[Federal Register Volume 59, Number 248 (Wednesday, December 28, 1994)]
[Unknown Section]
[Page ]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-31827]


[Federal Register: December 28, 1994]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1


Early Warning Reporting Requirements for Futures Commission 
Merchants

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rules.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or 
``CFTC'') is proposing to amend Rule 1.12 to: make paragraph (g), which 
requires the reporting of certain reductions in adjusted net capital, 
applicable to all futures commission merchants (``FCMs''), rather than 
just those FCMs subject to the risk assessment reporting requirements 
of Rule 1.15; require reporting of a margin call that exceeds an FCM's 
excess adjusted net capital which remains unanswered by the close of 
business on the day following the issuance of the call; and require 
reporting by an FCM 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.

DATES: Comments must be received on or before January 27, 1995.

ADDRESSES: Comments on the proposed rules should be sent to Jean A. 
Webb, Secretary of the Commission, Commodity Futures Trading 
Commission, 2033 K Street, N.W., Washington, D.C. 20581.

FOR FURTHER INFORMATION CONTACT: Paul H. Bjarnason, Chief Accountant, 
or Lawrence B. Patent, Associate Chief Counsel, Division of Trading and 
Markets, Commodity Futures Trading Commission, 2033 K Street, N.W., 
Washington, D.C. 20581; telephone (202) 254-8955.

SUPPLEMENTARY INFORMATION:

Background

    On March 1, 1994, the Commission proposed Risk Assessment Rules for 
Holding Company Systems, 59 FR 9689. Certain portions of the rules were 
adopted by the Commission and are published elsewhere in this edition 
of the Federal Register. The proposed rules generally would have 
required, inter alia, FCMs to notify the Commission of certain events 
or transactions that would reduce or potentially reduce an FCM's net 
capital. The triggering events were originally proposed to be included 
in a new Rule 1.15. Several commenters suggested that the reporting of 
certain of these triggering events would more appropriately be part of 
the Commission's existing early warning reporting system set forth in 
Rule 1.12. The Commission agrees. Therefore, although it has adopted as 
part of the risk assessment rulemaking one of the triggering provisions 
relating to declines in capital at the FCM, the final rule is relocated 
in Sec. 1.12(g) of the Commission's early warning rules.\1\ As proposed 
and adopted, this rule would require only those FCMs which are required 
to file reports under Rule 1.15 also to report the triggering event 
specified in Rule 1.12(g). However, certain commenters had suggested 
that this triggering event should be applicable to all FCMs, not just 
those subject to the risk assessment rules. The Commission agrees and 
is hereby proposing to further amend Rule 1.12 to make the reporting of 
capital declines applicable to all FCMs and to make certain other 
changes to the early warning system as an adjunct to its risk 
assessment initiative.
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    \1\The balance of the proposed trigger event provisions remains 
under consideration by the Commission.
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Early Warning Rule

Reportable Events

    The Commission has required FCMs\2\ to report to the Commission and 
to the FCMs' designated self-regulatory organization (``DSRO'') certain 
situations that involve an FCM's financial position, an FCM's 
procedures for safeguarding customer and firm assets, and its ability 
to monitor its financial position through an appropriate system of 
records and reports. The purpose of such reporting is to make the 
Commission and the FCM's DSRO aware of situations that have or 
potentially could have a negative impact on the FCM's ability to carry 
on normal business operations consistent with the Commission's 
prudential requirements and pose a potential threat to customer funds 
or the FCM's financial integrity. Receipt of such notices results in a 
heightened degree of surveillance over the FCM by the Commission and 
the DSRO. The situations to be reported include undercapitalization, 
the FCM's capital falling below its early warning level (i.e., 150 
percent of the minimum required), failure to maintain current books and 
records, the existence of material inadequacies in the FCM's accounting 
systems or internal controls, and the issuance of a margin call 
exceeding the FCM's adjusted net capital. Collectively, these are known 
as the Commission's early warning reporting requirements and are set 
forth in Rule 1.12.
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    \2\Section 1.12 requires reports from FCMs, introducing brokers 
(``IBs''), self-regulatory organizations (``SROs''), and exchange 
clearing organizations depending on the nature of the matter to be 
reported. The current changes relate only to reporting by FCMs. 
There are no changes proposed with respect to reporting requirements 
imposed on IBs, SROs, or clearing organizations.
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Reductions in adjusted Net Capital

