No-action relief for certain Introducing Brokers from filing certified and unaudited financial statements and calculating capital under regulation 1.17.

Summary: No-action relief for certain Introducing Brokers from filing certified and unaudited financial statements and calculating capital under regulation 1.17.

U.S. COMMODITY FUTURES TRADING COMMISSION

Three Lafayette Centre

1155 21st Street, NW, Washington, DC 20581

Telephone: (202) 418-5000

Facsimile: (202) 418-5521

www.cftc.gov

Division of Swap Dealer and

Intermediary Oversight

Gary Barnett

Director

CFTC Letter No. 13-82

No-Action

December 23, 2013

Division of Swap Dealer and Intermediary Oversight

Re:

Staff No-Action Position Regarding Introducing Brokers’ Compliance with Certain

Financial Reporting and Capital Computation Requirements under Commodity

Futures Trading Commission Regulations 1.10 and 1.17

Introduction

The Commodity Exchange Act (the “Act”)1 and the regulations of the Commodity

Futures Trading Commission (the “Commission”) issued thereunder2 impose various

requirements on persons who are registered, or who are required to register, as introducing

brokers (“IBs”).3 In this letter, and as more fully discussed below, the Division of Swap Dealer

and Intermediary Oversight (the “Division”) is providing no-action relief to certain IBs from

compliance with specified financial reporting and capital computation requirements imposed by

Regulations 1.10 and 1.17, respectively.

1

7 U.S.C. § 1 et seq. The Act may be accessed through the Commodity Futures Trading Commission’s Web site,

www.cftc.gov.

2

17 CFR Part 1 et seq. The Commission’s regulations similarly may be accessed through the Commission’s

Web site

al reporting and capital computation requirements imposed by

Regulations 1.10 and 1.17, respectively.

1

7 U.S.C. § 1 et seq. The Act may be accessed through the Commodity Futures Trading Commission’s Web site,

www.cftc.gov.

2

17 CFR Part 1 et seq. The Commission’s regulations similarly may be accessed through the Commission’s

Web site.

3 An IB is defined under the Act as any person (except an individual who elects to and is registered as an

associated person of a futures commission merchant (“FCM”)) who is registered with the Commission as an IB,

or any person who is engaged in soliciting or in accepting orders for the purchase or sale of: (1) any commodity

for future delivery, security futures product, or swap; (2) any agreement, contract, or transaction described in

section 2(c)(2)(C)(i) of the Act (i.e., certain foreign currency transactions with counterparties that are not

eligible contract participants) or section 2(c)(2)(D)(i) of the Act (i.e., certain leveraged or margined commodity

transactions with counterparties that are not eligible contract participants or eligible commercial entities); (3)

any commodity option authorized under section 4c of the Act; or (4) any leverage transaction authorized under

section 19 of the Act. 7 U.S.C. § 1a(31).

December 23, 2013

Page 2

Background

On July 21, 2010, President Obama signed the Dodd-Frank Act into law.4 Title VII of

the Dodd-Frank Act established a comprehensive new regulatory framework for swaps and

security-based swaps

)

any commodity option authorized under section 4c of the Act; or (4) any leverage transaction authorized under

section 19 of the Act. 7 U.S.C. § 1a(31).

December 23, 2013

Page 2

Background

On July 21, 2010, President Obama signed the Dodd-Frank Act into law.4 Title VII of

the Dodd-Frank Act established a comprehensive new regulatory framework for swaps and

security-based swaps. The new regulatory framework included revising the definition of the

term “introducing broker” under the Act to include persons that engage in soliciting or accepting

orders for the purchase or sale of swaps.5

Revising the IB definition to include the solicitation of, or the acceptance of orders for,

swap transactions, and the subsequent listing of certain energy transactions that previously had

been transacted in the over-the-counter markets as futures contracts by designated contract

markets, has resulted in persons that historically have brokered swap or over-the-counter

transactions outside of the Commission’s jurisdiction to be required to register with the

Commission as IBs. These new IB registrants include persons domiciled in the United States

(“U.S.”) and outside of the U.S.

The Division has received requests for no-action relief from several of these entities that

have recently registered as IBs, or are in the process of registering as IBs.6 Specifically, U.S. and

non-U.S. domiciled IBs have requested relief from the Commission’s capital rule and financial

reporting requirements. A discussion of the no-action requests is set forth below.

