CFTC under attack over residual interest rule

Blog first appeared in DanCollinsReport on Oct. 4, 2013

COST/BENEFIT ANALYSIS ANYONE?

What was apparent from the testimony is that that the CFTC doesn’t particular feel a need to understand how these markets work and don’t care to seek guidance from people much more knowledgeable than them.

They are required to do a cost benefit analysis of all rule proposals but it is clear from this and other rules they have put out that they do not take this requirement seriously.

Mr. Michael J. Anderson (Anderson testimony), representing the National Grain and Feed Association, testified that the CFTC could not have fulfilled its obligation to do a serious cost benefit analysis. He provided an example of a typical grain elevator business having to hedge $5 million in corn, wheat and soybeans. He noted that with current rules their margin requirements would be $920,000; if the residual interest rule is enacted they would be required to post an additional $1 million, more than doubling their margin requirement. And in the case of MF Global that means they would have stood to lose more than double.

Theodore of L. Johnson, President, Frontier Futures, Inc., said that all regulation should have a cost benefit standard, adding, “The benefit of the residual interest rule is less clear but the cost is real and substantial.”

Roth pointed out that the CFTC did not contact the NFA on the residual interest rule. “They didn’t seek our input,” Roth says.

Think about that for a second. The NFA is basically the point of contact as a regulator for all regulated entities in the Futures market. They perform audits, visit firms, and confirm segregated balances. They are much more involved with the day to day regulation of these markets yet the CFTC does not confer with them on a rule of this magnitude? While it would be fair to criticize the NFA for not catching the 20-year PFG fraud earlier, it was improvements in its oversight that revealed it. Those changes, as opposed to the CFTC rule, would not have allowed created a potentially worse scenario.

Perhaps most enlightening and disturbing about the testimony offered is the complete lack of interest by the Commission of industry concerns.

According to several panelists the CFTC simply stated that their “hands were tied,” because the rule clearly states that no customer segregated funds can be used to back another customer. This despite a 39-year history of interpreting this rule differently. Roth noted that it was odd the commission misinterpreted a rule for 39 years.

Agriculture Committee Chairman Frank Lucas (R-Okla.) sat in on the hearing and was struck incredulous when the panelists confirmed to him that the CFTC had not consulted with the U.S. Department of Agriculture over its concerns with this proposal and were not optimistic that the CFTC would change the rule. (Later in the hearing Roth did state that he was “Optimistic reason would prevail”). Lucas Letter

In an earlier post I suggested that the CFTC had become out of touch and out of control. The lack of willingness by the Commission to engage the industry’s concerns as demonstrated by the testimony of the panelists at this hearing seem to confirm this.

Lucas asked Duffy what would be impact of the rule five to 10 years out. Duffy responded that he had met with all the major Ag producers and they ensured him that it would not take that long, they would be out of the market in five to 10 minutes.

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About the Author
Daniel P. Collins

Editor-in-Chief of Futures Magazine, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange. Dan joined Futures in 2001 and in 2005 he was promoted to Managing Editor, responsible for overseeing all the content that went into Futures and futuresmag.com. Dan’s incisive reporting and no-holds barred commentary places him among the most recognized national media figures covering futures, derivative trading and alternative investments.

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