Forex Transactions: Regulatory Guide | NFA (2024)

Minimum financial requirements help protect customers and market participants by requiring Members to maintain enough capital to remain solvent and meet their financial obligations.

FDM Capital Requirements

Each FDM must maintain adjusted net capital (ANC) (See CFTC Regulation 5.7) equal to or in excess of the greatest of:

1. $20,000,000; or
2. The amount required by (i) plus:
   1. 5% of all liabilities the FDM owes to customers (as customer is defined in NFA Compliance Rule 2-36(s(2)) and to eligible contract participant counterparties that are not an affiliate of the FDM and are not acting as a dealer exceeding $10,000,000; and
   2. 10% of all liabilities the FDM owes to eligible contract participant counterparties that are an affiliate of the FDM not acting as a dealer; and
   3. 10% of all liabilities eligible contract participant counterparties that are an affiliate of the FDM and acting as a dealer owe to their customers (including eligible contract participant), including liabilities related to retail commodity transactions as described in Section 2(c)(2)(D) of the CEA; and
   4. 10% of all liabilities the FDM owes to eligible contract participant counterparties acting as a dealer that are not an affiliate of the FDM, including liabilities related to retail commodity transactions as described in Section 2(c)(2)(D) of the Act; or
3. For FCMs, any other amount required under NFA Financial Requirements Section 1.

An FDM may not include assets held by an affiliate or an unregulated person in its current assets for purposes of determining its ANC under CFTC Regulation 5.7. An affiliate is any person that controls, is controlled by, or is under common control with the FDM. An unregulated person is defined as any person that is not one of the following:

1. A bank or trust company regulated by a U.S. banking regulator;
2. A broker-dealer registered with the SEC and a member of FINRA;
3. An FCM registered with the CFTC and a Member of NFA;
4. An RFED registered with the CFTC and a Member of NFA;
5. A bank or trust company regulated in a money center country and which has in excess of $1 billion in regulatory capital.

An FDM for which NFA is the DSRO that is required to file any document with or give any notice to its DSRO under CFTC Regulation 5.6, 5.7 and 5.12, or is required to file any financial report or statement with any other securities or futures self-regulatory organization (SRO) of which it is a Member shall also file one copy of these documents or give notice to NFA at its Chicago office no later than the date such document or notice is due to be filed with the CFTC or the SRO.

An FDM may not consider offsetting currency transactions or positions executed with or held by or through an affiliate or unregulated person for purposes of determining net currency positions and the required capital deductions under CFTC Regulation 1.17(c)(5).

Net Capital Calculation

The formula for determiningANCis:

Current Assets – Liabilities – Charges Against Net Capital = ANC

CFTC Regulation 1.17 defines these terms (except that NFA's Financial Requirements Section 11 limits current assets as described above). Your firm's financial statements must be prepared according to generally accepted accounting principles (GAAP). In some cases, however, CFTC Regulation 1.17 is more restrictive than GAAP. You must always follow CFTC Regulation 1.17 when calculating your firm's net capital.

FDMs must prepare CFTC Form 1-FR in accordance with CFTC Regulation 5.7 and file it with NFA and its DSRO on a monthly basis. An independent public accountant must certify the financial statement prepared as of the firm's fiscal year end. Although the Form 1-FR contains a number of different financial statements, only the applicable statements need to be prepared for each filing.

Unaudited Form 1-FR must contain the following:

• Statement of financial condition;
• Statement of the computation of minimum capital requirements;
• Statement of changes in ownership equity; and
• Statement of changes in liabilities subordinated to the claims of general creditors pursuant to a satisfactory subordination agreement (if applicable).

The certified year-end Form 1-FR must also include:

• The statement of income; and
• The statement of cash flows.

The certified statement must also contain any necessary footnote disclosures, an auditor’s opinion covering all statements, and an auditor’s supplemental report on material inadequacies.

