Deposit of Customer Funds in Foreign Depositories

SUMMARY: The Commodity Exchange Act ("Act") requires that all money, securities and property received by futures commission merchants ("FCMs") to margin, guarantee, or secure trades or contracts of any customer on domestic designated contract markets or accruing to such customer as the result of such trades or contracts be segregated pursuant to Section 4d(2) of the Act, 7 U.S.C. §6d(2), and the regulations promulgated thereunder. The Commodity Futures Trading Commission ("Commission") is providing further guidance with respect to where customer funds relating to contracts traded on domestic exchanges may be deposited consistent with Section 4d(2). The Commission generally has required that such funds be held in the United States with the exception of certain funds held on behalf of foreign-domiciled customers. In view of the interest in pricing and settling certain domestic futures and option contracts in foreign currencies, the Commission has determined that it is appropriate to permit funds of customers domiciled in the United States to be deposited in foreign depositories under certain conditions designed to insure consistency with the segregation requirements of the Act. The Commission also finds that the special provisions of the Bankruptcy Code applicable to the bankruptcy of commodity brokers generally require that in the event of the bankruptcy or insolvency of an FCM all segregated funds be distributed on a pro-rata basis to customers of the same class. Accordingly, in order to assure the consistent treatment of all customer funds held outside the United States with respect to designated United States futures and options, the Commission has determined to apply certain limitations prospectively to foreign-domiciled customers whose funds relating to contracts traded on or subject to the rules of a contract market in the United States are held overseas. This interpretation modifies Commodity Exchange Authority Administrative Determination No. 238 (September 4, 1974) ("A.D. 238").

FOR FURTHER INFORMATION CONTACT: John C. Lawton, Associate Director, Division of Trading and Markets, Commodity Futures Trading Commission, 2033 K Street N.W., Washington, D.C. 20581, telephone: (202) 254-8955.

treat and deal with all money, securities, and property received by such [FCM] to margin, guarantee, or secure the trades or contracts of any customer of such [FCM], or accruing to such customer as the result of such trades or contracts, as belonging to such customer. Such money, securities, and property shall be separately accounted for and shall not be commingled with the funds of such [FCM] or be used to margin or guarantee the trades or contracts, or to secure or extend the credit, of any customer or person other than the one for whom the same are held.

The Commission and its predecessor agency, the Commodity Exchange Authority ("CEA"), have construed this provision to require that customer funds deposited with an FCM relating to futures or option trading on a designated contract market be kept in the United States unless the funds are being held for a foreign-domiciled customer. In Administrative Determination No. 238, the Administrator of the CEA stated that an FCM "cannot directly or indirectly shift regulated commodity customers' funds to foreign banks in order to permit the firm to better its business relations with such foreign banks or for any other reason." (emphasis added) In monitoring segregation, the Commission consistently has applied this interpretation.1

The Commission has interpreted Section 4d(2) and the regulations thereunder generally to preclude the use of foreign segregated depository accounts because permitting customer funds to be held offshore would expose them to risks which potentially could weaken the safeguards intended to be afforded by segregation.2 For example, the Commission and self-regulatory organizations ("SROs") ordinarily would have less ready access to such depositories and, therefore, could encounter difficulties confirming balances and monitoring funds held in such depositories on an ongoing basis. An inability to detect potential problems quickly could hamper the ability of the Commission or an SRO to take steps to resolve incipient problems before they become more serious. The risk of shortfalls in these accounts also may be greater to the extent that these contracts attract foreign-based traders, since past experience indicates that FCMs find it more difficult to recover debit balances from defaulting foreign-based customers than from domestic customers. In addition, a foreign depository may not be responsive to Commission concerns when compliance by a regulatee with segregation requirements comes into question, or a court might refuse to enforce applicable provisions of the Commission's regulations that prohibit a foreign depository from offsetting obligations of the FCM against customer funds or from otherwise mishandling or permitting the mishandling of customer funds. Similarly, in the event of an FCM insolvency, deposits maintained at a foreign depository might not be handled or distributed in accordance with United States bankruptcy law. Finally, a foreign government could limit the use of, freeze, or confiscate assets held within its jurisdiction. As a result of any of these events, segregated funds might not be recoverable fully by customers upon demand, or in a bankruptcy or receivership.

