Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 5577

Dated: January 13, 2005. 

Julie L. Williams, 

Acting Comptroller of the Currency. 

By order of the Board of Governors of the 

Federal Reserve System on January 26, 2005. 

Jennifer J. Johnson, 

Secretary of the Board.

Federal Deposit Insurance Corporation.

By order of the Board of Directors.

Dated at Washington, DC, this 18th day of 

January, 2005. 

Robert E. Feldman, 

Executive Secretary. 

Dated: January 25, 2005. 

James E. Gilleran, 

Director, Office of Thrift Supervision.

[FR Doc. 05–2079 Filed 2–2–05; 8:45 am] 

BILLING CODE 4810–33–C; 6210–01–C; 6714–01–C; 

6720–01–C

COMMODITY FUTURES TRADING 

COMMISSION 

17 CFR Part 1 

RIN 3038–AC15 

Investment of Customer Funds and 

Record of Investments

AGENCY: Commodity Futures Trading 

Commission.

ACTION: Proposed rule.

SUMMARY: The Commodity Futures 

Trading Commission (‘‘Commission’’) is 

proposing to amend its regulations 

regarding investment of customer funds 

and related recordkeeping requirements. 

The proposed amendments address 

standards for investing in instruments 

with embedded derivatives, 

requirements for adjustable rate 

securities (including auction rate 

securities), concentration limits on 

reverse repurchase agreements (‘‘reverse 

repos’’), transactions by futures 

commission merchants (‘‘FCMs’’) that 

are also registered as securities brokerdealers (‘‘FCM/BDs’’), rating standards 

and registration requirement for money 

market mutual funds (‘‘MMMFs’’), 

auditability standard for investment 

records, and certain technical changes. 

Among those technical changes is an 

amendment to the Commission’s 

recordkeeping rules in connection with 

repurchase agreements (‘‘repos’’) and 

proposed transactions by FCM/BDs.

DATES: Comments must be received on 

or before March 7, 2005.

ADDRESSES: Comments on the proposed 

amendments should be sent to Jean A. 

Webb, Secretary, Commodity Futures 

Trading Commission, Three Lafayette 

Centre, 1155 21st Street, NW., 

Washington, DC 20581. Comments may 

be sent by facsimile transmission to 

(202) 418–5521, by e-mail to 

secretary@cftc.gov, or electronically by 

accessing http://www.regulations.gov.

Reference should be made to ‘‘Proposed 

Amendments to Rule 1.25.’’

FOR FURTHER INFORMATION CONTACT:

Phyllis P. Dietz, Special Counsel, 

Division of Clearing and Intermediary 

Oversight, Commodity Futures Trading 

Commission, Three Lafayette Centre, 

1155 21st Street, NW., Washington, DC 

20581. Telephone (202) 418–5430.

Table of Contents 

I. Background 

II. Discussion of the Proposed Rules 

A. Instruments With Embedded Derivatives 

B. Adjustable Rate Securities 

1. Permitted Benchmarks 

2. Supplemental Requirements 

3. Technical Amendments 

4. Auction Rate Securities 

C. Reverse Repos—Concentration Limits 

D. Transactions by FCM/BDs 

E. Rating Standards for MMMFs 

F. Registration Requirement for MMMFs 

G. Auditability Standard for Investment 

Records 

H. Additional Technical Amendments 

1. Clarifying and Codifying MMMF 

Redemption Requirements 

(i) Next-Day Redemption Requirement 

(ii) Exceptions to the Next-Day Redemption 

Requirement

2. Clarifying Rating Standards for 

Certificates of Deposit 

3. Clarifying Corporate Bonds as Permitted 

Investments 

4. Clarifying References to Transferred 

Securities 

5. Clarifying Payment and Delivery 

Procedures for Reverse Repos and Repos 

6. Changing Paragraph (a)(1) ‘‘Customer 

Funds’’ to ‘‘Customer Money’’

7. Conforming Reference to 

‘‘Marketability’’ Requirement 

8. Conforming Terminology for 

‘‘Derivatives Clearing Organizations’’

9. Conforming Terminology for 

‘‘Government Sponsored Enterprise’’

10. Conforming Terminology for ‘‘Futures 

Commission Merchant’’

11. Clarifying the Meaning of ‘‘NRSRO’’

III. Time to Maturity—Treasury Portfolio 

IV. Section 4(c) 

V. Related Matters 

A. Regulatory Flexibility Act 

B. Paperwork Reduction Act 


EP03FE05.110</GPH>
5578 Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 

1Section 4d(a)(2) of the Act, 7 U.S.C. 6d(a)(2), 

requires segregation of customer funds. It provides, 

in relevant part, that customer-deposited ‘‘money, 

securities, and property shall be separately 

accounted for and shall not be commingled with the 

funds of [the FCM] or be used to margin or 

guarantee the trades or contracts, or to secure or 

extend the credit, of any customer or person other 

than the one for whom the same are held.’’

2See 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).

3 68 FR 38654 (June 30, 2003).

4 69 FR 6140 (Feb. 10, 2004).

5 In addition to addressing the issues raised in its 

June 30, 2003 release, the Commission is also 

proposing two supplemental requirements for 

adjustable rate securities, as well as technical 

amendments relating to terminology. Among the 

technical amendments is a proposal to substitute 

the term ‘‘adjustable rate security’’ for the term 

‘‘variable-rate security,’’ as the latter term is 

currently used. See Section II.B.3. of this release for 

a discussion of proposed changes in terminology.

6These comment letters are available in the 

comment file accompanying the June 30, 2003 

release, at http://www.cftc.gov.

7 In connection with this proposal, the 

Commission is also proposing technical 

amendments to Rule 1.27 to clarify the 

recordkeeping requirements applicable to repos and 

proposed transactions by FCM/BDs.

8Rule 1.25(b)(3)(i) currently provides that ‘‘[w]ith 

the exception of money market mutual funds, no 

permitted investment may contain an embedded 

derivative of any kind, including but not limited to 

a call option, put option, or collar, cap, or floor on 

interest paid.’’

C. Costs and Benefits of the Proposed Rules 

Text of Rules

SUPPLEMENTARY INFORMATION: 

I. Background 

Commission Rule 1.25 (17 CFR 1.25) 

sets forth the types of instruments in 

which FCMs and derivatives clearing 

organizations (‘‘DCOs’’) are permitted to 

invest customer assets that are required 

to be segregated under the Commodity 

Exchange Act 1 (‘‘Act’’). The 

Commission believes that it is important 

to have customer funds invested in a 

manner that minimizes their exposure 

to credit, liquidity, and market risks not 

only because they are customer assets, 

but also because, to the extent they 

represent a performance bond against 

customer obligations under derivatives 

contracts, these assets must be capable 

of being quickly converted to cash at a 

predictable value to minimize systemic 

risk.

Rule 1.25 was substantially amended 

in December 2000 to expand the list of 

permitted investments beyond the 

Treasury and municipal securities that 

are expressly permitted by the Act.2 In 

connection with that expansion, the 

Commission added several provisions 

intended to control exposures to credit, 

liquidity, and market risks associated 

with the additional investments.

On June 30, 2003, the Commission 

published for public comment proposed 

amendments to two provisions of Rule 

1.25, and it further requested comment 

(without proposing specific 

amendments) on several other 

provisions of the rule.3 In February 

2004, the Commission adopted final 

rule amendments regarding repos with 

customer-deposited securities and 

modified time-to-maturity requirements 

for securities deposited in connection 

with certain collateral management 

programs of DCOs.4 The Commission 

did not, however, take any action on the 

other matters raised in its June 30, 2003 

release.

The Commission is now proposing 

specific rule amendments related to the 

remaining issues raised in its June 30, 

2003 request for public comment. These 

proposed amendments, discussed in 

section II.A. through C. of this release, 

relate to standards for investing in 

instruments with embedded derivatives, 

permitted benchmarks for adjustable 

rate securities,5 and concentration limits 

on reverse repos. The discussion of 

these issues incorporates comments 

submitted by the Futures Industry 

Association (‘‘FIA’’), National Futures 

Association (‘‘NFA’’), and Lehman 

Brothers, in 2003.6

The Commission is also proposing 

amendments that address several new 

issues, as discussed in section II.D. 

through G. of this release. In this regard, 

the Commission is proposing an 

amendment requested by the FIA 

regarding certain transactions by FCM/

BDs,7 an amendment to eliminate the 

rating requirement for MMMFs, an 

amendment to require that all permitted 

MMMFs be registered with the 

Securities and Exchange Commission 

(‘‘SEC’’), and an amendment 

establishing an auditability standard for 

investment records.

Further, in Section II.H. of this 

release, the Commission is proposing 

technical amendments to Rule 1.25 to 

clarify the following: (1) The next-day 

redemption requirement for MMMFs 

(also codifying previously published 

exceptions to that requirement); (2) the 

rating standards for certificates of 

deposit; (3) the permissibility of 

investing in corporate bonds; (4) the 

inapplicability of segregation rules to 

securities transferred pursuant to a repo; 

(5) payment and delivery procedures for 

repos and reverse repos; and (6) the 

distinction between investment of 

customer money and investment of 

customer-deposited securities. The 

technical amendments would also 

conform references to applicable 

marketability standards, update and 

conform the terminology referring to a 

DCO, conform the terminology referring 

to a government sponsored enterprise 

(‘‘GSE’’), conform the terminology 

referring to an FCM, and clarify the 

meaning of the term ‘‘NRSRO.’’

The Commission solicits comment on 

all aspects of the proposed amendments 

to Rules 1.25 and 1.27. Commenters are 

welcome to offer their views regarding 

any other matters that are raised by the 

proposed rules. 

II. Discussion of the Proposed Rules 

A. Instruments With Embedded 

Derivatives 

Rule 1.25(b)(3)(i) expressly prohibits 

investment of customer funds in 

instruments with embedded 

derivatives.8 Some market participants 

have suggested that there are certain 

instruments containing embedded 

derivatives that have a level of risk 

similar to or lower than some of the 

other investments permitted under the 

rule and that embedded derivatives may 

otherwise have risk-neutral or even riskmitigating effects. In June 2003, the 

Commission requested comment on 

whether Rule 1.25(b)(3)(i) should be 

amended to modify the prohibition on 

investments in securities that contain an 

embedded derivative. In this regard, 

commenters were asked to describe how 

the level of risk of such securities could 

be limited.

The FIA commented that many GSE 

securities contain caps, floors, puts, and 

calls. The FIA recommended that the 

Commission permit FCMs to invest in 

securities with such features, provided 

they are directly related to the interest 

rate characteristics of the security. The 

FIA stated that this standard is similar 

to one found in Generally Accepted 

Accounting Principles Statement of 

Financial Accounting Standards No. 

133, under which embedded derivatives 

that are ‘‘clearly and closely related’’ to 

the ‘‘host contract’’ are accounted for 

together with the underlying 

instrument. The FIA further stated that 

caps, floors, puts and calls would all be 

considered ‘‘clearly and closely related’’

as long as they are a function of the 

same rate in the underlying security. 

Since the FIA submitted its comment 

letter, FIA representatives have held 

further discussions with Commission 

staff to consider the establishment of 

more specific criteria that could provide 

greater clarity for FCMs and DCOs, as 

well as designated self-regulatory 

organization and Commission auditors. 

Such standards would be more readily 

auditable, furthering the goal of 

ensuring compliance. 

Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 5579

9See 65 FR at 39014.

10See Section II.B.3. of this release for a 

discussion of the Commission’s proposed 

amendments to clarify use of the terms ‘‘adjustable 

rate,’’ ‘‘floating rate,’’ and ‘‘variable rate.’’

As the Commission has previously 

stated, it believes that expanding the list 

of permitted investments can enhance 

the yield available to FCMs, DCOs, and 

their customers, without compromising 

the ability of FCMs to quickly convert 

such investments to cash at a 

predictable value.9 In light of 

discussions with market participants, 

the Commission acknowledges that 

there are some embedded derivatives 

that, at a minimum, do not appear to 

heighten the material risks of permitted 

investments and may serve to mitigate 

risks under certain circumstances.

