[Federal Register Volume 61, Number 85 (Wednesday, May 1, 1996)]
[Rules and Regulations]
[Pages 19177-19187]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-10714]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
Early Warning Reporting Requirements, Minimum Financial
Requirements, Prepayment of Subordinated Debt, Gross Collection of
Exchange-Set Margin for Omnibus Accounts and Capital Charge on
Receivables From Foreign Brokers
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rules.
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SUMMARY: Rule 1.12 of the Commodity Futures Trading Commission
(Commission or CFTC) sets forth the financial early warning reporting
requirements for futures commission merchants (FCMs) and introducing
brokers (IBs), which are designed to afford the Commission and industry
self-regulatory organizations (SROs) sufficient advance notice of a
firm's financial or operational problems to take such protective or
remedial action as may be needed to assure the safety of customer funds
and the integrity of the marketplace. The Commission has determined to
adopt amendments to Commission Rule 1.12, applicable to FCMs only, that
will: amend paragraph (g) to require the reporting of a reduction in
net capital of 20 percent or more within two business days and a
planned reduction in excess adjusted net capital of 30 percent or more
two business days prior thereto, and to make that paragraph applicable
to all FCMs, rather than just those FCMs subject to the risk assessment
reporting requirements of Commission Rule 1.15; require reporting of a
margin call that exceeds an FCM's excess adjusted net capital which
remains unanswered by the close of business on the day following the
issuance of the call; and require reporting by an FCM when-ever its
excess adjusted net capital is less than six percent of the maintenance
margin required to support positions of noncustomers carried by the
FCM, unless the noncustomer is itself subject to the Commission's
minimum financial requirements for an FCM or the Securities and
Exchange Commission's (SEC's) minimum financial requirements for a
securities broker-dealer (BD).
The Commission has also determined to adopt amendments to: Rules
1.17(a)(1)(i) and (ii) to (a) increase the minimum required dollar
amount of adjusted net capital for FCMs from $50,000 to $250,000, (b)
increase the minimum required dollar amount of adjusted net capital for
IBs from $20,000 to $30,000, and (c) make the amount of adjusted net
capital required by a registered futures association for its member
FCMs and IBs an element of the Commission's minimum financial
requirements for FCMs and IBs; Rule 1.17(h)(2)(vii) with respect to the
procedure to obtain approval for prepayment of subordinated debt; and
Rule 1.58, which governs gross collection of exchange-set margins for
omnibus accounts, to make it applicable to omnibus accounts carried by
FCMs for foreign brokers. The Commission believes that these amendments
will conform the Commission's rules with those of SROs and therefore
should not require changes in the operations of most firms. In
addition, the Commission has determined that the five percent capital
charge for unsecured receivables from a foreign broker will not apply
where the receivables represent deposits required to maintain futures
or options positions, the foreign broker has been granted comparability
relief under Commission Rule 30.10, and the asset is held in accordance
with the relevant grant of relief under Rule 30.10 at the foreign
broker, with another foreign broker that has been granted comparability
relief under Commission Rule 30.10, or at a depository in the same
jurisdiction as either foreign broker in accordance with Commission
Rule 30.7.
EFFECTIVE DATE: May 31, 1996.
FOR FURTHER INFORMATION CONTACT: Paul H. Bjarnason, Jr., Chief
Accountant, or Lawrence B. Patent, Associate Chief Counsel, Division of
Trading and Markets, Commodity Futures Trading Commission, 1155 21st
Street, N.W., Washington, D.C. 20581; telephone (202) 418-5459 or 418-
5439.
[[Page 19178]]
SUPPLEMENTARY INFORMATION:
I. Early Warning Rules
A. Reportable Events in General
The Commission has required each FCM 1 to report to the
Commission and to the FCM's designated self-regulatory organization
(DSRO) certain events pertaining to the FCM's financial condition, the
FCM's procedures for safeguarding customer and firm assets, and its
ability to monitor its financial condition through an appropriate
system of records and reports. The purpose of such reporting is to make
the Commission and the FCM's DSRO aware of circumstances that have or
potentially could have a negative impact on the FCM's ability to carry
on normal business operations consistent with the Commission's
prudential requirements and pose a potential threat to customer funds
or the FCM's financial integrity. Receipt of such notices results in a
heightened degree of surveillance over the FCM by the Commission and
the DSRO. The events to be reported include undercapitalization, the
FCM's adjusted net capital being below its early warning level (i.e.,
150 percent of the minimum required), failure to maintain current books
and records, the existence of material inadequacies in the FCM's
accounting systems or internal controls, and the issuance of a margin
call exceeding the FCM's adjusted net capital. Collectively, these are
known as the Commission's early warning reporting requirements and are
set forth in Rule 1.12. With respect to notices relative to reductions
in capital, one purpose of this rulemaking has been to harmonize
required notices to the SEC and relevant futures and securities SROs.
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\1\ Rule 1.12 also requires certain reports from FCMs, IBs, and
exchange clearing organizations. The rule amendments that have been
adopted relate only to reporting by FCMs. No changes have been made
with respect to reporting requirements imposed on FCM applicants,
IBs or IB applicants, or clearing organizations.
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B. Background of This Rulemaking
On March 1, 1994, the Commission published proposed Risk Assessment
Rules for Holding Company Systems, 59 FR 9689. Certain portions of
these proposals were adopted as final rules by the Commission. 59 FR
66674 (Dec. 28, 1994). The proposed risk assessment rules generally
would have required, inter alia, an FCM to notify the Commission of
certain events or transactions that would reduce or potentially reduce
the FCM's net capital. These ``triggering'' events were originally
proposed to be included in a new Rule 1.15 as part of the risk
assessment reporting rules. However, several of the commenters on the
risk assessment proposals suggested that the reporting of certain of
these triggering events should more appropriately be part of the
Commission's early warning reporting system set forth in Rule 1.12, and
the Commission agreed. Therefore, when the Commission adopted as part
of the risk assessment rulemaking one of the triggering provisions
relating to declines in an FCM's adjusted net capital, that provision
was adopted as Rule 1.12(g) instead of as a provision of Rule 1.15, and
was made applicable only to those FCMs which are required to file
reports under Rule 1.15.2
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\2\ The balance of the proposed trigger event provisions remains
under consideration by the Commission.
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Certain commenters on the risk assessment proposals had suggested
that the notice provision relating to declines in capital should be
applicable to all FCMs, not just those subject to the risk assessment
rules. The Commission agreed, but was concerned that FCMs which
believed that they were not subject to the risk assessment rules may
not have availed themselves of the opportunity to comment upon the
Commission's March 1994 risk assessment proposals, including the
provision adopted as Rule 1.12(g). Therefore, the Commission adopted
Rule 1.12(g) in December 1994 as applicable only to those FCMs subject
to the risk assessment rules and at the same time proposed to amend
Rule 1.12(g) to make the reporting of capital declines applicable to
all FCMs. 59 FR 66822 (Dec. 28, 1994). In the same Federal Register
release which announced the proposed amendment to Rule 1.12(g), the
Commission also proposed to make certain other changes to the early
warning system as an adjunct to its risk assessment initiative and in
response to comments received on the March 1994 risk assessment rule
proposals which would: (1) require an FCM to report a margin call that
exceeds its excess adjusted net capital and remains unanswered by the
close of business on the day following the issuance of the call
(proposed Rule 1.12(f)(4)); and (2) require an FCM to report whenever
its excess adjusted net capital is less than six percent of the
maintenance margin required to support proprietary and noncustomer
positions carried by the FCM (proposed Rule 1.12(f)(5)).
The Commission originally permitted 30 days for public comment on
the proposed amendments to Rule 1.12 and it extended the comment period
for an additional 30 days in response to a request from the Securities
Industry Association (SIA). 60 FR 7925 (Feb. 10, 1995). The Commission
received six written comments on these proposals, including two from
contract markets (Chicago Board of Trade (CBT) and Chicago Mercantile
Exchange (CME)), two from trade associations (Futures Industry
Association (FIA) and SIA), one from an FCM, Bielfeldt & Company
(Bielfeldt), and one from an associated person, Alvin L. Goldberg. The
Commission's Division of Trading and Markets (Division) also received
two letters from the Intermarket Financial Surveillance Group
(IFSG),3 dated February 22 and April 8, 1996, respectively, which
bear directly upon one of these proposals and have been considered
along with the other comment letters.
