The MFA has submitted a comment letter to the CFTC on its proposed rulemaking on “Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations” (see: 77 FR 67865). The MFA letter begins by stating that the perspective of its member firms is as customers of FCMs who are at risk of losing money as a result of the default of an FCM. The letter expresses MFA’s concern with the recent MF Global and Peregrine defaults and applauds the CFTC for recognizing the potential weaknesses in the current customer protection regime, as well as proposing additional measures to increase the protection of customers’ assets.
More specifically, MFA encouraged the CFTC to:
- Require each futures commission merchant (“FCM”) to make certain of its financial information and custodial account information publicly available;
- Review its proposed rules to confirm that FCMs are not subject to double capital charges in respect of undermargined customer accounts;
- Not shorten the time period before FCMs must take a capital charge in respect of an undermargined customer account;
- Not require FCMs to calculate and maintain adequate customer margin on a “real time” basis, as opposed to an end-of-day basis;
- Reevaluate annually the proposed rules’ efficacy and the need for additional enhancements to the customer protection regime with existing CFTC guidance in that area;
- Continue to evaluate the viability of a full physical segregation option for collateral posted by customers on their cleared swaps positions; and
- Ensure that the proposed rules facilitate portfolio margining.
Lofchie Comment: The MFA’s comment letter implicitly highlights a few of the tensions in, and uncertainties of, the Dodd-Frank regulatory regime. One of these tensions involves the trade-off between the safety of the custodial regime and its expense. Another of these tensions is the extent to which the requirements of the regime will benefit institutional vs. retail customers. The great uncertainty is whether the new Dodd-Frank regulatory regime will be safer for customers than the preexisting swaps regime.
Let’s take the trade-off between safety and expense first. The MFA letter opposes shortening the time period before FCMs must take a capital charge for maintaining undermargined customer accounts. While this may seem counter-intuitive from the standpoint of protecting customers’ assets, it reflects the economic reality that FCMs would likely be required to respond to this rule change by (i) raising margin levels, (ii) shortening margin delivery periods and (iii) perhaps declaring defaults more quickly. In this regard, MFA comes down on the side of accepting somewhat more risk, so that the expenses of the custodial system are not substantially increased.
The letter advocates that FCMs provide greater public disclosure as to their financial situation. This raises an interesting policy question because (i) any negative disclosure raises the possibility of a run on the FCM and (ii) institutional customers are likely to be able to run before retail customers. (This issue is also touched upon in the National Futures Association comment letter, also covered in today’s news.)
The MFA letter observes that many investors would have been able to obtain better protection of their collateral in the pre-Dodd-Frank swaps markets than they will now be able to achieve in the post-Dodd-Frank futures market (see Part III of the letter at page 9). I believe that this observation is not only accurate, it is worrisome, particularly because post-Dodd-Frank collateral levels are likely to be materially higher than pre-Dodd-Frank collateral levels. In short, investors will be required, post Dodd-Frank, to post more collateral at FCMs than they would have been required, pre-Dodd-Frank, to post at banks. This means that these investors will have more credit exposure to less creditworthy financial intermediaries. This credit risk imposed on customers also goes to the question of U.S. competitiveness: will non-U.S. investors prefer to trade offshore where they can keep less collateral at a bank, rather than trade in the United States where they will keep more collateral at an FCM?
Click here to view letter in full (links externally to MFA website).
Related News Items: CFTC Roundtable on Enhancing Protections Afforded Futures Customers (February 6, 2013) and Enhancing Protections Afforded to Customers and Customer Funds Held by FCMs and Derivatives Clearing Organizations; Notice of Proposed Rulemaking (CFTC; Fed. Reg. Version) (November 15, 2012).