[Federal Register Volume 60, Number 239 (Wednesday, December 13, 1995)]
[Proposed Rules]
[Pages 63994-64000]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-30360]
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[[Page 63995]]
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
Minimum Financial Requirements, Prepayment of Subordinated Debt
and Gross Collection of Exchange-Set Margin for Omnibus Accounts
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rules.
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SUMMARY: The Commodity Futures Trading Commission (Commission) proposes
to amend: (1) Rules 1.17(a)(1)(i) and (ii) to (a) increase the minimum
required dollar amount of adjusted net capital for futures commission
merchants (FCMs) from $50,000 to $250,000, (b) increase the minimum
required dollar amount of adjusted net capital for introducing brokers
(IBs) from $20,000 to $30,000, and (c) make the amount of adjusted net
capital required by a registered futures association for its member
FCMs and IBs an element of the Commission's minimum financial
requirements for FCMs and IBs; (2) Rule 1.17(h)(2)(vii) with respect to
the procedure to obtain approval for prepayment of subordinated debt;
and (3) Rule 1.58, which governs gross collection of exchange-set
margins for omnibus accounts, to make it applicable to omnibus accounts
carried by FCMs for foreign brokers. The Commission believes that these
amendments will conform the Commission's rules with those of industry
self-regulatory organizations (SROs) and therefore should not require
changes in the operations of most firms.
DATES: Comments on the proposed amendments must be received on or
before January 12, 1996.
ADDRESSES: Comments should be sent to Jean A. Webb, Secretary of the
Commission, Commodity Futures Trading Commission, 1155 21st Street, NW,
Washington, DC 20581. Please refer to ``Financial Rule Amendments.''
FOR FURTHER INFORMATION CONTACT: Lawrence B. Patent, Associate Chief
Counsel, Division of Trading and Markets, Commodity Futures Trading
Commission, 1155 21st Street, NW, Washington, DC 20581. Telephone:
(202) 418-5439.
SUPPLEMENTARY INFORMATION:
I. Minimum Financial Requirements
A. Minimum Financial Requirements for FCMs
Rule 1.17(a)(1)(i) requires FCMs to maintain adjusted net capital
equal to or in excess of the greatest of: (1) $50,000, (2) four percent
of the sum of the amount of funds required to be segregated under
Section 4d(2) of the Commodity Exchange Act (Act) 1(i.e., for
trading in U.S. markets) and the amount of funds required to be set
aside under Commission Rule 30.7 2 for customers trading foreign
markets (referred to as the ``secured amount''); or (3) if an FCM is
also registered as a securities broker-dealer, the amount of net
capital required by the Securities and Exchange Commission (SEC).3
The $50,000 minimum dollar requirement was established in 1978
4and has remained unchanged. On August 27, 1990, the Commission
approved amendments to Rule 201 of the Chicago Board of Trade (CBT) and
Section 1 of NFA's Financial Requirements increasing their respective
FCM members' minimum adjusted net capital requirement to
$250,000.5 The NFA proposed the minimum adjusted net capital
increase based upon the growth in trading volume in the
industry,6the increase in segregated funds per FCM 7and the
decrease in the value of the dollar that had occurred since 1978. The
Commission approved these amendments to provide FCM customers with the
same degree of protection that was provided by the $50,000 minimum
adjusted net capital requirement when it was originally adopted in
1978.
\1\ 7 U.S.C. 6d(2) (1994).
\2\ 17 CFR 30.7 (1995).
\3\ Commission Rule 170.15 mandates that each person required to
register as an FCM become and remain a member of a futures
association which provides for the membership therein of such FCM
unless there is no registered futures association. National Futures
Association (NFA) is the only registered futures association. It has
an FCM membership category and virtually all FCMs are NFA members.
However, there are approximately 90 firms registered as FCMs (out of
a total of approximately 260) that do not handle customer funds and
therefore are not required to register as FCMs. Accordingly, these
firms are not required to be NFA members pursuant to Commission Rule
170.15 but almost all of them are NFA members anyway. However, there
still are approximately ten registered FCMs that are not members of
any SRO and thus have a current minimum dollar adjusted net capital
requirement of $100,000 under Commission Rule 1.17(a)(1)(i)(A).
Since such a small number of firms are in this category, for ease of
discussion we shall assume that all registered FCMs currently have a
minimum dollar requirement of adjusted net capital of $50,000 under
Commission rules.
\4\ See 43 FR 39956 (September 8, 1978).
\5\ On November 24, 1992, the SEC also adopted rule amendments
to raise its minimum net capital requirement for securities broker-
dealers holding customer funds, which had been $25,000, to $250,000
in stages. The requirement increased to $100,000 effective July 1,
1993, $175,000 effective January 1, 1994 and to the current level of
$250,000 effective July 1, 1994. See 57 FR 56973, 56990 (Dec. 2,
1992); 17 CFR Sec. 240.15c3-1e(a)(1995).
\6\ This trend has continued. In fiscal year 1990, 334.2 million
futures and option contracts were traded on U.S. contract markets,
and that number increased more than 50 percent in the last five
years to approximately 504.8 million in fiscal year 1995.