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\3\ The IFSG was formed in 1988 to provide a coordinating body
to address financial surveillance issues relevant to both futures
and securities markets. It includes representatives of most of the
principal commodity and securities exchanges as well as the National
Futures Association (NFA) and the National Association of Securities
Dealers, Inc. Staff members of the CFTC and of the SEC frequently
attend IFSG meetings as observers.
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The Commission has carefully considered the comments received. The
Commission has determined to adopt the proposed amendment concerning
unanswered margin calls as proposed. The Commission has also
determined, based upon a review of the comments and its own
reconsideration of the proposal, that the provision of the early
warning system for FCMs requiring a comparison of excess adjusted net
capital to six percent of the maintenance margin level will only apply
to those positions carried by an FCM on behalf of a noncustomer that is
not itself subject to the Commission's minimum financial requirements
for an FCM or the minimum financial requirements of the SEC for a BD.
The Commission is therefore not adopting Rule 1.12(f)(5) as proposed,
which would have applied six percent of the maintenance margin level to
all positions held in noncustomer and proprietary accounts. The
Commission has further determined to modify slightly the standards in
Rule 1.12(g) concerning notice of substantial declines in capital in
light of the comments received, particularly the IFSG letters, and its
own reconsideration of the issue. The Commission has also clarified
certain matters in response to issues raised in the comment letters, as
discussed more fully below.
C. Reductions in Capital
As noted above, the Commission in December 1994 added to the list
of
[[Page 19179]]
reportable events under Rule 1.12 a new paragraph (g), requiring that
certain FCMs (i.e., those FCMs required to file risk assessment
reports) report capital declines which may not necessarily result in
the FCM being undercapitalized or its capital declining below early
warning levels, but which are sufficiently material to the FCM's
regulatory capital to warrant enhanced monitoring by the Commission and
the FCM's DSRO.4
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\4\ There are approximately 190 FCMs required to file risk
assessment reports, and the extension of Rule 1.12(g) would cover
the remaining FCMs, approximately 70 firms.
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The event currently required to be reported under Rule 1.12(g) is
the occurrence of any transaction or condition that results in a
reduction of more than 20 percent in the adjusted net capital of an FCM
from that reported in the most recent financial report filed with the
Commission pursuant to Commission Rule 1.10.5 The rule draws a
distinction, with respect to when the event must be reported, between
those events occurring in the normal course of business and those which
are extraordinary. If the decline in adjusted net capital is due to
activities in the normal course of an FCM's business, the reduction is
to be reported within two business days following the event. These
events are not normally planned for in advance, such as operating
losses, proprietary trading losses or increased charges against net
capital. However, where a transaction or series of transactions is
planned to be taken which will reduce adjusted net capital by more than
20 percent, the notice must be filed at least two business days in
advance of the transaction or series of transactions.6 This would
permit Commission or DSRO staff to make further inquiries concerning
the transaction before the transaction is effected to assure that the
FCM has adequately considered the effect of the transaction on its
overall liquidity. Ideally, an explanation would be included to
facilitate this process. The rule does not provide for Commission
approval or disapproval of the transaction prior to the FCM effecting
the transaction, nor does it provide a means for the Commission to
delay or prevent the FCM from carrying out the transaction.7
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\5\ Certain exchanges have a similar requirement. The rule
amendment whose adoption is announced herein is intended to induce
all SROs to conform their similar rules to the Commission
requirement. See CME Rule 972A; CBT Rule 285.03; New York Mercantile
Exchange Rule 2.14(d) and Clearing Rule 9.22(c)(i) and (ii);
Commodity Exchange, Inc. Rule 7.08(a); Coffee, Sugar and Cocoa
Exchange, Inc. Clearing Rule 302(c)(i); Kansas City Board of Trade
Rule 1311.00; Kansas City Board of Trade Clearing Corporation Rule
8.01(c); and Minneapolis Grain Exchange Rule 2088.00.
\6\ The SEC also has a similar rule, Rule 240.15c3-1(e)(1), 17
CFR 240.15c3-1(e)(1)(1995), which requires a BD to provide notice
two business days prior to withdrawals of equity capital that on a
net basis exceed in the aggregate in any 30 calendar day period, 30
percent of the firm's excess net capital, or two business days after
such withdrawals during any 30 calendar day period exceed 20 percent
of the firm's excess net capital.
\7\ As more fully discussed below, the Commission requested
comment as to whether Rule 1.12(g) should establish a mechanism by
which the Commission could delay or prevent an FCM from carrying out
the transaction. The SEC has authority to restrict capital
withdrawals for up to twenty business days under certain conditions.
17 CFR 240.15c3-1(e)(3)(1995).
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The filing under Rule 1.12(g) is to be made, in accordance with
Rule 1.12(h), with the regional office of the Commission with which the
FCM normally files its financial reports under Rule 1.10, with the
principal office of the Commission in Washington, D.C., with the FCM's
DSRO and with the SEC if the FCM is also registered as a BD. Rule
1.12(g) also provides that, following receipt of a notice from an FCM,
the Director of the Division, or the Director's designee, may request
additional information concerning the effect of the reported event on
the FCM's financial or operational condition. The FCM is required to
provide such additional information within three business days, or
sooner if the Division believes prompter filing is needed to address
the condition causing the filing of the early warning notice and so
requests.
As adopted in December 1994, Rule 1.12(g) applies only to those
FCMs which are required to file reports with the Commission under the
risk assessment rules. Several commenters on the Commission's March
1994 risk assessment proposals, including FIA and NFA, suggested that
the reporting requirement now in paragraph (g) be made applicable to
all FCMs, not just those required to report under Rule 1.15. The
Commission agreed that this reporting requirement serves to alert the
Commission and DSRO to potential problems resulting from transactions
that affect an FCM directly and therefore should not be limited to
those FCMs subject to the risk assessment rules. Since FCMs that
believed they were not subject to the risk assessment rules may not
have taken the opportunity to comment on the Commission's March 1994
risk assessment rule proposals, the Commission determined to publish
these proposed changes to Rule 1.12(g) for comment.
All of the commenters on the Commission's December 1994 proposals
addressed the Commission's proposal concerning Rule 1.12(g). Two
commenters expressed support for the extension of Rule 1.12(g) to all
FCMs. Three commenters noted that several regulators and SROs had
similar, but slightly different, requirements in this area. They
further pointed out that the IFSG was attempting to develop a consensus
on how to harmonize the various requirements directed at the same types
of reporting and requested that the Commission not adopt its proposals
until the IFSG completed its study. One of these commenters, FIA,
suggested in the alternative that the Commission adopt a ``no-action''
position to permit an FCM to follow a related rule of its DSRO or the
New York Stock Exchange, Inc. (NYSE), as elected by the FCM. The IFSG
reported on its harmonization efforts in its letters to the Division
dated February 22 and April 8, 1996 and stated that the Commission and
SEC should adopt similar rules which would require two business days
prior notice when excess adjusted net capital is to be reduced 30
percent or more and notice within two business when net capital has
been reduced by 20 percent or more.8
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\8\ IFSG's first letter dated February 22, 1996, which was
superseded by its April 8, 1996 letter, recommended that the notices
be made 48 hours, rather than two business days, prior to or
following the event, and that such notices be based upon net capital
declines in either situation, rather than upon a decline in excess
adjusted net capital with respect to prior notice. The prior notice
rule adopted herein is the same as that of the SEC adjusted to apply
to FCMs and the subsequent notice in the same as that required by
the NYSE so adjusted. FCMs that are BDs will continue to have to
file any additional notices required by the SEC which in the case of
post-reduction notices may include some notices triggered by
haircuts.
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As noted above, the Commission requested comment as to whether Rule
1.12(g) should establish a mechanism by which the Commission could
delay or prevent an FCM from carrying out planned transactions that
would reduce adjusted net capital by more than 20 percent. Three
commenters stated that the Commission should not be able to delay or
prevent capital reductions. A fourth commenter, SIA, stated that for
firms dually registered as FCMs and BDs, only the SEC should have such
authority, but it supported CFTC authority to delay or prevent capital
reductions for other FCMs (i.e., those not also registered as BDs).
