FUTURES INDUSTRY ASSOCIATION
2001 Pennsylvania Avenue N.W., Suite 600
Washington, DC 20006-1807
Fax: (202) 296-3184
November 4, 2002
Mr. Jonathan G. Katz
Secretary to the Commission
Securities and Exchange Commission
450 Fifth Street
Washington DC 20549-0609
Re: Reserve Requirements for Margin Related to Security Futures Products,
67 Fed.Reg. 59748 (September 23, 2002), File No. S7-34-02
Dear Mr. Katz:
The Futures Industry Association ("FIA")1 is pleased to submit the following comments on the Security and Exchange Commission's ("Commission's") proposed amendments to Commission Regulation 15c3-3a under the Securities and Exchange Act of 1934 ("Exchange Act"), which sets out the formula by which broker-dealers calculate their reserve requirements under Regulation 15c3-3 ("Reserve Formula").2 The proposed amendments provide that a broker dealer would not be able to treat as a debit item customer margin required and on deposit with a clearing organization in connection with customer transactions in security futures products ("SFPs"), unless the clearing organization meets specific criteria prescribed in Note G to the Reserve Formula. Note G provides, in part, that a clearing organization must either: (1) maintain the highest investment grade rating from a nationally recognized securities rating organization; or (2) maintain security deposits from clearing members of at least $500 million and an assessment power over members of $1.5 billion.3
FIA Cannot Support the Proposed Criteria.
We respectfully submit that the Commission should permit a broker-dealer to treat as a debit item under Regulation 15c3-3a customer funds held at any clearing organization that has made the requisite demonstration for registration under the applicable statute. In each instance, either the Commission or the Commodity Futures Trading Commission has determined that registered clearing organizations under their respective jurisdictions have the financial and operational capacity to protect customer funds in the event of a default of a clearing member.4 It is incongruous to suggest that funds held at a clearing organization with respect to which either agency has made such a finding are somehow at greater risk, simply because the funds are held in connection with SFPs, and the Commission has not enunciated any policy reason to support such a result. Moreover, the proposed amendment would inappropriately impose on broker-dealers the responsibility to determine whether a clearing organization is complying with these criteria. Broker-dealers would not have direct knowledge of many of the facts necessary to make such a determination.
FIA shares the Commission's concern that clearing organizations have sufficient guaranty deposits and other assets, as well as risk management and other policies and procedures in place, to assure that customer funds are not at risk in the event of a default of a clearing member. However, the proposed criteria bear no apparent relationship to the risk that a clearing organization may be assuming. By focusing almost exclusively on the size of the clearing organization's guarantee fund and the clearing organization's assessment authority, the proposed amendments fail to take into account other relevant factors, such as anticipated volume and open interest, historic volatility of the underlying securities, the type of SFP traded (i.e., futures on individual securities or narrow based indices), other contracts cleared and the manner in which such contracts are settled, as well as other risk management policies and procedures.
Finally, we note that The Options Clearing Corporation ("OCC") currently maintains the highest investment grade rating from a nationally recognized securities rating organization and, therefore, would be a permitted clearing organization for purposes of the proposed amendment. Nonetheless, OCC has filed a comment letter opposing the amendment on a number of grounds. OCC argues that the proposed amendments "would require OCC to fundamentally change the way in which OCC and its clearing members handle margin deposits and would substantially reduce the efficiency of the clearing process." With one critical exception, we generally support OCC's objections to the proposed amendments. We do not agree that the Commission has the statutory authority to establish different criteria for derivatives clearing organizations that clear SFPs.
For all of the above reasons, we respectfully request the Commission to withdraw the proposed amendments to Regulation 15c3-3a. In its place, the Commission should adopt a rule, which provides that, for purposes of calculating its reserve requirement, a broker-dealer may treat as a debit item customer funds held at any registered clearing agency or derivatives clearing organization in connection with transactions in SFPs, provided the appropriate regulatory authority has authorized such registered clearing agency or derivatives clearing organization to clear SFPs.
FIA appreciates this opportunity to comment on the proposed amendments to Regulation 15c3-3a. If the Commission has any questions concerning the comments in this letter, please contact Barbara Wierzynski, FIA's General Counsel, at (202) 466-5460.
John M. Damgard
cc: Honorable Harvey L. Pitt, Chairman
Honorable Cynthia A. Glassman, Commissioner
Honorable Paul S. Atkins, Commissioner
Honorable Roel C. Campos, Commissioner
Honorable Harvey J. Goldschmid, Commissioner
Annette L. Nazareth, Director, Division of Market Regulation
|1|| FIA is a principal spokesman for the commodity futures and options industry. FIA's regular membership is comprised of approximately 40 of the largest futures commission merchants ("FCMs") in the United States, the majority of which are also registered broker-dealers and are members of the NASD. Among its associate members are representatives from virtually all other segments of the futures industry, both national and international.
|2|| The proposed amendments affect only broker-dealers that elect to carry security futures products in a securities account. The proposed amendments would not affect notice registered broker-dealers that are required, or broker-dealer/FCMs that elect, to carry SFPs in a customer segregated account under section 4d(2) of the Commodity Exchange Act.
|3|| The criteria would apply both to clearing agencies registered under section 17A of the Exchange Act and to derivatives clearing organizations registered under section 5b of the Commodity Exchange Act. For convenience, registered clearing agencies and derivatives clearing organizations are both referred to in this letter as "clearing organizations".
|4|| Under section 17A of the Exchange Act, an applicant for registration as a clearing agency must demonstrate to the Commission that the applicant "is so organized and has the capacity to . . . safeguard securities and funds in its custody or control." Exchange Act, §17A(a)(3)(A). Similarly, an applicant for registration as a derivatives clearing organization under section 5b of the Commodity Exchange Act must demonstrate to the Commodity Futures Trading Commission that it "has adequate financial, operational, and managerial resources to discharge the responsibilities of a derivatives clearing organization." Commodity Exchange Act, §5b(c)(2)(A).