House Ag on the Future of the CFTC : Customer Protections
AT
OCTOBER 2ND’S HOUSE AGRICULTURE SUBCOMMITTEE on General Farm Commodities and Risk
Management hearing entitled “The Future of the CFTC: Perspectives on Customer
Protections,” lawmakers discussed the Commodity Futures Trading Commission’s
(CFTC) proposed
rulemaking on customer protections with industry associations and market
participants.
-
All panel witnesses expressed concern
with the residual interest requirement of the CFTC’s proposed rule, saying it
would: cause smaller FCMs to go out of business or be consolidated; increase
costs to market participants and consumers; and would not address the problem
of FCM malfeasance.
-
Study commissioned by the FIA, NFA, and
CME finds that a universal customer asset protection insurance fund would not
be feasible without a government backstop, and recommends use of voluntary,
market-based solution.
-
CME’s Duffy stated that a CFTC
transaction tax would increase liquidity provider’s cost of doing business by
70 percent, leading to higher costs for commodity consumers and cost taxpayers
“billions of dollars” due to increased Treasury yields.
Opening
Remarks
Subcommittee
Chairman Michael Conaway (R-Texas) stated that Americans depend on well
functioning markets and that Futures Commission Merchants (FCMs) help firms
compete by providing access to financial tools used to mitigate and hedge
risk. He noted that the futures industry has taken steps to address the
issues raised by the events that took place at MF Global and Peregrine
Financial, but that no surveillance system is fool proof.
He
noted that many farmers and ranchers are skeptical of the CFTC’s proposed rule
on customer protections and are concerned the requirements will increase the
cost of operating in the marketplace. Conaway stressed that it is
essential to instill confidence that investor funds will remain safe if other
customers experience trouble, but that the costs of the rules need to be
measured against their ultimate benefits.
Subcommittee
Ranking Member David Scott (D-Ga.) stated that protection of FCM participants
is “one of the core functions” of the CFTC but has, unfortunately, been an area
where “startling lapses in oversight” have been witnessed. Scott noted
that the CFTC has been “asked to provide oversight for markets that have grown
exponentially,” but have not been given sufficient funding to do their
job. He said the lack of funds has forced the agency to rely on third
party auditing, which creates more opportunity for errors and “outright
criminal activity.”
Scott
concluded that “whatever regime the CFTC puts in place” must work well for all
market participants by reducing risk and protecting customer funds, “without
significantly raising prices.”
Witness
Testimony
Terrence
A. Duffy,
Executive Chairman and President, CME Group, Inc., in his testimony,
stated that the CFTC “has proposed a bad rule,” referring to the residual
interest requirement which states each customer account must be fully
collateralized at all times. He said this rule will lead to a doubling of
margin requirements from customers or a contribution of large sums of capital
from FCMs that could increase costs to participants or drive smaller FCMs out
of business.
Duffy
said that a phase-in approached, considered by the Commission, would not fix
the problem and that the CME supports the alternative put forth by the Futures
Industry Association (FIA) which would permit an FCM to calculate residual
interest as of 6:00 p.m. on the day after the trade.
Daniel
J. Roth,
President and CEO, National Futures Association (NFA), in his testimony,
stated that the NFA has implemented a wide range of regulatory enhancements at
FCMs including confirmation of daily customer balance and automated comparisons
to identify discrepancies. He noted that he was pleased to see some of
these enhancements written in to the CFTC’s proposed rule, but that the
proposal has “some troubling parts” as well.
On
the residual interest requirement, Roth said the proposal could have
devastating impacts on end users and FCMs that serve the agriculture industry.
He stated that the CFTC “has never taken this position before” on residual
interest and said the problems at MF Global “had nothing to do with customers
not meeting margin calls.”
Christopher
L. Culp,
Senior Advisor, Compass Lexecon, in his remarks,
gave a progress report on a study his firm is conducting which assesses how a
customer asset protection insurance scheme might work in the U.S. His
study looked at four possible scenarios for an insurance program to be
developed under: 1) a private market where primary insurance carriers provide
insurance directly to individual customers; 2) insurance provided on a
FCM-by-FCM, one-off basis; 3) an industry risk retention group where an
insurance company is owned by participating FCMS; and 4) a mandated, universal
structure requiring payments from FCMs up to 0.5 percent of previous annual
gross revenues.
