[Federal Register Volume 59, Number 7 (Tuesday, January 11, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-608]
[[Page Unknown]]
[Federal Register: January 11, 1994]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 30, 33, and 190
Risk Disclosure by Futures Commission Merchants, Introducing
Brokers, Commodity Pool Operators and Commodity Trading Advisors to
Customers; Bankruptcy Disclosure
AGENCY: Commodity Futures Trading Commission.
ACTION: Advance notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)
is requesting public comment on the text of a draft two page generic
risk disclosure statement currently being discussed among various
international futures regulators that potentially could be used to meet
the risk disclosure requirements for both domestic and foreign
commodity futures and commodity option products subject to regulation
by the CFTC. As contemplated by Commission rule 1.55(c), the text of
the generic risk disclosure statement is being published, in part, to
further these discussions relative to the development of one document
to satisfy the risk disclosure requirements of the CFTC and such
foreign jurisdictions as may choose to adopt its language for use in
their jurisdictions. Based on the comments received, the CFTC may be
better able to provide input to these discussions and to consider rule
amendments to permit the substitution of this statement under rule
1.55(c) and certain other rules for firms doing cross-border business.
DATES: Comments must be submitted on or before February 10, 1994.
ADDRESSES: Comments should be sent to the Secretariat, Commodity
Futures Trading Commission, 2033 K Street, NW., Washington, DC 20581.
Reference should be made to ``Generic Risk Disclosure--Advance
Notice.''
FOR FURTHER INFORMATION CONTACT: Jane C. Kang, Esq., or Robert H.
Rosenfeld, Esq., Division of Trading and Markets, Commodity Futures
Trading Commission, 2033 K Street, NW., Washington, DC 20581; telephone
(202) 254-8955.
SUPPLEMENTARY INFORMATION:
Background
On March 30, 1993, the Commission, among other things, adopted
final rule amendments to Commission rule 1.55(b) which simplified the
risk disclosure process by consolidating the risk disclosure statements
applicable to domestic futures transactions and foreign futures and
foreign commodity options transactions in rules 1.55 and 30.6,
respectively.\1\ The use of such a statement was intended to greatly
simplify the risk disclosure process for U.S. firms conducting cross-
border business.
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\1\58 FR 17496 (April 5, 1993). These amendments also:
--eliminated the requirement that the rule 190.10 disclosure
regarding treatment of non-cash margin be acknowledged by the
customer;
--clarified that the rule 1.55 risk disclosure statement may be
included in a booklet of account opening documents, provided it
appears on the cover page or following the cover page of such
booklet;
--provided that the Commission may approve a risk disclosure
statement that has been approved by a foreign jurisdiction or
foreign SRO for use in lieu of the Commission-required statement;
--permitted the use of a single acknowledgement for rule 1.55
and 33.7 statements and other elections, subject to specified
conditions; and
--simplified the disclosure requirements regarding the bulk
transfer of accounts.
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In response to Commission suggestions in the notice of proposed
rulemaking concerning rule 1.55 that it also was considering the
development of a ``plain language'' options disclosure statement,\2\
some commenters supported that course of action and further suggested
that the Commission not only shorten the rule 33.7 disclosure statement
applicable to exchange-traded commodity option transactions but also
consolidate it with the new combined domestic futures and foreign
futures and foreign commodity options statement. In response, the
Commission noted that certain international regulators were endeavoring
to develop a single risk disclosure statement that could be used in
multiple jurisdictions to satisfy the risk disclosure requirements
applicable to domestic and cross-border transactions in futures and
options. The Commission stated that if a universal statement were to be
developed, it would consider permitting the use of such a statement in
lieu of the new consolidated rule 1.55 risk disclosure statement as
well as the options risk disclosure statement required by current rule
33.7.\3\ Under amended rule 1.55(c), the Commission may permit the
substituted use of a risk disclosure statement approved by a foreign
regulatory or self-regulatory organization if the Commission determines
that such statement reasonably is calculated to provide the disclosure
required by Commission rule 1.55(b).\4\
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\2\See 57 FR 46101, 46108 (October 7, 1992).
\3\58 FR at 17497 and 17502 (April 5, 1993).
\4\58 FR at 17503-17504 (April 5, 1993).
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For some time, a working group\5\ of international regulators
worked towards developing a single risk disclosure statement which
could satisfy the risk disclosure requirements applicable, in the
multiple participating jurisdictions, to domestic and cross-border
transactions in futures and options (``generic disclosure
statement'').\6\ Following extensive discussions, the draft generic
disclosure statement set forth herein was developed and the draft text
was passed to those regulatory authorities (including the CFTC) who
were interested in taking the work forward. The text remains subject to
final discussion and approval by the regulatory authorities of the
participating jurisdictions.
