Comment Text:
Overall, I applaud the proposal. Lots of good stuff here, and well conceived. There is no need to go into the provisions that I support, so unfortunately my comment reads like a litany of complaints. That should not be taken as a sign that the proposal is generally flawed; this was a big effort and very well done, and I have a few suggestions that I think will improve the final rule, which, after all, is the point of notice and comment rulemaking.
Definitions - the definition of proprietary funds should make it clear that the funds are “solely to margin . . . .” because direct members might deposit funds for other reasons, such as fee payments.
39.15 - the Division should consider recognizing the benefits of holding funds in FDIC insured sweep accounts, as these products are very useful in managing bank risk. The Division should devise ways to encourage funds to be held in such accounts.
39.15(f)(1) - the Division should clarify that there is no prohibition on holding the DCO’s own fees in the same account as clearing member and proprietary funds. Similarly, funds for maintenance fees for the account and other similar related expenses should be allowed to be held in the account. It’s ok to require DCOs to consider such funds member/proprietary funds for the purposes of a bankruptcy, similar to the way residual interests are considered customer funds for FCMs, but operationally it would be very odd to have an outright prohibition. How else are DCOs supposed to collect fees? (This is likely a problem with the existing rule too, so this would be a good opportunity to fix it and clarify that the DCO is allowed to collect fees and keep account maintenance funds in the same account.)
39.15(f)(2) - the letter for proprietary funds for cleared swaps should follow the template in part 22, and not be a different letter, for consistency. If that is the intention, the Division should clarify.
39.15(f)(4) - the Division should consider how this rule applies to fully collateralized DCOs, and if there is anything that would be an unnecessary burden on such DCOs, that burden should be clarified to not apply to them.
As a global comment (applicable to all proposed changes) the Division should consider aligning the treatment of proprietary funds to both customer funds and also cleared swaps customer collateral (instead of just customer funds).
39.15(g) - it would be helpful for the Division to clarify how to classify funds that are deposited that can be used to collateralize both futures and swaps.
The rules in this section are overly prescriptive and inconsistent with the principles based regulatory regime established by the CEA as well as overly burdensome without evidence-based justifications for the burden. The stated purpose of this proposal is to verify it has funds available and quickly identify misuse of funds. The proposed rule is very prescriptive in how DCO’s must do this, including requiring segregation of duties that complies with US GAAP, which is an audit standard. In other words, stated plainly, the Division is requiring DCOs to perform a US GAAP audit on a daily basis. There are two problems with this that the Division should fix in the final rule.
The first is the overly prescriptive nature of the proposed rule. It should be up to DCOs to ensure that they are in compliance with their basic obligation of safeguarding their members’ money. This highly detailed regimen in the proposed rule removes all meaningful discretion from the DCO, and substitutes the Division’s or the Commission’s judgment for the DCO’s. Second, and relatedly the proposed rule does not identify any instances where this audit would have prevented misuse.
One additional point, even if no DCO comments on this, the silence cannot be construed as acquiescence to the rule absent the analyses above.
Relatedly, what alternatives were considered? Here’s a good alternative for the Division to consider: allowing a DCO to electronically automatically reconcile in lieu of a US GAAP audit reconciliation. Alerts can be sent to DCO staff in the event of a mismatch widely enough to have the same salubrious effect as a segregation of duty US GAAP audit. This would reduce the burden on the staff of the DCO, with at least the same level of reliability of the proposed rule. This is also a good illustration of how the proposed rule is overly prescriptive. The rule prescribes a particular way of doing things when there are really multiple ways to achieve the same result, which is generally understood to be the opposite of a principles based regulatory regime.
The Division should, at the very least, refrain from finalizing this proposal, and should repropose the rule with an explanation as to (1) why it is being so prescriptive, (2) what evidence it has that there is actually a problem that it is solving with the imposition of a very detailed, prescriptive, and costly audit (see comments on the CBA below), and (3) what alternatives it considered.
With regard to the specific questions the Division asked for comment on:
Reporting - not unless the Division can show that there is an actual need for this. How many instances of misuse can it identify? How would this have helped to address those instances? Without that information, the public reasonably can assume the answer is zero, and therefore, reporting would be an additional burden that is not useful. To the extent that such reporting would be required, it should be done in an automated manner, or at least with the option for it to be done in an automated manner. Additionally, there is no thought given to the variations in size and staffing and resources between the smaller DCOs and the larger. That needs to be done and the Division should not finalize this without taking that into account in the cost/benefit analysis.
