In the listed derivatives world, trading firms and fund managers now have an embarrassment of riches.
There are more than 70 exchanges around the world offering futures and options, and fund managers
are more willing than ever to enter new markets in distant places.
Having so many markets available can be a challenge, however. How can a trading firm keep track of
local regulations? How can a fund manage multiple currency exposures and a wide variety of statements
and trade data formats? And does it have to find a creditworthy and knowledgeable broker in
each market, or instead can it rely on a global broker to handle these issues?
"It used to be that customers were trading
in only a few overseas markets and they often
used a different broker for each market, but
as more and more markets become available
internationally, they are increasingly looking
to a global broker to provide a consolidated
statement and manage their currency risk
and regulatory compliance in a consolidated
way," states Angelique Murphy, global head
of sales management at Calyon Financial.
Trading firms also look to their global
brokers for access to markets that are particularly
difficult to enter.
"We don't necessarily need the FCM
[futures commission merchant] to provide us
a backbone for all markets," noted Evan
Nosek, director of international trading at
Tradelink. "But we're in the business of trading, not in the business of relationship building.
Whether or not we use a global broker to
obtain exchange access depends on the number
of hurdles an exchange or a country puts
in front of our obtaining access," Nosek continued.
Having so many markets available also
creates challenges for the brokers, however.
No global broker can justify the expense of
joining every exchange in every emerging
market, particularly in the initial stages when
volumes are low and structures are not well
established. Global brokers therefore establish
relationships with local brokers, and a
key part of this relationship is the so-called
omnibus account.
What Are Omnibus Accounts?
In the futures world, an omnibus account
is defined as an account between two brokerage
firms whereby a number of individual
customer accounts of one firm are grouped
into a single account at a second firm. The
latter firm, i.e., the one carrying the omnibus
account and executing the trades, usually
does not have information about the individual
client accounts underlying the omnibus
account and usually does not provide individual
accounting for each of the client
accounts.
The omnibus account structure is commonly
used to facilitate relationships among
brokers, especially when operating in different
jurisdictions. The omnibus account structure is an efficient way to bunch customer
trading activity into a single account,
saving money through economies of scale,
and allowing for trades executed at many
brokers to be consolidated at a single global
broker. In fact, a brokerage firm may establish
an omnibus account with its own affiliate
at a foreign exchange. Customers often
prefer to have all of their trading conducted
through a single account carried at one firm,
rather than at multiple affiliates of that firm.
Omnibus accounts are especially important
for U.S. customers. U.S. futures regulations
require that customer funds be held
initially at a broker registered with the
Commodity Futures Trading Commission, so
that the agency can be sure that the funds are
in safe hands. Consequently, U.S. customers
who want to do business in overseas markets
generally cannot use a foreign broker, unless
that foreign broker has registered with the
CFTC as a futures commission merchant.
In certain cases, the CFTC has provided
an exemption from these rules. This exemption,
the so-called Part 30.10 exemption, is
granted when a foreign regulator or self-regulatory
organization, such as an exchange,
demonstrates that brokers under its authority
are subject to a "comparable" regulatory system.
A number of foreign futures exchanges
have obtained this exemption, including
Australia's Sydney Futures Exchange, Brazil's
Bolsa de Mercadorias & Futuros, Germany's
Eurex Deutscheland, and Japan's Tokyo
Grain Exchange (see accompanying table).
In practical terms, what this means is that
foreign brokers that are covered by a 30.10
exemption can market foreign futures and
options directly to U.S. customers after filing
notice with the National Futures Association
and complying with any terms and conditions
set out in the CFTC exemptive order.
Unfortunately, many of the largest and
fastest growing futures markets outside the
U.S., including the Korea Exchange, the
Mexican Derivatives Exchange, the
National Stock Exchange of India and the
Taiwan Futures Exchange, are not yet covered
by this exemption. This means that brokers
in these jurisdictions cannot market
their services directly to U.S. customers, and
U.S. customers have to rely instead on
CFTC-registered brokers to gain access to
these markets.
Here is where omnibus accounts really
become important. For countries like Korea
and Taiwan, the most practical solution to
this problem is to use omnibus accounts,
whereby the CFTC-registered broker establishes
an omnibus account with the foreign
broker and passes the orders through to the
foreign exchange. In this way, the CFTC can
be satisfied that U.S. customer funds are sufficiently
protected, and the customers can
trade in dynamic new markets overseas without
breaking any U.S. rules.
"Omnibus is the door that allows foreign
brokers that are not members of the local
exchange to use local brokers, and in this
way the customer trades can be passed
through to the exchange," says Gary
DeWaal, general counsel at Fimat Group.
"Omnibus accounts are effectively the portal
for cross-border trading."
Regulatory Concerns
Although omnibus accounts are widely
used in cross-border trading, this structure
does present problems for exchanges and regularity
authorities, mainly because they do
not have information about the customers
coming into the host market through these
accounts. This is particularly a concern when
financial authorities are seeking to prevent
money laundering or where the authorities
are worried that large funds, particularly nondomestic
funds, might manipulate less liquid
contracts and destabilize the market.
| Part 30.10 Exemptions
As of December 2005, the Commodity Futures Trading Commission had granted Part
30.10 exemptions to the following exchanges and regulatory organizations. As a result, any
futures brokers that are subject to regulation by these exchanges, or the FSA in the case of
the U.K., are allowed to market foreign futures and options directly to U.S. customers. Vice
versa, foreign brokers that are not eligible for this exemption may not do business directly
with U.S. customers, and must instead rely on other intermediaries. The exemptions are
based on the CFTC's determination that the firm's home-country regulator has demonstrated
that it provides a "comparable" system of regulation and has entered into an informationsharing
agreement with the CFTC.
