| Interpretation to Chapter 9 - Capital Charge for Rule 106.D.Lessees and Trading Permit Holders As part of the CME�s on-going efforts to keep clearing members apprised of regulatory issues, we have updated the Question & Answer Guide regarding CME Rule 106.D. Lessee and Trading Permit Holder Capital Charges. The original guide was distributed in May 1997 in Audit Information Bulletin #9703 in conjunction with several amendments to the Interpretation to Chapter 9 � Capital Charge for Rule 106.D. Lessees and Trading Permit Holders. The Question & Answer Guide was updated to further clarify some of the issues surrounding the application of Rule 106.D. Capital Charges. The following topics were added and/or clarified: - The combination of customer segregated and 30.7 secured accounts.
- The treatment of joint accounts.
- The utilization of a seat owner�s membership to guarantee himself as a lessee and, in addition, another lessee.
- Lessee capital charges applicable to fractions leased of a GEM membership.
In addition, to assist clearing members in complying with the requirements of the Rule 106.D. Interpretation, we have attached: - A copy of the CME�s Interpretation to Chapter 9 Capital Charges for a Rule 106.D. Transferee (Lessee) and Trading Permit Holder. Note: No changes have been made to the Interpretation to Chapter 9.
- A Sample (Suggested Language) Unconditional Guarantee Agreement.
- A Sample (Suggested Language) Third Party Guarantee Agreement.
Finally, keep in mind, that effective January 1, 1998, the CME, CBOT, and BOTCC implemented new capital requirements based on risk margin/performance bond requirements. The CME will continue to assess Rule 106.D. lessee charges under the new risk based capital requirements. If you have any questions, please call the Audit Department at (312) 930-3230 or e-mail us at audits@cme.com.
Interpretations & Special Notices Relating to Chapter 9 CAPITAL CHARGE FOR A RULE 106.D.
TRANSFEREE (LESSEE) AND TRADING PERMIT HOLDER A capital charge in the following amounts will be assessed to a clearing member's adjusted net capital: i) $50,000 for each CME, IMM, and IOM Rule 106.D. transferee (lessee) for whom the clearing member has indemnified the transferor (lessor); ii) $25,000 capital charge for each GEM 106.D. lessee for whom the clearing member has indemnified the lessor; and iii) $25,000 for each trading permit holder. A clearing member may not avoid this charge by lending funds or guaranteeing a loan to the lessee or trading permit holder to enable the lessee or trading permit holder to meet the $50,000 or $25,000 requirement unless such loan is secured by readily marketable collateral in accordance with CFTC Regulation 1.17. The capital charge may be reduced by equity in excess of maintenance performance bond requirements in the respective lessee's or trading permit holder's account with the clearing member. The capital charge will not apply with respect to a lessee or trading permit holder if any of the following are satisfied: A. The lessee or trading permit holder has been unconditionally guaranteed by an equity member qualified by the same clearing member. The clearing member must obtain a properly executed guarantee agreement from the equity member. An equity member may only guarantee one lessee or trading permit holder for each membership owned. A GEM equity member may only guarantee a GEM lessee. B. The lessee or trading permit holder has been guaranteed by a third party depositing at least $50,000 (for a CME, IMM, or IOM lessee) or $25,000 (for a GEM lessee or any trading permit holder) with the clearing member in performance bond deposits acceptable under Rule 930.C. The clearing member must obtain a properly executed guarantee agreement from the third party for each lessee or trading permit holder so guaranteed and may not use the deposit for any other purpose. C. The lessee or trading permit holder trades exclusively for the proprietary account of the qualifying clearing member. to top
CME Rule 106.D. Lessee and Trading Permit Holder Capital Charges EQUITY MEMBER UNCONDITIONAL GUARANTEE The undersigned, as Guarantor, hereby unconditionally guarantees the account and the full and prompt payment of any and all amounts due and owing to ___________________________ ("Clearing Member") from the trading of: ________________________________________________________________ Lessee Guarantor understands and acknowledges that this unconditional guarantee is not limited to the $50,000 financial requirement required of the Lessee, or to the value of the Guarantor�s membership. It is hereby acknowledged that after the Lessee, the Guarantor becomes the primary obligor for all debts owed by the Lessee to the Clearing Member. This is a continuing guarantee and shall remain in effect until it is terminated by the Guarantor by providing written notice to the Clearing Member. Such termination shall be effective only as to claims which arise out of transactions entered into by Lessee after receipt of the notice of termination. There are no conditions or limitations on this guarantee and this writing represents the entire understanding of the Guarantor. This guarantee may not be amended or modified except by a written agreement signed by the Guarantor. __________________________________________ Name of Guarantor __________________________________________ Signature of Guarantor __________________________________________ Date to top
