[Federal Register Volume 62, Number 249 (Tuesday, December 30, 1997)]
[Notices]
[Pages 67841-67847]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-33955]


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COMMODITY FUTURES TRADING COMMISSION


Concept Release on the Denomination of Customer Funds and the 
Location of Depositories

AGENCY: Commodity Futures Trading Commission.

ACTION: Request for comment.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'') is 
publishing this release to obtain the views of the public on how to 
address risks related to holding segregated funds offshore or in 
foreign currencies. The Commission wishes to consider how to update and 
otherwise to revise existing regulatory standards to avoid inhibiting 
transnational commodity futures activities or causing undue costs or 
operational inconvenience, without increasing risks to market 
participants. This initiative is part of the Commission's recently 
adopted strategic plan, which includes ensuring ``sound financial 
practices of clearing organizations and firms holding customer funds'' 
and facilitating ``the continued development of an effective, flexible, 
regulatory environment responsive to evolving market conditions.'' 
1
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    \1\ See Vision and Strategies for the Future: Facing the 
Challenges of 1997 through 2002, published by the Commission 
(September 1997).
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    The Commodity Exchange Act (``Act'') 2 requires that all 
money, securities and property received by futures commission merchants 
(``FCMs'') to margin, guarantee, or secure customer trades or contracts 
on domestic contract markets, or accruing to customers as a result of 
these trades or contracts, be segregated. Until 1988, the Commission 
generally required that such money, securities and property 
(hereinafter collectively referred to as ``customer funds'') be held in 
the United States (``U.S.'') with the exception of certain funds held 
on behalf of non-U.S.-domiciled customers.3
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    \2\ 7 U.S.C. 1 et seq.
    \3\ See Commodity Exchange Authority Administrative 
Determination No. 238 (September 4, 1974).
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    In November 1988, the Commission issued Financial and Segregation 
Interpretation No. 12, ``Deposit of Customer Funds in Foreign 
Depositories'' (``Interpretation No. 12'').4 Interpretation 
No. 12 permits customer funds to be held in depositories located 
outside of the U.S., subject to limitations and conditions intended for 
the protection of these funds. At the time Interpretation No. 12 was 
issued, the Commission stated its intention to ``monitor experience 
under this interpretation * * * to alter or supplement the conditions 
for keeping segregated funds offshore as such experience renders 
advisable.'' Various developments since 1988 make it appropriate to 
revisit this area.
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    \4\ 53 FR 46911 (November 21, 1988).

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     Date: Comments must be received on or before March 2, 1998.

FOR FURTHER INFORMATION CONTACT: France M.T. Maca, Special Counsel, 
Division of Trading and Markets, Commodity Futures Trading Commission, 
Three Lafayette Center, 1155 21st Street, N.W. Washington, D.C. 20581. 
Telephone: (202) 418-5482.

Table of Contents

I. Background                                                           
    A. Current Regulatory Requirements                                  
    1. Commodity Regulation                                             
    2. Bankruptcy Regulation                                            
    3. Banking Regulation                                               
    B. Developments Since the Issuance of Interpretation No. 12         
II. Policy Considerations                                               
    A. Goals                                                            
    B. Risks                                                            
III. Potential Approaches                                               
    A. Permissible Denominations of Obligations                         
    1. Alternatives                                                     
    2. Discussion                                                       
    B. Permissible Denominations of Assets                              
    1. Alternatives                                                     
    2. Discussion                                                       
    C. Permissible Locations of Segregated Funds                        
    1. Alternatives                                                     
    2. Discussion                                                       
    D. Qualifications of Depositories                                   
    1. Alternatives                                                     
    2. Discussion                                                       
    E. Segregation and Net Capital Treatment                            
    1. Alternatives                                                     
    2. Discussion                                                       
    F. Bankruptcy Treatment                                             
    1. Alternatives                                                     
    2. Discussion                                                       
IV. A Specific Approach                                                 
V. Request for Comment                                                  
                                                                        

SUPPLEMENTARY INFORMATION:

I. Background

A. Current Regulatory Requirements

1. Commodity Regulation
    The maintenance and location of customer funds is prescribed by 
Section 4d of the Act which requires that each FCM:

    Treat and deal with all money, securities, and property received 
by such [FCM] to margin, guarantee, or secure the trades or 
contracts of any customer of such [FCM], or accruing to such 
customer as the result of such trades or contracts, as belonging to 
such customer. Such money, securities, and property shall be 
separately accounted for and shall not be commingled with the funds 
of such [FCM] or be used to margin or guarantee the trades or 
contracts, or to secure or extend the credit, of any customer or 
person other than the one from whom the same are held.

    It further provides that:

    It shall be unlawful for any person, including but not limited 
to any clearing agency of a contract market and any depository, that 
has received any money, securities, or property for deposit in a 
separate account as provided in paragraph (2) of this section, to 
hold, dispose of, or use any such money, securities, or property as 
belonging to the depositing [FCM] or any person other than the 
customers of such [FCM].

