[Federal Register: October 11, 2005 (Volume 70, Number 195)]
[Proposed Rules]
[Page 58985-58999]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr11oc05-9]
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Proposed Rules
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains notices to the public of
the proposed issuance of rules and regulations. The purpose of these
notices is to give interested persons an opportunity to participate in
the rule making prior to the adoption of the final rules.
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[[Page 58985]]
COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 145 and 147
RIN 3038-AC19
Alternative Market Risk and Credit Risk Capital Charges for
Futures Commission Merchants and Specified Foreign Currency Forward and
Inventory Capital Charges
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rules.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is issuing this release to propose amendments to Commission
rules that impose minimum financial and related reporting requirements
upon each person registered as a futures commission merchant (``FCM'').
Pursuant to rule amendments that became effective in August of 2004,
the Securities and Exchange Commission (``SEC'') has established a
method for securities brokers or dealers (``BDs'') that voluntarily
elect SEC consolidated supervision for their ultimate holding companies
and affiliates, and that also meet specified minimum capital and other
requirements, to request approval to use internal mathematical models
to determine their capital deductions for market risk and credit risk
associated with their proprietary trading assets. Under the rule
amendments that are proposed in this release, FCMs that are also BDs
(``FCM/BDs'') would have the option, subject to the reporting and other
requirements that are specified in the proposed rulemaking, of electing
to compute their adjusted net capital using their SEC-approved
alternative market risk and credit risk capital deductions in lieu of
CFTC requirements. The Commission is also proposing other rule
amendments that address confidential treatment for the reports and
statements that would be required to be filed under the proposed
amendments, and also to address the confidential treatment of certain
other information that all FCM/BDs must file with both the Commission
and the SEC.
Finally, the Commission is also proposing rule amendments in this
release that would amend the minimum financial requirements of FCMs and
introducing brokers (``IBs'') by reducing the capital deductions for
their uncovered inventory or forward contracts in specified foreign
currencies. The proposed reduction is consistent with guidance
currently provided by the Commission to FCMs and IBs.
DATES: Comments must be received on or before November 10, 2005.
ADDRESSES: You may submit comments, identified by RIN 3038-AC19, by any
of the following methods:
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
E-mail: secretary@cftc.gov. Include ``Proposed Amendment
to Rule 1.17'' in the subject line of the message.
Fax: (202) 418-5521.
Mail: Send to Jean A. Webb, Secretary of the Commission,
Commodity Futures Trading Commission, 1155 21st Street, NW., Washington
DC 20581.
Courier: Same as Mail above.
All comments received will be posted without change to http://www.cftc.gov
, including any personal information provided.
FOR FURTHER INFORMATION CONTACT: Thomas J. Smith, Associate Deputy
Director and Chief Accountant, at (202) 418-5430, or Thelma Diaz,
Special Counsel, at (202) 418-5137, Division of Clearing and
Intermediary Oversight, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street, NW., Washington, D.C. 20581.
Electronic mail: (tsmith@cftc.gov) or (tdiaz@cftc.gov).
SUPPLEMENTARY INFORMATION:
I. Background
A. Capital Charges for Proprietary Trading Assets
Commission Rule 1.17(a) requires each FCM to maintain a minimum
amount of ``adjusted net capital'', which is defined as the FCM's net
capital less the deductions, or ``haircuts'', that are specified in
Rule 1.17(c)(5) and (8).\1\ For purposes of the required haircuts on
the FCM's proprietary positions in securities, Rule 1.17(c)(5)
incorporates by reference percentage deductions that are set forth in
SEC regulations 17 CFR 240.15c3-1(c)(2)(vi) and (vii).\2\ Also,
Commission Rule 1.17(c)(2)(ii), in a manner similar to the SEC's
requirements for BDs under 17 CFR 240.15c3-1(c)(2)(iv), requires
unsecured receivables arising from an FCM's transactions in over-the-
counter (``OTC'') derivatives to be excluded from the FCM's current
assets for purposes of determining the firm's regulatory capital. The
deductions required for other proprietary assets of the FCM are set
forth in other parts of Commission Rule 1.17(c).
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\1\ The rules of the Commission cited in this release may be
found at 17 CFR Ch. I (2005). SEC rules cited in this release may be
found at 17 CFR Ch. II (2005).
\2\ Commission Rule 1.17(c)(5)(v) provides that the haircuts for
an FCM's proprietary securities are ``the percentages specified in
Rule 240.15c3-1(c)(2)(vi) of the Securities and Exchange Commission
(17 CFR 240.15c3-1(c)(2)(vi)) (`securities haircuts') and 100
percent of the value of `nonmarketable securities' as specified in
Rule 240.15c3-1(c)(2)(vii) of the Securities and Exchange Commission
(17 CFR 240.15c3-1(c)(2)(vii)).''
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The Commission and SEC have, to the extent practical, harmonized
their respective capital rules in order to avoid creating inconsistent
regulatory obligations for firms that are dually-registered FCMs and
BDs. This harmonization of capital rules extends to the computation of
net capital and adjusted net capital, and to the qualifications that
subordinated debt must meet in order to qualify as regulatory capital.
Furthermore, if an FCM is also registered as a BD, it may file an SEC
Form X-17a-5, ``Financial and Operational Combined Uniform Single
Report'' (``FOCUS Report'') to satisfy its requirement to file with the
Commission a Form 1-FR-FCM financial report. In particular, Commission
Rule 1.10(h) treats Part II and Part IIA of the FOCUS report as
acceptable substitutes for the Form 1-FR-FCM, provided that the FOCUS
report includes all information required to be furnished on and
submitted with Form 1-FR-FCM. Also, for those portions of the Form 1-
FR-FCM that the Commission has designated as either publicly available
or as exempt from mandatory public disclosure for purposes of the
Freedom of Information Act and the Government in the Sunshine Act, the
Commission extends
[[Page 58986]]
the same treatment to those portions of the FOCUS Report that are
equivalent to the Form 1-FR-FCM. The uniform capital computations, and
related single-form filing requirements, harmonize the regulatory
requirements imposed upon dual registrants while providing the
Commission and SEC with the necessary financial information to assess
whether firms maintain a minimum level of regulatory capital while
engaging in futures and securities businesses.
B. SEC Amendments To Establish Alternative Capital Deductions
On June 21, 2004, the SEC adopted final rule amendments to its
capital rules to provide an ``alternative net capital computation for
broker-dealers that voluntarily elect to be supervised on a
consolidated basis,'' (the ``Alternative Capital Computation'').\3\ As
amended, SEC Rule 15c3-1(a)(7), (17 CFR 240.15c3-1(a)(7)), provides
that the SEC may approve a BD's application, if submitted in accordance
with the provisions of a new Appendix E (17 CFR 240.15c3-1e), for
approval to use the Alternative Capital Computation when calculating
its net capital. To the extent approved by the SEC, the BD using the
Alternative Capital Computation would compute a total ``deduction for
market risk'' for positions in the proprietary accounts of the BD, in
accordance with the specific standards set forth in Appendix E (the
standards are discussed in Part II of this release). The BD would
calculate its regulatory capital using this deduction in lieu of the
haircuts that SEC Rules 15c3-1(c)(2)(vi) and (c)(2)(vii) require for
the BD's positions in securities.\4\ The SEC may also approve
alternative market risk deductions for the BD's proprietary positions
in forward contracts and commodity futures contracts. Also, Appendix E
provides that where the alternative market risk deduction has been used
to compute the deduction on the underlying instrument for OTC
derivatives of the BD, the BD would compute a ``deduction for credit
risk,'' using the standards set forth in Appendix E, and it would use
this deduction in lieu of the capital charges that SEC Rule 15c3-
1(c)(2)(iv) requires for the BD's credit exposures arising from OTC
transactions in derivatives.
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\3\ The SEC's new rule was published at 69 FR 34428 (June 21,
2004). The effective date of the rule was August 20, 2004.
\4\ As an example of the haircuts required by SEC Rule 15c3-
1(c)(2)(vi), the haircut for equity securities is equal to 15
percent of the market value of the greater of the long or short
equity position plus 15 percent of the market value of the lesser
position, but only to the extent this position exceeds 25 percent of
the greater position. The deduction for securities with no ready
market is 100 percent under SEC Rule 15c3-1(c)(2)(vii).
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The amended SEC rules limit the availability of the Alternative
Capital Computation to BDs that comply with enhanced net capital,
notification, recordkeeping, and reporting requirements. SEC Rule 15c3-
1(a)(7) requires the BD to maintain at all times ``tentative net
capital'' \5\ of not less than $1 billion and net capital of not less
than $500 million, and to provide same day notice if the BD's tentative
net capital is less than $5 billion, or some other ``early warning''
amount specified by the SEC.\6\ The amended rules specify that the
SEC's response to an early warning notice may include imposing
additional conditions on the use of the Alternative Capital
Computation.\7\
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\5\ The BD's ``tentative net capital'' consists of its net
capital before the approved deductions for market and credit risk
under the SEC's amended rule, and also increased by the balance
sheet value (including counterparty net exposure) resulting from
transactions in derivative instruments that would otherwise be
deducted by virtue of paragraph (c)(2)(iv) of Rule 15c3-1.
\6\ Upon written application by a BD, the SEC may lower the
threshold for the early warning requirement, either unconditionally
or subject to specified terms and conditions. The SEC will consider
various factors to determine whether the requirement is unnecessary.
69 FR at 34461.
\7\ The additional conditions that may be imposed on the BD
include restricting the BD's business on a product-specific,
category-specific or general basis; requiring submission of a plan
to increase its net capital or tentative net capital; requiring more
frequent reporting; requiring modifications to the BD's internal
risk management control procedures; or requiring capital deductions
using the SEC's standardized haircuts. See 17 CFR 240.15c3-1e(e).
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The Alternative Capital Computation is also limited to those BDs
who: (i) Have in place an internal risk management system that complies
with 17 CFR 240.15c3-4 (previously applicable only to OTC derivatives
dealers registered with the SEC), which addresses not only their market
risk and credit risk, but also liquidity, legal and operational risks
at the firm; and (ii) whose ultimate holding company and affiliates
have consented to SEC consolidated supervision, i.e., they become a
``consolidated supervised entity'' (``CSE''). For purposes of such
consolidated supervision, the BD's ultimate holding company and
affiliated entities must consent to direct examination by the SEC,
unless the holding company is subject to supervision by the Federal
Reserve or foreign banking regulators because it is a U.S. holding
company or foreign bank that has elected financial holding company
status under the Bank Holding Company Act of 1956.\8\ The SEC has added
a new Appendix G to Rule 15c3-1 (17 CFR 240.15c3-1g), which establishes
the minimum reporting, recordkeeping, and notification requirements for
all holding companies of BDs that apply for, or have received approval
for the use of, the Alternative Capital Computation.\9\
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\8\ The CSE rule specifically exempts FCM affiliates of BDs, and
other functionally regulated BD affiliates, from the SEC's direct
examination.
\9\ To minimize duplicative regulation, Appendix G imposes fewer
requirements on holding companies that have elected financial
holding company status.
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In adopting the Alternative Capital Computation, the SEC has also
responded to concerns expressed by several U.S. BDs that are required,
pursuant to a directive issued by the European Union (``EU'') at the
end of 2002 (the ``Financial Groups Directive''), to demonstrate
holding company supervision that is equivalent to EU consolidated
supervision.\10\ Absent a demonstration of comparable group-wide
supervision, the EU may restrict or otherwise place conditions upon the
operations of the European-based affiliates of these BDs. The
consolidated supervision requirements in the SEC's amended rules
provide a regulatory structure that is intended to satisfy the
requirements of the Financial Groups Directive.
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\10\ See ``Directive 2002/87/EC of the European Parliament and
of the Council of 16 December 2002.''