The foregoing risks may be described as sovereign or location risk. Currency exchange rate fluctuations, that is, currency risk, also can be a concern where deposits securing United States contracts are maintained in multiple currencies. Specifically, if an FCM becomes bankrupt or is placed in receivership while holding foreign currency-denominated deposits, both the size of the pool of funds available for distribution to customers and the size of individual claims against that pool may vary from day to day during the pendency of the proceeding. This could have the effect of exposing customers with dollar-denominated claims to currency risk.

The Commission currently has pending before it several applications from domestic exchanges to trade futures or option contracts on foreign financial instruments or indices.3 The exchanges plan to price and settle the proposed contracts in the currency of the underlying instrument or index in order to enhance the effectiveness of the contracts for hedging purposes. The Board of Governors of the Federal Reserve System ("Federal Reserve"), however, has a policy which discourages banks from offering in the United States accounts denominated in foreign currencies.4 Therefore, the CME and CBT have requested that the Commission modify its interpretation regarding the deposit of customer funds in foreign banks.

The Commission believes that in light of the growing internationalization of the futures and option markets, modification of the Commission interpretation, as set forth in A.D. 238, concerning appropriate segregated depository accounts is warranted to the extent set forth herein. Accordingly, the Commission hereby is modifying that interpretation so as to permit FCMs to carry segregated funds of domestic customers in certain foreign depositories if certain conditions are met.5 These conditions are designed to minimize the risks to customers incident to carrying their funds overseas and generally to prevent the dilution of customer funds held in segregation in the United States. The Commission intends to monitor experience under this interpretation and may determine to alter or supplement the conditions for keeping segregated funds offshore as such experience renders advisable.6

First, to be segregated properly, funds of U.S.-domiciled customers may be held offshore if such funds are used to margin, guarantee, or secure positions in a contract traded on a domestic contract market that is priced and settled in a foreign currency or accrue to such a customer as a result of positions in such contracts. The Commission believes that some flexibility is appropriate with regard to the amounts which may be deposited and the timeframe within which they may be deposited. For example, customers may have a business reason for depositing funds in advance of taking a position or in excess of margin requirements.

Nevertheless, the Commission also believes that some constraints are necessary to prevent the transfer of funds overseas for reasons unrelated to trading in the relevant contracts. An FCM must obtain specific written authorization from a customer to maintain funds offshore in that customer's segregated account to acquire and hold futures and option positions that are priced and settled in foreign currencies.7 FCMs that carry these accounts also should establish written internal procedures for ensuring that segregated funds are held offshore solely for the above-stated purpose.8 These procedures will be subject to SRO and Commission oversight.9

Second, the funds must be held in depositories that meet the criteria used by the Commission under Regulation 30.7(c) for foreign futures and option depositories10 and are located in the country of origin of the applicable currency or in a country with whose applicable regulatory body the Commission has appropriate information sharing arrangements.11 In addition, pursuant to Commission Regulations 1.20(a) and 1.20(b), each FCM and clearing organization must obtain from each such foreign depository an appropriate acknowledgment of the applicability of Commission regulations regarding customer segregated funds as is provided by domestic depositories.

