CFTC Covers Own Mistakes With New Rule Interpretation

Reuters is reporting that the Commodity Futures Trading Commission (CFTC) is digging in its heals regarding a rule proposal that would force futures commission merchants (FCMs) to top up customer margin with their own funds when customers face a margin call.

The rule proposal, which is actually a reinterpretation of an existing rule, caused sharp reaction from the industry during Congressional hearings on the reauthorization of the CFTC last week.

The story cites an International Swaps and Derivatives Association (ISDA) analysis that estimates the CFTC reinterpretation of margin rules “would cost the futures industry as much as $120 billion and the swaps industry as much as $558 billion.”

Reuters reported that CFTC Director Division of Clearing Ananda Radhakrishnan says it is merely a clarification what the law already says: funds from one customer must not be used to pay for the position or deficit of another customer.

Numerous stories discussing the new rule interpretation talks about margin deficits. To be clear, margin typically covers the likely worst case scenario for a one day move. When a customer faces a margin call they must add additional margin money and if they don’t could face liquidation of the position by their broker. It doesn’t mean that position is negative as existing margin would cover any trading loss, it means that in order to keep that position open they must add margin money so that buffer is rebuilt.

Radhakrishnan says in the Reuters piece, “Nobody’s been able to make the argument, with all due respect, that what we are suggesting is not what the law says it is. The arguments we’ve heard … (are) that it’s going to be expensive, the earth is going to fall and so on and so forth. But nobody has done, to my view, a legal analysis saying, ‘your analysis is wrong.’”

If this is the case one needs to ask, why has the CFTC interpreted the rule the way it had over the last 30 years. It seems disingenuous for a regulator to propose what the industry sees as a dramatic change that will have a huge impact on the business and say, “this is what the law has always said.”

An industry source told me, “This could put a lot of people out of business.”

Those most affected by the rule interpretation would be farmers and ranchers and the FCMs that service them. These are the folks who were the largest victims of the MF Global and Peregrine Financial Group failures and they are being punished further by the regulator who failed to protect them in the first place. This doesn’t seem fair.

I wrote last week that regulators tend to change rules after a failure in an attempt deflect blame from themselves. The MF Global debacle was handled terribly. There is consensus that bankruptcy rules need to be addressed so that the intent of the Commodity Exchange Act customer segregation rules are in fact enforced.

The flippant way Mr. Radhakrishnan referred to industry concerns over the new rule interpretation is disturbing. Especially given the numerous breakdowns by the regulator. Chairman Gary Gensler said during Congressional hearings regarding the MF Global failure that customer funds have to be segregated all of the time 24-7. That didn’t happen hear making this a failure of enforcement not an issue with the rules.

The CFTC failed to vigorously uphold its rules at the outset of the MF Global debacle in October 2011. In fact, it failed to proactively address numerous red flags at the broker during the previous year. While the industry applauded the recent civil charges against MF Global, Corzine and Edith O’Brien, the CFTC knew while it was going on or days after that MF Global failed to properly segregate funds and that they also filed false reports. A CFTC attorney (as well as attorney for the SEC and Department of Justice) failed to point out to the bankruptcy judge on Nov. 1, 2011 that there was indeed a shortfall in customer fund —after an attorney for MF Global Holdings Ltd. erroneously stated that there was no shortfall — and the judge should not allow a Chapter 11 bankruptcy filing for the parent company until all funds belonging to the FCM were returned.

The industry at large should not be forced to pay an additional penalty for regulatory enforcement failures and the Department of Justice’s refusal to prosecute Jon Corzine.



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