Minimum Financial Requirements, Prepayment of Subordinated Debt and Gross Collection of Exchange-Set Margin for Omnibus Accounts

[[Page 63995]]

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1

Minimum Financial Requirements, Prepayment of Subordinated Debt

and Gross Collection of Exchange-Set Margin for Omnibus Accounts

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rules.

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SUMMARY: The Commodity Futures Trading Commission (Commission) proposes

to amend: (1) Rules 1.17(a)(1)(i) and (ii) to (a) increase the minimum

required dollar amount of adjusted net capital for futures commission

merchants (FCMs) from $50,000 to $250,000, (b) increase the minimum

required dollar amount of adjusted net capital for introducing brokers

(IBs) from $20,000 to $30,000, and (c) make the amount of adjusted net

capital required by a registered futures association for its member

FCMs and IBs an element of the Commission's minimum financial

requirements for FCMs and IBs; (2) Rule 1.17(h)(2)(vii) with respect to

the procedure to obtain approval for prepayment of subordinated debt;

and (3) Rule 1.58, which governs gross collection of exchange-set

margins for omnibus accounts, to make it applicable to omnibus accounts

carried by FCMs for foreign brokers. The Commission believes that these

amendments will conform the Commission's rules with those of industry

self-regulatory organizations (SROs) and therefore should not require

changes in the operations of most firms.

DATES: Comments on the proposed amendments must be received on or

before January 12, 1996.

ADDRESSES: Comments should be sent to Jean A. Webb, Secretary of the

Commission, Commodity Futures Trading Commission, 1155 21st Street, NW,

Washington, DC 20581. Please refer to ``Financial Rule Amendments.''

FOR FURTHER INFORMATION CONTACT: Lawrence B. Patent, Associate Chief

Counsel, Division of Trading and Markets, Commodity Futures Trading

Commission, 1155 21st Street, NW, Washington, DC 20581. Telephone:

(202) 418-5439.

SUPPLEMENTARY INFORMATION:

I. Minimum Financial Requirements

A. Minimum Financial Requirements for FCMs

Rule 1.17(a)(1)(i) requires FCMs to maintain adjusted net capital

equal to or in excess of the greatest of: (1) $50,000, (2) four percent

of the sum of the amount of funds required to be segregated under

Section 4d(2) of the Commodity Exchange Act (Act) 1(i.e., for

trading in U.S. markets) and the amount of funds required to be set

aside under Commission Rule 30.7 2 for customers trading foreign

markets (referred to as the ``secured amount''); or (3) if an FCM is

also registered as a securities broker-dealer, the amount of net

capital required by the Securities and Exchange Commission (SEC).3

The $50,000 minimum dollar requirement was established in 1978

4and has remained unchanged. On August 27, 1990, the Commission

approved amendments to Rule 201 of the Chicago Board of Trade (CBT) and

Section 1 of NFA's Financial Requirements increasing their respective

FCM members' minimum adjusted net capital requirement to

$250,000.5 The NFA proposed the minimum adjusted net capital

increase based upon the growth in trading volume in the

industry,6the increase in segregated funds per FCM 7and the

decrease in the value of the dollar that had occurred since 1978. The

Commission approved these amendments to provide FCM customers with the

same degree of protection that was provided by the $50,000 minimum

adjusted net capital requirement when it was originally adopted in

1978.

\1\ 7 U.S.C. 6d(2) (1994).

\2\ 17 CFR 30.7 (1995).

\3\ Commission Rule 170.15 mandates that each person required to

register as an FCM become and remain a member of a futures

association which provides for the membership therein of such FCM

unless there is no registered futures association. National Futures

Association (NFA) is the only registered futures association. It has

an FCM membership category and virtually all FCMs are NFA members.

However, there are approximately 90 firms registered as FCMs (out of

a total of approximately 260) that do not handle customer funds and

therefore are not required to register as FCMs. Accordingly, these

firms are not required to be NFA members pursuant to Commission Rule

170.15 but almost all of them are NFA members anyway. However, there

still are approximately ten registered FCMs that are not members of

any SRO and thus have a current minimum dollar adjusted net capital

requirement of $100,000 under Commission Rule 1.17(a)(1)(i)(A).

Since such a small number of firms are in this category, for ease of

discussion we shall assume that all registered FCMs currently have a

minimum dollar requirement of adjusted net capital of $50,000 under

Commission rules.

\4\ See 43 FR 39956 (September 8, 1978).

\5\ On November 24, 1992, the SEC also adopted rule amendments

to raise its minimum net capital requirement for securities broker-

dealers holding customer funds, which had been $25,000, to $250,000

in stages. The requirement increased to $100,000 effective July 1,

1993, $175,000 effective January 1, 1994 and to the current level of

$250,000 effective July 1, 1994. See 57 FR 56973, 56990 (Dec. 2,

1992); 17 CFR Sec. 240.15c3-1e(a)(1995).

\6\ This trend has continued. In fiscal year 1990, 334.2 million

futures and option contracts were traded on U.S. contract markets,

and that number increased more than 50 percent in the last five

years to approximately 504.8 million in fiscal year 1995.