\7\ In NFA's 1990 submission, it noted that the average amount
of funds in segregation at each FCM more than tripled from 1980 to
1985, increasing from $8.7 million to $28.5 million. That amount
more than tripled again in the last ten years and now exceeds $100
million.
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Pursuant to paragraph (a)(2) of Commission Rule 1.17, the
Commission's minimum financial requirements are not applicable to a
registrant that is a member of an SRO and that conforms to the minimum
financial standards set by such SRO. As noted above, all persons
required to register as FCMs are required to be NFA members under
Commission Rule 170.15. Consequently, when the Com-mission approved
NFA's amendment of the minimum dollar amount of adjusted net capital
required of its member FCMs in 1990, the Commission effectively raised
the dollar level of minimum adjusted net capital for all FCMs to
$250,000.
The Commission nonetheless believes that raising the required
minimum dollar amount of adjusted net capital for FCMs under Commission
Rule 1.17 to that required by NFA and CBT for their members is
necessary and appropriate for the following reasons. Section 8c(a)(1)
of the Act, 7 U.S.C. 12c(a)(1) (1994), authorizes the Commission to
discipline a member of an exchange in accordance with the rules of that
exchange if the exchange fails to do so. Section 17(l)(1) of the Act, 7
U.S.C. 21(1)(1) (1994), authorizes the Commission to suspend a
registered futures association that has failed to enforce compliance
with its own rules. However, the Commission does not have the authority
to discipline an exchange member for violation of an exchange rule in
the absence of the exchange's failure to act, or to enforce compliance
with a registered futures association's own rule upon a member thereof.
This limitation upon the Commission's enforcement remedies in the
context of SRO rules does not, of course, exist in the context of
violations of the Act or Commission regulations. Section 6c of the Act,
7 U.S.C. 13a-1 (1994), authorizes the Commission, whenever it appears
that a person has engaged, is engaging, or is about to engage in any
act or practice constituting a violation of any provision of the Act or
any rule or regulation thereunder, to bring an action to enjoin such
act or practice, or to enforce compliance with the Act or any rule or
regulation thereunder.
The proposed amendment to Rule 1.17(a)(1)(i)(A) thus would permit
the Commission to use its authority under Section 6c of the Act to
enforce
[[Page 63996]]
compliance with what is effectively, for the reasons discussed above,
the current minimum adjusted net capital requirement applicable to FCMs
with the benefit of all of the remedies available to it under the Act
for the enforcement of compliance with any provision of the Act and any
rule promulgated thereunder. In addition, this amendment would
harmonize the Commission's minimum dollar requirement for FCMs with the
prevailing standards established by NFA rules and support the objective
of assuring that FCMs have a substantial base of liquid capital from
which to meet their obligations to customers, an objective for which an
increased requirement appears appropriate given the increase in the
amount of funds held by FCMs and the change in the value of the dollar
since 1978.
The Commission believes it is necessary to clarify its authority to
require the transfer of positions at such time as a firm is no longer
in compliance with the NFA rule. The Commission further believes that a
base minimum adjusted net capital requirement of $250,000 is now
essential to providing both an adequate stake in doing business in
accordance with Commission rules and otherwise to provide a cushion
sufficient with applicable haircuts and segregation of customer funds
to permit the Commission to act in an emergency.
The Commission also believes that the rule amendment is necessary to
eliminate any confusion that may have existed as to whether the
Commission could take action where an FCM's adjusted net capital is
below $250,000 yet still exceeds $50,000.
Accordingly, the Commission is proposing to amend Rule
1.17(a)(1)(i)(A) to increase the minimum dollar amount of adjusted net
capital for FCMs to $250,000.8 In light of the amount of the
proposed increase and the fact that, unlike the situation in 1978, very
few FCMs are not members of any SRO and that those few FCMs in that
category cannot handle customer funds, the Commission sees no need to
maintain a higher dollar amount of required adjusted net capital for an
FCM that is not a member of any SRO. In any event, such FCMs would have
an increase in their adjusted net capital requirement from the current
$100,000 to the proposed $250,000 that would apply to all FCMs.
\8\ The Commission believes, for the reasons discussed above,
that an increase from $50,000 to $250,000 is necessary and that it
is unnecessary to phase this in over time as the SEC did in that
most firms already meet the NFA requirement. The Commission also
notes that when it adopted the current $50,000 standard in 1978,
that was also a five-fold, one-step increase in the existing
standard of $10,000 of working capital originally adopted by the
Commission's predecessor agency, the Commodity Exchange Authority,
effective March 17, 1969. 34 FR 599 (Jan. 16, 1969).
