U.S. Commodity Futures Trading Commission Finalizes Margin Adequacy and Separate Account Treatment Rules

On December 20, 2024, the U.S. Commodity Futures Trading Commission (CFTC) adopted new CFTC Regulation 1.44 (the Final Rule)¹, which will allow clearing and nonclearing futures commission merchants (FCMs), in certain circumstances, to treat separate accounts of a single beneficial owner as accounts of different legal entities for purposes of the CFTC margin adequacy regulations (i.e., separate account treatment). The Final Rule codifies and modifies no-action relief the CFTC staff granted in 2019 and subsequent extensions of that relief set to expire on June 30, 2025. The Final Rule follows two separate proposals on the topic and represents the culmination of years of engagement with the CFTC staff by market participants and various industry groups.

The Final Rule takes effect on March 24, 2025, and for FCMs that elect separate account treatment, compliance will be required on July 21, 2025, for FCMs that are clearing members of a derivatives clearing organization (DCO) and January 22, 2026, for all other FCMs.²

Sidley’s Take

The Final Rule provides investment funds, sovereign wealth funds, pension plans, insurance companies, corporate end users, and other investors that allocate trading capital to multiple trading advisors or that otherwise want to separate their derivatives trading into multiple accounts with long-term comfort that their FCMs may continue to determine margin adequacy on an account-by-account, rather than customer-by-customer, basis. Absent such relief, management of initial margin across multiple accounts would be substantially more difficult and require a level of coordination between trading advisors that is not consistent with current practices. Notwithstanding this long-term comfort, before seeking to rely on separate account treatment, it is important to understand the nuances and details of the Final Rule.

Key Takeaways

If you are a customer of an FCM, please note the following.

• The Final Rule is a positive development for FCM customers, preserving the benefits and advantages of separate account treatment for customers. The treatment of separate accounts as distinct entities for regulatory purposes will allow each separate account to be managed independently, providing the ability to leverage specific investment strategies without the risk of one account's performance affecting another. This is particularly beneficial for institutional customers such as investment funds, pension funds, and sovereign wealth funds that allocate assets to different investment advisors.
• The application of margin requirements across multiple accounts of the same beneficial owners would have imposed significant commercial disadvantages, including (i) reducing the operational efficiency and flexibility of managing different trading strategies, investment managers, or hedging activities across separate accounts; (ii) exposing the excess margin or profits in one account to the risk of being used to cover the margin deficits or losses in another account of the same customer, regardless of the control or allocation of the accounts by different investment managers or advisors; and (iii) undermining the incentive structure and performance measurement of portfolio management teams or investment advisors compensated based on the results of their own strategies or accounts and not on the aggregate performance of the customer.
• Customers using multiple accounts at the same FCM should be aware that there are limitations on the benefits of the Final Rule:
  • FCMs are permitted under the Final Rule to elect separate account treatment, but they also are permitted to subsequently opt out of it. A customer entering into a relationship with an FCM in reliance on the FCM’s agreeing to allow separate account treatment should take steps to ensure that the FCM will continue to allow separate account treatment and should consider discussing with their FCMs the conditions under which the FCM may change this election.
  • The Final Rule requires each separate account to be on a one-business-day margin call. This means a customer may not be able to negotiate a cure period for margin shortfalls (although a grace period is permitted for margin shortfalls that are the result of an administrative error).
  • An FCM is permitted to offer separate account treatment to a customer only when operating in the “ordinary course of business.” The Final Rule sets out a list of events that are inconsistent with the ordinary course of business, which are discussed in more detail below.

• Advisors and subadvisors should take care to ensure that “nonrecourse” and similar provisions in advisory and subadvisory agreements are properly updated to ensure consistency with the Final Rule.

If you are an FCM, please note the following.

