CFTC Staff Letter 14-106: No-action relief for CME regarding Regulations 1.20(d) and 22.5(a)

U.S. COMMODITY FUTURES TRADING COMMISSION
Three Lafayette Centre
1155 21st Street, NW, Washington, DC 20581
Telephone: (202) 418-5000
Facsimile: (202) 418-5521
CFTC Letter No. 14-106
No-Action
August 18, 2014
Division of Swap Dealer and Intermediary Oversight Division of Clearing and Risk Mr. Jason Silverstein Executive Director and Associate General Counsel Chicago Mercantile Exchange, Inc. 20 South Wacker Street Chicago, IL 60606 RE: Request for Permanent No-Action Relief regarding the Written Acknowledgment Requirements in Commission Regulations 1.20(d) and 22.5(a) Dear Mr. Silverstein:
This is in response to your letter dated July 2, 2014 (“Letter”), to the Division of Clearing and Risk and the Division of Swap Dealer and Intermediary Oversight (“Divisions”) of the Commodity Futures Trading Commission (“Commission”).1 In the Letter, you request that the Divisions confirm that they will not recommend that the Commission take enforcement action against: (1) the Clearing House of the Chicago Mercantile Exchange, Inc. (“CME Clearing”), (2) certain clearing members of CME Clearing, or (3) depositories holding customer funds2 for such clearing members, in connection with the execution and submission to the Commission and the relevant designated self-regulatory organization (“DSRO”) of a modified version of the template acknowledgment letter set forth in Appendix A to Regulation 1.20. Prior to November 2013, Regulations 1.20 and 22.5 required, among other things, that futures commission merchants (“FCMs”) obtain, from each depository with which the FCM deposits customer funds, a written acknowledgment that the depository had been informed that the funds deposited were customer funds being held in accordance with the Commodity Exchange Act.3 In November 2013, the Commission amended Regulation 1.20 to require that FCMs use the template acknowledgment letter set forth in Appendix A to Regulation 1.20

1 Chicago Mercantile Exchange, Inc. submitted a revised version of the Letter to the Divisions on July 21, 2014, with minor technical corrections. 2 The term “customer funds” means cleared swaps customer collateral, as defined in Regulations 1.3(eeee) and 22.1, and futures customer funds, as defined in Regulation 1.3(jjjj). See 17 C.F.R. § 1.3(gg). 3 Regulation 22.5 applies, by cross-reference, the acknowledgment letter requirements of Regulation 1.20 to FCMs in connection with the holding of cleared swaps customer collateral, as defined in Regulations 1.3(eeee) and 22.1.

Mr. Jason Silverstein
August 18, 2014
(“Acknowledgment Letter”).
4
For customer accounts5 existing at the time, the Commission required FCMs to obtain new Acknowledgment Letters and submit them to the Commission by July 12, 2014. 6

By letter dated June 11, 2014 (“Extension Request”), CME Clearing informed the Divisions that: (1) it and certain of its FCM clearing members required modifications to the Acknowledgment Letter; (2) it would submit a separate request for no-action relief (i.e., the Letter) to use a modified Acknowledgment Letter; and (3) it therefore required a temporary extension of the compliance deadline for Regulation 1.20 to allow the Divisions to review the proposed modifications to the Acknowledgment Letter. Based on CME Clearing’s representations and the Divisions’ understanding of the relevant facts, the Divisions granted a temporary extension of the compliance deadline to CME Clearing, certain of its FCM clearing members, and the depositories holding customer funds for such clearing members.7 The no￾action relief was time-limited, set to expire as of the date on which the Divisions respond to the Letter.

Statement of Facts
Based upon the representations made by CME Clearing to the Divisions in the Letter, we understand the relevant facts to be as follows:
Since 2003, CME Clearing has operated a program, Interest Earning Facility 4 (“IEF4”), that permits CME Clearing’s members to pledge certain types of high quality corporate bonds as initial margin for futures and cleared swaps positions (other than credit default swaps). Under the IEF4 program, an FCM clearing member opens one or more customer accounts with a depository that participates in the IEF4 program (each an “IEF4 Depository”) and the high quality corporate bonds are pledged to such accounts as initial margin. In accordance with Regulation 39.13(g)(14),8 CME Clearing requires that each of its clearing members participating in the IEF4 program (each an “Affected Clearing Member”) enter into an Account Administration and Control Agreement (“Agreement”) by and between itself

4 See Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations, 78 Fed. Reg. 68,506 (Nov. 14, 2013). 5 In the Letter, CME Clearing refers to “customer segregated accounts and cleared swaps customer accounts.” For purposes of this letter, the Divisions use the term “customer account,” which is defined as both a cleared swaps customer account, as defined in Regulations 1.3(dddd) and 22.1, and a futures account, as defined in Regulation 1.3(vv). See 17 C.F.R. § 1.3(gggg). 6 Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations, 78 Fed. Reg. at 68,578 (setting forth the compliance date for Regulation 1.20). 7 See CFTC Letter No. 14-92 (July 9, 2014). 8 Regulation 39.13(g)(14) requires that “[i]f a [DCO] permits its clearing members to pledge assets for initial margin while retaining such assets in accounts in the names of such clearing members, the [DCO] shall ensure that such assets are unencumbered and that such a pledge has been validly created and validly perfected in the relevant jurisdiction.” 17 C.F.R. § 39.13(g)(14).