    The Commission has now added to the list of reportable events under 
Rule 1.12 a new paragraph (g), requiring that certain FCMs (i.e., those 
FCMs required to file risk assessment reports) report declines in 
capital which may not necessarily result in the FCM being 
undercapitalized or its capital declining below early warning levels, 
but which are sufficiently material to the FCM's regulatory capital as 
to warrant enhanced monitoring by the Commission and the FCM's DSRO. 
The reporting of such an event was initially proposed as a part of the 
Commission's March 1, 1994, rule proposals relating to risk management 
for holding company systems (``risk assessment rules'')\3\ and included 
in Sec. 1.15(b)(2)(i) of those proposed rules. Several commenters noted 
that this reportable event would more appropriately be included in the 
Commission's Sec. 1.12 early warning rule. The Commission has issued 
final rules on certain of the proposed risk assessment rules and in 
that connection, in accordance with these comments, adopted this 
reporting requirement as paragraph (g) of Rule 1.12. This action of the 
Commission is addressed elsewhere in this edition of the Federal 
Register.
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    \3\59 FR 9689.
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    As adopted, Rule 1.12(g) applies only to those FCMs which are 
required to file reports with the Commission under the risk assessment 
rules. Several commenters, including the Futures Industry Association 
and National Futures Association, suggested that the reporting 
requirement now in paragraph (g) be made applicable to all FCMs, not 
just those required to report under Rule 1.15. The Commission agrees 
that this reporting requirement serves to alert the Commission and DSRO 
to potential problems resulting from transactions that affect an FCM 
directly and therefore should not be limited to those FCMs subject to 
the risk assessment rules.4 Since FCMs that believed they were not 
subject to the risk assessment rules may not have taken advantage of 
the opportunity to comment on the Commission's March 1994 risk 
assessment rule proposals, the Commission is publishing this proposed 
change to Sec. 1.12(g) for comment.
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    \4\Certain exchanges have a similar requirement. See Chicago 
Mercantile Exchange (``CME'') Rule 972A; Chicago Board of Trade Rule 
285.03; New York Mercantile Exchange Rule 2.14(d) and Clear- ing 
Rule 9.22(c) (i) and (ii); Commodity Exchange, Inc. Rule 7.08(a); 
Coffee, Sugar and Cocoa Exchange, Inc. Clearing Rule 302(c)(i); 
Kansas City Board of Trade Rule 1311.00; Kansas City Board of Trade 
Clearing Corporation Rule 8.01(c); and Minneapolis Grain Exchange 
Rule 2088.00.
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    The event to be reported, which is set forth in Rule 1.12(g), is 
the occurrence of any transaction or condition that results in a 
reduction of more than 20 percent in the adjusted net capital of the 
FCM from that reported in the most recent financial report filed with 
the Commission pursuant to Rule 1.10. If the decline in adjusted net 
capital is due to activities in the normal course of the FCM's 
business, the reduction is to be reported within two business days 
following the reduction in adjusted net capital. These are events that 
are not normally planned for in advance. However, where a transaction 
or series of transactions is planned to be taken which will reduce 
adjusted net capital by more than 20 percent, the notice must be filed 
at least two business days in advance of the transaction or series of 
transactions. This would permit Commission or DSRO staff to make 
further inquiries concerning the transaction before the transaction is 
effected to assure that the FCM has adequately considered the effect of 
the transaction on its overall liquidity. The rule does not provide for 
Commission approval or disapproval of the transaction prior to the FCM 
effecting the transaction, nor does it provide a means for the 
Commission to delay or prevent the FCM from carrying out the 
transactions.5
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    \5\See Securities and Exchange Commission Rule 240.15c3-1(e)(1), 
17 CFR 240.15c3-1(e)(1) (1994), which requires a securities broker-
dealer to provide notice two business days prior to withdrawals of 
equity capital that on a net basis exceed in the aggregate in any 30 
calendar day period, 30 percent of the firm's excess net capital, or 
two business days after such withdrawals during any 30 calendar day 
period exceed 20 percent of the firm's excess net capital. The 
Commission requests comment as to whether Rule 1.12(g) should 
establish a mechanism by which the Commission could delay or prevent 
an FCM from carrying out the relevant transactions.
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    The Commission's early warning rules relating to an FCM's level of 
capital contemplate that the FCM will have systems in place to monitor 
its capital levels and its compliance with the Commission's net capital 
rules on a day-to-day basis. The Commission requires each FCM to be 
able to demonstrate its capital compliance at any time and not just on 
a required formal computation or filing date.6 Consequently, the 
effect of planned transactions on net capital should be readily 
determinable.
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    \6\See Commission Rules 1.17(a)(3)-(5) and 1.18(b), 17 CFR 
1.17(a)(3)-(5) and 1.18(b) (1994).
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    The initial filing is to be made, pursuant to redesignated Rule 
1.12(h), with the regional office of the Commission with which the FCM 
normally files its financial reports under Rule 1.10, with the 
principal office of the Commission in Washington, D.C., with the FCM's 
designated self-regulatory organization, and with the Securities and 
Exchange Commission if the FCM is also registered as a securities 
broker/dealer. Rule 1.12(g) also provides that, following receipt of a 
notice from an FCM, the Director of the Commission's Division of 
Trading and Markets, or the Director's designee, may request additional 
information concerning the effect of the reported event on the FCM's 
financial or operational condition. The FCM is required to provide such 
additional information within three business days, or sooner if the 
Commission believes prompter filing is needed to address the early 
warning condition and so requests.

