[Federal Register Volume 59, Number 40 (Tuesday, March 1, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-4570]
[[Page Unknown]]
[Federal Register: March 1, 1994]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
Risk Assessment for Holding Company Systems
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rules.
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SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or
``Commission'') is proposing for comment rules to implement the risk
assessment provisions of the Futures Trading Practices Act of 1992. The
proposed rules would enhance the Commission's financial surveillance
program by providing the Commission with access to information
concerning the activities of affiliates of registered futures
commission merchants (``FCMs'') whose activities are reasonably likely
to have a material impact on the financial or operational condition of
the FCM. As proposed, these rules would require registered FCMs to
maintain certain records concerning the financial activities of such
material affiliates, to file certain information with the Commission on
an annual and quarterly basis and to provide additional information to
the Commission upon the occurrence of specified events.
DATES: Comments must be received on or before May 2, 1994.
ADDRESSES: Comments on the proposed rules should be sent to Jean A.
Webb, Secretary of the Commission, Commodity Futures Trading
Commission, 2033 K Street, NW., Washington, DC 20581. Reference should
be made to ``Proposed Risk Assessment Rules.''
FOR FURTHER INFORMATION CONTACT: Susan C. Ervin, Deputy Director/Chief
Counsel, Lawrence B. Patent, Associate Chief Counsel, or Lawrence T.
Eckert, Attorney Adviser, Division of Trading and Markets, Commodity
Futures Trading Commission, 2033 K Street, NW., Washington, DC 20581.
Telephone (202) 254-8955.
SUPPLEMENTARY INFORMATION:
I. Background
Following the failures of certain FCMs operating as part of a group
of affiliated companies, the Commission requested and received new
statutory authority, codified in the Futures Trading Practices Act of
1992 (``FTPA''),\1\ to obtain information concerning affiliate
activities that could pose material risks to the FCM. The Commission is
proposing rules to implement this new authority. The proposed rules, in
accordance with the statutory authority granted the Commission,
establish three basic types of risk assessment requirements: (1)
Recordkeeping; (2) reporting to the Commission of certain information
on a routine basis; and (3) reporting to the Commission upon the
occurrence of certain events that warrant further review.
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\1\Pub. L. No. 102-546, 106 Stat. 3590 (1992). The FTPA was
enacted on October 28, 1992.
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First, the proposed rules require that FCMs maintain certain
records. These records concern FCM risk management policies, procedures
and systems and the activities of their affiliates that could result in
material risks to the FCM's financial condition or operations. They
include information concerning on-balance sheet and off-balance
financial activities of the FCM's material affiliates, and consolidated
financial information for the group of companies of which the FCM is a
part.
Second, the proposed rules would require reporting by the FCM to
the Commission, generally on an annual basis unless significant changes
in the reported information occur, of the risk management and affiliate
activity information required to be maintained by the FCM. Aggregate
information concerning the noncustomer accounts carried by the
reporting FCM would be required on a routine quarterly basis. These
routine reporting requirements are designed to facilitate
identification of FCMs whose financial condition or operations may be
affected by their relationships with affiliate firms, to provide
Commission staff background information on the group and its activities
to enable it to better evaluate non-routine reports and permit more
efficient and informed responses by the Commission in emergency
situations, to permit identification of significant changes in the
scope, types and risk of those activities, to permit the Commission to
better understand how the group is funded, and to provide the
Commission with information concerning the types of affiliate
activities that are likely to pose risks to the FCM.
Third, the proposed rules would require that FCMs give notice to
the Commission of certain events such as a decline in the FCM's capital
or losses at a material affiliate exceeding specified thresholds. These
``trigger'' events have been constructed with a view towards providing
the Commission with notice of circumstances likely to warrant further
scrutiny. Upon receipt of such a notice, the Commission may seek
additional information, as warranted in the circumstances, from another
regulator and/or from the FCM. The use of specified events triggering
notice to the Commission is also intended to reduce the need for
routine reports to the Commission without compromising the overall
objectives of the risk assessment program.
The rules contain certain required exemptions for banks and
insurance companies and defer to certain Securities Exchange Act
requirements in the case of broker-dealer FCMs.
Comment is requested concerning all aspects of the proposed rules
and specifically concerning the appropriate balance of routine
reporting requirements, event-specific notice requirements, and use of
statutory special call authority.
A. Current Financial Regulatory Framework
Section 229 of the FTPA, entitled ``Risk Assessment for Holding
Company Systems,'' added new section 4f(c)\2\ to the Commodity Exchange
Act (``CEA'' or ``Act''). Section 4f(c) provides the Commission with
authority to obtain information concerning activities of an FCM's
affiliates that could pose material risks to the FCM. The Commission's
new risk assessment authority augments long-standing provisions of the
CEA and Commission regulations designed to safeguard funds held by FCMs
on behalf of futures customers and to assure that FCMs maintain a
minimum level of capital to support their obligations to customers and
the marketplace on an ongoing basis.
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\2\7 U.S.C. 6f(c) (Supp. IV 1992).
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Section 4d(2) of the CEA and Commission regulations require that
one hundred percent of customer funds and property, that is, all funds
and property deposited to ``margin, guarantee or secure'' futures or
commodity option positions, and all accruals thereon, be maintained for
the exclusive benefit of the depositing customer and segregated from
the funds of the FCM.\3\ The segregation requirement bars the use by an
FCM of one customer's funds for any purpose other than to margin or
secure that customer's trades and facilitates customer recovery on a
first priority basis in the event of the bankruptcy of the FCM. Under
Section 4d(2) and Commission rules, an FCM must always maintain
sufficient funds in segregation to satisfy the claims of all customers
holding accounts with positive net equities. An FCM therefore is
required to add its own funds to the segregated customer funds account
to cover any debit or deficit account balance of any customer by the
close of business on the day the deficit occurs. As a consequence, if
the segregation requirements are satisfied, an FCM's financial failure
generally should not result in a loss of customer funds, and one
customer's withdrawal of funds or failure to satisfy margin demands
should not affect the funds of any other customer.\4\
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\3\7 U.S.C. 6d(2) (1988).
\4\See, generally, Commission Rules 1.20-1.30 and Part 190.
Commission rules referred to herein are found at 17 CFR Ch. I
(1993).
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The CEA and Commission rules requiring that FCMs maintain
regulatory capital at or above specified minimum levels buttress the
security of customer funds and the overall financial integrity of the
futures markets. Minimum capital requirements for FCMs are designed to
assure that futures firms are financially sound and have liquid assets
sufficient to sustain normal market reverses without losses to
customers. The CFTC's financial regulations also establish an ``early
warning'' system to identify firms whose capital levels or other
conditions warrant intensified surveillance. This system requires
notice to the Commission when an FCM's capital falls below 150 percent
of its required minimum capital and when certain other conditions exist
that constitute or could lead to capital impairment or other financial
deficiencies.\5\
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\5\Commission rules require, for example, that an FCM provide
notice to the Commission if the FCM fails to keep current books and
records, is notified by an independent public accountant of a
material inadequacy under Rule 1.16(d)(2), becomes subject to
trading restrictions for failure to meet a margin call or determines
that it is carrying an account that is undermargined by an amount
exceeding its adjusted net capital. See Commission Rule 1.12.
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Other safeguards for customer funds established by the CEA and CFTC
regulations include protections against the use of customer funds by
depositories, such as banks or clearing organizations, to offset
obligations of the FCM to the depository, limitations on investments of
customer funds to U.S. government or municipal securities, and the
requirement that an FCM's independent public accountant review and
report upon the adequacy of the firm's internal controls and procedures
for safeguarding customer assets.
The statutory and regulatory framework administered by the
Commission requires that each futures exchange, as a self-regulatory
organization (``SRO''), adopt and enforce minimum financial
requirements and reporting rules for its member FCMs that are at least
as stringent as those established by Commission regulations. As SROs,
the futures exchanges and the National Futures Association (``NFA''),
an industry-wide self-regulatory organization responsible for firms
that are not members of an exchange, have the primary direct
responsibility to ensure the financial integrity of their member
firms.6 The Commission is responsible for oversight of the SROs'
financial surveillance and rule enforcement programs.
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\6\Responsibility for routine periodic audits of firms that are
members of more than one SRO is allocated among the SROs under a
Joint Audit Plan in which all of the exchanges and NFA participate.
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The Commission's routine financial oversight activities include
evaluation and monitoring of SRO financial surveillance and audit
activities, direct audits of FCMs and introducing brokers (``IBs'') as
a quality control check of SRO audit work, and targeted reviews of FCMs
that have ``early warning'' conditions or have otherwise been
identified as high risk firms. The Commission's financial oversight
program makes use of various types of information to target firms for
heightened surveillance and to better understand firm operations,
including among other sources of relevant information, data identifying
the holders of large market positions generated on a daily basis by the
Commission's large-trader reporting system, notices of adjusted net
capital being below early warning levels, and financial data, including
pay and collect data, generated by the SROs' surveillance systems.
B. Purposes of Risk Assessment Authority
The risk assessment provisions of the FTPA are designed to
facilitate financial oversight of FCMs which are part of holding
company groups whose activities may affect the FCM's overall financial
condition, or where the structure of the group of companies places
control of funding outside the FCM. As such, the risk assessment
provisions are intended to enhance the effectiveness of existing
safeguards of customer funds by providing the Commission with increased
access to material information concerning the operations of affiliates
of the FCM whose activities may expose the FCM to financial or
operational risks. This new statutory authority recognizes that, as
illustrated by the experience of the CFTC and other regulators with
several recent failures of regulated brokerage firms, the operations of
regulated FCMs may be materially affected by, and only understood in
conjunction with, the activities of affiliated entities, many of which
may be unregulated. Concomitantly, the effectiveness of ongoing
financial oversight programs may depend upon access to information
concerning risks to the FCM created by affiliate activity, and the
efficacy of regulatory responses to financial problems at the regulated
entity may be enhanced by access to information concerning relevant
affiliate activity.
For example, Commission staff and futures industry self-regulators
worked closely with securities and banking regulators to facilitate the
rapid wind-down of Drexel Burnham Lambert, Inc. (``DBL''), a registered
FCM and securities broker-dealer, and to minimize adverse effects of
the wind-down on customers and the markets. Approximately 1700 futures
accounts were transferred from DBL to other futures firms during a two-
week period in February 1990.7 The immediate cause of DBL's
failure was the inability of its parent firm, The Drexel Burnham
Lambert Group, Inc. (``DBL Group''), to meet certain debt payments,
some of which consisted of commercial paper, following a reduction of
DBL's credit rating. DBL Group filed a bankruptcy petition on February
13, 1990. Previously, approximately $220 million of DBL's excess
capital had been transferred to DBL Group in the form of short-term
loans.8
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\7\No regulated futures customers suffered losses due to DBL's
insolvency.
\8\The New York Stock Exchange subsequently ordered DBL to
maintain excess capital of $300 million.
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In addition to monitoring and facilitating the transfer of DBL's
futures accounts to other firms, Commission staff monitored the
liquidation of futures positions of Drexel Burnham Lambert Trading
Corporation (``Drexel Trading''), a noncustomer affiliate whose account
was carried by DBL. Drexel Trading's futures account at DBL was
apparently used to hedge its commodity trading activities in
unregulated cash and forward markets. The wind-down of Drexel Trading's
business thus entailed the liquidation of futures positions that were
related to unregulated cash positions. In the course of the Drexel
events, the availability of information concerning the developing
problems at DBL Group and better understanding of the unregulated
activities of Drexel Trading and other Drexel Group entities that
carried futures positions in noncustomer accounts at DBL to manage the
risks of related cash operations and swaps positions would have
facilitated the Commission's financial oversight of DBL and the
development and tailoring of regulatory responses to those events.
Commission staff also monitored the wind-down of Stotler and
Company (``Stotler''), a registered FCM and government securities
broker-dealer. On July 25, 1990, Stotler Group, Inc. (``Stotler
Group''), Stotler's parent firm, formally announced that it had
defaulted on $750,000 of commercial paper obligations and that Stotler
would be winding down its futures brokerage business. As those events
unfolded, it became apparent that Stotler's FCM was dependent upon
financing from Stotler Group, which in turn was dependent upon the
issuance of commercial paper for its own financing. Stotler had already
commenced informally winding down its futures brokerage business on
July 12, 1990, following notification by the Commission that it did not
meet minimum capital requirements, due to adjustments to Stotler's
reported capital to correct, among other things, the failure to reflect
in Stotler's capital computations liabilities purportedly transferred
to Stotler Group. In a period of approximately eight weeks, Stotler,
with the assistance and monitoring of the CFTC and self-regulatory
authorities, transferred more than 65,000 futures customer accounts and
customer segregated funds totaling over $309 million.9 Access to
information concerning Stotler Group's commercial paper operations, on
which Stotler drew for financing, would have assisted the Commission in
its oversight of Stotler and aided in the identification of the
developing difficulties of the Stotler entities.
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\9\Less than one percent of customer segregated funds had not
been returned to customers prior to the filing by Stotler and
Stotler Group of petitions in bankruptcy on August 24, 1990. The
remaining one percent was subsequently returned.
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The well-publicized problems of the Metallgesellschaft AG group of
companies provide the most recent example of the potential utility of
information on entities affiliated with an FCM. MG Futures, Inc. (``MG
Futures''), a registered FCM and a wholly-owned subsidiary of
Metallgesellschaft AG, carried large, purported hedge positions in the
energy futures markets for the MG group of companies. Large losses
sustained by the MG Group of companies in late 1993 apparently caused
severe cash flow problems for MG Futures, the regulated intermediary.
The losses, which occurred at an affiliated entity, were not reflected
in the financial reports filed by MG Futures with the Commission and
materially affected MG Futures' funding arrangements.
The interrelationships between FCMs and their affiliates may
include a wide range of financial relationships that render the FCM
dependent upon certain affiliates' financial condition or expose the
FCM's capital to withdrawal or other impairment to support an affiliate
experiencing funding difficulties. These types of financial
relationships include, for example, guarantee arrangements between the
FCM and its parent or other affiliate, arrangements to shift capital
from the FCM to an affiliate, financing or investment relationships
between the FCM and an affiliate, maintenance by the FCM of a futures
account for an affiliate, and business referral arrangements or other
forms of contractual arrangements that create financial
interdependencies between the FCM and an affiliate. Further, even in
the absence of direct exposure of the FCM's resources to an affiliate's
activities pursuant to contract or common ownership, the existence of
management or ownership linkages between the FCM and an affiliate may
have the result that financial or operational difficulties of a closely
linked affiliate adversely affect the FCM's credit or customer
relationships, and thus its liquidity.