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As the SEC noted when first proposing rules for the Alternate
Capital Computation, the required market risk and credit risk
deductions are expected to be substantially smaller in amount than the
standardized deductions.\11\ As the SEC rule amendments were being
discussed and proposed, Commission staff identified that continued
harmonization of the capital rules of the two agencies would require
amendment of Rule 1.17, and communicated this to various market
participants potentially affected by the difference between the SEC's
proposed rules and Rule 1.17. After the SEC adopted rule amendments
allowing BDs to apply for approval to use the Alternative Capital
Computation, several FCM/BDs, along with representatives of the
Securities Industry Association and the Futures Industry Association,
contacted staff of the Commission's Division of Clearing and
Intermediary Oversight (the ``Division'') to express their support for
Commission rulemaking that would allow dually-registered FCM/BDs to use
their SEC-approved alternative market risk and credit risk deductions
when computing their adjusted net capital under Rule 1.17.\12\ In
addition, two
[[Page 58987]]
dually-registered FCM/BDs that had received SEC approval for the
Alternative Capital Computation requested no-action positions from
Division staff, without which the Alternative Capital Computation could
not be used for purposes of their capital computation and reporting
requirements to the Commission. The Division granted such relief on an
interim basis, to be superseded by such final rules as the Commission
might eventually adopt in connection with the Alternative Capital
Computation.
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\11\ The SEC's proposed rules for the Alternative Capital
Computation were published in the Federal Register in 2003. 68 FR
62872 (November 6, 2003).
\12\ The Securities Industry Association and the Futures
Industry Association are industry trade groups whose members include
broker-dealers, futures commission merchants, and representatives of
other segments of the securities and futures industries.
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II. SEC Requirements for BDs Using Alternative Capital Computation
A. SEC Appendix E Requirements for Computation of Alternative
Deductions for Market Risk and Credit Risk.
1. Deduction for Market Risk.
The computation for the alternative market risk deduction is set
forth in paragraph (b) of the new Appendix E (17 CFR 240.15c3-1e(b)),
and is the sum of the following:
For proprietary positions for which the SEC has approved
the BD's use of ``value at risk'' (``VaR'') models, ``the VaR of the
positions multiplied by the appropriate multiplication factor,'' which
is initially set at three.\13\ VaR models are mathematical models that
are used to generate a summary measure of market risk for a portfolio
of assets, and the VaR of a portfolio can be expressed in terms of the
estimated loss in value, over a given time period, that is expected to
be equaled or exceeded with a given, small probability. Under Appendix
E, the loss estimates under the BD's VaR models must use price changes
equivalent to a ten business-day period movement in rates and prices,
and a confidence level of 99 percent, i.e., the VaR of the BD's
positions can be expressed as the ten business-day loss that is
expected to be equaled or exceeded 1 percent of the time.\14\ Appendix
E also requires that the BD monitor whether the ``multiplication
factor'' should be increased, by requiring the BD to conduct
backtesting of the model beginning three months after the BD begins
using the VaR model to calculate market risk. Backtesting
``exceptions'' will be determined by comparing the actual daily net
trading profit or loss of the BD with the corresponding VaR measure
generated by its model. As further specified in Appendix E, on the last
business day of each quarter, the BD must identify the number of
business days, for each of the past 250 business days, for which the
actual net trading loss exceeded the corresponding VaR measure. The BD
will then use, until it obtains the next quarter's backtesting results,
the multiplication factor indicated in the table included in Appendix
E, which increases the required multiplication factor based on the
number of backtesting exceptions.
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\13\ The multiplication factor may be increased based upon the
number of exceptions observed during model backtesting, which the BD
is required to perform, but may not be less than three.
\14\ Incorporating VaR models into the firm's capital
calculations offers the firm the advantage of increasing its ability
to recognize the correlations and hedges in its trading portfolio,
and reducing its capital charge for market risk as a consequence.
For example, as the SEC has noted, its fixed-percentage securities
haircuts recognize only limited hedging activities, and do not
account for historical correlations between foreign securities and
U.S. securities or between equity securities and debt securities.
According to the SEC, by ``failing to recognize offsets from these
correlations between and within asset classes, the fixed percentage
haircut method may cause firms with large, diverse portfolios to
reserve capital that actually overcompensates for market risk.'' 62
FR 68011, 68014 (December 30, 1997) (SEC concept release regarding
the extent to which statistical models might be considered for use
in setting the capital requirements for a BD's proprietary
positions).
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For any positions for which the VaR model does not
incorporate ``specific risk,'' which is the risk that any position,
particularly one with no ready market, does not have price moves that
correlate to broad market moves, an additional deduction must be
included in the BD's computation of its alternative market risk
deduction. As part of the review of the BD's application, the SEC will
review the BD's methodology for determining specific risk deductions.
For proprietary positions for which the SEC has approved
the use of ``scenario analysis,'' the required deduction is the
greatest loss, as indicated by the analysis, resulting from a range of
adverse movements in relevant risk factors, prices, or spreads for the
positions,\15\ or is some multiple of the greatest loss based on the
liquidity of the positions subject to scenario analysis.\16\ This
deduction is subject to a ``floor,'' so that irrespective of the
deduction otherwise indicated under scenario analysis, the resulting
deduction for market risk must be at least $25 per 100 share equivalent
contract for equity positions, or one-half of one percent of the face
value of the contract for all other types of contracts.
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\15\ The relevant risk factors, prices, or spreads are designed
to represent a negative movement greater than, or equal to, the
worst ten-day movement over the four years preceding the calculation
of the greatest loss.
\16\ If historical data is insufficient, the SEC requires the
deduction for positions for which scenario analysis is used to be
the largest loss within a three standard deviation movement in those
risk factors, prices, or spreads over a ten-day period, multiplied
by an appropriate liquidity adjustment factor.
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For all remaining proprietary positions for which the SEC
has not approved the BD's use of VaR models or scenario analysis, the
standard deductions specified in SEC rules 17 CFR 240.15c3-1(c)(2)(vi),
(c)(2)(vii), and applicable appendices to Sec. 240.15c3-1.
When first proposing the Alternative Capital Computation, the SEC
noted that it had been modeled on rule amendments previously adopted by
the SEC for OTC derivatives dealers in 1998.\17\ In turn, the rules for
OTC derivatives dealers parallel those that U.S. banking agencies had
adopted in 1996 to require banks to compute a market risk charge, and
to establish standards for the internally-generated market risk
estimates that banks could use to compute the charge.\18\ The rules
adopted by the banking agencies implemented recommendations of the
Basel Committee on Banking Supervision (``Basel Committee''),\19\ which
recognized the growing use of VaR models as part of the risk management
procedures of internationally active banks with large trading
portfolios.\20\ The rules adopted by the banking agencies implemented
capital charges for the market risks incurred by such banks, and
approved the use of proprietary VaR models as part of the calculation
of the required market risk charges, subject to the models satisfying
certain ``qualitative'' and ``quantitative'' conditions.\21\ These
[[Page 58988]]
conditions included the requirement of an appropriate multiplication
factor, initially set at three and increased as indicated by
backtesting results.\22\
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\17\ 68 FR at 62872.
\18\ The SEC first proposed rules for OTC derivatives dealers in
1997, and stated that they were consistent with the market risk
capital requirements adopted by the U.S. banking agencies. 62 FR
67940, 67947 (December 30, 1997).
\19\ The Basel Committee on Banking Supervision is a committee
of banking supervisory authorities established in 1974 by the
central-bank Governors of the Group of Ten countries. It consists of
senior representatives of bank supervisory authorities and central
banks from Belgium, Canada, France, Germany, Italy, Japan,
Luxembourg, Netherlands, Sweden, Switzerland, United Kingdom and the
United States. It usually meets at the Bank for International
Settlements in Basel, where its permanent Secretariat is located.
\20\ In 1988, the Basel Committee published a document titled
the ``International Convergence of Capital Measurement and Capital
Standards'' (the ``Basel Capital Accord''), which set forth an
agreed framework for measuring capital adequacy and the minimum
requirements for capital for banking institutions. There have been
several amendments to the Basel Capital Accord in the intervening
years, including, in January of 1996, the ``Amendment to the Capital
Accord to Incorporate Market Risks.'' Most recently, the Basel
Committee issued a revised framework in June of 2004 (``Basel II'')
that amends provisions related to credit risk and adds provisions to
address operational risk.
\21\ See, generally, 61 FR 47358 (September 6, 1996) (final
rules adopted by federal banking agencies to require market risk
capital charge and adopting standards for the ``internal models''
approach for calculation of the charge).
\22\ The table in Appendix E that provides the required VaR
multiplication factor is consistent with the recommendations made by
the Basel Committee in 1996. See ``Supervisory Framework for the Use
of Backtesting in Conjunction with the Internal Models Approach to
Market Risk Capital Requirements'' (January 1996).
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The amended SEC rules similarly specify several qualitative and
quantitative requirements for the VaR models used by those BDs that are
approved to use the Alternative Capital Computation. The qualitative
requirements set forth in Appendix E include certain requirements
already described above, i.e., those related to the multiplication
factors applied to VaR based on backtesting results, and also include
the following: (i) VaR models used to calculate market risk or credit
risk must be integrated into the daily internal risk management system
of the BD; (ii) VaR models must be reviewed both periodically (by
either the BD's internal audit staff or an outside auditor) and
annually (by a registered public accounting firm, as that term is
defined in section 2(a)(12) of the Sarbanes-Oxley Act of 2002 (15
U.S.C. 7201 et seq.); and (iii) the BD must have, for purposes of
incorporating specific risk into its VaR model, methodologies in place
to capture liquidity, event, and default risk adequately for each
position. Other requirements for the models used to calculate
deductions for specific risk include that they explain the historical
price variation in the portfolio; capture concentration in terms of
magnitude and changes in composition; be robust to an adverse
environment; and be validated through backtesting.
The quantitative requirements for the VaR models are also set forth
in Appendix E, and in addition to the requirement, described above, for
market risk VaR models to be based on a 99 percent confidence level and
ten-day holding period, also include the following: (i) The VaR model
must use an effective historical observation period of at least one
year; (ii) the BD must consider the effects of market stress in its
construction of the model; (iii) the historical data sets used for the
models must be updated at least monthly and reassessed whenever market
prices or volatilities change significantly; and (iv) the VaR model
must take into account and incorporate all significant, identifiable
market risk factors applicable to positions in the accounts of the
BD.\23\ An additional quantitative requirement, related to the VaR
models used for the BD's deduction for credit risk, is discussed below.
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\23\ The required market risk factors under the SEC's rule
include not only specific risk for individual positions, but also
the following general market risks: (i) Risks arising from the non-
linear price characteristics of derivatives and the sensitivity of
the market value of those positions to changes in the volatility of
the derivatives' underlying rates and prices; (ii) empirical
correlations with and across risk factors or, alternatively, risk
factors sufficient to cover all the market risk inherent in the
positions in the proprietary or other trading accounts of the BD,
including interest rate risk, equity price risk, foreign exchange
risk, and commodity price risk; and (iii) where applicable, spread
risk, and segments of the yield curve sufficient to capture
differences in volatility and imperfect correlation of rates along
the yield curve for securities and derivatives that are sensitive to
different interest rates.
