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Federal Register, Volume 77 Issue 220 (Wednesday, November 14, 2012)[Federal Register Volume 77, Number 220 (Wednesday, November 14, 2012)]
[Proposed Rules]
[Pages 67865-67971]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-26435]
[[Page 67865]]
Vol. 77
Wednesday,
No. 220
November 14, 2012
Part II
Commodity Futures Trading Commission
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17 CFR Parts 1, 3, 22 et al.
Enhancing Protections Afforded Customers and Customer Funds Held by
Futures Commission Merchants and Derivatives Clearing Organizations;
Proposed Rule
Federal Register / Vol. 77 , No. 220 / Wednesday, November 14, 2012 /
Proposed Rules
[[Page 67866]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 3, 22, 30, and 140
RIN 3038-AD88
Enhancing Protections Afforded Customers and Customer Funds Held
by Futures Commission Merchants and Derivatives Clearing Organizations
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
———————————————————————–
SUMMARY: The Commodity Futures Trading Commission (“Commission” or
“CFTC”) is proposing to adopt new regulations and amend existing
regulations to require enhanced customer protections, risk management
programs, internal monitoring and controls, capital and liquidity
standards, customer disclosures, and auditing and examination programs
for futures commission merchants (“FCMs”). The proposal also
addresses certain related issues concerning derivatives clearing
organizations (“DCOs”) and chief compliance officers (“CCOs”). The
proposed rules will afford greater assurances to market participants
that: customer segregated funds and secured amounts are protected;
customers are provided with appropriate notice of the risks of futures
trading and of the FCMs with which they may choose to do business; FCMs
are monitoring and managing risks in a robust manner; the capital and
liquidity of FCMs are strengthened to safeguard their continued
operations; and the auditing and examination programs of the Commission
and the self-regulatory organizations (“SROs”) are monitoring the
activities of FCMs in a prudent and thorough manner.
DATES: Comments must be received on or before January 14, 2013.
ADDRESSES: You may submit comments, identified by RIN 3038-AD88, by any
of the following methods:
Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments
through the Web site.
Mail: Send to David A. Stawick, Secretary, Commodity
Futures Trading Commission, 1155 21st Street NW., Washington, DC 20581.
Hand delivery/Courier: Same as Mail above.
Federal eRulemaking Portal: http://www.regulations.gov/search/index.jsp.
Follow the instructions for submitting comments.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
http://www.cftc.gov. You should submit only information that you wish
to make available publicly. If you wish the Commission to consider
information that is exempt from disclosure under the Freedom of
Information Act, a petition for confidential treatment of the exempt
information may be submitted according to the procedures set forth in
Sec. 145.9 of the Commission’s regulations.1
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1 Commission regulations referred to herein are found at 17
CFR Ch. 1 (2012). Commission regulations are accessible on the
Commission’s Web site, www.cftc.gov.
_____________________________________-
The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from www.cftc.gov that it may deem to be inappropriate for
publication, such as obscene language. All submissions that have been
redacted or removed that contain comments on the merits of the
rulemaking will be retained in the public comment file and will be
considered as required under the Administrative Procedure Act and other
applicable laws, and may be accessible under the Freedom of Information
Act.
FOR FURTHER INFORMATION CONTACT:
Division of Swap Dealer and Intermediary Oversight: Gary Barnett,
Director, 202-418-5977, [email protected]; Thomas Smith, Deputy
Director, 202-418-5495, [email protected]; Frank Fisanich, Chief Counsel,
202-418-5949, [email protected]; or Ward P. Griffin, Associate Chief
Counsel, 202-418-5425, [email protected], Three Lafayette Centre, 1155
21st Street NW., Washington, DC 20581, or Kevin Piccoli, Deputy
Director, 646-746-9834, [email protected], 140 Broadway, 19th Floor,
New York, NY 10005.
Division of Clearing and Risk: Robert B. Wasserman, Chief Counsel, 202-
418-5092, [email protected], Three Lafayette Centre, 1155 21st Street
NW., Washington, DC 20581.
Office of the Chief Economist: Camden Nunery, Economist,
[email protected], 202-418-5723, Three Lafayette Centre, 1155 21st
Street NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
A. General Statutory and Current Regulatory Structure
The protection of customers–and the safeguarding of money,
securities or other property deposited by customers with an FCM–is a
fundamental component of the Commission’s disclosure and financial
responsibility framework. Section 4d(a)(2) 2 of the Commodity
Exchange Act (“Act”) 3 requires each FCM to segregate from its own
assets all money, securities and other property deposited by futures
customers to margin, secure, or guarantee futures contracts and options
on futures contracts traded on designated contract markets.4 Section
4d(a)(2) further requires an FCM to treat and deal with futures
customer funds as belonging to the futures customer, and prohibits an
FCM from using the funds deposited by a futures customer to margin or
extend credit to any person other than the futures customer that
deposited the funds. Section 4d(f) of the Act, which was added by
section 724(a) of the Dodd-Frank Wall Street Reform and Consumer
Protection Act,5 requires each FCM to segregate from its own assets
all money, securities and other property deposited by Cleared Swaps
Customers to margin transactions in Cleared Swaps.6
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2 7 U.S.C. 6d(a)(2).
3 7 U.S.C. 1 et seq.
4 The term ” futures customer” is defined in Sec. 1.3(iiii)
to include any person who uses a futures commission merchant as an
agent in connection with trading in any contract for the purchase or
sale of a commodity for future delivery or an option on such
contract (excluding any proprietary accounts under Sec. 1.3(y)).
The Commission adopted the definition of the term “futures
customer” on October 16, 2012 as part of the final rulemaking that
amended existing Commission regulations to incorporate swaps. The
Federal Register release adopting the final rules can be accessed at
http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister101612.pdf.
5 See Dodd-Frank Act, Public Law 111-203, 124 Stat. 1376
(2010). The text of the Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
6 The term “Cleared Swaps Customer” is defined in Sec. 22.1
as any person entering into a Cleared Swap, but excludes: (1) Any
owner or holder of a Cleared Swaps Proprietary Account with respect
to the Cleared Swaps in such account; and (2) A clearing member of a
DCO with respect to Cleared Swaps cleared on that DCO.
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The Commission has adopted Sec. Sec. 1.20 through 1.30, and Sec.
1.32, to implement section 4d(a)(2) of the Act, and adopted Part 22 to
implement section 4d(f) of the Act. The purpose of these regulations is
to safeguard funds deposited by futures customers and Cleared Swaps
Customers, respectively.
Regulation 1.20 requires each FCM and DCO to separately account for
and to segregate from its own proprietary funds all money, securities,
or other property deposited by futures customers for trading on
designated contract markets. Regulation 1.20 also provides that an FCM
or DCO may deposit futures customer funds only with a bank, trust
company, and for FCMs only, a DCO or another FCM. The funds must be
deposited under an account
[[Page 67867]]
name that clearly identifies the funds as belonging to the futures
customers of the FCM or DCO and further shows that the funds are
segregated as required by section 4d(a)(2) of the Act and Commission
regulations. FCMs and DCOs also are required to obtain a written
acknowledgment from a depository stating that the depository was
informed that funds deposited are customer funds being held in
accordance with the Act.
FCMs and DCOs also are restricted in their use of futures customer
funds. Regulations 1.20 and 1.22 provide that the funds deposited by
one futures customer may not be used to margin or to secure the
contracts or option positions, or extend credit to any person, other
than the futures customer that deposited the funds. An FCM or DCO,
however, may for convenience commingle and hold funds deposited as
margin by multiple futures customers in the same account or accounts
with one of the recognized depositories. An FCM or DCO also may invest
futures customer funds in certain permitted investments under Sec.
1.25.
Part 22 of the Commission’s regulations, which governs Cleared
Swaps transactions, implements section 4d(f) of the Act and parallels
many of the provisions in Part1 addressing the manner in which, and the
responsibilities imposed upon, an FCM holding funds for futures
customers trading on designated contract markets.7 Regulation 22.2
requires an FCM to treat and to deal with funds deposited by Cleared
Swaps Customers as belonging to such Cleared Swaps Customers and to
hold such funds separately from the FCM’s own funds. Regulation 22.4
provides that an FCM may deposit Cleared Swaps Customer Collateral with
a bank, trust company, DCO, or another registered FCM. Regulation 22.6
requires that the account holding the Cleared Swaps Customers
Collateral must clearly identify the account as an account for Cleared
Swaps Customers of the FCM engaging in cleared swap transactions and
that the funds maintained in the account are subject to the segregation
provisions of section 4d(f) of the Act and Commission regulations.
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7 The Commission approved the part 22 regulations on January
11, 2012, with an effective date of April 9, 2012. Compliance with
the part 22 regulations is required by November 8, 2012. See,
Protection of Cleared Swaps Customer Contracts and Collateral;
Conforming Amendments to the Commodity Broker Bankruptcy Provisions,
77 FR 6336 (Feb. 7, 2012).
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Regulation 22.2(d) also prohibits an FCM from using the funds
deposited by one Cleared Swaps Customer to purchase, margin, or settle
cleared swap transactions of any person other the Cleared Swaps
Customer that deposited the funds. Further, Sec. 22.2(c) permits an
FCM to commingle the Cleared Swaps Customer Collateral of multiple
Cleared Swaps Customers into one or more accounts, and Sec. 22.2(e)(1)
permits an FCM to invest Cleared Swaps Customer Collateral in permitted
investments under Sec. 1.25.
In addition to holding funds for futures customers transacting on
designated contract markets and for Cleared Swaps Customers engaging in
cleared swap transactions, FCMs also hold funds for persons trading
futures contracts listed on foreign boards of trade. Section 4(b) of
the Act provides that the Commission may adopt rules and regulations
proscribing fraud and requiring minimum financial standards, the
disclosure of risk, the filing of reports, the keeping of books and
records, the safeguarding of the funds deposited by persons for trading
on foreign markets, and registration with the Commission by any person
located in the United States who engages in the offer or sale of any
contract of sale of a commodity for future delivery that is made
subject to the rules of a board of trade located outside of the United
States. Pursuant to the statutory authority of section 4(b), the
Commission adopted Part 30 of its regulations to address foreign
futures and foreign option transactions.
The segregation provisions for funds deposited by foreign futures
or foreign options customers to margin foreign futures or foreign
options transactions under Part 30, however, are significantly
different from the requirements set forth in Sec. 1.20 for futures
customers trading on designated contract markets and Part 22 for
Cleared Swaps Customers engaging in cleared swap transactions.
Regulation 30.7 provides that an FCM may deposit the funds belonging to
foreign futures or foreign options customers in an account or accounts
maintained at a bank or trust company located in the United States; a
bank or trust company located outside of the United States that has in
excess of $1 billion of regulatory capital; an FCM registered with the
Commission; a DCO; a member of a foreign board of trade; a foreign
clearing organization; or a depository selected by the member of a
foreign board of trade or foreign clearing organization. The account
with the depository must be titled to clearly specify that the account
holds funds belonging to the foreign futures or foreign options
customers of the FCM that are trading on foreign futures markets. An
FCM also is permitted to invest the funds deposited by foreign futures
or foreign option customers in accordance with Sec. 1.25.
However, unlike Sec. 1.20 and Part 22, which require an FCM to
hold a sufficient amount of funds in segregation to meet the total
account equities of all of the FCM’s futures customers and Cleared
Swaps Customers at all times (i.e., the Net Liquidating Equity Method),
Sec. 30.7 requires an FCM to maintain in separate accounts an amount
of funds only sufficient to cover the margin required on open foreign
futures contracts, plus or minus any unrealized gains or losses on such
open positions, plus any funds representing premiums payable or
received on foreign options (including any additional funds necessary
to secure such options, plus or minus any unrealized gains or losses on
such options) (i.e., the “Alternative Method”). Thus, under the Part
30 Alternative Method an FCM is not required to maintain a sufficient
amount of funds in such separate accounts to pay the full account
balances of all of its foreign futures or foreign options customers at
all times.
In addition to the segregation requirements of sections 4d(a)(2)
and 4d(f) of the Act, and the secured amount requirements in Part 30 of
the Commission’s regulations, FCMs also are subject to minimum net
capital and financial reporting requirements that are intended to
ensure that such firms meet their financial obligations in a regulated
marketplace, including their financial obligations to customers and
DCOs. Each FCM is required to maintain a minimum level of “adjusted
net capital,” which is generally defined under Sec. 1.17 as the
firm’s net equity as computed under generally accepted accounting
principles, less all of the firm’s liabilities and further excluding
all assets that are not liquid or readily marketable. Regulation
1.17(c)(5) further requires an FCM to impose capital charges (i.e.,
deductions) on certain of its liquid assets to protect against possible
market risks in such assets.
FCMs also are subject to financial recordkeeping and reporting
requirements. FCMs that carry customer accounts are required under
Sec. 1.32 to prepare a schedule each business day demonstrating their
compliance with the segregation and secured amount requirements.
Regulation 1.32 requires the calculation to be performed by noon each
business day, reflecting the account balances and open positions as of
the close of business on the previous business day.
Each FCM also is required by Sec. 1.10 to file with the Commission
and with its
[[Page 67868]]
designated self-regulatory organization (“DSRO”) monthly unaudited
financial statements and an annual audited financial report, as well as
notices of certain predefined events.8 Regulation 1.12 requires an
FCM to file a notice with the Commission and with the firm’s DSRO
whenever, among other things, the firm: (1) Fails to maintain
compliance with the Commission’s capital requirements; (2) fails to
hold sufficient funds in segregated or secured amount accounts to meet
its regulatory requirements; (3) fails to maintain current books and
records; or (4) experiences a significant reduction in capital from the
previous month-end. The purpose of the regulatory notices is to alert
the Commission and the firm’s DSRO as early as possible to potential
financial issues at the firm that may adversely impact the ability of
the FCM to comply with its obligations to safeguard customer funds, or
to meet its financial obligations to other FCMs or DCOs.
—————————————————————————
8 The term “self-regulatory organization” is defined by
Sec. 1.3 to mean a contract market, a swap execution facility, or a
registered futures association. A DSRO is the SRO that is appointed
to be primarily responsible for conducting ongoing financial
surveillance of an FCM under a joint audit agreement submitted to
and approved by the Commission under Sec. 1.52.
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The statutory mandate to segregate customer funds–to treat them as
belonging to the customer and not use the funds inappropriately–takes
on greater meaning in light of the devastating events experienced over
the past year. Those events, which are discussed in greater detail
below, demonstrate that the risks of misfeasance and malfeasance, and
the risks of failing to maintain sufficient excess funds in
segregation: (i) Put customer funds at risk; and (ii) are exacerbated
by stresses on the business of the FCM. Many of those risks can be
mitigated significantly by better risk management systems and controls,
along with an increase in risk-oriented oversight and examination of
the FCMs.
Determining what is a “sufficient” amount of excess funds in
segregation for any particular FCM requires a full understanding of the
business of that FCM, including a proper analysis of the factors that
affect the actual amount of segregated funds held by the FCM relative
to the minimum amount of segregated funds it is required to hold.
Further, appropriate care must be taken to avoid withdrawing such
excess funds at times of great stress to cover needs unrelated to the
purposes for which excess segregated and secured funds are maintained.
In times of stress, excess funds may look like an easy liquidity source
to help cover other risks of the business; yet withdrawing it makes it
unavailable when it may be most needed. The recent market events
illustrate both the need to: (i) Require that care be taken about
monitoring excess segregated and secured funds, and the conditions
under and the extent to which such funds may be withdrawn; and (ii)
place appropriate risk management controls around the other risks of
the business to help relieve (A) the likelihood of an exigent event or,
(B) if such an event occurs, the likelihood of a failure to prepare for
such an event, which in either case could create pressures that result
in an inappropriate withdrawal of customer funds.
Although the Commission’s existing regulations provide an essential
foundation to fostering a well-functioning marketplace, wherein
customers are protected and institutional risks are minimized, recent
events have demonstrated that additional measures are necessary to
effectuate the fundamental purposes of the statutory provisions
discussed above. Further, concurrently with the enhanced
responsibilities for FCMs that are proposed herein, the oversight and
examination systems must be enhanced to mitigate risks and effectuate
the statutory purposes.
B. Self-Regulatory Structure
The Commission’s oversight structure provides that SROs are the
frontline regulators of FCMs, introducing brokers (“IBs”), commodity
pool operators, and commodity trading advisors. In 2000, Congress
affirmed the Commission’s reliance on SROs by amending section 3 of the
Commodity Exchange Act to state: “It is the purpose of this Act to
serve the public interests through a system of effective self-
regulation of trading facilities, clearing systems, market participants
and market professionals under the oversight of the Commission.”
As part of its oversight responsibility, an SRO is required to
conduct periodic examinations of member FCMs’ compliance with
Commission and SRO financial and related reporting requirements,
including the FCMs’ holding of customer funds in segregated and secured
accounts. The Commission oversees the SROs by examining them for the
performance of their duties. More recently, the Commission has moved to
conducting quarterly reviews of the SROs’ FCM examination program in
which the Commission selects a small sample of the SRO’s FCM work
papers to review. In addition, the Commission also conducts limited-
scope reviews of FCMs in a “for cause” situation that are sometimes
referred to as “audits,” but they are not full-scale audits as
accountants commonly use that term.
In addition, because there are multiple SROs who share the same
member FCMs, to avoid subjecting FCMs to duplicative examinations from
SROs, the Commission has a permissive system that allows the SROs to
agree how to allocate FCMs amongst them. An SRO who is allocated
certain FCMs for such examination is referred to as the DSRO of those
FCMs.
Under Commission regulations, FCMs must have their annual financial
statements audited by an independent certified public accountant
following U.S. Generally Accepted Auditing Standards (“U.S. GAAS”).
As part of this certified annual report, the independent accountant
also must conduct appropriate reviews and tests to identify any
material inadequacies in systems and controls that could violate the
Commission’s segregation or secured amount requirements. Any such
inadequacies are required to be reported to the FCM’s DSRO and to the
Commission.
C. Futures Commission Merchant Insolvencies and Failures of Risk
Management
Recent events demonstrate the need for revisions to the
Commission’s customer protection regime. Since October 2011, two FCMs
have entered into insolvency proceedings. On October 31, 2011, MF
Global, Inc. (“MFGI”), which was dually-registered as an FCM with the
Commission and as a securities broker-dealer (“BD”) with the U.S.
Securities and Exchange Commission (“SEC”), was placed into a
liquidation proceeding under the Securities Investor Protection Act by
the Securities Investor Protection Corporation (“SIPC”). The trustee
appointed to oversee the liquidation of MFGI has reported a potential
$900 million shortfall of funds necessary to repay the account balances
due to customers trading futures on designated contract markets, and an
approximately $700 million shortfall in funds immediately available to
repay the account balances of customers trading on foreign futures
markets.9 The shortfall in customer segregated accounts is
attributable by the MFGI Trustee to significant transfers of funds out
of the customer accounts that were used by MFGI for various purposes
other than to meet obligations to or on
[[Page 67869]]
behalf of customers. The trustee also is attempting to recover
approximately $640 million of customer funds that was deposited by MFGI
with its London, U.K. affiliate, MFGUK, as margin funds for trading on
foreign markets. The MFGI trustee and the Special Administrators
handling the liquidation of MFGUK are disputing the legal status of the
funds and whether they are customer funds under English law. The
outcome of this dispute will have a significant impact on the amount of
funds that are returned to MFGI.
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9 See Report of the Trustee’s Investigation and
Recommendations, In re MF Global Inc., No. 11-2790 (MG) SIPA (Bankr.
S.D.N.Y. Jun. 4, 2012).
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In addition, the Commission filed a civil injunctive complaint in
federal district court on July 10, 2012, against Peregrine Financial
Group, Inc. (“PFG”), a registered FCM and its Chief Executive Officer
(“CEO”) and sole owner, Russell R. Wasendorf, Sr., alleging that PFG
and Wasendorf, Sr. committed fraud by misappropriating customer funds,
violated customer fund segregation laws, and made false statements
regarding the amount of funds in customer segregated accounts in
financial statements filed with the Commission. The complaint states
that in July 2012 during an NFA examination PFG falsely represented
that it held in excess of $220 million of customer funds when in fact
it held approximately $5.1 million.10
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10 Complaint, U.S. Commodity Futures Trading Commission v.
Peregrine Financial Group, Inc., and Russell R. Wasendorf, Sr., No.
12-cv-5383 (N.D. Ill. July 10, 2012). A copy of the Commission’s
complaint has been posted to the Commission’s Web site.
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Recent incidents also have demonstrated the value of establishing
robust risk management systems within FCMs and enhanced early warning
systems to detect and address capital issues. In particular, problems
that arise through an FCM’s non-futures-related business can have a
direct and significant impact on the FCM’s regulatory capital, raising
questions as to whether the FCM will be able to maintain the minimum
financial requirements mandated by the Act and Commission
regulations.11
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11 See, e.g., Edward Krudy, Jed Horowitz and John McCrank,
“Knight’s Future in Balance After Trading Disaster,” Reuters (Aug.
3, 2012), available at http://in.reuters.com/article/2012/08/03/knightcapital-loss-idINL2E8J27QE20120803 (noting that a software
issue caused the firm to incur a $440 million trading loss, which
represented much of the firm’s capital); Chris Dieterich and
Nathalie Tadena, “Penson Worldwide’s US Securities Accounts To Be
Acquired By Apex Clearing,” available at http://online.wsj.com/article/BT-CO-20120531-717791.html (discussing circumstances that
led Penson to sell its futures business).
—————————————————————————
These recent incidents have highlighted weaknesses in the customer
protection regime prescribed in the Commission’s regulations and
through the self-regulatory system. In particular, questions have
arisen on the requirements surrounding the holding and investment of
customer funds, including the ability of FCMs to withdraw funds from
customer segregated accounts and Part 30 secured accounts.
Additionally, the incidents have underscored the need for additional
safeguards–such as robust risk management systems, strengthened early-
warning systems surrounding margin and capital requirements, and
enhanced public disclosures–to promote the protection of customer
funds and to minimize the systemic risk posed by certain actions of
market participants. Further questions have arisen on the system of
audits and examinations of FCMs, and whether the system functions
adequately to monitor FCMs’ activities, verify segregated fund and
secured amount balances, and detect fraud. Consequently, the Commission
has taken steps to study and address the issues raised by the
incidents, and industry participants likewise have taken steps to
address the issues. Such steps are described in greater detail in the
next section.
D. Recent Commission Rulemakings and Other Initiatives Relating to
Customer Protection
Since late 2011, the Commission has promulgated rules directly
impacting the protection of customer funds. The Commission also has
studied the current regulatory framework surrounding customer
protection, particularly in light of the recent incidents outlined
above, in order to identify potential enhancements to the systems and
Commission regulations protecting customer funds. The Commission’s
efforts have been informed, in part, by efforts undertaken by industry
participants. The proposed rule amendments set forth in this release
have been informed by the efforts detailed below.
In December 2011, the Commission adopted final rule amendments
revising the types of investments that an FCM or DCO can make with
customer funds under Sec. 1.25, for the purpose of affording greater
protection for such funds.12 Among other changes to Sec. Sec. 1.25
and 30.7, the final rule amendments removed from the list of permitted
investments: (1) corporate debt obligations not guaranteed by the
United States; (2) foreign sovereign debt; and (3) in-house and
affiliate transactions.
—————————————————————————
12 See, Investment of Customer Funds and Funds Held in an
Account for Foreign Futures and Foreign Options Transactions, 76 FR
78776 (Dec. 19, 2011).
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In adopted the amendments to Sec. 1.25, the Commission was mindful
that customer segregated funds must be invested by FCMs and DCOs in a
manner that minimizes their exposure to credit, liquidity, and market
risks both to preserve their availability to customers and DCOs, and to
enable investments to be quickly converted to cash at a predictable
value in order to avoid systemic risk. The amendments are consistent
with the general prudential standard contained in Sec. 1.25, which
provides that all permitted investments must be “consistent with the
objectives of preserving principal and maintaining liquidity.”
The Commission also approved final regulations that require DCOs to
collect initial customer margin from FCMs on a gross basis.13 Under
the final regulations, FCMs are no longer permitted to offset one
customer’s margin requirement against another customer’s margin
requirements and deposit only the net margin collateral with the DCO.
As a result of the rule change, a greater portion of customer initial
margin will be posted by FCMs to the DCOs.
—————————————————————————
13 See Commission Regulation 39.12(g)(8)(i) and Derivatives
Clearing Organization General Provisions and Core Principles, 76 FR
69334 (Nov. 8, 2011).
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The Commission also approved a new margining regime for cleared
swaps positions.14 Under the traditional futures margining model,
DCOs hold an FCM’s customer funds on a collective basis and are
permitted to use the collective margin funds held for the FCM’s
customers to satisfy a margin deficiency caused by a single customer.
The Commission approved an alternative margin rule for cleared swap
transactions. Under the “LSOC rule” (legal segregation with
operational comingling), the DCOs that clear swaps transactions have
greater information regarding the margin collateral of individual Swaps
Customers, and each Swaps Customer’s collateral is protected
individually all the way to the clearinghouse.
—————————————————————————
14 See 77 FR 6336 (Feb. 7, 2012).
—————————————————————————
The Commission also included customer protection enhancements in
the final rule for designated contract markets. These provisions codify
into rules staff guidance on minimum requirements for SROs regarding
their financial surveillance of FCMs.15 The rules require that a DCM
have arrangements and resources for effective
[[Page 67870]]
rule enforcement and trade and financial surveillance programs,
including the authority to collect information and examine books and
records of members and market participants. The rules also establish
minimum financial standards for both member FCMs and IBs and non-
intermediated market participants. The Commission expressly noted in
the preamble of the Adopting Release that “a DCM’s duty to set
financial standards for its FCM members involves setting capital
requirements, conducting surveillance of the potential future exposure
of each FCM as compared to its capital, and taking appropriate action
in light of the results of such surveillance.” 16 Further, the rules
mandate that DCMs adopt rules for the protection of customer funds,
including the segregation of customer and proprietary funds, the
custody of customer funds, the investment standards for customer funds,
intermediary default procedures and related recordkeeping.
—————————————————————————
15 See Core Principles and Other Requirements for Designated
Contract Markets, 77 FR 36612 (June 19, 2012).
16 Id. at 36646.
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In addition to the rulemaking efforts outlined above, the
Commission has sought additional information through a series of
roundtables and other meetings. On February 29 and March 1, 2012, the
Commission solicited comments and held a public roundtable to solicit
input on customer protection issues from a broad cross-section of the
futures industry, including market participants, FCMs, DCOs, SROs,
securities regulators, foreign clearing organizations, and
academics.17 The roundtable focused on issues relating to the
advisability and practicality of modifying the segregation models for
customer funds; alternative models for the custody of customer
collateral; enhancing FCM controls over the disbursement of customer
funds; increasing transparency surrounding an FCM’s holding and
investment of customer funds; and lessons learned from recent commodity
brokerage bankruptcy proceedings.
—————————————————————————
17 Further information on the public roundtable, including
video recordings and transcripts of the discussions, have been
posted to the Commission’s Web site. See http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff022912 (relating to Feb. 29,
2012); http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff030112 (relating to Mar. 1, 2012).
—————————————————————————
The Commission also hosted a public meeting of the Technology
Advisory Committee (“TAC”) on July 26, 2012.18 Panelists and TAC
members discussed potential technological solutions directed at
enhancing the protection of customers funds by identifying and
exploring technological issues and possible solutions relating to the
ability of the Commission, SROs and customers to verify the location
and status of funds held in customer segregated accounts.
—————————————————————————
18 Additional information, including documents submitted by
meeting participants, has been posted to the Commission’s Web site.
See http://www.cftc.gov/PressRoom/Events/opaevent_tac072612.
—————————————————————————
Commission staff hosted an additional roundtable on August 9, 2012,
to discuss SRO requirements for examinations of FCMs and Commission
oversight of SRO examination programs. The roundtable also focused on
the role of the independent public accountant in the FCM examination
process, and proposals addressing various alternatives to the current
system for segregating customer funds.
In developing the proposals set forth in this release, the
Commission also has been informed by efforts undertaken by industry
participants. On February 29, 2012, the Futures Industry Association
(“FIA”) initiated steps to educate customers on the extent of the
protections provided under the current regulatory structure. FIA issued
a list of Frequently Asked Questions (“FAQ”) prepared by members of
the FIA Law and Compliance Division addressing the basics of
segregation, collateral management and investments, capital
requirements and other issues for FCMs and joint FCM/BDs, and
clearinghouse guaranty funds.19 The FAQ is intended to provide
existing and potential customers with a better understanding of the
risks of engaging in futures trading and a clear explanation of the
extent of the protections provided to customers and their funds under
the Act and Commission regulations.
—————————————————————————
19 The FIA’s release addressing FAQs on the protection of
customer funds is accessible on the FIA’s Web site at http://www.futuresindustry.org/downloads/PCF-FAQs.PDF.
—————————————————————————
FIA also issued a series of initial recommendations for the
protection of customer funds.20 The recommendations were prepared by
the Financial Management Committee, whose members include
representatives of FIA member firms, DCOs and depository institutions.
The initial recommendations address enhanced disclosure on the
protection of customer funds, reporting on segregated funds balances by
FCMs, FCM internal controls surrounding the holding and disbursement of
customer funds, and revisions to Part 30 regulations to make the
protections comparable to those provided for customers trading on
designated contract markets.
—————————————————————————
20 The FIA’s initial recommendations are accessible on the
FIA’s Web site at http://www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer_Funds_Protection.pdf.
—————————————————————————
On July 13, 2012, the Commission approved new FCM financial
requirements proposed by the National Futures Association
(“NFA”).21 The NFA Financial Requirements Section 16 and its
related Interpretive Notice entitled NFA Financial Requirements Section
16: FCM Financial Practices and Excess Segregated Funds/Secured Amount
Disbursements (collectively referred to as “the Segregated Funds
Provisions”) were developed in consultation with Commission staff.
—————————————————————————
21 For more information relating to the new FCM financial
requirements, see http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072.
—————————————————————————
NFA’s Segregated Funds Provisions require each FCM to: (1) Maintain
written policies and procedures governing the deposit of the FCM’s
proprietary funds (i.e., excess or residual funds) in customer
segregated accounts and Part 30 secured accounts; (2) maintain a
targeted amount of excess funds in segregate accounts and Part 30
secured accounts; (3) file on a daily basis the FCM’s segregation and
Part 30 secured amount computations with NFA; (4) obtain the approval
of senior management prior to a withdrawal that is not for the benefit
of customers, whenever the withdrawal equals 25 percent or more of the
excess segregated or Part 30 secured amount funds; (5) file a notice
with NFA of any withdrawal that is not for the benefit of customers,
whenever the withdrawal equals 25 percent or more of the excess
segregated or Part 30 secured amount funds; (6) file detailed
information regarding the depositories holding customer funds and the
investments made with customer funds as of the 15th day (or the next
business day if the 15th is not a business day) and the last business
day of each month; and (7) file additional monthly net capital and
leverage information with NFA.
Significantly, NFA’s Segregated Funds Provisions also require FCMs
to compute their Part 30 secured amount requirement and compute their
targeted excess Part 30 secured funds using the same Net Liquidating
Equity Method that is required by the Act and Commission regulations
for computing the segregation requirements for customers trading on
U.S. contract markets under section 4d of the Act. FCMs are not
permitted under the NFA rules to use the Alternative Method to compute
the Part 30 secured amount requirement. The failure of an FCM to
maintain its targeted amount of excess Part 30 funds computed using the
Net
[[Page 67871]]
Liquidating Equity Method may result in NFA initiating a Membership
Responsibility Action (“MRA”) against the firm.
In addition, in setting the target amount of excess funds, the
FCM’s management must perform a due diligence inquiry and consider
various factors relating, as applicable, to the nature of the FCM’s
business, including the type and general creditworthiness of the FCM’s
customers, the trading activity of the customers, the types and
volatility of the markets and products traded by the FCM’s customers,
and the FCM’s own liquidity and capital needs. The FCM’s Board of
Directors (or similar governing body), CEO or Chief Financial Officer
(“CFO”) must approve in writing the FCM’s targeted residual amount,
any changes thereto, and any material changes in the FCM’s written
policies and procedures.
The NFA Board of Directors also approved on August 16, 2012,
amendments to NFA financial requirements for FCMs that will require
each FCM to provide its DSRO with view-only access via the Internet to
account information for each of the FCM’s customer segregated funds
account(s) maintained and held at a bank or trust company. The same
requirement would apply to the FCM’s customer secured account(s) held
for customers trading on foreign futures exchanges.
In addition, the NFA rule amendments provide that if a bank or
trust company is unable to allow the FCM to provide its DSRO with view-
only full access via the Internet, the bank or trust company will not
be deemed an acceptable depository to hold customer segregated and
secured accounts. NFA intends to expand its oversight of FCMs under the
amended rules, once the amendments are implemented, to receive daily
reports from all depositories for customer segregated and secured
accounts, including FCMs that are clearing members of DCOs. NFA plans
to develop a program to compare the balances reported by the
depositories with the balances reported by the FCMs in their daily
segregation reports. An immediate alert would be generated for any
material discrepancies.
E. Commission’s Proposal
The incidents outlined above, coupled with the information
generated through the recent efforts undertaken by the Commission and
industry participants, demonstrate the need for new rules and
amendments to existing rules. In particular, an examination of FCM
business operations–including the non-futures business of FCMs–and
the currently regulatory framework evince a need for enhanced customer
protections, risk management programs, disclosure requirements, and
auditing and examination programs. The amendments proposed herein
address these issues in several ways.
First, recognizing problems surrounding the treatment of customer
segregated funds and foreign futures or foreign options secured
amounts, the Commission is proposing to amend several components of
Parts 1, 22, and 30 of the Commission’s regulations. The Commission
believes that the proposed amendments will provide greater certainty to
market participants that the customer funds entrusted to FCMs will be
protected. Second, to address shortcomings in the risk management of
FCMs, the Commission is proposing a new Sec. 1.11 that will establish
robust risk management programs. Third, the Commission determined that
the current regulatory framework should be re-oriented to implement a
more risk-based, forward-looking perspective, affording the Commission
and SROs with read-only access to accounts holding customer funds and
additional information on depositories and the customer assets held in
such depositories. The proposed amendments to Sec. Sec. 1.10, 1.12,
1.20, 1.26, and 1.32 address those and other issues. Fourth, given the
difficulties that can arise in an FCM’s business, and the direct and
significant impact on the FCM’s regulatory capital that can result from
such difficulties, the Commission is proposing to amend Sec.
1.17(a)(4) to ensure that an FCM’s capital and liquidity are sufficient
to safeguard the continuation of operations at the FCM. Fifth, to
effect the change in orientation needed in FCM examinations programs,
as well as to assure quality control over program contents,
administration and oversight, the Commission is proposing to amend
Sec. 1.52, which, among other things, addresses the formation of Joint
Audit Committees and the implementation of Joint Audit Programs. And
sixth, recognizing the need to increase the information provided to
customers concerning the risks of futures trading and the FCMs with
which they may choose to conduct business, the Commission is proposing
amendments to Sec. 1.55 that will enhance the disclosures provided by
FCMs. These amendments are discussed in greater detail in the next
Section.
II. Section by Section Analysis of Proposed Commission Regulations and
Proposed Amendments to Existing Commission Regulations
A. Proposed Amendments to Sec. 1.10: Financial Reports of Futures
Commission Merchants and Introducing Brokers
Regulation 1.10 requires each FCM to file with the Commission and
with the firm’s DSRO an unaudited financial report each month. The
financial report must be prepared using Form 1-FR-FCM. An FCM, however,
that is dually-registered as a BD, may file a Financial and Operational
Combined Uniform Single Report under the Securities Exchange Act of
1934 (“FOCUS Report”) in lieu of the Form 1-FR-FCM. Each FCM also is
required to file an annual report certified by an independent public
accountant with the Commission and with its DSRO.
The unaudited monthly and certified annual financial reports are
required to contain basic financial statements including a statement of
financial condition, a statement of income (loss), and a statement of
changes in ownership equity. The financial statements also are required
to include additional schedules designed to address specific regulatory
objectives to demonstrate that the FCM is in compliance with minimum
capital and customer funds segregation requirements. These additional
schedules include a statement of changes in liabilities subordinated to
claims of general creditors, a statement of the computation of the
minimum capital requirements (“Capital Computation Schedule”), a
statement of segregation requirements and funds in segregation for
customers trading on U.S. commodity exchanges (“Segregation
Schedule”) and a statement of secured amounts and funds held in
separate accounts for foreign futures and foreign options customers
(“Secured Amount Schedule”). In addition, the certified annual report
must contain a reconciliation of material differences between the
Capital Computation Schedule, the Segregation Schedule, and the Secured
Amount Schedule contained in the certified annual report and the
unaudited monthly report for the FCM’s year-end month.
The Forms 1-FR-FCM and the FOCUS Reports are necessary financial
reporting for Commission and DSRO staff to assess the ongoing financial
condition of an FCM and provide significant information regarding the
operations of the firm that may impact the FCM’s ability to maintain
[[Page 67872]]
compliance with Commission requirements and the protection of customer
funds. The Form 1-FR-FCM and FOCUS Reports are filed electronically
with the Commission and are subject to automated edits by the
Commission’s financial statement surveillance software. Alerts and edit
checks, which may indicate a need for further analysis and follow-up by
staff, are generated by the financial surveillance software and major
issues are immediately and automatically forwarded to Commission staff
for review.
The Segregation Schedule and the Secured Amount Schedule generally
indicate, respectively, the total amount of funds held by the FCM in
segregated or secured accounts, the total amount of funds that the FCM
must hold in segregated or secured accounts to meet its regulatory
obligations to futures customers and foreign futures or foreign options
customers, and whether the firm holds excess segregated or secured
funds in the segregated or secured accounts as of the reporting date.
The Commission is proposing to amend Sec. 1.10 to require each FCM to
also disclose in the Segregation Schedule and in the Secured Amount
Schedule 22 a target amount of “residual interest” (denoting the
FCM’s proprietary funds) that the FCM is required to maintain in
customer segregated accounts and secured accounts based upon its
written policies and procedures for computing a targeted amount
required under the new risk management provisions in Sec. 1.11
discussed in Section II.B below.23 In addition to the target amount
of residual interest, the FCM also will be required to report on the
Segregation Schedule and the Secured Amount Schedule the sum of
outstanding margin deficits of the relevant customers for each
computation, to ensure that the residual interest is at all times in
excess of such sum, demonstrating compliance with the newly proposed
procedures in Sec. Sec. 1.22 and 1.23, which shall require residual
interest to exceed the sum of such margin deficits.
—————————————————————————
22 The Commission also proposes to revise the title of the
“Secured Amount Schedule” by adding the term “30.7 Customer” to
specify that the secured amount will include both U.S.-domiciled and
foreign-domiciled customers consistent with the proposed amendments
to Part 30 of the Commission Regulations discussed in Section II.R
below.
23 The NFA recently adopted a similar amendment to its rules,
mandating that its member FCMs maintain written policies and
procedures identifying a target amount that the FCM will seek to
maintain as its residual interest in customer segregated and secured
accounts. See NFA Notice I-12-14 (July 18, 2012), available at
http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072.
—————————————————————————
As more fully discussed in Section II.B below, proposed Sec. 1.11
will require each FCM that carries customer funds to determine a
necessary level of excess segregated and secured funds that the firm
should hold in segregated or secured accounts to ensure against
becoming undersegregated or undersecured as a result of the withdrawal
of proprietary funds from segregated or secured accounts. Each FCM is
required under proposed Sec. 1.11 to compute or determine the
necessary target of residual interest based upon appropriate due
diligence and consideration of various factors relating to the nature
of the FCM’s business,24 including the type and general
creditworthiness of the customer base, the amount of the undermargined
customer accounts on any given day, and the volatility and liquidity of
the markets and products traded by customers.
—————————————————————————
24 The term “Cleared Swaps Customer Collateral” is defined
in Sec. 22.1 to mean all money, securities, or other property
received by a futures commission merchant or by a derivatives
clearing organization from, for, or on behalf of a Cleared Swaps
Customer to margin a Cleared Swap or the settlement value of a
Cleared Swap, and includes any accruals on such Cleared Swap
transactions.
—————————————————————————
The disclosure of the targeted amount of the FCM’s residual
interest in segregated or secured accounts will allow the Commission
and DSRO to assess the size of the target relative to both the total
funds held in segregation or secured accounts and to compare the target
to other FCMs. Such information will assist the Commission and DSROs in
assessing the potential risk that a firm may become undersegregated or
undersecured, and will enhance the Commission’s and DSRO’s ability to
protect customer funds.
The Commission also is proposing to revise Form 1-FR-FCM to adopt a
new “Statement of Cleared Swap Customer Segregation Requirements and
Funds in Cleared Swap Customer Accounts Under Section 4d(f) of the
Act” (“Cleared Swaps Segregation Schedule”). The Commission is
proposing the Cleared Swaps Segregation Schedule to implement
provisions in section 724(a) of the Dodd-Frank Act.25 Section 724(a)
amended section 4d of the Act, and requires an FCM to segregate from
its own assets any money, securities and other property deposited by a
Cleared Swaps Customer to margin its cleared swaps positions. As part
of the implementation of section 724(a) of the Dodd-Frank Act, the
Commission adopted Sec. 22.2(g) which requires an FCM to compute, as
of the close of business each business day, a segregation computation
demonstrating compliance with its obligation to hold sufficient funds
in segregated accounts in an amount sufficient to cover the total Net
Liquidating Equity of each of the FCM’s Cleared Swaps Customers.26
The proposed Cleared Swaps Segregation Schedule will be comparable to
the current Segregation Schedule and will allow the Commission and the
FCM’s DSRO to obtain information on the FCM’s holding of Cleared Swaps
Customer Collateral to ensure that such funds are held in accordance
with the provisions of Part 22 of the Commission’s regulations and that
the FCM is reporting that it has sufficient funds in segregated
accounts to meet its obligations to all of its Cleared Swaps Customers
computed under the Net Liquidating Equity Method.
—————————————————————————
25 See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the
Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
26 See 77 FR 6336 (February 7, 2012).
—————————————————————————
The Commission previously proposed a Cleared Swaps Segregation
Schedule as part of its proposed regulations to adopt capital
requirements for swap dealers and major swap participants.27 In light
of the Commission’s decision to revise the Cleared Swaps Segregation
Schedule from the version that was published for comment as part of the
Commission’s proposed capital rules for swap dealers and major swap
participants by requiring the FCM to separately disclose its targeted
residual interest in Cleared Swaps Customer Accounts and the sum of
margin deficits for such accounts, the Commission is republishing the
Cleared Swaps Segregation Schedule as part of this proposal to provide
the public with an opportunity to comment on the proposal.28
—————————————————————————
27 See Capital Requirements of Swap Dealers and Major Swap
Participants, 76 FR 27802 (May 12, 2011).
28 Regulation 1.10(h) provides that a dually-registered FCM/BD
may file a FOCUS Report in lieu of the Form 1-FR-FCM provided that
all information that is required to be included in the Form 1-FR-FCM
is included in the FOCUS Report. Currently, dual-registrant FCM/BDs
include a Segregation Schedule and a Secured Amount Schedule in the
FOCUS Report filings as supplemental schedules. If the Commission
were to adopt a Cleared Swaps Segregation Schedule, dual-registrant
FCM/BDs would have to include such schedule in their Focus Report
filings.
—————————————————————————
The Commission also is proposing to amend Sec. 1.10(g)(2) to
provide that the Cleared Swaps Segregation Schedule is a public
document. Regulation 1.10 currently provides that the Commission will
treat the monthly Form 1-FR-FCM
[[Page 67873]]
reports and monthly FOCUS Reports as exempt from mandatory public
disclosure for purposes of the Freedom of Information Act and the
Government in the Sunshine Act, except for certain capital numbers and
other financial information including the Segregation Schedules and the
Secured Amount Schedules contained in the financial reports. The
Commission is proposing to amend Sec. 1.10(g)(2) to provide that the
Cleared Swaps Segregation Schedule is a public document in the same
manner as the Segregation Schedule and Secured Amount Schedule, and is
available by requesting copies from the Commission.
Making the Cleared Swaps Segregation Schedule publicly available
will benefit customers and potential customers by allowing them to
review an FCM’s compliance with its regulatory obligations and will
provide a certain amount of detail as to how the FCM holds customer
funds, which customers and potential customers will be able to assess
from a risk perspective and also use to compare to other firms. This
information, coupled with additional firm risk disclosures that the
Commission is proposing in Sec. 1.55 and discussed in detail in
Section II.P below, will provide customers with greater transparency
regarding the risks of entrusting their funds and engaging in
transactions with particular FCMs. Customers also will be able to view
the total amount of the targeted residual interest each FCM holds and
to assess for themselves the adequacy of the targeted residual interest
and whether the FCM holds funds in excess of the targeted residual
interest.
The Commission also is proposing to amend several statements in the
Form 1-FR-FCM. The Commission is proposing to amend the Statement of
Financial Condition by adding a new line item 1.D. Line 1 currently
separately details the amount of funds in segregation or separate
accounts for futures customers and foreign futures or foreign option
customers. Proposed line item 1.D. will set forth the amount of funds
held by the FCM in segregated accounts for Cleared Swaps Customers.
This amendment is necessary due to the adoption of the Part 22
regulations, which require the segregation of Cleared Swaps Customer
Collateral and the proposed adoption of the Cleared Swaps Segregation
Schedule as part of the Form 1-FR-FCM.
The Commission also is proposing to amend the Statement of
Financial Condition by adding a new line item 22.F., which requires the
separate disclosure of the FCM’s liability to Cleared Swaps Customers.
The Commission also is proposing to revise current line item 27.J. to
require the FCM to disclose its obligation to retail forex customers.
Currently, an FCM’s obligation to retail forex customers is included
with other miscellaneous liabilities and reported under current line
item 27.J. “Other.” The separate reporting of an FCM’s retail forex
obligation will provide greater transparency on the Statement of
Financial Condition regarding the firm’s obligations to its retail
counterparties in off-exchange foreign currency transactions, and is
appropriate given the Commission’s direct jurisdiction over such
activities under section 2(c) of the Act when conducted by an FCM.
The Commission also is proposing to amend Sec. 1.10(b)(1)(ii) to
require that an FCM submit its certified annual report to the
Commission and to its DSRO within 60 days of its year-end date.
Currently, an FCM is required to submit the annual certified financial
statements within 90 days of the firm’s year-end date, except for FCMs
that are dually-registered as FCM/BDs, which are require to submit the
certified annual report within 60 days of the year-end date under both
Commission and SEC regulations. Therefore, the proposal will only
impact FCMs that are not dually-registered as BDs.
The proposal will align the filing deadlines for both FCMs and dual
registrant FCMs/BDs. The annual certified financial report is a key
component of the Commission’s and DSROs’ financial surveillance
program, as it represents that an independent entity has conducted an
audit following U.S. generally accepted auditing standards for the
purpose of expressing an opinion on the financial statements of the
FCM. Requiring standalone FCMs to submit the certified financial
statements within 60 days of the firm’s year-end date will allow
Commission and DSRO staff to review the financial statements on a more
timely basis to identify and address accounting or auditing issues that
may impact the financial condition of the FCM.
In addition, the Commission notes that, pursuant to Sec.
3.3(f)(2), the annual report of an FCM’s CCO must be furnished
electronically to the Commission simultaneously with the submission of
Form 1-FR-FCM, as required under Sec. 1.10(b)(2)(ii); simultaneously
with the FOCUS Report, as required under Sec. 1.10(h); or
simultaneously with the financial condition report, as required under
section 4s(f) of the Act, as applicable. Given the 60-day deadline
proposed herein, the Commission is proposing a conforming amendment to
Sec. 3.3(f)(2) to reflect the proposed 60-day deadline.
The Commission is proposing to add a new requirement in Sec.
1.10(b)(5) to require each FCM to file with the Commission on a monthly
basis its balance sheet leverage ratio. FCMs currently are required to
file the same leverage information with the NFA on a monthly basis. The
Commission does not expect the imposition of this regulation to have
any significant impact on the FCMs as the ratio is calculated from
existing reported balances and already provided to NFA.
The leverage ratio will provide information regarding the amount of
assets supported by the FCM’s capital base. The Commission views
leverage information as an important element in assessing the financial
condition of an FCM as a high degree of balance sheet leverage may
indicate that the firm does not have the capital to support its
investment decisions, particularly if such investments loose a
significant amount of their value in a short period of time or require
substantial margin payments or other payments to support.
The Commission also is proposing to amend Sec. 1.10(c)(2)(i) to
require that all monthly unaudited Forms 1-FR-FCM or FOCUS Reports be
filed electronically with the Commission. The Commission also is
proposing to amend Sec. 1.10(c)(2)(i) to require an FCM to file its
certified financial statement in electronic format.
FCMs currently file the monthly unaudited financial statements with
the Commission using the WinJammer Online Filing System (“WinJammer”)
electronic filing system, and the proposed amendments are simply
codifying current practices.29 Annual certified financial reports
currently are required to be filed in paper form, and are required to
contain the manual signature of the public accountant that conducted
the examination. Under the Commission’s proposal, an FCM will use the
WinJammer system to file its certified financial report as a “PDF”
document. The electronic filing of certified annual reports will ensure
that such documents are received in a timely manner and will allow
Commission staff to initiate prompt reviews of the public accountant’s
report to identify any accounting issues or material inadequacies that
might have been identified during the examination. The
[[Page 67874]]
timely review of the certified financial statements will enhance
customer protections as deficiencies and other accounting issues will
be promptly identified and reviewed.
—————————————————————————
29 WinJammer is a web-based application developed jointly by
the Chicago Mercantile Exchange (“CME”) and the NFA. FCMs
currently use WinJammer to transmit Forms 1-FR-FCM, FOCUS Reports,
and other financial information and regulatory notices to the
Commission and to the SROs.
—————————————————————————
The Commission also is proposing a technical amendment to Sec.
1.10(c)(1). Regulation 1.10(c)(1) provides that any report or
information required to be provided to the Commission by an IB or FCM
will be considered filed when received by the Commission Regional
office with jurisdiction over the state in which the FCM has its
principal place of business. To ensure that reports are filed
expeditiously with the correct Commission Regional office, the
Commission’s proposed amendment to Sec. 1.10(c)(1) cross-references
Sec. 140.02, which sets forth the jurisdiction of each of the
Commission’s three Regional offices.
The Commission requests comment on all aspects the proposed
amendments to Sec. 1.10. Specifically, the Commission requests
comments on the following questions:
Should other schedules in the Form 1-FR-FCM be amended to
provide additional information to the Commission and the FCM’s SROs?
The Commission is proposing to require FCMs to submit to
the Commission and the firm’s DSRO a monthly computation of the FCM’s
balance sheet leverage. The proposal is consistent with the leverage
computation set forth in the rules of the NFA. Are there other measures
of leverage that the Commission should consider adopting? Are there
other financial statement ratios in addition to leverage that the
Commission should consider requiring FCMs to submit to the Commission
and DSROs?
B. Proposed Sec. 1.11: Risk Management Program for Futures Commission
Merchants
Proposed Sec. 1.11 requires each FCM that carries customer
accounts 30 to establish a risk management program designed to
monitor and manage the risks associated with the FCM’s activities as an
FCM. It further provides: (1) That such risk management program consist
of written policies and procedures; (2) that such policies and
procedures be approved by the governing body of the FCM and be
furnished to the Commission; and (3) that a risk management unit that
is independent from the business unit be established to administer the
risk management program.
—————————————————————————
30 Proposed Sec. 1.11 contains an applicability provision in
paragraph (a) that makes clear that the risk management program is
only required of FCMs that accept money, securities, or property to
margin or secure the trades or contracts of customers transacting in
futures, options on futures, and swaps.
—————————————————————————
Paragraph (b) of proposed Sec. 1.11 establishes definitions for
the terms “Customer,” “Customer Account,” “Business Unit,”
“Governing Body,” “Segregated Funds,” and “Senior Management.”
“Business Unit” is defined to clearly delineate the separation of
the risk management unit required by the proposed rule from the other
personnel of an FCM.
The term “Customer” is defined broadly to include futures
customers (as defined in Sec. 1.3) trading futures contracts or
options on futures contracts listed on designated contract markets,
30.7 Customers (as proposed to be defined in Sec. 30.1) trading
futures contract or options on futures contracts listed on foreign
contract markets, and Cleared Swaps Customers (as defined in Sec.
22.1) engaging in cleared swap transactions.
The term “Customer Funds” is defined to mean funds deposited by
futures customers, 30.7 Customers, and Cleared Swap Customers as margin
or funds accruing to such customers from open futures or cleared swap
transactions. Existing Commission regulations require FCMs to hold each
of these types of customer deposited funds, as applicable, in separate
accounts and to segregate such Customer Funds from the FCM’s own funds
and from each other type.
The term “Governing Body” is defined as the sole proprietor, if
the FCM is a sole proprietorship; a general partner, if the FCM is a
partnership; the board of directors, if the FCM is a corporation; and
the chief executive officer, chief financial officer, the manager, the
managing member, or those members vested with the management authority
if the FCM is a limited liability company or limited partnership.
“Senior Management” is defined to mean any officer or officers
specifically granted the authority and responsibility to fulfill the
requirements of senior management by the Governing Body. These
definitions, as used in proposed Sec. 1.11, are designed to ensure
that there is accountability at the highest levels for the FCM’s key
internal controls and processes designed to protect the funds of the
FCM’s customers.
The term “Segregated Funds” is defined to mean money, securities,
or other property held by a futures commission merchant in separate
accounts pursuant to Sec. 1.20 for futures customers, pursuant to
Sec. 22.2 for cleared swaps customers, and pursuant to Sec. 30.7 for
foreign futures and options customers. The definition makes clear that
the requirements of Sec. 1.11 applies to all customer funds that may
be held by an FCM.
Proposed Sec. 1.11(c)(4) requires FCMs to provide copies of the
risk management policies and procedures to the Commission and the FCM’s
DSRO in order to allow the Commission and DSROs to monitor the status
of risk management practices among FCMs. Submission of such policies
and procedures to the Commission without further comment or action by
the Commission or Commission staff should not be construed as an
endorsement of the completeness or effectiveness of the risk management
policies and procedures and no FCM should make a representation to the
contrary. The Commission invites comments on the submission of risk
management policies and procedures and, more generally, on whether the
provisions of Sec. 1.11 have achieved a sufficient level of detail for
the purposes of designing a comprehensive risk management program.
Proposed Sec. 1.11(e) provides for a non-exclusive list of the
elements that must be a part of the risk management program of an FCM.
Such policies and procedures should include: (1) identifying risks
(including risks posed by affiliates, all lines of business of the FCM,
and all other trading activity of the FCM) and setting of risk
tolerance limits; (2) providing periodic risk exposure reports to
senior management and the governing body; (3) operational risk
controls; (4) capital controls; and (5) establishing a risk management
program that takes into account risks associated with the safekeeping
and segregation of customer funds.
In regard to customer funds, the Commission notes that FCMs are
required by the Act and Commission regulations to segregate and
safeguard funds deposited by customers for trading futures and/or swap
contracts. Recent events have emphasized that it is essential that FCMs
maintain adequate systems of internal controls, involving the
participation and review of the firm’s senior management, in order to
properly safeguard customer funds. Accordingly, proposed Sec.
1.11(e)(3)(i) requires that the risk management policies and procedures
of an FCM related to the risks associated with safekeeping and
segregation of customer funds must include: (1) The evaluation and
monitoring of depositories; 31 (2)
[[Page 67875]]
account opening procedures that ensure the FCM obtains the
acknowledgment required under Sec. 1.20 from the depository and that
the account is properly titled as belonging to the customers of the
FCM; 32 (3) establishing and maintaining an adequate targeted amount
of excess funds in customer accounts reasonably designed to ensure the
FCM is at all times in compliance with the segregation requirements for
customer funds under the Act and Commission regulations, as discussed
further below; (4) controls ensuring that withdrawal of cash,
securities, or other property from accounts holding customer funds not
for the benefit of customers are in compliance with the Act and
Commission regulations; 33 (5) procedures for assessing the
appropriateness of investing customer funds in accordance with Sec.
1.25; 34 (6) the valuation, marketability, and liquidity of customer
funds and permitted investments made with customer funds; (7) the
appropriate separation of duties of personnel responsible for
compliance with the Act and Commission regulations relating to the
protection and financial reporting of customer funds; 35 (8)
procedures for the timely recording of transactions in the firm’s books
and records; and (9) annual training of personnel responsible for
compliance with the Act and Commission regulations relating to the
protection and financial reporting of customer funds.
—————————————————————————
31 The evaluation process must include documented criteria
that any depository will be assessed against in order to qualify to
hold funds belonging to Customers. The criteria must address a
depository’s capitalization, creditworthiness, operational
reliability, access to liquidity. The criteria must also address
risks associated with concentration of Customer funds in any
depository or group of depositories, the availability of deposit
insurance, and the regulation and supervision of depositories. The
evaluation criteria is intended to ensure that the FCM adopts an
evaluation process which reviews potential depositories against
substantive criteria relevant to the safe custody of Customer funds
and that the FCM’s process for evaluating and selecting depositories
can be reviewed by regulators and auditors. The FCM also must
maintain a documented process addressing the ongoing monitoring of
selected depositories, including a thorough due diligence review of
each depository at least annually.
32 As required by Sec. 1.20, such account opening
documentation is necessary to ensure that the depositories are aware
of their obligations regarding the accounts and the statutory and
regulatory protections afforded the funds held in the accounts due
to their status as Segregated Funds.
33 The controls must include the conditions for pre-approval
and the notice to the Commission for such withdrawals required by
proposed Sec. 1.23, Sec. 22.17, or Sec. 30.7, discussed below.
34 The FCM’s assessment must take into consideration the
market, credit, counterparty, operational, and liquidity risks
associated with the investments.
35 The policies and procedures must provide for the separation
of duties among personnel that are responsible for customer trading
activities, and approving and overseeing cash receipts and
disbursements (including investment and treasury operations). The
policies and procedures must further require that any movement of
funds to affiliated companies or parties be approved and documented.
—————————————————————————
Regarding the proposed requirement that FCMs establish and maintain
an adequate targeted amount of excess funds in customer accounts, the
Commission notes that FCMs currently deposit proprietary funds into
both customer segregated accounts and Part 30 secured accounts as a
buffer to minimize the possibility of the firm being in violation of
its segregated and secured fund obligations at any time. Under the
proposal, senior management of the FCM must perform appropriate due
diligence in setting the amount of this buffer and must consider the
nature of the FCM’s business including the type and general
creditworthiness of its customer base, the types of markets and
products traded by the firm’s customers, the proprietary trading
activities of the FCM, the volatility and liquidity of the markets and
products traded by the customers and the FCM, the FCM’s own liquidity
and capital needs, and historical trends in customer segregation and
secured account funds balances, customer debits and margin deficits.
The FCM also must reassess the adequacy of the targeted residual
interest quarterly.
The Commission believes that each FCM must set the amount of excess
segregated and secured funds required utilizing a quantitative and
qualitative analysis that reasonably ensures compliance at all times
with segregated and secured fund obligations. Such analysis must take
into account the various factors that could affect segregated and
secured balances, and must be sufficiently described in writing to
allow the DSRO of the FCM and Commission to duplicate the calculations
and test the assumptions. The analysis must provide a reasonable level
of assurance that the excess is at an appropriate level for the
FCM.36 A failure to adopt or maintain appropriate risk management
policies and procedures or to implement, monitor and enforce controls
required by Sec. 1.11 may result in a referral to the Commission’s
Division of Enforcement for appropriate action.
—————————————————————————
36 Separate from requiring the establishment of a target for
residual interest, the Commission is further requiring, as discussed
in more detail under Sections II.G, II.H, and II.I for Sec. Sec.
1.20, 1.22, and 1.23, respectively, that residual interest at all
times exceed the sum of outstanding margin deficits to provide a
mechanism for ensuring compliance with the prohibition of the funds
of one customer being used to margin or guarantee the positions of
another customer under the Act and existing regulations.
—————————————————————————
Finally, to ensure the effectiveness of a risk management program,
Sec. 1.11(e)(4) requires that the risk management program include a
supervisory system that is reasonably designed to ensure that the risk
management policies and procedures are diligently followed.
Furthermore, Sec. 1.11(f) requires an annual review and testing of the
adequacy of each FCM’s risk management program by internal audit staff
or a qualified external, third party service.
The Commission requests comment on all aspects of proposed Sec.
1.11. Specifically, the Commission requests comment on the following:
Should the Commission have different risk management
requirements for FCMs based upon some measureable criteria, such as
size of the firm or type of customers? How would the Commission design
such criteria to distinguish between firms? Which elements in proposed
Sec. 1.11 should apply to smaller FCMs vs. larger FCMs? What elements
should apply to all FCMs irrespective of the size of the firm?
Does the proposed risk management program address the
appropriate minimum elements that should be covered by an FCM risk
management program?
Regulation 3.3 requires the CCO of an FCM to provide an
annual report to the Commission that must review each applicable
requirement under the Act and Commission regulations, and with respect
to each applicable requirement, identify the policies and procedures
that are reasonably designed to ensure compliance with the requirement,
and provide an assessment of the effectiveness of the policies and
procedures.37 The annual report also must include a certification by
the CCO that, to the best of his or her knowledge and reasonable
belief, and under penalty of law, the information contained in the
annual report is accurate and complete. The Commission requests comment
on whether the standard for the CCO’s certification in the annual
report (i.e., based upon the CCO’s knowledge and reasonable belief) is
adequate for a certification of the FCM’s compliance with policies and
procedures for the safeguarding of customer funds. Should Sec. 1.11
contain a separate CCO certification requirement
[[Page 67876]]
that would impose a higher duty of strict liability or some other
higher obligation on a CCO?
—————————————————————————
37 Such report is mandated by Sec. 3.3 of the Commission’s
regulations; See Swap Dealer and Major Swap Participant
Recordkeeping, Reporting, and Duties Rules; Futures Commission
Merchant and Introducing Broker Conflicts of Interest Rules; and
Chief Compliance Officer Rules for Swap Dealers, Major Swap
Participants, and Futures Commission Merchants, 77 FR 20128, Apr. 3,
2012 (promulgating final rules concerning the CCOs of FCMs, swap
dealers, and major swap participants); see also Sec. 4d(d) of the
Act, 7 U.S.C. 6d(d).
—————————————————————————
Should the risk management program require an FCM to
conduct quarterly or periodic audits to detect any breach of the
policies and procedures that address the proper segregation of customer
funds?
Should the Commission establish a phased-in compliance
provision for Sec. 1.11? If so, how long of a phase-in period should
be provided? Should there be different phase-in periods for different
provisions of the proposed regulation?
C. Proposed Amendments to Sec. 1.12: Maintenance of Minimum Financial
Requirements by Futures Commission Merchants and Introducing Brokers
The regulatory notices required under Sec. 1.12 are intended to
provide the Commission and SROs with prompt notice of potential adverse
conditions at FCMs or IBs that may indicate or lead to a threat to the
financial condition of the firm or the protection of customer funds
held by the FCM. In adopting Sec. 1.12 in 1978, the Commission stated
that the establishment of an early warning system was necessary because
“[a] fundamental purpose of the Act is to protect the public from
financially irresponsible FCMs who handle customer funds.” 38
—————————————————————————
38 43 FR 39956, 39967 (Sept. 8, 1978).
—————————————————————————
Regulation 1.12 currently obligates FCMs and IBs to provide notice
to the Commission and to the respective DSROs if certain specified
reportable events occur. Reportable events include: failing to maintain
the minimum level of required regulatory capital (Sec. 1.12 (a));
failing to maintain current books and records (Sec. 1.12(c)); and
failing to comply with the requirements to properly segregate customer
funds (Sec. 1.12(h)). The Commission is proposing to amend Sec. 1.12
to include several additional reportable events and to revise the
process for submitting reportable events to the Commission and DSROs.
Regulation 1.12(a) requires an FCM or IB that fails to maintain the
minimum level of adjusted net capital required by Sec. 1.17 to provide
immediate notice to the Commission and to the entity’s DSRO. The notice
must include additional information to adequately reflect the FCM’s or
IB’s current capital condition as of any date that the entity is
undercapitalized.
The Commission is proposing to amend Sec. 1.12(a) to explicitly
provide that if the FCM or IB cannot compute or document its actual
capital at the time it knows that it is undercapitalized, it must still
provide the written notice required by Sec. 1.12(a) immediately and
cannot delay filing the notice until it has adequate information to
compute its actual level of adjusted net capital. A purpose of the
notice provision under Sec. 1.12(a) is to provide the Commission and
the DSROs with immediate notice of the undercapitalized condition of an
FCM or IB. If an FCM or IB were to delay alerting the Commission that
it was undercapitalized due to the fact that it could not accurately
assess its capital condition, it would frustrate the intent of the
notice provision. It is imperative that an FCM or IB provide immediate
notice if the firm is undercapitalized. Upon the filing of a notice,
Commission and SRO staff will contact the FCM or IB to obtain greater
details of the financial condition of the firm, including information
regarding its current financial condition or issues associated with the
firm’s inability to accurately determine its current financial
condition.
Regulation 1.12(h) currently requires an FCM that fails to hold
sufficient funds in segregated accounts to meet its obligations to
futures customers, or that fails to hold sufficient funds in separate
accounts for foreign futures or foreign options customers, to provide
immediate notice to the Commission and to the FCM’s DSRO. The
Commission is proposing to amend paragraph (h) to include an explicit
requirement that an FCM provide immediate notice to the Commission and
to its DSRO if the FCM fails to hold sufficient funds in segregated
accounts for Cleared Swaps Customers to meet its obligation to such
customers.
Commencing November 8, 2012, the compliance date for certain
Commission Part 22 regulations, FCMs will be required under Sec. 22.2
to hold a sufficient amount of funds in Cleared Swaps Customer Accounts
to meet the Net Liquidating Equity of each Cleared Swaps Customer.39
Immediate notification of a failure to hold sufficient funds in
segregation for Cleared Swaps Customers is essential for the Commission
and DSROs to promptly assess the financial condition of an FCM and to
determine if there are threats to the safety of the Cleared Swaps
Customers’ funds held by the FCM. The proposed amendment to Sec.
1.12(h) also harmonizes the notice requirements whenever an FCM fails
to hold sufficient funds for futures customers, 30.7 Customers, and
Cleared Swaps Customers.
—————————————————————————
39 77 FR 6336 (Feb. 7, 2012).
—————————————————————————
The Commission also is proposing to amend Sec. 1.12 by adding new
paragraph (i) to require an FCM to provide notice whenever it discovers
or is informed that it has invested funds held for customers in
investments that are not permitted investments under Sec. 1.25, or if
the FCM holds permitted investments in a manner that is not in
compliance with the provisions of Sec. 1.25 (such as the investment
concentration limits). The proposal will apply to funds held for
futures customers, 30.7 Customers, and Cleared Swaps Customers.
The protection of customer funds is a core element of the
Commission’s regulatory program. FCMs are entrusted with a
responsibility to use customer funds only for the benefit of the
depositing customers.40 FCMs are permitted, however, to invest
customer funds pursuant to the standards and conditions set forth in
Sec. 1.25. Regulation 1.25 contains a list of permitted investments
and other criteria that are intended to allow an FCM to receive the
benefit of investing customer funds while also preserving the principal
and maintaining the liquidity of the customer funds.
—————————————————————————
40 Regulation 1.20(a), 17 CFR 1.20(a).
—————————————————————————
Requiring an FCM to provide prompt notice of a Sec. 1.25 violation
will allow Commission and DSRO staff to assess whether customer funds
are endangered and to work with the FCM to ensure that the
impermissible investments are appropriately liquidated and customer
funds remain intact. Commission and DSRO staff also will benefit from
receiving notices of Sec. 1.25 violations in that the notices will
provide information regarding new investments that FCMs may engage in
that are not permitted investments under Sec. 1.25. Such information
will be helpful for the Commission and DSRO in conducting reviews of
other FCMs and in providing regulatory updates to the industry.41
—————————————————————————
41 The Commission further notes that investing customer funds
in investments that are not permitted investments under Sec. 1.25,
or holding investments in a manner that is otherwise not compliant
with Sec. 1.25 does not change the legal status of the funds as
customer funds in the event of the bankruptcy of the FCM.
—————————————————————————
The Commission also is proposing to amend Sec. 1.12 to provide a
new paragraph (j) that will require an FCM to provide immediate notice
to the Commission and to the firm’s DSRO if the FCM does not hold an
amount of funds in segregated accounts for futures customers or for
Cleared Swaps Customers, or if the FCM does not hold sufficient funds
in separate accounts for 30.7 Customers, sufficient to meet the firm’s
targeted residual interest in one or more of these accounts as computed
[[Page 67877]]
under proposed Sec. 1.11, or if its residual interest in one or more
of these accounts is less than the sum of outstanding margin deficits
for such accounts. Proposed Sec. 1.11 will require each FCM that
carries customer funds to calculate an appropriate amount of excess
funds (i.e., proprietary funds) to hold in segregated or secured
accounts to mitigate the FCM from being undersegregated or undersecured
due to a withdrawal of proprietary funds from a segregated or secured
account. The fact that an FCM is not holding a sufficient amount of
excess funds in customer accounts to meet its targeted residual
interest may be indicative of more severe financial or operational
issues at the firm. In addition, if an FCM’s residual interest is less
than the sum of outstanding margin deficits in one such account, it is
possible that funds of one customer in such account are at risk of
margining or guaranteeing the open positions of another customer.
Accordingly, the Commission is proposing to require an FCM to file
immediate notice of such an event to allow Commission and DSRO staff to
contact the FCM to assess the condition of the firm and the safety of
customer funds.
The Commission also is proposing new paragraphs (k) and (l) for
Sec. 1.12. Paragraphs (k) and (l) will require an FCM to provide
notice to the Commission and to the firm’s DSRO in the event of a
material adverse impact in the financial condition of the firm or a
material change in the firm’s operations. Proposed paragraph (k) will
require an FCM to provide immediate notice if the FCM, its parent, or a
material affiliate, experiences a material adverse impact to its
creditworthiness or its ability to fund its obligations. Indications of
a material adverse impact of an FCM’s creditworthiness may include a
bank or other financing entity withdrawing credit facilities, a credit
rating downgrade, or the FCM being placed on “credit watch” by a
credit rating agency. Proposed paragraph (l) will require an FCM to
provide immediate notice of material changes in the operations of the
firm, including: A change in senior management; the establishment or
termination of a material line of business; a material change in the
FCM’s clearing arrangements; or a material change in the FCM’s credit
arrangements. Paragraph (l) is intended to provide the Commission with
notice of material events, such as the departure of the FCM’s CCO, CFO,
or CEO.
As noted above, Sec. 1.12 is intended to provide the Commission
and DSROs with notice of potential issues that may impact the financial
condition of an FCM or the safety of customer funds. The regulatory
objective is for FCMs to provide material information to the Commission
and DSROs as early as possible so that the Commission and DSROs can
assess the information and communicate with the FCMs prior to a more
serious issue developing that may impair the financial condition of the
firms or the safety of customer funds. Proposed paragraphs (k) and (l)
will provide the Commission and DSROs with notice of major events that
will initiate a dialogue between the Commission, DSROs, and FCMs which
will have the benefit of informing the Commission and DSROs of material
events impacting FCMs. Such information would be used by the Commission
and DSROs in setting the scope of the review and monitoring of the
FCMs, including the determination of the risk of the firms for purposes
of scheduling future examinations. Without paragraphs (k) and (l), the
Commission and DSROs may not learn of material events at FCMs until the
firms are subject to periodic examinations.
The Commission is proposing to add a new paragraph (m) to Sec.
1.12 that will require an FCM that receives a notice, examination
report, or any other correspondence from the SEC or a SRO to file a
copy of such notice, examination report, or correspondence with the
Commission. In order to perform comprehensive oversight of an FCM, the
Commission and the DSROs need to receive prompt notice of any concern
or adverse action taken by the SEC or a securities SRO. The protection
of futures customers funds are not immune from issues that arise from
the securities operations or business of a dual registrant FCM/BD.
Requiring an FCM to provide prompt notice to the Commission and the
firm’s DSRO of any notice, examination report, or correspondence that
the firm receives from the SEC or a securities SRO will allow the
Commission and the DSRO to identify potential threats to the safety of
customer funds.
The Commission is further proposing to amend the process that an
FCM uses to file the notices required by Sec. 1.12. Currently, Sec.
1.12 requires an FCM to provide the Commission and DSROs with
telephonic and facsimile notice in some situations, and to provide
written notice by mail in other situations. An FCM also is permitted,
but not required, to file notices and written reports with the
Commission and with its DSRO using an electronic filing system in
accordance with instructions issued by or approved by the Commission.
The Commission is proposing to amend Sec. 1.12(n) to require that
all notices and reports filed by an FCM with the Commission or with the
FCM’s DSRO must be in writing and submitted using an electronic filing
system. Each FCM currently uses WinJammer to file regulatory notices
with the Commission and with the firm’s DSRO. The WinJammer system
provides for the most effective mechanism for ensuring that regulatory
notices are promptly received by the Commission and by the DSROs.42
The regulation further provides that if the FCM cannot file a notice
due to the electronic system being inoperable or for any other reason,
it must contact the Commission Regional office with jurisdiction over
the firm and make arrangements for the filing of the regulatory notices
by filing the notice with the Commission via electronic mail at a
specially designated email address established by the Commission;
[email protected]. The Commission also is proposing to amend Sec.
1.12(n) to require that each notice filed by an FCM, IB, or SRO under
Sec. 1.12 must include a discussion of what caused the reportable
event, and what steps have been, or are being taken, to address the
reportable event. The reporting entity, however, may not delay the
reporting of a reportable event if it does not possess complete
information on what caused the event, or the steps that have been taken
or are being taken to address the event.
—————————————————————————
42 The Commission’s proposed amendment to require the
electronic filing of reports applies to both registered FCMs and
applicants for registration as FCMs. Applicants for FCM registration
currently file regulatory notices with NFA using WinJammer.
