Financial service firms are mounting an aggressive campaign to kill a proposal aimed at protecting customer funds in the event that a brokerage misuses its clients’ money to cover losses.
The Commodity Futures Trading Commission’s draft rules have unexpectedly emerged as one of the most hotly lobbied issues this year because they would affect the trading of futures and swaps — financial derivatives that banks, agriculture and energy interests use to hedge market risk.
Public confidence in the futures industry was shaken by the loss of $1.6 billion of customer funds in the 2011 collapse of MF Global Inc. and by the theft of more than $215 million from customers of the failed Peregrine Financial Group Inc. However, the industry maintains that CFTC efforts to restore trust in the market it oversees could bankrupt some firms by requiring brokerages to keep $100 billion or more in extra collateral to cover trading shortfalls.
“Any way you look at it, it will cost a great deal more for it to make sense,” said John Roe, co-founder and vice president of the Commodity Customer Coalition in Chicago. Roe said that some in the industry were caught unaware by the complex rules, which were issued when players were sorting out the effects of the Dodd-Frank financial overhaul and lesser regulations.
“Nobody noticed it until it was almost too late,” he said.
Industry executives say the rules would tie up capital and force clients to front up more money to meet the strengthened requirements. The Futures Industry Association in Washington said brokerages and the CFTC have already taken meaningful steps since the demise of MF Global and Peregrine to improve transparency in the market.
“We believe it would be premature to impose additional requirements before fully assessing the impact of the safeguards that have already been adopted,” Walt Lukken, president and CEO of the group, wrote in comments to the CFTC.
The rules also may complicate a planned congressional reauthorization of the CFTC. Sen. Pat Roberts, R-Kan., during a Senate Agriculture Committee hearing last month questioned whether the agency is engaging in “an ad hoc approach” to regulation and whether it did a sufficient cost-benefit analysis of the proposed rules. Roberts is particularly concerned the proposal could drive up transaction costs for farmers and ranchers who use futures as a hedge.
CFTC Chairman Gary Gensler has said he was “taken aback” by initial industry and investor response to the proposal and may modify it. The agency hasn’t said when a revised plan may be ready.
“What we put in the proposal, I thought, was just law that you shouldn’t use one customer’s money to benefit another customer,” Gensler told the Agriculture panel. “What we’ve found is actually intra-day, during the midst of a day, if one customer has a deficit, the other customer’s surplus might have actually be benefiting. So we’re trying to deal with that practical circumstance.”
The Senate Agriculture Committee is soliciting comments on the rules, and industry sources expect the House Agriculture Committee to follow suit ahead of any reauthorization.
Futures are standardized contracts to sell an asset for an agreed-on price at a future date. Investors back their positions with collateral that’s usually placed in a co-mingled account at the beginning of the trading day.
The “residual interest” proposal would require brokers to keep enough funds in separate accounts all the time to cover customers’ deficits if the futures price changes during the day. This is intended to prevent situations in which unscrupulous firms shift money between accounts to hide big trading losses.
The agency also has proposed tougher accounting standards and new requirements on disclosure of risk.
The futures industry says the agency should consider alternatives, including the creation of an insurance fund for futures accounts or keeping collateral in banks instead of brokerages. Some are also calling on the agency to give firms an extra day to cover deficits.
Farmers, ranchers and small- and mid-sized brokerages that aren’t affiliated with banks would bear the burden of the tougher requirement and have to borrow more to stay in compliance, according to industry officials. The rules “would dramatically alter the way that [brokerages] and their customers have done business for decades and would substantially impact some customers’ ability to hedge their commercial risks,” Gerald Corcoran, CEO of R.J. O’Brien & Associates, the biggest U.S. futures brokerage, wrote in comments to the CFTC.
The scope and potential cost of the proposal is prompting some financial firms to keep a closer eye on regulatory agencies’ rule-making.
“They can’t hire enough people to do compliance and then they’re blindsided by a big stack of rules,” Roe said. “These are very complicated regulations that are hard to digest ... You can’t just wait for agencies to generate them.”