The potential risks to FCM operations created by affiliate
activities may be exacerbated, and the importance of ready access to
information concerning affiliate activities heightened, by the nature
of the affiliate activities. Because FCM activities are subject to
minimum capital requirements designed to measure, and provide resources
adequate to protect against, the risks of various types of
transactions, a holding company group may elect to conduct activities
giving rise to capital charges in unregulated affiliates rather than
the regulated entity. As a result, activities conducted on an
unregulated basis but that nonetheless may create significant market,
credit or other risk exposures, may be concentrated in affiliated
entities that are not subject to federal or state oversight.10
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\1\0As the SEC noted in proposing its risk assessment rules for
broker-dealers, ``the activities carried out by the affiliates of a
broker-dealer are, in the aggregate, generally more highly leveraged
and riskier than permitted by the net capital rule.'' 56 FR 44014,
44015 (September 6, 1991).
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C. Statutory Risk Assessment Provisions
The risk assessment provisions added to the CEA by the FTPA provide
a mechanism for the Commission to obtain information concerning FCM
affiliate activities that should facilitate both a better understanding
of the ongoing risk exposures of the FCM and an improved ability to
determine appropriate intervention in the event of financial
difficulties at the FCM or in other circumstances of heightened risk.
New Section 4f(c) of the Act authorizes the Commission to require each
registered FCM to obtain ``such information and make and keep such
records as the Commission, by rule or regulation, prescribes concerning
the registered futures commission merchant's policies, procedures or
systems for monitoring and controlling financial and operational risks
to it resulting from the activities of any of its affiliated persons,
other than a natural person.''11 The statute provides that the
required records should ``describe, in the aggregate, each of the
futures and other financial activities conducted by, and the customary
sources of capital and funding of, those of its affiliated persons
whose business activities are reasonably likely to have a material
impact on the financial or operational condition of the futures
commission merchant, including its adjusted net capital, its liquidity,
or its ability to conduct or finance its operations.''12 The
Commission is authorized to require, by rule or regulation, summary
reports of such information to be filed no more frequently than
quarterly. Section 4f(c) also authorizes the Commission to require the
filing by FCMs of supplemental reports if, as a result of adverse
market conditions, based on reports provided pursuant to this section,
or other available information, the Commission ``reasonably concludes''
that it has concerns regarding the financial or operational condition
of any registered FCM.13
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\1\17 U.S.C. 6f(c)(2)(A) (Supp. IV 1992).
\1\27 U.S.C. 6f(c)(2)(B) (Supp. IV 1992).
\1\37 U.S.C. 6f(c)(3)(A) (Supp. IV 1992).
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Section 4f(c) also provides that the Commission may exempt ``any
person or class of persons'' from recordkeeping or reporting
requirements established pursuant to that provision. In granting such
exemptions, the Commission is directed to consider, ``among other
factors,'' whether information of the type required is available from
the Securities and Exchange Commission (``SEC''), a state insurance
commission or similar state agency, a supervisory agency as defined in
section 1101(7) of the Right to Financial Privacy Act of 197814 or
a similar foreign regulator; the primary business of any affiliated
person; the nature and extent of domestic or foreign regulation of the
affiliated person's activities; the nature and extent of the FCM's
futures and options activities; and, with respect to the FCM and its
affiliated persons, on a consolidated basis, the amount and proportion
of assets devoted to, and revenues derived from, activities in the U.S.
futures markets.15 The legislative history reflects that the
Commission ``may determine not to require information concerning
holding companies or other affiliates of FCMs that are primarily
engaged in nonfinancial activities such as merchandising, construction
(other than equity investment or financing), travel services, real
estate brokerage, consumer lending, publishing or nonfutures-related
information processing.''16
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\1\4The term ``supervisory agency'' is defined in section
1101(7) of the Right to Financial Privacy Act of 1978, 12 U.S.C.
3401(7), to include the following agencies which have the statutory
authority to examine the financial condition, business operations,
or records or transactions of a financial institution, holding
company, or subsidiary thereof: (1) The Federal Deposit Insurance
Corporation; (2) the Director, Office of Thrift Supervision; (3) the
National Credit Union Administration; (4) the Board of Governors of
the Federal Reserve System; (5) the Comptroller of the Currency; (6)
the Securities and Exchange Commission; (7) the Secretary of the
Treasury; and (8) any state banking or securities department or
agency.
\1\57 U.S.C. 6f(c)(9) (Supp. IV 1992).
\1\6S. Rep. No. 22, 102d Cong., 2d Sess. 50 (1992).
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Section 4f(c) provides that generally an FCM will be considered to
have complied with a recordkeeping or reporting requirement adopted by
the Commission concerning an affiliated person subject to examination
by, or reporting requirements of, a federal banking agency if the FCM
uses for that purpose copies of reports filed by the affiliated person
with the relevant federal banking agency pursuant to specified
statutory provisions. However, the Commission is authorized to require
the FCM to obtain, maintain or report supplemental information if the
Commission makes a finding that such information is necessary to inform
the Commission concerning potential risks to the FCM and first requests
the federal banking agency to expand its requirements to include the
information.\17\
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\17\Section 4f(c)(5) also provides that prior to making a
request for supplemental information pursuant to section 4f(c)(3)
with respect to an affiliated person that is subject to examination
by or reporting requirements of a federal banking agency, the
Commission shall notify the agency of the information requested and
consult with the agency to determine whether the information
required is available from the agency and for other purposes,
``unless the Commission determines that any delay resulting from the
consultation would be inconsistent with ensuring the financial and
operational condition of the futures commission merchant or the
stability or integrity of the futures markets.'' 7 U.S.C. 6f(c)(5)
(Supp. IV 1992).
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The risk assessment provisions of the FTPA require the Commission
to treat any risk assessment information required to be provided to it
pursuant to that authority as subject to the confidentiality provisions
of section 8 of the Act. The Commission therefore is generally
prevented from disclosing such information to third parties.\18\
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\18\Section 8 of the Act provides generally that the Commission
may not publish data and information that would separately disclose
the business transactions or market positions of any person and the
trade secrets or names of customers unless such information has been
previously disclosed in connection with a congressional proceeding
or an administrative or judicial proceeding brought under the Act. 7
U.S.C. 12 (1988 & Supp. IV 1992).
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D. SEC Final Temporary Risk Assessment Regulations
The Commission's statutory risk assessment authority is
substantially similar to that granted to the SEC under Section 4 of the
Market Reform Act of 1990.\19\ Pursuant to this risk assessment
authority, the SEC has adopted ``final temporary'' rules\20\ which
generally require securities broker-dealers to maintain and preserve
records and file quarterly reports containing information concerning
the financial and securities activities of the broker-dealers' material
affiliates.\21\ The SEC's risk assessment structure includes
recordkeeping and reporting rules applicable generally to all broker-
dealers that maintain capital equal to or greater than twenty million
dollars or that carry customer accounts and maintain capital of
$250,000. Under the SEC's risk assessment rules, broker-dealers are
required to maintain an organizational chart identifying material
associated persons, to depict the broker-dealer's risk management
policies and procedures, to provide certain financial data on the
affiliated system, including consolidated and consolidating financial
statements, to provide aggregate securities and commodities positions,
including financial instruments with off-balance sheet risk and
concentrations of credit risk (as defined in Statement of Financial
Accounting Standards No. 105 (``SFAS 105'')) on a disaggregated basis
for each material associated person, and other financial and
securities-related information. Under the SEC's risk assessment
program, the information required to be maintained by broker-dealers
under the recordkeeping rule generally is required to be filed within
60 days after the end of each quarter on SEC Form 17-H.\22\
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\19\Pub. L. No. 101-432, 104 Stat. 963 (1990).
\20\The SEC adopted ``final temporary'' rules as an interim step
in the adoption of final regulations to enable the agency to gain
experience with the information obtained pursuant to its risk
assessment rules and to evaluate the operation of the risk
assessment program based upon review of this information. The SEC's
Division of Market Regulation will prepare a study evaluating the
effectiveness of the rules which will be published 90 days after the
rules have been in full effect for two years. After evaluating
public comment on this report, the SEC will determine what
modifications to the rule, if any, are necessary. See 57 FR 32159,
32161 (July 21, 1992).
\21\57 FR 32159 (July 21, 1992).
\22\The SEC's rules require broker-dealers to file an
organizational chart as part of its first risk assessment filing and
with each year-end filing. Quarterly updates are required only if a
material change has occurred. The risk management policies must be
filed only with the first risk assessment filing, unless a material
change has occurred, in which case a quarterly update is required.
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The SEC's rules include provisions designed to diminish the
necessity for broker-dealers to create additional sets of records where
records substantially similar to those required by the risk assessment
rules are created for the use of other federal or state regulators. For
example, under the SEC's rules, a broker-dealer will be deemed in
compliance with the recordkeeping and reporting requirements concerning
a material associated person subject to the CFTC's supervision if it
maintains and files copies of Forms 1-FR-FCM or 1-FR-IB filed by the
FCM or the IB, respectively, with the CFTC.23 In adopting its risk
assessment rules, the SEC stated that these special provisions for CFTC
registrants were appropriate ``because entities regulated by the CFTC
are subject to recordkeeping, reporting, and supervisory requirements
similar to those imposed by the Commission on broker-dealers.''24
The SEC's risk assessment rules also include special provisions for
reporting broker-dealers with respect to other types of regulated
affiliates, including banks, insurance companies, and entities subject
to the supervision of foreign financial regulatory authorities.
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\2\3The CFTC and SEC, in cooperation with securities and futures
industry self-regulatory organizations, have developed a draft of a
new, combined Form 1-FR/FOCUS report, which will further harmonize
and facilitate electronic financial reporting for broker-dealers and
FCMs and will capture certain information on a regulated firm's
derivative product positions. The draft form is expected to be
published for public comment within the next several months.
\2\457 FR at 32163.
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E. Coordination With Other Regulators
The legislative history of the FTPA indicates that Congress
intended that the Commission take into account the existing reporting
systems of other relevant financial regulators in exercising the risk
assessment authority conferred upon it.25 The Commission has
consulted extensively with other financial regulators to develop, to
the extent possible, a coordinated approach to information-gathering
concerning regulated affiliates of FCMs. Commission staff have met with
securities and banking regulators on multiple occasions and have
reviewed various reports and filings required under the securities and
banking regulatory frameworks. In particular, Commission staff have
explored the extent to which other federal financial regulators may
share relevant risk assessment information concerning entities subject
to their supervision with the CFTC on a confidential basis in order
that requirements for reporting to the CFTC with respect to such
entities might be minimized. The Commission believes that, subject to
appropriate confidentiality safeguards such as are afforded by section
8 of the CEA, information-sharing among federal financial regulators
responsible for oversight of various entities operating within the same
holding company group should be fostered to facilitate financial
oversight of the group and its regulated component entities and to
minimize reporting requirements under the various individual regulatory
structures. For example, Commission staff have explored the extent to
which various types of event-specific information could be provided
directly to the CFTC by the relevant regulatory authority. The staff
also has discussed establishing lead regulator type responsibilities to
the extent practicable.
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\2\5S. Rep. No. 22, 102d Cong., 2d Sess. at 50.
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Further, the Commission has given extensive consideration to the
risk assessment rules adopted by the SEC pursuant to the risk
assessment authority granted it in the Market Reform Act of 1990. To
the extent possible, the Commission has designed its risk assessment
provisions with a view towards permitting FCMs which are broker-dealers
(or which are part of holding company groups that include a broker-
dealer) required to report pursuant to the SEC's risk assessment rules
to use reports prepared pursuant to the SEC's requirements to fulfill
the Commission's requirements. Generally, the Commission's proposed
rules would require filing of a subset of the information called for by
the SEC on a routine basis but call for certain additional information
specific to the operations of FCMs acting as clearing firms for
affiliated entities. The proposed rules are designed to permit the use
of the SEC risk assessment form, Form 17-H, given appropriate
supplementation, on an elective basis in lieu of new CFTC Form 1.15A.
To the extent that the Commission's approach alters that of the SEC, it
is intended to give early warning of events that would cause the CFTC
to request further information or to seek assistance from other
regulators and to take account of the more limited resources available
to the Commission to assess the information provided.
II. The Proposed Rules
Proposed Rule 1.14 would require FCMs to maintain and preserve
certain records and information concerning, among other things, the
organizational structure of which the FCM is part, the FCM's policies
and systems for monitoring and controlling risks arising from the
activities of its affiliates, consolidated and consolidating financial
statements for the FCM and its ultimate parent company, and aggregate
information concerning futures, forwards and financial instruments with
off-balance sheet risk and concentrations of credit risk. Proposed Rule
1.15 requires FCMs to file with the Commission, generally on an annual
basis, the information required to be maintained under proposed Rule
1.14 and to provide the Commission with notice upon the occurrence of
certain specified events, such as large decreases in the reported
adjusted net capital of FCMs or the equity of their parent companies.
Maintenance of the records required under proposed Rule 1.14 and
reporting of the data required pursuant to proposed Rule 1.15 are
intended to impose a discipline on the FCM relative to its own risk
management activities as well as to permit the Commission to make
informed assessments relevant to market events and to the analysis of
possible regulatory responses to such events. For example, risk
assessment information may permit more effective and moderate
management of financial market disruptions than would occur in the
absence of pertinent information.
The risk assessment provisions being proposed by the Commission
would apply generally to FCMs that hold customer funds of $6,250,000 or
greater, maintain adjusted net capital in excess of $5,000,000 or that
are clearing members of a contract market. As proposed, however, the
rules make special provisions for FCMs that are dually registered with
the SEC as broker-dealers, or that are part of a holding company group
that includes a broker-dealer, filing reports pursuant to the SEC's
risk assessment rules. Further, in general, the proposed rules would
allow FCMs that have affiliates subject to regulation by a federal
banking agency, a state insurance commission or similar state agency,
or a foreign futures authority or other relevant foreign authority to
comply with certain reporting and recordkeeping requirements by filing
or maintaining records that the regulated affiliate is required to file
with the relevant regulator.
A. Definition of Material Affiliated Person
The FTPA requires that, in general, FCMs maintain certain records
regarding ``their affiliated persons whose business activities are
reasonably likely to have a material impact on the financial or
operational condition of the FCM.''26 For the purpose of
determining which affiliated persons are covered under this standard,
the proposed rules would define the term ``material affiliated person''
(``MAP'') by reference to several illustrative factors relevant to the
activities of the FCM and its affiliate and the relationship between
the entities. The factors specified are intended to provide guidance
and not to be exhaustive. FCMs should consider all of the facts and
circumstances pertinent to the identification of their affiliated
entities whose business activities are reasonably likely to have a
material impact on the financial or operational condition of the FCM.
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\2\6Specifically, Section 4f(c)(2)(A) of the Act states that
each FCM ``shall obtain such information and make and keep such
records as the Commission, by rule or regulation prescribes
concerning the registered (FCM's) policies, procedures or systems
for monitoring and controlling financial and operational risks to it
resulting from the activities of any of its affiliated persons,
other than natural persons.'' 7 U.S.C 6f(c)(2)(A) (Supp. IV 1992).
