[Federal Register Volume 63, Number 115 (Tuesday, June 16, 1998)]
[Rules and Regulations]
[Pages 32725-32726]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-15975]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1


Minimum Financial Requirements for Futures Commission Merchants

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'') is 
amending its minimum financial requirements for futures commission 
merchants (``FCMs''). The amendment will eliminate a charge presently 
required to be taken by FCMs in the computation of the amount of their 
net capital. This charge is commonly referred to as the ``short option 
value charge'' (``SOV charge''). The Commission is rescinding this 
charge, because it has found that the charge is not closely correlated 
to the actual risk of the customers' short option positions and, in any 
event, there are other protections in place to address this risk.

EFFECTIVE DATE: July 16, 1998.

FOR FURTHER INFORMATION CONTACT: Paul H. Bjarnason, Jr., Chief 
Accountant, or Lawrence B. Patent, Associate Chief Counsel, Division of 
Trading and Markets, Commodity Futures Trading Commission, 1155 21st 
Street, N.W. Washington, D.C. 20581; telephone (202) 418-5459 or 418-
5439.

SUPPLEMENTARY INFORMATION:

I. Background

    The minimum adjusted net capital requirement for an FCM is 
currently the greatest of: (A) $250,000; (B) four percent of the 
customer funds required to be segregated pursuant to the Commodity 
Exchange Act and the foreign futures or foreign options secured amount, 
less the market value of commodity options purchased by customers on or 
subject to the rules of a contract market or a foreign board of trade: 
Provided, however, that the deduction for each customer shall be 
limited to the amount of customer funds in such customer's account(s) 
and foreign futures and foreign options secured amounts; (C) the amount 
of adjusted net capital required by a registered futures association of 
which it is a member; or (D) for securities brokers and dealers, the 
amount of net capital required by Rule 15c3-1(a) of the Securities and 
Exchange Commission (17 CFR 240.15c3-1(a)).
    In calculating the amount of adjusted net capital needed to meet 
the minimum requirement, FCMs are presently required under Commission 
Rule 1.17(c)(5)(iii) to deduct a capital charge, based upon four 
percent of the market value of commodity options granted (sold) by 
option customers on or subject to the rules of a contract market or a 
foreign board of trade. The Commission adopted this provision in 1982 
to require that an FCM recognize the risk involved in customers selling 
or going short an option. Under this provision, an FCM is required to 
take this charge, regardless of the trading strategy of the customer. 
Some customers have used a short option position in combination with 
another futures or commodity option position, such as an inter-month 
spread position. Although such a position would involve less risk than 
a naked position, the SOV charge would be the same or, perhaps, 
greater.
    On March 9, 1998, the Commission proposed an amendment to the 
minimum financial requirements for futures commission merchants which 
would eliminate Rule 1.17(c)(5)(iii).<SUP>1</SUP> The Commission 
received two (2) comment letters. Both supported elimination of the 
charge. One letter was jointly signed by representatives from each of 
seven (7) U.S. commodity exchanges and the other was filed by an FCM.
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    \1\ 63 FR 12713 (March 16, 1998).
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    The effect of the amendment is to decrease the amount of charges 
taken against capital in the computation of net capital. The reduction 
in capital charges taken by an FCM will result in an increase in the 
stated amount of adjusted net capital of an FCM carrying short option 
positions in customer accounts. The total amount of the increase in an 
FCM's net capital would depend on the quantity and value of short 
options carried in the accounts of the FCM's customers.
    As stated in the proposing release, the Commission proposed to 
rescind this rule, because the charge is not closely correlated to the 
actual risk of the options carried on behalf of customers and, in any 
event, there are other protections in place to address the risk of 
short options. In particular, the Standard Portfolio Analysis of Risk 
(``SPAN'') margining system has been effectively used in setting 
appropriate levels of risk margin, and there are many other non-capital 
protections. These protections include effective self-regulatory 
organization (``SRO'') audit and financial surveillance programs and 
modern risk management and control systems at FCMs. All of the comments 
received on the Commission's proposal to rescind the SOV charge 
confirmed these views. Moreover, no comments were received which 
provided any reason to believe that the SOV charge should not be 
rescinded.