Regulation 1.17 Capital Requirements for Introducing Brokers

Regulation 1.17(a)(1)(iii) provides that each person registered as an IB must maintain

“adjusted net capital” equal to or in excess of the greatest of: (1) $45,000; (2) the amount of

adjusted net capital required by a registered futures association of which the IB is a member;7 or,

ion of the no-action requests is set forth below.

Regulation 1.17 Capital Requirements for Introducing Brokers

Regulation 1.17(a)(1)(iii) provides that each person registered as an IB must maintain

“adjusted net capital” equal to or in excess of the greatest of: (1) $45,000; (2) the amount of

adjusted net capital required by a registered futures association of which the IB is a member;7 or,

(3) for IBs that are also registered as brokers or dealers (“BDs”) with the Securities and

Exchange Commission (“SEC”), the amount of net capital required by SEC Rule 15c3-1(a) (17

CFR 240.15c3-1(a)).8 Regulation 1.17 is intended, as discussed below, to require an IB to hold a

sufficient amount of highly liquid assets to cover its total balance sheet liabilities (excluding

certain qualifying subordinated debt).

4

See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

The text of the Dodd-Frank Act also may be accessed through the Commission’s Web site.

5

See section 721of the Dodd-Frank Act.

6

Entities that are registered as IBs and entities that are pending registration as IBs are referred to collectively as

“IBs” in this letter.

7

The National Futures Association (“NFA”) is currently the only registered futures association.

8

An IB that is not also registered with the SEC as a BD is exempt from the capital and financial reporting

requirements if it elects to operate pursuant to a “guarantee agreement” with an FCM. See Regulations

1.17(a)(2)(ii), 1.10(b)(2), and 1.10(j).

to collectively as

“IBs” in this letter.

7

The National Futures Association (“NFA”) is currently the only registered futures association.

8

An IB that is not also registered with the SEC as a BD is exempt from the capital and financial reporting

requirements if it elects to operate pursuant to a “guarantee agreement” with an FCM. See Regulations

1.17(a)(2)(ii), 1.10(b)(2), and 1.10(j).

December 23, 2013

Page 3

The term “adjusted net capital” is defined in Regulation 1.17(c)(5) and generally means

the IB’s net equity or net worth, as computed under U.S. generally accepted accounting

principles (“GAAP”), less illiquid assets (such as property, plant, and equipment), and further

reduced by capital charges to cover the potential market risks of the highly liquid assets.9

Regulation 1.17(c)(2)(ii) also generally provides that an IB, in computing its adjusted net capital,

must exclude unsecured receivables, advances and loans. The Regulation, however, allows an

IB to include unsecured commission receivables due from other brokers or dealers that are

outstanding for no longer than 30 days from their due dates.10 This provision has allowed IBs

that have operated in the futures markets to recognize commission receivables as part of their

adjusted net capital as the IBs historically have been paid their commissions within 30 days of

the due dates.

Several IBs have requested relief from Regulation 1.17. These IBs state that they earn

commission income from brokering transactions for customers that are traditional swap market

participants that are now engaging in both futures transactions and swap transactions. The IBs

also state that the commission payment structure for these customers is significantly different

from the traditional commission structure for the futures markets

ulation 1.17. These IBs state that they earn

commission income from brokering transactions for customers that are traditional swap market

participants that are now engaging in both futures transactions and swap transactions. The IBs

also state that the commission payment structure for these customers is significantly different

from the traditional commission structure for the futures markets. The IBs state that they

typically directly bill customers for commissions earned on both swap and futures transactions,

and that generally they receive payment several months after the commissions are earned and

due. Accordingly, these IBs are required to exclude unsecured commission receivables as

current assets in computing their adjusted net capital.

The IBs also further represent that in many cases part of the commissions that are due

from their customers are required to be passed on to their employees that brokered the

transactions under the terms of the employees’ compensation agreements. Some IBs further

represent that they maintain agreements with their employees that provide that the IBs’

obligation to compensate the employees is contingent upon the receipt of the commissions from

the customers.