The term ``affiliated person'' is defined for purposes of section
4f(c)(1)(i) of the Act to mean ``any person directly or indirectly
controlling, controlled by or under common control with a futures
commission merchant, as the Commission, by rule or regulation, may
determine will effectuate the purposes of this subsection.'' Natural
persons are generally excluded from risk assessment requirements. 7
U.S.C. 6f(c) (2)(A) and (3)(A) (Supp. IV 1992).
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The material affiliated person definition used in the Commission's
proposed rules is similar to that used in SEC Rule 17h-1T.27
However, for purposes of these rules, the Commission has used the term
``affiliated person'' rather than ``associated person'' to avoid
confusion with the associated person registration category described in
section 4k of the Act28 and Commission Rule 3.12. Like the SEC
under its risk assessment regulations, the Commission proposes to leave
the determination as to which entities affiliated with an FCM are MAPs
with the reporting FCM, in the first instance, based on the FCM's
examination of all relevant facts and circumstances.
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\2\717 CFR 240.17h-1T (1993).
\2\87 U.S.C. 6k (1988 & Supp. IV 1992).
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A first relevant factor in determining the materiality of an
affiliated person is the legal relationship between the FCM and the
affiliated person, i.e., the nature and proximity of the relationship
between the FCM and the affiliated person. In a two-tier holding
company structure, for example, the first tier may include the direct
holding company parent of the FCM and several related financial service
entities. The entities at this first tier are very likely to be
material to the FCM in light of their close proximity and consequent
potential for direct financial impact upon the FCM and its funding. In
some cases, entities other than the FCM's parent and the parent's
affiliates may be required to be deemed MAPs. For example, intermediate
holding companies and the ultimate parent corporation may be deemed
MAPs if, for example, a bankruptcy of the ultimate parent could
significantly affect the FCM's ability to obtain needed credit. If,
however, after evaluating all of the relevant facts and circumstances,
it appears that an affiliated person in the upper tiers of a holding
company structure could have only a remote impact on the financial or
operational condition of the FCM, the affiliate would not be required
to be designated as a MAP. Moreover, if the ultimate parent in a multi-
tiered holding company structure primarily is engaged in activities
which are not related to the futures or financial markets, such as
manufacturing or retailing, the parent would not generally be required
to be designated a MAP. However, an ultimate parent company which is
engaged in non-financial activities may clear its futures account
through the FCM in order to manage the risk of cash commodity positions
and this relationship could expose the FCM to potential risks relative
to cash or over-the-counter trading that would render the parent
company a MAP.
A second factor relevant to the identification of MAPs is the
degree of financial dependence of the FCM on its affiliate and the
nature of the FCM's financing requirements. For example, if the FCM's
obligations are guaranteed by a parent or other affiliate, the FCM has
a degree of financial dependence upon the guarantor entity such that,
absent unusual circumstances, that entity would be a MAP. Similarly, if
the FCM relies for financing upon a parent company whose capacity to
provide such financing depends upon the issuance of commercial paper or
other sources of unsecured credit, the FCM would be materially affected
by an acceleration or call by the holders of these obligations,
especially if the FCM did not have sufficient liquid assets or
alternative financing available to replace the financing provided by
its parent company.
A third materiality factor is the degree to which an FCM or its
customers rely upon an affiliated person for operational services or
support. If an FCM relies upon an affiliated person for significant
operational facilities or support, the operations or financial
difficulties of the affiliated person could materially impact the FCM's
operations.
Another relevant factor in the materiality determination is the
level of market, credit and other risk present in an affiliated
entity's activities. A high volume of over-the-counter derivative
transactions conducted through an unregulated affiliated entity may
give rise to market, credit, operational or other risks that require
sophisticated risk management strategies and internal control
procedures to protect against potential losses that could jeopardize
the resources of the affiliate and potentially impact related entities.
Position taking by an affiliate may also expose the affiliate to risks
that create the potential for spillover effects upon the FCM.
Generally, affiliated entities that assume greater risk exposures may
incur an increased likelihood of liquidity declines or other financial
difficulties that increase the potential for adverse effects upon the
FCM.
Finally, the extent to which an affiliated person has the authority
or ability to negatively impact the FCM's capital is a factor in
determining the materiality of the affiliated entity. The activities of
a parent company or other affiliate that has the ability to remove
capital from the FCM, such as for the purpose of repayment of loans or
debt, generally are material to the FCM (e.g., a parent company of an
FCM may have the ability to withdraw capital from a subsidiary FCM if
the parent is unable to meet interest or principal payments on
debt).29
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\2\9Of course, the parent could only lawfully withdraw capital
to the extent that the FCM would remain in compliance with the
Commission's net capital requirements.
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B. Information Required To Be Maintained and Filed on a Routine Basis
The proposed rules generally require two forms of risk assessment
activity by FCMs: Recordkeeping and reporting. FCMs subject to the
rules would generally be required to maintain specified types of
information and to file reports of that information on a routine basis,
in most cases annually, absent a material change in reported data. The
categories of information called for are discussed below, with specific
reference to the relevant recordkeeping and reporting requirements of
the proposed rules.
1. Organizational Chart
Proposed Rule 1.14(a)(1)(i) would require an FCM to maintain an
organizational chart depicting the holding company structure of which
the FCM is a part. The chart should provide an overview of the entire
organization and identify those affiliated persons that are MAPs of the
FCM, as determined by the registrant in accordance with the standards
set forth in the proposed rule and discussed above. The chart should
also indicate which MAPs file routine financial or risk exposure
reports with the SEC, a federal banking agency, an insurance
commissioner or other similar official or agency of a state or a
foreign regulatory authority. In addition, the chart should indicate
whether a MAP is a dealer or end user (or both) of financial
instruments with off-balance sheet risk. End-users employ financial
instruments to facilitate the management of financial risks that arise
in the course of their business. Dealers are distinguished from end-
users by their readiness to make two-way markets in financial
instruments, thereby providing end-users (and other dealers) with the
financial instrument positions they seek. As proposed, Rule
1.15(a)(1)(i) would require the FCM to file its organizational chart
within 90 calendar days after the effective date of the rule or within
60 calendar days of registration if that occurs after the rule's
effective date. Where there is a material change in the information
provided, an updated organizational chart is required to be filed
within five calendar days after the end of the fiscal quarter in which
the change occurred. If no material change occurs, no updates are
required.30
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\3\0A statement that updates required under Rule 1.15 in the
event of a change in previously reported information are not
required because no change sufficient to trigger the update
requirement has occurred may be requested on the new combined 1-FR/
FOCUS report.
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2. Risk Management Policies
Paragraph (a)(1)(ii) of proposed Rule 1.14 would require an FCM to
maintain records relating to the FCM's procedures for monitoring and
controlling financial and operational risks to it resulting from the
activities of its affiliates. Like the SEC's risk assessment rules, the
Commission's proposed rule would require that FCMs maintain and
preserve their written policies, procedures or systems concerning
methods for monitoring and controlling financial and operational risks
resulting from the activities of any of their affiliated persons and
concerning their financing and capital adequacy, including information
regarding sources of funding and a narrative discussion by management
of the liquidity of the material assets, the structure of debt capital
and sources of alternative funding. Also like the SEC rule, the
Commission's proposed rule would require the FCM to maintain written
policies concerning trading positions and risks, such as records
regarding reporting responsibilities for trading activities,
limitations on trading activities and a description of the types of
reviews conducted to monitor existing positions. However, the CFTC's
proposed requirement relating to records of policies, procedures and
systems with respect to trading activity, while incorporating the
matters covered by the SEC's rules, includes specific reference to the
FCM's internal controls with respect to the market risks, credit risks
and other risks created by the FCM's proprietary and noncustomer
clearing activities, reflecting risks entailed in the performance of
the clearing function typical of FCMs operating within a holding
company structure. These would include, for example, as specified in
proposed Rule 1.14(a)(1)(ii), systems and policies for supervising,
monitoring, reporting and reviewing trading activities in securities,
futures contracts, commodity options, forward contracts or financial
instruments such as swaps, and policies for hedging or managing risks
created by its proprietary trading activities and reviewing hedging and
risk management strategies of noncustomer affiliates.
Subject to the CEA and Commission regulations, in particular any
requirements encompassed by existing Rule 166.3, the proposed rule does
not itself require an FCM to create specific risk management policies
and procedures.31 It is sufficient for purposes of the risk
assessment requirements for an FCM to document, in writing, the
policies in place or the absence of such policies in the unlikely event
that it operates without them. However, the Commission believes that
from the perspective of prudent risk management, FCMs subject to these
rules should review their existing internal controls and risk
management systems and procedures with a view towards assuring that
those systems are sufficient in light of the potential risks created by
their own and their affiliates' activities. The types of risk
management policies and internal controls referred to in the proposed
rule, while by no means exclusive of those necessary to prudent risk
management,32 are indicative of the types of risk management
systems that may be warranted to address risks engendered by affiliate
activities.
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\3\1See 57 FR at 32165 (wherein the SEC notes that broker-
dealers need not create risk management policies for purposes of the
SEC risk assessment requirements if none exist).
\3\2Simulation analyses or major market move scenarios to
measure the impact upon positions carried and upon regulatory
capital of extreme price movements would be one tool for management
of the risk of positions carried by the FCM, one which has been
favorably mentioned by audit staff in oversight reviews of exchange
financial surveillance programs. Separation of functions, periodic
reconciliations of key accounts, daily marking-to-market of
positions, and on-going assessments of the effectiveness of hedge
positions, are examples of other internal controls generally
important to an FCM's business, some of which are explicitly
required under the CEA and Commission rules.
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Paragraph (a)(1)(ii) of Rule 1.15 requires an FCM to file the
information referred to above with the Commission within 90 calendar
days from the effective date of the rule or 60 days following the FCM's
registration if that occurs after the rule's effective date. Where
there is a material change in the information provided, such a change
is required to be reported to the Commission within five calendar days
after the end of the fiscal quarter in which the change occurred. If
there is no material change, no update is required.33
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\3\3In this regard, the Commission's proposed rule departs from
the SEC's reporting structure which requires similar information to
be filed on an annual basis.
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3. Financial Statements
The following financial statements would be required on a
consolidated basis for the FCM and its ultimate parent company and
would be required to be filed within 105 calendar days after the end of
each fiscal year: (1) Balance sheet; (2) statement of income; (3)
statement of cash flows; and (4) explanatory notes to the financial
statements. Additionally, a consolidating balance sheet and statement
of income must be filed annually for the FCM and its ultimate parent
company. The consolidated and consolidating financial statements would
be required to be prepared in accordance with United States generally
accepted accounting principles, consistently applied (``U.S. GAAP''),
except as indicated below. If an annual audit and certification is
performed as an ordinary and customary part of the entity's business,
the consolidated statements should be certified by an independent
certified public accountant. The consolidating financial statements
must show separately the FCM, its ultimate parent company and each MAP.
With respect to affiliated persons that use a comprehensive set of
accounting principles other than U.S. GAAP, a note to the financial
statements indicating the comprehensive body of accounting principles
used to prepare the financial statements should be included. The note
should provide a narrative description of the items that are treated
differently by U.S. GAAP. The consolidated financial statements also
should be accompanied by the footnotes required by GAAP and any other
information necessary for an understanding of the information being
presented (e.g., the summary of significant accounting policies).
The Commission requests comment as to whether quantification of any
material differences in the contents of the financial statements, in
addition to a narrative description of items treated differently from
U.S. GAAP, should be required where accounting principles other than
U.S. GAAP are used.
The financial statements required to be maintained and filed
pursuant to the proposed rules are the same as those required under the
SEC's risk assessment program. The proposed rules, however, require the
consolidated financial statements to be certified if an audit is
ordinarily performed. The Commission does not believe that this should
create any additional burdens for FCMs also subject to the SEC's
regulations, because the proposed rules would not impose the added
expense of an annual audit if an annual audit is not customarily
performed. Moreover, the Commission is requesting financial statements
to be filed on an annual basis rather than quarterly as required under
SEC rules. However, the Commission requests comment as to whether
consolidated and consolidating financial statements are customarily
prepared on a quarterly basis and, if so, whether they should be
required to be filed quarterly so as to provide more current financial
data.
4. Aggregate Securities and Commodity Positions
Paragraph (a)(1)(v) of proposed Rule 1.14 would require FCMs to
maintain records of the fair market value as of the end of each fiscal
quarter of each MAP's inventory of long and short securities and
physical commodity positions as specified in new Form 1.15A, including
a separate listing for each MAP of any aggregate unhedged exposure,
other than U.S. government or agency securities, denominated in dollars
and measured by interest rate, duration, instrument or other measure as
specified by the reporting entity, which exceeds a Materiality
Threshold. For purposes of the proposed rules, the term ``materiality
threshold'' is defined as the greatest of: (i) $20 million; (ii) 10
percent of the FCM's adjusted net capital on the most recent financial
reports filed by the FCM with the Commission pursuant to Rule 1.10;
(iii) 10 percent of the MAP's tangible net worth; or (iv) for an FCM
that is required, or that has a MAP that is required, to file pursuant
to SEC Rule 17h-2T, the Materiality Threshold specified in SEC Rule
17h-1T.
The Commission requests comment as to whether the Materiality
Threshold should be applied on a product-by-product basis with respect
to each MAP or on an aggregate basis for all transactions of a MAP with
a single counterparty. If product-by-product differentiation is more
appropriate for credit risk assessment purposes, what product
breakdowns are desirable?
The information required under this provision of the proposed rules
is intended to encompass only the types of items which appear on the
balance sheet of the FCM. Accordingly, records of physical (spot)
commodities would be maintained under this paragraph and reported under
the ``aggregate securities and commodities'' heading of Form 1.15A,
while off-balance sheet items such as futures and forwards are covered
in paragraph (a)(1)(vi) of proposed Rule 1.14 which concerns
``financial instruments,'' as discussed below.
The on-balance sheet items provide more particularity by instrument
than required financial reports and some information relative to
funding. Nonetheless, the Commission requests comment concerning the
scope of the requirement for on-balance sheet information, in
particular as to whether the specified on-balance sheet items should
generally be required or only required where the item is part of a
financing transaction.
Rule 1.15 requires the information discussed above to be filed on
Form 1.15A on an annual basis within 105 days after the end of each
fiscal year. Quarterly updates would be required only if a change of 20
percent or greater in a line item has occurred since the FCM's last
filing with the Commission. Rather than require routine quarterly
reporting of on-balance sheet aggregate securities and commodities
information, the Commission is proposing to require quarterly updates
only when a significant change in previously reported information has
occurred. When filing any quarterly update referred to herein, only the
particular line item in which the 20 percent or greater change occurred
need be updated, not the entire form. However, an FCM may elect to file
this information for each fiscal quarter.