Unanswered Margin Calls

    In its March 1994 risk assessment rule proposal, the Commission had 
proposed to adopt Rule 1.15(b)(2)(iii), which would have required an 
FCM to notify the Division of Trading and Markets whenever aggregate 
cumulative losses in all noncustomer accounts exceeded the greater of: 
(A) in any 30-day period, 10 percent of the last reported consolidated 
stockholders' equity of the FCM's parent or $50 million, and (B) in any 
12-month period, 20 percent of the last reported stockholders' equity 
of the FCM's parent or $100 million. The proposal was opposed by a 
number of commenters. Several commenters suggested that, as an 
alternative, an FCM be required to notify the Commission within two 
business days after a margin call to a noncustomer remains outstanding 
for two business days, if the margin call exceeds 20 percent of the 
FCM's adjusted net capital.
    The original proposal was intended to require the reporting of 
holding company group losses that could adversely affect the regulatee, 
and as such the suggestions of the commenters are that a failure to pay 
margin is a proxy for such losses and more readily reportable using 
existing systems. The Commission therefore has determined to propose a 
narrower early warning notice requirement based upon an unsatisfied 
margin call on a customer, noncustomer or omnibus account that exceeds 
the firm's excess adjusted net capital. This notice would augment 
existing notice requirements by identifying potentially delinquent 
margin payments which could affect the firm's integrity. The Commission 
is therefore proposing that it be notified pursuant to paragraph (f)(4) 
of Rule 1.12 if the call to the account owner is not answered by the 
close of business on the day following the day the call is made. The 
Commission would also take account of favorable market moves in 
determining whether the margin call is required to be reported under 
this rule.
    For purposes of this rule, a margin call would be taken to mean any 
deposit of funds required by the FCM to margin, guarantee or secure a 
futures or commodity option position. Thus, if, with respect to an 
exchange-traded contract, the FCM requires a deposit in excess of the 
minimum required pursuant to exchange rules, that greater amount is the 
amount to be used in determining whether a call has been collected from 
an account holder. Although exchanges may exempt firms from the 
requirements of Commission Rule 1.12(f)(3), which requires notice of 
issuance of a margin call in excess of a firm's entire adjusted net 
capital, such waivers would not be permitted from the Rule 1.12(f)(4) 
notice requirement. The Commission also requests additional comment, 
however, on the originally proposed trigger event for which this was 
proposed as an alternative.

Maintenance Margin Factor

    Some commenters on the Commission's risk assessment proposals also 
suggested that the Commission amend Rule 1.12 to add an early warning 
reporting requirement to require an FCM to report to the Commission 
whenever its excess adjusted net capital is less than 6 percent of the 
maintenance margin requirement applicable to positions in proprietary 
and noncustomers' accounts in lieu of certain other reports of losses 
in noncustomer accounts. These commenters noted that the CME imposes 
such a capital requirement on an informal basis on its clearing 
members. The Commission agrees that a similar provision should be 
included on an industry-wide basis as a part of the Commission's early 
warning rule.
    For purposes of proposed paragraph (f)(5), ``maintenance margin'' 
includes all deposits which the FCM requires its noncustomers to 
maintain in order to carry a position at the futures commission 
merchant. With respect to an FCM's proprietary account positions, 
maintenance margin shall mean the amount of funds the FCM is required 
to maintain at the exchange's clearing organization or with its 
clearing broker, or 5 percent of the value of the contract, whichever 
is greater. The Commission requests comment on these standards for 
calculating maintenance margin for purposes of this rule.
    This requirement is intended to address the risk attendant to 
positions not currently subject to the 4 percent and 6 percent factors 
applied to account equity in accounts of customers to establish minimum 
adjusted net capital requirements and early warning capital levels, 
respectively, for an FCM. An FCM that trades for its own account and 
handles accounts of noncustomers currently bears the risk of such 
positions, without any incremental increase in its net capital 
requirement over an FCM that does not do so. The Commission believes 
that that risk should be reflected in the early warning reporting 
requirement, which will represent some measure of that risk and apprise 
the Commission and DSROs that an FCM is carrying positions that bear a 
certain risk but are not factored into the adjusted net capital 
requirement.7
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    \7\The CME currently assesses clearing members an informal 
capital charge based on this amount as do bank regulators for bank-
affiliated FCMs.
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Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA), 5 U.S.C. 601-611 (1988), 
requires that agencies, in proposing rules, consider the impact of 
those rules on small businesses. The rules discussed herein will affect 
FCMs. The Commission already has established certain definitions of 
``small entities'' to be used by the Commission in evaluating the 
impact of its rules on such small entities in accordance with the 
RFA.8 FCMs have been determined not to be small entities under the 
RFA. The Commission believes that the proposals, if adopted, would not 
have a significant economic impact on smaller entities.
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    \8\47 FR 18618-18621 (April 30, 1982).
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    Accordingly, pursuant to Rule 3(a) of the RFA, 5 U.S.C. 605(b), the 
Chairman, on behalf of the Commission, certifies that these proposed 
rules will not have a significant economic impact on a substantial 
number of small entities. The Commission nonetheless invites comment 
from any registered FCM who believes that these rules would have a 
significant impact on its operations.