The Commission, having carefully 

considered the merits of permitting 

investment of customer money in a 

limited selection of instruments with 

embedded derivatives, proposes to 

amend Rule 1.25(b)(3)(i) to permit FCMs 

and DCOs to invest in instruments with 

certain embedded derivatives, subject to 

certain express standards. Commission 

staff have worked with market 

participants to develop these standards, 

with the goal of excluding inappropriate 

instruments while including 

instruments that offer an attractive yield 

at an acceptable level of risk. 

As a preliminary matter, the 

Commission proposes a technical 

amendment to paragraph (b)(3)(iii), to 

clarify its continued intent to maintain 

an express prohibition against any 

instrument that, itself, constitutes a 

derivative instrument. This was the 

original intent of paragraph (b)(3)(iii) 

which already prohibits payments 

linked to any underlying commodity 

except as expressly permitted by 

paragraph (b)(3)(iv) with respect to 

adjustable rate securities. 

Proposed paragraph (b)(3)(i) would 

continue to generally prohibit 

investments in instruments with 

embedded derivatives, carving out an 

exception only for two categories of 

embedded derivatives that may be 

contained in instruments that meet 

specified criteria. 

Proposed paragraph (b)(3)(i) sets forth 

the types of embedded derivatives that 

would be permissible. First, proposed 

paragraph (b)(3)(i)(A) permits an 

instrument to have a call feature, in 

whole or in part, at par, on the principal 

amount of the instrument before its 

stated maturity date. The Commission 

notes that the issuer’s right to call an 

instrument prior to maturity does not 

jeopardize the principal amount, but 

merely accelerates the maturity of the 

instrument. Because the issuer of a 

callable instrument typically offers a 

higher return to investors in return for 

the right to call the issue if prevailing 

interest rates fall, or for other reasons, 

a callable instrument can afford its 

holders the opportunity to achieve a 

higher yield without exposing 

themselves to greater credit risk by 

seeking higher yields from other issuers 

that may be less creditworthy. That is, 

the reinvestment risk presented by 

callable instruments is of far less 

supervisory concern, if any, than the 

credit risk that may be presented by a 

shifting of investments to less 

creditworthy issuers, even within the 

population permitted by the credit 

rating requirements and other 

requirements of Rule 1.25. 

Second, proposed paragraph 

(b)(3)(i)(B) addresses permissible 

interest rate features. The proposed 

revision now would permit caps, floors, 

or collars on the interest paid pursuant 

to the terms of an adjustable rate 

instrument. Upper and/or lower limits 

on interest do not jeopardize the 

principal amount payable at maturity. 

Although upper limits (caps) on 

adjustable rates may constrain the yield 

achieved if prevailing rates rise 

substantially, lower limits (floors) may 

protect the yield achieved if prevailing 

rates fall significantly. 

Proposed paragraph (b)(3)(i) further 

provides that the terms of the 

instrument must obligate the issuer to 

fully repay the principal amount of the 

instrument at not less than par value, 

upon maturity. The preservation of 

principal is a fundamental premise 

upon which the Commission has based 

its policies regarding permitted 

investments. It is important to ensure 

that principal is protected, especially as 

instruments become more complex in 

their structure.

B. Adjustable Rate Securities 

1. Permitted Benchmarks 

Rule 1.25(b)(3)(iv) currently permits 

investment in ‘‘variable-rate 

securities,’’ 10 provided that the interest 

rates thereon correlate closely and on an 

unleveraged basis to a benchmark of 

either the Federal Funds target or 

effective rate, the prime rate, the threemonth Treasury Bill rate, or the onemonth or three-month LIBOR rate. 

Market participants have noted that the 

benchmarks used in the marketplace 

evolve over time. In its June 30, 2003 

release, the Commission requested 

comment on whether the provision on 

permitted benchmarks should be 

amended and, if so, what the applicable 

standard should be.

The FIA recommended that Rule 

1.25(b)(3)(iv) be amended to provide 

that permissible benchmarks can 

include any fixed rate instrument that is 

a ‘‘permitted investment’’ under the 

rule. The FIA reasoned that, if an FCM 

is authorized to purchase a fixed rate 

instrument, e.g., a six-month Treasury 

bill, and continuously roll that 

instrument over, then it should be able 

to purchase an instrument benchmarked 

to that fixed rate security. This would 

allow FCMs to respond to new 

benchmarks as they evolve. In this 

regard, the FIA noted its understanding 

that, in Europe, the Euribor has become 

more popular than LIBOR as a 

benchmark in many instruments. 

The Commission agrees that it is 

appropriate to afford greater latitude in 

establishing benchmarks for floating rate 

securities, thereby enabling FCMs and 

DCOs to more readily respond to 

changes in the market. The Commission 

therefore proposes to amend Rule 

1.25(b)(3)(iv), proposing new paragraph 

(b)(3)(iv)(A)(2), to provide that, in 

addition to the benchmarks already 

enumerated in the rule, floating rate 

securities may be benchmarked to rates 

on any fixed rate instruments that are 

‘‘permitted investments’’ under Rule 

1.25(a). It should be noted that any 

resulting interest payment must be 

determined solely by reference to one or 

more permissible interest rates or 

relationships between a constant and 

one or more permissible interest rates. 

In addition, the Commission believes 

it appropriate to clarify that neither the 

existing text requiring that the interest 

payments on variable rate securities 

‘‘correlate closely and on an 

unleveraged basis’’ to certain 

benchmark rates, nor the proposed text 

requiring that the interest payments on 

floating rate securities ‘‘be determined 

solely by reference, on an unleveraged 

basis,’’ to those and other benchmarks, 

should be read to foreclose interest 

payments that include some fixed 

arithmetic spread added to the 

benchmark rate itself, provided that no 

such spread may constitute any 

multiple of the benchmark rate. This 

reflects the original intent of this 

provision, and should eliminate 

potential errors or ambiguities in 

interpreting what is meant by the phrase 

‘‘unleveraged basis.’’

2. Supplemental Requirements 

The Commission is proposing to 

amend paragraph (b)(3)(iv) by adding 

two supplemental requirements that it 

believes are prudent and necessary in 

light of the increasing number and 

5580 Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 

11See SEC Rule 2a–7(a)(13), 17 CFR 270.2a–

7(a)(13).

12See SEC Rule 2a–7(a)(29), 17 CFR 270.2a–

7(a)(29).

13Under Rule 1.25(b)(5), the portfolio time-tomaturity calculation is computed pursuant to SEC 

Rule 2a–7.

14As used in this release, the term ‘‘reverse repo’’

means an agreement under which an FCM or DCO 

buys a security that is a permitted investment from 

a qualified counterparty, with a commitment to 

resell that security to the counterparty at a later 

date. A ‘‘repo’’ is an agreement under which an 

FCM or DCO sells a security to a qualified 

counterparty, with a commitment to repurchase that 

security at a later date.

15See 65 FR 77993, 78002 (Dec. 13, 2000).

complexity of adjustable rate securities 

that could qualify as permitted 

investments for FCMs and DCOs. Under 

proposed paragraph (b)(3)(iv)(A)(3), any 

benchmark rate would have to be 

expressed in the same currency as the 

adjustable rate security referencing it. 

This eliminates the need to calculate 

and account for changes in applicable 

currency exchange rates. Under 

proposed paragraph (b)(3)(iv)(A)(4), the 

periodic coupon payments could not be 

a negative amount. This is designed to 

prevent FCMs and DCOs from investing 

in instruments that the Commission 

believes do not reflect an acceptable 

level of risk. 

3. Technical Amendments 

The Commission is proposing to 

revise certain terminology used in 

paragraph (b)(3)(iv) for the purpose of 

clarifying, not changing, the meaning of 

this provision. Paragraph (b)(3)(iv) 

currently uses the term ‘‘variable-rate 

securities’’ without distinguishing 

between securities for which periodic 

interest payments vary by formula or 

other reference calculation any time a 

specified interest rate changes (termed a 

‘‘floating rate security’’ by the SEC),11

and those for which periodic interest 

payments are adjusted on set dates 

(termed a ‘‘variable rate security’’ by the 

SEC).12 For purposes of clarity and to 

ensure consistency with the paragraph 

(b)(5) time-to-maturity provision,13 the 

Commission is proposing to amend 

paragraph (b)(3)(iv) to distinguish the 

terms ‘‘floating rate security’’ and 

‘‘variable rate security’’ and, where 

appropriate, to use the term ‘‘adjustable 

rate security,’’ to refer to either or both 

of the foregoing.

In this regard, the Commission 

proposes to add a new paragraph 

(b)(3)(iv)(B), defining the above terms 

for purposes of paragraph (b)(3)(iv). 

Proposed paragraph (b)(3)(iv)(B)(1) 

defines ‘‘adjustable rate security’’ as 

described above. Using the SEC’s 

definition, proposed paragraph 

(b)(3)(iv)(B)(2) defines ‘‘floating rate 

security’’ as a security, the terms of 

which provide for the adjustment of its 

interest rate whenever a specified 

interest rate changes and that, at any 

time until the final maturity of the 

instrument or the period remaining 

until the principal amount can be 

recovered through demand, can 

reasonably be expected to have a market 

value that approximates its amortized 

cost. Also using the SEC’s definition, 

proposed paragraph (b)(3)(iv)(B)(3) 

defines ‘‘variable rate security’’ as a 

security, the terms of which provide for 

the adjustment of its interest rate on set 

dates (such as the last day of a month 

or calendar quarter) and that, upon each 

adjustment until the final maturity of 

the instrument or the period remaining 

until the principal amount can be 

recovered through demand, can 

reasonably be expected to have a market 

value that approximates its amortized 

cost. 

4. Auction Rate Securities 

The Commission received an inquiry 

from an FCM interested in investing 

customer funds in certain auction rate 

securities (‘‘ARS’’). The specific 

instruments described by this FCM were 

issued by a quasi-governmental 

corporate entity established in the 

Commonwealth of Massachusetts. Such 

an issuer cannot be considered to be a 

political subdivision of a State as 

described in the Act and in paragraph 

(a)(ii) of Rule 1.25 but, rather, must be 

considered to be a corporate issuer 

under paragraph (a)(vi). 

Currently, paragraph (a)(vi) uses the 

term ‘‘corporate notes,’’ which may 

create some uncertainty as to the 

Commission’s intent regarding the 

duration of such instruments. In 

particular, the specific instruments that 

were the subject of the inquiry have 

maturity dates many years in the future. 

As discussed in section II.H.3. of this 

release, the Commission is proposing a 

technical change to now use the term 

‘‘corporate notes or bonds,’’ for clarity. 

Accordingly, an ARS that had an initial 

term to maturity exceeding five or even 

ten years would not be prohibited 

outright, but would, as with all other 

securities in the portfolio, be subject to 

the portfolio time-to-maturity 

requirements consistent with paragraph 

(b)(5), which focuses on the remaining 

time to maturity.

This inquiry also raises the separate 

question of whether the process by 

which the periodic interest payments 

are determined for ARS is permissible. 

It appears that the typical process is to 

reset the interest rate through ‘‘Dutch 

auctions’’ held on relatively short 

cycles, such as 7, 14, 28, or 35 days, 

with interest paid at the end of each 

auction period. The full principal is due 

at a set maturity date, typically years 

from the date of issue. In such an 

auction, broker-dealers submit bids to 

an auction agent (typically a large 

money center bank). The interest rate for 

the next period is set by identifying the 

lowest rate that will clear the total 

outstanding amount of securities. The 

‘‘auctions’’ are for the purpose of ratesetting and, absent other express terms 

of the agreement, do not constitute an 

opportunity either for the holders to put 

the securities to the issuer or for the 

issuer to call the securities from the 

holders. As with other debt securities, 

holders of ARS may attempt to resell 

them by contacting broker-dealers or 

other potential buyers, but there is no 

continuous bid/offer stream, although 

bids and offers may be available upon 

request from major dealers active in the 

market. 

