U.S futures regulators on Thursday signaled they will keep new rules barring brokers from using excess money from one customer to cover the temporary shortfall of another, despite criticism that the change could cost the industry hundreds of billions of dollars.
The rules are part of a broader regulatory effort to protect customer money after the spectacular failures of two large brokerages, MF Global Inc and Peregrine Financial Group, led to giant and unanticipated shortfalls in client funds.
Grain traders, futures brokers and even the powerful head of the world's biggest futures exchange operator, CME Group Inc, have assailed the Commodity Futures Exchange Commission's proposed rules on margin, saying they impose unnecessary costs that could drive traders away from regulated markets, and put more, not less, customer money at risk in the event of a broker bankruptcy.
At issue is the collateral, known as margin, that customers lodge with their brokers to back their futures trades. If the exchange demands additional collateral and the money is not already in the customer's account, the proposed rule would force futures brokers to use their own capital to cover the shortfall.
Alternatively, the broker could collect extra money from customers ahead of time, to ensure their margin accounts do not fall into deficit.
Either way, the cost would be huge, many in the industry have argued. One trade group, the International Swaps and Derivatives Association, told the CFTC the margin rules would cost the futures industry as much as $120 billion and the swaps industry, where trading is newly subject to CFTC rules, as much as $558 billion.
But on Thursday, at an open meeting of the Agricultural Advisory Committee to the CFTC, regulators were unmoved by the criticism.
The proposed rules, said Ananda Radhakrishnan, director of the CFTC's division of clearing and risk, merely clarify what the law already says: funds from one customer must not be used to pay for the position or deficit of another customer
"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," Radhakrishnan said. "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.'"
Radhakrishnan stopped short of saying the CFTC was committed to the proposed rule, emphasizing that his view was that of the CFTC staff, and the CFTC's commissioners would have final say.
The CFTC staff plans to get a final draft of the new rules in front of the agency's four commissioners in coming weeks.
But CFTC Chairman Gary Gensler, who also attended the meeting, gave little sense that he disagreed with the staff.
Under current practice, brokers give traders as much as three days to pony up the money to make a margin call, even though the money is actually due on the same day the call is made. The broker covers any shortfall during that time, and it is "totally appropriate" to use its own capital to do so, Gensler said.
The problem, Gensler said, is if the futures brokerage uses the extra money from another of its customers to cover the first trader's temporary margin deficit -- and then the brokerage goes belly up.
A show of hands, he asked the group, from any who would want their surplus margin to be used for another's deficit?
"I haven't seen any raised hands," he said. "That's the challenge that we have."