FCMs that choose to provide separate account treatment will benefit from greater flexibility in meeting customer needs and preferences as well as potentially attracting more business from investors who seek such treatment. FCMs that provide separate account treatment will also face additional costs and obligations, such as

• updating their systems, procedures, and customer agreements to comply with the Final Rule and to monitor and enforce the conditions for separate account treatment, including the one-business-day margin call requirement and the cessation of disbursements in certain circumstances
• obtaining and maintaining sufficient information from separate account customers and their investment managers to assess their financial resources, margin adequacy, and parent company relationships

The Use of Separate Accounts

There are several commercial reasons the same customer — whether an investment fund, sovereign wealth fund, pension plan, insurance company, or corporate end user — might seek to maintain multiple accounts at the same FCM. For example, an investment fund, pension plan, or sovereign wealth fund that allocates capital to multiple investment advisors may allocate a preset amount of capital and establish separate accounts for each advisor and grant each advisor power of attorney over only a single account to ensure that each advisor is able to manage on the capital allocated to it and pursue its strategy independently of other advisors.

The same approach may be taken by an investment fund that operates separate strategies and wishes to keep each strategy separate to maintain clear strategy-by-strategy track records or to allow portfolio management teams to receive incentive compensation solely tied to the performance of their own strategies. Corporate entities may wish to establish separate accounts to house different types of hedging (e.g., physical commodity hedging in one account and interest rate and foreign exchange hedging in another account), whereas insurance companies may wish to establish separate accounts to differentiate trading among their general account, insurance regulatory “separate accounts,” and/or different reinsurance asset portfolios. Separate accounts may also facilitate the trading and settlement activities of branches that are part of the same banking organization but that operate in different countries and across time zones.

Importantly, the use of separate accounts typically allows excess margin to be withdrawn from one account, even if another account of the same beneficial owner is currently in margin deficit.

The JAC Regulatory Alerts

Prior to 2019, FCMs often allowed customers to establish multiple accounts with the same beneficial ownership and agreed to treat the accounts as accounts of different beneficial owners for margin and other purposes. FCMs also would include “nonrecourse” or “limited recourse” provisions in their customer agreements, pursuant to which they agreed to limit their ability to look across accounts for purposes of determining margin adequacy and covering trading losses. On May 14, 2019, this practice was called into question when the Joint Audit Committee (JAC)³ issued two regulatory alerts: JAC Regulatory Alert #19-02⁴ and JAC Regulatory Alert #19-03.⁵

JAC Regulatory Alert #19-02: Combining Accounts for Margin Purposes

CFTC regulations require DCOs to collect margin from FCMs with respect to their customer accounts on a gross basis — that is, without netting excess customer margin against customer margin deficits. This requirement limits “fellow-customer risk” because it makes it less likely that a default by one customer will cause the default of the FCM, with any resulting shortfall in customer funds shared pro rata across other customers of the FCM (i.e., “fellow-customer risk”).

One of the rules designed to facilitate this approach is CFTC Regulation 39.13(g)(8)(iii), which requires DCOs to require their clearing members to “ensure that their customers do not withdraw funds from their accounts with such clearing members unless the net liquidating value plus the margin deposits remaining in a customer’s account after such withdrawal are sufficient to meet the customer initial margin requirements with respect to all products and swap portfolios held in such customer’s account which are cleared by the [DCO].”⁶

In line with this requirement, JAC Regulatory Alert #19-02 reminded FCMs that “[a]ll accounts of the same beneficial owner within the same regulatory account classification (i.e., customer segregated, customer secured, cleared swaps customer, or noncustomer) should be combined for margin purposes.” The alert further stated that “when determining an account’s margin funds available for disbursement, all accounts of the same beneficial owner, even if under different control, within the same regulatory account classification must be combined [… and] an account’s available funds from one regulatory account classification cannot be used for disbursement from another regulatory account classification.”

JAC Regulatory Alert #19-03: Guarantees Against Loss

CFTC Regulation 1.56(b) prohibits FCMs from representing that they will guarantee customers against loss, limit the losses of customers, or not call for, or attempt to collect, initial or maintenance margin. JAC Regulatory Alert #19-03 reminded FCMs of their obligations under Regulation 1.56(b) and indicated that it was JAC’s view that limited recourse and nonrecourse clauses in FCM customer agreements are not consistent with those obligations because CFTC regulations “require an FCM to have at all times the absolute right to look to funds in all accounts of the beneficial owner, including accounts that are under different control, as well as the right to call the beneficial owner for funds.”

