CFTC Issues Advisory Regarding FCM Segregation of Virtual Currency Held as Customer Funds | Practical Law

CFTC Issues Advisory Regarding FCM Segregation of Virtual Currency Held as Customer Funds | Practical Law

The CFTC's Division of Swap Dealer and Intermediary Oversight (DSIO) issued CFTC Letter No. 20-34, which addresses futures commission merchant (FCM) holdings of virtual currency (VC) as customer funds.

CFTC Issues Advisory Regarding FCM Segregation of Virtual Currency Held as Customer Funds

by Practical Law Finance
Published on 26 Oct 2020USA (National/Federal)
The CFTC's Division of Swap Dealer and Intermediary Oversight (DSIO) issued CFTC Letter No. 20-34, which addresses futures commission merchant (FCM) holdings of virtual currency (VC) as customer funds.
On October 21, 2020, the CFTC's Division of Swap Dealer and Intermediary Oversight (DSIO) issued CFTC Letter No. 20-34, in which DSIO addresses futures commission merchant (FCM) holdings of virtual currency (VC) as customer funds:
According to the advisory, because VCs present a degree of custodian risk that is beyond what is currently present with depositories such as banks and trust companies, DSIO reminds FCMs that they must adhere to the following when holding VC as customer funds:
  • VC held as customer funds by an FCM must be deposited only with a bank, trust company, or another FCM, or with a clearing organization that clears virtual currency futures, options on futures, or cleared swap contracts (each such entity, a depository).
  • An FCM must deposit VC held as customer funds with a depository under an account name that clearly identifies the funds as customer funds and shows that the funds are segregated as required by the Commodity Exchange Act (CEA) and CFTC regulations. An FCM also is required to obtain the appropriate written acknowledgment letter from each depository holding customer funds.
  • VC must be available for withdrawal from a depository upon demand of an FCM, so that delivery under the terms of the contracts to which the VC relates will be made without delay.
  • An FCM, in preparing its daily and month-end segregation statements, must report customer VC at fair market value (FMV) on Line 1.B. ("Net ledger balance –Securities (at market)") and on Line 12 ("Segregated funds on hand"). The FCM must report as supplemental information the total FMV of customer VC held at a bank or custodian, at a derivatives clearing organization (DCO), or at another FCM. FMV of the VC must be reported in US dollars, and must reflect the FCM's reasoned judgment based on spot market or other appropriate market transactions.
  • An FCM, in computing its daily and month-end segregation requirement, may not offset a debit or deficit in a futures customer's or cleared swaps customer's account by the value of any VC held in the respective customer's account. Therefore, an FCM may be required to deposit its own funds into segregation to cover any debit or deficit.
  • An FCM may not deposit its own VC in futures customer or cleared swaps customer segregated accounts for any reason, including in order to meet targeted or residual interest requirements.
  • An FCM may not invest any segregated futures customer or segregated cleared swap customer funds in VC to be held on behalf of customers.
The advisory also establishes the following guidance that an FCM "should" follow when designing and maintaining its risk-management programs if the FCM does accept VC as customer funds:
  • An FCM should limit the acceptance of VC into segregated and cleared swaps segregated accounts as follows:
    • the particular type of VC (bitcoin or ether) relates solely to customer trading of futures (or options on such futures) or cleared swaps contracts that provide for the physical delivery of that VC, provided that the VC is intended to margin, guarantee, or secure such customer trading and has been formally determined to be an acceptable form of collateral for those contracts by the relevant clearing organization; and
    • the amount of VC accepted reasonably relates to the customer's level of trading in those contracts during each calendar quarter, with the reasonable relationship to be determined by the FCM and the determination to be documented in the books and records of the FCM in accordance with its risk-management program policies and procedures.
  • All VC accepted by an FCM should not provide margin value to any contracts other than the contracts identified in the above sub-bullets; provided, however, that an FCM would be entitled to use any VC held in a customer's trading account to cover the customer's default resulting from losses on VC or non-VC futures or cleared swap transactions, as applicable.
  • An FCM that holds VC for a customer should contact the customer and initiate a return of that VC if the customer has ceased trading the contracts to which the VC relates and thus there is no related open futures position, with the notice and return to be completed within a reasonable time frame that should not exceed 30 days after the customer has ceased trading for a period of 90 days (the return to be effected within a total of 120 days from the cessation of trading).
  • Each withdrawal of VC from a depository upon demand by the FCM in order to liquidate customer accounts or return customer funds should be completed within a time that is technologically and operationally possible, but should not exceed one day, unless the procedures of the depository specify additional time as part of its controls related to transfers of VC.
  • Before accepting any VC into segregation, an FCM should provide 45 days prior written notice to all futures and cleared swaps customers that the FCM will begin accepting virtual currency as of a specified date. This notice should be delivered to customers in the same manner as those customers have elected to receive other communications regarding their accounts with the FCM. An FCM should thereafter include the total amount of customer activity in VC being supported by the deposit of actual VC by customer origin as part of its disclosures required under CFTC Regulation 1.55.
In addition, DSIO notes in the advisory that CFTC Regulation 1.11(e)(3)(i)(J) requires FCMs that receive VC from customers to consider the specific risks presented by holding such VC as segregated or cleared swap customer funds.