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2. Deduction for Credit Risk
To determine its alternative deduction ``for credit risk on
transactions in derivative instruments (if [Appendix E] is used to
calculate a deduction for market risk on those instruments),'' Appendix
E requires the BD to compute three separate capital charges and add
them together. As set forth in 17 CFR 240.15c3-1e(c), the alternative
deduction for credit risk is an amount equal to the sum of the
following three charges:
(1) A ``counterparty exposure charge'' in an amount equal to the
sum of the following: (i) The net replacement value in the account of
each counterparty that is insolvent, or in bankruptcy, or that has
senior unsecured long-term debt in default; and (ii) For each of the
BD's other counterparties, a ``credit equivalent amount'' (generally
speaking, the extent to which, after taking into account available
collateral and enforceable netting agreements, the BD is exposed to the
creditworthiness of the counterparty, both in terms of the current cost
of replacing the positive cash flow under the OTC agreement if the
counterparty were to default, and in terms of the potential for the
replacement cost to increase over the length of the contract, due to
movements in the rates or prices underlying the contract (the firm's
``maximum potential exposure'')), multiplied by the ``credit risk
weight'' of the counterparty (counterparties with lower credit ratings
have higher credit risk weights),\24\ multiplied by 8 percent.\25\
``Maximum potential exposure'' will be determined using a VaR model,
which, like the market risk VaR model, must use a 99 percent confidence
level, but the price changes will be equivalent to a one-year movement
in rates and prices.\26\ The VaR for maximum potential exposure must
also be multiplied by a multiplication factor, which will be initially
set at one, but is also subject to increases based on backtesting
exceptions, in accordance with a schedule of multiplication factors
that has been proposed by the BD and approved by the SEC.
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\24\ Appendix E assigns specific credit weights, ranging from 20
percent to 150 percent, based either on the ratings made by a
nationally recognized statistical rating organization or internally
by the firm. A BD may request approval to determine credit risk
weights based on internal calculations. The BD must make and keep
current a record of the basis for the credit rating, and credit risk
weight, for each counterparty.
\25\ The SEC stated that the 8 percent multiplier is consistent
with the calculation of credit risk in the OTC derivatives dealer
rules and applicable requirements in Basel Committee publications,
and is designed to dampen leverage to help ensure that the firm
maintains a safe level of capital.
\26\ The SEC may approve a shorter time horizon (but not less
than ten business days), based on a review of the BD's procedures
for managing collateral, the daily mark-to-market of the collateral,
and the BD's ability to call for additional collateral daily.
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(2) A ``concentration charge by counterparty,'' which is the total
determined by adding together, for each counterparty of a given credit
risk weight, a specified percentage of the amount of the BD's current
exposure to the counterparty that is in excess of 5 percent of the BD's
tentative net capital.\27\
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\27\ Appendix E requires that for each counterparty with a
credit risk weight of 20 percent or less, the concentration charge
is 5 percent of the amount of the current exposure to the
counterparty that is in excess of 5 percent of the BD's tentative
net capital; for each counterparty with a credit risk weight of
greater than 20 percent but less than 50 percent, the charge is 20
percent of the current exposure to the counterparty that is in
excess of 5 percent of the BD's tentative net capital; and for each
counterparty with a credit risk weight of greater than 50 percent,
the charge is 50 percent of the current exposure to the counterparty
that is in excess of 5 percent of the BD's tentative net capital.
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(3) A ``portfolio concentration charge'' of 100 percent of the
amount of the BD's aggregate current exposure for all counterparties in
excess of 50 percent of the tentative net capital of the BD.
The SEC has stated that the provisions related to OTC derivatives
in the amended rules are based on its experience with the reporting
provided by the Derivatives Policy Group,\28\ and
[[Page 58989]]
also with the SEC's regulation of OTC derivatives dealers.\29\ The
provisions for OTC derivatives also reflect the reporting
recommendations made by the Basel Committee and the Technical Committee
of the International Organization of Securities Commissions (``IOSCO'')
in a joint report issued in 1995 and revised in 1998, which included
recommendations for the reporting by banks and securities firms related
to the credit risk of their OTC derivatives, particularly their current
and potential credit exposures to their counterparties, the credit
quality of their counterparties, and the concentration of credit risk
with these counterparties.\30\
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\28\ The Derivatives Policy Group (``DPG'') consists of several
U.S. firms that are most active in the OTC derivatives market. The
DPG was formed at the request of the SEC to address the public
policy issues arising from the activities of unregistered affiliates
of BDs. In March of 1995 the DPG published its ``Framework for
Voluntary Oversight, a Framework for Voluntary Oversight of the OTC
Derivatives Activities of Securities Firm Affiliates to Promote
Confidence and Stability in Financial Markets,'' under which the
members of the DPG agreed to report voluntarily to the SEC on their
activities in the OTC derivatives market.
\29\ 68 FR at 62879.
\30\ See ``Framework for Supervisory Information about
Derivatives and Trading Activities,'' published in September of 1998
by the Basel Committee and IOSCO. IOSCO provides an international
cooperative forum for securities regulatory agencies, and its member
securities agencies regulate more than 90 percent of the world's
securities markets.
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B. SEC Application Process
The approval process under Appendix E of SEC Rule 15c3-1 is
initiated by the filing of an application by the BD, which is required
to: (i) Describe the mathematical models used to price positions and to
compute market risk and credit risk capital deductions, and explain how
the models meet the required quantitative and qualitative standards set
forth in SEC regulations; (ii) describe the BD's internal risk
management control system and how that system satisfies the
requirements set forth in SEC regulations; (iii) include corrected or
updated information going forward as appropriate; and (iv) provide a
written undertaking and certain information from the BD's holding
company. Furthermore, the BD must amend or resubmit an application to
obtain SEC approval of any material change to its approved mathematical
models. The SEC may approve the application in whole or in part, and
the SEC may revoke its approval upon certain conditions. The SEC
delegates to the Director of the SEC's Division of Market Regulation
the authority to undertake specific activities and determinations under
the rule, including the authority to approve any amendments to the BD's
application. If a BD decides it no longer wishes to continue using its
approved alternative market risk and credit risk charges, it must give
notice to the SEC 45 days (or a shorter or longer period as approved by
SEC) prior to the BD ceasing use of the approved models and reverting
to the standard haircuts. The SEC has also specified in Appendix E, at
paragraph (a)(11), that the BD's approval to use the Alternative
Capital Computation may be revoked by SEC order, upon a finding that
the exemption is no longer necessary or appropriate in the public
interest or for the protection of investors. The rule further states
that in making its finding, the SEC will consider the compliance
history of the BD related to its use of models, the financial and
operational strength of the BD and its ultimate holding company, the
BD's compliance with its internal risk management controls, and the
holding company's compliance with its written undertaking with the SEC.
C. Reporting Required by SEC for the Alternative Capital Computation
To implement other conditions for the use of the Alternative
Capital Computation, the SEC also amended its Rule 17a-5 (17 CFR
240.17a-5), which sets forth financial reporting requirements
applicable to all BDs. In addition to the information otherwise
required under SEC Rule 17a-5(a), a BD that uses the Alternative
Capital Computation must, on a monthly basis, file reports that
include: (i) Regular risk reports supplied to the BD's senior
management in the format described in the application; (ii) for each
product for which the BD calculates a deduction for market risk in
accordance with Appendix E, the product category and the amount of the
deduction for market risk; (iii) a graph reflecting, for each business
line, the daily intra-month VaR; (iv) the aggregate value at risk for
the BD; (v) for each product for which the BD uses scenario analysis,
the product category and the deduction for market risk; and (vi) credit
risk information on derivatives exposures. More specifically, the
credit risk information to be filed for OTC derivatives exposures
includes: (i) The BD's overall current exposure; (ii) its current
exposure (including commitments) listed by counterparty for the 15
largest exposures; (iii) the 10 largest commitments listed by
counterparty; (iv) the BD's maximum potential exposure listed by
counterparty for the 15 largest exposures; (v) the BD's aggregate
maximum potential exposure; (vi) a summary report reflecting the BD's
current and maximum potential exposures by credit rating category; and
(vii) a summary report reflecting the BD's current exposure for each of
the top ten countries to which the BD is exposed (by residence of the
main operating group of the counterparty).
The amended SEC Rule 17a-5(a) also requires quarterly reports that
include: (i) the number of business days for which the actual daily net
trading loss exceeded the corresponding daily VaR; and (ii) the results
of backtesting of all internal models used to compute allowable
capital, including VaR and credit risk models, indicating the number of
backtesting exceptions. BDs approved to use the Alternative Capital
Computation must also file supplements to their annual financial
statements, which under amended SEC Rule 17a-5(k) are to consist of:
(i) An accountant's report on management controls (indicating the
results of the review made by a registered public accounting firm of
the BD's internal risk management control system); and (ii) a related
statement, made prior to commencement of the accountant's review, that
describes the review procedures agreed to by the BD and the accountant.
III. Proposed Rules for FCMs Registered as BDs To Use Their SEC-
Approved Capital Charges
The SEC, in adopting its rules permitting alternative capital
charges incorporating VaR measurements for qualifying BDs subject to
consolidated supervision, commented that ``the alternative method of
computing net capital responds to [broker and dealer] requests to align
their supervisory risk management practices and regulatory capital
requirements more closely.'' \31\ Absent the changes that are being
proposed in this release to Commission Rule 1.17, the potential for
reduced capital charges that is available to dual registrants under the
Alternative Capital Computation would not be available under the
Commission's rules. As a result, FCM/BDs would be faced with
potentially complex capital computations and compliance burdens. Given
the commonality of purpose between the capital charges required by the
SEC for BD registrants and by the Commission for FCM registrants, the
Commission is therefore proposing to permit dual registrants that have
qualified for the exemption under the SEC's net capital rule to use the
same alternative charges with respect to their calculation of minimum
CFTC net capital, subject to the general requirement that the
Commission receive the same notices and the monthly, quarterly and
annual reporting information, as described above, that the SEC's
amended rules require FCM/BDs to provide to the SEC. As for holding
company information that is provided to the SEC under the new Appendix
G to SEC Rule 15c3-1, or as part of the
[[Page 58990]]
application that the BD files with the SEC to request approval to use
the Alternative Capital Computation, the proposed rules in the release
do not require the Commission's receipt of such holding company
information, because such information is being provided to the SEC for
purposes of the SEC's consolidated supervision of the holding company.
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\31\ 69 FR at 34428.
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In formulating the proposed amendments, the Commission has taken
into consideration that the Alternative Capital Computation, unlike the
current standardized charges, is determined by an ongoing oversight
process that results in individualized capital charges that require
considerable firm-specific information. Pursuant to Commission Rule
1.17(a)(3), FCMs must be able to demonstrate to the satisfaction of the
Commission their compliance with their minimum financial requirements
under the Commodity Exchange Act and implementing regulations of the
Commission. The proposed amendments to Rule 1.17 would enable FCM/BDs
to elect to use their SEC approved capital charges in satisfaction of
their requirements under Rule 1.17, subject to compliance with FCM
notification and filing requirements that would promote the
Commission's risk oversight of FCMs, given their critically important
role as risk intermediaries in the futures and options markets.
The Commission is not proposing any amendments in this release to
Rules 1.14 and 1.15, pursuant to which FCMs are required to maintain
and report ``risk assessment'' information to the Commission concerning
the FCM's material affiliates. The SEC imposes similar requirements on
BDs, through SEC Rules 17h-1T and 17h-2T, for recordkeeping and
reporting on the material affiliates of the BD. A firm that is dually
registered as a BD and an FCM must comply with the risk assessment
regulations of the SEC and the Commission, but Commission Rule
1.15(d)(1) permits FCM/BDs to meet their filing requirements by
providing copies to the Commission of the risk assessment documents
that are filed with the SEC.\32\
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\32\ To comply with SEC Rule 17h-2T, BDs file SEC Form 17-H, and
Commission Rule 1.15(d)(1) allows FCM/BDs to comply with the
requirements in Rules 1.15(a)(1)(i) and (a)(2) by filing copies with
the Commission of their Forms 17-H, if these are additionally
supplemented to ensure that the Commission receives all of the
information required under Rule 1.15.