—————————————————————————
The amendments to Sec. Sec. 1.12(b), (d), (e), (f) and (g) are
necessary and technical in nature, and primarily revise internal cross-
references to the filing requirements in Sec. 1.12(n).
The Commission request comment on all aspects of the proposed
amendments to Sec. 1.12. Specifically, the Commission requests comment
on the following:
Are there other reportable events that the Commission
should consider adding to Sec. 1.12 that would benefit the Commission
and the DSROs in the monitoring of the financial and operating
conditions of FCMs?
Should the Commission consider removing any of the
reportable events listed in Sec. 1.12? If so, why?
Should any of the reportable events be made public by the
Commission, SROs, or FCMs? If so, which reportable events? What benefit
would the public receive from the disclosure of the reportable events?
What would be the costs of disclosing the reportable events to the
FCMs? Are there any negative
[[Page 67878]]
impacts of disclosing the reportable events?
Are the reporting standards in proposed paragraphs (k) and
(l) adequately detailed and objective so that an FCM can determine when
there is a reportable event? If not, what standards should the
Commission use to define a reportable event under paragraphs (k) and
(l)?
D. Proposed Amendments to Sec. 1.15: Risk Assessment Reporting
Requirement for Futures Commission Merchants
Regulation 1.15 requires FCMs to submit certain risk assessment
reports to the Commission. The risk assessment filings include FCM
organizational charts; financial, operational, risk management
policies, and systems maintained by the FCM; and fiscal year-end
consolidated and consolidating financial information for the FCM and
its highest level material affiliate.
The Commission is proposing to amend Sec. 1.15(a)(4) to require
each FCM that is subject to Sec. 1.15 to submit its risk assessment
information to the Commission electronically in accordance with
instructions issued by the Commission. The Commission intends for FCMs
to file the risk assessment materials using the WinJammer electronic
filing system. The Commission requests comments on its proposed
amendments to Sec. 1.15.
E. Proposed Amendments to Sec. 1.16: Qualifications and Reports of
Accountants
Regulation 1.16 sets forth the qualifications a public accountant
must possess in order to conduct audits of Commission registrants.
Currently, a public accountant must be registered and in good standing
under the laws of the place of the public accountant’s principal office
in order to conduct examinations of FCMs.
The Commission is proposing to amend Sec. 1.16(b)(1) to require
that the public accountant be registered with the Public Company
Accounting Oversight Board (“PCAOB”) in addition to being in good
standing with the relevant state licensing authorities. In addition,
the public accountant must have undergone an examination by the PCAOB
and any deficiencies noted during such examination must have been
remediated to the satisfaction of the PCAOB. Regulation Sec.
1.16(b)(4) also will impose an obligation on an FCM’s governing body to
ensure that a public accountant is qualified to perform an audit of the
FCM by assessing the firm’s experience in auditing FCMs, the firm’s
experience and knowledge of the Act and Commission regulations, and the
depth and experience of the firm’s auditing staff.
The Commission also is proposing to amend Sec. 1.16(c)(2) to
require a public accountant to state in the audit opinion whether the
audit was conducted in accordance with U.S. GAAS after full
consideration of the auditing standards adopted by the PCAOB.
Currently, all audits of the certified financial statements of FCMs
must be performed under U.S. GAAS. However, as the Commission is now
proposing that certified public accountants must be registered with the
PCAOB, it is necessary to also require that the auditing standards
promulgated by the PCAOB be considered and adhered to where applicable.
PCAOB requires auditors opining on a public company financial
statements to comply with all applicable auditing standards, including
PCAOB standards; whereas U.S. GAAS is required for the audits of non-
public companies.
In 2003, the PCAOB adopted existing U.S. GAAS as interim standards,
subject to periodic revision as the PCAOB deemed necessary. Since that
time, the PCAOB has issued its own auditing standards in areas of the
audit in which differentiated audit procedures or reporting
requirements have been considered necessary. These areas largely
pertain to audits of internal control over financial reporting as well
as reports on those controls, audit documentation and engagement
quality review. Generally speaking, the most significant difference
between U.S. GAAS and PCAOB standards relates to the auditor’s testing
of internal controls over financial reporting which are meant to cover
the auditor’s opinion on the Sarbanes-Oxley Act Section 404 report on
internal controls. From a regulatory perspective, an auditor’s focus on
internal controls is critical to helping to ensure that material errors
in financial or regulatory reporting are identified on a timely basis,
and the PCAOB standards provide more focus on the auditing standards in
this regard. It should also be noted that auditors of BDs are now
required to register with the PCAOB and follow PCAOB standards; thus,
any dually-registered FCM/BDs will already have to comply with this
requirement.
The proposed amendments to Sec. Sec. 1.16(b)(1) and (c)(2) are
designed to reasonably ensure the quality and competence of public
accountants that engage in the audits of FCMs. FCMs are sophisticated
financial market participants that are subject to extensive regulation.
In addition, the complexity of FCM audits is increased substantially
when a firm is engaged in proprietary trading or dually-registered as
an FCM/BD. Public accountants must be knowledgeable regarding the
business operations, regulatory obligations and financial reporting
requirements for FCMs, and the governing body of the FCM must ensure
that the public accountant has the knowledge, experience, and resources
to conduct the audits. Also, requiring the public accountant to be
registered with PCAOB will ensure that the public accountant is subject
to periodic reviews to assess its compliance with industry standards.
While the Commission does not expect the proposed PCAOB
registration requirement to have a material impact on FCMs, it
recognizes that not all FCMs currently use CPAs that are registered
with the PCAOB or CPAs that have been subject to an examination by the
PCAOB. Currently, 111 of the 116 FCMs are examined by CPAs that are
registered with the PCAOB. Also, 12 CPAs that are registered with the
PCAOB have not yet been subject to a PCAOB examination. These 12 CPAs
conduct examinations of 20 FCMs. Therefore, currently 25 of the 116
FCMs would not satisfy the proposed requirement that only PCAOB-
registered CPAs that have been subject to at least one PCAOB review may
be engaged to conduct an examination of the FCM’s financial
statements.43
—————————————————————————
43 The Commission further notes, however, that 7 of the 20
FCMs are audited by a PCAOB-registered CPA that also conducts audits
of BDs or public companies and, therefore, will be subject to PCAOB
examination at a future date.
—————————————————————————
The Commission is proposing a technical amendment to Sec. 1.16 to
revise the definition of the term “customer.” Regulation 1.16 details
the standards that a public accountant must meet in conducting a
financial examination of an FCM. Currently, Sec. 1.16(a)(4) defines
the term “customer” to include futures customers, Cleared Swaps
Customers, and foreign futures or foreign options customers. The
Commission is proposing to amend Sec. 1.16(a)(4) to revise the
definition of customer to replace the term “foreign futures or foreign
options customer” with the term “30.7 Customer” to make the
provision consistent with the amendments contained in Part 30 of the
Commission’s regulations.
The Commission also is proposing to amend paragraph (f)(1)(i)(C) of
Sec. 1.16 to provide that any filing of a notice of the extension of
time to file the audited financial reports must be submitted by the FCM
to the Commission using an electronic filing system. The Commission
intends for FCMs to use the WinJammer electronic filing system.
[[Page 67879]]
The Commission also is proposing to remove the requirement from
Sec. 1.16(c)(1) that annual financial reports contain the manual
signature of the public accountant. Under the proposed amendments to
Sec. 1.10 discussed above, FCMs will be filing annual financial
reports electronically, which will preclude the use of manual
signature.
The Commission requests comment on all aspects of proposed Sec.
1.16. Specifically, the Commission request comment on the following:
A purpose of the requirement that FCMs engage only CPAs
that are registered with the PCAOB and have been reviewed by the PCAOB
is to enhance the quality of the audit examination conducted by CPAs.
Does the PCAOB registration and examination process enhance the quality
of FCM audit engagements?
Are there viable alternatives that the Commission should
consider to enhance the quality of CPA FCM examinations in lieu of
PCAOB registration and examination?
Should the Commission consider allowing the non-PCAOB
registered CPAs or PCAOB-registered CPAs that have not been subject to
a PCAOB review to contractually engage for a peer review from a
qualified CPA who is aware of the reason for the peer review as a
short-term measure to allow the non-compliant CPAs to continue to
conduct audits of FCMs?
If the Commission adopts the PCAOB registration and
examination requirement, how should the Commission implement the
effective or compliance dates? What factors should the Commission
consider in setting an effective date or compliance date for this
provision?
F. Proposed Amendments to Sec. 1.17: Minimum Financial Requirements
for Futures Commission Merchants and Introducing Brokers
The Commission is proposing to amend Sec. 1.17 by adding a new
provision that will authorize the Commission to require an FCM to
transfer its customer business and cease operating as an FCM if the FCM
cannot immediately certify to the Commission, and demonstrate with
verifiable evidence, that the FCM has sufficient access to liquidity to
continue operating as a going concern. The Commission also is proposing
to amend Sec. 1.17 to permit an FCM that is not a dually-registered
FCM/BD to develop the framework proposed by the SEC, as set forth
below, to establish, maintain and enforce written policies and
procedures for determining creditworthiness, and upon a determination
that a particular type of security has minimal credit risk, to apply
lower deductions to such securities in computing the FCM’s adjusted net
capital.
Section 4f(b) of the Act provides that no person may be registered
as an FCM unless such person meets the minimum financial requirements
that the Commission has established by regulation to ensure that an FCM
meets its obligations at all times as an FCM to its customer and to
market participants, including DCOs. The Commission’s minimum capital
requirements for FCMs are set forth in Sec. 1.17 and generally require
an FCM to maintain adjusted net capital equal to or in excess of the
greater of: $1 million; 8 percent of the risk maintenance margin
required on customer and non-customer futures and options on futures
positions carried by the FCM; 44 the amount of adjusted net capital
required by the NFA; or, for dual-registrants, the amount of net
capital required by the SEC. The term “adjusted net capital” is
generally defined as the FCM’s net, liquid assets less all of the FCM’s
liabilities (except certain qualifying subordinated debt). In computing
its adjusted net capital, an FCM is required to reduce the value of
proprietary futures and securities positions included in its liquid
assets by certain prescribed amounts or percentages of the market value
(otherwise known as “haircuts”) to discount for potential adverse
market movements in the securities.
—————————————————————————
44 The term “noncustomer” is generally defined under Sec.
1.17 as affiliates or management of an FCM.
—————————————————————————
Commission Regulation 1.17(a)(4) currently provides that an FCM
must cease operating as an FCM and transfer its customers positions to
another FCM if the FCM is not in compliance with the minimum capital
requirements, or is unable to demonstrate its compliance with the
minimum capital requirements. The FCM, however, can initiate customer
trades for liquidation purposes only. Regulation 1.17(a)(4) further
provides that the Commission or the FCM’s DSRO may grant the FCM up to
a maximum of 10 days to come back into compliance with the minimum
capital requirements without having to cease operating as an FCM or
transferring customer accounts.
The Commission is proposing to add an additional clause to Sec.
1.17(a)(4), which will specify that the Commission may request
certification in writing from an FCM that it has sufficient liquidity
to continue operating as a going concern, and that if such
certification is not provided immediately or the FCM is not able to
demonstrate its access to liquidity with verifiable evidence, the FCM
must transfer all customer accounts and immediately cease doing
business as an FCM. The proposed liquidity provision is intended to
cover circumstances that require immediate attention. The proposal is
not intended to provide a mechanism for the Commission to require FCMs
to demonstrate that they are a going concern for an extended period of
time into the future. Rather, the purpose of the proposal is to provide
the Commission with a means of addressing exigent circumstances by
requiring an FCM to produce a written analysis showing the sources and
uses of funds over a short period of time not to exceed one week.
The Commission believes this clause provides additional protection
to customers in the event of an imminent liquidity drain on a
registrant, which may not be immediately reflected in its accounting or
regulatory capital business records. Market events or other external
indicators may come to the attention of the Commission which suggest an
FCM is under severe liquidity stress, which demonstrates that although
the firm is still able to demonstrate compliance with required
regulatory capital, conditions are such that it will not be able to
meet liquidity requirements out a period of time not to exceed one
week. This provision will allow the Commission to essentially require
an FCM on demand to be able to certify its access to liquidity
sufficient to continue operating as a going concern for a period not to
exceed one week. The inability of the FCM to satisfy this requirement
will allow the Commission to direct the FCM to transfer customer
accounts and cease doing business as an FCM.
The Commission believes the ability to certify, and if requested,
demonstrate with verifiable evidence, sufficient liquidity to operate
as a going concern to meet immediate financial obligations, is a
minimum financial requirement necessary to ensure an FCM will continue
to meet its obligations as a registrant as set forth under Sec.
4(f)(b) of the Act. The certification required must satisfy the same
oath or affirmation requirements as those required for the submission
of monthly financial reports under Sec. 1.10(d)(4), to ensure that it
is made by an appropriate individual and that it is in writing under
oath of the individual that it is true and correct to the best
knowledge and belief of such individual. If a registrant certifies to
the Commission its access to liquidity, but is not able to demonstrate
with sufficient evidence such liquidity (for example such evidence may
include confirmations by third parties of access
[[Page 67880]]
to credit lines with available credit or of unrestricted cash balances
available to meet projected short term cash requirements), the
Commission believes it would be prudent to require the registrant to
transfer customer accounts. Circumstances related to a liquidity drain
could also result in a breakdown of management controls and result in
an erroneous or false certification, and in such circumstances, the
protection of customers must be paramount. The Commission requests
comment on the proposed additional clause to Sec. 1.17(a)(4).
Regulation 1.17 further requires an FCM to take a haircut against
the value of securities the FCM holds as investments of customer funds
under Sec. 1.25. A primary purpose of these haircuts is to provide a
margin of safety against losses that might be incurred by the FCM as a
result of market fluctuations in the prices of, or lack of liquidity
in, the security positions.
For futures positions, an FCM that is a member of the clearing
organization where the positions are cleared is required to take a
haircut equal to the margin required by the clearing organization on
such futures positions.45 For securities positions, Sec. 1.17
incorporates by reference the securities haircuts that a BD is required
to take in computing its net capital under the SEC’s regulations.46
The structure of the Commission’s net capital rule referring to the
SEC’s net capital rule is a result of the Commission’s determination to
defer to the SEC in areas of its expertise, specifically with respect
to market risk and appropriate haircuts on securities positions.47
—————————————————————————
45 See Sec. 1.17(c)(5)(x)(A).
46 Commission Regulations 1.17(c)(5)(v) and 1.32(b) both
incorporate 17 CFR 240.15c3-1(c)(2)(vi) by reference.
47 See 43 FR 15072 (Apr. 10, 1978) at 15077 and 43 FR 39956
(Sept. 8, 1978) at 39963.
—————————————————————————
The SEC capital rule currently applies a general or “default”
haircut of 15 percent of the market value of commercial paper,
convertible debt instruments, and nonconvertible debt instruments if
the securities are readily marketable, and 100 percent of the market
value if the securities are not readily marketable. The SEC capital
rule also provides for a lower haircut for commercial paper,
convertible debt instruments, and nonconvertible debt instruments if
the securities are rated in higher rating categories by at least two
nationally recognized statistical rating organizations (“NRSROs”). To
receive the benefit of a reduced haircut on commercial paper, the
commercial paper must be rated in one of the three highest rating
categories by at least two NRSROs. To receive the benefit of a reduced
haircut on a nonconvertible debt security or a convertible debt
security, the security must be rated in one of the four highest rating
categories by at least two NRSROs.
The SEC has proposed rule amendments to implement the Dodd-Frank
Act requirement to remove references to credit ratings in its
regulations and substitute a standard for creditworthiness deemed
appropriate, including a proposed amendment to its net capital rule for
BDs at 17 CFR 240.15c3-1.48 Under the SEC proposal, a BD may impose
the default haircuts of 15 percent of the market value of readily
marketable commercial paper, convertible debt, and nonconvertible debt
instruments or 100 percent of the market value of nonmarketable
commercial paper, convertible debt, and nonconvertible debt
instruments. A BD, however, may impose lower haircut percentages for
commercial paper, convertible debt, and nonconvertible debt instruments
that are readily marketable, if the BD determines that the investments
have only a minimal amount of credit risk pursuant to its written
policies and procedures designed to assess the credit and liquidity
risks applicable to a security.
—————————————————————————
48 See 76 FR 26550 (May 6, 2011).
—————————————————————————
Under the SEC proposal, the BD’s written policies and procedures
may assess a security’s credit risk using the following factors, to the
extent appropriate, instead of exclusively relying on NRSROs ratings:
Credit spreads (i.e., whether it is possible to
demonstrate that a position in commercial paper, nonconvertible debt,
and preferred stock is subject to a minimal amount of credit risk based
on the spread between the security’s yield and the yield of Treasury or
other securities, or based on credit default swap spreads that
reference the security);
Securities-related research (i.e., whether providers of
securities-related research believe the issuer of the security will be
able to meet its financial commitments, generally, or specifically,
with respect to securities held by the broker-dealer);
Internal or external credit risk assessments (i.e.,
whether credit assessments developed internally by the broker-dealer or
externally by a credit rating agency, irrespective of its status as an
NRSRO, express a view as to the credit risk associated with a
particular security);
Default statistics (i.e., whether providers of credit
information relating to securities express a view that specific
securities have a probability of default consistent with other
securities with a minimal amount of credit risk);
Inclusion on an index (i.e., whether a security, or issuer
of the security, is included as a component of a recognized index of
instruments that are subject to a minimal amount of credit risk);
Priorities and enhancements (i.e., the extent to which a
security is covered by credit enhancements, such as
overcollateralization and reserve accounts, or has priority under
applicable bankruptcy or creditors’ rights provisions);
Price, yield and/or volume (i.e., whether the price and
yield of a security or a credit default swap that references the
security are consistent with other securities that the broker-dealer
has determined are subject to a minimal amount of credit risk and
whether the price resulted from active trading); and
Asset class-specific factors (e.g., in the case of
structured finance products, the quality of the underlying assets).
A BD that maintains written policies and procedures and determines
that the credit risk of a security is minimal is permitted under the
SEC proposal to apply the lesser haircut requirement currently
specified in the SEC capital rule for commercial paper (i.e., between
zero and [frac12] of 1 percent), nonconvertible debt (i.e., between 2
percent and 9 percent), and preferred stock (i.e., 10 percent).
For FCMs that are dually-registered as BDs, any changes adopted by
the SEC to these securities haircuts will be applicable under Sec.
1.17(c)(5)(v) unless the Commission specifically provides an alternate
treatment for FCMs.49 However, FCMs that are not dual registrants
would be required to take the default haircuts of 15 percent for
readily marketable securities. The Commission does not believe that it
is appropriate to exclude standalone FCMs from using an internal
process to assess the credit risk of certain securities. Therefore, the
Commission’s proposed amendment to Sec. 1.17(c)(v) will permit an FCM
that is not a BD to develop the framework proposed by the SEC to
establish, maintain and enforce written policies and procedures for
determining creditworthiness, and upon a determination that a
particular type of security has minimal credit risk, to apply lower
deductions to such
[[Page 67881]]
securities. An FCM will be required to maintain its written policies
and procedures in accordance with the general recordkeeping
requirements of Sec. 1.31, and the implementation of the policies and
procedures will be subject to review by the FCM’s DSRO. An FCM that
elects to develop written policies and procedures will be subject to
review by its DSRO.
—————————————————————————
49 See discussion adopting Sec. 1.17(c)(5)(vi) for options
haircuts at 43 FR 39956 at 39964, with respect to the applicability
of provisions incorporating by reference and referring to the rules
of the SEC for securities broker dealers also registered as futures
commission merchants.
—————————————————————————
Regulation 1.17 also requires an FCM to reduce its capital (i.e.,
take a capital charge) for customer, noncustomer, and omnibus accounts
that are undermargined for more than a specified period of time.
Regulation 1.17(c)(5)(viii) requires an FCM to take a capital charge if
a customer account is undermargined for three business days after the
margin call is issued. The capital charge is equal to the amount of
funds necessary to restore the account to the initial margin
requirement.
Regulation 1.17(c)(5)(ix) requires an FCM to take a capital charge
for noncustomer and omnibus accounts that are undermargined for two
business days after the margin call is issued. The capital requirement
for undermargined noncustomer and omnibus accounts is the amount of
funds necessary to restore the account to the maintenance margin level.
For purposes of these Commission regulations, a margin call is
presumed to be issued by the FCM the day after an account becomes
undermargined. Thus, if a customer’s account is undermargined at the
close of business on Monday, the FCM will issue a margin call on
Tuesday, and the regulation requires the FCM to take an undermargined
capital charge at the close of business on Friday if the margin call is
not met. For noncustomer and omnibus accounts that were undermargined
at the close of business on Monday, the FCM would take a capital charge
as of the close of business on Thursday.
The Commission is proposing to amend Sec. Sec. 1.17(c)(5)(viii)
and (ix) to require an FCM to take capital charges for undermargined
customer, noncustomer, and omnibus account that are undermargined for
more than one business day after a margin call is issued. Therefore, an
FCM will impose a capital charge as of the close of business on
Wednesday for any customer, noncustomer, or omnibus account that did
not fully satisfy a margin call that is issued by the FCM on Tuesday
for an account that was undermargined as of the close of business on
Monday.
The timely collection of margin is a critical component of an FCM’s
risk management program and is intended to ensure that an FCM holds
sufficient funds deposited by account owners to meet potential
obligations to a DCO. As guarantor of the financial performance of the
customer, noncustomer, and omnibus accounts that it carries, the FCM is
financially responsible if the owner of an account cannot meet its
margin obligations to the FCM and ultimately to a DCO. The timeframe
for meeting margin calls currently provided in Sec. Sec.
1.17(c)(5)(viii) and (ix) may have been appropriate when the capital
rules were adopted in the 1970s when the use of checks and the mail
system were more prevalent for depositing margin with an FCM. The
Commission believes, however, that in today’s markets, with the
increasing use of technology, 24-hour-a-day trading, and the use of
wire transfers to meet margin obligations, that the timeframe for
taking a capital charge should be reduced both to incentivize FCMs to
exercise prudent risk management and to strengthen the financial
protection of FCMs, their customers, and the clearing systems by
requiring the FCMs to reserve capital for undermargined customer,
noncustomer, and omnibus accounts that fail to meet a margin call on a
timely basis.
The Commission also is proposing, as discussed in Section II.I
below, to require an FCM to maintain a residual interest in customer
segregated accounts in an amount sufficient to cover all customer
accounts that are undermargined as of the close of business on the
previous trading day, thereby ensuring that residual interest in
customer segregated accounts exceeds the sum of outstanding margin
calls for customers, and that the funds of one customer are not used to
margin or guarantee the positions of another customer. The FCM may only
maintain as residual interest cash and assets that qualify as permitted
investments under Sec. 1.25. Margin deficits will be calculated as
enough to restore the customer’s account equity to the maintenance
margin requirement on the account.
The Commission also is proposing technical amendments to certain
definitions in Sec. 1.17 to reflect proposed changes discussed in
Section II.R below concerning the Sec. 30.7 secured amount
calculation. The Sec. 1.17(b)(2) and (7) definitions of the terms
“customer” and “customer account” are being proposed to be amended,
the first to include “30.7 Customer” (which is a new definition being
proposed in Sec. 30.1 to include foreign domiciled persons) and the
second to remove surplus language due to the revised definition of
“customer.”
The Commission requests comment on the proposed amendments to Sec.
1.17. Specifically, the Commission requests comment on the following:
Does the proposed amendment to require an FCM to certify
that it has sufficient liquidity to operate as a going concern provide
a sufficient and objective standard for FCMs to assess whether they are
in compliance with the provision? Are there alternative standards or
approaches that the Commission should consider to meet its objective of
ensuring that an FCM has sufficient liquidity to meet its pending
short-term obligations so that customer funds would not be put at risk
in the event of the insolvency of the FCM?
Should the Commission consider alternative timeframes for
the imposition of a capital charge for undermargined accounts?
G. Proposed Amendments to Sec. 1.20: Futures Customer Funds To Be
Segregated and Separately Accounted for
The Commission is proposing to reorganize the structure of Sec.
1.20 by providing additional paragraph subdivisions to the existing
specific requirements, applying headings to the regulation to assist in
the reading and understanding of the regulation. The Commission also is
proposing to add new provisions designed to enhance the protection of
customer funds.
Regulation 1.20 implements the provisions of section 4d(a)(2) of
the Act, which provides, in relevant part, that an FCM must: (1)
Separately account for all futures customer funds and segregate such
funds as belonging to its futures customers; (2) not commingle futures
customer funds with the FCM’s proprietary funds; (3) not use the funds
of one futures customer to margin or extend credit to any person other
than to the futures customer that deposited the funds; and (4) deposit
futures customer funds in any bank, trust company or DCO.
Paragraph (a) of Sec. 1.20 sets forth the general principle under
section 4d(a)(2) of the Act by requiring an FCM to separately account
for all futures customer funds and to segregate such funds from the
FCM’s proprietary funds by depositing them under an account name that
clearly shows that the funds are futures customer funds and segregated
as required by the Act. Paragraph (g)(1) applies the same general
principle to futures customer funds received by a DCO from its members.
Paragraph (a) also requires each FCM to perform appropriate due
diligence on all depositories in accordance with its risk management
policies and procedures required under proposed
[[Page 67882]]
Sec. 1.11 to ensure that the depositories holding customer funds are
financially sound. The FCM must annually update its due diligence.
Paragraph (a) of Sec. 1.20 also provides that an FCM must be in
compliance with its segregation obligations at all times. It is not
sufficient for an FCM to be in compliance at the end of a business day,
but to fail to meet its segregation obligations on an intra-day basis.
If an FCM was not in compliance with the segregation requirements on an
intra-day basis that would necessarily mean that the FCM was using the
funds of one customer to margin positions of another customer or to
cover losses of another customer.
Paragraph (b) of Sec. 1.20 lists the permitted depositories for
futures customer funds as any bank, trust company, derivatives clearing
organization, or another FCM. These permitted depositories are listed
in existing Sec. 1.20 and the Commission is not proposing to amend the
list. Proposed paragraph (g)(2) lists the permitted depositories for
futures funds received by a DCO as any bank or trust company, and
clarifies that the term “bank” includes a Federal Reserve Bank. This
proposed amendment implements section 806(a) of the Dodd-Frank Act,
which provides that a Federal Reserve Bank may establish and maintain a
deposit account for a “financial market utility” (in the present
case, a DCO) that has been designated as systemically important.
Paragraph (c) provides that an FCM may hold futures customer funds
in depositories outside of the United States only in accordance with
the current provisions of Sec. 1.49. Paragraph (g)(3) sets forth the
same limitation for a DCO. Regulation 1.49 currently permits an FCM or
DCO to hold futures customer funds in certain foreign depositories
provided that the FCM or DCO holds sufficient funds in the United
States to meet its U.S. dollar-denominated obligations to futures
customers. Regulation 1.49 also requires specific futures customer
authorization for an FCM or DCO to hold futures customer funds in
certain foreign jurisdictions. The Commission is not proposing to amend
Sec. 1.49 as part of this rulemaking.
Proposed Sec. 1.20(e) prohibits an FCM from commingling futures
customer funds with the FCM’s proprietary funds, and prohibits the FCM
from commingling funds deposited by futures customers with funds
deposited by 30.7 Customers or Cleared Swaps Customers. Regulation
1.20(e), however, does permit an FCM to commingle the funds of multiple
futures customers in a single account or accounts for operational
convenience. Similarly, proposed Sec. 1.20(g)(5) prohibits a DCO from
commingling futures customer funds with the DCO’s proprietary funds or
with any proprietary account of any of its clearing members, and
prohibits the DCO from commingling funds held for futures customers
with funds deposited by clearing members on behalf of their Cleared
Swaps Customers. DCOs would be permitted to commingle the funds of
multiple futures customers in a single account or accounts for
operational convenience.
Proposed Sec. 1.20(f) restricts an FCM’s use of customer funds. An
FCM is prohibited from using one futures customer’s funds to margin or
secure another futures customer’s positions. An FCM also is prohibited
from using a futures customer’s funds to extend credit to any other
person. The FCM also may obligate futures customers’ funds to a DCO or
another FCM solely to purchase, margin, or guarantee futures and
options positions of futures customers.
The Commission is proposing a new paragraph (h) which states that
all futures customer funds deposited with a bank or trust company must
be available for immediate withdrawal upon demand by the FCM or DCO.
Paragraph (h) codifies a long-standing interpretation of the
Commission’s Division of Swap Dealer and Intermediary Oversight and
predecessor divisions derived from an administration determination by
the Commission’s predecessor, the Commodity Exchange Authority of the
U.S. Department of Agriculture.50 The requirement, as proposed, is a
practical necessity to the effective functioning of FCMs and futures
markets. Should a depository have the ability to delay an FCM from
withdrawing customer funds, the FCM may not be able to meet margin
obligations to DCOs, or requests by futures customers for access to
their funds. In addition, an inability of an FCM to have immediate
access to the futures customer funds that it holds may adversely impact
the transfer of futures customers positions in the event of the FCM’s
insolvency.51
—————————————————————————
50 See Administrative Determination No. 29 of the Commodity
Exchange Administration dated Sept. 28, 1937 stating, “the deposit,
by a futures commission merchant, of customers’ funds * * * under
conditions whereby such funds would not be subject to withdrawal
upon demand would be repugnant to the spirit and purpose of the
Commodity Exchange Act. All funds deposited in a bank should in all
cases by subject to withdrawal on demand.”
51 In the case of the bankruptcy of Lehman Brothers, for
example, immediate access to customer funds allowed the commodity
customer accounts to be effectively transferred to Barclays over the
weekend of September 20-21, 2008, immediately following the
commencement of the liquidation of the firm. This transfer was
authorized in the hours immediately following the commencement of
Lehman’s liquidation, and was implemented in the hours immediately
thereafter.
—————————————————————————
The Commission is proposing a new paragraph (i), which
mirrors what was recently adopted in Part 22 for Cleared Swaps
Customers, by providing more detail implementing the Net Liquidating
Equity Method of calculating segregation requirements. In addition,
because a customer may have Net Liquidating Equity (i.e., a credit
balance) in his or her account, requiring segregation of his or her
funds, and still be undermargined relative to open positions, proposed
paragraph (i) requires an FCM to record in the accounts of its futures
customers the amount of margin required for such customers’ open
positions, and to calculate margin deficits for each such customer.
Moreover, the Commission is proposing to require that an FCM maintain
residual interest in segregated accounts in an amount that exceeds the
sum of all futures customers’ margin deficits. A margin deficit occurs
when the value of the futures customer funds for a futures customer’s
account is less than the total amount of collateral required by DCOs
for that account’s contracts. Currently, the Commission requires FCMs
to hold sufficient funds in segregated futures customer accounts to
ensure that those accounts do not become undersegregated. Proposed new
paragraph (i) will affirmatively require an FCM to maintain enough
funds in the futures customer accounts to cover all margin deficits as
well as to ensure that the accounts are not undersegregated. The
Commission requests comments on all aspects of proposed new Sec.
1.20(i), including the costs and benefits of this proposed regulation.
The Commission specifically requests comment on the following:
Will this proposal serve to increase the protections to
customer funds in the event of an FCM bankruptcy?
To what extent would this proposal increase costs to FCMs
and/or futures customers?
To what extent would this proposal benefit futures
customers and/or FCMs?
To what extent would this proposal increase or mitigate
market risk?
To what extent would this proposal lead to FCMs requiring
customers to provide margin for their trades before placing them?
To what extent is this likely to lead to a re-allocation
of costs from customers with excess margin to undermargined customers?
For purposes of margin deficit calculations, should the
Commission
[[Page 67883]]
address issues surrounding the timing of when an FCM must have
sufficient funds in the futures customer account to cover all margin
deficits? If so, how should the Commission address such issues?
In addition to the foregoing, the Commission also is proposing to
revise requirements regarding the written acknowledgment letter that an
FCM or DCO is required to obtain from a depository holding futures
customer funds. Regulation 1.20 currently requires an FCM or DCO to
obtain a written acknowledgment from each depository, unless the
depository is a DCO that has rules approved by the Commission providing
for the segregation of customer funds. The written acknowledgment must
state that the depository was informed that the futures customer funds
deposited belong to futures customers and are being held in accordance
with the provisions of the Act and Commission regulations.
The Commission previously proposed amendments to the acknowledgment
letter regulations. On February 20, 2009, the Commission published
proposed amendments to Sec. Sec. 1.20, 1.26, and 30.7 for public
comment (the “Original Proposal”).52 The Original Proposal set out
specific representations that would have been required to be included
in all acknowledgment letters in order to reaffirm and to clarify the
obligations that depositories incur when accepting customer funds or
secured amount funds.53
—————————————————————————
52 74 FR 7838 (February 20, 2009).
53 The Commission notes that both the current and proposed
definition of “customer funds” in Regulation 1.3(gg) do not
include “secured amount funds” as defined in Regulation 30.7
(i.e., funds deposited by foreign futures or foreign options
customers). See 76 FR 33066, 33085 (June 7, 2011). However, as used
in this notice, unless otherwise specified, the term “customer
funds” is meant to include secured amount funds. The regulations
adopted by this notice are also being amended to use the term
“customer” as newly proposed (i.e., in this rulemaking the
Commission is deleting references to “commodity or option
customers”. As necessary, the Commission distinguishes between the
two types of funds in this notice by referring to “customer
segregated funds” and “customer secured amount funds.”
—————————————————————————
In light of the comments on the Original Proposal, the Commission
determined to re-propose the amendments with several changes made in
response to comments (the “Revised Proposal”).54 As part of the
Revised Proposal, the Commission proposed the required use of standard
template acknowledgment letters which were included as Appendix A to
each of Sec. 1.20 and 1.26, and Appendix E to Part 30 of the
Commission’s regulations (referred to herein as the “Template
Letters” or “Acknowledgment Letters”).
—————————————————————————
54 75 FR 47738 (Aug. 9, 2010).
—————————————————————————
The Commission received nine comment letters on the Revised
Proposal.55 In general, the commenters were supportive of the
Commission’s Revised Proposal and, in particular, were very supportive
of requiring the use of Template Letters. It was noted by certain
commenters that use of a standard template will simplify the process of
obtaining an Acknowledgment Letter.56 In addition, it was noted by
commenters that uniformity of Acknowledgment Letters will provide
consistency and legal certainty across the commodities and banking
industries.57
—————————————————————————
55 Letters were submitted by: Hunton & Williams on behalf of
the Working Group of Commercial Energy Firms (“Energy Working
Group”); International Derivatives Clearinghouse LLC (“IDCH”);
Futures Industry Association (“FIA”); Harris, N.A. (“Harris”);
Katten Muchin Rosenman LLP (“Katten”); CME Group Inc. (“CME”);
The Minneapolis Grain Exchange (“MGEX”); JPMorgan Chase Bank, N.A.
(“JP Morgan”); and The Federal Reserve Bank of Chicago, Financial
Markets Group (“FRB Chicago”).
56 See MGEX CL-00007 at 1; FIA CL-00003 at 2; Harris CL-00004
at 1.
57 See MGEX CL-00007 at 1; CME CL-00006 at 2; FRB Chicago CL-
00010 at 1.
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The Commission is proposing revised amendments to the
Acknowledgment Letters in this release to address several issues that
have arisen as a result of the recent MF Global and Peregrine failures
and the adverse impact on customers that had funds on deposit with
these FCMs. The additional amendments are discussed below. The
Commission also has revised the Acknowledgment Letters to address
comments to the Revised Proposal. These revisions are discussed
immediately below.
1. Obligation To Obtain New Acknowledgment Letters
Under the Revised Proposal, an FCM or DCO would be required to
obtain a new Acknowledgment Letter within 60 days of changes in the
name of any party to the Acknowledgment Letter or changes to the
account number(s) under which customer funds are held. FIA stated that
it is unduly burdensome to require the parties to execute a new
Acknowledgment Letter in the event of a party changing its name within
60 days of the event.58 FIA recommended instead including “binding
effect” language in the Template Letters to ensure parties remain
subject to the applicable provisions.59 If the Commission determines
to adopt the amendment requirement, FIA requested that the time period
be extended from 60 to 120 days because a change in name often occurs
in the context of a merger or acquisition in which case the relevant
party will be in the process of amending numerous agreements and
related documentation.
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58 FIA CL-00003 at page 2.
59 FIA suggests, for example, the following language: “The
terms of this letter shall remain binding upon the parties, their
successors and assigns, including for the avoidance of doubt,
regardless of the change in name of any party.” FIA CL-00003 at
page 2.
—————————————————————————
The Commission has determined to add to the Template Letter the
“binding effect” language as proposed by FIA, as this language will
ensure the continued applicability of the Acknowledgment Letter in the
event of a name change to the parties. The Commission, however, is
proposing to require that FCMs and DCOs file new Acknowledgment Letters
in the event of a name, address, or other change as specified in the
proposed rule because the Commission believes it is important to
maintain current and accurate Acknowledgment Letters to provide clear
legal status of the customer account, which will better protect
customers in the event of a dispute regarding the legal status of the
account. The Commission is proposing a 120-day time period for an FCM
to obtain new Acknowledgment Letters. Given the use of the Template
Letter, which is not open to negotiation, and electronic filing, the
Commission believes that 120 days is a sufficient period of time for
FCMs and DCOs to obtain and file the new Acknowledgment Letters.
2. Technical Amendments to Acknowledgment Letter for Omnibus Accounts;
Abbreviation of Account Names
Regulation 1.20 provides that customer funds, when deposited with a
depository, “shall be deposited under an account name that clearly
identifies them as such and shows that they are segregated as required
by the Act and [Part 1 of the CFTC Regulations].” FIA noted that the
account naming convention used in the proposed forms of Template
Letters 60 may present certain issues with respect to Acknowledgment
Letters obtained by FCMs maintaining customer funds with
[[Page 67884]]
another FCM through a customer omnibus account relationship.61 The
first issue is with respect to operational limits on the number of
characters available for account names. Secondly, naming conventions
for such accounts typically include the words “Customer Omnibus
Account” and the relevant account number. FIA accordingly requested
the Commission to clarify that the Template Letters may be modified to
permit the use of the words “CFTC Regulated FCM Customer Omnibus
Account” to describe such accounts.
—————————————————————————
60 Proposed Appendix A to Regulation 1.20 provides that the
Account will be entitled “[Name of Futures Commission Merchant or
Derivatives Clearing Organization] CFTC Regulation 1.20 Customer
Segregated Account.” 75 FR 47738, 47743 (Aug. 9, 2010); Proposed
Appendix A to Regulation 1.26 provides that the Account will be
entitled “[Name of Futures Commission Merchant or Derivatives
Clearing Organization] CFTC Regulation 1.26 Customer Segregated
Money Market Mutual Fund Account.” 75 FR 47738, 47744 (Aug. 9,
2010); and Proposed Appendix E to part 30 provides that the Account
will be entitled “[Name of Futures Commission Merchant] CFTC
Regulation 30.7 Customer Secured Account.” 75 FR 47738, 47745 (Aug.
9, 2010).
61 FIA CL-00003 at 4 and 5.
—————————————————————————
The Commission has modified the proposed Template Letters to
provide an option to add the words “CFTC Regulated FCM Customer
Omnibus Account” to describe such accounts when applicable. In
addition, the Commission is proposing that if the name of the account
as set forth in the Template Letter is too long for a depository’s
system to include all characters, the depository may abbreviate the
name in order to accommodate its system, provided that (i) it remains
clear that the account is a CFTC regulated segregated/secured account
held for the benefit of customers (e.g., “segregated” may be
shortened to “seg;” “customer” may be shortened to “cust;”
“account” to “acct;” etc.), and (ii) when completing an
Acknowledgment Letter, such letter must include both the long and short
versions of the account name.
3. Clarification Regarding Notice, Authentication, and Instruction
Protocol for Commission Authorized Withdrawals
Four of the commenters to the Revised Proposal addressed the need
for the Commission to establish specific standards with respect to the
notice, authentication and instruction protocol regarding Commission
instructions for the immediate release of funds from a Customer
Account.62
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62 In the Revised Proposal, the Template Letter provides that
“the Funds in the Account(s) shall be released immediately, * * *
upon proper notice and instruction from an appropriate officer or
employee * * * of the CFTC. [FCM/DCO] will not hold [depository]
responsible for acting pursuant to any instruction from the CFTC
upon which [depository] has relied after having taken reasonable
measures to assure that such instruction was provided to
[depository] by a duly authorized officer or employee of the CFTC.”
—————————————————————————
The FRB Chicago pointed out that, as the Acknowledgment Letters
will have been filed electronically with the Commission, the Commission
will know all of the Depositories that have signed such letters, their
location, and basic contact information. In light of this, the FRB
Chicago suggests that the Commission could establish for each
depository a basic but unique authentication identifier. The Commission
believes this suggestion has merit, and it will consider implementing
this type of data collection and identification as it works to
implement the operational aspects of the electronic filing of
Acknowledgment Letters.
JP Morgan suggests that the Acknowledgment Letter include a notice
provision with contact information for the depository so that the
Commission has information on how best to contact the depository. The
Commission agrees with this suggestion and has revised the Template
Letters to indicate where depository contact information may be
inserted as optional information. The Commission recognizes that such
information may be subject to frequent change and, therefore, at this
time, the Commission is not requiring that an amended Acknowledgment
Letter be filed in the event there are changes to such contact
information.
Katten asserts that Depositories face legal uncertainty with
respect to their release of customer funds in reliance on instructions
from the Commission. Katten states that the Commission’s reluctance to
define “proper notice” or “reasonable measures” imposes on
Depositories the conflicting obligations (i) to the Commission, to
release customer funds “immediately upon proper notice,” and (ii) to
its customer FCM, to take “reasonable measures” first to assure that
such notice was “duly authorized.”
With respect to due authorization, Katten requests that the
Commission reconsider its decision to permit an instruction to transfer
customer funds to be made orally, with written confirmation to follow.
Katten believes that the depository’s obligation to take “reasonable
measures” may require it to await written confirmation in any event.
In addition, Katten believes that the proposed amendments to Sec. Sec.
1.20, 1.26, 30.7 and 140.91 do not limit the identity of the Commission
officers and employees that may issue a notice to a depository or the
process that must be followed before such a notice is issued. Katten
submits that a depository would have a reasonable basis to conclude
that an instruction to transfer customer funds was duly authorized if
the depository could be assured that any instruction to transfer
customer funds would be issued only by the Director of the Division of
Clearing and Intermediary Oversight (or the Director’s designee).63
Katten recommends that “the Commission revise the proposed rules to
confirm that any such instruction may be made only by the Commission or
by the director of DCIO (or the director’s designee) acting with the
concurrence of the General Counsel (or Deputy General Counsel).” 64
FIA requests, at a minimum, that the Commission define and limit the
term “appropriate officer or employee” of the Commission (for
example, authorization limited to Division Directors or other senior
designated personnel such as Deputy Directors or Associate
Directors).65
—————————————————————————
63 In October 2011, the Commission reorganized the Division of
Clearing and Intermediary Oversight into two divisions, the Division
of Clearing and Risk and the Division of Swap Dealer and
Intermediary Oversight. With respect to a transfer of customer funds
as contemplated in this rulemaking, instructions would come from
either the Director of the Director of the Division of Clearing and
Risk or the Director of the Division of Swap Dealer and Intermediary
Oversight (or one of the Director’s designees).
64 See Katten CL-00005 at FN 3.
65 FIA CL-00003 at page 3.
—————————————————————————
With respect to a “duly authorized officer or employee of the
CFTC,” the Commission has determined to provide that any such
instruction to transfer customer funds may be made by the Director of
the Division of Clearing and Risk (or the Director’s designee), or by
the Director of the Division of Swap Dealer and Intermediary Oversight
(or the Director’s designee). Accordingly, the Template Letter now
specifies that such instructions may only be given by the Director of
the Division of Clearing and Risk (or any successor division), the
Director of the Division of Swap Dealer and Intermediary Oversight (or
any successor division), or the designees of such Directors under
delegated authority.66 With regard to the role of the General
Counsel, the General Counsel will be consulted by the Director of the
Division of Clearing and Risk (or any successor division), the Director
of the Division of Swap Dealer and Intermediary Oversight (or any
successor division), or the designees of such Directors prior to the
exercise of the delegated authority.
—————————————————————————
66 The Commission will publish on its Web site the identity of
the Director of the Division of Clearing and Risk, the Director of
the Division of Swap Dealer and Intermediary Oversight, and the
individual(s) who are authorized to serve as their designees. The
Template Letters do not explicitly refer to instructions provided by
“the Commission” because in exigent circumstances, it is not
likely that action approved by a majority of Commissioners will be
feasible.
—————————————————————————
The Commission does not believe, as asserted by Katten, that
“reasonable measures” may require the depository to await written
confirmation. For example, due to the nature of the
[[Page 67885]]
exceptional circumstances that would prompt a call from the Commission,
it is likely that the depository would already be aware of certain
problems facing the FCM or DCO and would not be surprised to receive a
phone call from a Division Director (or his or her designee). In
addition, while the Commission believes it is desirable that any such
instruction to release customer funds be in writing, or, if oral, to be
confirmed in writing, the Commission is not limiting the manner of
notice in the Template Letter given the potential exigencies of the
situation and the need for flexibility in communication. For example,
either the Commission or the depository could be experiencing
unexpected technical problems in its respective email servers or
facsimile machines. It is critical that the transfer of customer funds
from a Segregated Account not be delayed as a result of technical or
other operational issues.
With respect to the release of customer funds “immediately upon
proper notice,” Katten commented that it appreciates the Commission’s
recognition of the potential practical obstacles to immediate release
(e.g., Fedwire is unavailable). However, Katten remains concerned that,
in the absence of further guidance or clarification, the use of the
term “immediately” may subject a depository to potential claims by
either FCMs or the Commission in the event that there is a delay in the
transfer of customer funds, even if such delay is the result of
reasonable actions on the part of the depository or events beyond the
control of the depository. In addition, FIA commented that it would
like the Commission to confirm that its authority to require the
transfer of customer funds would be expected to be used sparingly
(i.e., “only in exceptional circumstances”).
After considering these comments, the Commission is proposing to
retain the use of the word “immediately” in the Template Letter
regarding instructions to a depository for release of customer funds.
First, in response to FIA’s comment, the Commission clarifies that the
use of its authority to require the immediate release of customer funds
would be in exceptional circumstances. As stated in the Revised
Proposal, “[t]he Commission would issue such an instruction only when,
in the judgment of the Commission, it is necessary to do so for the
protection of customer funds. For example, the prospective insolvency
of the FCM could prompt an instruction from the Commission to release
the customer funds.” 67 Next, the Commission notes that anything
less than the term “immediate” could leave the timing open to
interpretation, which could cause delays in the transfer of funds and
have a potential impact on safety and soundness of customer funds and
positions. In this regard, the Commission notes that customer funds in
the Segregated Account have always been subject to withdrawal
immediately upon demand by the FCM.68
—————————————————————————
67 75 FR 47738, 47740. The Revised Proposal also noted that,
as set forth in the Template Letter, in the event the FCM becomes
subject to a voluntary or involuntary petition for relief under the
U.S. Bankruptcy Code, the depository will have no obligation to
release the customer funds except upon instruction from the
bankruptcy trustee or pursuant to a court order. Id.
68 See Amended Financial and Segregation Interpretation No.
10, 70 FR 24768 (May 11, 2005) (“Thus any impediments or
restrictions on the FCM’s ability to obtain immediate and unfettered
access to customer funds are not permitted. The immediate and
unfettered access requirements is [sic] intended to prevent
potential delay or interruption in securing required margin payments
that, in times of significant market disruption, could magnify the
impact of such market disruption and impair the liquidity of other
FCMs and clearinghouses.”)
—————————————————————————
4. Limiting the “Merger” Clause in the Acknowledgment Letter
CME believes that the use of an integration clause (i.e., the
statement that the Acknowledgment Letter “constitutes the entire
understanding of the parties with respect to its subject matter”) in
the Template Letters is inappropriate and could have a number of
serious and unintended consequences. For example, the parties to the
Acknowledgment Letter could be prevented from relying upon and
enforcing terms of applicable account (or similar) agreements that do
not conflict with the Acknowledgment Letter. CME believes the term
“subject matter” is ambiguous and could be interpreted very broadly
thereby casting doubt on the validity and interpretation of existing
agreements between the parties. The CME suggests the following more
narrowly tailored language for the integration clause in the Template
Letters: “This letter agreement supersedes and replaces any prior
agreement between the parties in connection with the Account(s),
including but not limited to any prior Acknowledgment Letter, to the
extent that such prior agreement is inconsistent with the terms
hereof.”
FIA agrees with the CME’s comment that the scope of the “merger
clause” in the Template Letters should be narrowed to make clear that
these clauses do not invalidate the terms of other agreements that may
have been entered into by the parties and that do not conflict with the
Template Letters. The FRB Chicago also believes that this provision
should be narrowed so that a bank’s standard account opening
agreements, corporate resolutions and other agreements incorporated by
reference should govern the remainder of the account relationship, but
not matters specific to section 4d of the Act. Should there be a
conflict, the Acknowledgment Letter should govern matters specific to
section 4d of the Act.
The Commission agrees with the commenters that the scope of the
“merger clause” language in the Template Letter 69 should be
narrowed. Accordingly, the Commission is replacing the clause with
CME’s suggested language above. In addition, in order to incorporate
the comment of the FRB Chicago and to ensure that future agreements
between the parties do not negate the Acknowledgment Letter, the
Commission is adding the following sentence to the end of the new
language: “In the event of any conflict between this letter agreement
and any other agreement between the parties in connection with the
Account(s), this letter agreement shall govern with respect to matters
specific to section 4d of the Act and the CFTC’s regulations, as
amended.”
—————————————————————————
69 The merger clause language in the Revised Proposal’s
Template Letter reads as follows: “This letter agreement
constitutes the entire understanding of the parties with respect to
its subject matter and supersedes and replaces all prior writings,
including any applicable agreement between the parties in connection
with the Account(s), with respect thereto.”
—————————————————————————
5. New Proposed Amendments to Acknowledgment Letters
The Commission is also now proposing under Appendix A to Sec. 1.26
and Appendix F to Sec. 30.7 an additional acknowledgment letter
template form for money market mutual funds (to the extent they are
permissible investments under Sec. 1.25). The template form for money
market mutual funds is substantially the same as the Acknowledgment
Letters. The Commission requests comment on all aspects of the template
form.
In addition, the Commission is proposing to add language to its
proposed Acknowledgment Letters (under Sec. 1.20, Sec. 1.26 and Sec.
30.7) authorizing and requiring the depository to grant–at all times–
read-only electronic access to such accounts to the Commission and, in
the case of an FCM, to the FCM’s DSRO. Given recent events, the
Commission believes such access is crucial to the protection of
customer funds. The Commission is also proposing a substantive
requirement for
[[Page 67886]]
this access in Sec. Sec. 1.20, 1.26 and 30.7 in addition to the
language in the Acknowledgment Letters.
The proposal for read-only access is not intended to require a
depository to have the ability to provide the Commission or an FCM’s
DSRO with real-time information regarding an FCM’s account balance. The
Commission understands that depositories may not have the capability to
provide customers or any other party with real-time account balances
and position information. The conditions of the proposal would be
satisfied if the depository had the capability to provide read-only
access to account information as of the close of the prior business
day.
The Commission intends to continue to explore possible uses of
technology to enhance its ability to protect customer funds. Read-only
access will allow Commission staff to review an FCM’s segregated
account balances reported by depositories and to compare those balances
to the FCM’s reported account balances either as part of a review of
the firm, or in circumstances where the Commission is concerned about
the financial condition of the firm. The read-only access is an
additional tool that Commission staff may use as part of its assessment
of the financial condition of an FCM and the safety of customer funds.
The Commission will continue to review how direct access to account
balances and the use of technology can provide greater assurance as to
the safety of customer funds held by an FCM.
The Commission requests comment on all aspects of the proposed
amendments to Sec. 1.20. Specifically, the Commission requests comment
on the following:
The proposal requires each depository to provide the
Commission and an FCM’s DSRO with direct, read-only access to the FCM’s
accounts held by the depository. What technology issues are raised by
the Commission’s proposal? How can the Commission adequately address
such technology issues?
What account information can depositories currently
provide to the Commission and to DSROs via the internet on a read-only
basis? Do all depositories (e.g., banks, trust companies, derivatives
clearing organizations, or other FCMs) have the capability of using the
Internet to provide account access to the Commission and DSROs? Are
there other options for depositories to provide read-only access to FCM
accounts other than the internet?
How should the Commission implement this requirement? What
timeframe would be appropriate to make the requirement effective?
Please provide analysis with your comment.
H. Proposed Amendments to Sec. 1.22: Use of Futures Customer Funds
The Commission proposes to amend Sec. 1.22 by clarifying that the
prohibition on the FCM’s use of one futures customer’s funds to margin
or secure the positions of another futures customer, or to extend
credit to another person, applies at all times.
Regulation 1.22 provides that an FCM may not use the cash,
securities or other property deposited by one futures customer to
purchase, margin or settle the trades, contracts, or other positions of
another futures customer, or to extend credit to any other person.
Regulation 1.22 further provides that an FCM may not use the funds
deposited by a futures customer to carry trades or positions, unless
the trades or positions are traded through a designated contract
market.
The proposed amendment to clarify that the prohibition on the FCM’s
use of one futures customer’s funds to margin positions of another
futures customer is intended to remove any question as to the
permissibility of being undersegregated at any point in time during the
day. Section 4d(a)(2) requires an FCM to segregate futures customers’
funds from its own funds, and prohibits an FCM from using the funds of
one customer to margin or extend credit to any other futures customer
or person. The Commission believes that section 4d(a)(2) is intended to
provide a maximum level of protection to futures customer funds, which
would be thwarted and inconsistent with the reading of the Act if an
FCM only recognized this principle at the end of the trading day.
Further, the Commission is proposing language providing a clear
mechanism to ensure compliance with this prohibition, which is to
require an FCM to maintain residual interest in segregated accounts in
an amount which exceeds the sum of all margin deficits for futures
customers. The Commission also is proposing that the sum of all margin
deficits be reported on the Segregation Schedule (as discussed
previously with respect to proposed amendments to Sec. 1.10) and also
required to be reported on the daily segregation calculation (as
discussed further herein with respect to proposed amendments to Sec.
1.32), so that compliance review of this mechanism can be performed.
I. Proposed Amendments to Sec. 1.23: Interest of Futures Commission
Merchant in Segregated Futures Customer Funds; Additions and
Withdrawals
The Commission is proposing to amend Sec. 1.23 to require
additional safeguards with respect to an FCM withdrawing futures
customer funds from segregated accounts that are part of the FCM’s
residual interest in such accounts.
Regulation 1.23 provides that an FCM may deposit unencumbered
proprietary funds, including securities that qualify as permitted
investments under Sec. 1.25, into segregated futures customer accounts
in order to ensure that the firm always maintains sufficient funds in
such accounts to meet its total obligations to futures customers. FCMs,
by virtue of practical necessity, must keep proprietary funds in
segregated futures customer accounts in order to act as a buffer
between futures customers whose funds are commingled in such accounts.
In the event that any futures customer were to experience losses such
that the customer has insufficient funds to meet the margin
requirements at clearing organizations associated with its positions,
or if all of the funds deposited by the futures customer were depleted
and the account had a debit balance, without proprietary funds of the
FCMs being held in such accounts to absorb the debit balance as it
accrued, funds of other futures customers would be used to guarantee
the undermargined amount or the debit. For this reason, FCMs are
permitted to deposit their own funds into segregated accounts and to
maintain a residual financial interest in such accounts. Regulation
1.23 further provides that an FCM’s books and records must always
reflect the firm’s residual interest in the accounts of its futures
customers.
In addition, an FCM is permitted to withdraw funds from futures
customer accounts for the FCM’s proprietary use to the extent of the
FCM’s actual residual interest in such accounts. The withdrawal,
however, may not result in the FCM failing to hold sufficient funds to
meet its obligations to its futures customers, or in the funds of one
futures customer margining or securing the positions of another futures
customer. The Commission also is proposing that the residual amount
maintained by an FCM be required to exceed the sum of margin deficits
for futures customers, as discussed previously with respect to
Sec. Sec. 1.20 and 1.22, to provide a clear mechanism to ensure that
the funds of one futures customer are not used to margin or guarantee
the positions of
[[Page 67887]]
another futures customer. Irrespective of the procedures permitting
withdrawals of residual interest under the amendments proposed, the
proposed amendments further make clear that no withdrawals may be made
of residual interest to the extent of the sum of margin deficits.
If an FCM does not have adequate internal controls governing the
calculation and withdrawal of its residual interest from futures
customer accounts, the FCM’s actions may actually result in the
withdrawal of futures customer funds and not the FCM’s residual
interest. Such a withdrawal would be a violation of section 4d(a)(2) of
the Act.
The Commission, therefore, is proposing to amend Sec. 1.23 to
include additional safeguards applicable to an FCM’s withdrawal of
funds from the accounts of futures customers that are part of the FCM’s
residual interest in such accounts. Under proposed Sec. 1.23(a), an
FCM will still have access to its own funds deposited into futures
customer accounts to the extent of the FCM’s residual interest therein,
subject to the restriction on withdrawal of residual interest equal to
the sum of margin deficits. However, proposed Sec. 1.23(b) will
prohibit an FCM from withdrawing any of its residual interest or excess
funds from futures customer accounts (any withdrawal not made for the
benefit of futures customers would be considered a withdrawal of the
FCM’s residual interest) on any given business day unless the FCM had
completed the daily calculation of funds in segregation pursuant to
Sec. 1.32 as of the close of the previous business day, and the
calculation showed that the FCM maintained excess segregated funds in
the futures customer accounts as of the close of business on the
previous business day. Proposed Sec. 1.23(b) further requires that the
FCM adjust the excess segregated funds reported on the daily
segregation calculation to reflect other factors, such as overnight and
current day market activity and the extent of current customer
undermargined or debit balances, to develop a reasonable basis to
estimate the amount of excess funds that remain on deposit since the
close of business on the previous day prior to initiating a withdrawal.
The Commission also is proposing several additional required layers
of authorization and documentation if the withdrawal exceeds,
individually or in the aggregate with other such withdrawals, 25
percent of the FCM’s residual interest. Proposed Sec. 1.23(c)
prohibits an FCM from withdrawing more than 25 percent of its residual
interest in futures customer accounts unless the FCM’s CEO, CFO, or
other senior official that is listed as a principal on the firm’s Form
7-R registration statement and is knowledgeable about the FCM’s
financial requirements (“Financial Principal”) pre-approves the
withdrawal in writing.
Regulation 1.23(c) will further require the FCM to immediately file
a written notice with the Commission and with the firm’s DSRO of any
withdrawal that exceeds 25 percent of its residual interest. The
written notice must be signed by the CEO, CFO, or Financial Principal
that pre-approved the withdrawal, specifying the amount of the
withdrawal, its purpose, its recipient(s), and contain an estimate of
the residual interest after the withdrawal. The written notice also
must contain a representation from the person that pre-approved the
withdrawal that to such person’s knowledge and reasonable belief, the
FCM remains in compliance with its segregation obligations. The
proposal further requires that the official in making this
representation specifically consider any other factors that may cause a
material change in the FCM’s residual interest since the close of
business on the previous business day, including known unsecured
futures customer debits or deficits, current day market activity, and
any other withdrawals. The written notice would be required to be filed
with the Commission and with the FCM’s DSRO electronically.
Proposed Sec. 1.23(d) requires an FCM that has withdrawn funds
from segregated futures customer accounts for its own purposes, and
such withdrawal causes the firm to fall below its targeted residual
interest in such accounts, to deposit proprietary funds into the
accounts to restore the residual interest balance to the targeted
amount. The FCM must deposit the proprietary funds into the segregated
account prior to the close of the next business day. Alternatively, the
FCM may revise its targeted residual interest amount, if appropriate,
in accordance with its written policies and procedures for
establishing, documenting, and maintaining its target residual
interest, in accordance with the requirements of proposed Sec. 1.11.
Should an FCM’s residual interest, however, be exceeded by the sum of
the FCM’s futures customers’ margin deficits, an amount necessary to
restore residual interest to that sum must be deposited immediately.
The Commission’s proposal is consistent in most respects with NFA’s
recent rule amendments that require FCMs to maintain written policies
and procedures regarding the withdrawal of proprietary funds from
futures customers’ segregated accounts discussed in Section I.D above.
The proposal will continue to provide FCMs with flexibility to access
the residual interest in segregated funds, but with the responsibility
to ensure that any withdrawals of residual interest are, in fact, the
firm’s own funds. This responsibility exists currently by virtue of the
language of section 4d(a)(2) of the Act and Sec. 1.23, however the
processes necessary to ensure that the responsibility was carried out
were not specified by regulation.
By providing a prohibition on withdrawals until the segregation
calculation is performed by the FCM and submitted to the Commission and
to the DSRO, and further requiring written approvals by the FCM’s
senior officials prior to any withdrawals in excess of 25 percent of
the prior day’s residual interest with notice to the Commission and a
DSRO, any withdrawal of funds in excess of the residual interest will
be clear violations of proposed Sec. 1.23, and the responsibility for
such violations will be clear from written pre-approvals made by the
CEO, CFO or Financial Principal, or the lack thereof.
J. Proposed Amendments to Sec. 1.25: Investment of Customer Funds
The Commission is proposing to amend Sec. 1.25(b)(3)(v) to provide
that the 25-percent counterparty concentration limit for reverse
repurchase agreements applies not only to a single counterparty, but to
all counterparties under common control or ownership. The Commission
also is proposing to delete paragraph (b)(6) of Sec. 1.25 because the
information that an FCM is required to record and maintain under
paragraph (b)(6) is currently required by Sec. 1.27. Further, the
Commission is proposing to amend Sec. 1.25(d) to clarify the
conditions under which an FCM may deposit firm-owned securities into
segregation.
Regulation 1.25 sets forth the financial investments that an FCM or
DCO may make with customer funds. As one of the permitted investments,
FCMs and DCOs may use customer funds to purchase securities from a
counterparty under an agreement for the resale of the securities back
to the counterparty (“reverse repurchase agreements”). Regulation
1.25 places conditions on such repurchase or reverse repurchase
agreements, including limiting permitted counterparties to certain
banks and government securities brokers or dealers, and prohibiting an
FCM or DCO from entering into such
[[Page 67888]]
agreements with affiliate. Regulation 1.25(b)(3)(v) also imposes a
counterparty concentration limit on reverse repurchase agreements that
prohibits an FCM or DCO from purchasing securities from a single
counterparty that exceeds 25 percent of the total assets held in
segregation by the FCM or DCO.
Under the proposed amendment to Sec. 1.25(b)(3)(v), an FCM or DCO
must aggregate the value of the securities purchased from two or more
different counterparties under repurchase agreements if the
counterparties are under common control or ownership. The aggregate
value of the securities purchased under the repurchase agreements from
the counterparties must not exceed 25 percent of the total assets held
in segregation by the FCM or DCO. The Commission believes that
expanding the concentration limitation to counterparties under common
control or ownership is consistent with the original intention of the
concentration limitation, which was to minimize the potential losses or
disruptions due to the default of a counterparty. If the counterparties
are under common control or ownership, a default by one counterparty
may adversely impact all of the counterparties.
The Commission also is proposing to amend Sec. 1.25 by deleting
paragraph (b)(6), which requires an FCM or DCO to prepare a record, on
a daily basis, detailing the type of instruments in which customer
funds were invested, the original costs of the investments, and the
current market value of the investments. As noted above, the
information that an FCM is required to record and maintain under
paragraph (b)(6) is currently required by Sec. 1.27.
Finally, the Commission is proposing to amend Sec. 1.25(d)(7) to
recognize that a DCO designated as systemically important (“SIDCO”)
by the Financial Stability Oversight Council may keep securities
transferred to the SIDCO under a repurchase or reverse repurchase
agreement in a safekeeping account with a Federal Reserve Bank, as
authorized by section 806 of the Dodd-Frank Act.
K. Proposed Amendments to Sec. 1.26: Deposit of Obligations Purchased
With Futures Customer Funds
As discussed above, the Commission has previously proposed to amend
Sec. 1.26 along with Sec. 1.20 to require a template form of
Acknowledgment Letter–in addition to other substantive requirements
and obtaining and filing such Acknowledgment Letters–with respect to
the deposit of instruments purchased with customer funds, including
money market mutual funds. As discussed earlier with respect to Sec.
1.20, the Commission received and analyzed comments on those proposals.
As noted above, the Commission is herein proposing changes to the
template Acknowledgment Letter set forth in Appendix A to Sec. 1.26
for money market mutual funds, which incorporate revisions based on the
Commission’s analysis of prior comments, and is proposing new additions
to such template. The Commission is also proposing new substantive
requirements applicable to obtaining and filing such written
Acknowledgment Letters. A new substantive requirement under Sec. 1.26,
as proposed to be amended and included in the template form, is a
requirement that depositories provide the Commission and, and in the
case of an FCM, the FCM’s DSRO–at all times–with read-only electronic
access to all FCM and DCO accounts holding customer funds.
L. Proposed Amendments to Sec. 1.29: Increment or Interest Resulting
From Investment of Customer Funds
The Commission is proposing to amend Sec. 1.29 to explicitly
provide that an FCM bears sole responsibility for any losses resulting
from the investment of customer funds in financial instruments
permitted under Sec. 1.25.
Regulation 1.29 provides that an FCM is not prohibited from keeping
as its own any interest or other gain resulting from the investment of
customer funds in financial instruments permitted under Sec. 1.25.
Regulation 1.25 also provides that an FCM must manage the permitted
investments consistent with the objectives of preserving principal and
maintaining liquidity.
The proposed amendment clarifies that an FCM is solely responsible
for any losses that result from the investment of customer funds in the
financial instruments listed under Sec. 1.25. An FCM may not charge or
otherwise allocate any such losses to the accounts of the FCM’s
customers. To allocate losses on the investment of customer funds would
result in the use of customer funds in a manner that is not consistent
with section 4d(a)(2) and Sec. 1.20, which provides that customer fund
can only be used for the benefit of futures customers and limits
withdrawals from futures customer accounts, other than for the purpose
of engaging in trading, to certain commissions, brokerage, interest,
taxes, storage or other fees or charges lawfully accruing in connection
with futures trading.
The Commission requests comment on the proposed amendment to
explicitly provide that losses resulting from the investment of
customer funds may not be allocated by an FCM to customers. The
Commission also requests comment on how any losses associated with bank
deposits should be addressed. The Commodity Exchange Authority issued
an Administrative Determination (“AD”) in 1971 that provides that an
FCM may not be liable for losses resulting from the deposit of customer
funds with a bank that subsequently closes or is unable to repay the
FCM’s deposit.70 The AD provides that an FCM would not be liable if
it had used due care in selecting the bank, had not otherwise breached
its fiduciary responsibilities toward the customers, and had fully
complied with the requirements of the Act and the Commission
regulations relating to the handling of customers’ funds. The
Commission requests comment on whether the regulations should be
revised to impose an obligation on an FCM to repay customer funds in
the event of a default by a bank holding customer funds. Should there
be a distinction drawn between U.S.-domiciled and regulated banks and
non-U.S.-domiciled banks?
—————————————————————————
70 Liability of Futures Commission Merchants and Clearing
Associations, Administrative Determination No. 230 (Nov. 23, 1971).
—————————————————————————
M. Proposed Amendments to Sec. 1.30: Loans by Futures Commission
Merchants: Treatment of Proceeds
The Commission is proposing to amend Sec. 1.30 to provide that an
FCM may not loan funds to finance a customer’s trading account on an
unsecured basis, or accept as collateral for the loan the customer’s
trading account.
Regulation 1.30 provides that Commission regulations do not prevent
an FCM from lending its own funds to a customer that has pledged
securities and property, or from repledging or selling the customer’s
securities or property pursuant to specific written agreement of the
customer. This provision generally allows customers to deposit non-cash
collateral as initial and variation margin. Absent the provisions in
Sec. 1.30, an FCM may be required to liquidate the non-cash collateral
if the customer was subject to an initial or variation margin call.
The Commission is proposing to amend Sec. 1.30 to prohibit an FCM
from loaning funds to finance a customer’s trading account on an
unsecured basis, or from accepting a customer’s trading account as
collateral for the loan. The Commission believes that extending
unsecured loans to customers is not a
[[Page 67889]]
common occurrence as the current capital requirements in Sec. 1.17
would require the FCM to take a 100 percent capital charge on the
unsecured receivables from the customers associated with such loans.
Commission staff has, however, had to provide its views on whether a
customer trading account may be used to collateralize a loan from the
FCM.
A trading account does not qualify as readily marketable securities
that are generally required to collateralize a loan for the FCM to
avoid the 100 percent unsecured receivable capital charge.71 Rules of
the CME also prohibit an FCM from providing unsecured financing to a
customer for margin purposes.72 The Commission is proposing to
explicitly prohibit unsecured lending by FCMs to customers in the
proposed amendments in Sec. 1.30. Should customers have liquidity
needs sufficient to require unsecured lending, the Commission believes
it to be prudent to require that such unsecured lending be done by a
party other than the FCM carrying the customer account. This newly
proposed prohibition comports with the Commission’s existing regulatory
requirement contained in Sec. 1.56 that provides that no FCM may
represent that it will not call for or attempt to collect initial and
maintenance margin as established by the rules of the applicable board
of trade.
—————————————————————————
71 Regulation 1.17(c)(3).
72 CME Rule 930.G.–Loans to Account Holders–provides that
clearing members may not make loans to account holders to satisfy
their performance bond requirements unless such loans are secured by
readily marketable collateral that is otherwise unencumbered and
which can be readily converted into cash.
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N. Proposed Amendments to Sec. 1.32: Segregated Account: Daily
Computation and Record
The Commission is proposing to amend Sec. 1.32 to require
additional safeguards with respect to futures customer funds on deposit
in segregated accounts, and to require FCMs to provide twice each month
a detailed listing to the Commission of depositories holding customer
funds.
Regulation 1.32 requires an FCM to prepare a daily record as of the
close of business each day detailing the amount of funds the firm holds
in segregated accounts for futures customers trading on designated
contract markets, the amount of the firm’s total obligation to such
customers computed under the Net Liquidating Equity Method, and the
amount of the FCM’s residual interest in the futures customer
segregated accounts. In addition, the daily record must detail the sum
of the futures customers’ margin deficits, to ensure that residual
interest equals or exceeds such sum. In performing the calculation, an
FCM is permitted to offset any futures customer’s debit balance by the
market value (less haircuts) of any readily marketable securities
deposited by the particular customer with the debit balance as margin
for the account. The amount of the securities haircuts are as set forth
in SEC Rule 15c3-1(c)(vi).
FCMs are required to perform the segregation calculation prior to
noon on the next business day, and to retain a record of the
calculation in accordance with Sec. 1.31. Both the CME and NFA require
their respective member FCMs to file the segregation calculations with
the CME and NFA, as appropriate, each business day. FCMs, however, are
only required to file a segregation calculation with the Commission at
month end as part of the Form 1-FR-FCM (or FOCUS Reports for dual-
registrant FCM/BDs). Regulation 1.12, as discussed in Section II.C
above, requires the FCM to provide immediate notice to the Commission
and to the firm’s DSRO if the FCM is undersegregated at any time.
The Commission is proposing to amend Sec. 1.32 to require each FCM
to file its segregation calculation with the Commission and with its
DSRO each business day. The Commission also is proposing to amend Sec.
1.32 to require FCMs to use the Segregation Schedule contained in the
Form 1-FR-FCM (or FOCUS Report for dual-registrant FCM/BDs) to document
its daily segregation calculation.
As noted above, the CME and NFA require their respective member
FCMs to file their segregation calculations with them on a daily basis.
The CME and NFA also require the FCMs to document their segregation
calculation using the Segregation Schedule contained in the Form 1-FR-
FCM. Therefore, the additional requirement of filing a Segregation
Schedule with the Commission is not a material change to the
regulation.73
—————————————————————————
73 In fact, since FCMs file the Segregation Schedules with the
CME and NFA via WinJammer, the Commission already has access to the
filings, and the amendment will not require an FCM to change any of
its operating procedures.
—————————————————————————
The Commission believes that the filing of a Segregation Schedule
by each FCM each day will significantly enhance its ability to monitor
and protect customer funds. Commission staff will be able to determine
almost immediately upon receipt of the Segregation Schedule whether a
firm is undersegregated and immediately take steps to determine if the
firm is experiencing financial difficulty or if customer funds are at
risk.74 Commission staff also can coordinate the review of the daily
segregation computations with the additional bank and other depository
information that it will have access to under proposed Sec. 1.23.
—————————————————————————
74 Each Form 1-FR-FCM and FOCUS Report is received by the
Commission via WinJammer. The financial forms are automatically
electronically reviewed within several minutes of being received by
the Commission and if a firm is undersegregated an alert is
immediately issued to Commission staff members via an email notice.
—————————————————————————
In addition, the use of the Segregation Schedule provides a uniform
way for each FCM to present its information to the Commission, in a
format that both the Commission and FCMs are familiar with that will
reduce significantly the possibility of a miscommunication regarding
the information that is reported. The standardized Segregation Schedule
will also facilitate the Commission’s ability to compare one FCM to
another, and to perform additional trend and other analysis to identify
potential issues with the holding of customer funds. The filing of
daily segregation records also will allow staff to monitor significant
movements in the balances of segregated funds on a day-to-day basis.
Proposed Sec. 1.32(d) provides that the Segregation Statement must
be filed with the Commission and with the FCM’s DSRO electronically
using a form of user authentication assigned in accordance with
procedures established or approved by the Commission. The Commission is
not proposing to change the timeframe for the preparation of the
Segregation Statements. The Segregation Statement must be filed by noon
(based upon the location of the FCM) the next business day.
The Commission also is proposing to amend Sec. 1.32(b) to provide
that in determining the haircuts for commercial paper, convertible debt
instruments, and nonconvertible debt instruments deposited by customers
as margin, the FCM may develop written policies and procedures to
assess the credit risk of the securities as proposed by the SEC and
discussed more fully in Section II.F above. If the FCM’s assessment of
the credit risk is that it is minimal, the FCM may apply haircut
percentages that are lower than the 15 percent default percentage under
SEC Rule 15c3-1(c)(2)(vi).