The IBs, however, are required to record the liability to their employees under GAAP and

Regulation 1.17(c)(4) when the swap or futures transactions are brokered and the obligation is

due to the IBs’ employees. Therefore, Regulation 1.17 requires the IBs to exclude commission

receivables as a current asset while also requiring the IBs to recognize a liability to its employees

for the portion of such commissions that the employees are entitled to as part of their

compensation agreements

tion 1.17(c)(4) when the swap or futures transactions are brokered and the obligation is

due to the IBs’ employees. Therefore, Regulation 1.17 requires the IBs to exclude commission

receivables as a current asset while also requiring the IBs to recognize a liability to its employees

for the portion of such commissions that the employees are entitled to as part of their

compensation agreements. The IBs request that the Division provide no-action relief such that

the IBs, in computing their adjusted net capital under Regulation 1.17, may reduce their accounts

payable to the extent that the accounts payable to employees derives from commission

receivables from customers which are excluded from current assets, when the IB’s obligation to

9 For example, IBs are required to take capital charges against proprietary securities that are included in the

firms’ computation of adjusted net capital to cover potential market risks with the securities. See 17 CFR

1.17(c)(5)(v).

10 17 CFR 1.17(c)(2)(ii)(B).

December 23, 2013

Page 4

pay the liability to employees is contingent upon the receipt of the commissions from the

customers.

The Division has considered the IBs’ request and has determined that it will not

recommend that the Commission initiate an enforcement action if an IB does not include as a

liability, in computing its adjusted net capital under Regulation 1.17, certain employee

compensation that is associated with commissions due from the IB’s customers for swaps and

futures transactions. The Division’s position is subject to the following conditions for an IB in

computing its adjusted net capital:

(1) The full amount of any unsecured commission receivable that is outstanding more

than 30 days after the due date of the commission receivable must be excluded from

the IB’s current assets in accordance with Regulation 1.17(c)(2)(ii)(B);

omers for swaps and

futures transactions. The Division’s position is subject to the following conditions for an IB in

computing its adjusted net capital:

(1) The full amount of any unsecured commission receivable that is outstanding more

than 30 days after the due date of the commission receivable must be excluded from

the IB’s current assets in accordance with Regulation 1.17(c)(2)(ii)(B);

(2) To exclude a payable to an employee from its liabilities under Regulation 1.17(c)(4),

the related commission receivable must be excluded from the IB’s current assets and

the IB must have executed a written agreement with the employee to which

commissions are payable stipulating that the employee waives the payment of any

commissions from the IB until the IB receives the related commissions from its

customers; and

(3) The IB’s liability for the commission payable to an employee is limited solely to the

proceeds from the related commission receivable.

Accounting Principles Used in Preparing IB Financial Reports

Commission regulations require each IB to file with the NFA: (1) an unaudited financial

Form 1-FR-IB semiannually as of the middle and the close of the IB’s fiscal year;11 and (2) an

audited financial Form 1-FR-IB (i.e., certified annual financial report) as of the close of the IB’s

fiscal year.12 Each unaudited Form 1-FR-IB and certified annual financial report must be

completed in accordance with the instructions to the form and contain: (1) a statement of

financial condition; (2) a statement of income (loss); (3) a statement of changes in ownership

equity; (4) a statement of changes in liabilities subordinated to the claims of general creditors;

and (5) a statement of the computation of minimum capital requirements pursuant to Regulation

1.17.13 The certified annual financial report must further include a statement of cash flows;

appropriate footnote disclosures; and, a reconciliation of the material differences between the

11 Regulation

bordinated to the claims of general creditors;

and (5) a statement of the computation of minimum capital requirements pursuant to Regulation

1.17.13 The certified annual financial report must further include a statement of cash flows;

appropriate footnote disclosures; and, a reconciliation of the material differences between the

11 Regulation 1.10(b)(2)(i). Regulation 1.10(b)(2)(i) further provides that each Form 1-FR-IB must be filed no

later than 17 business days after the date for which the report is made.

12 Regulation 1.10(b)(2)(ii)(A). Regulation 1.10(b)(2)(ii)(A) further provides that each certified annual financial

report must be filed within 90 days of the IB’s fiscal year end, with the exception of IBs that are also registered

with the SEC as BDs, who must file such repots within 60 days of their fiscal year end.

