House Approves Bill to Reauthorize CFTC and Amend the Commodity Exchange Act
Commentary by Steven Lofchie and Bob Zwirb
The House of Representatives approved the "Commodity End-User Relief Act" (H.R. 2289). This legislation would reauthorize the CFTC until 2019 and make material amendments to the Commodity Exchange Act.
The "Commodity End-User Relief Act" was introduced by House Agriculture Committee Chair K. Michael Conaway (R-TX), Rep. James Austin Scott (R-GA) and Rep. David Albert Scott (D-GA). It passed by a vote of 246 to 141, which demonstrates a moderately high degree of bipartisan support. As passed by the House, the bill was amended in a variety of ways that made it different from the version that had been approved by the House Agriculture Committee. (See House Agriculture Committee Passes Bill to Reauthorize CFTC and Amend CEA (with Patel and Lofchie Comments) (May 14, 2015).) Following passage of the Agriculture Committee bill, CFTC Chair Massad released a letter stating his opposition to it. (See CFTC Chair Massad Sends Letter to Congressman Criticizing Legislation to Reauthorize the CFTC (with Lofchie and Zwirb Comments) (June 9, 2015).) In addition, the White House released a Statement of Administration Policy stating that it recommended a Presidential veto of the proposed bill because it would "hinder the CFTC's progress in successfully implementing [its] critical responsibilities without providing the more robust and reliable funding that the agency needs."
The following is a summary of the major provisions of the bill.
Statement of Policy: "In the past five years, the CFTC has finalized approximately 50 rules to enforce the new law. In that time span, the CFTC has also issued an unprecedented 258 'no-action' letters, 56 exemptive letters and 43 statements of guidance, interpretation and advice in order to delay, revise, or exempt the application of these regulations upon various market participants. This haphazard patchwork of exemptions has been widely used in lieu of a thorough and well-reasoned rulemaking process. H.R. 2289 reauthorizes the CFTC through 2019 and makes reforms to CFTC operations to help ensure that all Commissioners' voices are heard as a part of a more deliberative rulemaking process."
Customer Protection - Residual Interest: Requires futures commission merchants ("FCMs") to maintain written policies and procedures governing maintenance of "residual interest" in customer-segregated funds accounts, including cleared swaps customer collateral accounts, and requires SROs to establish rules governing the withdrawal, transfer, or disbursement of a member's residual interest in customer segregated funds, in foreign futures and foreign options customer secured amount funds, and from cleared swaps customer collateral.
FCM Bankruptcy: Authorizes the CFTC to require that the property of a commodity broker that also is in Chapter 7 debtor-in-bankruptcy be included in customer property to the extent that customer property is insufficient to satisfy the net equity claims of the broker's public customers.
Cost-Benefit Requirement: Modifying the cost-benefit analysis requirements for proposed rules of the Commodity Exchange Act ("CEA") to track those set forth in Executive Order 13563 more closely, and requiring such analysis to be done by the Office of Chief Economist.
Strategic Technology Plan: Requires the CFTC to submit to certain congressional committees every five years a detailed strategic technology plan focused on the CFTC's acquisition and use of technology.
Safeguarding of Market Data Held by CFTC: Requires CFTC staff to develop comprehensive internal risk control mechanisms to safeguard and govern the storage of all market data, including CFTC market data sharing agreements, as well as academic research performed at the CFTC using market data.
De Minimis Threshold: Requires a new affirmative CFTC rule or regulation in order to reduce the de minimis quantity of swap dealing that is currently set at $8 billion (and which is set to go down to $3 billion).
Capital and Margin Determinations: Permits swap dealers and major swap participants ("MSPs") that are not banks to use financial models for calculating capital and margin requirements.
Bona Fide Hedging: Authorizes the CFTC to define a bona fide hedging transaction, as is consistent with certain CEA requirements.
Cross-Border: (1) directs the CFTC to issue rules governing cross-border regulation of derivatives transactions; (2) directs the CFTC to consider the swaps regulatory requirements of eight foreign jurisdictions with the largest swaps markets to be comparable to, and as comprehensive as, U.S. swaps requirements; (3) exempts from U.S. swaps requirements either a non-U.S. person or a transaction between two non-U.S. persons if the person or transaction is in compliance with the swaps regulatory requirements of specified foreign jurisdictions; and (4) entitles a petition for review to expedited CFTC consideration when it is requested by either a registered entity, a commercial market participant or a CFTC registrant with respect to a CFTC determination regarding foreign jurisdiction regulatory requirements.
