In 2012, NFA and CFTC introduced a range of rules aimed at increasing protection of customer funds held at FCMs. These rules, some of which are final and some of which are proposed but appear well on their way to implementation, generally enhance transparency, cement requirements for FCMs maintenance of FCM 'residual interest' amounts in customer segregated accounts, tighten up the types of investments FCMs may make with customer segregated assets, and require DCOs to compute FCM margin requirements without allowing the FCM to net the FCM's different customers' positions against each other.
The rules heighten transparency by requiring FCMs to report segregated asset and net capital numbers more frequently and in more detail and mandating that DSROs and CFTC receive 'view only' real-time access to FCMs segregated asset accounts. NFA's BASIC system now displays to the public for each FCM a net capital report that is updated monthly and segregated and secured asset reports that are updated twice per month and that provide breakdowns of types of investments held. DSROs and CFTC will have 'view only' real-time access to see all of an FCM's cash accounts holding segregated and secured assets, and at some point this should, as technology permits, expand to include non-cash accounts holding securities or funds at DCOs, other FCMs and elsewhere.
A new regime relating to FCM maintenance of 'residual interest' levels in segregated accounts (ie, FCM proprietary funds 'topping up' segregated and secured accounts) requires each FCM to establish a level of residual interest the FCM will maintain and restricts an FCM's ability to withdraw substantial amounts of that residual interest. Each FCM must draft policies and procedures approved by the board, CEO or CFO, establishing a 'targeted residual interest' amount that is either a dollar amount or percentage of segregated assets. The FCM may not withdraw more than 25% of the residual interest without pre-approval from a 'financial principal' and a notice filing to regulators. If an FCM's residual interest drops below the target amount it should either add more to the residual interest or amend the policy to reduce the target amount.
New limitations on FCM investments of customer segregated assets now further restrict the types of investments FCMs may use, increase liquidity requirements and add new concentration limits. A range of investments are no longer allowed, including corporate debt not guaranteed by the US, foreign sovereign debt, transactions with affiliates, and Fannie Mae and Freddie Mac debt to the extent Fannie Mae and Freddy Mac become no longer under FHFA receivership with US capital support. All investments must be 'highly liquid' such that the investments may be converted into cash within one business day without material discount in value, and CDs must be redeemable within one business day without penalty. Finally, new asset-based concentration limits apply that prevent FCMs from allocating amounts beyond fixed percentages into individual asset classes.
'Gross margining' now requires each FCM to post more margin to DCOs, at an amount equal to the sum of the margin requirements of the FCM's customers without taking into account a netting of the FCM's customer's positions. Under the prior rule, which permitted such netting, FCMs could require more margin from their customers than the FCMs posted to the DCOs. The new system, which requires DCOs to be able to see the positions of each FCM customer, lays the groundwork for future implementation of 'Legal Segregation, Operational Commingling,' or LSOC. LSOC removes FCM customer liability for losses stemming from fellow customer trading losses so large that they wipe out the loss-making customer's account equity, the loss-making customer's other capital and the FCM's net capital, and will likely be implemented for all futures customers at some point down the road.
Neal R. Stevens
Of Counsel
nstevens@SRCattorneys.com
312 565.1045 tel (chi) | 212 334.7948 tel (nyc)
Schuyler, Roche & Crisham, P.C
www.SRCattorneys.com
