[Federal Register: June 16, 1998 (Volume 63, Number 115)]
[Rules and Regulations]
[Page 32725-32726]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]



17 CFR Part 1

Minimum Financial Requirements for Futures Commission Merchants

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.


SUMMARY: The Commodity Futures Trading Commission ("Commission") is
amending its minimum financial requirements for futures commission
merchants ("FCMs"). The amendment will eliminate a charge presently
required to be taken by FCMs in the computation of the amount of their
net capital. This charge is commonly referred to as the "short option
value charge" ("SOV charge"). The Commission is rescinding this
charge, because it has found that the charge is not closely correlated
to the actual risk of the customers' short option positions and, in any
event, there are other protections in place to address this risk.

EFFECTIVE DATE: July 16, 1998.

Accountant, or Lawrence B. Patent, Associate Chief Counsel, Division of
Trading and Markets, Commodity Futures Trading Commission, 1155 21st
Street, N.W. Washington, D.C. 20581; telephone (202) 418-5459 or 418-


I. Background

    The minimum adjusted net capital requirement for an FCM is
currently the greatest of: (A) $250,000; (B) four percent of the
customer funds required to be segregated pursuant to the Commodity
Exchange Act and the foreign futures or foreign options secured amount,
less the market value of commodity options purchased by customers on or
subject to the rules of a contract market or a foreign board of trade:
Provided, however, that the deduction for each customer shall be
limited to the amount of customer funds in such customer's account(s)
and foreign futures and foreign options secured amounts; (C) the amount
of adjusted net capital required by a registered futures association of
which it is a member; or (D) for securities brokers and dealers, the
amount of net capital required by Rule 15c3-1(a) of the Securities and
Exchange Commission (17 CFR 240.15c3-1(a)).
    In calculating the amount of adjusted net capital needed to meet
the minimum requirement, FCMs are presently required under Commission
Rule 1.17(c)(5)(iii) to deduct a capital charge, based upon four
percent of the market value of commodity options granted (sold) by
option customers on or subject to the rules of a contract market or a
foreign board of trade. The Commission adopted this provision in 1982
to require that an FCM recognize the risk involved in customers selling
or going short an option. Under this provision, an FCM is required to
take this charge, regardless of the trading strategy of the customer.
Some customers have used a short option position in combination with
another futures or commodity option position, such as an inter-month
spread position. Although such a position would involve less risk than
a naked position, the SOV charge would be the same or, perhaps,
    On March 9, 1998, the Commission proposed an amendment to the
minimum financial requirements for futures commission merchants which
would eliminate Rule 1.17(c)(5)(iii).1 The Commission
received two (2) comment letters. Both supported elimination of the
charge. One letter was jointly signed by representatives from each of
seven (7) U.S. commodity exchanges and the other was filed by an FCM.

    \1\ 63 FR 12713 (March 16, 1998).

    The effect of the amendment is to decrease the amount of charges
taken against capital in the computation of net capital. The reduction
in capital charges taken by an FCM will result in an increase in the
stated amount of adjusted net capital of an FCM carrying short option
positions in customer accounts. The total amount of the increase in an
FCM's net capital would depend on the quantity and value of short
options carried in the accounts of the FCM's customers.
    As stated in the proposing release, the Commission proposed to
rescind this rule, because the charge is not closely correlated to the
actual risk of the options carried on behalf of customers and, in any
event, there are other protections in place to address the risk of
short options. In particular, the Standard Portfolio Analysis of Risk
("SPAN") margining system has been effectively used in setting
appropriate levels of risk margin, and there are many other non-capital
protections. These protections include effective self-regulatory
organization ("SRO") audit and financial surveillance programs and
modern risk management and control systems at FCMs. All of the comments
received on the Commission's proposal to rescind the SOV charge
confirmed these views. Moreover, no comments were received which
provided any reason to believe that the SOV charge should not be