    The Commission's segregation requirements are set forth in 
Regulations 1.20-1.30, 1.32 and 1.36, 17 CFR 1.20-1.30, 1.32 and 1.36. 
They provide, among other things, that a customer's funds: must be 
accounted for separately by the FCM; may not be commingled with the 
FCM's own funds or those of any other person; must be available 
immediately upon demand; and must be used only to margin or to secure 
contracts traded on or subject to the rules of a designated contract 
market. Neither Section 4d of the Act nor these regulations address the 
holding of customer funds offshore or in foreign currencies.
    Interpretation No. 12 permits the deposit of U.S. customer funds 
offshore, subject to conditions intended to ensure consistency with the 
segregation requirements of the Act and ``generally to prevent the 
dilution of customer funds held in segregation in the United States.'' 
Accordingly, Interpretation No. 12 limits the circumstances under which 
funds may be held offshore; requires specified qualifications for 
foreign depositories; requires a certain

[[Page 67842]]

amount of funds to be held in dollars in the U.S.; and requires that 
customers whose funds are deposited offshore subordinate their claims 
against segregated funds to those of customers whose funds are 
deposited in the U.S. or in other currencies.
    More specifically, Interpretation No. 12 permits customer funds, 
including funds of U.S. customers, to be held offshore subject to the 
following conditions:
    1. With respect to U.S.-domiciled customers, only funds held for 
trading contracts that are priced and settled in a foreign currency may 
be held in foreign depositories;
    2. FCMs must segregate sufficient funds in dollars in the U.S. to 
meet all dollar-denominated obligations to customers;
    3. Customer funds may be held only in the country of origin of the 
applicable currency or in a country with which the Commission has an 
information sharing arrangement;
    4. Foreign depositories must meet Commission Regulation 30.7(c) 
criteria; 5 and
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    \5\ These criteria are detailed in Part III C infra.
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    5. FCMs must obtain from customers a subordination agreement 
whereby the customer authorizes the deposit of its funds in a foreign 
depository and subordinates its claim thereto to the claims of 
customers whose accounts are denominated in U.S. dollars.6 
The subordination agreement would be activated in the event the FCM is 
placed in bankruptcy or receivership and there are insufficient 
customer funds available for distribution to satisfy all customer 
claims.
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    \6\ Commission staff has interpreted this requirement to apply 
with respect to funds denominated in foreign currencies, wherever 
held. See, fn. 11 infra and accompanying text.
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2. Bankruptcy Regulation
    Subchapter IV of Chapter 7 of the Bankruptcy Code (11 U.S.C.) 
accords customers of an insolvent commodity broker priority in the 
distribution of customer property:

    The trustee shall distribute customer property ratably to 
customers on the basis and to the extent of such customers' allowed 
net equity claims, and in priority to all other claims, except 
claims * * * attributable to the administration of customer 
property.

    In 1983, the Commission adopted Part 190 of its regulations to 
implement the Bankruptcy Reform Act of 1978.7 Part 190 
recognizes different account classes to permit ``the implementation of 
the principle of pro rata distribution so that the differing 
segregation requirements with respect to different classes of accounts 
benefit customer claimants based on the class of account for which they 
were imposed.'' 8 The account classes are: futures accounts, 
foreign futures accounts, leverage accounts, commodity options 
accounts, and delivery accounts.9 Futures and options 
accounts that trade foreign currency contracts, contain foreign 
currencies, or are located offshore are not recognized as a separate 
account class. The subordination agreement required by Interpretation 
No. 12, in effect, results in these accounts being treated as belonging 
to separate account classes in the event of an FCM's bankruptcy.
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    \7\ 48 FR 8716 (1983).
    \8\ See Part 190 proposal, 46 Fed. Reg. 57535 (1981) (the 
``Proposing Release'').
    \9\ Commodity options accounts do not constitute a separate 
class to the extent they relate to transactions subject to 
regulation under the Act and the Commission's regulations, because 
FCMs are permitted to commingle funds required to be segregated. 
Section 4d(2) of the Act, 7 U.S.C. 6d(2); Commission's Regulations 
190.01 and 1.3(hh).
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3. Banking Regulation
    Prior to 1988, the Board of Governors of the Federal Reserve had a 
policy discouraging banks in the U.S. from accepting deposits of 
foreign currencies. Shortly after the Commission issued Interpretation 
No. 12, in order to address the needs of contracts settled in foreign 
currencies, the Board changed its policy and began to allow banks 
located in the U.S. to accept foreign currency deposits.
    Regulation Q (12 CFR Sec. 217) generally prohibits U.S. banks from 
paying interest on demand deposits. 10 Regulation Q does not 
prohibit foreign branches of U.S. banks from paying interest on demand 
deposits, provided that the U.S. bank does not expressly guarantee 
repayment of the deposits in the U.S.
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    \10\  The Commission requirement that customer funds be 
available upon demand results in these funds being categorized by 
banks as demand deposits. A bill to repeal the prohibition on the 
payment of interest on demand deposits was introduced by Rep. 
Metcalf on July 31, 1997, and is currently pending. See H.R. 2323, 
105th Cong., 1st Sess. (1997).
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B. Developments Since the Issuance of Interpretation No. 12