It has been represented to the 

Commission that the interest payments 

on the particular issue which was the 

subject of the inquiry, and those of 

many other ARS issues, demonstrate 

close historical correlation to key shortterm interest rates. As described, 

therefore, the process of establishing 

periodic interest payments in such a 

manner would not violate the 

requirements of current paragraph 

(b)(3)(iv) or proposed paragraph 

(b)(3)(iv)(A)(1), if, in fact, they are 

closely correlated to a permitted 

benchmark. 

C. Reverse Repos—Concentration Limits 

Rule 1.25(b)(4)(iii) establishes 

concentration limits for reverse repos.14

These restrictions, which were adopted 

in response to public comment, take 

into consideration the identity of both 

the issuer of the securities and the 

counterparty to the reverse repo. 

Consideration as to counterparty was 

based on the counterparty having direct 

control over which specific securities 

would be supplied in a transaction.15

Given industry experience over the past 

several years, however, it has been 

brought to the attention of the 

Commission that the ability of FCMs 

and DCOs to monitor compliance with 

this two-prong standard has proven to 

be operationally unworkable. As a 

result, in June 2003, the Commission 

requested comment on market 

participants’ experience with the 

current provisions relating to reverse 

repos and suggestions on how best to 

address the risks of these transactions.

The FIA commented that, although 

the concentration limits for reverse 

repos were imposed to remove 

restrictions that commenters previously 

Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 5581

16See 65 FR 39008, 39020 (June 22, 2000). 17Since the submission of its comment letter, the 

FIA has further requested that the provision also 

address transactions in which customer-deposited 

securities are exchanged for cash. 18 7 U.S.C. 6d(a)(2).

19The current paragraph (e) would be 

redesignated as paragraph (f).

had identified as inhibiting their use of 

reverse repos, as a practical matter, an 

FCM cannot monitor such transactions 

by security, size and counterparty 

except through manual processing. As a 

result, this investment alternative has 

not proved to be viable. The FIA 

expressed the view that all securities 

held by an FCM, either through an 

investment of customer funds or 

through a reverse repo, should be 

subject to the concentration limits for 

direct investments. 

The Commission proposes to amend 

paragraph (b)(4)(iii) to make reverse 

repos subject to the concentration limits 

for direct investments under Rule 

1.25(b)(4)(i). In re-evaluating the 

existing concentration limits, the 

Commission has concluded that 

imposing issuer-based concentration 

limits, as originally proposed for 

permitted investments including 

securities obtained through reverse 

repos, is an appropriate and adequate 

safeguard.16 The Commission’s primary 

regulatory concern focuses on the actual 

holdings in the customer segregated 

account (i.e., cash, securities, or other 

property) at any given time. 

Accordingly, under the proposal, all 

investment securities in the account, 

whether obtained pursuant to direct 

investment or reverse repo, would be 

subject to the same concentration limits.

D. Transactions by FCM/BDs 

In its comment letter responding to 

the Commission’s June 30, 2003 request 

for public comment, the FIA proposed 

adding a new provision to Rule 1.25 that 

would permit an FCM/BD to engage in 

transactions that involve the exchange 

of customer money or customerdeposited securities for securities that 

are held by the FCM in its capacity as 

a securities broker-dealer (‘‘in-house 

transactions’’).17 Lehman Brothers also 

submitted a comment letter in support 

of the FIA’s proposal.

The FIA recommended that the 

Commission authorize an FCM/BD that, 

in its capacity as a broker-dealer, owns 

or has the unqualified right to pledge 

securities that are ‘‘permitted 

investments,’’ to invest customer money 

by effecting a transfer of such securities 

to the customer segregated account. 

Similarly, in lieu of using customerdeposited securities in a repo with a 

third party, the FIA proposed that an 

FCM/BD should be authorized to effect 

similar transactions by means of a 

transfer of customer-owned securities in 

exchange for permitted investments that 

the FCM/BD holds in its capacity as a 

broker-dealer. The FIA further proposed 

that the FCM/BD transactions be subject 

to the recordkeeping requirements of 

Commission rules 1.25, 1.26, 1.27, 1.28, 

and 1.36, as well as applicable SEC 

rules. With respect to transactions 

involving customer-owned securities, 

the FIA stated that the records should 

reflect the customer’s continued 

ownership interest in those securities. 

The FIA proposed to apply to inhouse transactions certain standards 

that currently apply to repos and reverse 

repos under Rule 1.25(d), i.e., the 

identification of securities by coupon 

rate, par amount, market value, maturity 

date, and CUSIP or ISIN number 

(paragraph (d)(1)); the ability to unwind 

a transaction within one business day or 

on demand (paragraph (d)(5)); and the 

recognition of an accomplished 

transaction only when the securities are 

actually received by the custodian of the 

FCM’s customer segregated account 

(paragraph (d)(8)). The FIA proposed to 

apply the concentration requirements 

applicable to direct investments 

(paragraph (b)(4)(i)) and to treat the 

securities deposited in the customer 

segregated account as a result of the inhouse transaction as having a one-day 

time-to-maturity. 

Lehman Brothers asserted its belief 

that such transactions are permissible 

under Section 4d(a)(2) of the Act 18 and 

Rule 1.25, and do not present any 

unique customer protection concerns. 

Lehman Brothers described the 

proposed transactions as an alternative 

to reverse repos and repos entered into 

between an FCM/BD and a third party.

In considering issues related to the 

investment of customer money or 

securities by an FCM, the Commission’s 

primary interest is in preserving the 

integrity of the customer segregated 

account. Not only must there be 

sufficient value in the account at all 

times, but the quality of investments 

must reflect an acceptable level of 

credit, market, and liquidity risk. In this 

regard, it is important that non-cash 

assets can be quickly converted to cash 

at a predictable value.

The in-house transactions proposed 

by FIA and Lehman Brothers are 

intended to provide the economic 

equivalent of repos and reverse repos 

with third parties. A key benefit that the 

in-house transactions offer is that they 

can assist an FCM both in achieving 

greater capital efficiency and in 

accomplishing important risk 

management goals, including internal 

diversification targets. For example, 

customer-deposited securities that are 

not acceptable as collateral for DCO 

performance bond requirements could 

be exchanged for securities that are 

acceptable. This would permit the more 

efficient use of an FCM/BD’s total 

holdings. There also would be certain 

operational efficiencies given the ability 

to readily substitute forms of collateral 

prior to delivering that collateral to a 

DCO. 

The Commission recognizes that all 

permitted investments under Rule 

1.25(a)(1) do not have the same risk 

profile, and that substitution of one type 

of permitted investment for another 

could alter the risk profile of a customer 

segregated account. However, the 

Commission has previously determined 

that all of the instruments that are 

permitted investments are appropriate 

investments for customer money, 

subject to specified requirements. Thus, 

the substitution of one permitted 

investment for another in an in-house 

transaction will not present an 

unacceptable level of risk to the 

customer segregated account. 

In light of the above considerations, 

the Commission is proposing to amend 

Rule 1.25 by adding new paragraphs 

(a)(3) and (e) 19 to permit FCM/BDs to 

engage in in-house transactions subject 

to specified requirements.

Proposed paragraph (a)(3)(i) provides 

that customer money may be exchanged 

for securities that are permitted 

investments and are held by an FCM/BD 

in connection with its securities broker 

or dealer activities. Proposed paragraph 

(a)(3)(ii) provides that securities 

deposited by customers as margin may 

be exchanged for securities that are 

permitted investments and are held by 

an FCM/BD in connection with its 

securities broker or dealer activities. 

Proposed paragraph (a)(3)(iii) provides 

that securities deposited by customers 

as margin may be exchanged for cash 

that is held by an FCM/BD in 

connection with its securities broker or 

dealer activities. 

The authority granted under 

paragraph (a)(3) would be subject to the 

requirements of proposed new 

paragraph (e), which incorporates many 

of the same restrictions currently 

imposed on repo and reverse repo 

transactions under paragraph (d). 

Certain provisions of paragraph (e) have 

been adapted to reflect the operational 

differences between an in-house 

transaction and a third-party 

transaction. 

Proposed paragraph (e)(1) requires 

that the FCM, in connection with its 

5582 Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 

20 17 CFR 240.15c3–1.

21See section II.C. of this release.

22Note that the Commission has not included in 

this paragraph the FIA’s proposed one-day time-tomaturity treatment for securities transferred to the 

customer segregated account. Although an in-house 

transaction could be reversed within one day, the 

rule would not require that it be reversed within 

that time frame. Effectively, these instruments 

would be subject to the same risks associated with 

the price sensitivity of direct investments and, 

accordingly, should be subject to the same 

standards in order to maximize the protection of 

principal. Special treatment would undermine the 

purpose of the time-to-maturity requirement.

securities broker or dealer activities, 

must own or have the unqualified right 

to pledge the securities that are 

exchanged for customer money or 

securities held in the customer 

segregated account. The securities may 

be held as part of the broker-dealer 

inventory or may have been deposited 

with the broker-dealer by its customers. 

Proposed paragraph (e)(2) requires 

that the transaction can be reversed 

within one business day or upon 

demand. This standard also applies to 

repos and reverse repos under Rule 

1.25(d)(5), with the goal of establishing 

investment liquidity. 

Proposed paragraph (e)(3) 

incorporates the Rule 1.25(d)(1) 

requirement that the securities 

transferred from and to the customer 

segregated account be specifically 

identified by coupon rate, par amount, 

market value, maturity date, and CUSIP 

or ISIN number. 

Proposed paragraph (e)(4) establishes 

two general requirements for the types 

of customer-deposited securities that 

can be used in the in-house 

transactions. These same requirements 

apply to customer-deposited securities 

used in repos under Rule 1.25(a)(2)(ii). 

Paragraph (e)(4)(i) incorporates the Rule 

1.25(a)(2)(ii)(A) requirement that the 

securities must be ‘‘readily marketable’’

as defined in SEC Rule 15c3–1.20

Paragraph (e)(4)(ii) incorporates the 

Rule 1.25(a)(2)(ii)(B) requirement that 

the securities not be ‘‘specifically 

identifiable property’’ as defined in Rule 

190.01(kk).

Proposed paragraph (e)(5) establishes 

requirements for securities that will be 

transferred to the customer segregated 

account as a result of the in-house 

transaction, clarifying the treatment of 

these securities once they are held in 

the customer segregated account. 

Proposed paragraph (e)(5)(i) requires 

that the securities be priced daily based 

on the current mark-to-market value. 

Proposed paragraph (e)(5)(ii) provides 

that the securities will be subject to the 

concentration limit requirements 

applicable to direct investments, as 

provided in proposed Rule 1.25(b)(4)(iv) 

(discussed below). This is the same 

treatment that the Commission is 

proposing to apply to repos and reverse 

repos.21 Proposed paragraph (e)(5)(iii) 

provides that the securities transferred 

to the customer segregated account must 

be held in a safekeeping account with a 

bank, a DCO, or the Depository Trust 

Company in an account that complies 

with the requirements of Rule 1.26. This 

same requirement is applied to repos 

and reverse repos under Rule 

1.25(d)(6).22

Proposed paragraph (e)(5)(iv) 

incorporates the Rule 1.25(d)(7) 

restrictions on the subsequent use of the 

securities. It provides that the securities 

may not be used in another similar 

transaction and may not otherwise be 

hypothecated or pledged, except such 

securities may be pledged on behalf of 

customers at another FCM or a DCO. It 

permits substitution of securities if: (1) 

The securities being substituted and the 

original securities are specifically 

identified by date of substitution, 

market values substituted, coupon rates, 

par amounts, maturity dates and CUSIP 

or ISIN numbers; (2) substitution is 

made on a ‘‘delivery versus delivery’’

basis; and (3) the market value of the 

substituted securities is at least equal to 

that of the original securities. 

Proposed paragraph (e)(6) sets forth 

the payment and delivery procedures 

for in-house transactions. Adapted from 

Rule 1.25(d)(8), the provisions are 

designed to ensure that in-house 

transactions are carried out in a manner 

that does not jeopardize the adequacy of 

funds held in the customer segregated 

account. 

