Market Matters Blog

Late last fall, the CFTC issued a highly controversial set of rules designed to enhance customer protections. While most of the provisions addressed issues raised by the failures of MF Global and Peregrine Financial, two rules regarding capital charges for under-margined accounts and a change in residual interest calculations provoked the industry's ire.

A recent issue of the National Grain and Feed Association's newsletter suggests that a final CFTC staff draft could be presented to the commissioners by the end of August, only a few business days away. The NGFA newsletter suggests a public meeting would follow in the early fall.

It will be interesting to see if the two controversial components stand. One rule would require futures commission merchants to take a capital charge for accounts that are under-margined one day after the margin call was issued, shortening the timeframe from three days, which many argue is impractical, especially since many brokerage clients prefer to write checks, which take several days to cash.

The other provision on residual interest requires FCMs to keep enough residual interest in segregated customer accounts to cover all margin deficits. Many in the futures industry argue this rule would force brokerage to require customers to pre-fund potential margin calls.

Combined, these two provisions would put more customer funds in FCM hands, which would actually increase customers' exposure in the case of another FCM bankruptcy.

CFTC Chairman Gary Gensler has said several times he thinks these provision are simply restating the law -- not proposing something radical and new. He argues that no customers' funds should be able to cover another's deficits even on an interim basis.

Yet the business practicality of these two provisions could be burdensome, forcing more consolidation in the brokerage industry. What the CFTC staff does with these controversial provisions will be interesting.

On an enforcement note, CFTC announced this week it's permanently barred Peregrine's accountant from working in the futures industry. In a press release, the CFTC states the accountant's audits didn't adhere to generally accepted auditing standards and didn't adequately test Peregrine's internal controls, which would have revealed that Russell Wasendorf Sr. was the only person with access to segregated customer funds.

David Meister, the CFTC's Director of Enforcement, stated, "As the Peregrine debacle shows, the importance of the independent accountant's gatekeeper function cannot be overstated. FCMs and, most importantly, their customers, rely on auditors to approach each and every auditing assignment professionally and with due care. There is no place in the CFTC-regulated world for below-standard audits or auditors who do not have a sufficient understanding of the futures industry."

Protecting customers from the failure of their futures commission merchant has become a paramount issue for many in the grain industry. Another issue that’s bubbled to the surface over the past year -- really ever since USDA started releasing crop reports when the market was open -- is the issue of high-frequency traders and whether or not their actions distort the market.

The Wall Street Journal reported earlier this week that the CFTC is close to completing a road map it will use to develop new rules to calm the rambunctious trading practice that's lead to several flash crashes, claims of wash trades that distort price discovery. It will address issues CFTC Commissioner Bart Chilton told the NGFA conference like how to tame runaway algorithms and whether or not high frequency trading firms have to register with the CFTC. The roadmap is expected to be discussed at a Sept. 12 meeting of the CFTC's Technology Advisory Committee.

You can read the whole WSJ story here: http://on.wsj.com/…

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