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Proposed Rule

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PROPOSED AMENDMENTS
(additions are underscored and deletions are stricken through)

FINANCIAL REQUIREMENTS

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SECTION 11. FOREX DEALER MEMBER FINANCIAL REQUIREMENTS

(a) Each Forex Dealer Member must maintain "Adjusted Net Capital" (as defined in CFTC Regulation 1.17) equal to or in excess of the greatest of:

    (i) $1,000,000 $5,000,000;

    (ii) 5% of all liabilities owed to customers (as customer is defined in Compliance Rule 2-36(i); or

    (iii) Any other amount required by Section 1 of these Financial Requirements.

(b) A Forex Dealer Member may not include assets held by an affiliate (unless approved by NFA) or an unregulated person in its current assets for purposes of determining its adjusted net capital under CFTC Rule 1.17. An affiliate is any person that controls, is controlled by, or is under common control with the Forex Dealer Member. Each Forex Dealer Member must take a concentration charge on transactions with an unaffiliated, unregulated counterparty if the Forex Dealer Member's net open position with the unregulated counterparty exceeds 10% of the Forex Dealer Member's total long or short position in a particular currency. The amount exceeding 10% will be subject to the CFTC's haircut for uncovered positions regardless of the Forex Dealer Member's overall position. The amount of the concentration charge may be reduced by the net liquidating value of the counterparty's forex account held by the Forex Dealer Member, except that the Forex Dealer Member may use only those assets allowable as capital under CFTC Rule 1.17 and must apply the haircuts required by that rule (except those for open positions). With the same restrictions, the concentration charge may also be reduced by the amount of the net liquidating value of the counterparty's regulated commodity accounts held by the Forex Dealer Member in compliance with CFTC Rule 1.20 or 30.7 that is in excess of any margin requirement, if the Forex Dealer Member has the right under an agreement with the counterparty to transfer funds from these accounts to reduce the debit balance incurred in the counterparty's forex account.

For purposes of this section and section (c), a person counterparty is unregulated unless it is:

    (i) a financial institution regulated by a U.S. banking regulator;

    (ii) a broker-dealer registered with the U.S. Securities and Exchange Commission and a member of NASD Inc.;

    (iii) a futures commission merchant registered with the U.S. Commodity Futures Trading Commission and a Member of NFA;

    (iv) an insurance company regulated by any U.S. state;

    (v) an entity regulated as a foreign equivalent of any of the above if regulated in a money center country as defined in CFTC Regulation 1.49; or

    (vi) any other entity approved by NFA.

(c) A Forex Dealer Member may not use an affiliate (unless approved by NFA) or an unregulated person, as defined in section (b), to cover its currency positions for purposes of CFTC Rule 1.17(c)(5). Unless exempted from this section by NFA, each Forex Dealer Member must also take a concentration charge on transactions with affiliates equal to the greater of the following:
    (i) The sum of the amounts by which the Member's net open position with a single affiliate exceeds 10% of the Forex Dealer Member's total long or short position in a particular currency; or

    (ii) The amount by which the Member's net open position with all affiliates combined exceeds 10% of the Forex Dealer Member's total long or short position in a particular currency.

This amount will be subject to the CFTC's haircut for uncovered positions regardless of the Forex Dealer Member's overall position.

(d) For purposes of this rule:

    (1) "Forex" has the same meaning as in Bylaw 1507(b);

    (2) "Forex Dealer Member" has the same meaning as in Bylaw 306; and

    (3) As used in sections (b) and (c), "currency" refers to open foreign currency positions with counterparties regardless of whether those counterparties are eligible contract participants as defined in Section 1a(12) of the Act.

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    INTERPRETIVE NOTICES

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    FOREX TRANSACTIONS

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    C. OTHER REQUIREMENTS

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    2. Financial Requirements Section 11(b)

    Section 11(b) prohibits a Forex Dealer Member from including assets held by an affiliate (unless approved) or an unregulated person in the firm's current assets for purposes of determining its adjusted net capital under CFTC Rule 1.17. This means an FDM may not count any part of those assets for capital purposes.17 imposes a concentration charge on a Forex Dealer Member that has a material position with a single unregulated counterparty (including a customer) that is not an affiliate.