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The Commission further notes that several provisions of the
Commission's minimum financial rules for FCMs, as well as one provision
of the financial early warning system, contain cross-references to Rule
1.17(a)(1)(i)(A). Certain actions are restricted or required if the
specified levels of adjusted net capital, which in all cases exceed 100
percent of the minimum dollar amount, are breached. These include Rule
1.17(e)(1)(i) (restricting the withdrawals of equity capital as well as
the following paragraphs of Rule 1.17 concerning subordinated debt:
paragraph (h)(2)(vi)(C)(1) (restricting the parties to a secured demand
note (SDN) agreement from providing in such agreement that the unpaid
principal amount of an SDN can be reduced below a floor amount if the
value of collateral securing the SDN declines below the unpaid
principal amount); paragraphs (h)(2)(vii)(A)(1) and (B)(1) (restricting
prepayments and special prepayments); (h)(2)(viii)(A)(1) (requiring
suspension of repayment); (h)(3)(ii)(A) (requiring notice of maturity
or accelerated maturity); and (h)(3)(v)(A) (restricting use of
temporary subordinations). In addition, Rule 1.12(b)(1) establishes the
``early warning'' minimum dollar level of adjusted net capital as 150
percent of the minimum dollar requirement, triggering notice and
follow-up reporting requirements when an FCM's adjusted net capital is
below that level. Even though the Commission is not amending the
provisions of Rules 1.12 and 1.17 that cross-reference Rule
1.17(a)(1)(i)(A), the proposed amendment of the latter will have a
corresponding impact on the various FCM activities or obligations
referred to above.9
\9\ For example, equity capital withdrawals from an FCM
currently cannot reduce the FCM's adjusted net capital below $60,000
(120 percent of the minimum amount); if the amendment proposed
herein to Rule 1.17(a)(1)(i)(A) were adopted, equity capital
withdrawals would not be permitted to reduce the FCM's adjusted net
capital below $300,000. Similarly, the ``early warning'' level of
adjusted net capital would increase from $75,000 to $375,000 despite
the fact that Rule 1.12(b)(1) itself would not be amended.
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The Commission held a roundtable on capital on September 18, 1995
where several issues were discussed pertaining to minimum financial
requirements. One of the issues discussed was whether the second prong
of the current requirement, based upon four percent of the sum of
segregated customer funds and the secured amount, should be amended in
an effort to make an FCM's minimum adjusted net capital requirement
reflect more closely the risks to an FCM caused by carrying open
positions. The Commission may address that issue in a subsequent
release following a review of empirical data being developed by the
SROs but is not prepared to do so at this time.
B. Minimum Financial Requirements for IBs
Rule 1.17 also requires introducing brokers (IBs) 10 to
maintain certain prescribed minimum amounts of adjusted net capital.
Pursuant to Rule 1.17(a)(1)(ii), each person registered as an IB must
maintain adjusted net capital equal to or in excess of the greater of:
(A) $20,000 ($40,000 for each person registered as an IB who is not a
member of an SRO); 11 or, (B) if the IB is also a securities
broker-dealer, the amount of net capital required by the SEC.
\10\ Section 1a(14) of the Act, 7 U.S.C. 1a(14)(1994), defines
an IB as ``any person (except an individual who elects to be and is
registered as an associated person of [an FCM]) engaged in
soliciting or in accepting orders for the purchase or sale of any
commodity for future delivery on or subject to the rules of any
contract market who does not accept any money, securities or
property (or extend credit in lieu thereof) to margin, guarantee, or
secure any trades or contracts that result or may result
therefrom.'' Commission Rule 1.3(mm), 17 CFR 1.3(mm) (1995), also
includes in the definition of an IB any person required to register
as such by virtue of Part 33 of the Commission's rules, 17 CFR Part
33 (1995).
\11\ As is the case with FCMs discussed above, virtually all
registered IBs are members of NFA. Any IB that is registered but not
an NFA member would be precluded from introducing customer accounts
to an FCM and thus could not act as an IB.
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On October 6, 1992, the Commission approved NFA rule amendments
which, among other things, increased the required minimum dollar amount
of adjusted net capital for member IBs from $20,000 to $30,000.
However, the Commission did not at that time amend Commission Rule
1.17(a)(1)(ii)(A) to conform to NFA's rule amendment. The Commission
believes that since it is now proposing to raise the minimum dollar
amount of required adjusted net capital for FCMs as discussed above, it
is appropriate also to propose an increase in the required minimum
dollar amount of adjusted net capital for IBs. Accordingly, the
Commission is proposing to amend Rule 1.17(a)(1)(ii)(A) to raise the
minimum dollar amount of required net capital for a registered IB to
$30,000. For reasons similar to those discussed above concerning FCMs,
the Commission would eliminate any higher requirement for an IB that is
not a member of an SRO.
[[Page 63997]]
This proposed amendment, like the proposal applicable to FCMs,
would conform the Commission's rule to the general industry standard
established by NFA. Therefore, there should be essentially no impact on
the operations of IBs as a result of this amendment. In any event, the
proposed amendment would only affect the minority of IBs who raise
their own capital. Those IBs who have entered into guarantee agreements
with FCMs would be unaffected by the proposed amendment.12
\12\ More than two-thirds of IBs enter into guarantee agreements
with FCMs in accordance with Commission Rules 1.17(a)(2)(ii) and
1.10(j) in lieu of raising their own capital.
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C. Conforming Commission and Registered Futures Association Rules
The Commission also approved NFA rule amendments on October 6, 1992
which provide that a member IB's minimum adjusted net capital
requirement, as well as that of a member FCM, can be determined by the
number of offices it operates and the number of APs it sponsors.13
When NFA presented these provisions to the Commission, NFA stated that
the amount of the IB minimum financial requirement should be linked to
the size of an IB's operation and that it concluded, after studying
several factors related to an IB's business, that the number of offices
operated or APs sponsored by an IB were the most relevant factors to be
used in a formula establishing an IB's minimum financial requirement.