    At the time Interpretation No. 12 was issued, the Commission stated 
its intention to ``monitor experience under this interpretation * * * 
to alter or supplement the conditions for keeping segregated funds 
offshore as such experience renders advisable.'' Various developments 
since 1988 make it appropriate to revisit this area. First, as noted 
above, when Interpretation No. 12 was issued, U.S. banks generally did 
not hold foreign currencies in the U.S. Therefore, Interpretation No. 
12 does not explicitly address risks related to customer funds 
denominated in foreign currencies and held in the U.S.11 
Second, since 1988, U.S. contract markets have listed many futures and 
option contracts that are priced and settled in foreign currencies. The 
use of foreign currencies in connection with trading these contracts, 
particularly the use of currencies of countries that are major 
financial centers, has become commonplace. Third, trading volume in the 
competing offshore and over-the-counter markets has increased 
dramatically since 1988, raising competitiveness concerns in the 
industry. Fourth, industry sources have expressed the view to 
Commission staff that the subordination requirement of Interpretation 
No. 12 is cumbersome, unnecessarily penalizes customers who deposit 
foreign currencies with FCMs, and is an impediment to access to the 
U.S. futures markets for non-U.S. customers who may be reluctant to 
subordinate their claims.12
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    \11\ However, Commission staff has interpreted the subordination 
requirement of Interpretation No. 12 to be applicable to customer 
funds denominated in foreign currencies, wherever held.
    \12\ Interpretation No. 12 ``has the effect of making overseas 
customers less willing to use U.S. futures markets because it 
imposes a subordination requirement on foreign currency deposits 
that is obsolete in today's global economy * * *.'' (Letter dated 
November 4, 1997, to the Commission from the Chicago Mercantile 
Exchange). A number of brokerage firms interviewed by Commission 
staff in connection with reviewing the requirements of 
Interpretation No. 12 expressed the same view.
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    Finally, several FCMs and a clearing organization have requested 
permission to maintain in offshore accounts customer funds denominated 
in foreign currencies. The FCMs represented that holding funds offshore 
would better serve the needs of their foreign-domiciled clientele. The 
clearing organization contended that it could draw interest on customer 
funds held offshore, which would permit it to be more competitive. 
Interpretation No. 12 allows customer funds to be held offshore only if 
``such funds are used to margin, guarantee, or secure positions in a 
contract traded on a domestic contract market that is priced and 
settled in a foreign currency'' and only with the express consent and 
subordination of the customer. Moreover, Interpretation No. 12 clearly 
states the Commission's belief that ``some constraints are necessary to 
prevent the transfer of funds overseas for reasons unrelated to trading 
in the relevant contracts.'' Accordingly, a clearing organization could 
not move and maintain customer funds offshore except as permitted by 
Interpretation No. 12 or unless it

[[Page 67843]]

obtained relief from the requirements thereof.13
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    \13\ Indeed, on a case by case basis, the Division of Trading 
and Markets has permitted customer funds to be maintained by 
clearing organizations in London and Mexico City.
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II. Policy Considerations

A. Goals

    The protection of customer funds is a cornerstone of the Act and 
the Commission's regulations. Typically, U.S. market participants 
deposit dollars or dollar-denominated assets with their FCM. These 
assets are held in segregation in the U.S. Increasingly, however, there 
appears to be a need or desire to hold customer funds overseas or in 
non-U.S. dollar denominations.
    Historically, the Commission has proceeded with caution in allowing 
customer funds to be held offshore or denominated in foreign currencies 
and intends to continue to do so. Nevertheless, at this juncture, the 
Commission wishes to take a comprehensive look at the needs and 
practices of the industry in evaluating possible revisions of its 
requirements. Three distinct questions must be considered: (1) Whether 
and under what circumstances customers may choose to have segregated 
funds deposited offshore or denominated in foreign currencies; (2) 
whether and under what circumstances FCMs may choose to hold segregated 
funds offshore or in foreign currencies; and (3) whether and under what 
circumstances clearing organizations may choose to hold segregated 
funds offshore or in foreign currencies.
    In each case, the extent of the need or desire for holding customer 
funds offshore or in foreign currencies must be assessed against the 
related risks. Risk limiting measures must be considered, and the 
question of who should bear the risks that cannot be eliminated must be 
explored. One of the premises of Interpretation No. 12 is that 
customers whose accounts are denominated in U.S. dollars must be 
insulated from the risks resulting from an FCM holding funds offshore 
or in foreign currencies. The continuing viability of this premise has 
been questioned by some industry participants.
    The Commission encourages commenters to describe their current 
practices and to provide a detailed analysis of the reasons for their 
desire or need to keep segregated funds offshore. Commenters should 
discuss related risks and how these risks should be addressed for the 
protection of customers. Commenters should also explain how revisions 
to the current requirements could affect their business.