II. Summary of Comments

A. Portfolio Margining System

    Commenters noted that the four percent capital charge is not
closely correlated to the actual risk of customer

[[Page 32726]]

short option positions and that, subsequent to the adoption of Rule
1.17(c)(5)(iii), the SPAN margining system was developed. SPAN uses
option pricing models to calculate the theoretical gains and losses on
an option at various market prices of the underlying commodity and is a
significant improvement in measuring the risk of an option. All U.S.
commodity exchanges and many foreign exchanges have adopted SPAN to
assess option risk. In addition, SPAN recognizes trading strategies in
which short option positions are risk reducing and SPAN has been tested
and proven to assess adequately the risk in the customer's portfolio.

B. Large Trader Positions

    Commenters also noted that the commodity exchanges closely monitor
large trader positions in each contract market to identify those market
participants that may pose a financial risk to the FCM carrying their
account. This includes option positions at clearing firms carrying
option customers' accounts. Safeguards such as intraday variation
margin calls, continuous monitoring of the markets and direct contact
with the FCMs alert the exchanges to any potential problems.

C. Financial Surveillance

    Commenters further noted that additional protection exists in the
form of capital and segregation requirements for FCMs. Commission
regulations require FCMs not only to maintain a minimum amount of
adjusted net capital, but also to maintain a sufficient amount of
excess adjusted net capital. In the event an FCM's adjusted net capital
falls below an early warning level, generally 150% of the minimum
dollar amount (e.g., 6% of customer segregated funds), the FCM is
required to notify the Commission within five (5) business days. The
FCM must continue filing financial reports monthly until the FCM's
adjusted net capital is at or above the early warning level for three
consecutive months. In calculating adjusted net capital, FCMs must
deduct deficits and any undermargined amounts in customer accounts.
With respect to the segregation requirements, an FCM is required to
deposit customer funds in accounts designated for the benefit of
customers. The FCM must also make a daily calculation showing whether
there are sufficient funds in segregated accounts.

III. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) 5 U.S.C. 601 et seq., requires
that agencies, in proposing rules, consider the impact of those rules
on small businesses. The Commission has previously determined that FCMs
are not "small entities" for purposes of the RFA.2
Therefore, the Chairperson, on behalf of the Commission, hereby
certifies, pursuant to 5 U.S.C. 605(b), that the action taken herein
will not have a significant economic impact on a substantial number of
small entities.

    \2\ 47 FR 18619-18620 (April 30, 1982).

B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 3 imposes certain
requirements on federal agencies (including the Commission) in
connection with their conducting or sponsoring any collection of
information as defined by the Paperwork Reduction Act. While this
proposed rule has no burden, the group of rules (3038-0024) of which
this is a part has the following burden:

    \3\ Pub. L. No. 104-13, 109 Stat. 163 (1995).

    Average burden hours per response: 128.
    Number of respondents: 235.
    Frequency of response: Monthly.
    Copies of the OMB-approved information collection package
associated with this rule may be obtained from the Desk Officer, CFTC,
Office of Management and Budget, Room 10202, NEOB Washington, DC 20503,
(202) 395-7340.

List of Subjects in 17 CFR Part 1

    Brokers, Commodity futures, Consumer protection, Net capital
requirements, Reporting and recordkeeping requirements.

    In consideration of the foregoing and pursuant to the authority
contained in the Commodity Exchange Act and, in particular, Sections
4f, 4g and 8a(5) thereof, 7 U.S.C. 6d, 6g and 12a(5), the Commission
hereby amends Chapter I of Title 17 of the Code of Federal Regulations
as follows:


    1. The authority citation for part 1 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f,
6g, 6h, 6I, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a,
12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24.

Sec. 1.17  [Amended]

    2. Section 1.17(c)(5)(iii) is removed and reserved.

    Issued in Washington, DC on June, 10, 1998, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 98-15975 Filed 6-15-98; 8:45 am]

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