    An unregulated person counterparty is any person entity that is not:

      (i) a financial institution regulated by a U.S. banking regulator;

      (ii) a broker-dealer registered with the U.S. Securities and Exchange Commission and a member of NASD Inc.;

      (iii) a futures commission merchant registered with the U.S. Commodity Futures Trading Commission and a Member of NFA;

      (iv) an insurance company regulated by any U.S. state;

      (v) an entity regulated as a foreign equivalent of any of the above if regulated in a money center country as defined in CFTC Regulation 1.49; or

      (vi) any other entity approved by NFA.

    Any Forex Dealer Member may ask NFA to approve an otherwise unregulated person a counterparty for purposes of Financial Requirements Sections 11(b) and (c) making transactions with that counterparty exempt from the concentration charge. In determining whether to approve an unregulated person that is not an affiliate the counterparty, NFA will consider a number of factors, including:

    • Whether the person counterparty is regulated in another jurisdiction and, if so, the type and extent of regulation;

    • The person's counterparty's capital; and

    • The person's counterparty's credit rating.

    NFA's approval of a particular person counterparty means that all unaffiliated Forex Dealer Members may treat that person as regulated under Sections 11(b) and (c) exempts all Forex Dealer Members from the concentration charge for transactions with that counterparty. NFA may also approve categories of counterparties (e.g., banks regulated in a particular jurisdiction or with a particular credit rating).

    A Forex Dealer Member may not engage in Section 11(b) or (c) transactions with a regulated affiliate without NFA's approval. The Member may, however, ask NFA to authorize it to cover its positions with specified affiliates (including unregulated affiliates). An affiliate is any entity that controls, is controlled by, or is under common control with the Forex Dealer Member. The standards for approving affiliated persons are significantly higher than those for unaffiliated persons. For example, NFA will also consider:

    • The parent company's and affiliated person's capital;

    • Whether the parent company and the affiliated person are regulated entities;

    • Whether the parent company will guarantee the obligations of the affiliated person (unless the parent company and the affiliated person are the same entity);

    • The parent company's credit rating;

    • Whether the affiliated person has strong risk-management policies to limit its value-at-risk; and

    • For purposes of Section 11(c), whether the affiliated person limits the amount of offsetting transactions it enters into with unregulated counterparties.

    The concentration charge applies whenever an unaffiliated, unregulated counterparty's net position with a Forex Dealer Member in a particular currency exceeds 10% of the Member's total long or short position in that currency. The part of the position that exceeds the 10% threshold is treated as uncovered and is subject to the CFTC's 6% or 20% haircut, depending on the currency. Any uncovered amount above the 10% threshold is subject to only one charge, and any uncovered amount below the 10% threshold is subject to the regular CFTC haircut.

    To calculate the concentration charge with unaffiliated, unregulated counterparties, follow these steps:

    • Calculate the total long value for each currency pair by adding up the Member's long positions with all counterparties (including ECPs, affiliates, and principals), multiplying by the contract size, and converting to U.S. dollars using the relevant exchange rate;

    • Multiply the total long value by 10%;

    • Calculate the total short value for each currency pair by adding up the Member's short positions with all counterparties, multiplying by the contract size, and converting to U.S. dollars using the relevant exchange rate;

    • Multiply the total short value by 10%;

    • For each unregulated counterparty that is counterparty to more than 10% of the Forex Dealer Member's total long position or total short position in that currency, subtract 10% of the total long value from the Member's net long position with the unregulated counterparty or subtract 10% of the total short value from the Member's net short position with the unregulated counterparty; and

    • Multiply the result by the haircut for uncovered positions in that currency; and

    • For each unaffiliated, unregulated counterparty subject to the concentration charge that maintains an account at the Forex Dealer Member (i.e., a customer), the Member may subtract the net liquidating value of the counterparty's forex and the excess funds in regulated commodity accounts. In determining these amounts, include only those assets allowable as capital under CFTC Rule 1.17 and apply the haircuts required by that rule (except those for open positions).

