Economist Craig Pirrong (“If the law supposes that…,”Streetwise Professor) argues that the CFTC’s defense of its stance on the residual interest proposal for FCMs in the face of industry opposition “is purely legalistic, and does not even attempt to address the fundamental economic issues,” which Pirrong argues includes “negative impacts of the regulation on liquidity, costs, and systemic risk.” Pirrong asserts that the CFTC is hiding behind the legalisms in order to force through a proposal, despite the fact that it will increase costs and risks to users of futures.
Lofchie Comment: The specific CFTC rule proposal to which Professor Pirrong refers is the amendment to CFTC Rule 1.21(f), which reads as follows,
(f) Limitation on use of futures customer funds. (1) A futures commission merchant shall treat and deal with the funds of a futures customer as belonging to such futures customer. A futures commission merchant shall not use the funds of a futures customer to secure or guarantee the commodity interests, or to secure or extend the credit, of any person other than the futures customer for whom the funds are held.
That proposal would prohibit an FCM from using one customer’s funds to secure another customer’s clearing obligations even on an intraday basis. Accordingly, on an intraday basis, either the FCM or each customer who is losing money that day will have to top-up its account on an intraday basis. This will either require FCMs to maintain much more cash to support their customers (which expense will have to be passed on to customers) or require customers to keep much more margin at their FCMs in order to support potential intraday losses (which expense will be borne directly by customers). As Professor Pirrong points out, this “improvement” in regulation is totally irrelevant to the losses at MF Global and Peregrine, neither of which were caused by customers’ losses. Rather, if customers are required to post more margin to their FCMs, customers will be at more risk to their FCMs, thus exacerbating the MF Global and Peregrine problems.