More interesting suggested changes:
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February 23, 2009
Via Federal Express
Mr. David A. Stawick
Office of the Secretariat
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st Street, N.W.
Washington, DC 20581
Re: National Futures Association: Forex Security Deposits - Proposed
Amendments to NFA Financial Requirements Section 12 and Interpretive
Notice Regarding Forex Transactions
Dear Mr. Stawick:
Pursuant to Section 17(j) of the Commodity Exchange Act, as amended,
National Futures Association (“NFA”) hereby submits to the Commodity Futures Trading
Commission (“CFTC” or “Commission”) proposed amendments to NFA Financial
Requirements Section 12 and the Interpretive Notice regarding Forex Transactions.
This proposal was approved by NFA’s Board of Directors (“Board”) on February 19,
2009. NFA respectfully requests Commission review and approval of the proposed
amendments.
PROPOSED AMENDMENTS
(additions are underscored and deletions are stricken through)
FINANCIAL REQUIREMENTS
* * *
SECTION 12. SECURITY DEPOSITS FOR FOREX TRANSACTIONS WITH
FOREX DEALER MEMBERS.
(a) Except as provided in (b) below, eEach Forex Dealer Member shall collect
and maintain the following minimum security deposit for each forex transaction
between the Forex Dealer Member and a person that is not an eligible contract
participant as defined in Section 1a(12) of the Act:
* * *
Mr. David A. Stawick February 23, 2009
2
(b) A Forex Dealer Member that consistently maintains adjusted net capital of
at least 150% of the greater of the amount required by Section 11(a)(i) or (ii) of
these Financial Requirements is exempt from (a) above.
(c) The Executive Committee may temporarily increase these requirements
under extraordinary market conditions.
(d)(c) For purposes of this rule:
(1) “Forex” has the same meaning as in Bylaw 1507(b); and
(2) “Forex Dealer Member” has the same meaning as in Bylaw 306.
(e)(d) In addition to cash, a Forex Dealer Member required to collect and
maintain a minimum security deposit under (a) above may accept those
instruments described in CFTC Rule 1.25 as collateral for customers’ security
deposit obligations. The collateral must be in the FDM’s possession and control
and is subject to the haircuts in CFTC Rule 1.17.
* * *
INTERPRETIVE NOTICES
* * *
FOREX TRANSACTIONS
* * *
C. OTHER REQUIREMENTS
* * *
4 Financial Requirements Section 12
* * *
This requirement does not apply to any Forex Dealer Member that
consistently maintains adjusted net capital equal to or in excess of 150% of the
Mr. David A. Stawick February 23, 2009
3
greater of the amount required by Section 11(a)(i) or (ii) of the Financial
Requirements. A Forex Dealer Member claiming the exemption must file
advance written notice with NFA. If a firm that claims the exemption falls below
150% of its capital requirement under Section 11(a)(i) and (ii), it must
immediately notify NFA. If the firm does not come back into compliance within 48
hours, it must collect the required security deposits on all customer positions and
may not claim the exemption for six months. A firm that claims the exemption but
falls below the required capital amount three times within 90 days may not claim
the exemption for six months.18
_____
18 For this purpose, underages within the same U.S calendar day are one
occurrence.
EXPLANATION OF PROPOSED AMENDMENTS
NFA Financial Requirements Section 12 requires Forex Dealer Members
("FDMs") to collect a security deposit of 1% of the notional value for specified currencies
(called major currencies in the rest of this discussion) and 4% of the notional value for
all other currencies.1 The rule also provides an exemption from collecting these
amounts if an FDM maintains 150% of its capital requirement.
When NFA adopted Section 12 in 2003, it required a security deposit of
2% for major currencies and 4% for all other currencies. This was consistent with the
margin requirements on the CME’s IMM at the time, which averaged 2% for major
currencies and 3.9% for other currencies.
Before the rule became effective, NFA met with a number of FDMs that
were concerned with the 2% requirement for the major currencies. These FDMs
represented that the industry standard was 1% and that NFA’s requirement put them at
a competitive disadvantage. NFA agreed to re-examine the security deposit
requirement and issued an interim no-action position, allowing firms to charge 1% for
the major currencies while NFA studied the matter. After evaluating its experience with
the 1% level, NFA amended Section 12 to lower the requirement for the major
1 The currencies that qualify for the 1% security deposit are the British pound, the Swiss
franc, the Canadian dollar, the Japanese yen, the Euro, the Australian dollar, the New
Zealand dollar, the Swedish krona, the Norwegian krone, and the Danish krone.
Mr. David A. Stawick February 23, 2009
4
currencies to 1%, and it adopted the exemption mentioned above, except that firms
were required to maintain twice their capital requirement to qualify.
When NFA adopted the exemption, the minimum capital requirement for
FDMs was $250,000. Given the substantial increase in the minimum capital
requirement, in August 2008 NFA lowered the exemption threshold from 200% to 150%
of an FDM’s capital requirement.2 The Board understood, however, that staff was
continuing to study the security deposit requirement and ultimately would recommend a
different approach.
Staff's research focused on two areas. First, staff examined IMM margins
to see how they compare with the security deposits required by Section 12. Second,
staff also examined the actual leverage amounts offered by individual FDMs .
