Futures Markets Weigh In on CFTC

Terry Flanagan

Futures traders and exchanges are weighing in on the Commodity and Futures Trading Commission’s role in regulating their markets in the post-Dodd-Frank era.

At a hearing on Wednesday of the Senate committee that’s responsible for reauthorization of the CFTC, Terry Duffy, executive chairman and president of CME Group, and Adam Cooper, senior managing director and chief legal officer at Citadel LLC, presented their views on swaps execution, and a host of other issues.

Duffy took strong exception to the argument that moving swaps toward a futures model would undermine efforts to control the OTC instruments.

“Futures markets have a long history of strong oversight and regulation,” he said. “That history rebuts those that claim the ‘futurization’ of swaps markets is a way to secure weaker regulation and more favorable margin treatment.”

CFTC rules set a floor for the amount of initial margin that clearinghouses must collect. At the CME’s clearing house, margin is determined by risk management procedures design to account for the actual risk profile of the product—“its underlying volatility and liquidation risk—not its label as a swaps or a future,” he said.

In fact, many of CME’s futures products require initial margin based on a two-day volatility measure, in excess of the CFTC’s regulatory minimum for futures.

Cooper, speaking on behalf of the Managed Funds Association, was wary of CFTC efforts to impose position limits more broadly pursuant to Dodd-Frank.

“We are concerned that inappropriate limits could reduce hedging activity, decrease market liquidity, and artificially raise commodity prices,” he said. “We believe position limits should be limited to the spot month where the deliverable supply of the commodity may be limited and thus subject to control and manipulation.”

Cooper urged Congress to amend Chapter 7 of the Bankruptcy Code so that, upon an FCM’s insolvency, customer assets posted as collateral on cleared swaps transactions would not be subject to pro rata distribution, as required under current law,
The CFTC has adopted the legally segregated operationally commingled (LSOC) model for cleared swaps, which should reduce the likelihood of their being a customer asset shortfall in certain FCM default scenarios.

However, LSOC is a new segregation model, so there is some uncertainty as to how it will perform in an FCM insolvency.

The MFA believes that Congress should amend the Commodity Exchange Act to focus commodity pool operator (CPO) regulation on entities that are meaningfully engaged in trading commodity interests.

“MFA believes that the CFTC’s regulatory resources should be focused on CPOs that are engaged primarily in trading commodity interests, rather than stretched to cover already regulated investment entities whose trading in commodity interests in incidental to their primary trading activities in other financial instruments or that have indirect commodity interest exposures,” said Cooper.

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