\7\ In NFA's 1990 submission, it noted that the average amount

of funds in segregation at each FCM more than tripled from 1980 to

1985, increasing from $8.7 million to $28.5 million. That amount

more than tripled again in the last ten years and now exceeds $100

million.

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Pursuant to paragraph (a)(2) of Commission Rule 1.17, the

Commission's minimum financial requirements are not applicable to a

registrant that is a member of an SRO and that conforms to the minimum

financial standards set by such SRO. As noted above, all persons

required to register as FCMs are required to be NFA members under

Commission Rule 170.15. Consequently, when the Com-mission approved

NFA's amendment of the minimum dollar amount of adjusted net capital

required of its member FCMs in 1990, the Commission effectively raised

the dollar level of minimum adjusted net capital for all FCMs to

$250,000.

The Commission nonetheless believes that raising the required

minimum dollar amount of adjusted net capital for FCMs under Commission

Rule 1.17 to that required by NFA and CBT for their members is

necessary and appropriate for the following reasons. Section 8c(a)(1)

of the Act, 7 U.S.C. 12c(a)(1) (1994), authorizes the Commission to

discipline a member of an exchange in accordance with the rules of that

exchange if the exchange fails to do so. Section 17(l)(1) of the Act, 7

U.S.C. 21(1)(1) (1994), authorizes the Commission to suspend a

registered futures association that has failed to enforce compliance

with its own rules. However, the Commission does not have the authority

to discipline an exchange member for violation of an exchange rule in

the absence of the exchange's failure to act, or to enforce compliance

with a registered futures association's own rule upon a member thereof.

This limitation upon the Commission's enforcement remedies in the

context of SRO rules does not, of course, exist in the context of

violations of the Act or Commission regulations. Section 6c of the Act,

7 U.S.C. 13a-1 (1994), authorizes the Commission, whenever it appears

that a person has engaged, is engaging, or is about to engage in any

act or practice constituting a violation of any provision of the Act or

any rule or regulation thereunder, to bring an action to enjoin such

act or practice, or to enforce compliance with the Act or any rule or

regulation thereunder.

The proposed amendment to Rule 1.17(a)(1)(i)(A) thus would permit

the Commission to use its authority under Section 6c of the Act to

enforce

[[Page 63996]]

compliance with what is effectively, for the reasons discussed above,

the current minimum adjusted net capital requirement applicable to FCMs

with the benefit of all of the remedies available to it under the Act

for the enforcement of compliance with any provision of the Act and any

rule promulgated thereunder. In addition, this amendment would

harmonize the Commission's minimum dollar requirement for FCMs with the

prevailing standards established by NFA rules and support the objective

of assuring that FCMs have a substantial base of liquid capital from

which to meet their obligations to customers, an objective for which an

increased requirement appears appropriate given the increase in the

amount of funds held by FCMs and the change in the value of the dollar

since 1978.

The Commission believes it is necessary to clarify its authority to

require the transfer of positions at such time as a firm is no longer

in compliance with the NFA rule. The Commission further believes that a

base minimum adjusted net capital requirement of $250,000 is now

essential to providing both an adequate stake in doing business in

accordance with Commission rules and otherwise to provide a cushion

sufficient with applicable haircuts and segregation of customer funds

to permit the Commission to act in an emergency.

The Commission also believes that the rule amendment is necessary to

eliminate any confusion that may have existed as to whether the

Commission could take action where an FCM's adjusted net capital is

below $250,000 yet still exceeds $50,000.

Accordingly, the Commission is proposing to amend Rule

1.17(a)(1)(i)(A) to increase the minimum dollar amount of adjusted net

capital for FCMs to $250,000.8 In light of the amount of the

proposed increase and the fact that, unlike the situation in 1978, very

few FCMs are not members of any SRO and that those few FCMs in that

category cannot handle customer funds, the Commission sees no need to

maintain a higher dollar amount of required adjusted net capital for an

FCM that is not a member of any SRO. In any event, such FCMs would have

an increase in their adjusted net capital requirement from the current

$100,000 to the proposed $250,000 that would apply to all FCMs.

\8\ The Commission believes, for the reasons discussed above,

that an increase from $50,000 to $250,000 is necessary and that it

is unnecessary to phase this in over time as the SEC did in that

most firms already meet the NFA requirement. The Commission also

notes that when it adopted the current $50,000 standard in 1978,

that was also a five-fold, one-step increase in the existing

standard of $10,000 of working capital originally adopted by the

Commission's predecessor agency, the Commodity Exchange Authority,

effective March 17, 1969. 34 FR 599 (Jan. 16, 1969).

