Customers are furious, Congress is up in arms, and lenders are reviewing their potential exposure in providing margin monies to fund hedge accounts. Hearings are important to get at the bottom of what happened and to hold accountable those who may have done wrong. But equally urgent is changing the system to protect customer funds. The safety of customer collateral — including your working capital and the margin money your lenders send to Chicago or KC or Minneapolis — has been what has allowed agriculture to offer the wide array of marketing alternatives to farmers, and to rapidly and easily trade cash grain among commercial firms with pricing via exchange of futures. If lenders are reluctant or won’t completely fund margin requirements, borrowers will have to reassess how far forward they’ll buy grain. Everyone recalls the margin demands the industry faced in 2008 and again in 2011 as prices skyrocketed!
Rapid change is essential and CFTC Commissioner Bart Chilton summed it up well in the introduction to his Jan. 11 statement to that day’s commission hearing on swaps regulations: “When things go wrong … for so many years, we had the confidence that customer funds were so very well protected by the federal commodities segregated account statutes and regulations. But MF Global was a stone-cold, Sumatra-bold, no-holds barred wake-up call — this was a hit to the very heart of who we are as regulators and who we are as an industry.”
Now the hard work is underway
The CFTC just finalized customer collateral protection regulations for swaps customers as required under Dodd-Frank legislation. Trillions of dollars of swaps business will be moving to clearing on exchanges in the years ahead, and swaps customers are equally concerned about their collateral. CFTC adopted an LSOC regulation: “Legally Segregated, Operationally Commingled,” where all customer funds are commingled but accounted for individually, the same as for futures and options. But there are some differences in how swaps funds would be handled in a bankruptcy situation. The key to the protections is what might constitute “Legally Segregated.” In private-over the-counter swaps, for example, some big participants demand their dollars be held in a third-party bank of their choice for extra security. That is not an option under LSOC.
Brave new world
In a Post-MF Global world for both futures and swaps, “Legally Segregated” might involve the creation of an entirely new model, such as a Central Depository, that would receive and hold all funds for all customers — entirely separate from the futures firms. Customers of Abracadabra Futures, in that case, would wire funds to the C.D. — not to Abracadabra’s bank. Or a Central Depository might actually be an existing bank, but one that handles no “house accounts” for any futures firm, does no proprietary trading, and in no way would put customer Segregated Funds at risk. Any earnings on such Seg Funds would likely be managed by the CD and divided proportionally among all of the futures firms whose clients’ funds are deposited.
Another previously unrecognized risk facing both futures and swaps customers is outlined in confusing verbiage covering the event of a default by a customer which in turn triggers a default by a Clearing Member to the CME: “…if a default occurred in either segregated accounts or customer secured accounts, CME Clearing has the right to apply all performance bond deposits; performance bond deposits and positions deposited by customers not causing the default are potentially at risk.” In plain English, if MF Global had not been able to meet margin calls at CME because an MF Global customer failed to meet their obligation, CME could come back to other customers.
The Devil’s always in the details, and any dramatic overhaul will require regulatory change at the CFTC level, and perhaps legislative change. And for every risk that’s eliminated another may be found that has to be tackled. Insuring customer funds sounds like an easy solution for example; skeptics counter that raises “moral hazards.” But a lot of people are already hard at work behind the scenes, swapping ideas and finding the weaknesses as well as the strengths, to quickly craft a better system so agriculture can get back to the business of managing risk and feeding the world.
You can help by writing or calling your representatives and senators, and writing or emailing the CFTC, telling them that your willingness and ability to use futures and options, and your lenders’ willingness to finance hedging, depend on your money being safe — regardless of the firm.
Diana Klemme is a longtime contributor to Feed & Grain. Contact her at Grain Service Corporation, Atlanta, GA, by calling (800) 845-7103 or e-mail at firstname.lastname@example.org.