Culp
said that while they have not yet received quotes from insurance companies and
re-insurers, they all “remain interested.” He said that the universal
coverage scheme has significant drawbacks including: 1) accruing benefits to
customers who do not bear the costs; 2) crowding out innovative market
solutions; and 3) complicating the ability of voluntary solutions to “close the
gap.” He also noted that a mandated solution would “likely be feasible
only with either implicit or explicit taxpayer-backed government
support.” He concluded that “if there is sufficient demand” for asset
protection insurance at a price the insurance market charges and FCMs are
willing to cover the first-loss layer, then a non-mandated, market based
solution could provide this protection.
Michael
J. Anderson,
Regional Sales Manager, The Andersons Inc., on behalf of the National Grain and
Feed Association (NGFA), stated
that the CFTC’s proposed rule would “change the industry dramatically” and
“increase customer risk.” He said that the CFTC should maintain the three
day timeline for customer margin calls as the proposed one day requirement may
not be possible to achieve for some users, especially for those who write
checks.
He
said the residual interest rule would have greater impacts on smaller FCMs and
make them unable to compete as their customers would have to prefund their
margin accounts. He added that he was confused by the CFTC departure’s
from their historical interpretation of the Commodities Exchange Act (CEA)
dealing with customer’s margin accounts and was “mystified” by their lack of a
cost benefit analysis on this change. He concluded that he would
rather work with the CFTC to address these problems but said legislation may be
needed if these issues are not addressed.
James
L. Koutoulas,
Esq., President and Co-Founder, Commodity Customer Coalition, Inc. (CCC), stated
that the CFTC proposal is asking customers to “double down” on an FCM system
that they do not trust after the events of MF Global and Peregrine Financial.
He said the rule will do more harm than good and asking farmers and
ranchers to be more exposed to FCM malfeasance is “ridiculous.” He also
said that a private opt-in insurance model is the only feasible method to
provide customer asset protection.
Theodore
L. Johnson,
President, Frontier Futures, Inc., stated
that he supports rules that codify the changes put in place to confirm daily
account balances but that the requirement to maintain a separate risk
management department at FCMs would be expensive and ignores that the entire
staff at his FCM is involved in risk management.
He
also expressed concern with the residual interest provision, saying that small
customers who cannot meet margin calls on a moment’s notice, risk having their
position liquidated. He added that the rule would favor larger FCMs with access
to more capital and would lead to consolidation in the industry.
Question
and Answer
Conaway began the question
and answer segment asking if the CFTC has a sound legal basis for their
reinterpretation of the CEA on customer accounts needed to be collateralized at
all times. Roth said that the CFTC has told his group that their “hands
are tied” by the statue but said it “flies in the face of logic” as the CFTC
has taken a different position on this statute for the past 39 years.
David
Scott
asked for clarification on how the FIA alternative to the residual interest
proposal would accomplish what the CFTC is aiming to address. Duffy replied
that most FCMs believe they can collect between 80 – 90 percent of margin due by
the next day, but that since not every customer uses wire transfers to post
their margin, they would not be able to comply with the requirement.
Scott
then asked whether more risk is posed to customers segregated accounts due to
FCM malfeasance or by losses in other customer accounts. Roth replied
that FCM malfeasance is the most frequent cause of insolvency, but that
customer losses could pose a large risk when looking at the magnitude of the
impact.
Next,
Scott asked if the current punishments for violations are sufficient to deter
market violations. Roth replied that while civil cases are important, it is
really criminal enforcement of the laws that is the strongest deterrent for bad
behavior.
Full
Committee Chairman Frank Lucas (R-Okla.) said he worried that the
CFTC “missed the mark with much of the proposal” and that a one day margin
requirement is “simply unrealistic.” He noted a letter
that he co-signed and sent to the CFTC asking for meaningful changes, and noted
there is a lack of optimism that this will occur. He then asked what the
FCM market will look like in five to 10 years.