Proposed paragraph (e)(6)(i) governs 

transactions under proposed paragraph 

(a)(3)(i). It provides that the transfer of 

securities to the customer segregated 

custodial account must be made 

simultaneously with the transfer of 

money from the customer segregated 

cash account. Money held in the 

customer segregated cash account 

cannot be disbursed prior to the transfer 

of securities to the customer segregated 

custodial account. Any transfer of 

securities to the customer segregated 

custodial account cannot be recognized 

as accomplished until the securities are 

actually received by the custodian of 

such account. Upon unwinding of the 

transaction, the customer segregated 

cash account must receive same-day 

funds credited to such account 

simultaneously with the delivery or 

transfer of securities from the customer 

segregated custodial account. 

Proposed paragraph (e)(6)(ii) governs 

transactions under proposed paragraph 

(a)(3)(ii). It provides that the transfer of 

securities to the customer segregated 

custodial account must be made 

simultaneously with the transfer of 

securities from the customer segregated 

custodial account. Securities held in the 

customer segregated custodial account 

cannot be released prior to the transfer 

of securities to that account. Any 

transfer of securities to the customer 

segregated custodial account cannot be 

recognized as accomplished until the 

securities are actually received by the 

custodian of such account. Upon 

unwinding of the transaction, the 

customer segregated custodial account 

must receive the securities 

simultaneously with the delivery or 

transfer of securities from the customer 

segregated custodial account. 

Proposed paragraph (e)(6)(iii) governs 

transactions under proposed paragraph 

(a)(3)(iii). It provides that the transfer of 

money to the customer segregated cash 

account must be made simultaneously 

with the transfer of securities from the 

customer segregated custodial account. 

Securities held in the customer 

segregated custodial account cannot be 

released prior to the transfer of money 

to the customer segregated cash account. 

Any transfer of money to the customer 

segregated cash account cannot be 

recognized as accomplished until the 

money is actually received by the 

custodian of such account. Upon 

unwinding of the transaction, the 

customer segregated custodial account 

must receive the securities 

simultaneously with the disbursement 

of money from the customer segregated 

cash account. 

Proposed paragraph (e)(7) provides 

that the FCM must maintain all books 

and records with respect to the in-house 

transactions in accordance with Rules 

1.25, 1.27, 1.31, and 1.36, as well as the 

applicable rules and regulations of the 

SEC. This clarifies the pre-existing 

obligations of the FCM, and it is adapted 

from Rule 1.25(d)(10). 

Proposed paragraph (e)(8) 

incorporates the requirements of Rule 

1.25(d)(11). It provides that an actual 

transfer of securities by book entry must 

be made consistent with Federal or State 

commercial law, as applicable. 

Moreover, at all times, securities 

transferred to the customer segregated 

account are to be reflected as ‘‘customer 

property.’’

Proposed paragraph (e)(9) provides 

that, for purposes of Rules 1.25, 1.26, 

1.27, 1.28 and 1.29, securities 

transferred to the customer segregated 

account will be considered to be 

customer funds until the money or 

securities for which they were 

exchanged are transferred back to the 

customer segregated account. As a 

Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 5583

23See Rule 1.25(b)(2)(i)(E).

24The Commission notes that a substantial 

percentage of customer money invested in MMMFs 

is invested in unrated funds.

25See letter from Melanie L. Fein, Goodwin 

Proctor LLP, on behalf of Federated, dated April 8, 

2004, available in the comment file accompanying 

this proposed rulemaking, at http://www.cftc.gov.

26 17 CFR 270.2a–7.

27A fund sponsor may petition for exemption 

from this requirement, and the Commission may 

grant an exemption, if the fund can demonstrate 

that it will operate in a manner designed to preserve 

principal and to maintain liquidity. As discussed in 

Section II.F. of this release, however, the 

Commission is proposing to eliminate this 

exemption provision.

result, in the event of the bankruptcy of 

the FCM, any securities transferred to 

and held in the customer segregated 

account as a result of an in-house 

transaction could be immediately 

transferred to another FCM. This 

provision adapts, in part, the provisions 

set forth in Rule 1.25(d)(12). 

Proposed paragraph (e)(10) addresses 

the failure to return customer-deposited 

securities to the customer segregated 

account. Adapted from Rule 

1.25(a)(2)(ii)(D), it provides that in the 

event the FCM is unable to return to the 

customer any customer-deposited 

securities used in an in-house 

transaction the FCM must act promptly 

to ensure that there is no resulting direct 

or indirect cost or expense to the 

customer. 

As explained above, under proposed 

paragraph (e)(5)(ii), the Commission 

would apply the concentration limits for 

direct investments to securities 

transferred to the customer segregated 

account as a result of an in-house 

transaction. To effect this treatment, the 

Commission proposes to amend Rule 

1.25(b)(4) by adding a new paragraph 

(iv) to provide that, for purposes of 

determining compliance with applicable 

concentration limits, securities 

transferred to a customer segregated 

account pursuant to Rule 1.25(a)(3) will 

be combined with securities held by the 

FCM as direct investments. In adding 

this new provision, the Commission 

would also redesignate existing 

paragraphs (b)(4)(iv) and (v) as (b)(4)(v) 

and (vi), respectively. 

The Commission also proposes an 

additional technical amendment to Rule 

1.27 to clarify the applicability of 

recordkeeping requirements to 

securities transferred to and from the 

customer custodial account pursuant to 

repos and in-house transactions. Rule 

1.27 provides that each FCM that 

invests customer funds and each DCO 

that invests customer funds of its 

clearing members’ customers or option 

customers must keep a record showing 

specified information. Among the items 

to be recorded are the amount of money 

so invested (paragraph (a)(3)) and the 

date on which such investments were 

liquidated or otherwise disposed of and 

the amount of money received of such 

disposition, if any (paragraph (a)(6)). 

The Commission proposes to insert, 

after the reference to ‘‘amount of 

money’’ the phrase ‘‘or current market 

value of securities.’’ This would clarify 

that amounts recorded must include the 

value of securities, as well as cash. 

E. Rating Standards for MMMFs 

Rule 1.25 permits FCMs and DCOs to 

invest customer funds in MMMFs, 

subject to certain standards set forth in 

the rule. Among those standards is the 

requirement that MMMFs that are rated 

by a nationally recognized statistical 

rating organization (‘‘NRSRO’’) must be 

rated at the highest rating of the 

NRSRO.23 While the rule does not 

permit investments in lower rated 

MMMFs, it does not prohibit 

investments in unrated MMMFs. As a 

result, a rated MMMF that does not have 

the highest rating is not acceptable as a 

permitted investment, but an unrated 

MMMF is acceptable.24

The Commission has been asked to 

consider eliminating the rating 

requirement for MMMFs. In particular, 

Federated Investors, Inc., (‘‘Federated’’) 

has expressed the view that the rating 

requirement creates a competitive 

inequity for rated MMMFs that have 

yield and portfolio characteristics 

similar to the unrated funds that are 

commonly used by FCMs for investment 

of customer funds.25 According to 

Federated, lower rated MMMFs, like 

many unrated MMMFs, do not qualify 

for the highest rating by an NRSRO 

because they hold split-rated and other 

securities in their portfolios, which are 

not approved by the NRSROs for tripleA rated funds, and because the average 

maturity of their portfolios may exceed 

60 days.

As an example of the competitive 

inequity, Federated points to its 

Federated Prime Value Obligations 

Fund, a single-A rated fund that it 

describes as having essentially the same 

yield and portfolio characteristics as 

unrated competitors. Like unrated 

competitors, the fund cannot receive a 

triple-A rating because it holds splitrated and other securities in its 

portfolio, which are not approved by the 

NRSROs for triple-A rated funds, and 

because the average maturity of its 

portfolio may exceed 60 days. Because 

of the single-A rating, however, the 

Prime Value Obligations Fund, unlike 

competing unrated funds, cannot be 

used for investment of customer funds. 

Federated believes that the fact that the 

fund is rated should make it a more 

acceptable investment than an unrated 

fund. 

Federated asserts that the rating 

limitation does not provide additional 

investor protections. It further argues 

that the investor protections afforded by 

SEC Rule 2a–7 26 make the rating 

requirement unnecessary. In this regard, 

Federated observes that the rule 

imposes strict portfolio quality, 

diversification, and maturity standards, 

which greatly limit the possibility of 

significant deviation between the share 

price of a fund and its per share net 

asset value. Additionally, Federated 

notes that MMMFs are subject to board 

oversight regarding credit quality 

requirements and investment 

procedures.

Rule 1.25(c) sets forth additional 

requirements for MMMFs. Paragraph 

(c)(1) establishes SEC Rule 2a–7 as a 

basic standard of adequacy. More 

specifically, paragraph (c)(1) provides 

that, generally, the MMMF must be an 

investment company that is registered 

with the SEC under the Investment 

Company Act of 1940 and that holds 

itself out to investors as an MMMF in 

accordance with SEC Rule 2a–7.27

It appears that the rating requirement 

for MMMFs under Rule 1.25(b)(2)(i)(E) 

is not essential in light of the other risklimiting provisions applicable to 

MMMFs under Rule 1.25 and SEC Rule 

2a–7. In consideration of the anomalous 

situation created by the use of unrated 

funds as permitted investments, the 

Commission is proposing to amend Rule 

1.25(b)(2)(i)(E) to eliminate the rating 

requirement for MMMFs. 

F. Registration Requirement for MMMFs 

As discussed above, Rule 1.25(c)(1) 

provides that, generally, an MMMF 

must be an investment company that is 

registered with the SEC under the 

Investment Company Act of 1940 and 

that holds itself out to investors as an 

MMMF in accordance with SEC Rule 

2a–7. Paragraph (c)(1) further provides 

that an MMMF sponsor may petition the 

Commission for an exemption from this 

requirement, and the Commission may 

grant such an exemption if the MMMF 

can demonstrate that it will operate in 

a manner designed to preserve principal 

and to maintain liquidity. The 

exemption request must include a 

description of how the fund’s structure, 

operations and financial reporting are 

expected to differ from the requirements 

in SEC Rule 2a–7 and applicable risklimiting provisions contained in Rule 

1.25. In addition, the MMMF must 

specify the information that it would 

5584 Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 

28Related to this, the Commission also proposes 

a technical amendment that would delete the 

reference to ‘‘a fund exempted in accordance with 

paragraph (c)(1) of this section’’ at the end of 

paragraph (c)(2). 29See discussion in Section II.E. of this release. 30See 65 FR at 78003.

make available to the Commission on an 

on-going basis. 

The Commission has not received any 

formal exemption requests under 

paragraph (c)(1), but it has received 

several informal inquiries. In evaluating 

these inquiries, Commission staff have 

explored alternative standards that 

could be used to ascertain whether an 

MMMF will operate in a manner 

designed to preserve principal and to 

maintain liquidity and, therefore, could 

be exempted. As a result of this 

exercise, it has become apparent that 

establishing such standards presents 

substantial practical and policy issues. 

For example, from a practical 

standpoint, granting an exemption 

would require that the Commission, on 

a case-by-case basis, review a particular 

MMMF’s risk-limiting policies and 

procedures and determine that, 

notwithstanding deviations from the 

Rule 2a–7 requirements, those policies 

and procedures will operate to preserve 

principal and to maintain liquidity. 

Moreover, if an exemption were granted, 

Commission staff would have to 

maintain oversight over the exempt 

MMMF to ascertain that it continues to 

operate in accordance with the 

Commission’s standards. The 

Commission believes that it would be 

inefficient to devote substantial 

resources to the exemption process. In 

addition, the Commission is concerned 

that this process could produce 

inconsistent results and give rise to an 

uncertain framework for regulatory 

oversight. 

From a policy standpoint, the 

Commission is concerned that by 

granting an exemption, the Commission 

may be perceived as expressing a view 

about the adequacy of an MMMF’s 

overall risk-limiting policies and 

procedures and, ultimately, upon the 

investment quality of any particular 

MMMF. The Commission does not wish 

to provide, or be perceived as providing, 

any such assurances to FCMs or DCOs 

that might be interested in investing 

customer money in an exempt MMMF.

In light of the above considerations, 

the Commission believes that the 

exemptive process, in this situation, 

does not serve the best interests of the 

futures industry or the public. 

