January 2021 business law today Bankruptcy & Finance CFTC Overhauls Its Commodity Broker Bankruptcy Rules 10 Min Read By: Vincent E. Lazar, Kathryn Trkla | January 23, 2021 n December 8, 2020, the Commodity regulations promulgated by the CFTC, apply to the grace periods, and depository institution Futures Trading Commission (“CFTC”) bankruptcy of a U.S. futures commission merchant acknowledgement forms.[7] These included Oapproved a major overhaul of its Part (“FCM”) or derivatives clearing organization rules requiring that any custodian holding 190 regulations governing commodity broker (“DCO”). Unlike regulated U.S. securities markets, customer property must agree to provide the bankruptcy cases.[1] The ABA played a lead role there is no customer account insurance program CFTC and industry self-regulatory organizations in proposing and fostering these rule changes, covering participants in U.S. derivatives markets. with direct, daily access to view customer and the ABA Part 190 Subcommittee was honored As a result, segregation of customer property is segregated account balance information.[8] with the CFTC “Chairman’s Award for Regulatory the hallmark protection for commodity broker • To address problems identified during MF Excellence” by CFTC Chairman Tarbert. customers. The CFTC’s Part 190 regulations, which Global pertaining to MF Global’s use of affiliated largely rely upon and complement the segregation foreign carrying broker accounts, the CFTC framework, are of paramount importance both for limited the ability of an FCM to opt out of protecting customer property and reducing the foreign segregation schemes, and limited the potential systemic impact of a commodity broker amount of customer property that can be insolvency. held in foreign accounts to only the amounts necessary to meet margin requirements, plus a In the aftermath of three high-profile FCM small buffer.[9] bankruptcies, MF Global,[2] Peregrine Financial • In response to MF Global complications related Group,[3] and Sentinel Management Group,[4] the to customer account transfers,[10] the CFTC CFTC implemented a number of rules in the general rules now require a DCO to collect margin on a regulations under the Commodity Exchange Act to “gross” basis from clearing member FCMs.[11] improve customer protection. Among others: • In response to bankruptcies where the scope of permitted investments was perceived to • The CFTC formalized an FCM’s obligation have contributed to excessive risk-taking, the to deposit funds into segregation to cover CFTC imposed strict limits on the types of customer debit balances,[5] and required an investments in which an FCM could invest their FCM to cover undermargined amounts in customer’s funds (an FCM is the derivatives customer accounts and establish “targeted equivalent of a securities broker-dealer), residual interest” amounts of excess funds they eliminated credit rating-based investment will maintain in segregation. It also imposed criteria, and prohibited the use of so-called restrictions on an FCM’s ability to withdraw “internal” repurchase transactions.[12] more than 25% of its residual interest without BACKGROUND. specified approvals.[6] These rule changes were critical to restoring • The CFTC made extensive rule changes customer and industry confidence. The Part A special liquidation subchapter of the Bankruptcy related to risk management, audit and 190 regulations are also important for customer Code (subchapter IV of chapter 7), and the Part 190 financial reporting standards, capital charge protection and instilling confidence, as they 1 January 2021 address the other side of the coin: how customers customer protections, and the establishment of proceeding administered by the Federal Deposit are protected if their commodity broker fails. a process for administering the liquidation of a Insurance Corporation. However, the Part 190 regulations had remained DCO. The CFTC, adopting the recommendation of largely unchanged since they were promulgated the ABA subcommittee, reorganized Part 190 into Although no U.S. DCO has ever been the subject of in 1983 – when cleared derivatives markets were three subparts: a bankruptcy case, the new subpart C rules drew far less diversified and long before the advent of significant attention during the comment process electronic trading, email, and nearly continuous 24- • Subpart A contains general provisions given the importance of clearing to financial market hour markets – and needed to be modernized. applicable in all commodity broker bankruptcy stability and the substantial volume and diversity cases. It explains the CFTC’s statutory authority of cleared derivatives. Several factors have led to to adopt the rules, the organization of Part 190, major increases in