Duffy
replied that he was not sure what the market would look like that far into the
future, but said that some market participants would leave the market
instantaneously if these rules were finalized without changes. He added
that this is a “critical issue” for liquidity to be available to farmers and
ranchers and that bid offer spreads would widen dramatically, increasing costs
for producers and American consumers.
Rep.
Dan Benishek
(R-Mich.) asked for further clarification on what the response to end-user’s
concerns has been from the CFTC. Roth replied that the CFTC seems willing
to extend the timeline to the end of the clearing cycle at 3:00 a.m. but said
this is does not solve the issue.
Rep.
Austin Scott
(R-Ga.) asked if there are any parts of the rule that the CFTC got right. Roth
and Anderson both agreed that many parts of the proposal are good and cited the
testing of internal controls and improved transparency as examples.
Rep.
Randy Neugebauer
(R-Texas.) asked if the FCMs are managing their risk to meet exchange
requirements, to which Johnson replied they are constantly doing so, by
monitoring customer accounts. He added that is a customer is unable to meet a
margin requirement, the FCM’s “money is on the line first.”
Neugebauer
then asked what legislative fix would be helpful to address these issues. Roth
and suggested inserting language in the CEA Reauthorization to state that the
Commissions rule is invalid and not necessary. Duffy followed up saying
that the language should state that the rule should allow for “trade day plus
one at 6:00 p.m.” for meeting margin requirements.
Rep.
Vicky Hartzler
(R-Mo.) asked if a customer asset protection insurance plan would require a
taxpayer line of credit. Culp replied that it would be extremely unlikely to
have enough funding for a universal program that did not include a government
backstop for catastrophic losses.
Rep.
Doug LaMalfa
(R-Calif.) asked the panel what would happen if the White House’s proposal for
a transaction tax to fund the CFTC came to fruition. Duffy replied that in
order to get to the $300 million funding level for the CFTC, as set forth in
the proposal, there would need to be a user fee of 4.5 cents on each
transaction for liquidity providers, representing a 70 percent increase in
cost. He said that this would widen the bid offer spread and that the
costs would be passed on to consumers.
Duffy
added that “If that spread widens in the futures market, because the cost of
business goes up by 70 percent, the amount that will cost the taxpayers in
facilitating that debt will go up by billions and billions of dollars, because
those spreads will widen. That will force the yield to go up on the Treasury
debt.”
Rep.
Martha Roby
(R-Ala.) asked for more specifics on the impacts the proposed rule would have
on small farmers and FCMs. Johnson replied that smaller market
participants may have a difficult time doing business with larger entities if
consolidation occurs in the market, because the marginal return for a large FCM
dealing with a small customer is not large enough to make it worthwhile. He
said this would lead to smaller participants leaving the market or having to
pay more to manage their risk.
Rep.
Rodney Davis
(D-Ill.) followed LaMalfa’s line of questioning by asking what the impact of a
transaction tax would be. Duffy said the change could end up costing
Americans billions in increased costs as bid offer spreads widen, making it
more difficult to facilitate debt and increasing end costs for things such as
wheat and grain. He noted that even though the derivatives market has 640
trillion in notional value, there are only about 2,000 transactions conducted
every day and that funding for the agency should be based off of the volume of
transactions and not the notional value of contracts in the market.
Conaway
and David Scott both focused their last remarks and questions on the use of
cost-benefit analysis at the CFTC. Conaway said that the costs determined by
the agency often end up being greatly understated. Scott noted that since
the CFTC does not have the funding it needs, it cannot conduct proper
cost-benefit analysis, but needs to do so in order to better protect themselves
against lawsuits.
Duffy
and Koutoulas both agreed that the CFTC needs to be adequately funded to
perform their job of overseeing the vast derivatives market. Duffy added
that the rule proposal process is not yet complete and that he remains hopeful
that proper cost-benefit considerations will be taken into account before a
final vote.
For
more information on this hearing, please click here.
To
view a webcast of this hearing, please click here.