Third, all FCMs, at all times, must segregate sufficient funds denominated in dollars in the United States to meet all dollar-denominated obligations to U.S.-domiciled customers. Any shortfall in the dollar account(s) would constitute a segregation violation regardless of whether there were excess funds in segregation in a foreign currency-denominated account.12

Fourth, before placing a customer's funds overseas, an FCM must obtain from the customer a subordination agreement in the form set forth below. The agreement would authorize the deposit of segregated funds into a foreign depository if such funds are used to margin, guarantee, or secure such contracts or accrue as a result of positions in such contracts. The agreement also would authorize the subordination of the customer's claim attributable to funds held offshore in a particular foreign currency to the claims of customers whose funds are held in dollars or other foreign currencies in the event the FCM is placed in bankruptcy or receivership13 and there are insufficient funds available for distribution from the funds held in the particular currency to satisfy all customer claims against those funds. The subordination will apply whether the insufficiency is due to underfunding of the account or the inability to recover all funds in the account.14

Such an agreement generally will prevent an insufficiency of available funds in one foreign currency from diluting customer funds held in dollars or in other foreign currencies. It also will shield customers with dollar claims or claims in other foreign currencies from exposure to that currency's conversion risks during the pendency of the bankruptcy or receivership. The Commission believes that generally the risks attendant to holding funds in a particular currency should not be shared by customers whose funds are held in dollars or in different foreign currencies.

The subordination agreement will apply only to claims against segregated funds. All customers will retain an equal claim status as to claims against other assets of the FCM.15

The Commission notes that for many years it has permitted the funds of foreign-domiciled customers trading on domestic markets to be held overseas.16 The Commission believes that in a bankruptcy or receivership these customers should be treated equivalently to other customers for whom funds are held offshore in segregated accounts. To the extent funds located offshore are segregated funds, the same potential exists for dilution of domestic segregated funds in the event of bankruptcy or receivership. Accordingly, the Commission will require that foreign-domiciled customers who desire to have funds relating to trading on a domestic market held in a foreign account also consent to subordinate their claims based on such funds. In order to give customers and FCMs the opportunity to make any adjustments necessitated by this change in policy, FCMs will be allowed six months from the date of this interpretation to bring themselves into compliance. Thereafter, an FCM will not be permitted to hold in a customer segregated account foreign currency deposited by a foreign-domiciled customer in connection with trading on or subject to the rules of a United States contract market, unless the customer has signed a subordination agreement as set forth below.17

The subordination agreement may be incorporated into the bankruptcy disclosure document required by Commission Regulation 190.10(c) or may be separately executed and retained by an FCM. The agreement must contain the following language:

Funds of customers trading on United States contract markets may be held in accounts denominated in a foreign currency with depositories located outside the United States or its territories if the customer is domiciled in a foreign country or if the funds are held in connection with contracts priced and settled in a foreign currency. Such accounts are subject to the risk that events could occur which would hinder or prevent the availability of these funds for distribution to customers. Such accounts also may be subject to foreign currency exchange rate risks.

By signing the accompanying acknowledgment the customer authorizes the deposit of funds into such foreign depositories. For customers domiciled in the United States, this authorization permits the holding of funds in regulated accounts offshore only if such funds are used to margin, guarantee, or secure positions in such contracts or accrue as a result of such positions.

In order to avoid the possible dilution of other customer funds, a customer who has funds held outside the United States must further agree that his claims based on such funds will be subordinated as described below in the unlikely event both of the following conditions are met: (1) the customer's futures commission merchant is placed in receivership or bankruptcy, and (2) there are insufficient funds available for distribution denominated in the foreign currency as to which the customer has a claim to satisfy all claims against those funds.

By signing the accompanying acknowledgment the customer agrees that if both of the conditions listed above occur, the customer's claim against the futures commission merchant's assets attributable to funds held overseas in a particular foreign currency may be satisfied out of segregated customer funds held in accounts denominated in dollars or other foreign currencies only after each customer whose funds are held in dollars or in such other foreign currencies receives its pro-rata portion of such funds. It is further agreed that in no event may a customer whose funds are held overseas receive more than its pro-rata share of the aggregate pool consisting of funds held in dollars, funds held in the particular foreign currency, and non-segregated assets of the futures commission merchant.