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Given the overlap between information that the SEC requires under
the newly adopted Appendix G and under SEC Rules 17h-1T and 17h-2T, the
SEC amended its rules so that BDs whose holding companies are directly
examined by the SEC are relieved of having to also meet the filing
obligations required by SEC Rules 17h-1T and 17h-2T. Because the
Commission does not require holding company information under the
amendments to Rule 1.17 proposed in this release, the proposed rule
amendments do not duplicate the filing requirements of Commission Rules
1.14 and 1.15. FCM/BDs that elect to use the Alternative Capital
Computation will therefore continue to be required to comply with the
provisions of Rules 1.14 and 1.15.
A. Proposal to Permit FCMs To Elect To Use Their SEC-Approved Capital
Charges
The Commission proposes to amend paragraph (c)(6) of Rule 1.17 by
providing that an FCM/BD may elect, if it satisfies the requirements of
proposed paragraph (c)(6), to compute its adjusted net capital using
alternative capital deductions that the SEC has approved by written
order under 17 CFR 240.15c3-1(a)(7). To the extent that the SEC has
approved alternative capital deductions for the FCM/BD's unsecured
receivables from OTC transactions in derivatives, or for its
proprietary positions in securities, forward contracts, or futures
contracts, the FCM/BD may use these same alternative capital deductions
when computing its adjusted net capital. These alternative deductions
would be used in lieu of the amounts that otherwise would be required
by the following regulations: Rule 1.17(c)(2)(ii) for unsecured
receivables from OTC derivatives transactions; Rule 1.17(c)(5)(ii) for
proprietary positions in forward contracts; Rule 1.17(c)(5)(v) for
proprietary positions in securities; and Rule 1.17(c)(5)(x) for
proprietary positions in futures contracts. The proposed rulemaking
would not alter or affect the haircuts that Rule 1.17(c)(5)(v) and Rule
1.32(b) require for securities that are held in segregation under
Section 4d of the Commodity Exchange Act, because the alternative
deductions apply solely to an FCM/BD's proprietary positions.\33\
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\33\ FCM/BDs using the Alternative Capital Computation would
continue to be required, under Rule 1.17(c)(5)(v), to deduct the
securities haircuts specified in SEC Rules 15c3-1(c)(2)(vi) and
(vii) from the value of securities that are held in segregated
accounts under Section 4d and the Commission's implementing
regulations and which were not deposited by customers. Such FCM/BDs
would also continue to be required, when computing the amount of
funds required to be in segregated accounts, to use the standard SEC
securities haircut expressly referenced in Rule 1.32(b), i.e., SEC
Rule 15c3-1(c)(2)(vi). Rule 1.32 applies this haircut for purposes
of the permissible offset of any net deficit in a customer's account
against the current market value of readily marketable securities,
less the SEC standard haircut, that are held for the same customer's
account.
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B. Proposed Requirements for FCMs Electing the Alternative Capital
Computation
1. Notice of Election or of Changes to Election
Proposed paragraph (c)(6)(ii) of Rule 1.17 would specify that an
FCM's election to use the Alternative Capital Computation would not be
effective unless and until it has filed with the Commission a notice,
addressed to the Director of the Division of Clearing and Intermediary
Oversight, that is to include: (i) A copy of the SEC order approving
its alternative market risk and credit risk capital charges; and (ii) a
statement that identifies the amount of tentative net capital below
which the FCM is required to provide notice to the SEC, and that also
includes portions of the information made available to the SEC for
purposes of its request for approval to use the Alternative Capital
Computation, as follows: \34\
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\34\ As noted earlier, SEC Rule 15c3-1(a)(7)(ii) requires same-
day notice to the SEC if the BD's tentative net capital is less than
$5 billion, or a lower amount that has been agreed to by the SEC.
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(1) A list of the categories of positions that the firm holds in
its proprietary accounts, and, for each such category, a description of
the methods that the firm will use to calculate its deductions for
market risk and credit risk, and, if calculated separately, its
deductions for specific risk;
(2) A description of the VaR models to be used for its market risk
and credit risk deductions, and an overview of the integration of the
models into the internal risk management control system of the firm;
(3) A description of how the firm will calculate current exposure
and maximum potential exposure for its deductions for credit risk;
(4) A description of how the firm will determine internal credit
ratings of counterparties and internal credit risk weights of
counterparties, if applicable; and
(5) A description of the estimated effect of the alternative market
risk and credit risk deductions on the amounts reported by the firm as
net capital and adjusted net capital.
Proposed Rule 1.17(c)(6)(ii) would also require the FCM to
supplement its statement, upon the request of the Commission made at
any time, with any other explanatory information for the firm's
computation of its alternative market risk and credit risk deductions
as the Commission may require at its
[[Page 58991]]
discretion. The requests for explanatory information under proposed
Rule 1.17(c)(6)(ii) may be made by the Director of the Division of
Clearing and Intermediary Oversight, to whom, as set forth in
Commission Rule 140.91(a)(6), the Commission has delegated authority
for the functions reserved for the Commission under Rule 1.17.
Proposed Rule 1.17(c)(6)(ii) would further provide that the FCM
must file, as a supplemental notice with the Director of the Division
of Clearing and Intermediary Oversight, a notice advising that the SEC
has imposed additional or revised conditions after the date of the SEC
order filed with the FCM's original notice to the Director of the
Division of Clearing and Intermediary Oversight. The FCM must also file
as a supplemental notice a copy of any approval by the SEC of
amendments that the firm has requested for its application to use the
Alternative Capital Computation.
An FCM would also be permitted under the proposed rule to
voluntarily change its election, by filing with the Director of the
Division of Clearing and Intermediary Oversight a written notice that
specifies a future date as of which its market risk and credit risk
capital charges will no longer be determined by the Alternative Capital
Computation, but will instead be computed as otherwise required under
the Commission's rules.
2. Conditions UNDER Which FCM May No Longer Elect Alternative Capital
Charges
Proposed paragraph (c)(6)(iii) of Rule 1.17 would provide that an
FCM may no longer elect to use its SEC-approved alternative market risk
and credit risk deductions, and shall instead compute the charges
otherwise required under Rules 1.17(c)(5) or 1.17(c)(2), upon the
occurrence of any of the following: (i) The SEC revokes its approval of
the firm's market risk and credit risk deductions; (ii) the firm fails
to come into compliance with its filing requirements under the proposed
rule, after having received from the Director of the Division of
Clearing and Intermediary Oversight written notification that the firm
is not in compliance with its filing requirements, and must cease using
the Alternative Capital Computation if it has not come into compliance
by a date specified in the notice; or (iii) the Commission by written
order finds that permitting the firm to continue to use such
alternative market risk and credit risk deductions is no longer
appropriate for the protection of customers of the FCM or the financial
integrity of the futures or options markets.\35\
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\35\ Because the proposed rule would permit only dual
registrants to use the Alternative Capital Computation, an FCM's
election to use the Alternative Capital Computation would
automatically terminate immediately, without further action by the
Commission, if it ceases to be dually-registered as a BD.
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3. Additional Filing Requirements
In addition to the notice and supplemental notices described above,
proposed paragraph (c)(6)(iv) of Rule 1.17 would also provide that any
firm that elects to use the Alternative Capital Computation must file
with the Commission copies of all additional monthly, quarterly, and
annual reporting items that BDs who are approved to use the Alternative
Capital Computation must file with SEC, as discussed above. The FCM
would also be required to file with the Commission a copy of the notice
that it must file with the SEC whenever its tentative net capital falls
below the amount required by the SEC, or of the notice filed with the
SEC or the firm's designated examining authority in regard to planned
withdrawals of excess net capital.
Specifically, the proposed rule would require the following to be
filed with the Commission, at the same time that originals are filed
with the SEC:
(1) All information that the firm files on a monthly basis with its
designated examining authority or the SEC in satisfaction of SEC Rule
17a-5(a)(5)(i), whether by way of schedules to the firm's FOCUS reports
or by other filings;
(2) The quarterly reports required by SEC Rule 17a-5(a)(5)(ii);
(3) The supplemental annual filings as required by SEC Rule 17a-
5(k), which consist of a report on management controls that is prepared
by a registered public accounting firm and is filed by the firm
concurrently with its annual audit report, and also a related
statement, filed prior to the commencement of the accountant's review
but no later than December 10 of each year, that includes a description
of the procedures agreed to by the firm and the accountant and a notice
describing changes to the agreed-upon procedures, if any, or stating
that there are no changes; and
(4) Any notification to the SEC or the firm's designated examining
authority of planned withdrawals of excess net capital, and any
notification that the firm is required to file with the SEC when its
tentative net capital is below an amount specified by the SEC.
BDs that use the Alternative Capital Computation also file a
revised Part II to the FOCUS report, designated ``Part II CSE''. This
revised FOCUS report includes financial information that BDs previously
reported in Part II of the FOCUS Report, and also includes new
schedules that provide much of the additional information that BDs who
use the Alternative Capital Computation must report on a monthly basis.
In order to facilitate the firm's reporting requirements and reduce
administrative burden, the Commission proposes to amend Rule 1.10(h) to
specify that a dual registrant may file, in lieu of its Form 1-FR-FCM
report, a copy of the FOCUS Report, Part II CSE that the firm files
with the SEC.\36\
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\36\ Several other Commission rules include references to Parts
II and Part IIA of the FOCUS report, in order to facilitate the
filing of the FOCUS report in lieu of the Form 1-FR-FCM. The
Commission also proposes be amend these rules to add a reference to
Part II CSE. In particular, the Commission proposes to amend the
following rules: Rule 1.10(d)(4)(ii), which sets forth the
requirements for ``authorized signers'' of the FOCUS report; Rule
1.10(f)(1), which sets forth the procedures required to obtain
extensions of time for filing the FOCUS report; Rule 1.16(c)(5),
which requires the accountant's supplemental report on material
inadequacies to be filed as of the same date as the Form 1-FR or
FOCUS report; Rules 1.18(a) and (b)(2), which permit FOCUS filings
to satisfy certain recordkeeping requirements of the FCM; and Rule
1.52(a), which permits the designated self-regulatory organization
of a dual registrant to accept a FOCUS report in lieu of a Form 1-
FR-FCM.
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C. Treatment of Information Received From FCMs Electing the Alternative
Capital Computation
1. The Freedom of Information and Sunshine Acts
The Freedom of Information Act, 5 U.S.C. 552 et seq. (``FOIA''),
provides generally that the public has a right of access to federal
agency records except to the extent such records, or portions of them,
are protected from disclosure by one (or more) of nine narrow
exemptions. The Government in the Sunshine Act, 5 U.S.C. 552b
(``Sunshine Act''), enacted to ensure that agency action is open to
public scrutiny, contains identical exceptions. Accordingly, the
Commission is required by the FOIA and the Sunshine Act to make public
its records and actions unless a specific exemption is available.
Historically, portions of the Form 1-FR and FOCUS reports that are
filed with the Commission under Rule 1.10 have been available to the
public.\37\
[[Page 58992]]
Other portions of these reports currently are exempt from disclosure
\38\ as confidential commercial or financial information pursuant to
Commission regulation 145.5(d), which tracks the language of its FOIA
counterpart, exemption (b)(4).\39\ Similarly, Commission meetings (or
portions of meetings) may be ``closed'' under the Sunshine Act where
the Commission determines that open meetings will likely reveal
information protected by an exemption.\40\
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\37\ The statement of financial condition, which consists of a
balance sheet showing assets, liabilities and ownership equity; the
computations for net capital and minimum capital requirements; and
the statements related to the segregation of customer funds under
Section 4d of the Commodity Exchange Act. See 17 CFR 1.10g. Since
1995, the Commission routinely has published on its Web site
selected financial information for every FCM from the publicly
available statements and schedules listed in rule 1.10(g): (1) Total
adjusted net capital; (2) minimum capital requirement; (3) adjusted
net capital in excess of the minimum requirement; (4) customer funds
that the Commission requires to be held in segregated accounts in
accordance with Section 4d of the Act; and (5) customer funds that
the Commission requires to be held in secured accounts in accordance
with Part 30 of the Commission's regulations.