,Blog Tags:,Blog Categories:,Blog TrackBack:,Blog Pingback:No,Hearing Summaries Issues:Derivatives,Hearing Summaries Agency:House Agriculture Committee,Publish Year:2013
AT
OCTOBER 2ND’S HOUSE AGRICULTURE SUBCOMMITTEE on General Farm Commodities and Risk
Management hearing entitled “The Future of the CFTC: Perspectives on Customer
Protections,” lawmakers discussed the Commodity Futures Trading Commission’s
(CFTC) proposed
rulemaking on customer protections with industry associations and market
participants.
-
All panel witnesses expressed concern
with the residual interest requirement of the CFTC’s proposed rule, saying it
would: cause smaller FCMs to go out of business or be consolidated; increase
costs to market participants and consumers; and would not address the problem
of FCM malfeasance.
-
Study commissioned by the FIA, NFA, and
CME finds that a universal customer asset protection insurance fund would not
be feasible without a government backstop, and recommends use of voluntary,
market-based solution.
-
CME’s Duffy stated that a CFTC
transaction tax would increase liquidity provider’s cost of doing business by
70 percent, leading to higher costs for commodity consumers and cost taxpayers
“billions of dollars” due to increased Treasury yields.
Opening
Remarks
Subcommittee
Chairman Michael Conaway (R-Texas) stated that Americans depend on well
functioning markets and that Futures Commission Merchants (FCMs) help firms
compete by providing access to financial tools used to mitigate and hedge
risk. He noted that the futures industry has taken steps to address the
issues raised by the events that took place at MF Global and Peregrine
Financial, but that no surveillance system is fool proof.
He
noted that many farmers and ranchers are skeptical of the CFTC’s proposed rule
on customer protections and are concerned the requirements will increase the
cost of operating in the marketplace. Conaway stressed that it is
essential to instill confidence that investor funds will remain safe if other
customers experience trouble, but that the costs of the rules need to be
measured against their ultimate benefits.
Subcommittee
Ranking Member David Scott (D-Ga.) stated that protection of FCM participants
is “one of the core functions” of the CFTC but has, unfortunately, been an area
where “startling lapses in oversight” have been witnessed. Scott noted
that the CFTC has been “asked to provide oversight for markets that have grown
exponentially,” but have not been given sufficient funding to do their
job. He said the lack of funds has forced the agency to rely on third
party auditing, which creates more opportunity for errors and “outright
criminal activity.”
Scott
concluded that “whatever regime the CFTC puts in place” must work well for all
market participants by reducing risk and protecting customer funds, “without
significantly raising prices.”
Witness
Testimony
Terrence
A. Duffy,
Executive Chairman and President, CME Group, Inc., in his testimony,
stated that the CFTC “has proposed a bad rule,” referring to the residual
interest requirement which states each customer account must be fully
collateralized at all times. He said this rule will lead to a doubling of
margin requirements from customers or a contribution of large sums of capital
from FCMs that could increase costs to participants or drive smaller FCMs out
of business.
Duffy
said that a phase-in approached, considered by the Commission, would not fix
the problem and that the CME supports the alternative put forth by the Futures
Industry Association (FIA) which would permit an FCM to calculate residual
interest as of 6:00 p.m. on the day after the trade.
Daniel
J. Roth,
President and CEO, National Futures Association (NFA), in his testimony,
stated that the NFA has implemented a wide range of regulatory enhancements at
FCMs including confirmation of daily customer balance and automated comparisons
to identify discrepancies. He noted that he was pleased to see some of
these enhancements written in to the CFTC’s proposed rule, but that the
proposal has “some troubling parts” as well.
On
the residual interest requirement, Roth said the proposal could have
devastating impacts on end users and FCMs that serve the agriculture industry.
He stated that the CFTC “has never taken this position before” on residual
interest and said the problems at MF Global “had nothing to do with customers
not meeting margin calls.”