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The Commission further notes that several provisions of the

Commission's minimum financial rules for FCMs, as well as one provision

of the financial early warning system, contain cross-references to Rule

1.17(a)(1)(i)(A). Certain actions are restricted or required if the

specified levels of adjusted net capital, which in all cases exceed 100

percent of the minimum dollar amount, are breached. These include Rule

1.17(e)(1)(i) (restricting the withdrawals of equity capital as well as

the following paragraphs of Rule 1.17 concerning subordinated debt:

paragraph (h)(2)(vi)(C)(1) (restricting the parties to a secured demand

note (SDN) agreement from providing in such agreement that the unpaid

principal amount of an SDN can be reduced below a floor amount if the

value of collateral securing the SDN declines below the unpaid

principal amount); paragraphs (h)(2)(vii)(A)(1) and (B)(1) (restricting

prepayments and special prepayments); (h)(2)(viii)(A)(1) (requiring

suspension of repayment); (h)(3)(ii)(A) (requiring notice of maturity

or accelerated maturity); and (h)(3)(v)(A) (restricting use of

temporary subordinations). In addition, Rule 1.12(b)(1) establishes the

``early warning'' minimum dollar level of adjusted net capital as 150

percent of the minimum dollar requirement, triggering notice and

follow-up reporting requirements when an FCM's adjusted net capital is

below that level. Even though the Commission is not amending the

provisions of Rules 1.12 and 1.17 that cross-reference Rule

1.17(a)(1)(i)(A), the proposed amendment of the latter will have a

corresponding impact on the various FCM activities or obligations

referred to above.9

\9\ For example, equity capital withdrawals from an FCM

currently cannot reduce the FCM's adjusted net capital below $60,000

(120 percent of the minimum amount); if the amendment proposed

herein to Rule 1.17(a)(1)(i)(A) were adopted, equity capital

withdrawals would not be permitted to reduce the FCM's adjusted net

capital below $300,000. Similarly, the ``early warning'' level of

adjusted net capital would increase from $75,000 to $375,000 despite

the fact that Rule 1.12(b)(1) itself would not be amended.

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The Commission held a roundtable on capital on September 18, 1995

where several issues were discussed pertaining to minimum financial

requirements. One of the issues discussed was whether the second prong

of the current requirement, based upon four percent of the sum of

segregated customer funds and the secured amount, should be amended in

an effort to make an FCM's minimum adjusted net capital requirement

reflect more closely the risks to an FCM caused by carrying open

positions. The Commission may address that issue in a subsequent

release following a review of empirical data being developed by the

SROs but is not prepared to do so at this time.

B. Minimum Financial Requirements for IBs

Rule 1.17 also requires introducing brokers (IBs) 10 to

maintain certain prescribed minimum amounts of adjusted net capital.

Pursuant to Rule 1.17(a)(1)(ii), each person registered as an IB must

maintain adjusted net capital equal to or in excess of the greater of:

(A) $20,000 ($40,000 for each person registered as an IB who is not a

member of an SRO); 11 or, (B) if the IB is also a securities

broker-dealer, the amount of net capital required by the SEC.

\10\ Section 1a(14) of the Act, 7 U.S.C. 1a(14)(1994), defines

an IB as ``any person (except an individual who elects to be and is

registered as an associated person of [an FCM]) engaged in

soliciting or in accepting orders for the purchase or sale of any

commodity for future delivery on or subject to the rules of any

contract market who does not accept any money, securities or

property (or extend credit in lieu thereof) to margin, guarantee, or

secure any trades or contracts that result or may result

therefrom.'' Commission Rule 1.3(mm), 17 CFR 1.3(mm) (1995), also

includes in the definition of an IB any person required to register

as such by virtue of Part 33 of the Commission's rules, 17 CFR Part

33 (1995).

\11\ As is the case with FCMs discussed above, virtually all

registered IBs are members of NFA. Any IB that is registered but not

an NFA member would be precluded from introducing customer accounts

to an FCM and thus could not act as an IB.

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On October 6, 1992, the Commission approved NFA rule amendments

which, among other things, increased the required minimum dollar amount

of adjusted net capital for member IBs from $20,000 to $30,000.

However, the Commission did not at that time amend Commission Rule

1.17(a)(1)(ii)(A) to conform to NFA's rule amendment. The Commission

believes that since it is now proposing to raise the minimum dollar

amount of required adjusted net capital for FCMs as discussed above, it

is appropriate also to propose an increase in the required minimum

dollar amount of adjusted net capital for IBs. Accordingly, the

Commission is proposing to amend Rule 1.17(a)(1)(ii)(A) to raise the

minimum dollar amount of required net capital for a registered IB to

$30,000. For reasons similar to those discussed above concerning FCMs,

the Commission would eliminate any higher requirement for an IB that is

not a member of an SRO.

[[Page 63997]]

This proposed amendment, like the proposal applicable to FCMs,

would conform the Commission's rule to the general industry standard

established by NFA. Therefore, there should be essentially no impact on

the operations of IBs as a result of this amendment. In any event, the

proposed amendment would only affect the minority of IBs who raise

their own capital. Those IBs who have entered into guarantee agreements

with FCMs would be unaffected by the proposed amendment.12

\12\ More than two-thirds of IBs enter into guarantee agreements

with FCMs in accordance with Commission Rules 1.17(a)(2)(ii) and

1.10(j) in lieu of raising their own capital.

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C. Conforming Commission and Registered Futures Association Rules

The Commission also approved NFA rule amendments on October 6, 1992

which provide that a member IB's minimum adjusted net capital

requirement, as well as that of a member FCM, can be determined by the

number of offices it operates and the number of APs it sponsors.13

When NFA presented these provisions to the Commission, NFA stated that

the amount of the IB minimum financial requirement should be linked to

the size of an IB's operation and that it concluded, after studying

several factors related to an IB's business, that the number of offices

operated or APs sponsored by an IB were the most relevant factors to be

used in a formula establishing an IB's minimum financial requirement.