\38\ See 17 CFR 145.5 and 147.3. Those portions are: the
Statement of Income (Loss); the Statement of Cash Flows; the
Statement of Changes in Ownership Equity; the Statement of Changes
in Liabilities Subordinated to the Claims of General Creditors
Pursuant to a Satisfactory Subordination Agreement; the Statement of
Changes in Financial Position; the Computation for Determination of
Reserve Requirements for Broker-Dealers under (SEC) Rule 15c3-3; the
Statement denoted ``Exemptive Provision Under (SEC) Rule 15c3-3;''
the Statement of Ownership Equity and Subordinated Liabilities
maturing or proposed to be withdrawn within the next six months and
accruals, which have not been deducted in the computation of net
capital, and the Recap thereof; the Statement of Financial and
Operational Data; and the accountant's report on material
inadequacies filed under Rule 1.16(c)(5). The foregoing include
items that all FCMs and IBs are required to file, and also include
items that are filed only by BDs that file FOCUS reports in lieu of
Form 1-FR.
\39\ Both the FOIA exemption (b)(4) and Commission rule 145.5(d)
exempt from disclosure matters that are ``trade secrets and
commercial or financial information obtained from a person and
privileged or confidential.''
\40\ As noted, the Sunshine Act exemptions are identical to
their FOIA counterparts. The Commission's Sunshine Act obligations
are codified in its Part 147 rules, 17 CFR 147.
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The Commission believes that the filings required by the proposed
amendments, as well as certain portions of the Form 1-FR and FOCUS
reports presently filed with the Commission pursuant to Rule 1.10, also
are protected from disclosure by FOIA and Sunshine Act exemption (8),
pursuant to which the Commission is authorized to withhold from the
public matters ``contained in or related to examination, operating, or
condition reports prepared by, on behalf of, or for the use of an
agency responsible for the regulation or supervision of financial
institutions.'' 5 U.S.C. 552(b)(8) and 5 U.S.C. 552b(c)(8). Commission
Rules 145.5(h) and 147.3(b)(8) similarly provide that the Commission
generally will not make public matters that are ``contained in or
related to examinations, operating, or condition reports prepared by,
on behalf of, or for the use of the Commission or any other agency
responsible for the regulation or supervision of financial
institutions.''
Because the term ``financial institution'' is not defined either in
the FOIA or its legislative history, courts have relied on the
legislative history of the Government in the Sunshine Act,\41\ a
statute in pari materia with the FOIA, to take an inclusionary and
expansive view of the term.\42\ The Commission is aware that no court
directly has considered whether Commission registrants are financial
institutions for purposes of either exemption 8; the Commission
believes, however, that the language of the Sunshine Act's legislative
history contemplates the inclusion of commodities professionals,
including futures commission merchants, designated contract markets,
derivatives transaction execution facilities, commodity pool operators
and commodity trading advisors. Recent legislation bolsters this view.
The USA PATRIOT Act \43\ defines FCMs, CPOs and CTAs as financial
institutions for purposes of the anti-money laundering requirements of
the Bank Secrecy Act, 31 U.S.C. 5311 et seq.; 31 U.S.C. 5312(c), and
identifies the Commission as a ``federal functional regulator.'' \44\
Similarly, Section 5g(a) of the Commodity Exchange Act provides that
any FCM, CTA, CPO or IB that is subject to the Commission's
jurisdiction with respect to any financial activity shall be treated as
a financial institutions for purposes of the privacy requirements in
Title V of the Gramm-Leach-Bliley Act. 7 U.S.C. 7b-2(a).\45\
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\41\ The Senate Report accompanying the Sunshine Act states
that: [The term is] intended to include banks, savings and loan
associations, credit unions, brokers and dealers in securities or
commodities, exchanges dealing in securities or commodities, such as
the New York Stock Exchange, investment companies, investment
advisors, self-regulatory organizations subject to 15 U.S.C. 78s,
and institutional managers as defined in 15 U.S.C. 78m. S. Rep. No.
354, 94th Cong., 1st Sess. 24 (1975). (emphasis supplied).
\42\ Accordingly, several district courts have interpreted the
term ``financial institutions'' broadly for purposes of FOIA
exemption 8. See Mermelstein v. SEC, 629 F.Supp.672, 673-75 (D.D.C.
1986) (Congress did not take a restrictive view of ``financial
institutions'' and intended to include securities exchanges);
Berliner, Zisser, Walter & Gallegos, P.C. v. SEC, 962 F.Supp. 1348,
1352-53 (D. Colo. 1997) (including investment advisors, as
fiduciaries who direct and make important investment decisions, in
the definition ``furthers Exemption 8's dual purposes of protecting
the integrity of financial institutions and facilitating cooperation
between the SEC and the entities regulated by it''); Feshbach v.
SEC, 5 F.Supp. 2d 774, 781 (N.D. Cal. 1997) (the term financial
institution encompasses self-regulatory organizations such as the
NASD).
\43\ The Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act
of 2001, Pub. L. 107-56, 115 Stat. 272 (2001).
\44\ Section 509(2) of the Gramm-Leach-Bliley Act includes as
federal functional regulators the Board of Governors of the Federal
Reserve System; the Office of the Comptroller of the Currency; the
Board of Directors of the Federal Deposit Insurance Corporation; the
Director of the Office of Thrift Supervision; the National Credit
Union Administration Board; and the Securities and Exchange
Commission.
As a separate matter, the Chairman of the Commission is a member
of the President's Working Group on Financial Markets, along with
the Secretary of the Treasury, the Chairman of the Board of
Governors of the Federal Reserve System, and the Chairman of the
Securities and Exchange Commission. The Working Group was formed
with the goal of enhancing the integrity, efficiency, orderliness,
and competitiveness of the U.S. financial markets and maintaining
investor confidence. See Executive Order 12631 (March 18, 1988).
\45\ Generally, Title V of the Gramm-Leach-Bliley Act limits the
instances in which a financial institution may disclose nonpublic
personal information about a consumer to nonaffiliated third
parties, and requires a financial institution to disclose to all of
its customers the institution's privacy policies and practices with
respect to information sharing with both affiliates and
nonaffiliated third parties.
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The primary purposes of FOIA exemption 8 have been described as
``protecting the integrity of financial institutions and facilitating
cooperation between [agencies] and the entities regulated by [them].''
\46\ In light of the expanded activities and growing impact of FCMs as
financial institutions,\47\ and the delineation in the Commodity
Futures Modernization Act of 2000 (``CFMA'') \48\ of the Commission's
oversight role with respect to all Commission registrants, these goals
are especially desirable.
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\46\ Berliner, Zisser, Walter & Gallegos, supra.
\47\ The Commission noted the increased significance of FCMs in
global financial markets when proposing, and subsequently adopting,
amendments to Rule 1.10 to require that Form 1-FR--FCM reports and
equivalent FOCUS reports be filed on a monthly rather than quarterly
basis. 69 FR 49874 (August 12, 2004).
\48\ Pub. L. 106-554, App. E, 114 Stat. 2763 (2000).
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2. Proposed Amendments to Parts 1, 145, and 147
In light of these considerations, the Commission proposes to treat
as nonpublic certain financial information filed with it by FCMs and
BDs. Under the proposed amendments to Rule 1.10(g), statements of
financial condition in monthly FOCUS reports, the full computations of
net capital, and the minimum capital requirements in monthly FOCUS
reports would no longer be publicly available. The express mandates of
the Commodity Exchange Act, however, support the Commission's
determination that certain information that is filed in Form 1-FR and
FOCUS reports remain
[[Page 58993]]
publicly available. As proposed to be amended, Rule 1.10(g) would
provide that the following information in Forms 1-FR and FOCUS reports
would be publicly available: (i) The amounts for a registrant's
adjusted net capital, its minimum capital requirement under Rule 1.17,
and its adjusted net capital in excess of its minimum capital
requirement; (ii) the statement of financial condition in the certified
annual financial report, and footnote disclosures thereof; and (iii)
the statements related to customer funds that the Commission requires
to be held in segregated accounts in accordance with Section 4d of the
Commodity Exchange Act, or in secured accounts in accordance with Part
30 of the Commission's regulations.\49\ Such information provides
insight into the financial resources of an FCM relative to its
aggregate obligations and assures that market users may assess the
financial integrity of the intermediaries they employ in their trading
activities.
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\49\ Rule 1.10(g) currently provides, and will continue to
provide, that all information on Forms 1-FR and FOCUS reports that
is nonpublic will be available for official use by any official or
employee of the United States or any State, by any self-regulatory
organization of which the person filing such report is a member, by
the National Futures Association in the case of an applicant, and by
any other person to whom the Commission believes disclosure of such
information is in the public interest. Rule 1.10(g) also specifies
that the rule does not limit the authority of any self-regulatory
organization to request or receive any information relative to its
members' financial condition.
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Accordingly, the Commission proposes to amend Rules 145.5 and 147.3
to exempt from mandatory public disclosure, pursuant to FOIA exemption
8,\50\ the following specific categories of information, except as
provided for in Rules 1.10(g) and 31.13:
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\50\ Certain of this information would continue to be exempt
from disclosure under FOIA exemption 4 as well.
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(1) Forms 1-FR required to be filed pursuant to Rule 1.10;
(2) FOCUS reports that are filed in lieu of Forms 1-FR pursuant to
Rule 1.10(h);
(3) Forms 2-FR \51\ required to be filed pursuant to Rule 31.13;
and
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\51\ Rule 31.13 requires leverage transaction merchants
(``LTMs'') to file with the Commission financial condition
information using ``Forms 2-FR,'' and provides that certain
information in such reports shall be deemed public. For a number of
years there have been no registered LTMs, and the Commission is not
proposing any amendments to Rule 31.13 in this release.
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(4) All reports and statements required to be filed pursuant to
Rule 1.17(c)(6).\52\
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\52\ The accountant's report on material inadequacies filed in
accordance with Rule 1.16(c)(5), which is already included in Rules
145 and 147 as exempt from disclosure under FOIA Exemption 4, would
also be included as exempt from disclosure under FOIA Exemption 8.
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IV. Proposed Amendment To Reduce Capital Charges for Foreign Currency
Forwards and Inventory in Specified Currencies
The Commission is further proposing to amend Commission Rule
1.17(c)(5)(ii), pursuant to which an FCM or IB, in computing its
adjusted net capital, must deduct from its net capital specified
percentages of the market value of its inventory, fixed price
commitments and forward contracts. Such capital charges, which are
imposed in percentages of up to twenty percent of market value, are
reduced if the FCM's or IB's inventory, fixed price commitments or
forward contracts are covered (i.e., hedged) by an open futures
contract or commodity option.\53\ For example, the capital charge for a
forward contract that is covered by an open futures contract is ten
percent, which is less than the twenty percent capital charge applied
to an uncovered forward contract. Rule 1.17(c)(5)(ii) also includes a
proviso that eliminates any capital charge for inventory and forward
contracts that are in a foreign currency purchased or sold for future
delivery on or subject to the rules of a contract market, and which are
covered by an open futures contract.
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\53\ The term ``cover,'' as used in the Commission's capital
rule, is defined in Rule 1.17(j).
