“The impact will be for FCMs to require customers to hold larger excess balances 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 also will 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,” Guinan explains.
Gerry Corcoran, chairman and CEO of R.J. O’ Brien & Associates, says ” We believe the residual interest rule went too far,” adding, “This likely will have a profound impact on those in the agricultural community — even before the “at all times” phase-in after five years — which is very unfortunate.”
Scott Gordon, chairman and CEO of Rosenthal Collins Group, agrees. “As currently constructed with the phase-in provision, we have to be mindful of the prospective impact on clients whose livelihoods make it difficult to comply with the provisions. For example, smaller commercial hedgers, and also international clients, may have operational difficulty posting funds with their FCM to comply with the new deadlines being phased in.”
And despite the tightening of rules it might appear to be, says Tom Kadlec, president of ADMIS, it’s yet another cost for the customer. “Over time, the rule will increase the amount of capital required to be maintained by FCMs, which will decrease our returns. It also will increase the frequency of wire transactions and the amount of customer funds posted at FCMs, 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.”
The irony, muses TD’s Roberts, is if these rules were written due to the MF Global and PFG messes, “Peregrine would have asked you to prefund your account, [and] would have stolen more. Instead of $200 million, [PFG] would have walked out with $400 million. [Jon]Corzine’s positions would have been exponentially larger.” He’s glad the regulator has taken “iterative steps” with this rule to make sure it helps rather than hurts the business.
Granted, this is one rule of many, but when asked about how the Dodd-Frank rules impact their business overall, all FCMs were vocal. Keep in mind, according to the TABB Study, which interviewed 16 U.S.-based FCMs, of which represented almost 75% of the $157.7 billion in total seg funds, “addressing regulation remains the most time-consuming and energy-resource-heavy activity,” the report states, adding, “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.” For a business that has razor-thin margins, regulation always has raised blood pressures.
Guinan, always to-the-point, notes, “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 an 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 aftermath 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.”