NFA also stated that an FCM's minimum financial requirement should
parallel that of an IB in this regard.14 The Commission believes
that it should incorporate the NFA standards concerning the number of
offices or APs sponsored into the minimum financial requirements for
FCMs and IBs in Rule 1.17, and eliminate the necessity to amend Rule
1.17 each time NFA amends its minimum financial requirements in order
to avoid a recurrence of the current situation where NFA's minimum
dollar amount of adjusted net capital for an FCM is $250,000 and the
Commission's minimum is $50,000. Therefore, the Commission is proposing
to redesignate paragraphs (a)(1)(i)(C) and (a)(1)(ii)(B) as paragraphs
(a)(1)(i)(D) and (a)(1)(ii)(C), respectively, of Rule 1.17, and to add
new paragraphs (a)(1)(i)(C) and (a)(1)(ii)(B) that would provide that
``the amount of adjusted net capital required by a registered futures
association of which it is a member'' is an element of the Commission's
minimum financial requirement for FCMs and IBs. The Commission is also
proposing conforming amendments to the early warning level of adjusted
net capital for FCMs,15 the restriction on withdrawals of equity
capital and the various provisions of Rule 1.17(h) discussed above
concerning subordinated debt.16
\13\ Section 9 of NFA's Financial Requirements is entitled
``Introducing Broker Financial Requirements'' and provides as
follows:
Each Member IB, except an IB operating pursuant to a guarantee
agreement which meets the requirements set forth in CFTC Regulation
1.10(j), must maintain ``Adjusted Net Capital'' (as defined in
Schedule A hereto) equal to or in excess of the greatest of:
(i) $30,000; or,
(ii) $6,000 per office operated by the IB (including the main
office); or,
(iii) $3,000 for each AP sponsored by the IB; or
(iv) (for securities brokers and dealers), the amount of net
capital required by Rule 15c3-1(a) of the Securities and Exchange
Commission (17 CFR 240.15c3-1(a)).
The corresponding provision for an FCM with respect to offices
and APs is based upon ``$6,000 for each remote location operated
(i.e., proprietary branch offices, main office of each guaranteed IB
and branch offices of each guaranteed IB); or, $3,000 for each AP
sponsored (including APs sponsored by guaranteed IBs).'' Section 1
of NFA's Financial Requirements.
\14\ According to discussions with NFA staff, there are
currently less than ten FCMs and less than ten IBs whose minimum
financial requirement is based upon the number of offices operated
or APs sponsored. As of September 30, 1995, of the registered IBs,
1,080 operated pursuant to guarantee agreements with an FCM and 388
were raising their own capital.
\15\ See proposed new paragraph (b)(3) of Rule 1.12, which is
based upon 150% of the amount of adjusted net capital required by a
registered futures association, and is proportional to the other
elements of Rule 1.12(b).
\16\ See the following proposed new Rule 1.17(e)(1)(iii) and the
proposed new paragraphs of Rule 1.17: (h)(2)(vi)(C)(3) (restricting
reductions in unpaid principal amount of an SDN); (h)(2)(vii)(A)(3)
(restricting prepayments); (h)(2)(vii)(B)(3) (restricting special
prepayments); (h)(2)(viii)(A)(3) (requiring suspension of
repayment); (h)(3)(ii)(C) (requiring notice of maturity or
accelerated maturity); and (h)(3)(v)(C) (restricting use of
temporary subordinations). The levels of adjusted net capital set
forth in the proposed new paragraphs of Rule 1.17 are 120 percent of
the registered futures association's minimum amount, except for the
provision concerning special prepayment which would be 200 percent.
These percentages correspond to the current levels in those rules
that are based upon the minimum dollar amount.
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II. Prepayment of Subordinated Debt
For purposes of computing net capital, debt covered by
``satisfactory subordinated agreements'' can be excluded from
liabilities.17 Rule 1.17(h)(2)(vii)(A) generally prohibits any
prepayment of subordinated debt for one year following the date upon
which the governing subordination agreement became effective. However,
Rule 1.17(h)(2)(vii)(B) permits special prepayment of subordinated debt
at any time (even during the first year) provided that, after giving
effect thereto, the applicant's or registrant's adjusted net capital
does not fall below certain amounts prescribed in the rule, which are
approximately one and one-half times the amounts of capital required
for a normal prepayment. In addition, no prepayment and no special
prepayment may occur unless the registrant has obtained written
approval of its designated self-regulatory organization (DSRO), if any,
and the Commission.18
\17\ See Commission Rule 1.17(h) for a definition of the term
``satisfactory subordination agreement''.
\18\ An applicant for registration must obtain prior written
approval of NFA.