The Commission is further proposing to amend Sec. 1.32 by
requiring each FCM to file detailed information regarding depositories
and the substance of the investment of customer funds under Sec. 1.25.
Proposed paragraphs (f) and (j) of Sec. 1.32 will require each FCM to
submit
[[Page 67890]]
to the Commission and to the firm’s DSRO a listing of every bank, trust
company, DCO, other FCM, or other depository or custodian holding
customer funds.
The listing must specify separately for each depository the total
amount of cash and Sec. 1.25 permitted investments held by the
depository for the benefit of the FCM’s customers. Specifically, each
FCM must list the total amount of cash, United States government
securities, United States agency obligations, municipal securities,
certificates of deposit, money market mutual funds, commercial paper,
and corporate notes held by each depository, computed at current market
values. The listing also must specify: (1) If any of the depositories
are affiliated with the FCM; (2) if any of the securities are held
pursuant to an agreement to resell the securities to a counterparty
(reverse repurchase agreement) and if so, how much; and (3) the
depositories holding customer-owned securities and the total amount of
customer-owned securities held by each of the depositories. The FCM is
also required to disclose if any of the depositories are affiliated
with the FCM.
Each FCM is required to submit the listing of the detailed
investments to the Commission and to the firm’s DSRO twice each month.
The filings must be made as of the 15th day of each month (or the next
business day, if the 15th day of the month is not a business day) and
the last business day of the month. The filings are due to the
Commission and to the firm’s DSRO by 11:59 p.m. on the next business
day.
Proposed paragraph (k) of Sec. 1.32 will require each FCM to
retain the Segregation Statement prepared each business day and the
detailed investment information, together with all supporting
documentation, in accordance with Sec. 1.31.
The Commission’s proposal is similar to existing SRO practices and
rules. The CME and NFA recently adopted rules requiring member FCMs to
submit detailed information on how they invest customer funds and the
depositories holding customer funds. The information required to be
filed by FCMs with the CME and NFA is consistent with the information
that FCMs are required to file with the Commission and DSROs under the
proposed amendments to Sec. 1.32, with the exception that the current
CME rule does not require member FCMs to submit information regarding
the holding of customer-owned securities. The proposed timeframes for
both preparing and filing both the Segregation Statements and the
detailed investment information are consistent between the SRO rules
and proposed Sec. 1.32.
The Commission also notes that NFA will be publishing information
on its Web site regarding how each FCM invests and holds customer
funds. Commission staff is consulting with NFA and is assessing whether
NFA should be the primary method for the public to obtain information
on how FCMs hold and invest customer funds.
The twice monthly filing of information on the investment of
customer funds will provide the Commission and SROs with more timely
detailed information regarding how FCMs are holding and investing
customer funds, which will allow the Commission and SROs to more
closely monitor customer funds to assess their safety. In this regard,
the reporting of the use of depositories that are affiliated with the
FCM will alert staff to review such relationships more closely to
ensure that transactions are done in an appropriate arms-length manner
and not to the benefit of the affiliated depository. Staff also can
compare reported the reported investment balances with information
maintained directly by the depositories using the on-line access that
the depositories will be required to provide to Commission staff under
Sec. 1.20 discussed above.
The Commission request comment on all aspects of the proposed
amendments to Sec. 1.32. Specifically, the Commission requests
comments on the following:
Should the Commission amend the regulations to require
each FCM to disclose information regarding its investments of customer
funds? If so, what information should be disclosed? What investment
information would be of the most benefit to market participants in
assessing whether to entrust funds to a particular FCM? How would the
investment information be used by market participants?
How frequently should investment information be disclosed?
What format should be used to disclose the information? How should the
information be disclosed? Should the information be posted on the FCM’s
internet web site?
Should NFA act as the primary source for the disclosure of
how FCMs hold and invest customer funds?
O. Proposed Amendments to Sec. 1.52: Self-Regulatory Organization
Adoption and Surveillance of Minimum Financial Requirements
SROs are required by the Act and Commission regulations to monitor
their member FCMs for compliance with the Commission’s and SROs’
minimum financial and related reporting requirements. Specifically, DCM
Core Principle 11 provides, in relevant part, that a board of trade
shall establish and enforce rules providing for the financial integrity
of any member FCM and the protection of customer funds.75 In
addition, section 17 of the Act requires NFA to establish minimum
capital, segregation, and other financial requirements applicable to
its member FCMs, and to audit and to enforce compliance with such
requirements.76
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75 7 U.S.C. 7(d)(11).
76 7 U.S.C. 21(p).
—————————————————————————
The Commission also has established in Sec. 1.52 minimum elements
that each SRO financial surveillance program must contain to satisfy
the statutory objectives of Core Principle 11 and section 17 of the
Act. In this regard, Sec. 1.52 requires, in part, each SRO to adopt
and to submit for Commission approval rules prescribing minimum
financial and related reporting requirements for member FCMs. The rules
of the SRO also must be the same as, or more stringent than, the
Commission’s requirements for financial statement reporting under Sec.
1.10 and minimum net capital under Sec. 1.17.
In addition, the Commission adopted final amendments to Sec. 1.52
on May 10, 2012, to codify previously issued CFTC staff guidance
regarding the minimum elements of an SRO financial surveillance
program.77 The final amendments require an SRO to: (1) Maintain staff
of an adequate size, training, experience, and independence to
effectively implement a supervisory program; (2) maintain a program
that provides for the ongoing surveillance of FCMs through review of
financial statements and regulatory notices; (3) identify firms that
pose a high degree of potential risk, including risk to customer funds;
(4) conduct routine, periodic onsite examinations of FCMs; and (5)
adequately document all aspects of the operation of the supervisory
program, including the conduct of risk-based scope setting and the
risk-based surveillance of high-risk member registrants, and the
imposition of remedial and punitive actions for material violations.
—————————————————————————
77 77 FR 36611 (June 19, 2012).
—————————————————————————
In order to effectively and efficiently allocate SRO resources over
FCMs that are members of more than one SRO, Sec. 1.52(c) currently
permits two or more SROs to enter into an agreement to establish a
joint audit plan for purpose of assigning to one of the SROs (the DSRO)
of the joint audit plan the function of monitoring and examining member
FCMs for compliance with
[[Page 67891]]
certain regulatory and financial reporting obligations. The audit plan
must be submitted to the Commission for approval. The Commission may
approve a joint audit plan, or part of such a plan, after notice and
comment if the Commission determines that the plan: (1) Is necessary or
appropriate to serve the public interest; (2) is for the protection and
in the interest of customers; (3) reduces multiple monitoring and
auditing for compliance with the minimum financial requirements; (4)
reduces multiple reporting of financial information; (5) fosters
cooperation and coordination; and (6) does not hinder the development
of a registered futures association. Currently all active SROs are
members of a joint audit plan that was approved by the Commission on
March 18, 2009.78
—————————————————————————
78 The original signatories of the joint audit plan approved
on March 18, 2009 are as follows: Board of Trade of the City of
Chicago, Inc.; Board of Trade of Kansas City; CBOE Futures Exchange,
LLC; Chicago Climate Futures Exchange, LLC; Chicago Mercantile
Exchange Inc.; Commodity Exchange, Inc; ELX Futures, L.P.;
HedgeStreet, Inc.; ICE Futures U.S., Inc.; INET Futures Exchange,
L.L.C.; Minneapolis Grain Exchange; NASDAQ OMX Futures Exchange;
National Futures Association; New York Mercantile Exchange, Inc.;
NYSE Liffe US, L.L.C.; OneChicago, L.L.C.
—————————————————————————
The Commission is proposing additional amendments to Sec. 1.52 in
light of recent events that highlight a need for strengthening the
minimum requirements that SROs must abide by in conducting financial
surveillance to minimize the chances that FCMs that engage in unlawful
activities that result, or could result, in the loss of customer funds
or the inability of the firms to meet their financial obligations to
market participants, including DCOs, go undetected. The proposed
amendments to Sec. 1.52 revise the current supervisory program
required to be established and implemented by SROs pursuant to existing
Sec. 1.52(b) with respect to their FCM members. In addition, for SROs
that choose to delegate their duties to oversee and examine FCMs that
are members of two or more SROs to a DSRO pursuant to a plan
established under existing Sec. 1.52(c) in lieu of each conducting its
own oversight and examinations of such common FCM members, proposed
Sec. 1.52 provides that the plan adopt certain requirements to assure
the quality of the DSRO oversight and examinations conducted under the
plan, both as to the substance of the oversight and examination program
and the application of such program.
Proposed Sec. 1.52(b) requires each SRO to adopt rules requiring
its member FCMs to establish a risk management program that is at least
as stringent as the risk management program required in proposed Sec.
1.11. Proposed Sec. 1.11 is discussed in Section II.B above, and
requires an FCM to establish a risk management program designed to
monitor and manage risks associated with the activities of the FCM.
Proposed Sec. 1.52 does not make significant changes to the
existing SRO supervisory programs with respect to the oversight and
examination of retail foreign exchange dealer and IB member
registrants. However, with respect to the oversight and examination of
FCMs, proposed Sec. 1.52 requires an SRO to adopt significant new
requirements in its supervisory program. The supervisory program for
FCMs will now explicitly require, among other things, controls testing
as well as substantive testing, and the examination process for each
FCM must be driven by the risk profile of each such FCM. In addition,
the supervisory program must conform to U.S. GAAS after giving full
consideration to those auditing standards as prescribed by the PCAOB.
The supervisory program also must contain written standards addressing
numerous aspects of the examination process over FCMs as provided in
proposed Sec. 1.52(c)(2)(iii), including the examination of the risk
assessment process, the examination of the planning process, and the
quality control procedures to ensure that the examinations maintain the
level of quality expected by the SRO.
The Commission believes that an examination of an FCM must include
a review and assessment of the firm’s internal controls in order to
identify where there may be potential weaknesses and to properly gauge
the risks associated with such weaknesses including their potential
impact on the financial condition of the firm and the protection of
customer funds.
The SRO also must engage an “examinations expert” under Sec.
1.52(c)(2) to review its supervisory program and the application of the
supervisory program at least once every two years. The term
“examinations expert” is proposed to be defined under Sec. 1.52(a)
as a nationally recognized accounting and auditing firm with
substantial expertise in audits of FCMs, risk assessment and internal
control reviews, and is someone acceptable to the Commission. The
Commission is proposing to delegate to the Director of the Division of
Swap Dealer and Intermediary Oversight the responsibility of assessing
whether a particular entity is qualified and approved as an
examinations expert to review the SRO’s supervisory program
The review will require the examinations expert to assess the
sufficiency of the SRO’s risk-based approach and the internal controls
testing and also whether the supervisory program is being appropriately
applied by the SRO in its examinations of its member FCMs. In addition,
the review will require that the examinations expert provide an opinion
as to whether the supervisory program is reasonably likely to identify
a material deficiency in internal controls of the FCM or in any of the
other items that are the subject of an examination conducted in
accordance with the supervisory program. Furthermore, the review will
require that the examinations expert also provide recommendations on
new or best practices prescribed by industry sources that should be
incorporated in the supervisory program. The SRO must receive a written
report from the examinations expert describing, among other things, the
items mentioned in this paragraph.
Upon receipt of the written report, the SRO must provide such
written report to the Commission. The SRO must update the supervisory
program and coordinate with the Commission to resolve any issues raised
by the written report and any Commission questions and comments before
the updated supervisory program becomes the standard for the SRO’s
examinations of its registered FCM members. Proposed Sec.
1.52(c)(2)(vi) also requires each SRO to submit an initial supervisory
program within 120 days of the effective date of the regulation, or a
longer period of time that Director of the Division of Swap Dealer and
Intermediary Oversight (acting pursuant to authority delegated by the
Commission) may approve. The initial supervisory program must contain
an affirmation from the examinations expert regarding the evaluation of
the supervisory program, including the sufficiency of the risk-based
approach and the internal controls testing. The examinations expert
also must opine as to whether the supervisory program is reasonably
likely to identify a material weakness in internal controls over
financial or regulatory reporting.
Consistent with the current regulation, and in order to avoid
duplicative examinations and oversight of FCMs, retail foreign exchange
dealers, or IBs, proposed Sec. 1.52(d)(1) provides that when two or
more SROs have a common member registrant, such SROs may voluntarily
agree to establish a plan to delegate to a single DSRO the function of
overseeing and examining such common member registrant otherwise
required from each such SRO.
[[Page 67892]]
Proposed amendments to Sec. 1.52(d)(1) would further provide that
while an SRO may delegate the functions of examining a member FCM for
compliance with the minimum financial and reporting and risk management
requirements, the delegating SRO retains responsibility for its member
FCM’s compliance with such requirements.
If SROs choose to take advantage of the efficiency provided by a
joint audit plan with respect to their oversight and examinations over
common member FCMs, then the plan must satisfy the requirements of
proposed Sec. 1.52(d)(2), which will assure the quality of the SROs,
both as to the substance of the oversight and examination program and
the application of such program. Proposed Sec. 1.52(d)(2) requires in
such a plan that the SROs form a Joint Audit Committee and adopt a
Joint Audit Program pursuant to which FCMs are overseen and examined by
a DSRO.
The Joint Audit Committee members will be subject to a number of
duties according to proposed Sec. 1.52(d)(2). The most important of
these is that the Joint Audit Committee members establish and maintain
a Joint Audit Program that the DSROs must apply in their oversight and
examinations of FCMs.
The requirements for the establishment and maintenance of the Joint
Audit Program are identical in many ways to the establishment and
maintenance of the standalone supervisory program with respect to FCMs
described in proposed Sec. Sec. 1.52(b) and (c). For example, the
Joint Audit Program and the standalone supervisory program both require
controls testing as well as substantive testing, and the examination
process for each FCM must be driven by the risk profile of each such
FCM. Both programs are required to be reviewed by an examinations
expert every two years. Both must have standards addressing the items
listed in proposed Sec. 1.52(c)(2)(iii), including the examination
risk assessment, examination planning, and quality control to ensure
that the examinations maintain the level of quality expected. The
rationale for this approach is because one of the goals of proposed
Sec. 1.52(d)(2) is to ensure that the SRO and examinations of FCMs is
at least up to the same heightened standard, regardless of whether the
oversight and examinations are conducted by the SRO itself or by a DSRO
designated by the Joint Audit Committee.
The proposed revisions to Sec. 1.52(d) would not nullify the
existing joint audit plan approved by the Commission on March 18, 2009.
Furthermore, the Commission believes that the new minimum requirements
for a Joint Audit Program under proposed Sec. 1.52(d)(2) will not
require revisions to the current joint audit plan. In this regard, the
joint audit plan approved by the Commission includes a provision in
paragraph 3 that provides that the minimum practices and procedures
followed by each DSRO in the conduct of examinations of FCMs shall be
established to conform with the requirements of Sec. 1.52, Commission
staff interpretations, and any other Commission requirements
hereinafter in effect relating to audits and financial reviews. The
Commission believes that this provision would require the DSROs of the
current joint audit plan to revise their Audit Program to meet the new
requirements of proposed 1.52, but not require a new joint audit plan
to be submitted to the Commission.79
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79 The Commission’s view is only that the current agreement
does not have to be revised as a result of the proposed amendments.
The SRO members of the current joint audit plan, however, are not
precluded from making any amendments or otherwise revising the joint
audit program consistent with the terms included in the agreement
for making such revisions.
—————————————————————————
The members of the current joint audit plan would be required to
establish, operate and maintain a Joint Audit Program under proposed
Sec. 1.52(d)(2)(i). The members of the current joint audit plan also
would be required to submit to the Commission for its review and
comment a Joint Audit Program within 120 days (or such other time as
the Commission may approve) of the effective date of the amendments to
Sec. 1.52 under proposed Sec. 1.52(d)(2)(ii)(H). The Joint Audit
Program must be accompanied by a written report from an examinations
expert affirming that the examinations expert has evaluated the Joint
Audit Program and the examinations expert’s opinion as to whether the
Joint Audit Program is reasonably likely to identify a material
deficiency in internal controls over financial and regulatory
reporting, and other items that are subject of an examination conducted
in accordance with the Joint Audit Program.
The Commission is proposing to delegate the responsibility for
granting an extension of time to submit an initial Joint Audit Program
to the Director of the Division of Swap Dealer and Intermediary
Oversight. In this connection, the Commission anticipates that the
Division of Swap Dealer and Intermediary Oversight will be performing
ongoing consultation with SROs regarding the examination programs and,
therefore, would be in position to assess the adequacy of, and
necessity for, any request for an extension of the filing deadline. It
is anticipated that the Director of the Division of Swap Dealer and
Intermediary Oversight will grant requests for reasonable extensions of
time for the submission of the Joint Audit Program.
The Commission requests comments on all aspects of proposed Sec.
1.52. The Commission also requests comments on the following:
The Commission is proposing to require that the SRO and/or
JAC program be subject to an evaluation by an examinations expert at
least once every two years. The examinations expert is defined as a
nationally recognized accounting and auditing firm. Is the proposed
definition of the examinations expert sufficiently clear or detailed to
identify which entities may qualify as an examinations expert? If not,
how can the Commission make the definition more objective? Should the
Commission consider entities other than accounting and auditing firms
(such as consulting firms) to act as examinations experts?
Is the requirement for the examinations expert to conduct
an evaluation of the SRO or JAC program at least once every two years
an appropriate timeframe? Should the Commission consider a shorter
interval between evaluations? If so, why? Alternatively, should the
Commission consider a longer interval between evaluations? If so, why?
What criteria should the Commission consider in setting the interval?
Should the Commission allow SRO or JAC programs that have minimal
issues raised by the examinations expert be subject to a longer
evaluation interval than programs that have more issues identified by
the examinations expert? If so, how would the Commission implement such
a program?
Does the requirement for an examinations expert add
sufficient value to the SRO or JAC program to justify the costs of such
evaluations? Please provide detail in your response to assist the
Commission in assessing the costs of such evaluations.
Are there alternatives to the examinations expert’s
evaluation to assess the adequacy of the SRO and JAC program that the
Commission should consider? Please provide detail in your response.
The Commission is proposing that an SRO submit an initial
supervisory program and that the members of a Joint Audit Committee
submit an initial Joint Audit Program within 120 days of the effective
date of the regulation. The initial supervisory program and the initial
Joint Audit Program must include
[[Page 67893]]
a written report containing an affirmation from an examinations expert
regarding the evaluation of the supervisory program or the Joint Audit
Program, including the sufficiency of the risk-based approach and the
internal controls testing. The examinations expert also must opine as
to whether the supervisory program or the Joint Audit Program is
reasonably likely to identify a material weakness in internal controls
over financial or regulatory reporting. Is the proposed 120-day period
a sufficient period of time for an SRO or JAC to obtain such report
from an examinations expert and to submit its respective supervisory
program or Joint Audit Program? If not, what is a sufficient period of
time?
P. Proposed Amendments to Sec. 1.55: Public Disclosures by Futures
Commission Merchants
The Commission is proposing to amend Sec. 1.55 to enhance the
disclosures provided to customers and potential customers regarding the
extent to which customer funds are protected when deposited with an FCM
as margin or to guarantee performance for trading commodity interests.
The Commission also is proposing to require each FCM to disclose
certain firm specific information regarding the FCM’s financial
condition and operations to allow customers and potential customers to
assess the risks of engaging the firm to conduct futures trading and
the risks of entrusting their funds to the FCM.
Regulation 1.55(a) currently requires an FCM, or an IB in the case
of an introduced account, to provide each customer with a risk
disclosure statement prior to opening the customer’s account (“Risk
Disclosure Statement’).80 Regulation 1.55(b) provides a standard form
Risk Disclosure Statement that each FCM or IB is required to provide to
each prospective customer. The current Risk Disclosure Statement is
primarily intended to provide a customer with disclosure of the market
risks of engaging in futures trading and addresses, among other things,
risks associated with leverage, market movements, and the inability to
exit the market due to limit moves. The FCM or IB also is required to
receive a signed acknowledgment from the customer stating that the
customer received and understood the Risk Disclosure Statement.
—————————————————————————
80 FCMs and IBs are not required to provide disclosure
documents to institutional customers, defined as eligible contract
participants under section 1a of the Act. See Sec. 1.55(f).
—————————————————————————
The Commission is proposing to amend Sec. 1.55 to require FCMs to
provide additional disclosures to prospective customers. Specifically,
the Commission is proposing to add new provisions to paragraph (b) that
will require the Risk Disclosure Statement to contain a statement that:
(1) Customer funds are not protected by insurance in the event of the
bankruptcy or insolvency of the FCM, or if customer funds are
misappropriated in the event of fraud; (2) customer funds are not
protected by SIPC, even if the FCM is a BD registered with the SEC; and
(3) customer funds are not insured by a DCO in the event of the
bankruptcy or insolvency of the FCM holding the customer funds. The
proposed amendments also will require an FCM to disclose that each
customer’s funds are not held in an individual segregated account by an
FCM, but rather are commingled in one or more accounts, and that FCMs
may invest funds deposited by customers in investments listed in Sec.
1.25. The proposed amendments also will require that each FCM disclose
that funds deposited by customers may be deposited with affiliated
entities of the FCM, including affiliated banks and brokers.
The Commission also is proposing to revise the Risk Disclosure
Statement required by Sec. 1.55(b) to include a new disclosure that
informs a potential customer that each futures commission merchant is
required by Commission regulations to make certain firm specific
disclosures and financial information publicly available on the futures
commission merchant’s Web site to assist the customer with his or her
assessment and selection of a futures commission merchant. The firm
specific disclosures are detailed in proposed paragraph (k) of Sec.
1.55 and are discussed below. The Risk Disclosure Statement also must
include the futures commission merchant’s Web site address where the
additional firm specific and financial information may be obtained by
the customer.
The Commission is proposing the additional disclosures in response
to the recent failures of MF Global and Peregrine. The Commission is
concerned that the current Risk Disclosure Statement does not provide
customers with adequate or complete information regarding the risks of
engaging in trading through an FCM. Current disclosures in the Risk
Disclosure Statement focus on the market risks of engaging in futures
trading. However, the Commission understands that many of MF Global’s
former customers did not have adequate and meaningful information
regarding the risks that their funds were exposed to beyond general
market risks. Specifically, the Commission understands that some
customers believed that their funds were covered by insurance or other
protection. Some customers also believed that DCOs guaranteed customer
funds in the event of a bankruptcy of an FCM.
The proposed additional disclosures in the Risk Disclosure
Statement are intended to provide customers with a greater
understanding of the risks of entrusting their funds with an FCM. This
includes disclosures regarding the meaning and operation of the term
“segregation” under the Act and Commission regulations. In addition,
the Commission believes that customers will benefit from an awareness
that FCMs may use affiliated entities to hold customer funds.
The Commission also is proposing that the Risk Disclosure Statement
include a new provision that informs potential customers to the fact
that additional firm specific disclosures and financial information
about a particular FCM may be obtained from information maintained on
each FCM’s respective Web site. The content of the additional firm
specific and financial disclosures are discussed below.
The Commission also is proposing to amend Sec. 1.55, by adding new
paragraphs (i) through (n) which will require an FCM to provide to each
customer an additional disclosure document that will set forth firm
specific information and address firm-specific risk factors to allow
customers to have more information regarding the FCM and the risks
associated with entrusting their funds to the FCM, or otherwise
conducting business with or through the FCM (“Firm Specific Disclosure
Document”). The additional risk information provided also will enable
customers to make more meaningful judgments regarding the
appropriateness of selecting an FCM by providing tools and information
for the meaningful comparisons of business models and risks across
FCMs. Such additional information will greatly enhance the due
diligence that a customer can conduct both prior to opening an account
and on an ongoing basis, as the proposal will require that the FCM
update the risk disclosure information on a periodic basis. The
Commission believes that the proposed Firm Specific Disclosure
Document, coupled with the existing Risk Disclosure Statement, will
provide customers with a more complete perspective regarding the risks
of participating in the futures markets.
[[Page 67894]]
Under the proposal, in addition to providing general firm contact
information, the Firm Specific Disclosure Document will contain the
names, business contacts, and backgrounds for the FCM’s senior
management and members of the FCM’s board of directors. The Firm
Specific Disclosure Document also will include firm risk disclosures
including: (1) A discussion of the significant types of business
activities and product lines that the FCM engages in; (2) a discussion
of the FCM’s significant lines of business and the approximate amount
of assets and capital devoted to each line of business; (3) a
discussion of the material risks of the firm including the FCM’s
creditworthiness, leverage, capital and liquidity condition, and an
explanation of how such risks may be material to customers that deposit
funds for futures trading with the firm; and (4) a discussion of any
material administrative, civil, criminal, or enforcement actions
pending or any enforcement actions taken in the last three years.
The proposed Firm Specific Disclosure Document also will require
each FCM to disclose firm specific information regarding its operations
in the futures marketplace. An FCM will be required to disclose the
name of the firm’s DSRO, and to provide an overview of customer funds
segregation protections and limitations, and how it manages its
collateral management and investments. Each FCM also will be required
to disclose the clearinghouses and carrying brokers that its uses to
conduct its business, as well as its policies and procedures concerning
the choice of depositories, custodians and counterparties.
The proposed Firm Specific Disclosure Document also will require
the FCM to disclose certain financial and risk management information
including the firm’s total equity, regulatory capital, and net worth as
of the most recent month end when the disclosure document is prepared.
The FCM also is required to disclose information regarding: (1) The
amount of the FCM’s proprietary margin requirements as a percentage of
the total segregated and secured funds that the FCM holds; (2) the
number of customers that comprise 50 percent of the firm’s total
customer segregated and secured amount requirements; (3) the aggregate
notional value, by asset class, of all non-hedged, principal over-the-
counter transactions into which the FCM has entered; (4) the amount,
generic source and purpose of any unsecured lines of credit (or similar
short-term funding) the FCM has obtained but not yet drawn upon; (5)
the aggregate amount of financing the FCM provides for customer
transactions involving illiquid financial products for which it is
difficult to obtain timely and accurate prices; (6) the percentage of
customer receivables that the FCM had to write-off as uncollectable
during the prior year compared to the current segregated and secured
amount balances; and (7) a summary of the FCM’s current risk practices,
controls and procedures.
An FCM is obligated to update the Firm Specific Disclosure Document
as necessary to keep the information accurate, but at least on an
annual basis. An FCM also is required to make the Firm Specific
Disclosure Document available to its customers and the general public
on its Web site. An FCM may, however, use an alternative electronic
means to make the Firm Specific Disclosure Document available to its
customers provided that the electronic version is presented in a format
that is readily communicated to its customers. The Proposal further
provides that an FCM shall provide a paper copy of the Firm Specific
Disclosure Document to a customer upon the customer’s request.
The Commission also is proposing to amend Sec. 1.55 to require
each FCM to disclose on its Web site to the general public financial
information that is publicly available under existing Commission
regulations. Specifically, proposed paragraph (o) of Sec. 1.55 will
require each FCM to make available on its Web site the daily
Segregation Schedule; the daily Secured Amount Schedule; and the daily
Cleared Swaps Segregation Schedule. Each FCM will be required to
maintain 12 months of the above segregation and secured schedules
available on its Web site.
Proposed paragraph (o) also requires each FCM to disclose on its
Web site a summary schedule of the firm’s adjusted net capital, net
capital, and excess net capital for the 12 most recent month-end dates.
Each FCM also will be required to disclose on its Web site the
following statements and schedules from the most current year end
annual report that is certified by an independent public accountant in
accordance with Sec. 1.16: the Statement of Financial Condition; the
Segregation Schedule; Secured Amount Schedule; the Cleared Swaps
Segregation Schedule; and all footnotes related to the above statement
and schedules.
The information that the proposal requires each FCM to disclose on
its Web site is information that is currently publicly available under
Commission regulations, or proposed by this rulemaking in the case of
the Cleared Swaps Segregation Schedule, to be public information.
Regulation 1.10(g) currently provides that the Segregation Schedules
and Secured Amount Schedules contained in the monthly unaudited Forms
1-FR-FCM are public information. Regulation 1.10(g) further provides
that the amounts of an FCM’s adjusted net capital, minimum net capital
requirement, and excess net capital as reported in the firm’s unaudited
monthly Form 1-FR-FCM are public information. Lastly, Sec. 1.10(g)
provides that the Statement of Financial Condition, Segregation
Schedule, Secured Amount Schedule, and related footnote disclosures
contained in an FCM’s audited annual financial report are public
documents.
The Commission also is proposing in paragraph (o) of Sec. 1.55 to
require each FCM to include a statement on its Web site that is
available to the public that additional information, including
information on how the FCM invests customer funds, may be obtained from
the NFA. The FCM also is required to include a link on its Web site to
the NFA web page which shows financial information for the FCM. Lastly,
proposed paragraph (o) requires each FCM to include a statement
regarding the Commission’s reporting of select FCM financial
information and a link to the Commission’s Web site.
The Commission is proposing paragraph (o) as it believes that
customers will make more informed choices regarding which FCMs to use
to carry their account and to entrust their funds to if they have the
opportunity to have access to FCM financial information. Requiring FCMs
to make the information available to the public on their respective Web
sites will allow customers and potential customers with a convenient
method of obtaining and reviewing the information to assist with their
selection process. Customers will have the ability to compare and
contrast financial data from all FCMs to assist with the decision
making process of determining which firms meet their criteria for
holding their funds.
The Commission requests comment on all aspects of proposed
amendments to Sec. 1.55. Specifically, the Commission requests comment
on the following:
Do the existing and proposed disclosures required to be
included in the Risk Disclosure Statement and Firm Specific Disclosure
Document adequately convey to retail and/or institutional investors the
market and firm specific risks of engaging in futures trading and the
risks of using an FCM to execute trades on customers’ behalf and to
hold customers’ funds? If not, how should the Risk Disclosure
[[Page 67895]]
Statement and Firm Specific Disclosure Document be amended?
Are there other disclosures that the Commission should
require to be included in Risk Disclosure Statement? If so, what are
the additional disclosures and how would such disclosures benefit
customers?
Are there other disclosures that the Commission should
require to be included in a Firm Specific Disclosure Document? If so,
what are the additional disclosures and how would such disclosures
benefit customers?
Are the proposed additional firm-specific disclosures too
broad? If so, how should the Commission refine the disclosures to be
more specific, yet provide the type of information that the Commission
would like customers to receive?
The Commission is proposing to require an FCM to disclose
in the Firm Specific Disclosure Document the number of customers that
comprise 50 percent of the FCM’s customer fund balances for futures
customers, Cleared Swaps Customers, and 30.7 Customers. Should the
Commission consider additional or different percentages? If so, what
should the percentages be and why?
The Commission requests comment on how the new or revised
Risk Disclosure Statement and Disclosure Documents should be provided
to existing customers. Should FCMs be required to obtain new signature
acknowledgments from existing customers for a revised Risk Disclosure
Statement? How should existing customers be informed of the new Firm
Specific Disclosure Statement? How can the Commission be assured that
all existing customers have been informed of the new disclosure
documents, and the availability of the FCM financial data?
If FCMs are required to provide existing customers with
new Risk Disclosure Statements, how should Commission address the
implementation of the requirement? What would be an adequate period of
time for FCMs to obtain new acknowledgment from existing customers?
Q. Proposed Amendments to Part 22
The Commission recently adopted final regulations in Part 22
implementing the provisions of the Dodd Frank Act that provide for the
protection of Cleared Swaps Customer contracts and collateral.81
Although substantive differences in the segregation regimes between
futures and cleared swaps at the clearing level exist under the final
Part 22 regulations as adopted, requirements with respect to collateral
which is not posted to clearinghouses and maintained by FCMs for
Cleared Swaps Customers replicate or incorporate by reference the same
regulatory requirements applicable to the segregation of futures
customer funds under section 4d(a)(2) of the Act (for example, holding
funds separate and apart from proprietary funds, limitations on the
FCM’s use of customer funds, titling of depository accounts,
Acknowledgment Letter from depository requirements, and limitations on
investment of swap customers’ funds are currently contained in Part 22
regulations).
—————————————————————————
81 77 FR 6336 (February 7, 2012).
—————————————————————————
The determination that appropriate enhancements are necessary with
respect to the regulatory requirements discussed above for segregated
futures customer funds under section 4d(a)(2) of the Act is equally
applicable to Cleared Swaps Customer Collateral. The written policies
and procedures requirements proposed in Sec. 1.11 would be applicable
to Cleared Swaps Customer Collateral, the new withdrawal limitations
requirements proposed in Sec. 1.23 are proposed to be replicated in a
new Sec. 22.17, and the changes to the daily segregation calculations
and filing of such calculations, as well as requirements for detailed
depository and investment information, are proposed to apply to Cleared
Swaps Customer funds through proposed amendments to Sec. 22.2(g). In
addition, changes discussed above regarding Sec. 1.17 with respect to
securities haircuts are also proposed with respect to Sec. 22.2(f),
which similarly incorporates by reference the applicable SEC securities
haircuts. Finally, the proposed Sec. 1.20(i) requirement that an FCM
maintain residual interest in segregated accounts in an amount that
exceeds the sum of all futures customers’ margin deficits is also
proposed with respect to Cleared Swaps. As stated above, this
requirement provides a clear mechanism for demonstrating FCM compliance
with the prohibition under the Act and existing Commission regulations
on using the collateral of one Cleared Swaps Customer to support the
obligations of another Cleared Swaps Customer.
R. Amendments to Sec. 1.3: Definitions; and Sec. 30.7: Treatment of
Foreign Futures or Foreign Options Secured Amount
Part 30 of the Commission’s regulations were adopted in 1987 and
govern trading on foreign futures markets.82 Regulation 30.7 requires
an FCM to set aside in separate accounts for the benefit of its foreign
futures or foreign options customers an amount of funds defined as the
“foreign futures or foreign options secured amount.” The term
“foreign futures or foreign options secured amount” is defined in
Sec. 1.3(rr) as the amount of funds necessary to margin the foreign
futures or foreign options positions held by the FCM for its foreign
futures or foreign options customers, plus or minus any gains or losses
on such open positions. The calculation of the foreign futures or
foreign options secured amount is referred to as the “Alternative
Method.”
—————————————————————————
82 52 FR 28980 (Aug. 5, 1987).
—————————————————————————
Foreign futures or foreign options customers receive substantially
less protection for their account deposits under the Alternative Method
than futures customers receive for their account deposits under section
4d(a)(2) of the Act and Commission regulations. Section 4d(a)(2) of the
Act and Commission regulations require an FCM to segregate in separate
accounts sufficient funds to satisfy the full account equities of all
of its futures customers trading on designated contract markets (i.e.,
the Net Liquidating Equity Method). The regulatory objective of the Net
Liquidating Equity Method is to ensure that an FCM has sufficient funds
in segregated accounts to cover the full account equities of all of its
futures customers. This would allow the FCM to transfer the futures
customers’ positions and margin collateral in the event of the
insolvency of the FCM to another firm that was financial sound. If the
FCM does not maintain sufficient funds in segregation to cover the full
account equities, the futures customers may not be able to be
transferred to another FCM, or the futures customers may be required to
deposit margin funds with the transferee FCM to adequately margin the
positions.
In contrast, the Alternative Method only obligates an FCM to set
aside an amount of funds in separate accounts sufficient to cover the
margin required on open foreign futures and foreign options positions,
plus or minus any unrealized gains or losses on such positions. Any
funds deposited by foreign futures or foreign options customers in
excess of the required amount to be set aside in separate accounts
under the Alternative Method may be held by the FCM in operating cash
accounts and may be used by the FCM as if it were its own capital.
Therefore, an FCM is not required to set aside in separate accounts a
sufficient
[[Page 67896]]
amount funds to repay the full account balances of each of its foreign
futures or foreign options customers, and, in the event of an FCM
insolvency, the foreign futures or foreign options customers may not
recover 100 percent of the value of their accounts or be able to
transfer their positions to another FCM.
The Commission is proposing to amend the Part 30 regulations to
eliminate the Alternative Method and to require FCMs to use the Net
Liquidating Equity Method to compute the amount of funds they must set
aside in separate accounts for the benefit of its foreign futures or
foreign options customers. The amount of funds held for foreign futures
and foreign options customers has grown dramatically in the last 10
years. FCMs held approximately $36.4 billion for foreign futures or
foreign options customers as of June 30, 2012, compared to a total of
$7.9 billion held as of March 31, 2002 (an approximate 470 percent
increase).83 In addition, the amount of funds held by FCMs for
foreign futures or foreign options customers has increased relative to
the amount of segregated funds held by FCMs during the last 10 years.
Funds held for foreign futures or foreign options customers represented
approximately 13 percent of the total customer funds held by FCMs as of
March 31, 2002, and represented approximately 21 percent of total
customer funds as of June 30, 2012.84
—————————————————————————
83 The total amount of customer funds held by FCMs is
available on the Commission’s Web site at http://www.cftc.gov/MarketReports/FinancialDataforFCMs/index.htm.
84 Id.
—————————————————————————
Accordingly, the Commission is proposing to amend Sec. 1.3(rr) to
define the term “foreign futures or foreign options secured amount”
to mean the amount of funds an FCM needs to satisfy the full account
balances of each 30.7 Customer at all times (i.e., the Net Liquidating
Equity Method).
The term “30.7 Customer” is proposed to be defined in Sec. 30.1
to mean both U.S.-domiciled customers and foreign-domiciled customers
trading foreign futures or foreign options. As originally adopted, FCMs
were only required to hold funds for U.S.-domiciled customers. The Net
Liquidating Equity Method will require the FCM to set aside a
sufficient amount of funds in secured accounts to repay the total
account balances of all of its 30.7 Customers, which will align the
requirement with the segregation requirements for both futures
customers and Cleared Swaps Customers. The proposed amendments will
significantly enhance the protection afforded to funds deposited by
customers trading on foreign markets.
The Commission also is proposing to substantively revise the
regulations governing an FCM’s holding of funds deposited by a customer
for trading on foreign futures markets. The proposed amendments to the
foreign futures or foreign options secured amount requirement establish
many of the regulatory requirements that currently exist, or are
proposed to be adopted under this rulemaking, with regard to segregated
funds deposited by customers trading on a designated contract market
under Part 1 and deposited by Cleared Swaps Customers under Part 22 of
the Commission’s Regulations.
Regulation 30.7(a) requires an FCM to set aside in separate
accounts sufficient funds to meet its current obligations to foreign
futures or foreign option customers denominated as the “foreign
futures or foreign options secured amount.” The term “foreign futures
or foreign options customer” is defined in Sec. 30.1 to mean any
person located in the United States, its territories, or possessions.
The term “foreign futures or foreign options secured amount” is
defined at Sec. 1.3(rr) and means an amount of money, securities, or
other property sufficient to margin, guarantee, or secure open foreign
futures contracts plus any unrealized gains or losses on such
contracts, and any money securities or property representing premiums
paid or received, and any other funds necessary to guarantee or secure,
open foreign option transactions (i.e., the Alternative Method of
computing the secured amount requirement). Thus, an FCM is not required
to set aside in separate accounts all funds deposited by or otherwise
belonging to foreign futures or foreign option customers. Funds
deposited by foreign futures or foreign options customers that exceed
the foreign futures or foreign options secured amount may be commingled
with the FCM’s proprietary funds and used by the FCM as part of its
business capital.
In addition, Sec. 30.7(b) requires only that an FCM set aside the
required margin funds for foreign futures customers that are located
within the United States, its territories, or possessions. Regulation
30.7 permits the FCM to include foreign futures customers that are
located outside of the United States, but the FCM is not obligated to
include such foreign-domiciled customers.
Furthermore, Commission staff previously issued guidance to FCMs
stating that an FCM could carry positions other than foreign futures
and foreign option positions in foreign futures or foreign options
customers’ accounts. Thus, FCMs could commingle and carry customers’
non-foreign futures positions, such as foreign currency positions and
over-the-counter positions, in such customers’ foreign futures or
foreign options account.
The intent of the following amendments is to align the regulatory
approach and customer protections by raising the requirements for
foreign futures or foreign options secured amount to make it consistent
with the FCM’s segregation requirements for customers trading on
designated contract market or engaging in cleared swap transactions.
As stated above, the Commission is proposing to require FCMs to
compute the foreign futures or foreign options secured amount using the
Net Liquidating Equity Method by amending the definition in Sec.
1.3(rr) of the term “foreign futures or foreign options secured
amount” to match structurally the definition in Sec. 1.3(gg) of the
term “customer funds,” which encompasses the Net Liquidating Equity
Method of computing the amount of funds an FCM is required to maintain
in customer segregated accounts. Specifically, the proposed definition
of the term “foreign futures or foreign options secured amount” would
be amended to mean all money, securities and property received by an
FCM for, or on behalf of, “30.7 Customers” to margin, guarantee, or
secure foreign futures contracts and foreign option transactions, and
all funds accruing to “30.7 Customers” as a result of such foreign
futures and foreign options transactions. The term “30.7 Customer” is
proposed to be defined in Sec. 30.1 to mean any person, whether
domiciled within or outside of the United States, that engages in
foreign futures or foreign options transactions through the FCM.
Requiring an FCM to set aside in separate accounts the funds
deposited by both domestic and foreign-domiciled customers provides
comparable customer protections to customers notwithstanding their
place of domicile. In addition, requiring the FCM to hold U.S.-
domiciled and foreign-domiciled customer funds in separate accounts
under Sec. 30.7 ensures that such customers receive equal protections
in the event of the bankruptcy of the firm. Part 190 of the
Commission’s regulations and the U.S. Bankruptcy Code 85 provide that
in the event of a commodity broker bankruptcy liquidation, customers in
the account
[[Page 67897]]
class entitled to a preference to the amounts in set-aside accounts for
customers trading on foreign boards of trade include both U.S.-
domiciled and foreign-domiciled customers.86 The Commission is
proposing to require funds to be set aside equally for U.S.-domiciled
and foreign-domiciled customers trading on foreign boards of trade in
the computation under Sec. 30.7 by establishing a new definition of
30.7 Customers that includes existing foreign futures or foreign
options customers (which are U.S.-domiciled persons trading foreign
futures or foreign options) as well as any foreign-domiciled persons
trading foreign futures or foreign options through the registered FCM.
The secured amount definition, as proposed to be amended in Sec.
1.3(rr), will reference “30.7 Customers” instead of “foreign futures
or foreign options customers,” to ensure FCMs are required to set
aside funds equal to the net liquidating equity of all such persons.
Combined with the proposed amendment to require net liquidating equity,
this should result in at all times an amount required to be set aside
for all persons equal to the amount owed to such persons that would
share in the account class for foreign futures in a commodity broker
liquidation. The Commission is also proposing amendments in Sec. 1.10
and Sec. 1.17 to reference “30.7 Customers” instead of foreign
futures or foreign options customers in the title of the schedules
prepared by an FCM.
—————————————————————————
85 See 11 U.S.C. 761-766.
86 Id. By definition, “foreign future” under section 761 of
the Bankruptcy Code is not limited to transactions entered on
foreign boards of trade on behalf of U.S. domiciled persons, and
“customer” is not limited to U.S. domiciled persons. The result is
that by the application of these definitions a preferential account
class at a commodity broker for customers trading foreign futures
would not be limited to U.S. domiciled customers.
—————————————————————————
In addition, the Commission is proposing to add language to Sec.
30.7(a) to provide an equivalent offset to that available in the
futures customer segregation calculation under Sec. 1.32(b) for
deficits in accounts secured by securities, subject to language
updating the reference to applying securities haircuts in calculating
the offset as discussed in Section II.F above. The result of these
amendments as discussed should be accord between the methodologies
applied in the 4d segregation calculation and the Sec. 30.7
calculation.
Consistent with proposed changes in Sec. 1.20(i) and Part 22, the
Commission also is proposing to add language to Sec. 30.7(a) to
provide that an FCM must hold residual interest in accounts set aside
for the benefit of 30.7 Customers equal to the sum of all margin
deficits for such accounts, to provide an equivalent clear mechanism
for ensuring that the funds of one 30.7 Customer are not margining or
guaranteeing the positions of another 30.7 Customer. Although this
prohibition is not specified in the Act as it is with respect for
futures customers and Cleared Swaps Customers, the Commission is
proposing to the extent possible to replicate wherever practical and
advisable customer protection provisions for futures customers and
Cleared Swaps Customers to 30.7 Customers. As a result, most of the
amendments proposed earlier in various provisions for these customers
also are being proposed in Sec. 30.7.
The Commission requests comment on the proposed amendments to Sec.
30.7(a).
Proposed paragraph (b) of Sec. 30.7 sets forth the permitted
depositories for holding 30.7 Customer funds. The proposal does not
alter the list of depositories that are currently permitted under Sec.
30.7 to hold 30.7 Customers’ funds: (1) A bank or trust company located
in the United States; (2) a bank or trust company located outside of
the United States that maintains in excess of $ 1 billion of regulatory
capital; (3) an FCM registered with the Commission; (4) a DCO; (5) the
clearing organization of a foreign board of trade; (6) a member of a
foreign board of trade; and (7) the depositories used by the clearing
organization of a foreign board of trade or a member of a foreign board
of trade.
Proposed Sec. 30.7(c) would limit the amount of 30.7 Customers’
funds that an FCM could hold in non-U.S. jurisdictions. Under the
proposal, an FCM must hold 30.7 Customer funds in the United States,
except to the extent that the funds held outside of the United States
are necessary to margin, guarantee, or secure (including any prefunding
obligations) the foreign futures or foreign options positions of an
FCM’s 30.7 Customers. The Commission also is proposing to allow an FCM
to deposit additional 30.7 Customer Funds equal to 10 percent of the
total amount of funds required to be held by non-U.S. brokers or
foreign clearing organizations for 30.7 Customers as a cushion to the
required margin requirements, so that the FCM has a certain degree of
flexibility in managing its daily cash movements and to ensure that the
foreign futures or foreign options positions are not undermargined at
foreign brokers or clearing organizations. The Commission recognizes
that due to differences in time zones, trading hours, banking holidays,
as well needs for cash transfers to foreign jurisdictions to settle and
to be credited to accounts, a customer may not be able to immediately
transfer funds to its FCM, and an FCM may not be able to immediately
transfer funds to a foreign broker or foreign clearing organization to
meet a margin call. The proposed cushion is intended to provide an FCM
with sufficient flexibility to meet its customers’ trading obligations
on foreign markets, while also requiring as much of the total 30.7
Customer funds to be held within the United States in order to minimize
the impact of the repatriation risk in the event of an FCM insolvency.
The Commission previously proposed changes to the form of the
Acknowledgment Letter required from depositories holding funds set
aside as the foreign futures or foreign options secured amount.87 The
Commission here re-proposes in a revised paragraph (d) to Sec. 30.7
the requirements for obtaining and submitting Acknowledgment Letters
for Sec. 30.7 accounts, which proposed changes include further revised
template forms of Acknowledgment Letter included as Appendices E and F.
The proposed template forms, in addition to incorporating earlier
proposed changes previously summarized with respect to the Sec. 1.20
Acknowledgment Letters, have been further revised to include a
depository’s agreement to provide read-only account access to
Commission or DSRO staff, in order for Commission or DSRO staff to
directly verify balances as necessary. The Commission is also proposing
subparagraphs (3), (4) and (5) of Sec. 30.7(d), which substantively
require 24 hour a day direct read-only electronic access to the
depository account by the Commission and the DSRO, require the
depository to file the written Acknowledgment Letter directly with the
Commission and the FCM’s DSRO, and require the depository to provide
confirmations to the Commission and the FCM’s DSRO directly upon
request. The Commission requests comment on the revised requirements
for Acknowledgment Letters for Sec. 30.7 accounts as proposed in
paragraph (d) and the new template forms of the Acknowledgment Letters
proposed in Appendices E and F.
—————————————————————————
87 See Acknowledgment Letters for Customer Funds and Secured
Amount Funds, 75 FR 47738 (Aug. 9, 2010).
—————————————————————————
As part of its participation in the public roundtable discussed in
the Background section above, FIA recommended that the Commission
eliminate the ability of FCMs to commingle funds from unregulated
[[Page 67898]]
transactions with funds for foreign futures and options trading in Part
30 set aside accounts, except by Commission order, as is the case under
4d(a)(2) of the Act for segregated funds. The Commission agrees with
this recommendation. The comments cited in the release adopting Part 30
with respect to back office operational difficulties of establishing
multiple “customer” origins were persuasive at the time Part 30 was
adopted.88 With the technological changes of intervening decades,
however, these concerns should no longer dictate the advisability of
commingling the funds of regulated foreign futures and foreign options
transactions with unregulated transactions. Therefore, the Commission
is proposing to amend Sec. 30.7 by adopting new paragraph (e), which
will extend the prohibition against commingling to any funds of account
holders of an FCM unrelated to trading foreign futures or foreign
options, except as the Commission shall by order permit, under terms
and conditions as specified. Should there be a need to permit
commingling of funds, the Commission will continue to have the ability
to permit such commingling under the formalities of processes
associated with a Commission order. The Commission requests comment on
this proposed amendment to Sec. 30.7(e).
—————————————————————————
88 See 52 FR 28980 at 28985-28986.
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The Commission has proposed to adopt a new paragraph (f) and a new
paragraph (k) in Sec. 30.7, to extend regulatory provisions from
Sec. Sec. 1.20, 1.21, 1.22 and 1.24, that previously were applicable
only to 4d segregated funds, to funds set aside as the foreign futures
or foreign options secured amount under Sec. 30.7. The Commission
requests comment on replicating these regulatory requirements
applicable to segregated funds to funds set aside as the foreign
futures or foreign options secured amount. These proposed requirements
would make clear that FCMs would not be permitted to use funds set
aside as the foreign futures or foreign options secured amount other
than for the benefit of 30.7 Customers, and that funds set aside as the
foreign futures or foreign options secured amount should not be
invested in any obligations of clearing organizations or boards of
trade, and that further, no funds placed at foreign brokers should be
included as funds set aside as the foreign futures or foreign options
secured amount unless those funds are on deposit to margin the foreign
futures or foreign options trading of 30.7 Customers. In addition to
extending these existing Commission regulations to Sec. 30.7 in
proposed paragraphs (f) and (k), the Commission is also proposing a new
requirement prohibiting a FCM from imposing any liens or allowing any
liens to be imposed on funds set aside as the foreign futures or
foreign options secured amount. The Commission has previously adopted a
lien prohibition with respect to the segregation of Cleared Swaps
Customer collateral at Sec. 22.2(d)(2) and therefore proposes to
extend this lien prohibition to funds set aside as the foreign futures
or foreign options secured amount in Sec. 30.7. The Commission
requests comment on the proposed amendments providing limitations on
use and permitted withdrawals as contained in Sec. Sec. 30.7(f) and
(k).
As discussed in Section II.I above, the Commission has proposed new
limitations on withdrawals of segregated funds in Sec. 1.23. The
proposed amendments provide for an FCM’s residual interest in
segregated funds, and permits withdrawals from segregated funds for the
proprietary use of the FCM to the extent of such residual interest,
subject to the requirement that the withdrawal must not occur prior to
the completion of the daily segregation computation for the prior day,
and should the withdrawal (individually or aggregated with other
withdrawals) exceed 25 percent of the prior day residual interest, the
withdrawal must be subject to specific approvals by senior management
and appropriately documented, and further subject to a complete
prohibition on withdrawals of residual interest to the extent of margin
deficits. The Commission has proposed paragraph (g) of Sec. 30.7 to
apply the same restrictions on withdrawals of an FCM’s residual
interest in funds set aside as the foreign futures or foreign options
secured amount. The Commission requests comment on proposed paragraph
(g) of Sec. 30.7.
Regulation 30.7(g) was recently adopted by the Commission to
provide that the investment of Sec. 30.7 funds be subject to the
investment limitations contained in Sec. 1.25.89 The Commission is
proposing to now move this permitted investment requirement to a new
paragraph Sec. 30.7(h), and further to adopt a new paragraph Sec.
30.7(i), which makes clear that FCMs are solely responsible for any
losses resulting from the permitted investment of funds set aside as
the foreign futures or foreign options secured amount. The new
paragraph Sec. 30.7(i) is intended to apply the same standard as is
being proposed in the amendment to Sec. 1.29 for segregated funds
discussed above. The Commission is also requesting comment on whether
the investment of 30.7 property should be restricted in cases of
jurisdictions where client asset protection of such property cannot be
assured? If so, what assurances should be required? For example, in
cases of jurisdictions where client asset protections can be waived,
should the Commission require that the Commission or a DSRO be
practicably able to audit for evidence of such waiver? What are the
relevant costs and benefits of adopting any of these alternatives?
—————————————————————————
89 76 FR 78776 at 78802 (December 19, 2011).
—————————————————————————
The Commission also is proposing in an amended paragraph (j) to
Sec. 30.7 to clarify the circumstances under which an FCM may make
secured loans to 30.7 Customers and to adopt the same restriction on
unsecured lending to 30.7 Customers as has been proposed with respect
to futures customers and 4d segregated funds in the proposed amendment
to Sec. 1.30 discussed above. The Commission requests comment on
applying this restriction in relation to 30.7 Customers.
Finally, the Commission is proposing an amended paragraph (l) to
Sec. 30.7 to require the daily computation of the foreign futures or
foreign options secured amount and the filing of such daily computation
with the Commission and DSROs, as well as to require the FCM to provide
investment detail of the foreign futures or foreign options secured
amount as of the middle and end of the month. The proposed amendments
to paragraph (l) of Sec. 30.7 are intended to be consistent with the
requirements for the daily segregation calculation for segregated
customer funds and the provision of the segregation investment detail
which are proposed in Sec. 1.32. The Commission requests comment on
the proposed changes requiring the filing of the daily secured amount
computation and the investment detail as proposed in Sec. 30.7(l).
III. Consideration of Costs and Benefits
The misuse or mishandling of customer funds at specific FCMs like
MF Global or Peregrine not only imposes a burden on those customers
whose funds have been misused, but also creates a burden to the public
by eroding the trust of the American public in all market
intermediaries. This loss of trust could deter market participants from
the benefits of using regulated, transparent markets and clearing. The
overarching purpose of this rule is to provide regulators the means by
which to detect and deter the misuse or mishandling of customer funds
by FCMs in order to produce the benefits that
[[Page 67899]]
accrue by virtue of avoiding similar defaults in the future and to
prevent the costs, including lost customer funds, decreased market
liquidity that follows from a crisis in confidence, and the potential
for the failure of one FCM to cause instability in other clearing
members.90
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90 The failure of one clearing member could lead to
instability in other clearing members if the losses due to the first
member’s failure are large enough to exhaust the guarantee fund and
require additional capital infusion from other clearing members.
—————————————————————————
The Commission’s proposal builds on recent efforts by the
Commission and industry to better protect customer funds. As discussed
above in section I.D., in December 2011 the Commission amended Sec.
1.25 of its regulations to eliminate certain options for the
permissible investments of customer funds.91 Two months later, the
Commission approved a margin rule for cleared swap transactions
referred to as “LSOC” (legal separation with operational commingling)
in which each swaps customer’s collateral is protected individually all
the way to the clearinghouse.92 The Commission also convened a
roundtable in late February 2012 to discuss what amendments should be
made to Commission regulations in order to provide additional
protection to customer funds. Further, in June 2012, the Commission
finalized rules for DCMs and included amendments to Sec. 1.52 which
codify staff guidance on minimum requirements for SROs regarding their
financial surveillance of FCMs.93 With the recent default of another
FCM, Peregrine, the Commission held two additional roundtables to
discuss, among other things, technological approaches to mitigating the
risk of fraud, and possible amendments to the Commission’s rules
regarding protection of customer funds.94
—————————————————————————
91 In the final rule amending Sec. 1.25, the Commission
stated, “the Commission is narrowing the scope of investment
choices in order to eliminate the potential use of portfolios of
instruments that may pose an unacceptable level of risk to customer
funds.” See “Investment of Customer Funds and Funds Held in an
Account for Foreign Futures and Foreign Options Transactions,” 76
FR 78776, December 19, 2011.
92 77 FR 6336 (Feb. 7, 2012) (Protection of Cleared Swaps
Customer Contracts and Collateral; Conforming Amendments to the
Commodity Broker Bankruptcy Provisions).
93 77 FR 36612 (June 19, 2012) (Core Principles and Other
Requirements for Designated Contract Markets).
94 Public Meeting of the Technology Advisory Committee, July
26, 2012. See http://www.cftc.gov/PressRoom/Events/opaevent_tac072612. Public Roundtable to Discuss Additional Customer
Protections, August 9, 2012. See http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff080912.
—————————————————————————
In this rulemaking, the Commission is proposing amendments to
improve the protection of customer funds. The content of the
Commission’s proposal can be categorized in seven parts: (1) Requiring
FCMs to implement extensive risk management programs including written
policies and procedures related to various aspects of their handling of
customer funds; (2) increasing reporting requirements for FCMs related
to segregated customer funds, including daily reports to the Commission
and DSRO; (3) requiring FCMs to establish target amounts of residual
interest to be maintained in segregated accounts as well as creating
restrictions and increased oversight for FCM withdrawals out of such
residual interest in customer segregated accounts, specifically
including clear sign off and accountability from senior management for
such withdrawals; (4) strengthening requirements for the acknowledgment
letters that FCMs and DCOs must obtain from their depositories; (5)
eliminating the Alternative Method for calculating 30.7 Customer funds
segregation requirements and requiring FCMs to include foreign
investors’ funds in segregated accounts; (6) strengthening the
regulatory requirements applicable to SRO and DSRO oversight of FCMs,
including regulating oversight provided under the function of a Joint
Audit Committee that would establish standards for, and oversee the
execution of, FCM audits; and (7) requiring FCMs to provide additional
disclosures to investors.
Statutory Mandate To Consider the Costs and Benefits of the
Commission’s Action: Commodity Exchange Act Section 15(a)
Section 15(a) of the Act requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the Act or issuing certain orders. Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
the following five broad areas of market and public concern: (1)
Protection of market participants and the public; (2) efficiency,
competitiveness and financial integrity of futures markets; (3) price
discovery; (4) sound risk management practices; and (5) other public
interest considerations. The Commission considers the costs and
benefits resulting from its discretionary determinations with respect
to the section 15(a) considerations.
There are four considerations relevant to this proposal. These are:
(1) Protection of market participants and the public; (2) efficiency,
competitiveness and financial integrity of futures markets; (3) sound
risk management practices; and (4) other public interest
considerations. The Commission proposes that the amendments would not
have any effect on price discovery.
In the discussion that follows, the Commission provides an overview
of the proposed rules in light of the three relevant 15(a) cost-benefit
considerations previously identified, and then considers the costs and
benefits of each section individually in light of the same 15(a) public
interest considerations. The Commission concludes with additional
requests for public comment on all aspects of its preliminary
consideration of the costs and benefits of the rule proposals.
Overview of the Costs and Benefits of the Proposed Rules and Amendments
in Light of the 15(a) Considerations
Protection of Market Participants and the Public
As stated above, the Commission is proposing amendments to improve
protection of customer funds. Each of the seven parts of the proposal
95 would increase levels of protection for customer funds. Requiring
FCMs to implement risk management programs that include documented
policies and procedures regarding various aspects of handling customer
funds would help protect customer funds by promoting robust internal
risk controls and reducing the likelihood of errors or fraud that could
jeopardize customer funds. In addition, by requiring each FCM to
document certain policies and procedures, the proposed rules would
enable the Commission, DSROs, and
[[Page 67900]]
other auditors to evaluate each FCM’s compliance with their own
policies and procedures. Moreover, the proposed requirement that FCMs
establish a program for quarterly audits by independent or external
people that is designed to identify any breach of the policies and
procedures would help to ensure regular, independent validation that
the procedures are followed diligently. Audits of this sort provide
more thorough review of internal procedures than the Commission or
DSROs would be able to perform regularly with existing resources, which
would provide helpful scrutiny of each FCM’s procedures on a regular
basis. This, together with the proposed requirement that FCMs establish
a program of governing supervision that is designed to ensure the
policies required in Sec. 1.11 are followed, will tend to promote
compliance with the FCM’s own policies and procedures. And by promoting
such compliance, the requirements would reduce the risk of operational
errors, lax risk management, and fraud, and thus the risk of consequent
loss of customer funds.
—————————————————————————
95 The seven parts of the proposal are: (1) Requiring FCMs to
implement risk management programs including extensive written
policies and procedures related to various aspects of their handling
of customer funds; (2) increasing reporting requirements for FCMs
related to segregated customer funds, including daily reports to the
Commission and DSROs; (3) requiring FCMs to establish target amounts
of residual interest to be maintained in segregated accounts as well
as creating restrictions and increased oversight for FCM withdrawals
out of such residual interest in customer segregated accounts,
including clear sign off and accountability from senior management
for such withdrawals; (4) strengthening requirements for the
acknowledgment letters that FCMs and DCOs must obtain from their
depositories; (5) eliminating the Alternative Method for calculating
30.7 Customer funds segregation requirements and requiring FCMs to
include foreign-domiciled customers’ funds in segregated accounts;
(6) strengthening the regulatory requirements applicable to SRO and
DSRO oversight of FCMs, including regulating oversight provided
under the function of a Joint Audit Committee (Joint Audit Program)
that would establish standards for, and oversee the execution of,
FCM audits; and (7) requiring FCMs to provide additional disclosures
to investors.
—————————————————————————
Increasing reporting requirements for FCMs related to segregated
customer funds would help the Commission and DSRO identify FCMs that
should be monitored more closely in order to safeguard customer funds.
Moreover, by making some additional reported information public, the
proposed rules would facilitate additional market discipline that
further promotes protection of customer funds.
Creating restrictions and increased oversight for FCM withdrawals
out of its residual interest in customer segregated accounts, and
requiring sign off from senior management for large withdrawals would
protect customers by helping to ensure that such withdrawals do not
cause segregated account balances to drop below their segregation
requirements. Moreover, it would promote effective oversight of
customer segregated accounts by senior management by increasing their
accountability for withdrawals that affect the balance of such
accounts.
The acknowledgments and commitments depositories would be required
to make through proposed Sec. Sec. 1.20, 1.26, and 30.7 would provide
additional protection for customer funds by, among other things,
requiring depositories that accept customer funds to acknowledge that
customer funds cannot be used to secure the FCM’s obligations to the
depository. Such an acknowledgment would provide additional protection
of customer funds in the event of an FCM’s default. In addition,
depositories would agree in the acknowledgment letter to give the
Commission and DSROs read-only electronic access to an FCM’s segregated
accounts, which would benefit customers by enabling the Commission and
DSROs to monitor the accounts for discrepancies between the FCM’s
reports and the balances on deposit at various depositories. This would
provide an additional mechanism by which customers would be protected
against a shortfall in customer funds due to operational errors or
fraud.
Requiring FCMs to include foreign-domiciled investors’ funds in
segregated accounts ensures that all customers placing funds on deposit
for use in trading foreign futures and foreign options will benefit
from the same protections provided by the Act and Commission
regulations. As discussed below, the Commission understands that most,
if not all FCMs currently extend the same protections to U.S.-domiciled
and to foreign-domiciled customers. However, incorporating foreign-
domiciled customers within the protections provided to 30.7 Customers
places regulatory weight behind the protections and ensures that FCMs
are not permitted to cut corners with respect to protecting foreign-
domiciled customers’ funds during a time of financial strain.
Similarly, eliminating the Alternative Method provides additional
protection to customer funds by ensuring that FCMs are not allowed to
reduce their segregation requirements for 30.7 Accounts during a time
financial strain. As discussed below, this change would provide
protection to both U.S-domiciled and foreign-domiciled customers with
funds in 30.7 Accounts.
The proposed provisions in Sec. 1.52 include additional
requirements for both the supervisory program for SROs as well as for
the formation of a Joint Audit Committee to oversee the implementation
and operation of a Joint Audit Program that directs audits of FCMs by
DSROs. By requiring both the SRO supervisory programs and the Joint
Audit Program to comply with U.S. generally accepted audit standards,
to develop written policies and procedures, to require controls testing
as well as substantive testing, and to have an examinations expert
review the programs at least once every two years, the proposed
amendments would help to ensure that audits of FCMs by SROs or DSROs
are thorough, effective, and continue to incorporate emerging best
practices for such audits. As a consequence, the proposed amendments
would help to ensure that audits are as effective as possible at
identifying potential fraud, strengthening internal controls, and
verifying the integrity of FCMs’ financial reports, each of which tend
to provide protection for FCMs’ customers, counterparties, and
investors.
In addition the proposed Sec. 1.55 would require disclosure of
firm-specific risks to customers. This additional information would
assist them with due diligence when selecting an FCM and would help to
ensure that they are aware of any changes at the FCM that could prompt
them to reconsider their decision to deposit funds with the FCM. In
doing so, the proposed rules would promote market discipline that
incents FCMs to manage their risks carefully and would assist customers
in understanding how their funds are held and what risks may be
relevant to the safety of their funds.
Efficiency, Competitiveness and Financial Integrity of Futures Markets
The proposed amendments would increase the efficiency and financial
integrity of the futures markets by ensuring that FCMs have strong risk
management controls that are subject to multiple and enhanced external
checks, by enhancing reporting requirements, facilitating increased
oversight by the Commission and DSROs, by allowing FCMs flexibility in
the development of newly required policies and procedures wherever the
Commission has determined that such flexibility is appropriate, and by
requiring FCMs to implement training regarding the handling of customer
funds. In addition, the proposed rules include some requirements that
many industry participants have requested as necessary for the adequate
protection of customers and also highlighted as best practices already
adopted within the industry. Requiring such standards to be adopted by
all FCMs will promote the competitiveness of futures markets by
ensuring a level playing field at a minimum level necessary for the
protection of customers, and not allowing any FCMs to, at the expense
of customers, maintain an unfair competitive advantage to their
counterparts who utilize best practices and may have such protections
already in place. There are also provisions in the proposal that permit
FCMs that are not broker-dealers to implement certain securities net
capital haircuts that have been proposed to apply to jointly registered
FCM/BDs by the SEC, which similarly enhances competition by keeping a
level playing field between sole FCMs and jointly registered FCM/BDs
with respect to such requirements.
More specifically, the proposed amendments to Sec. Sec. 1.10,
1.11, 1.12, 1.32,
[[Page 67901]]
22.2, and 30.7 would increase reporting requirements for FCMs related
to segregated customer funds, including daily, bi-monthly, and
additional event-triggered reports to the Commission and DSROs. The
expanded range and frequency of information that the Commission and
DSRO would receive under the proposed regulations would enhance their
ability to monitor each FCM’s segregated accounts, which would promote
the integrity of futures markets by helping to ensure proper handling
of customer funds at FCMs.
In addition, the proposed changes would facilitate increased
oversight by the Commission and DSROs by including additional
notification requirements, obligating FCMs to alert the Commission when
certain events occur that could indicate an FCM’s financial strength is
deteriorating or that important operational errors have occurred. Such
notifications would enable the Commission and DSROs to increase
monitoring of such FCMs to ensure that customer funds are handled
properly in such circumstances. The proposed rules would also require
FCMs and DCOs to obtain an acknowledgment letter from depositories that
would give the Commission and DSROs electronic access to view customer
accounts at each depository. That would enable both the Commission and
DSROs to verify the presence of customer funds which would provide a
safeguard against fraud and would promote the integrity of markets for
futures, cleared options, and cleared swaps.
The proposed rules would also require FCMs to establish policies
and procedures regarding several aspects of how they handle customer
funds. The rules would give FCMs the flexibility, where appropriate, to
develop policies and procedures tailored to the unique composition of
their customer base, size, and other operational disincentives. This
flexible approach protects FCMs from additional regulatory compliance
costs that could otherwise result from rules requiring every FCM to
operate in exactly the same way without sacrificing the additional
accountability that results from written policies and procedures that
the Commission or DSRO can review and use as the basis for FCM audits.
The proposed requirement that FCMs would provide annual training to
all finance, treasury, operations, regulatory, compliance, settlement
and other relevant employees regarding the segregation requirements for
segregated funds, for notices under Sec. 1.12, procedures for
reporting non-compliance, and the consequences of failing to comply
with requirements for segregated funds, would enhance the integrity of
the futures markets by promoting a culture of compliance by the FCM’s
personnel. The training would help to ensure that FCM employees
understand the relevant policies and procedures, that they are
empowered and incented to abide by them, and that they know how to
report non-compliance to appropriate authorities.
Last, the proposing form of the rule would allow FCMs that are not
dual registrants (i.e., are not both FCMs and BDs) to follow the same
procedures as dual registrants when determining what regulatory capital
haircut applies to certain types of securities in which the FCM invests
its own capital or customer funds. This proposed change is needed as
the SEC has proposed a change for broker-dealers which would permit
joint registrants to possibly apply a lower regulatory haircut for
certain securities, but which would not be applicable to sole FCMs
without the proposal. Therefore, the proposal would ensure that sole
FCMs are not competitively disadvantaged and are able to continue
applying the same regulatory capital haircuts for such securities as
joint registrants.
Sound Risk Management
The amendments proposed here, if adopted, would promote sound risk
management by facilitating market discipline, enhancing internal
controls, enabling the Commission and DSROs to monitor FCMs for
compliance with those controls, by minimizing the risk that an FCM’s
financial strain could interfere with customers’ ability to manage
their positions, by requiring FCMs to notify the Commission in
additional circumstances that could indicate emerging financial strain,
and by requiring senior management to be involved in the process of
setting targets for residual interest.
The proposed reporting requirements would enhance market discipline
by providing additional information to investors regarding the location
of their funds, and the size of residual interest buffer that an FCM
targets and maintains in its segregated accounts. This additional
information would be valuable to customers selecting an FCM and
monitoring the location of their funds deposited with the FCM which
would promote market discipline. For example, if an FCM were to
establish a low target for residual interest, or maintain a very low
residual interest, market participants would likely recognize this as a
practice that could increase risk to the funds they have on deposit at
the FCM, and would likely either apply pressure to the FCM to raise
their target, or take their business to a different FCM that maintains
a larger residual interest in customer fund accounts. This market
discipline would incent FCMs to maintain a level of residual interest
that is adequate to ensure that a shortfall does not develop in the
customer segregated accounts.
The proposed rules would also enhance FCM internal controls by
requiring them to establish a risk management program that includes
policies and procedures related to various aspects of how segregated
customer funds are handled. For example, FCMs would be required to
establish procedures for continual monitoring of depositories where
segregated customer funds are held, and would have to establish a
process for evaluating the marketability, liquidity, and accuracy of
pricing for Sec. 1.25 compliant investments.
In addition, documented policies and procedures would benefit the
FCM customers and the public by providing the Commission and DSROs
greater ability to monitor and enforce procedures that FCMs perform to
ensure that the protection of customer funds is achieved, with the
effect that the Commission would have a greater ability to address and
protect against operational errors and fraud that put customer funds at
risk of loss.
Further, through the proposed amendments to Sec. 1.17(a)(4), FCMs
will need to manage their access to liquidity so as to be able to
certify to the Commission, at its request, that they have sufficient
access to liquidity to continue operating as a going concern. This
proposal will provide the Commission with the flexibility to deal with
emerging liquidity drains at FCMs which may endanger customers,
potentially prior to instances of regulatory capital non-compliance,
allowing customer positions and funds to be transferred intact and
quickly to another FCM. This change would promote sound risk management
practices by helping to ensure that customers maintain control of their
positions without interruption.
The proposed additions to notification requirements established in
Sec. 1.12 would enhance the Commission’s ability to identify
situations that could lead to financial strain for the FCM, which makes
it possible for the Commission to monitor further developments with
that FCM more carefully and to begin planning earlier for the
possibility that the FCM’s customer positions may need to be
transferred to other FCMs, in the event
[[Page 67902]]
that the FCM currently holding those positions defaults. Advance notice
helps to ensure customers’ positions are protected by enabling the
Commission to work closely with DCOs and DSROs to identify other FCMs
that have requisite capital to meet regulatory requirements if they
were to take on additional customer positions, thus facilitating smooth
transition of those positions in the event that it is necessary.
Last, residual interest is an important aspect of protection for
customer funds because it enables the FCM to ensure that it can meet
all customer obligations at any time without using another customer’s
funds to do so. In general, the larger the residual interest, the more
secure customer funds are in this respect. By requiring that senior
management set the target for residual interest, and that they conduct
adequate due diligence in order to inform that decision, the proposed
rule promotes both informed decision making about this important form
of protection, and accountability among senior management for this
decision, both of which are consistent with sound risk management
practices.
Other Public Interest Considerations
As discussed above, the recent failures of MF Global and Peregrine,
FCMs to which customers have entrusted their funds, sparked a crisis of
confidence regarding the security of those funds. This crisis in
confidence could deter market participants from using regulated,
transparent markets and clearing which would create additional costs
for market participants and losses in efficiency and safety that could
create additional burdens for the public. The Commission anticipates
that this rule will not only address the current crisis of confidence,
but that it will produce benefits for the public by virtue of avoiding
similar defaults in the future.
These proposed amendments are not, however, without costs. The most
significant costs created by the proposed amendments are those that
increase the amount of capital that FCMs would be required to
contribute to segregated accounts as part of establishing a target for
their residual interest, incent them to hold additional capital,
prevent them from holding excess segregated funds overseas, and that
are created operationally by the formation of a risk management unit
and adoption of new policies and procedures.
Multiple proposed changes would incent or require FCMs to increase
the amount of residual interest that they maintain in segregated
accounts including: (1) Requiring FCMs to establish a target for
residual interest that reflects proper due diligence on the part of
senior management; (2) disclosing the FCMs’ targeted residual interest
publicly; and (3) requiring them to report to the Commission and their
DSRO any time their residual interest drops below that target. In
addition by restricting FCMs’ ability to withdraw residual interest
from segregated accounts and obligating FCMs to report to the
Commission and their respective DSRO each time the residual interest
drops below the target, the proposed regulations would incent FCMs to
hold additional capital, which is also likely to be a significant cost.
