It’s ironic that I’m writing this on the day the insurance study commissioned by the industry after the MF Global and PFG blow ups was released. Ironic because if implemented in some form, it would mean more costs and more rules for futures commission merchants (FCMs) and probably their customers.
Very simply, the study’s findings weren’t ground breaking: Insurance is doable — but at a cost. One example of a private option for insurance provided by the FCM would be in a pool of one medium and five small firms, and the cost would range from $3 million to $4.5 million in premiums per FCM per year. After hearing about the expenses FCMs have footed in implementing new rules and regulations to be compliant, I doubt they would jump at that option, the one that has the most potential (see “Top 50 Brokers: Bruised, battered but coming back strong,”).
FCMs have taken it on the chin the last few years, and mostly because of others’ bad behavior. I know all are tired of hearing the names MF Global and PFG, but the fact remains those are the main culprits behind the new customer protection rules.
And it’s not surprising the FCMs are grumpy about the new rules because they are squeezing firms’ profitability. A TABB Group study found that of the FCMs they interviewed, “addressing regulation remains the most time consuming and energy resource heavy activity. Yet, 43% of FCMs say they do not factor regulations into pricing, while 21% are still evaluating their decisions on how to charge for it.”
Although MF Global and PFG customers were violated the most in those demises, collateral damage was spread across the industry: To regulators, to exchanges, and yes, to other FCMs. Perhaps some brokers may have gotten some new customers, but it probably netted out in the end with other clients leaving due to lack of confidence in a system that had operated fairly well for years.
So an insurance program, which is admirable and may work one day, probably isn’t a priority for a group of firms that already believe they’ve complied and spent a lot of money to do so. Also, with new customer protections in place, insurance might be a redundancy that isn’t necessary.
Furthermore, it might not accomplish what it is meant to do — protect and reimburse customers. According to the Compass Lexecon, the group that did the study, the most positive private option would depend on the amount of the total customer asset loss. If, for example, the FCM had $100 million in losses, and was insured up to $50 million, customers would only get 50% of their money back. The government-mandated option might be so poorly funded that in PFG’s case only 12% of customer loses would have been covered. So the industry has some talking and deciding what to do. But after hearing from our panel of FCMs, my belief at this point is 1) the insurance study findings just came out so it’s too early to make any determination, and 2) that said, I highly doubt FCMs want to absorb more costs.
This is especially true with news that came out in early November that the CME Group would be implementing new and higher fees. That’s another story. But we did ask the FCMs what the impact of fewer futures exchanges had on their business. Many thought it made life easier as far as connectivity and systems, but they rue the lack of competition between exchanges. One FCM that also is in the equity options space, which has close to 13 exchanges, notes that a high number of exchanges can be a headache, but it sure keeps fees competitive.
The good news is that after the last several years, including the 2008 financial crisis, most FCMs see daylight from implementing new rules and are actually optimistic; finally they can get back to what they do best: Execute, trade and make money.