CME Rule 106.D. Lessee and Trading Permit Holder Capital Charges THIRD PARTY GUARANTEE The undersigned, as Guarantor, hereby guarantees and deposits with ____________________________ ("Clearing Member") an amount at least equal to $50,000 (for a CME, IMM, or IOM lessee) or an amount at least equal to $25,000 (for a GEM lessee or any trading permit holder) in performance bond deposits which are acceptable under Rule 930.C. These funds shall be held in a nonregulated escrow account for the sole purpose of guaranteeing ______________________________________ ("Lessee") in accordance with the CME Interpretation to Chapter 9 - Capital Charge for Rule 106.D. Lessees and Trading Permit Holders. The escrow account shall be maintained in the name of the Guarantor. The funds in the escrow account shall not be used for any purpose other than to guarantee the indicated lessee or trading permit holder. This is a continuing guarantee and shall remain in effect until it is terminated by the Guarantor by providing written notice to the Clearing Member. Such termination shall be effective only as to claims which arise out of transactions entered into by Lessee after receipt of the notice of termination. This writing represents the entire understanding of the Guarantor. This guarantee may not be amended or modified except by a written agreement signed by the Guarantor. __________________________________________ Name of Guarantor __________________________________________ Signature of Guarantor __________________________________________ Date to top
Question & Answer Guide Unless otherwise indicated, the following questions and answers only refer to lessees and imply a required capital charge of $50,000 to a clearing member�s adjusted net capital for each lessee for whom the clearing member has indemnified the lessor. The principles of the questions and answers apply equally to GEM lessees and trading permit holders who are subject to a $25,000 capital charge. 1. What is the purpose of the lessee capital charge? Answer: The lessee capital charge addresses the risks associated with a clearing member that qualifies lessees. A lessee maintains the ability to execute orders at his own discretion without the qualifying clearing member�s direct supervision/approval. The clearing member can reduce the $50,000 capital charge with equity in excess of maintenance performance bond requirements in the lessee�s account with the clearing member. The clearing member can also avoid the capital charge by obtaining an appropriate guarantee from an equity member (See Attached Equity Member Unconditional Guarantee) or third party (See Attached Third Party Guarantee) who deposits $50,000 in collateral with the clearing member. The capital charge does not apply to a lessee trading exclusively for the proprietary account of the qualifying clearing member.
2. Can an assigned membership be used to guarantee a lessee? Answer: No. An assigned membership must be immediately available to the Exchange in the event a clearing member cannot meet its obligations to the Exchange. The Exchange may direct the sale of an assigned membership and use the proceeds to satisfy the Exchange of any outstanding obligations of the clearing member.
3. If a lessee only does floor brokerage and does not trade for his own account, does the lessee capital charge apply? Answer: Yes. While the lessee is only executing orders and not trading for himself, he is still on the trading floor with the ability to trade for himself and/or improperly execute orders.
4. If a lessee trades from "upstairs" in the clearing member�s office, does the lessee capital charge apply? Answer: Yes. Similar to question 3, the lessee trading from "upstairs" still maintains the ability to trade for himself on the trading floor.
5. If a lessee only executes orders on behalf of the proprietary account of a clearing member, would the lessee capital charge apply? Answer: No. The proprietary capital charge required by CFTC regulations already assesses the risks associated with proprietary trading activity. To be exempt from the lessee capital charge, the lessee must exclusively trade for the proprietary account (including error accounts) of the qualifying clearing member and may not have a personal trading account with the clearing member.
