Welcome to Futures Industry
Leslie Sutphen & Jeff Huang
Published 2/6/2006

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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.

    • Sydney Futures Exchange
    • ASX Futures Proprietary Limited
    • Bolsa de Mercadorias & Futuros
    • Winnipeg Commodity Exchange
    • Montreal Exchange
    • Toronto Futures Exchange
    • Marché à Terme International de France
    • Eurex Deutschland
    • Tokyo Grain Exchange
    New Zealand
    • New Zealand Futures and Options Exchange
    • Singapore International Monetary Exchange
    • Meff
    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.
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