NFA also stated that an FCM's minimum financial requirement should

parallel that of an IB in this regard.14 The Commission believes

that it should incorporate the NFA standards concerning the number of

offices or APs sponsored into the minimum financial requirements for

FCMs and IBs in Rule 1.17, and eliminate the necessity to amend Rule

1.17 each time NFA amends its minimum financial requirements in order

to avoid a recurrence of the current situation where NFA's minimum

dollar amount of adjusted net capital for an FCM is $250,000 and the

Commission's minimum is $50,000. Therefore, the Commission is proposing

to redesignate paragraphs (a)(1)(i)(C) and (a)(1)(ii)(B) as paragraphs

(a)(1)(i)(D) and (a)(1)(ii)(C), respectively, of Rule 1.17, and to add

new paragraphs (a)(1)(i)(C) and (a)(1)(ii)(B) that would provide that

``the amount of adjusted net capital required by a registered futures

association of which it is a member'' is an element of the Commission's

minimum financial requirement for FCMs and IBs. The Commission is also

proposing conforming amendments to the early warning level of adjusted

net capital for FCMs,15 the restriction on withdrawals of equity

capital and the various provisions of Rule 1.17(h) discussed above

concerning subordinated debt.16

\13\ Section 9 of NFA's Financial Requirements is entitled

``Introducing Broker Financial Requirements'' and provides as

follows:

Each Member IB, except an IB operating pursuant to a guarantee

agreement which meets the requirements set forth in CFTC Regulation

1.10(j), must maintain ``Adjusted Net Capital'' (as defined in

Schedule A hereto) equal to or in excess of the greatest of:

(i) $30,000; or,

(ii) $6,000 per office operated by the IB (including the main

office); or,

(iii) $3,000 for each AP sponsored by the IB; or

(iv) (for securities brokers and dealers), the amount of net

capital required by Rule 15c3-1(a) of the Securities and Exchange

Commission (17 CFR 240.15c3-1(a)).

The corresponding provision for an FCM with respect to offices

and APs is based upon ``$6,000 for each remote location operated

(i.e., proprietary branch offices, main office of each guaranteed IB

and branch offices of each guaranteed IB); or, $3,000 for each AP

sponsored (including APs sponsored by guaranteed IBs).'' Section 1

of NFA's Financial Requirements.

\14\ According to discussions with NFA staff, there are

currently less than ten FCMs and less than ten IBs whose minimum

financial requirement is based upon the number of offices operated

or APs sponsored. As of September 30, 1995, of the registered IBs,

1,080 operated pursuant to guarantee agreements with an FCM and 388

were raising their own capital.

\15\ See proposed new paragraph (b)(3) of Rule 1.12, which is

based upon 150% of the amount of adjusted net capital required by a

registered futures association, and is proportional to the other

elements of Rule 1.12(b).

\16\ See the following proposed new Rule 1.17(e)(1)(iii) and the

proposed new paragraphs of Rule 1.17: (h)(2)(vi)(C)(3) (restricting

reductions in unpaid principal amount of an SDN); (h)(2)(vii)(A)(3)

(restricting prepayments); (h)(2)(vii)(B)(3) (restricting special

prepayments); (h)(2)(viii)(A)(3) (requiring suspension of

repayment); (h)(3)(ii)(C) (requiring notice of maturity or

accelerated maturity); and (h)(3)(v)(C) (restricting use of

temporary subordinations). The levels of adjusted net capital set

forth in the proposed new paragraphs of Rule 1.17 are 120 percent of

the registered futures association's minimum amount, except for the

provision concerning special prepayment which would be 200 percent.

These percentages correspond to the current levels in those rules

that are based upon the minimum dollar amount.

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II. Prepayment of Subordinated Debt

For purposes of computing net capital, debt covered by

``satisfactory subordinated agreements'' can be excluded from

liabilities.17 Rule 1.17(h)(2)(vii)(A) generally prohibits any

prepayment of subordinated debt for one year following the date upon

which the governing subordination agreement became effective. However,

Rule 1.17(h)(2)(vii)(B) permits special prepayment of subordinated debt

at any time (even during the first year) provided that, after giving

effect thereto, the applicant's or registrant's adjusted net capital

does not fall below certain amounts prescribed in the rule, which are

approximately one and one-half times the amounts of capital required

for a normal prepayment. In addition, no prepayment and no special

prepayment may occur unless the registrant has obtained written

approval of its designated self-regulatory organization (DSRO), if any,

and the Commission.18

\17\ See Commission Rule 1.17(h) for a definition of the term

``satisfactory subordination agreement''.

\18\ An applicant for registration must obtain prior written

approval of NFA.

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On September 10, 1985, the Commission's Division of Trading and

Markets (Division) advised all registered IBs, FCMs and SROs of its

intention to recommend to the Commission that Rule 1.17(h)(2)(vii) be

changed to require only the DSRO's approval for prepayment of

subordinated debt.19 ``The requirement for dual approval has been

in effect for approximately seven years'', the Division stated,

``[d]uring [which] time, the DSROs have gained greater familiarity

regarding subordinated debt and * * * have demonstrated * * * an

ability to work together in the area of financial surveillance.'' This

change would ``make the treatment of prepayment of subordinated debt

consistent with the treatment of approval of new subordinated debt or

amendments to subordinated agreements.''