When FCMs hold excess customer funds overseas, such funds will
likely be held at depositories that are themselves subject to foreign
insolvency regimes, which may provide protections for customer funds
that are less effective than those applicable under U.S. law. By
prohibiting FCMs from holding excess customer funds overseas, the
proposed regulations could reduce the returns that FCMs may obtain on
invested customer funds.
And last, the proposed requirements related to operational
procedures are likely to create significant costs, particularly related
to creating and documenting policies and procedures, as well as
complying with ongoing training, due diligence, and audit requirements.
However, in several cases the implementation costs of proposed changes
would be minimal. For example, some proposed requirements would
obligate FCMs to provide the Commission and DSROs more regular access
to information that FCMs and their depositories are already required to
maintain, or in some cases are already reporting to their DSROs. The
Commission also anticipates that some of the changes proposed codify
best practices for risk management that many FCMs and DCOs may already
follow. In such cases, the costs of compliance would be mitigated by
the compliance programs or best practices that the firm already has in
place. Moreover, in other cases the proposed changes codify practices
that are already required by SROs, and therefore would impose no
additional costs.
The initial and ongoing costs of the proposed rules for FCMs would
vary significantly depending on the size of each FCM, the policies and
procedures that they already have in place, and the frequency with
which they experience certain events that would create additional costs
under the proposed rules. The Commission estimates that the initial
operational cost 96 of implementing the proposed rules would be
between $193,000 and $1,850,000 per FCM.97 And the initial cost to
the SROs and DSROs would be between $41,100 and $63,500 per SRO or
DSRO. The Commission estimates that the ongoing operational cost to
FCMs would be between $287,000 and $2,300,000 per FCM per year.98 As
described below in Sec. 1.52, the Commission does not have adequate
information to determine the ongoing cost of the proposed requirements
for SROs and DSROs.
—————————————————————————
96 The Commission is not able to quantify the costs that would
result from increased residual interest held in customer segregated
accounts, from increased capital held by the FCM, or from lost
investment opportunities due to restrictions on the amount of funds
that may be held overseas. The Commission does not have sufficient
data to estimate the amount of additional residual interest FCMs are
likely to need as a consequence of proposed, the amount of
additional capital they may hold for operational purposes, the cost
of capital for FCMs, or the opportunity costs FCMs may experience
because of restrictions on the amount of customer funds they can
hold overseas, each of which would be necessary in order to estimate
such costs.
97 The lower bound assumes an FCM requires the minimum
estimated number of personnel hours to be compliant with these new
rules and that, when possible, they already have policies,
procedures, and systems in place that would satisfy the proposed
requirements. The upper bound assumes an FCM requires the maximum
amount of personnel hours and do not have pre-existing policies,
procedures, and systems in place that would satisfy the proposed
requirements. The greatest amount of variation within in the range
would depend on the number of new depositories an FCM must establish
relationships with due to current depositories that would not be
willing to sign the required acknowledgment letter. The lower bound
assumes that an FCM does not need to establish any new relationships
with depositories. The Commission estimates that the largest FCMs
may have as many as 30 depositories, and as a conservative estimate,
the Commission assumes for the upper bound that an FCM would have to
establish new relationships with 15 depositories.
98 As above, the lower bound assumes that an FCM requires the
minimum estimated number of personnel hours to be compliant and that
for event-triggered costs, the FCM bears the minimum number of
possible events. The upper bound assumes an FCM requires the maximum
number of personnel hours to be compliant. It also assumes an FCM
has to notify the Commission pursuant to the proposed amendments in
Sec. 1.12 five times per year, and that an FCM withdraws funds from
residual interest for proprietary use 50 times per year. The
estimate does not include additional costs that would result if FCMs
increase the amount of residual interest or capital that they hold
in response to the proposed rules, or certain operational costs that
the Commission does not have sufficient information to estimate.
—————————————————————————
In the sections that follow, the Commission considers the costs and
benefits of the proposed changes, section by section, in light of the
relevant 15(a) public interest, cost-benefit considerations.
[[Page 67903]]
Consideration of Costs and Benefits Related to Proposed Changes in Each
Section
Sec. 1.3(rr)–Definition of “Foreign Futures or Foreign Options
Secured Amount”
Proposed Changes
As described above in II.R, the proposed amendments to Sec.
1.3(rr) would replace the term “foreign futures or foreign options
customers” with the term “30.7 Customers.” The former only includes
U.S.-domiciled customers, whereas the term “30.7 Customers” includes
both U.S.-domiciled and foreign-domiciled customers who place funds in
the care of an FCM for trading on foreign boards of trade. This change
expands the range of funds that the FCM must include as part of the
foreign options or foreign futures secured amount.
In addition, the definition of “foreign futures or foreign options
secured amount” currently means “all money, securities and property
held by or held for or on behalf of a futures commission merchant from,
for, or on behalf of foreign futures or foreign options customers as
defined in Sec. 30.1.” The proposed definition would change the
meaning of “foreign futures or foreign options secured amount” so
that it is equal to the amount of funds an FCM needs in order to
satisfy the full account balances of each of its customers at all
times. This definitional change supports the shift in Sec. 30.7 from
the “Alternative Method” to the “Net Liquidating Equity Method” of
calculating the foreign futures or foreign options secured amount.
Benefits and Costs
These definitional changes would determine what funds are
considered part of the “foreign futures or foreign options secured
amount.” However, the costs and benefits of these changes are
attributable to the substantive requirements related to the definitions
and, therefore, are discussed in the cost and benefit considerations
related to Sec. 30.7.
Sec. 1.10–Financial Reports of Futures Commission Merchants and
Introducing Brokers
Proposed Changes
As described above in II.A, the proposed amendments would make four
changes. First, they would amend the 1-FR-FCM to create a new schedule
called the “Cleared Swap Segregation Schedule” that would be included
in the FCM’s monthly report, together with the Segregation Schedule and
Secured Amount Schedule. Second, it would make the Cleared Swap
Segregation Schedule a public document.99 Third, the proposed
amendments would require each of the Schedules to include the FCM’s
target for residual interest in the accounts relevant to that Schedule,
as well as a calculation of any surplus or deficit in residual interest
with respect to that target. And fourth, the proposed rule would
require each FCM to submit to the Commission a monthly statement
reporting the FCM’s leverage.
—————————————————————————
99 The Segregation Schedule and Secured Amount Schedule are
already public documents.
—————————————————————————
Benefits
The proposal to include target residual interest and monthly
calculation of the deviation from that target on the monthly Schedules
provides important benefits with respect to the safety of customer
funds. The data in the reports is public information. Public disclosure
incentivizes FCMs to set a reasonable target for residual interest.
Under proposed regulations, FCMs would have to notify the Commission
and their respective DSRO each time they drop below their targeted
residual interest, which gives them an incentive to set a low target,
even if they intend to keep more residual interest in their accounts.
However, by disclosing an FCM’s targeted residual interest to the
public, the proposed rule would enable customers and potential
customers of an FCM to incorporate the size of the FCM’s targeted
residual interest, and the corresponding amount of protection to
customers’ funds provided by that level of residual interest, into
their selection of an FCM. Holding all other considerations constant,
FCMs that have higher targets relative to their segregation
requirements would presumably be more attractive to customers than FCMs
that target smaller levels of residual interest relative to their
segregation requirements because of the additional protection of
customer funds it provides. This additional information permits
customers to weigh this consideration along with considerations of
price in selecting an FCM. Last, by requiring FCMs to report their
leverage monthly, the proposed amendments would assist the Commission
in monitoring each FCM’s overall risk profile, which would help the
Commission to identify FCMs that should be monitored more closely for
further developments that could weaken their financial position.
Costs
As stated above, all else equal, by requiring FCMs to include their
residual interest target in the monthly report, and by making the
contents of those reports public, the proposed rule would incent FCMs
to set a higher target for their residual interest in customer
segregated funds. However, maintaining a larger targeted residual
interest would create some costs for FCMs. Proprietary funds deposited
into customer segregated accounts by an FCM are only allowed to be
invested in Sec. 1.25 investments and, therefore, are not available
for other investments. In addition, placing additional capital in the
customer segregated accounts reduces the amount of capital that an FCM
has to meet operational needs, which would likely prompt the firm to
raise or retain additional capital. Estimating the lost revenue that
would result from the investment opportunities an FCM misses is not
possible because the Commission is not able to estimate either the
amount of increased residual interest that an FCM would, on average,
maintain as the result of this proposed change, or the differential in
return on investment between FCM funds placed into customer segregated
accounts versus proprietary funds not held in such accounts. Similarly
the Commission does not have adequate information to determine the
average cost of capital for FCMs or the amount of additional capital
that they would likely raise or retain as a consequence of this
proposed change. The proposed requirement regarding monthly leverage
statements will require FCMs to produce an additional report each
month. The Commission anticipates that each FCM will incur a one-time
cost in order to modify their systems to create the report, and then
ongoing costs will be negligible because the report is likely to be
automated. The Commission estimates that the one-time setup costs are
likely to be between $2,800 and $5,700.100
—————————————————————————
100 This assumes 40-80 hours of time from both a programmer
and 20-40 hours from an intermediate accountant. The average
compensation for a programmer is $53.64/hour [$82,518 per year/(2000
hours per year)*1.3 = $53.64/hour]; $53.64*40= $2,145.47 and
$53.64*80= $4,290.94. The average compensation for an intermediate
accountant is $34.11/hour [$52,484.00 per year/(2000 hours per
year)*1.3 is $34.11per hour]; $34.11*20= $682.29 and $34.11*40=
$1,364.58. All figures are taken from the 2011 SIFMA Report on
Management and Professional Earnings in the Securities Industry.
—————————————————————————
Requests for Comment 101
—————————————————————————
101 The Commission has numbered its questions throughout the
Cost Benefit Considerations section. When responding to specific
questions, please reference the number of the question. In addition,
commenters should provide analysis and empirical data to support
their views on the costs and benefits associated with the proposed
rule, and should provide information to the Commission that would
enable it to replicate and verify any quantitative estimates.
—————————————————————————
Question 1: The Commission requests comment regarding the costs and
[[Page 67904]]
benefits of these proposed rules, including making residual interest
targets public information. Please explain and, if possible, quantify
the relevant costs and benefits.
Question 2: In addition, the Commission requests comment regarding
the costs and benefits that would result from providing each FCM’s
daily calculation of residual interest public. Would the disclosure of
an FCM’s daily calculations of residual interest pose a risk to such
FCM, the markets, to customers, or the public? If so, please explain.
Or, conversely, would a lack of disclosure exacerbate risks to FCM
customers or the public? If so, please explain.
Question 3: Market participants have suggested that additional
information from FCMs’ daily, bi-monthly, and monthly reports should be
disclosed to the public. What alternatives should the Commission
consider in this respect? What would be the costs and benefits of that
alternative?
Question 4: In addition, the Commission requests information or
data that would assist the Commission in quantifying the cost to FCMs
of placing additional proprietary funds into the customer segregated
account and the benefit to customers of having such additional funds in
the segregated accounts.
Sec. 1.11 Risk Management Program for Futures Commission Merchants
Proposed Changes
As discussed in II.B above, proposed Sec. 1.11 would require an
FCM that carries accounts for customers to establish a risk management
unit that is independent from the business unit and reports directly to
senior management. In addition, it would require each FCM to establish
and document a risk management program, approved by the governing body
of the FCM, that, at a minimum: (a) Identifies risks and establishes
risk tolerance limits related to various risks that are approved by
senior management; (b) includes policies and procedures for detecting
breaches of risk tolerance limits, and for reporting them to senior
management; (c) provides risk exposure reports quarterly and whenever a
material change in the risk exposure of the FCM is identified; (d)
includes annual review and testing of the risk management program; and
(e) meets specific requirements related to segregation risk,
operational risk, and capital risk.
Regarding segregation risk, the proposed rule would require that
each FCM must establish written policies and procedures that require,
at a minimum: (1) Documented criteria for selecting depositories that
would hold segregated funds; (2) a program to monitor depositories on
an ongoing basis; (3) an account opening process that ensures the
depository acknowledges that funds in the account are customers’ funds
before any deposits are made to the account, and that also ensures
accounts are titled appropriately; (4) a process for determining a
residual interest target for the FCM that involves due diligence from
senior management; (5) a process for the withdrawal of an FCM’s
residual interest when such a withdrawal is not made for the benefit of
the FCM’s customers; (6) a process for determining the appropriateness
of investing funds in Sec. 1.25 compliant investments; (7) procedures
to assure that securities and other non-cash collateral held as
segregated funds are properly valued and readily marketable and highly
liquid; (8) procedures that help to ensure appropriate separation of
duties between those who account for funds and are responsible for
statutory and regulatory compliance vs. those who act in other
capacities with the company (e.g., those who are responsible for
treasury functions); (9) a process for the timely recording of all
transactions; and (10) a program for annual training of FCM employees
regarding the requirements for handling customer funds.
The proposed rule would require automated financial risk management
controls that address operational risk, and written procedures
reasonably designed to ensure that an FCM has sufficient capital to be
in compliance with the Act and regulations and to meet its liquidity
needs for the foreseeable future.
Benefits
Establishing a risk management unit with adequate authority;
qualified personnel; and financial, operational and other resources to
carry out the Risk Management Program would enhance protection of
customer funds by mitigating the risk that the effectiveness of the
Program is compromised by a lack of resources. Moreover, separation of
the Risk Management Unit from the Business Unit mitigates the risk that
conflicts of interest could interfere with the effectiveness of the
risk management unit in avoiding situations that may lead to a loss of
customer funds.
Furthermore, by requiring that the risk management unit report
directly to senior management, Sec. 1.11(d) would help ensure that the
risk management unit’s operations and concerns receive prompt attention
from personnel who are able to address any problems that arise, and
also minimizes the risk that conflicts of interest could cause a
breakdown in communications that undermines the effectiveness of the
risk management unit or the Risk Management Program. Each of these
elements, by promoting the risk management unit’s effectiveness, would
help to ensure that the unit will identify and address emerging risks
before such risks threaten the health of the FCM or the security of
segregated customer funds.
The Commission believes the establishment of the proposed risk
management program would provide several benefits to FCMs, customers,
and the public, in particular with respect to the protection of
customer funds.
a. The proposed requirement for FCMs to establish, as part of their
risk management program, specific risk tolerance limits, would provide
additional protection to FCMs by helping to ensure that they have a
system in place to identify emergent risks to the business. By
requiring an underlying methodology for establishing the limits, the
proposed rule would promote reasoned decision making regarding the
limits as they are set and updated. Quarterly review of the risk limits
by senior management and annual review by the Governing Body would help
to ensure that limits are current as the market, business, and customer
base evolve, and also provide accountability for periodic evaluation of
such risks at the most senior levels of the organization, which helps
to ensure that senior leaders are proactively discussing and addressing
the full range of risks that are facing the business. As a consequence,
these measures would help ensure that an FCM is taking whatever steps
are necessary in order to reduce and mitigate the effects of emerging
risks. Moreover, customer funds held at the FCM may face elevated risk
of loss due to misuse or operational errors during times of financial
strain at the FCM. By protecting the health of the FCM, the proposed
requirements mitigate the risk that financial strain at the FCM would
lead to a loss of customer funds that it holds.
b. By requiring policies and procedures for detecting breaches of
the risk tolerance limits and notifying appropriate personnel, the
proposed
[[Page 67905]]
rule would promote objectivity when monitoring of each risk that the
policies address, thus mitigating the risk that poor individual
judgment could cause important emerging risks to go unnoticed, or could
prevent proper personnel from being notified, leading to a loss of
customer funds.
c. The contents of the proposed Risk Exposure Reports would help to
ensure that attention is regularly given to an evaluation of each risk
that is covered in the FCM’s Risk Management Program and that senior
management and the Governing Body of the FCM are made aware of the
findings. They will also help to ensure that the Risk Management
Program is continuously updated to reflect changing risks that face the
business by requiring recommendations to be included in such reports,
which promotes the effectiveness of the Program in protecting customer
funds. Moreover, status updates on any incomplete implementation of
previous recommendations from such reports provide accountability at
the most senior levels of the FCM regarding implementation of
initiatives to improve the Program.
d. Similar to above, review and testing of the risk management
program on an annual basis as well as whenever there is a material
change in the business, would help to ensure that the Risk Management
Program continues to evolve as the risks facing the business evolve,
thus promoting the effectiveness of the program, which in turn, would
help protect the FCM. By requiring an analysis of adherence to the
program the proposed requirement would promote compliance with it. And
requiring the review and testing to be conducted by staff that are
independent of the Business Unit or by an external third party promotes
objectivity and rigor in the findings that would result, and requiring
senior management and the Governing Body of the FCM to review the
findings promptly helps to ensure that any breaches of compliance or
other findings of the review are addressed promptly and effectively. As
above, each of these elements promotes protection for the FCM, which in
turn, reduces the likelihood that risk to the FCM could cause elevated
risk of operational errors that could result in a loss of customer
funds.
e. Regarding segregation risk, the requirements set forth in
proposed Sec. 1.11 would benefit customers and the financial integrity
of markets by requiring FCMs to implement rigorous internal controls
designed to detect and mitigate the risk that operational errors or
fraud could lead to a loss of customer funds. More specifically, and as
discussed above, proposed Sec. 1.11 requires FCMs to establish written
policies and procedures that address 12 components of segregation risk.
The Commission addresses each of those components below.
1. Proposed Sec. 1.11(e)(3)(i)(A) would establish a minimum set of
factors that the FCM would have to incorporate into its due diligence
standards and depositories would have to meet those standards in order
to be eligible to be selected by the FCM to hold customer segregated
funds. As a consequence, customers would have greater clarity about
what factors were considered as their FCM selected individual
depositories, leading to market discipline that encourages the
protection of customer funds.
Documenting the process would enable regulators to review and audit
for rigor of the process and adherence to it. Such documentation would
help regulators identify risk creating operational patterns or errors
that could increase risk to customer funds before those risks are
realized. In addition, documenting such criteria helps to ensure that
the depository is evaluated against substantive criteria that are
relevant to the safety of customer funds held by the depository as a
precondition for placing customer funds there. The proposed
requirement, by specifying certain criteria that must be included in
the FCM’s policies and procedures, would also promote market discipline
by giving customers clarity about what factors, at a minimum, are
considered as part of the FCM’s program for evaluating potential
depositories.
Together, these benefits help to ensure that the FCM and depository
have developed and adhere to procedures that minimize risk to customer
funds, which reduces the risk that an FCM would experience a shortfall
in their customer segregated funds account.
2. Regulation 1.11(e)(3)(i)(B) would require each FCM to establish
a program to monitor depositories on an ongoing basis. This would
mitigate the risk of loss of customer funds resulting from depository
default or malfeasance because FCMs would be better able to discern
emerging problems at the depository in time to move such funds to
another depository before the customer segregated funds are affected.
In addition, as above, documenting such a program would enable the
Commission and DSRO to evaluate the FCM’s diligence in monitoring its
depositories by auditing the FCM’s compliance with its own procedures
in this respect, which would again lead to more effective protection of
customer funds.
3. The proposal makes it clear that before an FCM is permitted to
deposit any customer segregated funds at a depository, the depository
must agree that, if instructed to do so by the Director of DSIO or the
Director of DCR, it will make such transfers without delay. Requiring
the acknowledgment letter to be signed before any funds are deposited
removes uncertainty about whether the depository has been put on notice
that it is required to move funds without delay when directed by the
Director of DSIO or the Director of DCR. In the event of a default by
an FCM, the Commission and relevant DCOs would immediately move
customer funds in order to move open positions to a different FCM.
4. The proposal requires senior management to conduct due diligence
to understand various factors that could impact the amount of residual
interest that would be prudent to maintain in the segregated funds
account, and then reach a determination about a targeted amount. The
benefit of such a requirement is that it would protect customer funds
by creating accountability for senior management. Requiring such due
diligence helps ensure that senior management is attentive to the
causes of segregated funds account underfunding. The requirement allows
both flexibility and accountability in that it allows FCMs to account
for relevant factors that vary across firms when determining an
appropriate target, rather than requiring all FCMs to maintain a common
target for residual interest. However, by requiring them to establish
such a target and to conduct due diligence in doing so, it allows the
Commission and DSROs to audit the FCMs to ensure that they reached
their target through a reasoned decision-making process, and ensures
that the respective boards approve and are responsible for the target.
Maintaining a target enhances market discipline by creating public
accountability for an FCM. It communicates to customers that the FCM
intends to maintain a certain residual interest in the account, and
gives customers an opportunity to consider, when selecting an FCM, the
additional security that varied levels of residual interest may provide
for their funds.
5. A process for the withdrawal of residual interest that is not
for the benefit of customers would help to ensure good communication
and that senior managers are appropriately involved in the decision to
remove
[[Page 67906]]
residual interest from segregated customer accounts. Good
communication, deliberate decision-making, and proper involvement of
senior managers would promote accountability when an FCM is removing
residual interest. These benefits are particularly important at times
when FCMs experience financial stress because good communication,
deliberate decision-making, and proper involvement of senior management
in decisions related to residual interest may be more likely to fail at
such times, creating risk to segregated customer funds. By requiring
FCMs to establish and follow procedures for withdrawals of residual
interest, the rule would help to ensure that such failures do not
occur.
An additional, related benefit is that by ensuring proper
communication with and approval from relevant senior managers before
such withdrawals occur, the proposed changes would enhance
accountability among those managers for decisions that could create
risk for segregated customer funds.
6. FCMs have a range of potential investments that are compliant
with Sec. 1.25. By requiring FCMs to establish a process for deciding
how to invest those funds, the requirement would provide the Commission
and DSRO with a standard by which such investment decisions could be
judged, which would help prevent the FCM from investing primarily in
the least credit-worthy Sec. 1.25 investments. FCMs have an incentive
to invest customer funds in Sec. 1.25 compliant investments that offer
the highest rate of return possible, but it is possible that the Sec.
1.25 investments offering the highest rates of return are also less
credit-worthy or less liquid than other Sec. 1.25 investments.
Requiring FCMs to set up, document and follow a process for assessing
the appropriateness of investing segregated funds in Sec. 1.25
investments ensures that FCMs take steps not only to determine whether
an investment complies with Sec. 1.25 as required by current
regulation, but that the investment is also evaluated with respect to
any risk it may pose to the FCM’s primary responsibilities of
preserving principal and maintaining liquidity when handling customer
funds. In other words, this provision would help to prevent the
possibility of a “race to the bottom” for FCMs investing in Sec.
1.25 compliant assets.
7. If the FCM is not able to get accurate pricing for Sec. 1.25
assets, it is difficult to know whether or not sufficient funds are in
the segregated account. A shortage (and thus, in the event of
insolvency, a loss of customer funds) could occur simply because the
FCM can’t accurately estimate the value of the assets that are there,
or it could also make it easier for the FCM to intentionally skew their
reports regarding funds in the customer segregated accounts by making
favorable assumptions about the value of assets that are difficult to
price. Requiring the FCM to establish a program for assessing the ease
of pricing for Sec. 1.25 assets helps reduce these risks and gives the
Commission and DSRO an opportunity to understand the FCM’s procedures
and to enforce the FCM’s compliance with them. This, in turn, promotes
reasoned and disciplined decision-making with respect to the FCM’s
investment of customer funds in Sec. 1.25 investments. Establishing
procedures to evaluate the liquidity of Sec. 1.25 instruments will
help FCMs minimize the risk of such problems.
8. Appropriate internal controls are critical to the prevention of
fraud. The Commission understands that FCMs typically require that
certain duties are performed by separate people or separate groups of
people in order to ensure that a proper system of checks and
verification remains in place.102 In particular, FCMs generally
ensure that the individuals responsible for reporting and associated
calculations are separate from the individuals responsible for
operational transfers of funds. In the absence of such internal
controls, one person or group of people with access to both movement
and reporting of funds could transfer funds and then, for a time, hide
those transfers from senior management, auditors, and the public.
—————————————————————————
102 See “Initial Recommendations for Customer Funds
Protection” by the FIA Futures Markets Financial Integrity Task
Force.
—————————————————————————
The proposed rule would help protect customer funds by establishing
a regulatory requirement that all FCMs develop procedures to ensure
that the individuals responsible for calculating and reporting
segregation account requirements and segregation account funds do not
share duties with those who are responsible for transferring or
investing segregated funds. This should result in controls to prevent
fraudulent fund transfers.
9. The Commission regulations already require timely recording of
transactions in Sec. 1.35(b), but this proposed addition would require
that FCMs develop written policies and procedures ensure that they have
a consistent process to achieve that outcome. Again, requiring FCMs to
document their procedures helps protect customer funds by enabling the
Commission and DSROs to audit for compliance, detecting and preventing
operational issues that could pose risk to customer funds before those
risks result in an actual loss to customer funds.
10. Proper training of employees would help to ensure that
employees understand the written procedures regarding segregated funds.
The proposed training requirement provides flexibility for an FCM to
determine whether it should develop the required training in house, or
to pay a vendor to develop a training program. Training regarding the
requirements of the Act and Commission regulations regarding handling
customer funds will help to ensure that employees understand how the
procedures and requirements related to customer funds apply to various
situations they face in their work for the FCM. Training regarding the
second and third points mentioned above will help to ensure that the
Commission and DSRO are notified promptly whenever any of the
circumstances covered in Sec. 1.12 occur, or whenever there is a
breach of the FCM’s own policies and procedures, even if the
circumstances in Sec. 1.12 have not occurred. Moreover, by requiring
broad participation in training focused on these points, the proposed
requirement would protect customer funds by encouraging a culture of
accountability and transparency through self-disclosure. Training
regarding the consequences of failing to comply will help to ensure
that employees understand the seriousness with which the Commission
regards violation of these standards, thereby providing an incentive to
diligently adhere to them. In addition, requiring FCMs to provide the
training annually helps ensure that the critical content of this
training is not lost due to the passing of time, or employee turnover.
In addition, by requiring automated financial risk management
controls, the proposed Risk Management Program would reduce operational
risk that could result from “fat finger” errors when submitting
trades, or from technological “glitches” using automated trading.
Several events have demonstrated that such operational risks are
difficult to predict, tend to emerge so quickly that non-automated
forms of risk management may not be able to contain them, and can
threaten an FCM’s continued viability. Automated controls would help to
reduce these operational risks, thereby providing additional protection
to FCMs and mitigating the risk of loss to customer funds.
Last, by requiring an FCM to develop and implement written policies
that ensure it has sufficient capital and liquidity not only to comply
with the
[[Page 67907]]
Act and Commission regulations but also to meet its foreseeable needs,
the proposed rule would promote reasoned decision making regarding
capital retention and allocation decisions because such decisions would
have to be made according to the established policies and procedures,
weighing the factors and inputs included therein. Moreover, written
procedures could be used by the Commission and relevant SROs as the
basis for audits to check for compliance with such procedures, which
would help the Commission and relevant SRO identify operational
problems that could lead to loss of customer funds.
In many cases the proposed rules provide flexibility to FCMs by
requiring that they develop and document their own policies and
procedures rather than prescribing specific procedures for them. In so
doing, the proposal gives FCMs an opportunity to tailor policies and
procedures that accommodate their specific needs and operational
patterns, which may vary from one FCM to another based on differences
in their size, involvement in specific markets, and the characteristics
of their investor base. This approach is likely to be less costly for
FCMs when compared to the alternative of a more prescriptive approach
because it is less likely to require changes to operational patterns if
existing procedures are adequate to provide the same protections to
customer funds. In addition, the flexibility of this approach benefits
market participants and customers alike because it is the FCM that is
in the best position to define the precise form of internal controls
that will best protect customer funds from operational errors and
fraud.
In addition, as suggested above, requiring FCMs to document their
policies and procedures regarding their Risk Management Program would
enable the Commission and DSRO to audit for operational problems that
could put customer funds at risk before those risks turn into actual
losses. This would strengthen the critical first line of defense
against operational errors and fraud.
Costs
The risk management unit, required by the proposed rule, would
create certain personnel costs. The Commission estimates that such a
unit would require between one and ten full-time staff depending on the
size and complexity of the FCM. Therefore, the Commission estimates
that the annual cost for the risk management unit would be between
$171,000 and $1,934,000.103
—————————————————————————
103 This assumes 2,000-10,000 hours per year from compliance
attorneys (i.e., 1-5 full time compliance attorneys) and 0-10,000
hours per year from a senior risk management specialist (i.e., 0-5
full time senior risk management specialists). The average
compensation for a compliance attorney is $85.35/hour [$131,303 per
year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*2000 =
$170,693.90 and $85.35*10,000 = $853,469.50. The average
compensation for a senior risk management specialist is $83.13/hour
[$166,251.00 per year/(2000 hours per year)*1.3 is $83.13 per hour];
$83.13*0 = $0 and $83.13*10,000 = $1,080,631.50.
—————————————————————————
There are costs associated with the Risk Management Program
proposed in Sec. 1.11.
a. Each FCM would likely have to review its operations, business
model, market conditions, customer base, and a number of other factors
in order to identify the risks that it should be monitoring. In
addition, each FCM would have to develop and document methodologies for
establishing risk tolerance limits for each risk that they choose to
monitor. Last, for each FCM, the risks and proposed limits for those
risks would have to be reviewed and approved quarterly by its senior
management and annually by the board. The Commission estimates that the
initial cost for identifying relevant risks and developing and
documenting methodologies for establishing thresholds would be between
$28,800 and $68,400.104 The ongoing cost for reviewing the risks and
limits and approving them would be between $27,900 and $99,700 per
year.105
—————————————————————————
104 For initial costs, this estimates initial costs of 50-250
hours from compliance attorneys, 10-100 hours from risk management
personnel, 36 hours (total) of time from the board, and 10-20 hours
each from the CEO, CFO, COO, and CCO. The average compensation for a
compliance attorney is $85.35/hour [$131,303 per year/(2000 hours
per year)*1.3 is $85.35 per hour]; $85.35*50 = $4,267.35 and
$85.35*250 = $21,336.77. The average compensation for a risk
management specialist is $65.33/hour [$100,500 per year/(2000 hours
per year)*1.3 is $65.33 per hour]; $65.33*10 = $653.25 and
$65.33*100 = $6,532.50. The average compensation for a member of a
firm’s board of directors is estimated by the Commission to be
$200.00/hour [$100,000 per year/(500 hours per year) is $200 per
hour]; $200.00*36 = $7,200.00. The average compensation for a chief
executive officer is estimated by the Commission to be $650.00/hour
[$1,000,000 per year/(2000 hours per year)*1.3 is $650.00 per hour];
$650.00*10 = $6,500.00 and $650.00*20 = $13,000. The average
compensation for both a chief financial officer and a chief
operations officer is estimated by the Commission to be $455.00/hour
[$700,000 per year/(2000 hours per year)*1.3 is $455.00 per hour];
$455.00*10 = $4,550.00 and $455.00*20 = $9,100.00. The average
compensation for a chief compliance officer is $110.97/hour [
$170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];
$110.97*10 = $3,329.18 and $110.97*20 = $11,097.26.
105 For ongoing costs, this estimates annual costs of 20-200
hours from compliance attorneys, 50-300 hours from risk management
personnel, 48 hours (total) of time from the board, and 8-32 hours
each from CEO, CFO, COO, and CCO. Using the same compensation
figures listed above, this is $85.35 *20 = $1,706.94 and $85.35*200
= $17,069.39 for a compliance attorney; $65.33*50 = $3266.25 and
$65.33*300 = $19,597.50 for a risk management specialist; $200.00*48
= $9,600.00 for the board; $650.00*8 = $5,200.00 and $650.00*32 =
$20,800.00 for the CEO; $455.00*8 = $3,640.00 and $455.00*32 =
$14,560.00 for both the CFO and COO; and $110.97*8 = $887.78 and
$110.97*32 = $3,551.12 for the CCO. The compensations of an average
CEO and CFO are estimates by the Commission; the compensation of the
board of directors is based on the average compensation of the
boards of several large FCMs. All other figures are taken from the
2011 SIFMA Report on Management and Professional Earnings in the
Securities Industry.
—————————————————————————
b. Developing these policies and procedures for detecting breaches
of the risk tolerance limits and notifying appropriate personnel would
create an initial cost, but little ongoing cost since most of the
monitoring costs are included in other elements (quarterly reports,
annual audits, etc.). The Commission estimates that the initial cost to
develop these policies and procedures is between $3,400 and
$6,800.106
—————————————————————————
106 This estimates 40-80 hours of time from a compliance
attorney. The average compensation for a compliance attorney is
$85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35
per hour]; $85.35*40 = $3,413.88 and $85.35*80 = $6,827.76. These
figures are taken from the 2011 SIFMA Report on Management and
Professional Earnings in the Securities Industry.
—————————————————————————
c. Many of the activities necessary for completing the quarterly
review of risk thresholds will overlap with the activities necessary
for completing the Risk Exposure Reports. However, some additional time
will be required to compile the Report and to incorporate information
that is distinct from that which is required for the quarterly review
of risk thresholds. In addition, the FCM’s board and senior management
are obligated to review the report. Therefore, the Commission estimates
that each Risk Exposure Report will cost between $8,800 and $13,300 per
year.107
—————————————————————————
107 This estimates 20-50 hours of compliance attorney time,
20-50 hours from risk management personnel, 12 hours of board time,
and 2 hours from each of the CEO, CFO, COO, and CCO. The average
compensation for a compliance attorney is $85.35/hour [$131,303 per
year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*20 =
$1,706.94 and $85.35*50 = $4,267.35. The average compensation for a
risk management specialist is $65.33/hour [$100,500 per year/(2000
hours per year)*1.3 is $65.33 per hour]; $65.33*20 = $1,306.50 and
$65.33*50 = $3,266.25. The average compensation for a member of a
firm’s board of directors is estimated by the Commission to be
$200.00/hour [$100,000 per year/(500 hours per year) is $200 per
hour]; $200.00*12 = $2,400.00. The average compensation for a chief
executive officer is estimated by the Commission to be $650.00/hour
[$1,000,000 per year/(2000 hours per year)*1.3 is $650.00 per hour];
$650.00*2 = $1,300.00. The average compensation for both a chief
financial officer and a chief operations officer is estimated by the
Commission to be $455.00/hour [$700,000 per year/(2000 hours per
year)*1.3 is $455.00 per hour]; $455.00*2 = $910.00. The average
compensation for a chief compliance officer is $110.97/hour [
$170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];
$110.97*2 = $221.95. The compensations of an average CEO and CFO are
estimates by the Commission; the compensation of the board of
directors is based on the average compensation of the boards of
several large FCMs. All other figures are taken from the 2011 SIFMA
Report on Management and Professional Earnings in the Securities
Industry.
—————————————————————————
[[Page 67908]]
d. The Commission estimates that review and testing of the Risk
Management Program will cost between $6,000 and $24,300.108 An FCM
must conduct such a review and testing annually as well as any time it
experiences a material change in the business that is reasonably likely
to alter the risk profile of the FCM. The Commission does not have
adequate information to estimate how frequently such a change in the
business will occur, so it has assumed one review and testing per year.
—————————————————————————
108 This assumes four weeks’ worth of time from one to four
intermediate compliance specialists. The average compensation of an
intermediate compliance specialist is $37.90/hour [$58,303.00 per
year/(2000 hours per year)*1.3 is $37.90]; $37.90*40 hours/week*1 =
$6,063.51 and $37.90*40 hours/week*4 = $24,254.05. These figures are
taken from the 2011 SIFMA Report on Management and Professional
Earnings in the Securities Industry.
—————————————————————————
e. Regarding the policies and procedures that are required to
address segregation risk, proposed Sec. 1.11 would create three sets
of costs: (1) costs related to developing and documenting all required
policies and procedures; (2) initial implementation costs; and (3)
ongoing costs.109
—————————————————————————
109 Developing, documenting, and implementing the requisite
policies and procedures would require personnel hours from
compliance attorneys, senior management, and limited involvement
from others such as risk management, HR, and IT. Those costs are
would vary, perhaps significantly, depending on the extent to which
each FCM already has compliant procedures in place and the extent to
which such procedures may already be documented. However, the
Commission has endeavored to estimate broad ranges of costs that
would likely result from efforts to develop and document the
requirements of Sec. 1.11, to implement compliant procedures, and
then to sustain such procedures on an ongoing basis. And while the
benefits are enumerated separately because their substantive
benefits, in several cases, vary from one requirement to the next,
the substantive costs are, in many cases, overlapping, and therefore
the Commission has addressed them collectively.
—————————————————————————
1. The Commission estimates that developing and documenting
requisite policies and procedures would require one or more compliance
attorneys to be heavily involved interpreting and explaining the Act
and Commission requirements to other affected employees, guiding other
subject matter experts in the development of compliant operations, and
drafting the required documentation. Risk management personnel would
also likely be involved in developing procedures to review banks and
Sec. 1.25 investments as well as to support the due diligence that
senior management will have to conduct in order to establish a target
residual interest for the FCM. The CFO and other senior personnel
reporting to the CFO would likely be involved with selecting a target
for the firm’s residual interest and developing procedures for making
withdrawals of residual interest for proprietary use. The CEO and board
would be involved in reviewing and approving the policies and
procedures required under Sec. 1.11. The Commission estimates that the
likely cost for developing and documenting the policies and procedures
that would be required under the proposed Sec. 1.11 would be between
$54,800 and $131,000.110
—————————————————————————
110 This estimate assumes 400-1000 hours of time from one or
more compliance attorneys re: all aspects of the requirements
(interpreting, summarizing, guiding compliance discussions,
drafting, etc.), 80-160 hours from a firm’s chief compliance officer
re: All aspects of the program, 10-100 hours from risk management
personnel re: bank selection, monitoring, process to assess Sec.
1.25 investment decisions, and due diligence to support targeted
residual amount decision, 4-20 hours from a firm’s chief financial
officer re: selection of target for residual funds and process for
withdrawal of segregated account funds not for the benefit of FCM
customers, 2-4 hours from a firm’s CEO, and 40-50 hours from board
collectively re: discussion and approval of written policies and
procedures. The average compensation for a compliance attorney is
$85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35
per hour]; $85.35*400 = $34,140.00 and $85.35*1000 = $85,350.00. The
average compensation for a chief compliance officer is $110.97/hour
[ $170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];
$110.97*60 = $6,658.35 and $110.97*100 = $11,097.26. The average
compensation for a risk management specialist is $65.33/hour
[$100,500 per year/(2000 hours per year)*1.3 is $65.33 per hour];
$65.33*10 = $653.25 and $65.33*100 = $6,532.50. The average
compensation for a chief financial officer is estimated by the
Commission to be $455.00/hour [$700,000 per year/(2000 hours per
year)*1.3 is $455.00 per hour]; $455.00*4 = $1,820.00 and $455.00*20
= $9,100.00. The average compensation for a chief executive officer
is estimated by the Commission to be $650.00/hour [$1,000,000 per
year/(2000 hours per year)*1.3 is $650.00 per hour]; $650.00*2 =
$1,300.00 and $650.00*4 = $2,600.00. The average compensation for a
member of a firm’s board of directors is estimated by the Commission
to be $200.00/hour [$100,000 per year/(500 hours per year) is $200
per hour]; $200.00*40 = $8,00.00 and $200.00*50 = $10,000.00. The
compensations of an average CEO and CFO are estimates by the
Commission; the compensation of the board of directors is based on
the average compensation of the boards of several large FCMs. All
other figures are taken from the 2011 SIFMA Report on Management and
Professional Earnings in the Securities Industry.
—————————————————————————
2. The policies and procedures must not only be documented, they
must be implemented, which will create some one-time costs that will
depend significantly on the extent to which an FCM already practices
some of the operational procedures that the Commission is requiring
here. While the Commission expects that some FCMs are likely to have
certain policies and procedures in place already that comply with Sec.
1.11, the Commission does not have adequate information to determine to
what extent this is true. Therefore, for the purposes of estimation we
have estimated the one-time costs for an entity that does not yet have
any of the required policies and procedures in place. The Commission
anticipates that in such a circumstance, implementing new policies and
procedures would require risk management personnel to conduct initial
due diligence on depositories and existing as well as prospective Sec.
1.25 investments. Human Resource (“HR”) personnel would have to
revise job descriptions to comply with policies to separate critical
functions related to handling of customer funds, and would also have to
develop new annual training.111 One or more compliance attorneys
would be involved ensuring that accounts are titled appropriately,
securing requisite acknowledgment letters from depositories, setting up
quarterly audits of policies and procedures, and providing general
oversight of the implementation process. IT personnel will likely be
required to automate certain aspects of the information collection that
is necessary, and the CCO would likely be involved on virtually a full-
time basis for some period of time as well, overseeing the
implementation of critical new policies and procedures. The Commission
estimates the cost for such an implementation would range between
$90,800 and $275,300.112
—————————————————————————
111 However, they are likely to outsource some pieces of the
implementation (e.g. annual training would likely be developed by
vendors to meet the needs of multiple market participants) which
will mitigate associated costs. If a firm chooses to use training
created by a vendor, that would likely reduce the HR one-time costs
significantly.
112 This estimate assumes 100-200 hours of risk management
personnel time (from employees of varying levels of pay) conducting
initial due diligence on depositories and evaluating Sec. 1.25
investments, 800-1000 hours of human resources personnel time (400-
500 at a junior level and 400-500 at a senior level) revising job
descriptions to accommodate separation of roles and developing
annual training, 20-400 hours of time from one or more compliance
attorneys for retitling accounts, securing requisite
acknowledgements from depositories, setting up quarterly audits, and
general oversight of implementation of new policies and procedures,
4-12 weeks of the time of a firm’s Chief Compliance Officer, or 160-
480 hours, and 160-800 hours of the time of IT personnel (140-700 at
a junior to intermediate level and 20-100 at a senior level) as the
firm will likely seek to automate some types of information
collection and other steps necessary to support requirements. The
average compensation for a senior risk management specialist is
$108.06/hour [$166,251 per year/(2000 hours per year)*1.3 is $108.06
per hour]; $108.06*100 = $10,806.00 and $108.06*500 = $54,030.00.
The average compensation for a risk management specialist is $65.33/
hour [$100,500 per year/(2000 hours per year)*1.3 is $65.33 per
hour]; $65.33*100 = $6,532.50 and $65.33*500 = $32,665.00. The
average compensation for a junior human resources representative is
$40.95/hour [$62,989 per year/(2000 hours per year)*1.3 is $40.95
per hour]; $40.95*800 = $32,760.00 and $40.95*1000 = $40,950.00. The
average compensation for a senior human resources representative is
$71.45/hour [$109,921 per year/(2000 hours per year)*1.3 is $71.45
per hour]; $71.45*100 = $7,144.87 and $71.45*500 = $35,724.33. The
average compensation for a compliance attorney is $85.35/hour
[$131,303 per year/(2000 hours per year)*1.3 is $85.35 per hour];
$85.35*20 = $1,706.94 and $85.35*400 = $34,138.78. The average
compensation for a chief compliance officer is $110.97/hour [
$170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];
$110.97*160 = $17,755.61 and $110.97*480 = $53,266.82. The average
compensation for a programmer is $53.64/hour [$82,518 per year/(2000
hours per year)*1.3 = $53.64/hour]; $53.64*140 = $7,509.14 and
$53.64*700 = $37,545.69. The average compensation for a senior
programmer is $74.56/hour [$114,714 per year/(2000 hours per
year)*1.3 = $74.56/hour]; $74.56*20 = $1,491.28 and $74.56*100 =
$7,456.41. All figures are taken from the 2011 SIFMA Report on
Management and Professional Earnings in the Securities Industry.
—————————————————————————
[[Page 67909]]
3. The costs necessary to sustain the policies and procedures
required under Sec. 1.11 are difficult to estimate because they would
depend on variables such as the size of the firm, the program of
governing supervision that they develop, and the degree of automation
they achieve in their various ongoing processes (monitoring
depositories, evaluating Sec. 1.25 investments, reevaluating residual
funds target, etc.), and the degree to which their operations are
already compliant with the policies and procedures they would develop
pursuant to the proposed Sec. 1.11. However, as a lower bound, the
ongoing costs would include expenses related to the time for: (1) The
CCO to review quarterly audits and conduct due diligence that is
necessary before providing certification of compliance with the Act,
regulations and its policies and procedures with respect to segregated
funds in the annual report; (2) risk management personnel to evaluate
Sec. 1.25 investments for liquidity and marketability and to monitor
depository institutions where customer segregated funds are held; (3)
the CFO and other senior management to review and determine the
continued appropriateness of the FCM’s target for residual interest;
and (4) HR personnel to organize and deliver annual training. The
Commission estimates that the lower bound for these costs is
approximately $20,000 and that costs may be higher, depending on the
variables mentioned above.113
—————————————————————————
113 This estimate assumes 20+ hours per year from the CCO for
due diligence and certification of compliance on annual report and
reviewing quarterly audits, 40+ hours each per year from junior and
senior risk management personnel evaluating Sec. 1.25 investments
for liquidity and marketability and monitoring depository
institutions where customer segregated funds are held, 6+ hours per
year from the CFO and other senior management for reviewing the
target for the firm’s residual interest, and 20+ hours each per year
from junior and senior HR–organizing and delivering annual
training, as well as at least a day’s training for 20 employees, or
160 hours from an average financial employee, such as a general
intermediate trader. The average compensation for a chief compliance
officer is $110.97/hour [$170,727 per year/(2000 hours per year)*1.3
= $110.97/hour]; $110.97*20 = $2,219.45. The average compensation
for a senior risk management specialist is $108.06/hour [$166,251
per year/(2000 hours per year)*1.3 is $108.06 per hour]; $108.06*40
= $4,322.53. The average compensation for a risk management
specialist is $65.33/hour [$100,500 per year/(2000 hours per
year)*1.3 is $65.33 per hour]; $65.33*40 = $2,613.00. The average
compensation for a chief financial officer is estimated by the
Commission to be $455.00 per/hour [$700,000 per year/(2000 hours per
year)*1.3 is $455.00 per hour]; $455.00*6 = $2,730. The average
compensation for a junior human resources representative is $40.94/
hour [$62,989.00 per year/(2000 hours per year) = $40.94/hour];
$40.94*20 = $818.86. The average compensation for a senior human
resources representative is $71.45/hour [$109,921.00 per year/(2000
hours per year) = $71.45/hour]; $71.45*20 = $1,428.97. The average
compensation for a general intermediate trader is $36.48/hour
[$56,130.00 per year/(2000 hours per year)*1.3 is $36.48 per hour];
$36.48*160 = $5,837.52. The compensations of an average CFO is an
estimate by the Commission. All other figures are taken from the
2011 SIFMA Report on Management and Professional Earnings in the
Securities Industry.
—————————————————————————
In addition, FCMs would have to implement automated financial risk
management controls that are reasonably designed to prevent entering of
erroneous trades. The Commission anticipates that some, but not all,
FCMs already have such systems in place. For those FCMs that do not yet
have such systems in place, the Commission proposes that it would cost
an FCM between $10,300 and $89,400 to implement such a system.114
—————————————————————————
114 This estimates 150-1500 hours of mid-level IT programming
time and 30-120 hours of senior level IT personnel time. The average
compensation for a programmer is $53.64/hour [$82,518 per year/(2000
hours per year)*1.3 = $53.64/hour]; $53.64*150 = $8,045.51 and
$53.64*1500 = $80,455.05. The average compensation for a senior
programmer is $74.56/hour [$114,714 per year/(2000 hours per
year)*1.3 = $74.56/hour]; $74.56*30 = $2,236.92 and $74.56*120 =
$8,947.69. All figures are taken from the 2011 SIFMA Report on
Management and Professional Earnings in the Securities Industry.
—————————————————————————
Sec. 1.12 Maintenance of Minimum Financial Requirements by Futures
Commission Merchants and Introducing Brokers
Proposed Changes
As described in the section by section discussion at II.C, the
proposed changes to Sec. 1.12 would alter the notice requirement so
that it is no longer acceptable to give “telephonic notice to be
confirmed, in writing, by facsimile.” Instead, all notices would be
made in writing and submitted through an electronic medium acceptable
to the Commission (currently, WinJammer).
In addition, as described above in II.C, the proposed changes would
require that if an FCM has a shortfall in net capital but is not sure
of their financial condition, the FCM should not delay notifying the
Commission about the shortfall in net capital. The FCM must communicate
each piece of information (knowledge of the shortfall and knowledge of
the financial condition of the FCM) to the Commission as soon as it is
known.
The proposed requirements in paragraphs (i), (j), (k) and (l) of
Sec. 1.12 identify additional circumstances in which the FCM must
provide immediate written notice to the Commission, relevant SRO and to
the SEC if the FCM is also a broker-dealer. Those circumstances are:
(1) If an FCM discovers that any of the funds in segregated accounts
are invested in investments not permitted under Sec. 1.25; (2) if an
FCM does not have sufficient funds in any of their segregated accounts
to meet their targeted residual interest; (3) if the FCM experiences a
material adverse impact to its creditworthiness or ability to fund its
obligations; (4) whenever the FCM has a material change in operations
including changes to senior management, lines of business, clearing
arrangements, or credit arrangements that could have a negative impact
on the FCM’s liquidity; and (5) if the FCM receives a notice,
examination report, or any other correspondence from a DSRO, the SEC,
or a securities industry self-regulatory organization, the FCM must
notify the Commission, and provide a copy of the communication as well
as a copy of their response to the Commission.
Last, proposed changes in paragraph (n) of Sec. 1.12 would require
that every notice or report filed with the Commission pursuant to Sec.
1.12 would include a discussion of how the reporting event originated
and what steps have been, or are being taken, to address the event.
Benefits
The proposed changes requiring that notice to the Commission be
given in written form via specified forms of electronic communication
not only adapt the rule to account for modern forms of communication,
but also reduce the possibility of notification being delayed in
reaching appropriate Commission staff. The proposed requirement would
ensure that such
[[Page 67910]]
notices are submitted to WinJammer, which forwards notices to
appropriate personnel within the Commission via email within a matter
of minutes, if not seconds.
With respect to the proposed change in Sec. 1.12(a)(2), if an FCM
knows that it does not have adequate capital to meet the requirements
of Sec. 1.17 or other capital requirements, and is also not able to
calculate or determine its financial condition, it is likely that the
FCM is in a period of extraordinary stress. In these circumstances,
time is of the essence for the solvency of the FCM and to the
protection of its customers and counterparties. Therefore, it is
important that the Commission, DSRO, and SEC (if the FCM is also a
broker-dealer) be notified immediately so that they can begin assessing
the FCM’s condition, and if necessary, making preparations to allow the
transfer of the customers’ positions to another FCM in the event that
the FCM currently holding those positions has insufficient regulatory
capital. These preparations help to ensure that the customers’ funds
are protected in the event of the FCM’s default, and that the positions
of its customers are transferred expeditiously to another FCM where
those customers may continue to hold and control those positions
without interruption to the customer’s positions.
The situations enumerated in proposed Sec. Sec. 1.12(i) and (j)
are more specific indicators of potential or existing problems in the
customer segregated funds accounts. Notifying the Commission in such
circumstances will enable it to monitor steps the FCM is taking to
address a shortfall in targeted residual interest, or to direct the FCM
as it takes steps to address improperly invested segregated funds. In
either case, the Commission will be able to be much more closely
involved in rectifying the situation and ensuring the continued
protection of customer segregated funds.
The situations enumerated in proposed Sec. Sec. 1.12(k) through
(l) are circumstances indicating that the FCM is undergoing changes
that could indicate or lead to financial strain. Alerting the
Commission and relevant SRO in such circumstances will enable both to
protect customer funds by monitoring the FCM more closely in order to
ensure that any developing problems are identified quickly and
addressed proactively by the FCM with the oversight of the Commission
and relevant SRO.
The proposed amendment requiring that the FCM notify the Commission
whenever it receives a notice or results of an examination from the
DSRO, SEC, or securities-industry self-regulatory body, would ensure
that the Commission is aware of any significant developments affecting
the FCM that have been observed or communicated by other regulatory
bodies. Such communications could prompt the Commission to heighten its
monitoring of specific FCMs, or create an opportunity for the
Commission to work collaboratively and proactively with other
regulators to address any concerns about how developments in the FCM’s
business could affect customer funds.
The proposed requirement that notifications to the Commission
pursuant to Sec. 1.12 include a discussion of what caused the
reporting event and what has been, or is being done about the event
would provide additional information to Commission staff that help them
quickly gauge the potential severity of related problems that have been
or are developing at the reporting FCM, IB, or SRO. It would also help
Commission staff discern how effectively the reporting entity is
responding to such problems, which could assist the staff in
determining whether the situation is likely to be corrected quickly or
to continue deteriorating.
Costs
As discussed above, the proposed rule requires that FCMs provide
immediate notice to the Commission and its DSRO in five additional
circumstances. These additional requirements create some minimal
reporting costs when such circumstances arise. The Commission estimates
that the total cost of completing and sending the requisite form is
approximately $9,700 and $19,400 per form.115
—————————————————————————
115 This estimates 8-16 hours of time from both the CCO and
the CFO, 10-20 from the General Counsel, 20-40 from a compliance
attorney, and 10-20 from a senior accountant. The average
compensation for a chief compliance officer is $110.97/hour [
$170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];
$110.97*2 = $221.95 and $110.97*4 = $443.89. The average
compensation for a chief financial officer is estimated by the
Commission to be $455.00/hour [$700,000 per year/(2000 hours per
year)*1.3 is $455.00 per hour]; $455.00*2 = $910.00 and $455.00*4 =
$1,820.00. The average compensation for a general counsel is
estimated by the Commission to be $260.00/hour [$400,000 per year/
(2000 hours per year)*1.3 is $260.00 per hour]; $260.00*10 =
$2,600.00 and $260.00*20 = $5,200.00. The average compensation for a
senior accountant is $44.18/hour [$67,971 per year/(2000 hours per
year)*1.3 = $44.18/hour]; $44.18*10 = $441.81 and $44.18*20 =
$883.62. These figures are taken from the 2011 SIFMA Report on
Management and Professional Earnings in the Securities Industry.
—————————————————————————
Ongoing monitoring for any of the five additional circumstances
that require reporting to the Commission, relevant SRO, and to the SEC
if the FCM is a broker-dealer will also create some costs. In its
consideration of the proposed rule, the Commission assumes that FCMs
will automate the process for monitoring residual interest for any
shortfall against the firm’s target. Furthermore, the Commission
anticipates that FCMs will build on the systems that they already have
in place to calculate residual interest once per day at the close of
business. The incremental cost of modifying such systems to monitor
residual interest compared to the target value on an ongoing basis is
likely to be between $1,800 and $6,300.116 Identifying instances
where their FCM has experienced a material adverse impact to its
creditworthiness or ability to fund its obligations, as would be
required by proposed Sec. 1.12(k), would likely require deliberation
among senior leaders at the FCM. Such deliberations, however, would
likely be prompted by observations that such leaders make in the
ordinary course of business, and therefore would not require proactive
monitoring. The Commission estimates that deliberations among senior
leaders to determine whether there is evidence suggesting a material
decrease in the FCM’s creditworthiness has occurred would cost at least
$6,600 per year.117
—————————————————————————
116 This estimates 20-90 hours of personnel time from a
programmer and 10-20 hours of personnel time from a senior
programmer. The average compensation for a programmer is $53.64/hour
[$82,518 per year/(2000 hours per year)*1.3 = $53.64/hour];
$53.64*20 = $1,072.73 and $53.64*90 = $4,827.30. The average
compensation for a senior programmer is $74.56/hour [$114,714 per
year/(2000 hours per year)*1.3; $74.56*10 = $745.64 and $74.56*20 =
$1,491.28. All figures are taken from the 2011 SIFMA Report on
Management and Professional Earnings in the Securities Industry.
117 This estimates at least 8 hours per year from the CFO, the
CCO, and the General Counsel. The average compensation for a chief
compliance officer is $110.97/hour [ $170,727 per year/(2000 hours
per year)*1.3 = $110.97/hour]; $110.97*8 = $887.78. The average
compensation for a chief financial officer is estimated by the
Commission to be $455.00/hour [$700,000 per year/(2000 hours per
year)*1.3 is $455.00 per hour]; $455.00*8 = $3,640. The average
compensation for a general counsel is estimated by the Commission to
be $260.00/hour $400,000.00 per year/(2000 hours per year)*1.3 is
$260.00 per hour]; $260.00*8 = $2,100.00. The figure for the CCO is
taken from the 2011 SIFMA Report on Management and Professional
Earnings in the Securities Industry; other compensations are
estimates by the Commission.
—————————————————————————
Material changes to the FCM’s leadership or business would create
some incremental costs. Some of the material changes envisioned, such
as changes in senior leadership, are discrete events that do not
require monitoring in order to identify. On the other hand, events that
constitute a material change in operations, credit arrangements, or
“any change that could adversely impact the firm’s liquidity
[[Page 67911]]
resources,” 118 would only be reliably recognized as a material
change by someone with a broad knowledge of the firm’s operations and
finances, so the Commission assumes that senior management would
fulfill these requirements. However, identifying and addressing
material changes to the business is a function that senior management
already plays, and therefore monitoring for such changes would not
create any incremental costs. The proposed rule would make it necessary
for senior management, in addition to identifying changes to the
business, to make a decision about whether or not those changes are
material and therefore should be reported. The Commission proposes that
the additional time senior management spends making determinations
about the materiality of changes to the business, as defined by the
proposed rule, would require approximately twenty hours of time from
both the CCO and CFO. Therefore, the Commission estimates that the
monitoring costs would be $11,300 and $22,600.119
—————————————————————————
118 Sec. 1.12(l).
119 This estimates 20-40 hours of time each from the CCO and
CFO. The average compensation for a chief compliance officer is
$110.97/hour [$170,727 per year/(2000 hours per year)*1.3 = $110.97/
hour]; $110.97*20 = $2,219.45 and $110.97*40 = $4,438.90. The
average compensation for a chief financial officer is estimated by
the Commission to be $455.00/hour [$700,000 per year/(2000 hours per
year)*1.3 is $455.00 per hour]; $455.00*20 = $9,100.00 and
$455.00*40 = $18,200.00. The compensations of an average CFO is an
estimate by the Commission. The figure for a CCO is taken from the
2011 SIFMA Report on Management and Professional Earnings in the
Securities Industry.
—————————————————————————
The proposed requirement that notices or reports filed with the
Commission pursuant to Sec. 1.12 include a discussion of how the
reporting event originated and what has been, or is being done to
address the reporting event, will increase the cost of such reports.
The Commission anticipates that this requirement would prompt the CFO,
General Counsel, and CCO of a reporting entity to invest additional
time in developing and reviewing the report. The Commission anticipates
that the incremental cost associated with the additional time spent by
the CFO, General Counsel, and CCO would be between $3,300 and $6,600
per report.120
—————————————————————————
120 This estimates that the CFO, General Counsel, and CCO will
each spend an additional 4-8 hours developing and reviewing the
report. The average compensation for a chief financial officer is
estimated by the Commission to be $455.00/hour [$700,000 per year/
(2000 hours per year)*1.3 is $455.00 per hour]; $455.00*4 =
$1,780.00 and $455.00*8 = $3,640.00. The average compensation for a
general counsel is estimated by the Commission to be $260.00/hour
[$400,000.00 per year/(2000 hours per year)*1.3 is $260.00 per
hour]; $260.00*4 = $1,040.00 and $260.00*8 = $2,100.00. The average
compensation for a chief compliance officer is $110.97/hour [
$170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];
$110.97*4 = $443.88 and $110.97*8 = $887.78. The figure for the CCO
is taken from the 2011 SIFMA Report on Management and Professional
Earnings in the Securities Industry; other compensations are
estimates by the Commission.
—————————————————————————
Additional proposed changes would introduce only minimal, if any,
additional costs. For example, all FCMs already use WinJammer to submit
certain reports to DSROs and to the Commission, so there would not be
any additional cost involved with Sec. 1.12(n)(3) requirement that
such notices to be submitted through that platform rather than via
fax.121 Nor is there any cost associated with this proposed change to
Sec. 1.12(a)(1). The FCM is still required to disclose its financial
condition to the Commission, DSRO and SEC (if applicable) as soon as it
can be ascertained. The proposed change does not alter the information
that the FCM must gather, calculate, or report. It merely requires that
each of the two pieces of information relevant to the requirements in
Sec. 1.12(a)(1-2) are submitted as soon as they are known.
—————————————————————————
121 See NFA Interpretive Notice 9028–NFA Financial
Requirements: The Electronic Filing of Financial Reports. Available
at: http://prodwebvip.futures.org/nfamanual/NFAManual.aspx?RuleID=9028&Section=9. See also CME Advisory Notice:
Enhanced Customer Protections & Rule Amendments, June 27, 2012.
Available at: http://www.cmegroup.com/tools-information/lookups/advisories/clearing/AIB12-08.html.
—————————————————————————
Request for Comment
Question 5: The Commission requests additional information
regarding the costs of these additional notification requirements.
Specifically, how much time will information technology and compliance
personnel have to invest in order to modify systems to calculate
residual interest on a continual basis? How much time would be
necessary to monitor for material changes in the business and what
level of personnel would have to participate in that in order to draw
reliable conclusions about whether or not a material event had
occurred?
Sec. 1.16 Qualifications and Reports of Accountants
Proposed Changes
As discussed above in II.E, the proposed changes would require that
in order for an accountant to be qualified to conduct an audit of an
FCM, that accountant would have to be registered with the Public
Company Accounting Oversight Board (“PCAOB”),122 have undergone at
least one examination by the PCAOB, and have addressed any deficiencies
noted by the PCAOB within three years of the report noting such a
deficiency.
—————————————————————————
122 “PCAOB is a nonprofit corporation established by Congress
to oversee the audits of public companies in order to protect the
interests of investors and further the public interest in the
preparation of informative, accurate and independent audit reports.
The PCAOB also oversees the audits of broker-dealers, including
compliance reports filed pursuant to federal securities laws, to
promote investor protection.” See http://pcaobus.org/Pages/default.aspx.
—————————————————————————
Second, the amendments would require that the governing body of the
FCM ensure that the accountant engaged for an audit is duly qualified,
and specifies certain qualifications that must be considered when
evaluating an accountant for such purpose.
Last, the Commission is proposing to require a public accountant to
state in the audit opinion whether the audit was conducted in
accordance with U.S. generally accepted auditing standards after full
consideration of the auditing standards adopted by the PCAOB.
Benefits
By requiring accountants to be registered with PCAOB and to have
undergone at least one examination by the same, the proposed rule would
help to ensure that the accountant is qualified to audit publicly
traded companies, which are often more complex than those that are
privately held. As a consequence, the proposed requirement would
promote selection of accounting firms that are more sophisticated and
experienced than would necessarily be the case in the absence of the
proposed amendment, which would help to ensure that the accountant is
large enough to maintain independence in its examination and has
adequate experience to deal with the unique aspects of an FCM’s
business model, operational processes, and financial records.
Requiring the FCM’s board to evaluate and approve accountants
conducting audits for the FCM would tend to enhance protection of
customer funds by increasing accountability among the board for any
errors resulting from an accountant’s lack of relevant experience.
Consequently, the requirement would incent the board to choose auditors
carefully, or to provide diligent oversight as senior management makes
such selections. This would promote selection of highly qualified
accountants, which would help to ensure that audits are as effective as
possible in identifying problems with operational controls, potential
indications of fraud, or other warning signs that could enable senior
[[Page 67912]]
management and the Commission or DSRO to protect customer funds more
effectively.
Costs
The Commission anticipates that auditors that are registered with
the PCAOB and that have undergone at least one examination by the PCAOB
are likely to charge more for audits, than those that do not have those
qualifications. However, the Commission does not have adequate
information to estimate the difference in costs.
Request for Comment
Question 6: The Commission requests comment regarding the cost of
audits for an FCM. Specifically, what is the range of costs and average
cost of an audit conducted by auditors with the credentials required in
the proposed rule? What is the range of costs and the average cost of
an audit conducted by auditors without such qualifications?
Sec. 1.17 Minimum Financial Requirements for Futures Commission
Merchants And Introducing Brokers 123
—————————————————————————
123 CEA 4(d)(2), referenced in Sec. 1.17, states, “It shall
be unlawful for any person, including but not limited to any
clearing agency of a contract market or derivatives transaction
execution facility and any depository, that has received any money,
securities, or property for deposit in a separate account as
provided in paragraph (2) of this section, to hold, dispose of, or
use any such money, securities, or property as belonging to the
depositing futures commission merchant or any person other than the
customers of such futures commission merchant.”
—————————————————————————
Proposed Changes
As described in the section by section discussion at II.F, the
Commission is proposing to amend Sec. 1.17 by adding a new provision
that will authorize the Commission to require an FCM to cease operating
as an FCM and transfer its customer accounts if the FCM is not able to
certify and demonstrate sufficient access to liquidity to continue
operating as a going concern.
In addition, FCMs that are dual registrants (FCM and BD) are
allowed to use the Securities and Exchange Commission’s broker-dealer
approach 124 to evaluating the credit risk of securities that the FCM
invests in and assigning smaller haircuts 125 to those that are
deemed to be a low credit risk, should the SEC adopt as final its
proposed rule to eliminate references to credit ratings. The proposed
change to Sec. 17(c)(5)(v) would allow FCMs that are not dual
registrants to use the same approach. Reducing the haircut assigned to
low credit risk securities that the FCM invests in (which would
potentially include some investments compliant with the requirements of
Sec. 1.25), reduces the capital charge that the FCM must take for
investing in those securities.
—————————————————————————
124 As stated above in II.F above, under the SEC proposal, a
BD may impose the default haircuts of 15 percent of the market value
of readily marketable commercial paper, convertible debt, and
nonconvertible debt instruments or 100 percent of the market value
of nonmarketable commercial paper, convertible debt, and
nonconvertible debt instruments. A BD, however, may impose lower
haircut percentages for commercial paper, convertible debt, and
nonconvertible debt instruments that are readily marketable, if the
BD determines that the investments have only a minimal amount of
credit risk pursuant to its written policies and procedures designed
to assess the credit and liquidity risks applicable to a security. A
BD that maintains written policies and procedures and determines
that the credit risk of a security is minimal is permitted under the
SEC proposal to apply the lesser haircut requirement currently
specified in the SEC capital rule for commercial paper (i.e.,
between zero and 1/2 of 1 percent), nonconvertible debt (i.e.,
between 2 percent and 9 percent), and preferred stock (i.e., 10
percent).
125 As stated above in II.F, in computing its adjusted net
capital, an FCM is required to reduce the value of proprietary
futures and securities positions included in its liquid assets by
certain prescribed amounts or percentages of the market value
(otherwise known as “haircuts”) to discount for potential adverse
market movements in the securities.
—————————————————————————
Last, the proposed amendments would change the period of time that
an FCM can wait for margin payments from a customer before taking a
capital charge from three days to one day.
Benefits
As discussed in II.F, an FCM’s ability to meet capital requirements
and segregation requirements is not necessarily a sufficient indicator
of the FCM’s continued viability as a going concern. If an FCM does not
have access to liquidity to meet identifiable, imminent financial
obligations, the FCM will likely default, regardless of the amount of
capital that is recognized on its balance sheet. In such circumstances,
transferring customer positions to another FCM before the current FCM
enters into bankruptcy provides additional protection to customer
funds. Once the FCM enters into bankruptcy, the transfer of customer
positions may be slowed by the trustee’s involvement, which could
interrupt customers’ ability to actively manage those positions. In
addition, if the FCM enters into bankruptcy before transferring
customers’ positions, customer segregated funds may be subject to
trustee fees. Transferring the positions before the FCM enters into
bankruptcy, therefore, provides additional protection to customers by
preserving their ability to continuously manage their accounts and by
protecting their funds from being subject to trustee fees.
By allowing FCMs that are not dual registrants to follow the same
rules as those that are dual registrants, the change would harmonize
the regulation of FCMs with respect to minimal financial requirements.
This would place FCMs that are not dual registrants on a level playing
field with those that are dual registrants, which contributes to the
competitiveness of the financial markets.
In Sec. 1.17(c)(5)(viii), the Commission proposes to reduce the
period of time an FCM can wait to receive margin call payments from
customers before taking a capital charge, which will incent FCMs to
exercise increased diligence when seeking such payments, and therefore
will likely prompt customers to provide such payments more quickly. As
a consequence, the risk that a debit balance could develop in a
customer’s account due to tardy margin call payments would be reduced,
and the amount of residual interest that the FCM would need to maintain
in the segregated accounts in order to protect against the possibility
that such debit balances could cause them to have less that is required
in their segregated accounts would also be reduced. This provides
benefits for the FCM by reducing the amount of capital that it must
contribute to the customer segregated accounts, and for customers, by
promoting more rapid margin call payments from other customers to
support their own positions.
Costs
With respect to costs, the proposed amendment Sec. 1.17(a)(4),
allowing the Commission to require an FCM to transfer its customer
positions if the FCM is not able to immediately certify that its
liquidity is adequate to continue as a going concern, would give the
Commission the authority to force the FCM to transfer its customer
positions to another FCM in such circumstances. This could create
additional costs for the FCM in two different ways. First, it is
possible that while the FCM may not be able to immediately certify that
it has sufficient liquidity to continue as a going concern but may
nevertheless obtain sufficient liquidity before its impending
obligations become due. If the FCM is forced to transfer its positions
before it obtains the liquidity necessary to demonstrate that it may
continue as a going concern, the FCM will have lost its FCM business.
Second, if the FCM is working on obtaining sufficient liquidity to
continue as a going concern, it may be able to obtain such liquidity
under more favorable terms if it has time to consider multiple offers.
However, if the FCM has a
[[Page 67913]]
shortened timeline to consider offers before being forced to transfer
its customer positions to another FCM, it may be forced to accept an
offer that is less attractive than what otherwise would have been the
case.
Regarding the proposed amendment to Sec. 1.17(c)(5)(v) changing
the haircutting procedures for FCMs, lowering the amount of capital
that the FCM must hold reduces the buffer it has to absorb any losses
that result from its own investments. However, the Commission proposes
that even in the absence of the amendment proposed here dual
registrants will be able to use the SEC’s haircutting procedure.
Therefore, only FCMs that are not dual registrants would be impacted by
the proposed change to Sec. 1.17. Moreover, the Commission proposes
that FCMs that are not dual registrants do not typically invest in
securities that would be subject to reduced haircuts under the SEC’s
proposed rules, and therefore the change would not have a significant
impact on the capital requirements for such FCMs.
Reducing the period of time FCMs can wait for customers’ margin
call payments before taking a capital charge may increase the capital
charge that FCMs take due to tardy margin call payments. As a
consequence, proposed Sec. 1.17(c)(5)(viii) would likely force FCMs to
hold more capital, or to more diligently collect margin from customers
on a prompt basis. The Commission does not have adequate information to
estimate the amount of additional capital that FCMs would likely be
required to hold, or the cost of that capital, and therefore is not
able to quantify this cost at this time.
Request for Comment
Question 7: The Commission requests comment regarding whether FCMs
that are not dual registrants typically invest in securities that would
be subject to reduced haircutting procedures under the SEC’s proposed
rules. If an FCM would be subject to reduced haircutting, please
quantify the effect that such investments are likely to have on the
capital requirements for such FCM.
Question 8: In addition, the Commission requests information that
would assist it in quantifying the costs and benefits associated with
reducing the number of days an FCM can wait for margin call payments
before taking a capital charge. Specifically, how much margin is
typically owed by those customers?
Question 9: The Commission also requests comment regarding the
amount of additional capital that FCMs would likely be required to hold
and the average cost of capital for an FCM. In addition, please provide
data and calculations that would enable the Commission to replicate and
validate the estimates you provide.
Sec. 1.20 Futures Customer Funds To Be Segregated and Separately
Accounted for
Proposed Changes
As described in the section by section discussion at II.G, the
proposed amendments to Sec. 1.20 reorganize the section, but also
alter the substance of the section’s requirements in certain places.
Proposed Sec. 1.20 includes a new Appendix A which is a template
for the acknowledgment letter that FCMs and DCOs must obtain from their
depositories. The proposed changes would require FCMs and DCOs to use
the letter in Appendix A to provide the acknowledgment that they must
obtain, and to clarify that the acknowledgment letter must be obtained
before depositing any funds with a depository. The proposed amendments
to Sec. 1.20 also requires FCMs and DCOs file the acknowledgment
letter with the Commission promptly, and to update the acknowledgment
letter whenever there are changes to the business name, address, or
account numbers referenced in the letter. Last, proposed Sec. 1.20
requires that customer funds deposited at a bank or trust company must
be available for immediate withdrawal upon demand by the FCM or DCO,
which effectively prevents them from placing funds into time-deposit
accounts with depositories.
Benefits
Proposed Sec. 1.20(d)(2) would require that FCMs and DCOs use the
template in Appendix A when obtaining written acknowledgments from
their depositories holding futures customer funds. Through this change
would require depositories accepting customer funds to: (1) Recognize
that the funds are customer segregated funds subject to the Act and
CFTC regulations; (2) agree not to use the funds to secure any
obligation of the FCM to the depository; (3) agree to allow the CFTC
and the FCM’s SRO to examine accounts at any reasonable time; (4) agree
to provide CFTC and SRO user login to have read-only access to
segregated accounts 24 hours a day; (5) and agree to release funds in
segregated accounts when instructed to do so by an appropriate officer
of FCM, the Director of DSIO, or the Director of DCR.
These acknowledgments and commitments would result in important
benefits. First, by acknowledging that the funds are subject to the Act
and CFTC regulations, the depository would become accountable for
complying with relevant statutory and regulatory requirements related
to its handling of those funds. Second, the depository would
acknowledge that the FCM is not permitted to use customer funds as
belonging to any person other than the customer which deposited them,
which would also prohibit an FCM from using customer funds to secure
its own obligations. By requiring the FCM or DCO to obtain a statement
from depositories holding customer funds acknowledging these
limitations on use, the proposed rule would ensure that each depository
is aware that the customers’ funds cannot be used to secure the FCM’s
obligations to the depository. Third, the letter constitutes written
permission by the depository to allow CFTC or DSRO officials to examine
the FCM’s customer accounts at any reasonable time, and to view the
those accounts online at any time. As a consequence, the letter would
enable both the Commission and the DSRO to monitor actual balances at
the depository more easily and regularly. This would increase the
probability that any discrepancy between balances reported by the FCM
on its daily customer segregation account reports, and balances
actually held by the depository would be identified quickly by the
Commission or the DSRO. Moreover, with standing authorization from the
depository to examine customer segregated accounts, both the Commission
and DSRO would be better able to move quickly to verify that there is a
problem.