The Commission requests comment as to whether the requirement for
quarterly updates would more appropriately be framed in terms of
whether a ``material change,'' rather than a 20 percent change, in such
data has occurred or whether a routine quarterly filing requirement
would be preferable.
The type of information required under the foregoing provisions is
the same as that required under the SEC's interim final regulations.
However, the information would be provided on new CFTC Form 1.15A in
the aggregate for the FCM's MAPs rather than separately for each MAP as
is required under the SEC's rules, unless such a presentation would
materially understate the risk relative to stockholders' equity of any
MAP, in which case the information must be provided separately for such
MAP. The Commission, however, is including a proposed Part C to Form
1.15A to elicit comment as to whether such a schedule is preferable for
identifying MAPs that require additional review and could be used for
reporting cases where aggregate data for all MAPs might disguise a
particular MAP's risk. For example, Part C would require information on
a MAP's trading book, and if a MAP maintains separate trading books for
different types of instruments, these must be discussed separately.
The Commission requests comment as to whether Part C should be used
in lieu of providing the information on Parts A and B for such MAP
separately. The Commission requests comment concerning Form 1.15A
generally as well as concerning Part C thereof, and the Commission
further requests comment as to whether reporting on Form 1.15A should
generally be required separately for each MAP rather than on an
aggregate basis for all MAPs.
The Commission's proposed rules also incorporate a lower
Materiality Threshold than is provided in the SEC's risk assessment
rules, which use the greater of $100 million or 10 percent of the
broker-dealer's tentative net capital or tangible net worth.34 The
Commission believes that a $20 million threshold is a more realistic
materiality figure for FCMs as opposed to generally larger broker-
dealers but requests comment on this point. To reduce reporting burdens
for FCMs that also file under the SEC's rules or are part of a holding
company group that includes a reporting broker-dealer, the Commission's
proposed threshold incorporates the SEC's higher materiality threshold
for such firms.
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\3\4Further, Form 1.15A, unlike SEC Form 17-H, does not call for
information concerning purchased options or risk arbitrage.
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5. Financial Instruments
Proposed Rule 1.14(a)(1)(vi) requires FCMs to maintain records of
the amount at the end of each fiscal quarter, on an aggregate basis for
the FCM and its MAPs, of the notional or contractual amounts, and in
the case of options, the value of the underlying instruments, of
exchange-traded futures and commodity option contracts, forward
contracts, over-the-counter commodity options, and financial
instruments with off-balance sheet risk and financial instruments with
concentrations of credit risk, as those terms are defined in SFAS 105,
broken down by contract type and maturity as specified in proposed Form
1.15A. The record must identify each instrument where credit risk with
respect to a counterparty exceeds the Materiality Threshold. SFAS 105
is applicable to all companies that prepare financial statements in
accordance with GAAP and requires disclosure of information about
financial instruments35 with off-balance sheet risk and financial
instruments with a concentration of credit risk. As noted above, in
contrast to paragraph (a)(1)(v) of Rule 1.14 which concerns ``on-
balance sheet'' aggregate securities and commodity positions, the
information regarding ``financial instruments'' is intended to
encompass off-balance sheet activities.
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\3\5The term ``financial instrument'' is defined in SFAS 105 as
cash, evidence of an ownership interest in an entity or a contract
that both:
a. Imposes on one entity a contractual obligation (1) to deliver
cash or another financial instrument to a second entity or (2) to
exchange financial instruments on potentially unfavorable terms with
the second entity; and
b. Conveys to that second entity a contractual right (1) to
receive cash or another financial instrument from the first entity
or (2) to exchange other financial instruments on potentially
favorable terms with the first entity.
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``Off-balance sheet risk'' is defined in SFAS 105 as the risk of
accounting loss.36 SFAS 105 defines ``credit risk'' as the
possibility that a loss may occur from the failure of another party to
perform under the terms of the contract. The proposed rules would
require an FCM to separately list each instrument where the credit risk
with respect to an individual counterparty exceeds the Materiality
Threshold at quarter end.
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\3\6''Accounting loss'' is further defined as the loss that may
have to be recognized due to credit and market risk as the result of
the obligations from a financial instrument.
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The reporting of futures, forwards and swaps on proposed Form 1.15A
differs slightly from that under SEC Form 17-H. While SEC Form 17-H
breaks out only interest rate and foreign exchange swaps, proposed Form
1.15A also includes separate entries for energy and precious metal
swaps. The same category breakdown would also apply for reporting
futures and forwards on proposed Form 1.15A. This is in contrast to SEC
Form 17-H, which breaks down the reporting of futures and forward
contracts by three categories of underlying instrument: (1) U.S.
Treasury and mortgage-backed securities; (2) other securities; and (3)
all others. In addition, Form 1.15A would require separate listing of
all swaps and forwards by three different maturities: less than one
year; one to five years; and more than five years.
These changes are intended to take account of differences between
banking and securities reporting of off-balance sheet exposures and
ongoing discussions on data relative to macro-prudential, as opposed to
micro-prudential, risk. The Commission requests comment as to whether
additional maturity breakdowns under one year or over five years would
be appropriate, particularly in the case of interest rate instruments.
Rule 1.15 requires the above information to be filed on Form 1.15A
on an annual basis within 105 days after the end of each fiscal year.
Quarterly updates would be required within 60 calendar days after the
end of any fiscal quarter in which a change of 20 percent or greater in
any line item has occurred since the FCM's last filing with the
Commission. An FCM may elect to file this information routinely for
each fiscal quarter.
The Commission requests comment as to whether a materiality
standard, as compared to a quantitative threshold, should be used to
determine whether quarterly updates are required or whether a routine
quarterly filing requirement would be preferable to an update
requirement triggered by a change in any line item. Comment is also
requested as to whether any efficiencies in reporting would be achieved
if large trader account numbers were substituted for domestic exchange
traded futures positions.
6. Extensions of Credit
Paragraph (a)(1)(vii) of proposed Rule 1.14 would require an FCM to
maintain records of the aggregate amount as of quarter end of all
material unsecured extensions of credit by each MAP, including a
description of any extensions of credit to a single borrower which
exceed the Materiality Threshold. Annual filing of this information
would be required on Form 1.15A pursuant to proposed Rule 1.15. If a
change of 20 percent or greater occurs in the information last filed
with the Commission, a quarterly update must be filed within 60
calendar days after the end of the fiscal quarter in which such a
change occurred. An FCM may, at its option, file this information
routinely for each fiscal quarter.
The information required under this paragraph is essentially the
same as that required under the SEC's risk assessment rules. However,
the Commission's proposal does not break out bridge loans as a separate
listing under this heading. Rather, a bridge loan, if material, would
be treated the same as and be grouped together with any other material
unsecured extensions of credit for recordkeeping and reporting purposes
under the Commission's proposal.
7. Commercial Paper and Other Financing Information
Paragraph (a)(1)(viii) of Rule 1.14 would require FCMs to keep
records of the aggregate amount at fiscal quarter end of commercial
paper, secured and unsecured borrowing, bank loans, lines of credit and
the principal installments of long-term or medium-term debt scheduled
to mature within one year. Under proposed Rule 1.15 this information
would be required to be filed on Form 1.15A annually unless a change of
20 percent or greater occurs in any of the information last filed with
the Commission pursuant to either paragraph (a)(2)(iii) or (a)(4) of
Rule 1.15, in which case a quarterly update would be required to be
filed within 60 calendar days after the end of the fiscal quarter in
which such a change occurred. An FCM may, at its option, file this
information routinely for each fiscal quarter. The information
discussed above is of the same nature as that called for under the
SEC's risk assessment regulations, except that the proposed rule
generally calls for such information to be reported in the aggregate
for the FCM's MAPs rather than for each MAP as required under SEC
rules.
8. Real Estate Information
Proposed Rule 1.14(a)(1)(ix) requires FCMs to maintain information
concerning the annual gross income derived from real estate activities,
including mortgage loans and investments, for each MAP that derived
more than 20 percent of its gross income (loss) from such activities
during the fiscal year. This information would be required to be
reported annually on Form 1.15A. The information required under the
SEC's risk assessment rules regarding a MAP's real estate activities is
considerably more detailed than that which would be required under the
Commission's proposed rules. The SEC's rules require that a broker-
dealer maintain and file information regarding any real estate
activities of a MAP, without regard to the percentage of gross income
derived from such activities, and call for a variety of types of
information concerning each MAP's real estate operations.37 The
proposed rules would require reporting of the annual gross income
derived from real estate activities for any MAP that derived more than
20 percent of its gross income (loss) from such activities during the
fiscal year. Although the Commission may ask for supplemental
information concerning a MAP's real estate activities if necessary in
the circumstances, the Commission believes that, in the first instance,
the information requested under the proposed rules should be sufficient
to highlight the real estate activities of those MAPs which may require
additional review. The Commission requests comment, however, as to
whether more detailed information, such as is called for by the SEC's
rules, should be required.
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\3\7For example, the SEC's rules require that a broker-dealer
maintain and file information concerning a material associated
person's real estate mortgage or loan investment type, a geographic
distribution of such activities by year, the value of loans that are
noncurrent, are in the process of foreclosure or have been
restructured, the allowance for losses on loans and investments and
information concerning risk concentration in the material associated
person's investment and loan portfolio. See 17 CFR 240.17h-
1T(a)(1)(x).
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9. Information Regarding Noncustomer Accounts
Paragraph (a)(1)(x) of Rule 1.14 would require an FCM to maintain
on a quarterly basis the gross notional value, long and short, of open
positions in noncustomer accounts, as that term is defined in Rule
1.17(b)(4),38 the percentage of this value compared to the FCM's
adjusted net capital, the percentage of the notional value of
noncustomer accounts carried by the futures commission merchant that
are bona fide hedging positions in accordance with Rule 1.3(z), and the
percentage of the aggregate notional value of noncustomer accounts
carried for the purpose of managing the risk of cash market commitments
that mature more than 12 months from quarter end and more than 60
months from quarter end, compared to the aggregate notional value of
open positions in all noncustomer accounts carried by the FCM. Large
positions carried in noncustomer accounts of an FCM may represent a
significant exposure of the FCM to risks created by its affiliate's
trading activities relative to cash flow or financing shortages. The
nature of the affiliate's activities, i.e., whether the positions are
for hedging purposes or for speculation and, if for hedging or risk
management purposes, the maturities of the cash positions being offset,
may bear significantly upon the risks assumed by the FCM carrying an
affiliate's account.
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\3\8Rule 1.17(b)(4) defines a ``noncustomer account'' as a
commodity futures or option account carried on the books of an FCM
``which is not included in the definition of customer or * * *
proprietary account (as defined in Sec. 1.17(b)(3)).'' ``Proprietary
account'' is defined in Rule 1.17(b)(3) to mean a commodity futures
or option account carried on the books of the FCM for the FCM
itself, or for general partners in the FCM. Essentially, the
definition of noncustomer account includes proprietary accounts as
defined in Rule 1.3(y) other than the account of the FCM itself or
its general partners. Noncustomer accounts would thus include, among
others, accounts of affiliates of the FCM that are under common
control with the FCM, that control the FCM, or are controlled by the
FCM.
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The Commission believes that the size and nature of noncustomer
accounts carried by the FCM are likely to be important components of
risk assessment information, particularly in circumstances in which
futures positions carried for affiliates are either not offset by, or
are imperfectly correlated with, cash positions at the affiliate.
Accordingly, information concerning such positions is necessary for a
complete risk assessment evaluation of an FCM. The noncustomer account
information that would be required under the proposed rules would, for
the most part, be maintained by the FCM as part of its required
recordkeeping under current rules39 and could be used to trigger
more extensive financial oversight by the CFTC. To the extent that
additional information is required to be maintained and reported
concerning the maturities of cash commitments which a MAP is hedging or
the risks of which the MAP is managing by means of futures transactions
carried by the FCM, the information requested is material to the FCM's
own risk management program and should be readily accessible to the
FCM.
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\3\9See, generally, Rule 1.35; see also Rules 1.33, 1.37 and
1.46.
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Rule 1.15(a)(1)(iii) would initially require filing of the
information discussed above within 90 calendar days of the rule's
effective date or 60 calendar days from the date of the FCM's
registration if later. Thereafter, Rule 1.15(a)(3) would require this
information to be filed within 60 calendar days after the end of each
fiscal quarter. and 1.46.
C. Information Required Upon the Occurrence of Certain Events
The proposed rules would require the majority of the required risk
assessment information to be filed on an annual basis, with updates to
be provided at the end of a quarter only if a change of 20 percent or
greater has occurred in the information provided to the Commission
since the FCM's last risk assessment filing. Only information
concerning noncustomer accounts, which is either wholly or largely
within the scope of the FCM's routine recordkeeping systems, would be
required routinely on a quarterly basis. This approach differs from
that adopted by the SEC, which generally requires routine quarterly
reporting. In lieu of requiring routine quarterly filing of substantial
information concerning each affiliate's activities, the Commission's
proposed rules identify certain extraordinary events which trigger a
required notice to the Commission. Upon receipt of notice of such an
event, the Commission may then determine whether supplemental
information should be requested of the FCM, in light of the
circumstances of the FCM and its affiliated entities, the nature of the
event triggering the notice requirement and other available information
concerning the FCM.
The proposed rule would require notification to the Commission upon
the occurrence of any of eight ``triggering'' events which may indicate
a basis for further inquiry or closer scrutiny of the FCM. In
specifying ``triggering'' events requiring notice to the Commission,
together with quarterly updates of significant changes in financial
information, the Commission has endeavored to construct a reporting
system that minimizes routine filings and operates instead to identify
potentially significant events from a financial monitoring perspective
that should be readily evident to the FCM, are objectively or
quantitatively defined, evidence circumstances likely to warrant
further review, and should occur infrequently. An FCM would be required
to notify the Commission (by notice to the Director of the Division of
Trading and Markets or the Director's designee)40 within three
business days of the occurrence of any event specified in paragraph
(b)(2) of proposed Rule 1.15 except to the extent that shorter periods
are specified in paragraphs (b)(2)(i) and (b)(2)(viii) with respect to
particular triggering events. After reviewing the notice filed by an
FCM, additional information may be requested from the firm or a
relevant regulatory agency, as determined to be necessary in the
circumstances. The Commission requests comment, however, as to whether
the notice of occurrence of a triggering event should be required to be
accompanied by an explanation of the circumstances giving rise to the
occurrence such that supplemental inquiries might be obviated in many
cases.
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\4\0The Director of the Division of Trading and Markets is
generally delegated the authority to act on behalf of the Commission
with respect to the proposed risk assessment regulations.