JAC provided an example to illustrate this point: “… [I]n the case of a separate account of a beneficial owner managed by an asset manager, the FCM must have at all times the absolute right to look to funds in all accounts of the beneficial owner even accounts that are under different control, as well as the right to call the underlying beneficial owner for funds even if beyond the amount the beneficial owner has allocated to the asset manager(s).”

CFTC Letter No. 19-17

The issuance of JAC Regulatory Alerts #19-02 and #19-03, although viewed by JAC and its members as reminders to FCMs of their existing obligations under CFTC regulations, caused a great deal of concern among market participants and industry groups because they called into question practices that had become common. A number of market participants and industry groups actively engaged with the CFTC staff to seek relief and avoid the inevitable disruption that would have been caused by widespread and sudden changes in market practice.

On July 10, 2019, the CFTC Divisions of Swap Dealer and Intermediary Oversight (the predecessor of today’s Market Participants Division) and Clearing and Risk jointly issued CFTC Letter No. 19-17: Advisory and Time-Limited No-Action Relief with Respect to the Treatment of Separate Accounts by Futures Commission Merchants.⁷

CFTC Letter No. 19-17 again emphasized the requirements of CFTC Regulation 1.56(b) and expressed the view that “the FCM must retain the ability to ultimately look to funds in other accounts of the beneficial owner, including accounts that may be under different control, as well as the right to call the beneficial owner for additional funds.” Nevertheless, the CFTC staff provided time-limited relief from CFTC Regulation 39.13(g)(8)(iii), allowing DCOs to permit their FCM members to treat the separate accounts of the same beneficial owner as accounts of separate entities for the purpose of determining the adequacy of margin in each account. To rely on the relief provided by CFTC Letter No. 19-17, FCMs were required to have and to comply with internal controls that satisfy a number of highly detailed and prescriptive requirements.

The relief was originally scheduled to expire on June 30, 2021, but was extended multiple times and was most recently scheduled to expire on June 30, 2025.

The Proposals

On April 14, 2023, the CFTC published a notice of proposed rulemaking⁸ to codify many aspects of Letter No. 19-17. In light of comments received on that proposal, the CFTC determined to withdraw the original proposal and replace it with a second proposal.

On March 1, 2024, the CFTC replaced the initial proposed rulemaking with a new proposed rulemaking⁹ that would allow FCMs, under certain circumstances and subject to certain conditions, to treat the separate accounts of a single customer as accounts of separate entities for margin purposes.

Summary of the Final Rule — Regulation 1.44

The Final Rule adopts the March 2024 proposal with modifications in response to the comments received by the CFTC. The Final Rule will allow clearing and nonclearing FCMs to treat separate accounts of the same beneficial owner as accounts of different beneficial owners for purposes of determining the adequacy and proper segregation of margin in each such account as long as the FCM and customer are operating in the “ordinary course of business.”

Undermargined Amount

The Final Rule defines what is classified as an “undermargined amount” for a specific account, triggering a margin call by an FCM.

Under the Final Rule, “undermargined amount” for an account means the amount, if any, by which the customer margin requirements with respect to all products held in that account exceed the net liquidating value plus the margin deposits currently remaining in that account. “Margin requirements” are the level of maintenance margin or performance bond required for the positions in the account by the applicable exchanges or clearing organizations.

An FCM generally may not allow a customer to withdraw funds from its account with the FCM if the account is undermargined. However, the Final Rule permits FCMs, during the “ordinary course of business,” to treat the separate accounts of a separate account customer as accounts of separate entities, thereby permitting disbursements from one account owned by a beneficial owner even if another account owned by the beneficial owner is undergmargined.

FCM Compliance Requirements

An FCM electing separate account treatment is required to comply with Regulation 1.44, as adopted in the Final Rule, and maintain written internal controls and procedures designed to ensure such compliance.