\19\ CFTC Interpretative Letter No. 85-17, [1984-1986 Transfer

Binder] Comm. Fut. L. Rep. (CCH) para.22,738 (Sept. 10, 1985).

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The Commission is proposing to implement the change contemplated in

Interpretative Letter No. 85-17 by amending Rule 1.17(h)(2)(vii) to

require submission of a request for approval of prepayment of

subordinated debt by a registrant to the DSRO only, if any, or to the

Commission in those rare instances where the registrant is not an SRO

member. Dual approval by the DSRO and the Commission would be required,

however, should the requested prepayment or special prepayment result

in a reduction of 20 percent or more of the registrant's adjusted net

capital. Therefore, if a firm's subordinated debt amounts to 25 percent

of its adjusted net capital and the firm wishes to prepay all of it and

simultaneously enter into new subordinated debt arrangements for the

same amount, but at a different maturity or interest rate, dual

approval would not be required since there would be no net effect on

the firm's adjusted net capital. Similarly, if a firm wanted to convert

subordinated debt to paid-in-capital, dual approval would not be

required so

[[Page 63998]]

long as such conversion did not result in a reduction of 20 percent or

more of the firm's adjusted net capital.

III. Gross Collection of Exchange-Set Margins

Pursuant to Commission Rule 1.58, each FCM which carries a

commodity futures or commodity option position for another FCM on an

omnibus basis must collect, and each FCM for which an omnibus account

is being carried must deposit, initial and maintenance margin on each

position reported in accordance with Commission Rule 17.04 at a level

no less than that established for customer accounts by the rules of the

applicable contract market. Rule 1.58 was proposed in 1981 20

following the bankruptcy of three FCMs who cleared trades solely by

means of omnibus accounts. The Commission was concerned that customer

funds were ``being held by firms that, in comparison to clearing FCMs,

generally [had] less capital and [were] less equipped to handle the

volatility of the commodity markets''.21 It is also the case, as

demonstrated during the collapse of Barings PLC, that net margining of

an omnibus account can mask risk to the clearing member. Thus, the

primary purposes of Rule 1.58 were to ``strengthen the industry and

enhance customer protection by moving segregated funds into the

normally better-capitalized hands of a clearing member'' and to provide

the Commission and the SROs with better information with respect to

omnibus accounts.22

\20\ 46 FR 62864 (Dec. 29, 1981).

\21\ Id.

\22\ 47 FR 21026 (May 17, 1982).

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As originally adopted and currently, Rule 1.58 does not apply to

omnibus accounts carried by FCMs on behalf of foreign brokers.23

On November 16, 1988, the Division issued Financial and Segregation

Interpretation No. 12 which, among other things, requires FCMs to

obtain an agreement from customers who desire to have funds held

offshore whereby such customers authorize the subordination of their

claims attributable to funds held offshore to the claims of other

customers should the FCM be placed in bankruptcy or receivership.

Although the Commission is in the process of reviewing this

Interpretation from the perspective of certain foreign currency

deposits in light of the provisions for settlement of certain contracts

traded on U.S. contract markets by means of foreign currency, certain

statements made relative to foreign location risk remain relevant

today. For example, in support of this Interpretation, the Commission

expressed its concern that ``in the event of an FCM insolvency,

deposits maintained at a foreign depository might not be handled or

distributed in accordance with United States bankruptcy law'' and that

``both the size of the pool of funds available for distribution to

customers and the size of individual claims against that pool may vary

from day-to-day.'' The Commission further stated that ``to the extent

foreign domiciled customers deposit [U.S.] dollars in connection with

United States futures or options, such funds should be held in the

United States'' because ``the Commission perceives no administrative

necessity for FCMs and customers to incur the location risks attendant

to holding such dollar deposits overseas''.24 Likewise, the

Commission is concerned that margin deposits maintained by a foreign

broker at a foreign depository might become unavailable in the event of

a bankruptcy of the clearing FCM due to differences in bankruptcy law

among jurisdictions and might be exposed to currency fluctuations

during the pendency of the bankruptcy. In addition, the Commission has

observed that in times of turbulent markets, such as occurred in

October 1987 and October 1989, accounts in the names of owners with

foreign addresses had greater difficulty meeting margin calls than did

domestic accounts, undoubtedly to some extent due to time zone

differences and currency conversion logistics.25 In this context,

the Commission has recognized that foreign brokers' omnibus accounts

carried by clearing FCMs can have a substantial impact on the financial

condition of clearing FCMs. Further, as a result of the collapse of

Barings PLC in February 1995, the Commission's concern has been

heightened with respect to FCMs having a clear view of the exposures in

omnibus accounts and the ability to assure proper handling and

segregation of customer funds.

\23\ Neither the proposing release nor the adopting release for

Rule 1.58 discuss omnibus accounts carried on behalf of foreign

brokers.

\24\ See 53 FR 46911 (Nov. 21, 1988), reprinted in 1 Comm. Fut.

