NGFA Demands Segregated Funds Reform


by Katie Micik, DTN Markets Editor

CHARLESTON, S.C. (DTN) — Futures commission merchants should be required to send daily segregation reports to their regulatory organization and CFTC and high level executives should be required to sign off on all transfers of segregated customer money, according to a preliminary set of recommendations from the National Grain and Feed Association’s MF Global task force.

The recommendations focus on advancing reporting requirements, traceability and accountability and largely agree with other sets of recommendations recently released by the National Futures Association and Futures Industry Association.

NGFA’s task force issued the set of preliminary recommendations to better protect customer segregated funds at its annual conference in Charleston, S.C., Sunday. The recommendations are preliminary, and the goal of the release is to gather input from membership before final recommendations sent to CFTC, self regulatory organizations and Congress, said NGFA acting President Randy Gordon.

“There is a sense of urgency to get solid recommendations before the CFTC and Congress that are well thought out. We need to be aware of the pros and cons and flip sides of some of the recommendations too,” he said. “Will they in effect add cost to the business that really won’t add commensurate protection? That kind of thing needs to be evaluated pretty closely to make sure they have their intended effect.”

The group outlined eight recommendations that would be relatively easy to achieve. The final recommendations could be ready in as little as a week and a half. NGFA will take more time to consider the various forms that segregated customer funds could be held in. Those recommendations could be finalized in about a month.

The eight recommendations are:

– CFTC should require daily reporting of segregated fund positions by futures commission merchants (FCMs) to both their self regulatory organization and to the CFTC.

– CFTC should require daily reporting of segregated fund investments by FCMs detailed by maturity and quality, to both CFTC and their self regulatory organization.

– CFTC and regulatory organizations should enhance monitoring of FCM reporting with more detailed and frequent audits as well as unannounced spot checks.

– CFTC should conduct a formal review of FCM investment options for customer funds, with a view to further limiting allowable investments to very safe instruments.

– CFTC should require FCMs to report significant changes in investment policies or holdings.

– FCMs should be required to provide greater transparency to customers about where segregated funds are invested, possibly by publishing a “prospectus” on their website.

– CFTC should require the signature of high level FCM executives (CEO, CFO or similar officers) on movements of customer funds to help assign accountability and prevent fraudulent activity.

– CFTC should conduct a rigorous review of capital requirements for FCMs and broker-dealers with a view to scrutinizing the current practice of allowing double counting of capital when a firm operates both as an FCM and a broker dealer.

Many of the recommendations address issues revealed by MF Global’s collapse. The firm held a large European sovereign debt position and was forced to raise capital. The undercapitalization was an issue because MF Global operated s a broker-dealer and FCM, which further complicates the bankruptcy proceeding and provides uneven protection for commodity customers and equities customers.

It’s still unclear who transferred the missing segregated funds estimated at $1.6 billion. Seventy two percent of those funds have been returned to MF Global’s clients and the trustee recently requested permission for another distribution that would put customers closer to 85{962fe9be9a8a5c386944bfa41f48d98b010325707b70b1fa6182bcabd27c5d7f} whole.

One of the larger questions on the table is whether the rules on the way segregated funds are held at the firm level need to be changed.

One option is the Legally Segregated, Operationally Comingled (LSOC) model that was recently approved for swaps customers’ collateral. Under LSOC, customer funds are held in the firm’s name but they’re not allowed to mingle with the FCM’s own money. The pro: it removes fellow customer risk and included the option to deposit with a third party. On the flipside, it doesn’t resolve the discrepancy with the bankruptcy code and the account could require a certain amount for segregation because the FCM can’t shore up the amount if investment yields dip.

There’s the Guaranteed Clearing Participant model, where the funds are completely segregated in the customer’s name at a separate bank, which offers the best protection for customer collateral. This is a popular option with pension funds. What’s unknown is the how much this model could cost in the futures industry.

The central repository model envisions all customer funds comingled in a central account. FCMs would get a percentage of the interest on the funds and would participate in a pooled insurance arrangement. This model is brand new and the costs are completely unknown.

Insurance for commodities customers modeled after the insurance for securities is the other model under consideration. That includes coverage up to $500,000 but the insurance costs, which are unknown, would be borne by customers and not the firms involved.

“We’re not comfortable enough to make a firm recommendation on a new model for segregation of customer funds,” NGFA Marketing Director Todd Kemp said. “While some MF Global customers may be willing to pay more, but how much is too much?”

CME Group’s Tim Andriesen stressed the importance of sorting through the facts before finding a solution. He said CME’s $100 million Family Farm and Rancher fund takes a first step to reducing systemic risks, but that the industry needs to figure out a way to better protect customer funds at the firm level.

“We recognize that a holistic solution, one that touches all aspects of the marketplace is needed. In that regard, we believe all viable alternatives should be up for consideration,” Andriesen said.

CoBank Chief Credit Officer Lori O’Flaherty reminded conference attendees that the system for segregating customer funds has worked flawlessly for 75 years.

“I’d want to be cautious not to over regulate or throw the baby out with the bathwater here. We think that we need to make some changes and we need to have a better oversight system in place for this, but we also have to be cognizant of overkill,” she said.


© Copyright 2012 DTN/The Progressive Farmer, A Telvent Brand. All rights reserved.

Posted with DTN Permission by Haylie Shipp


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