Although it did not directly address the question posed by the
Commission, the FCM commenter, Bielfeldt, stated that no notice under
Rule 1.12(g) should be required with respect to capital reductions
resulting from planned transactions. Another commenter, Mr. Goldberg,
expressed his belief that the capital rules as written do not require
[[Page 19180]]
firms to establish systems to monitor capital on a day-to-day basis; in
his view, it is sufficient if a firm can, at a later date, demonstrate
that it was in compliance on any date. Therefore, Mr. Goldberg believes
that the effect of planned transactions on a firm's capital would not
be readily determinable, rendering a firm incapable of providing early
warning with respect to such transactions.
There were two other comments related to the proposed amendment of
Rule 1.12(g). Two commenters requested clarification that notice under
the rule would not be required with respect to repayment or prepayment
of subordinated debt, since separate notice of such events and DSRO
approval is already required. Another commenter stated that the
calculation used in Rule 1.12(g) should be based upon net capital, as
modified by the dollar amount of deficit and undermargined accounts,
rather than adjusted net capital.
The Commission has carefully considered these comments and has
determined to amend Rule 1.12(g) consistent with the suggestions of the
IFSG.9 The Commission believes that this action will make its rule
concerning capital reductions consistent with the SEC's rule and the
rules of futures and securities industry SROs in this area. The IFSG's
letters were jointly addressed to the Division and to the SEC's
Division of Market Regulation (DMR) and the Division's staff has been
in contact with DMR staff to assure similarity of treatment regarding
early warning notices related to capital reductions. The Commission's
December 1995 proposals, which are discussed more fully below, as well
as the Commission's February 1996 proposals,10 were intended to
conform Commission minimum financial and related reporting requirements
with those of the SROs and SEC in various areas, as recommended by
several participants in the Commission's roundtable on capital issues
held on September 18, 1995. A uniform approach among the Commission,
SEC and the SROs with respect to notices of major capital reductions
should simplify the reporting requirements for FCMs that are also BDs
and/or members of more than one futures or securities SRO, eliminating
needless inconsistencies among required notices relating to the same
types of circumstances, and provide consistent and sufficient
information to financial regulators and SROs to permit them to monitor
effectively the financial condition of firms under their jurisdiction.
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\9\ The IFSG's April 8, 1996 letter made two other suggestions
in addition to those referred to above which were that: (1) notice
not be triggered by a futures or securities transaction in the
ordinary course of business between an FCM and an affiliate where
the FCM makes payment to or on behalf of such affiliate for such
transaction and then receives payment from such affiliate for such
transaction within two business days from the date of the
transaction; and (2) an FCM's DSRO have discretion to exempt the FCM
from filing notice under Rule 1.12(g) where withdrawals, advances or
loans in the aggregate, on a net basis, equal $500,000 or less. The
Commission is adopting the former suggestion as a proviso to Rule
1.12(g). As to the second suggestion, Commission staff discussed the
issue with an IFSG representative, who stated that it was included
in the letter since the SEC rule provides for such exemptions. The
IFSG representative further indicated that such a provision was not
an issue of concern to the futures industry members of IFSG so the
Commission is not including it in Rule 1.12(g).
\10\ 61 FR 7080 (Feb. 26, 1996). These proposals concerned the
financial reporting cycle and the debt-equity ratio requirements for
FCMs and IBs.
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The Commission notes that basing the event requiring notice within
two business days upon a decline in net capital rather than adjusted
net capital as currently in the rule will require larger reductions to
trigger the notice since net capital will normally exceed adjusted net
capital. Conversely, since the prior notice requirement will be based
upon a decline in excess adjusted net capital rather than adjusted net
capital as currently in the rule, smaller reductions could trigger the
notice since adjusted net capital will necessarily exceed excess
adjusted net capital, despite the fact that the percentage decline
required to trigger prior notice has been increased from 20 to 30
percent. The Commission believes that it has now achieved a balanced
approach in this area that implements its ongoing resolve to streamline
its rules and avoid unnecessary duplication or redundant or
inconsistent requirements to the extent consistent with customer
protection. It also further harmonizes the Commission's rules with SEC
rules and takes account of the ongoing harmonization project of the
IFSG.11
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\11\ For an FCM dually registered as a BD and taking advantage
of the option available under Commission Rule 1.10(h) to file a copy
of its Financial and Operational Combined Uniform Single (FOCUS)
Report in lieu of Form 1-FR-FCM (which includes about one-half of
all FCMs), the calculation for subsequent notice would be based upon
``tentative net capital'' as set forth in SEC Rule 240.15c3-1, i.e.,
net capital before securities haircuts, and the calculation for
prior notice would be based upon ``excess net capital.'' The
Commission's definition of net capital and the SEC's definition of
tentative net capital, as well as the Commission's definition of
excess adjusted net capital and the SEC's definition of excess net
capital, are for practical purposes the same.
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The Commission has also determined not to establish a mechanism
whereby it could delay or prevent an FCM from carrying out planned
transactions that would reduce excess adjusted net capital by 30
percent or more. The Commission continues to view the early warning
requirements under Rule 1.12 as essentially a mechanism for
notification of situations that have or potentially could have a
negative impact on a firm's ability to carry on normal business
operations consistent with the Commission's prudential requirements and
that pose a potential threat to customer funds or a firm's financial
integrity. In the case of a planned reduction, the Commission believes
that an explanation should accompany the notice. Although the
Commission's staff may wish to discuss reported events with the
FCM,12 the Commission does not believe that a formal mechanism to
delay or prevent events giving rise to a notice under Rule 1.12(g) is
warranted at this time. The Commission currently has the authority to
require specific reports from custodians upon the transfer of
segregated funds in certain circumstances and also requires 100 percent
segregation of customer obligations unlike the SEC that has a more
limited requirement. These two authorities make it less likely that
there could be a ``run'' on a futures firm or a misappropriation of
segregated funds without additional authority to preclude reductions of
capital. Moreover, the Commission is aware of the need for regulators
to be sensitive to the liquidity needs of a holding company system as a
whole consistent with its responsibilities to the regulated entity.
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\12\ The Commission notes that Rule 1.12(g)(3) provides that the
Director of the Division or the Director's designee may require an
FCM filing a notice under Rule 1.12(g) to furnish additional
information. The Commission believes that it is important to
maintain this flexibility and this is another reason why early
warning notices should be filed with the Commission as well as the
DSRO and not only with the latter as Bielfeldt suggested.
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The Commission also wishes to respond to the comments of Bielfeldt
and Mr. Goldberg that no notice should be required or can be prepared
with respect to capital reductions resulting from planned transactions.
As the Commission stated when it published the proposals:
The Commission's early warning rules relating to an FCM's level
of capital contemplate that the FCM will have systems in place to
monitor its capital levels and its compliance with the Commission's
net capital rules on a day-to-day basis. The Commission requires
each FCM to be able to demonstrate its capital compliance at any
time and not just on a required formal computation or filing
date.13 Consequently,
[[Page 19181]]
the effect of planned transactions on net capital should be readily
determinable.
\13\ See Commission Rules 1.17(a)(3)-(5) and 1.18(b), 17 CFR
1.17(a)(3)-(5) and 1.18(b) (1995).
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The Commission further notes that since it issued these proposals,
the failure of Barings PLC has occurred. That failure only reinforces
the need for FCMs to have robust internal controls and capital
monitoring systems that permit a firm to assess its financial position
on a day-to-day, if not more frequent, basis.
In response to the request of two of the commenters noted above,
the Commission wishes to make clear that Rule 1.12(g) does not require
separate notice with respect to repayment or prepayment of subordinated
debt since an FCM must always get approval for prepayment of
subordinated debt from its DSRO as discussed more fully below.14
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\14\ See Commission Rules 1.17(h)(2)(vii) and (viii), 17 CFR
1.17(h)(2)(vii) and (viii) (1995); CFTC Interpretative Letter No.
85-17, [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH)
para.22,738 (Sept. 10, 1985).