NFA must receive unaudited Form 1-FRs within 17 business days after the statement date. NFA must receive audited Form 1-FRs within 90 days after the statement date. Please note that if the FDM/RFED is registered as an FCM, NFA must receive audited Form 1-FRs within 60 days after the statement date.

The instructions for the Form 1-FR generally say where to classify items on the form. When the CFTC adopted Form 1-FR, however, registered firms generally did not conduct forex business. As a result, the form does not clearly indicate how to account for some items related to the forex activities of FDMs.

FDMs should account for their forex activities on the Form 1-FR form as follows: On the asset side of the balance sheet, funds received from customers for forex transactions should be classified as "Retail Forex Aggregate Assets." On the liability side, the firm should classify amounts owed to customers under accounts payable on the line designated as "Obligation to Retail FX Customers." Any forex activities with ECP clients should still be classified as "other" and forex income (retail and ECP) should still be classified under "other income."

Capital Charges for Forex Positions

FDMs must take a capital charge on all uncovered proprietary positions, although the firm may net on-exchange and off-exchange positions when determining the firm's uncovered position. Uncovered off-exchange proprietary positions are subject to a haircut charge that depends on the underlying currency. Net balances in British pounds, Japanese yen, Canadian dollars, Swiss francs and the Euro are subject to a 6% charge. Net balances in all other currencies are subject to a 20% charge.

When calculating its net position, your firm may include foreign currency held in deposit, investment, or trading accounts at banks, FCMs, broker-dealers, and similar entities if the following conditions are met:

• The foreign currency is unencumbered and immediately accessible, making it available to satisfy your firm's obligations to its customers; and
• Your firm treats the foreign currency in the account consistently for capital purposes (i.e., the foreign currency is always included when determining the firm's net position).

An FDM, however, may not include positions at an affiliate or an unregulated person when calculating its net position for purposes of the capital charge.

Subordinated Loan Agreements

Proceeds from subordinated loan agreements may be included in the firm's capital if the agreement meets the requirements in CFTC Regulation 1.17(h) and has been filed with and approved by the firm's DSRO. The firm must submit a signed copy of the agreement to its DSRO at least 10 days prior to the proposed effective date. A subordination agreement must include the name and address of the lender, state the business relationship of the lender to the firm, and indicate whether the firm carried funds or securities for the lender at or about the time firm files the proposed agreement. If a lender contributes 10 percent or more of the firm's capital, then the firm must list the lender as a principal.

In addition, the Member's DSRO must approve prepayments or special prepayments, and the Member must give its DSRO notice of accelerated maturity. The Member must also submit amendments to existing subordination agreements to its DSRO for approval. Finally, NFA has developed standardized Cash Subordination Loan Agreements and Secured Demand Notes. You can obtain copies of these agreements from NFA's website.

Assets Covering Liabilities to Retail Forex Customers

An FDM must calculate the amount owed to forex customers and hold assets, solely of the type permitted under CFTC Regulation 1.25, equal to or in excess of the amount at certain qualified institutions.

For assets held in the United States, a qualifying institution is:

1. a bank or trust company regulated by a U.S. banking regulator;
2. a broker-dealer registered with the U.S. Securities and Exchange Commission and a member of the Financial Industry Regulatory Authority; or
3. an FCM registered with the CFTC and a Member of NFA.

For assets held in a money center country as defined in CFTC Regulation 1.49, a qualifying institution is:

1. a bank or trust company regulated in the money center country which has in excess of $1 billion in regulatory; and
2. an FCM registered with the CFTC and a Member of NFA.

To calculate the amount owed, add up the net liquidating values of each forex account that liquidates to a positive number, using the fair market value for each asset other than open positions and the current market value for open positions.

Assets held in a money center country are not eligible to cover the amount owed to customers unless the FDM and the qualifying institution have entered into an agreement, acceptable to NFA, authorizing the institution to provide NFA and the CFTC with information regarding the FDM's accounts and to provide that information directly to NFA or the CFTC upon their request. This signed agreement must be filed with NFA.

