Proposed Rule

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Explanation of Proposed Amendment to NFA Financial Requirements

One of the FCMs for which NFA is the DSRO recently posed an unusual risk to its customers and other Members. As of July 31, 1999, this FCM maintained adjusted net capital of approximately $330,000. In the early part of August, through its review of the FCM's daily segregation numbers, NFA began noticing a large increase in trading activity. NFA learned that the increase in trading was attributable to two accounts owned and managed by one individual, an experienced, high profile trader. These accounts were trading in a volatile market and maintained a large number of long and short deep options and traded a small amount of short futures positions. Although the short options are considered in calculating margin, these positions are no longer a charge against capital. The two accounts took on a substantial amount of risk which jeopardized the firm's capital but had no effect on its minimum capital requirement.

This incident exposed a weakness in NFA's current capital requirements which stems largely from the elimination of the four percent capital charge for short options. Certainly, an unintended consequence of eliminating the short options charge is the very situation that developed here. The Board determined to address the problem by adopting a risk-based capital requirement similar to the requirements imposed by the Chicago Board of Trade and the Chicago Mercantile Exchange. Both exchanges adopted risk-based capital requirements in January 1998. Pursuant to these requirements, all exchange member FCMs must maintain adjusted net capital equal to or in excess of the greatest of:

  • Minimum dollar balances of the respective clearing organizations; or

  • CFTC/SEC minimum regulatory requirements; or

  • Eight percent of domestic and foreign domiciled customer and four percent of non-customer (excluding proprietary) risk maintenance margin/performance bond requirements for all domestic and foreign futures and options on futures contracts.

In September 1999, NFA forwarded a survey to the approximately 40 FCMs for which it serves as the DSRO to determine what impact, if any, risk-based capital requirements would have had upon their capital levels for June - August 1999. NFA received responses from approximately 24 FCMs. Based upon the information provided, NFA noted that an eight/four percent risk-based requirement, patterned after the exchanges' requirement, would have increased the capital requirements for three FCMs for all three months and one FCM for one month when compared to NFA's current minimum adjusted net capital requirements. These monthly capital increases ranged from approximately $136,000 to $21,450,000. Importantly, NFA also noted that even if an eight/four percent risk based requirement is applied, all four firms had more than sufficient adjusted net capital to meet their respective minimum adjusted net capital requirement and stay above the early warning level. Therefore, the Board determined that a risk-based requirement set at eight percent and four percent would not have a significant adverse effect upon Member firms unless positions carried by a firm pose a substantial financial threat to the firm and its customers.

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