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D. Unanswered Margin Calls
As part of the March 1994 risk assessment rule proposals, the
Commission had proposed Rule 1.15(b)(2)(iii), which would have required
an FCM to notify the Division whenever aggregate cumulative losses in
all noncustomer accounts exceeded the greater of: (A) in any 30-day
period, 10 percent of the last reported consolidated stockholders'
equity of the FCM's parent or $50 million, or (B) in any 12-month
period, 20 percent of the last reported consolidated stockholders'
equity of the FCM's parent or $100 million.15 This proposal was
opposed by several commenters. Some of the commenters suggested that,
as an alternative, an FCM be required to notify the Commission within
two business days after a margin call to a noncustomer remains
outstanding for two business days, if the margin call exceeds 20
percent of the FCM's adjusted net capital.
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\15\ 59 FR 9689, 9706 (March 1, 1994).
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In response to these comments, the Commission determined in
December 1994 to propose Rule 1.12(f)(4) which would require an FCM to
file an early warning notice when a margin call on a customer,
noncustomer or omnibus account that exceeds the firm's excess adjusted
net capital is not answered by the close of business on the day
following the day the call is made. The Commission's proposal would
permit FCMs to take into account favorable market moves in determining
whether the margin call would be required to be reported under this
rule.16
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\16\ 59 FR 66822, 66823-24.
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For purposes of proposed Rule 1.12(f)(4), a margin call would mean
any deposit of funds required by the FCM to margin, guarantee or secure
a futures or commodity option position. Thus, if, with respect to an
exchange-traded contract, the FCM requires a deposit in excess of the
minimum required pursuant to exchange rules, that greater amount would
be the amount used in determining whether a call has been collected
from an account holder. Although exchanges may exempt firms from the
requirements of Commission Rule 1.12(f)(3), which requires notice of
issuance of a margin call in excess of a firm's entire adjusted net
capital, the Commission proposed not to permit the granting of such
waivers from the Rule 1.12(f)(4) notice requirement. The Commission
also requested additional comment, however, on the originally proposed
trigger event for which Rule 1.12(f)(4) was proposed as an
alternative.17
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\17\ See proposed Rule 1.15(b)(2)(iii) in the March 1994 risk
assessment proposals, 59 FR 9689, 9706.
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The contract market and trade association commenters addressed
proposed Rule 1.12(f)(4). CBT supported the proposal. CME, FIA and SIA
stated that the rule should be based upon the exchange minimum
maintenance margin level only, since such a rule could otherwise be a
disincentive for FCMs to establish higher internal margin requirements.
FIA and SIA also requested that the Commission allow more time to meet
a margin call before notice is required if foreign customers are
involved. CBT and CME urged the Commission to repeal Rule 1.12(f)(3),
which requires an FCM to file a notice when an account is undermargined
by an amount in excess of the FCM's adjusted net capital, since it is
little used and similar to the proposal. FIA suggested two
clarifications: (1) That the Commission state that a margin call is
usually issued on the day following the day the account becomes
undermargined; and (2) that the provision be applied to all commodity
interest accounts subject to margining. FIA and SIA also requested that
the Commission define ``excess adjusted net capital.''
The Commission has carefully considered these comments and has
determined to adopt Rule 1.12(f)(4) as proposed. As to whether the
minimum margin standard in the rule should be the exchange minimum
level or any higher amount set by the FCM, the Commission believes that
FCMs establish margin requirements for accounts based upon an
assessment of the creditworthiness of the account owner and that a Rule
1.12(f)(4) notice requirement should have negligible impact in the
context of margin requirements intended to safeguard a firm's financial
position. Further, if the Commission adopted the view of certain
commenters that the exchange minimum maintenance margin level is the
appropriate level for purposes of Rule 1.12(f)(4) and an FCM set an
account's maintenance margin level higher than the minimum requirement
of an exchange, the FCM would be required to monitor the impact of the
lower exchange minimum requirement for purposes of Rule 1.12(f)(4). The
Commission believes that such a requirement could be more costly and
confusing to keep track of than simply requiring an FCM to treat a
margin call for the account as a margin call under Rule 1.12(f)(4).
Concerning the comment that more time be allowed to meet a margin
call if foreign customers are involved, the Commission is not persuaded
that this would be appropriate. As far back as the October 1987 market
break, the Division noticed a disproportionate incidence of customer
defaults and liquidations attributable to foreign traders. FCMs were
urged to establish procedures to assure that they obtain adequate
security from foreign customers to protect against the potential for
price fluctuations to result in aberrant margin calls that could not be
readily satisfied by such customers and that, for the FCM, could be
unduly costly or impossible to recover were legal action against the
customer ultimately required.18 The Commission believes that the
events that have occurred since 1987, including the growing
internationalization of the futures markets, and the Commission's
determination, as discussed below, to require gross collection of
exchange-set margin for all omnibus accounts, including those
originated by foreign brokers, lead to the conclusion that margin calls
attributable to foreign traders should not be given preferential
treatment in the context of the early warning notice requirement of
Rule 1.12(f)(4).
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\18\ Follow-up Report on Financial Oversight of Stock Index
Futures Markets During October 1987, CFTC Division of Trading and
Markets, at 84 (Jan. 6, 1988).
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In response to FIA's suggestions, the Commission wishes to make
clear that a margin call is usually issued on the business day
following the business day the account becomes undermargined and that
Rule 1.12(f)(4) as proposed and adopted ``applies to all accounts
carried by the futures commission merchant
[[Page 19182]]
* * * that are subject to margining * * *.'' As to the term ``excess
adjusted net capital,'' this means an FCM's adjusted net capital less
its required minimum adjusted net capital computed in accordance with
Commission Rule 1.17.19 The Commission further wishes to make
clear that the notice required by Rule 1.12(f)(4) must include account
name, date of margin call, amount of margin call and the FCM's excess
adjusted net capital. The Commission also believes that Rule 1.12(f)(3)
referred to above, although somewhat similar to Rule 1.12(f)(4), should
continue as a separate early warning notice requirement.
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\19\ See also 17 CFR 1.17(d)(3) (1995); Form 1-FR-FCM, page 8,
line 24.
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E. Maintenance Margin Factor
Some commenters on the Commission's March 1994 risk assessment
proposals also suggested that, in lieu of adopting the proposal
referred to above concerning the reporting of losses in noncustomer
accounts, the Commission amend Rule 1.12 to add an early warning
reporting requirement to require an FCM to report to the Commission
whenever its excess adjusted net capital is less than six percent of
the maintenance margin requirement applicable to positions in
proprietary and noncustomers' accounts. These commenters noted that the
CME imposes a capital requirement on an informal basis on its clearing
members that factors in a percentage of proprietary and noncustomers
margin requirements. The Commission determined to propose an amendment
to Rule 1.12 in December 1994 in line with the commenters' suggestions.
All of the commenters on the December 1994 proposals addressed this
provision and stated that proprietary positions are subject to haircuts
and thus should not be included in the calculation for an early warning
notice requirement.20 The trade association commenters also stated
that positions held by noncustomers who are subject to capital
requirements of the Commission, or of another regulator or an SRO,
either domestic or foreign, should not be included in the calculation
required by Rule 1.12(f)(5).
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\20\ Bielfeldt further commented that haircuts on proprietary
positions should be eliminated and all accounts should be treated
similarly for capital purposes. This comment addresses issues
outside of the scope of this rulemaking proceeding.
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The Commission has reconsidered its proposal in light of these
comments. As noted above, the proposal responded to comments on the
March 1994 risk assessment proposals which apparently misread the CME's
requirements, since the CME rule only adds a percentage of noncustomer
margin. The Commission recognizes that proprietary positions are
already accounted for in the minimum financial rule through haircuts;
however, noncustomer positions are not and neither are they factored
into the minimum financial requirement based upon four percent of
customer funds. Based upon the comments and its reconsideration of the
issue, the Commission has determined not to include proprietary
accounts as a factor in determining whether notice is required under
Rule 1.12(f)(5).21 However, noncustomer accounts will be included
in the calculation under Rule 1.12(f)(5), unless the noncustomer is
itself subject to the Commission's minimum financial requirements for
an FCM or the SEC's minimum financial requirements for a BD. This is
intended to reflect the fact that affiliates rarely retain excess funds
at the clearing firm. The Commission will reassess whether this
exclusion is appropriate in connection with its further review of the
capital rule as a whole.