B. Risks

    Holding segregated funds offshore or in foreign currencies creates 
three types of risk:

--currency risk;
--depository risk; and
--sovereign risk.
    Currency risk arises when an obligation is denominated in one 
currency and the asset held to meet that obligation is in another 
currency. Fluctuations in exchange rates can cause the amount of the 
obligation to change at a different rate than the value of the asset, 
thereby resulting in insufficient funds in segregation to meet the 
obligation.
    Depository risk is the danger that a depository holding customer 
funds may be unable or unwilling to release those funds on demand. This 
risk, of course, exists with domestic depositories but contains 
additional elements overseas, particularly insofar as the Commission's 
knowledge of, or authority over, foreign depositories may be less.
    Sovereign risk is the chance that a foreign government might take 
action preventing a depository or an FCM from releasing customer funds 
despite the requirements of Section 4d of the Act.

III. Potential Approaches

    This part of the concept release sets forth a number of possible 
methods to address the risks described above and the issues that have 
arisen since Interpretation No. 12 was issued. Some of the listed 
methods are existing requirements; others are measures suggested by 
industry members or devised by Commission staff. The listing of 
potential approaches in this concept release is designed only to elicit 
public comment. It is not intended as an endorsement or to indicate a 
willingness on the part of the Commission to adopt these approaches or 
to abandon existing provisions.
    The Commission requests commenters to indicate their preferred 
alternatives from among those listed or to suggest other methods. The 
alternatives are organized into six categories. These categories 
represent potential avenues for dealing with the risks described above. 
They are:
--the permissible denominations of FCMs' obligations to their 
customers;
--the permissible denominations of assets held in segregation;
--the permissible locations of segregated funds;
--the qualifications of non-U.S. depositories;
--the segregation and net capital treatment of customer funds held 
offshore or in foreign currencies; and
--the bankruptcy treatment of these funds.

    The first five categories above primarily involve steps that could 
reduce risks. The last category involves steps that could be taken to 
allocate losses equitably in the event that shortfalls in segregated 
funds nevertheless occur. The list of potential choices in each area of 
intervention generally proceeds from most restrictive to least 
restrictive. Each option may address more than one type of risk, and 
choices within one section are not necessarily mutually exclusive. 
Moreover, a choice under one area may affect a choice in another. For 
example, choices under section C, relating to countries where 
segregated funds may be held, must be made in conjunction with related 
requirements under section E, regarding the segregation treatment of 
customer funds. Each section is followed with a brief discussion of the 
potential impact of listed choices. A variety of overall approaches can 
be constructed by selecting different combinations.
    Because the Commission generally favors an approach that emphasizes 
prophylactic measures, most listed choices are intended to reduce 
relevant risks. However, the Commission recognizes that all risks 
cannot be prevented. Accordingly, possible procedures also are included 
to alleviate the consequences of residual risks, i.e., any risks that 
cannot be effectively eliminated.

A. Permissible Denominations of Obligations

1. Alternatives
    An FCM's obligation to a customer may be denominated in a currency 
other than U.S. dollars:
    a. In connection with contracts priced and settled in that 
currency.
    b. (i) In connection with contracts priced and settled in that 
currency; or (ii) if the customer is domiciled overseas.
    c. If the currency is acceptable for margin purposes on a U.S. 
contract market.
    d. With the customer's written authorization.
    e. Other, please specify.
2. Discussion
    As noted above, because currencies fluctuate at different rates, 
where obligations are denominated in one currency and assets held to 
meet these obligations are denominated in another,

[[Page 67844]]

an imbalance may result between assets and obligations resulting in 
insufficient funds in segregation to meet the obligations. Accordingly, 
the denomination of both assets and obligations to customers must be 
considered.
    Discussions with participants in the industry indicate that, under 
current practices, the agreement signed by a customer opening an 
account with an FCM usually specifies either that obligations to the 
customer are in U.S. dollars, unless otherwise agreed, or that the 
customer will be paid in the currency it deposits or in which any 
earnings are accrued. The discussions also indicate, however, that 
these principles are not uniformly applied and indeed that some FCMs 
may not have a clear agreement with their customers regarding the 
currencies in which customers are to be paid. This should be clarified 
as it may ultimately dictate whether gains and losses resulting from 
currency fluctuations will accrue to, or be borne by, the FCM or its 
customers. The choices made for this section must be considered in 
close conjunction with those made for the next section relating to 
permissible denomination of assets.