Christopher
L. Culp,
Senior Advisor, Compass Lexecon, in his remarks,
gave a progress report on a study his firm is conducting which assesses how a
customer asset protection insurance scheme might work in the U.S. His
study looked at four possible scenarios for an insurance program to be
developed under: 1) a private market where primary insurance carriers provide
insurance directly to individual customers; 2) insurance provided on a
FCM-by-FCM, one-off basis; 3) an industry risk retention group where an
insurance company is owned by participating FCMS; and 4) a mandated, universal
structure requiring payments from FCMs up to 0.5 percent of previous annual
gross revenues.
Culp
said that while they have not yet received quotes from insurance companies and
re-insurers, they all “remain interested.” He said that the universal
coverage scheme has significant drawbacks including: 1) accruing benefits to
customers who do not bear the costs; 2) crowding out innovative market
solutions; and 3) complicating the ability of voluntary solutions to “close the
gap.” He also noted that a mandated solution would “likely be feasible
only with either implicit or explicit taxpayer-backed government
support.” He concluded that “if there is sufficient demand” for asset
protection insurance at a price the insurance market charges and FCMs are
willing to cover the first-loss layer, then a non-mandated, market based
solution could provide this protection.
Michael
J. Anderson,
Regional Sales Manager, The Andersons Inc., on behalf of the National Grain and
Feed Association (NGFA), stated
that the CFTC’s proposed rule would “change the industry dramatically” and
“increase customer risk.” He said that the CFTC should maintain the three
day timeline for customer margin calls as the proposed one day requirement may
not be possible to achieve for some users, especially for those who write
checks.
He
said the residual interest rule would have greater impacts on smaller FCMs and
make them unable to compete as their customers would have to prefund their
margin accounts. He added that he was confused by the CFTC departure’s
from their historical interpretation of the Commodities Exchange Act (CEA)
dealing with customer’s margin accounts and was “mystified” by their lack of a
cost benefit analysis on this change. He concluded that he would
rather work with the CFTC to address these problems but said legislation may be
needed if these issues are not addressed.
James
L. Koutoulas,
Esq., President and Co-Founder, Commodity Customer Coalition, Inc. (CCC), stated
that the CFTC proposal is asking customers to “double down” on an FCM system
that they do not trust after the events of MF Global and Peregrine Financial.
He said the rule will do more harm than good and asking farmers and
ranchers to be more exposed to FCM malfeasance is “ridiculous.” He also
said that a private opt-in insurance model is the only feasible method to
provide customer asset protection.
Theodore
L. Johnson,
President, Frontier Futures, Inc., stated
that he supports rules that codify the changes put in place to confirm daily
account balances but that the requirement to maintain a separate risk
management department at FCMs would be expensive and ignores that the entire
staff at his FCM is involved in risk management.
He
also expressed concern with the residual interest provision, saying that small
customers who cannot meet margin calls on a moment’s notice, risk having their
position liquidated. He added that the rule would favor larger FCMs with access
to more capital and would lead to consolidation in the industry.
Question
and Answer
Conaway began the question
and answer segment asking if the CFTC has a sound legal basis for their
reinterpretation of the CEA on customer accounts needed to be collateralized at
all times. Roth said that the CFTC has told his group that their “hands
are tied” by the statue but said it “flies in the face of logic” as the CFTC
has taken a different position on this statute for the past 39 years.
David
Scott
asked for clarification on how the FIA alternative to the residual interest
proposal would accomplish what the CFTC is aiming to address. Duffy replied
that most FCMs believe they can collect between 80 – 90 percent of margin due by
the next day, but that since not every customer uses wire transfers to post
their margin, they would not be able to comply with the requirement.
Scott
then asked whether more risk is posed to customers segregated accounts due to
FCM malfeasance or by losses in other customer accounts. Roth replied
that FCM malfeasance is the most frequent cause of insolvency, but that
customer losses could pose a large risk when looking at the magnitude of the
impact.
Next,
Scott asked if the current punishments for violations are sufficient to deter
market violations. Roth replied that while civil cases are important, it is
really criminal enforcement of the laws that is the strongest deterrent for bad
behavior.
Full
Committee Chairman Frank Lucas (R-Okla.) said he worried that the
CFTC “missed the mark with much of the proposal” and that a one day margin
requirement is “simply unrealistic.” He noted a letter
that he co-signed and sent to the CFTC asking for meaningful changes, and noted
there is a lack of optimism that this will occur. He then asked what the
FCM market will look like in five to 10 years.
