Ag groups wary of new CFTC rule

Feb 22, 2013
by DTN

—Futures users worry rule change goes too far.

Portions of a proposed CFTC rule to enhance the protection of customers’ margin funds could make hedging prohibitively expensive for farmers and ranchers and the small- to mid-sized futures commission merchants that serve them, industry representatives fear. (Logo courtesy of the CFTC)

Portions of a proposed rule to enhance the protection of customers’ margin funds could make hedging prohibitively expensive for farmers and ranchers and the smallto mid-sized futures commission merchants (FCMs) that serve them, industry representatives said.

The National Grain and Feed Association (NGFA) said it feared the proposed rule “would bring about a dramatic and sudden change in the eco-system of the futures market as it has existed for decades, with disproportionate adverse impacts on the traditional users who are NGFA members, their farmer-customers and the FCMs that serve the agricultural hedging community.”

While many groups support the rule’s enhanced reporting requirements, they’re concerned the rule goes too far in its suggestions on managing margin funds, potentially making it harder for FCMs supporting the agriculture industry to stay in business.

The proposed rule includes a provision that would require the FCM to take a capital charge on all customer accounts that were under margined one day after a margin call was issued. Currently, there’s a three-day grace period, which allows time for Automated Clearing House (ACH) transfers and check deposits to be processed. The rule also requires that futures commission merchants keep enough residual interest in segregated customer accounts to cover all margin deficits.

The Commodity Futures Trading Commission (CFTC) rule says the purpose of this proposal is to encourage better risk management by FCMs, but if the change is enacted, FCMs would likely require customers to prefund potential margin calls. In its comments, INTL FCStone, Inc. said the rule assumes every customer can make a wire transfer that’ll be received within 24 hours.

“In reality, FCStone still receives checks from farmers and other agricultural clients. In addition, a sizeable portion of our clients meet margin calls with ACH payments, which typically cost the customers significantly less than a wire transfer,” FCStone’s comments state. That’s not including the challenges of international customers making timely wire transfers. If the industry moves away from checks and ACH deposits, NGFA said it could drive business away from the futures market and into overthe-counter products and into the cash markets.

“The proposed rule likely would have the effect of compelling hedgers to pre-margin their positions and send yet more money to their FCM, the polar opposite of many hedgers’ best practices today,” NGFA’s letter states. After the collapse of MF Global revealed the company was missing more than $1.2 billion of segregated customer funds, agricultural hedgers started managing their margin accounts closely, keeping little to any excess in the account at the end of the day.

“When the next FCM failure occurs, it would appear that an even greater amount of customer funds would be put at risk under the current proposal. It would be the ultimate irony that a rule designed to enhance customer protections in the aftermath of MF Global accomplishes the opposite,” the letter states. This portion of the CFTC proposal would have done nothing to prevent the loss of customer funds seen in the MF Global and Peregrine Financial Group cases or speed the return of funds to customers, NGFA stated.

And while the costs will be mostly born by the customers, the capital charges could create pressure on small- to mid-sized FCMs. CFTC must consider the competition issues this proposal raises, FCStone states.

Commercial traders, like farmers and co-ops, make up about 40 percent of futures volume in the agriculture markets, according to NG- FA, and they’re mostly served by FCMs that provide hands-on order processing, research and assistance tailored to the ag sector. Investment traders are mostly served by larger FCMs, many of which are also better-capitalized banks.

NGFA notes that for these large FCMs, capital charges may produce a smaller impact on the balance sheet.

“An overly prescriptive rule could have the perverse effect of relatively disadvantaging FCMs serving production agriculture and agribusiness, with the end result that risk could be consolidated and concentrated in a smaller number of FCMs.”

CHS Hedging Inc. is an FCM that’s not a bank, and it’s concerned the new rule will hurt business in the current economic environment.

“The difference between the cost of capital and the return and FCM could reasonably expect through investment of funds in a compliant and prudent manner would result in a material effect on the business of all FCMs. Additionally, if an FCM has a majority of customers that are similarly situated like CHI does, an adverse market movement would affect all the customers in a similar manner and this requirement would be unduly burdensome, especially when the customers are hedging.”

The CFTC will review the comments and consider changes before issuing a final rule. — Katie Micik, DTN