State Street Urges Futures Client Account Change After MF Global

U.S. futures regulators seeking to bolster protection of customer funds after the collapse of MF Global Holdings Ltd. and Peregrine Financial Group Inc. should allow clients to put collateral in separate accounts at custody banks, according to representatives of State Street Corp.

The U.S. Commodity Futures Trading Commission should revoke a policy enacted in 2005 that banned futures customers from using the accounts, State Street, the third largest custody bank, said in a presentation prepared for a discussion in Washington on possible new regulations. The agency should allow for so-called tri-party custody accounts between clients, brokers and custody banks, according to the presentation.

“Allowing tri-party custody accounts would help protect customer margin monies from misuse or fraud by the futures broker, without impacting the clearinghouses’ access to necessary funds,” Charley Cooper, senior managing director of State Street Global Markets, said in a statement today before the discussion. In tri-party accounts, futures brokers substitute their own collateral to fully fund the clearinghouse while client money remains at the custody bank.

The CFTC has been considering new regulations to increase protection of customer funds after a $1.6-billion gap resulted from MF Global’s collapse last October and more than $200 million is unaccounted for after Peregrine’s downfall in July. The CFTC, Securities and Exchange Commission and Justice Department are probing the MF Global failure.

Electronic Access

CFTC Chairman Gary Gensler and Scott O’Malia, a Republican commissioner, have called for new rules to provide regulators direct electronic access to bank account records to verify customer fund levels. The agency’s five members are considering a package of changes that may also include providing clients with more information about how brokers hold assets.

Bart Chilton, a Democratic commissioner, has called for the creation of an insurance fund of as much as $2.5 billion to protect futures clients. The fund, financed by a 0.5 percent fee on brokers’ prior year gross revenue from futures, would cap customer claims at $250,000 per account, Chilton said.

“There are insurance funds for banking and security customers, yet futures customers are left high and dry when an MF Global or Peregrine circumstance occurs,” Chilton said in an e-mail. “That’s totally unacceptable and we need a change in the law.”

The agency’s discussion in Washington today is also considering different rules governing how and where client funds can be held. The agency approved a regulation in January that allowed swaps clients to request that their collateral be kept in a custody account.

Custody Banks

Representatives of Och-Ziff Capital Management Group LLC and State Street had urged the CFTC to allow the use of the separate accounts to protect swaps collateral. Futures clients don’t have the same option under current regulations.

Custody banks keep records, track performance and lend securities for institutional investors including mutual funds, pension funds and hedge funds.

The agency in 2005 banned the use of third-party accounts for the futures markets because of concerns that futures brokers wouldn’t have quick access to the collateral to back trades. “The immediate and unfettered access requirements is intended to prevent potential delay or interruption in securing required margin payments that, in times of significant market disruption, could magnify the impact of such market disruption,” the CFTC said in its 2005 decision.

The decision was supported then by the Futures Industry Association and the National Futures Association, the industry-funded self-regulator. The Investment Company Institute, a Washington-based lobby association representing mutual funds, opposed the change in a letter to the regulator.

State Street’s Cooper said the absence of the third-party accounts makes the futures market an outlier compared to the swaps market, which have the option of the accounts. “Regulators can offer greater protection to customers who seek it while allowing market participants the flexibility to choose the arrangement that best suits their individual business needs,” he said in the statement.

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