The commitment to distribute funds when directed to do so by the
Director of DSIO, the Director of DCR, or appropriate officials of the
DSRO facilitates the immediate movement of customer funds, and avoids
delay in the release such funds which expedites to the transfer the
customers’ positions or to return the customers’ funds without delay.
The acknowledgment letter also provides some assurances to the
depository, namely, that it is not liable to the FCM for following
instructions to distribute funds from customer segregated accounts at
the direction of the Director of DSIO or the Director of DCR and that
the depository is not responsible for the FCM’s compliance with the Act
or Commission regulations beyond what is expressly stated in this
letter. The letter places depositories holding customer funds on notice
that they must release customer funds without delay when directed to do
so by
[[Page 67914]]
the Director of DSIO or the Director of DCR. The assurance that the FCM
will not hold the depository liable for following instructions from the
Director of DSIO or of DCR should reduce this potential cause for delay
in time-critical situations. Moreover, under the proposed amendments,
depositories must sign the acknowledgment letter in Appendix A in order
to receive funds from an FCM or DCO. If some depositories were not
willing to sign the letter, it would reduce the number of available
depositories for FCMs and DCOs and may force them to move some existing
depository accounts.
The benefit of requiring FCMs and DCOs to obtain an acknowledgment
letter from their depository prior to or contemporaneously with
transferring any customer funds to that depository is that it ensures
that all the protections provided for by the depository’s consent to
the terms of the letter are in place for the full time during which a
depository holds customer segregated funds. In other words, it prevents
the possibility of a gap in the protections created by the requirements
of this section.
By requiring FCMs and DCOs to submit the acknowledgment letters,
signed by their depositories, to both the Commission and the relevant
SRO, the proposed rules should make it easier for the Commission or
relevant SRO to act quickly, when necessary, being confident that the
correct legal permissions are in place. Additionally, requiring the
letters to be retained for five years past the time when customer
segregated funds are no longer held by each depository would ensure
that proper documentation of all relevant acknowledgments and
commitments is in the possession of each party that relies upon the
existence of those commitments in order to effectuate the protections
created by this section.
Last, Sec. 1.12(h) requires that funds deposited by an FCM be
available for immediate withdrawal. If an FCM places customer funds in
time-deposit accounts the depository has the contractual right to
require a period of notice from the FCM before distributing funds at
the FCM’s request. Under the proposed regulation, a period of notice
would not be acceptable given the obligation that the FCM has to return
customer funds to customers upon request. Moreover, placing funds in a
time-deposit account could prevent the DCO, Commission, or Trustee from
being able to effect the immediate movement of customer funds if
required to do so in the event of a default by the FCM. Requiring that
funds be available for immediate withdrawal at the request of the FCM
ensures prompt access to customer funds by all concerned.
Prohibiting FCMs from placing customer funds in time-deposit
accounts would codify a long-standing staff interpretation that
prohibits FCM’s from placing customer funds in such accounts.126 The
interpretation and proposed amendment prohibit such deposits because
time-deposit accounts, by law, must retain the right to a certain
number of days advance notice before allowing a customer to withdrawal
funds. This delay could prevent an FCM from returning all customer
funds in a prompt manner if those customers all demanded their funds
and could prevent the DCO from porting open positions to another FCM in
the event that the FCM currently holding those funds defaulted. The
benefits of codifying the current staff interpretation are that it will
provide additional clarity about the legal force of the requirement,
and will put the requirement in a location where relevant market
participants are much more likely to see it, which reduces the
likelihood that FCMs would violate this prohibition unknowingly.
—————————————————————————
126 See Administrative Determination No. 29 of the Commodity
Exchange Administration dated Sept. 28, 1937 stating, “the deposit,
by a futures commission merchant, of customers’ funds * * * under
conditions whereby such funds would not be subject to withdrawal
upon demand would be repugnant to the spirit and purpose of the
Commodity Exchange Act. All funds deposited in a bank should in all
cases by subject to withdrawal on demand.”
—————————————————————————
Costs
FCMs and DCOs are likely to bear some initial and ongoing costs as
a result of the proposed amendment requiring them to use the template
in Appendix A to obtain the acknowledgment letter from their
depositories. Regarding initial costs, the letter includes new
requirements that existing depositories want to discuss with the FCM or
DCO’s staff. In addition, some existing depositories may not be willing
to sign the new letter, which would force the FCM or DCO to move any
customer funds held by that depository to a different depository,
creating certain due diligence and operational costs. The Commission
estimates that the cost of obtaining a new acknowledgment letter from
each existing depository is between $1,300 and $4,200.127 Based on
conversations with industry participants, the Commission estimates that
FCMs and DCOs would have approximately 1-30 depositories each, from
which they must obtain a new acknowledgment letter. Therefore, the
Commission estimates that the cost of obtaining new acknowledgment
letters from existing depositories is between $2,700 and $82,000 per
FCM or DCO.128 In addition, based on conversations with industry
participants, the Commission estimates that identifying new potential
depositories, conducting necessary due diligence, formalizing necessary
agreements, opening accounts, and transferring funds to a new
depository is likely to take between three to six months and is likely
to require support from compliance attorneys, as well as operations,
risk management, and administrative personnel. The Commission estimates
that the cost of moving accounts from an existing depository that is
not willing to sign the letter is between $50,000 and $102,000.129
—————————————————————————
127 This estimate assumes 10-40 hours of time from a
compliance attorney and 10-20 hours from an office services
supervisor. The average compensation for a compliance attorney is
$85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35
per hour]; $85.35*10 = $853.47 and $85.35*40 = $3,413.88. The
average compensation for an office services supervisor is $40.15/
hour [$61,776.00 per year/(2000 hours per year)*1.3 is $40.15 per
hour]; $40.15*10 = $401.54 and $40.15*20 = $803.09. These figures
are taken from the 2011 SIFMA Report on Management and Professional
Earnings in the Securities Industry.
128 Total figures are taken from previous calculation.
($1,255.01+$4,216.97)/2 = $2,735.99; $2,735.99*1 = $2,735.99 and
$2,735.99*30 = $82,079.69.
129 This estimate assumes one compliance attorney working
full-time for 3-6 months, 50-200 hours from an office services
supervisor, 80-160 hours of time from a risk management specialist,
and 40-60 hours from an intermediate accountant. The average
compensation for a compliance attorney is $85.35/hour [$131,303 per
year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*40 hours/
week*4 weeks/month*3 months = $40,966.54 and $85.35*40 hours/week*4
weeks/month*6 months = $81,933.07. The average compensation for an
office services supervisor is $40.15/hour [$61,776.00 per year/(2000
hours per year)*1.3 is $40.15 per hour]; $40.15*50 = $2,007.72 and
$40.15*200 = $8,030.88. The average compensation for a risk
management specialist is $65.33/hour [$100,500 per year/(2000 hours
per year)*1.3 is $65.33 per hour]; $65.33*80 = $5,226.00 and
$268.84*160 = $10,452.00. The average compensation for an
intermediate accountant is $34.11/hour [$52,484.00 per year/(2000
hours per year)*1.3 is $34.11 per hour]; $34.11*40 = $1,364.58 and
$34.11*60 = $2,046.88. These figures are taken from the 2011 SIFMA
Report on Management and Professional Earnings in the Securities
Industry.
—————————————————————————
Ongoing costs include those created by the additional requirements
the FCM or DCO will have to explain to new depositories when obtaining
the required letter. There may be additional operational costs involved
with monitoring depositories for any change that would necessitate
updating the letter. The per-entity cost of obtaining the letter from
new depositories is likely to be the same as it would for obtaining the
letter from existing depositories (i.e.,
[[Page 67915]]
$1,300 and $4,200). The Commission estimates that the ongoing cost
associated with monitoring for changes that would require the
acknowledgement letter to be updated is between $1,100 and $2,800 per
year.130
—————————————————————————
130 This assumes 20-50 hours per year from an office manager
for monitoring costs. The average compensation for an office manager
is $55.82/hour [$85,875 per year/(2000 hours per year)*1.3 = $55.82/
hour]; $55.82*20 = $1,116.38 and $55.82*50 = $2,790.94. This figure
is taken from the 2011 SIFMA Report on Management and Professional
Earnings in the Securities Industry.
—————————————————————————
The proposed requirement, embedded in the acknowledgment letter,
that depositories provide to the Commission and DSRO online, read-only
access to accounts where customer segregated funds are held, would
create certain costs for depositories that would likely be passed onto
FCMs. The NFA Board of Directors recently approved rule amendments that
will require FCMs to provide their respective DSROs with on-line view-
only access to customer segregated/secured amount bank account
information. NFA has submitted the rule amendments to the Commission
for approval.131 Therefore, the pending NFA rule and the Commission’s
proposed requirement would require banks and trust companies to provide
the Commission and the DSROs with the same read-only access to account
information. The Commission estimates that the cost of this additional
access is between $270 and $540 per account.132
—————————————————————————
131 A copy of the NFA rule submission is available on the NFA
Web site, www.nfa.futures.org.
132 This assumes 4-8 hours per account from a senior database
administrator. The average compensation for a senior database
administrator is $$68.09/hour [$104,755 per year/(2000 hours per
year)*1.3 = $68.09/hour]; $68.09*4 hour = $272.36 and $68.09/hour *8
hours = $554.73. This figure is taken from the 2011 SIFMA Report on
Management and Professional Earnings in the Securities Industry.
—————————————————————————
For all other depositories, the Commission believes that providing
access read-only access to balances and transactions in cash accounts
is possible with existing technology and therefore, for depositories
that already provide such access to their customers, the cost of
providing that access to the Commission and DSRO is likely to be
relatively low. Based on conversations with industry participants, the
Commission estimates that on average an FCM or DCO is likely to have
approximately 5-30 accounts. The Commission estimates that the initial
set-up cost of providing access to each account at depositories that
already provide online access to their customers is approximately $270
and $550 per account.133
—————————————————————————
133 This assumes 4-8 hours per account from a senior database
administrator. The average compensation for a senior database
administrator is $$68.09/hour [ $104,755 per year/(2000 hours per
year)*1.3 = $68.09/hour]; $68.09*4 hour = $272.36 and $68.09/hour *8
hours = $554.73. This figure is taken from the 2011 SIFMA Report on
Management and Professional Earnings in the Securities Industry.
—————————————————————————
On the other hand, for depositories that do not currently provide
such access to their customers, setting up the capability to provide it
to the Commission and DSRO will require that the depository implement
additional technology. The Commission does not have adequate data to
estimate the cost for establishing such a system.
The Commission proposes that the requirement embedded in the
acknowledgment letter that depositories consent to release customer
funds whenever requested to do so by the Director of DCR or Director of
DSIO will not create any additional costs for FCMs, depositories, or
market participants.
The Commission does not anticipate any costs associated with
proposed Sec. 1.20(h) prohibiting an FCM from placing customer funds
in time-deposit accounts since it is codifying a current staff
interpretation and FCMs already abide by this standard.
The remaining requirements in proposed Sec. 1.20 are virtually
identical to those in the existing rule, but are reorganized in order
to improve readability. The changes that are merely the result of
reorganizing identical requirements do not result in any costs for
market participants.
Request for Comment
Question 10: The Commission requests data from which to estimate
the initial and ongoing costs for a depository to establish the
capability to provide read-only access to account balances and
transaction history.
Question 11: The Commission requests comment from the public
regarding the initial and ongoing cost of services provided by vendors
that have the ability to provide regular confirmation of balances at
depositories on both a scheduled and unscheduled basis. Also, would
such services be applicable to custodial accounts, and accounts held at
non-bank depositories (e.g. other FCMs or Money Market Mutual Funds)?
Question 12: The Commission requests comment regarding whether
depositories currently have systems that provide their customers with
continuous read-only access to accounts where securities are held that
provide: (1) Real time or end of day balances for each segregated
account; and (2) descriptions of the types of assets contained in each
account with balances associated with each type of asset. How do the
capabilities of systems that provide continuous read-only access to
customers vary across different types of depositories, foreign or
domestic (i.e. banks, FCMs, DCOs, or Money Market Mutual Funds)?
Question 13: If depositories do not currently have the ability to
provide continuous read-only access to accounts holding customer funds
that display transactions and balances for those accounts, what costs
would be required in order to create such a system?
Question 14: The Commission assumes that the costs and benefits
enumerated above capture the range of costs and benefits that would be
experienced by each type of depository. The Commission requests comment
and quantification regarding any additional costs or benefits that
would be experienced by certain types of depositories such FCMs, bank
and trust companies, depositories of an international affiliate.
Sec. 1.22 Use of Customer Funds Restricted
Proposed Changes
As described in the section by section discussion at II.H, the
Commission recently approved amendments to the definition of the term
“commodity and/or options customer.” 134 In order to retain the
meaning of the term “commodity and/or options customer” as it was
originally defined, the Commission is replacing the term with “futures
customer.” As above, the new term has the same meaning as the original
definition of the term that it is replacing, and therefore there are no
costs or benefits associated with this change.
—————————————————————————
134 The final rulemaking is available on the Commission’s Web
site, www.cftc.gov.
—————————————————————————
In addition, the proposed amendments to 1.22 clarify that the
prohibition against use of a futures customer’s funds to extend credit
to, or to purchase, margin, or settle the contracts of another person
applies at all times. Last, the proposed amendments would clarify that
in order to comply with the prohibition against using one customer’s
funds to “purchase, margin, or settle the trades, contracts, or
commodity options of, or to secure or extend the credit” 135 of any
other
[[Page 67916]]
person, the FCM would be required to ensure that its residual interest
in futures customer funds exceeds the sum of all its futures customer
margin deficits.
—————————————————————————
135 See proposed Sec. 1.22. N.B., the current form of Sec.
1.22 also includes a prohibition against using one customer’s funds
to “to purchase, margin, or settle the trades, contracts, or
commodity options of, or to secure or extend the credit of, any
person other than such customer or commodity option customer.”
—————————————————————————
Benefits
The benefit of the proposal is that it protects customer funds by
requiring continual customer segregation balancing thereby avoiding the
potential that an FCM could employ end-of-day balancing to obscure a
shortfall the FCM experienced in the middle of the day.
Under current regulations it is not permitted for an FCM to use one
customer’s funds to purchase, margin, secure or settle positions for
another customer. However, the current regulations do not specify how
FCMs must comply with this requirement. The proposed rule would specify
that FCMs must maintain residual interest in customer segregated
accounts that is larger than the sum of all customer margin deficits,
which would ensure that the FCM is not using one customer’s funds to
purchase, margin, secure, or settle positions for another customer.
Furthermore, when combined with the reporting requirements in
Sec. Sec. 1.10, 1.32, 22.2, and 30.7, which require the FCM to report
both the sum of their customer margin deficits as well as their
residual interest in customer segregated accounts, the proposed
approach would provide the Commission and the public with sufficient
information to verify that FCMs are not using one customer’s funds to
purchase, margin, secure or settle positions for another customer.
Costs
If the sum of an FCM’s customer margin deficits is greater than the
residual interest an FCM typically maintains in their customer
accounts, then the FCM would have to increase the amount of residual
interest it maintains in customer segregated accounts, which would
reduce the range of investment options the FCM has for those additional
funds and may prompt the FCM to maintain additional capital to meet
operational needs. On the other hand, if an FCM typically maintains
residual interest in customer segregated accounts that is greater than
the sum of their customer margin deficits, then the proposed rule would
not create any additional costs. In the past, the Commission has not
required FCMs to report the sum of their customers’ margin deficits.
Therefore, the Commission does not have adequate information to
determine whether FCMs typically hold residual interest that is greater
than the sum of their customers’ margin deficits and cannot estimate
the cost of the proposed rule.
Request for Comment
Question 15: The Commission requests comment regarding whether FCMs
typically maintain residual interest in their customer segregated
accounts that is greater than the sum of their customer margin
deficits, and data from which the Commission may quantify the average
difference between the amount of residual interest an FCM maintains in
customer segregated accounts and the sum of customer margin deficit.
Question 16: How much additional residual interest would FCMs hold
in their customer segregated accounts in order to comply with the
proposed regulation? What is the opportunity cost to FCMs associated
with increasing the amount of capital FCMs place in residual interest,
and data that would allow the Commission to replicate and verify the
calculated estimates provided.
Question 17: The Commission request information regarding the
additional amount of capital that FCMs would likely maintain in their
customer segregated accounts, if any, to comply with the proposed
regulation. What is the average cost of capital for an FCM? Please
provide data and calculations that would allow the Commission to
replicate and verify the cost of capital that you estimate?
Sec. 1.23 Interest of Futures Commission Merchants in Segregated
Funds; Additions and Withdrawals
Proposed Changes
As described in the section by section discussion at II.I, the
proposed text changes the term “customer funds” to “futures customer
funds.” This is a conforming change in order to retain the same
meaning once the term “customer” is redefined in Sec. 1.3.136 The
Commission anticipates that there are no costs or benefits associated
with this change.
—————————————————————————
136 The Commission recently approved final amendments to Sec.
1.3 that revised the definition of the term “customer” to include
commodity customers, options customers, and swap customers. A copy
of the Federal Register release is available on the Commission’s Web
site, www.cftc.gov.
—————————————————————————
The proposed Sec. 1.23 also places new restrictions regarding an
FCM’s withdrawal of residual interest funds for proprietary use. Under
the proposed Sec. 1.23, an FCM cannot withdraw funds for proprietary
use unless they have prepared the daily segregation calculation from
the previous business day and must adjust for any activity or events
that may have decreased residual interest since close of business the
previous day. In addition, an FCM is only permitted to withdrawal more
than 25% of its residual interest for proprietary use within one day if
it: (1) Obtains a signature from the CEO, CFO or other senior official
as described in Sec. 1.23(c)(1) confirming approval to make such a
withdrawal; and (2) sends written notice to the CFTC and DSRO
indicating that the requisite approvals from the CEO, CFO or other
senior official has been obtained, providing reasons for the
withdrawal, listing the names and amounts of funds provided to each
recipient, and providing an affirmation from the signatory indicating
that he or she has knowledge and reasonable belief that the FCM is
still in compliance with segregation requirements after the withdrawal.
In addition, if the FCM drops below its target threshold for
residual interest because of a withdrawal of residual interest for
proprietary use, the next day it must either replenish residual
interest enough to surpass its target, or if senior leadership believes
the original target is excessive, the FCM may revise its target in
accordance with its policies and procedures established in proposed
Sec. 1.11.
Benefits
The proposed restrictions on withdrawals of residual interest
provide an additional layer of protection for customer funds contained
in segregated accounts. An FCM may withdraw residual interest as long
as it always maintains sufficient FCM funds in the account to cover any
shortfall that exists in all of its customers’ segregated accounts.
However, as a practical matter, the segregation requirements fluctuate
constantly with market movements, and customer surpluses or deficits
also fluctuate depending on the speed with which customers meet margin
calls. As a consequence, an FCM is not expected to have a precise,
real-time knowledge of the amount of residual interest it has in a
segregated account. The Commission recognizes that any precise, real-
time, single calculation would almost immediately become obsolete as
the value of customers’ accounts and their obligations to the FCM
continue to fluctuate. Moreover, a sufficient amount of residual
interest to cover deficiencies in customers’ accounts at one point in
time may be inadequate to cover such deficiencies an hour later, or
even a few minutes later. Therefore, it is important
[[Page 67917]]
for an FCM to maintain sufficient residual interest to cover both
current deficiencies in customer accounts as well as any additional
deficiencies that could develop over a relatively short period of time.
Restrictions on withdrawals of residual interest help to ensure that
the FCM does not withdraw too much residual interest, either knowingly
or unknowingly, and jeopardize customer funds in the segregated
account.
Prohibiting any withdrawal of residual interest until the customer
segregation account calculations are complete for the previous day and
requiring the FCM take into account any subsequent developments in the
market or the account that could impact the amount of residual interest
before withdrawing funds protects customer funds by reducing the
likelihood that lack of current information could cause the FCM to make
a withdrawal from customer funds that is large enough to cause the
account to fall below its segregated funds requirement.
In addition, the proposed amendment would require several steps in
order for an FCM to remove more than 25% of their residual interest in
a single day. Large, single-day withdrawals of the FCM’s residual
interest in the customer segregated account could be an indication of
current or impending capital or liquidity strains at the FCM. The
additional steps ensure that senior management is knowledgeable of and
accountable for such withdrawals, that no shortfall in the customer
segregated accounts is created by the withdrawals and that the CFTC and
DSRO are both alerted and can monitor the FCM and its segregated
accounts closely over subsequent days and weeks. Additional monitoring,
in turn, would help to ensure that the integrity and sufficiency of the
FCM’s customer segregated accounts are carefully protected. In
addition, notifying the CFTC and DSRO gives both an opportunity to ask
questions about the FCM’s reasonable reliance on its estimations of the
adequacy of its funds necessary to meet segregation requirements. Such
questions may give the Commission and DSRO comfort that the transaction
does not indicate any strain on the FCMs financial position, or
conversely, may raise additional questions and alert the CFTC and DSRO
to the need for heightened monitoring of the FCM or further
investigation of its activities. Also, while the proposed regulations
would reduce the risk that customer funds could be missing in the event
of an FCM’s bankruptcy, the proposed rule would establish a second
layer of protection by ensuring that the Commission has records
regarding the name and address of parties receiving funds from the
distribution of residual interest.
In addition, requiring an FCM to replenish its residual funds the
following day any time a withdrawal causes it to drop below the FCM’s
target amount helps to ensure that residual interest is not used by the
firm to address liquidity needs in other parts of the firm unless those
needs are very short-term in nature (i.e., less than 24 hours).
Costs
These procedural requirements will create some costs for FCMs.
Restricting an FCMs ability to withdraw residual interest until daily
calculations have been completed may prevent the FCM from withdrawing
funds quickly in order to meet certain operational needs, or to take
advantage of specific investment opportunities. This restriction may
also force the FCM to hold additional capital in order to reduce the
potential that it would need funds from its residual interest in order
to meet any operational needs. The Commission does not have adequate
information to estimate the amount of additional capital that an FCM
might be likely to hold, or the cost of capital for those funds.
Moreover, calculating the opportunity cost for an FCM’s potential
missed opportunities is not possible since, by definition, they depend
on the alternative opportunities available to the FCM and the
Commission does not have adequate information to determine what those
opportunities might be.
In addition, abiding by the procedures for withdrawals of residual
interest for proprietary use, whether the withdrawals are less than or
greater than 25% of the FCM’s residual interest, would create
operational costs as these percentages must be calculated and requisite
permissions will require time to obtain. The additional cost created by
procedures that are required for additional withdrawals below 25% of
the FCM’s residual interest will depend significantly on the procedures
the FCM develops, and the extent to which the FCM has already
implemented similar procedures. The Commission does not have adequate
information to estimate these incremental costs. If an FCM withdraws
more than 25% in a given day they have to get certain signatures and
have to send a notification to the Commission. It is also likely that
the Commission would follow up with questions about the withdrawal. The
Commission proposes that obtaining the necessary signatures, reviewing
the notification sent to the Commission, and conducting any follow-up
conversations would require time from an attorney and office staff
personnel. Therefore, the Commission estimates that the additional cost
to an FCM for complying with procedures to withdraw 25% or more of
their residual interest in a single day is likely to be between $850
and $1,100 each time an FCM needs to make such withdrawals.137
—————————————————————————
137 This assumes 6-8 hours of a compliance attorney’s time and
6-8 hours of an office manager’s time. The average compensation for
a compliance attorney is $85.35/hour [$131,303 per year/(2000 hours
per year)*1.3 is $85.35 per hour]; $85.35*6 = $512.08 and $85.35*8 =
$682.78. The average compensation for an office manager is $55.82/
hour [$85,875 per year/(2000 hours per year)*1.3 = $55.82/hour];
$55.82*6 = $334.91 and $55.82*8 = $446.55. These figures are taken
from the 2011 SIFMA Report on Management and Professional Earnings
in the Securities Industry.
—————————————————————————
Request for Comment
Question 18: The Commission invites comment regarding the amount of
additional capital that FCMs would likely hold because of restrictions
on their ability to withdraw residual interest and the cost of capital
for those funds.
Question 19: In addition, the Commission requests comment regarding
the extent to which FCMs already have procedures in place that would
satisfy the requirements in Sec. Sec. 1.11 and 1.23 regarding
withdrawals of residual interest. For an FCM that do not have such
procedures in place already, please quantify the additional cost that
the FCM will bear as a consequence of complying with any policies and
procedures it may develop and implement in order to satisfy the
requirements of Sec. Sec. 1.11 and 1.23 with respect to withdrawals of
residual interest.
Sec. 1.25 Investment of Customer Funds
Proposed Changes
As described in the section by section discussion at II.J, Sec.
1.25 permits FCMs and DCOs to use customer funds to purchase securities
from a counterparty under an agreement for the resale of the securities
back to the counterparty. This type of transaction is often referred to
as a “repo,” and in effect, is a collateralized loan by the FCM to
its counterparty. Currently, Sec. 1.25(b)(3)(v) establishes a
counterparty concentration limit, prohibiting FCMs and DCOs from using
more than 25% of the total funds in the customer segregated account to
conduct reverse repos with a single counterparty. The proposed
amendment would expand the definition of a counterparty to include
additional entities under common ownership or control. The proposed
amendment
[[Page 67918]]
incorporates the Commission’s interpretation of the existing rule, and
therefore does not alter its meaning. Therefore, the Commission does
not anticipate that the proposed amendment will create any costs or
benefits.
The additional proposed changes to Sec. 1.25 are conforming
amendments proposed in order to harmonize this section with other
amendments proposed in this release, and therefore do not create any
additional costs or benefits.
Sec. 1.26 Deposit of Instruments Purchased With Customer Funds
Proposed Changes
As described in the section by section discussion at II.K, proposed
Sec. 1.26 would change the term “commodity or option customers” to
“futures customers.” This is a conforming change in order to retain
the same meaning once the term “customer” is redefined in Sec. 1.3.
In addition, the other changes proposed for Sec. 1.26(a-b) require
that FCMs and DCOs obtain a written acknowledgment letter from
depositories in accordance with the requirements established in Sec.
1.20. This change introduces significant additional specificity
regarding the timing and content of the letter that FCMs and DCOs must
obtain from their depositories. The specifics of those requirements, as
well as the costs and benefits of them, are detailed in the discussion
of costs and benefits for Sec. 1.20, discussed in the cost benefit
considerations section related to Sec. 1.20.
If, however, an FCM or DCO invests funds with a money market mutual
fund and those funds are held directly by the money market mutual fund
or its affiliate, then the FCM or DCO must use the acknowledgment
letter proposed in Appendix A of Sec. 1.26 rather than the
acknowledgment letters in the appendices of Sec. 1.20. The content of
the letter in Sec. 1.26 is identical to those in Sec. 1.20 except
that it includes three additional provisions related specifically to
funds held by the money market mutual fund or its affiliate (“MMMF”).
Specifically, it requires that: (1) the value of the fund must be
computed and made available to the FCM or DCO by 9:00 a.m. of the
following business day; (2) that the fund must be legally obligated to
redeem shares and make payments to its customers (i.e. the FCM or DCO)
by the following business day; and (3) the money market mutual fund
does not have any agreements in place that would prevent the FCM or DCO
from pledging or transferring fund shares.
Benefits
The benefits are largely the same as for the acknowledgment letters
required in Sec. 1.20, described above in the cost benefit section
related to Sec. 1.20. However, requiring FCMs and DCOs to have Money
Market Mutual Funds (“MMMFs”) sign a different acknowledgment letter
if customer funds are held directly with the money market mutual fund
or its affiliate has some benefits.
First, requiring the MMMF to compute the value of the fund and make
that available to the FCM or DCO by 9:00 a.m. the following business
day ensures that FCMs will have the information they need in order to
produce their daily segregation calculations by 12:00 p.m. the
following business day (i.e., three hours later), which is an existing
requirement for FCMs.138 This is important not only because it
enables the FCM to comply with the requirement to produce segregation
calculations by 12:00 p.m. the following day, but because under the
proposed rule, FCMs would not be allowed to withdraw residual interest
until the daily segregation calculations are completed. Second, by
requiring the fund to redeem shares and make payments to their
customers by the following business day, the proposed requirement
prohibits MMMFs from entering into any agreement with an FCM or DCO
that gives the MMMF a contractual right to delay payment, thus
preventing similar risks to what would occur if FCMs were allowed to
place funds in time-deposit accounts. Last, by prohibiting the MMMF
from imposing restrictions that would prevent the FCM or DCO from
pledging or transferring fund shares, the letter would ensure that FCMs
are able to use their shares as collateral at the DCO and that those
shares could be transferred from one FCM to another in the event of the
first FCM’s default.
—————————————————————————
138 See Sec. Sec. 1.32, 22.2, and 30.7.
—————————————————————————
Costs
As discussed above in the cost benefit considerations section
related to Sec. 1.20 the NFA already requires electronic read-only
access to customer accounts, so the Commission does not anticipate that
providing the same access to the Commission will create additional
costs.
In addition, if an FCM or DCO currently has an account with a money
market mutual fund that, either directly or through an affiliate, holds
its own funds, and that fund is either not compliant with the
additional provisions of the letter in Appendix A Sec. 1.26 or is
unwilling to sign the proposed acknowledgment letter, the FCM or DCO
would bear some costs related to identifying a compliant money market
mutual fund, conducting due diligence, and moving its accounts to that
fund. This would force the FCM or DCO to identify a new MMMF that is
qualified to accept its customer funds, creating the same costs that
are described above in the cost benefit considerations section related
to Sec. 1.20.
Request for Comment
Question 20: The Commission requests comment regarding the
likelihood that money market mutual funds holding segregated funds from
FCMs or DCOs are not compliant with the additional terms contained in
the proposed acknowledgment letter. In addition, what costs would an
FCM or DCO bear when identifying a compliant money market mutual fund
and transferring their customer funds to that money market?
Question 21: In addition, the Commission requests comment regarding
whether the requirements contained in the acknowledgment letter,
discussed in Sec. 1.20, would impact money market mutual funds
differently from any other depositories.
Sec. 1.29 Gains and Losses Resulting From Investment of Customer Funds
Proposed Changes
As described in the section by section discussion at II.L, under
the Commission’s existing regulations, Sec. 1.29(a) states that FCMs
or DCOs investing customer funds in Sec. 1.25 investments are entitled
to the return on those investments. Proposed Sec. 1.29(b) provides
that FCMs or DCOs investing customer segregated funds in instruments
described in Sec. 1.25 also bear sole responsibility for the losses
that result from those investments.
Benefits and Costs of the Proposed Changes
This change was recommended by FIA, which stated its belief that
the FCM or DCO’s responsibility for losses in Sec. 1.25 investments
“is clear and is implicit in the Act and the Commission’s rules.”
139 The Commission believes that market participants already
recognize this and act accordingly. Therefore the Commission does not
believe that
[[Page 67919]]
proposed Sec. 1.29(b) would create any additional costs.
—————————————————————————
139 FIA, “Initial Recommendations for Customer Funds
Protection.” Available at: http://www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer_Funds_Protection.pdf.
—————————————————————————
Sec. 1.30 Loans by Futures Commission Merchants; Treatment of Proceeds
Proposed Changes
As described in the section by section discussion at II.M, Sec.
1.30 permits the FCM to lend its own funds to a customer on securities
and property pledged by the customer, effectively performing a
collateral transformation service. The proposed amendment to Sec. 1.30
clarifies that, while an FCM may provide secured loans to a customer,
it may not make loans to a customer on an unsecured basis or use a
customer’s futures or options positions as security for a loan from the
FCM to that customer.
Benefits
The proposed prohibition against FCMs providing unsecured loans to
customers reduces counterparty risk borne by the FCM position because
it prevents the FCM from accumulating exposures to customers that have
not margined their positions. In addition, the proposed rule would
prohibit an FCM from using a customer’s positions to secure loans made
to customers, which would also reduce the FCM’s counterparty risk. If
an FCM used a customer’s positions to secure a loan to that customer,
the FCM would be using the same collateral to secure two different
liabilities: the liability associated with the open position; and the
liability associated with the unsecured loan. By prohibiting FCMs from
using a customer’s positions to secure a loan to that customer, the
proposed rule would prevent the additional exposure that would
otherwise result from using the same collateral to secure two different
liabilities, which again, reduces the FCM’s counterparty risk.
In addition, to the extent that the proposed change would force
customers to obtain such loans from another lender, it diversifies the
counterparty risk across multiple entities. That benefits the FCM that
would otherwise bear more concentrated customer risk, and likely would
be good for the markets more generally because of the additional
protection that it provides to any clearinghouse of which the FCM is a
member.
Costs
Regarding costs associated with the proposed restriction–customers
that need or prefer to use borrowed funds to meet their initial and
maintenance margin requirements for certain positions would be forced
to obtain loans necessary to fund their futures or options positions
from another lender. That would increase the customer’s operational
costs since they would have to transfer funds from one institution to
another and would have to administer both accounts. In addition, it is
likely that lenders will conduct more due diligence than would be the
case if the FCM were to loan the requisite funds, which will create
additional costs related to such a loan, both for the customer and for
the party lending the funds.
Request for Comment
Question 22: The Commission requests comment regarding how often
FCMs currently make loans to customers on either a secured or unsecured
basis, and what the processes and terms typify such loans (including
details regarding the process for evaluating credit risk, size of such
loans, payment terms, collateral, and any other details that commenters
believe the Commission should consider).
Question 23: In addition, the Commission requests information
regarding the additional operational costs that customers would bear if
they have to obtain a loan from an entity other than the FCM holding
their funds in a customer segregated account. If possible, please
quantify the additional costs.
Sec. 1.32 Reporting of Segregated Account Computation and Details
Regarding the Holding of Customer Funds
Proposed Changes
As described in the section by section discussion at II.N, The
proposed changes would allow an FCM that is not a dual registrant to
follow the same procedures as dual registrants (FCM/BDs) when assessing
a haircut to securities purchased with customer funds if the FCM
determines that those securities have minimal credit risk. This is the
same change as is proposed in Sec. 1.17 except that in Sec. 1.17 the
proposed change refers to securities purchased by an FCM with its own
capital, whereas the proposed change here would apply to securities
purchased with customer funds. The change proposed here would create
the same costs and benefits as described above in the cost benefit
considerations section related to Sec. 1.17.
In addition, the proposed changes would: (1) Require FCMs to report
daily Segregation Statements to the Commission and their DSRO
electronically by noon the following business day; (2) require that
twice per month, each FCM submit a detailed list of depositories report
listing of all the depositories and custodians where customers
segregated funds are held, including the amount of customer funds held
by each entity and a break-down of the different categories of Sec.
1.25 investments held by each entity; and (3) require that the detailed
list of depositories be submitted to the Commission electronically by
11:59 p.m. the following business day and that both Segregation
Statements and Detailed list of depositories be retained by the FCM in
accordance with Sec. 1.31.
Benefits
Requiring FCMs to submit their daily calculations to the Commission
and DSRO, together with the proposed amendments to Sec. Sec. 1.20 and
1.26 giving the Commission and DSRO electronic access to view the
balances of all depository accounts where customer segregated funds are
held, will enable the Commission and DSRO to better protect customer
funds by more closely monitoring for any discrepancies between the
assets in segregated accounts reported by the FCM and their
depositories. The ability of the Commission and DSRO to check for
discrepancies more regularly, without notice, is likely to provide an
additional disincentive to fraud. Moreover, it will enable both the
Commission and DSROs to monitor for any trends that would indicate
operational or financial problems are developing at the FCM, which
would give the Commission an opportunity to enhance its supervision and
to intervene, if necessary, to protect customer segregated funds.
The detailed list of depositories would provide additional
information to the Commission and DSRO beyond what would be available
to both by virtue of the electronic read-only access that has been
proposed in Sec. Sec. 1.20, 1.26, and 30.7. First, the detailed list
of depositories will provide additional account detail including the
types of securities and investments that constitute each account’s
assets rather than existing reports that only include the total value
securities. Second, the reports will account for any pending
transactions that would not necessarily be apparent when viewing a
depository account online. Third, FCMs will, in these reports, provide
to the Commission and DSRO a reconciled balance, which would not be
available to the Commission or DSRO simply by viewing an FCM’s
depository accounts online. Each of these additional forms of
information would enable the Commission and DSRO to provide better
oversight and create additional accountability for the FCM.
[[Page 67920]]
Costs
FCMs are already calculating segregated funds information daily and
reporting the results to the NFA via WinJammer by noon the following
day. Similarly, the detailed list of depositories that would be
required to be submitted twice per month is already required by NFA to
be produced and submitted to NFA via WinJammer.140 Requiring FCMs to
submit these reports to the Commission via the same platform should not
create any additional costs.
—————————————————————————
140 See Segregated Investment Detail Report at: http://www.nfa.futures.org/NFA-compliance/NFA-futures-commission-merchants/fcm-reporting.pdf.
—————————————————————————
Sec. 1.52 Self-Regulatory Organization Adoption and Surveillance of
Minimum Financial Requirements
Proposed Changes
As described in the section by section discussion at II.O, the
proposed amendments to 1.52 would revise the supervisory program that
SROs are required to create and adopt. In addition, for SROs that
choose to delegate the function to examine FCMs that are members of two
or more SROs to a DSRO, the amended rules would require a plan that
establishes a Joint Audit Committee which, in turn, must propose,
approve, and oversee the implementation of a Joint Audit Program. The
amended rules specify a number of additional requirements for the SRO
supervisory program as well as for the Joint Audit Program.
Benefits
Regarding SROs’ supervisory programs, the proposed amendments would
provide significant additional protection to FCMs’ counterparties,
investors, and customers by ensuring that SRO audits of member FCMs are
thorough and effective. The proposed amendments would help to ensure
thorough audits by requiring that an SRO’s audit program be designed to
address “all areas of risk to which futures commission merchants can
reasonably be foreseen to be subject,” that the scope and focus of
such audits would be determined by the risk profile that the SRO
develops for each FCM, and that the audit itself include both controls
testing as well as substantive testing. The last requirement, in
particular, would help to ensure that audits give adequate attention to
testing and review of internal controls, which are critical to help
ensure that each FCM is not only compliant with capital and segregation
requirements at the time of the audit, but that they continue to
operate in such a manner after the audit is completed by preventing
fraud or operational errors that could jeopardize the FCM and its
customers.141
—————————————————————————
141 While many auditors and market participants have noted the
importance of controls testing, the Commission understands that
currently, many audits tend to emphasize substantive testing and
give lesser attention to controls testing. See Public Roundtable to
Discuss Additional Customer Protections, August 9, 2012. A recording
of the roundtable is available at: http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff080912. See [customer protection
roundtable from 8/9].
—————————————————————————
By requiring that the supervisory program for the SRO must be
compliant with U.S. Generally Accepted Auditing Standards and standards
prescribed by the Public Company Accounting Oversight Board, the
proposed rules would ensure that the SROs’ supervisory programs draw
from established best practices, and that they address the full range
of issues that would impact the effectiveness of the SRO’s audits of
FCMs. This benefit is enhanced by the proposed list of specific issues
that each SRO must address in the standards they develop for their
supervisory program. And by promoting audits that are thorough, the
proposed rules would, again, promote protection of the FCM’s
counterparties, investors, and customers.
By requiring that an examinations expert evaluate the SRO’s
supervisory program at least once every two years, and that the results
of such examinations include a discussion and recommendation of any new
or best practices, the proposed rules would ensure that the supervisory
program and SRO audits continue to build on best practices, for audits,
which further promotes thorough and effective audits of FCMs.
The proposed rules for the Joint Audit Program would require the
Joint Audit Program to: (1) Establish standards covering all the same
issues; (2) require controls testing as well as substantive testing;
(3) address all areas of risk to which the registered FCM can
reasonably be foreseen to be subject; (4) conform to U.S. generally
accepted auditing standards and as well as those prescribed by the
Public Company Accounting Oversight Board; and (5) have an examinations
expert evaluate the Joint Audit Program at least once every two years.
Therefore, the proposed rules would produce identical benefits related
to audits conducted by a DSRO.
In addition, by requiring that the DSRO audits include examination
of an FCM’s compliance with rules and regulations governing minimum net
capital, obligations to segregate customer funds, financial reporting
requirements, etc., the proposed rule would ensure that these critical
elements of the FCM’s operations and finances are reviewed during each
audit. Each of these elements safeguard customers. Additionally, by
requiring the Joint Audit Committee to develop procedures to identify
high risk firms and perform enhanced monitoring of such firms, the
proposed rules would help to ensure that any risk to customer funds
that begins to materialize (e.g. the FCM’s residual interest begins to
drop) is identified and corrected quickly, thus reducing the risk of a
loss of customer funds.
In addition, commenters at the Commission’s August 9th roundtable
on customer protection noted that when audits take several months to
complete, the findings are less relevant when they are delivered to the
business than they would have been if they were communicated more
promptly.142 Therefore, by requiring that the Joint Audit Program
maintain adequate levels of staff with adequate training and
experience, the proposed requirements would facilitate timely
completion of audits, which is likely to enhance the protection of
customer funds by promoting more prompt identification and correction
of weaknesses identified in such audits. Moreover, if auditors are not
independent of the FCM they are auditing, their findings may be
compromised by conflicts of interest. By requiring standards related to
independence together with annual ethics training, the proposed rule
would help to ensure that the results of any audit conducted by the
DSRO are not compromised by the influence of any conflict of interests.
Each of these, in turn, facilitate thorough, effective, and timely
audits, which help protect the FCM’s customers, counterparties, and
investors by ensuring that the FCM’s financial reports are accurate,
and that internal controls are reviewed and tested.
—————————————————————————
142 See Public Roundtable to Discuss Additional Customer
Protections, August 9, 2012. A recording of the roundtable is
available at: http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff080912 See [roundtable on Aug 9th].
—————————————————————————
Costs
SROs are already required to establish and operate supervisory
programs for auditing FCMs. The proposed amendments require further
detail and documentation with regard to specific elements of such
supervisory programs. The Commission estimates that the cost for
developing these policies and procedures would be between $20,700 and
$31,000 per SRO.143
—————————————————————————
143 This estimate assumes 160-240 hours of time from both a
compliance attorney and a senior accountant. The average
compensation for a compliance attorney is $85.35/hour [$131,303 per
year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35 *160 =
$13,655.51 and $85.35 *240 = $20,483.27. The average compensation
for a senior accountant is $44.18/hour [$67,971.00 per year/(2000
hours per year)*1.3 is $44.18 per hour]; $44.18*160 = $7,068.98 and
$44.18*240 = $10,603.48. These figures are taken from the 2011 SIFMA
Report on Management and Professional Earnings in the Securities
Industry.
—————————————————————————
[[Page 67921]]
The Joint Audit Committee would have to develop policies and
procedures concerning the application of the Joint Audit Program in the
examination of FCMs. The standards would have to, at minimum, conform
to the U.S. GAAS and would also have to address the items in Sec.
1.52(c)(2)(iii). The development of such policies and procedures is
likely to require input from one attorney and one senior accountant at
each SRO, and therefore the Commission estimates that such involvement
will cost each SRO between $2,400 and $6,000.144 In addition, the
work required to further develop Joint Audit Program is likely to be
supported by full time staff at the DSRO. The Commission estimates that
such support will cost the DSRO between $18,000 and $26,400.145 In
addition the Joint Audit Program would be required to have an
examinations expert review the policies and procedures they develop.
—————————————————————————
144 This estimate assumes 20-50 hours of time from both a
compliance attorney and an intermediate accountant. The average
compensation for a compliance attorney is $85.35/hour [$131,303 per
year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*20 =
$1,706.94 and $85.35*50 = $4,267.35. The average compensation for an
intermediate accountant is $34.11/hour [$52,484.00 per year/(2000
hours per year)*1.3 is $34.11 per hour]; $34.11*20 = $682.29 and
$34.11*50 = $1,705.73. These figures are taken from the 2011 SIFMA
Report on Management and Professional Earnings in the Securities
Industry.
145 This estimate assumes 320-400 hours from an office
services supervisor and 40-80 hours from both a compliance attorney
and a senior accountant. The average compensation for an office
services supervisor is $40.15/hour [$61,776.00 per year/(2000 hours
per year)*1.3 is $40.15 per hour]; $40.15*320 = $12,849.41 and
$40.15*400 = $16,061.76. The average compensation for a compliance
attorney is $85.35/hour [$131,303 per year/(2000 hours per year)*1.3
is $85.35 per hour]; $85.35*40 = $3,413.88 and $85.35*80 =
$6,827.76. The average compensation for a senior accountant is
$44.18/hour [$67,971.00 per year/(2000 hours per year)*1.3 is $44.18
per hour]; $44.18*40 = $1,767.25 and $44.18*80 = $3,534.49. These
figures are taken from the 2011 SIFMA Report on Management and
Professional Earnings in the Securities Industry.
—————————————————————————
Ongoing costs to the SRO and Joint Audit Program would include fees
charged by the examinations expert for a review every other year, the
incremental cost of more extensive controls testing when auditing each
FCM, and the incremental cost resulting from standards that the SRO
develops to comply with the list of standards that must be addressed in
the supervisory program.146 The Commission does not have adequate
information to estimate the ongoing costs for biennial reviews by an
examinations expert, or the incremental costs of additional controls
testing or ongoing compliance with standards that the FCMs develop
pursuant to Sec. 1.52(c)(2)(iii).
—————————————————————————
146 See Sec. 1.52(c)(2)(iii).
—————————————————————————
Request for Comment
Question 24: The Commission requests comment regarding the costs
associated with increased controls testing. To what extent do SROs
currently conduct controls testing when auditing FCMs? What additional
testing would likely be involved in order to comply with the proposed
regulations?
Question 25: In addition, the Commission requests comment regarding
the costs for an expert examiner to conduct a review such as the one
contemplated in the proposed rules.
Question 26: Also, regarding costs associated with the Joint Audit
Committee and Joint Audit Program, which costs are likely to be borne
by the SROs and which are likely to be borne by the DSROs?
Sec. 1.55 Public Disclosures by Futures Commission Merchants
Proposed Changes
As described in the section by section discussion at II.P, the
proposed rules would add new provisions to the disclosure document that
FCMs are required to provide to prospective customers, detailed in
Sec. 1.55(b). The new provisions would require the disclosure document
to contain a statement that: (1) Customer funds are not protected by
insurance in the event of the bankruptcy or insolvency of the FCM, or
if customer funds are misappropriated in the event of fraud; (2)
customer funds are not protected by SIPC, even if the FCM is a BD
registered with the SEC; (3) customer funds are not insured by a DCO in
the event of the bankruptcy or insolvency of the FCM holding the
customer funds; (4) each customer’s funds are not held in an individual
segregated account by an FCM, but rather are commingled in one or more
accounts; (5) FCMs may invest funds deposited by customers in
investments listed in Sec. 1.25; and (6) funds deposited by customers
may be deposited with affiliated entities of the FCM, including
affiliated banks and brokers.
In addition, the proposed rule would require each FCM to provide a
Firm Specific Disclosure Document that would address firm specific
information regarding its business, operations, risk profile, and
affiliates that would be material to a customer’s decision to entrust
funds to and do business with the FCM.
As stated above, the Firm Specific Disclosure Document would be
made available on the FCM’s Web site and would provide material
information about: (1) General firm contact information; (2) the names,
business contacts, and backgrounds for the FCM’s senior management and
members of the FCM’s board of directors; (3) a discussion of the
significant types of business activities and product lines that the FCM
engages in and the approximate percentage of the FCM’s assets and
capital devoted to each line of business; (4) the FCM’s business on
behalf of its customers, including types of accounts, markets traded,
international businesses, and clearinghouses and carrying brokers used,
and the futures commission merchant’s policies and procedures
concerning the choice of bank depositories, custodians, and other
counterparties; (5) a discussion of the material risks of entrusting
funds to the FCM and an explanation of how such risks may be material
to its customers; 147 (6) the name and Web site address of the FCM’s
DSRO and the location of annual audited financial statements; (7) a
discussion of any material administrative, civil, criminal, or
enforcement actions pending or any enforcement actions taken in the
last three years (8) a basic overview of customer fund segregation, FCM
collateral management and investments, and of FCMs and joint FCM/BDs;
(9) information regarding how customers may file complaints about the
FCM with the Commission or appropriate DSRO; (10) certain financial
data from the most recent month-end when the disclosure document is
prepared; and (11) a summary of the FCMs current risk practices,
controls and procedures.
—————————————————————————
147 The material risks addressed must include, without
limitation, “the nature of investments made by the futures
commission merchant (including credit quality, weighted average
maturity, and weighted average coupon); the futures commission
merchant’s creditworthiness, leverage, capital, liquidity, principal
liabilities, balance sheet leverage and other lines of business;
risks to the futures commission merchant created by its affiliates
and their activities, including investment of customer funds in an
affiliated entity; and any significant liabilities, contingent or
otherwise, and material commitments.”
—————————————————————————
FCMs would be required to update the Firm Specific Disclosure
Document at least annually.
As described in the section by section discussion at II.P, FCMs
would also be
[[Page 67922]]
required to disclose on their Web sites their daily Segregation
Schedule, daily Secured Amount Schedule, and daily Cleared Swaps
Segregation Schedule. Each FCM would be required to maintain 12 months
of the segregation and secured schedules on its Web site. Each FCM
would also be required to disclose on its Web site as well as summary
schedules of its adjusted net capital, net capital, and excess net
capital for the 12 most recent month-end dates as well as the Statement
of Financial Condition, Segregation Schedule, Secured Amount Schedule,
Cleared Swaps Segregation Schedule, and all footnotes related to the
above statements and schedules from its most current year end annual
report that is certified by an independent public accountant.
Benefits
As explained above in the section by section discussion at II.P,
current regulations require FCMs to provide a risk disclosure to
potential customers before accepting customer funds. That risk
disclosure statement is primarily intended to provide a customer with
disclosure of the market risks of engaging in futures trading. The
proposed additions to that disclosure would help to ensure that
customers are aware of certain non-firm-specific risks that have been
relevant in recent FCM bankruptcies and that could be relevant in the
event of future FCM bankruptcies or insolvencies.
The Firm Specific Disclosure Document that would be required by the
proposed rules would address firm-specific risk, which would give
potential customers additional information that they could use when
conducting due diligence and selecting an FCM. By requiring that the
disclosure address several specific topics, the proposed rule would
ensure that certain topics that are relevant are addressed, even if
potential customers might not otherwise think to ask about them when
selecting or conducting due diligence on potential FCMs.
Specifically, by requiring the disclosure to provide information
about the business activities and product lines the FCM engages in, and
the percentage of the FCM’s assets and capital that are used in each
type of activity, the proposed rules would assist customers in
acquiring information that may assist them in determining the extent to
which the FCM’s business is focused on providing the types of services
that the customer needs, and the extent to which other business
interests could impact either the focus or stability of the FCM.
By requiring that FCMs provide the policies and procedures by which
it selects depositories, the proposed rules would assist potential and
existing customers in evaluating the sufficiency of due diligence
conducted by the FCM when selecting such depositories. This additional
measure of transparency would incent FCMs to be rigorous in conducting
such due diligence because potential or existing customers that are not
satisfied with the FCM’s policies and procedures in this respect could
take their business elsewhere.
Requiring FCMs to discuss their business on behalf of customers,
the proposed rules would ensure that customers and potential customers
are able to make a more thorough assessment of risks that the FCM or
customer funds held by the FCM might bear due to the markets or
businesses in which the FCM is active, the clearinghouses and carrying
brokers it uses, or the depositories that hold funds on behalf of the
FCM. Such an assessment could impact customers’ decisions as they
select the FCM(s) with which they will conduct business. Moreover,
additional transparency would promote market discipline, which would
provide additional incentive for FCMs to manage such risks diligently.
By requiring FCMs to disclose material risks together with an
explanation of how such risks may be material to its customers, the
proposed rules would ensure that the FCM is responsible to identify and
communicate such risks, which helps to ensure that potential and
existing customers would be aware of those risks when placing or
keeping funds on deposit with the FCM. In the absence of such a
requirement, potential or existing customers may not know the FCM’s
business as well as the FCM does, and therefore may not ask about
certain risks that are material to customers, may not have access to
adequate information to determine the magnitude of such risks, or may
not understand how certain risks could impact the FCM’s customers.148
The proposed amendment would make the FCM responsible both to identify
and provide information regarding all material risks and to provide
explanations that would help educate customers about how such risks
could affect them.
—————————————————————————
148 In the Public Roundtable to Discuss Additional Customer
Protections on August 9, 2012, participants suggested that FCMs may
not provide all customers and potential customers with equivalent
access to firm-specific data. See http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff080912.
As a result, larger customers may be able to conduct more
thorough due diligence when selecting an FCM. The proposed
requirements would help ensure that all customers have access to
FCM-specific data that is helpful when evaluating the risks that
would be relevant to customer funds entrusted to an FCM.
—————————————————————————
Requiring FCMs to provide information regarding how they may file a
complaint about the FCM with the Commission or the firm’s DSRO would
help to ensure that if customers perceive problems at an FCM, those
concerns are communicated to the proper regulatory bodies, giving the
Commission and DSRO an opportunity to investigate further, if
appropriate. As a consequence, the required information would promote
more effective oversight by the Commission and DSRO.
By requiring that FCMs provide an overview of customer fund
segregation and FCM collateral management and investment, the proposed
rules would promote the protection of customer funds by enhancing
market discipline through customer education. The proposed rules would
help customers understand how statutory and regulatory requirements are
designed to provide protections for their funds, and what steps FCMs
must take in order to comply with such regulations. Educated customers,
in turn, provide an additional layer of accountability for the FCM in
complying with such requirements. Moreover, customers will be better
able to understand public disclosures regarding disciplinary actions
against FCMs, updates regarding material risks to customer funds,
financial disclosures made by the FCM, and to make informed decisions
in response.
In particular, the disclosures proposed in Sec. 1.55(k)(10) could
assist customers in evaluating fellow customer risk that they would
bear at each FCM with which they consider doing business. By requiring
FCMs to disclose specific financial data as of the most recent month-
end when the disclosure document is produced, the proposed requirements
would further ensure that all customers have access to data that would
be helpful when considering potential risks associated with entrusting
funds to the FCM.
Requiring FCMs to disclose the dollar value of their proprietary
trading margin requirements as a percentage of margin required for
futures customers, Cleared Swap Customers, and 30.7 Customers would
help customers understand the magnitude of risk created by the FCM’s
proprietary positions relative to the magnitude of risk created by
customers’ positions. This information could prompt customers to ask
additional questions about the relationship between the risks created
by the firm’s
[[Page 67923]]
proprietary trading and trading on behalf of customers. It could also
prompt questions about how the firm’s operations related to proprietary
trading may impact their operations related to customer accounts.
By requiring FCMs to disclose the number of customers that
constitute 50% of the FCMs total funds held for futures customers,
Cleared Swaps Customers, and 30.7 Customers, customers would have
additional insight into the potential exposure that the FCM could have
due to a default by one of its largest customers.
The aggregate notional value of non-hedged, principal over-the-
counter transactions into which the FCM has entered, when calculated
and reported for each class of swaps, would give customers some sense
of the potential exposure the FCM has due to potential changes in the
value of its proprietary portfolio.
The aggregate amount of financing FCMs provide for customer
transactions involving illiquid financial products would give customers
additional insight into the potential challenges FCMs would face if a
fellow customer defaulted and the FCM had to liquidate such products in
order to mitigate the losses caused by the customer’s default.
Requiring FCMs to disclose the amount, source, and purpose of any
unsecured and uncommitted short term funding the FCM has access to
would help potential and existing customers gain insight into the FCM’s
capacity to meet unexpected liquidity needs that might occur due to a
fellow customer’s default.
Requiring FCMs to disclose the percentage of customer debts the FCM
experienced during the past 12-month period, as compared to the balance
of funds held for futures customers, Cleared Swaps Customers, and 30.7
Customers would give customers a sense for how effective the firm’s
risk management program is, as well as a sense for the quality of the
customer pool that the FCM has accepted.
Requiring FCMs to provide a summary of their current risk
management practices, controls and procedures would give customers
insight into the procedures that FCMs use to manage the risks
associated with fellow customers, which would be valuable to customers
when evaluating potential fellow customer risk at various FCMs.
By requiring each FCM to adopt policies and procedures reasonably
designed to ensure that its advertising and solicitation activities are
not misleading to its FCM customers, the proposed rules would
strengthen accountability for communication related to an FCM’s sales
and solicitation activities. Moreover, the Commission and DSROs would
be better equipped to monitor FCMs’ internal controls related to sales
and solicitation, and compliance with those controls, if FCMs have
established policies and procedures. In this way, the proposed rules
would promote consistently reliable communication associated with each
FCM’s sales and solicitation efforts.
By requiring FCMs to update the disclosure proposed in rule 1.55(i)
annually as well as any time there is a “material change to its
business operation, financial condition and other factors material to
the customer’s decision to entrust the customer’s funds and otherwise
do business with the futures commission merchant,” and requiring the
FCM to provide each updated disclosure to its customers, the rule would
make FCMs responsible to communicate with customers whenever such
events occur. This requirement would help to ensure that the FCM’s
financial condition, business operations, or other important factors do
not change in material ways without customers being aware of such
changes, and would likely prompt some customers to conduct additional
due diligence in such situations in order to determine whether their
funds are at risk, which would provide additional accountability for
FCMs.
By requiring FCMs to provide their daily Segregation Schedules,
daily Secured Amount Schedules, and daily Cleared Swaps Segregation
Schedules, as well as additional month end and annual financial data,
the proposed rules would facilitate transparency. All of the
information that firms would be required to post on their Web site is
information that would be public based on the requirements of this rule
even if it were not posted on each FCM’s Web site. However, if the
schedules mentioned above were not posted on each FCM’s Web site,
market participants would have to submit a request to the Commission in
order to access that information. Requiring each FCM to post the above
schedules and data on its Web site would help to ensure that market
participants are aware that it is available, and would also improve the
speed and efficiency of obtaining it.
Similarly, by requiring FCMs to provide a link to the Web site of
the NFA’s Basic System facilitate transparency by promoting awareness
of the additional information that is public regarding each FCM’s
investment of customer funds and by minimizing search costs for
obtaining that information.
Costs
FCMs would have to create the Firm Specific Disclosure Document
which would likely require time from compliance, legal, accounting, and
administrative personnel. The Commission estimates that the cost for
producing the content of the initial disclosure would be between $6,000
and $22,200.149 In addition, each FCM would have to update the
disclosure annually as well as any time there is a material change to
the business that could affect the customer’s willingness to do
business with the FCM. Producing the content of each update is likely
to be less costly than the initial disclosure, since some parts of the
disclosure will likely remain the same from one version to the next.
The Commission estimates that such updates would cost between $6,000
and $12,000.150
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149 This assumes 40-200 hours from a compliance attorney, 10-
50 hours from a senior accountant, 40-60 hours from an office
services supervisor, and 5 hours from the CCO. The average
compensation for a compliance attorney is $85.35/hour [$131,303 per
year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35 *40 =
$3,143.88 and $$85.35 *200 = $17,069.39. The average compensation
for a senior accountant is $44.18/hour [$67,971.00 per year/(2000
hours per year)*1.3 is $44.18 per hour]; $44.18*10 = $441.81 and
$44.18*50 = $2,209.06. The average compensation for an office
services supervisor is $40.15/hour [$61,776.00 per year/(2000 hours
per year)*1.3 is $40.15 per hour]; $40.15*40 = $1,606.18 and
$40.15*60 = $2,409.26. The average compensation for a chief
compliance officer is $110.97/hour [ $170,727 per year/(2000 hours
per year)*1.3 = $110.97/hour]; $110.97*5 = $554.86. These figures
are taken from the 2011 SIFMA Report on Management and Professional
Earnings in the Securities Industry.
150 This estimate assumes 40-80 hours from a compliance
attorney, 20-40 hours from an intermediate accountant, and 30-60
hours from an office services supervisor. The average compensation
for a compliance attorney is $85.35/hour [$131,303 per year/(2000
hours per year)*1.3 is $85.35 per hour]; $85.35*40 = $3,413.88 and
$85.35*80 = $6,827.768. The average compensation for an intermediate
accountant is $34.11/hour [$52,484.00 per year/(2000 hours per
year)*1.3 is $34.11 per hour]; $34.11*40 = $1364.58 and $34.11*80 =
$2729.17. The average compensation for an office services supervisor
is $40.15/hour [$61,776.00 per year/(2000 hours per year)*1.3 is
$40.15 per hour]; $40.15*20 = $803.09 and $40.15 *60 = $2,409.26.
These figures are taken from the 2011 SIFMA Report on Management and
Professional Earnings in the Securities Industry.
—————————————————————————
Posting the Firm Specific Disclosure Document and the schedules and
data that would be required by Sec. 1.55(o) would require firms to
update their Web site on a daily, monthly, and annual basis with the
information that would be required under Sec. 1.55(o). The Commission
estimates that these
[[Page 67924]]
updates would cost between $2,300 and $7,000 per year.151
—————————————————————————
151 This assumes 10-30 minutes of time per day from a
programmer. The average compensation for a programmer is $53.64/hour
[$82,518 per year/(2000 hours per year)*1.3 = $53.64/hour];
$53.64*43 = $2,145.47 and $53.64*130 is $6,972.77.
—————————————————————————
Request for Comment
Question 27: What modifications to the requirements of Sec.
1.55(k)(10) should the Commission consider in order to ensure that the
data provided from FCMs’ most recent month-end is valuable to customers
evaluating potential fellow customer risk?
In particular, Is there additional information FCMs could
provide related to the value of the FCM’s proprietary margin
requirements and customers’ margin requirements that would assist
current and potential customers when conducting due diligence on an
FCM?
Is there additional information FCMs could provide that
would give customers a more complete picture of its ability to meet
unexpected liquidity needs that could occur due to the default of one
of its customers?
Question 28: Would the data from an FCM’s most recent month-end be
more valuable to customers if it were coupled together with similar
data or the same data from other points in time? If so, what points in
time should the Commission consider?
Sec. 22.2 Futures Commission Merchants: Treatment of Cleared Swaps and
Associated Cleared Swap Customer Collateral
Proposed Changes
As described in the section by section discussion at II.Q, the
proposed amendments to Sec. 22.2 would incorporate changes with
respect to protection of funds for customers trading cleared swaps that
are identical to the changes proposed for protection of futures
customer funds. Those changes include: (1) Incorporating the same
change to haircutting procedures as was proposed above in Sec. 1.17
and Sec. 1.32 but for swaps; (2) requiring the FCM to send daily
Segregation Calculations for cleared swaps to the Commission and DSRO;
and (3) requiring that segregated investment detail report that FCMs
produce twice per month, listing assets on deposit at each depository,
to be sent to CFTC and DSRO electronically by 11:59 p.m. the following
business day. Records of both reports would be required to be
maintained in accordance with Sec. 1.31.
In addition, the proposed rule would specify that FCMs must
maintain residual interest in customer segregated accounts that is
larger than the sum of all customer margin deficits. This proposed
requirement is substantially identical to the proposed requirement in
Sec. Sec. 1.22 and 30.7.
Benefits
As discussed above with reference to Sec. 1.32, requiring FCMs to
submit their daily segregation reports to the Commission and DSRO will
enhance protection of customer funds by giving both of them additional
information that, together with permission to view depository accounts
online at any time, would enable both the Commission and DSRO to
monitor those accounts more closely for any discrepancies that may
result from operational errors or fraud. Moreover, requiring FCMs to
submit their detailed list of depositories to the Commission and DSRO
twice per month would give both organizations additional information
that could help them perform spot checks to ensure that the FCM is
valuing and haircutting securities correctly and, more generally, to
verify that the value of each account that is computed by the FCM is
accurate.
As described in the discussion of cost and benefit considerations
related to Sec. 1.22, by requiring that FCMs maintain residual
interest in their cleared swap customer segregated accounts, the
proposed rule would ensure that the FCM is not using one customer’s
funds to purchase, margin, secure, or settle positions for another
customer and when combined with the reporting requirements in Sec.
22.2 would provide the Commission and the public with sufficient
information to verify that FCMs are not using one customer’s funds to
purchase, margin, secure or settle positions for another customer.
Costs
With respect to costs, as described above, changes to the reporting
requirements codify requirements that are already established by the
DSROs. Therefore, the additional requirements will not introduce new
costs for market participants. On the other hand, reducing the haircut
increases the likelihood that adverse developments affecting the FCM’s
Sec. 1.25 investments could cause financial strain for the FCM, or
could cause losses that the FCM would not be able to cover, either of
which could increase risk to customer funds. However, as described
above in the cost benefit considerations section related to Sec. 1.17,
the Commission proposes that FCMs that are dual registrants will be
able to use the SEC’s haircutting procedures, and that FCMs that are
not dual registrants do not typically invest in securities that would
be subject to reduced haircuts under the SEC’s proposed rules.
By requiring FCMs to maintain residual interest in the cleared swap
customer segregated accounts that is greater than the sum of their
customers’ margin deficits, the proposed rule would create costs and
benefits that are substantially identical to those described in the
cost and benefit considerations related to Sec. 1.22. As discussed in
that section, the Commission does not have information to determine
whether FCMs typically maintain residual interest in their cleared swap
customer segregated accounts that is greater than or less than the sum
of their customers’ margin deficits, and requests information
sufficient to make such a determination, and to quantify the associated
costs, if any.
Request for Comment
Question 29: The Commission requests comment regarding whether FCMs
typically maintain residual interest in their customer segregated
accounts that is greater than the sum of their customer margin
deficits, and data from which the Commission may quantify the average
difference between the amount of residual interest an FCM maintains in
customer segregated accounts and the sum of customer margin deficit.
Question 30: How much additional residual interest would FCMs hold
in their customer segregated accounts in order to comply with the
proposed regulation? What is the opportunity cost to FCMs associated
with increasing the amount of capital FCMs place in residual interest,
and data that would allow the Commission to replicate and verify the
calculated estimates provided.
Question 31: The Commission request information regarding the
additional amount of capital that FCMs would likely maintain in their
customer segregated accounts, if any, to comply with the proposed
regulation. What is the average cost of capital for an FCM? Please
provide data and calculations that would allow the Commission to
replicate and verify the cost of capital that you estimate?
Sec. 22.17 Policies and Procedures Governing Disbursements of Cleared
Swaps Customer Collateral From Cleared Swap Customer Accounts
Proposed Changes
As described in the section by section discussion at in II.Q,
proposed Sec. 22.17 would impose restrictions on an FCM’s withdrawal
of its residual interest, and
[[Page 67925]]
requires that if a withdrawal of residual interest for proprietary use
causes the FCM to fall below its targeted residual interest that the
funds be replenished the following business day or the residual
interest target be lowered in accordance with its policies and
procedures established under Sec. 1.11.
Benefits and Costs of the Proposed Changes
The costs and benefits are similar to those created by Sec. Sec.
1.23 and 1.11 but apply to customer funds in Cleared Swaps Customer
Accounts rather than customer segregated accounts, and therefore are in
addition to those specified in Sec. Sec. 1.23 and 1.11.
Sec. 30.1 Definitions
Proposed Changes
Proposed Sec. 30.1 establishes definitions for “30.7 Customer,”
“30.7 Account,” and “30.7 Customer Funds.” The first is defined as
any foreign futures or foreign option customer, together with any
foreign-domiciled person who trades in foreign futures or foreign
options trough an FCM. “30.7 Account” and “30.7 Customer Funds” are
then defined accordingly. These definitions would replace the terms
“foreign futures or foreign options customer,” “foreign futures or
foreign options customer account,” and “foreign futures or foreign
options customer funds,” respectively. The existing term “foreign
futures or foreign options customer” only includes U.S.-domiciled
customers that deposit funds with an FCM for use in trading foreign
futures or foreign options. The proposed definitions, on the other
hand, would include both U.S. and foreign customers that deposit funds
with an FCM for use in trading foreign futures or foreign options.
Benefits and Costs of the Proposed Changes
These definitions play a `gatekeeping’ function with respect to
other rules by determining what customers are included as “30.7
Customers.” However, the costs and benefits of these changes are
attributable to the substantive requirements related to the
definitions, and therefore are discussed in the cost benefit
considerations related to Sec. 30.7.
Sec. 30.7 Treatment of Foreign Futures or Foreign Options Secured
Amount
Proposed Changes
As described in the section by section discussion at II.R, the
proposed amendments would: (1) Incorporate the funds of foreign-
domiciled investors deposited with an FCM for investment in foreign
futures and foreign options within the protections provided in 30.7;
(2) eliminate the Alternative Method and require the Net Equity
Liquidation Method for calculating 30.7 customer segregation
requirements; (3) add specificity to the written acknowledgments that
FCMs and DCOs must obtain from their depositories by providing required
templates; 152 (4) add restrictions on withdrawing from residual
interest; 153 (5) require that 30.7 Customer Funds deposited in a
bank must be available for immediate withdrawal at the request of the
FCM; (6) clarify that the FCM is responsible for any losses related to
investing 30.7 Customer Funds in investments that comply with Sec.
1.25; (7) add a prohibition against making unsecured loans to customers
or using the funds in the customer’s trading account as security for
the loan; (8) require daily segregation reports and detailed list of
depositories be submitted to the Commission and DSRO, and that targeted
residual interest be included in both of those reports; (9) allow FCMs
that are not dual registrants to use the broker-dealer (“BD”)
procedure for assigning a smaller haircut to instruments with low
default risk; (10) establish a limit on the amount of funds in a 30.7
Account that can be held outside the United States; 154 and (11)
require FCMs to maintain residual interest in 30.7 Accounts that is
larger than the sum of all 30.7 Customer margin deficits. This proposed
requirement is substantially identical to the proposed requirement in
Sec. Sec. 1.22 and 22.2.
—————————————————————————
152 The additional specificity incorporates the same
requirements for acknowledgment and agreement that are contained in
the templates in the appendices of Sec. Sec. 1.20 and 1.26.
153 The same requirements as are proposed for futures
customers’ funds and cleared swaps customers’ funds, including a
requirement for the FCM to abide by its policies and procedures
required in Sec. 1.11.
154 As a result of the proposed changes, the rules in Sec.
30.7 for the protection of 30.7 Customer Funds would be
substantially the same as the rules for the protection of segregated
customer funds under 4(d) and Sec. Sec. 1.11-1.32, and the rules
for the protection of cleared swaps customer funds in Sec. 22.
However, there are a few proposed changes to Sec. 30.7 that are
dissimilar to current or proposed regulations protecting futures
customer funds and cleared swap customer funds. They are: (1) the
definition of the minimum amount that must be deposited in a 30.7
Account for each 30.7 Customer is different than in the
corresponding requirements in 1.20 and 22.2. The difference is due
to the fact that 30.7 Customers’ funds may be deposited overseas
under a different regulatory regime and the proposed rule would
require an FCM to comply with the highest requirement that is
relevant to those funds, whether it is the U.S. or the foreign
regime; (2) the list of acceptable depositories for 30.7 Funds
includes banks or trusts outside of the U.S. with more than $1
billion in regulatory capital, and various other participants of
foreign boards of trade and their depositories; and (3) 30.7 limits
the amount of funds from a 30.7 Account that can be held outside the
U.S.
—————————————————————————
A. Compared to Customer Protections Under Sec. Sec. 1.20-1.32 and
Sec. 22
The result of the proposed changes is that the regulatory
requirements established in Sec. 30.7 for the protection of 30.7
Customer Funds would be substantially the same as those established for
segregated customer funds under 4(d) and Sec. Sec. 1.11-1.32, and for
cleared swaps customer funds in Sec. 22. However, the 30.7 regime
would have distinct requirements with respect to: (1) the definition of
the minimum amount that must be deposited in a 30.7 Account for each
30.7 Customer is different than in the corresponding requirements in
Sec. Sec. 1.12 and 22.2.155 The difference is due to the fact that
30.7 Customers’ funds may be deposited overseas under a different
regulatory regime. The rule requires that FCMs abide by the highest
requirement that is relevant to those funds, whether it is the United
States or the foreign regime; (2) the list of acceptable depositories
for 30.7 Funds includes banks or trusts outside of the United States
with more than $1 billion in regulatory capital, and various other
participants of foreign boards of trade and their depositories; and (3)
30.7 limits the amount of funds from a 30.7 Account that can be held
outside the United States. Of these three differences, the third is the
only one created by the proposed rule, and therefore is the only one
incorporated in the cost benefit considerations discussion.
—————————————————————————
155 See Sec. 30.7(a).
—————————————————————————
Benefits and Costs of the Proposed Changes
The proposed changes would establish regulations for the protection
of customer funds deposited for trading in foreign futures and options
that, with limited exceptions, is substantively identical to the
protections that exist for futures customer funds and cleared swaps
customer funds. Therefore, many of the costs and benefits of the
changes that are proposed are identical to those described above in the
cost benefit considerations related to Sec. Sec. 1.11-1.32 and Sec.
22.
1. Incorporating funds of foreign-domiciled investors deposited
with an FCM for investment in foreign futures and foreign options
within the protections provided in 30.7
[[Page 67926]]
Benefits
Currently, when an FCM receives funds from foreign customers for
use in trading foreign futures and foreign options, the FCM may choose,
but is not required, to keep foreign customer funds in a segregated
account. If the funds are not kept in a segregated account, they are
not subject to the same level of oversight and protection as other
customer funds. For example, those funds are not incorporated in the
daily or bi-monthly calculations that are submitted to the Commission
and DSRO, and the FCM is permitted to use the assets of one foreign
customer to cover the obligations of another foreign customer, may
allow a net deficiency to exist in the funds of foreign customers held
for use in foreign futures or foreign options, and is allowed to
commingle such funds with the FCM’s proprietary funds and use them as
part of its business capital.
