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EXPLANATION OF PROPOSED AMENDMENTS

In February 2005, the Board approved an amendment to NFA Financial Requirements Section 11 to impose a concentration charge when a Forex Dealer Member's ("FDM") net positions with a counterparty exceed 10% of its total long or short positions. The concentration charge is applicable to transactions with all affiliated counterparties, regardless of regulatory status, and to all other counterparties that are not regulated in either the U.S. or a money center country, as defined in CFTC Rule 1.49. Under the rule, NFA has the authority to provide an exemption for transactions between FDMs and unaffiliated counterparties. The rule, however, does not provide exemption authority where the counterparty is an affiliate of the FDM.

Subsequent to the adoption of the rule, several Members that exclusively cover their net exposure from customers through transactions with affiliates submitted requests for exemptions from the concentration charge. These Members indicated that the resulting concentration charge significantly affects their adjusted net capital. In one case, the concentration charge was $45 million.

The Board adopted the concentration requirement with the intention of preventing an FDM from hedging its exposure by entering into transactions with thinly capitalized affiliates or unregulated counterparties for the purpose of reducing their net capital requirements. NFA believes that there are circumstances in which transactions with an affiliate are not inconsistent with the intent of the rule. Of the requests for exemption received to date, NFA believes that the circumstances involved in some of these requests would be appropriate for granting an exemption. Accordingly, the Board amended the rule so that NFA may grant exemptions, at its discretion, where transactions with affiliated counterparties are not inconsistent with the intent of the rule and do not create undue risk for the customers of the FDM.

The standards that staff will apply for granting an exemption with regard to an affiliated counterparty will be significantly greater than those for unaffiliated counterparties. For example, an exemption may be granted where, among other things:

  • the parent company of the Member and the affiliated counterparty are highly capitalized;
  • either the parent company or the affiliated counterparty is a regulated entity;
  • the parent company will guarantee the obligations of the affiliated counterparty;
  • the parent company is rated in one of the highest categories by a rating organization, such as Standard and Poor's;
  • the affiliated counterparty will limit the amount of the offsetting transactions it enters into with unregulated counterparties; and
  • the affiliated counterparty has strong risk management policies in place to limit its value-at-risk.

In such circumstances, covering transactions with an affiliated counterparty does not pose an increased risk to customers and is consistent with the purpose of the rule. An exemption would not be appropriate if the parent of the FDM and affiliated counterparty does not have significant capital and is unable to provide an adequate guarantee that the affiliated counterparty could meet all of its obligations. This would be true even if the affiliated counterparty was regulated in the U.S. or a money center country.

NFA respectfully requests that the Commission review and approve the proposed amendments to Section 11 of NFA's Financial Requirements relating to the concentration charge on affiliate transactions.

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