Accordingly, the Commission is 

proposing to amend paragraph (c)(1) to 

eliminate the availability of an 

exemption for unregistered funds.28

While this removes the possibility of 

adding certain MMMFs to the pool of 

qualifying permitted investments, the 

Commission believes that this potential 

loss would be mitigated by the 

availability of additional MMMF 

investments under the Commission’s 

proposed amendment to permit 

investments in MMMFs that are rated 

below the top rating of an NRSRO.29

The requirement that all MMMFs be 

registered and qualify as SEC Rule 2a–

7 funds, without exception, is consistent 

with the Commission’s reliance on SEC 

Rule 2a–7 standards in its proposal to 

eliminate rating requirements for 

MMMFs.

G. Auditability Standard for Investment 

Records 

Rule 1.27 sets forth recordkeeping 

requirements for FCMs and DCOs in 

connection with the investment of 

customer funds under Rule 1.25. More 

specifically, the rule lists the types of 

information that an FCM or DCO must 

retain, subject to the further 

recordkeeping requirements of Rule 

1.31. 

The Commission proposes to amend 

Rule 1.27 by adding a new provision to 

establish an auditability standard for 

pricing information related to all 

instruments acquired through the 

investment of customer funds. Such a 

standard will facilitate the maintenance 

of reliable and readily available 

valuation information that can be 

properly audited. This is particularly 

important with respect to instruments 

for which historical valuation 

information may not be retrievable from 

third party sources at the time of an 

audit. 

Accordingly, the Commission 

proposes to amend Rule 1.27 by adding 

a new paragraph (a)(8), to require FCMs 

and DCOs to maintain supporting 

documentation of the daily valuation of 

instruments acquired through the 

investment of customer funds, including 

the valuation methodology and third 

party information. Such supporting 

documentation must be sufficient to 

enable auditors to verify information to 

external sources and recalculate the 

valuation for a given instrument. 

The Commission requests comment 

on the practices and procedures that 

FCMs and DCOs would have to 

implement in order to comply with such 

a standard and whether compliance 

would require substantial operational 

changes. To the extent that there may be 

issues regarding implementation of 

procedures to facilitate auditability, the 

Commission requests comment on how 

it should address those issues. 

H. Additional Technical Amendments 

1. Clarifying and Codifying MMMF 

Redemption Requirements 

The Commission currently permits 

FCMs and DCOs to invest customer 

money in MMMFs in accordance with 

the standards set forth in Rule 1.25(c). 

Among those standards is the 

requirement that the MMMF be able to 

redeem the interest of the FCM or DCO 

by the business day following a 

redemption request. The Commission 

proposes to amend paragraph (c)(5) to 

clarify that the MMMF must be legally 

obligated to redeem the interest and 

make payment in satisfaction thereof by 

the business day following the 

redemption request. In addition, the 

Commission proposes a further 

amendment to codify previously 

articulated exceptions to the next-day 

redemption requirement. 

(i) Next-Day Redemption Requirement 

In response to inquires from 

participants in the futures and mutual 

fund industries, the Commission 

proposes to amend paragraph (c)(5) to 

clarify that next-day redemption and 

payment is mandatory. To effect this, 

the Commission proposes to eliminate 

the language requiring that the MMMF 

‘‘must be able to redeem an interest by 

the next business day following a 

redemption request’’ and to substitute in 

its place a provision that requires the 

fund to ‘‘be legally obligated to redeem 

an interest and make payment in 

satisfaction thereof by the business day 

following a redemption request.’’ The 

revised language unambiguously 

establishes the mandatory nature of the 

redemption obligation and also clarifies 

the distinction between redemption 

(valuation) of MMMF interests and 

actual payment for those redeemed 

interests. 

The Commission recognizes that the 

phrase, ‘‘able to redeem,’’ on its face, 

could be interpreted to mean the 

MMMF must have the capability to 

redeem, but need not have the 

obligation to redeem. However, this is 

not the intended meaning of the 

provision. 

In adopting the next-day redemption 

requirement in December 2000, the 

Commission responded to a public 

comment recommending that the oneday liquidity requirement be extended 

to seven days to be consistent with SEC 

requirements and the longer settlement 

time frames associated with direct 

investments.30 The Commission 

explained its position as follows:

Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 5585

31 Id.

32See CFTC Staff Letter No. 01–31, [2000–2002 

Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶28,521 

(Apr. 2, 2001).

33 15 U.S.C. 80a–22(e).

34More specifically, Rule 1.25(b)(2)(i)(B) provides 

as follows: ‘‘Municipal securities, government 

sponsored agency securities, certificates of deposit, 

commercial paper, and corporate notes, except 

notes that are asset-backed, must have the highest 

short-term rating of an NRSRO or one of the two 

highest long-term ratings of an NRSRO.’’

The 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. Since a material portion of an 

FCM’s customer funds could well be 

invested in a single MMMF, this is an 

important provision of the rule. The 

Commission notes that, although sales 

of directly-owned securities settle in 

longer than one-day time-frames, an 

FCM or clearing organization could 

obtain liquidity by entering into a 

repurchase transaction. Therefore, the 

Commission has retained the one-day 

liquidity requirement imposed on 

investments in MMMFs and, in view of 

the importance of this provision, has 

clarified that demonstration that this 

requirement has been met may include 

either an appropriate provision in the 

offering memorandum of the fund or a 

separate side agreement between the 

fund and an FCM or clearing 

organization.31

Thus, the next-day redemption 

requirement is not met even if an 

MMMF, as a matter of practice, offers 

same-day or next-day redemption if 

there is no binding obligation to do so. 

The second provision of paragraph 

(c)(5) suggests two ways in which an 

FCM or DCO may demonstrate 

compliance with the next-day 

redemption requirement, i.e., an 

appropriate provision in the fund’s 

offering memorandum or a separate side 

agreement between the fund and the 

FCM or DCO. In view of the proposed 

changes in the first provision of 

paragraph (c)(5), the Commission 

believes that it is not necessary to 

specify ways in which an FCM or DCO 

can demonstrate that the requirement 

has been met. The Commission 

therefore proposes to eliminate the 

second provision and to substitute in its 

place a provision that requires the FCM 

or DCO to retain documentation 

demonstrating compliance with the 

next-day redemption requirement. Such 

documentation can then be produced 

for audit purposes.

(ii) Exceptions to the Next-Day 

Redemption Requirement 

In response to an inquiry from the 

Board of Trade Clearing Corporation in 

2001, the Commission’s Division of 

Trading and Markets issued a letter 

stating that it would raise no issue in 

connection with MMMFs that provide 

for certain exceptions to the practice of 

next-day redemption.32

The letter specifically identified 

circumstances in which next-day 

redemption could be excused: (1) Nonroutine closure of the Fedwire or 

applicable Federal Reserve Banks; (2) 

non-routine closure of the New York 

Stock Exchange or general market 

conditions leading to a broad restriction 

of trading on the New York Stock 

Exchange, i.e., a restriction of trading 

due to market-wide events; or (3) 

declaration of a market emergency by 

the SEC. The letter also included a 

catch-all provision that included 

emergency conditions set forth in 

Section 22(e) of the Investment 

Company Act of 1940.33

The Commission proposes to codify 

these exceptions in new paragraph 

(c)(5)(ii) and, in so doing, to redesignate 

the existing paragraph (c)(5), as 

amended, as paragraph (c)(5)(i). The 

Commission recognizes that there is 

some overlap between the enumerated 

exceptions and those contained in 

Section 22(e), but it believes that this is 

appropriate given the need to provide 

for all relevant circumstances. 

2. Clarifying Rating Standards for 

Certificates of Deposit 

Rule 1.25(b)(2)(i)(B) sets forth the 

rating requirements for municipal 

securities, GSE securities, commercial 

paper, corporate notes that are not assetbacked, and certificates of deposit.34

The Commission notes that certificates 

of deposit, unlike the other instruments 

listed in that paragraph, are not directly 

rated by an NRSRO.

Because NRSRO ratings reflect the 

financial strength of the issuer of an 

instrument, they offer a useful standard, 

among others, for determining whether 

an instrument can be a permitted 

investment for customer money. 

Although certificates of deposit are not 

rated by NRSROs, it is possible to apply 

a rating standard by using, as a proxy, 

the ratings of other instruments issued 

by the issuers of certificates of deposit. 

For example, the Commission has 

previously taken this approach in 

establishing standards for foreign 

depository institutions that may hold 

customer funds. In this regard, Rule 

1.49(d)(3)(i) provides that, in order to 

hold customer funds, a bank or trust 

company located outside the United 

States must satisfy either of the 

following requirements: (1) It must have 

in excess of $1 billion of regulatory 

capital; or (2) the bank or trust 

company’s commercial paper or longterm debt instrument, or if the 

institution is part of a holding company 

system, its holding company’s 

commercial paper or long-term debt 

instrument, must be rated in one of the 

two highest rating categories by at least 

one NRSRO. 

Consistent with this approach, the 

Commission believes that it is 

appropriate to use, as a proxy for a 

certificate of deposit rating, NRSRO 

ratings for the commercial paper or 

long-term debt instrument of the issuer 

of the certificate of deposit or such 

issuer’s parent holding company. 

Accordingly, the Commission proposes 

to delete the reference to certificates of 

deposit in paragraph (b)(2)(i)(B) of Rule 

1.25 and insert a new paragraph (E) that 

would apply the same standard 

contained in paragraph (b)(2)(i)(B) to the 

commercial paper or long-term debt 

instrument issued by the certificate of 

deposit issuer or its holding company. 

3. Clarifying Corporate Bonds as 

Permitted Investments 

Paragraph (a)(vi) currently uses the 

term ‘‘corporate note,’’ which may be 

interpreted by some market participants 

to mean obligations whose original term 

to maturity does not exceed five years 

or perhaps ten years. However, the 

Commission proposes to clarify that this 

is not its intent by amending paragraphs 

(a)(1)(vi), (b)(2)(i)(B) and (C), and 

(b)(4)(i)(C) to use the term ‘‘corporate 

notes or bonds.’’ Rather than constrain 

the types of permitted investments on 

the basis of their original term to 

maturity, the Commission has addressed 

the issue of the greater price sensitivity 

of longer-term and fixed rate 

instruments to changes in prevailing 

interest rates by adopting the portfolio 

time-to-maturity requirements of 

paragraph (b)(5); thus, it is the 

remaining term to maturity that is 

relevant. 

4. Clarifying References to Transferred 

Securities 

Rule 1.25(a)(2) permits FCMs and 

DCOs to enter into repos using 

customer-deposited securities and 

securities that are permitted 

investments purchased with customer 

money. Such transactions are subject to 

the provisions of paragraph (d) of Rule 

1.25. Among those provisions is 

paragraph (d)(6), which requires that the 

‘‘securities transferred under the 

5586 Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 

35Rule 1.26 addresses the treatment of 

instruments purchased with customer funds, but 

does not address the treatment of cash received by 

an FCM or DCO pursuant to a repo. The 

Commission believes that it is not necessary to 

specify in Rule 1.26 that cash acquired in exchange 

for securities under a repo must be held in a 

customer segregated cash account because this 

requirement is clear from the language of Section 

4d(a)(2) of the Act.

36The Commission notes that with respect to the 

in-house transactions discussed in Section II.D. of 

this release, proposed Rule 1.25(e)(5)(iii) 

specifically provides that securities transferred to 

the customer segregated account as a result of the 

transaction must be held in a safekeeping account 

with a bank, a DCO, or the Depository Trust 

Company in an account that complies with the 

requirements of Rule 1.26.

37 33 FR 14455 (Sept. 26, 1968).

38 46 FR 33312 (June 29, 1981).

39Appendix E of Pub. L. No. 106–554, 114 Stat. 

2763 (2000).

40See Section 5b of the Act, 7 U.S.C. 7a–1. See 

also Section 1a(9) of the Act, 7 U.S.C. 1a(9) 

(defining the term ‘‘derivatives clearing 

organization’’).

41See Section II.D. of this release.

agreement’’ must be held in a 

safekeeping account with a bank, a 

DCO, or the Depository Trust Company 

in an account that complies with the 

requirements of Rule 1.26. 