The benefit or requiring customer funds to be kept in segregated
accounts is that those funds would receive the same protections as
funds deposited by U.S.-domiciled investors. This enhances the safety
of funds deposited by both U.S. and foreign investors by ensuring that
the FCM maintains sufficient funds in segregated accounts to satisfy
its obligations regarding all customer funds that have been deposited
at the FCM.
The proposed change would extend equivalent oversight and
protection to the money, securities and property received by an FCM for
or on behalf of a foreign-domiciled customer for foreign futures or
foreign options trading. Specifically, FCMs would be required to hold
the funds of foreign-domiciled customers in 30.7 secured accounts, to
include such funds in daily and bi-monthly calculations of 30.7
requirements and funds set aside for 30.7 customers, and to abide by
other policies and procedures regarding handling of customer funds.
This is a benefit because FCMs would be required to hold sufficient
funds in 30.7 accounts at all times to cover the obligations they have
to their foreign-domiciled customers as well as their U.S.-domiciled
customers. Various regulations designed to ensure that this requirement
is met at all times would also apply, including the Sec. 30.7(g)
restrictions on an FCM’s withdrawal of its residual interest which is
commingled with customer 30.7 funds, and policies and procedures
developed by the FCM pursuant to Sec. 1.11 that are designed to ensure
safe handling of such funds.
Application of the additional protections designed for customer
funds will help to ensure that in the event an FCM has insufficient
regulatory capital, all 30.7 Customer Funds are available to be ported
to another FCM. This benefit is relevant both to foreign-domiciled
customers and to U.S.-domiciled customers holding money at an FCM where
foreign-domiciled customers also hold funds because, as described
above, in the event of a bankruptcy both groups of customers are
entitled to equivalent protections regardless of whether their funds
were held apart in separate accounts. Consequently, under the current
rules, if an FCM keeps foreign-domiciled customer funds out of 30.7
accounts and then defaults, there may not be sufficient funds to cover
the obligations of the FCM to all of their U.S.-domiciled as well as
foreign-domiciled customers. If this occurs, all customers would
receive a pro-rata share of the funds that were kept in 30.7 accounts,
regardless of which customers’ funds were kept in the 30.7 account.
U.S.-domiciled customers would possibly suffer a pro rata loss of their
funds in the event of the FCM’s bankruptcy because an FCM may not have
included foreign-domiciled customer funds in 30.7 accounts. The
proposed rule would prevent this situation from occurring, thus
providing increased protection not only to the foreign-domiciled
customers that deposited funds, but to the U.S.-domiciled customers as
well.
According to FIA, “FCMs have generally adopted policies and
procedures designed to provide protections to all customers trading on
foreign boards of trade that are comparable to the protections afforded
customers trading on U.S. futures markets.” 156 If true, the
proposed change would not create substantial costs or benefits in
periods of normal activity for the FCM. However, under current
regulations, FCMs still have the ability to diverge from the
aforementioned practices they have generally adopted, and can pull
foreign-domiciled customer funds out of 30.7 accounts and use those
funds as if they were their own. It is precisely in a time of stress
for an FCM that these protections for customer funds are most needed to
prevent the FCM from commingling such funds with its own capital and
using it to meet the general obligations of the firm. It is not
possible to quantify the value of the additional protection that would
be provided to non-U.S.-based customers on the basis of the proposed
change. To do so would require data sufficient to estimate the
probability and expected magnitude of losses due to lesser protections
for funds deposited by foreign-domiciled customers, and the Commission
does not have such data. The Commission, however, requests public
comment regarding these benefits, and specifically requests any data
commenters can provide that would assist the Commission in quantifying
such benefits.
—————————————————————————
156 FIA “Initial Recommendations for Customer Funds
Protection,” p. 10.
—————————————————————————
Costs
With respect to costs the Commission understands that in practice,
FCMs have generally adopted practices that provide equivalent
protections to funds deposited by customers domiciled in the U.S. and
those who are not. Therefore, during normal operations the proposed
requirement would not create any additional costs. However, the
proposed amendment will prevent an FCM from using foreign-domiciled
customer funds for trading foreign futures and foreign options as its
own capital, thus reducing the FCM’s liquidity which increases risk to
the FCM in times of stress. As a consequence, the FCM will have an
incentive to keep more capital in order to protect itself since it will
no longer be able to use such funds to meet or secure its own
obligations. The Commission does not have adequate data to quantify the
cost of FCMs’ decreased liquidity or the cost of the additional capital
they may hold as a result. Doing so would require estimates of
probabilities regarding the likelihood of an FCM’s liquidity crisis,
likelihood they hold foreign-domiciled customer funds for use in
foreign futures and foreign options trading, the amount of such funds,
the duration of the liquidity crisis, and a number of other factors
that the Commission does not have adequate information to estimate.
Request for Comment
Question 32: The Commission requests comment from the public
regarding the extent to which FCMs currently provide equivalent
protections to U.S.-domiciled and foreign-domiciled customers for
trading foreign futures and foreign options, as well as the probability
and expected size of losses that foreign-domiciled customers may face
due to lesser regulatory protection. In addition, the Commission
requests comment about any additional impact this change may have on
U.S. domiciled investors, foreign investors, or the public.157
—————————————————————————
157 Questions posed to the public have been numbered for
commenters’ convenience. The Commission requests that commenters
identify the number of the question they are addressing when
responding to specific questions posed by the Commission.
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[[Page 67927]]
2. Eliminate the Alternative Method and require the Net Equity
Liquidation Method for calculating 30.7 Customer segregation
requirements
Benefits
Under the current regulations FCMs are allowed to use the
Alternative Method, which only requires the maintenance of sufficient
funds in the foreign futures or foreign options account to satisfy the
margin required on open positions plus or minus any unrealized gains or
losses on such positions, and any funds representing option premiums or
funds necessary to margin or guarantee such options.
By removing the Alternative Method, which the Commission
understands is not in use, and requiring the Net Liquidating Equity
Method, the proposed rules benefit customers by reducing the risk that
a shortfall in customer funds could exist where an FCM operates in
compliance with Commission regulations. More specifically, by requiring
the FCM to segregate in separate accounts sufficient funds to satisfy
the full account equities of all of its customers trading foreign
futures or foreign options, the FCM would have sufficient funds in
segregated accounts to meet all of their obligations to all such
customers at any time, including in the event the FCM defaults.
Further, in the event of default, the proposed regulations would
facilitate the transfer of assets to another FCM by assuring the
receiving FCM that there are sufficient funds to cover the liabilities
that it may be assuming.
Costs
With respect to costs, as described above, the Commission
understands that in practice, all FCMs are currently using the Net
Liquidating Equity Method. However, FCMs currently have the option to
switch to the Alternative Method, which they would have an incentive to
do if the FCM needed additional liquidity. The proposal would prohibit
an FCM switching to the Alternative Method, thereby preventing an FCM
from using some portion of customer funds as if it were its own
operational capital. In doing so, the proposed rule would reduce the
FCM’s options for obtaining liquidity.
The Commission does not have adequate data to quantify the cost of
this change. Doing so would require estimates of probabilities
regarding the likelihood of an FCM’s liquidity crisis, likelihood they
hold foreign-domiciled customer funds for use in foreign futures and
foreign options trading, the amount of such funds, the amount that are
typically required to margin open positions for 30.7 Customers, and a
number of other factors that the Commission does not have adequate
information to estimate. However, as above, the Commission notes that
it does not believe that FCMs should consider any customer funds a
source of liquidity.
3. Specific requirements contained in the written acknowledgments
that FCMs and DCOs must obtain from their depositories
The costs and benefits resulting from this change are similar to
those discussed the cost benefit considerations sections related to
Sec. Sec. 1.20 and 1.26, but affect 30.7 Customer funds rather than
futures customer funds, and therefore are in addition to the costs and
benefits discussed in the cost benefit considerations sections related
to Sec. 1.20 and Sec. 1.26.
4. Restrictions on withdrawing from residual interest, including a
requirement for the FCM to abide by its policies and procedures
required in Sec. 1.11
The costs and benefits resulting from this change are similar to
those discussed the cost benefit sections related to Sec. Sec. 1.23
and 1.11, but affect 30.7 Customer funds rather than futures customer
funds, and therefore are in addition to the costs and benefits
discussed in cost benefit considerations sections related to Sec. Sec.
1.23 and 1.11.
5. Require that 30.7 Customer Funds deposited in a bank must be
available for immediate withdrawal at the request of the FCM
The costs and benefits resulting from this change are similar to
those discussed cost benefit considerations sections related to
Sec. Sec. 1.20, but affect 30.7 Customer Funds rather than futures
customer funds, and therefore are in addition to the costs and benefits
discussed in the cost benefit considerations section related to Sec.
1.20.
6. Clarification that the FCM is responsible for any losses related
to investing 30.7 Customer Funds in investments that comply with Sec.
1.25
The costs and benefits resulting from this change are similar to
those discussed in the cost benefit considerations section related to
Sec. 1.29, but affect 30.7 Customer Funds rather than futures customer
funds, and therefore are in addition to the costs and benefits
discussed in the cost benefit considerations sections related to
Sec. Sec. 1.20 and 1.29.
7. Prohibition against making unsecured loans to customers and
against using the funds in the customer’s trading account as security
for the loan
The costs and benefits resulting from this change are similar to
those discussed the cost benefit considerations section related to
Sec. 1.30, but affect 30.7 Customer funds rather than futures customer
funds, and therefore are in addition to the costs and benefits
discussed in that section.
8. Require daily segregation reports and segregated investment
detail reports be submitted to the Commission and DSRO, and that
targeted residual interest be included in those reports
The costs and benefits resulting from this change are similar to
those discussed the cost benefit considerations sections related to
Sec. 1.32, but affect 30.7 Customer funds rather than futures customer
funds, and therefore are in addition to the costs and benefits
discussed in that section.
9. Allow FCMs that are not dual registrants to abide by the BD
procedure for assigning a smaller haircut to investments purchased with
customer funds that have low default risk
The costs and benefits resulting from this change are similar to
those discussed in the cost benefit sections related to Sec. Sec. 1.32
and 22.2, but affect 30.7 Customer funds rather than futures customer
funds, and therefore are in addition to the costs and benefits
discussed in those sections.
Question
Question 33: However, the Commission requests comment regarding the
extent to which 30.7 Customer funds held outside the United States may
be invested in instruments that are subject to reduced haircuts under
the proposed SEC rules, and the effect that will have on the capital
requirements of U.S. domiciled FCMs.
10. Proposed Sec. 30.7(c) limits the amount of funds from a 30.7
Account that can be held outside the U.S.
Funds held overseas are subject to different regulatory and
bankruptcy regimes that may not offer comparable protections for
customer funds, creating additional repatriation risks to those funds.
For example, if an FCM carrying 30.7 funds, some of which were held in
depositories outside the U.S., were to default, it is possible that the
Trustee would not be able to recover sufficient funds to repay all the
FCM’s obligations to 30.7 Customers. As noted above, this is especially
true if the funds are deposited with an overseas affiliate of the FCM,
as the likelihood of coincident bankruptcies of affiliated financial
firms
[[Page 67928]]
is exceedingly high. In such an event, the funds held at the affiliate
would be distributed in accordance with the insolvency rules of the
foreign jurisdiction. In such a case each 30.7 Customer would likely
receive a pro-rata share of the funds that the Trustee is able recover,
when the Trustee is able to recover them. The proposed limit on amount
of funds that can be held outside the U.S. would ensure that as much of
the customers’ funds as possible remain subject to the U.S. regulatory
and bankruptcy regimes, eliminating repatriation risk to those funds.
By eliminating this risk for a larger percentage of the 30.7 funds, the
proposed rule promotes higher recovery rates for 30.7 account funds if
the FCM defaults, which helps ensure that 30.7 Customers receive the
largest pro rata distribution possible.
Regarding costs, the proposed change effectively prohibits FCMs
from increasing the amount of 30.7 Customer Funds they hold overseas.
This restriction may reduce the return that FCMs may be able to achieve
through their investment of customer funds.
11. As described in the discussion of cost and benefit
considerations related to Sec. 1.22, by requiring that FCMs maintain
residual interest in segregated accounts, the proposed rule would
ensure that the FCM is not using one customer’s funds to purchase,
margin, secure, or settle positions for another customer and when
combined with the reporting requirements in Sec. 30.7 would provide
the Commission and the public with sufficient information to verify
that FCMs are not using one customer’s funds to purchase, margin,
secure or settle positions for another customer.
Regarding costs, by requiring FCMs to maintain residual interest in
their 30.7 Accounts that is greater than the sum of their 30.7
Customers’ margin deficits, the proposed rule would create costs and
benefits that are substantially identical to those described in the
cost and benefit considerations related to Sec. 1.22. As discussed in
that section, the Commission does not have information to determine
whether FCMs typically maintain residual interest in their 30.7
Accounts that is greater than or less than the sum of their 30.7
Customers’ margin deficits, and requests information sufficient to make
such a determination, and to quantify the associated costs, if any.
Additional Requests for Comment Related to the Commission’s Proposed
Consideration of Costs and Benefits
Question 34: The Commission requests comment on all aspects of its
proposed consideration of the costs and benefits of the rulemaking.
More specifically, the Commission requests dollar estimates of the
costs and the value of the benefits of the proposed rules described
herein, including supporting data. In addition, the Commission requests
comment on whether there are additional costs or benefits related to
the proposed rules that the Commission should consider, as well as
whether there are alternative approaches that would be more effective
in light of the purpose of the proposal. Commenters should provide
analysis and empirical data to support their views on the costs and
benefits associated with the proposed rule.
Question 35: The Commission requests comment regarding the
different ways in which the proposed rules will impact FCMs that are
different sizes and that are operating with different business models.
In particular, are there any specific proposed requirements that would
be particularly costly for either small or large FCMs to follow? Are
there any specific proposed requirements that would be especially
costly for FCMs with a particular business model to follow? If so,
please explain and where possible please quantify specific costs.
Question 36: The Commission requests comment regarding the effects
of the proposed amendments on the composition of the FCM industry
including bank subsidiaries versus stand-alone FCMs, large versus
small, retail customer oriented versus wholesale, possible
consolidation, etc. Please explain and provide supporting data.
Question 37: The Commission also requests comment regarding the
potential impact of the proposed regulations on specific groups of
customers. Will the proposed rules make it more difficult for certain
groups of customers to obtain FCM services?
IV. Administrative Compliance
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (“RFA”) 158 requires Federal
agencies, in promulgating regulations, to consider the impact of those
regulations on small entities. The Commission has previously
established certain definitions of “small entities” to be used by the
Commission in evaluating the impact of its rules on small entities in
accordance with the RFA.159 The proposed regulations would affect
FCMs and DCOs. The Commission previously has determined that FCMs are
not small entities for purposes of the RFA, and, thus, the requirements
of the RFA do not apply to FCMs.160 The Commission’s determination
was based, in part, upon the obligation of FCMs to meet the minimum
financial requirements established by the Commission to enhance the
protection of customers’ segregated funds and protect the financial
condition of FCMs generally.161 The Commission also has previously
determined that DCOs are not small entities for the purpose of the
RFA.162 Accordingly, the Chairman, on behalf of the Commission,
hereby certifies pursuant to 5 U.S.C. 605(b) that the proposed
regulations will not have a significant economic impact on a
substantial number of small entities.
—————————————————————————
158 5 U.S.C. 601 et seq.
159 47 FR 18618 (Apr. 30, 1982).
160 Id. at 18619.
161 Id.
162 See 66 FR 45605, 45609, Aug. 29, 2001.
—————————————————————————
The Commission invites comments on the impact of this proposed
regulation on small entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act (“PRA”) provides that a federal
agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information unless it displays a currently
valid control number issued by the Office of Management and Budget
(“OMB”). This proposed rulemaking contains several collections of
information that have not been approved previously by OMB. The
collections contained in this rulemaking are proposed to be mandatory.
To avoid double accounting for the PRA burden hours of collections
that already have been assigned control numbers by OMB, or for burden
hours contained in pending collections of information–in particular
existing collection 3038-0024 and proposed revisions thereto, and
existing collections 3038-0052 and 3038-0091–this PRA analysis
contains only burden estimates for collections of information that have
not previously been submitted to OMB. The Commission seeks comment on
those collections of information contained in this rulemaking that
would increase the burden hours contained in each of the related
currently valid or proposed collections.
In particular, the Commission will submit to OMB information
collection requests (“ICR”) that address the new collection burdens
that would result from the finalization of these proposed rules on or
before the publication of the proposed rules, as required by 44 U.S.C.
3506(c)(2)(B) and 5 CFR 1320.11. All interested parties may submit
comments
[[Page 67929]]
on this analysis and the associated ICR to the Commission and to OMB,
as provided below.
The Commission will protect proprietary information according to
the Freedom of Information Act (“FOIA”) and 17 CFR part 145,
“Commission Records and Information.” In addition, section 8(a)(1) of
the Act strictly prohibits the Commission, unless specifically
authorized by the Act, from making public “data and information that
would separately disclose the business transactions or market positions
of any person and trade secrets or names of customers.” The Commission
is also required to protect certain information contained in a
government system of records according to the Privacy Act of 1974.
1. Collections of Information
The proposed amendments would require FCMs to adopt new policies
and procedures, keep records related to such policies and procedures
and submit reports of such policies and procedures, including certain
management approvals, to the Commission. In addition, the proposals
alter existing FCM reporting requirements in process and substance,
including changes to certain schedules and proposed schedules to the
Form 1-FR-FCM (the Segregation Schedule and Secured Amount Schedule);
changes to the process for filing such schedules and additional
frequency for such filings; and requiring detailed information
supporting such schedules to also be reported to the Commission and the
FCM’s designated self-regulatory organization.
Further FCMs and depositories accepting customer funds will be
required to obtain acknowledgment letters in specified formats and file
them directly with the Commission and the FCM’s designated self-
regulatory organization. Records will have to be kept of approvals of
certain withdrawals made of an FCM’s residual interest in customer
funds and further reported to the Commission. Additional notices will
also be required to be filed with the Commission under the proposed
amendments. The examination process of SROs and DSROs is proposed to be
amended with new recordkeeping and reporting requirements being
imposed, as well as a required report to be obtained from an
examinations expert and filed with the Commission. Lastly, disclosures
made by FCMs to customers will be enhanced and records of such
disclosures will have to be maintained and reported to the Commission.
As noted, some of these proposed amendments will result in the
alteration of existing regulations covered by existing collections
which have already been assigned OMB control numbers. Others will
result in additional or new collection burdens, which will be
incorporated into the most relevant existing collection maintained by
the Commission and previously approved by or submitted for approval to
OMB.
a. Proposed Revision to Collection 3038-0024
Collection 3038-0024 is currently in force, with its control number
having been provided by OMB. In addition, the collection was proposed
to be revised in May 2011, with the approval of and issuance of a
control number by OMB presently pending. Certain collections contained
in this rulemaking would result in further revisions to the collection,
as discussed herein.
First, the Segregation Schedules and the Secured Amount Schedule,
required to be filed under Sec. 1.10, have been proposed to be changed
to reflect the FCM’s target for residual amounts and the sum of margin
deficits. The proposed amendments will also increase the frequency of
filing these schedules to daily under Sec. Sec. 1.32 and 30.7.
However, daily computations were previously required with respect to
the subject matter of these schedules and monthly filing procedure for
these schedules is already in place, and these schedules are already
subject to an OMB control number. Thus, the revision of collection
3038-0024 requires only incremental change to capture the new elements
of Sec. 1.10. One time initial system changes, if any, that will need
to be made to effect daily filing of the detail previously required in
the monthly report is anticipated to require between 40 and 80 burden
hours for the approximately 72 firms required to comply with the new
provisions of Sec. 1.10, depending on the size of the firm the
complexity of their systems. The additional filing requirement, which
may be effected electronically by the approximately 72 firms that will
be required to make daily filings, is anticipated to increase the
burdens associated with Sec. 1.10 by an anticipated 10-20 minutes for
each of the approximately 20 days per month that such reports were not
previously required to be filed.
Additionally, the proposed amendments include new requirements for
FCMs to establish comprehensive risk management programs under new
Sec. 1.11, and maintain associated recordkeeping as well as furnish
reports related to such risk management programs to the Commission and
the FCM’s DSRO. Included within the risk management programs will be
specific requirements for FCMs to establish and maintain written
policies and procedures regarding the safeguarding of all customer
funds.
Collection burdens associated with the safeguarding of customer
funds under the Commission’s regulations prior to the proposed
amendments are already subject to OMB control numbers. Accordingly, the
proposed revisions to collection 3038-0024 require only incremental
change to capture the new elements of Sec. 1.11. The estimated burden
associated with Sec. 1.11 will be divided into two components, a
onetime cost to establish the written policies and procedures and an
annual burden to maintain the such policies and procedures. Currently
there are 72 respondents subject to this change, many of which are
expected simply to establish and maintain policies and procedures
around their existing risk management programs. The estimated number of
hours to create the initial set of policies and procedures by
consolidation of existing risk management practices is anticipated to
average 75 hours across the 72 respondents that will be obligated to
comply. The estimated total annual maintenance burden on each
respondent is anticipated increase by an average 25 hours annually
across the 72 recordkeepers.
The collection is further being revised to reflect additional
proposed requirements for notifications under Sec. 1.12, and the
additional required filings contained in the proposed amendments under
Sec. Sec. 1.20, 1.23, 1.32, and 30.7. Currently there are 72
respondents estimated to be subject to these changes. The total of all
proposed changes to the Schedules of the Form 1-FR, which is already
subject to an OMB control number, is anticipated to be incremental, and
it is estimated that the proposed changes will add 15 minutes to the
preparation and filing of each report.
The proposed revision to Sec. 1.12(i) will require FCMs to report
to the Commission if the FCM discovers or is informed that it has
invested funds held for futures customers in instruments that are not
permitted investments under Sec. 1.25. This new report will be done on
an as required basis. It is estimated that this report will be
completed by two respondents per year with a burden of one hour for
each report.
The proposed revision to Sec. 1.12(j) will require FCMs to
immediately report to the Commission if a withdrawal of funds from
accounts holding futures customers funds causes the amount on
[[Page 67930]]
deposit in such accounts to be less than the FCM’s targeted excess or
residual interest in such accounts, or if the residual interest is less
than the sum of all margin deficits. The accounting needed to make
these reports is already conducted under the Commission’s regulations
for the purpose of ensuring compliance with the Commission’s existing
customer protection regulations. Once an event requiring notice is
identified, it is anticipated that five respondents per year will be
obligated to provide notices to the Commission under Sec. 1.12(j),
with an additional burden of up to two hours for each notice.
The Commission is also proposing to amend paragraphs (k) and (l) of
Sec. 1.12 which will require an FCM to provide notice to the
Commission in the event of a material change in the financial condition
of the firm or the firm’s operations. These new reports each will be
prepared and submitted on an as required basis, and are similar to
other notices required to be filed by FCMs in Parts 1 and 190, for
example, of the Commission’s regulations. Moreover, FCMs are already
subject to significant regulations in Part 1 that require each FCM to
continuously monitor their financial condition and report shortfalls in
net capital. It is estimated that the notices that would be required
under paragraphs (k) and (l) of Sec. 1.12 will be made by five
respondents per year with a burden of up to three hours for each
notice.
FCMs will be required under Sec. 1.20 to obtain and submit to the
Commission written acknowledgments, in a form and format being proposed
and expected to be required by the Commission, from any depository
institution, including certain DCOs, at which futures customer funds
will be segregated. It is estimated that the execution and filing of
new acknowledgment letters will be completed by five respondents per
year with a burden of up to two hours for completion and filing. It is
estimated that the maintaining of acknowledgment letters prescribed by
the Commission will be conducted by as many as 40 depository
institutions annually with an estimated burden of 45 minutes per
respondent.
FCMs are currently required to obtain and maintain in its files an
acknowledgment letter from depositories for each account holding
customer funds, in the form specified by the Commission. The obtaining
and maintaining of the acknowledgement letters will be done on an as
required basis and are already subject to an OMB control number.
Proposed revisions to Sec. 1.20(d) additionally would require FCMs to
retain and file these acknowledgment letters electronically with the
Commission. This new retention and filing will be done on an as
required basis. It is estimated that the filing of an estimated 1 to 2
new acknowledgment letters will be conducted by 72 respondents per
year, with a burden of 30 minutes associated with the retention and
filing of each of these acknowledgments.
Finally with respect to Sec. 1.20, a derivatives clearing
organization may adopt and submit to the Commission rules providing for
the segregation of customer funds that may be carried by the DCO that
would substitute for the acknowledgment letters completed by other
depositories. It is anticipated that approximately 17 of the DCOs
registered with the Commission will adopt and submit such rules, with
an estimated burden of 45 hours for the adoption and submission of such
rules. The DCO also must obtain acknowledgment letters from any
depository institution at which the DCO places segregated funds, and
these depository institutions must provide the Commission with direct
access to the customer account information at all times. It is
anticipated that as many as 40 depository institutions may complete
such letters, and provide ongoing access to the Commission, with a one-
time burden of 45 minutes per respondent for the completion of such
letters, and an estimated annual burden of 60 hours associated with
providing account access to the Commission.
Similarly, Sec. 30.7(d) is being revised to require FCMs that
maintain 30.7 Customer Accounts to obtain and maintain in its files, an
acknowledgment letter from depositories for each account holding 30.7
Customer Funds, in the form specified by the Commission, and Sec. 1.26
provides for the same from any institution segregating customer funds
in a money market mutual fund account. The proposed revisions to these
regulations require FCMs to file such acknowledgment letters
electronically with the Commission. The obtaining and maintaining of
the acknowledgement letters will be done on an as required basis. It is
estimated that the maintaining of acknowledgment letters will be
completed by 56 respondents with a burden of 45 minutes per respondent.
The completion of the acknowledgment letters by the depositories,
estimated at approximately 90 institutions, is expected to be 45
minutes per letter. Additionally, the requirement that these
acknowledgement letters be electronically filed with the Commission is
anticipated to result in 6 minutes of burden to 56 respondents per year
with respect to the proposed revisions to Sec. 30.7 and the same for
the proposed revisions to Sec. 1.26.
The Commission is also proposing to amend Sec. 1.23(c) to require
an FCM to immediately file written notice with the Commission if the
firm withdraws more than 25 percent of its residual interest in
segregated accounts. This new filing will be done on an as required
basis. It is estimated that the filing of these notices will be
completed by ten respondents per year with a burden of one hour for
each filing.
Pursuant to the proposed revisions of Sec. Sec. 1.32(c) and (d),
the Segregation Statement shall be completed on a daily basis and filed
by noon the following business day. Although the rule proposed herein
now require daily filing of the Segregation Statement, it should be
noted that the Segregation Statement is statement is already required
to be prepared and retained on a daily basis, thus the additional time
electronically filing the statement on a daily basis is minimal.
Currently there are 72 respondents subject to this change. The
estimated total annual burden on each respondent is 2 hours.
Pursuant to the proposed revisions of Sec. 1.32(g) each FCM that
holds customer funds is required to file the segregated investment
detail report twice monthly. Although the rule proposed herein requires
twice monthly filing of the segregated investment detail report, it
should be noted that the segregated investment detail report is already
required to be prepared twice monthly by the FCM’s designated self-
regulatory organization. Thus the additional time to electronically
file the statement with the Commission is minimal. Currently there are
72 respondents subject to this change. The estimated total annual
burden on each respondent is 5 minutes per report.
Similar to the proposed revisions of Sec. 1.32 discussed above,
Sec. 30.7(m) requires that the Statement of Secured Amounts shall be
completed on a daily basis and filed electronically by noon the
following business day. Although the rule proposed herein now require
daily filing of the Secured Amounts Statement, it should be noted that
the Secured Amounts is statement is already required to be prepared and
retained on a daily basis, thus the additional time electronically
filing the statement on a daily basis is minimal. Currently there are
56 respondents subject to this change. The estimated total annual
burden on each respondent is 2 hours.
[[Page 67931]]
Revisions to Sec. 30.7(i) will also require that FCMs keep records
of customer funds including a daily valuation of each instrument and
supporting documentation of such daily valuation. Currently there are
56 respondents subject to this change. The estimated total annual
burden on each respondent is 100 hours.
Finally, Sec. 1.55 would require public disclosures to be made by
an FCM to its customers respecting the limitations applicable to and
risks associated with the segregation of funds, among other things. It
is anticipated that 72 FCMs will provide such notices through the
standardization of account opening documents or distribution of the
notices therewith. Each FCM is expected to expend up to 4-20 hours
incorporating the notice, which is prescribed by regulation, into its
account opening process for customers that will establish new accounts,
and up to 10 minutes per customer providing the notices on a one-time
basis to as many as 3,000 customers and accounts opened by existing
customers.
b. Proposed Revision to Collection 3038-0052
The above-referenced collection titled “Part 38–Designated
Contract Markets” includes all burden associated with Sec. 1.52,
“Self-regulatory organization adoption and surveillance of minimum
financial requirements”. The proposed amendments include additional
requirements for SROs to adopt for their examination procedures,
including the requirement to have examination programs reviewed by an
examinations expert and having the report of such examinations expert
filed with the Commission at least once every two years. Regulation
1.52 already contains significant requirements with respect to the
examination programs to be established and maintained by SROs, which
are subject already to an OMB control number. The increase in the
burden under this collection for the adoption of enhanced examination
procedures, including the recordkeeping and reporting, to the extent
such may be necessary by any SRO to which Sec. 1.52 is necessary, is
estimated to add up to 50 burden hours to as many as 15 DCMs.
c. Proposed Revision to Collection 3038-0091
Collection 3038-0091was established with the adoption of Part 22 of
the Commissions regulations concerning Cleared Swaps in .February 2012
The proposed amendments would require revisions to this collection with
respect to recordkeeping and reporting associated with additional
filings of the Cleared Swaps Segregation Schedule daily under Sec.
22.2(g), and the associated recordkeeping and reporting with respect to
notices of withdrawals under a newly proposed Sec. 22.17. The
collection burden associated with the proposed amendments is
anticipated to increase by 10 minutes per day and is anticipated to
affect 100 entities.
2. Information Collection Comments
The Commission invites the public and other Federal agencies to
comment on any aspect of the proposed information collection
requirements discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the
Commission will consider public comments on such proposed requirements
in:
[cir] Evaluating whether the proposed collections of information
are necessary for the proper performance of the functions of the
Commission, including whether the information will have a practical
use;
[cir] Evaluating the accuracy of the estimated burden of the
proposed information collection requirements, including the degree to
which the methodology and the assumptions that the Commission employed
were valid;
[cir] Enhancing the quality, utility, and clarity of the
information proposed to be collected; and
[cir] Minimizing the burden of the proposed information collection
requirements on FCMs, SDs, and MSPs, including through the use of
appropriate automated, electronic, mechanical, or other technological
information collection techniques, e.g., permitting electronic
submission of responses.
Copies of the submission from the Commission to OMB are available
from the CFTC Clearance Officer, 1155 21st Street NW., Washington, DC
20581, (202) 418-5160 or from http://RegInfo.gov. Organizations and
individuals desiring to submit comments on the proposed information
collection requirements should send those comments to the OMB Office of
Information and Regulatory Affairs at:
[cir] The Office of Information and Regulatory Affairs, Office of
Management and Budget, Room 10235, New Executive Office Building,
Washington, DC 20503, Attn: Desk Officer of the Commodity Futures
Trading Commission;
[cir] (202) 395-6566 (fax); or
[cir] [email protected] (email).
Please provide the Commission with a copy of submitted comments so
that all comments can be summarized and addressed in the final
rulemaking. Please refer to the ADDRESSES section of this rulemaking
for instructions on submitting comments to the Commission. OMB is
required to make a decision concerning the proposed information
collection requirements between thirty (30) and sixty (60) days after
publication of the NPRM in the Federal Register. Therefore, a comment
to OMB is best assured of receiving full consideration if OMB (as well
as the Commission) receives it within thirty (30) days of publication
of this NPRM. The time frame for commenting on the PRA does not affect
the deadline established by the Commission on the proposed rules,
provided in the DATES section of this rulemaking.
V. Text of Proposed Rules
List of Subjects
17 CFR Part 1
Brokers, Commodity futures, Consumer protection, Reporting and
recordkeeping requirements.
17 CFR Part 3
Associated persons, Brokers, Commodity futures, Customer
protection, Major swap participants, Registration, Swap dealers.
17 CFR Part 22
Brokers, Clearing, Consumer protection, Reporting and recordkeeping
requirements, Swaps.
17 CFR Part 30
Commodity futures, Consumer protection, Currency, Reporting and
recordkeeping requirements.
17 CFR Part 140
Authority delegations (Government agencies), Organization and
functions (Government agencies).
In consideration of the foregoing and pursuant to the authority
contained in the Act, as indicated herein, the Commission hereby
proposes to amend chapter I of title 17 of the Code of Federal
Regulations as follows:
PART 1–GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for part 1 continues to be read as
follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g,
6h, 6i, 6j, 6k, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a, 7b, 8, 9, 10a 12,
12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24 as amended by
Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).
2. Amend Sec. 1.3 by revising paragraph (rr) to read as follows:
[[Page 67932]]
Sec. 1.3 Definitions.
* * * * *
(rr) Foreign futures or foreign options secured amount. This term
means all money, securities and property received by a futures
commission merchant from, for, or on behalf of 30.7 Customers as
defined in Sec. 30.1 of this chapter:
(1) To margin, guarantee, or secure foreign futures contracts and
all money accruing to such 30.7 Customers as the result of such
contracts;
(2) In connection with foreign options transactions representing
premiums payable or premiums received, or to guarantee or secure
performance on such transactions; and
(3) All money accruing to such 30.7 Customers as the result of
trading in foreign futures contracts or foreign options.
* * * * *
3. Amend Sec. 1.10 by:
a. Revising paragraph (b)(1)(ii);
b. Adding paragraph (b)(5); and
c. Revising paragraphs (c)(1), (c)(2)(i), (d)(1)(v), (d)(2)(iv),
(d)(2)(vi), and (g)(2)(ii).
The revisions and addition read as follows:
Sec. 1.10 Financial reports of futures commission merchants and
introducing brokers.
* * * * *
(b) * * *
(1) * * *
(ii) In addition to the monthly financial reports required by
paragraph (b)(1)(i) of this section, each person registered as a
futures commission merchant must file a Form 1-FR-FCM as of the close
of its fiscal year, which must be certified by an independent public
accountant in accordance with Sec. 1.16, and must be filed no later
than 60 days after the close of the futures commission merchant’s
fiscal year: Provided, however, that a registrant which is registered
with the Securities and Exchange Commission as a securities broker or
dealer must file this report not later than the time permitted for
filing an annual audit report under Sec. 240.17a-5(d)(5) of this
title.
* * * * *
(5) Each futures commission merchant must file with the Commission
the measure of the future commission merchant’s leverage (i.e., total
balance sheet assets, less any instruments guaranteed by the U.S.
Government and held as an asset or to collateralize an asset (e.g., a
reverse repo) divided by total capital (the sum of stockholders’ equity
and subordinated debt) all computed in accordance with U.S. generally
accepted accounting principles as of the close of business each month.
The filing is required to be made to the Commission within 17 business
days of the close of the futures commission merchant’s month end.
(c) Where to file reports. (1) Form 1-FR filed by an introducing
broker pursuant to paragraph (b)(2) of this section need be filed only
with, and will be considered filed when received by, the National
Futures Association. Other reports or information provided for in this
section will be considered filed when received by the Regional office
of the Commission with jurisdiction over the state in which the
registrant’s principal place of business is located (as set forth in
Sec. 140.02 of this chapter) and by the designated self-regulatory
organization, if any; and reports or other information required to be
filed by this section by an applicant for registration will be
considered filed when received by the National Futures Association. Any
report or information filed with the National Futures Association
pursuant to this paragraph shall be deemed for all purposes to be filed
with, and to be the official record of, the Commission.
(2)(i) All filings or other notices prepared by a futures
commission merchant pursuant to this section must be submitted to the
Commission in electronic form using a form of user authentication
assigned in accordance with procedures established by or approved by
the Commission, and otherwise in accordance with instructions issued by
or approved by the Commission, if the futures commission merchant or a
designated self-regulatory organization has provided the Commission
with the means necessary to read and to process the information
contained in such report. A Form 1-FR required to be certified by an
independent public accountant in accordance with Sec. 1.16 which is
filed by a futures commission merchant must be filed electronically.
* * * * *
(d) * * *
(1) * * *
(v) For a futures commission merchant only, the statements of
segregation requirements and funds in segregation for customers trading
on U.S. commodity exchanges and for customers’ dealer options accounts,
the statement of secured amounts and funds held in separate accounts
for 30.7 Customers (as defined in Sec. 30.1 of this chapter) in
accordance with Sec. 30.7 of this chapter, and the statement of
cleared swaps customer segregation requirements and funds in cleared
swaps customer accounts under section 4d(f) of the Act as of the date
for which the report is made; and
* * * * *
(2) * * *
(iv) For a futures commission merchant only, the statements of
segregation requirements and funds in segregation for customers trading
on U.S. commodity exchanges and for customers’ dealer options accounts,
the statement of secured amounts and funds held in separate accounts
for 30.7 Customers (as defined in Sec. 30.1 of this chapter) in
accordance with Sec. 30.7 of the chapter, and the statement of cleared
swaps customers segregation requirements and funds in cleared swaps
customer accounts under section 4d(f) of the Act as of the date for
which the report is made;
* * * * *
(vi) A reconciliation, including appropriate explanations, of the
statement of the computation of the minimum capital requirements
pursuant to Sec. 1.17 of this part and, for a futures commission
merchant only, the statements of segregation requirements and funds in
segregation for customers trading on U.S. commodity exchanges and for
customers’ dealer option accounts, the statement of secured amounts and
funds held in separate accounts for 30.7 Customers (as defined in Sec.
30.1 of this chapter) in accordance with Sec. 30.7 of this chapter,
and the statement of cleared swaps customer segregation requirements
and funds in cleared swaps customer accounts under section 4d(f) of the
Act, in the certified Form 1-FR with the applicant’s or registrant’s
corresponding uncertified most recent Form 1-FR filing when material
differences exist or, if no material differences exist, a statement so
indicating; and
* * * * *
(g) * * *
(2) * * *
(ii) The following statements and footnote disclosures thereof: the
Statement of Financial Condition in the certified annual financial
reports of futures commission merchants and introducing brokers; the
Statements (to be filed by a futures commission merchant only) of
Segregation Requirements and Funds in Segregation for customers trading
on U.S. commodity exchanges and for customers’ dealer options accounts,
the Statement (to be filed by a futures commission merchant only) of
Secured Amounts and Funds held in Separate Accounts for 30.7 Customers
(as defined in Sec. 30.1of this chapter) in accordance with Sec. 30.7
of this chapter, and the Statement (to be filed by futures
[[Page 67933]]
commission merchants only) of Cleared Swaps Customer Segregation
Requirements and Funds in Cleared Swaps Customer Accounts under section
4d(f) of the Act.
* * * * *
4. Add Sec. 1.11 to read as follows:
Sec. 1.11 Risk Management Program for Futures Commission Merchants.
(a) Applicability. Nothing in this section shall apply to a futures
commission merchant that does not accept any money, securities, or
property (or extend credit in lieu thereof) to margin, guarantee, or
secure any trades or contracts that result from soliciting or accepting
orders for the purchase or sale of any commodity interest.
(b) Definitions. For purposes of this section:
(1) “Business Unit” means any department, division, group, or
personnel of a futures commission merchant or any of its affiliates,
whether or not identified as such that:
(i) Engages in soliciting or in accepting orders for the purchase
or sale of any commodity interest and that, in or in connection with
such solicitation or acceptance of orders, accepts any money,
securities, or property (or extends credit in lieu thereof) to margin,
guarantee, or secure any trades or contracts that result or may result
therefrom; or
(ii) Otherwise handles Segregated Funds, including managing,
investing, and overseeing the custody of Segregated Funds, or any
documentation in connection therewith, other than for risk management
purposes; and
(iii) Any personnel exercising direct supervisory authority of the
performance of the activities described in paragraph (b)(1)(i) or (ii)
of this section.
(2) “Customer” means a futures customer as defined at Sec. 1.3
of this part, Cleared Swaps Customer as defined at Sec. 22.1 of this
chapter, and 30.7 Customer as defined at Sec. 30.1 of this chapter.
(3) “Governing Body” means the proprietor, if the futures
commission merchant is a sole proprietorship; a general partner, if the
futures commission merchant is a partnership; the board of directors if
the futures commission merchant is a corporation; the chief executive
officer, the chief financial officer, the manager, the managing member,
or those members vested with the management authority if the futures
commission merchant is a limited liability company or limited liability
partnership.
(4) “Segregated Funds” means money, securities, or other property
held by a futures commission merchant in separate accounts pursuant to
Sec. 1.20 of this part for futures customers, pursuant to Sec. 22.2
of this chapter for Cleared Swaps Customers, and pursuant to Sec. 30.7
of this chapter for Sec. 30.7 Customers; and
(5) “Senior Management” means, any officer or officers
specifically granted the authority and responsibility to fulfill the
requirements of senior management by the Governing Body.
(c) Risk Management Program. (1) Each futures commission merchant
shall establish, maintain, and enforce a system of risk management
policies and procedures designed to monitor and manage the risks
associated with the activities of the futures commission merchant as
such. For purposes of this section, such policies and procedures shall
be referred to collectively as a “Risk Management Program.”
(2) Each futures commission merchant shall maintain written
policies and procedures that describe the Risk Management Program of
the futures commission merchant.
(3) The Risk Management Program and the written risk management
policies and procedures, and any material changes thereto, shall be
approved in writing by the Governing Body of the futures commission
merchant.
(4) Each futures commission merchant shall furnish a copy of its
written risk management policies and procedures to the Commission and
its designated self-regulatory organization upon application for
registration and thereafter upon request.
(d) Risk management unit. As part of the Risk Management Program,
each futures commission merchant shall establish and maintain a risk
management unit with sufficient authority; qualified personnel; and
financial, operational, and other resources to carry out the risk
management program established pursuant to this section. The risk
management unit shall report directly to Senior Management and shall be
independent from the Business Unit.
(e) Elements of the Risk Management Program. The Risk Management
Program of each futures commission merchant shall include, at a
minimum, the following elements:
(1) Identification of risks and risk tolerance limits. (i) The Risk
Management Program shall take into account market, credit, liquidity,
foreign currency, legal, operational, settlement, segregation,
technological, capital, and any other applicable risks together with a
description of the risk tolerance limits set by the futures commission
merchant and the underlying methodology in the written policies and
procedures. The risk tolerance limits shall be reviewed and approved
quarterly by Senior Management and annually by the Governing Body.
Exceptions to risk tolerance limits shall be subject to written
policies and procedures.
(ii) The Risk Management Program shall take into account risks
posed by affiliates, all lines of business of the futures commission
merchant, and all other trading activity engaged in by the futures
commission merchant. The Risk Management Program shall be integrated
into risk management at the consolidated entity level.
(iii) The Risk Management Program shall include policies and
procedures for detecting breaches of risk tolerance limits set by the
futures commission merchant, and alerting supervisors within the risk
management unit and Senior Management, as appropriate.
(2) Periodic Risk Exposure Reports. (i) The risk management unit of
each futures commission merchant shall provide to Senior Management and
to its Governing Body quarterly written reports setting forth all
applicable risk exposures of the futures commission merchant; any
recommended or completed changes to the Risk Management Program; the
recommended time frame for implementing recommended changes; and the
status of any incomplete implementation of previously recommended
changes to the Risk Management Program. For purposes of this section,
such reports shall be referred to as “Risk Exposure Reports.” The
Risk Exposure Reports also shall be provided to the Senior Management
and the Governing Body immediately upon detection of any material
change in the risk exposure of the futures commission merchant.
(ii) Furnishing to the Commission. Each futures commission merchant
shall furnish copies of its Risk Exposure Reports to the Commission
within five (5) business days of providing such reports to its Senior
Management.
(3) Specific risk management considerations. The Risk Management
Program of each futures commission merchant shall include, but not be
limited to, policies and procedures necessary to monitor and manage the
following risks:
(i) Segregation Risk. The written policies and procedures shall be
reasonably designed to ensure that Segregated Funds are separately
accounted for and segregated or secured as belonging to Customers as
required
[[Page 67934]]
by the Act and Commission regulations and must, at a minimum, include
or address the following:
(A) A process for the evaluation of depositories of Segregated
Funds, including, at a minimum, documented criteria that any depository
that will hold Segregated Funds, including an entity affiliated with
the futures commission merchant, must meet, including criteria
addressing the depository’s capitalization, creditworthiness,
operational reliability, and access to liquidity. The criteria should
further consider the extent to which Segregated Funds are concentrated
with any depository or group of depositories. The criteria also should
include the availability of deposit insurance and the extent of the
regulation and supervision of the depository;
(B) A program to monitor an approved depository on an ongoing basis
to assess its continued satisfaction of the futures commission
merchant’s established criteria, including a thorough due diligence
review of each depository at least annually;
(C) An account opening process for depositories, including
documented authorization requirements, procedures that ensure that
Segregated Funds are not deposited with a depository prior to the
futures commission merchant receiving the acknowledgment letter
required from such depository pursuant to Sec. 1.20 of this part, and
Sec. Sec. 22.2 and 30.7 of this chapter, and procedures that ensure
that such account is properly titled to reflect that it is holding
Segregated Funds pursuant to the Act and Commission regulations;
(D) A process for establishing a targeted amount of residual
interest that the futures commission merchant seeks to maintain as its
residual interest in the Segregated Funds accounts and such process
must be designed to reasonably ensure that the futures commission
merchant maintains the targeted residual amounts and remains in
compliance with the Segregated Funds requirements at all times. The
policies and procedures must require that Senior Management, in
establishing the total amount of the targeted residual interest in the
Segregated Funds accounts, perform appropriate due diligence and
consider various factors, as applicable, relating to the nature of the
futures commission merchant’s business including, but not limited to,
the composition of the futures commission merchant’s Customer base, the
general creditworthiness of the Customer base, the general trading
activity of the Customers, the types of markets and products traded by
the Customers, the proprietary trading of the futures commission
merchant, the general volatility and liquidity of the markets and
products traded by Customers, the futures commission merchant’s own
liquidity and capital needs, and the historical trends in Customer
Segregated Fund balances, including margin debit and net deficit
balances in Customers’ accounts. The analysis and calculation of the
targeted amount of the future commission merchant’s residual interest
must be described in writing with the specificity necessary to allow
the Commission and the futures commission merchant’s designated self-
regulatory organization to duplicate the analysis and calculation and
test the assumptions made by the futures commission merchant. The
adequacy of the targeted residual interest and the process for
establishing the targeted residual interest must be reassessed
periodically by Senior Management and revised as necessary;
(E) A process for the withdrawal of cash, securities, or other
property from accounts holding Segregated Funds, where the withdrawal
is not for the purpose of payments to or on behalf of the futures
commission merchant’s Customers. Such policies and procedures must
satisfy the requirements of Sec. 1.23 of this part, Sec. 22.17 of
this chapter, or Sec. 30.7 of this chapter, as applicable;
(F) A process for assessing the appropriateness of specific
investments of Segregated Funds in permitted investments in accordance
with Sec. 1.25 of this part. Such policies and procedures must take
into consideration the market, credit, counterparty, operational, and
liquidity risks associated with such investments, and assess whether
such investments comply with the requirements in Sec. 1.25 of this
part including that the futures commission merchant manage the
permitted investments consistent with the objectives of preserving
principal and maintaining liquidity;
(H) Procedures requiring the appropriate separation of duties among
individuals responsible for compliance with the Act and Commission
regulations relating to the protection and financial reporting of
Segregated Funds, including the separation of duties among personnel
that are responsible for advising customers on trading activities,
approving or overseeing cash receipts and disbursements (including
investment operations), and recording and reporting financial
transactions. The policies and procedures must require that any
movement of funds to affiliated companies and parties are properly
approved and documented;
(I) A process for the timely recording of all transactions,
including transactions impacting Customers’ accounts, in the firm’s
books of record;
(J) A program for conducting annual training of all finance,
treasury, operations, regulatory, compliance, settlement, and other
relevant officers and employees regarding the segregation requirements
for Segregated Funds required by the Act and regulations, the
requirements for notices under Sec. 1.12 of this part, procedures for
reporting of suspected breaches of the policies and procedures required
by this section to the chief compliance officer, without fear of
retaliation, and the consequences of failing to comply with the
segregation requirements of the Act and regulations; and
(K) Policies and procedures for assessing the liquidity,
marketability and mark-to-market valuation of all securities or other
non-cash assets held as Segregated Funds, including permitted
investments under Sec. 1.25 of this part, to ensure that all non-cash
assets held in the Customer segregated accounts, both customer-owned
securities and investments in accordance with Sec. 1.25 of this part,
are readily marketable and highly liquid. Such policies and procedures
must require daily measurement of liquidity needs with respect to
Customers; assessment of procedures to liquidate all non-cash
collateral in a timely manner and without significant effect on price;
and application of appropriate collateral haircuts that accurately
reflect market and credit risk.
(ii) Operational Risk. The Risk Management Program shall include
automated financial risk management controls reasonably designed to
prevent the placing of erroneous orders, including those that exceed
pre-set capital, credit, or volume thresholds. The Risk Management
Program shall ensure that the use of automated trading programs is
subject to policies and procedures governing the use, supervision,
maintenance, testing, and inspection of such programs.
(iii) Capital Risk. The written policies and procedures shall be
reasonably designed to ensure that the futures commission merchant has
sufficient capital to be in compliance with the Act and the
regulations, and sufficient capital and liquidity to meet the
reasonably foreseeable needs of the futures commission merchant.
(4) Supervision of the Risk Management Program. The Risk Management
Program shall include a supervisory system that is reasonably
[[Page 67935]]
designed to ensure that the policies and procedures required by this
section are diligently followed.
(f) Review and testing. (1) The Risk Management Program of each
futures commission merchant shall be reviewed and tested on at least an
annual basis, or upon any material change in the business of the
futures commission merchant that is reasonably likely to alter the risk
profile of the futures commission merchant.
(2) The annual reviews of the Risk Management Program shall include
an analysis of adherence to, and the effectiveness of, the risk
management policies and procedures, and any recommendations for
modifications to the Risk Management Program. The annual testing shall
be performed by qualified internal audit staff that are independent of
the Business Unit or by a qualified third party audit service reporting
to staff that are independent of the Business Unit. The results of the
annual review of the Risk Management Program shall be promptly reported
to and reviewed by the chief compliance officer, Senior Management, and
Governing Body of the futures commission merchant.
(3) Each futures commission merchant shall document all internal
and external reviews and testing of its Risk Management Program and
written risk management policies and procedures including the date of
the review or test; the results; any deficiencies identified; the
corrective action taken; and the date that corrective action was taken.
Such documentation shall be provided to Commission staff, upon request.
(g) Distribution of risk management policies and procedures. The
Risk Management Program shall include procedures for the timely
distribution of its written risk management policies and procedures to
relevant supervisory personnel. Each futures commission merchant shall
maintain records of the persons to whom the risk management policies
and procedures were distributed and when they were distributed.
(h) Recordkeeping. (1) Each futures commission merchant shall
maintain copies of all written approvals required by this section.
(2) All records or reports, including, but not limited to, the
written policies and procedures and any changes thereto, that a futures
commission merchant is required to maintain pursuant to this regulation
shall be maintained in accordance with Sec. 1.31 and shall be made
available promptly upon request to representatives of the Commission.
5. Amend Sec. 1.12 by revising paragraphs (a)(1) and (2), (b)(1),
(2), and (4), (c), (d), (e), (f)(2) through (4), (f)(5)(i), (g), (h),
and (i), and by adding new paragraphs (j), (k), (l), (m), and (n), to
read as follows:
Sec. 1.12 Maintenance of minimum financial requirements by futures
commission merchants and introducing brokers.
(a) * * *
(1) Give notice, as set forth in paragraph (n) of this section,
that the applicant’s or registrant’s adjusted net capital is less than
required by Sec. 1.17 of this part or by other capital rule,
identifying the applicable capital rule. The notice must be given
immediately after the applicant or registrant knows or should have
known that its adjusted net capital is less than required by any of the
aforesaid rules to which the applicant or registrant is subject; and
(2) Provide together with such notice documentation, in such form
as necessary, to adequately reflect the applicant’s or registrant’s
capital condition as of any date on which such person’s adjusted net
capital is less than the minimum required; Provided, however, that if
the applicant or registrant cannot calculate or otherwise immediately
determine its financial condition, it must provide the notice required
by paragraph (a)(1) of this section and include in such notice a
statement that the entity cannot presently calculate its financial
condition. The applicant or registrant must provide similar
documentation of its financial condition for other days as the
Commission may request.
(b) * * *
(1) 150 percent of the minimum dollar amount required by Sec.
1.17(a)(1)(i)(A) of this part;
(2) 110 percent of the amount required by Sec. 1.17(a)(1)(i)(B) of
this part;
* * * * *
(4) For securities brokers or dealers, the amount of net capital
specified in Rule 17a-11(c) of the Securities and Exchange Commission
(17 CFR 240.17a-11(c)), must file notice to that effect, as set forth
in paragraph (n) of this section, as soon as possible and no later than
twenty-four (24) hours of such event.
(c) If an applicant or registrant at any time fails to make or keep
current the books and records required by these regulations, such
applicant or registrant must, on the same day such event occurs,
provide notice of such fact as specified in paragraph (n) of this
section, specifying the books and records which have not been made or
which are not current, and as soon as possible, but not later than
forty-eight (48) hours after giving such notice, file a report as
required by paragraph (n) of this section stating what steps have been
and are being taken to correct the situation.
(d) Whenever any applicant or registrant discovers or is notified
by an independent public accountant, pursuant to Sec. 1.16(e)(2) of
this part, of the existence of any material inadequacy, as specified in
Sec. 1.16(d)(2) of this part, such applicant or registrant must give
notice of such material inadequacy, as provided in paragraph (n) of
this section, as soon as possible but not later than twenty-four (24)
hours of discovering or being notified of the material inadequacy. The
applicant or registrant must file, in the manner provided for under
paragraph (n) of this section, a report stating what steps have been
and are being taken to correct the material inadequacy within forty-
eight (48) hours of filing its notice of the material inadequacy.
(e) Whenever any self-regulatory organization learns that a member
registrant has failed to file a notice or report as required by this
section, that self-regulatory organization must immediately report this
failure by notice, as provided in paragraph (n) of this section.
(f) * * *
(2) Whenever a registered futures commission merchant determines
that any position it carries for another registered futures commission
merchant or for a registered leverage transaction merchant must be
liquidated immediately, transferred immediately or that the trading of
any account of such futures commission merchant or leverage transaction
merchant shall be only for purposes of liquidation, because the other
futures commission merchant or the leverage transaction merchant has
failed to meet a call for margin or to make other required deposits,
the carrying futures commission merchant must immediately give notice,
as provided in paragraph (n) of this section, of such a determination.
(3) Whenever a registered futures commission merchant determines
that an account which it is carrying is undermargined by an amount
which exceeds the futures commission merchant’s adjusted net capital
determined in accordance with Sec. 1.17 of this part, the futures
commission merchant must immediately provide notice, as provided in
paragraph (n) of this section, of such a determination to the
designated self-regulatory organization and the Commission. This
paragraph (f)(3) shall apply to any account carried by the futures
[[Page 67936]]
commission merchant, whether a customer, noncustomer, omnibus or
proprietary account. For purposes of this paragraph (f)(3), if any
person has an interest of 10 percent or more in ownership or equity in,
or guarantees, more than one account, or has guaranteed an account in
addition to its own account, all such accounts shall be combined.
(4) A futures commission merchant shall provide immediate notice,
as provided in paragraph (n) of this section, 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 of this part, 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, cleared
swaps, 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.
(5)(i) A futures commission merchant shall provide immediate
notice, as provided in paragraph (n) of this section, 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
or dealer.
* * * * *
(g) A futures commission merchant shall provide notice, as provided
in paragraph (n) of this section, 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 of this part. 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) of this part, tentative net
capital as defined in the rules of the Securities and Exchange
Commission) of 20 percent or more, notice must be provided as provided
in paragraph (n) of this section within two business days of the event
or series of events causing the reduction stating the reason for the
reduction and steps the futures commission merchant will be taking to
ensure an appropriate level of net capital is maintained by the futures
commission merchant; and
(2) If equity capital of the futures commission merchant or a
subsidiary or affiliate of the futures commission merchant consolidated
pursuant to Sec. 1.17(f) of this part (or 17 CFR 240.15c3-1e) would be
withdrawn by action of a stockholder or a partner or a limited
liability company member 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, limited
liability company member, 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) of
this part, excess net capital as defined in the rules of the Securities
and Exchange Commission) of 30 percent or more, notice must be provided
as provided in paragraph (n) of this section 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) Upon receipt of such notice from a futures commission merchant,
or upon a reasonable belief that a substantial reduction in capital has
occurred or will occur, the Director of the Division of Swap Dealer and
Intermediary Oversight or the Director’s designee may require that the
futures commission merchant provide or cause a Material Affiliated
Person (as that term is defined in Sec. 1.14(a)(2) of this part) 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.
(h) Whenever a person registered as a futures commission merchant
knows or should know that the total amount of its funds on deposit in
segregated accounts on behalf of customers trading on designated
contract markets, or the amount of funds on deposit in segregated
accounts for customers transacting in Cleared Swaps under part 22 of
this chapter, or that the total amount set aside on behalf of customers
trading on non-United States markets under part 30 of this chapter, is
less than the total amount of such funds required by the Act and the
regulations to be on deposit in segregated or secured amount accounts
on behalf of such customers, the registrant must report such deficiency
immediately by notice to the registrant’s designated self-regulatory
organization and the Commission, as provided in paragraph (n) of this
section.
(i) A futures commission merchant must provide immediate notice, as
set forth in paragraph (n) of this section, whenever it discovers or is
informed that it has invested funds held for futures customers trading
on designated contract markets pursuant to Sec. 1.20 of this part,
Cleared Swaps Customer Collateral, as defined in Sec. 22.1 of this
chapter, or 30.7 Customer Funds, as defined in Sec. 30.1 of this
chapter, in instruments that are not permitted investments under Sec.
1.25 of this part, or has otherwise violated the requirements governing
the investment of funds belonging to customers under Sec. 1.25 of this
part.
(j) A futures commission merchant must provide immediate notice, as
provided in paragraph (n) of this section, whenever the futures
commission merchant does not hold a sufficient amount of funds in
segregated accounts for futures customers under Sec. 1.20 of this
part, in segregated accounts for Cleared Swaps Customers under part 22
of this chapter, or in secured amount accounts for customers trading on
foreign market under part 30 of this chapter to meet the futures
commission merchant’s targeted residual interest in the segregated or
secured amount accounts pursuant to its policies and procedures
required under Sec. 1.11 of this part, or whenever the futures
commission merchant’s amount of residual interest in any such accounts
is less than the sum of all margin deficits for such accounts.
[[Page 67937]]
(k) A futures commission merchant must provide immediate notice, as
provided in paragraph (n) of this section, whenever the futures
commission merchant, or the futures commission merchant’s parent or
material affiliate, experiences a material adverse impact to its
creditworthiness or ability to fund its obligations.
(l) A futures commission merchant must provide immediate notice, as
provided in paragraph (n) of this section, whenever the futures
commission merchant experiences a material change in its operations or
risk profile, including a change in the senior management of the
futures commission merchant, the establishment or termination of a line
of business, a material adverse change in the futures commission
merchant’s clearing arrangements, or a material adverse change to the
futures commission merchant’s credit arrangements, including any change
that could adversely impact the firm’s liquidity resources.
(m) In the event that a futures commission merchant receives a
notice, examination report, or any other correspondence from a
designated self-regulatory organization, the Securities and Exchange
Commission or a securities industry self-regulatory organization, the
futures commission merchant must immediately file a copy of such
notice, examination report, or any other correspondence, and the
registrant’s response, as appropriate, as provided in paragraph (n) of
this section.
(n) Notice. (1) Every notice and report required to be filed by
this section by a futures commission merchant or a self-regulatory
organization must be filed with the Commission, with the designated
self-regulatory organization, if any, and with the Securities and
Exchange Commission, if such registrant is a securities broker or
dealer. Every notice and report required to be filed by this section by
an applicant for registration as a futures commission merchant must be
filed with the National Futures Association (on behalf of the
Commission), with the designated self-regulatory organization, if any,
and with the Securities and Exchange Commission, if such applicant is a
securities broker or dealer. Every notice or report that is required to
be filed by this section by a futures commission merchant or a self-
regulatory organization must include a discussion of how the reporting
event originated and what steps have been, or are being taken, to
address the reporting event.
(2) Every notice and report which an introducing broker or
applicant for registration as an introducing broker is required to file
by paragraphs (a), (c), and (d) of this section must be filed with the
National Futures Association (on behalf of the Commission), with the
designated self-regulatory organization, if any, and with every futures
commission merchant carrying or intending to carry customer accounts
for the introducing broker or applicant for registration as an
introducing broker. Any notice or report filed with the National
Futures Association pursuant to this paragraph shall be deemed for all
purposes to be filed with, and to be the official record of, the
Commission. Every notice or report that is required to be filed by this
section by an introducing broker or applicant for registration as an
introducing broker must include a discussion of how the reporting event
originated and what steps have been, or are being taken, to address the
reporting event.
(3) Every notice or report that is required to be filed by a
futures commission merchant with the Commission or with a designated
self-regulatory organization under this section must be in writing and
must be filed via electronic transmission using a form of user
authentication assigned in accordance with procedures established by or
approved by the Commission, and otherwise in accordance with
instructions issued by or approved by the Commission; Provided,
however, that if the registered futures commission merchant cannot file
the notice or report using the electronic transmission approved by the
Commission due to a transmission or systems failure, the futures
commission merchant must immediately contact the Commission’s Regional
office with jurisdiction over the futures commission merchant as
provided in Sec. 140.02 of this chapter, and by email to
[email protected]. Any such electronic submission must clearly
indicate the futures commission merchant on whose behalf such filing is
made and the use of such user authentication in submitting such filing
will constitute and become a substitute for the manual signature of the
authorized signer.
6. Amend Sec. 1.15 by revising paragraph (a)(4) to read as
follows:
Sec. 1.15 Risk assessment reporting requirements for futures
commission merchants.
(a) * * *
(4) The reports required to be filed pursuant to paragraphs (a)(1)
and (2) of this section must be filed via electronic transmission using
a form of user authentication assigned in accordance with procedures
established by or approved by the Commission, and otherwise in
accordance with instructions issued by or approved by the Commission.
Any such electronic submission must clearly indicate the registrant on
whose behalf such filing is made and the use of such user
authentication in submitting such filing will constitute and become a
substitute for the manual signature of the authorized signer.
* * * * *
7. Amend Sec. 1.16 by revising paragraphs (a)(4), (b)(1), (c)(1),
(c)(2), and (f)(1)(i)(C), and by adding paragraph (b)(4) to read as
follows:
Sec. 1.16 Qualifications and reports of accountants.
(a) * * *
(4) Customer. The term “customer” means customer, as defined in
Sec. 1.3 of this part, and 30.7 Customer, as defined in Sec. 30.1 of
this chapter.
(b) Qualifications of accountants. (1) The Commission will
recognize any person as a certified public accountant who is duly
registered and in good standing as such under the laws of the place of
his residence or principal office; Provided, however, that a certified
public accountant engaged to conduct an examination of a futures
commission merchant must be registered with the Public Company
Accounting Oversight Board, have undergone an examination by the Public
Company Accounting Oversight Board, and any deficiencies noted during
such examination must have been remediated to the satisfaction of the
Public Company Accounting Oversight Board within three years of such
report.
* * * * *
(4) The governing body of each futures commission merchant must
ensure that the certified public accountant engaged is duly qualified
to perform an audit of the futures commission merchant. Such an
evaluation of the qualifications of the certified public accountant
should include, among other issues, the certified public accountant’s
experience in auditing futures commission merchants, the depth of the
certified public accountant’s staff, the certified public accountant’s
knowledge of the Act and Regulations, the size and geographic location
of the futures commission merchant, and the independence of the
certified public accountant.
(c) * * *
(1) Technical requirements. The accountant’s report must:
(i) Be dated;
(ii) Indicate the city and State where issued; and
[[Page 67938]]
(iii) Identify without detailed enumeration the financial
statements covered by the report.
(2) Representations as to the audit. The accountant’s report must
state whether the audit was made in accordance with U.S. generally
accepted auditing standards after full consideration to the auditing
standards adopted by the Public Company Accounting Oversight Board, and
must designate any auditing procedures deemed necessary by the
accountant under the circumstances of the particular case which have
been omitted and the reasons for their omission. However, nothing in
this paragraph (c)(2) shall be construed to imply authority for the
omission of any procedure which independent accountants would
ordinarily employ in the course of an audit made for the purposes of
expressing the opinion required by paragraph (c)(3) of this section.
* * * * *
(f)(1) * * *
(i) * * *
(C) Any copy that under this paragraph (f)(1)(i) is required to be
filed with the Commission must be filed via electronic transmission
using a form of user authentication assigned in accordance with
procedures established by or approved by the Commission, and otherwise
in accordance with instructions issued by or approved by the
Commission. Any such electronic submission must clearly indicate the
registrant on whose behalf such filing is made and the use of such user
authentication in submitting such filing will constitute and become a
substitute for the manual signature of the authorized signer.
* * * * *
8. Amend Sec. 1.17 by revising paragraphs (a)(4), (b)(2), (b)(7),
(c)(5)(v), (c)(5)(viii), and (c)(5)(ix) to read as follows:
Sec. 1.17 Minimum financial requirements for futures commission
merchants and introducing brokers.
(a) * * *
(4) A futures commission merchant who is not in compliance with
this section, or is unable to demonstrate such compliance as required
by paragraph (a)(3) of this section, or who cannot certify to the
Commission immediately upon request and demonstrate with verifiable
evidence that it has sufficient access to liquidity to continue
operating as a going concern, must transfer all customer accounts and
immediately cease doing business as a futures commission merchant until
such time as the firm is able to demonstrate such compliance; Provided,
however, The registrant may trade for liquidation purposes only unless
otherwise directed by the Commission and/or the designated self-
regulatory organization; And, Provided further, That if such registrant
immediately demonstrates to the satisfaction of the Commission or the
designated self-regulatory organization the ability to achieve
compliance, the Commission or the designated self-regulatory
organization may in its discretion allow such registrant up to a
maximum of 10 business days in which to achieve compliance without
having to transfer accounts and cease doing business as required above.
Nothing in this paragraph (a)(4) shall be construed as preventing the
Commission or the designated self-regulatory organization from taking
action against a registrant for non-compliance with any of the
provisions of this section.
* * * * *
(b) * * *
(2) Customer. This term means a futures customer as defined in
Sec. 1.3 of this chapter, a cleared over the counter customer as
defined in paragraph (b)(10) of this section, and a 30.7 Customer as
defined in Sec. 30.1 of this chapter.
* * * * *
(7) Customer account. This term means an account in which commodity
futures, options or cleared over the counter derivative positions are
carried on the books of the applicant or registrant which is an account
that is included in the definition of customer as defined in Sec.
1.17(b)(2).
* * * * *
(c) * * *
(5) * * *
(v) In the case of securities and obligations used by the applicant
or registrant in computing net capital, and in the case of a futures
commission merchant that invests funds deposited by futures customers
as defined in Sec. 1.3 of this part, Cleared Swaps Customers as
defined in Sec. 22.1 of this chapter, and 30.7 Customers as defined in
Sec. 30.1 of this chapter in securities as permitted investments under
Sec. 1.25 of this part, the deductions specified in Rule 240.15c3-
1(c)(2)(vi) or Rule 240.15c3-1(c)(2)(vii) of the Securities and
Exchange Commission (17 CFR 240.15c3-1(c)(2)(vi) and 17 CFR 240.15c3-
1(c)(2)(vii)) (“securities haircuts”). Futures commission merchants
that establish and enforce written policies and procedures to assess
the credit risk of commercial paper, convertible debt instruments, or
nonconvertible debt instruments in accordance with Rule 240.15c3-
1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR 240.15c3-
1(c)(2)(vi)) may apply the lower haircut percentages specified in Rule
240.15c3-1(c)(2)(vi) for such commercial paper, convertible debt
instruments and nonconvertible debt instruments. Futures commission
merchants must maintain their written policies and procedures in
accordance with Sec. 1.31 of this part;
* * * * *
(viii) In the case of a futures commission merchant, for
undermargined customer commodity futures accounts and commodity option
customer accounts the amount of funds required in each such account to
meet maintenance margin requirements of the applicable board of trade
or if there are no such maintenance margin requirements, clearing
organization margin requirements applicable to such positions, after
application of calls for margin or other required deposits which are
outstanding no more than one business day. If there are no such
maintenance margin requirements or clearing organization margin
requirements, then the amount of funds required to provide margin equal
to the amount necessary, after application of calls for margin or other
required deposits outstanding no more than one business day, to restore
original margin when the original margin has been depleted by 50
percent or more: Provided, To the extent a deficit is excluded from
current assets in accordance with paragraph (c)(2)(i) of this section
such amount shall not also be deducted under this paragraph
(c)(5)(viii). In the event that an owner of a customer account has
deposited an asset other than cash to margin, guarantee or secure his
account, the value attributable to such asset for purposes of this
subparagraph shall be the lesser of (A) the value attributable to the
asset pursuant to the margin rules of the applicable board of trade, or
(B) the market value of the asset after application of the percentage
deductions specified in this paragraph (c)(5);
(ix) In the case of a futures commission merchant, for
undermargined commodity futures and commodity option noncustomer and
omnibus accounts the amount of funds required in each such account to
meet maintenance margin requirements of the applicable board of trade
or if there are no such maintenance margin requirements, clearing
organization margin requirements applicable to such positions, after
application of calls for margin or other required deposits which
[[Page 67939]]
are outstanding no more than one business day. If there are no such
maintenance margin requirements or clearing organization margin
requirements, then the amount of funds required to provide margin equal
to the amount necessary after application of calls for margin or other
required deposits outstanding no more than one business day to restore
original margin when the original margin has been depleted by 50
percent or more: Provided, To the extent a deficit is excluded from
current assets in accordance with paragraph (c)(2)(i) of this section
such amount shall not also be deducted under this paragraph (c)(5)(ix).
In the event that an owner of a noncustomer or omnibus account has
deposited an asset other than cash to margin, guarantee or secure his
account the value attributable to such asset for purposes of this
subparagraph shall be the lesser of the value attributable to such
asset pursuant to the margin rules of the applicable board of trade, or
the market value of such asset after application of the percentage
deductions specified in this paragraph (c)(5);
* * * * *
9. Revise Sec. 1.20 to read as follows:
Sec. 1.20 Futures customer funds to be segregated and separately
accounted for.
(a) General. A futures commission merchant must separately account
for all futures customer funds and segregate such funds as belonging to
its futures customers. A futures commission merchant shall deposit
futures customer funds under an account name which clearly identifies
them as futures customer funds and shows that such funds are segregated
as required by sections 4d(a) and 4d(b) of the Act and this part. A
futures commission merchant must at all times maintain in the separate
account or accounts money, securities and property in an amount at
least sufficient in the aggregate to cover its total obligations to all
futures customers. The futures commission merchant must perform
appropriate due diligence as required by Sec. 1.11 of this part on any
and all locations of futures customer funds, as specified in paragraph
(b) of this section, to ensure that the location in which the futures
commission merchant has deposited such funds is a financially sound
entity.
(b) Location of futures customer funds. A futures commission
merchant may deposit futures customer funds, subject to the risk
management policies and procedures of the futures commission merchant
required by Sec. 1.11 of this part, with the following depositories:
(1) A bank or trust company;
(2) A derivatives clearing organization; or
(3) Another futures commission merchant.
(c) Limitation on the holding of futures customer funds outside of
the United States. A futures commission merchant may hold futures
customer funds with a depository outside of the United States only in
accordance with Sec. 1.49 of this part.
(d) Written acknowledgment from depositories. (1) A futures
commission merchant must obtain a written acknowledgment from each
bank, trust company, derivatives clearing organization, or futures
commission merchant prior to or contemporaneously with the opening of
an account by the futures commission merchant with such depositories;
Provided, however, that a written acknowledgment need not be obtained
from a derivatives clearing organization that has adopted and submitted
to the Commission rules that provide for the segregation of futures
customer funds in accordance with all relevant provisions of the Act
and the rules and orders promulgated thereunder.
(2) The written acknowledgment must be in the form as set out in
Appendix A to this part.
(3) A futures commission merchant may deposit futures customer
funds only with a depository that provides the Commission and the
futures commission merchant’s designated self-regulatory organization
with direct, read-only access to account information on 24-hour a day
basis. The Commission and the futures commission merchant’s designated
self-regulatory organization must receive the direct access when the
account is opened. The written acknowledgment must contain the futures
commission merchant’s authorization to the depository to provide direct
and immediate account access to the Commission and the futures
commission merchant’s designated self-regulatory organization without
further notice to or consent from the futures commission merchant.
(4) A futures commission merchant may deposit futures customer
funds only with a depository that agrees to provide the Commission and
the futures commission merchant’s designated self-regulatory
organization with a copy of the executed written acknowledgment within
three business days of the opening of the account. The Commission must
receive the written acknowledgment from the depository via electronic
mail at [email protected]. The written acknowledgment must
contain the futures commission merchant’s authorization to the
depository to provide the written acknowledgment to the Commission and
to the futures commission merchant’s designated self-regulatory
organization without further notice to or consent from the futures
commission merchant.
(5) A futures commission merchant may deposit futures customer
funds only with a depository that agrees to reply promptly and directly
to the Commission’s or to the futures commission merchant’s designated
self-regulatory organization’s requests for confirmation of account
balances or other account information without further notice to or
consent from the futures commission merchant. The written
acknowledgment must contain the futures commission merchant’s
authorization to the depository to respond directly and immediately to
requests from the Commission or the futures commission merchant’s
designated self-regulatory organization for confirmation of account
balances and other account information without further notice to or
consent from the futures commission merchant.
