Whither Futures Market? (Part 2)

Terry Flanagan

In the second part of a four-part series about the futures market in the wake of the MF Global collapse, a CFTC Commissioner has his say.

“If segregated accounts worked like they should have, customers would have their money back already,” said CFTC Commissioner Bart Chilton, who was confirmed by the U.S. Senate in 2007 and previously headed government relations at the National Farmers Union and was deputy chief of staff to former U.S. Secretary of Agriculture Dan Glickman. “Do I think we need to reassess how segregated accounts are treated? Yes I do. This was a cold slap in the face and a wake-up call for regulators.”

Chilton has found mixed support for his three recommendations. The one garnering the least overt interest so far, he said, is a proposal to allow investors to choose whether FCMs can invest the funds in their segregated accounts. FCMs typically co-mingle customer funds from segregated accounts with their own funds and invest in ultra-safe instruments such as overnight repurchase agreements; MF Global went off-course on that count with a large bet on distressed European sovereign debt that appears to have involved customer funds. Even the shortest-term investments perceived as safest may be held in custody at different clearing and settlement houses, potentially entangling customer funds when precarious situations arise.

“It’s your money and margin, and you should have the choice whether an FCM uses it,” said Chilton, who has also recommended instituting a SIPC-like insurance fund, insuring customers up to perhaps $1 million. “I’ve talked with members of Congress in the House and Senate, and I don’t see any bills up there yet, but I hope it catches on,” he said.

Chilton’s third recommendation is for regulators to implement ‘deep data dives’. These would be assisted by the CME’s new requirement, going into effect May 1, for FCM clearing members to file daily segregated, secured and sequestered statements signed off on by a designated top executive. FCMs are already required to generate most of that data in-house, but reporting it would be new.

Chilton said the daily reporting should be accompanied by frequent spot checks by regulators to make sure customer funds are where FCMs say they are. The CFTC pursued 70 such checks in the weeks after MF Global’s collapse, but Chilton said they must be more systematic and less reactive. “There’s no reason in this age of electronics that banks can’t report to us or an SRO what’s in customer accounts at certain times throughout the day,” he said.

CME on April 2 said it would begin performing spot checks of customers’ segregated, secured and sequestered statements in addition to regular risk-based examinations. The Chicago-based futures exchange also plans at some point to require FCMs’ management to pre-approve in writing any disbursements in excess of 25% of a customer’s funds in a segregated account that are not made for the benefit of the customer. And starting July 1, clearing members will be required to file bi-monthly reports that detail how customers’ segregated funds are invested and where the assets are held.in custody.

Investors and traders with skin in the futures market welcome increased FCM disclosure.

“Consider how grateful MF Global’s customers would have been if MF Global had been required to provide the clearinghouse with daily records on customer positions… and if the clearinghouse took appropriate steps to confirm such information and present it accurately and completely and provide it on a timely basis,” said William Thum, principal and senior derivatives counsel at Vanguard, at a March 29 roundtable sponsored by CFTC that involved almost 50 futures-industry executives and regulatory officials.

Thum made his comment during a roundtable discussion that focused on applying to exchange-traded futures the Legally Segregated Operationally Comingled (LSOC) model the CFTC finalized in January for OTC swaps. The LSOC model, hailed by Thum for its robust disclosure requirements, mandates separation of customer and broker funds while instituting strict requirements to permit comingling of margin for operational purposes.

CME is bolstering its rules in conjunction with recommendations put out earlier in the year by other groups, such as the National Futures Association, an SRO overseeing smaller FCMs, and the Futures Industry Association. Many of the industry’s recommendations overlap. Additionally, the U.S. Senate Ag Committee has held discussions with market participants and will consider policies to help customers recover money and protect collateral.

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