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Comment is also requested, in view of the recordkeeping
requirements of proposed Rule 1.14, as to whether any efficiencies
would be achieved by limiting the reporting of certain information
required on Form 1.15A to a response for a request for information in
the event of a triggering event. In this connection, commenters should
specifically address what routine information would be sufficient to
provide such understanding of group activities and exposures as may be
necessary to provide background about the liquidity management of the
group and to assist in evaluating potential risks and the significance
of a triggering event to the regulated FCM. Commenters should also
address the practicability of developing particularized information on
a sufficiently timely basis, if such information were only provided
upon a triggering event, to assist the Commission's management of
emergency situations. For example, when market surveillance special
calls are made, generally a response is required within 24 hours.
Under the proposed rule, the following events would require notice
to the Commission.
1. Reduction in FCM's Adjusted Net Capital or Parent's Stockholders'
Equity
The Commission believes that a sudden major reduction in the
adjusted net capital of an FCM or the consolidated stockholders' equity
of the FCM's parent may be an indication of impending financial
difficulties and should be brought to the Commission's attention.
Accordingly, the Commission's proposed rules require that an FCM notify
the Commission of any such reduction. Paragraph (b)(2)(i) of Rule 1.15
requires an FCM to notify the Commission of any reduction of 20 percent
or more in its adjusted net capital as last reported on its financial
reports filed with the Commission pursuant to Rule 1.10. The FCM must
provide notice within two business days of any such reduction caused by
an activity in the normal course of business, such as an operating
loss, proprietary trading loss or increase in charges against net
capital, or at least two business days prior to any extraordinary
transactions or series of transactions, such as a dividend payment or
making of a loan. This notification requirement is essentially the same
as that provided in Rule 921 of the Chicago Mercantile Exchange
(``CME''), which requires that an FCM notify the CME within 48 hours
after activities in the normal course of business or at least two
business days prior to any extraordinary transaction or series of
transactions that cause greater than a twenty percent reduction in the
FCM's last reported adjusted net capital.41 SEC regulations also
require notice in the event of withdrawals, advances or loans by a
broker-dealer or its consolidated subsidiaries or affiliates that
exceed certain thresholds.42
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\4\1The Commodity Exchange, Inc. (``COMEX''), New York
Mercantile Exchange (``NYMEX'') and Chicago Board of Trade (``CBT'')
have adopted similar rules. See COMEX Rule 7.08(a); NYMEX Rule
2.14(D); and CBT Rule 285.03.
\4\217 CFR 240.15c3-1(e)(1) (1993). In general, the SEC rule
provides that a broker-dealer or consolidated subsidiary or
affiliate must notify the SEC: (1) Two business days prior to any
withdrawals, advances or loans which on a net basis exceed in the
aggregate in any 30 calendar day period 30 percent of the broker-
dealer's excess net capital; or (2) two business days after
withdrawals, advances or loans which on a net basis exceed in the
aggregate in any 30 calendar day period 20 percent of the broker-
dealer's excess net capital. The rule, however, is limited to the
following types of transactions that cause an equity reduction: (1)
Withdrawals by action of a stockholder or partner; (2) redemption or
repurchase of stock by a consolidated entity; (3) payment of
dividends or any similar distribution; or (4) an unsecured advance
or loan made to a stockholder, partner, sole proprietor, employee or
affiliate. Pursuant to SEC Rule 15c3-1(e)(3)(i), the SEC also may
restrict for up to twenty business days any withdrawal of equity
capital by a broker-dealer or unsecured loan or advance to a
stockholder, partner, sole proprietor, employee or affiliate if: (1)
Such advance or loan when aggregated with all other withdrawals,
advances or loans on a net basis during a 30 calendar day period
exceeds 30 percent of the broker-dealer's excess net capital; or (2)
the SEC concludes that the withdrawal, advance or loan may be
detrimental to the broker-dealer's financial integrity, may unduly
jeopardize the broker-dealer's ability to repay customer claims or
other liabilities which may cause a significant impact on the
markets or expose the broker-dealer's customers or creditors to
loss. 17 CFR 240.15c3-1(e)(3)(i) (1993). See also 17 CFR 240.15c3-
1(e)(2) (1993) (placing various other limitations on withdrawals of
broker-dealer's equity capital).
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Similarly, paragraph (b)(2)(v) of the rule requires an FCM to
notify the Commission of any reduction of 20 percent or more of its
parent's consolidated stockholders' equity from the date of the
parent's last quarterly consolidated financial statements. Such notice
must be provided within three calendar days of any such reduction.
2. Outflow of FCM's Assets
Paragraph (b)(2)(ii) of Rule 1.15 requires an FCM to notify the
Commission of any outflow of assets from the FCM which in the aggregate
in any 30 calendar day period exceeds 20 percent or more of the FCM's
excess adjusted net capital. The rule explicitly excludes, however,
securities transactions between FCMs and their MAPs which occur in the
ordinary course of business where payment is made within two business
days, and aggregate withdrawals equalling $500,000 or less (computed on
a net basis) within a 30 calendar-day period. This provision would
enable the Commission to receive current information on matters that
materially impact the financial resources of a futures commission
merchant and to update the Commission's records regarding the amount of
an entity's adjusted net capital and other financial resources
maintained by a firm, which otherwise could become materially
inaccurate. This notice requirement is similar to a requirement in the
SEC's net capital rule which requires broker-dealers to notify the SEC
of certain withdrawals of equity capital.43 The Commission's rule
is, however, both more lenient and broader than the SEC rule. The
Commission's proposal allows three business days for an FCM to notify
the Commission of any transaction which falls within the proposed rule,
as opposed to the advance notice or two business day notification
requirements established by the SEC. However, the Commission requires
notice of ``any outflow of assets'' that meets the criteria set forth
in the proposed rule and therefore potentially could require notice of
certain transactions that would not affect an entity's regulatory
capital and therefore would not fall within the SEC's notice
provisions.
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\4\3See supra note 42.
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3. Losses
Paragraph (b)(2)(iii) of proposed Rule 1.15 would require an FCM to
notify the Commission if aggregate cumulative losses occurring in all
noncustomer accounts (as defined in Rule 1.17(b)(4)) carried by the FCM
exceed: (1) In any 30 day period, the greater of 10 percent of the last
reported consolidated stockholders' equity of the FCM's parent or $50
million; or (2) in any 12-month period, the greater of 20 percent of
the last reported consolidated stockholders' equity of the FCM's parent
or $100 million.
This provision is designed to assure that the FCM alerts the
Commission to material losses in the futures markets to the extent such
losses are incurred by the consolidated group in noncustomer accounts
carried by the FCM. Since reporting under this provision is triggered
by losses in the futures markets and does not depend upon a computation
of corporate net income pursuant to generally accepted accounting
principles, it is a simple and relatively sensitive reporting device.
Although the Commission recognizes that losses on futures transactions
may be offset by corresponding gains on related cash positions, this
notice provision is intended to permit the Commission to make early
inquiries regarding financial strategies or positions that may be
causing material cash flow demands on the resources of the consolidated
group of which the FCM is a part.
Paragraph (b)(2)(iv) of Rule 1.15 is intended to alert the
Commission to large losses occurring at a MAP which may affect the
consolidated group's financial stability. This provision requires an
FCM to notify the Commission of any net loss at a MAP during any
quarter which exceeds 30 percent of the MAP's last reported net worth
or 20 percent of the FCM's adjusted net capital.
4. Changes in Credit or Capital Rating
Paragraph (b)(2)(vi) of Rule 1.15 requires an FCM to notify the
Commission of any reduction in a MAP's credit rating by Standard &
Poor's Corporation, Moody's Investor Services, Inc. or any other
nationally recognized rating service. As over-the-counter transactions
may be conducted through unregulated entities that are heavily
dependent upon high credit ratings for the conduct of their business, a
change in credit rating may be very material to such entities'
operations. Consequently, reporting under this provision will alert the
Commission to events which could adversely impact the FCM or its
consolidated group.
Paragraph (b)(2)(vii) requires an FCM to notify the Commission if a
MAP files a notice with a banking regulator stating that an adjustment
to its capital category may have occurred. A reduction in capital
category may have been due to financial or other events of which the
Commission has not yet become aware. Under banking regulations, an
entity subject to the supervision of the Board of Governors of the
Federal Reserve System, the Office of Thrift Supervision, the Federal
Deposit Insurance Corporation or the Office of the Comptroller of the
Currency must provide written notice to its supervisory agency or
agencies that an adjustment to the entity's capital category may have
occurred, no later than 15 calendar days following the date that any
material event has occurred that would cause the entity to be placed in
a lower capital category.44
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\4\4See 12 CFR 208.32(c)(1993); 12 CFR 565.3(c)(1993); 12 CFR
325.102(c)(1993); and 12 CFR 6.3(c)(1993).
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5. Guarantee Agreements
Paragraph (b)(2)(viii) of Proposed Rule 1.15 would require an FCM
to notify the Commission three business days prior to the effective
date of any agreement whereby the FCM agrees to guarantee the
obligation of any affiliated entity. The Commission wishes to emphasize
that this provision applies to agreements between the FCM and any
affiliate and is not limited to guarantee agreements entered into with
a MAP.45 Notice under this provision would inform the Commission
as to new financial obligations undertaken by an FCM that may have a
material impact upon the firm's regulatory capital and may not yet have
been reflected in financial reports filed with the Commission. Upon
receipt of a notice under this provision, depending upon the nature and
extent of the guarantee, the Commission may request a current pro forma
computation of an FCM's adjusted net capital position, which would
indicate the potential impact on adjusted net capital of any newly
undertaken guarantees.
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\4\5However, the establishment of such a guarantee arrangement
may result in the affiliate becoming a MAP.
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D. Exemptions and Special Provisions
Under Section 4f(c), the Commission may exempt, ``under such terms
and conditions and for such periods as the Commission shall provide,''
any person or class of persons from rules issued pursuant to that
provision. Section 4f(c) of the Act directs the Commission to consider
the following general factors in determining whether to grant such
exemptions: (1) Whether the information requested is available from
another supervisory agency; (2) the primary business of an affiliated
person; (3) the nature and extent of domestic or foreign regulation of
the affiliated person's activities; (4) the nature and extent of the
FCM's commodity futures and options activities; and (5) the amount of
assets and revenues derived from and involved in United States futures
markets.
Based upon these factors and the purposes of the risk assessment
rules, the Commission has determined to provide an exemption for FCMs
who, based on the amount of customer funds held and adjusted net
capital maintained, appear to engage in only small amounts of futures
and options activities. Further, the proposed rules provide special
provisions for entities which are subject to the regulatory oversight
of other domestic and foreign regulatory bodies. With respect to FCMs
that are not otherwise exempt, the proposed rules permit an FCM, by
application, to request individual exemptions from the rules which
would be considered by the Commission on a case-by-case basis.
1. Exemption Based on Level of Customer Funds and Net Capital
Preliminarily, the Commission has determined to focus its risk
assessment program upon those FCMs which appear to be significantly
engaged in futures and options trading or which, by virtue of their
status as clearing members46 of exchanges may have a significant
impact upon the financial integrity of the exchange marketplace. In
this regard, the Commission is proposing to exempt from the risk
assessment requirements all FCMs, other than clearing member firms,
that hold customer funds of less than $6,250,00047 and maintain
adjusted net capital of less than $5,000,000, calculated as of the
FCM's fiscal year-end.48 Of course, the Commission may re-evaluate
these customer funds and adjusted net capital levels at a later date
should experience indicate that they are either too high or too low
given the objective of the risk assessment rules to provide the
Commission with data designed to reduce risks to the futures markets
and users of regulated intermediaries transacting in these markets
arising from the financial deterioration of an FCM or related company.
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\4\6Rule 1.3(c) defines ``clearing member'' as any person who is
a member of, or enjoys the privilege of clearing trades in his own
name through, the clearing organization of a contract market.
\4\7In determining the dollar amount of customer funds held by
an FCM at fiscal year-end, funds required to be segregated pursuant
to section 4d(2) of the Act and set aside pursuant to part 30 of the
Commission's rules are required to be included. The Commission
requests comment as to whether the calculation of customer funds for
this purpose should be the same as that for Rule 1.17 capital
computation purpose, i.e., whether long option values should be
deducted.
\4\8The Commission estimates that approximately 200 FCMs would
be covered under the proposed rules. A substantial percentage of
these FCMs either are dually registered as broker-dealers reporting
under the SEC's risk assessment rules or are affiliated with a
reporting broker-dealer, bank or insurance company.
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Currently, the Commission requires an FCM to calculate its minimum
adjusted net capital requirement by multiplying the amount it is
required to segregate and set aside in special accounts for the benefit
of its customers by four percent, subject to a minimum dollar
requirement of $50,000.49 However, Commission Rule 170.15 provides
that ``(e)ach person required to register as a futures commission
merchant must become and remain a member of at least one futures
association which is registered under section 17 of the Act and which
provides for the membership therein of such futures commission
merchant, unless no such futures association is so registered.'' The
Commission approved an increase in the minimum dollar requirement for
member FCMs of the NFA, currently the only registered futures
association, from $50,000 to $250,000, effective December 31, 1990.
This increase effectively requires all FCMs to maintain adjusted net
capital of at least $250,000. Therefore, the Commission believes that
it is appropriate to use as the minimum level for the application of
those rules that level of customer funds carried by an FCM where an
increase in such amount of funds will effectively cause an increase in
the minimum adjusted net capital requirement. Based upon the NFA
minimum dollar amount and the Commission's basic four percent
calculation, that level is $6,250,000.
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\4\9See Commission Rule 1.17(a)(1)(i).
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The Commission further believes that, even if an FCM is not
carrying any customer funds, it may be engaged in proprietary trading
or trading for noncustomer accounts to an extent that could create the
potential for risks to other market participants or systemic risks. The
Commission is therefore proposing $5 million of adjusted net capital as
an additional minimum level for application of these rules, even if a
firm is not carrying the minimum level of customer funds of $6,250,000.
In determining this amount, the Commission examined data concerning the
financial condition of registered FCMs and comparable SEC rules.50
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\5\0The comparable SEC figure is $20 million. 17 CFR 240.17h-
1T(d)(1)(iv) and 240.17h-2T(b)(1)(iv). However, given the relative
size of securities and futures market activity, the degree of
leverage in futures transactions, and the fact that the Commission
is proposing a materiality threshold of $20 million, as compared to
the SEC's $100 million, a $5 million adjusted net capital ceiling
for exemption from these rules appears to be an appropriate level.
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The Commission requests comment as to the appropriateness of the
adjusted net capital and customer funds exemption levels established by
the proposed rules.