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\21\ Because of this determination, the Commission's proposal
that maintenance margin with respect to an FCM's proprietary account
shall mean the amount of funds the FCM is required to maintain at
the clearing organization with its clearing broker, or five percent
of the value of the contract, whichever is greater, is moot. The
Commission requested comment on that point and CME and Bielfeldt
objected to the five percent provision, while CBT thought such a
provision should be used only in the absence of margin being set by
the exchange or clearing organization.
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II. Minimum Financial Requirements for FCMs and IBs
On December 7, 1995, the Commission voted to propose amendments to
Rule 1.17 to: (a) Increase the required minimum dollar amount of
adjusted net capital for FCMs from $50,000 to $250,000; 22 (b)
increase the required minimum dollar amount of adjusted net capital for
``independent'' IBs from $20,000 to $30,000; 23 and (c) make the
amount of adjusted net capital required by a registered futures
association for its member FCMs and IBs an element of the Commission's
minimum financial requirements for FCMs and IBs.24
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\22\ This proposal would also have the effect of increasing an
FCM's ``early warning'' level of adjusted net capital from $75,000
to $375,000 despite the fact that Rule 1.12(b)(1) itself would not
be amended.
\23\ More than two-thirds of IBs enter into a guarantee
agreement with an FCM in accordance with Commission Rules
1.17(a)(2)(ii) and 1.10(j) in lieu of raising their own capital, and
thus would be unaffected by the proposed amendment.
\24\ These proposals and others discussed below were published
at 60 FR 63995 (Dec. 13, 1995).
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These amendments were proposed in order to permit the Commission to
use its authority under Section 6c of the Commodity Exchange Act (Act)
25 to enforce compliance with what are effectively, for the
reasons discussed when the proposals were published,26 the current
minimum adjusted net capital requirements applicable to FCMs and
independent IBs with the benefit of all of the remedies available to
the Commission under the Act for the enforcement of compliance with any
provision of the Act and any rule promulgated thereunder.27 In
addition, these amendments would harmonize the Commission's minimum
financial requirements for FCMs and independent IBs with the prevailing
standards established by NFA rules.28 The amendments would also
support the objective of assuring that FCMs have a substantial
commitment to meeting their regulatory obligations to customers, an
objective for which an increased requirement appears appropriate given
the increase in the amount of funds held by FCMs and the change in the
value of the dollar since 1978, the last time the Commission increased
the required minimum dollar amount of capital for FCMs.29 The
Commission also believed that the proposed amendments to Rule 1.17 were
necessary to clarify its authority to require the transfer of positions
at such time as a firm is no longer in compliance with the NFA rule,
and to eliminate any confusion that may have existed as to whether the
Commission could take action where an FCM's adjusted net capital is
below $250,000 yet still at least $50,000,30 or
[[Page 19183]]
an independent IB's adjusted net capital is below $30,000 yet still
$20,000 or more.31
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\25\ 7 U.S.C. 13a-1 (1994).
\26\ See 60 FR 63995, 63996.
\27\ Section 6c of the Act authorizes the Commission, whenever
it appears that a person has engaged, is engaging, or is about to
engage in any act or practice constituting a violation of any
provision of the Act or any rule or regulation thereunder, to bring
an action to enjoin such act or practice, or to enforce compliance
with the Act or any rule or regulation thereunder. However, the
Commission does not have the authority to discipline an exchange
member for violation of an exchange rule in the absence of the
exchange's failure to act, or to enforce compliance with a
registered futures association's own rule upon a member thereof. See
Sections 8c(a)(1) and 17(l)(1) of the Act, 7 U.S.C. 12c(a)(1) and
21(l)(1) (1994).
\28\ Commission Rule 170.15, 17 CFR 170.15 (1995), mandates that
each person required to register as an FCM become and remain a
member of a futures association which provides for the membership
therein of such FCM unless there is no registered futures
association. NFA is the only registered futures association.
\29\ 43 FR 39956, 39972 (Sept. 8, 1978).
\30\ On November 24, 1992, the SEC adopted rule amendments to
raise its minimum net capital requirements for BDs holding customer
funds, which had been $25,000, to $250,000 in stages. The
requirement increased to $100,000 effective July 1, 1993, $175,000
effective January 1, 1994 and to the current level of $250,000
effective July 1, 1994. See 57 FR 56973, 56990 (Dec. 2, 1992); 17
CFR 240.15c3-1e(a) (1995).
\31\ The Commission's minimum dollar amount of adjusted net
capital for independent IBs has remained unchanged at $20,000 since
1983, when rules governing IBs were first adopted, so the change in
the dollar's value since that time justifies an increase to $30,000
for the minimum amount. 48 FR 35248 (Aug. 3, 1983).
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Four comment letters were received on the December 1995 proposals,
submitted by FIA, NFA, CBT and CME. FIA and NFA supported the proposed
amendments to the Commission's minimum financial requirements for FCMs
and independent IBs. CBT and CME supported raising the minimum dollar
amounts of the Commission's financial requirements to those of the NFA
for FCMs and independent IBs, but objected to incorporating all aspects
of NFA's minimum financial requirements (i.e., the standards based on
number of branches and associated persons (APs)) into the Commission's
rules.32 CBT stated that:
\32\ NFA minimum financial requirements for FCMs and independent
IBs based upon the number of branches and APs are discussed in the
proposing release, 60 FR 63995, 63997.
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Many SROs have their own internal rules to determine capital
that have been developed to address a specific need identified by
that SRO. It can be anticipated that the NFA may develop further
capital standards to address the capital needs of the firms for
which it is primarily responsible and although all FCMs doing
customer business are subject to these requirements, by virtue of
being members of the NFA, if such requirements become Commission
mandates, there would be a greater responsibility placed on the
other DSROs to monitor compliance with what are in essence another
organization's internal capital requirements.
The Commission disagrees with this comment. A registered futures
association cannot impose a minimum financial requirement for its
member FCMs and IBs unless such a rule is approved by the Commission.
When the Commission approves such a rule of the registered futures
association, the proposed amendment would make that standard an element
of the Commission's minimum requirements. Therefore, SROs effectively
will be monitoring compliance with the minimum financial requirements
for doing Commission-regulated FCM business, not another organization's
internal capital requirements.33
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\33\ All SROs are required to have in effect and enforce rules
approved by the Commission prescribing minimum financial and related
reporting requirements for member FCMs and IBs. Such requirements
must be the same as, or more stringent than, those contained in
Commission Rules 1.10 and 1.17. See Commission Rule 1.52, 17 CFR
1.52 (1995).
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Based upon a review of the comments and its own consideration of
these issues, the Commission has determined to adopt the amendments to
Rule 1.17(a) as proposed. The Commission is also adopting conforming
amendments to the early warning level of adjusted net capital for FCMs
(new paragraph (b)(3) of Rule 1.12), the restrictions on withdrawals of
equity capital (new paragraph (e)(1)(iii) of Rule 1.17), and various
provisions of Rule 1.17(h) concerning subordinated debt.34 The
Commission further notes that several provisions of Rule 1.17 contain
cross-references to Rule 1.17(a)(1)(i)(A) and 1.17(a)(1)(ii)(A), the
minimum dollar amount of adjusted net capital for FCMs and independent
IBs, respectively. These other provisions of Rule 1.17 restrict or
require certain actions if specified levels of adjusted net capital,
which in all cases exceed 100 percent of the minimum dollar amount, are
breached. Thus, the amendments to Rule 1.17(a)(1)(i)(A) and
(a)(1)(ii)(A) will have a corresponding impact on various FCM and
independent IB activities or obligations referred to elsewhere in Rule
1.17.35
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\34\ See 60 FR 63995, 63997.
\35\ The other provisions of Rule 1.17 referred to herein are
discussed at 60 FR 63995, 63996.