13 See Regulation 1.10(d)(1).

December 23, 2013

Page 5

year-end unaudited and audited statements of minimum capital requirements.14 Furthermore, the

instructions to the Form 1-FR-IB provide that the unaudited and audited financial statements

must be prepared in accordance with GAAP.15

The Division has received a number of inquiries from IBs which have their principal

place of business outside of the U.S. (“Foreign IBs”). Specifically, these Foreign IBs have

requested relief from filing their financial statements under GAAP. Many of these Foreign IBs

have indicated that they currently prepare their financial statements in accordance with

accounting standards prescribed by their home jurisdiction, of which several are either identical

or nearly identical to the International Financial Reporting Standards (“IFRS”) issued by the

International Accounting Standards Board (“IASB”). Several of these Foreign IBs further state

that they are subject to financial reporting requirements by their home country regulators that

require that the financial information be prepared using home country accounting principles

re either identical

or nearly identical to the International Financial Reporting Standards (“IFRS”) issued by the

International Accounting Standards Board (“IASB”). Several of these Foreign IBs further state

that they are subject to financial reporting requirements by their home country regulators that

require that the financial information be prepared using home country accounting principles.

As a consequence of registering as an IB with the Commission, without relief these

Foreign IBs will incur additional, and in some circumstances substantial, costs associated with

either: (i) preparing an additional set of financial statements in accordance with GAAP, or (ii)

otherwise reconciling their financial statements prepared under local accounting principles to

financial statements prepared under GAAP. Further, several of these Foreign IBs have filed with

NFA unaudited financial statements prepared in accordance with local accounting principles that

indicate that the firms are in compliance with the Commission’s minimum capital requirement of

$45,000, as computed under Regulation 1.17.16

The Division notes that the financial reports required in Form 1-FR-IB serve an important

purpose of allowing the Commission and NFA to appropriately evaluate the financial condition

of an IB. For example, the Commission has traditionally regarded certified financial statements

as an important part of its minimum financial and related reporting requirements and the

financial surveillance program.17 Indeed, the Division believes that an accurate reporting of the

financial position of an IB will allow NFA to monitor the IB and highlight areas of financial

concern. In addition, the audited financial statements of an IB provide for an independent

assessment of whether an IB’s financial reporting is consistent with generally accepted

accounting principles and whether an IB meets the Commission’s minimum adjusted net capital

requirement of $45,000

of the

financial position of an IB will allow NFA to monitor the IB and highlight areas of financial

concern. In addition, the audited financial statements of an IB provide for an independent

assessment of whether an IB’s financial reporting is consistent with generally accepted

accounting principles and whether an IB meets the Commission’s minimum adjusted net capital

requirement of $45,000.

14 See Regulation 1.10(d)(2).

15 See Form 1-FR-IB Instruction Manual. See also, National Futures Association, Independent IB Financial

Requirements, available at https://www.nfa.futures.org/NFA-compliance/NFA-introducing-brokers/iib-

financial-requirements.HTML.

16 A preliminary review of these Foreign IBs indicates that the capital computations provided demonstrate a

sufficient amount of highly liquid assets to meet their total balance sheet obligations.

17 See Financial Reporting by Introducing Brokers; Valuation of Investment of Customer Funds by Futures

Commission Merchants, 58 FR 10,949 (Feb. 23, 1993).

December 23, 2013

Page 6

The Division is mindful, however, of the substantial expense that may be incurred by

Foreign IBs as a result of multiple filings (or reconciliations) of financial statements that are

required to be prepared using different accounting standards. The Division further recognizes

that while IBs are market intermediaries, they are prohibited from holding customer funds and

from engaging in proprietary trading, which materially minimizes the risks that IBs may present

to the safety of customer funds.18 In addition, IBs pose minimal risk to the clearing system as

they engage in no proprietary trading and do not guarantee their customers’ financial

performance to a derivatives clearing organization

ntermediaries, they are prohibited from holding customer funds and

from engaging in proprietary trading, which materially minimizes the risks that IBs may present

to the safety of customer funds.18 In addition, IBs pose minimal risk to the clearing system as

they engage in no proprietary trading and do not guarantee their customers’ financial

performance to a derivatives clearing organization.

The Division has considered the IBs’ requests and has determined that it will not

recommend that the Commission commence an enforcement action against a Foreign IB that

files unaudited Forms 1-FR-IB and certified annual financial reports that are not prepared in

accordance with GAAP subject to the following conditions:

(1) The Foreign IB is not a resident of the U.S.;

(2) The Foreign IB is not a corporation, partnership, limited liability company, business

or other trust, association, or any form of enterprise that is organized or incorporated

under the laws of a state or other jurisdiction in the U.S. or having its principal place

of business in the U.S.;

(3) The Foreign IB does not otherwise prepare unaudited or audited financial statements

in accordance with GAAP; and

(4) The Foreign IB files with NFA Forms 1-FR-IB and a certified annual financial report

prepared in accordance with IFRS as issued by the IASB containing the financial

statements and other information required by, and in accordance with the timeframes

established in, Regulation 1.10.