B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1980 (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. In compliance with the 
PRA the Commission has submitted these proposed rules and its 
associated information collection requirements to the Office of 
Management and Budget. The burden associated with this entire 
collection, including these proposed rules, is as follows:

Average Burden Hours Per Response: 18.00
Number of Respondents: 1,782
Frequency of Response: annually, quarterly and on occasion

The burden associated with these proposed rules, is as follows:

Average Burden Hours Per Response: 1.00
Number of Respondents: 12
Frequency of Response: on occasion

    Persons wishing to comment on the estimated paperwork burden 
associated with this proposed rule 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 Office, 2033 K Street, NW., 
Washington, DC 20581, (202) 254-9735.

List of Subjects in 17 CFR Part 1

    Commodity futures, Commodity options, Prohibited transactions.

    In consideration of the foregoing, and pursuant to the authority 
contained in the Commodity Exchange Act, and in particular Sections 
4f(b), 4f(c), 4g and 8a, 7 U.S.C. 6f(b), 6f(c), 6g, and 12a, the 
Commission hereby proposes to amend Part 1 of Chapter I of Title 17 of 
the Code of Federal Regulations as amended and published as a final 
rule elsewhere in this issue of the Federal Register 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 proposed to be amended by adding paragraphs 
(f)(4) and (f)(5) and by revising the first sentence of paragraph (g) 
introductory text to read as follows:


Sec. 1.12  Maintenance of minimum financial requirements by futures 
commission merchants and introducing brokers.

* * * * *
    (f) * * * (4) A futures commission merchant shall report 
immediately whenever any commodity interest account it carries is 
subject to a margin call, or call for other deposits required by the 
futures commission merchant, that exceeds the futures commission 
merchant's excess adjusted net capital, determined in accordance with 
Sec. 1.17, and such call has not been answered by the close of business 
on the day following the issuance of the call. This applies to all 
accounts carried by the futures commission merchant, whether customer, 
noncustomer, or omnibus, that are subject to margining, including 
commodity futures and options. In addition to actual margin deposits by 
an account owner, a futures commission merchant may also take account 
of favorable market moves in determining whether the margin call is 
required to be reported under this paragraph.
    (5) A futures commission merchant shall report immediately whenever 
its excess adjusted net capital is less than 6 percent of the total of: 
(i) the maintenance margin required by the futures commission merchant 
on all positions held in noncustomer accounts; and (ii) the maintenance 
margin applicable to all positions held in the futures commission 
merchant's proprietary accounts. For purposes of this paragraph, 
maintenance margin shall include all deposits which the futures 
commission merchant requires its noncustomers to maintain in order to 
carry the position at the futures commission merchant. With respect to 
a futures commission merchant's proprietary account positions, 
maintenance margin shall mean the amount of funds the futures 
commission merchant is required to maintain at the exchange's clearing 
organization or with its clearing broker, or 5 percent of the value of 
the contract, whichever is greater.
    (g) A futures commission merchant shall provide written notice of 
any reduction in adjusted net capital in excess of 20 percent of the 
futures commission merchant's adjusted net capital as last reported in 
financial reports filed with the Commission pursuant to Sec. 1.10. * * 
*
* * * * *
    Issued in Washington, D.C. on December 21, 1994, by the 
Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 94-31827 Filed 12-27-94; 8:45 am]
BILLING CODE 6351-01-P