B. Permissible Denominations of Assets

1. Alternatives
    Assets held in segregation may be denominated in a foreign currency 
only:
    a. In connection with contracts priced and settled in that 
currency.
    b. (i) In connection with contracts priced and settled in that 
currency; or (ii) if the customer is domiciled overseas.
    c. If the currency is acceptable for margin purposes on a U.S. 
contract market.
    d. With the customer's written authorization.
    e. Other, please specify.
2. Discussion
    Current Interpretation No. 12 permits the deposit offshore of funds 
``used to margin, guarantee, or secure positions in a contract traded 
on a domestic contract market that is priced and settled in a foreign 
currency or accrue to such a customer as a result of positions in such 
contracts.'' Provided that FCMs recompute the asset/obligation balance 
on a daily basis, any choice above would effectively address currency 
risk. Absent a requirement to rebalance asset/obligations daily, only 
choice (a) could result in a ``natural'' balance. The other choices 
would not ensure the continuous balance of assets and 
obligations.14 Commenters should indicate whether 
alternatives (b), (c), and (d) should be limited further to specific 
currencies.
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    \14\ However, potential imbalances would be mitigated by other 
measures such as a requirement that FCMs take a haircut in their net 
capital computation for any unhedged foreign currencies. See Part 
III E infra. 
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C. Permissible Locations of Segregated Funds

    1. Alternatives
    Segregated funds may be held at an approved depository in any of 
the following geographic locations (commenters should choose the 
appropriate combination):
    a. The U.S.
    b. The country of origin of the currency in which the related 
contract is priced and settled.
    c. A country with which the Commission has an information sharing 
arrangement.15
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    \15\ The Act enables the Commission to enter into various types 
of cooperative arrangements with foreign futures authorities. See, 
e.g., Sections 8(a)(1) and 12(f)(2) of the Act.
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    d. For a limited period of time, the country in which the customer 
is domiciled, and only for operational ease in receiving and disbursing 
funds from and to customers living in foreign countries and trading on 
U.S. contract markets.
    e. Without time limitation, the country of domicile of the 
customer.
    f. The G7 countries (plus Switzerland).16
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    \16\ The G7 is a group of industrialized countries. It includes: 
the U.S., Canada, France, Germany, Italy, Japan and the United 
Kingdom. For purposes of determining major money centers, 
Switzerland is often added to the list.
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    g. Some or all of the twenty-four countries that the Securities and 
Exchange Commission (``SEC'') considers as major money 
centers.17
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    \17\ SEC no action letter from Michael Macchiaroli to Douglas 
Preston of the Securities Industry Association [1992 Transfer 
Binder], SEC Rep. (CCH) para. 76,245 (August 21, 1992). Subject to 
certain conditions, the Market Regulation Division would not 
recommend any enforcement action against broker dealers who hold 
money market instruments in a ``major money market'' if they do not 
take a one hundred percent haircut on these instruments in 
calculating net capital under Rule 15c3-1 of the Securities Exchange 
Act of 1934. The letter lists twenty-four countries that are 
considered as major money markets. These countries are: Australia; 
Austria; Belgium; Canada; Denmark; Finland; France; Germany; Greece; 
Hong Kong; Ireland; Italy; Japan; Luxembourg; the Netherlands; New 
Zealand; Norway; Portugal; Singapore; Spain; Sweden; Switzerland; 
the United States; the United Kingdom.
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    h. Other, please specify.
2. Discussion
    Choice (a), requiring funds to be held in the U.S., is more 
restrictive than the current Interpretation No. 12 approach. This 
choice is more viable now than it was at the time Interpretation No. 12 
was issued because, as noted above, in the interim, the Federal Reserve 
changed its policy concerning foreign currency deposits in the U.S. 
Nevertheless, the Commission recognizes that it could impose additional 
costs on the industry. The requirement that segregated funds be held in 
the country of origin of the currency (choice (b)) is a current 
Interpretation No. 12 requirement. Under choice (b), an increase in the 
number of currencies in which contracts traded in U.S. contract markets 
settle would automatically trigger additional countries as permissible 
segregated funds locations.18 This choice may result in 
countries being added and taken off the list of permissible locations 
based on contract designations at any given time.
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    \18\ When Interpretation No. 12 was issued, no contracts priced 
and settled in a foreign currency were traded on U.S. contract 
markets. However, two applications were pending before the 
Commission for designation of such contracts. Currently, many 
contracts that margin and settle in foreign currencies are traded on 
U.S. contract markets.
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    Choice (c) also reflects current Interpretation No. 12. In 1988, 
the Commission had an information sharing arrangement with the 
Australian National Companies and Securities Commission and with the 
United Kingdom Securities and Investments Board. The Commission 
currently has information sharing or cooperation arrangements with 
regulators of over fifteen foreign jurisdictions. While the existence 
of a framework of cooperation with the Commission is a positive factor, 
other factors, such as economic and political soundness of the country, 
also are important. Choices (f) and (g) would limit possible depository 
countries to countries generally considered to be secure and to have 
sophisticated regulatory regimes. Alternative (e) would permit FCMs to 
hold customer funds offshore for operational convenience in any country 
where an FCM's customer is domiciled.