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On September 10, 1985, the Commission's Division of Trading and
Markets (Division) advised all registered IBs, FCMs and SROs of its
intention to recommend to the Commission that Rule 1.17(h)(2)(vii) be
changed to require only the DSRO's approval for prepayment of
subordinated debt.19 ``The requirement for dual approval has been
in effect for approximately seven years'', the Division stated,
``[d]uring [which] time, the DSROs have gained greater familiarity
regarding subordinated debt and * * * have demonstrated * * * an
ability to work together in the area of financial surveillance.'' This
change would ``make the treatment of prepayment of subordinated debt
consistent with the treatment of approval of new subordinated debt or
amendments to subordinated agreements.''
\19\ CFTC Interpretative Letter No. 85-17, [1984-1986 Transfer
Binder] Comm. Fut. L. Rep. (CCH) para.22,738 (Sept. 10, 1985).
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The Commission is proposing to implement the change contemplated in
Interpretative Letter No. 85-17 by amending Rule 1.17(h)(2)(vii) to
require submission of a request for approval of prepayment of
subordinated debt by a registrant to the DSRO only, if any, or to the
Commission in those rare instances where the registrant is not an SRO
member. Dual approval by the DSRO and the Commission would be required,
however, should the requested prepayment or special prepayment result
in a reduction of 20 percent or more of the registrant's adjusted net
capital. Therefore, if a firm's subordinated debt amounts to 25 percent
of its adjusted net capital and the firm wishes to prepay all of it and
simultaneously enter into new subordinated debt arrangements for the
same amount, but at a different maturity or interest rate, dual
approval would not be required since there would be no net effect on
the firm's adjusted net capital. Similarly, if a firm wanted to convert
subordinated debt to paid-in-capital, dual approval would not be
required so
[[Page 63998]]
long as such conversion did not result in a reduction of 20 percent or
more of the firm's adjusted net capital.
III. Gross Collection of Exchange-Set Margins
Pursuant to Commission Rule 1.58, each FCM which carries a
commodity futures or commodity option position for another FCM on an
omnibus basis must collect, and each FCM for which an omnibus account
is being carried must deposit, initial and maintenance margin on each
position reported in accordance with Commission Rule 17.04 at a level
no less than that established for customer accounts by the rules of the
applicable contract market. Rule 1.58 was proposed in 1981 20
following the bankruptcy of three FCMs who cleared trades solely by
means of omnibus accounts. The Commission was concerned that customer
funds were ``being held by firms that, in comparison to clearing FCMs,
generally [had] less capital and [were] less equipped to handle the
volatility of the commodity markets''.21 It is also the case, as
demonstrated during the collapse of Barings PLC, that net margining of
an omnibus account can mask risk to the clearing member. Thus, the
primary purposes of Rule 1.58 were to ``strengthen the industry and
enhance customer protection by moving segregated funds into the
normally better-capitalized hands of a clearing member'' and to provide
the Commission and the SROs with better information with respect to
omnibus accounts.22
\20\ 46 FR 62864 (Dec. 29, 1981).
\21\ Id.
\22\ 47 FR 21026 (May 17, 1982).
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As originally adopted and currently, Rule 1.58 does not apply to
omnibus accounts carried by FCMs on behalf of foreign brokers.23
On November 16, 1988, the Division issued Financial and Segregation
Interpretation No. 12 which, among other things, requires FCMs to
obtain an agreement from customers who desire to have funds held
offshore whereby such customers authorize the subordination of their
claims attributable to funds held offshore to the claims of other
customers should the FCM be placed in bankruptcy or receivership.
Although the Commission is in the process of reviewing this
Interpretation from the perspective of certain foreign currency
deposits in light of the provisions for settlement of certain contracts
traded on U.S. contract markets by means of foreign currency, certain
statements made relative to foreign location risk remain relevant
today. For example, in support of this Interpretation, the Commission
expressed its concern that ``in the event of an FCM insolvency,
deposits maintained at a foreign depository might not be handled or
distributed in accordance with United States bankruptcy law'' and that
``both the size of the pool of funds available for distribution to
customers and the size of individual claims against that pool may vary
from day-to-day.'' The Commission further stated that ``to the extent
foreign domiciled customers deposit [U.S.] dollars in connection with
United States futures or options, such funds should be held in the
United States'' because ``the Commission perceives no administrative
necessity for FCMs and customers to incur the location risks attendant
to holding such dollar deposits overseas''.24 Likewise, the
Commission is concerned that margin deposits maintained by a foreign
broker at a foreign depository might become unavailable in the event of
a bankruptcy of the clearing FCM due to differences in bankruptcy law
among jurisdictions and might be exposed to currency fluctuations
during the pendency of the bankruptcy. In addition, the Commission has
observed that in times of turbulent markets, such as occurred in
October 1987 and October 1989, accounts in the names of owners with
foreign addresses had greater difficulty meeting margin calls than did
domestic accounts, undoubtedly to some extent due to time zone
differences and currency conversion logistics.25 In this context,
the Commission has recognized that foreign brokers' omnibus accounts
carried by clearing FCMs can have a substantial impact on the financial
condition of clearing FCMs. Further, as a result of the collapse of
Barings PLC in February 1995, the Commission's concern has been
heightened with respect to FCMs having a clear view of the exposures in
omnibus accounts and the ability to assure proper handling and
segregation of customer funds.
\23\ Neither the proposing release nor the adopting release for
Rule 1.58 discuss omnibus accounts carried on behalf of foreign
brokers.