This subordination arrangement is designed to effectuate the following principles. Subject to subordination, all customer segregated funds deposited in connection with trading on United States contract markets, whether held in the United States or overseas, are part of a single pool available to be distributed ratably to customers in the event of bankruptcy or receivership. However, no customer whose funds are held in the United States may receive less than his pro-rata share of funds held in the United States as a result of the shortfall or unavailability of funds held outside the United States. No customer whose funds are held in a particular foreign currency may receive less than his pro-rata share of the funds held in that foreign currency as a result of the shortfall or unavailability of funds held in an account denominated in another foreign currency. No customer whose funds are held in a foreign currency may receive more than his pro-rata share of the pool consisting of funds held in dollars, funds held in the particular foreign currency, and non-segregated assets of the FCM. To illustrate the mechanics of such subordination the Commission offers the following examples:18

In this case, there are sufficient funds available to meet all claims. Thus, the subordination agreement would not come into play, and the bankruptcy or receivership distribution would proceed in the same fashion as a bankruptcy or receivership which does not involve funds held overseas.20

Example 2-Two Currencies; Sufficient Segregated Funds; Foreign Funds Unavailable

In this case, assume a foreign court has frozen the yen account. The claims of Customers A, B, and C would be satisfied in full by the trustee from the dollar account. Customers D and E would receive nothing from customer segregated funds until the funds in the yen account became available.21 However, as noted previously, unsatisfied customer claims could be paid from other assets of the FCM.

Example 3-Two Currencies; Insufficient Segregated Funds; Foreign Funds Available

In this case, D and E's claims on dollar funds are subordinated to the claims of A,B, and C because there was a shortfall in yen funds. A,B, and C each receive 1/3 of the $100 available in the dollar account. D and E each receive their pro-rata share of the funds in the yen account. They receive nothing from the dollar account because it was insufficient to satisfy A,B, and C, who took priority.

Subordination protects dollar customers from sovereign or location risk and from currency risk. Location risk is present to the extent the shortfall in the yen account occurred or was undetected as a result of the account's foreign location. Currency risk is present because the exchange rate can change during the pendency of a bankruptcy thereby causing claims on an underfunded account to grow more quickly than the assets available to meet such claims.

To illustrate the effect of currency risk in the absence of a subordination agreement, suppose that in Example 3 on the day of bankruptcy, one yen equals one dollar. A,B,C,D, and E each would have a claim at that time of $50. In the absence of subordination, each customer's pro-rata share would be equal to the ratio of his claim to total claims, or $50/$250, or 1/5. Therefore, each customer's pro-rata share would be 1/5 of the total available assets of $150, or $30.

Suppose further, however, that by the time the trustee had reviewed the records and marshalled the assets, one yen equalled two dollars. At that point, assets would total $200 ($100 + $100 worth of yen). Each yen customer's claim would grow to $100 (50 yen = $100). Each dollar customer's claim would remain $50. Each yen customer's pro-rata share would be equal to the ratio of his claim to total claims, or $100/$350, or 2/7. Each dollar customer's pro-rata share would be equal to the ratio of his claim to total claims, or $50/$350, or 1/7. Each dollar customer then would receive 1/7 of the total assets, or 1/7 x $200 or $28.57. Thus, each dollar customer's share would diminish as a result of currency risk.22

The subordination agreement insulates dollar customers from such risks by effectively making the dollar and yen accounts separate account classes in the event of a yen shortfall.23 All risks incident to holding funds overseas thus are imposed on those customers who have authorized such deposits.24

Example 4-Two Currencies; Insufficient Segregated Funds; Foreign Funds Unavailable

In this case, there are insufficient funds in segregation and the yen account has been frozen by court order. D and E's claims on the dollar funds are subordinated to the claims of A, B, and C because the yen funds are unavailable. The trustee would calculate A, B, and C's pro-rata share of the dollar funds as if the yen funds did not exist.