D. Qualifications of Depositories

1. Alternatives
    To qualify to hold segregated funds, a depository must provide the 
depositing FCM the segregation acknowledgment required by Commission 
Regulation 1.20 and:
    a. Must be located in the U.S.
    b. If located offshore, must have a branch or correspondent in the 
U.S. which guarantees repayment in the U.S. in the event the foreign 
depository fails to fulfill its obligation for any reason.

[[Page 67845]]

    c. If located offshore, must have a branch or correspondent in the 
U.S. which guarantees repayment in the U.S. in the event the foreign 
depository fails to fulfill its obligation for any reason other than 
sovereign action.
    d. If located offshore, must be an FCM or a designated bank or 
trust company as defined in Advisory 87-5.19
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    \19\ Pursuant to CFTC Advisory 87-5 (1987-1990 CCH Transfer 
Binder para. 23,997), FCMs are required to disclose on their Form 1-
FR the identity of offshore depositories. Any bank or trust company 
located outside the U.S. whose commercial paper or long term debt is 
rated in one of the two highest rating categories by Standard & 
Poors Corporation or Moody's Investors Service, Inc. is deemed 
automatically recognized. FCMs must submit an application for 
recognition of other non-U.S. located banks and trust companies not 
meeting this standard. Such banks or trust companies are deemed 
recognized unless the Division gives the FCM notice to the contrary 
within 60 days following receipt of the application. No such 
application has been received.
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    e. Some combination of the elements of alternatives (a) through d.
    f. Other, please specify.
2. Discussion
    Alternative (d), which relies on the commercial paper or long term 
debt rating of foreign depositories, is the current Interpretation No. 
12 requirement. Alternative (b) would effectively address location risk 
(both sovereign and depository risks) by requiring a repayment 
guarantee in the U.S. whatever the cause of the shortfall. However, as 
noted above, it appears that banks would not be allowed to pay interest 
if an unconditional guarantee were given. Accordingly, choice (b) would 
be unsatisfactory where customer funds are held offshore for the 
purpose of yielding interest. Alternative (c) would address only 
depository risk.

E. Segregation and Net Capital Treatment

1. Alternatives
    a. Customer funds must be segregated only in accounts payable in 
the U.S. No account located or payable outside the U.S. is considered 
an acceptable segregated deposit.
    b. A percentage of excess segregated funds on deposit in non-U.S. 
locations (e.g., ten to twenty-five percent) may be recognized as good 
segregated assets.
    c. Only funds received from foreign-domiciled customers may be held 
offshore. However, they will not be considered to be properly 
segregated.
    Segregated funds may be held offshore and/or in foreign currencies:
    d. Provided that sufficient funds are held in each currency to meet 
all obligations in that currency, as computed daily.
    e. Provided that sufficient U.S. dollars are segregated in a U.S. 
depository to meet all U.S. dollar obligations. To the extent other 
currencies are segregated in foreign depositories, excess U.S. dollars 
(e.g., 10%) must be held in the U.S. as a cushion.
    f. Provided that alternative sources of funding such as dedicated 
lines of credit, in a form acceptable to the Commission, are available 
to cover shortfalls or delays in payment.
    g. Some combination of the elements of alternatives (c) through 
(e).
    h. Other, please specify.
2. Discussion
    Under alternative (a), funds deposited by customers for trading on 
U.S. contract markets would be held in the U.S. only. This is founded 
on the proposition that futures and options positions are carried in 
the U.S., and therefore, the need for these funds, for variation 
settlements and for standing margin is in the U.S. Having these funds 
in the U.S. ensures that the funds will be available and subject to 
U.S. law in the event of insolvency and that they will be distributed 
according to the Bankruptcy Code and the regulations thereunder.
    Alternative (b) would recognize a percentage of excess segregated 
funds held offshore as properly segregated. All other segregated funds 
would be required to be held in the U.S. Alternative (c) would set no 
limit on the amount of foreign-domiciled customer funds held in 
offshore locations; however, these funds would not be recognized as 
good segregated funds. Under alternative (d) customer funds could be 
properly segregated offshore, subject to daily balancing of assets and 
obligations in each currency. This would address currency risk, but not 
location risk. Under alternative (e), all dollar obligations would be 
matched by U.S. dollars held in segregation in the U.S. An FCM could 
hold foreign currencies in segregation. As a protection against 
currency rate fluctuations, however, the FCM would be required to hold 
additional U.S. dollars in the U.S. Alternatives (a) through (e) all 
are intended to prevent the occurrence of shortfalls. Alternative (f) 
provides a method to cover shortfalls should they occur. As noted, 
these alternatives are not necessarily mutually exclusive.

