On December 8, 2020, the Commodity Futures Trading Commission (“CFTC”) approved a major overhaul of its Part 190 regulations governing commodity broker bankruptcy cases. The ABA played a lead role in proposing and fostering these rule changes, and the ABA Part 190 Subcommittee was honored with the CFTC “Chairman’s Award for Regulatory Excellence” by CFTC Chairman Tarbert.
A special liquidation subchapter of the Bankruptcy Code (subchapter IV of chapter 7), and the Part 190 regulations promulgated by the CFTC, apply to the bankruptcy of a U.S. futures commission merchant (“FCM”) or derivatives clearing organization (“DCO”). Unlike regulated U.S. securities markets, there is no customer account insurance program covering participants in U.S. derivatives markets. As a result, segregation of customer property is the hallmark protection for commodity broker customers. The CFTC’s Part 190 regulations, which largely rely upon and complement the segregation framework, are of paramount importance both for protecting customer property and reducing the potential systemic impact of a commodity broker insolvency.
In the aftermath of three high-profile FCM bankruptcies, MF Global, Peregrine Financial Group, and Sentinel Management Group, the CFTC implemented a number of rules in the general regulations under the Commodity Exchange Act to improve customer protection. Among others:
- The CFTC formalized an FCM’s obligation to deposit funds into segregation to cover customer debit balances, and required an FCM to cover undermargined amounts in customer accounts and establish “targeted residual interest” amounts of excess funds they will maintain in segregation. It also imposed restrictions on an FCM’s ability to withdraw more than 25% of its residual interest without specified approvals.
- The CFTC made extensive rule changes related to risk management, audit and financial reporting standards, capital charge grace periods, and depository institution acknowledgement forms. These included rules requiring that any custodian holding customer property must agree to provide the CFTC and industry self-regulatory organizations with direct, daily access to view customer segregated account balance information.
- To address problems identified during MF Global pertaining to MF Global’s use of affiliated foreign carrying broker accounts, the CFTC limited the ability of an FCM to opt out of foreign segregation schemes, and limited the amount of customer property that can be held in foreign accounts to only the amounts necessary to meet margin requirements, plus a small buffer.
- In response to MF Global complications related to customer account transfers, the CFTC rules now require a DCO to collect margin on a “gross” basis from clearing member FCMs.
- In response to bankruptcies where the scope of permitted investments was perceived to have contributed to excessive risk-taking, the CFTC imposed strict limits on the types of investments in which an FCM could invest their customer’s funds (an FCM is the derivatives equivalent of a securities broker-dealer), eliminated credit rating-based investment criteria, and prohibited the use of so-called “internal” repurchase transactions.
These rule changes were critical to restoring customer and industry confidence. The Part 190 regulations are also important for customer protection and instilling confidence, as they address the other side of the coin: how customers are protected if their commodity broker fails. However, the Part 190 regulations had remained largely unchanged since they were promulgated in 1983 – when cleared derivatives markets were far less diversified and long before the advent of electronic trading, email, and nearly continuous 24-hour markets – and needed to be modernized.
ABA Part 190 Subcommittee.
In February 2015, the ABA Derivatives and Futures Law and Business Bankruptcy committees jointly formed the ABA Part 190 Subcommittee. The subcommittee included over 45 member attorneys who work extensively in the areas of derivatives law, bankruptcy law, or both. Members included in-house counsel at DCOs, as well as representatives from several regulatory organizations and U.S. government agencies, and counsel for the trustees in the MF Global, Peregrine, and Sentinel bankruptcy cases.
Following 2½ years of work, the ABA Part 190 Subcommittee submitted proposed model rules to the CFTC for consideration in September 2017. Following a multi-year effort that included follow-up consultation with the ABA subcommittee, the CFTC proposed a comprehensive set of revisions to Part 190 in April 2020. The CFTC unanimously approved the proposed rules for public comment at an April 14, 2020 open meeting during which CFTC leadership recognized the work of the ABA Part 190 Subcommittee. After receiving public comment (including a comment letter from the ABA Part 190 Subcommittee) and making additional changes, the CFTC unanimously approved final amendments to the Part 190 Regulations at its December 8, 2020 open meeting. The revisions will become effective 30 days after the adopting release for the rules is published in the Federal Register. CFTC Chairman Tarbert honored the ABA Part 190 Subcommittee at the December 2020 open meeting with the CFTC’s “Chairman’s Award for Regulatory Excellence” recognizing its work and contributions to the Part 190 rulemaking effort.
The Part 190 Rule Changes.
The changes to CFTC Part 190 are comprehensive and overall received wide support from commenters. The rule changes reflect important themes such as enhancement of rule clarity and transparency, modernization, improvement of customer protections, and the establishment of a process for administering the liquidation of a DCO. The CFTC, adopting the recommendation of the ABA subcommittee, reorganized Part 190 into three subparts:
- Subpart A contains general provisions applicable in all commodity broker bankruptcy cases. It explains the CFTC’s statutory authority to adopt the rules, the organization of Part 190, core concepts embodied in the Part 190 Rules, the scope of the Part 190 Rules, and rules of construction.