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III. Approval of Prepayment of Subordinated Debt
The Commission also proposed in December 1995 to codify a Division
``no-action'' letter 36 by amending Commission Rule
1.17(h)(2)(vii)(C) generally to require submission by an FCM or
independent IB of a request for approval of prepayment of subordinated
debt only to its DSRO.37 However, the Commission also proposed
that dual approval by the DSRO and the Commission would be required if
the requested prepayment would result in a reduction of 20 percent or
more of the firm's adjusted net capital.38
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\36\ CFTC Interpretative Letter No. 85-17, [1984-1986 Transfer
Binder] Comm. Fut. L. Rep. (CCH) para. 22,738 (Sept. 10, 1985).
\37\ In those rare instances where the registrant is not a
member of any SRO (which would mean that it could not handle
customer business), such a request would be submitted to the
Commission.
\38\ The Commission made clear when it proposed this amendment
that if a firm's subordinated debt amounts to 25 percent of its
adjusted net capital and the firm wishes to prepay all outstanding
subordinated debt and simultaneously enter into new subordinated
debt arrangements for the same amount, but with a different maturity
date or interest rate, dual approval would not be required since
there would be no net effect on the firm's adjusted net capital.
Similarly, if a firm wanted to convert subordinated debt to paid-in
capital, dual approval would not be required so long as such
conversion did not result in a reduction of 20 percent or more of
the firm's adjusted net capital. 60 FR 63995, 63997-98.
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FIA supported the amendment as proposed, but NFA, CBT and CME each
raised objections to a requirement for dual approval by the DSRO and
the Commission where prepayments of subordinated debt would reduce a
firm's adjusted net capital by at least 20 percent. The commenters
stated that DSROs have demonstrated the capability to competently
handle prepayment of subordinated debt during the past ten years of the
no-action period. CME stated that a firm will be required to provide
notice of a decrease of 20 percent or more in adjusted net capital
pursuant to Rule 1.12(g), as discussed above. CBT recommended that the
Commission make clear that a prepayment of subordinated debt that
results in a decrease of 20 percent or more in adjusted net capital
constitutes a reporting event to the Commission.39 NFA recommended
that approval of such prepayment should only be required by the DSRO,
which in turn should be required to provide the Commission with notice
of any such approvals.
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\39\ The comment letters referred to the adjusted net capital
standard in the proposal. As noted above, the amendments to Rule
1.12(g) as adopted are based upon a reduction in a firm's net
capital or excess adjusted net capital.
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The Commission has considered this issue in light of the comments
received and the other rule amendments it is announcing herein,
particularly Rule 1.12(g) discussed above. The Commission believes that
dual approval by the DSRO and the Commission need not be required for
prepayment of subordinated debt, even if such prepayment would reduce
an FCM's or independent IB's net capital by 20 percent or more or its
excess adjusted net capital by 30 percent or more. In such cases,
however, the DSRO must immediately provide the Commission with a copy
of any notice of approval of prepayment of subordinated debt issued to
an FCM or an independent IB.40
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\40\ This requirement is in addition to the current requirement
that each DSRO report monthly to the regional office of the
Commission nearest to it all actions taken with respect to
subordinated loan agreements. Division of Trading and Markets
Financial and Segregation Interpretation No. 4-1, para. 25, 1 Comm.
Fut. L. Rep. (CCH) para. 7114A, at 7102 (July 29, 1985).
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IV. Gross Collection of Exchange-Set Margins
The Commission also proposed in December 1995 to amend Rule 1.58,
which governs gross collection of exchange-set margin for omnibus
accounts, to make it applicable to omnibus accounts carried by FCMs for
foreign brokers. The Commission made this proposal because, in view of
the
[[Page 19184]]
increasing internationalization of the financial markets, and in
particular the increasing use of foreign omnibus accounts, the
Commission believed that foreign broker omnibus accounts should be
treated in the same manner as omnibus accounts carried for domestic
FCMs. The Commission also noted that the proposals would conform Rule
1.58 to the industry practice since, as a result of staff
recommendations in rule enforcement reviews and SRO rule changes, all
active U.S. contract markets other than the New York Cotton Exchange
and the Philadelphia Board of Trade require that FCMs collect margin
for omnibus accounts of foreign brokers as well as other domestic FCMs
on a gross basis.
FIA, CBT and CME supported the proposed amendment to Rule 1.58 and
the Commission has determined to adopt this amendment as
proposed.41 The Commission believes that gross collection of
exchange-set margin at the clearing firm materially improves financial
control over the positions carried through omnibus accounts.
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\41\ A fuller discussion of this issue is set forth in the
proposing release. 60 FR 63995, 63998.
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V. Receivables From Foreign Brokers
Commission Rule 1.17(c)(5)(xiii) requires that an FCM or
independent IB, when computing its adjusted net capital, take a charge
against its net capital based upon:
Five percent of all unsecured receivables includable under
paragraph (c)(2)(ii)(D) of this section used by the applicant or
registrant in computing `net capital' and which are not receivable
from (A) a registered futures commission merchant, or (B) a broker
or dealer which is registered as such with the Securities and
Exchange Commission.42
\42\ This charge relates to funds deposited by an FCM with a
foreign broker for clearing transactions on non-U.S. markets, as
distinct from the exclusion from current assets for debit/deficit
accounts under Rule 1.17(c)(2)(i), where a customer of the FCM has a
debt to the FCM.
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This provision has been unchanged since it was adopted by the
Commission as part of the major overhaul of the minimum financial and
related reporting requirements in 1978.43 In 1978, foreign futures
business was totally unregulated and foreign options were banned.
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\43\ 43 FR 39956, 39975 (Sept. 8, 1978).
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By letter dated January 12, 1996 to the Division, the Joint Audit
Committee 44 requested that the Commission exempt from the five
percent capital charge set forth in Rule 1.17(c)(5)(xiii) those
unsecured receivables from a foreign broker that has been granted
``comparability relief'' under Commission Rule 30.10.45
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\44\ The Joint Audit Committee (JAC) is composed of
representatives of all U.S. futures SROs. It was established to
coordinate audit and financial surveillance, plans, policies and
procedures, particularly with respect to FCMs that are members of
more than one SRO. Responsibility for monitoring 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.
\45\ 17 CFR 30.10 (1995). Part 30 of the Commission's rules
governs foreign futures and options transactions (i.e., commodity
interest transactions entered into by a person located in the U.S.
on or subject to the rules of a foreign board of trade) and
generally requires, among other things, that persons engaged in such
transactions for or on behalf of customers located in the U.S.
register under the Act. However, the Part 30 rules contain an
exemptive provision pursuant to which the Commission may exempt a
firm located outside the U.S. from the application of certain of the
Commission's rules based upon substituted compliance by the firm
with corresponding regulatory requirements of the foreign
jurisdiction in areas such as registration, minimum financial
requirements, safeguarding of customer funds, record-keeping and
reporting requirements, and sales practice standards, and subject to
certain conditions primarily related to the protection of customer
funds.
The relief is granted to firms designated by a foreign entity
such as the United Kingdom Securities and Investments Board or the
Association of Futures Brokers and Dealers (U.K.). A listing of
these entities is set forth in Appendix C to the Commission's Part
30 rules.
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When the Commission adopted Rule 1.17(c)(5)(xiii) in 1978, there
were no Part 30 rules and the Commission had little interaction with
foreign regulators compared to what it has in that regard today.
Indeed, many foreign jurisdictions had no developed regulatory
structure for the futures industry at that time. The Commission was
therefore concerned that unsecured receivables from foreign brokers
represented greater risk to a firm's financial condition than those
from a registered FCM or BD, and should be subject to an additional
capital charge. The increased cooperation among regulators globally and
enhancement of capital standards monitoring today as compared to 1978
justifies a reconsideration of the appropriateness of Commission Rule
1.17(c)(5)(xiii). The Commission also notes that registered FCMs and
BDs today may have large exposures in a jurisdiction such as the U.K.
and an unsecured receivable from such an FCM or BD would not be subject
to a haircut whereas the same receivable from a U.K. affiliate of a
U.S. firm would be subject to the five percent charge so the five
percent charge is a regulatory rather than a location charge.