AML/KYC - first, I think that all direct member DCOs do perform KYC/AML as if they are required. This is a red herring at best, and a straw man at worst. Although there are Commissioners who have publicly commented on this in the past, I recommend that the Division be mindful of the actual reality of the current practice in the industry, which provides helpful context. [Also, I question whether the CFTC should be asking this question in the first place. The responsibility over the nation’s KYC and AML rules seems to belong to FinCEN, an agency in the Treasury. The KYC/AML rules are in the BSA, not the CEA. The proposed rule does not explain or give a justification for why the CFTC considers it the right regulator to discuss KYC and AML. This is not the CFTC’s area of expertise, nor is it the CFTC’s mandate. To make this more concrete with two examples: Many of the CFTC’s registrants earn a profit, requiring them to file income tax returns and pay income tax. Yet, there is no rule in the CFTC’s regs that say “registrants must pay taxes.” The reason for that is that tax administration is the IRS’s, not that CFTC’s. There is no rule in the part 39 regs that says that DCOs must have labor posters prominently displayed in accordance with DOL rules, because that is silly. If, for any reason, a DCO would not be covered by the requirement to post labor posters under the DOL rules, it would be wholly inappropriate for the CFTC to step in and say otherwise. This question here should similarly be left to FinCEN to ask and ultimately to answer. To the extent that there is concern that FinCEN’s regs have “fallen behind the times” and FinCEN is no longer aware of the state of play with DCOs, it seems that the correct way to handle this is for the up to date agency to bring the out of date agency up to speed. This does not require the public’s input.
To the extent that this is wrong, as it well might be, and it is indeed the CFTC’s responsibility under some secret MOU with FinCEN, then the question is a good one. The Division should explain its statutory authority over this area, and also make the public aware of its cooperation and relationship with FinCEN in this rulemaking.]
Paperwork Reduction Act
The analysis and estimate seems to be contrary to the basic rules under the PRA. The analysis and estimate only considers the burden of reporting in the rare event when there is a discrepancy. It ignores the burden of performing the analysis of whether there is a discrepancy or not on a daily basis. However, it seems that under the PRA, the correct analysis is required to take into account the work that a respondent would have to put in in order to determine if there is a discrepancy in the first place. The analysis ignores the fact that there is a big burden to determine whether there is or is not a discrepancy, which, unlike the Division’s assumption of 1 report a year for a discrepancy, is required every business day of the year.
The burden would need to consider the time and expense of the prescriptive rules (although I urge you to not go final on this, for the reasons above), and I think it’s pretty clear that the actual impact on the burden is going to be substantial.
Additionally, the PRA estimate on recordkeeping is also flawed. The fact that the information is there already is irrelevant. The reconciliation is a new record in new form that must be kept, which is a new recordkeeping requirement. Additionally, the rule does not make clear whether the supporting documentation must be kept too. That should be clarified, and will have a very big impact on the time burden for assembling the report (reporting burden) and on the amount that needs to be kept as records (recordkeeping burden). If the Division will not be requiring the actual reconciliation report to be kept and will not be requiring the underlying information and documentation used to make the reconciliation be kept, which seems to be clearly what the current PRA section assumes, the Division should clarify it. If that is not the Division’s intent, the PRA should be redone. Additionally, for the reasons noted above, the proposed rule should not be accepted in light of its overly prescriptive nature and the existence of better alternatives.
Cost benefit analysis
39.15(f)(1) - if the Division believes that all DCOs do this anyway (as it says in costs), then it is unclear how the Division considers the rule to be adding a benefit, because the end result will be the same as the current state without the reg?
39.15(g) - the PRA costs are off because for the same reason the PRA estimates are off. Also, it’s unclear why the Division would only estimate the costs of the PRA, even assuming that the PRA was correct, and omit the costs of the daily reconciliation?
Also, the discussion of the benefits should be expanded to explain why alerting the CFTC is a benefit, and also explain how the proposal will result in the money being available.