- Subpart B contains extensive provisions specific to an FCM bankruptcy proceeding (every commodity broker bankruptcy to date has involved an FCM). The subpart B rules retain many basic concepts found in the current rules, including customer class and account class distinctions, pro rata distribution of customer property, and the priority of public customers over non-public customers. New subpart B contains additional important changes to enhance customer protection and modernize the rules. Although the specifics of the rule changes are well beyond the scope of this article, the changes include (among others):
- a more customer-friendly template for the proof of claim form;
- recognition that hedge positions will likely be treated the same as other commodity contract positions;
- clarifications regarding the treatment of customer-posted letters of credit;
- an expansion of the definition of customer property to include the residual interest that an FCM is required to maintain in segregation under CFTC rules;
- detailed rules concerning delivery accounts and for completing deliveries under commodity contracts that move into a delivery position before they can be liquidated;
- rules governing transfers of customer accounts and property to other FCMs;
- rules governing partial transfers or liquidations of customer positions; and
- updated rules detailing how customer claims are to be calculated.
- Subpart C contains provisions that are specific to a bankruptcy proceeding in which the debtor is a DCO. They apply if a DCO becomes the subject of a liquidation proceeding under the Bankruptcy Code, and are also intended to provide guidance if the clearing organization were instead to become subject to an alternative orderly liquidation proceeding administered by the Federal Deposit Insurance Corporation.
Although no U.S. DCO has ever been the subject of a bankruptcy case, the new subpart C rules drew significant attention during the comment process given the importance of clearing to financial market stability and the substantial volume and diversity of cleared derivatives. Several factors have led to major increases in the volume of derivates that are centrally cleared, such as mandated clearing for certain swaps asset classes and available clearing for others, increased standardization of swaps transactions, and lower execution costs, among others.. The ability of a DCO to address and absorb an outsized swaps default has (fortunately) not been tested outside of simulations. There is continued debate around what role, if any, market participants should have in commenting on the recovery, resolution, or wind-down plans of a DCO.
Although the rule changes were comprehensive and received wide support, there are some open issues.
Issues to Address.
The rule changes do not fully address a lingering question about the CFTC’s authority to promulgate rules that provide – in the event of a customer property shortfall – that the debtor’s general assets are included within the scope of customer property, as that likely requires a legislative fix. The CFTC Reauthorization Act of 2019 proposes to amend the Commodity Exchange Act to provide that all of the commodity broker’s general estate property may be included as customer property, to the extent of a customer property shortfall, and if enacted would resolve this question.
The new rules also do not fully address the treatment of customer property held by an FCM outside of segregation, including property for commodity “deliveries” that is supplied by the customer more than 10 days prior to the delivery period. The CFTC has indicated it may consider rules to shore up the protection of unsegregated property associated with deliveries.
The CFTC’s Part 190 revisions enjoyed wide support and represent a welcome modernization of the rules. The ABA Part 190 Subcommittee played an integral part in moving those rule changes to fruition. The continuing thoughtful attention of the CFTC, market participants, and ABA members practicing in the relevant areas of law is critical to the development of workable insolvency rules applicable to the ever-evolving derivatives marketplace.
 17 C.F.R. §§ 190.01-190.19.
 In re MF Global Inc., No. 11-2790 (Bankr. S.D.N.Y. 2011).
 In re Peregrine Fin. Group, Inc., No. 12-27488 (Bankr. N.D. Ill. 2012).
 In re Sentinel Management Group, Inc., No. 07-14987 (Bankr. N.D. Ill. 2007).
 17 C.F.R. §§ 1.22(c), 22.2(f)(6), 30.7(f)(1)(ii), 22.f(6).
 17 C.F.R. §§ 1.11(e)(3)(i)(D), 1.23(c), 1.23(d), 30.7(g).
 CFTC, Investment of Customer Funds and Funds Held in an Account for Foreign Futures and Foreign Options Transactions, 76 Fed. Reg. 78,776 (Dec. 19, 2011); CFTC, Enhancing Protections Afforded Customer Funds and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations; Final Rule, 78 Fed. Reg. 68,506 (Nov. 14, 2013) (“Enhancing Protections”).
 17 C.F.R. §§ 1.20(d)(6), 22.5, 30.7(d)(5).
 CFTC, Enhancing Protections, supra note 7.
 Even though the DCOs where MF Global was a member held sufficient margin calculated on an omnibus (i.e. net) basis, several DCOs did not hold sufficient customer margin to permit a transfer (or “porting”) of customer positions to other clearing members on a fully margined, customer-by-customer basis due to netting.
 17 C.F.R. § 39.13(g)(8)(i).
 CFTC, Investment of Customer Funds and Funds Held in an Account for Foreign Futures and Foreign Options Transactions, 76 Fed. Reg. 78,776 (Dec. 19, 2011); CFTC, Enhancing Protections Afforded Customer Funds and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations; Final Rule, 78 Fed. Reg. 68,506 (Nov. 14, 2013).
 On January 20, 2021, the White House issued a “Regulatory Freeze Pending Review” memo ordering a freeze on all new rules until the new administration has an opportunity to review them. Although the memo is technically not applicable to the CFTC as an independent agency, the CFTC could follow it, which would negatively impact the timing of publication in the Federal Register. Even if delayed, however, the authors expect that the Part 190 revisions will ultimately be published without change, given the nature of the amendments and the CFTC Commissioner’s unanimous bipartisan approval of them.
 In re Griffin Trading Co., 245 B.R. 291 (Bankr. N.D. Ill. 2000), vacated as moot sub nom. Inskeep v. MeesPierson N.V. (In re Griffin Trading Co.), 270 B.R. 882 (N.D. Ill. 2001), the bankruptcy court found that the CFTC had exceeded its authority to regulate granted in the CEA and therefore that the regulation must be stricken.
CFTC Reauthorization Act of 2019, H.R. 4895, 116th Cong. (2019). As of ^, 2021, Congress had not yet acted on this bill.