\24\ See 53 FR 46911 (Nov. 21, 1988), reprinted in 1 Comm. Fut.
L. Rep. (CCH) para. 7122.
\25\ See Final CFTC Staff Report, Stock Index Futures and Cash
Market Activity--October 1987, at pp. 192-193 (Jan. 1988) (reprinted
in Comm. Fut. L. Rep. (CCH), Special Report No. 321, Feb. 5, 1988)
and Commodity Futures Trading Commission, Division of Economic
Analysis, Report on Stock Index Futures and Cash Market Activity
During October 1989 to the U.S. Commodity Futures Trading
Commission, at p. 143 (May 1990).
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In view of the increasing internationalization of the financial
markets, and in particular the increasing use of foreign omnibus
accounts, the Commission believes that foreign broker omnibus accounts
should be treated in the same manner as omnibus accounts carried for
domestic FCMs. Thus, FCMs carrying foreign broker omnibus accounts
would hold a higher level of funds, have less capital exposure and be
better able to transfer positions from such accounts in the event of a
financial disruption. Accordingly, the Commission is proposing to
expand the application of Rule 1.58 to include foreign brokers' omnibus
accounts carried by FCMs. As is the case with the proposed amendments
to Rule 1.17 concerning the minimum amount of adjusted net capital for
FCMs and IBs, the Commission is essentially proposing to conform its
rule relating to collection of margins for omnibus accounts to the
industry practice since, as a result of staff recommendations in rule
enforcement reviews and SRO rule changes, all active U.S. contract
markets other than the New York Cotton Exchange and the Philadelphia
Board of Trade require that FCMs collect margin for omnibus accounts of
foreign brokers as well as other domestic FCMs on a gross basis.
IV. Other Matters
As noted above, the Commission held a roundtable on capital issues
on September 18, 1995, during which several matters were discussed.
Although the Commission is not presenting any specific rule proposals
at this time related to issues discussed at the roundtable, the
Commission will be seeking additional information concerning certain of
the issues discussed with a view towards possible additional rule
amendments. These issues would include greater harmonization of the
CFTC/SEC financial requirements in several areas such as reporting
requirements and cycles, early warning requirements,26 risk
assessment data elements and the debt-equity ratio requirements with
respect to a firm's capital.27 The
[[Page 63999]]
Commission is also considering a rethinking of the no-action relief
provided to an FCM by the Division with respect to the short options
value charge,28 and the appropriateness of a concentration charge.
Separately, the Commission has discussed with the Joint Audit Committee
the data necessary to evaluate any proposals for a ``risk-based''
standard as a component of the minimum adjusted net capital
requirements. Although the Commission has no specific proposals in any
of these areas at this time, it nonetheless invites commenters to
address these matters if they so choose.
\26\ The Commission has proposed amendments to its Rule 1.12 to:
(1) make paragraph (g), which requires the reporting of certain
reductions in adjusted net capital, applicable to all FCMs, rather
than just those FCMs subject to the risk assessment reporting
requirements of Rule 1.15; (2) require reporting of a margin call
that exceeds an FCM's excess adjusted net capital which remains
unanswered by the close of business on the day following the
issuance of the call; and (3) require reporting by an FCM whenever
its excess adjusted net capital is less than six percent of the
maintenance margin required to support proprietary and noncustomer
positions carried by the FCM. 59 FR 66822 (Dec. 28, 1994).
\27\ SEC Rule 15c3-1(d) (17 CFR 240.15c3-1(d) (1995)) requires
that at least 30 percent of all of a broker-dealer's net capital
consist of equity capital. See Report of the Technical Committee of
IOSCO, ``Capital Requirements for Multinational Securities Firms,''
XV Annual Conference of the International Organization of Securities
Commissions (IOSCO), Santiago, Chile 1990. The general international
standard in this connection, as recommended by Working Party No. 3
of the Technical Committee of IOSCO, would also apply the debt-
equity requirement to all of a firm's capital. Although the
Commission originally proposed a debt-equity requirement for an FCM
that would have been similar to that of a broker-dealer under SEC
rules (see 42 FR 27166, 27177 (May 26, 1977)), in response to
comments that ``it would be inappropriate to penalize a firm that
maintains capital in the form of satisfactory subordination
agreements, which is in excess of the minimum required by
regulations'', the Commission revised the required debt-equity total
to which the 30 percent equity capital requirement applies to mean
total capital less the excess of the FCM's adjusted net capital,
i.e., only the required minimum adjusted net capital. See 43 FR
39956, 39965, 39976 (Sept. 8, 1978).
\28\ Commission Rule 1.17(c)(5)(iii), 17 CFR 1.17(c)(5)(iii)
(1995); CFTC Interpretative Letter 95-65, [Current Binder] Comm.
Fut. L. Rep. (CCH) para. 26,495 (July 26, 1995).
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V. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA), 5 U.S.C. 601 et seq.,
requires that agencies, in proposing rules, consider the impact of
those rules on small businesses. The rule amendments proposed herein
would affect FCMs and independent IBs. The Commission has previously
determined that, based upon the fiduciary nature of FCM/customer
relationships, as well as the requirement that FCMs meet minimum
financial requirements, FCMs should be excluded from the definition of
small entity.29
\29\ See 47 FR 18618, 18619 (Apr. 30, 1982).
