This article originally appeared in Futures Magazine.
The Commodity Customer Coalition (CCC) made numerous policy recommendations, warned that MF Global may not be an isolated incident and leveled serious charges against JPMorgan and others in presenting its “Recommendations on the Policy Response to the MF Global Bankruptcy,” to the Senate Committee on Agriculture, Nutrition and Forestry today.
The CCC, which has been advocating on behalf of former MF Global customers since shortly after the firm filed for bankruptcy on Oct. 31, 2011 pulled no punches in this broad report, which calls for, among other things, the creation of a customer protection fund, forced separation of dually registered broker-dealer (BD)/future commission merchants (FCMs), ending the distinction between segregated and secured funds, bankruptcy reforms and reforms in how bankruptcy trustees are selected.
The report states, “Without adequate changes to the regulatory regime governing FCMs, another MF Global-sized failure is not only possible, it is probable.”
It point out that half of the 116 FCMs reporting to the Commodity Futures Trading Commission (CFTC) as of March 2012, are dually registered as BDs and account for nearly 91% of all the customer property held by FCMs. And 80% of that property is concentrated in the top 10 firms, nine of which are publically traded. The report suggests this concentration in firms that are dually registered presents systemic risk.
It points out that those nine publically traded firms received 60% of the financial assistance, not including central banks, from the Fed during the 2008-09 financial crisis. “Some have criticized the effort for a policy response from Congress to the MF Global bankruptcy on the grounds that we do not need to extend bailouts to commodity brokers. The reality is that the biggest commodity brokers have already been bailed out,” the report concludes.
The report also is highly critical of the inherent conflicts with dually registered BD/FCMs. It points out that in both MF Global and Lehman’s cases, BD/FCMs were actively using segregated customer property held at their FCM to facilitate operations. “JPMorgan was a custodian of customer funds for both Lehman and MF Global. In both instances, JP Morgan withheld funds it knew or should have known belonged to customers,” the report claims adding, “JPMorgan was extending credit on the value of Lehman’s customers’ money for 22 months with impunity. Only after Lehman collapsed and JPMorgan tried to keep the property of Lehman’s customers did regulators uncover violations.”
It says a forced separation “would simplify and preserve the priority of classes in bankruptcy for each separate entity” and “would stop the wholesale raiding of customer property by a liquidity-stressed BD/FCM.”
On the bankruptcy side, it recommends establishing a legal right for customer representation on creditors’ committees in FCM Chapter 11 cases, preventing the application of Safe Harbor provisions in cases where customer segregated money is involved and applying market forces to determine attorney and trustee fees in bankruptcy proceedings.
In its summary the CCC states, “MF Global’s failure has shattered that notion and exposed tremendous shortcomings in the system designed to protect customer assets. For this reason, the collapse of MF Global deserves a robust policy response which amends the existing regulatory structure and contemplates new mechanisms in order to strengthen the safeguards which protect customer property.”
To emphasize this, it points out that the amount of excess customer funds held at FCMs has dropped considerably in the last year.