Futures brokerages say a proposed U.S. rule meant to protect customers’ money in a collapse like MF Global Holdings Ltd.’s bankruptcy may end up driving clients from the market and companies out of business.
Brokerages would be severely harmed by a Commodity Futures Trading Commission requirement that they set aside additional money to cover customers’ collateral deficits, the Futures Industry Association and two Chicago firms, Rosenthal Collins Group LLC and RJ O’Brien & Associates LLC, have told the agency.
The change would mean that some brokerages “will not be able to survive,” and may cost the industry and clients tens of billions of dollars, Mike Dawley, a Goldman Sachs Group Inc. managing director, said at a CFTC roundtable Feb. 5. “We can’t underestimate and under-appreciate how big of a deal that is,” Dawley said.
“If it were to survive, it would be an industry-killing rule,” Joe Guinan, chairman and chief executive officer of Advantage Futures LLC, said yesterday in a telephone interview.
Public comments are due by today on the proposal, which is part of a series of regulatory changes designed to increase confidence in the futures industry after MF Global collapsed in 2011 and reported a shortfall of $1.6 billion in customer funds. Russell Wasendorf Sr., founder and CEO of Peregrine Financial Group Inc., was sentenced Jan. 31 to 50 years in prison after being convicted of stealing more than $215 million from customers of that failed brokerage.
The CFTC measure, released in November, includes tougher auditing standards and disclosure of brokerage risks to clients. The rules also describe how self-regulatory organizations including the National Futures Association and CME Group Inc. should monitor brokerages to ensure customer funds are segregated.
To protect customer funds, the CFTC proposed a change in how collateral is kept. Futures customers back their trades by putting up collateral, which can be kept in a commingled account. When a position moves against them, clients must post additional collateral. Futures brokerages typically demand collateral at the beginning of the day, which is then posted during the course of the day.
Under the proposal, futures brokerages must at all times of the day keep so-called residual interest in an account to cover all deficits from their customers. The CFTC said the proposal would avoid the potential that brokerages would use end-of-day balancing to “obscure a shortfall.”
That change would tie up additional capital and would probably lead to increased costs for clients, according to the brokerages.
“This is a capital- and liquidity-intensive business with very low returns,” Gary DeWaal of consulting firm Gary DeWaal and Associates LLC and former general counsel at Newedge USA LLC, said in a telephone interview said yesterday. “The CFTC is jeopardizing the existence of the model.”
The rule would lead brokers to increase capital or margins to be current with the regulation at all times, Theodore L. Johnson, president and CEO of Frontier Futures Inc., a brokerage based in Cedar Rapids, Iowa. The impact of the rule “may be to force a number of small to mid-sized” brokers out of the market, Johnson said yesterday in a letter to the CFTC.
The proposal will hurt brokerages not affiliated with banks and those that have farmers and ranchers as customers, Rosenthal Collins executives said in a letter dated Feb. 12.
Non-bank brokerages had “little interest” in taking on MF Global customers who were farmers or ranchers, Leslie Rosenthal, managing member, J. Robert Collins, managing member, and Scott Gordon, chairman and CEO, said in the letter.
The CFTC hasn’t set a date to complete the regulation.
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