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Requirement for Implementation of, and Compliance with, Loss-cut Rules

 Many financial instruments firms or registered financial institutions engaged in foreign exchange margin transactions (hereinafter in this page, referred to as "FX transactions") (hereinafter referred to as "firms, etc.") have had loss-cut rules to effect loss-cut transactions ※1 at the predetermined level agreed with a customer since the early days. Despite existence of loss-cut rules, however, the rules have sometimes failed to operate properly.
 If loss-cut rules fail to operate as agreed with a customer, such customer may suffer unexpected losses, which could be considered as a failure of the customer protection.※2
 In the light of risk control of a firm, etc., there was a case that an FX firm itself has suffered large amount of losses from transactions with customers and gone bankrupt due to a price movement in the reverse direction because of the failure of effective functioning of loss-cut rules for transactions with customers, despite of unwinding of covering transaction at the time of an abrupt change in market prices.
 After considering such customer protection and risk control of firms, etc. as explained above, the Cabinet Office Ordinance on Financial Instruments Business, etc. (hereinafter referred to as "F.I. Business Ordinance") was amended in 2009 to make loss-cut rules requisite (it was an option of a firm, etc. before the amendment) and to require firms, etc. to prepare loss-cut rules, implement the execution control system of loss-cut transactions and to comply with agreements with customers regarding the execution of loss-cut rules.

※1
 "Loss-cut transaction" means a compulsory transaction by a firm, etc. to close a customer's position when the amount of losses that the customer will suffer from the closing of positions has reached the amount computed by the method agreed with the customer in advance.
※2
 Loss-cut transaction does not limit the amount of losses to an agreed amount. Procedures for such closing transaction begin usually when the amount of losses has reached the level of the amount of losses agreed in advance (hereinafter referred to as "loss-cut level"). Therefore, the actual amount of loss may be larger than the loss-cut level. Even if a loss-cut transaction was conducted in accordance with the loss-cut rules, the customer may suffer the amount of loss larger than the amount of margins deposited by the customer depending on the market conditions.

1.Scope, etc. of loss-cut requirement

 Only currency-related derivatives transactions including FX transactions (hereinafter in this Page, explanation is made only for FX transactions) ※4 with customers who are individuals ※3 are subject to loss-cut requirements.

※3
 Individual referred herein means an individual (including a specific investor) who is an ordinarily considered as a natural person excluding, in the case where such individual conducts currency-related derivatives transactions as an executive member, etc. of an association ((23) of Article 10.1 of the Cabinet Office Ordinance on Definitions as Provided in Article 2 of the Financial Instruments and Exchange Act) who meets the criterion referred to in (24) (b) (i) of said Article 10.1, such executive member, etc. of an association.
※4
 Which mean currency-related market derivatives transactions (Article 123.3 of the F.I. Business Ordinance), currency-related over-the-counter derivatives transactions (Article 123.4 of the F.I. Business Ordinance) or currency-related foreign market derivatives transactions (Article 123.5of the F.I Business Ordinance).

2.Requirement for Implementation of, and Compliance with, Loss-cut rules

 Article 40 (2) of the Financial Instruments and Exchange Act (hereinafter referred to as "F.I. Act") requires firms, etc. to carry out business to keep the state of business management from likeliness of being inconsistent with the public interest or constituting a failure of the protection of investors. The following two items were added to "the state of business management likely inconsistent with the public interest or constituting a failure of the protection of investors" (Article 123 of the F.I. Business Ordinance):

(1)
The state that the firm, etc. fails to implement a control system sufficient to conduct loss-cut transactions in the case where an individual customer conducts FX transactions;
(2)
The firm, etc. is determined that it fails to conduct loss-cut transactions for FX transactions.

These provisions explicitly require firms, etc., before offering FX transactions to customers, to prepare loss-cut rules, implement the system to execute the loss-cut rules and conduct loss-cut transactions in accordance with the rules so actually prepared.


3. Accountability to customers

 The Comprehensive Supervisory Guidelines for Financial Instruments Firms, etc. ※5 (hereinafter referred to as "Supervisory Guidelines") added, as remarks, requirement for accountability to customers concerning loss-cut transactions in the case of currency-related over-the-counter derivatives transactions including:

(1)
Whether a firm, etc. makes appropriate explanation of the fact that loss-cut transactions are facilitated and of the details thereof;
(2)
Whether the firm, etc. makes appropriate explanation of likeliness of incurring losses, etc. in the case where loss-cut transactions are not executed as scheduled.

These provisions require firms, etc. to make appropriate explanation to customers of the details of loss-cut transactions and risks thereof in a written statement furnished prior to entering into a contract.

※5
 Prepared by the Financial Services Agency to produce a comprehensive supervisory system concerning fundamental concepts for the supervision over financial instruments firms, etc., supervisory valuation and remarks on administration, and published to encourage firms, etc. to make a voluntary effort.

4.Implementation of risk control system and carrying out of business operations

 The Supervisory Guidelines added, as remarks on the implementation of a risk control system and carrying out business operations for loss-cut transactions in the case of currency-related over-the-counter derivatives transactions:

(1)
Whether the firm, etc. determines the level to execute loss-cut transactions after considering price movement risk or liquidity risk, etc. in order to prevent a customer's losses from exceeding the amount of margins deposited by the customer; ※6
(2)
Whether the firm, etc. prepares internal rules, etc. prescribing the agreements regarding loss-cut transactions clearly and reflects the internal rules, etc. to contracts with customers;
(3)
Whether the firm, etc. recognizes positions of each customer as of each time point during the trading hour appropriately and executes loss-cut transactions without exception when the level referred to in (1) above has been touched; ※7
(4)
Whether the firm, etc. reports to the board of directors, etc. of the state of execution of loss-cut transactions periodically and when needed.
※6
 This does not mean to absolutely preclude the possibility of causing the amount of losses exceeding the amount of margins.
※7
 The level of the execution of loss-cut transactions does not necessarily coincide with the level at which loss-cut transactions are actually concluded. In this provision, each firm, etc. is required to take procedures for loss-cut transactions immediately when the positions of a customer have met the conditions to execute loss-cut transactions as determined by the firm, etc.

5.Transitional measures

 Although the amended F.I. Business Ordinance took effect on August 1, 2009, a firm engaged in the business as of such date is subject to the transitional measures for 6 months until January 31, 2010 and the amendment has become applicable to existing firms as from February 1, 2010.


Notes, etc.:

  1.  Some statements in this Page may be different from actual clauses of the F.I. Business Ordinance or the Supervisory Guidelines as this Page aims to explain the outline of the recent amendment to regulations for FX transactions in a manner for general investors to understand easily. Please note, further, that this Page does not cover the whole of such clauses completely. Please refer the clauses of the relevant F.I. Business Ordinance, Supervisory Guidelines, etc. to the website of the Financial Services Agency.

      the website of the Financial Services Agency (Japanese Page)
       (F.I. Business Ordinance, etc.)     http://www.fsa.go.jp/news/21/syouken/20090703-2.html
       (Supervisory Guidelines)            http://www.fsa.go.jp/news/21/syouken/20090703-4.html

  2.  The actual operation of each firm, etc. may not coincide with the explanation in this Page completely to the extent not to depart from the purpose of regulations. Please confirm the written written statement furnished prior to entering into a contract (Explanatory Statement) furnished by the firm, etc. with whom you are going to trade.