L. Rep. (CCH) para. 7122.

\25\ See Final CFTC Staff Report, Stock Index Futures and Cash

Market Activity--October 1987, at pp. 192-193 (Jan. 1988) (reprinted

in Comm. Fut. L. Rep. (CCH), Special Report No. 321, Feb. 5, 1988)

and Commodity Futures Trading Commission, Division of Economic

Analysis, Report on Stock Index Futures and Cash Market Activity

During October 1989 to the U.S. Commodity Futures Trading

Commission, at p. 143 (May 1990).

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In view of the increasing internationalization of the financial

markets, and in particular the increasing use of foreign omnibus

accounts, the Commission believes that foreign broker omnibus accounts

should be treated in the same manner as omnibus accounts carried for

domestic FCMs. Thus, FCMs carrying foreign broker omnibus accounts

would hold a higher level of funds, have less capital exposure and be

better able to transfer positions from such accounts in the event of a

financial disruption. Accordingly, the Commission is proposing to

expand the application of Rule 1.58 to include foreign brokers' omnibus

accounts carried by FCMs. As is the case with the proposed amendments

to Rule 1.17 concerning the minimum amount of adjusted net capital for

FCMs and IBs, the Commission is essentially proposing to conform its

rule relating to collection of margins for omnibus accounts to the

industry practice since, as a result of staff recommendations in rule

enforcement reviews and SRO rule changes, all active U.S. contract

markets other than the New York Cotton Exchange and the Philadelphia

Board of Trade require that FCMs collect margin for omnibus accounts of

foreign brokers as well as other domestic FCMs on a gross basis.

IV. Other Matters

As noted above, the Commission held a roundtable on capital issues

on September 18, 1995, during which several matters were discussed.

Although the Commission is not presenting any specific rule proposals

at this time related to issues discussed at the roundtable, the

Commission will be seeking additional information concerning certain of

the issues discussed with a view towards possible additional rule

amendments. These issues would include greater harmonization of the

CFTC/SEC financial requirements in several areas such as reporting

requirements and cycles, early warning requirements,26 risk

assessment data elements and the debt-equity ratio requirements with

respect to a firm's capital.27 The

[[Page 63999]]

Commission is also considering a rethinking of the no-action relief

provided to an FCM by the Division with respect to the short options

value charge,28 and the appropriateness of a concentration charge.

Separately, the Commission has discussed with the Joint Audit Committee

the data necessary to evaluate any proposals for a ``risk-based''

standard as a component of the minimum adjusted net capital

requirements. Although the Commission has no specific proposals in any

of these areas at this time, it nonetheless invites commenters to

address these matters if they so choose.

\26\ The Commission has proposed amendments to its Rule 1.12 to:

(1) make paragraph (g), which requires the reporting of certain

reductions in adjusted net capital, applicable to all FCMs, rather

than just those FCMs subject to the risk assessment reporting

requirements of Rule 1.15; (2) require reporting of a margin call

that exceeds an FCM's excess adjusted net capital which remains

unanswered by the close of business on the day following the

issuance of the call; and (3) require reporting by an FCM whenever

its excess adjusted net capital is less than six percent of the

maintenance margin required to support proprietary and noncustomer

positions carried by the FCM. 59 FR 66822 (Dec. 28, 1994).

\27\ SEC Rule 15c3-1(d) (17 CFR 240.15c3-1(d) (1995)) requires

that at least 30 percent of all of a broker-dealer's net capital

consist of equity capital. See Report of the Technical Committee of

IOSCO, ``Capital Requirements for Multinational Securities Firms,''

XV Annual Conference of the International Organization of Securities

Commissions (IOSCO), Santiago, Chile 1990. The general international

standard in this connection, as recommended by Working Party No. 3

of the Technical Committee of IOSCO, would also apply the debt-

equity requirement to all of a firm's capital. Although the

Commission originally proposed a debt-equity requirement for an FCM

that would have been similar to that of a broker-dealer under SEC

rules (see 42 FR 27166, 27177 (May 26, 1977)), in response to

comments that ``it would be inappropriate to penalize a firm that

maintains capital in the form of satisfactory subordination

agreements, which is in excess of the minimum required by

regulations'', the Commission revised the required debt-equity total

to which the 30 percent equity capital requirement applies to mean

total capital less the excess of the FCM's adjusted net capital,

i.e., only the required minimum adjusted net capital. See 43 FR

39956, 39965, 39976 (Sept. 8, 1978).

\28\ Commission Rule 1.17(c)(5)(iii), 17 CFR 1.17(c)(5)(iii)

(1995); CFTC Interpretative Letter 95-65, [Current Binder] Comm.

Fut. L. Rep. (CCH) para. 26,495 (July 26, 1995).

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V. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA), 5 U.S.C. 601 et seq.,

requires that agencies, in proposing rules, consider the impact of

those rules on small businesses. The rule amendments proposed herein

would affect FCMs and independent IBs. The Commission has previously

determined that, based upon the fiduciary nature of FCM/customer

relationships, as well as the requirement that FCMs meet minimum

financial requirements, FCMs should be excluded from the definition of

small entity.29

\29\ See 47 FR 18618, 18619 (Apr. 30, 1982).