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\5\The working group was composed of representatives from Canada
(Ontario Securities Commission), France (the French Conseil du
Marche a Terme), Switzerland (the Swiss Ministry of Finance), the
United Kingdom (the U.K. Securities and Investments Board, which
chaired the working group), and the United States (the CFTC).
\6\See 58 FR at 17496, 17497 and 17502 (April 5, 1993).
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It is intended that the generic disclosure statement would specify,
in an addendum on a third page, the participating jurisdictions and the
specific products for which it could be used. The addendum would be
updated periodically as new jurisdictions adopted the text. In the
United States, it is contemplated that such risk disclosure statement,
if ultimately proposed and adopted after further public comment, would
satisfy only those risk disclosure obligations set forth in Commission
rules 1.55 (which incorporates the risk-disclosure contained in
Commission rule 30.6),\7\ the special disclosures related to futures-
style margining of options permitted on certain foreign exchanges,\8\
and the special bankruptcy disclosures of Commission rule 190.10(c)
related to the acceptance of non-cash margin.
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\7\The Commission notes in this regard that pending resolution
of the Commission's determination on this draft generic risk
disclosure statement, firms operating pursuant to Commission rule
30.10 relief should continue to comply with the risk disclosure
requirements set forth in the relevant Commission orders and that
for these purposes may continue to use the text of rule 30.6 as
published prior to the 1993 revisions to Commission rules 1.55 and
30.6 (which incorporated the rule 30.6 disclosures for foreign
futures into the rule 1.55 disclosures for domestic futures) (see 58
FR 17496 (April 5, 1993)).
\8\See, e.g., CFTC Advisory No. 90-1 [1987-1990 Transfer Binder]
Comm. Fut. L. Rep. (CCH) 24,597 (disclosure statement relating to
the deferred payment of option premiums for options, superseding
separate disclosure addenda required by orders concerning the London
International Financial Futures Exchange (54 FR 37636 (September 12,
1989)), the International Petroleum Exchange (54 FR 50356 (December
6, 1989)), and the London Futures and Options Exchange (renamed as
the London Commodity Exchange) (54 FR 50348 (December 6, 1989)); and
55 FR 14238 (April 17, 1990) (Sydney Futures Exchange).
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Approach Taken By Working Group
The approach taken by the international working group with respect
to risk disclosure has been to develop a draft generic statement which
focuses on the major risks of trading and contains the basic generic
disclosures required by most jurisdictions.
Thus, the approach of the working group was to eliminate much of
the definitional and educational material which currently is required
to be disclosed by Commission rule 33.7 and to treat options disclosure
in a manner equivalent to disclosure for futures. As such, the
statement is intended to focus customer attention on the risks of
trading, as currently is the practice with futures risk disclosure.
Further, the statement would highlight the importance of obtaining
sufficient information as to the specifics of trading without
attempting to address the differences from market to market.
The elimination of a Commission mandated description of options
trading and other educational material from the mandated risk
disclosure statement does not mean, however, that firms do not have the
obligation to provide all material disclosures in compliance with
Commission and National Futures Association (NFA) rules.\9\
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\9\See, e.g., Commission rule 1.55(d), which provides that: This
section [requiring distribution of a risk disclosure statement] does
not relieve a futures commission merchant or introducing broker from
any other disclosure obligation it may have under applicable law.
See also, NFA Compliance Rule 2-30 (customer information and
risk disclosure).
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Additional Topics
As the working group's objective was not only to create a risk
disclosure statement that categorized existing disclosure requirements
in most jurisdictions but also to incorporate new matters deemed
relevant in an evolving marketplace, the generic statement also
contains the following additional topics.
1. Supporting Systems
The current draft generic disclosure statement would briefly
disclose the fact that most open-outcry and electronic trading
facilities are supported by computer-based component systems, which are
vulnerable to temporary disruption or failure.
2. Electronic Trading
Differences in electronic trading systems are such that a common
disclosure appropriate to the specifics of each such system may not be
feasible and, in the case of domestic contract market electronic
systems, the draft generic disclosure statement would not substitute
for disclosure requirements that currently are required by individual
contract markets for such systems. However, as the purpose of the draft
generic disclosure statement is to articulate general risks common to
futures and options trading, it is possible in the case of electronic
systems to identify the risks common to any such system, such as the
possibility of system failure and that the liability of the system
provider may be limited. No attempt has been made to describe in detail
the specifics of any one system. On the contrary, the proposed
disclosure text encourages the customer to ask the firm with which it
is dealing for details in this respect.