2. Special Provisions for Certain Regulated Entities
a. Broker-Dealers. The legislative history of section 4f(c) of the
FTPA indicates that Congress intended that, in promulgating its risk
assessment rules, the Commission would ``avoid imposing unnecessary
paperwork burdens upon securities brokers or dealers regulated by the
SEC.''\51\ As noted above, the SEC has adopted interim risk assessment
rules which require recordkeeping and quarterly reporting of
comprehensive information concerning material affiliates of broker-
dealers. The proposed rules derive in significant measure from the
SEC's risk assessment rules and are intended to facilitate reporting by
FCMs that are either also registered as broker-dealers and are required
to report to the SEC pursuant to the SEC's rules or are part of a
holding company group that includes a broker-dealer reporting pursuant
to the SEC's rules. The rules also contemplate coordination with other
regulators and the use of triggering events to diminish routine
paperwork. In light of the SEC's risk assessment requirements, the
Commission's proposed rules permit FCMs that are dually registered as
securities broker-dealers or that have affiliates that are registered
as broker-dealers to file SEC Form 17-H, the SEC's risk assessment
information form, in partial compliance with the Commission's proposed
rules. Generally, under proposed Rule 1.15(d)(1), an FCM that is dually
registered as a broker-dealer or that has an affiliate that is
registered as a broker-dealer would be deemed to be in compliance with
all of the routine reporting requirements of proposed Rule 1.15, except
the filing of risk management policies pursuant to paragraph (a)(1)(ii)
of Rule 1.15\52\ and the reporting of information regarding the FCM's
noncustomer accounts under paragraphs (a)(1)(iii) and (a)(3) of
proposed Rule 1.15, if the FCM files SEC Form 17-H with the Commission.
However, if the SEC filing does not include as MAPs all of the entities
that would be MAPs of the FCM under the CFTC's rules, the SEC filing
would be required to be supplemented to include those MAPs. Only an
individual filing for the excluded MAP need be filed. Similarly, the
FCM would be deemed to be in compliance with all of the recordkeeping
requirements of proposed Rule 1.14, except for the requirements that
the FCM maintain records concerning the FCM's risk management policies
under paragraph (a)(1)(ii) and noncustomer accounts under paragraph
(a)(1)(x), if the FCM maintains, in accordance with the proposed rule,
copies of the records and reports maintained and filed on SEC Form 17-
H. The FCM would, however, be required to maintain supplemental
information for any entities required to be treated as MAPs under the
CFTC's rules that are not treated as MAPs for purposes of the SEC's
rules.
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\51\S. Rep. No. 22, 102d Cong., 2d Sess. at 50.
\52\The relief provided does not extend to filing of risk
management policies because although the SEC rules require filing of
many of the same types of written policies and procedures as the
CFTC's rules, the CFTC rule requires additional information relating
to FCM risk management policies with respect to noncustomer trading
activities.
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Because SEC Form 17-H is, with respect to certain reporting
requirements, more inclusive than the Commission's proposed reporting
requirements, Rule 1.15(d)(1) provides an FCM with the option of either
filing Form 17-H in its entirety, or filing the form with certain
modifications to omit information that would not be required under the
proposed rules. Specifically, the FCM may make the following changes to
its Form 17-H filing: (1) The FCM need not include information on
arbitrage and purchased options required under Items 10 and 11,
respectively, of Part I of Form 17-H; (2) the FCM may substitute the
real estate information required to be maintained under Rule
1.14(a)(ix) and reported under Section V of Form 1.15A for the detailed
information required under Section V of Form 17-H; and (3) the FCM may
file the information required under Part II of Form 17-H on an
aggregate basis for its MAPs rather than for each MAP as otherwise
required, provided that if this would materially understate risk in
relation to equity in any MAP, the information must be provided
separately for such MAP. The FCM may use either the Commission or the
SEC form for the latter purpose. As noted above, however, an FCM who
qualifies under the special provisions applicable to SEC filers would
remain responsible for maintaining and furnishing the Commission with
information concerning the FCM's risk management policies under
paragraph (a)(1)(ii) of proposed Rules 1.14 and 1.15 and noncustomer
accounts under paragraphs (a)(1)(x) of proposed Rule 1.14 and
(a)(1)(iii) and (a)(3) of proposed Rule 1.15. Moreover, the FCM would
remain responsible for notifying the Commission of the occurrence of
the events specified in Rule 1.15(b)(2) and providing supplemental
information, if requested. If, however, such a ``triggering'' event
occurs, the Division Director will attempt, in the first instance, to
obtain any necessary supplemental information from the FCM's or its
MAP's filings with the SEC.\53\
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\53\A letter from the FCM or a relevant MAP acknowledging the
Commission's right of access to relevant SEC risk assessment filings
may be requested in these circumstances.
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The Commission believes that compliance with the notice provisions
of proposed Rule 1.15(b) is essential to enable the Commission to act
expeditiously in emergency situations and to detect incipient problems.
The Commission does not believe that such compliance should impose an
undue burden on entities dually registered as FCMs and securities
broker-dealers, as the events that require notification under proposed
Rule 1.15(b) should occur infrequently.
b. Banks. Section 4f(c)(4)(B) of the Act provides generally that a
registered FCM shall be considered to have complied with recordkeeping
or reporting requirements adopted by the Commission ``concerning an
affiliated person that is subject to examination by, or reporting
requirements of, a Federal banking agency if the [FCM] utilizes for the
recordkeeping or reporting requirement copies of reports filed by the
affiliated person with the Federal banking agency'' pursuant to section
5211 of the Revised Statutes, section 9 of the Federal Reserve Act,
section 7(a) of the Federal Deposit Insurance Act, section 10(b) of the
Home Owners' Loan Act or section 5 of the Bank Holding Company Act. The
legislative history of the FTPA indicates, however, that an FCM may not
be required under any circumstances to obtain or furnish the Commission
with copies of examination reports.\54\
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\54\H.R. Rep. No. 978, 102d Cong., 2d Sess. 75 (1992).
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With respect to an FCM with a MAP that is subject to supervision by
a federal banking agency, the proposed rule provides that an FCM will
be deemed to be in compliance with all of the routine reporting
requirements of proposed Rule 1.15(a)(2) with respect to such MAP, if
the FCM maintains in accordance with Rule 1.14 copies of all reports
filed by the MAP with bank regulators.\55\ Paragraph (b)(2) of proposed
Rule 1.14 provides similar treatment with respect to recordkeeping
requirements. Generally, foreign banking organizations that are subject
to U.S. banking regulation will be treated in the same fashion as
domestic banks for purposes of the application of the proposed rules.
Additionally, as part of its risk assessment program with respect to
MAPs that are subject to the supervision of a federal banking agency,
the Commission intends to obtain and review, on an as-needed basis, the
Bank Holding Company Performance Report prepared by the Board of
Governors of the Federal Reserve and/or the Uniform Bank Performance
Report, prepared by the Federal Deposit Insurance Corporation, to gain
further information regarding the financial activities of such MAPs.
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\55\With respect to Form FR 2068, the Confidential Form of
Operations required to be filed with the Board of Governors of the
Federal Reserve System by foreign banking organizations, Commission
staff are exploring with Federal Reserve officials procedures by
which access to Form 2068 may be obtained on an as needed basis.
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c. Insurance Companies. Section 4f(c) of the Act requires that, in
granting exemptions from the reporting and recordkeeping requirements,
the Commission should consider, among other factors, whether
information of the type required is available from a state insurance
commission or similar state agency. The proposed rules would provide
relief comparable to that provided with respect to MAPs subject to
supervision by Federal banking agencies for MAPs subject to regulation
by an insurance commissioner or other similar state official or agency.
Under the proposed rule, an FCM with a MAP that is an insurance company
would satisfy the routine reporting requirements of proposed Rule
1.15(a)(2) with respect to such a MAP if, in the case of a mutual
insurance company or non-public stock company, the FCM maintains in
accordance with proposed Rule 1.14 copies of the annual reports filed
by the parent insurance company on forms prescribed by the National
Association of Insurance Commissioners. With respect to a MAP organized
as a public stock company, the FCM would be required, in addition to
maintaining state insurance reports, to maintain in accordance with
proposed Rule 1.14 copies of the filings the insurance company makes
under Sections 13 or 15 of the Securities Exchange Act of 1934 and
filings made under the Investment Company Act of 1940.
d. Firms subject to foreign regulatory supervision. With respect to
foreign firms that are regulated in a foreign jurisdiction, the
proposed rules would permit an FCM to maintain and file any financial
or risk exposure reports filed by a MAP with a foreign futures
authority, as that term is defined in section 1a(10) of the Commodity
Exchange Act, or other foreign regulatory authority with which the
Commission has an information-sharing agreement in effect. The proposed
rules require that the FCM file with the Commission a copy of the
original report as well as one copy translated into English. In the
absence of such an information-sharing agreement, the FCM would be
required to comply with the proposed rules with respect to foreign MAPs
subject to foreign regulation to the same extent as unregulated
entities.
III. Implementation Schedule
The Commission is proposing to phase in implementation of the risk
assessment rules in order to provide FCMs with the opportunity to make
any internal adjustments in their financial recordkeeping and reporting
operations which may be necessary prior to beginning compliance with
the risk assessment rules. The proposed rules would require that FCMs
maintain and file with the Commission the organizational chart, risk
management policy information and noncustomer account information
required by paragraphs (a)(1)(i), (a)(1)(ii) and (a)(1)(x) of proposed
Rule 1.14 and paragraphs (a)(1)(i), (a)(1)(ii) and (a)(1)(iii) of
proposed Rule 1.15 within 90 calendar days from the effective date of
the proposed rules. The first annual filings for fiscal years ending
December 31, 1994 or thereafter would be due, in accordance with the
proposed rules, within 105 calendar days of fiscal year-end.
IV. Other Matters
The Commission has proposed these rules recognizing the types and
formats of information provided to other reporting agencies and based
upon the types of information it uses to consider regulatory
intervention in financial disruptions. Nonetheless, the Commission
requests comment on whether alternative approaches could achieve the
Commission's and Congress' objectives and could be reasonably
integrated with the approaches of other financial regulators. In that
current events have caused the Commission to need enhanced authority to
obtain information concerning affiliate activity, the Commission will
only consider responses to this request for alternatives that are
sufficiently specific to reasonably convince it that the alternative
would address the Commission's objectives.
V. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA), 5 U.S.C. 601-611 (1988),
requires that agencies, in proposing rules, consider the impact of
those rules on small businesses. The rules discussed herein will affect
FCMs. The Commission already has established certain definitions of
``small entities'' to be used by the Commission in evaluating the
impact of its rules on such small entities in accordance with the
RFA.\56\ FCMs have been determined not to be small entities under the
RFA. Additionally, smaller FCMs generally will not be affected by the
proposed rules because the rules exempt from their requirements certain
smaller entities. The Commission believes that the proposals, if
adopted, would not have a significant economic impact on smaller
entities.
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\56\47 FR 18618-18621 (April 30, 1982).
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Accordingly, pursuant to Rule 3(a) of the RFA, 5 U.S.C. 605(b), the
Chairman, on behalf of the Commission, certifies that these proposed
rules will not have a significant economic impact on a substantial
number of small entities. The Commission nonetheless invites comment
from any registered FCM who believes that these rules would have a
significant impact on its operations.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1980 (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. In compliance with the
PRA the Commission has submitted these proposed rules and its
associated information collection requirements to the Office of
Management and Budget. The burden associated with this entire
collection, including these proposed rules, is as follows:
Average Burden Hours Per Response: 18.55
Number of Respondents: 1,990
Frequency of Response: Annually and on occasion
The burden associated with this specific proposed rule, is as
follows:
Average Burden Hours Per Response: 3.05
Number of Respondents: 620
Frequency of Response: Annually and on occasion
Persons wishing to comment on the estimated paperwork burden
associated with this proposed rule should contact Gary Waxman, 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 Office, 2033 K Street, NW.,
Washington, DC 20581, (202) 254-9735.
C. Electronic Filing
The Office of the Executive Director expects to include review of
this proposal in any plan to enhance and refine systems to accept
electronic filings. Should it appear that the filing of data
electronically would expedite the purposes of collecting the
information or provide a significant cost benefit to reporting entities
and the Commission, the Commission will work with the reporting
entities to define and implement a secure cost-effective reporting
method.
List of Subjects in 17 CFR Part 1
Financial reporting, Recordkeeping requirements, Risk assessment.
In consideration of the foregoing, and pursuant to the authority
contained in the Commodity Exchange Act, and in particular, sections
4f(b), 4f(c) 4g and 8a, 7 U.S.C. 6f(b), 6f(c), 6g and 12a, the
Commission hereby proposes to amend part 1 of 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 1.14 is proposed to be added to read as follows:
Sec. 1.14 Risk assessment recordkeeping requirements for futures
commission merchants.
(a) Requirement to maintain and preserve information. (1) Each
futures commission merchant registered with the Commission pursuant to
section 4d of the Act, unless exempt pursuant to paragraph (d) of this
section, shall prepare, maintain and preserve the following
information:
(i) An organizational chart which includes the futures commission
merchant and each of its affiliated persons. Included in the
organizational chart shall be a designation of which affiliated persons
are ``Material Affiliated Persons'' as that term is used in paragraph
(a)(2) of this section, which Material Affiliated Persons file routine
financial or risk exposure reports with the Securities and Exchange
Commission, a federal banking agency, an insurance commissioner or
other similar official or agency of a state, or a foreign regulatory
authority, and which Material Affiliated Persons are dealers, end users
or both;
(ii) Written policies, procedures, or systems concerning the
futures commission merchant's:
(A) Method(s) for monitoring and controlling financial and
operational risks to it resulting from the activities of any of its
affiliated persons;
(B) Financing and capital adequacy, including information regarding
sources of funding, together with a narrative discussion by management
of the liquidity of the material assets of the futures commission
merchant, the structure of debt capital, and sources of alternative
funding;
(C) Establishing and maintaining internal controls with respect to
market risk, credit risk, and other risks created by the futures
commission merchant's proprietary and noncustomer clearing activities,
including systems and policies for supervising, monitoring, reporting
and reviewing trading activities in securities, futures contracts,
commodity options, forward contracts and financial instruments;
policies for hedging or managing risks created by trading activities or
reviewing hedging and risk management strategies of noncustomer
affiliates, including a description of the types of reviews conducted
to monitor positions; and policies relating to restrictions or
limitations on trading activities:
Provided, however, that if the futures commission merchant has no such
written policies, procedures or systems, it must so state in writing.
