The MF Global (MFG) bankruptcy has been a nightmare for managed futures customers, brokers and introducing brokers, SROs and the CFTC. The bad news keeps coming – in addition to the headaches the bankruptcy has caused the industry from an operational standpoint, we have now heard from MFG trustee James Giddens that there is the distinct possibility MFG customers will ultimately not be made whole. Regardless of whether customers are made whole, the MFG bankruptcy has highlighted important issues with respect to oversight of the industry. The three most important of these issues include (1) the design of the current SRO structure, (2) the fact that there is no SIPC-like insurance for margin in segregated accounts, and (3) the lack of resources for the CFTC. These three issues will be in sharp focus in 2012 and beyond, and it is unclear how and when Congress will act to address these issues.
Current SRO Structure
The current self-regulatory organization (SRO) structure is integral to the securities industry as well as the managed futures industry. As we all know, the National Futures Association (NFA) is the most prominent SRO for futures players, but other groups like the CME Group also provide this oversight. While it is easy to see that there may have been conflicts of interest with having the CME Group regulate the activities of MFG, it is also clear that the futures industry is complicated, especially in comparison to the securities industry. Groups like the CME Group may actually be in the best position to assess whether back-office functions and regulations are being appropriately followed.
It is also not a given that the NFA, or any other SRO, would have or could have done a better job regulating MFG than the CME Group. The NFA is a member organization that is ultimately financed by member dues and there is a limit to the scalability of the organization. But scalability will be a big issue in 2012 and beyond as the new swaps regulations mandated by the Dodd-Frank Act begin to be shaped. Already the NFA has signed agreements to act as the regulatory organization to various swap execution facilities. Given the scope of the Dodd-Frank requirements and the strain that oversight will place on the CFTC, effective SRO oversight of the industry will need to be emphasized and we will likely be hearing more about this issue and the CME Group as more information becomes available.
No SIPC-like Insurance for Futures Accounts
There is no insurance mechanism for the margin in a futures customer’s segregated account. While the MFG bankruptcy is being handled pursuant to SIPC regulations (because the broker-dealer arm of MFG was required to be a SIPC member), SIPC insurance does not extend to the margin in customers’ accounts. Because there was no SIPC insurance for customer margin accounts, we witnessed what is perhaps a worse case scenario – customer positions being transferred to other FCMs and only a portion of the margin attributable to those positions also being transferred. As we all saw, customers were subject to immediate margin calls and many were forced to liquidate their positions, leaving portfolios unhedged and subject to catastrophe.
If there was some sort of insurance for customer’s margin on the futures side similar to SIPC insurance on deposits on the broker-dealer side, customers positions would likely have been preserved post transfer. Bringing insurance to margin accounts would be no easy task and would need to be initiated by Congressional action. Even if an insurance mechanism was proposed, there would likely be pushback from some institutions who would likely need to eat the fees associated with funding the insurance, and perhaps too from the customers to whom such fees would be passed. While a SIPC-like insurance program for margin would have helped customers transition more smoothly to another FCM, it would not have addressed what is perhaps the biggest issue on the managed futures regulatory front – the lack of funding for the CFTC.
Lack of CFTC Funding
While the first two areas we discussed are important and should be addressed by the industry and Congress after proper review, the lack of appropriate CFTC funding may be the real reason the MFG bankruptcy happened. Over (at least) the last two years the CFTC has continually noted to Congress that it lacks the necessary funding to appropriately oversee and regulate the futures markets. Congress has not appropriated a larger budget to the CFTC and has instead widened its mandate through requirements in the Dodd-Frank Act. The swaps regulations specifically have become the CFTC’s bête-noir to a certain extent – requiring numerous regulations be passed in an unrealistic time frame. In essence, the CFTC’s mandate is too large for it to properly do its job with its current budget. Given Congress’ aversion to appropriating more money to the CFTC (and the investment markets in general), it is unlikely that the CFTC’s budget will see any significant increase in the foreseeable future.
Conclusion
The MF Global bankruptcy is highlighting some of the problems inherent in the managed futures industry including inadequate self-regulation and no SIPC-like mechanism. However, the real problem is that the CFTC is short on funding and this will affect the industry during a time where important regulatory structures and issues are being considered. Oversight of the futures markets depends on proper CFTC funding and if there is another catastrophe in the futures markets, blame should ultimately land on Congress.
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Bart Mallon is a partner of the law firm Cole-Frieman & Mallon LLP. Mr. Mallon’s practice is focused on the securities and managed futures industry. If you have questions or comments regarding any of the items in this article, please contact Mr. Mallon directly at 415-868-5345 or by email at bmallon@colefrieman.com.