Each FDM must instruct each qualifying institution to report the balances in the FDM's account(s) to NFA or a third party designated by NFA in the form and manner prescribed by NFA on a daily basis. The qualifying institution must comply with this request in order to be deemed an acceptable qualifying institution to hold assets covering an FDM's liabilities to retail forex customers.

Any FDM funds that are not held in a qualifying institution as noted may not be considered as part of assets covering liabilities to forex customers.

Assets at Affiliates and Unregulated Entities

An FDM may not include assets held by an affiliate or an unregulated person in its current assets for purposes of determining its ANC under CFTC Regulation 5.7. An affiliate is any person that controls, is controlled by, or is under common control with the FDM.

Financial Books and Records

FDMs are required to prepare and maintain ledgers or other similar records that summarize each transaction affecting the Member's assets, liability, income, expense and capital accounts and include appropriate references to supporting documents. These ledgers must be classified into the account classification subdivisions on the CFTC Form 1-FR. Generally, the firm's records would include basic accounting documents such as a General Ledger and a Cash Receipts and Disbursem*nts Journal.

In order to demonstrate compliance with the capital requirements, an FDM should make and maintain daily records showing the transactions executed that day and their effect on the firm's obligations to its customers. The record of daily trades should show, at a minimum, the date, time, currency pair, price, and size of each transaction; commissions and fees; and the person for whom the transaction was made. For options, the record should include whether the option is a put or a call, the strike price, the delta, and the premium. The record of obligations to customers should include the gross profits and the gross losses to customers, the firm's open currency exposures to customers, the sum of the customers' cash balances, and the net liquidating value of all customer accounts combined.

The individuals responsible for preparing an FDM's books and records must be under the ultimate supervision of a listed principal and registered AP of the Member. Such principal is also responsible for researching and selecting the independent public accountant that certifies the firm's annual financial statements.

Financial Internal Controls

Prior to conducting business as an FDM, a firm must demonstrate to NFA that the Member has adequate internal financial controls. The FDM must demonstrate that its system of internal controls provides reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. The FDM must also demonstrate that its system of internal financial controls has no material weaknesses and that it is adequate for establishing and maintaining internal controls over financial reporting by the Member.

An FDM may satisfy this obligation by obtaining an internal control report that is prepared and certified by an independent public accountant who is registered under Section 102 of the Sarbanes-Oxley Act (SOX). The internal control report shall contain, at a minimum, a detailed explanation of the examination performed by the accountant and a representation by the accountant that it has examined and tested the FDM's system of internal controls and that the controls comply with the above standards.

If NFA believes that a Member's internal controls are inadequate at any time, NFA's Compliance department may require it to provide to NFA an internal control report that is prepared and certified by an independent public accountant who is registered under Section 102 of the SOX. The internal control report shall meet the above standards.

Forex Reporting Requirements

Each FDM must be able to properly account for all funds received from and owed to customers. FDMs should prepare a daily computation showing the total amount of customer funds on deposit, the total amount of customer open positions, and the total amount due to customers.

The firm must file with NFA three report types: daily electronic reports showing liabilities to customers and other financial and operational information; monthly operational and risk management reports; and quarterly reports that contain the most-recent performance disclosures required under CFTC Regulation 5.5(e)(1)(i)(iii).

The daily reports must be prepared each business day, and must be filed by noon on the following business day. The monthly reports must be filed within 17 business days after the end of each month for which the report is prepared. Similarly, the quarterly reports must be filed within 17 business days after the end of each quarter for which the report is prepared.

Submitting these reports certifies that the person filing it is a supervisory employee that is, or is under the ultimate supervision of, a listed principal who is also an NFA Associate, is duly authorized to bind the FDM, and that all information in the report is true, correct, and complete. Any report that is filed after it is due will incur a late fee of $1,000 for each business day that it is late.