(iii) Fiscal year end consolidated and consolidating balance sheets
for the futures commission merchant and its ultimate parent company,
prepared in accordance with generally accepted accounting principles,
which consolidated balance sheets shall be audited by an independent
certified public accountant if an annual audit is performed in the
ordinary course of business, but which otherwise may be unaudited, and
which shall include appropriate explanatory notes. The consolidating
balance sheet shall show separately the futures commission merchant,
its ultimate parent company and each Material Affiliated Person;
(iv) Fiscal year end consolidated and consolidating income
statements and consolidated cash flow statements for the futures
commission merchant and its ultimate parent company, prepared in
accordance with generally accepted accounting principles, which
consolidated statements shall be audited by an independent certified
public accountant if an annual audit is performed in the ordinary
course of business, but which otherwise may be unaudited, and which
shall include appropriate explanatory notes. The consolidating
statements shall show separately the futures commission merchant, its
ultimate parent company and each Material Affiliated Person;
(v) The fair market value as of the end of each fiscal quarter of
each Material Affiliated Person's inventory of long and short
securities and physical commodity positions as specified in Form 1.15A,
including a separate listing for each Material Affiliated Person of any
aggregate unhedged exposure, other than U.S. government or agency
securities, denominated in dollars measured by interest rate, duration,
instrument or other measure as specified by the reporting entity, that
exceeds the Materiality Threshold, as defined in this section, at any
fiscal quarter end;
(vi) The notional or contractual amounts, and in the case of
options, the value of the underlying instruments, as of the end of each
fiscal quarter, of exchange-traded futures and commodity option
contracts, forward contracts, over-the-counter commodity options, and
financial instruments with off-balance sheet risk or concentrations of
credit risk (as those terms are used in Statement of Financial
Accounting Standards No. 105), broken down by contract type and
maturity, as specified in Form 1.15A. The record must identify each
instrument or contract where the credit risk (as that term is used in
Statement of Financial Accounting Standards No. 105) with respect to a
counterparty exceeds the Materiality Threshold at the fiscal quarter
end;
(vii) The aggregate amount as of the end of each fiscal quarter of
all material unsecured extensions of credit (not including intra-group
receivables) with an initial or remaining maturity of less than one
year by each Material Affiliated Person, together with the allowance
for losses for such transactions;
(viii) The aggregate amount as of the end of each fiscal quarter of
commercial paper, secured and other unsecured borrowing, bank loans,
lines of credit, or any other borrowings, and the principal
installments of long-term or medium-term debt, scheduled to mature
within twelve months from the most recent fiscal quarter for each
Material Affiliated Person;
(ix) The percentage, as of fiscal year end, of annual gross income
or loss derived from real estate activities, including mortgage loans
and investments in real estate, with respect to each Material
Affiliated Person which derived greater than 20 percent of its gross
income or loss for the fiscal year from such activities; and
(x) The gross notional value, long and short, of open positions in
noncustomer accounts, as defined in Sec. 1.17(b)(4), carried by the
futures commission merchant as of the end of each fiscal quarter, the
percentage of such aggregate notional value compared to the futures
commission merchant's adjusted net capital, the percentage of the
aggregate notional value of open positions in noncustomer accounts
carried by the futures commission merchant that constitute bona fide
hedging positions in accordance with Sec. 1.3(z), and the percentage of
the aggregate notional value of noncustomer accounts carried for the
purpose of managing the risk of cash market commitments that mature
more than 12 months and 60 months, respectively, from fiscal quarter
end compared to the aggregate notional value of open positions in all
noncustomer accounts carried by the futures commission merchant.
(2) The determination of whether an affiliated person of a futures
commission merchant is a Material Affiliated Person shall involve
consideration of all aspects of the activities of, and the relationship
between, both entities, including without limitation, the following
factors:
(i) The legal relationship between the futures commission merchant
and the affiliated person;
(ii) The overall financing requirements of the futures commission
merchant and the affiliated person, and the degree, if any, to which
the futures commission merchant and the affiliated person are
financially dependent on each other;
(iii) The degree, if any, to which the futures commission merchant
or its customers rely on the affiliated person for operational support
or services in connection with the futures commission merchant's
business;
(iv) The level of market, credit or other risk present in the
activities of the affiliated person; and
(v) The extent to which the affiliated person has the authority or
the ability to cause a withdrawal of capital from the futures
commission merchant.
(3) The information, reports and records required by this section
shall be maintained and preserved, and made readily available for
inspection in accordance with the provisions of Sec. 1.31.
(4) For the purposes of this section and Sec. 1.15, the term
Materiality Threshold shall mean the greatest of:
(i) $20 million;
(ii) 10 percent of the futures commission merchant's adjusted net
capital as reported on its most recent financial reports filed pursuant
to Sec. 1.10;
(iii) 10 percent of the Material Affiliated Person's tangible net
worth; or
(iv) In the case of a futures commission merchant that is required,
or that has a Material Affiliated Person that is required, to maintain
and preserve information pursuant to Rule 240.17h-1T of this title, the
Materiality Threshold specified in Sec. 240.17h-1T or such other risk-
assessment regulations as the Securities and Exchange Commission may
adopt.
(b) Special provisions with respect to material affiliated persons
subject to the supervision of certain domestic regulators. A futures
commission merchant shall be deemed to be in compliance with the
recordkeeping requirements of paragraphs (a)(1)(i) and (a)(1)(iii)
through (ix) of this section if:
(1) The futures commission merchant is required, or has a Material
Affiliated Person that is required, to maintain and preserve
information pursuant to Rule 240.17h-1T of this title, or such other
risk assessment regulations as the Securities and Exchange Commission
may adopt, and maintains and makes available for inspection by the
Commission in accordance with the provisions of this section copies of
the records and reports maintained and filed on Form 17-H (or such
other forms or reports as may be required) by such futures commission
merchant or its Material Affiliated Person with the Securities and
Exchange Commission pursuant to Secs. 240.17h-1T and 240.17h-2T of this
title, or such other risk assessment regulations as the Securities and
Exchange Commission may adopt, provided, however, that if the futures
commission merchant has any Material Affiliated Persons for purposes of
this section and Sec. 1.15 that are not designated as Material
Associated Persons for purposes of Secs. 240.17h-1T and 240.17h-2T of
this title, the futures commission merchant must also maintain the
information required pursuant to paragraphs (a)(1)(v) through (ix) of
this section for any such Material Affiliated Person;
(2) In the case of a Material Affiliated Person that is subject to
examination by, or the reporting requirements of, a Federal banking
agency, the futures commission merchant maintains and makes available
for inspection by the Commission in accordance with the provisions of
this section copies of all reports submitted by such Material
Associated Person with the Federal banking agency pursuant to section
5211 of the Revised Statutes, section 9 of the Federal Reserve Act,
section 7(a) of the Federal Deposit Insurance Act, section 10(b) of the
Home Owners' Loan Act, or section 5 of the Bank Holding Company Act of
1956; or
(3) In the case of a Material Affiliated Person that is subject to
the supervision of an insurance commissioner or other similar official
or agency of a state, the futures commission merchant maintains and
makes available for inspection by the Commission in accordance with the
provisions of this section copies of the annual statements with
schedules and exhibits prepared by the Material Affiliated Person on
forms prescribed by the National Association of Insurance Commissioners
or by a state insurance commissioner.
(c) Special provisions with respect to material affiliated Persons
subject to the supervision of a Foreign Regulatory Authority. A futures
commission merchant shall be deemed to be in compliance with the
recordkeeping requirements of paragraphs (a)(iii) through (a)(ix) of
this section with respect to a Material Affiliated Person if such
futures commission merchant maintains and makes available for
inspection by the Commission in accordance with the provisions of this
section copies of any financial or risk exposure reports filed by such
Material Affiliated Person with a foreign futures authority or other
relevant foreign authority. The futures commission merchant shall
maintain a copy of the original report and a copy translated into the
English language.
(d) Exemptions. (1) The provisions of this section shall not apply
to any futures commission merchant which holds funds or property of or
for futures customers of less than $6,250,000, has less than $5,000,000
in adjusted net capital as of the futures commission merchant's current
fiscal year end, and is not a clearing member of an exchange.
(2) The Commission may, upon written application by a Reporting
Futures Commission Merchant, exempt from the provisions of this
section, either unconditionally or on specified terms and conditions,
any futures commission merchant affiliated with such Reporting Futures
Commission Merchant. The term ``Reporting Futures Commission Merchant''
shall mean, in the case of a futures commission merchant that is
affiliated with another registered futures commission merchant, the
futures commission merchant which maintains the greater amount of
adjusted net capital as last reported on financial reports filed with
the Commission pursuant to Sec. 1.10. In granting exemptions under this
section, the Commission shall consider, among other factors, whether
the records required by this section concerning the Material Affiliated
Persons of the futures commission merchant affiliated with the
Reporting Futures Commission Merchant will be available to the
Commission pursuant to this section or Sec. 1.15.
(e) Location of records. A futures commission merchant required to
maintain records concerning Material Affiliated Persons pursuant to
this section may maintain those records either at the principal office
of the Material Affiliated Person or at a records storage facility,
provided that the records are located within the boundaries of the
United States and the records are kept and available for inspection in
accordance with Sec. 1.31. If such records are maintained at a place
other than the futures commission merchant's principal place of
business, the Material Affiliated Person or other entity maintaining
the records shall file with the Commission a written undertaking, in a
form acceptable to the Commission, signed by a duly authorized person,
to the effect that the records will be treated as if the futures
commission merchant were maintaining the records pursuant to this
section and that the entity maintaining the records will permit
examination of such records at any time, or from time to time during
business hours, by representatives or designees of the Commission and
promptly furnish the Commission representative or its designee true,
correct, complete and current hard copy of any or all or any part of
such records. The election to maintain records at the principal place
of business of the Material Affiliated Person or at a records storage
facility pursuant to the provisions of this paragraph shall not relieve
the futures commission merchant required to maintain and preserve such
records from any of its responsibilities under this section or
Sec. 1.15.
(f) Confidentiality. All information obtained by the Commission
pursuant to the provisions of this section from a futures commission
merchant concerning a Material Affiliated Person shall be deemed
confidential information for the purposes of section 8 of the Act.
(g) Implementation schedule. Each futures commission merchant
subject to the requirements of this section shall maintain and preserve
the information required by this section commencing 90 days from the
effective date of this section.
3. Section 1.15 is proposed to be added to read as follows:
Sec. 1.15 Risk assessment reporting requirements for futures
commission merchants.
(a) Reporting requirements with respect to information required to
be maintained by Sec. 1.14. (1) Each futures commission merchant
registered with the Commission pursuant to Section 4d of the Act,
unless exempt pursuant to paragraph (c) of this section, shall file the
following with the regional office with which it files periodic
financial reports within 90 calendar days after the effective date of
this section, provided that in the case of a futures commission
merchant whose registration becomes effective after the effective date
of this section, such futures commission merchant shall file the
following within 60 calendar days after the effective date of such
registration:
(i) A copy of the organizational chart maintained by the futures
commission merchant pursuant to paragraph (a)(1)(i) of Sec. 1.14. Where
there is a material change in information provided, an updated
organizational chart shall be filed within five calendar days after the
end of the fiscal quarter in which the change has occurred;
(ii) Copies of the financial, operational, and risk management
policies, procedures and systems maintained by the futures commission
merchant pursuant to paragraph (a)(1)(ii) of Sec. 1.14. If the futures
commission merchant has no such written policies, procedures or
systems, it must file a statement so indicating. Where there is a
material change in information provided, such change shall be reported
within five calendar days after the end of the fiscal quarter in which
the change has occurred; and
(iii) The aggregate notional value of open positions in noncustomer
accounts, as defined in Sec. 1.17(b)(4), held by the futures commission
merchant as of the end of the most recent fiscal year, the percentage
of such aggregate notional value compared with the futures commission
merchant's adjusted net capital as of its fiscal year end, the
percentage of the aggregate notional value of open positions in
noncustomer accounts carried by the futures commission merchant that
constitute bona fide hedging positions in accordance with Sec. 1.3(z),
and the percentage of the aggregate notional value of open positions in
noncustomer accounts held for the purpose of managing the risks of cash
market commitments that mature more than 12 months and 60 months,
respectively, from the most recent fiscal quarter end, as compared to
the aggregate notional value of open positions in all noncustomer
accounts held by the futures commission merchant.
(2) Each futures commission merchant registered with the Commission
pursuant to section 4d of the Act, unless exempt pursuant to paragraph
(c) of this section, shall file the following with the regional office
with which it files periodic financial reports within 105 calendar days
after the end of each fiscal year:
(i) Fiscal year end consolidated and consolidating balance sheets
for the futures commission merchant and its ultimate parent company,
prepared in accordance with generally accepted accounting principles,
which consolidated balance sheet shall be audited by an independent
certified public accountant if an annual audit is performed in the
ordinary course of business, but which otherwise may be unaudited, and
which consolidated balance sheets shall include appropriate explanatory
notes. The consolidating balance sheet shall show separately the
futures commission merchant, its ultimate parent company and each
Material Affiliated Person.
(ii) Fiscal year end annual consolidated and consolidating income
statements and consolidated cash flow statements for the futures
commission merchant and its ultimate parent company, prepared in
accordance with generally accepted accounting principles, which
consolidated statements shall be audited by an independent certified
public accountant if an annual audit is performed in the ordinary
course of business, but which otherwise may be unaudited, and which
consolidated statements shall include appropriate explanatory notes.
The consolidating statements shall show separately the futures
commission merchant, its ultimate parent company and each Material
Affiliated Person.
(iii) Form 1.15A. The information required to be reported on Form
1.15A may be provided on an aggregate basis for the futures commission
merchant's Material Affiliated Persons, provided that if this would
materially understate the risk relative to stockholders' equity of any
Material Affiliated Person, the required information must be provided
separately for such Material Affiliated Person.
(3) Each futures commission merchant registered with the Commission
pursuant to Section 4d of the Act, unless exempt pursuant to paragraph
(c) of this section, shall file with the regional office with which it
files periodic financial reports within 60 calendar days after the end
of each fiscal quarter the aggregate notional value of open positions
in noncustomer accounts, as defined in Sec. 1.17(b)(4), held by the
futures commission merchant as of the end of each fiscal year, the
percentage of such aggregate notional value compared with the futures
commission merchant's adjusted net capital as of fiscal year end, the
percentage of the aggregate notional value of open positions in
noncustomer accounts carried by the futures commission merchant that
constitute bona fide hedging positions in accordance with Sec. 1.3(z),
and the percentage of the aggregate notional value of open positions in
noncustomer accounts held for the purpose of managing the risk of cash
market commitments that mature more than 12 months and 60 months,
respectively, from fiscal quarter end compared to the aggregate
notional value of open positions in all noncustomer accounts held by
the futures commission merchant.
(4) A futures commission merchant shall provide the Commission with
updated information within 60 calendar days after the end of each
fiscal quarter for any line item in which a change of 20% or greater
has occurred since the futures commission merchant's last filing with
the Commission with respect to any information required to be reported
pursuant to paragraph (a)(2)(iii) of this section, except information
relating to a Material Affiliated Person's real estate activities;
provided, however, that a futures commission merchant may, at its
option, file the information required by paragraph (a)(2)(iii) of this
section on a routine quarterly basis.