F. Bankruptcy Treatment \20\

1. Alternatives
    a. Customers whose funds are held offshore or in foreign currencies 
must subordinate their claims against these funds to those of customers 
whose funds are segregated in the U.S. and in U.S. dollars in the same 
manner as under current Interpretation No. 12.
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    \20\ As noted above, the special provisions of the Bankruptcy 
Code applicable to the bankruptcy of commodity brokers generally 
require that in the event of the bankruptcy or insolvency of an FCM 
all segregated funds be distributed on a pro rata basis to customers 
of the same class.
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    b. Customers whose funds are held offshore or in foreign currencies 
must subordinate their claims against these funds to those of customers 
whose funds are segregated in the U.S. and in U.S. dollars in the same 
manner as in Appendix B to the Commission's Bankruptcy 
regulations.21
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    \21\ 17 C.F.R. 190 Appendix B. Appendix B, which governs the 
distribution of property where a bankrupt FCM holds cross-margin 
funds, while intended to assure that non-cross-margining customers 
of such an FCM will not be adversely affected by a shortfall in the 
pool of cross-margining funds, modified the applicable 
distributional rules such that the required subordination is more 
limited.
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    c. Customers whose funds are held offshore or in foreign currencies 
must subordinate their claims against these funds to claims of 
customers whose funds are segregated in the U.S. and in U.S. dollars in 
the event there are shortfalls as a result of sovereign action. 
22
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    \22\ Some industry members believe that the risk that a foreign 
government would freeze deposits within its borders is ``remote, 
especially when dealing with the major global currencies.'' They 
recommend that the Commission exempt deposits of the major 
currencies, wherever held, from all aspects of Interpretation No. 
12. See letter dated October 16, 1997, to Chairperson Born from the 
Chicago Board of Trade.
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    d. In the event of bankruptcy of an FCM or foreign depository, 
segregated funds in each currency will constitute a separate pool, and 
each customer will recover to the extent that there are funds in the 
pool against which the customer holds a claim.
    e. In the event of bankruptcy of an FCM or foreign depository, all 
segregated funds will constitute a single pool and will be distributed 
pro rata without regard to the location or denomination of these funds.
    f. Other, please specify.
2. Discussion
    The majority of measures considered earlier in this release were 
intended to minimize risks. This section deals with apportioning losses 
should they occur. Alternative (a) is the requirement of current 
Interpretation No. 12. As noted

[[Page 67846]]

above, to ensure that in the event of an FCM bankruptcy customers whose 
funds are held in the U.S. and in U.S. dollars will not share pro rata 
in possible shortfalls in customer funds held offshore, Interpretation 
No. 12 requires that customers who deposit funds denominated in a 
foreign currency subordinate their claims to those of customers with 
U.S. dollar claims. Alternative (b) would use the same device in a 
manner that would be less adverse to customers with funds denominated 
in foreign currencies. Under alternative (c), the subordination would 
be activated only in the event shortfalls resulted from sovereign 
action. Other losses would be shared pro rata.
    Alternative (d) would pay each customer a pro rata share of the 
currency pool(s) against which it had a claim. In certain 
circumstances, this alternative could be inequitable to customers with 
foreign-denominated claims. For example, the bankruptcy of a depository 
could result in shortfalls in foreign currencies of the type held by 
the depository. Under this alternative, the shortfalls would be shared 
only by customers with claims against those currencies. However, some 
of these customers may not have had funds in that depository or any 
responsibility for its selection.
    As noted above, the Bankruptcy Code and regulations require pro 
rata sharing among customers in each account class. Accordingly, this 
alternative would require the Commission to amend its bankruptcy 
regulations to define each currency pool as a separate account class. 
By sharing all available customer funds among all customers without 
regard to the segregation locations, alternative (e) furthers the view 
that shortfalls should be shared among all customers without regard to 
the denomination or location of customer funds.

IV. A Specific Approach

    To illustrate the interrelationship of choices under the various 
headings and to assist the Commission further in reaching a resolution 
of the issues, staff has prepared a specific formulation combining 
choices from each category.23 The Commission is not 
endorsing this approach at this time, but the Commission believes that 
receiving comments on it would provide a valuable supplement to the 
other comments. This approach would address the concern that current 
regulatory standards may impede access to the U.S. futures market by 
eliminating the subordination agreement currently required by 
Interpretation No. 12. To facilitate the receipt of funds from offshore 
customers, this approach, however, would permit FCMs to maintain 
operating accounts in non-U.S. depositories. Under this approach:
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    \23\ This approach combines, with some modifications, choices 
(A)(1)(c), (B)(1)(c), (C)(1)(a), (D)(1)(a), (E)(1)(a), and 
(F)(1)(a).