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The Commission provides written instructions to assist FCMs in the
preparation of their Form 1-FR reports (``Form 1-FR-FCM Instructions
Manual'').\54\ As described in the Form 1-FR-FCM Instructions Manual,
those assets, liabilities, forward contracts, and fixed price
commitments of an FCM or IB that are denominated in the same foreign
currency are to be factored together, and any net balance that is not
covered is subject to a capital charge. The Form 1-FR-FCM Instructions
Manual further provides that the applicable capital charge is twenty
percent unless such uncovered net foreign currency balances are in
euros, British pounds, Japanese yen, Canadian dollars, and Swiss
francs, in which case the capital charge is six percent. This reduced
capital charge is less than that strictly called for by Commission Rule
1.17(c)(5)(ii), which would require an FCM to take a twenty percent
charge, but is consistent with similar capital charges that BDs are
required to deduct from their net capital under SEC regulations. The
New York Stock Exchange Interpretation Handbook (``NYSE Handbook''),
which provides general guidance for the financial reports prepared by
BDs, instructs them to treat uncovered balances in foreign currencies
as ``inventory,'' and to take a six percent capital charge for balances
held in seven identified foreign currencies, and a twenty percent
capital charge for other foreign currencies.\55\ In support of this
instruction, the NYSE Handbook cites a 1986 SEC no-action letter that
lists certain ``major'' non-U.S. currencies, and further equates the
haircut for unhedged forward positions in such currencies with the
haircut applicable to the unhedged underlying currency, which ``is set
at 6 [percent].'' \56\ The foreign currencies in the SEC letter include
the same national currencies specified in the Commission's Form 1-FR-
FCM Instructions Manual.\57\
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\54\ An electronic copy of the ``Instructions for Form 1-FR-
FCM'' is available to the public on the Commission's Web site, at
http://www.cftc.gov/files/tm/tminstructionsmanualfinalseptember2004.pdf
.
\55\ See NYSE Interpretation Handbook, Interpretation /01 to
Rule 15c3-1b(a)(3)(ix) (2003).
\56\ Letter from Michael A. Macchiaroli, Division of Market
Regulation, Securities and Exchange Commission, to Philadelphia
Stock Exchange, Inc., February 14, 1986, (SEC Staff No Action
Letter) reprinted at 1986 WL 67696. An SEC Commission release issued
in 1993 also includes the statement that the charge applied to
uncovered forward contracts in major currencies is 6 percent, and 20
percent for other currencies. See 58 FR 27486, fn. 34 (May 10,
1993).
\57\ As of 2002, two of the national currencies referred to in
the 1986 SEC Staff No Action Letter--the Deutschemark and the French
franc--have been replaced as legal tender by the euro.
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As noted in the earlier summary of Rule 1.17(c)(5)(ii), there is no
capital charge for the covered inventory and forward contracts of FCMs
and IBs in foreign currencies that are purchased or sold for future
delivery on, or subject to the rules of, a contract market. For all
inventory and forward contracts that are not covered, however, Rule
1.17(c)(5)(ii) establishes a capital charge of twenty percent, and the
Commission therefore proposes to amend the rule by adding a provision
that would specify a capital charge of six percent for uncovered
inventory and forward contracts in euros, British pounds, Canadian
dollars, Japanese yen, or Swiss francs. Uncovered forward contracts and
cash deposits in any other non-U.S. currency would remain subject to
the capital charge of twenty percent currently set forth in the rule.
The Commission believes that the proposed amendment would be
consistent with the reduced currency risk of these foreign currencies,
given their stability relative to the U.S. dollar. The proposed
amendment would also provide greater clarity and transparency to the
Commission's capital rule, as currently the lower capital charge for
the specified major non-U.S. currencies
[[Page 58994]]
is set forth only in the Commission's Form 1-FR Instructions Manual.
V. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq.,
requires that agencies, in proposing rules, consider the impact of
those rules on small businesses. The Commission previously has
established certain definitions of ``small entities'' to be used by the
Commission in evaluating the impact of its rules on such entities in
accordance with the RFA.\58\ The Commission has determined previously
that FCMs are not small entities for the purpose of the RFA.\59\ With
respect to IBs, the Commission has determined to evaluate within the
context of a particular rule proposal whether all or some IBs would be
considered ``small entities'' for purposes of the RFA and, if so, to
analyze at that time the economic impact on IBs of any such rule.\60\
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\58\ 47 FR 18618 (April 30, 1982).
\59\ 47 FR at 18619.
\60\ 47 FR at 18618, 18620.
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The Commission has previously determined, pursuant to 5 U.S.C.
605(b), that Part 145 rules relating to Commission records and
information do not have a significant economic impact on a substantial
number of small entities. Also, the proposed amendments to Rule
1.17(c)(6) would apply to FCMs only and therefore would have no
economic impact on IBs. Because the proposed amendment to Rule
1.17(c)(5)(ii) reduces the capital charge that an IB would otherwise be
required to incur under the Commission's existing regulations, the
proposed amendment should have no adverse economic impact on an IB's
financial operations.\61\ Therefore, the Chairman, on behalf of the
Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the
action proposed to be taken herein will not have a significant economic
impact on a substantial number of small entities.
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\61\ Moreover, many IBs are exempted from meeting the
requirement to file financial Forms 1-FR under the provisions of
Rule 1.10(b), which exempts those IBs that operate pursuant to an
FCM guarantee agreement that satisfies the requirements of Rule
1.10(h). Generally, at least two-thirds of registered IBs operate
pursuant to a guarantee agreement.
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B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \62\ 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. Except for the proposed revision of
Rule 1.17(c)(6), the other amendments being proposed would not, if
approved, require a new collection of information on the part of any
entities that would be subject to the proposed rule amendments.
Pursuant to the PRA, the Commission has submitted a copy of this
section to the Office of Management and Budget (``OMB'') for its
review.
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\62\ 44 U.S.C. 3507(d).
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Collection of Information. (Regulations and Forms Pertaining to the
Financial Integrity of the Marketplace, OMB Control Number 3038-0024.)
Under the proposed amendment to Rule 1.17(c)(6), an FCM that
voluntarily elects to use the Alternative Capital Computation would be
required to file with the Commission a statement that includes
information filed with its application to the SEC made under 17 CFR
240.15c3-1e, and would also be required to file copies of the monthly,
quarterly and annual filings that BDs using SEC-approved alternative
capital charges are required to file with the SEC. The collection of
information required by Rule 1.17(c)(6) is necessary for the
Commission's oversight of the FCM's compliance with its minimum
financial requirements under the Commodity Exchange Act and
implementing regulations of the Commission. The Commission estimates
that as of September 2005, in addition to the two FCM/BDs that have
already received approval orders from the SEC to use alternative
capital charges, there are eight other FCM/BDs who may elect to use the
alternative capital charges that would be permitted under the proposed
Rule 1.17(c)(6).\63\ Assuming that a total of ten FCM/BDs elect to use
the Alternative Capital Computation, the Commission estimates a minimal
increase in the annual reporting burden associated with OMB Collection
of Information Control No. 3038-004, as each of these registrants can
satisfy the Commission's filing requirements by filing copies of
documents that the FCM/BD will be required to file with the SEC. The
Commission has therefore determined that the proposed amendment to Rule
1.17(c)(6) would increase by 90 hours the total annual reporting burden
associated with the above-referenced collection of information, which
has been approved previously by OMB. Moreover, much of the required
monthly information will be provided as schedules included in the Part
II CSE FOCUS reports that FCM/BDs electronically file with both the
Commission and the SEC. The estimated burden of the proposed amendments
to Rule 1.17 was calculated as follows:
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\63\ When adopting it new rules in June of 2004, the SEC's PRA
analysis used an estimate of eleven BDs that would compute their net
capital using the alternative market risk and credit risk
deductions. 69 FR at 34451.
---------------------------------------------------------------------------
Estimated number of respondents: 10.
Reports annually by each respondent: 18.
Total annual responses: 180.
Estimated average number of hours per response: 0.5.
Annual reporting burden: 90.
Copies of the information collection submission to OMB are
available from the CFTC Clearance Officer, 1155 21st Street, NW.,
Washington, DC 20581 (202) 418-5160. The Commission considers comments
by the public on this proposed collection of information in--
Evaluating whether the proposed collection of information is
necessary for the proper performance of the functions of the
Commission, including whether the information will have a practical
use;
Evaluating the accuracy of the Commission's estimate of the burden
of the proposed collection of information, including the validity of
the methodology and assumptions used;
Enhancing the quality, utility, and clarity of the information to
be collected; and
Minimizing the burden of the collection of information on those who
are to respond, including through the use of appropriate automated,
electronic, mechanical, or other technological collection techniques or
other forms of information technology, e.g., permitting electronic
submission of responses.
Organizations and individuals desiring to submit comments on the
information collection should contact the Office of Information and
Regulatory Affairs, Office of Management and Budget, Room 10235, New
Executive Office Building, Washington, DC 20503, Attn: Desk Officer of
the Commodity Futures Commission. OMB is required to make a decision
concerning the collection of information contained in these proposed
regulations between 30 and 60 days after publication of this document
in the Federal Register. Therefore, a comment to OMB is best assured of
having its full effect if OMB receives it within 30 days of
publication. This does not affect the deadline for the public to
comment to the Commission on the proposed regulations.
[[Page 58995]]
C. Cost-Benefit Analysis
Section 15(a) of the Act, as amended by Section 119 of the CFMA,
requires the Commission to consider the costs and benefits of its
action before issuing a new regulation under the Act. By its terms,
Section 15(a) as amended does not require the Commission to quantify
the costs and benefits of a new regulation or to determine whether the
benefits of the regulation outweigh its costs. Rather, Section 15(a)
simply requires the Commission to ``consider the costs and benefits''
of its action.
Section 15(a) of the Act further specifies that costs and benefits
shall be evaluated in light of five broad areas of market and public
concern: protection of market participants and the public; efficiency,
competitiveness, and financial integrity of futures markets; price
discovery; sound risk management practices; and other public interest
considerations. Accordingly, the Commission could in its discretion
give greater weight to any one of the five enumerated areas and could
in its discretion determine that, notwithstanding its costs, a
particular rule was necessary or appropriate to protect the public
interest or to effectuate any of the provisions or to accomplish any of
the purposes of the Act.
The proposed amendment to Rule 1.17(c)(6) would permit FCM/BDs that
meet the requirements of the proposed rule to compute their adjusted
net capital using the same alternative capital deductions that have
been approved by the SEC.\64\ The proposed amendment to Rule
1.17(c)(5)(ii) would reduce a capital charge to which FCMs and IBs are
subject under the Commission's current regulations. The Commission is
considering the costs and benefits of these proposed rules in light of
the specific provisions of Section 15(a) of the Act, as follows:
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\64\ Section 4f(b) of the Act prohibits persons from becoming
registered as FCMs or IBs if they do not meet the minimum financial
requirements set forth in either the Commission's regulations or in
such Commission-approved requirements as may be established by the
contract markets and derivatives transaction execution facilities of
which the FCM or IB is a member.
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1. Protection of market participants and the public. The proposed
amendment to Rule 1.17(c)(6) provides the benefit of increasing the
accuracy of the reflection of risks in the net capital charges for FCM/
BDs approved for using the alternative net capital charges based on
internal risk measurement tools, while bettering the Commission's
ability to perform appropriate financial and risk oversight.
Furthermore, as the proposed rule would be an option available to
requesting FCM/BDs but not a requirement, the Commission considers that
no FCM/BD will request to use the charges unless the costs of
compliance would be outweighed by the benefits to such FCM/BD from
using the alternative net capital charges.
2. Efficiency and competition. The Commission anticipates that the
proposed amendment to Rule 1.17(c)(6) will benefit efficiency by
eliminating a difference in the computation of net capital charges
between the SEC and the CFTC for dually-registered FCM/BDs that have
been approved by the SEC to use such charges. The proposed amendment to
Rule 1.17(c)(5)(ii) will reduce the capital charges applicable to FCMs
and IBs, which may therefore result in the more efficient utilization
of their capital.
3. Financial integrity of futures markets and price discovery. The
notification and reporting requirements in proposed Rule 1.17(c)(6)
contribute to the benefit of ensuring that eligible FCMs can meet their
financial obligations to customers and other market participants.
Customers and other market participants would also benefit from the
provisions in proposed Rule 1.10(g) that would continue to make
publicly available certain information in Form 1-FR and FOCUS reports
related to capital requirements and requirements for customer funds to
be held in segregated or separate accounts. The proposed amendments
should have no effect, from the standpoint of imposing costs or
creating benefits, on the price discovery function of such markets.