(6) The futures commission merchant shall promptly file a copy of
the written acknowledgment with the Commission in the manner specified
by the Commission and in no event later than the later of:
(i) The effective date of this rule; or
(ii) Three business days after the account is opened.
(7) A futures commission merchant shall amend the written
acknowledgment and promptly file the amended acknowledgment with the
Commission within 120 days of any changes in the following:
(i) The name or business address of the futures commission
merchant;
(ii) The name or business address of the bank, trust company,
derivatives clearing organization or futures commission merchant
receiving futures customer funds; or
(iii) The account number(s) under which futures customer funds are
held.
(8) A futures commission merchant must maintain each written
acknowledgment readily accessible in its files in accordance with Sec.
1.31 of this part, for as long as the account remains open, and
thereafter for the period provided in Sec. 1.31 of this part.
(e) Commingling. (1) A futures commission merchant may for
convenience commingle the futures customer funds that it receives from,
or on behalf of, multiple futures customers in a single account or
multiple accounts with one or more of the depositories listed in
paragraph (b) of this section.
[[Page 67940]]
(2) A futures commission merchant shall not commingle futures
customer funds with the money, securities or property of such futures
commission merchant, or with any proprietary account of such futures
commission merchant, or use such funds to secure or guarantee the
obligation of, or extend credit to, such futures commission merchant or
any proprietary account of such futures commission merchant; Provided,
however, a futures commission merchant may deposit proprietary funds in
segregated accounts as permitted under Sec. 1.23 of this part.
(3) A futures commission merchant may not commingle futures
customer funds with funds deposited by 30.7 Customers as defined in
Sec. 30.1 of this chapter and set aside in separate accounts as
required by part 30 of this chapter, or with funds deposited by Cleared
Swaps Customers as defined in Sec. 22.1 of this chapter and held in
segregated accounts pursuant to Section 4d(f) of the Act; Provided,
however, that a futures commission merchant may commingle futures
customer funds with funds deposited by 30.7 Customers or Cleared Swaps
Customers if expressly permitted by a Commission regulation or order,
or by a derivatives clearing organization rule approved in accordance
with Sec. 39.15(b)(2) of this chapter.
(f) Limitation on use of futures customer funds. (1) A futures
commission merchant shall treat and deal with the funds of a futures
customer as belonging to such futures customer. A futures commission
merchant shall not use the funds of a futures customer to secure or
guarantee the commodity interests, or to secure or extend the credit,
of any person other than the futures customer for whom the funds are
held.
(2) A futures commission merchant shall obligate futures customer
funds to a derivatives clearing organization, a futures commission
merchant, or any depository solely to purchase, margin, guarantee,
secure, transfer, adjust or settle trades, contracts or commodity
option transactions of futures customers; Provided, however, that a
futures commission merchant is permitted to use the funds belonging to
a futures customer that are necessary in the normal course of business
to pay lawfully accruing fees or expenses on behalf of the futures
customer’s positions including commissions, brokerage, interest, taxes,
storage and other fees and charges.
(3) No person, including any derivatives clearing organization or
any depository, that has received futures customer funds for deposit in
a segregated account, as provided in this section, may hold, dispose
of, or use any such funds as belonging to any person other than the
futures customers of the futures commission merchant which deposited
such funds.
(g) Derivatives clearing organizations. (1) General. All futures
customer funds received by a derivatives clearing organization from a
member to purchase, margin, guarantee, secure or settle the trades,
contracts or commodity options of the clearing member’s futures
customers and all money accruing to such futures customers as the
result of trades, contracts or commodity options so carried shall be
separately accounted for and segregated as belonging to such futures
customers, and a derivatives clearing organization shall not hold, use
or dispose of such futures customer funds except as belonging to such
futures customers. A derivatives clearing organization shall deposit
futures customer funds under an account name that clearly identifies
them as futures customer funds and shows that the futures customer
funds are segregated as required by section 4(d)(a) and 4d(b) of the
Act and this part.
(2) Location of futures customer funds. A derivatives clearing
organization may deposit futures customer funds with a bank or trust
company, which shall include a Federal Reserve Bank with respect to
deposits of a systemically important derivatives clearing organization.
(3) Limitation on the holding of futures customer funds outside of
the United States. A derivatives clearing organization may hold futures
customer funds with a depository outside of the United States only in
accordance with Sec. 1.49 of this part.
(4) Written acknowledgment from depositories. (i) A derivatives
clearing organization must obtain a written acknowledgment from each
depository prior to or contemporaneously with the opening of a futures
customer funds account;
(ii) The written acknowledgment must be in the form as set out in
Appendix A to this part;
(iii) A derivatives clearing organization may deposit futures
customer funds only with a depository that provides the Commission with
direct, read-only access to account information on 24-hour a day basis.
The Commission must receive the direct access when the account is
opened. The written acknowledgment must contain the derivatives
clearing organization’s authorization to the depository to provide
direct and immediate account access to the Commission without further
notice to or consent from the derivatives clearing organization;
(iv) A derivatives clearing organization may deposit futures
customer funds only with a depository that agrees to provide the
Commission with a copy of the executed written acknowledgment within
three business days of the opening of the account. The Commission must
receive the written acknowledgment from the depository via electronic
mail at [email protected]. The written acknowledgment must
contain the derivatives clearing organization’s authorization to the
depository to provide the written acknowledgment to the Commission
without further notice to or consent from the derivatives clearing
organization;
(v) A derivatives clearing organization may deposit futures
customer funds only with a depository that agrees to reply promptly and
directly to the Commission’s requests for confirmation of account
balances or other account information without further notice to or
consent from the derivatives clearing organization. The written
acknowledgment must contain the derivatives clearing organization’s
authorization to the depository to respond directly and immediately to
requests from the Commission for confirmation of account balances and
other account information without further notice to or consent from the
derivatives clearing organization;
(vi) A derivatives clearing organization shall promptly file a copy
of the written acknowledgment with the Commission in the manner
specified by the Commission and in event later than the later of:
(A) The effective date of this rule; or
(B) Three business days after the account is opened.
(vii) A derivatives clearing organization shall amend the written
acknowledgment and promptly file the amended acknowledgment with the
Commission within 120 days of any changes in the following:
(A)The name or business address of the derivatives clearing
organization;
(B) The name or business address of the depository receiving
futures customer funds; or
(C) The account number(s) under which futures customer funds are
held.
(viii) A derivatives clearing organization must maintain each
written acknowledgment readily accessible in its files in accordance
with Sec. 1.31 of this part, for as long as the account remains open,
and thereafter for the period provided in Sec. 1.31 of this part.
(5) Commingling. (i) A derivatives clearing organization may for
[[Page 67941]]
convenience commingle the futures customer funds that it receives from,
or on behalf of, multiple futures commission merchants in a single
account or multiple accounts with one or more of the depositories
listed in paragraph (g)(2) of this section.
(ii) A derivatives clearing organization shall not commingle
futures customer funds with the money, securities or property of such
derivatives clearing organization or with any proprietary account of
any of its clearing members, or use such funds to secure or guarantee
the obligations of, or extend credit to, such derivatives clearing
organization or any proprietary account of any of its clearing members.
(iii) A derivatives clearing organization may not commingle funds
held for futures customers with funds deposited by clearing members on
behalf of their 30.7 Customers as defined in Sec. 30.1 of this chapter
and set aside in separate accounts as required by part 30 of this
chapter, or with funds deposited by clearing members on behalf of their
Cleared Swaps Customers as defined in Sec. 22.1 of this chapter and
held in segregated accounts pursuant section 4d(f) of the Act;
Provided, however, that a derivatives clearing organization may
commingle futures customer funds with funds deposited by clearing
members on behalf of their 30.7 Customers or Cleared Swaps Customers if
expressly permitted by a Commission regulation or order, or by a
derivatives clearing organization rule approved in accordance with
Sec. 39.15(b)(2) of this chapter.
(h) Immediate availability of bank and trust company deposits. All
futures customer funds deposited by a futures commission merchant or a
derivatives clearing organization with a bank or trust company must be
immediately available for withdrawal upon the demand of the futures
commission merchant or derivatives clearing organization.
(i) Requirements as to Amount. (1) For purposes of this paragraph
(i), the term “account” shall mean the entries on the books and
records of a futures commission merchant pertaining to the futures
customer funds of a particular futures customer.
(2) The futures commission merchant must reflect in the account
that it maintains for each futures customer:
(i) The market value of any futures customer funds that it receives
from such customer, as adjusted by:
(A) Any uses permitted under Sec. 1.20(f) of this part;
(B) Any accruals on permitted investments of such collateral under
Sec. 1.25 of this part that, pursuant to the futures commission
merchant’s customer agreement with that customer, are creditable to
such customer;
(C) Any gains and losses with respect to contracts for the purchase
or sale of a commodity for future delivery and any options on such
contracts;
(D) Any charges lawfully accruing to the futures customer,
including any commission, brokerage fee, interest, tax, or storage fee;
and
(E) Any appropriately authorized distribution or transfer of such
collateral.
(ii) The amount of collateral required for the futures customer’s
contracts for the purchase or sale of a commodity for future delivery
and any options on such contracts at each derivatives clearing
organization on which the futures commission merchant is a member, or
by each other futures commission merchant through which the futures
commission merchant clears futures customer contracts, and the total of
such required collateral amounts.
(3)(i) If the market value of futures customer funds in the account
of a futures customer is positive after adjustments, then that account
has a credit balance. If the market value of futures customer funds in
the account of a futures customer is negative after adjustments, then
that account has a debit balance.
(ii) If the value of the futures customer funds, as calculated in
paragraph (i)(2)(i) of this section, for a futures customer’s account
is less than the total amount of collateral required for that account’s
contracts for the purchase or sale of a commodity for future delivery
and any options on such contracts at derivatives clearing
organizations, as calculated in paragraph (i)(2)(ii) of this section,
the difference is a margin deficit.
(4) The futures commission merchant must maintain in segregation an
amount equal to the sum of any credit balances that the futures
customers of the futures commission merchant have in their accounts,
excluding from such sum any debit balances that the futures customers
of the futures commission merchant have in their accounts. In addition,
the futures commission merchant must at all times maintain residual
interest in segregated fund sufficient to exceed the sum of all margin
deficits that the futures customers of the futures commission merchant
have in their accounts. Such residual interest may not be withdrawn
pursuant to Sec. 1.23 of this part.
Appendix A to Sec. 1.20–Acknowledgment Letter for CFTC Regulation
1.20 Customer Segregated Account
[Date]
[Name and Address of Bank, Trust Company, Derivatives Clearing
Organization or Futures Commission Merchant]
We refer to the Segregated Account(s) which [Name of Futures
Commission Merchant or Derivatives Clearing Organization] (“we” or
“our”) have opened or will open with [Name of Bank, Trust Company,
Derivatives Clearing Organization or Futures Commission Merchant]
(“you” or “your”) entitled:
[Name of Futures Commission Merchant or Derivatives Clearing
Organization] [if applicable, add “FCM Customer Omnibus Account”]
CFTC Regulation 1.20 Customer Segregated Account
Account Number(s): [ ]
You acknowledge and agree that we have opened or will open the
above-referenced Account(s) for the purpose of depositing, as
applicable, money, securities and other property (collectively the
“Funds”) of our customers who trade commodities, options, swaps,
other cleared OTC derivatives products and other products, as
required by Commodity Futures Trading Commission (“CFTC”)
Regulations, including Regulation 1.20, as amended; that the Funds
held by you, hereafter deposited in the Account(s) or accruing to
the credit of the Accounts, will be separately accounted for and
segregated on your books from our own funds and all other accounts
maintained by us in accordance with the provisions of the Commodity
Exchange Act, as amended (the “Act”), and Part 1 of the CFTC’s
regulations, as amended; and that the Funds must otherwise be
treated in accordance with the provisions of the Act and CFTC
regulations.
Furthermore, you acknowledge and agree that such Funds may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, nor may they be used by us to secure credit
from you. You further acknowledge and agree that the Funds in the
Account(s) shall not be subject to any right of offset or lien for
or on account of any indebtedness, obligations or liabilities we may
now or in the future have owing to you. This prohibition does not
affect your right to recover funds advanced in the form of cash
transfers you make in lieu of liquidating non-cash assets held in
the Account(s) for purposes of variation settlement or posting
initial (original) margin.
In addition, you agree that the Account(s) may be examined at
any reasonable time by an appropriate officer, agent or employee of
the CFTC or a self-regulatory organization of which we are a member,
and this letter constitutes the authorization and direction of the
undersigned to permit any such examination or audit to take place.
You agree to respond promptly and directly to requests for
confirmation of account balances and other account information from
an appropriate officer, agent, or employee of the CFTC or a self-
regulatory organization of which we are a member, without further
notice to or consent from the futures
[[Page 67942]]
commission merchant or derivatives clearing organization, as
applicable. You also agree that, immediately upon instruction by the
director of the Division of Swap Dealer and Intermediary Oversight
of the CFTC or the director of the Division of Clearing and Risk of
the CFTC, or any successor divisions, or such directors’ designees,
or any appropriate official of a self-regulatory organization of
which we are a member, you will provide any and all information
regarding or related to the Funds or the Accounts as shall be
specified in such instruction and as directed in such instruction.
You further agree that you will provide the CFTC and our designated
self-regulatory organization with the necessary software, a user
log-in, and password that will allow the CFTC and our designated
self-regulatory organization to have read-only access to the
accounts listed above on your Web site or via an alternative
electronic medium on a 24-hour a day basis.
You acknowledge and agree that the Funds in the Account(s) shall
be released immediately, subject to the requirements of U.S. or non-
U.S. law as applicable, upon proper notice and instruction from an
appropriate officer or employee of us or from the director of the
Division of Clearing and Risk of the CFTC, the director of the
Division of Swap Dealer and Intermediary Oversight of the CFTC, or
any successor divisions, or such directors’ designees.
We will not hold you responsible for acting pursuant to any
instruction from the CFTC or the self-regulatory organization upon
which you have relied after having taken reasonable measures to
assure that such instruction was provided to you by the director of
the Division of Clearing and Risk of the CFTC, the director of the
Division of Swap Dealer and Intermediary Oversight of the CFTC, or
any successor divisions, or such directors’ designees, or any
appropriate official of a self-regulatory organization of which we
are a member.
In the event that we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Funds
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court. Notwithstanding anything in the foregoing to the
contrary, nothing contained herein shall be construed as limiting
your right to assert any right of set off against or lien on assets
other than assets maintained in the Account(s), nor to impose such
charges against us or any proprietary account maintained by us with
you. Further, it is understood that amounts represented by checks,
drafts or other items shall not be considered to be part of the
Account(s) until finally collected. Accordingly, checks, drafts and
other items credited to the Account(s) and subsequently dishonored
or otherwise returned to you, or reversed, for any reason and any
claims relating thereto, including but not limited to claims of
alteration or forgery, may be charged back to the Account(s), and we
shall be responsible to you as a general endorser of all such items
whether or not actually so endorsed. You may conclusively presume
that any withdrawal from the Account(s) and the balances maintained
therein are in conformity with the Act and CFTC regulations without
any further inquiry, provided that you have no notice of or actual
knowledge of, or could not reasonably know of, a violation of the
Act or other provision of law by us; and you shall not in any manner
not expressly agreed to herein be responsible for ensuring
compliance by us with the provisions of the Act and CFTC
regulations. You may, and are hereby authorized to, obey the order,
judgment, decree or levy of any court of competent jurisdiction or
any governmental agency with jurisdiction, which order, judgment,
decree or levy relates in whole or in part to the Account(s). In any
event, you shall not be liable by reason of any such action or
omission to act, to us or to any other person, firm, association or
corporation even if thereafter any such order, decree, judgment or
levy shall be reversed, modified, set aside or vacated.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns, including for the avoidance
of doubt, regardless of the change in name of any party. This letter
agreement supersedes and replaces any prior agreement between the
parties in connection with the Account(s), including but not limited
to any prior acknowledgment letter, to the extent that such prior
agreement is inconsistent with the terms hereof. In the event of any
conflict between this letter agreement and any other agreement
between the parties in connection with the Account(s), this letter
agreement shall govern with respect to matters specific to Section
4d of the Act and the CFTC’s regulations, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning the enclosed
copy of this letter. You further acknowledge and agree to provide a
copy of this fully executed letter directly to the CFTC (via
electronic mail to [email protected]) and our
designated self-regulatory organization.
[Name of Futures Commission Merchant or Derivatives Clearing
Organization]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Bank, Trust Company, Derivatives Clearing Organization
or Futures Commission Merchant]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
DATE:
10. Revise Sec. 1.22 to read as follows:
Sec. 1.22 Use of futures customer funds restricted.
(a) No futures commission merchant shall use, or permit the use of,
the futures customer funds of one futures customer to purchase, margin,
or settle the trades, contracts, or commodity options of, or to secure
or extend the credit of, any person other than such futures customer.
The prohibition on the use of one futures customer’s funds to extend
credit to, or to purchase, margin, or settle the contracts of another
person applies at all times. For this purpose, a futures commission
merchant which operationally commingles the funds of its futures
customers must ensure that at all times its residual interest in
futures customer funds exceeds the sum of the margin deficits of all of
its futures customers.
(b) Futures customer funds shall not be used to carry trades or
positions of the same futures customer other than in contracts for the
purchase of sale of any commodity for future delivery or for options
thereon traded through the facilities of a designated contract market.
11. Revise Sec. 1.23 to read as follows:
Sec. 1.23 Interest of futures commission merchant in segregated
futures customer funds; additions and withdrawals.
(a)(1) The provision in sections 4d(a)(2) and 4d(b) of the Act and
the provision in Sec. 1.20 of this part that prohibit the commingling
of futures customer funds with the funds of a futures commission
merchant, shall not be construed to prevent a futures commission
merchant from having a residual financial interest in the futures
customer funds segregated as required by the Act and the regulations in
this part and set apart for the benefit of futures customers; nor shall
such provisions be construed to prevent a futures commission merchant
from adding to such segregated futures customer funds such amount or
amounts of money, from its own funds or unencumbered securities from
its own inventory, of the type set forth in Sec. 1.25 of this part, as
it may deem necessary to ensure any and all futures customers’ accounts
from becoming undersegregated at any time.
(2) If a futures commission merchant discovers at any time that it
is holding insufficient funds in segregated accounts to meet its
obligations under Sec. Sec. 1.20 and 1.22 of this part, the futures
commission merchant shall immediately deposit sufficient funds into
segregation to bring the account into compliance.
(b) A futures commission merchant may not withdraw funds on any
business day for its own proprietary use from an account or accounts
holding futures customer funds unless the futures commission merchant
has prepared the daily segregation
[[Page 67943]]
calculation required by Sec. 1.32 of this part as of the close of
business on the previous business day. A futures commission merchant
that has completed its daily segregation calculation may make
withdrawals for its own use, to the extent of its actual residual
financial interest in funds held in segregated futures accounts,
adjusted to reflect market activity and other events that may have
decreased the amount of the firm’s residual financial interest since
the close of business on the previous business day, including the
withdrawal of securities held in segregated safekeeping accounts held
by a bank, trust company, derivatives clearing organization or other
futures commission merchant. Such withdrawal(s), however, shall not
result in the funds of one futures customer being used to purchase,
margin or carry the trades, contracts or commodity options, or extend
the credit of any other futures customer or other person.
(c) Notwithstanding paragraphs (a) and (b) of this section, each
futures commission merchant shall establish a targeted residual
interest (i.e., excess funds) that is in an amount that, when
maintained as its residual interest in the segregated funds accounts,
reasonably ensures that the futures commission merchant shall remain in
compliance with the segregated funds requirements at all times. Each
futures commission merchant shall establish policies and procedures
designed to reasonably ensure that the futures commission merchant
maintains the targeted residual amounts in segregated funds at all
times. The futures commission merchant shall maintain sufficient
capital and liquidity, and take such other appropriate steps as are
necessary or appropriate, to reasonably ensure that such amount of
targeted residual interest is maintained as the futures commission
merchant’s residual interest in the segregated funds accounts at all
times. In determining the amount of the targeted residual interest, the
futures commission merchant shall analyze all relevant factors
affecting the amounts in segregated funds from time to time, including
without limitation various factors, as applicable, relating to the
nature of the futures commission merchant’s business including, but not
limited to, the composition of the futures commission merchant’s
customer base, the general creditworthiness of the customer base, the
general trading activity of the customers, the types of markets and
products traded by the customers, the proprietary trading of the
futures commission merchant, the general volatility and liquidity of
the markets and products traded by customers, the futures commission
merchant’s own liquidity and capital needs, and the historical trends
in Customer segregated fund balances and debit balances in Customers’
and undermargined accounts. The analysis and calculation of the
targeted amount of the future commission merchant’s residual interest
must be described in writing with the specificity necessary to allow
the Commission and the futures commission merchant’s designated self-
regulatory organization to duplicate the analysis and calculation and
test the assumptions made by the futures commission merchant. The
adequacy of the targeted residual interest and the process for
establishing the targeted residual interest must be reassessed
periodically by the futures commission merchant and revised as
necessary. Notwithstanding any other provision of this section, a
futures commission merchant must at all times maintain an amount of
residual interest in segregated accounts that exceeds the sum of all
margin deficits of its futures customers under Sec. 1.20 of this part,
and such residual interest may not be withdrawn by the futures
commission merchant.
(d) Notwithstanding any other paragraph of this section, a futures
commission merchant may not withdraw funds for its own proprietary use,
in a single transaction or a series of transactions on a given business
day, from futures accounts if such withdrawal(s) would exceed 25
percent of the futures commission merchant’s residual interest in such
accounts as reported on the daily segregation calculation required by
Sec. 1.32 of this part and computed as of the close of business on the
previous business day, unless:
(1) The futures commission merchant’s Chief Executive Officer,
Chief Finance Officer or other senior official that is listed as a
principal of the futures commission merchant on its Form 7-R and is
knowledgeable about the futures commission merchant’s financial
requirements and financial position pre-approves in writing the
withdrawal, or series of withdrawals;
(2) The futures commission merchant files written notice of the
withdrawal or series of withdrawals, with the Commission and with its
designated self-regulatory organization immediately after the Chief
Executive Officer, Chief Finance Officer or other senior official as
described in paragraph (c)(1) of this section pre-approves the
withdrawal or series of withdrawals. The written notice must:
(i) Be signed by the Chief Executive Officer, Chief Finance Officer
or other senior official as described in paragraph (c)(1) of this
section that pre-approved the withdrawal, and give notice that the
futures commission merchant has withdrawn or intends to withdraw more
than 25 percent of its residual interest in segregated accounts holding
futures customer funds;
(ii) Include a description of the reasons for the withdrawal or
series of withdrawals;
(iii) List the amount of funds provided to each recipient and each
recipient’s name;
(iv) Include the current estimate of the amount of the futures
commission merchant’s residual interest in the futures accounts after
the withdrawal;
(v) Contain a representation by the Chief Executive Officer, Chief
Finance Officer or other senior official as described in paragraph
(c)(1) of this section that pre-approved the withdrawal, or series of
withdrawals, that, after due diligence, to such person’s knowledge and
reasonable belief, the futures commission merchant remains in
compliance with the segregation requirements after the withdrawal. The
Chief Executive Officer, Chief Finance Officer or other senior official
as described in paragraph (c)(1) of this section must consider the
daily segregation calculation as of the close of business on the
previous business day and any other factors that may cause a material
change in the futures commission merchant’s residual interest since the
close of business the previous business day, including known unsecured
futures customer debits or deficits, current day market activity and
any other withdrawals made from the futures accounts; and
(vi) Any such written notice filed with the Commission must be
filed via electronic transmission using a form of user authentication
assigned in accordance with procedures established by or approved by
the Commission, and otherwise in accordance with instruction issued by
or approved by the Commission. Any such electronic submission must
clearly indicate the registrant on whose behalf such filing is made and
the use of such user authentication in submitting such filing will
constitute and become a substitute for the manual signature of the
authorized signer. Any written notice filed must be followed up with
direct communication to the Regional office of the Commission that has
supervisory authority over the futures commission merchant whereby the
Commission acknowledges receipt of the notice; and
[[Page 67944]]
(3) After making a withdrawal requiring the approval and notice
required in paragraphs (c)(1) and (2) of this section, and before the
completion of its next daily segregated funds calculation, no futures
commission merchant may make any further withdrawals from accounts
holding futures customer funds, except to or for the benefit of
commodity and option customers, without, for each withdrawal, obtaining
the approval required under paragraph (c)(1) of this section and filing
a written notice in the manner specified under paragraph (c)(2) of this
section with the Commission and its designated self-regulatory
organization signed by the Chief Executive Officer, Chief Finance
Officer, or other senior official. The written notice must:
(i) List the amount of funds provided to each recipient and each
recipient’s name;
(ii) Disclose the reason for each withdrawal;
(iii) Confirm that the Chief Executive Officer, Chief Finance
Officer, or other senior official (and identify of the person if
different from the person who signed the notice) pre-approved the
withdrawal in writing;
(iv) Disclose the current estimate of the futures commission
merchant’s remaining total residual interest in the segregated accounts
holding futures customer funds after the withdrawal; and
(v) Include a representation that, after due diligence, to the best
of the notice signatory’s knowledge and reasonable belief the futures
commission merchant remains in compliance with the segregation
requirements after the withdrawal.
(e) If a futures commission merchant withdraws funds from futures
accounts for its own proprietary use, and the withdrawal causes the
futures commission merchant to not hold sufficient funds in the futures
accounts to meet its targeted residual interest, as required to be
computed under Sec. 1.11 of this part, the futures commission merchant
should deposit its own funds into the futures accounts to restore the
account balance to the targeted residual interest amount by the close
of business on the next business day, or, if appropriate, revise the
futures commission merchant’s targeted amount of residual interest
pursuant to the policies and procedures required by Sec. 1.11 of this
part. Notwithstanding the foregoing, if at any time the futures
commission merchant’s residual interest in customer accounts is less
than the sum of its futures customers’ margin deficits as set forth in
Sec. 1.20(i) of this part, the futures commission merchant must
immediately restore the residual interest to exceed the sum of such
margin deficits. Any proprietary funds deposited in the futures
accounts must be unencumbered and otherwise compliant with Sec. 1.25
of this part, as applicable.
12. Amend Sec. 1.25 by removing paragraph (b)(6) and by revising
paragraphs (b)(3)(v), (c)(3), (d)(7), (d)(11), and (e) to read as
follows:
Sec. 1.25 Investment of customer funds.
* * * * *
(b) * * *
(3) * * *
(v) Counterparty concentration limits. Securities purchased by a
futures commission merchant or derivatives clearing organization from a
single counterparty, or from one or more counterparties under common
ownership or control, subject to an agreement to resell the securities
to the counterparty or counterparties, shall not exceed 25 percent of
total assets held in segregation or under Sec. 30.7 of this chapter by
the futures commission merchant or derivatives clearing organization.
* * * * *
(c) * * *
(3) A futures commission merchant or derivatives clearing
organization shall maintain the confirmation relating to the purchase
in its records in accordance with Sec. 1.31 of this part and note the
ownership of fund shares (by book-entry or otherwise) in a custody
account of the futures commission merchant or derivatives clearing
organization in accordance with Sec. 1.26 of this part. The futures
commission merchant or the derivatives clearing organization shall
obtain the acknowledgment letter required by Sec. 1.26 of this part
from an entity that has substantial control over the fund shares
purchased with customer funds and has the knowledge and authority to
facilitate redemption and payment or transfer of the customer funds.
Such entity may include the fund sponsor or depository acting as
custodian for fund shares.
* * * * *
(d) * * *
(7) Securities transferred to the futures commission merchant or
derivatives clearing organization under the agreement are held in a
safekeeping account with a bank as referred to in paragraph (d)(2) of
this section, a Federal Reserve Bank, a derivatives clearing
organization, or the Depository Trust Company in an account that
complies with the requirements of Sec. 1.26 of this part.
* * * * *
(11) The transactions effecting the agreement are recorded in the
record required to be maintained under Sec. 1.27 of this part of
investments of customer funds, and the securities subject to such
transactions are specifically identified in such record as described in
paragraph (d)(1) of this section and further identified in such record
as being subject to repurchase and reverse repurchase agreements.
* * * * *
(e) Deposit of firm-owned securities into segregation. A futures
commission merchant may deposit unencumbered securities of the type
specified in this section, which it owns for its own account, into a
customer account. A futures commission merchant must include such
securities, transfers of securities, and disposition of proceeds from
the sale or maturity of such securities in the record of investments
required to be maintained by Sec. 1.27 of this part. All such
securities may be segregated in safekeeping only with a bank, trust
company, derivatives clearing organization, or other registered futures
commission merchant in accordance with the provisions of Sec. 1.20 of
this part. For purposes of this section and Sec. Sec. 1.27, 1.28,
1.29, and 1.32 of this part, securities of the type specified by this
section that are owned by the futures commission merchant and deposited
into a customer account shall be considered customer funds until such
investments are withdrawn from segregation in accordance with the
provisions of Sec. 1.23 of this part. Investments permitted by Sec.
1.25 that are owned by the futures commission merchant and deposited
into a futures customer account pursuant to Sec. 1.26 of the part
shall be considered futures customer funds until such investments are
withdrawn from segregation in accordance with Sec. 1.23 of this part.
Investments permitted by Sec. 1.25 that are owned by the futures
commission merchant and deposited into a Cleared Swaps Customer
Account, as defined in Sec. 22.1 of this chapter, shall be considered
Cleared Swaps Customer Collateral, as defined in Sec. 22.1 of this
chapter, until such investments are withdrawn from segregation in
accordance with Sec. 22.17 of this chapter.
* * * * *
13. Revise Sec. 1.26 to read as follows:
Sec. 1.26 Deposit of instruments purchased with futures customer
funds.
(a) Each futures commission merchant who invests futures customer
funds in instruments described in Sec. 1.25 of this part, except for
investments in money market mutual funds, shall separately account for
such instruments as futures
[[Page 67945]]
customer funds and segregate such instruments as funds belonging to
such futures customers in accordance with the requirements of Sec.
1.20 of this part. Each derivatives clearing organization which invests
money belonging or accruing to futures customers of its clearing
members in instruments described in Sec. 1.25 of this part, except for
investments in money market mutual funds, shall separately account for
such instruments as customer funds and segregate such instruments as
customer funds belonging to such futures customers in accordance with
Sec. 1.20 of this part.
(b) Each futures commission merchant or derivatives clearing
organization which invests futures customer funds in money market
mutual funds, as permitted by Sec. 1.25 of this part, shall separately
account for such funds and segregate such funds as belonging to such
futures customers. Such funds shall be deposited under an account name
which clearly shows that they belong to futures customers and are
segregated as required by sections 4d(a) and 4d(b) of the Act and this
part. Each futures commission merchant or derivatives clearing
organization, upon opening such an account, shall obtain and maintain
readily accessible in its files in accordance with Sec. 1.31 of this
part, for as long as the account remains open, and thereafter for the
period provided in Sec. 1.31 of this part, a written acknowledgment
and shall file such acknowledgment in accordance with the requirements
of Sec. 1.20 of this part. In the event such funds are held directly
with the money market mutual fund or its affiliate, the written
acknowledgment letter shall be in the form as set out in Appendix A to
this section. In the event such funds are held with a depository the
written acknowledgment letter shall be in the form as set out in
Appendix A to Sec. 1.20 of this part. In either case, the written
acknowledgment letter shall be obtained, provided to the Commission and
designated self-regulatory organizations, and retained as required
under Sec. 1.20 of this part.
Appendix to Sec. 1.26–Acknowledgment Letter for CFTC Regulation 1.26
Customer Segregated Money Market Mutual Fund Account
[Date]
[Name and Address of Money Market Mutual Fund]
We propose to invest funds held by [Name of Futures Commission
Merchant or Derivatives Clearing Organization] (“we” or “our”)
on behalf of our customers in shares of [Name of Money Market Mutual
Fund] (“you” or “your”) under account(s) entitled (or shares
issued to):
[Name of Futures Commission Merchant or Derivatives Clearing
Organization] [if applicable, add “FCM Customer Omnibus Account”]
CFTC Regulation 1.26 Customer Segregated Money Market Mutual Fund
Account
[If applicable, include any abbreviated name of the Account(s)
as reflected in the Depository’s electronic systems (provided any
such abbreviated name must reflect that the Account(s) is a CFTC
regulated customer segregated account)]
Account Number(s): [——– ]
(collectively, the “Account(s)”).
You acknowledge and agree that we are holding these funds,
including any shares issued and amounts accruing in connection
therewith (collectively, the “Shares”), for the benefit of our
customers who trade commodities, options, cleared OTC derivatives
products and other products (“Commodity Customers”), as required
by Commodity Futures Trading Commission (“CFTC”) Regulation 1.26,
as amended; that the Shares held by you, hereafter deposited in the
Account(s) or accruing to the credit of the Accounts, will be
separately accounted for and segregated on your books from our own
funds and from any other funds or accounts held by us in accordance
with the provisions of the Commodity Exchange Act, as amended (the
“Act”), and Part 1 of the CFTC’s regulations, as amended; and that
the Shares must otherwise be treated in accordance with the
provisions of the Act and CFTC regulations.
Furthermore, you acknowledge and agree that such Shares may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, nor may they be used by us to secure credit
from you. You further acknowledge and agree that the Shares in the
Account(s) shall not be subject to any right of offset or lien for
or on account of any indebtedness, obligations or liabilities we may
now or in the future have owing to you.
In addition, you agree that the Account(s) may be examined at
any reasonable time by an appropriate officer, agent or employee of
the CFTC or a self-regulatory organization, and this letter
constitutes the authorization and direction of the undersigned to
permit any such examination or audit to take place. You agree to
respond promptly and directly to requests for confirmation of
account balances and other account information from an appropriate
officer, agent, or employee of the CFTC or a self-regulatory
organization of which we are a member, without further notice to or
consent from the futures commission merchant or the derivatives
clearing organization, as applicable. You also agree that,
immediately upon instruction by the director of the Division of Swap
Dealer and Intermediary Oversight of the CFTC or the director of the
Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors’ designees, or any appropriate official
of a self-regulatory organization of which we are a member, you will
provide any and all information regarding or related to the Shares
or the Accounts as shall be specified in such instruction and as
directed in such instruction. You further agree that you will
provide the CFTC and our designated self-regulatory organization
with the necessary software, a user log-in, and password that will
allow the CFTC and our designated self-regulatory organization to
have read-only access to the accounts listed above on your Web site
on a 24-hour a day basis.
You acknowledge and agree that the Shares in the Account(s)
shall be released immediately, subject to the requirements of U.S.
or non-U.S. law as applicable, upon proper notice and instruction
from an appropriate officer or employee of us or from the director
of the Division of Clearing and Risk of the CFTC, or from the
director of the Division of Swap Dealer and Intermediary Oversight,
or any successor divisions, or such directors’ designees. We will
not hold you responsible for acting pursuant to any instruction from
the CFTC or from the self-regulatory organization upon which you
have relied after having taken reasonable measures to assure that
such instruction was provided to you by the director of the Division
of Clearing and Risk of the CFTC, or the director of the Division of
Swap Dealer and Intermediary Oversight, or any successor divisions,
or such directors’ designees, or any appropriate official of a self-
regulatory organization of which we are a member. You further
acknowledge that we will provide to the CFTC a copy of this
acknowledgment. In the event we become subject to either a voluntary
or involuntary petition for relief under the U.S. Bankruptcy Code,
we acknowledge that you will have no obligation to release the
Shares held in the Account(s), except upon instruction of the
Trustee in Bankruptcy or pursuant to the Order of the respective
U.S. Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of set off against or lien on assets other than
assets maintained in the Account(s), nor to impose such charges
against us or any proprietary account maintained by us with you.
Further, it is understood that amounts represented by checks, drafts
or other items shall not be considered to be part of the Account(s)
until finally collected. Accordingly, checks, drafts and other items
credited to the Account(s) and subsequently dishonored or otherwise
returned to you, or reversed, for any reason and any claims relating
thereto, including but not limited to claims of alteration or
forgery, may be charged back to the Account(s), and we shall be
responsible to you as a general endorser of all such items whether
or not actually so endorsed. You may conclusively presume that any
withdrawal from the Account(s) and the balances maintained therein
are in conformity with the Act and CFTC regulations without any
further inquiry, provided that you have no notice of or actual
knowledge of, or could not reasonably know of, a violation of the
Act or other provision of law by us; and you shall not in any manner
not expressly agreed to herein be responsible for ensuring
compliance by us with the provisions of the Act and CFTC
regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
[[Page 67946]]
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any such action or omission to
act, to us or to any other person, firm, association or corporation
even if thereafter any such order, decree, judgment or levy shall be
reversed, modified, set aside or vacated.
We are permitted to invest our Commodity Customers’ funds in
money market mutual funds pursuant to CFTC Regulation 1.25. That
rule sets forth the following conditions, among others, with respect
to any investment in a money market mutual fund:
(1) The net asset value of the fund must be computed by 9:00
a.m. of the business day following each business day and be made
available to us by that time;
(2) The fund must be legally obligated to redeem an interest in
the fund and make payment in satisfaction thereof by the close of
the business day following the day on which we make a redemption
request except as otherwise specified in CFTC Regulation
1.25(c)(5)(ii); and,
(3) The agreement under which we invest our Commodity Customers’
funds must not contain any provision that would prevent us from
pledging or transferring fund shares.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns, including for the avoidance
of doubt, regardless of the change in name of any party. This letter
agreement supersedes and replaces any prior agreement between the
parties in connection with the Account(s), including but not limited
to any prior acknowledgment letter, to the extent that such prior
agreement is inconsistent with the terms hereof. In the event of any
conflict between this letter agreement and any other agreement
between the parties in connection with the Account(s), this letter
agreement shall govern with respect to matters specific to Section
4d of the Act and the CFTC’s regulations, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning the enclosed
copy of this letter. You further acknowledge and agree to provide a
copy of this fully executed letter directly to the CFTC (via
electronic mail to [email protected]) and our
designated self-regulatory organization in accordance with CFTC
Regulation 1.20.
[Name of Futures Commission Merchant or Derivatives Clearing
Organization]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Money Market Mutual Fund]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
Date:
14. Revise Sec. 1.29 to read as follows:
Sec. 1.29 Gains and losses resulting from investment of customer
funds.
(a) The investment of customer funds in instruments described in
Sec. 1.25 of this part shall not prevent the futures commission
merchant or derivatives clearing organization so investing such funds
from receiving and retaining as its own any incremental income or
interest income resulting therefrom.
(b) The futures commission merchant or derivatives clearing
organization, as applicable, shall bear sole responsibility for any
losses resulting from the investment of customer funds in instruments
described in Sec. 1.25 of this part. No investment losses shall be
borne or otherwise allocated to the customers of the futures commission
merchant and, if customer funds are invested by a derivatives clearing
organization in its discretion, to the futures commission merchant.
15. Revise Sec. 1.30 to read as follows:
Sec. 1.30 Loans by futures commission merchants; treatment of
proceeds.
Nothing in these regulations shall prevent a futures commission
merchant from lending its own funds to customers on securities and
property pledged by such customers, or from repledging or selling such
securities and property pursuant to specific written agreement with
such customers. The proceeds of such loans used to purchase, margin,
guarantee, or secure the trades, contracts, or commodity options of
customers shall be treated and dealt with by a futures commission
merchant as belonging to such customers, in accordance with and subject
to the provisions of the Act and these regulations. A futures
commission merchant may not loan funds on an unsecured basis to finance
customers’ trading, nor may a futures commission merchant loan funds to
customers secured by the customer accounts of such customers.
16. Amend Sec. 1.32 by revising the section heading and paragraphs
(b) and (c) and by adding paragraphs (d), (e), (f), (g), (h), (i), (j),
and (k), to read as follows:
Sec. 1.32 Reporting of segregated account computation and details
regarding the holding of futures customer funds
* * * * *
(b) In computing the amount of futures customer funds required to
be in segregated accounts, a futures commission merchant may offset any
net deficit in a particular futures customer’s account against the
current market value of readily marketable securities, less applicable
deductions (i.e., “securities haircuts”) as set forth in Rule 15c3-
1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR 241.15c3-
1(c)(2)(vi)), held for the same futures customer’s account. Futures
commission merchants that establish and enforce written policies and
procedures to assess the credit risk of commercial paper, convertible
debt instruments, or nonconvertible debt instruments in accordance with
Rule 240.15c3-1(c)(2)(vi) of the Securities and Exchange Commission (17
CFR 240.15c3-1(c)(2)(vi)) may apply the lower haircut percentages
specified in Rule 240.15c3-1(c)(2)(vi) for such commercial paper,
convertible debt instruments and nonconvertible debt instruments. The
futures commission merchant must maintain a security interest in the
securities, including a written authorization to liquidate the
securities at the futures commission merchant’s discretion, and must
segregate the securities in a safekeeping account with a bank, trust
company, derivatives clearing organization, or another futures
commission merchant. For purposes of this section, a security will be
considered readily marketable if it is traded on a “ready market” as
defined in Rule 15c3-1(c)(11)(i) of the Securities and Exchange
Commission (17 CFR 240.15c3-1(c)(11)(i)).
(c) Each futures commission merchant is required to document its
segregation computation required by paragraph (a) of this section by
preparing a Statement of Segregation Requirements and Funds in
Segregation for Customers Trading on U.S. Commodity Exchanges contained
in the Form 1-FR-FCM as of the close of each business day. Nothing in
this paragraph shall affect the requirement that a futures commission
merchant at all times maintain sufficient money, securities and
property to cover its total obligations to all futures customers, in
accordance with Sec. 1.20 of this part.
(d) Each futures commission merchant is required to submit to the
Commission and to the firm’s designated self-regulatory organization
the daily Statement of Segregation Requirements and Funds in
Segregation for Customers Trading on U.S. Commodity Exchanges required
by paragraph (c) of this section by noon the following business day.
(e) Each futures commission merchant shall file the Statement of
Segregation Requirements and Funds in Segregation for Customers Trading
on U.S. Commodity Exchanges required by paragraph (c) of this section
in an electronic format using a form of user authentication assigned in
accordance with procedures established or approved by the Commission.
(f) Each futures commission merchant is required to submit to the
Commission
[[Page 67947]]
and to the firm’s designated self-regulatory organization a report
listing the names of all banks, trust companies, futures commission
merchants, derivatives clearing organizations, or any other depository
or custodian holding futures customer funds as of the fifteenth day of
the month, or the first business day thereafter, and the last business
day of each month. This report must include:
(1) The name and location of each entity holding futures customer
funds;
(2) The total amount of futures customer funds held by each entity
listed in paragraph (f)(1) of this section; and
(3) The total amount of cash and investments that each entity
listed in paragraph (f)(1) of this section holds for the futures
commission merchant. The futures commission merchant must report the
following investments:
(i) Obligations of the United States and obligations fully
guaranteed as to principal and interest by the United States (U.S.
government securities);
(ii) General obligations of any State or of any political
subdivision of a State (municipal securities);
(iii) General obligation issued by any enterprise sponsored by the
United States (government sponsored enterprise securities);
(iv) Certificates of deposit issued by a bank;
(v) Commercial paper fully guaranteed as to principal and interest
by the United States under the Temporary Liquidity Guarantee Program as
administered by the Federal Deposit Insurance Corporation;
(vi) Corporate notes or bonds fully guaranteed as to principal and
interest by the United States under the Temporary Liquidity Guarantee
Program as administered by the Federal Deposit Insurance Corporation;
and
(vii) Interests in money market mutual funds.
(g) Each futures commission merchant must report the total amount
of futures customer-owned securities held by the futures commission
merchant as margin collateral and must list the names and locations of
the depositories holding such margin collateral.
(h) Each futures commission merchant must report the total amount
of futures customer funds that have been used to purchase securities
under agreements to resell the securities (reverse repurchase
transactions).
(i) Each futures commission merchant must report which, if any, of
the depositories holding futures customer funds under paragraph (f)(1)
of this section are affiliated with the futures commission merchant.
(j) Each futures commission merchant shall file the detailed list
of depositories required by paragraph (f) of this section by 11:59 p.m.
the next business day in an electronic format using a form of user
authentication assigned in accordance with procedures established or
approved by the Commission.
(k) Each futures commission merchant shall retain its daily
segregation computation and the Statement of Segregation Requirements
and Funds in Segregation for Customers Trading on U.S. Commodity
Exchanges required by paragraph (c) of this section, and its detailed
list of depositories required by paragraph (f) of this section,
together with all supporting documentation, in accordance with the
requirements of Sec. 1.31 of this part.
17. Revise Sec. 1.52 to read as follows:
Sec. 1.52 Self-regulatory organization adoption and surveillance of
minimum financial requirements.
(a) For purposes of this section, the following terms are defined
as follows:
(1) “Examinations expert” is defined as a Nationally recognized
accounting and auditing firm with substantial expertise in audits of
futures commission merchants, risk assessment and internal control
reviews, and is an accounting and auditing firm that is acceptable to
the Commission;
(2) “Generally accepted auditing standards” is defined as U.S.
generally accepted auditing standards, developed by the Auditing
Standards Board of the American Institute of Certified Public
Accountants; and
(3) “Material weakness” is defined as a deficiency, or a
combination of deficiencies, in internal control over financial
reporting such that there is a reasonable possibility that a material
misstating of the entities financial statements and regulatory
computations will not be prevented or detected on a timely basis by the
entity’s internal controls;
(b)(1) Each self-regulatory organization must adopt rules
prescribing minimum financial and related reporting requirements for
members who are registered futures commission merchants, registered
retail foreign exchange dealers, or registered introducing brokers. The
self-regulatory organization’s minimum financial and related reporting
requirements must be the same as, or more stringent than, the
requirements contained in Sec. Sec. 1.10 and 1.17 of this part, for
futures commission merchants and introducing brokers, and Sec. Sec.
5.7 and 5.12 of this chapter for retail foreign exchange dealers;
provided, however, that a self-regulatory organization may permit its
member registrants that are registered with the Securities and Exchange
Commission as securities brokers or dealers to file (in accordance with
Sec. 1.10(h) of this part) a copy of their Financial and Operational
Combined Uniform Single Report under the Securities Exchange Act of
1934 (“FOCUS Report”), Part II, Part IIA, or Part II CSE, as
applicable, in lieu of Form 1-FR; provided, further, that such self-
regulatory organization must require such member registrants to provide
all information in Form 1-FR that is not included in the FOCUS Report
Part provided by such member registrant. The definition of adjusted net
capital must be the same as that prescribed in Sec. 1.17(c) of this
chapter for futures commission merchants and introducing brokers, and
Sec. 5.7(b)(2) of this chapter for futures commission merchants
offering or engaging in retail forex transactions and for retail
foreign exchange dealers.
(2) In addition to the requirements set forth in paragraph (b)(1)
of this section, each self-regulatory organization that has a futures
commission merchant member registrant must adopt rules prescribing risk
management requirements for futures commission merchant member
registrants that shall be the same as, or more stringent than, the
requirements contained in Sec. 1.11 of this part.
(c)(1) Each self-regulatory organization must establish and operate
a supervisory program that includes written policies and procedures
concerning the application of such supervisory program in the
examination of its member registrants for the purpose of assessing
whether each member registrant is in compliance with the applicable
self-regulatory organization and Commission regulations governing
minimum net capital and related financial requirements, the obligation
to segregate customer funds, risk management requirements, financial
reporting requirements, recordkeeping requirements, and sales practice
and other compliance requirements. The supervisory program also must
address the following elements:
(i) Adequate levels and independence of examination staff. A self-
regulatory organization must maintain staff of an adequate size,
training, and experience to effectively implement a supervisory
program. Staff of the self-regulatory organization, including officers,
directors, and supervising committee members, must maintain independent
judgment and its actions must not impair its independence nor appear to
impair its independence in matters related to the supervisory program.
The self-regulatory organization must
[[Page 67948]]
provide annual ethics training to all staff with responsibilities for
the supervisory program.
(ii) Ongoing surveillance. A self-regulatory organization’s ongoing
surveillance of member registrants must include the review and analysis
of financial reports and regulatory notices filed by member registrants
with the designated self-regulatory organization.
(iii) High-risk firms. A self-regulatory organization’s supervisory
program must include procedures for identifying member registrants that
are determined to pose a high degree of potential financial risk,
including the potential risk of loss of customer funds. High-risk
member registrants must include firms experiencing financial or
operational difficulties, failing to meet segregation or net capital
requirements, failing to maintain current books and records, or
experiencing material inadequacies in internal controls. Enhanced
monitoring for high risk firms should include, as appropriate, daily
review of net capital, segregation, and secured calculations, to assess
compliance with self-regulatory organization and Commission
requirements.
(iv) On-site examinations. (A) A self-regulatory organization must
conduct routine periodic on-site examinations of member registrants.
Member futures commission merchants and retail foreign exchange dealers
must be subject to on-site examinations no less frequently than once
every eighteen months. A self-regulatory organization shall establish a
risk-based method of establishing the scope of each on-site
examination; provided, however, that the scope of each on-site
examination of a futures commission merchant or retail foreign exchange
dealer must include an assessment of whether the registrant is in
compliance with applicable Commission and self-regulatory organization
minimum capital, customer fund protection, recordkeeping, and reporting
requirements.
(B) A self-regulatory organization must establish the frequency of
on-site examinations of member introducing brokers that do not operate
pursuant to guarantee agreements with futures commission merchants or
retail foreign exchange dealers using a risk-based approach; provided,
however, that each introducing broker is subject to an on-site
examination no less frequently than once every three years.
(C) A self-regulatory organization must conduct on-site
examinations of member registrants in accordance with uniform
examination programs and procedures that have been submitted to the
Commission.
(v) Adequate documentation. A self-regulatory organization must
adequately document all aspects of the operation of the supervisory
program, including the conduct of risk-based scope setting and the
risk-based surveillance of high-risk member registrants, and the
imposition of remedial and punitive action(s) for material violations.
(2) In addition to the requirements set forth in paragraph (c)(1)
of this section, the supervisory program of a self-regulatory
organization that has a registered futures commission merchant member
must satisfy the following requirements:
(i) The supervisory program must set forth in writing the
examination standards that the self-regulatory organization must apply
in its examination of its registered futures commission merchant
member. The supervisory program must be based on controls testing as
well as substantive testing and must address all areas of risk to which
futures commission merchants can reasonably be foreseen to be subject.
The determination as to which elements of the supervisory program are
to be performed on any examination must be based on the risk profile of
each registered futures commission merchant member as well as any
additional areas of risk to be addressed in such examination.
(ii) All aspects of the supervisory program, including the
standards pursuant to paragraph (c)(2)(iii) of this section, must, at
minimum, conform to generally accepted auditing standards after giving
full consideration to those auditing standards as prescribed by the
Public Company Accounting Oversight Board.
(iii) The supervisory program must, at a minimum, have standards
addressing the following:
(A) The ethics of an examiner;
(B) The independence of an examiner;
(C) The supervision, review, and quality control of an examiner’s
work product;
(D) The evidence and documentation to be reviewed and retained in
connection with an examination;
(E) The sampling size and techniques used in an examination;
(F) The examination risk assessment process;
(G) The examination planning process;
(H) Materiality assessment;
(I) Quality control procedures to ensure that the examinations
maintain the level of quality expected;
(J) Communications between an examiner and the regulatory oversight
committee of the self-regulatory organization of which the registered
futures commission merchant is a member;
(K) Communications between an examiner and a futures commission
merchant’s audit committee of the board of directors or other similar
governing body;
(L) Analytical review procedures;
(M) Record retention; and
(N) Required items for inclusion in the examination report, such as
repeat violations, material items, and high risk issues.
(iv) A self-regulatory organization must cause an examinations
expert to evaluate the supervisory program and such self-regulatory
organization’s application of the supervisory program at least once
every two years.
(A) The self-regulatory organization must obtain from such
examinations expert a written report that includes the following:
(1) An affirmation that the examinations expert has evaluated the
supervisory program, including the sufficiency of the risk-based
approach and the internal controls testing thereof, and comments and
recommendations in connection with such evaluation from such
examinations expert;
(2) An affirmation that the examinations expert has evaluated the
application of the supervisory program by the self-regulatory
organization, and comments and recommendations in connection with such
evaluation from such examinations expert;
(3) The examinations expert’s opinion as to whether the supervisory
program is reasonably likely to identify a material weakness in
internal controls over financial and/or regulatory reporting and in any
of the other items that are the subject of an examination conducted in
accordance with the supervisory program; and
(4) A discussion and recommendation of any new or best practices as
prescribed by industry sources, including, but not limited to, those
from the American Institute of Certified Public Accountants, the
Institute of Internal Auditors, and The Risk Management Association.
(B) The self-regulatory organization must provide the written
report to the Commission no later than fifteen days following the
receipt thereof. Upon resolution of any questions or comments raised by
the Commission, and upon notice from the Commission that it has no
further comments or questions on the supervisory program as amended (by
reason of the examinations expert’s proposals, considerations of the
Commission’s questions or comments, or otherwise), the self-regulatory
organization shall commence applying
[[Page 67949]]
such supervisory program as the standard for examining its registered
futures commission merchant members.
(v) The supervisory program must require the self-regulatory
organization to report to its risk and/or audit committee of the board
of directors with timely reports of the activities and findings of the
supervisory program to assist the risk and/or audit committee of the
board of directors to fulfill its responsibility of overseeing the
examination function.
(vi) The initial supervisory program shall be established as
follows. Within 120 days following the effective date of this section,
or such other time as the Commission may approve, the self-regulatory
organization shall submit a proposed supervisory program to the
Commission for its review and comment, together with a written report
that includes the elements found in paragraphs (c)(2)(iv)(A)(1) and (3)
of this section from an examinations expert who has evaluated the
supervisory program. Upon resolution of any questions or comments
raised by the Commission, and upon notice from the Commission that it
has no further comments or questions on the proposed supervisory
program as amended (by reason of the considerations of the Commission’s
questions or comments or otherwise), the self-regulatory organizations
shall commence applying such supervisory program as the standard for
examining its members that are registered as futures commission
merchants.
(d)(1) Any two or more self-regulatory organizations may file with
the Commission a plan for delegating to a designated self-regulatory
organization, for any registered futures commission merchant, retail
foreign exchange dealer, or introducing broker that is a member of more
than one such self-regulatory organization, the function of:
(i) Monitoring and examining for compliance with the minimum
financial and related reporting requirements and risk management
requirements, including policies and procedures relating to the
receipt, holding, investing and disbursement of customer funds, adopted
by such self-regulatory organizations and the Commission in accordance
with paragraphs (b) and (c) of this section; and
(ii) Receiving the financial reports and notices necessitated by
such minimum financial and related reporting requirements; provided,
however, that the self-regulatory organization that delegates the
functions set forth in this paragraph (d)(1) shall remain responsible
for its member registrants’ compliance with the regulatory obligations,
and if such self-regulatory organization becomes aware that a delegated
function is not being performed as required under this section, the
self-regulatory organization shall promptly take any necessary steps to
address any noncompliance.
(2) If a plan established pursuant to paragraph (d)(1) of this
section applies to any registered futures commission merchant, then
such plan must include the following elements:
(i) The Joint Audit Committee. The self-regulatory organizations
that choose to participate in the plan shall form a Joint Audit
Committee, consisting of all self-regulatory organizations in the plan
as members. The members of the Joint Audit Committee shall establish,
operate and maintain a Joint Audit Program in accordance with the
requirements of this section to ensure an effective and a high quality
program for examining futures commission merchants, to designate the
designated self-regulatory organizations that will be responsible for
the examinations of futures commission merchants pursuant to the Joint
Audit Program, and to satisfy such additional obligations set forth in
this section in order to facilitate the examinations of futures
commission merchants by their respective designated self-regulatory
organizations.
(ii) The Joint Audit Program. The Joint Audit Program must, at
minimum, satisfy the following requirements.
(A) The purpose of the Joint Audit Program must be to assess
whether each registered futures commission merchant member of the Joint
Audit Committee members is in compliance with the Joint Audit Program
and Commission regulations governing minimum net capital and related
financial requirements, the obligation to segregate customer funds,
risk management requirements, including policies and procedures
relating to the receipt, holding, investment, and disbursement of
customer funds, financial reporting requirements, recordkeeping
requirements, and sales practice and other compliance requirements.
(B) The Joint Audit Program must include written policies and
procedures concerning the application of the Joint Audit Program in the
examination of the registered futures commission merchant members of
the Joint Audit Committee members.
(C)(1) Adequate levels and independence of examination staff. A
designated self-regulatory organization must maintain staff of an
adequate size, training, and experience to effectively implement the
Joint Audit Program. Staff of the designated self-regulatory
organization, including officers, directors, and supervising committee
members, must maintain independent judgment and its actions must not
impair its independence nor appear to impair its independence in
matters related to the Joint Audit Program. The designated self-
regulatory organization must provide annual ethics training to all
staff with responsibilities for the Joint Audit Program.
(2) Ongoing surveillance. A designated self-regulatory
organization’s ongoing surveillance of futures commission merchant
member registrants over which it has oversight responsibilities must
include the review and analysis of financial reports and regulatory
notices filed by such member registrants with the designated self-
regulatory organization.
(3) High-risk firms. The Joint Audit Program must include
procedures for identifying futures commission merchant member
registrants over which it has oversight responsibilities that are
determined to pose a high degree of potential financial risk, including
the potential risk of loss of customer funds. High-risk member
registrants must include firms experiencing financial or operational
difficulties, failing to meet segregation or net capital requirements,
failing to maintain current books and records, or experiencing material
inadequacies in internal controls. Enhanced monitoring for high risk
firms should include, as appropriate, daily review of net capital,
segregation, and secured calculations, to assess compliance with self-
regulatory and Commission requirements.
(4) On-site examinations. A designated self-regulatory organization
must conduct routine periodic on-site examinations of futures
commission merchant member registrants over which it has oversight
responsibilities. Such member registrants must be subject to on-site
examinations no less frequently than once every eighteen months. A
designated self-regulatory organization shall establish a risk-based
method of establishing the scope of each on-site examination, provided,
however, that the scope of each on-site examination of a futures
commission merchant must include an assessment of whether the
registrant is in compliance with applicable Commission and self-
regulatory organization minimum capital, customer fund protection,
recordkeeping, and reporting requirements. A designated self-regulatory
organization must conduct on-site examinations of futures commission
merchant registrants in accordance with the Joint Audit Program.
[[Page 67950]]
(D) The Joint Audit Committee members must adequately document all
aspects of the operation of the Joint Audit Program, including the
conduct of risk-based scope setting and the risk-based surveillance of
high-risk member registrants, and the imposition of remedial and
punitive action(s) for material violations.
(E) The Joint Audit Program must set forth in writing the
examination standards that a designated self-regulatory organization
must apply in its examination of a registered futures commission
merchant. The Joint Audit Program must be based on controls testing as
well as substantive testing and must address all areas of risk to which
registered futures commission merchants can reasonably be foreseen to
be subject. The determination as to which elements of the Joint Audit
Program are to be performed on any examination must be based on the
risk profile of each registered futures commission merchant as well as
any additional areas of risk to be addressed in such examination.
(F) All aspects of the Joint Audit Program, including the standards
required pursuant to paragraph (d)(2)(ii)(G) of this section, must, at
minimum, conform to generally accepted auditing standards after full
consideration to those auditing standards as prescribed by the Public
Company Accounting Oversight Board.
(G) The Joint Audit Program must have standards addressing those
items listed in paragraph (c)(2)(iii) of this section.
(H) The initial Joint Audit Program shall be established as
follows. Within 120 days following the effective date of this section,
or such other time as the Commission may approve, the Joint Audit
Committee members shall submit a proposed initial Joint Audit Program
to the Commission for its review and comment, together with a written
report that includes the elements found in paragraphs (d)(2)(ii)(I)(1)
and (3) of this section from an examinations expert who has evaluated
the Joint Audit Program. Upon resolution of any questions or comments
raised by the Commission, and upon notice from the Commission that it
has no further comments or questions on the proposed Joint Audit
Program as amended (by reason of the considerations of the Commission’s
questions or comments or otherwise), the designated self-regulatory
organizations shall commence applying such Joint Audit Program as the
standard for examining their respective registered futures commission
merchants.
(I) Following the establishment of the Joint Audit Program, no less
frequently than once every two years, the Joint Audit Committee members
must cause an examinations expert to evaluate the Joint Audit Program
and each designated self-regulatory organization’s application of the
Joint Audit Program. The Joint Audit Committee members must obtain from
such examinations expert a written report, and must provide the written
report to the Commission no later than forty-five days prior to the
annual meeting of the members of the Joint Audit Committee to be held
in that year pursuant to paragraph (d)(2)(iii)(A) of this section. The
written report must include the following:
(1) An affirmation that the examinations expert has evaluated the
Joint Audit Program, including the sufficiency of the risk-based
approach and the internal controls testing thereof, and comments and
recommendations in connection with such evaluation from such
examinations expert;
(2) An affirmation that the examinations expert has evaluated the
application of the Joint Audit Program by each designated self-
regulatory organization, and comments and recommendations in connection
with such evaluation from such examinations expert;
(3) The examinations expert’s opinion as to whether the Joint Audit
Program is reasonably likely to identify a material deficiency in
internal controls over financial and/or regulatory reporting and in any
of the other items that are the subject of an examination conducted in
accordance with the Joint Audit Program; and
(4) A discussion and recommendation of any new or best practices as
prescribed by industry sources, including, but not limited to, those
from the American Institute of Certified Public Accountants, the
Internal Audit Association and The Risk Management Association.
(J) The Joint Audit Program must require each Joint Audit Committee
member to report to its risk and/or audit committee of the board of
directors with timely reports of the activities and findings of the
Joint Audit Program to assist the risk and/or audit committee of the
board of directors to fulfill its responsibility of overseeing the
examination function.
(iii) Meetings of the Joint Audit Committee. (A) No less frequently
than once every year, the Joint Audit Committee members must meet to
consider whether changes to the Joint Audit Program are appropriate,
and in considering such, in meetings corresponding to the biennial
written report obtained from an examinations expert pursuant to
paragraph (d)(2)(ii)(I) of this section, the Joint Audit Committee
members must consider such written report, including the results of the
examinations expert’s assessment of the Joint Audit Program and any
additional recommendations. The Commission’s questions, comments and
proposals must also be considered. Upon notice from the Commission that
it has no further comments or questions on the Joint Audit Program as
amended (by reason of the examinations expert’s proposals,
considerations of the Commission’s questions, comments and proposals,
or otherwise), the designated self-regulatory organizations shall
commence applying such Joint Audit Program as the standard for
examining their respective registered futures commission merchants.
(B) In addition to the items considered in paragraph (d)(2)(iii)(A)
of this section, the Joint Audit Committee members must consider the
following items during the annual meeting:
(1) The role of the Joint Audit Committee and its members as it
relates to self-regulatory organization responsibilities;
(2) Developing and maintaining the Joint Audit Program for all
designated self-regulatory organizations to follow with no exceptions;
(3) Coordinating self-regulatory organization responsibilities with
those of independent certified public accountants, the Commission and
other regulators and self-regulatory organizations (e.g., the
Securities and Exchange Commission, the Financial Industry Regulatory
Authority, and others, as the case may be for futures commission
merchants subject to regulation by multiple regulators and self-
regulatory organizations);
(4) Coordinating and sharing information between the Joint Audit
Committee members, including issues and industry concerns in connection
with examinations of futures commission merchants;
(5) Identifying industry financial and regulatory reporting issues
and financial and operational internal control issues and modifying the
Joint Audit Program accordingly;
(6) Issuing an annual risk alert for futures commission merchants;
(7) Issuing an annual examination alert for certified public
accountants and designated self-regulatory organization examiners;
(8) Responding to industry issues;
(9) Providing industry feedback to Commission proposals; and
[[Page 67951]]
(10) Developing and maintaining a standard of ethics and
independence with which all examination units of the Joint Audit
Committee members must comply.
(C) Minutes must be taken of all meetings and distributed to all
members on a timely basis.
(D) The Commission must receive timely prior notice of each
meeting, have to right to attend and participate in each meeting and
receive written copies of the reports and minutes required pursuant to
paragraphs (d)(2)(ii)(J) and (d)(2)(iii)(C) of this section,
respectively.
(3) The plan referenced in paragraph (d)(1) of this section shall
not be effective without Commission approval pursuant to paragraph (h)
of this section.
(e) Any plan filed under this section may contain provisions for
the allocation of expenses reasonably incurred by designated self-
regulatory organizations among the self-regulatory organizations
participating in such a plan.
(f) A plan’s designated self-regulatory organizations must report
to:
(1) That plan’s other self-regulatory organizations any violation
of such other self-regulatory organizations’ rules and regulations for
which the responsibility to monitor or examine has been delegated to
such designated self-regulatory organization under this section; and
(2) The Director of the Division of Swap Dealer and Intermediary
Oversight of the Commission any violation of a self-regulatory
organization’s rules and regulations or any violation of the
Commission’s regulations for which the responsibility to monitor,
audit, or examine has been delegated to such designated self-regulatory
organization under this section.
(g) The Joint Audit Committee members may, among themselves,
establish programs to provide access to any necessary financial or
related information.
(h) After appropriate notice and opportunity for comment, the
Commission may, by written notice, approve such a plan, or any part of
the plan, if it finds that the plan, or any part of it:
(1) Is necessary or appropriate to serve the public interest;
(2) Is for the protection and in the interest of customers;
(3) Reduces multiple monitoring and multiple examining for
compliance with the minimum financial rules of the Commission and of
the self-regulatory organizations submitting the plan of any futures
commission merchant, retail foreign exchange dealer, or introducing
broker that is a member of more than one self-regulatory organization;
(4) Reduces multiple reporting of the financial information
necessitated by such minimum financial and related reporting
requirements by any futures commission merchant, retail foreign
exchange dealer, or introducing broker that is a member of more than
one self-regulatory organization;
(5) Fosters cooperation and coordination among the self-regulatory
organizations; and
(6) Does not hinder the development of a registered futures
association under section 17 of the Act.
(i) After the Commission has approved a plan, or part thereof,
under paragraph (h) of this section, a self-regulatory organization
delegating the functions described in paragraph (d)(1) of this section
must notify each of its members that are subject to such a plan:
(1) Of the limited scope of the delegating self-regulatory
organization’s responsibility for such a member’s compliance with the
Commission’s and self-regulatory organization’s minimum financial and
related reporting requirements; and
(2) Of the identity of the designated self-regulatory organization
that has been delegated responsibility for such a member; provided,
however, that the self-regulatory organization that delegates, pursuant
to paragraph (d) of this section, the functions set forth in paragraphs
(b) and (c) of this section shall remain responsible for its member
registrants’ compliance with the regulatory obligations, and if such
self-regulatory organization becomes aware that a delegated function is
not being performed as required under this section, the self-regulatory
organization shall promptly take any necessary steps to address any
noncompliance.
(j) The Commission may at any time, after appropriate notice and
opportunity for hearing, withdraw its approval of any plan, or part
thereof, established under this section, if such plan, or part thereof,
ceases to adequately effectuate the purposes of section 4f(b) of the
Act or of this section.
(k) Whenever a registered futures commission merchant, a registered
retail foreign exchange dealer, or a registered introducing broker
holding membership in a self-regulatory organization ceases to be a
member in good standing of that self-regulatory organization, such
self-regulatory organization must, on the same day that event takes
place, give electronic notice of that event to the Commission at its
Washington, DC, headquarters and send a copy of that notification to
such futures commission merchant, retail foreign exchange dealer, or
introducing broker.
(l) Nothing in this section shall preclude the Commission from
examining any futures commission merchant, retail foreign exchange
dealer, or introducing broker for compliance with the minimum financial
and related reporting requirements, and the risk management
requirements, as applicable, to which such futures commission merchant,
retail foreign exchange dealer, or introducing broker is subject.
(m) In the event a plan is not filed and/or approved for each
registered futures commission merchant, retail foreign exchange dealer,
or introducing broker that is a member of more than one self-regulatory
organization, the Commission may design and, after notice and
opportunity for comment, approve a plan for those futures commission
merchants, retail foreign exchange dealers, or introducing brokers that
are not the subject of an approved plan (under paragraph (h) of this
section), delegating to a designated self-regulatory organization the
responsibilities described in paragraph (d) of this section.
18. Amend Sec. 1.55 by revising paragraphs (b)(2) through (8) and
by adding paragraphs (b)(9) through (14), (i), (j), (k), (l), (m), (n),
and (o), to read as follows:
Sec. 1.55 Public disclosures by futures commission merchants
* * * * *
(b) * * *
(2) The funds you deposit with a futures commission merchant for
trading futures positions are not protected by insurance in the event
of the bankruptcy or insolvency of the futures commission merchant, or
in the event your funds are misappropriated due to fraud.
(3) The funds you deposit with a futures commission merchant for
trading futures positions are not protected by the Securities Investor
Protection Corporation even if the futures commission merchant is
registered with the Securities and Exchange Commission as a broker or
dealer.
(4) The funds you deposit with a futures commission merchant are
not guaranteed or insured by a derivatives clearing organization in the
event of the bankruptcy or insolvency of the futures commission
merchant, or if the futures commission merchant is otherwise unable to
refund your funds.
(5) The funds you deposit with a futures commission merchant are
not held by the futures commission
[[Page 67952]]
merchant in a separate account for your individual benefit. Futures
commission merchants commingle the funds received from customers in one
or more accounts and you may be exposed to losses incurred by other
customers if the futures commission merchant does not have sufficient
capital to cover such other customers’ trading losses.
(6) The funds you deposit with a futures commission merchant may be
invested by the futures commission merchant in certain types of
financial instruments that have been approved by the Commission for the
purpose of such investments. Permitted investments are listed in
Commission Regulation 1.25 and include: U.S. government securities;
municipal securities; money market mutual funds; and certain corporate
notes and bonds. The futures commission merchant may retain the
interest and other earnings realized from its investment of customer
funds. You should be familiar with the types of financial instruments
that a futures commission merchant may invest customer funds in.
(7) Futures commission merchants are permitted to deposit customer
funds with affiliated entities, such as affiliated banks, securities
brokers or dealers, or foreign brokers. You should inquire as to
whether your futures commission merchant deposits funds with affiliates
and assess whether such deposits by the futures commission merchant
with its affiliates increases the risks to your funds.
(8) You should consult your futures commission merchant concerning
the nature of the protections available to safeguard funds or property
deposited for your account.
(9) Under certain market conditions, you may find it difficult or
impossible to liquidate a position. This can occur, for example, when
the market reaches a daily price fluctuation limit (“limit move”).
(10) All futures positions involve risk, and a “spread” position
may not be less risky than an outright “long” or “short” position.
(11) The high degree of leverage (gearing) that is often obtainable
in futures trading because of the small margin requirements can work
against you as well as for you. Leverage (gearing) can lead to large
losses as well as gains.
(12) In addition to the risks noted in the paragraphs enumerated
above, you should be familiar with the futures commission merchant you
select to entrust your funds for trading futures positions. The
Commodity Futures Trading Commission requires each futures commission
merchant to make publicly available on its Web site firm specific
disclosures and financial information to assist you with your
assessment and selection of a futures commission merchant. Information
regarding this futures commission merchant may be obtained by visiting
our Web site, www.[Web site address].
ALL OF THE POINTS NOTED ABOVE APPLY TO ALL FUTURES TRADING WHETHER
FOREIGN OR DOMESTIC. IN ADDITION, IF YOU ARE CONTEMPLATING TRADING
FOREIGN FUTURES OR OPTIONS CONTRACTS, YOU SHOULD BE AWARE OF THE
FOLLOWING ADDITIONAL RISKS:
(13) Foreign futures transactions involve executing and clearing
trades on a foreign exchange. This is the case even if the foreign
exchange is formally “linked” to a domestic exchange, whereby a trade
executed on one exchange liquidates or establishes a position on the
other exchange. No domestic organization regulates the activities of a
foreign exchange, including the execution, delivery, and clearing of
transactions on such an exchange, and no domestic regulator has the
power to compel enforcement of the rules of the foreign exchange or the
laws of the foreign country. Moreover, such laws or regulations will
vary depending on the foreign country in which the transaction occurs.
For these reasons, customers who trade on foreign exchanges may not be
afforded certain of the protections which apply to domestic
transactions, including the right to use domestic alternative dispute
resolution procedures. In particular, funds received from customers to
margin foreign futures transactions may not be provided the same
protections as funds received to margin futures transactions on
domestic exchanges. Before you trade, you should familiarize yourself
with the foreign rules which will apply to your particular transaction.
(14) Finally, you should be aware that the price of any foreign
futures or option contract and, therefore, the potential profit and
loss resulting therefrom, may be affected by any fluctuation in the
foreign exchange rate between the time the order is placed and the
foreign futures contract is liquidated or the foreign option contract
is liquidated or exercised.
THIS BRIEF STATEMENT CANNOT, OF COURSE, DISCLOSE ALL THE RISKS AND
OTHER ASPECTS OF THE COMMODITY MARKETS
I hereby acknowledge that I have received and understood this risk
disclosure statement.
———————————————————————–
Date
———————————————————————–
Signature of Customer
* * * * *
(i) Notwithstanding any other provision of this section, no futures
commission merchant may enter into a customer account agreement or
first accept funds from a customer, unless the futures commission
merchant discloses to the customer all information about the futures
commission merchant, including its business, operations, risk profile,
and affiliates, that would be material to the customer’s decision to
entrust such funds to and otherwise do business with the futures
commission merchant and that is otherwise necessary for full and fair
disclosure. In connection with the disclosure of such information, the
futures commission merchant shall provide material information about
the topics described in paragraph (k) of this section, expanding upon
such information as necessary to keep such disclosure from being
misleading, whether through omission or otherwise. The futures
commission merchant shall also disclose the same information required
by this paragraph to all customers existing on the effective date of
this paragraph even if the futures commission merchant and such
existing customers have previously entered into a customer account
agreement or the futures commission merchant has already accepted funds
from such existing customers. The futures commission merchant shall
update the information required by this section as and when necessary,
but at least annually, to keep such information accurate and complete
and shall promptly disclose such updated information to all of its
customers. In connection with such obligation to update information,
the futures commission merchant shall take into account any material
change to its business operation, financial condition and other factors
material to the customer’s decision to entrust the customer’s funds and
otherwise do business with the futures commission merchant since its
most recent disclosure pursuant to this paragraph, and for this purpose
shall without limitation consider events that require periodic
reporting required to be filed pursuant to Sec. 1.12 of this part. For
purposes of this section, the disclosures required pursuant to this
paragraph (i) will be referred to as the “Disclosure Documents.” The
Disclosure Documents shall provide a detailed table of contents
referencing and describing the Disclosure Documents.
