Securing the futures market

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The building housing the PFGBest headquarters is seen in Chicago. Photo – John Gress/Reuters

There seems to be a consensus among the regulators that there is no perfect solution in the futures market but there is a need to provide fixes to the system for the time being. In light of MF Global and Peregrine Financial scandals, there is move towards putting in checks and balances to move towards a solution for the long term. Commodity Futures Trading Commission head Bart Chilton has said that the first step is to protect the investors by safeguarding their investment and to have an insurance fund of $250,000. This mirrors the same fund that is used to protect securities customers against the same loss of account value.

This will give some ease to the market which needs some support after the $1.8 billion loss that was faced by the investors. Some of the other reforms discussed revolved around better auditing standards, margins required, and new liquidity requirements which faced opposition from some of the participants. These measures follow in line with the proposal already being considered where CFTC would have access to broker bank accounts overriding the banks completely. This will allow them to dip their hands into the broker’s assets in case of any scandal like MF Global or Peregrine Financial from happening again.

Complimenting that with the investor insurance fund, it would mean that the commission would be able to salvage more cents on the dollar than before. The practices that were carried out by the two firms have come under focus primarily with general measures also being discussed. These include looking into self regulatory organisations like National Futures Association and how it helps government agencies monitor the industry.

The insurance plan is going to focus on the investor’s money being protected in case the brokerage firm that holds the accounts collapses based on the risky trading that it carries out. The proposal under works is intended to raise around $2.5 billion and give a cushion of up to $250,000 to the investors each. Critics have already pointed out that raising this amount of money will be costly on the industry and they might take away some of the liquidity that the market holds right now.

They also feel that the guarantees provided by the government will give false sense of security to the investors while the brokerage involves in riskier trading as the loss would also be shouldered by the tax payer now. The arbitrary amount of $250,000 has also raised eye brows as it favours smaller clients rather than be more equitable and fair in that regard. It is a step towards the right direction, however, it needs to be modified to be made equitable, more effective and should be more in favour of safer operations carried out by the brokerage houses rather than condone riskier behaviour.

There are also renewed calls to end the 2005 reforms of banning third part accounts which were put in place to protect the investor’s capital without effecting clearing house procedures and margins that were allowed. The mechanism is to put the client’s investment in a third party account on which the client has the discretionary power compared to a broker account where the broker has the power to control the finances as well. By keeping them with a third party, the finances cannot be misused by the broker like it happened in the Peregrine Financial incident. However, they can still be used for margins by the broker and the client when there is a need. It acts like taking a collateral based loan on your house where the bank allows you to borrow against the house while the value of the house stays safe and secure.

It still stays to be seen how the regulators go about tackling this challenge and how much they would be able to get into a bill for Congress to sign. Currently, any bill being presented also seems out of questions as both sides of the aisle seem to be skeptical about opposing or supporting any plan at this stage. It seems like future markets are at the beckoning of the regulators right now with one eye on the future and the other on the past.

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