II. Summary of Comments

A. Portfolio Margining System

    Commenters noted that the four percent capital charge is not 
closely correlated to the actual risk of customer

[[Page 32726]]

short option positions and that, subsequent to the adoption of Rule 
1.17(c)(5)(iii), the SPAN margining system was developed. SPAN uses 
option pricing models to calculate the theoretical gains and losses on 
an option at various market prices of the underlying commodity and is a 
significant improvement in measuring the risk of an option. All U.S. 
commodity exchanges and many foreign exchanges have adopted SPAN to 
assess option risk. In addition, SPAN recognizes trading strategies in 
which short option positions are risk reducing and SPAN has been tested 
and proven to assess adequately the risk in the customer's portfolio.

B. Large Trader Positions

    Commenters also noted that the commodity exchanges closely monitor 
large trader positions in each contract market to identify those market 
participants that may pose a financial risk to the FCM carrying their 
account. This includes option positions at clearing firms carrying 
option customers' accounts. Safeguards such as intraday variation 
margin calls, continuous monitoring of the markets and direct contact 
with the FCMs alert the exchanges to any potential problems.

C. Financial Surveillance

    Commenters further noted that additional protection exists in the 
form of capital and segregation requirements for FCMs. Commission 
regulations require FCMs not only to maintain a minimum amount of 
adjusted net capital, but also to maintain a sufficient amount of 
excess adjusted net capital. In the event an FCM's adjusted net capital 
falls below an early warning level, generally 150% of the minimum 
dollar amount (e.g., 6% of customer segregated funds), the FCM is 
required to notify the Commission within five (5) business days. The 
FCM must continue filing financial reports monthly until the FCM's 
adjusted net capital is at or above the early warning level for three 
consecutive months. In calculating adjusted net capital, FCMs must 
deduct deficits and any undermargined amounts in customer accounts. 
With respect to the segregation requirements, an FCM is required to 
deposit customer funds in accounts designated for the benefit of 
customers. The FCM must also make a daily calculation showing whether 
there are sufficient funds in segregated accounts.

III. 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 has previously determined that FCMs 
are not ``small entities'' for purposes of the RFA.<SUP>2</SUP> 
Therefore, the Chairperson, on behalf of the Commission, hereby 
certifies, pursuant to 5 U.S.C. 605(b), that the action taken herein 
will not have a significant economic impact on a substantial number of 
small entities.
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    \2\ 47 FR 18619-18620 (April 30, 1982).
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B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 <SUP>3</SUP> imposes certain 
requirements on federal agencies (including the Commission) in 
connection with their conducting or sponsoring any collection of 
information as defined by the Paperwork Reduction Act. While this 
proposed rule has no burden, the group of rules (3038-0024) of which 
this is a part has the following burden:
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    \3\ Pub. L. No. 104-13, 109 Stat. 163 (1995).
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    Average burden hours per response: 128.
    Number of respondents: 235.
    Frequency of response: Monthly.
    Copies of the OMB-approved information collection package 
associated with this rule may be obtained from the Desk Officer, CFTC, 
Office of Management and Budget, Room 10202, NEOB Washington, DC 20503, 
(202) 395-7340.

List of Subjects in 17 CFR Part 1

    Brokers, Commodity futures, Consumer protection, Net capital 
requirements, Reporting and recordkeeping requirements.

    In consideration of the foregoing and pursuant to the authority 
contained in the Commodity Exchange Act and, in particular, Sections 
4f, 4g and 8a(5) thereof, 7 U.S.C. 6d, 6g and 12a(5), the Commission 
hereby amends Chapter I of Title 17 of the Code of Federal Regulations 
as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

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

    Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f, 
6g, 6h, 6I, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 
12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24.


Sec. 1.17  [Amended]

    2. Section 1.17(c)(5)(iii) is removed and reserved.

    Issued in Washington, DC on June, 10, 1998, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 98-15975 Filed 6-15-98; 8:45 am]
BILLING CODE 6351-01-P