Importantly, the Final Rule is permissive, not prescriptive. The regulation does not require FCMs to apply separate account treatment, and FCMs that do not presently apply separate account treatment, and do not desire to do so in the future, will not be required to alter their operations.

An FCM that opts to allow separate account treatment must satisfy the following requirements:

• The FCM must include the customer for which separate account treatment has been elected on a list of separate account customers maintained in its books and records. The list must include the identity of each separate account customer and the identity of each separate account of such customer, and it must be kept current over time.
• The FCM must notify the CFTC and the FCM’s designated self-regulatory organization (DSRO) within one business day of adding a customer to its list of separate account customers for the first time. Notwithstanding these requirements, the CFTC permits FCMs that previously provided notice of such election pursuant to the no-action conditions of CFTC Letter No. 19-17 to be deemed already in compliance with this requirement.

“Ordinary Course of Business”

The Final Rule allows separate account treatment by an FCM only during the “ordinary course of business.” The Final Rule enumerates the conditions that are inconsistent with the “ordinary course of business,” with one list of events that affect the ongoing separate account treatment of a particular customer and one list of events that affect the FCM’s overall ability to continue to offer separate account treatment.

Customer-Specific Events

The events inconsistent with the “ordinary course of business” with respect to the separate accounts of a particular separate account customer are as follows. The occurrence of any of these enumerated events would require the FCM to cease permitting disbursements on a separate account basis with respect to all accounts of the relevant separate account customer.

• The separate account customer, including any separate account of such customer, fails to deposit initial margin or maintain maintenance margin or make payment of variation margin or option premium on a one-business-day margin call basis, as described below.
• The occurrence and declaration by the FCM of an event of default as defined in the account documentation executed between the FCM and the customer.
• A “good faith determination” by the FCM’s chief compliance officer (CCO), one of its senior risk managers, or other senior manager, following the FCM’s own internal escalation procedures, that the customer is in financial distress, or there is significant and bona fide risk that the customer will be unable promptly to perform its financial obligations to the FCM, whether due to operational reasons or otherwise.
• The insolvency or bankruptcy of the customer or a parent company of the customer.
• Notification to the FCM that a board of trade, a DCO, a self-regulatory organization (SRO), the CFTC, or another regulator with jurisdiction over the customer has initiated an action with respect to the customer based on an allegation that the customer is in financial distress.
• Direction to the FCM to cease permitting disbursements on a separate account basis, with respect to the customer, by a board of trade, a DCO, a SRO, the CFTC, or another regulator with jurisdiction over the FCM, pursuant to, as applicable, board of trade, DCO, or SRO rules, government regulations, or law.

FCM-Specific Events

The following events are inconsistent with the “ordinary course of business” with respect to the separate accounts of all separate account customers of the FCM. The occurrence of any of these enumerated events would require the FCM to cease permitting disbursements on a separate account basis with respect to all of its customers.

• The FCM is notified by a board of trade, a DCO, a SRO, the CFTC, or another regulator with jurisdiction over the FCM that the board of trade, the DCO, the SRO, the CFTC, or other regulator, as applicable, believes the FCM is in financial or other distress.
• The FCM is under financial or other distress as determined in good faith by its CCO, senior risk managers, or other senior management.
• The insolvency or bankruptcy of the FCM or a parent company of the FCM.

Notice and Cure

An FCM must provide notice to its DSRO and the CFTC of the occurrence of any of the events enumerated as being inconsistent with the “ordinary course of business.” The notice must identify the event and (if applicable) the customer and be provided promptly in writing, in any case no later than the next business day following the date on which the FCM identifies or has been informed that such event has occurred.

