Proposed Rule

The amount of retail customer funds held by FDMs has increased strikingly since 2003 when NFA first adopted the FDM net capital requirements. In May 2003, staff noted that, taken together, FDMs held approximately $130 million in retail customer funds. As of September 30, 2006, the amount of retail customer funds held by FDMs had increased more than five-fold to over $770 million. One FDM currently holds in excess of $215 million, over 65% greater than the amount of funds held by all FDMs just three years ago.

NFA Financial Requirements Section 11 ("Section 11") sets forth the financial requirements for Forex Dealer Members ("FDMs") and requires them to maintain capital of at least 1% of the total net aggregate notional value of retail customer positions.

The current financial requirements for FDMs fail to reflect completely the increase in customer funds devoted to forex trading. Currently, an FDM is required to maintain minimum adjusted net capital equal to the greater of $1 million ($5 million if the FDM offers forex options), 1% of the total net aggregate notional value of all open forex futures and options transactions in retail customer and non-customer accounts, or any other amount that is required by virtue of the FDM being an FCM. The alternative capital requirement based upon the net aggregate notional value of open forex transactions is intended to measure the risk posed by the FDM's forex business. As indicated in NFA's June 2003 submission letter relating to the adoption of Section 11, NFA, however, has always recognized that it is not a perfect measure of risk.

In the intervening three years since its adoption, experience has pointed out at least two issues with the alternative requirement. First, although NFA desired to adopt a simple capital calculation, the current requirement has proven cumbersome for both FDMs and staff. Second, it fails to recognize the increase in size of an FDM's business. An FDM might have a significant increase in the amount of customer funds it holds for trading forex, but because the customer positions result in a negligible net aggregate value, the FDM must only meet the floor of the minimum adjusted net capital requirements - $1 million. This is the case with regard to two FDMs, which, as of September 30, 2006, held approximately $33 million and $27 million in customer funds, respectively, but must each have only $1 million in adjusted net capital. Placing emphasis upon recognizing the amount of customer funds held by an FDM is particularly important in forex transactions because the customer funds are not passed on to a clearing organization but are held by the FDM as counterparty to the customer.

NFA is replacing the current FDM alternative capital requirement (1% of the net aggregate notional value) with one that is simpler and better recognizes the amount of customer funds at risk. Specifically, the Board amended NFA Financial Requirements Section 11 to require that an FDM maintain adjusted net capital equal to or greater than 5% of liabilities to customers. FDMs, as futures commission merchants, are already calculating the amount of liabilities owed to customers, which includes any unrealized profits, and, therefore, calculating the proposed alternative requirement will not pose any undue difficulty. An accurate accounting of customer liabilities is essential for the proposed capital requirement, so the amendment to the Interpretive Notice entitled "Forex Transactions with Forex Dealer Members" makes clear that an FDM must maintain records of these liabilities.

As all FDMs must maintain at least $1 million, this amendment will only increase the minimum adjusted net capital for the largest FDMs: those with more than $20 million in customer liabilities. As of September 30, 2006, there are nine FDMs with greater than $20 million in customer liabilities. When the proposed requirement is applied to these FDMs, the median change in the required minimum adjusted net capital is approximately $350,000. One of the nine FDMs has no change in its required minimum adjusted net capital.¹ The largest change is approximately $2.2 million.²

Only one of the nine FDMs does not currently maintain adjusted net capital in excess of the increased requirement. This FDM presents an example of why it is important that the capital requirement better recognize an increase in an FDM's customer liabilities. The FDM held over $27 million in customer funds as of September 30, 2006, an increase of over $12 million, or 80%, of the amount of customer funds held by the firm as of August 31, 2006. During the same month that the FDM saw such tremendous growth, its adjusted net capital decreased by almost $350,000 and the FDM's capital requirement remained the minimum of $1 million only. Under the proposed requirement, this FDM's minimum capital will increase by slightly more than $350,000. As of September 30, 2006, this FDM would have had to add approximately $105,000 to its adjusted net capital to meet the increased requirement.

NFA respectfully requests that the Commission review and approve the proposed amendments to the NFA Financial Requirements for FDMs.

¹ This FDM also conducts an on-exchange futures business and its required adjusted net capital for that business is significantly higher than any requirement under Financial Requirements Section 11.

² As of August 31, 2006, this FDM held over $155 million in customer funds but due to the netting of its customers positions was only required to maintain $1 million in adjusted net capital. As of September 30, 2006, due to differences in its customer positions, the FDM's minimum net capital increased by approximately $5.7 million.