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With respect to IBs, the Commission stated that it is appropriate

to evaluate within the context of a particular rule proposal whether

some or all IBs should be considered to be small entities and, if so,

to analyze the economic impact on such entities at that time.30

The proposed amendment to Rule 1.17(h)(2)(vii) would generally reduce

the burden associated with the procedure to obtain approval for

permissive prepayment of subordinated debt. Accordingly, that amendment

should impose no additional requirements on an independent IB. In

addition, the proposed amendment to the minimum adjusted net capital

requirement for an IB would conform the Commission's requirement to

that of the NFA and therefore there should be no impact on an IB's

financial operations. Thus, if adopted, these proposals would not have

a significant economic impact on a substantial number of IBs.

Therefore, pursuant to Section 3(a) of the RFA, 5 U.S.C. 605(b), the

Chairman certifies that these proposed rule amendments will not have a

significant economic impact on a substantial number of small entities.

\30\ See 48 FR 35248, 35275-78 (Aug. 3, 1983).

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B. Paperwork Reduction Act

The Paperwork Reduction Act of 1990, (PRA) 44 U.S.C. 3501 et seq.,

imposes certain requirements on Federal agencies (including the

Commission) in connection with their conducting or sponsoring any

collection of information as defined by the PRA. While the amendments

proposed herein have no burden,31 Rules 1.12, 1.17 and 1.58 are

parts of groups of rules with the following burdens.

\31\ The proposed increase in the dollar amount of minimum

adjusted net capital for an FCM and an IB would necessitate only a

change in line item 23E of the Statement of the Computation of

Minimum Capital Requirements on Form 1-FR-FCM and in line item 15 of

that Statement on Form 1-FR-IB.

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The burden associated with the collection required by Rules 1.12

and 1.17 (3038-0024), including these proposed amendments, is as

follows:

Average Burden Hours Per Response: 1.50.

Number of FCM Respondents: 165.00.

Number of IB Respondents: 62.00.

Frequency of Response: 1.00.

The burden associated with the collection required by Rule 1.58

(3038-0026), including these proposed amendments, is as follows:

A. Reporting

Average Burden Hours Per Response: 0.04.

Number of Respondents: 100.00.

Frequency of Response: 50.00.

B. Recordkeeping

Average Burden Hours Per Response: 1.00.

Number of Respondents: 300.00.

Frequency of Response: 1.00.

Persons wishing to comment on the estimated paperwork burden

associated with these proposed rule amendments should contact Jeff

Hill, Office of Management and Budget, Room 3228, NEOB, Washington, DC

20503, (202) 395-7340. Copies of the information collection submission

to OMB are available from Joe F. Mink, CFTC Clearance Officer, 1155

21st Street, N.W., Washington, DC 20581, (202) 418-5170.

List of Subjects in 17 CFR Part 1

Commodity futures, minimum financial requirements.

In consideration of the foregoing and pursuant to the authority

contained in the Commodity Exchange Act and, in particular, Sections

4f, 4g and 8a(5) thereof, 7 U.S.C. 6f, 6g and 12a(5), the Commission

hereby proposes to amend Chapter I of Title 17 of the Code of Federal

Regulations as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

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

Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f,

6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a,

12c, 13a, 13a-1, 16, 16a, 19, 21, 23 and 24.

2. Section 1.12 is amended by removing the word ``or'' at the end

of paragraph (b)(2), by redesignating paragraph (b)(3) as paragraph

(b)(4), and by adding a new paragraph (b)(3) to read as follows:

Sec. 1.12 Maintenance of minimum financial requirements by futures

commission merchants and introducing brokers.

* * * * *

(b) * * *

(3) 150 percent of the amount of adjusted net capital required by a

registered futures association of which it is a member; or

* * * * *

3. Section 1.17 is amended as follows:

3.1. By revising paragraph (a)(1);

3.2. By removing the word ``or'' at the end of paragraph

(e)(1)(ii), by redesignating paragraph (e)(1)(iii) as (e)(1)(iv), and

by adding a new paragraph (e)(1)(iii);

3.3. By removing the word ``or'' at the end of paragraph

(h)(2)(vi)(C)(2), by redesignating paragraph (h)(2)(vi)(C)(3) as

paragraph (h)(2)(vi)(C)(4), and by adding a new paragraph

(h)(2)(vi)(C)(3);

3.4. By removing the word ``or'' at the end of paragraph

(h)(2)(vii)(A)(2), by redesignating paragraph (h)(2)(vii)(A)(3) as

paragraph (h)(2)(vii)(A)(4) and, as redesignated, revising it, and by

adding a new paragraph (h)(2)(vii)(A)(3);

3.5. By removing the word ``or'' at the end of paragraph

(h)(2)(vii)(B)(2), by redesignating paragraph (h)(2)(vii)(B)(3) as

paragraph (h)(2)(vii)(B)(4) and, as redesignated, revising it, and by

adding new paragraphs (h)(2)(vii)(B)(3) and (h)(2)(vii)(C);

3.6. By removing the word ``or'' at the end of paragraph

(h)(2)(viii)(A)(2), by redesignating paragraph (h)(2)(viii)(A)(3) as

paragraph

[[Page 64000]]

(h)(2)(viii)(A)(4), and by adding a new paragraph (h)(2)(viii)(A)(3);

3.7. By removing the word ``or'' at the end of paragraph

(h)(3)(ii)(B), by redesignating paragraph (h)(3)(ii)(C) as paragraph

(h)(3)(ii)(D), and by adding a new paragraph (h)(3)(ii)(C); and

3.8. By redesignating paragraphs (h)(3)(v) (C) and (D) as

paragraphs (h)(3)(v) (D) and (E) and by adding a new paragraph

(h)(3)(v)(C). The revised and added paragraphs read as follows:

Sec. 1.17 Minimum financial requirements for futures commission

merchants and introducing brokers.