3. Off-Exchange Trading
The draft generic disclosure statement also contains a reference to
the risks of off-exchange trading. The international working group
drafting the consolidated disclosure statement concluded that such a
provision, if worded appropriately, would not mislead or confuse
customers in those jurisdictions which, for example, do not permit
retail customers to participate in off-exchange markets.
Request For Comment
The Commission is inviting public comment and suggestions generally
on the draft text of the generic risk disclosure statement so that any
material public concerns can be considered by the Commission. The
Commission also requests public comment on whether the use of a generic
disclosure statement to substitute for current disclosures contained in
rules 1.55, 33.7, 190.10 and Commission orders and Advisories regarding
disclosures related to futures-style margining of option premiums
allowed by certain foreign exchanges would be most useful if made
mandatory for certain categories of registrants, and if so, which
categories should be included, and whether use should be limited to
firms doing cross-border business or more broadly available.
Text of Draft Generic Risk Disclosure Statement
Risk Disclosure Statement for Futures and Options
This brief statement does not disclose all of the risks and other
significant aspects of trading in futures and options. In light of the
risks, you should undertake such transactions only if you understand
the nature of the contracts (and contractual relationships) into which
you are entering and the extent of your exposure to risk. Trading in
futures and options is not suitable for many members of the public. You
should carefully consider whether trading is appropriate for you in
light of your experience, objectives, financial resources and other
relevant circumstances.
Futures
1. Effect of ``Leverage'' or ``Gearing''
Transactions in futures carry a high degree of risk. The amount of
initial margin is small relative to the value of the futures contract
so that transactions are ``leveraged'' or ``geared.'' A relatively
small market movement will have a proportionately larger impact on the
funds you have deposited or will have to deposit: this may work against
you as well as for you. You may sustain a total loss of initial margin
funds and any additional funds deposited with the firm to maintain your
position. If the market moves against your position or margin levels
are increased, you may be called upon to pay substantial additional
funds on short notice to maintain your position. If you fail to comply
with a request for additional funds within the time prescribed, your
position may be liquidated at a loss and you will be liable for any
resulting deficit.
2. Risk-reducing Orders or Strategies
The placing of certain orders (e.g. ``stop-loss'' orders, where
permitted under local law, or ``stop-limit'' orders) which are intended
to limit losses to certain amounts may not be effective because market
conditions may make it impossible to execute such orders. Strategies
using combinations of positions, such as ``spread'' and ``straddle''
positions may be as risky as taking simple ``long'' or ``short''
positions.
Options
3. Variable Degree of Risk
Transactions in options carry a high degree of risk. Purchasers and
sellers of options should familiarize themselves with the type of
option (i.e. put or call) which they contemplate trading and the
associated risks. You should calculate the extent to which the value of
the options must increase for your position to become profitable,
taking into account the premium and all transaction costs.
The purchaser of options may offset or exercise the options or
allow the options to expire. The exercise of an option results either
in a cash settlement or in the purchaser acquiring or delivering the
underlying interest. If the option is on a future, the purchaser will
acquire a futures position with associated liabilities for margin (see
the section on Futures above). If the purchased options expire
worthless, you will suffer a total loss of your investment which will
consist of the option premium plus transaction costs. If you are
contemplating purchasing deep-out-of-the-money options, you should be
aware that the chance of such options becoming profitable ordinarily is
remote.
Selling (``writing'' or ``granting'') an option generally entails
considerably greater risk than purchasing options. Although the premium
received by the seller is fixed, the seller may sustain a loss well in
excess of that amount. The seller will be liable for additional margin
to maintain the position if the market moves unfavorably. The seller
will also be exposed to the risk of the purchaser exercising the option
and the seller will be obligated to either settle the option in cash or
to acquire or deliver the underlying interest. If the option is on a
future, the seller will acquire a position in a future with associated
liabilities for margin (see the section on Futures above). If the
option is ``covered'' by the seller holding a corresponding position in
the underlying interest or a future or another option, the risk may be
reduced. If the option is not covered, the risk of loss can be
unlimited.
Certain exchanges in some jurisdictions permit deferred payment of
the option premium, exposing the purchaser to liability for margin
payments not exceeding the amount of the premium. The purchaser is
still subject to the risk of losing the premium and transaction costs.