An FCM that has ceased permitting disbursements on a separate account basis to a separate account customer due to the occurrence of any of the events specified as being inconsistent with the “ordinary course of business” may resume permitting disbursements on a separate account basis to that customer (or, respectively, all customers) if the FCM reasonably believes, based on new information, that those circumstances have been cured and the FCM documents in writing the factual basis and rationale for that conclusion.¹⁰

One-Day Margin Calls

To be treated as a separate account under CFTC Regulation 1.44, an account must be on a one-business-day margin call — that is, the separate account customer generally would be required to meet a margin call from its FCM by no later than the close of the Fedwire Funds Service on the business day on which the margin call is issued. As part of this Final Rule, the CFTC amended the definition of “business day” in CFTC Regulation 1.17 to mean any day other than a Saturday, Sunday, or holiday.¹¹

Exceptions to the one-business-day requirement would be made for margin calls denominated in currencies other than U.S. dollars or Canadian dollars, as follows:¹²

• Australian dollar (AUD), Chinese renminbi (CNY), Hong Kong dollar (HKD), Hungarian forint (HUF), Israeli new shekel (ILS), Japanese yen (JPY), New Zealand dollar (NZD), Singapore dollar (SGD), South African rand (ZAR), Turkish lira (TRY): Margin must be received by the FCM no later than the end of the second business day after the margin call is issued.
• All other fiat currencies: Margin must be received by the FCM no later than the end of the business day after the margin call is issued.

The foregoing margin deadlines may not be extended by agreement between the customer and the FCM. However, a failure of a specific separate account to deposit, maintain, or pay margin or option premium called pursuant to this requirement does not constitute a failure to comply with this requirement where such failure is caused by administrative error or operational constraints. For these purposes, an FCM’s determination that a failure is due to administrative error or operational constraint must be based on the FCM’s reasonable belief in light of information known to the FCM at the time the FCM learns of the relevant administrative error or operational constraint.

Overall, the Final Rule may have a significant impact on futures and cleared swaps account structures and margin procedures, providing conclusive comfort to investors that use multiple trading advisors that margin adequacy can be determined on an account-by-account basis.

Insights

Although the Final Rule governs the conduct of FCMs, it carries significant impact for the customers of FCMs, including investment funds, sovereign wealth funds, pension plans, insurance companies, and corporate end users as well as the trading advisors with discretion over the trading accounts of such customers.

• Understanding Separate Account Treatment and its Benefits — FCM customers should recognize that the Final Rule allows for the treatment of separate accounts as distinct entities for regulatory purposes. This means that each separate account can be managed independently, providing the ability to leverage specific investment strategies without the risk of one account’s performance affecting another. This is particularly beneficial for such institutional customers as investment funds, pension funds, and sovereign wealth funds that allocate assets to different investment advisors.
• Compliance With Margin Requirements — FCM customers must ensure that each separate account meets the initial and maintenance margin requirements independently. The Final Rule mandates that FCMs treat each separate account as if it were a separate entity, which means that margin calls must be satisfied on a one-business-day basis. Failure to meet these requirements could result in the suspension of disbursements on a separate account basis, affecting liquidity and investment strategies across all the beneficial owner’s accounts.
• Account Documentation and Disclosure Obligations — FCM customers need to be aware of the documentation and disclosure requirements imposed by the Final Rule. FCMs are required to maintain a list of all separate accounts and provide disclosures to customers about the treatment of these accounts in the event of the FCM’s bankruptcy. FCM customers should ensure that they provide accurate and up-to-date information to FCMs and understand the implications of these disclosures for their clients.
• Monitoring and Managing Financial Distress — FCM customers should be prepared for scenarios where an FCM may cease permitting disbursements on a separate account basis if the customer is in financial distress. This includes situations where the customer fails to meet margin requirements, is declared in default, or is undergoing insolvency or bankruptcy. Customers should have contingency plans in place to manage such events and ensure that they can continue to meet their financial obligations. Moreover, FCM customers will need to review the events that are classified as inconsistent with “the ordinary course of business” to ensure they have procedures in place to determine whether they are falling into any of these scenarios.
• Impact of Non-USD Transfers and Administrative Errors — FCM customers dealing with non-USD currencies should be aware of the specific provisions regarding the treatment of pending non-USD transfers. The Final Rule allows FCMs to consider these transfers as received under certain conditions, which can affect the calculation of margin requirements and the timing of disbursements. Additionally, customers should understand the criteria for administrative errors or operational constraints that may excuse a margin shortfall, as these can affect the overall management of separate accounts.