6. If a clearing member leases a membership for a floor manager, clerk, or other employee for purposes other than to either trade for themselves or to execute orders, does the lessee capital charge apply? Answer: In certain situations, a clearing member may lease a membership for a floor manager/clerk to allow the floor manager/clerk to execute orders in an emergency situation (e.g., to P&S trades made in error). The floor manager/clerk does not trade for himself nor does he fill orders. If all orders executed by the floor manager/clerk are for emergency situations of the qualifying clearing member, the leased membership would not be subject to the capital charge. The clearing member must demonstrate compliance with this condition to the Audit Department to avoid the capital charge. In other situations, a clearing member may lease a membership for an employee to allow the employee to solicit customers on the trading floor. If a clearing member does not allow the lessee to trade under any circumstance, the leased membership would not be subject to the charge. The clearing member must demonstrate compliance with this condition to the Audit Department to avoid the capital charge.
7. Where must funds deposited by lessees to meet the $50,000 requirement be held? Answer: Funds deposited by the lessee must be held in the lessee�s segregated account. Such funds would be used in determining the account�s net liquidating value and available to meet performance bond requirements. A lessee may not deposit funds in a non-regulated account to meet the lessee capital charge.
8. Why must the seat owner and lessee be qualified by the same clearing member in order for the seat owner to guarantee the lessee? Answer: The seat owner and lessee must be qualified by the same clearing member to ensure sufficient controls are in place to monitor the trading activities of both the seat owner (guarantor) and lessee (guarantee). In addition, if the seat owner and lessee were qualified by different clearing members and the lessee suffered a loss, the lessee�s qualifying clearing would have a lower priority claim to the membership than the seat owner�s qualifying clearing member pursuant to Rule 110 (Claims Against Member, Application of Proceeds).
9. May a lessee, who also owns a membership, use the membership that he owns to guarantee another lessee? Answer: Yes, provided the clearing member qualifying the individual leasing the seat owner�s membership indemnifies the seat owner and the seat owner has executed an unconditional guarantee agreement (See Attached Equity Member Unconditional Guarantee) for the guaranteed lessee. Further, the guaranteed lessee and the seat owner must be qualified by the same clearing member.
10. May a lessee, who also owns a membership, use the membership that he owns to guarantee himself and/or another lessee? Answer: Yes. No guarantee agreement is required for a seat owner guaranteeing himself. The seat owner may also guarantee another lessee provided the provisions detailed in Question 9 above are met. In this situation, John may guarantee himself and Matt for the Rule 106.D. lessee capital charges. Such guarantees are allowed as (1) Paul�s qualifying clearing member has indemnified John as lessor; (2) John has executed an equity member unconditional guarantee for Matt; and (3) John and Matt are both qualified by the same clearing member, namely ABC, Inc.
11. May an equity member provide a guarantee based upon a membership at another exchange? Answer: Yes. A full Chicago Board of Trade (CBOT) membership, a CBOT Associate membership, a New York Mercantile Exchange membership, or a Chicago Board Options Exchange membership may be used to guarantee a lessee provided the requirements of the capital charge Interpretation are met. Depending upon the value of memberships at other exchanges, they may be acceptable for a Rule 106.D. guarantee. Consult the Audit Department for further guidance as to a particular memberships� acceptability.
12. When a third party guarantees a lessee, why must the collateral be deposited into a non-regulated account to be used for the purposes of meeting the lessee capital charge requirement? Answer: CFTC Regulation 1.20 requires a clearing member to deposit funds received from a customer to margin, guarantee, or secure that customer�s trading activity on U.S. exchanges into a segregated account. CFTC Regulation 1.20 prohibits a clearing member from depositing funds received from a third party to guarantee the customer�s trading activity into a segregated account. Such funds must be held in a non-regulated account in the name of the third party guarantor. Likewise, the funds may not be deposited into a CFTC Regulation 30.7 secured account.
13. If a lessee has both a customer segregated and 30.7 secured account, must the two accounts be combined for purposes of computing the lessee capital charge? Answer: Yes. A lessee who has both a customer segregated and 30.7 secured account must combine the accounts for purposes of computing the lessee capital charge. The two accounts must be combined as this represents the total funds that the firm maintains to support the trading and associated risks of the individual lessee. Thus, all accounts owned by a lessee must be combined for Rule 106. D. capital charge purposes regardless of origin.