[[Page 67953]]
(j)(1) Each futures commission merchant shall make the Disclosure
Documents available to each customer to whom disclosure is required
pursuant to paragraph (i) of this section (for purposes of this
section, its “FCM Customers”) and to the general public.
(2) A futures commission merchant shall make the Disclosure
Documents available to FCM Customers and to the general public by
posting a copy of the Disclosure Documents on the futures commission
merchant’s Web site. A futures commission merchant, however, may use an
electronic means other than its Web site to make the Disclosure
Documents available to its FCM Customers; provided that:
(i) The electronic version of the Disclosure Documents shall be
presented in a format that is readily communicated to the FCM
Customers. Information is readily communicated to the FCM Customers if
it is accessible to the ordinary computer user by means of commonly
available hardware and software and if the electronically delivered
document is organized in substantially the same manner as would be
required for a paper document with respect to the order of presentation
and the relative prominence of information; and
(ii) A complete paper copy of the Disclosure Documents shall be
provided to an FCM Customer upon request.
(k) Specific Topics. The futures commission merchant shall provide
material information about the following specific topics:
(1) The futures commission merchant’s name, address of its
principal place of business, phone number, fax number, and email
address;
(2) The names and business addresses of the futures commission
merchant’s directors and senior management, including titles, business
background, areas of responsibility, and the nature of duties of each;
(3) The significant types of business activities and product lines
engaged in by the futures commission merchant, and the approximate
percentage of the futures commission merchant’s assets and capital that
are used in each type of activity;
(4) The futures commission merchant’s business on behalf of its
customers, including types of accounts, markets traded, international
businesses, and clearinghouses and carrying brokers used, and the
futures commission merchant’s policies and procedures concerning the
choice of bank depositories, custodians, and other counterparties;
(5) The material risks, accompanied by an explanation of how such
risks may be material to its customers, of entrusting funds to the
futures commission merchant, including, without limitation, the nature
of investments made by the futures commission merchant (including
credit quality, weighted average maturity, and weighted average
coupon); the futures commission merchant’s creditworthiness, leverage,
capital, liquidity, principal liabilities, balance sheet leverage and
other lines of business; risks to the futures commission merchant
created by its affiliates and their activities, including investment of
customer funds in an affiliated entity; and any significant
liabilities, contingent or otherwise, and material commitments;
(6) The name of the futures commission merchant’s designated self-
regulatory organization and its Web site address and the location where
the annual audited financial statements of the futures commission
merchant is made available;
(7) Any material administrative, civil, enforcement, or criminal
action then pending, and any enforcement actions taken in last three
years;
(8) A basic overview of customer fund segregation, futures
commission merchant collateral management and investments, futures
commission merchants, and joint futures commission merchant/broker
dealers;
(9) Information on how a customer may obtain information regarding
filing a complaint about the futures commission merchant with the
Commission or with the firm’s designated self-regulatory organization:
and
(10) The following financial data as of the most recent month-end
when the Disclosure Document is prepared:
(i) The futures commission merchant’s total equity, regulatory
capital, and net worth, all computed in accordance with U.S. Generally
Accepted Accounting Principles and Sec. 1.17 of this part, as
applicable;
(ii) The dollar value of the futures commission merchant’s
proprietary margin requirements as a percentage of the aggregate margin
requirement for futures customers, Cleared Swaps Customers, and 30.7
Customers;
(iii) The number of futures customers, Cleared Swaps Customers, and
30.7 Customers that comprise 50 percent of the futures commission
merchant’s total funds held for futures customers, Cleared Swaps
Customers, and 30.7 Customers, respectively;
(iv) The aggregate notional value, by asset class, of all non-
hedged, principal over-the-counter transactions into which the futures
commission merchant has entered;
(v) The amount, generic source and purpose of any unsecured lines
of credit (or similar short-term funding) the futures commission
merchant has obtained but not yet drawn upon;
(vi) The aggregated amount of financing the futures commission
merchant provides for customer transactions involving illiquid
financial products for which it is difficult to obtain timely and
accurate prices; and
(vii) The percentage of futures customer, Cleared Swaps Customer,
and 30.7 Customer receivable balances that the futures commission
merchant had to write-off as uncollectable during the past 12-month
period, as compared to the current balance of funds held for futures
customers, Cleared Swaps Customers, and 30.7 Customers; and
(11) A summary of the futures commission merchant’s current risk
practices, controls and procedures.
(l) In addition to the foregoing, each futures commission merchant
shall adopt policies and procedures reasonably designed to ensure that
advertising and solicitation activities by each such futures commission
merchant and any introducing brokers associated with such futures
commission merchant are not misleading to its FCM Customers in
connection with their decision to entrust funds to and otherwise do
business with such futures commission merchant.
(m) The Disclosure Document required by paragraph (i) of this
section is in addition to the Risk Disclosure Statement required under
paragraph (a) of this section.
(n) All Disclosure Documents, with each Disclosure Document dated
the date of first use, shall be maintained in accordance with Sec.
1.31 and shall be made available promptly upon request to
representatives of its designated self-regulatory organization,
representatives of the Commission, and representatives of applicable
prudential regulators.
(o)(1) Each futures commission merchant shall make the following
financial information publicly available on its Web site:
(i) The daily Statement of Segregation Requirements and Funds in
Segregation for Customers Trading on U.S. Exchanges for the most
current 12-month period;
(ii) The daily Statement of Secured Amounts and Funds Held in
Separate Accounts for 30.7 Customers Pursuant to Commission Regulation
30.7 for the most current 12-month period;
(iii) The daily Statement of Cleared Swaps Customer Segregation
Requirements and Funds in Cleared
[[Page 67954]]
Swaps Customer Accounts Under Section 4d(f) of the Act for the most
current 12-month period;
(iv) A summary schedule of the futures commission merchant’s
adjusted net capital, net capital, and excess net capital, all computed
in accordance with Sec. 1.17 of this part and reflecting balances as
of the month-end for the 12 most recent months; and
(v) The Statement of Financial Condition, the Statement of
Segregation Requirements and Funds in Segregation for Customers Trading
on U.S. Exchanges, the Statement of Secured Amounts and Funds Held in
Separate Accounts for 30.7 Customers Pursuant to Commission Regulation
30.7, the Statement of Cleared Swaps Customer Segregation Requirements
and Funds in Cleared Swaps Customer Accounts Under Section 4d(f) of the
Act, an all related footnotes to the above schedules that are part of
the futures commission merchant’s most current certified annual report
pursuant to Sec. 1.16 of this part.
(2) Each futures commission merchant must include a statement on
its Web site that is available to the public that financial information
regarding the futures commission merchant, including how the futures
commission merchant invests and holds customer funds, may be obtained
from the National Futures Association and include a link to the Web
site of the National Futures Association’s Basic System where
information regarding the futures commission merchant’s investment of
customer funds is maintained.
(3) Each futures commission merchant must include a statement on
its Web site that is available to the public that additional financial
information on all futures commission merchants is available from the
Commodity Futures Trading Commission, and include a link to the
Commodity Futures Trading Commission’s web page for financial data for
futures commission merchants.
PART 3–REGISTRATION
19. The authority citation for part 3 continues to read as follows:
Authority: 5 U.S.C. 552, 552b; 7 U.S.C. 1a, 2, 6a, 6b, 6b-1, 6c,
6d, 6e, 6f, 6g, 6h, 6i, 6k, 6m, 6n, 6o, 6p, 6s, 8, 9, 9a, 12, 12a,
13b, 13c, 16a, 18, 19, 21, and 23, as amended by Title VII of the
Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L.
111-203, 124 Stat. 1376 (Jul. 21, 2010).
20. Amend Sec. 3.3 by revising paragraph (f)(2) to read as
follows:
Sec. 3.3 Chief compliance officer.
* * * * *
(f) * * *
(2) The annual report shall be furnished electronically to the
Commission not more than 60 days after the end of the fiscal year of
the futures commission merchant, swap dealer, or major swap
participant, simultaneously with the submission of Form 1-FR-FCM, as
required under Sec. 1.10(b)(2)(ii) of this chapter, simultaneously
with the Financial and Operational Combined Uniform Single Report, as
required under Sec. 1.10(h) of this chapter, or simultaneously with
the financial condition report, as required under section 4s(f) of the
Act, as applicable.
* * * * *
PART 22–CLEARED SWAPS
21. The authority citation for part 22 continues to read as
follows:
Authority: 7 U.S.C. 1a, 6d, 7a-1 as amended by Title VII of the
Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L.
111-203, 124 Stat. 1376 (Jul. 21, 2010).
22. Amend Sec. 22.2 by revising paragraphs (d)(1), (e)(1), (f)(2),
(f)(4), (f)(5)(iii)(B), and (g)(2), and by adding paragraphs (f)(6) and
(g)(3) through (10) to read as follows:
Sec. 22.2 Futures Commission Merchants: Treatment of Cleared Swaps
and Associated Cleared Swap Customer Collateral.
* * * * *
(d) Limitations on use. (1) No futures commission merchant shall
use, or permit the use of, the Cleared Swaps Customer Collateral of one
Cleared Swaps Customer to purchase, margin, or settle the Cleared Swaps
or any other trade or contract of, or to secure or extend the credit
of, any person other than such Cleared Swaps Customer. Cleared Swaps
Customer Collateral shall not be used to margin, guarantee, or secure
trades or contracts of the entity constituting a Cleared Swaps Customer
other than in Cleared Swaps, except to the extent permitted by a
Commission rule, regulation or order. For this purpose, a futures
commission merchant which operationally commingles the funds of its
Cleared Swaps Customers must ensure that at all times its residual
interest in Cleared Swaps Customer Accounts exceeds the sum of the
margin deficits of all of its Cleared Swaps Customers.
* * * * *
(e) * * *
(1) Permitted investments. A futures commission merchant may invest
money, securities, or other property constituting Cleared Swaps
Customer Collateral in accordance with Sec. 1.25 of this chapter,
which shall apply to such money, securities, or other property as if
they comprised customer funds or customer money subject to segregation
pursuant to section 4d(a) of the Act and the regulations thereunder;
Provided, however, that the futures commission merchant shall bear sole
responsibility for any losses resulting from the investment of customer
funds in instruments described in Sec. 1.25 of this chapter. No
investment losses shall be borne or otherwise allocated to Cleared
Swaps Customers of the futures commission merchant.
* * * * *
(f) * * *
(2) The futures commission merchant must reflect in the account
that it maintains for each Cleared Swaps Customer the market value of
any Cleared Swaps Customer Collateral that it receives from such
customer, as adjusted by:
(i) Any uses permitted under Sec. 22.2(d) of this part;
(ii) Any accruals on permitted investments of such collateral under
Sec. 22.2(e) of this part that, pursuant to the futures commission
merchant’s customer agreement with that customer, are creditable to
such customer;
(iii) Any gains and losses with respect to Cleared Swaps;
(iv) Any charges lawfully accruing to the Cleared Swaps Customer,
including any commission, brokerage fee, interest, tax, or storage fee;
and
(v) Any appropriately authorized distribution or transfer of such
collateral.
* * * * *
(4) The futures commission merchant must, at all times, maintain in
segregation, in its FCM Physical Locations and/or its Cleared Swaps
Customer Accounts at Permitted Depositories, an amount equal to the sum
of any credit balances that the Cleared Swaps Customers of the futures
commission merchant have in their accounts, excluding from such sum any
debit balances that the Cleared Swaps Customers of the futures
commission merchant have in their accounts.
(5) * * *
(iii) * * *
(B) Reduce such market value by applicable percentage deductions
(i.e., “securities haircuts”) as set forth in Rule 15c3-1(c)(2)(vi)
of the Securities and Exchange Commission (Sec. 240.15c3-1(c)(2)(vi)
of this title). Futures commission merchants that establish and enforce
written policies and procedures to assess the credit risk of commercial
paper, convertible debt instruments, or nonconvertible debt instruments
in accordance with Rule
[[Page 67955]]
240.15c3-1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR
240.15c3-1(c)(2)(vi)) may apply the lower haircut percentages specified
in Rule 240.15c3-1(c)(2)(vi) for such commercial paper, convertible
debt instruments and nonconvertible debt instruments. The portion of
the debit balance, not exceeding 100 percent, that is secured by the
reduced market value of such readily marketable securities shall be
included in calculating the sum referred to in paragraph (f)(4) of this
section.
(6) The FCM must reflect in the account it maintains for each
Cleared Swaps Customer the amount of collateral required for the
Cleared Swaps Customer’s Cleared Swaps at each derivatives clearing
organization on which the futures commission merchant is a member, or
by each other futures commission merchant through which the futures
commission merchant clears Cleared Swaps, and the total of such
required collateral amounts. If the value of the Cleared Swaps Customer
Collateral, as calculated in this section, for a Cleared Swaps Customer
is less than the total amount of collateral required for that Cleared
Swaps Customer’s Cleared Swaps at such derivatives clearing
organizations and such other futures commission merchants, the
difference is a margin deficit. The futures commission merchant must at
all times maintain a residual interest in Cleared Swaps Customer
Accounts sufficient to exceed the sum of all margin deficits that
Cleared Swaps Customers of the futures commission merchant have in
their accounts. Such residual interest may not be withdrawn pursuant to
any provision of this chapter.
(g) * * *
(2) Each futures commission merchant is required to document its
segregation computation required by paragraph (g)(1) of this section by
preparing a Statement of Cleared Swaps Customer Segregation
Requirements and Funds in Cleared Swaps Customer Accounts Under 4d(f)
of the CEA contained in the Form 1-FR-FCM as of the close of business
each business day.
(3) Each futures commission merchant is required to submit to the
Commission and to the firm’s designated self-regulatory organization
the daily Statement of Cleared Swaps Customer Segregation Requirements
and Funds in Cleared Swaps Customer Accounts Under 4d(f) of the CEA
required by paragraph (g)(2) of this section by noon the following
business day.
(4) Each futures commission merchant shall file the Statement of
Cleared Swaps Customer Segregation Requirements and Funds in Cleared
Swaps Customer Accounts Under 4d(f) of the CEA required by paragraph
(g)(2) of this section in an electronic format using a form of user
authentication assigned in accordance with procedures established or
approved by the Commission.
(5) Each futures commission merchant is required to submit to the
Commission and to the firm’s designated self-regulatory organization a
report listing of the names of all banks, trust companies, futures
commission merchants, derivatives clearing organizations, or any other
depository or custodian holding Cleared Swaps Customer Collateral as of
the fifteenth day of the month, or the first business day thereafter,
and the last business day of each month. This report must include:
(i) The name and location of each entity holding Cleared Swaps
Customer Collateral;
(ii) The total amount of Cleared Swaps Customer Collateral held by
each entity listed in this paragraph (g)(5); and
(iii) The total amount of cash and investments that each entity
listed in this paragraph (g)(5) holds for the futures commission
merchant. The futures commission merchant must report the following
investments:
(A) Obligations of the United States and obligations fully
guaranteed as to principal and interest by the United States (U.S.
government securities);
(B) General obligations of any State or of any political
subdivision of a State (municipal securities);
(C) General obligation issued by any enterprise sponsored by the
United States (government sponsored enterprise securities);
(D) Certificates of deposit issued by a bank;
(E) Commercial paper fully guaranteed as to principal and interest
by the United States under the Temporary Liquidity Guarantee Program as
administered by the Federal Deposit Insurance Corporation;
(F) Corporate notes or bonds fully guaranteed as to principal and
interest by the United States under the Temporary Liquidity Guarantee
Program as administered by the Federal Deposit Insurance Corporation;
and
(G) Interests in money market mutual funds.
(6) Each futures commission merchant must report the total amount
of customer owned securities held by the futures commission merchant as
Cleared Swaps Customer Collateral and must list the names and locations
of the depositories holding customer owned securities.
(7) Each futures commission merchant must report the total amount
of Cleared Swaps Customer Collateral that has been used to purchase
securities under agreements to resell the securities (reverse
repurchase transactions).
(8) Each futures commission merchant must report which, if any, of
the depositories holding Cleared Swaps Customer Collateral under
paragraph (g)(5) of this section are affiliated with the futures
commission merchant.
(9) Each futures commission merchant shall file the detailed list
of depositories required by paragraph (g)(5) of this section by 11:59
p.m. the next business day in an electronic format using a form of user
authentication assigned in accordance with procedures established or
approved by the Commission.
(10) Each futures commission merchant shall retain its daily
segregation computation and the Statement of Cleared Swaps Customer
Segregation Requirements and Funds in Cleared Swaps Customer Accounts
under section 4d(f) of the CEA required by paragraph (g)(2) of this
section and the detailed listing of depositories required by paragraph
(g)(5) of this section, together with all supporting documentation, in
accordance with Sec. 1.31 of this chapter.
23. Add Sec. 22.17 to read as follows:
Sec. 22.17 Policies and procedures governing disbursements of Cleared
Swaps Customer Collateral from Cleared Swaps Customer Accounts.
(a) The provision in section 4d(f)(2) of the Act that prohibits the
commingling of Cleared Swaps Customer Collateral with the funds of a
futures commission merchant, shall not be construed to prevent a
futures commission merchant from having a residual financial interest
in the funds segregated as required by the Act and the regulations in
this part and set apart for the benefit of Cleared Swaps Customers; nor
shall such provisions be construed to prevent a futures commission
merchant from adding to such segregated funds such amount or amounts of
money, from its own funds or unencumbered securities from its own
inventory, of the type set forth in Sec. 1.25 of this chapter, as it
may deem necessary to ensure any and all Cleared Swaps Customer
Accounts are not undersegregated at any time.
(b) A futures commission merchant may not withdraw funds on any
business day for its own proprietary use from a Cleared Swaps Customer
Account unless the futures commission merchant has prepared the daily
segregation calculation required by Sec. 22.2 of this part as of the
close of business on the previous business day.
[[Page 67956]]
A futures commission merchant that has completed its daily segregation
calculation may make withdrawals for its own use, to the extent of its
actual residual financial interest in funds held in segregated
accounts, including the withdrawal of securities held in segregated
safekeeping accounts held by a bank, trust company, derivatives
clearing organization or other futures commission merchant. Such
withdrawal(s) shall not result in the funds of one Cleared Swaps
Customer being used to purchase, margin or carry the trades, contracts
or swaps positions, or extend the credit of any other Cleared Swaps
Customer or other person. Notwithstanding any other provision of this
chapter, a futures commission merchant must at all times maintain an
amount of residual interest in Cleared Swaps Customer Accounts for the
benefit of Cleared Swaps Customers that exceeds the sum of all Cleared
Swaps Customers’ margin deficits and such residual interest may not be
withdrawn by the futures commission merchant.
(c) A futures commission merchant may not withdraw funds for its
own proprietary use, in a single transaction or a series of
transactions on a given business day, from Cleared Swaps Customer
Accounts if such withdrawal(s) would exceed 25 percent of the futures
commission merchant’s residual interest in such accounts as reported on
the daily segregation calculation required by Sec. 22.2 of this part
and computed as of the close of business on the previous business day,
unless:
(1) The futures commission merchant’s Chief Executive Officer,
Chief Finance Officer or other senior official that is listed as a
principal of the futures commission merchant on its Form 7-R and is
knowledgeable about the futures commission merchant’s financial
requirements and financial position pre-approves in writing the
withdrawal, or series of withdrawals;
(2) The futures commission merchant files written notice of the
withdrawal or series of withdrawals, with the Commission and with its
designated self-regulatory organization immediately after the Chief
Executive Officer, Chief Finance Officer or other senior official pre-
approves the withdrawal or series of withdrawals. The written notice
must:
(i) Be signed by the Chief Executive Officer, Chief Finance Officer
or other senior official that pre-approved the withdrawal, and give
notice that the futures commission merchant has withdrawn or intends to
withdraw more than 25 percent of its residual interest in such accounts
holding Cleared Swaps Customer Accounts funds;
(ii) Include a description of the reasons for the withdrawal or
series of withdrawals;
(iii) List the amount of funds provided to each recipient and the
name of each recipient;
(iv) Include the current estimate of the amount of the futures
commission merchant’s residual interest in the swaps customer funds
after the withdrawal;
(v) Contain a representation by the Chief Executive Officer, Chief
Finance Officer or other senior official that pre-approved the
withdrawal, or series of withdrawals, that, after due diligence, to
such person’s knowledge and reasonable belief, the futures commission
merchant remains in compliance with the segregation requirements after
the withdrawal. The Chief Executive Officer, Chief Finance Officer or
other senior official must consider the daily segregation calculation
as of the close of business on the previous business day and any other
factors that may cause a material change in the futures commission’s
residual interest since the close of business the previous business
day, including known unsecured customer debits or deficits, current day
market activity and any other withdrawals made from the Cleared Swaps
Customer Accounts; and
(vi) Any such written notice filed with the Commission must be
filed via electronic transmission using a form of user authentication
assigned in accordance with procedures established by or approved by
the Commission, and otherwise in accordance with instruction issued by
or approved by the Commission. Any such electronic submission must
clearly indicate the registrant on whose behalf such filing is made and
the use of such user authentication in submitting such filing will
constitute and become a substitute for the manual signature of the
authorized signer. Any written notice filed must be followed up with
direct communication to the Regional office of Commission which has
supervisory authority over the futures commission merchant whereby the
Commission acknowledges receipt of the notice; and
(3) After making a withdrawal requiring the approval and notice
required in paragraphs (c)(1) and (2) of this section, and before the
next daily segregated funds calculation, no futures commission merchant
may make any further withdrawals from accounts holding Cleared Swaps
Customer Account funds, except to or for the benefit of Cleared Swaps
Customers, without complying with paragraph (c)(1) of this section and
filing a written notice with the Commission under (c)(2)(vi) of this
section and its designated self-regulatory organization signed by the
Chief Executive Officer, Chief Finance Officer, or other senior
official. The written notice must:
(i) List the amount of funds provided to each recipient and each
recipient’s name;
(ii) Disclose the reason for each withdrawal;
(iii) Confirm that the Chief Executive Officer, Chief Finance
Officer, or other senior official (and identify of the person if
different from the person who signed the notice) pre-approved the
withdrawal in writing;
(iv) Disclose the current estimate of the futures commission
merchant’s remaining total residual interest in the segregated accounts
holding Cleared Swaps Customer Account funds after the withdrawal; and
(v) Include a representation that to the best of the notice
signatory’s knowledge and reasonable belief the futures commission
merchant remains in compliance with the segregation requirements after
the withdrawal.
(d) If a futures commission merchant withdraws funds from Cleared
Swaps Customer Accounts for its own proprietary use, and the withdrawal
causes the futures commission merchant to not hold sufficient funds in
Cleared Swaps Customer Accounts to meet its targeted residual interest,
as required to be computed under Sec. 1.11 of this chapter, the
futures commission merchant must deposit its own funds into the Cleared
Swaps Customer Accounts to restore the targeted amount of residual
interest on the next business day, or, if appropriate, revise the
futures commission merchant’s targeted amount of residual interest
pursuant to the policies and procedures required by Sec. 1.11 of this
chapter. Notwithstanding the foregoing, if at any time the futures
commission merchant’s residual interest in Cleared Swaps Customer
Accounts is less than the sum of its Cleared Swaps Customers’ margin
deficits, the futures commission merchant must immediately restore the
residual interest to exceed the sum of such margin deficits. Any
proprietary funds deposited in Cleared Swaps Customer Accounts must be
unencumbered and otherwise compliant with Sec. 1.25 of this chapter,
as applicable.
(e) Notwithstanding any other provision of this part, a futures
commission merchant may not withdraw funds for its own proprietary use
from a Cleared Swaps Customer Account unless the futures commission
merchant follows its policies and procedures required by Sec. 1.11 of
this chapter.
[[Page 67957]]
PART 30–FOREIGN FUTURES AND FOREIGN OPTIONS TRANSACTIONS
24. The authority citation for part 30 continues to read as
follows:
Authority: 7 U.S.C. 1a, 2, 4, 6, 6c, and 12a, as amended by
Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act, Pub. L. 111-203, 124 Stat. 1376 (Jul. 21, 2010).
25. Amend Sec. 30.1 by adding paragraphs (f), (g), and (h) to read
as follows:
Sec. 30.1 Definitions.
* * * * *
(f) 30.7 Customer means any foreign futures or foreign options
customer as defined in paragraph (c) of this section as well as any
foreign-domiciled person who trades in foreign futures or foreign
options through a futures commission merchant; Provided, however, that
an owner or holder of a proprietary account as defined in paragraph (y)
of Sec. 1.3 of this chapter shall not be deemed to be a 30.7 customer.
(g) 30.7 Account means any account maintained by a futures
commission merchant for or on behalf of 30.7 Customers to hold money,
securities, or other property to margin, guarantee, or secure foreign
futures or foreign option positions.
(h) 30.7 Customer Funds means any money, securities, or other
property received by a futures commission merchant from, for, or on
behalf of 30.7 Customers to margin, guarantee, or secure foreign
futures or foreign option positions, or money, securities, or other
property accruing to 30.7 Customers as a result of foreign futures and
foreign option positions.
26. Revise Sec. 30.7 to read as follows:
Sec. 30.7 Treatment of foreign futures or foreign options secured
amount.
(a) General. Except as provided in this section, a futures
commission merchant must at all times maintain in a separate account or
accounts money, securities and property in an amount at least
sufficient to cover or satisfy all of its obligations to 30.7 Customers
denominated as the foreign futures or foreign options secured amount.
In computing the foreign futures or foreign options secured amount, a
futures commission merchant may offset any net deficit in a particular
30.7 Customer’s Account against the current market value of readily
marketable securities held for the same particular 30.7 Customer’s
Account as provided for in paragraph (l) of this section. The amount
that must be deposited in such separate account or accounts for 30.7
Customers must be no less than the amount required to be held in a
separate account or accounts for or on behalf of 30.7 Customers
pursuant to any law, or rule, regulation or order thereunder, or any
rule of any self-regulatory organization authorized thereunder, in the
jurisdiction in which the depository or the 30.7 Customer, as
appropriate, is located. In addition, the futures commission merchant
must at all times maintain residual interest in separate accounts for
30.7 Customers sufficient to exceed the sum of all margin deficits that
the 30.7 Customers of the futures commission merchant have in their
30.7 Accounts. Such residual interest may not be withdrawn pursuant to
any provision of this section. If the value of a 30.7 Customer’s Funds
for a 30.7 Account is less than the total amount of collateral required
for that 30.7 Customer’s 30.7 Account for foreign futures or foreign
options, the difference is a margin deficit.
(b) Location of 30.7 Customer Funds. A futures commission merchant
shall deposit the foreign futures or foreign options secured amount
under an account name that clearly identifies the funds as belonging to
30.7 Customers and shows that the foreign futures or foreign options
secured amount is set aside as required by this part. A futures
commission merchant may deposit funds set aside as the foreign futures
or foreign options secured amount with the following depositories:
(1) A bank or trust company located in the United States;
(2) A bank or trust company located outside the United States that
has in excess of $1 billion of regulatory capital;
(3) A futures commission merchant registered as such with the
Commission;
(4) A derivatives clearing organization;
(5) The clearing organization of any foreign board of trade;
(6) A member of any foreign board of trade; or
(7) Such member’s or clearing organization’s designated
depositories.
(c) Limitation on holding foreign futures or foreign options
secured amount outside of the United States. A futures commission
merchant may not deposit or hold the foreign futures or foreign options
secured amount in accounts maintained outside of the United States with
any of the depositories listed in paragraph (b) of this section except
to meet margin requirements, including prefunding margin requirements,
established by rule, regulation, or order of foreign boards of trade or
foreign clearing organizations, or to meet margin calls issued by
foreign brokers carrying the 30.7 Customers’ foreign futures and
foreign option positions; Provided, however, that a futures commission
merchant may deposit an additional amount of up to 10 percent of the
total amount of funds necessary to meet margin and prefunding margin
requirements to avoid daily transfers of funds between the futures
commission merchant’s 30.7 Accounts maintained in the United States and
those maintained outside of the United States. An FCM must deposit 30.7
Customer Funds under the laws and regulations of the foreign
jurisdiction that provide the greatest degree of protection to such
funds. An FCM may not by contract or otherwise waive any of the
protections afforded customer funds under the laws of the foreign
jurisdiction.
(d) Written acknowledgment from depositories. (1) Each futures
commission merchant must obtain a written acknowledgment from each
depository as set out in Appendix E to this part in accordance with the
requirements of this part; Provided, however, that an acknowledgment
need not be obtained from a derivatives clearing organization that has
adopted and submitted to the Commission rules that provide for the
separate holding of the foreign futures or foreign options secured
amount, in accordance with all relevant provisions of the Act, this
part and the regulations and orders promulgated thereunder, of all
funds held on behalf of 30.7 Customers and all instruments purchased
with funds set aside as the foreign futures or foreign options secured
amount as provided for under paragraph (i) of this section.
(2) The written acknowledgment must be in the form as set out in
Appendix E to this part: Provided, however, that if the futures
commission merchant invests funds set aside as the foreign futures or
foreign options secured amount in money market mutual funds as a
permitted investment under paragraph (i) of this section and in
accordance with the terms and conditions of Sec. 1.25(c) of this
chapter, the written acknowledgment with respect to such investment
must be in the form as set out in Appendix F to this part.
(3) A futures commission merchant may deposit 30.7 Customer Funds
only with a depository that provides the Commission and the futures
commission merchant’s designated self-regulatory organization with
direct, read-only access to account information on 24-hour a day basis.
The Commission and the futures commission merchant’s designated self-
regulatory organization must receive the direct access when the account
is opened. The written acknowledgment must contain the
[[Page 67958]]
futures commission merchant’s authorization to the depository to
provide direct and immediate account access to the Commission and the
futures commission merchant’s designated self-regulatory organization.
(4) A futures commission merchant may deposit 30.7 Customer Funds
only with a depository that agrees to provide the Commission and the
futures commission merchant’s designated self-regulatory organization
with a copy of the executed written acknowledgment within three
business days of the opening of the account. The Commission must
receive the written acknowledgment from the depository via electronic
mail at [email protected]. The written acknowledgment must
contain the futures commission merchant’s authorization to the
depository to provide the written acknowledgment to the Commission and
to the futures commission merchant’s designated self-regulatory
organization without further notice to or consent from the futures
commission merchant.
(5) A futures commission merchant may deposit 30.7 Customer Funds
only with a depository that agrees to reply promptly and directly to
the Commission’s or to the futures commission merchant’s designated
self-regulatory organization’s requests for confirmation of account
balances or other account information without further notice to or
consent from the futures commission merchant. The written
acknowledgment must contain the futures commission merchant’s
authorization to the depository to respond directly and immediately to
requests from the Commission or the futures commission merchant’s
designated self-regulatory organization for confirmation of account
balances and other account information without further notice to or
consent from the futures commission merchant.
(6) The futures commission merchant shall promptly file a copy of
the written acknowledgment with the Commission in the manner specified
by the Commission and in no event later than the later of:
(i) The effective date of this rule; or
(ii) Three business days after the account is opened.
(7) The futures commission merchant shall amend the written
acknowledgment and promptly file the amended written acknowledgment
with the Commission within 120 days of any changes in the following:
(i) The name or business address of the futures commission
merchant;
(ii) The name or business address of the depository; or
(iii) The account number(s) under which the foreign futures or
foreign options secured amount are held.
(8) Each futures commission merchant must maintain each written
acknowledgment readily accessible in its files in accordance with Sec.
1.31 of this chapter, for as long as the account remains open, and
thereafter for the period provided in Sec. 1.31 of this chapter.
(e) Commingling. (1) A futures commission merchant may commingle
the funds set aside as the foreign futures or foreign options secured
amount that it receives from, or on behalf of, multiple 30.7 Customers
in a single account or multiple accounts with one or more of the
depositories listed in paragraph (b) of this section.
(2) A futures commission merchant may not commingle the funds set
aside as the foreign futures or foreign options secured amount held for
30.7 Customers with the money, securities or property of such futures
commission merchant, with any proprietary account of such futures
commission merchant, or use such funds to secure or guarantee the
obligations of, or extend credit to, such futures commission merchant
or any proprietary account of such futures commission merchant;
Provided, however, a futures commission merchant may deposit
proprietary funds into 30.7 Customer Accounts as permitted under
paragraph (g) of this section.
(3) A futures commission merchant may not commingle funds held for
30.7 Customers with funds deposited by futures customers as defined in
Sec. 1.3 of this chapter and held in account segregated pursuant to
Section 4d(a) and 4d(b) of the Act or with funds deposited by Cleared
Swap Customers as defined under Sec. 22.1 of this chapter and held in
segregated accounts pursuant to Section 4d(f) of the Act, or with funds
of any account holders of the futures commission merchant unrelated to
trading foreign futures or foreign options; Provided, however, that a
futures commission merchant may commingle 30.7 Customer funds with
funds deposited by futures customers or Cleared Swaps Customers
pursuant to the terms of a Commission regulation or order authorizing
such commingling.
(f) Limitations on use of 30.7 Customer Funds. (1) A futures
commission merchant shall not use, or permit the use of, the funds of
one 30.7 Customer to purchase, margin or settle the trades, contracts,
or commodity options of, or to secure or extend credit to, any person
other than such 30.7 Customer. This prohibition on the use of the funds
of one 30.7 customer to extend credit to, or to purchase, margin or
settle the trades, contracts, or commodity options of another 30.7
Customer applies at all times. For this purpose, a futures commission
merchant which operationally commingles the funds of its 30.7 Customers
must ensure that at all times its residual interest in funds set aside
as the foreign futures or foreign options secured amount exceeds the
sum of all its 30.7 Customers’ margin deficits.
(2) A futures commission merchant may not impose or permit the
imposition of a lien on any funds set aside as the foreign futures or
foreign options secured amount, including any residual financial
interest of the futures commission merchant in such funds.
(3) A futures commission merchant may not include in funds set
aside as the foreign futures or foreign options secured amount any
money invested in securities, memberships, or obligations of any
clearing organization or board of trade. A futures commission merchant
may not include in funds set aside as the foreign futures or foreign
options secured amount any other money, securities, or property held by
a member of a foreign board of trade, board of trade, or clearing
organization, except if the funds are deposited to margin, secure, or
guarantee 30.7 Customers’ foreign futures or foreign options positions
and the futures commission merchant obtains the written acknowledgment
from the member of the foreign board of trade, board of trade, or
clearing organization as required by paragraph (d) of this section.
(g) Futures commission merchant’s residual financial interest and
withdrawal of funds. (1) The provision in paragraph (e) of this
section, which prohibits the commingling of funds set aside as the
foreign futures or foreign options secured amount with the funds of a
futures commission merchant, shall not be construed to prevent a
futures commission merchant from having a residual financial interest
in the funds set aside as required by the regulations in this part for
the benefit of 30.7 Customers; nor shall such provisions be construed
to prevent a futures commission merchant from adding to such set aside
funds such amount or amounts of money, from its own funds or
unencumbered securities from its own inventory, of the type set forth
in Sec. 1.25 of this chapter, as it may deem necessary to ensure any
and all 30.7 Accounts from becoming undersecured at any time.
(2) A futures commission merchant may not withdraw funds on any
business day for its own proprietary use
[[Page 67959]]
from an account or accounts holding the foreign futures and foreign
options secured amount unless the futures commission merchant has
prepared the daily 30.7 calculation required by paragraph (l) of this
section as of the close of business on the previous business day. A
futures commission merchant that has completed its daily 30.7
calculation may make withdrawals to its own order, to the extent of its
actual residual financial interest in funds held in 30.7 Accounts,
including the withdrawal of securities held in secured amount
safekeeping accounts held by a bank, trust company, contract market,
clearing organization, member of a foreign board of trade, or other
futures commission merchant. Such withdrawal(s) shall not result in the
funds of one 30.7 Customer being used to purchase, margin or carry the
foreign futures or foreign options positions, or extend the credit of
any other 30.7 Customer or other person. Notwithstanding any other
provision of this section, a futures commission merchant must at all
times maintain an amount of residual interest in separate accounts for
the benefit of 30.7 Customers that exceeds the sum of all 30.7
Customers’ margin deficits and such residual interest may not be
withdrawn by the futures commission merchant.
(3) A futures commission merchant may not withdraw funds for its
own proprietary use, in a single transaction or a series of
transactions on a given business day, from an account or accounts
holding 30.7 Customer Funds if such withdrawal(s) would exceed 25
percent of the futures commission merchant’s residual interest in such
accounts as reported on the daily secured amount calculation required
by paragraph (l) of this section and computed as of the close of
business on the previous business day, unless the futures commission
merchant’s Chief Executive Officer, Chief Finance Officer or other
senior official that is listed as a principal of the futures commission
merchant on its Form 7-R and is knowledgeable about the futures
commission merchant’s financial requirements and financial position
pre-approves in writing the withdrawal, or series of withdrawals.
(4) A futures commission merchant must file written notice of the
withdrawal or series of withdrawals that exceed 25 percent of the
futures commission merchant’s residual interest in 30.7 Customer Funds
as computed under paragraph (h)(2) of this section with the Commission
and with its designated self-regulatory organization immediately after
the Chief Executive Officer, Chief Finance Officer or other senior
official as described in paragraph (g)(2) of this section pre-approves
the withdrawal or series of withdrawals. The written notice must:
(i) Be signed by the Chief Executive Officer, Chief Finance Officer
or other senior official that pre-approved the withdrawal, and give
notice that the futures commission merchant has withdrawn or intends to
withdraw more than 25 percent of its residual interest in accounts
holding 30.7 Customer Funds;
(ii) Include a description of the reasons for the withdrawal or
series of withdrawals;
(iii) List the amount of funds provided to each recipient and the
name of each recipient;
(iv) Include the current estimate of the amount of the futures
commission merchant’s residual interest in the 30.7 Customer Funds
after the withdrawal;
(v) Contain a representation by the Chief Executive Officer, Chief
Finance Officer or other senior official as described in paragraph
(g)(3) of this section that pre-approved the withdrawal, or series of
withdrawals, that to such person’s knowledge and reasonable belief, the
futures commission merchant remains in compliance with the secured
amount requirements after the withdrawal. The Chief Executive Officer,
Chief Finance Officer or other appropriate senior official as described
in paragraph (g)(2) of this section must consider the daily 30.7
calculation as of the close of business on the previous business day
and any other factors that may cause a material change in the futures
commission’s residual interest since the close of business the previous
business day, including known unsecured customer debits or deficits,
current day market activity and any other withdrawals made from the
30.7 Customer Accounts; and
(vi) Any such written notice filed with the Commission must be
filed via electronic transmission using a form of user authentication
assigned in accordance with procedures established by or approved by
the Commission, and otherwise in accordance with instruction issued by
or approved by the Commission. Any such electronic submission must
clearly indicate the registrant on whose behalf such filing is made and
the use of such user authentication in submitting such filing will
constitute and become a substitute for the manual signature of the
authorized signer. Any written notice filed must be followed up with
direct communication to the Regional office of Commission which has
supervisory authority over the futures commission merchant whereby the
Commission acknowledges receipt of the notice.
(5) After making a withdrawal requiring the approval and notice
required in paragraphs (c)(1) and (2) of this section, and before the
next daily secured amount calculation, no futures commission merchant
may make any further withdrawals from accounts holding 30.7 Customer
Funds, except to or for the benefit of 30.7 Customers, without, for
each withdrawal, obtaining the approval required under paragraph (c)(1)
of this section and filing a written notice with the Commission under
paragraph (g)(4)(vi) of this section and its designated self-regulatory
organization signed by the Chief Executive Officer, Chief Finance
Officer, or other senior official. The written notice must:
(i) List the amount of funds provided to each recipient and each
recipient’s name;
(ii) Disclose the reason for each withdrawal;
(iii) Confirm that the Chief Executive Officer, Chief Finance
Officer, or other senior official (and identify of the person if
different from the person who signed the notice) pre-approved the
withdrawal in writing;
(iv) Disclose the current estimate of the futures commission
merchant’s remaining total residual interest in the secured accounts
holding 30.7 Customer Funds after the withdrawal; and
(v) Include a representation that to the best of the notice
signatory’s knowledge and reasonable belief the futures commission
merchant remains in compliance with the secured amount requirements
after the withdrawal.
(6) If a futures commission merchant withdraws funds from the
separate accounts holding 30.7 Customer Funds for its own proprietary
use, and the withdrawal causes the futures commission merchant to not
hold sufficient funds in the separate accounts for the benefit of the
30.7 Customers to meet its targeted residual interest, as required to
be computed under Sec. 1.11 of this chapter, the futures commission
merchant must deposit its own funds into the separate accounts for the
benefit of 30.7 Customers to restore the account balance to the
targeted residual interest amount on the next business day, or, if
appropriate, revise the futures commission merchant’s targeted amount
of residual interest pursuant to the policies and procedures required
by Sec. 1.11 of this chapter. Notwithstanding the foregoing, if at any
time the futures commission merchant’s residual interest in separate
accounts for the benefit of 30.7 Customers is less than the sum of
[[Page 67960]]
its 30.7 Customer’s margin deficits, the futures commission merchant
must immediately restore the residual interest to exceed the sum of
such margin deficits. Any proprietary funds deposited in the 30.7
Customer Accounts must be unencumbered and otherwise compliant with
Sec. 1.25 of this section, as applicable.
(7) Notwithstanding any other provision of this part, a futures
commission merchant may not withdraw funds for its own proprietary use
from 30.7 Accounts unless the futures commission merchant follows its
policies and procedures required by Sec. 1.11 of this chapter.
(h) Permitted investments and deposits of 30.7 Customer Funds. (1)
A futures commission merchant may invest 30.7 Customer Funds subject
to, and in compliance with, the terms and conditions of Sec. 1.25 of
this chapter. Regulation 1.25 of this chapter shall apply to the
investment of 30.7 Customer Funds as if such funds comprised customer
funds or customer money subject to segregation pursuant to section 4d
of the Act and the regulations thereunder.
(2) Each futures commission merchant that invests money, securities
or property on behalf of 30.7 Customers must keep a record showing the
following:
(i) The date on which such investments were made;
(ii) The name of the person through whom such investments were
made;
(iii) The amount of money or current market value of securities so
invested;
(iv) A description of the obligations in which such investments
were made, including CUSIP or ISIN numbers;
(v) The identity of the depositories or other places where such
investments are maintained;
(vi) The date on which such investments were liquidated or
otherwise disposed of and the amount of money received or current
market value of securities received as a result of such disposition;
(vii) The name of the person to or through whom such investments
were disposed of; and
(viii) A daily valuation for each instrument and readily available
documentation supporting the daily valuation for each instrument. Such
supporting documentation must be sufficient to enable third parties to
verify the valuations and the accuracy of any information from external
sources used in those valuations.
(3) Any 30.7 Customer Funds deposited in a bank or trust company
located in the United States or in a foreign jurisdiction must be
available for immediate withdrawal upon the demand of the futures
commission merchant.
(4) Futures commission merchants that invest 30.7 Customer Funds in
instruments described in Sec. 1.25 of this chapter shall include such
instruments in the computation of its secured amount requirements,
required under paragraph (l) of this section, at values that at no time
exceed current market value, determined as of the close of the market
on the date for which such computation is made.
(i) Responsibility for Sec. 1.25 investment losses. A futures
commission merchant shall bear sole financial responsibility for any
losses resulting from the investment of 30.7 Customer Funds in
instruments described in Sec. 1.25 of this chapter. No investment
losses shall be borne or otherwise allocated to the 30.7 Customers of
the futures commission merchant.
(j) Loans by futures commission merchants; Treatment of proceeds. A
futures commission merchant may lend its own funds to 30.7 Customers on
securities and property pledged, or from repledging or selling such
securities and property pursuant to specific written agreement with
such 30.7 Customers. The proceeds of such loans used to purchase,
margin, guarantee, or secure the trades, contracts, or commodity
options of 30.7 Customers shall be treated and dealt with by a futures
commission merchant as belonging to such 30.7 Customers. A futures
commission merchant may not loan funds on an unsecured basis to finance
a 30.7 Customer’s foreign futures and foreign options trading, nor may
a futures commission merchant loan funds to a 30.7 Customer secured by
the 30.7 Customer’s trading account.
(k) Permitted withdrawals. A futures commission merchant may
withdraw funds from 30.7 Customer Accounts in an amount necessary in
the normal course of business to margin, guarantee, secure, transfer,
or settle 30.7 Customers’ foreign futures or foreign option positions
with a foreign broker or clearing organization. A futures commission
merchant also may withdraw funds from 30.7 Customer Accounts to pay
commissions, brokerage, interest, taxes, storage, and other charges
lawfully accruing in connection with the 30.7 Customers’ foreign
futures and foreign options positions.
(l) Daily computation of 30.7 Customer secured amount requirement
and details regarding the holding and investing of 30.7 Customer Funds.
(1) Each futures commission merchant is required to prepare a Statement
of Secured Amounts and Funds Held in Separate Accounts for 30.7
Customers pursuant to Commission Regulation 30.7 contained in the Form
1-FR-FCM as of the close of each business day. Futures commission
merchants that invest funds set aside as the foreign futures or foreign
options secured amount in instruments described in Sec. 1.25 of this
chapter shall include such instruments in the computation of its
secured amount requirements at values that at no time exceed current
market value, determined as of the close of the market on the date for
which such computation is made. Nothing in this paragraph shall affect
the requirement that a futures commission merchant at all times
maintain sufficient money, securities and property to cover its total
obligations to all 30.7 Customers, in accordance with paragraph (a) of
this section.
(2) A futures commission merchant may offset any net deficit in a
particular 30.7 Customer’s Account against the current market value of
readily marketable securities, less deductions (i.e. “securities
haircuts”) as set forth in Rule 15c3-1(c)(2)(vi) of the Securities and
Exchange Commission (17 CFR 240.15c3-1(c)(2)(vi)), held for the same
particular 30.7 Customer’s Account in computing the daily Foreign
Futures and Foreign Options Secured Amount. Futures commission
merchants that establish and enforce written policies and procedures to
assess the credit risk of commercial paper, convertible debt
instruments, or nonconvertible debt instruments in accordance with Rule
240.15c3-1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR
240.15c3-1(c)(2)(vi)) may apply the lower haircut percentages specified
in Rule 240.15c3-1(c)(2)(vi) for such commercial paper, convertible
debt instruments and nonconvertible debt instruments. The futures
commission merchant must maintain a security interest in the
securities, including a written authorization to liquidate the
securities at the futures commission merchant’s discretion, and must
set aside the securities in a safekeeping account compliant with
paragraph (c) of this section. For purposes of this section, a security
will be considered “readily marketable” if it is traded on a “ready
market” as defined in Rule 15c3-1(c)(11)(i) of the Securities and
Exchange Commission (17 CFR 240.15c3-1(c)(11)(i)).
(3) Each futures commission merchant is required to submit to the
Commission and to the firm’s designated self-regulatory organization
the daily Statement of Secured Amounts and Funds Held in Separate
Accounts for
[[Page 67961]]
30.7 Customers pursuant to Commission Regulation 30.7 required by
paragraph (l)(1) of this section by noon the following business day.
(4) Each futures commission merchant shall file the Statement of
Secured Amounts and Funds Held in Separate Accounts for 30.7 Customers
pursuant to Commission Regulation 30.7 required by paragraph (l)(1) of
this section in an electronic format using a form of user
authentication assigned in accordance with procedures established or
approved by the Commission.
(5) Each futures commission merchant is required to submit to the
Commission and to the firm’s designated self-regulatory organization a
report listing of the names of all banks, trust companies, futures
commission merchants, derivatives clearing organizations, foreign
brokers, foreign clearing organizations, or any other depository or
custodian holding 30.7 Customer Funds as of the fifteenth day of the
month, or the first business day thereafter, and the last business day
of each month. This report must include:
(i) The name and location of each depository holding 30.7 Customer
Funds;
(ii) The total amount of 30.7 Customer Funds held by each
depository listed in paragraph (l)(5) of this section; and
(iii) The total amount of cash and investments that each depository
listed in paragraph (l)(5) of this section holds for the futures
commission merchant. The futures commission merchant must report the
following investments:
(A) Obligations of the United States and obligations fully
guaranteed as to principal and interest by the United States (U.S.
government securities);
(B) General obligations of any State or of any political
subdivision of a State (municipal securities);
(C) General obligation issued by any enterprise sponsored by the
United States (government sponsored enterprise securities);
(D) Certificates of deposit issued by a bank;
(E) Commercial paper fully guaranteed as to principal and interest
by the United States under the Temporary Liquidity Guarantee Program as
administered by the Federal Deposit Insurance Corporation;
(F) Corporate notes or bonds fully guaranteed as to principal and
interest by the United States under the Temporary Liquidity Guarantee
Program as administered by the Federal Deposit Insurance Corporation;
and
(G) Interests in money market mutual funds.
(6) Each futures commission merchant must report the total amount
of customer owned securities held by the futures commission merchant as
30.7 Customer Funds and must list the names and locations of the
depositories holding customer owned securities.
(7) Each futures commission merchant must report the total amount
of 30.7 Customer Funds that have been used to purchase securities under
agreements to resell the securities (reverse repurchase transactions).
(8) Each futures commission merchant must report which, if any, of
the depositories holding 30.7 Customer Funds under paragraph (l)(5) of
this section are affiliated with the futures commission merchant.
(9) Each futures commission merchant shall file the detailed list
of depositories required by paragraph (l)(5) of this section by 11:59
p.m. the next business day in an electronic format using a form of user
authentication assigned in accordance with procedures established or
approved by the Commission.
(10) Each futures commission merchant shall retain its daily
secured amount computation, the Statement of Secured Amounts and Funds
Held in Separate Accounts for 30.7 Customers pursuant to Commission
Regulation 30.7 required by paragraph (l)(1) of this section, and the
detailed list of depositories required by paragraph (l)(5) of this
section, together with all supporting documentation, in accordance with
the requirements of Sec. 1.31 of this part.
27. Add Appendix E and Appendix F to part 30 to read as follows:
Appendix E to Part 30–Acknowledgment Letter for CFTC Regulation 30.7
Customer Secured Account
[Date]
[Name and Address of Depository]
We refer to the Secured Amount Account(s) which [Name of Futures
Commission Merchant] (“we” or “our”) have opened or will open
with [Name of Depository] (“you” or “your”) entitled:
[Name of Futures Commission Merchant] [if applicable, add “FCM
Customer Omnibus Account”] CFTC Regulation 30.7 Customer Secured
Account [If applicable, include any abbreviated name of the
Account(s) as reflected in the Depository’s electronic systems
(provided any such abbreviated name must reflect that the Account(s)
is a CFTC regulated customer secured account)]
Account Number(s):
(collectively, the “Account(s)”).
You acknowledge and agree that we have opened or will open the
above-referenced Account(s) for the purpose of depositing, as
applicable, money, securities and other property (collectively
“Funds”) for or on behalf of our customers who are entering into
foreign futures and/or foreign options transactions (as such terms
are defined in U.S. Commodity Futures Trading Commission (“CFTC”)
Regulation 30.1, as amended). The Funds deposited in the Account(s)
or accruing to the credit of the Accounts will be kept separate and
apart and separately accounted for on your books from our own funds
and all other accounts maintained by us in accordance with the
provisions of the Commodity Exchange Act, as amended (the “Act”),
and Part 30 of the CFTC’s regulations, as amended, and may not be
commingled with our own funds in any proprietary account we maintain
with you and the Funds must otherwise be treated in accordance with
the provisions of the Act and CFTC Regulations.
Furthermore, you acknowledge and agree that such Funds may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, nor may they be used by us to secure credit
from you. You further acknowledge and agree that the Funds in the
Account(s) shall not be subject to any right of offset or lien for
or on account of any indebtedness, obligations or liabilities we may
now or in the future have owing to you, and that you understand the
nature of the Funds held or hereafter deposited in the Account(s)
and that you will treat and maintain such Funds in accordance with
the provisions of the Act and CFTC regulations. This prohibition
does not affect your right to recover funds advanced in the form of
cash transfers you make in lieu of liquidating non-cash assets held
in the Account(s) for purposes of variation settlement or posting
initial (original) margin.
In addition, you agree that the Account(s) may be examined at
any reasonable time by an appropriate officer, agent or employee of
the CFTC or a self-regulatory organization, and this letter
constitutes the authorization and direction of the undersigned to
permit any such examination or audit to take place. You agree to
respond promptly and directly to requests for confirmation of
account balances and other account information from an appropriate
officer, agent, or employee of the CFTC or a self-regulatory
organization of which we are a member, without further notice to or
consent from the futures commission merchant. You also agree that,
immediately upon instruction by the director of the Division of Swap
Dealer and Intermediary Oversight of the CFTC or the director of the
Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors’ designees, or any appropriate official
of a self-regulatory organization of which we are a member, you will
provide any and all information regarding or related to the Funds or
the Accounts as shall be specified in such instruction and as
directed in such instruction. You further agree that you will
provide the CFTC and our designated self-regulatory organization
with the necessary software, a user log-in, and password that will
allow the CFTC and our designated self-regulatory organization to
have read-only access to the accounts listed above on your Web site
on a 24-hour a day basis. This letter further constitutes the
consent and authorization of the undersigned for you to respond
immediately to requests from appropriate officers, agents, or
employees of the CFTC or a self-regulatory
[[Page 67962]]
organization for information and/or confirmation of current and
historical account balances of the Account(s).
You acknowledge and agree that you meet the requirements
detailed for depositories in CFTC Regulation 30.7, as amended. You
further acknowledge and agree that the Funds in the Account(s) shall
be released immediately, subject to the requirements of US or non-
U.S. law as applicable, upon proper notice and instruction from an
appropriate officer or employee of us or from the director of the
Division of Clearing and Risk of the CFTC, the director of the
Division of Swap Dealer and Intermediary Oversight, or any successor
divisions, or such directors’ designees. We will not hold you
responsible for acting pursuant to any instruction from the CFTC
upon which you have relied after having taken reasonable measures to
assure that such instruction was provided to you by the director of
the Division of Clearing and Risk or the director of the Division of
Swap Dealer and Intermediary Oversight of the CFTC, or any successor
divisions, or such directors’ designees.
In the event we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Funds
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of set off against or lien on assets other than
assets maintained in the Account(s), nor to impose such charges
against us or any proprietary account maintained by us with you.
Further, it is understood that amounts represented by checks, drafts
or other items shall not be considered to be part of the Account(s)
until finally collected. Accordingly, checks, drafts and other items
credited to the Account(s) and subsequently dishonored or otherwise
returned to you, or reversed, for any reason and any claims relating
thereto, including but not limited to claims of alteration or
forgery, may be charged back to the Account(s), and we shall be
responsible to you as a general endorser of all such items whether
or not actually so endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that you have no notice of or actual knowledge of, or could
not reasonably know of, a violation of the Act or other provision of
law by us; and you shall not in any manner not expressly agreed to
herein be responsible for ensuring compliance by us with the
provisions of the Act and CFTC regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any such action or omission to
act, to us or to any other person, firm, association or corporation
even if thereafter any such order, decree, judgment or levy shall be
reversed, modified, set aside or vacated.
The terms of this letter agreement shall remain binding upon the
parties, their successors and assigns, including for the avoidance
of doubt, regardless of the change in name of any party. This letter
agreement supersedes and replaces any prior agreement between the
parties in connection with the Account(s), including but not limited
to any prior acknowledgment letter, to the extent that such prior
agreement is inconsistent with the terms hereof. In the event of any
conflict between this letter agreement and any other agreement
between the parties in connection with the Account(s), this letter
agreement shall govern with respect to matters specific to the Act
and the CFTC’s regulations, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning the enclosed
copy of this letter. You further acknowledge and agree to provide a
copy of this fully executed letter directly to the CFTC (via
electronic mail to [email protected]) and our
designated self-regulatory organization.
[Name of Futures Commission Merchant]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Depository]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
DATE:
Appendix F to Part 30:
CFTC Regulation 30.7–Acknowledgment Letter for CFTC Regulation
30.7 Customer Secured Money Market Mutual Fund Account [All of this
was not proposed]
[Date]
[Name and Address of Money Market Mutual Fund]
We propose to invest funds held by [Name of Futures Commission
Merchant or Derivatives Clearing Organization] (“we” or “our”)
on behalf of our customers in shares of [Name of Money Market Mutual
Fund] (“you” or “your”) under account(s) entitled (or shares
issued to):
[Name of Futures Commission Merchant or Derivatives Clearing
Organization] [if applicable, add “FCM Customer Omnibus Account”]
CFTC Regulation 30.7 Customer Secured Money Market Mutual Fund
Account
[If applicable, include any abbreviated name of the Account(s)
as reflected in the Depository’s electronic systems (provided any
such abbreviated name must reflect that the Account(s) is a CFTC
regulated customer segregated account)]
Account Number(s): [ ]
(collectively, the “Account(s)”).
You acknowledge and agree that we are holding these funds,
including any shares issued and amounts accruing in connection
therewith (collectively, the “Shares”), for the benefit of our
customers who are entering into foreign futures and/or foreign
options transactions (as such terms are defined in U.S. Commodity
Futures Trading Commission (“CFTC”) Regulation 30.1, as amended);
that the Shares held by you, hereafter deposited in the Account(s)
or accruing to the credit of the Accounts, will be kept separate and
apart and separately accounted for on your books from our own funds
and from any other funds or accounts held by us in accordance with
the provisions of the Commodity Exchange Act, as amended (the
“Act”), and Part 30 of the CFTC’s regulations, as amended; and
that the Shares must otherwise be treated in accordance with the
provisions of the Act and CFTC regulations.
Furthermore, you acknowledge and agree that such Shares may not
be used by you or by us to secure or guarantee any obligations that
we might owe to you, nor may they be used by us to secure credit
from you. You further acknowledge and agree that the Shares in the
Account(s) shall not be subject to any right of offset or lien for
or on account of any indebtedness, obligations or liabilities we may
now or in the future have owing to you.
In addition, you agree that the Account(s) may be examined at
any reasonable time by an appropriate officer, agent or employee of
the CFTC or a self-regulatory organization, and this letter
constitutes the authorization and direction of the undersigned to
permit any such examination or audit to take place. You agree to
respond promptly and directly to requests for confirmation of
account balances and other account information from an appropriate
officer, agent, or employee of the CFTC or a self-regulatory
organization of which we are a member, without further notice to or
consent from the futures commission merchant. You also agree that,
immediately upon instruction by the director of the Division of Swap
Dealer and Intermediary Oversight of the CFTC or the director of the
Division of Clearing and Risk of the CFTC, or any successor
divisions, or such directors’ designees, or any appropriate official
of a self-regulatory organization of which we are a member, you will
provide any and all information regarding or related to the Funds or
the Accounts as shall be specified in such instruction and as
directed in such instruction. You further agree that you will
provide the CFTC and our designated self-regulatory organization
with the necessary software, a user log-in, and password that will
allow the CFTC and our designated self-regulatory organization to
have read-only access to the accounts listed above on your Web site
on a 24-hour a day basis. This letter further constitutes the
consent and authorization of the undersigned for you to respond
immediately to requests from appropriate officers, agents, or
employees of the CFTC or a self-regulatory organization for
information and/or confirmation of current and historical account
balances of the Account(s).
[[Page 67963]]
You acknowledge and agree that the Shares in the Account(s)
shall be released immediately, subject to the requirements of U.S.
or non-U.S. law as applicable, upon proper notice and instruction
from an appropriate officer or employee of us or from the director
of the Division of Clearing and Risk or the director of the Division
of Swap Dealers and Intermediary Oversight of the CFTC, or any
successor divisions, or such directors’ designees. We will not hold
you responsible for acting pursuant to any instruction from the CFTC
upon which you have relied after having taken reasonable measures to
assure that such instruction was provided to you by the director of
the Division of Clearing and Risk of the CFTC, or any successor
division, or such director’s designee. You further acknowledge that
you will provide to the CFTC a copy of this fully executed
acknowledgment (via electronic mail to
In the event we become subject to either a voluntary or
involuntary petition for relief under the U.S. Bankruptcy Code, we
acknowledge that you will have no obligation to release the Shares
held in the Account(s), except upon instruction of the Trustee in
Bankruptcy or pursuant to the Order of the respective U.S.
Bankruptcy Court.
Notwithstanding anything in the foregoing to the contrary,
nothing contained herein shall be construed as limiting your right
to assert any right of set off against or lien on assets other than
assets maintained in the Account(s), nor to impose such charges
against us or any proprietary account maintained by us with you.
Further, it is understood that amounts represented by checks, drafts
or other items shall not be considered to be part of the Account(s)
until finally collected. Accordingly, checks, drafts and other items
credited to the Account(s) and subsequently dishonored or otherwise
returned to you, or reversed, for any reason and any claims relating
thereto, including but not limited to claims of alteration or
forgery, may be charged back to the Account(s), and we shall be
responsible to you as a general endorser of all such items whether
or not actually so endorsed.
You may conclusively presume that any withdrawal from the
Account(s) and the balances maintained therein are in conformity
with the Act and CFTC regulations without any further inquiry,
provided that you have no notice of or actual knowledge of, or could
not reasonably know of, a violation of the Act or other provision of
law by us; and you shall not in any manner not expressly agreed to
herein be responsible for ensuring compliance by us with the
provisions of the Act and CFTC regulations.
You may, and are hereby authorized to, obey the order, judgment,
decree or levy of any court of competent jurisdiction or any
governmental agency with jurisdiction, which order, judgment, decree
or levy relates in whole or in part to the Account(s). In any event,
you shall not be liable by reason of any such action or omission to
act, to us or to any other person, firm, association or corporation
even if thereafter any such order, decree, judgment or levy shall be
reversed, modified, set aside or vacated.
We are permitted to invest our Commodity Customers’ funds in
money market mutual funds pursuant to CFTC Regulation 1.25. That
rule sets forth the following conditions, among others, with respect
to any investment in a money market mutual fund:
(1) The net asset value of the fund must be computed by 9:00
a.m. of the business day following each business day and be made
available to us by that time;
(2) The fund must be legally obligated to redeem an interest in
the fund and make payment in satisfaction thereof by the close of
the business day following the day on which we make a redemption
request except as otherwise specified in CFTC Regulation
1.25(c)(5)(ii); and
(3) The agreement under which we invest our Commodity Customers’
funds must not contain any provision that would prevent us from
pledging or transferring fund shares. The terms of this letter
agreement shall remain binding upon the parties, their successors
and assigns, including for the avoidance of doubt, regardless of the
change in name of any party. This letter agreement supersedes and
replaces any prior agreement between the parties in connection with
the Account(s), including but not limited to any prior
acknowledgment letter, to the extent that such prior agreement is
inconsistent with the terms hereof. In the event of any conflict
between this letter agreement and any other agreement between the
parties in connection with the Account(s), this letter agreement
shall govern with respect to matters specific to Section 4d of the
Act and the CFTC’s regulations, as amended.
This letter agreement shall be governed by and construed in
accordance with the laws of [Insert governing law] without regard to
the principles of choice of law.
Please acknowledge that you agree to abide by the requirements
and conditions set forth above by signing and returning the enclosed
copy of this letter. You further acknowledge and agree to provide a
copy of this fully executed letter directly to the CFTC and our
designated self-regulatory organization.
[Name of Futures Commission Merchant or Derivatives Clearing
Organization]
By:
Print Name:
Title:
ACKNOWLEDGED AND AGREED:
[Name of Money Market Mutual Fund]
By:
Print Name:
Title:
Contact Information: [Insert phone number and email address]
DATE:
PART 140–ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION
28. The authority citation for part 140 continues to read as
follows:
Authority: 7 U.S.C. 2 and 12a.
29. In Sec. 140.91, redesignate paragraph (a)(8) as paragraph
(a)(12) and paragraph (a)(7) as paragraph (a)(8), add new paragraphs
(a)(7), (a)(9), (a)(10), and (a)(11), and revise paragraph (b) to read
as follows:
Sec. 140.91 Delegation of authority to the Director of the Division
of Clearing and Risk and to the Director of the Division of Swap Dealer
and Intermediary Oversight.
(a) * * *
(7) All functions reserved to the Commission in Sec. 1.20 of this
chapter.
* * * * *
(9) All functions reserved to the Commission in Sec. 1.26 of this
chapter.
(10) All functions reserved to the Commission in Sec. 1.52 of this
chapter.
(11) All functions reserved to the Commission in Sec. 30.7 of this
chapter.
* * * * *
(b) The Director of the Division of Clearing and Risk and the
Director of the Division of Swap Dealer and Intermediary Oversight may
submit any matter which has been delegated to him or her under
paragraph (a) of this section to the Commission for its consideration.
* * * * *
BILLING CODE P
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BILLING CODE C
Issued in Washington, DC, on October 23, 2012 by the Commission.
Stacy Yochum,
Counsel.
Appendices to Enhancing Protections Afforded Customers and Customer
Funds Held by Futures Commission Merchants and Derivatives Clearing
Organizations–Commission Voting Summary and Statements of
Commissioners
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendix 1–Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Sommers,
Chilton, O’Malia and Wetjen voted in the affirmative; no
Commissioner voted in the negative.
Appendix 2– Statement of Chairman Gary Gensler
I support the proposed rules to enhance the protections afforded
customers that participate in the futures and swaps markets,
including the protection of customer funds held by futures
commission merchants (FCMs) and derivatives clearing organizations.
The CFTC’s mission is to ensure the integrity of the futures and
swaps markets. As part of this, we must do everything within our
authorities and resources to strengthen oversight programs and the
protection of customers and their funds. And that’s the goal of this
proposal. It’s about ensuring customers have confidence that the
funds they post as margin or collateral are fully segregated and
protected.
CFTC Commissioners and staff have reached out broadly on ways to
enhance customer protections. We hosted two roundtables this year on
issues ranging from the segregation of customer funds to examining
the CFTC’s oversight of self-regulatory organizations (SROs).
In July, the CFTC approved a National Futures Association (NFA)
proposal that stemmed from a coordinated effort by the CFTC, the
SROs, other financial regulators, and market participants, including
from the CFTC’s roundtable earlier this year.
This customer protection proposal incorporates these NFA rules
into the Commission’s regulations so that the CFTC
[[Page 67970]]
can directly enforce these important rules. Under this proposal,
FCMs would be required to:
Hold sufficient funds in Part 30 secured accounts
(funds held for U.S. foreign futures and options customers trading
on foreign contract markets) to meet their total obligations to
customers trading on foreign markets computed under the net
liquidating equity method. FCMs would no longer be allowed to use
the alternative method, which had allowed them to hold a lower
amount of funds representing the margin on their foreign futures;
Maintain written policies and procedures governing the
maintenance of excess funds in customer segregated and Part 30
secured accounts. Withdrawals of 25 percent or more would
necessitate pre-approval in writing by senior management and must be
reported to the designated SRO and the CFTC; and
Make additional reports available to the SRO and the
CFTC, including daily computations of segregated and Part 30 secured
amounts.
Beyond the NFA rules, additional reforms in this proposal
benefited from the CFTC’s broad outreach and consultation with the
SROs and market participants, as well as substantial feedback from
CFTC Commissioners. They include:
First, bringing the regulators’ view of customer
accounts into the 21st century by giving the SROs and the CFTC
direct electronic access to FCMs’ bank and custodial accounts for
customer funds, without asking the FCMs’ permission. Further,
acknowledgement letters and confirmation letters must come directly
to regulators from banks and custodians.
Second, increasing disclosures to customers regarding
the risks associated with futures trading and using FCMs to invest
their funds. Futures customers, if they wish, should have access to
information about how their assets are held, similar to that which
is available to mutual fund and securities customers. FCMs would be
required to provide current and potential customers with specific
information about the FCM’s risks.
Third, enhancing controls at FCMs regarding how
customer accounts are handled, including policies and procedures on
supervision and risk management of customer funds.
Fourth, setting standards for the SROs’ examinations
and the annual certified financial statement audits, including
raising minimum standards for independent public accountants who
audit FCMs.
Fifth, requiring FCMs to ensure they back up segregated
customer accounts with funds to cover potential margin deficits.
Sixth, implementing a more effective early warning
system for the Commission and the SROs that alerts them to certain
problems, including a) when an FCM’s funds are insufficient to meet
the targeted residual interest in customer accounts b) when there is
a material adverse impact to the FCM’s creditworthiness and c) when
there is a material change to the FCM’s clearing or financial
arrangements.
And seventh, instituting a liquidity requirement for
FCMs, in addition to the existing capital requirement, to better
detect FCMs that have become distressed and may put customer funds
at risk.
Prior to this proposal, the Commission already made some
important improvements to protections for customer funds. They
include:
The completed amendments to rule 1.25 regarding the
investment of funds that bring customers back to protections they
had prior to exemptions the Commission granted between 2000 and
2005. Importantly, this prevents use of customer funds for in-house
lending through repurchase agreements;
Clearinghouses will have to collect margin on a gross
basis and FCMs will no longer be able to offset one customer’s
collateral against another and then send only the net to the
clearinghouse;
The so-called “LSOC rule” (legal segregation with
operational comingling) for swaps ensures customer money is
protected individually all the way to the clearinghouse; and
The Commission included customer protection
enhancements in the final rule for designated contract markets.
These provisions codify into rules staff guidance on minimum
requirements for SROs regarding their financial surveillance of
FCMs.
It is crucial that the CFTC, working with SROs and market
participants, continues its efforts to enhance protections for the
funds of both futures and swaps customers. We look forward to
reviewing the public input on this proposal.
Appendix 3–Statement of Commissioner Jill E. Sommers
Today the Commission has proposed a new set of rules to, among
other things, increase customer protections and disclosures,
strengthen risk management programs, and enhance auditing and
examination procedures for futures commission merchants (FCMs). In
light of the recent events surrounding MF Global and Peregrine, I
am, of course, supportive of such steps to the extent that they lead
to greater customer protection and increased customer awareness of
the risks associated with their futures and swaps accounts.
As always, I am sensitive to the fact that some regulation,
while well intended, may not further its stated goals or may be so
burdensome that the benefits do not justify the costs. I encourage
members of the public to comment, both to support the aspects of
this proposed rule that take appropriate steps towards achieving the
Commission’s objectives and to highlight the areas of the proposal
that they believe may be unnecessary or that could be accomplished
through more efficient means. In particular, I welcome comment on
the Commission’s proposal requiring an FCM to maintain residual
interest in segregated accounts in an amount that exceeds the sum of
all futures customers’ margin deficits. Additionally, it would be
helpful to hear from self-regulatory organizations (SROs) regarding
whether reviews by an examinations expert would assist the SROs in
the application of their respective supervisory programs.
I am hopeful that, with the help of thoughtful recommendations
from market participants, the Commission will finalize an effective
and streamlined rule improving protections for futures and swaps
customers.
Appendix 4–Statement of Commissioner Scott O’Malia
In response to the Peregrine and MF Global failures, the
Commission has proposed a new set of rules to enhance the level of
protection afforded customers of the futures markets. In particular,
the proposal calls for FCMs to maintain adequate capital in their
customer accounts to ensure customers are not bearing the credit
risk of their fellow customers, implement controls around the risks
specific to a particular FCM’s business, increase the level of
disclosures provided to customers, and create an independent
segregation account balance verification system. While these
measures are a good start, I believe that it is essential to focus
on a comprehensive technological solution that goes beyond what the
Commission has proposed in this release. Technology can be a cost
effective oversight tool for both customers and the Commission to
enhance transparency and improve risk management. Improving our
capacity to monitor money flows can serve as a significant deterrent
against fraudulent behavior.
I encourage industry participants to voice their opinion as to
how the proposals put forth today can be improved upon.
Specifically, what technological solutions can be employed to
facilitate the dissemination of information about FCMs to their
customers so that they may “know their FCM”? How can firms
implement the new capital requirements in the most cost effective
manner? What is the best method for an FCM to monitor its level of
risk? I look forward to hearing from market participants on the most
effective ways to implement the customer protection rules proposed
by the Commission today.
I would also like to highlight one of today’s proposals that
will require additional development in order to fulfill the goal of
customer protection. Today’s proposal calls for the creation of an
electronic balance confirmation process that would allow the
Commission and Self-Regulatory Organizations (“SROs”) to
independently check the balance of each segregated account held on
behalf of customers. While this can be used to aid in the
surveillance of account balances, the Commission proposal only works
on an individual basis and requires significant human involvement to
log in and monitor individual accounts. What the industry needs is a
fully automated system that allows the Commission and SROs to
download the account balances for each segregated account held for a
customer and compare that balance to the figures on record at each
FCM. In response to the Peregrine and MF Global failures, industry
participants discussed the implementation of such a system in July
of this year during the Commission’s Technology Advisory Committee
(TAC) meeting. During the meeting, the TAC members present were
virtually unanimous in their belief that an automated customer fund
verification system was needed. Certain TAC members also made
presentations discussing the technological
[[Page 67971]]
hurdles that must be overcome in order to put such a system in
place.
On October 30th we will have another TAC meeting during which
SROs will update us on the status of this system’s implementation
and their estimates for when it will be fully operational. Only when
this system is up and running can customers of the futures industry
feel secure that their investments are in safe hands and properly
monitored by both the Commission and SROs. This is an issue of
utmost importance and requires collaboration on the part of the
Commission, SROs and each and every Commission registrant. The end
result of this process will provide customers with the assurance
they need to continue investing in the derivatives markets.
I hope market participants will provide thoughtful
recommendations to improve customer protections and deploy
technology that is cost-effective to create and maintain. I also
encourage market participants to provide specific data that the
Commission can use to develop a robust cost benefit analysis.
[FR Doc. 2012-26435 Filed 11-13-12; 8:45 am]
BILLING CODE P
Last Updated: November 14, 2012
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