Audit Advisory Notice
 | 
From Audit Department
Subject Update: Regulator Treatment of Debit/Deficits
Effective Date 08/10/01
Notice Number 01-04

The CFTC recently amended Rule 1.32 to allow readily marketable securities (rather than only U.S. Treasury securities) to offset debit/deficits for segregation and secured amount statement reporting. Refer to JAC Regulatory Update #0104 for further details. As a result, the Audit Department has updated AIB #00-04, which summarized the regulatory treatment of debit/deficits on the segregation and secured amounts statements and balance sheet, to reflect the amendment.

Segregation and Secured Amounts Statements Reporting

  • All identically owned accounts, by origin, should be combined to determine an account�s net liquidating value debit/deficit. However, identically owned accounts of different legal entities (e.g. sister companies) should not be combined for debit/deficit purposes. Note: For segregated accounts, amounts denominated in different currencies may be combined. For 30.7 secured accounts, amounts denominated in different currencies should be combined.

  • Debit/deficits for cross-margin accounts are computed using the combined commodity and security cross-margin equity balances. Such debit/deficits are computed independently for cross-margin and noncross-margin accounts and are reported on the respective segregation statement.

  • Readily marketable securities held in the same origin as the debit/deficit may be used to offset the debit/deficit. The account�s debit/deficit may be offset to the extent of the securities' collateral value (i.e. market value less applicable haircuts). Additionally, the securities must be held in a proper segregated/secured, as appropriate, safekeeping account and the firm must possess a written authorization from the customer to liquidate the securities at the firm's discretion. Note: Letters of credit cannot be used to offset a debit/deficit.

Balance Sheet Reporting

  • All identically owned accounts, by origin, should be combined to determine an account�s net liquidating value debit/deficit. However, identically owned accounts of different legal entities (e.g. sister companies) should not be combined for debit/deficit purposes. Note: Amounts denominated in different currencies within an origin should be combined.

Broker/dealers may reflect total equity debit/deficits on the balance sheet with an additional evaluation performed to determine the capital impact of an account�s option value. That is, net long option value in an account may be used to secure a total equity debit/deficit. Further, a charge to net capital is necessary for the amount of net short option value in an account which is not covered by total equity and is otherwise not secured.

  • Debit/deficits for cross-margin accounts are computed using the combined commodity and security cross-margin equity balances. Such debit/deficits are computed independently for cross-margin and noncross-margin accounts.

  • Debit/deficits may be secured (i.e. treated as a current/allowable asset on the balance sheet) with the following:

Readily Marketable Securities

Readily marketable securities used to secure a debit/deficit must be held in the same origin as the account in debit/deficit. With the exception of delivery debits, an account�s debit/deficit may be secured to the extent of the securities' collateral value (i.e. market value less applicable haircuts). Customer debit/deficits resulting from the financing of deliveries may be secured with the full market value of the warehouse receipts. Further, the firm must possess a written authorization from the customer/noncustomer to liquidate the securities at the firm's discretion. Note: If the securities are held in a different origin, they would be part of the "free funds" computation discussed below.

One Day Debit/Deficit

A debit/deficit may be considered secured if the firm issues an equity call for the full debit/deficit balance and (1) the account was not in debit/deficit on the previous business day, or (2) the account was in debit/deficit on the previous day and the firm received sufficient funds to delete, in its entirety, the previous day�s equity call.

Free Funds in an Identically Owned Account in a Different Origin

A customer/noncustomer debit/deficit may be secured to the extent that the account owner has "free funds" in another type of account. With respect to a commodity trading account, "free funds" are funds in excess of the initial margin requirements (i.e. net liquidating value plus marketable securities less initial margin requirements). Further, to secure with "free funds", a written authorization to transfer funds between account types must be on file; however, the actual transfer of funds is not required.

Third Party Guarantee Accounts

A noncustomer or non-regulated account may guarantee and secure a customer or noncustomer account in debit/deficit. The debit/deficit may only be secured to the extent that there are "free funds" in the account of the guarantor. The firm must possess a satisfactory written guarantee agreement from the guarantor specifying the accounts of the guarantor and the accounts guaranteed and providing an authorization to transfer funds. Finally, any limits on the dollar amount of the guarantee, or that no limit exists, must be specified. The actual transfer of funds is not required.

A customer segregated or 30.7 secured account (regulated accounts) cannot guarantee another account�s debit/deficit. An actual transfer of funds must occur from the guarantor's account thereby reducing or eliminating the debit/deficit in the guarantee's account. Further, the firm must possess a written authorization to transfer funds.

Commission Holdbacks

Commission withholdings may be used to secure a debit/deficit provided a proper agreement exists between the firm and the individual or entity owed the commissions. Such agreement must allow the firm to withhold commissions from the individual/entity to cover specific customer/noncustomer debit/deficits and must be specific as to the extent and manner in which the commissions will be withheld. Finally, the commissions withheld must be due to the individual/entity at the report date and the firm must continue to withhold those commissions until the customer/noncustomer repays their debit/deficit.

The above is a summary of the requirements for recording debit/deficit balances in your financial statements. Please consult the CFTC Regulations and 1-FR Instruction Manual for further guidance.

If you have any questions, please call the Audit Department at (312) 930-3230 or e-mail us at audits@cme.com.