In addition, the Division will not recommend that the Commission commence an

enforcement action against a Foreign IB if the Foreign IB files an unaudited Form 1-FR-IB for

the six-month period ending December 31, 2013, or a certified annual financial report for the

year ending December 31, 2013, in accordance with local accounting principles. This relief is

limited solely to the financial statements that are due as of December 31, 2013

d that the Commission commence an

enforcement action against a Foreign IB if the Foreign IB files an unaudited Form 1-FR-IB for

the six-month period ending December 31, 2013, or a certified annual financial report for the

year ending December 31, 2013, in accordance with local accounting principles. This relief is

limited solely to the financial statements that are due as of December 31, 2013. Any unaudited

Forms 1-FR-IB or certified annual financial reports that are required to be filed by a Foreign IB

with a reporting date after December 31, 2013, must be prepared in accordance with GAAP or

IFRS as issued by the IASB.

18 See Regulation 1.57 which provides, in relevant part, that an IB may not carry proprietary accounts, and may

not accept any money, securities, or property (or extend credit in lieu thereof) to margin, guarantee, or secure

trades of customers.

December 23, 2013

Page 7

Relief from Filing a Certified Annual Financial Report for the Year Ending December 31,

2013

The Division has received requests from several IBs with a fiscal year end date of

December 31, 2013, that had their IB registration applications approved by NFA during the last

several months of calendar year 2013. These IBs request relief from the certified annual

financial report requirements of Regulation 1.10(b)(2)(ii)(A). These IBs generally state that,

prior to registering as IBs, they were not obligated to prepare certified annual financial reports.

The IBs further cite the costs involved in obtaining an initial audit and note that they have been

registered for only a part of calendar year 2013.

The Division has considered these requests and has determined that it will not

recommend that the Commission commence an enforcement action against an IB that does not

file a certified annual financial report for fiscal year ending December 31, 2013, subject to the

following conditions:

obtaining an initial audit and note that they have been

registered for only a part of calendar year 2013.

The Division has considered these requests and has determined that it will not

recommend that the Commission commence an enforcement action against an IB that does not

file a certified annual financial report for fiscal year ending December 31, 2013, subject to the

following conditions:

(1) The IB’s registration must have been approved by NFA during the period October 1,

2013 through December 31, 2013. Any IB whose registration was approved prior to

October 1, 2013, must file a certified annual financial report for the fiscal year ending

December 31, 2013;19

(2) The IB must file an unaudited financial report for the six-month period ending

December 31, 2013, within 17 business days of December 31, 2013, as currently

required by Regulation 1.10(b)(2)(i); and

(3) The IB’s first certified financial report must cover the full period from the effective

date of the IB’s registration through December 31, 2014.

An IB, however, that is otherwise eligible for this no-action relief and prepares a certified

annual financial report for the year ending December 31, 2013, must file such certified annual

financial report with the NFA as required by Regulation 1.10(b)(2)(ii)(A). Such certified annual

financial report may be prepared using GAAP, IFRS, or local accounting principles, as

applicable, provided that if the IB has a certified annual financial report that was prepared using

GAAP, the IB must file such report with the NFA.

Conclusion

This letter, and the positions taken herein, represent the view of DSIO only, and do not

necessarily represent the position or view of the Commission or of any other office or division of

the Commission

local accounting principles, as

applicable, provided that if the IB has a certified annual financial report that was prepared using

GAAP, the IB must file such report with the NFA.

Conclusion

This letter, and the positions taken herein, represent the view of DSIO only, and do not

necessarily represent the position or view of the Commission or of any other office or division of

the Commission. The relief issued by this letter does not excuse persons relying on it from

compliance with any other applicable requirements contained in the Act or in the regulations

19 This no-action letter does not apply to IBs that also are registered with the SEC as BDs, as such IBs are required

to file with the SEC a certified annual financial report for the year ending December 31, 2013.

December 23, 2013

Page 8

issued thereunder. Further, this letter, and the relief contained herein, is based upon the facts

represented to the Division. Any different, changed, or omitted material facts or circumstances

might render this no-action relief void.

Should you have any questions, please do not hesitate to contact Francis Kuo, Attorney-

Advisor, at 202-418-5695, or Joshua Beale, Attorney-Advisor, 202-418-5446.

Very truly yours,

Gary Barnett