Australia
- Sydney Futures Exchange
- ASX Futures Proprietary Limited
Brazil
- Bolsa de Mercadorias & Futuros
Canada
- Winnipeg Commodity Exchange
- Montreal Exchange
- Toronto Futures Exchange
France
- Marché à Terme International de France
Germany
Japan
New Zealand
- New Zealand Futures and Options Exchange
Singapore
- Singapore International Monetary Exchange
Spain
United Kingdom
- Financial Services Authority
Source: CFTC |
|
Regulatory authorities in some countries
have responded by banning omnibus
accounts, but this leads to at least two problems.
First, it becomes less efficient for global
brokers and their customers to enter those
markets, and in some cases legally impossible.
Second, some market participants will resort
to trading "look-alike" contracts with their
broker on an over-the-counter basis. The
broker then offsets these contracts by establishing
an identical position on the
exchange. This arrangement does allow these
customers to trade these markets, but it provides
the regulators with even less information
on the ultimate customer. In any case,
many institutional investors do not like the
lack of price transparency of over-thecounter
contracts, so they avoid these markets.
This deprives new exchanges of liquidity.
The attitude towards omnibus accounts
appears to be changing as these markets have
gained more experience with regulating their
participants. For example, Taiwan and
Mexico are moving to permit omnibus
accounts, partly because they would like to
encourage more foreign participation in their
markets.
Mexico, for example, implemented new
regulations last year that will allow foreign
brokers to open omnibus accounts at local
brokers, subject to certain conditions. The
foreign broker must present an application to
the Mexican Derivatives Exchange through
the trader or clearing member that they
intend to use. The foreign broker also must
present documents issued by the appropriate
authorities or institution in their country of
origin, confirming that they trade and/or
clear derivatives transactions in another
futures market recognized by the exchange.
The foreign broker must also agree to be
bound by the rules and provisions issued by
the authorities, the exchange, and the clearinghouse.
"Omnibus accounts are a more efficient
way to manage the clearing and settlement of
cross-border business," says Robert Gaffney,
managing director for global futures at ABN
Amro. "Combined with electronic trading, it
makes overseas exchanges more accessible for
our customers and adds liquidity to the global
marketplace."
Using a Large Trader
Reporting System
One way to address the concerns about
manipulation is to establish a large trader
reporting system and make sure that it
reaches through the omnibus structure to the
ultimate customers. In the U.S., for example,
the Commodity Futures Trading Commission
requires all market participants to report
their positions if they are above certain
thresholds. This is true even if the omnibus
account holder is located abroad and is not
under CFTC jurisdiction. If the omnibus
account holder did not fulfill its reporting
obligation, the clearing FCM would be obligated
to close the account.
Although the CFTC's scheme is designed
to identify large positions, it effectively captures
70% of all trading, so it gives the regulator
a fairly comprehensive view of market
activity by all the major players, not just at
the level of the clearing broker, but all the
way down to the level of individual clients. It
is critical, therefore, for the regulator setting
up such a scheme to have the ability to aggregate
positions owned or controlled by a single
entity, even if those positions are maintained
across several brokers. (See "Large Trader
Reporting: The Great Equalizer" in the
July/August issue of Futures Industry at
http://www.futuresindustry.org/fimagazi-1929.asp?a=1054.)
Fimat's DeWaal notes that large trader
reporting schemes exist in many countries
and argues that these schemes are the most
efficient way for regulators and exchanges to
monitor participation in their markets.
"Regulators can require the omnibus account
holder to disclose the ultimate clients," he
says. "This is the most effective technique."
Any broker that refuses to provide this
information can be barred from the market,
notes ABN Amro's Gaffney. "If the FCM
does not disclose information on the ultimate
customer when required, then the exchange
or regulator can force the clearing firm to
close the omnibus account and block the
firm from access to the market."
Some of the newly emerging futures markets
have authorized omnibus accounts with
an additional requirement for ultimate
clients to register as so-called qualified foreign
institutional investors. "Taiwan will
allow omnibus accounts early next year but
will still require investors to register for an FII
identification," notes Murphy. "Brazilian regulatory
authorities require the ultimate customer
to obtain a unique ID so that the
customer is known even if it is part of an
omnibus account of a large FCM."
China, one of the most promising emerging
markets for listed derivatives, has not yet
allowed foreign trading firms or fund managers
into its futures markets, but government
officials have stated on several
occasions that they are considering such a
move. One issue under consideration is
whether to use a QFII registration system for
futures investors, similar to what it has developed
on the equity side.
Currently, all account level information is
kept at the exchange level in China.
However, the regulatory authorities recognize
the need for clearing member and non-clearing
member arrangements and for ways to
accommodate the requirements of global
futures brokers if China is to attract global
futures trading activity. The China Securities
Regulatory Commission is currently in discussions
with major FCMs and other global
futures regulatory authorities on different
approaches to facilitating foreign participation
while preventing market manipulation.
Lesilie Sutphen is global head of ebrokerage strategy and implementation at Calyon Financial. She worked for many years as a consultant on technology and strategy issues affecting the futures and options industry.
Jeff Huang is the president and chief executive officer of ChiSurf, a Beijing-based cross-border merger and acquisition advisory firm.