The Commission has been asked 

whether the reference to ‘‘securities 

transferred under the agreement’’ is 

intended to include not only in-coming 

securities, but out-going securities as 

well. Such an interpretation would 

mean that any out-going securities, in 

addition to any in-coming cash, would 

have to be held in a customer segregated 

account in accordance with Rule 1.26.35

This is not the intended outcome, and 

the Commission therefore is proposing 

to amend paragraph (d)(6) to clarify that 

Rule 1.26 applies only to securities 

transferred to (not from) an FCM or 

DCO.36

The Commission also is proposing 

technical amendments to paragraphs 

(d)(3) and (d)(11) to similarly clarify that 

the securities referred to in those 

provisions are securities transferred to 

(not from) the customer segregated 

custodial account of an FCM or DCO. 

5. Clarifying Payment and Delivery 

Procedures for Reverse Repos and Repos 

The Commission is proposing to 

amend paragraph (d)(8) to clarify 

payment and delivery procedures for 

reverse repos and repos. Paragraph 

(d)(8) currently provides that the 

‘‘transfer of securities’’ must be made on 

a delivery versus payment basis in 

immediately available funds. The 

Commission proposes to amend this 

provision to clarify that the delivery 

versus payment requirement applies to 

the transfer of securities to (not from) 

the customer segregated custodial 

account, as would be the case in a 

reverse repo. The Commission further 

proposes to add a sentence clarifying 

that the transfer of funds to the 

customer segregated cash account, as 

would be the case in a repo, must be 

made on a payment versus delivery 

basis. 

The Commission requests comment 

on whether these amendments 

accurately reflect the current practices 

of FCMs and DCOs and, if not, how 

existing business practices operate to 

otherwise enable FCMs and DCOs 

engaging in repurchase transactions to 

maintain the proper amount of funds in 

segregated accounts at all times.

6. Changing Paragraph (a)(1) ‘‘Customer 

Funds’’ to ‘‘Customer Money’’

Rule 1.25(a)(1) authorizes FCMs and 

DCOs to invest ‘‘customer funds’’ in 

enumerated permitted investments. 

Paragraph (a)(1) uses the term 

‘‘customer funds’’ to describe customer 

money deposited with an FCM or a DCO 

to margin futures or options positions. 

Because the term ‘‘customer funds’’ is 

otherwise defined in Rule 1.3(gg) to 

include more than customer money, the 

Commission proposes to amend 

paragraph (a)(1) to substitute the term 

‘‘customer money’’ for the term 

‘‘customer funds.’’

The word ‘‘money’’ is used in Section 

4d(a)(2) of the Act with reference to 

permitted investments, and the term 

‘‘customer money’’ was originally used 

in Rule 1.25. The term was changed to 

‘‘customer funds’’ in 1968 when the 

Commission’s predecessor agency, the 

Commodity Exchange Authority, 

adopted revisions to conform the rule to 

amendments to Section 4d of the Act.37

No explanation was given for the change 

in terminology.

Subsequently, in 1981, the 

Commission adopted a definition of 

‘‘customer funds’’ in Rule 1.3(gg), when 

it adopted rules related to futures 

options.38 That term encompasses more 

than money, and includes securities and 

other property belonging to the 

customer.

Substituting the term ‘‘customer 

money’’ for the term ‘‘customer funds’’

in paragraph (a)(1) conforms the 

language of that paragraph to the 

language of Section 4d(a)(2) of the Act 

and clarifies the meaning of the term in 

relation to other provisions of Rule 1.25. 

The need for this proposed change in 

terminology arises in the context of 

distinguishing between customer money 

and customer-deposited securities, 

which are the subject of Rule 

1.25(a)(2)(ii) (repos with customerdeposited securities) and proposed Rule 

1.25(a)(3)(ii) and (iii) (in-house 

transactions with customer-deposited 

securities). 

7. Conforming Reference to 

‘‘Marketability’’ Requirement 

Rule 1.25(a)(2)(ii), which permits 

FCMs and DCOs to sell customerdeposited securities pursuant to repos, 

sets forth various requirements for such 

transactions. Among them is the 

requirement, under paragraph 

(a)(2)(ii)(A), that securities subject to 

repurchase must meet the marketability 

requirement contained in paragraph 

(b)(1) of Rule 1.25. Paragraph (b)(1), in 

turn, cross-references the marketability 

requirement contained in SEC Rule 

15c3–1. For purposes of clarity, the 

Commission proposes to amend Rule 

1.25(a)(2)(ii)(A) to eliminate the crossreference to paragraph (b)(1) and 

substitute that paragraph’s direct crossreference to SEC Rule 15c3–1. 

8. Conforming Terminology for 

‘‘Derivatives Clearing Organizations’’

Rule 1.25 uses the term ‘‘clearing 

organization’’ to describe an entity that 

performs clearing functions. The Act, as 

amended by the Commodity Futures 

Modernization Act of 2000,39 now 

provides that a clearing organization for 

a contract market must register as a 

‘‘derivatives clearing organization’’ and 

must comply with core principles set 

forth in the statute.40 The Commission 

proposes technical amendments to Rule 

1.25 to change the term ‘‘clearing 

organization’’ to ‘‘derivatives clearing 

organization.’’ This will conform the 

language of Rule 1.25 to the language of 

the Act, more accurately reflecting the 

current statutory framework.

As an additional matter, in 

connection with its proposed technical 

amendments to Rule 1.27,41 the 

Commission also proposes to change the 

term ‘‘clearing organization’’ to 

‘‘derivatives clearing organization’’ in 

that rule.

9. Conforming Terminology for 

‘‘Government Sponsored Enterprise’’

The Commission is also proposing a 

technical amendment to Rule 1.25 to 

change terminology referring to 

government sponsored ‘‘agency’’

securities to government sponsored 

‘‘enterprise’’ securities. This would 

conform the language in the rule to the 

terminology commonly used in the 

marketplace. This change would be 

reflected in the list of permitted 

investments (paragraph (a)(1)(iii)), the 

rating requirements (paragraph 

Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 5587

42See 17 CFR 1.17(c)(5)(v).

43See 17 CFR 270.2a–7.

44See discussion of the terms ‘‘floating rate 

security’’ and ‘‘variable rate security’’ in Section 

II.B.3. of this release.

45 7 U.S.C. 6(c).

46 7 U.S.C. 6d(a)(2).

(b)(2)(i)(B)), and the concentration limits 

(paragraph (b)(4)(i)(B)). 

10. Conforming Terminology for 

‘‘Futures Commission Merchant’’

The Commission is proposing a 

technical amendment to Rule 1.25 to 

substitute the term ‘‘futures commission 

merchant’’ for the acronym, ‘‘FCM,’’ as 

used in paragraph (c)(3). This would 

provide conformity in the use of the 

term futures commission merchant 

throughout the rule. 

11. Clarifying the Meaning of ‘‘NRSRO’’

Rule 1.25(b)(2) sets forth the rating 

requirements for permitted investments. 

The rule refers to ratings by an 

‘‘NRSRO,’’ the acronym for a 

‘‘nationally recognized statistical rating 

organization.’’ The Commission 

proposes to amend paragraph (b)(2)(i) to 

formally set forth the acronym as a 

defined term and to cross-reference the 

definition of that term contained in SEC 

Rule 2a–7.

III. Time to Maturity—Treasury 

Portfolio 

Rule 1.25(b)(5) limits the dollarweighted average of the time to maturity 

for permitted investments to no longer 

than 24 months. In expanding the range 

of permitted investments in December 

2000, the Commission added this 

requirement as a means for addressing 

the greater market risk associated with 

longer-term and fixed rate instruments. 

In June 2003, the Commission 

requested comment on the applicability 

of time-to-maturity requirements for an 

FCM that invests solely in obligations of 

the U.S. Treasury. It had been suggested 

that, because Treasury securities do not 

pose the same credit risks as other 

permitted investments, the time-tomaturity limitation should not apply. 

The Commission requested comment 

specifically on whether an alternate 

safeguard to limit risk, such as 

appropriate haircuts, would be more 

meaningful than the time-to-maturity 

requirement of Rule 1.25(b)(5). 

Both the FIA and NFA supported the 

elimination of the time-to-maturity 

requirement for a portfolio of securities 

consisting solely of Treasury 

instruments. The FIA observed that, 

prior to the adoption of the December 

2000 amendments to Rule 1.25, an FCM 

could invest customer money 

exclusively in Treasury securities 

without regard to the dollar-weighted 

time to maturity of such instruments. 

Acknowledging that a portfolio 

consisting solely of long-dated Treasury 

instruments is not without (market) risk, 

the FIA concluded that these risks are 

addressed by the Commission’s 

minimum financial requirements, 

pursuant to which the haircuts on 

Treasury instruments increase as the 

time to maturity increases.42 However, 

the Commission believes that a situation 

in which an FCM would have to turn to 

its own capital to meet its obligations to 

a clearing organization or customers is 

far less desirable than one in which an 

FCM is able to quickly convert assets 

acquired with customer funds into cash 

at a predictable value.

The NFA, while noting that Treasury 

instruments do not pose the same 

(credit) risks as other permitted 

investments, stated its belief that these 

instruments should be subject to 

haircuts. However, the introduction of 

haircut requirements into the 

segregation calculations would be 

unprecedented, could involve 

substantial operational challenges or 

costs for FCMs, and has not otherwise 

been proposed or determined to be 

appropriate. 

The Commission believes that the 

time-to-maturity requirement added by 

the December 2000 amendments 

remains an important constraint on the 

greater market risk inherent with longerterm and fixed rate instruments in a 

portfolio of customer funds. Rule 

1.25(b)(5) requires the calculation of 

portfolio time-to-maturity as that 

average is computed pursuant to SEC 

Rule 2a–7 for MMMFs.43 It should be 

noted that this calculation addresses 

floating rate government securities and 

variable rate government securities that 

are adjusted at least every two years by 

deeming the time to maturity for such 

instruments to be, respectively, either 

one day or the time remaining to the 

next variable rate adjustment.44 The 

Commission believes this approach 

properly considers the lower relative 

price sensitivities of short-term versus 

long-term instruments and adjustable 

rate (floating or variable) versus fixed 

rate instruments.

Accordingly, the Commission 

continues to believe that application of 

this requirement to all portfolios, 

including those consisting solely of 

Treasuries or other government 

securities, does not unduly or 

improperly restrict an FCM’s investment 

flexibility under Rule 1.25. Thus, the 

Commission has determined that it will 

not propose any changes to its time-tomaturity requirement for portfolios 

consisting solely of Treasury securities. 

The Commission would be pleased to 

receive comments on this decision from 

any interested persons. 

IV. Section 4(c) 

Section 4(c) of the Act 45 provides 

that, in order to promote responsible 

economic or financial innovation and 

fair competition, the Commission, by 

rule, regulation or order, after notice 

and opportunity for hearing, may 

exempt any agreement, contract, or 

transaction, or class thereof, including 

any person or class of persons offering, 

entering into, rendering advice or 

rendering other services with respect to, 

the agreement, contract, or transaction, 

from the contract market designation 

requirement of Section 4(a) of the Act, 

or any other provision of the Act other 

than Section 2(a)(1)(C)(ii) or (D), if the 

Commission determines that the 

exemption would be consistent with the 

public interest.

The proposed rules would be 

promulgated under Section 4d(a)(2) of 

the Act,46 which governs investment of 

customer funds. Section 4d(a)(2) 

provides that customer money may be 

invested in obligations of the United 

States, in general obligations of any 

State or of any political subdivision 

thereof, and in obligations fully 

guaranteed as to principal and interest 

by the United States. It further provides 

that such investments must be made in 

accordance with such rules and 

regulations and subject to such 

conditions as the Commission may 

prescribe.

The Commission proposes to expand 

the range of instruments in which FCMs 

may invest customer funds beyond 

those listed in Section 4d(a)(2) of the 

Act (i.e., securities with embedded 

derivatives and MMMFs rated below the 

highest rating of an NRSRO), to enhance 

the yield available to FCMs, DCOs, and 

their customers without compromising 

the safety of customer funds. These 

proposed rules should enable FCMs and 

DCOs to remain competitive globally 

and domestically, while maintaining 

safeguards against systemic risk. 