--Funds used by an FCM to meet its obligations to customers who trade 
on U.S. contract markets must be segregated in accounts payable in the 
U.S. That is, no account located or payable outside of the U.S. would 
be considered an acceptable segregated depository. In addition:
--As an operational convenience, an FCM would be permitted to receive 
commodity margin funds into non-U.S. accounts from customers located 
outside the U.S. However, funds in these accounts would not be 
recognized as segregated assets. This means that customer funds in 
accounts located outside of the U.S. would not have to be transferred 
to the U.S. An FCM would be considered in compliance with the 
segregation rules as long as there were sufficient funds segregated in 
the U.S. to cover its obligations to all of its customers, including 
the non-U.S. customers whose funds had not yet been transferred to the 
U.S.
--A deposit of any customers' funds into an account outside of the U.S. 
would result in an increase in the FCM's segregated liability to its 
customers. The FCM's excess segregated funds would be used to cover the 
credit to the customer's account. This coverage must be made 
immediately upon receipt of the funds in the non-U.S. account.
--An FCM would be permitted to recognize as segregated assets foreign 
currencies credited to the FCM in segregated foreign currency accounts 
with banks located in the U.S. as long as the account balances were 
payable in the U.S. The non-U.S. currencies which would be recognized 
as segregated assets would be limited to those foreign currencies which 
would have been identified as acceptable for margin purposes by the 
contract markets on which the FCM's customers trade.
--An FCM must take appropriate action to maintain a balance between the 
currencies it had in segregated accounts and its obligations to 
customers denominated in the same foreign currency. To achieve this, an 
FCM must perform a daily calculation of the balance between its foreign 
currency deposits and its obligations to its customers in those 
currencies, including U.S. dollars. This calculation must be performed 
as part of the daily segregation calculation. Imbalances must be 
corrected by the day following the ``as of'' date of the calculation. 
An appropriate capital charge must be taken on any imbalances, pursuant 
to the Commission's net capital rule, regardless of any rebalancing 
achieved the following day.

    This approach would not compel an FCM to transfer any funds into 
the U.S., provided the FCM had sufficient excess segregated assets in 
the U.S. FCMs could maintain accounts in non-U.S. locations and use 
such accounts to take in deposits from foreign-domiciled customers and 
to make disbursements. However, the funds contained in these accounts 
would not count towards meeting the FCM's segregated liability. 
Although funds in these accounts would not qualify as good segregated 
funds, they could qualify for net capital purposes, provided the 
accounts met the requirements of the net capital rule, which are less 
stringent than those of the segregation rule.

V. Request for Comment

    The Commission requests comment on the need for and effectiveness 
of the various alternatives and, in particular, on the ``specific 
approach.'' In formulating their choices, commenters should consider 
the following factors: (a) FCMs increasingly have a customer base 
offshore; (b) U.S. banks are currently prohibited by the Board of 
Governors of the Federal Reserve from paying interest on demand 
deposits while unguaranteed offshore deposits may yield interest; (c) 
some U.S. depositories are reluctant to hold a substantial amount of 
foreign currencies; (d) as the volume of contracts that are priced and 
settled in foreign currencies increases, the need to deposit customer 
funds denominated in foreign currencies also increases; (e) the 
enforceability of the subordination agreement has not been tested and 
is not clear in the event of a bankruptcy adjudicated by a non-U.S. 
court; and (f) other steps outside the Commission's purview could help 
reduce the risks related to customer funds held offshore or in foreign 
currencies, such as steps to facilitate the movement of foreign 
currencies through the Fedwire.
    The Commission encourages commenters to provide information on 
their current business practices and how they could be affected by the 
methods listed in this release and any additional

[[Page 67847]]

methods they propose. The Commission also requests comment on the 
practicality of the various methods.
    Finally, the Commission requests comment on whether it is 
appropriate to allow exchanges and/or clearing organizations to hold 
customer funds offshore without the customers' express authorization 
and without a direct operational necessity. If so, commenters should 
indicate what conditions and limitations should be imposed. The 
Commission welcomes any cost-benefit analysis commenters care to 
provide in support of their choices.
    The Commission requests that commenters, in making their choice 
among the proposed alternatives or in indicating other alternatives, 
clearly indicate whether the provision should apply at the FCM level 
and/or at the clearing level. The Commission will give serious 
consideration to the comments in determining an appropriate manner in 
which to revise the requirements set forth in Interpretation No. 12. 
The Commission wishes: (a) To facilitate access to the United States 
markets for the growing international customer base using them; (b) to 
reduce the regulatory burden, where practicable, on FCMs and clearing 
organizations that accept customer deposits in foreign denominations 
and use foreign depositories; and (c) to maintain the safety of 
customer funds.

    Issued in Washington, DC on December 23, 1997, by the 
Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 97-33955 Filed 12-29-97; 8:45 am]
BILLING CODE 6351-01-P