Duffy
replied that he was not sure what the market would look like that far into the
future, but said that some market participants would leave the market
instantaneously if these rules were finalized without changes. He added
that this is a “critical issue” for liquidity to be available to farmers and
ranchers and that bid offer spreads would widen dramatically, increasing costs
for producers and American consumers.
Rep.
Dan Benishek
(R-Mich.) asked for further clarification on what the response to end-user’s
concerns has been from the CFTC. Roth replied that the CFTC seems willing
to extend the timeline to the end of the clearing cycle at 3:00 a.m. but said
this is does not solve the issue.
Rep.
Austin Scott
(R-Ga.) asked if there are any parts of the rule that the CFTC got right. Roth
and Anderson both agreed that many parts of the proposal are good and cited the
testing of internal controls and improved transparency as examples.
Rep.
Randy Neugebauer
(R-Texas.) asked if the FCMs are managing their risk to meet exchange
requirements, to which Johnson replied they are constantly doing so, by
monitoring customer accounts. He added that is a customer is unable to meet a
margin requirement, the FCM’s “money is on the line first.”
Neugebauer
then asked what legislative fix would be helpful to address these issues. Roth
and suggested inserting language in the CEA Reauthorization to state that the
Commissions rule is invalid and not necessary. Duffy followed up saying
that the language should state that the rule should allow for “trade day plus
one at 6:00 p.m.” for meeting margin requirements.
Rep.
Vicky Hartzler
(R-Mo.) asked if a customer asset protection insurance plan would require a
taxpayer line of credit. Culp replied that it would be extremely unlikely to
have enough funding for a universal program that did not include a government
backstop for catastrophic losses.
Rep.
Doug LaMalfa
(R-Calif.) asked the panel what would happen if the White House’s proposal for
a transaction tax to fund the CFTC came to fruition. Duffy replied that in
order to get to the $300 million funding level for the CFTC, as set forth in
the proposal, there would need to be a user fee of 4.5 cents on each
transaction for liquidity providers, representing a 70 percent increase in
cost. He said that this would widen the bid offer spread and that the
costs would be passed on to consumers.
Duffy
added that “If that spread widens in the futures market, because the cost of
business goes up by 70 percent, the amount that will cost the taxpayers in
facilitating that debt will go up by billions and billions of dollars, because
those spreads will widen. That will force the yield to go up on the Treasury
debt.”
Rep.
Martha Roby
(R-Ala.) asked for more specifics on the impacts the proposed rule would have
on small farmers and FCMs. Johnson replied that smaller market
participants may have a difficult time doing business with larger entities if
consolidation occurs in the market, because the marginal return for a large FCM
dealing with a small customer is not large enough to make it worthwhile. He
said this would lead to smaller participants leaving the market or having to
pay more to manage their risk.
Rep.
Rodney Davis
(D-Ill.) followed LaMalfa’s line of questioning by asking what the impact of a
transaction tax would be. Duffy said the change could end up costing
Americans billions in increased costs as bid offer spreads widen, making it
more difficult to facilitate debt and increasing end costs for things such as
wheat and grain. He noted that even though the derivatives market has 640
trillion in notional value, there are only about 2,000 transactions conducted
every day and that funding for the agency should be based off of the volume of
transactions and not the notional value of contracts in the market.
Conaway
and David Scott both focused their last remarks and questions on the use of
cost-benefit analysis at the CFTC. Conaway said that the costs determined by
the agency often end up being greatly understated. Scott noted that since
the CFTC does not have the funding it needs, it cannot conduct proper
cost-benefit analysis, but needs to do so in order to better protect themselves
against lawsuits.
Duffy
and Koutoulas both agreed that the CFTC needs to be adequately funded to
perform their job of overseeing the vast derivatives market. Duffy added
that the rule proposal process is not yet complete and that he remains hopeful
that proper cost-benefit considerations will be taken into account before a
final vote.
For
more information on this hearing, please click here.
To
view a webcast of this hearing, please click here.