In light of the foregoing, the 

Commission believes that the adoption 

of the proposed rules regarding the 

expansion of permitted instruments for 

the investment of customer funds would 

promote responsible economic and 

financial innovation and fair 

competition, and would be consistent 

with the ‘‘public interest,’’ as that term 

is used in Section 4(c) of the Act. 

The Commission solicits public 

comment on whether the proposed rules 

5588 Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 

47 5 U.S.C. 601 et seq.

48 47 FR 18618 (Apr. 30, 1982).

49 Id. at 18619.

50 66 FR 45604, 45609 (Aug. 29, 2001).

satisfy the requirements for exemption 

under Section 4(c) of the Act. 

V. Related Matters 

A. Regulatory Flexibility Act 

The Regulatory Flexibility Act 

(‘‘RFA’’) 47 requires Federal agencies, in 

promulgating rules, to consider the 

impact of those rules on small 

businesses. The rule amendments 

adopted 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.48 The Commission has previously 

determined that registered FCMs 49 and 

DCOs 50 are not small entities for the 

purpose of the RFA. Accordingly, 

pursuant to 5 U.S.C. 605(b), the Acting 

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.

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 Act requires that 

the Commission, before promulgating a 

regulation under the Act or issuing an 

order, consider the costs and benefits of 

its action. By its terms, Section 15(a) 

does not require the Commission to 

quantify the costs and benefits of a new 

rule or determine whether the benefits 

of the rule outweigh its costs. Rather, 

Section 15(a) simply requires the 

Commission to ‘‘consider the costs and 

benefits’’ of its action. 

Section 15(a) further specifies that 

costs and benefits shall be evaluated in 

light of the following considerations: (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. Accordingly, the 

Commission could, in its discretion, 

give greater weight to any one of the five 

considerations and could, in its 

discretion, determine that, 

notwithstanding its costs, a particular 

rule was necessary or appropriate to 

protect the public interest or to 

effectuate any of the provisions or to 

accomplish any of the purposes of the 

Act. 

The Commission has evaluated the 

costs and benefits of the proposed rules 

in light of the specific considerations 

identified in Section 15(a) of the Act, as 

follows: 

1. Protection of market participants 

and the public. The proposed rules 

facilitate greater capital efficiency for 

FCMs and DCOs, while protecting 

customers by establishing prudent 

standards for investment of customer 

funds. Several of the proposed 

amendments narrow and refine earlier 

standards based on industry and 

Commission experience since the 

December 2000 rulemaking in which 

Rule 1.25 was substantially revised and 

expanded. In this regard, for example, 

the proposed amendments relating to 

the mandatory registration requirement 

for MMMFs and auditability standard 

for investment records establish stricter 

standards. Similarly, proposed 

amendments that expand investment 

opportunities for FCMs and DCOs, such 

as those permitting investment in 

instruments with embedded derivatives, 

carefully circumscribe the activity in 

order to protect the customer segregated 

account. 

2. Efficiency, competitiveness, and 

financial integrity of futures markets. 

The proposed rules will facilitate greater 

efficiency and competitiveness for 

FCMs and DCOs, but they will not affect 

the efficiency and competitiveness of 

futures markets. The proposed 

amendments will not affect the financial 

integrity of futures markets. 

3. Price discovery. The proposed 

amendments will not affect price 

discovery. 

4. Sound risk management practices. 

The proposed amendments impose 

sound risk management practices upon 

FCMs and DCOs that invest customer 

funds under the rules. They balance the 

need for investment flexibility with the 

need to preserve customer funds. For 

example, while proposing to permit 

FCM/BDs to engage in in-house 

transactions, the Commission sets forth 

specific requirements for such 

transactions. These include standards 

relating to the type of securities that 

may be transferred to the customer 

segregated account, treatment of those 

securities when held in the account, and 

procedures for effecting transactions. 

Proposed requirements are designed to 

ensure that at no time will in-house 

transactions cause the customer 

segregated account to fall below a 

sufficient level. Certain other proposed 

amendments, such as the registration 

requirement for MMMFs and 

clarification as to mandatory next-day 

redemption and payment for MMMF 

interests, strengthen risk management 

standards that are already in place. 

5. Other public considerations. The 

proposed amendments reflect industry 

and Commission experience with Rule 

1.25 since the rule was expanded in 

December 2000. They provide FCMs 

and DCOs with greater flexibility in 

making investments with customer 

funds, while strengthening the rules that 

protect the safety of such funds and 

preserve the rights of customers. For 

example, the proposed amendments 

governing in-house transactions provide 

FCM/BDs with an efficient and costeffective method for maximizing 

investment opportunities within the 

confines of strict risk management 

requirements. Similarly, the proposed 

amendments expand the range of 

investments to include certain 

instruments with embedded derivatives 

and MMMFs of any rating, and enable 

FCMs and DCOs to consider a broader 

range of investment possibilities within 

prescribed limitations. 

The proposed amendments are 

expected to enhance the ability of FCMs 

and DCOs to earn revenue from the 

investment of customer funds, while 

maintaining safeguards against systemic 

risk. FCMs and DCOs choosing to make 

such investments will bear all costs 

associated with their investments. 

Accordingly, after considering the five 

factors enumerated in the Act, the 

Commission has determined to propose 

the rules and rule amendments set forth 

below. The Commission invites public 

comment on its application of the costbenefit provision. Commenters also are 

invited to submit, with their comment 

letters, any data that quantifies the costs 

and benefits of the proposal.

Lists of Subjects in 17 CFR Part 1 

Brokers, Commodity futures, 

Consumer protection, 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 

Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 5589

of the Code of Federal Regulations as 

follows:

PART 1—GENERAL REGULATIONS 

UNDER THE COMMODITY EXCHANGE 

ACT 

1. The authority citation for part 1 

continues 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 Commodity Futures Modernization Act of 

2000, Appendix E of Public Law 106–554, 

114 Stat. 2763 (2000).

2. Section 1.25 is proposed to be 

revised to read as follows:

§ 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) General obligations issued by any 

enterprise sponsored by the United 

States (government sponsored enterprise 

securities); 

(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; 

(vi) Corporate notes or bonds; 

(vii) General obligations of a sovereign 

nation; and 

(viii) 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 (viii) 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 ‘‘readily 

marketable’’ as defined in § 240.15c3–1 

of this title. 

(B) Securities subject to such 

repurchase agreements must not be 

‘‘specifically identifiable property’’ as 

defined in § 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. 

(3) In addition, subject to the 

provisions of paragraph (e) of this 

section, a futures commission merchant 

that is also registered with the Securities 

and Exchange Commission as a 

securities broker or dealer pursuant to 

section 15(b)(1) of the Securities and 

Exchange Act of 1934 may enter into 

transactions in which: 

(i) Customer money is exchanged for 

securities that are permitted 

investments and are held by the futures 

commission merchant in connection 

with its securities broker or dealer 

activities; 

(ii) Securities deposited by customers 

as margin are exchanged for securities 

that are permitted investments and are 

held by the futures commission 

merchant in connection with its 

securities broker or dealer activities; or 

(iii) Securities deposited by customers 

as margin are exchanged for cash that is 

held by the futures commission 

merchant in connection with its 

securities broker or dealer activities. 

(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) Marketability. Except for interests 

in money market mutual funds, 

investments must be ‘‘readily 

marketable’’ as defined in § 240.15c3–1 

of this title. 

(2) Ratings. (i) Initial requirement.

Instruments that are required to be rated 

by this section must be rated by a 

nationally recognized statistical rating 

organization (NRSRO), as that term is 

defined in § 270.2a–7 of this title. For an 

investment to qualify as a permitted 

investment, ratings are required as 

follows: 

(A) U.S. government securities and 

money market mutual funds need not be 

rated; 

(B) Municipal securities, government 

sponsored enterprise securities, 

commercial paper, and corporate notes 

or bonds, except notes or bonds that are 

asset-backed, must have the highest 

short-term rating of an NRSRO or one of 

the two highest long-term ratings of an 

NRSRO; 

(C) Corporate notes or bonds that are 

asset-backed must have the highest 

ratings of an NRSRO; 

(D) Sovereign debt must be rated in 

the highest category by at least one 

NRSRO; and 

(E) With respect to certificates of 

deposit, the commercial paper or longterm debt instrument of the issuer of a 

certificate of deposit or, if the issuer is 

part of a holding company system, its 

holding company’s commercial paper or 

long-term debt instrument, must have 

the highest short-term rating of an 

NRSRO or one of the two highest longterm ratings of an NRSRO. 

(ii) Effect of downgrade. If an NRSRO 

lowers the rating of an instrument that 

was previously a permitted investment 

on the basis of that rating to below the 

minimum rating required under this 

section, the value of the instrument 

recognized for segregation purposes will 

be the lesser of: 

(A) The current market value of the 

instrument; or 

(B) The market value of the 

instrument on the business day 

preceding the downgrade, reduced by 

20 percent of that value for each 

business day that has elapsed since the 

downgrade. 

(3) 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 as follows:

(A) 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; or 

(B) An instrument that meets the 

requirements of paragraph (b)(3)(iv) of 

this section may provide for a cap, floor, 

or collar on the interest paid; provided, 

however, that the terms of such 

instrument obligate the issuer to 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 except as provided in 

paragraph (b)(3)(iv) of this section, and 

it may not otherwise constitute a 

derivative instrument. 

(iv) (A) Adjustable rate securities are 

permitted, subject to the following 

requirements: 

5590 Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 

(1) The interest payments on variable 

rate securities must correlate closely 

and on an unleveraged basis to a 

benchmark of either the Federal Funds 

target or effective rate, the prime rate, 

the three-month Treasury Bill rate, or 

the one-month or three-month LIBOR 

rate; 

(2) The interest payment, in any 

period, on floating rate securities must 

be determined solely by reference, on an 

unleveraged basis, to a benchmark of 

either the Federal Funds target or 

effective rate, the prime rate, the threemonth Treasury Bill rate, the one-month 

or three-month LIBOR rate, or the 

interest rate of any fixed rate instrument 

that is a permitted investment listed in 

paragraph (a)(1) of this section; 

(3) Benchmark rates must be 

expressed in the same currency as the 

adjustable rate securities that reference 

them; and 

(4) No interest payment on an 

adjustable rate security, in any period, 

can be a negative amount. 

(B) For purposes of this paragraph, the 

following definitions shall apply: 

(1) The term adjustable rate security

means, a floating rate security, a 

variable rate security, or both. 

(2) The term floating rate security

means a security, the terms of which 

provide for the adjustment of its interest 

rate whenever a specified interest rate 

changes and that, at any time until the 

final maturity of the instrument or the 

period remaining until the principal 

amount can be recovered through 

demand, can reasonably be expected to 

have a market value that approximates 

its amortized cost. 

(3) The term variable rate security

means a security, the terms of which 

provide for the adjustment of its interest 

rate on set dates (such as the last day of 

a month or calendar quarter) and that, 

upon each adjustment until the final 

maturity of the instrument or the period 

remaining until the principal amount 

can be recovered through demand, can 

reasonably be expected to have a market 

value that approximates its amortized 

cost. 

(v) Certificates of deposit, if 

negotiable, must be able to be liquidated 

within one business day or, if not 

negotiable, 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. 

(4) Concentration. (i) Direct 

investments. (A) U.S. Government 

securities and money market mutual 

funds shall not be subject to a 

concentration limit or other limitation. 

(B) Securities of any single issuer of 

government sponsored enterprise 

securities held by a futures commission 

merchant or derivatives clearing 

organization may not exceed 25 percent 

of total assets held in segregation by the 

futures commission merchant or 

derivatives clearing organization. 

(C) 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. 

(D) Sovereign debt is subject to the 

following limits: A futures commission 

merchant may invest in the sovereign 

debt of a country to the extent it has 

balances in segregated accounts owed to 

its customers denominated in that 

country’s currency; a derivatives 

clearing organization may invest in the 

sovereign debt of a country to the extent 

it has balances in segregated accounts 

owed to its clearing member futures 

commission merchants denominated in 

that country’s currency. 

