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The last time NFA raised the FCM minimum was in 1990, when it increased from $50,000 to $250,000, and in 1992 NFA raised the independent IB minimum from $20,000 to $30,000. Additionally, the FCM minimum was developed for firms engaged in agency transactions, not dealer transactions. Therefore, the amendments raise the minimums to the following levels:
- $500,000 for FCMs that are not Forex Dealer Members;
- $1,000,000 for Forex Dealer Members; and
- $45,000 for independent IBs.
The Consumer Price Index has risen over 50% in the fifteen years since NFA raised the minimum capital requirement for FCMs. In the same period, exchange volume has grown almost 500%. Based on these figures, NFA believes the minimum capital requirement for FCMs should be raised to $500,000 to ensure that it continues to provide adequate protection.
As of October 31, 2005, only 26 of the 179 registered FCMs had less than $500,000 in adjusted net capital. NFA is the DSRO for twenty-four of these firms, and the other two are exchange members that do not carry segregated customer funds. Of the twenty-four firms for which NFA is the DSRO, eight were inactive on October 31, eight were active Forex Dealer Members1, one subsequently withdrew its FCM registration and became an IB, and six others did exchange-traded business on a fully-disclosed basis. Additionally, one non-Forex Dealer Member that would be affected carried segregated funds for customers trading on futures exchanges. Therefore, raising the FCM minimum to $500,000 should maintain the level of protection adopted in 1990 without creating an undue burden.
Forex Dealer Member Capital Requirement
The amendments also raise the minimum capital requirement for Forex Dealer Members to $1,000,000. As of October 31, 2005, eighteen of the 34 active Forex Dealer Members had less than $1 million in adjusted net capital. NFA believes this is a cause for serious concern.
Dealer activities create greater financial risks than the agency transactions involved in traditional exchange-traded futures and options. In fact, when NFA first proposed adopting special capital requirements for Forex Dealer Members, one of the affected firms commented that market makers should have a much higher capital requirement than firms dealing on an agency basis, and it recommended a $2.5 million minimum capital requirement.
Historically, the Commission has also recognized that acting as a dealer increases financial risk. In 1978, the Commission imposed a $5,000,000 net worth requirement on FCMs granting dealer options on physical commodities. In 1984, the Commission imposed a capital requirement on Leverage Transaction Merchants that started at $2,500,000 and increased based upon the LTM's business. The Commission noted that there was no clearing organization for these transactions and the registrant was the sole guarantor of performance.
NFA's enforcement experience reinforces the need for a higher minimum. Less than 25% of the registered FCMs are Forex Dealer Members, but they account for over 80% of the Member Responsibility Actions issued to FCMs for failure to comply with the capital requirement. Since December 21, 2000, when Congress passed the Commodity Futures Modernization Act, five of the six MRAs issued to FCMs were to Forex Dealer Members.
The need for adequate capital is particularly acute for firms engaged in retail off-exchange forex. To date, customers trading off-exchange forex have not received a priority under the Bankruptcy Code. Even if a firm maintains its customer funds in a separate account, those funds could be subject to claims from general and priority creditors.
Independent IB Capital Requirement
Finally, the amendments raise the minimum for independent IBs from $30,000 to $45,000. This increase covers the more than 40% rise in the Consumer Price Index since 1992, when NFA last raised this requirement.
Based on the latest financial filings, 61 of 468 independent IBs would be undercapitalized if the minimum were raised to $45,000. If any of these IBs are unable to infuse the additional capital, they will have to find a guarantor but will not be out of business.
NFA respectfully requests that the Commission review and approve the proposed amendments to Sections 1 of NFA's Financial Requirements regarding FCMs; Section 5 regarding IBs; and Section 11 regarding Forex Dealer Members.
1 One of these Forex Dealer Members also carries segregated funds.