    For example, assume a Forex Dealer Member incurs a concentration charge with regard to two unregulated Counterparties, Counterparty A and Counterparty B. Counterparty B is a customer and the net liquidating value in its forex account and the excess funds in its segregated account under CFTC Rule 1.20 total $32,075. Further, the Forex Dealer Member has an agreement with Counterparty B to permit it to transfer funds from the segregated account to reduce the debit balance incurred in the forex account. For the following positions with unregulated Counterparties A and B in British Pounds, Euros, and Mexican Pesos, the calculation would look like this:

    Currency Total Long Value of Member's Open Positions 10% of Long Value Total Short Value of Member's Open Positions 10% of Short Value
    British Pound $2,500,000 $250,000 $3,000,000 $300,000
    Euro $4,125,000 $412,500 $3,250,000 $325,000
    Mexican Peso $ 250,000 $ 25,000 $ 250,000 $ 25,000

    Currency Value of Net Long Positions with Counterparty A Value of Net Short Positions with Counterparty A Value in Excess of 10%
    British Pound $425,000 $125,000
    Euro $500,000 $ 87,500
    Mexican Peso $ 20,000 $ 0

    Concentration Charge for Counterparty A
    Concentration Charge for British Pounds ($125,000 x 6%) $ 7,500
    Concentration Charge for Euros ($87,500 x 6%) $ 5,250
    Concentration Charge for Mexican Pesos ($0 x 20%) $ 0
    Total Concentration Charge $12,750

    Currency Value of Net Long Positions with Counterparty B Value of Net Short Positions with Counterparty B Value in Excess of 10%
    British Pound $500,000 $250,000
    Euro $300,000 $ 0
    Mexican Peso $100,000 $ 75,000

    Concentration Charge for Counterparty B
    Concentration Charge for British Pounds ($250,000 x 6%) $15,000
    Concentration Charge for Euros ($0 x 6%) $ 0
    Concentration Charge for Mexican Pesos ($75,000 x 20%) $15,000
    Total $30,000
    Less Net Liquidating Value of Counterparty B's Accounts $32,075
    Total Concentration Charge $0

    Concentration Charge for Counterparty A $12,750
    Concentration Charge for Counterparty B $ 0
    Total Concentration Charge Incurred $12,750

    3. Financial Requirements Section 11(c)

    Section 11(c) prohibits Forex Dealer Members from using affiliates (unless approved) and unregulated persons to cover their foreign currency positions for purposes of CFTC Rule 1.17(c)(5).

    The rule does not prohibit Forex Dealer Members from entering into positions with unregulated or unapproved counterparties. They may not, however, count positions with those counterparties when calculating their covered positions for purposes of CFTC Rule 1.17(c)(5).

    For purposes of Section 11(c), Forex Dealer Members have four different types of counterparties. In particular:

    • Account holders are those counterparties for whom it carries accounts and includes both retail customers and eligible contract participants.

    • Trading partners are counterparties with whom the Member trades but who do not have accounts with the Member. For purposes of the calculations under Section 11(c), this category does not include affiliates (approved or unapproved) or regulated counterparties.

    • Affiliates are entities that control, are controlled by, or are under common control with the Forex Dealer Member. For purposes of Section 11(c) only, this category does not include affiliates who have been approved by NFA under Section 11(b).

    • Regulated entities are those counterparties that meet the definition in Section 11(b) and include entities-including affiliates-approved by NFA under that Section.

    A Forex Dealer Member may net its exposure across account holders, across trading partners, and across affiliates, but it may not net its exposure between these categories. The Member may, however, net its exposure in any of these categories against regulated counterparties. Here is the information in chart form.

    Type of Counterparty Account Holders Trading Partners Affiliates Regulated Entities
    Account Holders Yes No No Yes
    Trading Partners No Yes No Yes
    Affiliates No No Yes Yes
    Regulated Entities Yes Yes Yes Yes

    A Forex Dealer Member is required to take a charge on the larger of its unnetted long or short position but not on both.

    Example

    Assume a Forex Dealer Member has the following Euro positions:

    Type Long Short Net Long Net Short
    Account Holders 11,154,912 6,011,794 5,143,118
    Trading Partners 4,987,345 7,299,886 2,312,541
    Affiliates 3,790,754 2,640,553 1,150,201
    Regulated Entities 1,280,555 4,125,018 2,844,463

    In determining the uncovered amount for purposes of the 6% haircut, the Forex Dealer Member can offset its net long position with account holders against the net short position with regulated entities but cannot offset its position with its trading partners or its position with unapproved affiliates against any category except regulated entities.

