The U.S. Commodity Futures Trading Commission may complete rules next week that set protections for swap traders’ collateral as some hedge funds and mutual funds push for additional safety measures in the wake of the collapse of MF Global Holdings Ltd.
The CFTC may approve its rule, required under the 2010 Dodd-Frank Act, on Jan. 11, according to four people briefed on the matter who spoke on condition of anonymity because the schedule hasn’t been made public. The new requirement seeks to insulate swaps traders from a brokerage’s default while allowing customer funds to be pooled.
The investment companies, including Och-Ziff Capital Management Group LLC and Fidelity Investments, are asking the commission to reconsider its rulemaking until it can offer them the option of keeping their money in a separate account that can be independently monitored. They cited the $1.2 billion in customer funds that has gone missing at MF Global.
“The prolonged delay in determining both the amount and location of missing customer funds in the wake of MF Global’s collapse highlights the need for stringent measures,” Scott C. Goebel, senior vice president and general counsel at Fidelity, wrote in a Dec. 8 letter to the CFTC. The company asked for “full physical segregation” for the collateral they put up for swap trades.
The debate highlights a divide in the financial industry between those investment companies and others that support the CFTC’s proposal, including BlackRock Inc., the world’s largest asset manager. The Managed Funds Association, which represents hedge funds, has been holding weekly industry conference calls to attempt to find consensus on the issue, according to people who’ve been part of the discussions.
Possible New Measures
In a nod to the political sensitivity of the issue, the agency’s commissioners are expected at the Jan. 11 meeting to raise the possibility of additional measures that could give firms more options to protect their money, people briefed on the matter said.
The CFTC rule would set up new procedures for protecting collateral in trades guaranteed by clearinghouses, entities that stand between buyers and sellers of derivatives. The final plan, which could still change, is expected to closely track a proposal the CFTC issued in April that prohibits clearinghouses from drawing on the collateral of a non-defaulting client when another client’s downfall results in their broker’s default.
The plan could offer less safety than some investors in the non-regulated over-the-counter derivatives market enjoy today. Traders in those markets often negotiate agreements where their collateral is held by an independent third party such as a custody bank.
One such firm, State Street Corp., wrote the CFTC on Dec. 14, urging that the commission at least allow investment firms the option of negotiating their own deals, citing “the recent challenges in recovering funds from customer accounts following the bankruptcy of MF Global.”
The CFTC proposal exposes clients to risk when brokers don’t keep adequate records of their clients’ funds, Jeffrey C. Blockinger, chief legal officer at Och-Ziff, wrote to the CFTC’s five commissioners. Boston-based Fidelity and Och-Ziff, a New York hedge fund with $28.8 billion under management, urged the CFTC to allow for swap buyers to have their collateral fully segregated in separate accounts rather than operationally commingled.
Federal authorities including the CFTC, the Securities and Exchange Commission, U.S. Justice Department and the bankruptcy trustee are reviewing whether MF Global misused clients’ funds. James W. Giddens, the trustee, has estimated that as much as $1.2 billion in customer funds are missing.
MF Global used about $700 million of customer funds to “meet liquidity issues” at its broker-dealer in the days prior to its Oct. 31 bankruptcy filing, according to CME Group Inc., which was MF Global’s auditor.
Before MF Global’s collapse, support had coalesced around the CFTC’s proposal after more than a year of debate, two daylong CFTC roundtables, 40 meetings between industry and agency officials and more than 40 letters commenting on how to protect collateral in the $708 trillion over-the-counter swaps market.
The proposal, known as “complete legal segregation,” would require clearinghouses and brokers to keep records tracking each client’s collateral while allowing it to be managed in a single account. If a broker defaults, the clearinghouse couldn’t tap the collateral of a broker’s non- defaulting client in an effort to guarantee the trades.
The plan was “the most appropriate choice” and “an important first step in arranging appropriate customer protections,” Robert Pickel, executive vice chairman at the International Swaps and Derivatives Association Inc., said in an Aug. 8 letter to the CFTC. The association represents the world’s largest swap dealers, including JPMorgan Chase & Co., Deutsche Bank AG and Morgan Stanley.