Based upon its consideration of this issue, the Commission has
determined to add a proviso to Rule 1.17(c)(5)(xiii) such that the
haircut will not apply to an unsecured receivable due from a foreign
broker if the receivable represents deposits required to maintain
futures and commodity option positions (i.e., ``excess'' deposits by an
FCM with a foreign broker are still subject to the five percent
charge), the foreign broker has been granted comparability relief
pursuant to Commission Rule 30.10 and the receivable is held in
compliance with the customer funds protection requirements of the
relevant Commission order made under Rule 30.10 by the foreign broker
itself, with another foreign broker that has been granted comparability
relief under Commission Rule 30.10, or at a depository in the same
jurisdiction as either foreign broker that would qualify as a
depository for funds in accordance with Commission Rule 30.7.
Essentially, the Commission is interpreting the existing rule to treat
``Rule 30.10 firms'' akin to a registered FCM, provided the conditions
about the nature and location of the receivable are also met. As this
relieves a burden on FCMs and independent IBs in computing their
adjusted net capital, and follows a request for such relief by the JAC
on behalf of the member firms of the SROs, the Commission finds good
cause that it is unnecessary to publish this rule amendment for public
comment.46 However, although the Commission is publishing this
amendment as a final rule, it would encourage any interested parties to
submit comments on this amendment.
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\46\ See 5 U.S.C. 553(b) (1994). Preliminary review of data
related to this charge by the Commission's staff indicates that
these receivables are not a substantial asset for most firms. The
Commission also notes that its staff will review firms' financial
statements to determine if unsecured receivables from foreign
brokers are a substantial portion, such as 25 percent, of a firm's
assets and, if so, may undertake discussions with the firms
concerning the circumstances involved.
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VI. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA), 5 U.S.C. 601-611 (1994),
requires that agencies, in proposing rules, consider the impact of
those rules on small businesses. The rule amendment discussed herein
would affect FCMs and independent IBs. The Commission has previously
determined that, based upon the fiduciary nature of FCM/customer
relationships, as well as the requirement that FCMs meet minimum
financial requirements, FCMs should be excluded from the definition of
small entity.47
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\47\ See 47 FR 18618, 18619 (Apr. 30, 1982).
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With respect to IBs, the Commission stated that it is appropriate
to evaluate within the context of a particular rule whether some or all
IBs should be considered to be small entities and, if
[[Page 19185]]
so, to analyze the economic impact on such entities at that
time.48 The amendments to Rules 1.17(c)(5)(xiii) and (h)(2)(vii)
eliminate the capital charge for unsecured receivables from certain
foreign brokers and reduce the burden associated with the procedure to
obtain approval for prepayment of subordinated debt, respectively.
Accordingly, these amendments impose no additional requirements on an
independent IB. In addition, the amendment to the minimum adjusted net
capital requirement for an IB conforms the Commission's requirement to
that of the NFA and therefore there should be no impact on an IB's
financial operations. Therefore, these rule amendments will not have a
significant economic impact on a substantial number of small entities.
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\48\ See 48 FR 35248, 35275-78 (Aug. 3, 1983).
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B. Paperwork Reduction Act
The Paperwork Reduction Act of 1980 (PRA), 44 U.S.C. 3501 et seq.
(1994), 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 submitted the December 1994 proposed rule
amendments and their associated information collection requirements to
the Office of Management and Budget. The burden associated with that
entire collection (3038-0024) including the December 1994 proposed rule
amendments, is as follows:
Average Burden Hours Per Response: 18.00.
Number of Respondents: 1,782.
Frequency of Response: annually, quarterly and on occasion.
The burden associated with the December 1994 proposed rule
amendments was as follows:
Average Burden Hours Per Response: 1.00.
Number of Respondents: 12.
Frequency of Response: on occasion.
The Office of Management and Budget approved the December 1994
submission concerning collection 3038-0024 on February 1, 1995.
When the Commission proposed rule amendments in December 1995, it
noted that the proposed rule amendments had no burden,49 although
Rules 1.12, 1.17 and 1.58 are part of groups of rules with the
following burdens.
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\49\ The proposed increase in the dollar amount of minimum
adjusted net capital for an FCM and IB would necessitate only a
change in line item 23E of the Statement of the Computation of
Minimum Capital Requirements on Form 1-FR-FCM and in line item 15 of
that Statement on Form 1-FR-IB, as well as a calculation of the
minimum adjusted net capital requirement based upon a firm's branch
offices and APs.
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The burden associated with the collection required by Rules 1.12
and 1.17 (3038-0024), including the rule amendments proposed in
December 1995, is as noted above. The burden associated with the
collection required by Rule 1.58 (3038-0026), including the rule
amendments proposed in December 1995, is as follows:
A. Reporting
Average Burden Hours Per Response: 0.04.
Number of Respondents: 100.00.
Frequency of Response: daily.
B. Recordkeeping
Average Burden Hours Per Response: 1.00.
Number of Respondents: 300.00
Frequency of Response: annually.
Persons wishing to comment on the estimated paperwork burden
associated with these rule amendments should contact Jeff Hill, Office
of Management and Budget, room 3228, NEOB, Washington, DC 20503 (202)
395-7340. Copies of the information collection submissions to OMB are
available from Joe F. Mink, CFTC Clearance Officer, 1155 21st Street,
NW., Washington, DC 20581, (202) 418-5170.
List of Subjects in 17 CFR Part 1
Commodity futures, Minimum financial requirements.
In consideration of the foregoing, and pursuant to the authority
contained in the Commodity Exchange Act, and in particular Sections
4f(b), 4f(c), 4g and 8a, 7 U.S.C. 6f(b), 6f(c), 6g, and 12a, the
Commission hereby amends 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 1.12 is amended by removing the word ``or'' at the end
of paragraph (b)(2), by redesignating paragraph (b)(3) as paragraph
(b)(4), by adding a new paragraph (b)(3), by adding paragraphs (f)(4)
and (f)(5) and by revising the introductory text of paragraph (g),
paragraph (g)(1) and paragraph (g)(2) to read as follows:
Sec. 1.12 Maintenance of minimum financial requirements by futures
commission merchants and introducing brokers.
* * * * *
(b) * * *
(3) 150 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member; or
* * * * *
(f) * * *
(4) A futures commission merchant shall report immediately whenever
any commodity interest account it carries is subject to a margin call,
or call for other deposits required by the futures commission merchant,
that exceeds the futures commission merchant's excess adjusted net
capital, determined in accordance with Sec. 1.17, and such call has not
been answered by the close of business on the day following the
issuance of the call. This applies to all accounts carried by the
futures commission merchant, whether customer, noncustomer, or omnibus,
that are subject to margining, including commodity futures and options.
In addition to actual margin deposits by an account owner, a futures
commission merchant may also take account of favorable market moves in
determining whether the margin call is required to be reported under
this paragraph.
(f)(5)(i) A futures commission merchant shall report immediately
whenever its excess adjusted net capital is less than six percent of
the maintenance margin required by the futures commission merchant on
all positions held in accounts of a noncustomer other than a
noncustomer who is subject to the minimum financial requirements of:
(A) A futures commission merchant, or
(B) The Securities and Exchange Commission for a securities broker
and dealer.
(ii) For purposes of paragraph (f)(5)(i), maintenance margin shall
include all deposits which the futures commission merchant requires the
noncustomer to maintain in order to carry its positions at the futures
commission merchant.
(g) A futures commission merchant shall provide written notice of a
substantial reduction in capital as compared to that last reported in a
financial report filed with the Commission pursuant to Sec. 1.10. This
notice shall be provided as follows:
(1) If any event or series of events, including any withdrawal,
advance, loan or loss cause, on a net basis, a reduction in net capital
(or, if the futures commission merchant is qualified to use the filing
option available under Sec. 1.10(h), tentative net capital as defined
in the rules of the Securities and Exchange Commission) of 20 percent
or more, notice must be provided within two business days of
[[Page 19186]]
the event or series of events causing the reduction; and
(2) If equity capital of the futures commission merchant or a
subsidiary or affiliate of the futures commission merchant consolidated
pursuant to Sec. 1.10(f) (or 17 CFR 240.15c3-1e) would be withdrawn by
action of a stockholder or a partner or by redemption or repurchase of
shares of stock by any of the consolidated entities or through the
payment of dividends or any similar distribution, or an unsecured
advance or loan would be made to a stockholder, partner, sole
proprietor, employee or affiliate, such that the withdrawal, advance or
loan would cause, on a net basis, a reduction in excess adjusted net
capital (or, if the futures commission merchant is qualified to use the
filing option available under Sec. 1.10(h), excess net capital as
defined in the rules of the Securities and Exchange Commission) of 30
percent or more, notice must be provided at least two business days
prior to the withdrawal, advance or loan that would cause the
reduction: Provided, however, That the provisions of paragraphs (g)(1)
and (g)(2) of this section do not apply to any futures or securities
transaction in the ordinary course of business between a futures
commission merchant and any affiliate where the futures commission
merchant makes payment to or on behalf of such affiliate for such
transaction and then receives payment from such affiliate for such
transaction within two business days from the date of the transaction.