4. Sound risk management practices. The alternative capital
computation permitted under proposed Rule 1.17(c)(6) is limited to FCMs
who have in place an internal risk management system that expressly
addresses market risk, credit risk, liquidity risk, legal risk and
operational risks at the firm. The proposed rule also requires that the
Commission receive copies of written reviews, which are to be prepared
annually by registered public accountants, of the firm's internal risk
management control system. The proposed amendment may therefore
contribute to the sound risk management practices of futures
intermediaries.
5. Other public interest considerations. The Commission also
believes that the proposed amendment to Rule 1.17(c)(6) is beneficial
in that it minimizes what would otherwise be a conflict between the
Commission and SEC rules, which conflict would otherwise make the SEC's
opportunity for qualifying BDs to use alternative net capital charges
unavailable to dually registered FCM/BDs, despite the commonality of
interest and purpose for the CFTC and SEC minimum net capital rules.
The proposed amendment to Rule 1.17(c)(5)(ii), which will incorporate
agency guidance not presently included in the Commission's regulations,
will enhance the transparency of the Commission's rulemaking for FCMs
and IBs.
After considering these factors, the Commission has determined to
propose the amendments discussed above. The Commission invites public
comment on its application of the cost-benefit provision. Commenters
also are invited to submit any data that they may have quantifying the
costs and benefits of the proposal with their comment letters.
List of Subjects
17 CFR Part 1
Brokers, Commodity futures, Reporting and recordkeeping
requirements.
17 Part 145
Freedom of information.
17 Part 147
Sunshine Act.
Accordingly, 17 CFR Chapter I is proposed to be amended 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, 5, 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, as amended by the Commodity
Futures Modernization Act of 2000, Appendix E of Pub.L. No. 106-554,
114 Stat. 2763 (2000).
2. Section 1.10 is proposed to be amended by revising paragraphs
(d)(4)(ii), (f)(1) introductory text, (g)(1), (g)(2), (g)(4), and (h)
to read as follows:
Sec. 1.10 Financial reports of futures commission merchants and
introducing brokers.
* * * * *
(d) * * *
(4) * * *
(ii) If the registrant or applicant is registered with the
Securities and Exchange Commission as a securities broker or dealer,
the representative authorized under Sec. 240.17a-5 of this title to
file for the securities broker or dealer its Financial and Operational
Combined Uniform Single Report under the Securities Exchange Act of
1934, Part II, Part IIA, or Part II CSE. In the
[[Page 58996]]
case of a Form 1-FR filed via electronic transmission in accordance
with procedures established by the Commission, such transmission must
be accompanied by the Commission-assigned Personal Identification
Number of the authorized signer and such Personal Identification Number
will constitute and become a substitute for the manual signature of the
authorized signer for the purpose of making the oath or affirmation
referred to in this paragraph.
* * * * *
(f) Extension of time for filing uncertified reports. (1) In the
event a registrant finds that it cannot file its Form 1-FR, or, in
accordance with paragraph (h) of this section, its Financial and
Operational Combined Uniform Single Report under the Securities
Exchange Act of 1934, Part II, Part IIA, or Part II CSE (FOCUS report),
for any period within the time specified in paragraphs (b)(1)(i) or
(b)(2)(i) of this section without substantial undue hardship, it may
request approval for an extension of time, as follows:
* * * * *
(g) Public availability of reports. (1) Forms 1-FR filed pursuant
to this section, and FOCUS reports filed in lieu of Forms 1-FR pursuant
to paragraph (h) of this section, will be treated as exempt from
mandatory public disclosure for purposes of the Freedom of Information
Act and the Government in the Sunshine Act and parts 145 and 147 of
this chapter, except for the information described in paragraph (g)(2)
of this section.
(2) The following information in Forms 1-FR, and the same or
equivalent information in FOCUS reports filed in lieu of Forms 1-FR,
will be publicly available:
(i) The amount of the applicant's or registrant's adjusted net
capital; the amount of its minimum net capital requirement under Sec.
1.17 of this chapter; and the amount of its adjusted net capital in
excess of its minimum net capital requirement; and
(ii) The following statements and footnote disclosures thereof: the
Statement of Financial Condition in the certified annual financial
reports of futures commission merchants and introducing brokers; the
Statements (to be filed by a futures commission merchant only) of
Segregation Requirements and Funds in Segregation for customers trading
on U.S. commodity exchanges and for customers' dealer options accounts,
and the Statement (to be filed by a futures commission merchant only)
of Secured Amounts and Funds held in Separate Accounts for foreign
futures and foreign options customers in accordance with Sec. 30.7 of
this chapter.
(3) * * *
(4) All information that is exempt from mandatory public disclosure
under paragraph (g)(1) of this section will, however, be available for
official use by any official or employee of the United States or any
State, by any self-regulatory organization of which the person filing
such report is a member, by the National Futures Association in the
case of an applicant, and by any other person to whom the Commission
believes disclosure of such information is in the public interest.
Nothing in this paragraph (g) will limit the authority of any self-
regulatory organization to request or receive any information relative
to its members' financial condition.
* * * * *
(h) Filing option available to a futures commission merchant or an
introducing broker that is also a securities broker or dealer. Any
applicant or registrant which is registered with the Securities and
Exchange Commission as a securities broker or dealer may comply with
the requirements of this section by filing (in accordance with
paragraphs (a), (b), (c), and (j) of this section) a copy of its
Financial and Operational Combined Uniform Single Report under the
Securities Exchange Act of 1934, Part II, Part IIA, or Part II CSE
(FOCUS report), in lieu of Form 1-FR: Provided, however, That all
information which is required to be furnished on and submitted with
Form 1-FR is provided with such FOCUS report.
* * * * *
3. Section 1.16 is proposed to be amended by revising paragraph
(c)(5) to read as follows:
Sec. 1.16 Qualifications and reports of accountants.
* * * * *
(c) * * *
(5) Accountant's report on material inadequacies. A registrant must
file concurrently with the annual audit report a supplemental report by
the accountant describing any material inadequacies found to exist or
found to have existed since the date of the previous audit. An
applicant must file concurrently with the audit report a supplemental
report by the accountant describing any material inadequacies found to
exist as of the date of the Form 1-FR being filed: Provided, however,
That if such applicant is registered with the Securities and Exchange
Commission as a securities broker or dealer, and it files (in
accordance with Sec. 1.10(h)) a copy of its Financial and Operational
Combined Uniform Single Report under the Securities Exchange Act of
1934, Part II, Part IIA, or Part II CSE, in lieu of Form 1-FR, the
accountant's supplemental report must be made as of the date of such
report. The supplemental report must indicate any corrective action
taken or proposed by the applicant or registrant in regard thereto. If
the audit did not disclose any material inadequacies, the supplemental
report must so state.
* * * * *
4. Section 1.17 is proposed to be amended by revising paragraph
(c)(5)(ii) and adding (c)(6) to read as follows:
Sec. 1.17 Minimum financial requirements for futures commission
merchants and introducing brokers.
* * * * *
(c) * * *
(5) * * *
(ii) In the case of all inventory, fixed price commitments and
forward contracts, the applicable percentage of the net position
specified as follows:
(A) Inventory which is currently registered as deliverable on a
contract market and covered by an open futures contract or by a
commodity option on a physical.--No charge.
(B) Inventory which is covered by an open futures contract or
commodity option.--5 percent of the market value.
(C) Inventory which is not covered.--20 percent of the market
value.
(D) Inventory and forward contracts in those foreign currencies
that are purchased or sold for future delivery on or subject to the
rules of a contract market, and which are covered by an open futures
contract.--No charge.
(E) Inventory and forward contracts in euros, British pounds,
Canadian dollars, Japanese yen, or Swiss francs, and which are not
covered by an open futures contract or commodity option.--6 percent of
the market value.
(F) Fixed price commitments (open purchases and sales) and forward
contracts which are covered by an open futures contract or commodity
option.--10 percent of the market value.
(G) Fixed price commitments (open purchases and sales) and forward
contracts which are not covered by an open futures contract or
commodity option.--20 percent of the market value.
* * * * *
(6) Election of alternative capital deductions that have received
approval of Securities and Exchange Commission pursuant to section
240.15c3-1(a)(7) of this title. (i) Any futures commission merchant
that is also registered with the Securities and Exchange Commission as
a securities broker or dealer, and who also satisfies the other
requirements of
[[Page 58997]]
this paragraph (c)(6), may elect to compute its adjusted net capital
using the alternative capital deductions that, under section 240.15c3-
1(a)(7) of this title, the Securities and Exchange Commission has
approved for it by written order. To the extent that a futures
commission merchant is permitted by the Securities and Exchange
Commission to use alternative capital deductions for its unsecured
receivables from over-the-counter transactions in derivatives, or for
its proprietary positions in securities, forward contracts, or futures
contracts, the futures commission merchant may use these same
alternative capital deductions when computing its adjusted net capital,
in lieu of the deductions that would otherwise be required by paragraph
(c)(2)(ii) of this section for its unsecured receivables from over-the-
counter derivatives transactions; by paragraph (c)(5)(ii) of this
section for its proprietary positions in forward contracts; by
paragraph (c)(5)(v) of this section for its proprietary positions in
securities; and by paragraph (c)(5)(x) of this section for its
proprietary positions in futures contracts.
(ii) Notifications of election or of changes to election. (A) No
election to use the alternative market risk and credit risk deductions
referenced in paragraph (c)(6)(i) of this section shall be effective
unless and until the futures commission merchant has filed with the
Commission, addressed to the Director of the Division of Clearing and
Intermediary Oversight, a notice that is to include a copy of the
approval order of the Securities and Exchange Commission referenced in
paragraph (c)(6)(i) of this section, and to include also a statement
that identifies the amount of tentative net capital below which the
futures commission merchant is required to provide notice to the
Securities and Exchange Commission, and which also provides the
following information: A list of the categories of positions that the
futures commission merchant holds in its proprietary accounts, and, for
each such category, a description of the methods that the futures
commission merchant will use to calculate its deductions for market
risk and credit risk, and also, if calculated separately, deductions
for specific risk; a description of the value at risk (VaR) models to
be used for its market risk and credit risk deductions, and an overview
of the integration of the models into the internal risk management
control system of the futures commission merchant; a description of how
the futures commission merchant will calculate current exposure and
maximum potential exposure for its deductions for credit risk; a
description of how the futures commission merchant will determine
internal credit ratings of counterparties and internal credit risk
weights of counterparties, if applicable; and a description of the
estimated effect of the alternative market risk and credit risk
deductions on the amounts reported by the futures commission merchant
as net capital and adjusted net capital.
(B) A futures commission merchant must also, upon the request of
the Commission at any time, supplement the statement described in
paragraph (c)(6)(ii)(A) of this section, by providing any other
explanatory information regarding the computation of its alternative
market risk and credit risk deductions as the Commission may require at
its discretion.
(C) A futures commission merchant must also file the following
supplemental notices with the Director of the Division and Clearing and
Intermediary Oversight:
(1) A notice advising that the Securities and Exchange Commission
has imposed additional or revised conditions for the approval evidenced
by the order referenced in paragraph (c)(6)(i) of this section, and
which describes the new or revised conditions in full, and
(2) A notice which attaches a copy of any approval by the
Securities and Exchange Commission of amendments that a futures
commission merchant has requested for its application, filed under 17
CFR 240.15c3-1e, to use alternative market risk and credit risk
deductions approved by the Securities and Exchange Commission.
