staff whether the staff had any concerns about the CFTC’s proposed changes, and the staff expressed no concerns. Moreover, Sterling and Olear said that filing revised Form CPO-PQR with the CFTC would not interfere with the SEC-filing of Form PF.

Part 50 clearing requirement. Simultaneously approved with the above final Margin Rule revision was a proposed amendment to the CFTC’s Part 50 rules pertaining to the CEA’s Section 2(h)(1) on swap clearing agreements. As proposed, new regulations 50.75 and 50.76 would codify existing exemptions from the clearing requirement for swaps entered into with certain central banks, sovereign entities, and international financial institutions. The major reason for approving the proposal, as stated by Commissioner Berkovitz, is twofold: (1) the proposed new rules would basically be a mere codification of exemptions that the abovementioned central banks, sovereign entities and international financial institutions have been successfully relying for years; and (2) the number of swaps that would fall within the exemptions would be relatively small compared to the swaps requiring CFTC clearance.

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