Judicial Review of CFTC Rule: Allows the direct review of CFTC rules by the D.C. Circuit without requiring the review to go first to the federal district court.
Definition of Commodity Pool Operator: Provides that the term "commodity pool operator" does not include a person who serves as an investment adviser to an investment company registered pursuant to the Investment Company Act of 1940 if the investment company or adviser invests, reinvests, owns, holds or trades in commodity interests limited to only financial commodity interests.
Commentary
The bill is a reflection of a widely (though not universally) shared view that the hasty rulemaking activities of the CFTC, after the passage of Dodd Frank, resulted in damage to the economy and poisoned relationships with financial regulators around the world. There is no doubt that the proposed amendments would make it more difficult for the CFTC to adopt rules, insofar as the amendments would subject the CFTC to the requirement of a demonstration that its rules could be justified economically. On the other hand, it is not clear why the CFTC should be exempted from making this demonstration. The SEC is subject to this requirement, as are numerous other federal agencies. If the White House is opposed to this requirement for the CFTC, then the White House should either (i) express its general opposition to any agency being subject to cost-benefit requirements or (ii) explain why its views on the CFTC are different. There is also a good argument to be made that the CFTC might actually have been more efficient in adopting rules if it had undertaken a more considered analysis. As things stand, the CFTC has been forced to issue literally hundreds of no-action letters to amend or delay its own rules.
There is no question that the CFTC is massively underfunded given its new responsibilities under Dodd-Frank. But this is a consequence of its own making. The CFTC under former Chair Gensler made no effort to pick and choose where its resources should be spent (a good example being the double regulation of SEC-registered investment companies as commodity pools), which meant that allocating money to the agency arguably was dumping it into a black hole. More deliberation and consensus-building up front may have led to more appropriate levels of funding.
Commentary
Among the numerous provisions of this bill is one that would overturn the decision by the U.S. Bankruptcy Court for the Northern District of Illinois in In re Griffin Trading Company, Debtor, 245 B.R. 291 (N.D. Ill. 2000), which held that customers of an insolvent FCM were not entitled to the general assets of an insolvent FCM in the event of a shortfall in segregated customer property; i.e., that such customers were entitled only to their share of assets that are identifiable or traceable to the customer account. The Court's holding has been criticized by those who take a somewhat populist view of customer rights. See Andrea M. Corcoran and Susan C. Ervin, Maintenance of Market Strategies in Futures Broker Insolvencies: Futures Positions Transfers from Troubled Firms, 44 Wash. and Lee. L. Rev. 849, 894 (1987) (characterizing as "anachronistic" the view that the priority claims of insolvent FCMs' non‑defaulting customers do not extend beyond segregated funds).
However, the Bankruptcy Court's holding, which rejected the CFTC's view that customers were entitled to all property in an FCM's bankrupt estate, is arguably sound on both legal and policy grounds. See T. Russo, Regulation of the Commodities Futures and Options Markets Sections 18-72 (1983) (the CFTC's broad definition of customer property "somewhat trivializes the concept of customer property"); Tueting and King, Funds Protections: An Overview of What Happens When a Commodity Broker Becomes Insolvent, 7 J. Fut. Mkts. 93, 99 (1987) (the CFTC's position arguably conflicts with Code and "may not be enforceable").
The House reauthorization bill sides with the CFTC view, and clarifies that the CFTC has authority under CEA Section 20(a) of the CEA "to provide for the broad use of the assets of a commodity broker's estate . . . to satisfy shortfalls in customer property beyond what was held in customer segregated accounts at the time of a firm's failure." In doing so, it overturns the long-standing policy rationale of Section 766 of the Bankruptcy Code. See Griffin Trading Co. (CFTC's position unfairly "swallows the entire estate in one gulp" and renders meaningless Bankruptcy Code Section 766(j)(2), which provides that customer claims not paid out of customer property are entitled to distribution only as general unsecured claims).
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