When the option is exercised or expires, the purchaser is responsible
for any unpaid premium outstanding at that time.
Additional Risks Common to Futures and Options
4. Terms and Conditions of Contracts
You should ask the firm with which you deal about the terms and
conditions of the specific futures or options which you are trading and
associated obligations (e.g. the circumstances under which you may
become obligated to make or take delivery of the underlying interest of
a futures contract and, in respect of options, expiration dates and
restrictions on the time for exercise). Under certain circumstances the
specifications of outstanding contracts (including the exercise price
of an option) may be modified by the exchange or clearing house to
reflect changes in the underlying interest.
5. Suspension or Restriction of Trading and Pricing Relationships
Market conditions (e.g. illiquidity) and/or the operation of the
rules of certain markets (e.g. the suspension of trading in any
contract or contract month because of price limits or ``circuit
breakers'') may increase the risk of loss by making it difficult or
impossible to effect transactions or liquidate/offset positions. If you
have sold options, this may increase the risk of loss.
Further, normal pricing relationships between the underlying
interest and the future, and the underlying interest and the option may
not exist. This can occur when, for example, the futures contract
underlying the option is subject to price limits while the option is
not. The absence of an underlying reference price may make it difficult
to judge ``fair'' value.
6. Deposited Cash and Property
You should familiarize yourself with the protections accorded money
or other property you deposit for domestic and foreign transactions,
particularly in the event of a firm insolvency or bankruptcy. The
extent to which you may recover your money or property may be governed
by specific legislation or local rules. In some jurisdictions, property
which had been specifically identifiable as your own will be pro-rated
in the same manner as cash for purposes of distribution in the event of
a shortfall.
7. Commission and Other Charges
Before you begin to trade, you should obtain a clear explanation of
all commission, fees and other charges for which you will be liable.
These charges will affect your net profit (if any) or increase your
loss.
8. Transactions in Other Jurisdictions
Transactions on markets in other jurisdictions, including markets
formally linked to a domestic market, may expose you to additional
risk. Such markets may be subject to regulation which may offer
different or diminished investor protection. Before you trade you
should enquire about any rules relevant to your particular
transactions. Your local regulatory authority will be unable to compel
the enforcement of the rules of regulatory authorities or markets in
other jurisdictions where your transactions have been effected. You
should ask the firm with which you deal for details about the types of
redress available in both your home jurisdiction and other relevant
jurisdictions before you start to trade.
9. Currency Risks
The profit or loss in transactions in foreign currency-denominated
contracts (whether they are traded in your own or another jurisdiction)
will be affected by fluctuations in currency rates where there is a
need to convert from the currency denomination of the contract to
another currency.
10. Trading Facilities
Most open-outcry and electronic trading facilities are supported by
computer-based component systems for the order-routing, execution,
matching, registration or clearing of trades. As with all facilities
and systems, they are vulnerable to temporary disruption or failure.
11. Electronic Trading
Trading on an electronic trading system may differ not only from
trading in an open-outcry market but also from trading on other
electronic trading systems. If you undertake transactions on an
electronic trading system, you will be exposed to risks associated with
the system including the failure of hardware and software. The result
of any system failure may be that your order is either not executed
according to your instructions or is not executed at all. Your ability
to recover certain losses which are particularly attributable to
trading on a market using an electronic trading system may be limited
to less than the amount of your total loss. Limits on liability may be
imposed by the system provider, the market, the clearing house and/or
member firms. Such limits may vary: You should ask the firm with which
you deal for details in this respect.
12. Off-exchange Transactions
In some jurisdictions, and only then in restricted circumstances,
firms are permitted to effect off-exchange transactions. The firm with
which you deal may be acting as your counterparty to the transaction.
It may be difficult or impossible to liquidate an existing position, to
assess the value, to determine a fair price or to assess the exposure
to risk. For these reasons, these transactions may involve increased
risks.
Off-exchange transactions may be less regulated or subject to a
separate regulatory regime. Before you undertake such transactions, you
should familiarize yourself with applicable rules.
This disclosure document meets the risk disclosure requirements in
the jurisdictions identified below ONLY for those instruments which are
specified:
Jurisdiction ``A'':
futures
options on futures
Jurisdiction ``B'':
futures
options on futures
options on commodities
Jurisdiction ``C'':
futures
options on futures
options on equities
etc.
Issued in Washington, DC. on January 5, 1994 by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 94-608 Filed 1-10-94; 8:45 am]
BILLING CODE 6351-01-P
