America’s commodity futures markets and the national regulator are taking measures to make it harder for unprincipled participants to use customer funds for their own prop trading. But can anything actually stop an unscrupulous broker from marauding your money if he wants to?
In July, a committee of futures industry self-regulatory organisations (SROs) proposed additional requirements to SRO rules to strengthen safeguards for customer segregated and secured funds held by CME and other markets. Futures commission merchants (FCMs) would have to provide their designated self-regulatory organisation (DSRO) with direct online access to confirm segregated and secured funds balances at the banks holding the FCM’s customer segregated and secured funds.
In January, the committee began the process of confirming the balances of customer segregated bank accounts for all FCMs using a web-based electronic confirmation process. Under the measures, any bank depository failing to provide electronic online access will not be considered an acceptable depository for holding customer segregated and secured funds.
The committee had already made initial recommendations in May regarding the current rules and practices that require all FCMs to file daily segregation and secured reports, as well as file bimonthly Segregation Investment Detail Reports, reflecting how customer segregated and secured funds are invested and where those funds are held.
Recommendations include requiring a principal of the FCM to approve any disbursement of customer segregated and secured funds not made for the benefit of customers and that exceed 25% of the firm’s excess segregated or secured funds. The firm would also be required to immediately notify its SRO.
The new rules are designed to bring a more transparent and cohesive approach to monitoring the segregation of customer funds – an issue which was brought into sharp focus when it was learned MF Global had used around US$1.6 billion of client cash to make its US$6 billion bad bet on European debt last year.
At the time, the unwinding of client positions was treated with substantial discrepancy by clearers around the world and while these new measures may bring unity to the US approach, differences may still exist globally.
Barely two days after MF Global went into receivership, in Europe Deutsche Börse-owned Eurex liquidated the positions of MF Global, whereas CME came under fire for not releasing funds quick enough.
The SRO committee included representatives from the CME Group, National Futures Association (NFA), InterContinental Exchange, Kansas City Board of Trade and the Minneapolis Grain Exchange. Its recommendations become effective 1 September.
Heat from DC
The Commodity Futures Trading Commission (CFTC) is also considering its own measures after recently being deceived by paper submissions from FCM Peregrine.
In July, the agency filed a complaint against Peregrine and owner Russell Wasendorf Sr alleging he misappropriated customer funds, violated customer fund segregation laws and make false statements in financial documents filed with the agency.
The CFTC alleged that during an NFA audit, Peregrine falsely claimed it held in excess of US$220 million in customer funds, when it only held around US$5.1 million. Wasendorf attempted suicide on 9 July 2012.
In a CFTC Technology Advisory Committee (TAC) meeting 26 July, TAC discussed the viability of using technology to protect segregated customer funds.
Commissioner Scott O'Malia, a Republican, said he wanted real-time monitoring of customer segregated funds.
“The system must be fully automated to draw feeds directly from the relevant entities to compare balances,” O’Malia said. “If balances don’t match, an automated alert should be sent to both the appropriate SRO and the commission.”
And the idea has attracted bi-partisan support.
“We need to do a better job and have the right tools to protect customers funds,” said commissioner Bart Chilton, a Democrat. “We need regular and robust deep data dives to make sure customer money is where it’s supposed to be, twenty-four/seven, 365. We need to make sure we can’t have the wool pulled over our eyes by somebody with Photoshop and a bottle of white out.”
Still no choice
But whether or not the solution will be adequate effective for the buy-side is yet to be seen.
“It’s hard to say whether or not this would actually help but at least you’re monitoring the situation more closely,” said Sean Owens, director, fixed income and derivatives at financial consultancy Woodbine Associates. “The more desirable solution would be to eliminate the problem altogether, as in the OTC derivatives market where the buy-side has said it wants total segregation.”
Owens said the ultimate answer would be to give customers the choice to select segregated funds at the FCM or a central counterparty or third party custodian.
“Granted, there is a cost associated with this option, because the FCM can’t invest the excess customer margin and earn returns, but it is a choice the buy-side presently does not have,” he said.