Derivatives Industry Vexed Over FCM Rule

Terry Flanagan

The derivatives industry has lashed out at a rule issued on Wednesday by the Commodity Futures Trading Commission that will require futures commission merchants (FCMs) to maintain a residual interest in its customer accounts that’s at least equal to its customers’ aggregate undermargined accounts for the prior trade date.

The rule, which was adopted in accordance with the Dodd-Frank Act, is intended to shift the risk of loss in the event of a double default by the FCM and one or more of its customers away from customers with excess margin.

In a statement, the Futures Industry Association said that the residual interest requirements are based on an interpretation of FCM obligations that goes against decades of CFTC and industry practice. “We disagree with this interpretation, and while we support studying the impact of the changes required by the new requirements, we want the study to be meaningful,” the FIA said. “Importantly this residual interest provision would not protect customers in an MF Global situation.”

CFTC Commissioner Scott O’Malia, in a dissent, said that the “rules impose overly broad and nonsensical regulatory requirements and, in doing so, impede the industry’s ability to operate in an efficient manner.”

O’Malia’s chief concern with the final rules is their “radical reinterpretation of the longstanding residual interest deadline. This reinterpretation decreases the time in which customers’ margin calls must arrive to their FCM from the current three days to just one day.” Such a change would mean a drastic increase in pre-funding of margin, perhaps nearly double the amounts currently required, he said.

O’Malia proposed an amendment that would continue to make progress to accelerate the collection of margin of customers from 3 days after the settlement date to 1 day after settlement at 6 pm EST.

The main difference between O’Malia’s amendment and the final rule is that the amendment doesn’t mandate that in 5 years’ time, customers will need to meet their margin obligations by the end of the settlement cycle. The amendment simply lets a future Commission make a determination about the best way to proceed after it has collected all the evidence. The amendment would be phased in one year following the date of publication of the rules would require a study to determine the feasibility of changing the collection date and the costs associated with such a move.

“We think the better course would have been to adopt Commissioner O’Malia’s amendment, which would have achieved the Commission’s purpose without seeming to pre-determine the outcome,” the FIA said.

The CFTC also adopted a rule on Wednesday on requirements for segregated accounts for uncleared swaps, under which if a counterparty elects segregation, the account must be held at a custodian that is independent of both the counterparty and the swap dealer. There must also be a written custody agreement between the posting the initial margin, the swap dealer, and the custodian.

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