This article originally appeared in the November 15, 2013 edition of the Financial Times. Please view the original here.
By Gregory Meyer in New York and Neil Munshi in Chicago
Government-authorised insurance for customers of collapsed futures brokers would take half a century to become fully funded, requiring a taxpayer backstop in the interim, an industry-backed study has found.
The conclusion is ominous for the creation of a futures market version of the Securities Investor Protection Corporation, which covers up to $500,000 in losses suffered by US stock investors if their broker fails.
The study was commissioned in November 2012, after a year in which the collapse of brokers MF Global and Peregrine Financial Group shook traders’ faith in the safety of futures markets.
More than $1bn in customer collateral held by MF Global went missing in the broker’s chaotic final days in October 2011. At Peregrine $200m vanished in a fraud.
In the aftermath traders advocated the creation of an insurance fund like SIPC, which Congress authorised in 1970.
The futures study, whose sponsors included futures exchange operator CME Group, the National Futures Association self-regulatory body and the Futures Industry Association, examined the viability of a “Futures Insurance and Customer Protection Corporation” similar to SIPC.
The corporation would cover up to $250,000 per customer and be funded by a 0.5 per cent annual assessment on futures brokers’ gross revenue.
Assuming no payouts, the corporation would take about 55 years to reach a target funding level of $2.5bn.
“A universal government-mandated solution would take a long time to fund,” said Christopher Culp, who led the team of study authors.
A US regulator who supports an insurance scheme cast doubt on the conclusions. “Look, firms don’t want to pay for an insurance pool to protect customers,” said Bart Chilton of the Commodity Futures Trading Commission. “Now we have a study funded by those guys that gives reasons why it’s a bad idea. I’m certainly not shocked.”
An alternative plan involving a private insurance company owned by futures brokers and backed by reinsurers stoked interest from a syndicate of eight reinsurance companies. The syndicate proposed covering up to $300m in claims, with participating brokers bearing the first $50m in losses.
The cost, estimated at $18m-$27m per year, was deemed “restrictive” but the study indicated that brokers might be able to negotiate a better rate.
Gary DeWaal, a consultant and former general counsel at Newedge, the futures broker, said that the government-mandated alternative appeared “dead on arrival”. “The problem is it would just take an eternity to come up with a useful level [of funds],” he said. “I can’t imagine there’s any appetite in the federal government to provide a loan if there was a blow-up in the interim.”
John Roe, an NFA board member who heads a group advocating for former MF Global customers, said that the industry is clamouring for some sort of customer account insurance.
“The pricing is going to be the rub here – you’re going to have to have a big enough field of folks here to bring the costs down to make it effective,” he said.