In the wake of customer funds missing at MF Global and apparent misappropriation and fraud at PFGBest, the futures industry has felt a one-two punch to the supposed bulwark surrounding customer funds. That was what made the futures industry stand apart — brokerages could fail, but the segregation of customer funds would ensure client funds were safe. With two crises in less than a year, that air of superiority definitely has gone out of the sails. So what is a trader to do?
The New York Institute of Finance (NYIF) hosted a virtual class this week to address that issue. The class, dubbed “Futures Trading and the Protection (and Preservation) of Customer Funds,” sought to peel back the curtain surrounding futures regulations and show just how safe (or not) customer funds really are.
Beginning with an explanation of the three-tiered regulatory structure the futures industry currently has, instructor Larry Schneider explained how we got to the point we now are and how legislation has shaped our regulatory structure. At one point, Schneider illustrated the entire regulatory regime with the below flow chart as to who regulates who.
From this basis, Schneider traced the actual route a customer’s funds may travel as he opens an account at an Introducing Broker (IB). With client’s money traveling between an IB, a non-clearing futures commission merchant (FCM), a clearing FCM and potentially another clearing FCM with memberships at other exchanges, it can beg the question, “Who is your broker?”
If there is one thing MF Global and PFG has taught customers, it is to not just trust your money is safe. To that end, Schneider offered four ways of protecting your capital:
1) Keep only the margin you need for open positions in your account.
Although some firms may not like it, you are allowed to make as many wire transfers in and out of your account as you like. Be aware, though, there likely will be fees associated with these transfers, so you may need to weigh whether it is worth it. Another thing to remember is that any open trade equity you have earned can be used to meet margin requirements.
2) Consider a firm that is both a broker/dealer and an FCM.
By having your trading account at a firm that is both a broker/dealer and an FCM, you can transfer funds between your futures account and your securities account. By transferring funds to a securities account, those funds then fall under the Securities Insurance Protection Corp.’s protection and you then have some insurance against losses due to the failure of the broker.
3) Have a second trading account at another FCM.
This probably has become the most obvious protection any customer can have since MF Global and PFG went under. In the wake of each bankruptcy, many customers were completely locked out of the market. By having a second account, you at least could continue to trade if one FCM gets locked out of the exchange.
4) Look beyond your broker’s balance sheet.
A broker’s balance sheet can be a good starting point when you are considering opening an account, but as we saw with PFG, it doesn’t necessarily tell the whole story. Schneider recommends considering other factors, such as: Does the firm have a history of arbitrations against it? Who is the auditor? What are some of the recent actions of the CEO or chairman? Has the firm been in the news recently — perhaps for building a new $18 million headquarters?
Looking ahead, Schneider expects to see changes coming in the way funds are protected, but doesn’t know exactly what those changes may look like. One caution he offered, though, was, “When everyone is in agreement with a new customer funds protection rule right away, keep looking.” If everyone is happy, then the rule probably isn’t strong enough.
Schneider has a number of other classes coming up in Trading Futures.