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Proposed Rule

Minimum Financial Requirements for Futures Commission Merchants and Introducing Brokers; Amendment to the Capital Charge on Unsecured Receivables Due From Foreign Brokers

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Information about this document as published in the Federal Register.

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AGENCY:

Commodity Futures Trading Commission.

ACTION:

Proposed rule.

SUMMARY:

The Commodity Futures Trading Commission (“Commission”) is proposing to amend Rule 1.17(c)(5)(xiii) which requires a futures commission merchant (“FCM”) or an independent introducing broker (“IBI”), when computing its adjusted net capital, to take a capital charge for certain unsecured receivables due from foreign brokers.[1] The capital charge is equal to five percent of the unsecured receivable Start Printed Page 52052balance. In computing the capital charge, however, the FCM or IBI may exclude that portion of the unsecured receivable that represents the amount required to be on deposit to maintain futures and option positions (i.e., margin or performance bond requirements) on a foreign board of trade provided that certain conditions are met. The foreign broker must have received confirmation of “comparability relief” pursuant to Rule 30.10 from the Commission and the margin deposit must be held by the foreign broker itself, by another foreign broker granted Rule 30.10 “comparability relief,” or by a depository in the same jurisdiction as either foreign broker that would qualify as a depository for funds under Rule 30.7. In addition, to be exempt from the capital charge, customer funds must be held by the foreign broker in compliance with any conditions imposed by the applicable Rule 30.10 order.

The proposal would amend the current rule by increasing the amount of the unsecured receivable that is eligible to be exempt from the capital charge from the minimum amount required to maintain futures and option positions to the greater of: 150 percent of the amount required to maintain the current futures and option positions in the account; or 100 percent of the greatest amount required to support futures and option positions in the account at any time during the preceding six-month period. The proposal also would continue to require the foreign broker to receive Rule 30.10 “comparability relief” but would not condition the exemption on the margin deposits be held by the foreign broker itself, another foreign broker granted Rule 30.10 “comparability relief,” or with a depository in the same jurisdiction as either foreign broker that would qualify as a depository for funds under Rule 30.7.

DATES:

Comments must be received on or before September 27, 2000.

ADDRESSES:

Comments should be mailed to: Jean A. Webb, Secretary, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581. In addition, comments may be sent by facsimile to (202) 418-5521, or by electronic mail to secretary@cftc.gov. Reference should be made to “Capital Charge on Unsecured Receivables Due from Foreign Brokers.”

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FOR FURTHER INFORMATION CONTACT:

Thomas J. Smith, Special Counsel, Division of Trading and Markets, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581; telephone (202) 418-5495; electronic mail tsmith@cftc.gov; or Henry J. Matecki, Financial Audit and Review Branch, Division of Trading and Markets, Commodity Futures Trading Commission, 300 South Riverside Plaza, Suite 1600 North, Chicago, IL 60606; telephone (312) 886-3217; electronic mail hmatecki@cftc.gov.

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SUPPLEMENTARY INFORMATION:

I. Background

In 1978, the Commission implemented major revisions to its regulations governing the minimum financial requirements for FCMs.[2] As part of these revisions, the Commission adopted Rule 1.17(c)(5)(xiii) which required an FCM, in computing its adjusted net capital, to take a capital charge for unsecured receivables resulting from commodity futures and option transactions executed on foreign boards of trade and which were due from foreign brokers that were not registered with the Commission as FCMs or with the Securities and Exchange Commission (“SEC”) as securities brokers or dealers. The capital charge was equal to five percent of the unsecured receivable balance.

The Commission had minimal interaction with foreign regulators and limited experience with trading on foreign futures and option markets when it adopted Rule 1.17(c)(5)(xiii). The capital charge reflected the Commission's concern that unsecured receivables from foreign brokers represented a greater risk to an FCM's financial condition than comparable receivables due from registered FCMs or securities brokers or dealers which, under Commission and SEC capital rules, are required to maintain sufficient liquid assets to cover liabilities associated with funds received to maintain or carry futures and option positions on foreign boards of trade.

Subsequently, the Commission gained greater experience with foreign futures and option trading. In this regard, in 1987 the Commission adopted Part 30 of its regulations to govern the domestic offer and sale of futures and option contracts traded on foreign boards of trade.[3] Furthermore, in 1996 the Commission, citing an enhancement of capital standards monitoring and an increased cooperation among regulators globally, amended Rule 1.17(c)(5)(xiii) to exclude from the five percent capital charge that portion of the unsecured receivable that represented amounts required to be on deposit to maintain futures and option positions transacted on foreign boards of trade.[4] Deposits in excess of required margin or performance bond continued to be subject to the capital charge. In addition, to be exempt from the capital charge, the receivable had to be due from a foreign broker that had received confirmation of “comparability relief” in accordance with a Commission order issued under Rule 30.10 and the margin deposits had to be held by the foreign broker itself, another foreign broker that had received confirmation of Rule 30.10 “comparability relief,” or at a depository that qualified as a depository pursuant to Rule 30.7 and which was located within the same jurisdiction as either foreign broker.[5]