Example 5-Three Currencies; Insufficient Segregated Funds; Shortfall in One Foreign Currency

The claims of pound customers are subordinated to the claims of dollar and yen customers because there is a shortfall in the pound account. Dollar and yen customers are both shielded from currency risk in the underfunded pound account.

Example 6-Three Currencies; Insufficient Segregated Funds; Shortfall in Both Foreign Currencies

The claims of pound and yen customers are subordinated to the claims of dollar customers because there is a shortfall in both foreign currency accounts. Furthermore, because of these shortfalls, the foreign currency customers are subject to a reciprocal subordination to one another. That is, D, E, and F have priority as to yen while G, H, and I have priority as to pounds. Effectively, in this case the trustee would treat the funds as three separate pools.

The case illustrates the asymmetry created by the subordination agreement. Customers with claims on the dollar account are not subordinated in the event of a shortfall in that account. This outcome is consistent with the usual principles of pro-rata distribution. The exception to those general principles created in the previous examples is appropriate there because of the unique risks discussed above that are created by the carrying of funds overseas.

The approach described in this interpretation is intended to facilitate growth and innovation in domestic futures markets without compromising existing standards of customer protection. This interpretation does not imply any position on the merits of pending contract designation applications. The Commission is reviewing independently each proposed contract to which this interpretation might apply. The Commission also is analyzing whether additional regulatory action beyond the scope of this interpretation is appropriate in connection with the holding of customer segregated funds offshore.

¹ See Foreign Options and Foreign Futures Transactions, 51 FR 12104, 12110, n.36 (April 8, 1986); see also Leverage Transactions, Comm. Fut. L. Rep. ¶21,742 at p. 26,952, n.52 (May 25, 1983).

² The Commission's segregation requirements are set forth in Regulations 1.20-1.30, 1.32 and 1.36, 17 C.F.R. §§1.20-1.30, 1.32 and 1.36, which provide, among other things, that customer funds must be accounted for separately by the FCM, must not be commingled with the FCM's own funds, must be held for the benefit of customers, must be available to the customer and the FCM immediately upon demand, and must be handled in a manner that will prevent the use of one customer's funds to margin or secure another person's position or to margin or secure customer obligations other than with respect to contracts traded on or subject to the rules of a designated contract market.

³ For example, the Chicago Mercantile Exchange ("CME") has applied to trade futures on the Nikkei Stock Average and the Chicago Board of Trade ("CBT") has applied to trade futures on Long-Term Japanese Government Bonds.

⁴ See letter dated October 23, 1973, from Arthur F. Burns, Chairman, Federal Reserve, to A.W. Clausen, President, Bank of America.

⁵ All funds held overseas pursuant to this interpretation must continue to be segregated from the proprietary funds of the FCM, from the foreign futures and options secured amount, and from any non-regulated accounts. Such funds must be held in accounts which clearly identify them as customer segregated funds and for which the depository has provided the appropriate acknowledgment. The form in which FCMs may accept such deposits, i.e., whether certain securities such as yen bonds will be acceptable as margin, will continue to be governed by exchange and clearing house rules. Commission Regulation 1.25, which implements similar language in Section 4d(2) of the Act, also will continue to require that customer funds in whatever currency deposited, may be invested by an FCM or clearing organization only in obligations of the United States, in general obligations of any State or of any political subdivision thereof, or in obligations fully guaranteed as to principal and interest by the United States.

⁶ Development of information sharing arrangements with foreign regulators may assist the Commission in this regard.

⁷ This authorization is included with the subordination agreement described below and must be retained by the FCM pursuant to Commission Regulation 1.31.

⁸ When, by industry standards, funds cease to be held to margin, guarantee, or secure positions in the relevant contracts, an FCM should move such funds out of the foreign currency-denominated segregation account. Customer instructions pertinent to such transfers may be provided in advance as part of the customer agreement.

⁹ In this connection, the Commission believes that the Joint Audit Committee, working with the futures industry, should develop uniform internal procedures and audit standards, consistent with this interpretation, to address the appropriate oversight of funds held offshore.