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With respect to IBs, the Commission stated that it is appropriate
to evaluate within the context of a particular rule proposal whether
some or all IBs should be considered to be small entities and, if so,
to analyze the economic impact on such entities at that time.30
The proposed amendment to Rule 1.17(h)(2)(vii) would generally reduce
the burden associated with the procedure to obtain approval for
permissive prepayment of subordinated debt. Accordingly, that amendment
should impose no additional requirements on an independent IB. In
addition, the proposed amendment to the minimum adjusted net capital
requirement for an IB would conform the Commission's requirement to
that of the NFA and therefore there should be no impact on an IB's
financial operations. Thus, if adopted, these proposals would not have
a significant economic impact on a substantial number of IBs.
Therefore, pursuant to Section 3(a) of the RFA, 5 U.S.C. 605(b), the
Chairman certifies that these proposed rule amendments will not have a
significant economic impact on a substantial number of small entities.
\30\ See 48 FR 35248, 35275-78 (Aug. 3, 1983).
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B. Paperwork Reduction Act
The Paperwork Reduction Act of 1990, (PRA) 44 U.S.C. 3501 et seq.,
imposes certain requirements on Federal agencies (including the
Commission) in connection with their conducting or sponsoring any
collection of information as defined by the PRA. While the amendments
proposed herein have no burden,31 Rules 1.12, 1.17 and 1.58 are
parts of groups of rules with the following burdens.
\31\ The proposed increase in the dollar amount of minimum
adjusted net capital for an FCM and an IB would necessitate only a
change in line item 23E of the Statement of the Computation of
Minimum Capital Requirements on Form 1-FR-FCM and in line item 15 of
that Statement on Form 1-FR-IB.
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The burden associated with the collection required by Rules 1.12
and 1.17 (3038-0024), including these proposed amendments, is as
follows:
Average Burden Hours Per Response: 1.50.
Number of FCM Respondents: 165.00.
Number of IB Respondents: 62.00.
Frequency of Response: 1.00.
The burden associated with the collection required by Rule 1.58
(3038-0026), including these proposed amendments, is as follows:
A. Reporting
Average Burden Hours Per Response: 0.04.
Number of Respondents: 100.00.
Frequency of Response: 50.00.
B. Recordkeeping
Average Burden Hours Per Response: 1.00.
Number of Respondents: 300.00.
Frequency of Response: 1.00.
Persons wishing to comment on the estimated paperwork burden
associated with these proposed rule amendments should contact Jeff
Hill, Office of Management and Budget, Room 3228, NEOB, Washington, DC
20503, (202) 395-7340. Copies of the information collection submission
to OMB are available from Joe F. Mink, CFTC Clearance Officer, 1155
21st Street, N.W., Washington, DC 20581, (202) 418-5170.
List of Subjects in 17 CFR Part 1
Commodity futures, minimum financial requirements.
In consideration of the foregoing and pursuant to the authority
contained in the Commodity Exchange Act and, in particular, Sections
4f, 4g and 8a(5) thereof, 7 U.S.C. 6f, 6g and 12a(5), the Commission
hereby proposes to amend Chapter I of Title 17 of the Code of Federal
Regulations as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for Part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f,
6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a,
12c, 13a, 13a-1, 16, 16a, 19, 21, 23 and 24.
2. Section 1.12 is amended by removing the word ``or'' at the end
of paragraph (b)(2), by redesignating paragraph (b)(3) as paragraph
(b)(4), and by adding a new paragraph (b)(3) to read as follows:
Sec. 1.12 Maintenance of minimum financial requirements by futures
commission merchants and introducing brokers.
* * * * *
(b) * * *
(3) 150 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member; or
* * * * *
3. Section 1.17 is amended as follows:
3.1. By revising paragraph (a)(1);
3.2. By removing the word ``or'' at the end of paragraph
(e)(1)(ii), by redesignating paragraph (e)(1)(iii) as (e)(1)(iv), and
by adding a new paragraph (e)(1)(iii);
3.3. By removing the word ``or'' at the end of paragraph
(h)(2)(vi)(C)(2), by redesignating paragraph (h)(2)(vi)(C)(3) as
paragraph (h)(2)(vi)(C)(4), and by adding a new paragraph
(h)(2)(vi)(C)(3);
3.4. By removing the word ``or'' at the end of paragraph
(h)(2)(vii)(A)(2), by redesignating paragraph (h)(2)(vii)(A)(3) as
paragraph (h)(2)(vii)(A)(4) and, as redesignated, revising it, and by
adding a new paragraph (h)(2)(vii)(A)(3);
3.5. By removing the word ``or'' at the end of paragraph
(h)(2)(vii)(B)(2), by redesignating paragraph (h)(2)(vii)(B)(3) as
paragraph (h)(2)(vii)(B)(4) and, as redesignated, revising it, and by
adding new paragraphs (h)(2)(vii)(B)(3) and (h)(2)(vii)(C);
3.6. By removing the word ``or'' at the end of paragraph
(h)(2)(viii)(A)(2), by redesignating paragraph (h)(2)(viii)(A)(3) as
paragraph
[[Page 64000]]
(h)(2)(viii)(A)(4), and by adding a new paragraph (h)(2)(viii)(A)(3);
3.7. By removing the word ``or'' at the end of paragraph
(h)(3)(ii)(B), by redesignating paragraph (h)(3)(ii)(C) as paragraph
(h)(3)(ii)(D), and by adding a new paragraph (h)(3)(ii)(C); and
3.8. By redesignating paragraphs (h)(3)(v) (C) and (D) as
paragraphs (h)(3)(v) (D) and (E) and by adding a new paragraph
(h)(3)(v)(C). The revised and added paragraphs read as follows:
Sec. 1.17 Minimum financial requirements for futures commission
merchants and introducing brokers.