(D) A futures commission merchant may voluntarily change its
election to use the alternative market risk and credit risk deductions
referenced in paragraph (c)(6)(i) of this section, by filing with the
Director of the Division of Clearing and Intermediary Oversight a
written notice specifying a future date as of which it will it no
longer use the alternative market risk and credit risk deductions, and
will instead compute such deductions in accordance with the
requirements otherwise applicable under paragraph (c)(2)(ii) of this
section for unsecured receivables from over-the-counter derivatives
transactions; by paragraph (c)(5)(ii) of this section for proprietary
positions in forward contracts; by paragraph (c)(5)(v) of this section
for proprietary positions in securities; and by paragraph (c)(5)(x) of
this section for proprietary positions in futures contracts.
(iii) Conditions under which election terminated. A futures
commission merchant may no longer elect to use the alternative market
risk and credit risk deductions referenced in paragraph (c)(6)(i) of
this section, and shall instead compute the deductions otherwise
required under paragraph (c)(2)(ii) of this section for unsecured
receivables from over-the-counter derivatives transactions; by
paragraph (c)(5)(ii) of this section for proprietary positions in
forward contracts; by paragraph (c)(5)(v) of this section for
proprietary positions in securities; and by paragraph (c)(5)(x) of this
section for proprietary positions in futures contracts, upon the
occurrence of any of the following:
(A) The Securities and Exchange Commission revokes its approval of
the market risk and credit risk deductions for such futures commission
merchant;
(B) A futures commission merchant fails to come into compliance
with its filing requirements under this paragraph (c)(6), after having
received from the Director of the Division of Clearing and Intermediary
Oversight written notification that the futures commission merchant is
not in compliance with its filing requirements, and that it must cease
using the alternative capital deductions permitted under this paragraph
(c)(6) if it has not come into compliance by a date specified in the
notice; or
(C) The Commission by written order finds that permitting the
futures commission merchant to continue to use such alternative market
risk and credit risk deductions is no longer necessary or appropriate
for the protection of customers of the futures commission merchant or
of the integrity of the futures or options markets.
(iv) Additional filing requirements. Any futures commission
merchant that elects to use the alternative market risk and credit risk
deductions referenced in paragraph (c)(6)(i) of this section must file
with the Commission, in addition to the filings required by paragraph
(c)(6)(ii) of this section, copies of any and all of the following
documents, at such time as the originals are filed with the Securities
and Exchange Commission:
(A) Information that the futures commission merchant files on a
monthly basis with its designated examining authority or the Securities
and Exchange Commission, whether by way of schedules to its FOCUS
reports or by other filings, in satisfaction of 17 CFR 240.17a-
5(a)(5)(i);
(B) The quarterly reports required by 17 CFR 240.17a-5(a)(5)(ii);
(C) The supplemental annual filings as required by 17 CFR 240.17a-
5(k);
[[Page 58998]]
(D) Any notification to the Securities and Exchange Commission or
the futures commission merchant's designated examining authority of
planned withdrawals of excess net capital; and
(E) Any notification that the futures commission merchant is
required to file with the Securities and Exchange Commission when its
tentative net capital is below an amount specified by the Securities
and Exchange Commission.
* * * * *
5. Section 1.18 is proposed to be amended by revising paragraphs
(a) and (b)(2) to read as follows:
Sec. 1.18 Records for and relating to financial reporting and monthly
computation by futures commission merchants and introducing brokers.
(a) No person shall be registered as a futures commission merchant
or as an introducing broker under the Act unless, commencing on the
date his application for such registration is filed, he prepares and
keeps current ledgers or other similar records which show or summarize,
with appropriate references to supporting documents, each transaction
affecting his asset, liability, income, expense and capital accounts,
and in which (except as otherwise permitted in writing by the
Commission) all his asset, liability and capital accounts are
classified into either the account classification subdivisions
specified on Form 1-FR-FCM or Form 1-FR-IB, respectively, or, if such
person is registered with the Securities and Exchange Commission as a
securities broker or dealer and he files (in accordance with Sec.
1.10(h)) a copy of his Financial and Operational Combined Uniform
Single Report under the Securities Exchange Act of 1934, Part II, Part
IIA, or Part II CSE (FOCUS report) in lieu of Form 1-FR-FCM or Form 1-
FR-IB, the account classification subdivisions specified on such
Report, or categories that are in accord with generally accepted
accounting principles. Each person so registered shall prepare and keep
current such records.
(b) * * *
(2) An applicant or registrant that has filed a monthly Form 1-FR
or Statement of Financial and Operational Combined Uniform Single
Report under the Securities Exchange Act of 1934, Part II, Part IIA, or
Part II CSE (FOCUS report) in accordance with the requirements of Sec.
1.10(b) will be deemed to have satisfied the requirements of paragraph
(b)(1) of this section for such month.
* * * * *
6. Section 1.52 is proposed to be amended by revising paragraph (a)
to read as follows:
Sec. 1.52 Self-regulatory organization adoption and surveillance of
minimum financial requirements.
(a) Each self-regulatory organization must adopt, and submit for
Commission approval, rules prescribing minimum financial and related
reporting requirements for all its members who are registered futures
commission merchants. Each self-regulatory organization other than a
contract market must adopt, and submit for Commission approval, rules
prescribing minimum financial and related reporting requirements for
all its members who are registered introducing brokers. Each contract
market which elects to have a category of membership for introducing
brokers must adopt, and submit for Commission approval, rules
prescribing minimum financial and related reporting requirements for
all its members who are registered introducing brokers. Each self-
regulatory organization shall submit for Commission approval any
modification or other amendments to such rules. Such requirements must
be the same as, or more stringent than, those contained in Sec. Sec.
1.10 and 1.17 and the definition of adjusted net capital must be the
same as that prescribed in Sec. 1.17(c): Provided, however, A
designated self-regulatory organization may permit its member
registrants which are registered with the Securities and Exchange
Commission as securities brokers or dealers to file (in accordance with
Sec. 1.10(h)) a copy of their Financial and Operational Combined
Uniform Single Report under the Securities Exchange Act of 1934, Part
II, Part IIA, or Part II CSE, in lieu of Form 1-FR: And, provided
further, A designated self-regulatory organization may permit its
member introducing brokers to file a Form 1-FR-IB in lieu of a Form 1-
FR-FCM.
* * * * *
PART 145--COMMISSION RECORDS AND INFORMATION
7. The authority citation for part 145 continues to read as
follows:
Authority: Pub. L. 99-570, 100 Stat. 3207; Pub. L. 89-554, 80
Stat. 383; Pub. L. 90-23, 81 Stat. 54; Pub. L. 98-502, 88 Stat.
1561-1564 (5 U.S.C. 552); Sec. 101(a), Pub. L. 93-463, 88 Stat. 1389
(5 U.S.C. 4a(j)); unless otherwise noted.
8. Section 145.5 is proposed to be amended by revising paragraphs
(d)(1) and (h) to read as follows:
Sec. 145.5 Disclosure of nonpublic records.
* * * * *
(d) Trade secrets and commercial or financial information obtained
from a person and privileged or confidential, including, but not
limited to:
(1)(i) Reports of stocks of grain, such as Forms 38, 38C, 38M and
38T required to be filed pursuant to 17 CFR 1.44;
(ii) Statements of reporting traders on Form 40 required to be
filed pursuant to 17 CFR 18.04;
(iii) Statements concerning special calls on positions required to
be filed pursuant to 17 CFR part 21;
(iv) Statements concerning identification of special accounts on
Form 102 required to be filed pursuant to 17 CFR 17.01;
(v) Reports required to be filed pursuant to parts 15 through 21 of
this chapter;
(vi) Reports concerning option positions of large traders required
to be filed pursuant to part 16 of this chapter;
(vii) Form 188; and
(viii) The following reports and statements that are also set forth
in paragraph (h) of this section, except as specified in 17 CFR
1.10(g)(2) or 17 CFR 31.13(m): Forms 1-FR required to be filed pursuant
to 17 CFR 1.10; FOCUS reports that are filed in lieu of Forms 1-FR
pursuant to 17 CFR 1.10(h); Forms 2-FR required to be filed pursuant to
17 CFR 31.13; the accountant's report on material inadequacies filed in
accordance with 17 CFR 1.16(c)(5); and all reports and statements
required to be filed pursuant to 17 CFR 1.17(c)(6);
* * * * *
(h) Contained in or related to examinations, operating, or
condition reports prepared by, on behalf of, or for the use of the
Commission or any other agency responsible for the regulation or
supervision of financial institutions, including, but not limited to
the following reports and statements that are also set forth in
paragraph (d)(1)(viii) of this section, except as specified in 17 CFR
1.10(g)(2) or 17 CFR 31.13(m): Forms 1-FR required to be filed pursuant
to 17 CFR 1.10; FOCUS reports that are filed in lieu of Forms 1-FR
pursuant to 17 CFR 1.10(h); Forms 2-FR required to be filed pursuant to
17 CFR 31.13; the accountant's report on material inadequacies filed in
accordance with 17 CFR 1.16(c)(5); and all reports and statements
required to be filed pursuant to 17 CFR 1.17(c)(6); and
* * * * *
PART 147--OPEN COMMISSION MEETINGS
9. The authority citation for part 147 continues to read as
follows:
[[Page 58999]]
Authority: Sec. 3(a), Pub. L. 94-409, 90 Stat. 1241 (5 U.S.C.
552b); sec. 101(a)(11), Pub. L. 93-463, 88 Stat. 1391 (7 U.S.C.
4a(j) (Supp. V, 1975)), unless otherwise noted.
10. Section 147.3 is proposed to be amended by revising paragraphs
(b)(4)(i) and (b)(8) to read as follows:
Sec. 147.3 General requirement of open meetings; grounds upon which
meetings may be closed.
* * * * *
(b) * * *
(4)(i) Disclose trade secrets and commercial or financial
information obtained from a person and privileged or confidential
including, but not limited to:
(A) Reports of stocks of grain, such as Forms 38, 38C, 38M and 38T,
required to be filed pursuant to 17 CFR 1.44;
(B) Statements of reporting traders on Form 40 required to be filed
pursuant to 17 CFR 18.04;
(C) Statements concerning special calls on positions required to be
filed pursuant to 17 CFR part 21;
(D) Statements concerning identification of special accounts on
Form 102 required to be filed pursuant to 17 CFR 17.01;
(E) Reports required to be filed pursuant to parts 15 through 21 of
this chapter;
(F) Reports concerning option positions of large traders required
to be filed pursuant to part 16 of this chapter;
(G) Form 188; and
(H) The following reports and statements that are also set forth in
paragraph (b)(8) of this section, except as specified in 17 CFR
1.10(g)(2) or 17 CFR 31.13(m): Forms 1-FR required to be filed pursuant
to 17 CFR 1.10; FOCUS reports that are filed in lieu of Forms 1-FR
pursuant to 17 CFR 1.10(h); Forms 2-FR required to be filed pursuant to
17 CFR 31.13; the accountant's report on material inadequacies filed in
accordance with 17 CFR 1.16(c)(5); and all reports and statements
required to be filed pursuant to 17 CFR 1.17(c)(6);
* * * * *
(8) Disclose information contained in or related to examination,
operating, or condition reports prepared by, on behalf of, or for the
use of the Commission or any other agency responsible for the
regulation or supervision of financial institutions, including, but not
limited to the following reports and statements that are also set forth
in paragraph (b)(4)(i)(H) of this section, except as specified in 17
CFR 1.10(g)(2) or 17 CFR 31.13(m): Forms 1-FR required to be filed
pursuant to 17 CFR 1.10; FOCUS reports that are filed in lieu of Forms
1-FR pursuant to 17 CFR 1.10(h); Forms 2-FR required to be filed
pursuant to 17 CFR 31.13; the accountant's report on material
inadequacies filed in accordance with 17 CFR 1.16(c)(5); and all
reports and statements required to be filed pursuant to 17 CFR
1.17(c)(6);
* * * * *
Issued in Washington, DC, on October 4, 2005 by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 05-20258 Filed 10-7-05; 8:45 am]
BILLING CODE 6351-01-P