(ii) Repurchase agreements. For 

purposes of determining compliance 

with the 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. 

(iii) Reverse repurchase agreements.

For purposes of determining compliance 

with the 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) Transactions under paragraph 

(a)(3). For purposes of determining 

compliance with the concentration 

limits set forth in this section, securities 

transferred to a customer segregated 

account pursuant to paragraphs (a)(3)(i) 

or (a)(3)(ii) of this section shall be 

combined with securities held by the 

futures commission merchant as direct 

investments. 

(v) Treatment of securities issued by 

affiliates. For purposes of determining 

compliance with the concentration 

limits set forth in this section, securities 

issued by entities that are affiliated, as 

defined in paragraph (b)(6) 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. 

(vi) Treatment of customer-owned 

securities. For purposes of determining 

compliance with the 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. 

(5) 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 

§ 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 oneday 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 § 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. 

(6) 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. 

Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 5591

(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. 

(7) 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. 

(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 § 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 § 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 § 1.26(a). If the futures 

commission merchant or the derivatives 

clearing organization holds its shares of 

the fund with the fund’s shareholder 

servicing agent, the sponsor of the fund 

and the fund itself are required to 

provide the acknowledgment letter 

required by § 1.26. 

(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) Non-routine closure of the 

Fedwire or applicable Federal Reserve 

Banks; 

(B) Non-routine closure of the New 

York Stock Exchange or general market 

conditions leading to a broad restriction 

of trading on the New York Stock 

Exchange; 

(C) Declaration of a market emergency 

by the Securities and Exchange 

Commission; or 

(D) Emergency conditions set forth in 

section 22(e) of the Investment 

Company Act of 1940. 

(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. 

(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 (viii) 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) 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) 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)(4)(ii) and (iii) of this 

section. 

(4) 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 (d)(12) of 

this section and which states that the 

parties thereto intend the transaction to 

be treated as a purchase and sale of 

securities. 

(5) The term of the agreement is no 

more than one business day, or reversal 

of the transaction is possible on 

demand. 

(6) 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 § 1.26. 

(7) 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. 

(8) 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 

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 

5592 Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 

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. 

(9) 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. 

(10) The transactions effecting the 

agreement are recorded in the record 

required to be maintained under § 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. 

(11) 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.’’

(12) 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) Transactions by futures 

commission merchants that are also 

registered securities brokers or dealers.

A futures commission merchant that is 

also registered with the Securities and 

Exchange Commission as a securities 

broker or dealer pursuant to section 

15(b)(1) of the Securities and Exchange 

Act of 1934 may enter into transactions 

pursuant to paragraph (a)(3) of this 

section, subject to the following 

requirements: 

(1) The futures commission merchant, 

in connection with its securities broker 

or dealer activities, owns or has the 

unqualified right to pledge the securities 

that are exchanged for customer money 

or securities held in the customer 

segregated account. 

(2) The transaction can be reversed 

within one business day or upon 

demand. 

(3) Securities transferred from the 

customer segregated account and 

securities transferred to the customer 

segregated account as a result of the 

transaction are specifically identified by 

coupon rate, par amount, market value, 

maturity date, and CUSIP or ISIN 

number. 

(4) Securities deposited by customers 

as margin and transferred from the 

customer segregated account as a result 

of the transaction are subject to the 

following requirements: 

(i) The securities are ‘‘readily 

marketable’’ as defined in § 240.15c3–1 

of this title. 

(ii) The securities are not ‘‘specifically 

identifiable property’’ as defined in 

§ 190.01(kk) of this chapter. 

(5) Securities transferred to the 

customer segregated account as a result 

of the transaction are subject to the 

following requirements: 

(i) The securities are priced each day 

based on the current mark-to-market 

value. 

(ii) The securities are subject to the 

concentration limit requirements set 

forth in paragraph (b)(4)(iv) of this 

section. 

(iii) The securities 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 § 1.26.

(iv) The securities may not be used in 

another similar transaction and may not 

otherwise be hypothecated or pledged, 

except such 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: 

(A) 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; 

(B) Substitution is made on a 

‘‘delivery versus delivery’’ basis; and 

(C) The market value of the 

substituted securities is at least equal to 

that of the original securities. 

(6) The transactions are carried out in 

accordance with the following 

procedures: 

(i) With respect to transactions under 

paragraph (a)(3)(i) of this section, the 

transfer of securities to the customer 

segregated custodial account shall be 

made simultaneously with the transfer 

of money from the customer segregated 

cash account. In no event shall money 

held in the customer segregated cash 

account be disbursed prior to the 

transfer of securities to the customer 

segregated custodial account. Any 

transfer of securities to the customer 

segregated custodial account shall not 

be recognized as accomplished until the 

securities are actually received by the 

custodian of such account. Upon 

unwinding of the transaction, the 

customer segregated cash account shall 

receive same-day funds credited to such 

account simultaneously with the 

delivery or transfer of securities from 

the customer segregated custodial 

account. 

(ii) With respect to transactions under 

paragraph (a)(3)(ii) of this section, the 

transfer of securities to the customer 

segregated custodial account shall be 

made simultaneously with the transfer 

of securities from the customer 

segregated custodial account. In no 

event shall securities held in the 

customer segregated custodial account 

be released prior to the transfer of 

securities to that account. Any transfer 

of securities to the customer segregated 

custodial account shall not be 

recognized as accomplished until the 

securities are actually received by the 

custodian of the customer segregated 

custodial account. Upon unwinding of 

the transaction, the customer segregated 

custodial account shall receive the 

securities simultaneously with the 

delivery or transfer of securities from 

the customer segregated custodial 

account. 

(iii) With respect to transactions 

under paragraph (a)(3)(iii) of this 

section, the transfer of money to the 

customer segregated cash account shall 

be made simultaneously with the 

transfer of securities from the customer 

segregated custodial account. In no 

event shall securities held in the 

customer segregated custodial account 

be released prior to the transfer of 

money to the customer segregated cash 

account. Any transfer of money to the 

customer segregated cash account shall 

not be recognized as accomplished until 

the money is actually received by the 

custodian of the customer segregated 

cash account. Upon unwinding of the 

transaction, the customer segregated 

custodial account shall receive the 

securities simultaneously with the 

disbursement of money from the 

customer segregated cash account. 

(7) The futures commission merchant 

maintains all books and records with 

respect to the transactions in accordance 

Federal Register / Vol. 70, No. 22 / Thursday, February 3, 2005 / Proposed Rules 5593

with §§ 1.25, 1.27, 1.31, and 1.36 and 

the applicable rules and regulations of 

the Securities and Exchange 

Commission. 

(8) An actual transfer of securities by 

book entry is made consistent with 

Federal or State commercial law, as 

applicable. At all times, securities 

transferred to the customer segregated 

account are reflected as ‘‘customer 

property.’’

(9) For purposes of §§ 1.25, 1.26, 1.27, 

1.28 and 1.29, securities transferred to 

the customer segregated account are 

considered to be customer funds until 

the customer money or securities for 

which they were exchanged are 

transferred back to the customer 

segregated account. In the event of the 

bankruptcy of the futures commission 

merchant, any securities exchanged for 

customer funds and held in the 

customer segregated account may be 

immediately transferred. 

(10) In the event the futures 

commission merchant is unable to 

return to the customer any customerdeposited securities exchanged 

pursuant to paragraphs (a)(3)(ii) or 

(a)(3)(iii) of this section, the futures 

commission merchant shall act 

promptly to ensure that such inability 

does not result in any direct or indirect 

cost or expense to the customer. 

(f) 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 § 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 §§ 1.25, 

1.26, 1.27, 1.28 and 1.29, investments 

permitted by § 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. 

3. Section 1.27 is proposed to be 

amended as follows: 

A. By adding the word ‘‘derivatives’’

before the term ‘‘clearing organization’’

in paragraphs (a) and (b); 

B. By adding the phrase ‘‘or current 

market value of securities’’ after the 

phrase ‘‘The amount of money’’ in 

paragraph (a)(3); 

C. By removing the word ‘‘and’’ at the 

end of paragraph (a)(6); 

D. By removing the period at the end 

of paragraph (a)(7) and adding ‘‘; and’’

in its place; and 

E. By adding paragraph (a)(8) to read 

as follows:

§ 1.27 Record of investments. 

(a) * * * 

(8) Daily valuation for each 

instrument and documentation 

supporting the daily valuation for each 

instrument. Such supporting 

documentation must be sufficient to 

enable auditors to validate the valuation 

and verify the accuracy of input 

information used in the valuation to 

external sources for any instrument.

* * * * *

Issued in Washington, DC, on January 27, 

2005, by the Commission. 

Jean A. Webb, 

Secretary of the Commission.

[FR Doc. 05–2000 Filed 2–2–05; 8:45 am] 

BILLING CODE 6351–01–P

ENVIRONMENTAL PROTECTION 

AGENCY 

40 CFR Part 51 

[OAR 2003–0079, FRL–7867–1] 

RIN 2060–AJ99 

Implementation of the 8-Hour Ozone 

National Ambient Air Quality 

Standard—Phase 1: Reconsideration

AGENCY: Environmental Protection 

Agency (EPA).

ACTION: Proposed rule; notice of public 

hearing. 

SUMMARY: The EPA is requesting 

comment on two issues raised in a 

petition for reconsideration action of 

EPA’s rule to implement the 8-hour 

ozone national ambient air quality 

standard (NAAQS or standard). In 

addition, EPA is proposing to clarify 

two aspects of the implementation rule. 

On April 30, 2004, EPA issued a final 

rule addressing key elements of the 

program to implement the 8-hour ozone 

NAAQS. Subsequently, on June 29, 

2004 and September 24, 2004, three 

different parties each filed a petition for 

reconsideration of certain specified 

aspects of the final rule. By letter dated 

September 23, 2004, EPA granted 

reconsideration of three issues raised in 

the petition for reconsideration filed by 

Earthjustice on behalf of several 

environmental organizations. Today, we 

are providing additional information 

and soliciting comment on two of the 

issues on which we granted 

reconsideration. The issues that we are 

addressing today are whether the 

section 185 fee provisions apply once 

the 1-hour NAAQS is revoked and the 

timing for determining what is an 

‘‘applicable requirement’’ for purposes 

of anti-backsliding once the 1-hour 

NAAQS is revoked. We will shortly 

address the issue of new source review 

(NSR) anti-backsliding in a separate 

action. We are requesting public 

comment on the issues discussed in this 

action, which are described in section 

III of the Supplementary Information 

section of this preamble. We plan to 

issue a final decision on these issues no 

later than May 20, 2005. 

We are also proposing to revise the 

implementation rule in two respects. 

First we are proposing to find that 

contingency measures for failure to 

make reasonable further progress or 

attain by the applicable attainment date 

for the 1-hour ozone standard are no 

longer required of an area after 

revocation of that standard. Second, 

although § 51.905 of the rule provided 

that areas designated nonattainment for 

the 1-hour NAAQS at the time of 

designation as nonattainment for the 8-

hour NAAQS remain subject to any 

outstanding 1-hour attainment 

demonstration requirement, we failed to 

list the attainment demonstration as an 

‘‘applicable requirement.’’ We are 

proposing to revise the definition of 

‘‘applicable requirement’’ to include the 

1-hour attainment demonstration. 

We are seeking comment only on the 

issues specifically identified in this 

document. We do not intend to respond 

to comments addressing other issues.

DATES: Comments must be received on 

or before March 21, 2005. A public 

hearing will be held on February 18, 

2005 and will convene at 9 a.m. and end 

at 2 p.m. Because of the need to resolve 

the issues in this document in a timely 

manner, EPA will not grant requests for 

extensions of the public comment 

period. For additional information on 

the public hearing, see the 

SUPPLEMENTARY INFORMATION section of 

this preamble.

ADDRESSES: Submit your comments, 

identified by Docket ID No. OAR–2003–

0079, by one of the following methods: 

• Federal Rulemaking Portal: http://

www.regulations.gov. Follow the on-line 

instructions for submitting comments. 

Attention E-Docket No. OAR–2003–

0079. 

• Agency Website: http://

www.epa.gov/edocket. EDOCKET, EPA’s