the volume of derivates that ABA PART 190 core concepts embodied in the Part 190 Rules, are centrally cleared, such as mandated clearing SUBCOMMITTEE. the scope of the Part 190 Rules, and rules of for certain swaps asset classes and available construction. clearing for others, increased standardization of In February 2015, the ABA Derivatives and Futures • Subpart B contains extensive provisions swaps transactions, and lower execution costs, Law and Business Bankruptcy committees specific to an FCM bankruptcy proceeding among others.. The ability of a DCO to address and jointly formed the ABA Part 190 Subcommittee. (every commodity broker bankruptcy to date absorb an outsized swaps default has (fortunately) The subcommittee included over 45 member has involved an FCM). The subpart B rules not been tested outside of simulations. There is attorneys who work extensively in the areas retain many basic concepts found in the continued debate around what role, if any, market of derivatives law, bankruptcy law, or both. current rules, including customer class and participants should have in commenting on the Members included in-house counsel at account class distinctions, pro rata distribution recovery, resolution, or wind-down plans of a DCO. DCOs, as well as representatives from several of customer property, and the priority of regulatory organizations and U.S. government public customers over non-public customers. Although the rule changes were comprehensive agencies, and counsel for the trustees in the MF New subpart B contains additional important and received wide support, there are some Global, Peregrine, and Sentinel bankruptcy cases. changes to enhance customer protection open issues. and modernize the rules. Although the Following 2½ years of work, the ABA Part 190 specifics of the rule changes are well beyond Subcommittee submitted proposed model rules the scope of this article, the changes include ISSUES TO ADDRESS. to the CFTC for consideration in September 2017. (among others): The rule changes do not fully address a lingering Following a multi-year effort that included follow- • a more customer-friendly template for the question about the CFTC’s authority to promulgate up consultation with the ABA subcommittee, the proof of claim form; rules that provide - in the event of a customer CFTC proposed a comprehensive set of revisions • recognition that hedge positions will likely property shortfall - that the debtor’s general assets to Part 190 in April 2020. The CFTC unanimously be treated the same as other commodity are included within the scope of customer property, approved the proposed rules for public comment contract positions; as that likely requires a legislative fix.[14] The CFTC at an April 14, 2020 open meeting during which • clarifications regarding the treatment of Reauthorization Act of 2019 proposes to amend the CFTC leadership recognized the work of the ABA customer-posted letters of credit; Commodity Exchange Act to provide that all of the Part 190 Subcommittee. After receiving public • an expansion of the definition of customer commodity broker’s general estate property may comment (including a comment letter from property to include the residual interest be included as customer property, to the extent of the ABA Part 190 Subcommittee) and making that an FCM is required to maintain in a customer property shortfall, and if enacted would additional changes, the CFTC unanimously segregation under CFTC rules; resolve this question.[15] approved final amendments to the Part 190 • detailed rules concerning delivery Regulations at its December 8, 2020 open meeting. accounts and for completing deliveries The new rules also do not fully address the The revisions will become effective 30 days after under commodity contracts that move treatment of customer property held by an FCM the adopting release for the rules is published in into a delivery position before they can outside of segregation, including property for the Federal Register.[13] CFTC Chairman Tarbert be liquidated; commodity “deliveries” that is supplied by the honored the ABA Part 190 Subcommittee at the • rules governing transfers of customer customer more than 10 days prior to the delivery December 2020 open meeting with the CFTC’s accounts and property to other FCMs; period. The CFTC has indicated it may consider “Chairman’s Award for Regulatory Excellence” • rules governing partial transfers or rules to shore up the protection of unsegregated recognizing its work and contributions to the Part liquidations of customer positions; and property associated with deliveries. 190 rulemaking effort. • updated rules detailing how customer claims are to be calculated. THE PART 190 RULE • Subpart C contains provisions that are CONCLUSION. specific