(5) For the purposes of this section, the term Material Affiliated
Person shall have the meaning used in Sec. 1.14.
(b) Notice and additional reporting requirements upon the
occurrence of certain events. (1) A futures commission merchant shall
notify the Director of the Division of Trading and Markets or the
Director's designee of the occurrence of any event specified in
paragraph (b)(2) of this section. Such notice must be provided within
three business days of such occurrence unless a different reporting
period is specified in paragraph (b)(2) of this section. Upon receipt
of such notice from a futures commission merchant, the Director of the
Division of Trading and Markets or the Director's designee may require
that the futures commission merchant provide or cause a Material
Affiliated Person to provide, within three business days from the date
of request or such shorter period as the Division Director or designee
may specify, such other information as the Division Director or
designee determines to be necessary based upon market conditions,
reports provided by the futures commission merchant, or other available
information.
(2) The following events shall require a futures commission
merchant to notify the Director of the Division of Trading and Markets
or the Director's designee in accordance with paragraph (b)(1) of this
section.
(i) Any reduction in adjusted net capital in excess of 20 percent
of the futures commission merchant's adjusted net capital as last
reported in financial reports filed with the Commission pursuant to
Sec. 1.10 shall be reported as follows.
(A) With respect to activities in the normal course of business
(e.g., operating losses, proprietary trading losses, increased charges
against net capital) that cause such reduction, written notification
must be received within two business days of such reduction; and
(B) With respect to any extraordinary transaction or series of
transactions that will cause such reduction, written notification must
be received at least two business days in advance of the transaction or
the first in the series of transactions.
(ii) Any outflow of assets from the futures commission merchant,
including but not limited to any loans, advances, asset transfers,
redemption or repurchase of a consolidated entity's stock,
recapitalization of stock or payment of dividends, which withdrawal,
advance or loan on a net basis exceeds in the aggregate in any 30
calendar day period 20 percent or more of the futures commission
merchant's excess adjusted net capital, provided, however, that this
paragraph shall not apply to:
(A) Securities transactions in the ordinary course of business
between a futures commission merchant and a Material Affiliated Person
where the futures commission merchant makes payment to or on behalf of
such Material Affiliated Person for the securities transaction within
two business days of the transaction; or
(B) Withdrawals, advances or loans which in the aggregate in any
thirty calendar day period, on a net basis, equal $500,000 or less.
(iii) Aggregate, cumulative losses occurring in all non-customer
accounts carried by the futures commission merchant, as defined in
Sec. 1.17(b)(4), which exceed the greater of: (A) In any 30-day period,
10 percent of the last reported consolidated stockholders' equity of
the parent company of the futures commission merchant or $50 million;
and (B) in any 12-month period, 20 percent of the last reported
consolidated stockholders' equity of the parent company of the futures
commission merchant or $100 million;
(iv) Negative net income at a Material Associated Person during any
quarter which is the greater of:
(A) 30 percent of the Material Associated Person's last-reported
net worth; or
(B) 20 percent of the futures commission merchant's adjusted net
capital;
(v) A reduction of 20 percent or more of the consolidated
stockholders' equity of the futures commission merchant's parent from
the date of the parent's last quarterly consolidated financial
statements;
(vi) Any reduction in the credit rating of a Material Affiliated
Person as reported by Standard & Poor's Corporation, Moody's Investor
Services, Inc. or any other nationally recognized rating organization;
(vii) Filing of a notice by a Material Associated Person with the
Board of Governors of the Federal Reserve, the Federal Deposit
Insurance Corporation, the Office of Thrift Supervision, or the Office
of the Comptroller of the Currency pursuant to 12 CFR 208.32(c), 12 CFR
325.102(c), 12 CFR 565.3(c) or 12 CFR 6.3(c), with respect to possible
adjustment of a Material Affiliated Person's capital category; or
(viii) Agreement by the futures commission merchant to guarantee
any obligation of any affiliated entity, such notice to be filed within
three business days before such guarantee is to become effective.
(3) The reports required to be filed pursuant to paragraphs (a)(1),
(a)(2), (a)(3) and (a)(4) of this section shall be considered filed
when received by the regional office of the Commission with whom the
futures commission merchant files financial reports pursuant to
Sec. 1.10. Any notice required to be filed pursuant to paragraph (b)(1)
of this section shall be considered filed when received at the
Commission's principal office in Washington, DC.
(c) Exemptions. (1) The provisions of this section shall not apply
to any futures commission merchant which holds funds or property of or
for futures customers of less than $6,250,000, has less than $5,000,000
in adjusted net capital as of the futures commission merchant's fiscal
year end, and is not a clearing member of an exchange.
(2) The Commission may, upon written application by a Reporting
Futures Commission Merchant, exempt from the provisions of this
section, either unconditionally or on specified terms and conditions,
any futures commission merchants affiliated with the Reporting Futures
Commission merchant. The term ``Reporting Futures Commission Merchant''
shall mean, in the case of a futures commission merchant that is
affiliated with another registered futures commission merchant, the
futures commission merchant which maintains the greater amount of net
capital as last reported on its financial reports filed with the
Commission pursuant to Sec. 1.10. In granting exemptions under this
section, the Commission shall consider, among other factors, whether
the records and other information required to be maintained pursuant to
Sec. 1.14 concerning the Material Affiliated Persons of the futures
commission merchant affiliated with the Reporting Futures Commission
Merchant will be available to the Commission pursuant to the provisions
of this section.
(d) Special provisions with respect to Material Affiliated Persons
subject to the supervision of certain domestic regulators. (1) In the
case of a futures commission merchant which is required to file, or has
a Material Affiliated Person which is required to file, Form 17-H (or
such other forms or reports as may be required) with the Securities and
Exchange Commission pursuant to Secs. 240.17h-2T of this title or such
other risk assessment regulations as the Securities and Exchange
Commission may adopt, such futures commission merchant shall be deemed
to be in compliance with the reporting requirements of paragraphs
(a)(1)(i) and (a)(2) of this section if the futures commission
furnishes, in accordance with paragraph (a)(2) of this section, a copy
of the most recent Form 17-H filed by the futures commission merchant
or its Material Affiliated Person with the Securities and Exchange
Commission, provided however, that if the futures commission merchant
has designated any of its affiliated persons as Material Affiliated
Persons for purposes of this section and Sec. 1.14 which are not
designated as Material Associated Persons for purposes of the Form 17-H
filed pursuant to Secs. 240.17h-1T and 240.17h-2T of this title, the
futures commission must also file any information required pursuant to
paragraph (a)(2)(iii) of this section with respect to any such Material
Affiliated Person and designate any such affiliated person as a
Material Affiliated Person on the organizational chart required as Item
1 of Part I of Form 17-H. To comply with paragraphs (a)(1)(i) and
(a)(2) of this section, such futures commission merchant may, at its
option, file Form 17-H in its entirety or file such form with the
following amendments:
(i) The information concerning arbitrage and purchased options
required to be reported on Items 10 and 11, respectively, of Part I of
Form 17-H need not be included;
(ii) The information concerning real estate activities required to
be maintained under Rule 1.14(a)(1)(ix) and reported on Section V of
Form 1.15A may be included in lieu of the information required under
Section V of Part II of Form 17-H; and
(iii) The information required to be reported on Part II of Form
17-H may be provided on an aggregate basis for the futures commission
merchant's Material Affiliated Persons, provided that if this would
materially understate the risk relative to stockholders' equity of any
Material Affiliated Person, the required information must be provided
separately for such Material Affiliated Person.
(2) In the case of a Material Affiliated Person that is subject to
examination by or the reporting requirements of a Federal banking
agency, the futures commission merchant shall be deemed to be in
compliance with the reporting requirements of paragraph (a)(2) of this
section with respect to such Material Affiliated Person if the futures
commission merchant or such Material Affiliated Person maintains in
accordance with Sec. 1.14 copies of all reports filed by the Material
Affiliated Person with the Federal banking agency pursuant to section
5211 of the Revised Statutes, section 9 of the Federal Reserve Act,
section 7(a) of the Federal Deposit Insurance Act, section 10(b) of the
Home Owners Loan Act, or section 5 of the Bank Holding Company Act of
1956.
(3) In the case of a futures commission merchant that has a
Material Affiliated Person that is subject to the supervision of an
insurance commissioner or other similar official or agency of a state,
such futures commission merchant shall be deemed to be in compliance
with the reporting requirements of paragraph (a)(2) of this section
with respect to the Material Affiliated Person if:
(i) With respect to a Material Affiliated Person organized as a
mutual insurance company or a non-public stock company, the futures
commission merchant maintains in accordance with Sec. 1.14 copies of
the annual statements with schedules and exhibits prepared by the
Material Affiliated Person on forms prescribed by the National
Association of Insurance Commissioners or by a state insurance
commissioner; and
(ii) With respect to a Material Affiliated Person organized as a
public stock company, the futures commission merchant maintains, in
addition to the annual statements with schedules and exhibits required
to be maintained pursuant to Sec. 1.14, copies of the filings made by
the Material Affiliated Person pursuant to sections 13 or 15 of the
Securities Exchange Act of 1934 and the Investment Company Act of 1940.
(4) No futures commission merchant shall be required to furnish to
the Commission any examination report of any Federal banking agency or
any supervisory recommendations or analyses contained therein with
respect to a Material Affiliated Person that is subject to the
regulation of a Federal banking agency. All information received by the
Commission pursuant to this section concerning a Material Affiliated
Person that is subject to examination by or the reporting requirements
of a Federal banking agency shall be deemed confidential for the
purposes of section 8 of the Act.
(5) The furnishing of any information or documents by a futures
commission merchant pursuant to this section shall not constitute an
admission for any purpose that a Material Affiliated Person is
otherwise subject to the Act.
(e) Special provisions with respect to Material Affiliated Persons
subject to the supervision of a Foreign Regulatory Authority. A futures
commission merchant shall be deemed to be in compliance with the
reporting requirements of paragraph (a)(2) of this section with respect
to a Material Affiliated Person if such futures commission merchant
furnishes, in accordance with the provisions of this section, copies of
any financial or risk exposure reports filed by such Material
Affiliated Person with a foreign futures authority or other foreign
regulatory authority with which the Commission has entered into an
information sharing agreement which remains in effect as of the futures
commission merchant's fiscal year end. The futures commission merchant
shall file a copy of the original report and a copy translated into the
English language. For the purposes of this section, the term Foreign
Futures Authority shall have the meaning set forth in section 1a(10) of
the Act.
(f) Confidentiality. All information obtained by the Commission
pursuant to the provisions of this section from a futures commission
merchant concerning a Material Associated Person shall be deemed
confidential information for the purposes of section 8 of the Act.
(g) Implementation schedule. Each futures commission merchant
subject to the requirements of this section shall file the information
required by paragraph (a)(1) of this section within 90 calendar days
from the effective date of this section. Commencing December 31, 1994,
the provisions of this section shall apply in their entirety.
Risk Assessment Report for Futures Commission Merchants CFTC Form
1.15A--Instructions
1. This form contains three parts. Part A is the cover page and
includes a summary of the FCM's Material Affiliated Persons that are
included in this report as well as the FCM's attestation. Part B
contains information concerning the FCM's MAPs' on-balance sheet
financial instruments (Section I); financial instruments with off-
balance sheet risk (Section II); extensions of credit (Section III);
sources of funding for operations (Section IV); and real estate
activities (Section V). Part C contains information for individual MAPs
whose positions with a single counterparty exceed the Materiality
Threshold as defined in paragraph 9 of these instructions.
2. The information requested in Part B is to be completed in the
aggregate for all MAPs. However, if this would materially understate
the risk exposure relative to stockholders' equity of any MAP, an
additional Part B must be prepared showing the required information for
just that MAP. In addition, Part C must also be prepared for such
separately reported MAP, if applicable.
3. This Form contains line items for reporting numerical and other
data required by paragraphs (a)(1)(v) through (ix) of Rule 1.14. The
information to be provided on this Form is in addition to the reporting
requirements of paragraphs (a)(1) (organizational chart, risk
management policies, and initial filing of aggregate notional value of
open positions in noncustomer accounts), (a)(2)(i) and (ii) (annual
consolidated and consolidating balance sheets, income statements and
cash flow statements), and (a)(3) (quarterly noncustomer account data)
of Rule 1.15.
4. The report is to be prepared as of the last day of the FCM's
fiscal year or fiscal quarter if a quarterly update is required under
Rule 1.15. This Form is to be filed within 105 calendar days after the
end of each fiscal year. An update as to the particular line item only
must be filed within 60 calendar days after the end of each fiscal
quarter for which any line item change of 20 percent or more has
occurred since the FCM's last filing with the Commission.
5. If an FCM is affiliated with one or more other registered FCMs,
each FCM is required to file a separate Form 1.15A. The Commission may
exempt from the filing requirements all FCMs affiliated with an FCM
that has been designated a ``Reporting Futures Commission Merchant'' as
defined in Rules 1.14 and 1.15, i.e., the FCM which maintains the
greater amount of adjusted net capital as last reported to the
Commission. An FCM seeking designation as a Reporting Futures
Commission Merchant must apply to the Commission for such designation
pursuant to Rule 1.15. Pending such designation, each FCM affiliated
with the FCM requesting such designation is required to file a separate
Form 1.15A.
6. Whenever a replacement cost is required to be reported, the
methodology for determining such amount must be stated.
7. Although specific maturities only for swaps and forwards need be
identified, an FCM should also indicate if the maturities of any other
instruments reported herein represent unusual risk.
8. All amounts should be reported in thousands of U.S. dollars.
9. The term ``Materiality Threshold'' shall mean the greatest of:
(i) $20 million; (ii) 10 percent of the FCM's adjusted net capital as
reported on its most recent financial report; (iii) 10 percent of the
Material Affiliated Person's tangible net worth; or (iv) in the case of
an FCM that is required, or that has a Material Affiliated Person that
is required, to maintain and preserve information pursuant to SEC Rule
240.17h-1T, the Materiality Threshold specified in that rule or such
other risk assessment rules as the SEC may adopt.
10. The term ``Designated Country'' shall mean Canada, France,
Germany, Japan, Switzerland, and the United Kingdom. The term
``Designated Currency'' shall mean Canadian dollar, French franc,
Deutschemark, Japanese yen, Swiss franc, British pound, and European
currency unit.
BILLING CODE 6351-01-P
TP01MR94.005
TP01MR94.006
TP01MR94.007
TP01MR94.008
TP01MR94.009
TP01MR94.010
TP01MR94.011
TP01MR94.012
TP01MR94.013
BILLING CODE 635-01-C
Issued in Washington, DC, on February 23, 1994, by the
Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 94-4570 Filed 2-28-94; 8:45 am]
BILLING CODE 6351-01-P