II. Proposal

The Joint Audit Committee (“JAC”) has asked the Commission to amend Rule 1.17(c)(5)(xiii) to expand the capital charge exemption on unsecured receivables from a foreign broker that has received “comparability relief” under Rule 30.10, but is not a registered FCM or a registered securities broker or dealer.[6] Specifically, the JAC has asked that the exemption be expanded to include balances in excess of required Start Printed Page 52053margin deposits. In support of its request, the JAC has stated that FCMs and IBIs generally deposit amounts in excess of required margin with foreign brokers as part of prudent risk management policies. In addition, the JAC has stated that increasing the amount of the deposit subject to the exclusion would allow FCMs to leave more funds on deposit with a foreign broker, thereby reducing costs associated with frequent transfers of funds between an FCM or IBI and a foreign broker. Accordingly, the JAC has asked that the amount exempted from the capital charge be expanded to a “reasonable amount of funds” to support the commodity futures and option trading activity conducted through the foreign broker.

The Commission agrees with the JAC in principle and is proposing to amend Rule 1.17(c)(5)(xiii) in this regard. The Commission believes, however, that the phrase “reasonable amount” is overly broad and subject to a wide range of interpretation. Therefore, for purposes of Rule 1.17(c)(5)(xiii), the maximum amount eligible for exclusion from the five percent capital charge is proposed to be the greater of: (1) 150 percent of the amount currently required to support futures and option transactions in an account; or (2) 100 percent of the maximum amount required to support futures and option transactions at any time during the preceding six-month period. The Commission believes that the proposed amendment would provide the cash management flexibility that the JAC has requested on behalf of its member FCMs and IBIs without unnecessarily broadening the capital charge exemption. The Commission further believes that the proposal would provide greater legal certainty than the phrase “reasonable amount.”

The JAC also has asked the Commission to amend Rule 1.17(c)(5)(xiii) to eliminate the requirement that an FCM or IBI be responsible for monitoring the ultimate destination of funds deposited with a foreign broker in order for such funds to be exempt from the capital charge. As set forth above, to be exempt from the capital charge, the funds must be held in accordance with the mandates of the applicable Rule 30.10 order by the foreign broker itself, another foreign broker that has received confirmation of Rule 30.10 “comparability relief,” or at a depository that qualifies as a depository pursuant to Rule 30.7 and is within the jurisdiction of either foreign broker. In support of its request, the JAC has stated that requiring FCMs and IBIs to monitor the flow of funds deposited with a foreign broker is impractical from an operational standpoint and overly burdensome.

By granting Rule 30.10 “comparability relief” to a foreign broker, the Commission has made a determination that the foreign broker is subject to a regulatory structure that is comparable to the regulatory structure imposed on entities that operate on U.S. exchanges by the Commodity Exchange Act and Commission regulations.[7] Of particular relevance to the relief requested by the JAC, the Commission, as part of the Rule 30.10 petition process, assesses the extent to which a foreign regulator's or SRO's regulatory program imposes bona fide minimum financial requirements on its regulatees or members as well as the protections afforded customers by the segregation of funds and the bankruptcy rules.[8] The Commission's determination that standards and protections exist pursuant to the foreign regulatory structure supports an easing of the capital charge.

Furthermore, the proposed amendments to the capital rule do not alter a foreign broker's obligation to comply with the applicable Rule 30.10 order when dealing with the funds of U.S. customers trading on foreign futures and option markets nor an FCM's or IBI's obligation to comply with applicable provisions of Part 30. Accordingly, the Commission is proposing to amend Rule 1.17(c)(5)(xiii) to eliminate the requirement that, to be exempt from the capital charge, margin deposits must be held by the foreign broker itself, another foreign broker granted Rule 30.10 “comparability relief,” or a depository in the same jurisdiction as either foreign broker that qualifies as a depository for funds under Rule 30.7.

III. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (“RFA”), 5 U.S.C. 601-611, requires that agencies, in proposing rules, consider the impact of those rules on small businesses. The rule amendments discussed herein would affect registered FCMs and IBIs. The Commission has previously determined that, based upon the fiduciary nature of FCM/customer relationships, as well as the requirement that FCMs meet minimum financial requirements, FCMs should be excluded from the definition of small entity.[9]

With respect to IBIs, the Commission stated that it is appropriate to evaluate within the context of a particular rule whether some or all introducing brokers should be considered to be small entities and, if so, to analyze the economic impact on such entities at that time.[10] The proposed amendments to Rule 1.17(c)(5)(xiii) do not impose additional requirements on an IBI. Thus, on behalf of the Commission, the Chairman certifies that the proposed amendments will not have a significant economic impact on a substantial number of small entities.