* * * * *
3. Section 1.17 is amended as follows:
3.1. By revising paragraph (a)(1);
3.2. By revising paragraph (c)(5)(xiii);
3.3. By removing the word ``or'' at the end of paragraph
(e)(1)(ii), by redesignating paragraph (e)(1)(iii) as (e)(1)(iv), and
by adding a new paragraph (e)(1)(iii);
3.4. By removing the word ``or'' at the end of paragraph
(h)(2)(vi)(C)(2), by redesignating paragraph (h)(2)(vi)(C)(3) as
paragraph (h)(2)(vi)(C)(4), and by adding a new paragraph
(h)(2)(vi)(C)(3);
3.5. By removing the word ``or'' at the end of paragraph
(h)(2)(vii)(A)(2), by redesignating paragraph (h)(2)(vii)(A)(3) as
paragraph (h)(2)(vii)(A)(4) and, as redesignated, revising it, and by
adding a new paragraph (h)(2)(vii)(A)(3);
3.6. By removing the word ``or'' at the end of paragraph
(h)(2)(vii)(B)(2), by redesignating paragraph (h)(2)(vii)(B)(3) as
paragraph (h)(2)(vii)(B)(4) and, as redesignated, revising it, and by
adding new paragraphs (h)(2)(vii)(B)(3) and (h)(2)(vii)(C);
3.7. By removing the word ``or'' at the end of paragraph
(h)(2)(viii)(A)(2), by redesignating paragraph (h)(2)(viii)(A)(3) as
paragraph (h)(2)(viii)(A)(4), and by adding a new paragraph
(h)(2)(viii)(A)(3);
3.8. By removing the word ``or'' at the end of paragraph
(h)(3)(ii)(B), by redesignating paragraph (h)(3)(ii)(C) as paragraph
(h)(3)(ii)(D), and by adding a new paragraph (h)(3)(ii)(C); and
3.9. By redesignating paragraphs (h)(3)(v)(C) and (D) as paragraphs
(h)(3)(v)(D) and (E) and by adding a new paragraph (h)(3)(v)(C). The
revised and added paragraphs read as follows:
Sec. 1.17 Minimum financial requirements for futures commission
merchants and introducing brokers.
(a)(1)(i) Except as provided in paragraph (a)(2)(i) of this
section, each person registered as a futures commission merchant must
maintain adjusted net capital equal to or in excess of the greatest of:
(A) $250,000;
(B) Four percent of the following amount: The customer funds
required to be segregated pursuant to the Act and these regulations and
the foreign futures or foreign options secured amount, less the market
value of commodity options purchased by customers on or subject to the
rules of a contract market or a foreign board of trade: Provided,
however, That the deduction for each customer shall be limited to the
amount of customer funds in such customer's account(s) and foreign
futures and foreign options secured amounts;
(C) The amount of adjusted net capital required by a registered
futures association of which it is a member; or
(D) For securities brokers and dealers, the amount of net capital
required by Rule 15c3-1(a) of the Securities and Exchange Commission
(17 CFR 240.15c3-1(a)).
(ii) Except as provided in paragraph (a)(2) of this section, each
person registered as an introducing broker must maintain adjusted net
capital equal to or in excess of the greatest of:
(A) $30,000;
(B) The amount of adjusted net capital required by a registered
futures association of which it is a member; or
(C) For securities brokers and dealers, the amount of net capital
required by Rule 15c3-1(a) of the Securities and Exchange Commission
(17 CFR 240.15c3-1(a)).
* * * * *
(c) * * *
(5) * * *
(xiii) Five percent of all unsecured receivables includable under
paragraph (c)(2)(ii)(D) of this section used by the applicant or
registrant in computing ``net capital'' and which are not receivable
from
(A) A registered futures commission merchant, or
(B) A broker or dealer which is registered as such with the
Securities and Exchange Commission: Provided, however, That if the
unsecured receivable represents deposits required to maintain futures
and commodity option positions, is receivable from a broker which has
been granted comparability relief pursuant to Sec. 30.10 of this
chapter, and is held by the broker itself, with another foreign broker
that has been granted comparability relief under Sec. 30.10 of this
chapter, or at a depository in the same jurisdiction as either foreign
broker that would qualify as a depository for funds in accordance with
Sec. 30.7 of this chapter, and, in the case of customer funds, is held
in accordance with the special requirements of the applicable
Commission order issued under Sec. 30.10 of this chapter, there will be
no charge.
* * * * *
(e) * * *
(1) * * *
(iii) 120 percent of the amount of adjusted net capital required by
a registered futures association of which it is a member; or
* * * * *
(h) * * *
(2) * * *
(vi) * * *
(C) * * *
(3) 120 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member; or
* * * * *
(vii) * * *
(A) * * *
(3) 120 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member; or
(4) For an applicant or registrant which is also a securities
broker or dealer, the amount of net capital specified in Rule 15c3-
1d(b)(7) of the Securities and Exchange Commission (17 CFR 240.15c3-
1d(b)(7)).
(B) * * *
(3) 120 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member; or
(4) For an applicant or registrant which is also a securities
broker or dealer, the amount of net capital specified in Rule 15c3-
1d(c)(5)(ii) of the Securities and Exchange Commission (17 CFR
240.15c3-1d(c)(5)(ii)): Provided, however, That no special prepayment
shall be made if pre-tax losses during the latest three-month period
were greater than 15 percent of current excess adjusted net capital.
[[Page 19187]]
(C) Notwithstanding the provisions of paragraphs (h)(2)(vii)(A) and
(h)(2)(vii)(B) of this section, in the case of an applicant, no
prepayment or special prepayment shall occur without the prior written
approval of the National Futures Association; in the case of a
registrant, no prepayment or special prepayment shall occur without the
prior written approval of the designated self-regulatory organization,
if any, or of the Commission if the registrant is not a member of a
self-regulatory organization. The designated self-regulatory
organization shall immediately provide the Commission with a copy of
any notice of approval issued where the requested prepayment or special
prepayment will result in the reduction of the registrant's net capital
by 20 percent or more or the registrant's excess adjusted net capital
by 30 percent or more.
(viii) * * *
(A) * * *
(3) 120 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member; or
* * * * *
(3) * * *
(ii) * * *
(C) 120 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member; or
* * * * *
(v) * * *
(C) 120 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member;
* * * * *
4. Section 1.58 is revised to read as follows:
Sec. 1.58 Gross collection of exchange-set margins.
(a) Each futures commission merchant which carries a commodity
futures or commodity option position for another futures commission
merchant or for a foreign broker on an omnibus basis must collect, and
each futures commission merchant and foreign broker for which an
omnibus account is being carried must deposit, initial and maintenance
margin on each position reported in accordance with Sec. 17.04 of this
chapter at a level no less than that established for customer accounts
by the rules of the applicable contract market.
(b) If the futures commission merchant which carries a commodity
futures or commodity option position for another futures commission
merchant or for a foreign broker on an omnibus basis allows a position
to be margined as a spread position or as a hedged position in
accordance with the rules of the applicable contract market, the
carrying futures commission merchant must obtain and retain a written
representation from the futures commission merchant or from the foreign
broker for which the omnibus account is being carried that each such
position is entitled to be so margined.
Issued in Washington, D.C. on April 25, 1996, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 96-10714 Filed 4-30-96; 8:45 am]
BILLING CODE 6351-01-P
