CFTC to roll out new set of requirements aimed at enhancing client protection and market transparency, admits NFA needs to improve

Today CFTC’s Chairman Gary Gensler gave a testimony before the U.S. Senate Committee on Agriculture. The testimony focused on PFG, the

Today CFTC’s Chairman Gary Gensler gave a testimony before the U.S. Senate Committee on Agriculture. The testimony focused on PFG, the reform CFTC is structuring aimed at improving its oversight of FCMs, SROs (Self Regulatory Organizations) such as the NFA and basically trying to reinstate customer confidence in financial markets.

It’s interesting to see CFTC actually admitting (in a very limited scope of course..) that it together with the NFA failed in preventing PFG’s fraud: “The NFA and CFTC staff over the years did not detect Mr. Wasendorf’s alleged stealing of customer funds, which came to light only a few weeks ago. Though the local police cannot prevent every bank robbery and market regulators cannot prevent every financial fraud, we all must do better. We must do everything within our authorities and resources to strengthen oversight programs and the protection of customer funds.”

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Comparison to local police and robbers isn’t exactly appropriate as there are x50 more robbers than policeman while CFTC has probably more employees than the number of FCMs it oversees.

CFTC Customer Protection Reforms to Date

The Commission has been actively working to improve protections for customer funds. This includes:

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  • The completed amendments to rule 1.25 regarding the investment of funds bring(ing) customers back to protections they had prior to exemptions the Commission granted between 2000 and 2005. Importantly, this prevents use of customer funds for in-house lending through repurchase agreements;
  • Clearinghouses will have to collect margin on a gross basis and FCMs will no longer be able to offset one customer’s collateral against another and then send only the net to the clearinghouse;
  • The so-called “LSOC rule” (legal segregation with operational comingling) for swaps ensures customer money is protected individually all the way to the clearinghouse; and
  • The Commission included customer protection enhancements in the final rule for DCMs. These provisions codify into rules staff guidance on minimum requirements for SROs regarding their financial surveillance of FCMs.

In addition, last month, we approved an NFA proposal that stemmed from a coordinated effort by the CFTC, the SROs, and market participants, including from the CFTC’s two-day roundtable earlier this year on customer protection.

The three key areas of reform included in the NFA rules are:

  • First, FCMs must hold sufficient funds in Part 30 secured accounts (funds held for U.S. foreign futures and options customers trading on foreign contract markets) to meet their total obligations to customers trading on foreign markets computed under the net liquidating equity method. FCMs will no longer be allowed to use the alternative method, which had allowed them to hold a lower amount of funds representing the margin on their foreign futures;
  • Second, FCMs must maintain written policies and procedures governing the maintenance of excess funds in customer segregated and Part 30 secured accounts. Withdrawals of 25 percent or more of excess funds in these accounts (that are not for the benefit of customers) must be pre-approved in writing by senior management and reported to the NFA; and
  • Third, FCMs must make additional reports available to the NFA, including daily computations of segregated and Part 30 secured amounts, as well as twice monthly detailed information regarding the cash deposits and investments of customer funds.
CFTC is also becoming very aggressive on how it intends to monitor client funds held with FCMs by finally combining requirements and pro-active oversight: 

  • First, we must incorporate the NFA rules approved last month into the Commission’s regulations so that the CFTC can directly enforce these important reforms.
  • Second, I believe it is critical that we bring the regulators’ view of customer accounts into the 21st century. We must give the SROs and the CFTC direct electronic access to FCMs’ bank and custodial accounts for customer funds, without asking the FCMs’ permission. Further, acknowledgement letters (letters acknowledging that accounts contain segregated customer funds) and confirmation letters must come directly to regulators from banks and custodians.
  • Third, I believe we need more transparency to customers about their funds. Futures customers, if they wish, should have access to information about how their assets are held and with whom, similar to that which is available to mutual fund and securities customers.

It seems CFTC is not entirely happy with the NFA as “Recent CFTC examinations of the NFA included recommendations for clearer documentation of audit procedures, enhanced training and supervisory review procedures, and establishing requirements for the filing of amended financial statements.”

It would be much more sensible for the CFTC to fine NFA if it found deficiencies in its practices, just like NFA does with its members, however CFTC chose to increase the oversight of SROs such as the NFA internally: “The CFTC also has implemented a significant restructuring, based on a new strategic plan, regarding our oversight of SROs and intermediaries. The CFTC last year established a new division dedicated solely to the oversight of the SROs and intermediaries. We created a branch within the division to specifically oversee examinations. We were able to attract talented individuals from the private sector with many years of relevant experience to lead this new division and branch. We have begun the process of strengthening our examination program, including adding risk and control elements.”

This seems like first steps in the right direction. Customer confidence in financial markets, including in brokers and banks, has never been lower. Brokers worldwide and in US in particular struggle to cope with the negative image isolated cases like PFG and MF have given to the whole financial industry and many clients say the same simple thing: “We don’t know whom to trust anymore”. Unless confidence and transparency is brought back to the market these customers may never be able to trust their broker again. It’s important to note that this confidence will not be restored by introducing rules that will actually make it even more difficult for honest brokers to operate or through certain SROs over-zealousness for going after their members, but through realistic and constructive measures that will assure both brokers and traders can easily operate in a safe system.

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