(a)(1)(i) Except as provided in paragraph (a)(2)(i) of this
section, each person registered as a futures commission merchant must
maintain adjusted net capital equal to or in excess of the greatest of:
(A) $250,000;
(B) Four percent of the following amount: The customer funds
required to be segregated pursuant to the Act and these regulations and
the foreign futures or foreign options secured amount, less the market
value of commodity options purchased by customers on or subject to the
rules of a contract market or a foreign board of trade: Provided,
however, That the deduction for each customer shall be limited to the
amount of customer funds in such customer's account(s) and foreign
futures and foreign options secured amounts;
(C) The amount of adjusted net capital required by a registered
futures association of which it is a member; or
(D) For securities brokers and dealers, the amount of net capital
required by Rule 15c3-1(a), of the Securities and Exchange Commission
(17 CFR 240.15c3-1(a)).
(ii) Except as provided in paragraph (a)(2) of this section, each
person registered as an introducing broker must maintain adjusted net
capital equal to or in excess of the greatest of:
(A) $30,000;
(B) The amount of adjusted net capital required by a registered
futures association of which it is a member; or
(C) For securities brokers and dealers, the amount of net capital
required by Rule 15c3-1(a) of the Securities and Exchange Commission
(17 CFR 240.15c3-1(a)).
* * * * *
(e) * * *
(1) * * *
(iii) 120 percent of the amount of adjusted net capital required by
a registered futures association of which it is a member; or
* * * * *
(h) * * *
(2) * * *
(vi) * * *
(C) * * *
(3) 120 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member; or
* * * * *
(vii) * * *
(A) * * *
(3) 120 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member; or
(4) For an applicant or registrant which is also a securities
broker or dealer, the amount of net capital specified in Rule 15c3-
1d(b)(7) of the Securities and Exchange Commission (17 CFR 240.15c3-
1d(b)(7)).
(B) * * *
(3) 120 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member; or
(4) For an applicant or registrant which is also a securities
broker or dealer, the amount of net capital specified in Rule 15c3-
1d(c)(5)(ii) of the Securities and Exchange Commission (17 CFR
240.15c3-1d(c)(5)(ii)): Provided, however, That no special prepayment
shall be made if pre-tax losses during the latest three-month period
were greater than 15 percent of current excess adjusted net capital.
(C) Notwithstanding the provisions of paragraphs (h)(2)(vii)(A) and
(h)(2)(vii)(B) of this section, in the case of an applicant, no
prepayment or special prepayment shall occur without the prior written
approval of the National Futures Association; in the case of a
registrant, if the requested prepayment or special prepayment will
result in the reduction of the registrant's adjusted net capital by 20
percent or more, no prepayment or special prepayment shall occur
without the prior written approval of the designated self-regulatory
organization, if any, and of the Commission, or, if the requested
prepayment or special prepayment will result in the reduction of the
registrant's adjusted net capital by less than 20 percent without the
prior written approval of the designated self-regulatory organization,
if any, or of the Commission if the registrant is not a member of a
self-regulatory organization.
(viii) * * *
(A) * * *
(3) 120 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member; or
* * * * *
(3) * * *
(ii) * * *
(C) 120 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member; or
* * * * *
(v) * * *
(C) 120 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member;
* * * * *
4. Section 1.58 is revised to read as follows:
Sec. 1.58 Gross collection of exchange-set margins.
(a) Each futures commission merchant which carries a commodity
futures or commodity option position for another futures commission
merchant or for a foreign broker on an omnibus basis must collect, and
each futures commission merchant and foreign broker for which an
omnibus account is being carried must deposit, initial and maintenance
margin on each position reported in accordance with Sec. 17.04 of this
chapter at a level no less than that established for customer accounts
by the rules of the applicable contract market.
(b) If the futures commission merchant which carries a commodity
futures or commodity option position for another futures commission
merchant or for a foreign broker on an omnibus basis allows a position
to be margined as a spread position or as a hedged position in
accordance with the rules of the applicable contract market, the
carrying futures commission merchant must obtain and retain a written
representation from the futures commission merchant or from the foreign
broker for which the omnibus account is being carried that each such
position is entitled to be so margined.
Issued in Washington, D.C. on December 7, 1995 by the
Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 95-30360 Filed 12-12-95; 8:45 am]
BILLING CODE 6351-01-P
