From the December 2013 issue of Futures Magazine • Subscribe!

FCMs speak out

Some of our Top 50 brokers had a lot to say

In putting together our 2013 story on the top brokers, we sent a questionnaire to more than a score of industry leaders, getting their input on various topics. Many of these comments appear in the overview article, however, here is there one-on-one responses in full. (Listed in Alphabetical order by firm name)

Joe Guinan, Chairman and CEO of Advantage Futures (2013 ranking: #27)

  1. What are your thoughts on the Residual Interest changes made with the CFTC’s new Customer Protection rules? How will it affect the brokerage business overall? 

JG: The rule erroneously equates margin calls with debits and does so without regard to the size of the call relative to the account size (treating all margin calls the same regardless of the true riskiness posed by a given client). If a large double A credit insurance company has a margin call of $5 million, that is treated the same as John Q. Public having a $5 million dollar call. The situation doesn’t matter if the client has $150 million on deposit and has a $5 million call or if he has no money and a $5 million call. This is ridiculous! The impact will be for FCMs to require customers to hold larger excess balances in order to avoid margin calls causing a negative capital impact to the FCM—even from relatively minor market movements and position marks. This increase in margin required by FCMs effectively raises the client’s cost to trade. The need to resolve margin calls more quickly will tend to increase volatility at exactly the wrong time (during extreme market moves) as the FCM will be forced to liquidate more quickly (rather than take the appropriate time and do it in an orderly manner). The rule will also preclude people from initiating positions that may serve to temper a big market move (for fear of generating margin calls)—big moves in any market will be exacerbated by this rule. Intuitively, regulators should want to help foster liquidity that can dampen extreme market moves. This rule will force more intraday liquidation to avoid margin calls whenever a severe market movement occurs; some market segments may utilize alternative markets (cash or spot, forward, etc.) to hedge risk rather than deposit the extra funds, further reducing futures’ liquidity.

 2. We've seen a number of other Dodd-Frank rules come online over the last year. Have any of these had an impact on your business? If so, which rule(s) and how? How are you dealing with change? 

  • JG: There are now mandatory and severely punitive fines for irrelevant, immaterial rule violations that in times past were handled more reasonably. Not long ago, exchanges and regulators employed a ‘reasonable man’ yardstick in evaluating mistakes made by an FCM. If investigation revealed a minor human error had occurred and there was no pattern of negligence or deception, fines were usually set to a level acknowledging the error and economically encouraging FCM actions to minimize any recurrence. Now, in the after-math of the great recession, the overarching regulatory goal seems to be to fine every firm and market participant as much as possible for any infraction that can be identified. Their need not be malice or mal-intent or negligence—a simple minor human error can now be met with a severe financial penalty. Over time, this will certainly result in higher commissions and costs for clients as FCMs will be forced to pass along this higher regulatory operating cost.
  • There are relentless inquiries that drag on for months or years over insignificant issues or rules that can’t even be clearly defined as being violated.
  • It has increased the workload on the compliance, operations, IT and risk management staff with no apparent benefit to the marketplace. Importantly, the regulators also demand the time of the most senior people in the firm.
  • Educating the regulators requires enormous time from various employees—usually during the busiest of market conditions when we have the least excess capacity.    

  • 3.       Do you see any contracts with exceptional growth potential? Where is your main growth coming from: Domestic or international? Has China/Asia been a factor in your growth plans?

 JG: The VIX has been a rising star. There are some margin issues they need to and are resolving. Over the next few years the family of VIX products should see strong growth in volume and open interest. We have experienced more international growth over the past year as we have devoted more efforts internationally. China/Asia have been part of our international expansion as has London.  

4. Customer confidence continues to get hit with more incidents, such as AlphaMetrix’s cash flow problems. What actions have you taken to deal with client concerns? 

JG: Primarily we worked to clearly articulate our story because it resonates with traders. Advantage has NO proprietary trading. There is no affiliate or subsidiary trading proprietarily. Our entire company is dedicated to serving our clients and their trading needs. This clear story magnifies our client’s attention on those firms riddled with various conflicts of interest in servicing both prop and client trading. Post-MF, some clients were reluctant to leave the same amounts of money on deposit that they had in the past.  It took awhile for them to regain the comfort level that existed previously. It’s not all the way back even now. As a firm, we point to the great care we take with investment of customer monies. We post on our website each month a detailed analysis of how the funds were invested.    

