Whither Futures Market? (Part 3)

Terry Flanagan

In the third part of a four-part series about the futures market in the wake of the MF Global collapse, market participants debate remedies.

If there were not already a sufficient number of proposed initiatives regarding the futures market, the Customer Commodity Coalition, formed by former MF Global customers, has proposed six changes to regulation, policies and bankruptcy law to bolster account protections. These include bringing financial oversight of all brokers under CME; establishing commodity customers as first in line for recovered segregated funds in a bankrupt FCM’s estate; and encouraging CME and other exchanges to increase industry-supported protection funds.

FCMs have also weighed in, at times drawing the distinction between pure FCMs that provide brokerage services only in the futures market, and others including MF Global and big Wall Street firms that are active in other financial markets and are regulated by the U.S. Securities and Exchange Commission.

R.J. O’Brien, one of the largest pure, privately owned FCMs, felt reverberations from MF Global. RJO Chief Executive Gerry Corcoran noted in December testimony before the House Committee on Agriculture that his firm received 20,000 MF Global accounts in light of the collapse. That was the good news – the bad news was that clients were requesting financial data at previously unseen rates and withdrawing cash “because there is a lack of confidence in the system as a whole.”

Corcoran suggested FCMs engaging in proprietary trading use other FCMs, or create a separately capitalized, special-purpose FCM for that activity. His other suggestions included requiring accounts exceeding certain margin thresholds on an intra-day basis to fund via direct wire transfers, ensuring margin calls are met, and requiring a certain portion of an FCM’s capital be placed in a customer-segregated account.

While the MF Global debacle has fueled legislative and populist anger and sparked calls for immediate action, market participants say it will take time to sort out and craft the right response.

“All of the proposed solutions put forward appear to enhance customer protection, but they will likely result in unexpected costs advantaging some participants over others.” said John Hiatt, chief administrative officer at Chicago-based proprietary trader Ronin Capital, and former chief executive at Board of Trade Clearing Corp.

Applying fixes without knowing what happened to MF Global’s customer funds would essentially unleash solutions in search of a problem, Hiatt said.

The CFTC roundtable event covered topics relevant to safeguarding customer funds, including alternative models for the custody of customer assets, and issues related to dually registered FCMs and broker-dealers. In terms of LOSC requirements, which many FCMs are already implementing for their over-the-counter activities, panelists generally agreed that more disclosures would likely increase margin requirements for investors.

Kenneth Ackerman, counsel at Olsson, Frank, Weeda, Terman, Matz, noted little has been published about the costs or benefits of LSOC rules for the cleared OTC swaps market, and by extension, if similar disclosures are applied to the futures market. Ackerman participated in the investigation of the collapse of Volume Investors Corp. in 1985, the only other publicized instance where FCM customers lost money, in that case approximately $3 million.

“If you look at the Volume Investors case and MF Global, and the big void in between them, that’s a very small risk that can be measured and contained,” Ackerman said.

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