Archive for the ‘FIA’ Category

A Modest Proposal For A Better Way For Regulators To Track U.S. Futures Customer Segregated Funds

January 30, 2012

John Lothian has created a website where he is asking for users/registrants to add ideas for ways that the U.S. futures industry can recover from the collapse of future commission merchant (FCM) MF Global following the disclosure that hundreds of millions, possibly as much as $1.2 billion, of Customer Segregated Funds is “missing” from MF Global’s bank accounts. Lothian’s Futures Crowd Site

For the uninitiated: Customer Seg Funds are funds are cash balances and collateral deposited at FCMs, or funds earned from trading, that are, by rule and by law, required to be kept separate from firm money, and are intended to be held for the exclusive benefit of FCMs’ clients. I do not share the opinion that the Seg Funds “missing” from MF Global are missing due to any accounting error or “mistake.” I believe that the Seg Funds were taken by someone or some multiple people at the failed FCM to cover firm shortfalls. If and when this proves to be true, someone or some multiple people could well face prison, but that may be years from now.

In the meantime, John Lothian is asking for interested parties to offer ideas on how the U.S. futures industry can move forward after the apparent “disappearance” of millions of dollars of client funds. One of the ideas that was proposed was that missing client money should be restored immediately. That Suggestion Is Here. The original post was this:

“The number one priority: make customers whole…The number one priority to restore customer confidence should be to make the customers whole. Agree or disagree? No specific mechanism for making them whole is suggested here.

I concur with this idea and added the following comment:

I completely agree that the top priority is to make customers whole. I have had this argument with others and I do not buy into the “Slippery Slope” argument. I do not buy into the notion, though, that CME should make all the customers whole. Why not ICE, OCC, MGE, KCBOT too?

The American taxpayers got stuck bailing out so-called TBTF financial institutions. Know what really is Too Big To Fail? The U.S. Futures Industry, that’s what.

For one-six-hundreth of the cost of those bailouts, American taxpayers can restore integrity to the market, and make whole famers, retail investors, locals, and yes, even (GASP) speculators. . That needs to happen.

It won’t happen without industry-led regulatory changes, though. I have a proposal that is germinating in my mind about what that can and should look like. I will be adding that in the next day or two.

FCMs that are also broker-dealers must file a Financial and Operational Combined Uniform Single Report (FOCUS report) with the SEC every month. Part of the FOCUS report required for broker-dealers that are also FCMs is the Supplement Report called “Statement of Segregation Requirements and Funds in Segregation For Customers Trading on U.S. Commodity Exchanges.” I took a look at this report last November. For broker-dealers, the SEC passes along the Statement of Segregated Funds to the CFTC from each broker-dealers FOCUS report. The CFTC reports on this each month when it releases “FCM Data” and I’ve talked about those CFTC releases several times in the past: November, 2011 and June, 2011 and February, 2011 and January, 2011, for example.

FCMs that are not also broker-dealers must complete the exact same report – called the CFTC 1FR-FCM report – and submit it to the CFTC every month. The FCM 1-FR reports are incorporated into the CFTC FCM Data reports along with the FOCUS reports for broker-dealers.

As we see from the Statement of Segregation reports, whether from FOCUS (broker-dealer) or 1-FR (FCM), the FCMs track all required aspects of Customer Seg money on a regular basis. Each FCM must put this information together, at the very least, once per month. Some, it seems likely, do so daily as a normal part of their daily client processing. Those that do not calculate these figures daily certainly should. But none of them report the information, daily, in any meaningful way.

They should. Here’s how: today, every day, during an FCM’s night processing cycle, they calculate CFTC Large Trader position reports and create a print-image file (which gets archived in their data warehouse, whether it is Laser Vault, Speedscan, whatever). At the same time, the FCM creates an 80-byte Large Trader disk file which is delivered to the CFTC electronically, typically via FTP. The CFTC uses this information to track economic data and create economic reports.

I’d propose that FCM back-office systems be modified to do the same thing, for Customer Segregated Funds, on a daily basis. The systems already generate print-image reports that FCMs and broker-dealers use to complete their 1-FRs or FOCUS reports. These reports simply aggregate back-office system data at user-defined levels and create print-image reports (which are archived in data warehouses). The aggregation can be done monthly for regulatory reporting to SEC and/or CFTC – that’s already proven, FCMs do that regularly, so systems and functionality already exists for that. What does not exist today – what should be added – is creation of electronic files which can be delivered to regulators daily and used to track Customer Seg Funds, not just at the firm (FCM) level, but at the individual account level. (That’s what the back-office reports already do today, they generate detail reports at the customer level and also at the firm level. An FCM reports the firm-level, and archives the backing detail reports.)