5. So far there have been no criminal charges levied two years after MF Global went down. Do you believe the CFTC action is enough? Do you believe the changes made, such as the regular capital updates on NFA site, will help earn back customer confidence? 

JG: I think most industry insiders as well as the general public believe the top brass at MF Global committed a crime. At a minimum they seemed to be criminally negligent.

Capital updates, residual interest levels, and several other reporting items proposed or enacted are probably not especially useful to a customer and may well serve to harm smaller firms that don’t flash the “big numbers.”

Confirming the bank balances of FCMs on a daily basis represents one positive enhancement of the recent past.

6.Would merging the CFTC and SEC make your life easier, harder? Please explain.

JG: We can’t know in advance exactly how this would play out. It would likely be quite a mess. We want efficient and good regulators. We don’t necessarily need fewer regulators. A decade ago, NY State Attorney General Eliot Spitzer exposed the mutual fund timing scam that Wall Street firms were facilitating. The SEC completely missed this activity. The foxes have an ability to take over the chicken coops. Two regulators are better than one. 

7.       How is life with fewer (futures)/more (securities options) exchanges? How have exchange fees changed?

 JG: Most things in the futures arena are better -more portfolio margining for positions within one clearinghouse, we deal with the same staff for different markets. Compared to equity markets with bifurcated liquidity, futures exchanges with great liquidity and open interest look like they have a better formula for all the players. I think everyone wins with a centralized marketplace for liquidity in any given product. Exchange fees have been basically flat for some time.     

8. How has the futurization of swaps affected your business? Do you see it as a key area of growth? 

JG: So far this has not affected our business and we do not see it as a key area of growth in the near term.

 9. Do you believe that high-frequency or algo traders have affected the markets? Do they affect your business? If so, how? 

JG: Most high frequency traders provide a positive contribution to the marketplace. The massive volume they trade enhances liquidity trading at nearly every price. This benefits retail and institutional clients alike. We believe these traders benefit our clients. 

10.   Can you share three trends you see now impacting the FCM community?

 JG: Five years after the onset of the great recession, we have likely witnessed the peak in bond prices. As the fixed income market descends, volume and return on investment of client funds should rise concomitantly—benefitting the entire FCM community.

  • Greater regulatory costs will need to be passed on to clients in some manner.
  • As this rash of regulatory over-reach subsides, the FCM industry can focus on expansion and the exchanges can turn their attention to creating new products rather than jousting in Washington.

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Tom Kadlec, President, ADM Investment Services (2013 ranking: #13)

1.       What are your thoughts on the Residual Interest changes made with the CFTC’s new Customer Protection rules? How will it affect the brokerage business overall?

TK:  I remind all that the Commodity Exchange Act has not changed - rather CFTC is re-interpreting an existing rule.  Hopefully the upcoming RI study will be objective and truly consider the effects on FCM capital requirements and all costs that affect ADMIS core customers, namely the small and mid-tier farmer and ranchers. 

Over time, the rule will increase the amount of capital required to be maintained by FCM’s which will decrease our returns. 

It will also increase the frequency of wire transactions and the amount of customer funds posted at FCM’s, and increase the cost of hedging for mid-level accounts.  This will possibly drive customers to other risk management products such as crop insurance or off-loading production to large processors earlier in the cycle to avoid increased hedging costs. 

2.       We've seen a number of other Dodd-Frank rules come online over the last year. Have any of these had an impact on your business? If so, which rule(s) and how? How are you dealing with change?

TK: Dodd-Frank mainly affected banks, OTC participants and broker dealers. However, it has affected ADM Investor Services in several operational areas including our foreign exchange services, the risk controls surrounding our Give Up process, the recording of phone lines and the manner in which we prepare our Customer Segregation reports. 