¹¹ See, e.g., the information sharing arrangements established between the Commission and the Australian National Companies and Securities Commission in connection with granting the Sydney Futures Exchange relief under Part 30 of the Commission's rules and the Financial Information Sharing Memorandum of Understanding signed by, among others, the Commission and the United Kingdom Securities and Investments Board on September 1, 1988.

¹² In addition, to be in compliance with segregation requirements an FCM must maintain total funds in segregation sufficient to meet its total customer obligations in all currencies. An FCM, however, would be permitted to maintain such funds in dollars rather than in the currency of the obligation. The amount of dollars necessary to cover such obligations would change on a daily basis as the conversion rate changes. In any such case, the books and records of the FCM would have to identify clearly the extent to which funds were being held in dollars to satisfy obligations denominated in a foreign currency.

In the event of FCM insolvency, the trustee or receiver ordinarily should convert foreign currency denominated claims against such funds to dollars as soon as possible in order to avoid conversion risk during the remainder of the proceeding. See Commission Regulation 190.01(ff). To the extent that an FCM is holding dollars to satisfy its obligations to customers denominated in foreign currencies, the subordination agreement contained herein would not apply.

¹³ In many cases where a firm's financial condition is impaired or a receivership is contemplated, it should be possible to transfer accounts from one clearing member to another clearing member pursuant to existing regulations notwithstanding the location of such segregated funds, provided there is no shortfall and all funds are in depositories which have supplied appropriate acknowledgments. Pre-bankruptcy transfers remain the preferred regulatory treatment for failing firms. The subordination contained herein is intended to facilitate the calculation of funds available with respect to dollar and foreign currency customers so that position transfers can take place where there are sufficient funds in a particular currency.

¹⁴ Procedures for the liquidation of an FCM in bankruptcy and for the distribution of such FCM's assets to customers are set forth in Subchapter IV of Chapter 7 of the Bankruptcy Code, 11 U.S.C. §761, et seq., and Part 190 of the Commission's regulations, 17 C.F.R. §§190.01, et seq. Generally, these procedures provide for the pro-rata distribution of assets among customers according to account class. Subordination agreements, however, are enforceable under the Bankruptcy Code. 11 U.S.C. §510(a). The Commission believes that the same distribution principles that are articulated in the code should apply in receiverships despite the lack of any express statutory scheme for receivership.

¹⁵ In cases where the subordination is triggered, it would be necessary for the bankruptcy trustee to modify the calculations under Part 190 of the Commission's regulations accordingly. For example, in calculating "funded balances" pursuant to Commission Regulation 190.07, the trustee would do separate calculations for segregated funds and for other assets of the FCM. With regard to segregated funds, the trustee generally would treat customers with claims denominated in different currencies as if they were members of different account classes. With regard to other assets of the FCM, the trustee would treat such customers as part of the same account class.

¹⁷ To the extent foreign-domiciled customers deposit dollars in connection with United States futures or options, such funds should be held in the United States. The Commission perceives no administrative necessity for FCMs and customers to incur the location risks attendant to holding such dollar deposits overseas. If an FCM believes it has reasons for holding such deposits outside the United States, it may submit a request to the Division of Trading and Markets for relief from this requirement. Any such relief would include a requirement that such dollar deposits held overseas be subordinated to dollar deposits in the United States.

¹⁸ Because the examples were designed to illustrate specific points about the mechanics of the subordination, the scenarios set forth are less complex than those which could be expected to occur in an actual bankruptcy. For instance, as noted above, a trustee or receiver would have to undertake separate calculations to allocate shares of non-segregated assets of the FCM. Moreover, some customers are likely to have claims for more than one currency. Thus, the differences in actual distributions among customers might be less marked than indicated by these examples.

¹⁹ Although these funds would be held in yen, for purposes of calculating the total FCM segregation and net capital requirements the amount would be converted to dollars. Therefore, in each of these examples the amount of money held in the foreign currency account is expressed in dollars.

