FM: Of the regulatory changes enacted and proposed, which will help prevent another MF Global-type failure? What don’t you like? Do you see potential unintended consequences of any rules? What additional measures would you like to see? What has been the response of your customers? Are they satisfied with the changes?
NB: Certainly, NFA and CME new rules requiring greater accountability prior to the removal of a large portion of an FCM’s residual interest potentially would have helped clients of MF Global, while new rules requiring certain depositories to provide “real time,” “read only” access to FCM’s statements to regulators is a step in the right direction to help protect against the type of fraud at PFG.
However, Newedge has publicly promoted — both through testimony at a CFTC Technology Advisory Committee during early 2012 and subsequently through a formal submission to the CFTC — adoption of an automated daily third-party reconciliation of FCMs’ stated segregation requirements with their depositories’ records of funds on deposits by such FCMs for their customers. This is a system Newedge has been subject to in China since the creation of its joint venture there — CITIC Newedge Futures — in 2008, under the auspices of the China Futures Margin Monitoring Center.
The NFA post-PFG announced plans to move to this type of program, and we applaud such development. We only wish this idea had been embraced and acted upon earlier.
FM: Ever since MF Global went bankrupt the idea of a SIPC-style insurance program has been floated. What is your opinion of this? It also has been suggested that customer funds could be placed in a third-party repository (Phil Johnson plan) or even completely held at the clearinghouse. What are your thoughts on these recommendations?
NB: We have already publicly endorsed a study of the possibility of offering some type of customer insurance. However, the issue with an insurance fund is who is going to pay for it? As discussed, it’s a challenging time for the industry and while regulators are doing the best they can, there is a significant increase in the cost of doing business as a result of Dodd-Frank as well as other recent regulatory initiatives. It is obvious that brokers have been underpricing their business and will have to deal with that moving forward. The system rests on our ability to make customers whole in the event of a default and we already don’t price for this situation adequately, if at all.
Although we believe there is merit to discuss permitting certain customers to maintain third party custodial arrangements to further protect their funds, we certainly are not in favor of mandatorily placing additional funds at clearinghouses. Dodd-Frank has already mandated a significant concentration of risk at clearinghouses, and we believe that any further mandatory concentration is not advisable.
As mentioned before, we think a more effective way to ensure the safety of customer funds is the third-party verification process to which our Chinese joint venture is already subject. And given the NFA’s endorsement and proposal of a similar model for the United States, it’s certainly a development we’ll be monitoring closely.
FM: What is your opinion regarding the changes in Rule 1.25 regarding how you can invest customer funds? Did changes go far enough? To far? Given the current zero interest rate world, which the Fed has extended out to 2015, is now a good time to end this practice?
NB: After proposals to amend 1.25 had been dormant for some time, they were rapidly instituted after the collapse of MF Global. Most of the restrictions adopted were sound, but some — such as the prohibition to invest in foreign sovereign debt — continue to make no sense to us. Ironically, one idea that would have made sense — reducing the permissible weighted average maturity of customer investments to something materially less than two years, as currently permitted — was not adopted.
Although it is not the responsibility of the CFTC to help FCMs make money, it appears to have been a common denominator of both the MF Global and PFG collapses that the firms were struggling prior to the events that led to their demise.
FCMs should invest customer funds in a conservative fashion no matter what (even applying today’s current approved investments under Rule 1.25). However, the CFTC probably should have been a bit less reactive to headlines in amending Rule 1.25 and been more conscious to restrict only those investments previously allowed that clearly were problematic.