When we deal with regulatory changes we need to take the time to fully understand the intended purpose of the legislation and how it affects ADMIS and our customers.  Additionally, we need to communicate the changes to our customers and brokers and help them understand how to implement and follow the new rules.  The CFTC, NFA, and the exchanges could help immensely with this by putting out guidance letters and white papers that bridge the gap between theoretical rules and the practical implementation of the new rules.

3.       Do you see any contracts with exceptional growth potential? Where is your main growth coming from: Domestic or international?  Has China/Asia been a factor in your growth plans? 

TK: ADM Investor Services continues to grow organically both domestically and internationally in our traditional areas of servicing hedgers and producers.  Additionally, we have seen significant growth in our managed futures offerings and institutional and professional traders. 

ADM Investor Services offices in Hong Kong, Taiwan, Shanghai, Singapore and Mumbai have experienced significant growth over recent years.  We – along with our parent company Archer Daniels Midland - view this region as an important growth area for our businesses.  We are using our international framework and presence to develop new entrants to U.S. and European futures markets.

4.       Customer confidence continues to get hit with more incidents, such as AlphaMetrix’s cash flow problems. What actions have you taken to deal with client concerns? 

TK: ADM Investor Services did not do business directly with AlphaMetrix other than providing them data per the CME requirement. We are a conservative company with strong parental oversight, and we support the vast majority of new reporting and customer protection procedures.  My colleagues at ADM Investor Services and I spend a great deal of time talking with our customers and listening to their concerns.  We know how important it is for them to understand our conservative financial policies and the extensive steps we take to safeguard their customer’s funds.  We do not proprietarily trade on a speculative basis or allow employees to speculate by trading futures; our focus is solely on servicing customers.   

 5.        So far there have been no criminal charges levied two years after MF Global went down. Do you believe the CFTC action is enoughDo you believe the changes made, such as the regular capital updates on NFA site, will help earn back customer confidence?   

TK: I trust the CFTC enforcement division will be thorough in their process and if warranted other parts of our legal system will get involved. 

Regulatory and exchange oversight, customer education and providing extensive financial transparency such as ongoing looks into each FCM’s capital are certainly part of the process.  These measures combined with a long period of time where no FCM’s experience problems will help restore trust in our industry.  At ADM Investor Services we know it is critically important to spend a lot of time talking to – and listening to – our customers and helping them to understand our conservative management processes and strong financial position.

 6.       Would merging the CFTC and SEC make your life easier, harder? Please explain. 

TK: Currently, ADM Investor Services does not interact with the SEC so this is a big unknown for us.  However, I would imagine that such a transition would be challenging if there are new rules and little support from regulators in understanding and implementing them.   It also may be a real challenge from a Congressional oversight standpoint.  It is worth noting that both the U.K and Hong Kong currently – and successfully - have one set of regulators for multiple asset classes.  If the U.S. wants to help harmonize rules across multiple assets classes and even the regulatory playing field this may be one way to move forward.

 7.       How is life with fewer (futures)/more (securities options) exchanges? How have exchange fees changed?

TK: Competition between exchanges often brings a direct reaction by the other.  A move toward exchange provided front ends is an example of this.  It is not in the best interest of an FCM – or, in my opinion the futures industry - for customers to bypass FCM pre-trade risk controls.  An exchange is not in a position to provide robust risk controls or complete proper customer due diligence.  However, there is a substantial push by major exchanges to drive customers to the proprietary trading platforms and compete for customer volume. 

 Exchange fees continue to be an area of muddled confusion for exchange members and customers.  I would urge exchanges to simplify the fee process and reduce fees accordingly.

8.       How has the futurization of swaps affected your business? Do you see it as a key area of growth?

TK:  ADMIS concentrates on cleared products so the transition is seen as a growth area for us; energy products are the early volume leader and an area of importance to us.

 9.       Do you believe that high-frequency or algo traders have affected the markets? Do they affect your business? If so, how? 

TK: High-frequency traders provide liquidity and market making capacity; they are vital to price discovery and efficient execution. It is up to exchange regulators and CFTC to ensure the market place is transparent and all transactions are executed in a fair and equitable manner. 

 

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