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February 14, 2013

FCM Residual Interest – “changing an ecosystem which has existed for decades”

An issue is exercising FCMs in America, that of a new rule issued by the NFA requiring each FCM to define a minimum amount of money to be maintained at the FCM to cover the margin requirements of their clients. It moves FCMs further towards the LSOC model, and away from their profit making Omnibus model, and is therefore a direct erosion of profit for being an FCM, hence the excitement in FCM circles. At the CFTC last week: “changing an ecosystem which has existed for decades”. Maybe this is the issue which Bart Chilton referred to as “Swapifying” the futures market ;-)

These links give the detailed background:

  1. The rule: https://www.nfa.futures.org/nfamanual/NFAManual.aspx?RuleID=SECTION%2016&Section=7
  2. A briefing: https://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072
  3. Letter to the CFTC: http://www.nfa.futures.org/news/PDF/CFTC/FR_Sec_16_ProtectionCustomerFunds_IntNotc_0517.pdf

Summary of the requirement

In establishing the target amount of residual interest, the Board of Directors or similar governing body, CEO, or CFO must perform a due diligence inquiry and consider various factors, if applicable, relating to the nature of the firm’s business, including but not limited to: the firm’s type of customers, their general creditworthiness, and trading activity; the type of markets and products traded by the firm’s customers and the firm itself; the general volatility and liquidity of those markets and products; the firm’s own liquidity and capital needs; and historical trends in customer segregated/secured amount funds balances and customer debits. Member FCMs are required to create a written record containing a description of the analysis of the factors used by the FCM to determine its targeted residual amount. The primary purpose of the residual interest is to ensure that sufficient funds are on deposit with an FCM to meet customer obligations and to remain in compliance at all times with the segregation requirements.

Restrictions on FCM Residual Interest in Segregated & Secured Pools

  • FRS16 requires each FCM to establish a policy target amount of residual interest the FCM will maintain; policy must be based on extensive due diligence analysis of a range of fact specific items and approved by “financial principal”
  • Policy target amount can be dollar amount or % based, and can be flat number or range
  • Withdrawal of >25% of FCM’s residual interest relative to prior day’s amount requires preapproval of FCM “financial principal” & filing with NFA; further withdrawals not allowed unless similar preapproval and filing occurs
  • If residual amount drops below the target amount, by next day FCM must add house money to bring it back or amend policy with financial principal signing off on it

Further coverage at Tabb / Lothian

Video: http://tabbforum.com/videos/cftc-proposal-poses-%22monumental%22-challenge-to-fcms


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