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.
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.
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):
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.
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:
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.
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:
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.