Proposed Rule

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Customer funds for transactions on U.S. exchanges must be held in segregated accounts under CFTC Regulation 1.20 and funds of U.S. customers trading on foreign exchanges ("the secured amount") must be held in separate accounts under CFTC Regulation 30.7. Where those funds can be held is also governed by CFTC Regulations 1.49 (for segregated funds) and 30.7 (for secured amounts).

NFA does not require Forex Dealer Members ("FDMs") to keep their forex customer funds separate from their operating funds. The practice probably would not protect the funds in an insolvency and could, in fact, give customers false comfort.

Similarly, provisions limiting where FDMs can hold U.S. customer funds will not guarantee that customers will receive those funds if an FDM becomes insolvent. On the other hand, requiring firms to maintain sufficient assets in qualifying locations to cover liabilities to customers may discourage firms from using customer funds for money-laundering activities and could help NFA confirm financial balances.1

For example, NFA recently took a Member Responsibility Action against an FDM for not producing books and records requested by staff. Among other problems, the firm's records showed approximately $3.5 million deposited at a foreign bank while the bank's records showed approximately $500,000 less - a difference that put the FDM under its capital requirement. If NFA had direct access to the information from the foreign bank, it might have identified the issue earlier.

Adopting Section 14 to the Financial Requirements would require FDMs to maintain sufficient assets at qualifying institutions located in the United States or a money center country (as defined in CFTC Regulation 1.49) to pay liabilities to U.S. retail customers.

Section 14 generally tracks the location requirements in CFTC Regulations 1.49 and 30.7, including the description of qualifying institutions. Because of the nature of these markets, however, NFA has expanded the qualifying institutions to include certain broker-dealers and futures commission merchants regulated in a money center country.2

Assets held in the U.S. could be deposited with a bank or trust company, an SEC-registered broker-dealer that is a member of NASD, or a CFTC-registered FCM that is an NFA Member. Outside the U.S., these assets may only be held at a qualifying depository located in Canada, France, Italy, Germany, Japan, or the United Kingdom. To qualify, the depository must be a CFTC-registered FCM that is an NFA Member or must be a bank, trust company, broker-dealer, or futures commission merchant regulated by the money center country. Furthermore, a foreign bank or trust company must have at least $1 billion in regulatory capital and a foreign broker-dealer or futures commission merchant must have at least $100 million in regulatory capital unless the entity's credit-rating is in one of the two highest categories.

If the assets are held in a money center country, Section 14 further requires the FDM to enter into an agreement with the depository giving NFA and the CFTC direct access to information about the FDM's accounts. The agreement must be acceptable to and filed with NFA.

Section 14 defines U.S. customers using tests drawn from various CFTC no-action and exemption letters. The following are U.S. customers under Section 14:

  • Natural persons who are U.S. residents;
  • Business entities and collective investment vehicles organized in the U.S. or with their principal place of business in the U.S.;
  • Estates and trusts that are subject to U.S. income taxes even on income earned elsewhere; and
  • Passive investment vehicles 10% or more owned by U.S. persons.
Section 14 would be counterproductive if FDMs and their Associates and agents used this requirement as a selling point to give customers false comfort. Therefore, the Board amended the Interpretive Notice to prohibit them from representing that forex funds are more secure because of it.

1 The countries where the funds could be kept all have anti-money-laundering laws.

2 Members of foreign exchanges can hold secured funds under CFTC Regulation 30.7, and foreign broker-dealers and futures commission merchants play a somewhat equivalent role in dealer markets to that played by a member of a foreign exchange in an on-exchange market. NFA added capital/credit-rating requirements for these firms.

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