B. Paperwork Reduction Act

The Paperwork Reduction Act of 1995, 44 U.S.C. 3501 et seq. (Supp. I 1995), imposes certain requirements on federal agencies (including the Commission) to review rules and rule amendments to evaluate the information collection burden that they impose on the public. The Commission believes that the proposed amendments to Rule 1.17(c)(5)(xiii) will impose a minimal information collection burden on the public, namely those FCMs and IBIs who wish to take advantage of the exemption will be required to maintain a record of the margins required to be on deposit with a foreign broker over the preceding six month period. However, this burden is believed to be minimal when compared to the capital savings to be generated by the exclusion of increased amounts from the capital charge.

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List of Subjects in 17 CFR Part 1

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In consideration of the foregoing and pursuant to the authority contained in the Commodity Exchange Act and, in particular, Sections 4(b), 4f, 4g and 8a(5) thereof, 7 U.S.C. 6(b), 6d, 6g and 12a(5), the Commission hereby proposes to amend Chapter I of Title 17 of the Code of Federal Regulations as follows:

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PART 1—GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

1. The authority citation for Part 1 continues to read as follows:

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Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24.

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2. Section 1.17 is proposed to be amended by revising paragraph (c)(5)(xiii) to read as follows:

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Minimum financial requirements for futures commission merchants and introducing brokers.
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(c) * * *

(5) * * *

(xiii) Five percent of all unsecured receivables includable under paragraph (c)(2)(ii)(D) of this section used by the applicant or registrant in computing “net capital” and which are not due from:

(A) A registered futures commission merchant;

(B) A broker or dealer that is registered as such with the Securities and Exchange Commission; or

(C) A foreign broker that has been granted comparability relief pursuant to § 30.10 of this chapter, Provided, however, that the amount of the unsecured receivable not subject to the five percent capital charge is no greater than 150 percent of the current amount required to maintain futures and option positions in accounts with the foreign broker, or 100 percent of such greater amount required to maintain futures and option positions in the accounts at any time during the previous six-month period, and Provided that, in the case of customer funds, such account is treated in accordance with the special requirements of the applicable Commission order issued under § 30.10 of this chapter.

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Issued in Washington D.C. on August 23, 2000 by the Commission.

Jean A. Webb,

Secretary of the Commission.

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Footnotes

1.  Commission regulations cited herein may be found at 17 CFR Ch. I (2000).

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2.  43 FR 39956 (September 8, 1978).

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3.  52 FR 28980 (August 5, 1987). The Part 30 rules generally extended the Commission's existing customer protection requirements for products offered or sold on contract markets in the United States to foreign futures and option products sold to United States customers by foreign firms. Specifically, the Part 30 rules include requirements with respect to registration, risk disclosure, capital adequacy, protection of customer funds, recordkeeping and transaction reporting, sales practices and compliance procedures that are generally comparable to those applicable to transactions conducted on or subject to the rules of U.S. contract markets.

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4.  61 FR 19177, 19184 (May 1, 1996).

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5.  Under Rule 30.10 and Appendix A thereto, the Commission may exempt a foreign firm from compliance with certain Commission rules provided that a comparable regulatory system exists in the firm's home country and that certain safeguards are in place to protect U.S. customers, including an information-sharing arrangement between the Commission and the firm's home country regulator or self-regulatory organization (“SRO”). Once the Commission determines that the foreign jurisdiction's regulatory structure offers comparable regulatory oversight, the Commission issues an order granting general relief subject to certain conditions. Foreign firms seeking confirmation of this relief must make certain representations set forth in the Rule 30.10 order issued to the regulator or SRO from the firm's home country. Appendix C to Part 30 lists those foreign regulators and SROs that have been issued a Rule 30.10 order by the Commission.

Rule 30.7(c) sets forth acceptable depositories for funds deposited by U.S. customers with foreign brokers for futures and option trading on foreign boards of trade.

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6.  The JAC is comprised of representatives of the audit and compliance departments of the domestic SROs and the National Futures Association. The JAC coordinates the industry's audit and ongoing surveillance activities to promote a uniform framework of self-regulation.

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7.  U.S.C. 1 et seq. (1994).

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8.  The specific elements examined in evaluating whether a particular foreign regulatory program provides a basis for permitting substituted compliance for purposes of exemptive relief pursuant to Rule 30.10 are set forth in Appendix A to Part 30.

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9.  47 FR 18618-18621 (April 30, 1982).

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10.  48 FR 35248, 35275-78 (August 3, 1983).

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[FR Doc. 00-21904 Filed 8-25-00; 8:45 am]

BILLING CODE 6351-01-P