    The math works this way (using only absolute numbers):

      Net long position with account holders 5,143,118
      Minus net short position with regulated entities -2,844,463
      2,298,655
       
      Uncovered long position with account holders 2,298,655
      Plus net long position with affiliates +1,150,201
      Total uncovered long position 3,448,856
       
      Net short position with trading partners 2,312,541
       
      Larger of net long or short position 3,448,856
       
      Haircut on Euros (3,448,856 X .06) $206,931

    The concentration charge also applies to a Forex Dealer Member's positions with its affiliates if its net position with any single affiliate exceeds 10% of the Forex Dealer Member's total net long or short position in a particular currency or if its combined position with all affiliates exceeds 10% of the Forex Dealer Member's total long or short position in a particular currency. An affiliate is any entity that controls, is controlled by, or is under common control with the Forex Dealer Member.

    To calculate the concentration charge for positions with affiliates, follow these steps:

    • Calculate 10% of the total long and short values for each currency pair using the same steps as for unaffiliated unregulated counterparties under Section 11(b);

    • For each affiliate that is counterparty to more than 10% of the Forex Dealer Member's total long position or total short position in that currency, subtract 10% of the total long value from the Member's net long position with the affiliate or subtract 10% of the total short value from the Member's net short position with the affiliate;

    • Multiply that amount by the haircut for uncovered positions in that currency to calculate the charge for each affiliate;

    • Add the charges for each affiliate to calculate the total charge based on the Forex Dealer Member's positions with single affiliates;

    • Compute the Forex Dealer Member's net position with all affiliates combined and subtract 10% of the total long value from the Member's combined long position or subtract 10% of the total short value from the Member's combined short position;

    • Multiply the result by the haircut for uncovered positions in that currency to calculate the charge based on the Forex Dealer Member's positions with all affiliates combined; and

    • Take the larger charge.

    For example, assume the Forex Dealer Member from the previous example has British Pound and Euro positions with three affiliates. The calculation for the affiliate concentration charge on British Pounds would look like this:

    Affiliate 10% of Long Value 10% of Short Value Value of Net Long Positions with Affiliate Value of Net Short Positions with Affiliate Value in Excess of 10% Charge (Excess Value X 6% Haircut)
    A $125,705 $125,705 $192,554 $ 66,849 $4,011
    B $125,705 $125,705 $285,109 $159,404 $9,564
    C $125,705 $125,705 $ 99,573 $0 $0

    Charge for Affiliate A $ 4,011
    Charge for Affiliate B 9,564
    Charge for Affiliate C 0
    Sum of Charges for Single Affiliates $13,575

    Long position, Affiliate B $285,109
    Short position, Affiliate A + Affiliate C $292,127
    Net position, all affiliates combined ($292,127 - $285,109) $ 7,018
    Amount over 10% ($7,018 - $125,705) $0
    Charge for Combined Positions ($0 X .06) $0

    Affiliate Concentration Charge on British Pounds $13,575

    The calculation for the affiliate concentration charge on Euros would look like this:

    Affiliate 10% of Long Value 10% of Short Value Value of Net Long Positions with Affiliate Value of Net Short Positions with Affiliate Value in Excess of 10% Charge (Excess Value X 6% Haircut)
    A $243,326 $243,326 $304,711 $61,385 $3,683
    B $243,326 $243,326 $240,112 $0 $0
    C $243,326 $243,326 $228,775 $0 $0

    Charge for Affiliate A $3,683
    Charge for Affiliate B 0
    Charge for Affiliate C 0
    Sum of Charges for Single Affiliates $3,683

    Long position, Affiliate A + Affiliate B + Affiliate C $773,598
    Short position $0
    Net position, all affiliates combined ($773,598 - $0) $773,598
    Amount over 10% ($773,598 - $243,326) $530,272
    Charge for Combined Positions ($530,272 X .06) $ 31,816

    Affiliate Concentration Charge on Euros $31,816

    4. Financial Requirements Section 12

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    This requirement does not apply to any Forex Dealer Member that consistently maintains adjusted net capital equal to or in excess of two times the greater amount required by Section 11(a)(i) or (ii) of the Financial Requirements. A Forex Dealer Member claiming the exemption must file advance written notice with NFA. If a firm that claims the exemption falls below double its capital requirement under Section 11(a)(i) and (ii), it must immediately notify NFA. If the firm does not come back into compliance within 48 hours, it must collect the required security deposits on all customer positions and may not claim the exemption for six months. A firm that claims the exemption but falls below the required capital amount three times within 90 days may not claim the exemption for six months.1718


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    17 Where the CFTC's requirements for holding current assets are more stringent, those requirements apply.

    1718 For this purpose, underages within the same U.S. calendar day are one occurrence.

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