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In November, NFA's Board adopted a new alternative capital requirement that requires an FDM to maintain adjusted net capital equal to or greater than 5% of customer liabilities.1 When it adopted this requirement, NFA recognized that it could provide a disincentive to FDMs to collect additional customer funds as security deposits because doing so will increase the adjusted net capital requirement. NFA determined that the benefits of the new requirement, including the more straightforward calculation and better recognition of the growth of an FDM's business, outweighed this risk.
FDMs are also subject to a concentration charge when an FDM's net positions with a counterparty exceed 10% of its total long or short positions. Under Section 11(b) of NFA's Financial Requirements, the concentration charge is applicable to transactions with all unaffiliated unregulated counterparties, including customers of an FDM. This charge is not affected by the change to the alternative capital requirement.
NFA's Board adopted this concentration requirement to mitigate the FDM's counterparty risk. There are some situations, however, where the concentration charge overcompensates for that risk. Currently, the concentration charge does not take into account the amount of funds deposited with the FDM that might be applied to any losses resulting from the customer's positions.2 Reducing the concentration charge by the net liquidating value of the off-exchange foreign currency account and by excess funds in any regulated commodity accounts held by the FDM for the customer subject to the concentration charge will encourage the FDM to collect additional customer funds from its largest customers without losing the benefit of the concentration charge. For purposes of this rule, excess funds in a regulated account is that portion of the net liquidating value of the account in excess of any margin requirements.3
Funds in an off-exchange foreign currency account held as security deposits are immediately available to cover any deficit resulting from these positions. Funds in a regulated account that are required to margin futures positions are not available to cover such deficits. Accordingly, while the amendments permit reducing the concentration charge by the net liquidating value of an off-exchange foreign currency account, only the amount of excess funds in a regulated account will be available to reduce the concentration charge.
Depending on the currency, the concentration charge is either 6% or 20% of the value of the position that exceeds 10% of the FDM's total long or short position. By permitting the amount of the concentration charge to be reduced by the amount of the net liquidating value of the customer's accounts, the FDM will have an incentive to obtain additional funds from the customer and avoid a concentration charge that is larger than the alternative capital requirement. This is particularly true in the case of currencies subject to the 20% charge, which tend to be more thinly traded so that the FDM has few customers trading and, therefore, is more likely to have a customer meeting the 10% threshold for the concentration charge.
The amendments place an additional condition on the use of excess funds in the customer's regulated commodity accounts, i.e., its segregated account or secured funds account. To use those funds to offset the concentration charge, the FDM must have the right under an agreement with the customer to apply excess funds in the regulated accounts to meet any losses incurred in the customer's off-exchange foreign currency account.
Since the FDM will be able to reduce the concentration charge without moving the excess funds out of the regulated account, these provisions will not affect the protection given these funds. Funds in regulated accounts will not be commingled with funds in unregulated accounts, and regulated accounts will continue to be subject to all the requirements and enjoy all the protections accorded those accounts unless they are actually transferred to an off-exchange foreign currency account to cover a debit.
Regardless of whether the customer's assets are in a regulated commodity account or an off-exchange foreign currency account, the concentration charge can only be reduced by the value such assets would have under CFTC Rule 1.17 when calculating adjusted net capital. In other words, in determining the net liquidating value or excess funds of a customer's account, the assets in the account will be subject to the same haircuts as they would under CFTC Rule 1.17.
NFA respectfully requests that the Commission review and approve the proposed amendments to Section 11 of NFA's Financial Requirements for FDMs and the Interpretive Notice regarding Forex Transactions.
1 The Commission has approved this change and it will become effective as of March 31, 2007.
2 For purposes of this discussion only, the term customer includes eligible contract participants (e.g., commodity pools).
3 Using the net liquidating value, rather than the amount of free credit balances or cash in an account, ensures that any loss from existing positions is taken into consideration before reducing the concentration charge.