²⁰ Note, however, that customer A may have deposited yen and be entitled to receive yen in return while customer B may have deposited the dollar equivalent of that amount of yen and be entitled to receive dollars in return. The risk of this conversion would be borne by the customer in the absence of agreement otherwise between the FCM and the customer. Because the exchange margin requirement would be expressed in yen, an FCM who accepted dollars would be performing the additional service of currency conversion for his customer which should be treated as a separate transaction. Under Commission Regulation 1.55, any currency conversion risk inherent in trading a particular contract would be a material fact which an FCM would be required to disclose to its customers.

²¹ For ease of comparison, all these examples involve different customers in the yen and dollar accounts. With one exception, the concepts illustrated, however, would be applicable equally if a single customer had claims against both accounts. Generally, in such a case, his claims would be treated separately, as if they belonged to two individuals. To see how a customer with claims against both accounts would fare, simply substitute A for E in each scenario. A's claim against the dollar funds would remain the same as currently set forth; A's claim against the yen funds would be the same as E's claim.

The exception would be the case where a customer has a claim against one account and a debit balance in the other, i.e., the trustee has a claim against the customer in that account. Pursuant to Commission Regulations 190.07(b)(2) and (b)(3) these amounts would be netted. The Commission recognizes that this procedure could defeat the subordination if the debit balance is in the dollar account because in the netting process a customer could receive the full value of his foreign currency claim. The Commission notes, however, that an analogous situation can occur in a dollars-only bankruptcy where a customer effectively may receive as a result of netting an amount greater than what his pro-rata share otherwise would be. Such anomalies have been permitted in the interest of efficient administration of bankrupt estates. Absent such netting, estates could be forced to incur the expense and delay of litigation in order to recover claims against customers with respect to whom the firm is holding deposits.

²² This currency risk is similar to the price risk which can occur in cases where an FCM becomes insolvent while holding customer deposits in forms which fluctuate in value, e.g., Treasury securities. In such cases, customers who have deposited cash may be exposed to some extent to the market risks of these Treasury securities. However, there are several significant distinctions between this type of price risk and the currency risk discussed in the text which make it not inappropriate to treat the two situations differently. First, all customers of an FCM which accepts Treasury securities have the opportunity to post Treasury securities as margin while only customers trading certain contracts would have the opportunity to post foreign currency. Therefore, it is more equitable to spread the former risk among all customers in the event of bankruptcy than it is the latter. Second, shortfalls in foreign currency accounts, and thus potential exposure of third parties to currency risk, are more likely than shortfalls in the amount of Treasury securities held by an FCM. This is because currency accounts are subject to the location risks described above while Treasury securities held in the United States are not. In addition, since margin calls are denominated in cash, a customer failure to meet a foreign currency margin call could lead to a shortfall in the amount of foreign currency in the account, while a customer failure to meet a margin call in an account holding Treasury securities would lead to a shortfall in dollars not Treasury securities. Third, it may be easier and quicker for a trustee or receiver to convert Treasury securities held in the United States to cash than to convert foreign currency held overseas into dollars. Therefore, the pool of customer assets may be exposed to currency risk for a longer time than it is exposed to Treasury security market risks.

²³ The subordination agreement, however, would not create separate account classes in all situations. Because the subordination is not reciprocal, dollar customers would have a claim on yen funds in the event of a dollar shortfall. Such a situation is illustrated in Example 7 below. The Commission may consider whether it would be appropriate to establish by regulation separate account classes in bankruptcy for each currency.

²⁴ Moreover, if proper segregation is maintained by an FCM with respect to overseas accounts, that is, all deficits are covered, no subordination should be required except in cases of theft or adverse sovereign action. In fact, there has been only one case in the last decade where a customer default led to a segregation deficit which was not covered by other assets of the carrying firm. See Volume Investors Corporation, Report of the Division of Trading and Markets (July 1985).