Mr. Jason Silverstein
August 18, 2014
(i.e., the Affected Clearing Member), the relevant IEF4 Depository, and CME Clearing. The purpose of the Agreement is to establish that all funds deposited into the account shall be subject to CME Clearing’s first priority, perfected security interest and shall be under the control of CME Clearing, to the fullest extent permitted by applicable law. The result of this control and first priority, perfected security interest is that CME Clearing would be able to exercise remedies against the funds deposited into the account in the event of a default by the Affected Clearing Member of its obligations owing to CME Clearing, including the Affected Clearing Member’s insolvency. Discussion of Request for No-Action Relief and Applicable Legal Requirements CME Clearing’s request for relief is premised upon a potential conflict between the terms of the Acknowledgment Letter and the requirements of Regulation 39.13(g)(14). Specifically, Regulation 39.13(g)(14) provides for an arrangement in which the customer funds deposited by a derivatives clearing organization’s (“DCO’s”) FCM clearing member with a depository are subject to a security interest held by the DCO. The terms of the Acknowledgment Letter do not address this particular arrangement and, thus, an Acknowledgment Letter executed by an IEF4 Depository and an Affected Clearing Member would not recognize CME Clearing’s security interest in the customer funds held under the IEF4 program. In the Letter, CME Clearing proposed certain modifications to the Acknowledgment Letter that would recognize CME Clearing’s control over and first priority, perfected security interest in the funds. The relief sought in the Letter would permit IEF4 Depositories and Affected Clearing Members to execute a modified version of the Acknowledgment Letter, as proposed in the Letter and set forth in an attachment to this no-action letter (“Revised Acknowledgment”). The Acknowledgment Letter requirements were recently finalized and are currently being implemented, and the Divisions have not been presented with a request for relief encompassing the issues presented in the Letter. 9 The Divisions believe granting the relief requested by CME Clearing is appropriate in order to avoid the potential conflict described in the Letter. Grant of No-Action Relief Based on the facts presented and the representations CME Clearing has made, the Divisions will not recommend that the Commission take enforcement action against: (1) CME Clearing, (2) Affected Clearing Members, or (3) IEF4 Depositories, for Affected Clearing

9 The Division of Clearing and Risk issued time-limited no-action relief to ICE Clear Europe Limited and LCH.Clearnet Limited concerning the Acknowledgment Letter that those DCOs would execute with the Bank of England. See CFTC Letter No. 14-93 (July 10, 2014) (granting no-action relief to ICE Clear Europe); and CFTC Letter No. 14-94 (July 10, 2014) (granting no-action relief to LCH.Clearnet Limited). The Division of Swap Dealer and Intermediary Oversight granted no-action relief to FCMs concerning a depository’s provision of read-only access to account information, as provided for in the Acknowledgment Letter, and the need to execute online access agreements. See CFTC Letter No. 14-91 (July 10, 2014). The relief granted in these no-action letters extended the relevant compliance deadline, but did not address modifications to the Acknowledgment Letter.

Mr. Jason Silverstein
August 18, 2014
Members and IEF4 Depositories executing and submitting to the Commission and the Affected Clearing Member’s DSRO, the Revised Acknowledgment attached to this no-action letter. For any customer account opened under the IEF4 program prior to or as of the date of this letter, Affected Clearing Members and the corresponding IEF4 Depositories are required to execute and submit to the Commission and the Affected Clearing Member’s DSRO (within three days of execution), the Revised Acknowledgment; this process shall be completed no later than October 17, 2014. The issuance of this no-action letter hereby terminates the relief provided in response to the Extension Request.10 The position taken herein concerns enforcement action only and does not represent a legal conclusion with respect to the applicability of any provision of the Commodity Exchange Act or the Commission’s regulations. In addition, the Divisions’ position does not necessarily reflect the views of the Commission or any other division or office of the Commission. Because this position is based upon the representations contained in the Letter, it should be noted that any different, changed, or omitted material facts or circumstances may require a different conclusion or render this letter void. Finally, as with all no-action letters, the Divisions retain the authority to condition further, modify, suspend, terminate, or otherwise restrict the terms of the no-action relief provided herein, in their discretion. Should you have any questions, please do not hesitate to contact Parisa Abadi, Attorney￾Advisor, at (202) 418-6620. Sincerely, ___________________________________________ Ananda Radhakrishnan Director, Division of Clearing and Risk ____________________________________________ Gary Barnett Director, Division of Swap Dealer and Intermediary Oversight Attachment

10 See CFTC Letter No. 14-92 (July 9, 2014) (granting a temporary extension of the compliance deadline for Regulation 1.20 to allow the Divisions to consider the proposed modifications set forth in the Letter).