On December 19, 2017, the Securities and Exchange Commission (the SEC) issued permanent no-action assurance (the "Letter") in connection with placing assets in the custody of a futures commission merchant (FCM) registered with the Commodity Futures Trading Commission (CFTC). The Letter states that the SEC's Division of Investment Management would not recommend enforcement action under Section 17(f) of the Investment Company Act of 1940 (the "1940 Act") if a registered investment company (a "Fund") or its custodian places and maintains cash and/or certain securities in the custody of a FCM or related clearing member for the purposes of meeting certain margin requirements for swaps1 that are cleared by the Chicago Mercantile Exchange (each a "CME Clearing Member").
The Letter updates temporary no-action assurance issued in 2015. At that time, the CFTC was required under the Dodd-Frank Act to adopt rules and issue interpretations with respect to the centralized clearing of swaps transactions. The temporary no-action assurance was a flexible interpretation of the custody requirements of the 1940 Act as the CFTC was actively working to improve protections for customer assets. The CFTC has now finalized the rules and regulations for implementing the framework for central clearing of swaps (the "CFTC Clearing Rules").
The Letter relies on representations contained in prior no-action letters, which have been updated to reflect the CFTC Clearing Rules. These representations hold that CME Clearing Members holding Fund assets and wishing to clear swaps on the CME will address the requirements of Rule 17f-6 under the 1940 Act. In that regard, a written contract will govern the manner in which a CME Clearing Member will maintain a Fund's assets, which contract provides that:
- The CME Clearing Member will comply with the requirements relating to the separate treatment of customer funds under the CFTC Clearing Rules;
- The CME Clearing Member may place and maintain the Fund's assets to effect the clearance of its swap transactions through the CME in accordance with the CFTC Clearing Rules;
- The CME Clearing Member will furnish records pertaining to Fund assets to the SEC upon request;
- Gains may be maintained by the CME Clearing Member only until the next business day following receipt (other than de minimis amounts); and
- The Fund can withdraw assets from the CME Clearing Member as soon as is reasonably practicable if the custodial arrangements no longer meet the requirements of Rule 17f-6.
The Letter helps further the underlying policies of the Dodd-Frank Act that are intended to facilitate the central clearing of swap transactions to reduce systemic risk in the global financial markets, while also minimizing unnecessary disruption and costs to the markets.
[1] For purposes of the Letter, "swaps" means interest rate swaps, credit default swaps, cash settled commodity index swap contracts, and foreign currency swap contracts.