CME Clearing, a division of the CME Group that clears futures, options and swaps, released a statement entitled, "IEF2 Impact Due to Recent CFTC Staff Interpretation on Prime Money Market Funds earlier this week. It says, "On August 8, 2016, staff of the Commodity Futures Trading Commission's Division of Clearing and Risk released an interpretation concerning the impact of new Securities Exchange Commission (SEC) regulations that, as part of a more comprehensive reform effort, require the boards of directors of prime money market funds to have discretion, under certain circumstances, to temporarily suspend redemptions in such funds. In staff's view, when these discretionary redemption gates take effect on October 14, 2016, prime funds and government funds electing to have this discretion would cease to be eligible as margin collateral for a derivatives clearing organization."

The update explains, "CME Clearing fully recognizes the impact that staff's interpretation may have on our IEF-2 program for clearing members and money market funds, and we stand ready to facilitate steps that our clearing members and money market funds may need to take to minimize disruptions to their businesses and the markets generally. CME Clearing is taking two steps to assist clearing members invested in the impacted money market funds that are interested in orderly drawing down their investments."

It tell us, "First, CME Clearing is providing a suggested draw down schedule, which clearing members could use as a guideline for a measured draw down of investments in the impacted money market funds. [The draw down schedule says 50% of Prime MMFs must be sold by Sept. 15, and 100% by Sept. 23.] Second, `CME Clearing will enact a temporary suspension of new deposits into the impacted money market funds, effective September 1, 2016. Please note that clearing members may transition balances into any of the government funds on CME's IEF-2 platform (none of which are planning to become electing government funds)."

The document from the CFTC, entitled, "Staff Interpretation Regarding CFTC Part 39 In Light Of Revised SEC Rule 2a-7," says, "Part 39 of the Commodity Futures Trading Commission ("CFTC") regulations governs the activities of derivatives clearing organizations ("DCOs"). The CFTC published Part 39 in 2011 to implement revised Section 5b(c)(2) of the Commodity Exchange Act ("CEA"), which sets forth core principles a DCO must comply with in order to be registered and to maintain registration as a DCO. As relevant here, Part 39 regulations restrict the types of assets in which a DCO may choose to hold initial margin and funds belonging to clearing members and their customers. An additional regulation under Part 39 restricts the types of assets in which a SIDCO or Subpart C DCO may hold its own funds. Each of these regulations contains provisions requiring DCOs to minimize the liquidity risk of financial resources relied upon by the DCO. In this letter, the Division of Clearing and Risk ("Division") interprets these provisions in light of amendments to Securities and Exchange Commission ("SEC") Rule 2a-7 to the Investment Company Act that will take effect on October 14, 2016."

Acting Director Jeffrey Bandman writes, "Rule 2a-7 is the principal rule governing money market funds. The rule's provisions include: requirements pertaining to the maturity, quality, diversification, and liquidity of the assets comprising a fund's portfolio; recordkeeping and reporting obligations; and share price calculation requirements. In 2014, the SEC published amendments to Rule 2a-7, including several pertaining to a money market fund that is not a "government money market fund" (hereinafter, a "Prime Fund"). These amendments include: new reporting rules;7 new stress testing requirements; the requirement that a Prime Fund compute its price per share according to a floating net asset value instead of according to a stable $1 per share; and the requirement that a Prime Fund charge a fee on redemptions if the fund has less than 10 percent of its total assets invested in "weekly liquid assets," unless the fund's board of directors, including a majority of the directors who are not interested persons of the fund, determines that imposing this fee would not be in the fund's best interests."

He explains, "One provision of revised Rule 2a-7 that will take effect on October 14, 2016 requires the board of directors of a Prime Fund to reserve the right to suspend redemptions in the fund for up to 10 days under certain circumstances. Specifically, redemptions may be suspended if the fund has less than 30 percent of its total assets invested in weekly liquid assets, and the fund's board of directors, including a majority of the directors who are not interested persons of the fund, determines that such a suspension would be in the fund's best interests. This provision is intended to enable a Prime Fund to manage high levels of redemptions, as well as to create time for the fund to rebuild its own internal liquidity and for shareholders to reconsider whether redemptions are still desired or warranted. Rule 2a-7 does not permit a fund's board of directors to waive the right to suspend redemptions. Whereas it may not be in the best interests of some of the fund's shareholders for a fund to suspend redemptions, Rule 2a-7(c)(2)(i) requires the board to consider the best interests of the fund, not the interests of particular shareholders."

The letter adds, "Finally, revised Rule 2a-7 permits a "government money market fund" "to choose to rely on the ability to impose liquidity fees and suspend redemptions" in the same manner that a Prime Fund must consider imposing a liquidity fee and suspending redemptions under Rule 2a-7(c)(2)(i). A government money market fund that opts into this framework (“Electing Government Fund”) would notify investors of the election in Form N-1A."

The CFTC letter continues, "Regulation 39.13 obligates a DCO to follow certain risk management practices. Under Regulation 39.13(g)(10), a DCO "shall limit the assets it accepts as initial margin to those that have minimal credit, market, and liquidity risks [emphasis added]." To date, the Division has not defined "minimal." A dictionary definition of "minimal" is "least possible." Together with the other Part 39 regulations discussed below, Regulation 39.13(g)(10) requires a DCO to maintain liquid financial resources in order that the DCO can accomplish one of its most important functions: making on-time payments to its members with net gains, despite any default by members with net losses. In the event of a default by a member, it is crucial for a DCO to maintain initial margin in assets that can be promptly liquidated in order that the DCO can, even on the day of default, make prompt payments to members with positions opposite the defaulting member."

It adds, "As a result of the fact that under revised Rule 2a-7(c)(2)(i), a Prime Fund might suspend redemptions for up to 10 days, the Division believes that a Prime Fund poses more than minimal liquidity risks. With regard to other securities, such as equities and U.S. government securities, a secondary market may generally be available even when an issuer is in financial distress. Such securities may be sold at a discount (which may be a material discount to face value), but can still be liquidated. By contrast, the Division has not been presented with any evidence suggesting there may be a secondary market for interests in a Prime Fund or Electing Government Fund for which redemptions have been suspended. For all the reasons stated above, the Division interprets Regulation 39.13(g)(10) to prohibit a DCO from holding or accepting shares in a Prime Fund or Electing Government Fund as initial margin beginning October 14, 2016."

Finally, it says, "The fact that revised SEC rule 2a-7 will, after October 14, 2016, require a Prime Fund or Electing Government Fund to consider suspending redemptions for up to 10 days under certain circumstances means that a DCO holding assets in Prime Funds or Electing Government Funds would face the risk that its access to such assets would be delayed, and thus the risk of such delay would not be minimized. In other words, such funds will have a liquidity profile that is materially different than other asset classes. The Division believes that in order for a DCO effectively to minimize the risk that the resources the DCO relies on to fulfill its cash obligations may become illiquid, a DCO cannot rely on an investment in a Prime Fund or Electing Government Fund after revised Rule 2a-7(c)(2)(i) takes effect. For all the reasons stated above, the Division interprets Regulation 39.11(e)(1)(i) to prohibit a DCO from holding assets in a Prime Fund or Electing Government Fund beginning October 14, 2016."

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