The following fields need to be tracked, daily, for each FCM, for each customer account, and delivered electronically to CFTC, SEC, or some other outside entity that can use the data to track for anomalies, discrepancy, or other issues. If FCMs know that customer segregated funds are being tracked and analysed and reviewed daily, they’d be much more likely to preserve those funds when the FCM is in duress. And the data included in these new data files would likely make it much easier, in the event of an FCM failure, to move funds and positions to other FCMs in good standing, since they’d have ready access to the information.

1. Net Ledger Balance for each FCM client account.
1a. Cash
1b. Market Value of Securities

2. Net Unrelized P&L on futures positions (Open Trade Equity)

3. Option Value
3a. Add value of LONG options
3b. Subtract value of SHORT options

4. Net Equity: add lines 1, 2 and 3

5. Accounts liquidating to the negative Seg balance
5a. gross amount
5b. less market value of securities in those debit-balance accounts.

6. Amount to be Segregated (add lines 4 plus 5)

The figures above are the “client side” or the amounts in the bookkeeping system for clients. The figures below are the “house side” or the amounts that MUST be available. These figures might not be – and often are not – in the back-office bookkeeping system. Lines 1 though 5 should be generated for each client account, every day. Line 6 is the total amount of client funds that must be segregated. The lines below should also be tracked daily – and this might require changes to operational procedures at an FCM.

7. Amount deposited in Segregated Bank Accounts
7a. Cash
7b. Market value of securities posted by clients
7c. Market value of securities purchased with client money

8. Margin amount posted at regulated clearinghouses (DCOs)
9. Net Settlement (pay/collect) due to/from regulated clearinghouses (DCOs)

10. Option values cleared by FCM
10a. Add LONG option value
10b. Subtract SHORT option value

11. Amounts held at other FCMs for the clients of the FCM
11a. Net liquidating equity
11b. MArket value of securities purchased with customer funds
11c. FCM client securities pledged to the other FCM

12. Segregated funds in hand (petty cash)

13. Total (add lines 7 – 12)
14. Amount actually in Segregation (line 13 less line 6)

NOTE: I am closing the comment thread here (once I figure out how I figured out how) so the discussion can be encapsulated in one place. The place to discuss this topic is at John Lothian’s Futures Crowd website, in the Idea Thread for this topic. The link to that comment thread is here.

CFTC Rule to Require DCOs to Report Member Firm Client Positions Daily

January 30, 2012

Just some resources as I investigate this rule change and the impact to back-offices from which the reports must be made.

DCOs are derivative clearing organizations, aka clearinghouses.
FCMs are futures commission merchants, aka DCO clearing member firms.
FIA is Futures Industry Association, a futures industry trade group of which Needham Consulting is a member.

FIA has created a small committee of interested parties from DCOs, FCMs and industry consultants to review these rules and determine the best way for DCOs and FCMs to meet the new requirements. I am privileged to be a member of that committee.

CFTC Rule from the Federal Register: Federal Register

Text:

(1) Gross margin for customer accounts.

Proposed Sec. 39.13(g)(8)(i) would require a DCO to collect

initial margin on a gross basis for each clearing member’s customer

account equal to the sum of the initial margin amounts that would be

required by the DCO for each individual customer within that account if

each individual customer were a clearing member. A DCO would not be

permitted to net positions of different customers against one another,

but it could collect initial margin for its clearing members’ house

accounts on a net basis.

The Commission recognizes that gross margining of customer accounts

would be a change from current margin practices at certain DCOs.

However, the Commission believes that gross margining of customer

accounts would more appropriately address the risks posed to a DCO by

its clearing members’ customers than margining all of a particular

clearing member’s customer accounts on a net basis. Gross margining

would increase the financial resources available to a DCO in the event

of a customer default. Moreover, with respect to cleared swaps, the

requirement for gross margining of customers’ portfolios supports the

requirement in proposed Sec. 39.13(g)(2)(iii) that a DCO would have to

margin each swap portfolio at a minimum 99% confidence level.

The Commission recently proposed a new Sec. 39.19(c)(1)(iv) under

which a DCO would be required, on a daily basis, to report the end-of-

day positions for each clearing member, by origin.\43\ In connection

with the proposed Sec. 39.13(g)(8)(i) requirement for DCOs to collect

initial margin for customer accounts on a gross basis, the Commission

is proposing to amend proposed Sec. 39.19(c)(1)(iv) to additionally

require a DCO, for the customer origin, to report the gross positions

of each beneficial owner.