(a)(1)(i) Except as provided in paragraph (a)(2)(i) of this

section, each person registered as a futures commission merchant must

maintain adjusted net capital equal to or in excess of the greatest of:

(A) $250,000;

(B) Four percent of the following amount: The customer funds

required to be segregated pursuant to the Act and these regulations and

the foreign futures or foreign options secured amount, less the market

value of commodity options purchased by customers on or subject to the

rules of a contract market or a foreign board of trade: Provided,

however, That the deduction for each customer shall be limited to the

amount of customer funds in such customer's account(s) and foreign

futures and foreign options secured amounts;

(C) The amount of adjusted net capital required by a registered

futures association of which it is a member; or

(D) For securities brokers and dealers, the amount of net capital

required by Rule 15c3-1(a), of the Securities and Exchange Commission

(17 CFR 240.15c3-1(a)).

(ii) Except as provided in paragraph (a)(2) of this section, each

person registered as an introducing broker must maintain adjusted net

capital equal to or in excess of the greatest of:

(A) $30,000;

(B) The amount of adjusted net capital required by a registered

futures association of which it is a member; or

(C) For securities brokers and dealers, the amount of net capital

required by Rule 15c3-1(a) of the Securities and Exchange Commission

(17 CFR 240.15c3-1(a)).

* * * * *

(e) * * *

(1) * * *

(iii) 120 percent of the amount of adjusted net capital required by

a registered futures association of which it is a member; or

* * * * *

(h) * * *

(2) * * *

(vi) * * *

(C) * * *

(3) 120 percent of the amount of adjusted net capital required by a

registered futures association of which it is a member; or

* * * * *

(vii) * * *

(A) * * *

(3) 120 percent of the amount of adjusted net capital required by a

registered futures association of which it is a member; or

(4) For an applicant or registrant which is also a securities

broker or dealer, the amount of net capital specified in Rule 15c3-

1d(b)(7) of the Securities and Exchange Commission (17 CFR 240.15c3-

1d(b)(7)).

(B) * * *

(3) 120 percent of the amount of adjusted net capital required by a

registered futures association of which it is a member; or

(4) For an applicant or registrant which is also a securities

broker or dealer, the amount of net capital specified in Rule 15c3-

1d(c)(5)(ii) of the Securities and Exchange Commission (17 CFR

240.15c3-1d(c)(5)(ii)): Provided, however, That no special prepayment

shall be made if pre-tax losses during the latest three-month period

were greater than 15 percent of current excess adjusted net capital.

(C) Notwithstanding the provisions of paragraphs (h)(2)(vii)(A) and

(h)(2)(vii)(B) of this section, in the case of an applicant, no

prepayment or special prepayment shall occur without the prior written

approval of the National Futures Association; in the case of a

registrant, if the requested prepayment or special prepayment will

result in the reduction of the registrant's adjusted net capital by 20

percent or more, no prepayment or special prepayment shall occur

without the prior written approval of the designated self-regulatory

organization, if any, and of the Commission, or, if the requested

prepayment or special prepayment will result in the reduction of the

registrant's adjusted net capital by less than 20 percent without the

prior written approval of the designated self-regulatory organization,

if any, or of the Commission if the registrant is not a member of a

self-regulatory organization.

(viii) * * *

(A) * * *

(3) 120 percent of the amount of adjusted net capital required by a

registered futures association of which it is a member; or

* * * * *

(3) * * *

(ii) * * *

(C) 120 percent of the amount of adjusted net capital required by a

registered futures association of which it is a member; or

* * * * *

(v) * * *

(C) 120 percent of the amount of adjusted net capital required by a

registered futures association of which it is a member;

* * * * *

4. Section 1.58 is revised to read as follows:

Sec. 1.58 Gross collection of exchange-set margins.

(a) Each futures commission merchant which carries a commodity

futures or commodity option position for another futures commission

merchant or for a foreign broker on an omnibus basis must collect, and

each futures commission merchant and foreign broker for which an

omnibus account is being carried must deposit, initial and maintenance

margin on each position reported in accordance with Sec. 17.04 of this

chapter at a level no less than that established for customer accounts

by the rules of the applicable contract market.

(b) If the futures commission merchant which carries a commodity

futures or commodity option position for another futures commission

merchant or for a foreign broker on an omnibus basis allows a position

to be margined as a spread position or as a hedged position in

accordance with the rules of the applicable contract market, the

carrying futures commission merchant must obtain and retain a written

representation from the futures commission merchant or from the foreign

broker for which the omnibus account is being carried that each such

position is entitled to be so margined.

Issued in Washington, D.C. on December 7, 1995 by the

Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 95-30360 Filed 12-12-95; 8:45 am]

BILLING CODE 6351-01-P