July 6, 2007

 

National Futures Association

200 W. Madison Street, Suite 1600

Chicago, Illinois 60606

E-mail: forex@nfa.futures.org

Fax: (312) 658-4193

 

Re:       NFA Request for Comments on Forex Capital and Internal Controls

 

 

Dear Executive Committee Members:

 

Knight Capital Group, Inc. (Knight)[1] and Hotspot FXr, L.L.C. (Hotspot) (collectively, “the Firm”) welcome the opportunity to offer our comments to the recent request of the National Futures Association (NFA) for comment on its proposal pertaining to Forex Dealer Members (FDMs) minimum adjusted net capital requirement, concentration charges and internal financial controls.

 

For the reasons set forth below, the Firm respectfully opposes these proposals and requests that the NFA consider further these issues before taking any action.

 

As noted in the NFA’s Request for Comments, the entrance of new FDMs to the marketplace and related growth in the amount of retail customer funds the FDMs handle has created the potential for greater financial risk.  Although we agree with the NFA’s view that more regulatory oversight is needed in certain circumstances, we disagree, however, with the proposed “one-size-fits-all” approach toward net capital requirements. 

 

Certain FDMs, like Hotspot, do not operate their business like a traditional dealer.  As the NFA noted in its Request for Comments, many FDMs function as principal in Forex transactions, effectively taking “the other side of every [contract] entered into by a [customer]...”  Thus, the NFA concluded, “…the FDM ‘is the sole guarantor of performance of the [contract].”  However, other FDMs, like Hotspot, automatically offset (real-time) all client trades with bank market makers or client subscribers. As such, Hotspot effectively operates on a “riskless principal” basis on behalf of its clients, thereby reducing dramatically any associated risk with that transaction and its clients’ funds.  Hotspot’s bank market makers include some of the largest banks in the world (i.e., UBS Investment Bank, Dresdner and Deutschebank).  Hotspot does not have a trading desk, nor does it trade against its clients. 

 

Thus, since Hotspot and other FDMs similarly situated do not directly offset client trades, they are not subject to the same market volatility and risk as are FDMs that take the other side of client trades and putting their client accounts (deposits) at risk.  Since Hotspot is not acting as a traditional “dealer” as referenced in the NFA Request for Comment, which also makes reference to Leveraged Transaction Merchants and their required higher net capital requirement, its client “risk” is minimal because it offsets the contra-side of the client trade immediately with a bank market maker.  Consequently, the rationale for the proposed additional capitalization requirement does not apply under these circumstances.

 

As it relates to the NFA’s proposal to eliminate the concentration charge on significant positions with unregulated counterparties, Hotspot’s business model as described above reduces the need for concentration charge calculations altogether– as all trades are offset simultaneously with the contra-side and the FDM is never the contra-party.  

 

The NFA correctly notes that the Bankruptcy Code does not provide priority to customers trading off-exchange forex.  However, increasing the net capital requirements of an FDM will not cure this limitation.  Accordingly, rather than increase the amount of capital required of FDMs, we think the more prudent and effective course of action is to amend the CFTC Bankruptcy Rules to insure that OTC forex customers receive similar priority and protection as customers in the exchange-traded futures industry. 

 

Finally, we concur fully with the proposition that FDMs must be required to have a robust system of financial controls and procedures.  Indeed those FDMs, like Hotspot, that are subsidiaries of publicly traded companies have their controls are reviewed under the parent company’s Sarbanes Oxley reporting obligation. 

 

However, we do not believe it is appropriate to require that a CFO become registered with the NFA as an “associated person (AP).”  As you know, NFA rules and guidance clearly distinguish between APs and principals, and for good reason. 

 

An AP is typically defined as an individual,

 

“…who solicits orders, customers or customer funds (or who supervises persons so engaged) on behalf of an FCM, IB, CTA or CPO. An AP is, in effect, anyone who is a salesperson or who supervises salespersons for any of these categories of individuals or firms.”[2]

 

 

Under NFA rules, a “principal” includes someone who is,

 

“…a director, president, chief executive officer, chief operating officer, chief financial officer or a person in charge of a business unit, division or function subject to regulation by the Commission of a corporation, limited liability company or limited liability partnership;” (emphasis supplied)[3]

 

 

 

As a result, in the role of a registered principal, the CFO performs supervisory functions relating to a firm’s financial processes and controls.  In that capacity, the CFO is clearly subject to regulatory oversight and disciplinary action.  However, since in most instances the CFO has no supervisory responsibility over a firm's sales activities, the CFO does not fall within the definition of an AP.  Based upon the above discussion, there does not appear to be any reason to add such a registration requirement.

 

Conclusion

 

We commend the NFA for their diligence and for the spirit of the proposals referenced in this comment letter.  For the reasons stated above, we believe the NFA needs to make distinctions in capital requirements depending upon the business model of the FDM.  Further, we believe that the protection of forex customers would be best served by modifying the CFTC’s Bankruptcy Rules or, if necessary, the CEA to require the segregation of OTC forex customer funds as is the case with exchange traded futures customers.  Finally, Forex firms that maintain poor financial controls and procedures should be required to remedy those deficiencies immediately or face swift regulatory action.

 

Thank you again for providing us with the opportunity to comment on these proposals.  We would welcome the opportunity to discuss our comments with the NFA at its earliest convenience.

 

 

 

Sincerely yours,

 

 

 

 

 

Leonard J. Amoruso                                                     Barry E. Calder

General Counsel                                                           Compliance Director

Knight Capital Group, Inc.                                            Hotspot FXr, L.L.C.

Tel (201) 557-6892                                                     Tel (212) 209-1412

 

 

 

 

 

cc         CFTC Acting Chairman Walter Lukken

CFTC Commissioner Michael V. Dunn

 

 

 

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