Current IMM margins are substantially higher than they were at the time
Section 12 was adopted. As of December 24, 2008, margins for the major currencies
averaged 5.6% and ranged from 3.5% to 8.2%. Margins for the other currencies traded
on the IMM averaged 8.1% and ranged from 3.2% to 12.5%.
As with exchange margin, the primary purpose of the security deposit is to
protect the FDM from absorbing the losses of defaulting customers which, if significant
enough, could affect the FDM’s capital and put the funds of its other customers at risk.
Based on our experience with FDM practices, including that most FDMs use systems
that liquidate customer positions before they reach a negative balance, NFA believes
that the 1% and 4% security deposit requirement amounts remain sufficient at this time
to protect against financial harm to FDMs and their customers even though they are
significantly lower than margin requirements for on-exchange equivalents.
On the other hand, NFA is concerned that higher leverage amounts can
deplete a customer’s account balance — and result in forced liquidation — much faster
than retail customers realize.
Of 21 FDMs, eight have the exemption from collecting
minimum security deposits. Of these eight, one offers leverage of 700:1, four offer
leverage of 400:1, two offer leverage of 200:1, and one offers leverage of 50:1. One of
the firms without the exemption also offers leverage of 50:1.
A proportionately greater
number of the firms that offer higher leverage have also been the subjects of NFA
2 The FDM capital requirement was $5 million in August and will increase to $20 million
by May 2009.
Mr. David A. Stawick February 23, 2009
5
complaints, while neither of the firms that offer 50:1 leverage has ever been the subject
of an NFA or CFTC enforcement action.3
These statistics indicate that FDMs can compete while offering leverage of
100:1 or less and that higher amounts can lead to abuses. The amendments leave the
minimum security deposit amount at 1% and 4% and eliminate the exemption.
Under
the amendments, no FDM would be allowed to offer more than 100:1 leverage on the
major currencies or more than 25:1 leverage on other currencies.
This would bring the
operation of the forex requirement more in line with on-exchange margins, which are not
affected by the firm’s capitalization, while the required amounts would still allow FDMs
to offer significantly higher leverage than is currently available for IMM contracts.
NFA's FCM Advisory Committee supported these amendments. NFA also
sent the amendments to the FDMs for their comments and received eight responses.
One FDM with a large customer base fully supported this proposal, noting that it uses
50:1 leverage for the major currencies and has resisted customer requests for higher
leverage because these levels force liquidation too quickly and frequently to be in a
customers’ best interests. Another FDM supported eliminating the exemption but
suggested that the requirement be changed to allow FDMs to offer 200:1 leverage in
order to compete internationally. Five other letters also claimed that restricting them to
100:1 leverage would put them at a competitive disadvantage internationally. While
these letters opposed the proposal, several of them stated that the international average
is 200:1 and this level would be an acceptable compromise. The other FDM opposed
the proposal because it limits an FDM’s ability to use increased leverage as an incentive
to place close-in stop orders.4
Commenters proposed several other alternatives besides increasing the
allowable leverage to 200:1. One suggested providing exemptions for FDMs with
effective risk management systems. Another commenter — whose preferred result is to
increase the leverage to 200:1 — proposed, alternatively, that the rule only apply to
U.S. customers. The ability to make these distinctions, however, may be problematic
since one commenter stated that even the disparity between the allowable leverage for
major and minor currencies creates programming inefficiencies.
3 Of the 20 FDMs, eight have been named in ten complaints issued by the Business
Conduct Committee in connection with their forex business. Seven of those complaints
were against five FDMs that offer more than 100:1 leverage (including two firms with
two complaints each).
4 This firm offers as much as 700:1 leverage.
Mr. David A. Stawick February 23, 2009
6
Finally, three letters took issue with comparing OTC security deposits with
exchange margins. These letters suggested three factors that give FDMs more control
over the risk in customer transactions than FCMs have over on-exchange transactions:
FDM systems generally automatically liquidate positions before the account goes into
deficit; the OTC forex markets operate continuously, with no gap between closing prices
and the next day’s opening prices; and market-making gives firms more control over
prices.
After reviewing the comments, NFA believes that the amendments are the
best way to address NFA’s customer protection concerns with certain FDMs’ use of
leverage. As noted above, the amendments already take the difference between onexchange
and off-exchange markets into account and allow higher leverage for OTC
trades than is currently available for exchange transactions. Regarding the competition
issue, two FDMs voluntarily use 50:1 leverage and those without exemptions manage
with 100:1 leverage, indicating that firms can engage in the retail forex business and
attract customers at these levels. Furthermore, the FDM that uses higher leverage to
encourage close-in stop orders actually exemplifies one of the problems NFA is trying to
address — that higher leverage can deplete the account balance and result in forced
liquidation much faster than customers may realize.
NFA respectfully requests that the Commission review and approve the
amendments to NFA Financial Requirements Section 12 and the Interpretive Notice
regarding Forex Transactions.
Respectfully submitted,
Thomas W. Sexton
Vice President and General Counsel
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Laverage... I trade with 50:1, with other firm I usually go with 100:1.
I've never trade with higher than 100:1...but 25:1.... might be some trouble...
