CME’s Duffy Warns Senate That Proposed CFTC Rule to Hurt Brokers

A proposed U.S. rule meant to protect futures customers’ money in a collapse like MF Global Holdings Ltd. could “fundamentally change” how the market functions, according to Terrence Duffy, executive chairman of CME Group Inc.

The Commodity Futures Trading Commission proposal that futures brokerages set aside enough of their own money to cover customers’ collateral deficits throughout the day may end up driving clients from the market and companies out of business, the Futures Industry Association and two Chicago firms, Rosenthal Collins Group LLC and RJ O’Brien & Associates LLC, told the agency earlier this year.

The proposal is part of a series of regulatory changes designed to increase confidence in the futures industry after it suffered two of its largest failures in the last two years. MF Global collapsed in 2011 and reported a shortfall of $1.6 billion in customer funds. Russell Wasendorf Sr., founder and CEO of futures brokerage Peregrine Financial Group Inc., was sentenced in January to 50 years in prison after being convicted of stealing more than $215 million from his customers.

While CME Group, owner of the world’s largest futures market, supports improving customer protections, “if a proposed ‘protective’ measure is so expensive or its impact on market structure is so severe that customers cannot effectively use futures markets to mitigate risk or discover prices, the reason to implement that measure needs to be re-examined,” Duffy said in prepared testimony today for a Senate Committee on Agriculture, Nutrition and Forestry hearing on reauthorizing the CFTC.

Tougher Standards

“It does not appear that any system currently exists or could be constructed in the near future that will permit FCMs to accurately calculate customer margin deficiencies, continuously in real-time,” Duffy said, referring to brokerages as futures commission merchants, or FCMs.

The proposal is still being considered by the CFTC, Steve Adamske, a spokesman, said in an e-mail. He declined to comment on the criticism of the measure.

The CFTC regulation, released in November, includes tougher auditing standards and disclosure of brokerage risks to clients. The rules also describe how self-regulatory organizations including the National Futures Association and CME Group should monitor brokerages to ensure customer funds are segregated.

To protect customer funds, the CFTC proposed a change in how collateral is kept. Futures customers back their trades by putting up collateral. When a position moves against them, clients must post variation margin, which can only be in the form of cash. Futures brokerages typically call for the variation margin overnight to be posted by the beginning of the next day.

Residual Interest

Under the proposal, futures brokerages must at all times of the day keep enough of their own proprietary money, or so-called residual interest, on hand to cover all deficits from their customers, whose positions can be in deficit prior to the margin call. The CFTC said the proposal would avoid the potential that brokerages would use end-of-day balancing to “obscure a shortfall.”

That change would tie up additional capital and would probably lead to increased costs for clients, according to the brokerages.

The change would mean that some firms “will not be able to survive,” and may cost the industry and clients tens of billions of dollars, Mike Dawley, a Goldman Sachs Group Inc. managing director and chairman of the industry-backed FIA, said at a CFTC roundtable Feb. 5. “We can’t underestimate and under-appreciate how big of a deal that is,” he said.

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