WASHINGTON, D.C., U.S. — The National Grain and Feed Association (NGFA) testified on Oct. 2 that two specific elements of a rulemaking proposal issued by the Commodity Futures Trading Commission (CFTC) would "dramatically increase customer risk," having the opposite of its intended effect.
In testimony presented at a hearing conducted by the U.S. House Agriculture Committee's Subcommittee on General Farm Commodities and Risk Management, the NGFA said that for years, grain hedgers and futures commission merchants (FCMs) have relied on a consistent interpretation of the Commodity Exchange Act by the CFTC.
"Unfortunately, in the name of customer protection, that interpretation recently has been thrown into question by a new proposal from the CFTC that we believe would dramatically increase customer risk," said MJ Anderson, regional sales manager for The Andersons Inc, Union City, Tennessee, U.S., who testified on behalf of NGFA.
"The rule seeks to bolster futures customer protections - a laudable goal that the NGFA supports fully," testified Anderson, a member of the NGFA's Risk Management Committee. "However two very troublesome provisions would have the perverse effect of significantly increasing financial risk to futures customers - and in the process, dramatically changing the way business has been conducted in futures markets for decades."
The first provision of the proposed rule cited by the NGFA would decrease the time in which customers' margin calls must arrive to their FCM from the current three days to just one day. If it didn't, the FCM would be required by the CFTC to take a capital charge for that "under-margined" amount.
The second provision would change the timing of FCMs' calculation of "residual interest," which are the funds the FCM contributes from its own money to "top-up" customer accounts until margin calls are received. For decades, this provision of the Commodity Exchange Act has been interpreted by the agency as allowing a period of time for FCMs to do so. But now, the CFTC's proposal seeks to change that consistent historical interpretation to require that every customer be fully margined on a 24/7 basis.
"We believe strongly that neither proposal accomplishes the commission's stated goal of enhancing customer protection," the NGFA testified. "To the contrary, customers would be sending much larger amounts to their FCMs, leading to much greater volume of funds at risk if another MF Global situation occurs."
In fact, Anderson testified, "if this rule had been in place when MF Global failed, perhaps twice as much customer money would have been missing and a correspondingly larger amount still would not be returned to customers."
In its testimony, the NGFA also cited a Sept. 18 letter to the CFTC commissioners signed by 21 national organizations - including NGFA - warning of negative consequences if the two troublesome provisions were implemented, including the following:
• Many producers who use futures directly will be discouraged from using futures markets to hedge their production risk.
• Due to the significantly increased funding requirements of pre-margining - perhaps nearly double the amounts currently required - many small agribusiness hedgers will be forced to consider alternative risk management tools or be forced out of the market.
• Futures customers will be compelled to send excess margin money to their FCMs in anticipation of future market movements on existing positions - many billions of dollars more than needed to cover existing positions. The letter noted this is the last thing customers want to do now, in the wake of MF Global and Peregrine Financial Group insolvencies.
In addition, the joint letter and the NGFA's testimony both urged the CFTC to conduct serious cost-benefit analysis before any further action on the capital change and residual interest provisions.