14. If a lessee is an owner in a joint account, is the entire joint account equity used in computing the lessee capital charge? Answer: Yes. If the joint account owners are joint and severally liable, then for lessee owners of the joint account, the total balances (equity and performance bond requirements) in the joint account are compared to the total lessee requirement to determine the charge. Since the entire joint account�s equity is at risk, the total account is considered in the computation of the lessee capital charge.
15. If a lessee has an individual and joint account, should the two accounts be combined for purposes of computing the lessee capital charge? Answer: Yes. A lessee who has an individual and joint account (for which the parties are jointly and severally liable) must combine the two accounts for purposes of computing the lessee capital charge. The two accounts must be combined as this represents the total funds that the firm maintains to support the trading and associated risks of the individual lessee. Since the equity of the lessee�s individual and joint accounts is at risk, both accounts are considered in the computation of the lessee capital charge.
16. How does a lessee capital charge apply when a lessee is part of a trading group that has non-lessee participants? Answer: For lessees included in a trading group, the total balances (equity and performance bond requirements) in the trading group account are compared to the total lessee requirement (e.g., if three lessees are part of the trading group, the total lessee requirement is $150,000) to determine the lessee capital charge. Since the entire trading group�s equity is at risk, the total account is considered in the computation of the capital charge. For example, a trading group consists of 5 lessees and 5 members, has account equity of $300,000, and performance bond requirements of $75,000. The lessee requirement is $250,000 (5 lessees multiplied by $50,000) which can be reduced by $225,000 (account equity of $300,000 less performance bond requirements of $75,000) resulting in a $25,000 lessee capital charge.
17. How is the lessee capital charge computed for cross-margin accounts? Answer: In determining excess equity, the clearing member must include the lessee�s cross-margin account and non-cross-margin commodity account (e.g., all segregated accounts). Excess equity is based on the SPAN performance bond requirement, not the SEC Rule 15c3-1(c)(2)(x) haircut. Excess equity in the lessee�s non-cross-margin security account cannot be used to meet the $50,000 requirement until a transfer of available funds to a segregated account occurs.
18. How many fractions must an individual lease before they are subject to the $25,000 GEM lessee charge? Answer: The capital charge of $25,000 for GEM lessees is applied when an individual leases at least 2/5ths (4 fractions) of a GEM membership (i.e. sufficient fractions to trade certain GEM products) and does not own at least 2/5ths of a GEM membership. That is, the charge does not apply when a member owns at least 2/5ths of a GEM membership and leases the additional fractions to trade other GEM products. If a GEM lessee charge applies, the charge is based on the $25,000 requirement regardless of the number of fractions leased.
19. How many fractions must a GEM equity member own to guarantee a GEM lessee? Answer: A GEM equity member must own the equivalent of a full GEM membership to guarantee a GEM lessee.
20. If an individual transfers his membership under Rule 106.C. (Family Transfer), may the membership still be used to guarantee a Rule 106.D. lessee? Answer: As background to the question, a Rule 106.C. transfer is a family transfer. The clearing member qualifying the 106.C. transferee cannot indemnify the transferor -- the owner of the membership. A 106.C. transferee cannot directly guarantee a 106.D. lessee. The owner of the membership must guarantee the lessee or grant permission to the 106.C. transferee to guarantee the lessee through a power of attorney. [Note: Such power of attorney is limited and only allows the membership to be used by the 106.C. transferee to guarantee a 106.D. lessee. Such power of attorney must be maintained by the qualifying clearing member of the 106.C. transferee.] A membership subject to a 106.C. transfer may be used to guarantee a Rule 106.D. lessee as follows: (1) The 106.C. transferor, 106.C. transferee, and the 106.D. lessee are qualified by the same clearing member. In this case, the 106.C. transferor either owns and/or leases another membership in order to be qualified by a clearing member. The 106.C. transferor guarantees the 106.D. lessee by executing an unconditional guarantee (See Attached Equity Member Unconditional Guarantee); or (2) The 106.C. transferee and the 106.D. lessee are qualified by the same clearing member, but the 106.C. transferor is not. The 106.C. transferee may guarantee the 106.D. lessee using the transferred membership by (a) executing an unconditional guarantee (See Attached Equity Member Unconditional Guarantee), and (b) obtaining a power of attorney from the 106.C. transferor to use the membership for a 106.D. guarantee.
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