National Grain and Feed, Futures Industry Association say changes to margin requirements could hurt farmers
July 22, 2013 | 05:04 AM
When the Senate Agriculture Committee held a hearing on the reauthorization of the Commodity Futures Trading Commission last week, the National Grain and Feed Association and the Futures Industry Association testified that a CFTC-proposed rule on margin requirements would have negative effects on farmers and the businesses that serve them.
In the wake of the 2008 financial crisis and the MF Global and Peregrine Financial Group cases, the CFTC has been trying to enhance customer protection. But two provisions of a rule that the CFTC proposed last November “would dramatically increase customers’ risk,” John Heck, senior vice president of The Scoular Company in Omaha, Neb., testified at the hearing on Wednesday.
If the CFTC continues to take the position that “its hands are tied due to provisions of the Commodity Exchange Act, congressional action may be needed to clarify the matter,” Heck said, who serves as chairman of NGFA’s Finance and Administration Committee, co-chairs the association’s Customer Protection Task Force, and serves on the NGFA’s board of directors and executive committee. NGFA represents more than 1,000 companies in farm service businesses.
John Heck
One provision of the proposal would decrease the time in which customers’ margin calls must arrive to their futures commission merchant (FCM) from the current three days to just one day. If it didn’t, the FCM would have to take a capital charge for that “undermargined” amount.
The NGFA is “urging the CFTC to maintain the current three-day timeline,” Heck said. “Otherwise, we fear FCMs would require their customers to pre-margin their hedge accounts. That would result in customers being required to send more money to their FCM, potentially putting a greater amount of segregated customer funds at risk in the event of another FCM insolvency.”
The second provision of CFTC’s proposal that is objectionable to the NGFA 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,” Heck said. But the CFTC’s proposal seeks to change that consistent historical interpretation to require that every customer be fully margined on a continual, 24/7 basis, he noted.
“Contrary to the commission’s intent, this proposal actually exposes futures customers to much more risk,” said Heck, because they would have to send more money to their FCMs.
If these provisions stay in place, he said, “Some customers likely would exit futures markets in favor of lower-cost risk management alternatives. We believe this potential exodus from futures markets would be most clearly seen among agricultural producers who utilize futures for risk management purposes and among smaller grain-hedging firms.”
Heck also testified that NGFA believes the U.S. bankruptcy code “needs to be harmonized with the Commodity Exchange Act and CFTC regulations to clarify and ensure that customers come first in FCM insolvencies.”
But he also said that NGFA urges a cautious approach to specific new customer protections because the group is “very mindful that most new customer protections will come at a cost – and that, eventually, the cost most likely will be borne by the customer.”
“On the bright side,” Heck added, “since the collapse of MF Global, significant new operational safeguards that should enhance the safety of customer funds have been put in place on commodity futures accounts by exchanges and regulators. These enhancements, already in place, should help mitigate costs of insurance or other customer protection efforts.”
He said that NGFA has not taken a formal view of whether proposed insurance to protect customers should be offered by the government or the private sector.
Walter Lukken
Walter Lukken, president and CEO of the Futures Industry Association, testified that the reinterpretation of the “residual interest” application of the CEA “will result in a tremendous drain on liquidity that will make trading significantly more expensive for customers hedging their financial or commercial risks, and will adversely affect the ability of many FCMs to operate effectively.”
It would result “in customers being asked to pre-fund their margin or pay to use the capital of the FCM as an injection into the customer account,” he said.
“Assume a grain elevator places a short corn hedge at the open on Monday morning,” Lukken testified. “During Monday’s trading, adverse news drives the price of corn limit up (40 cents). Under the new interpretation, the FCM will need to require the elevator to have sufficient money in the account before placing the trade on Monday to cover initial margin as well as a daily limit move.”
“This ‘prefunding’ is a problem for the elevator because it forces the elevator to keep excess funds at the FCM at all times,” he continued. “It is also a problem for the elevator’s bank, because banks will generally not lend for margin until the position has been established and the FCM provides a confirmation of the position to the bank.”
In her opening statement, Senate Agriculture Committee Chairman Debbie Stabenow, D-Mich., noted that the 2008 near-collapse of the global financial markets had cost 8 million Americans their jobs. In what appeared to be a reaction to industry criticism of the Dodd-Frank financial services reform act, Stabenow said, “There was no question that we needed serious market reform.”
In the reauthorization, she added, “We need to examine lessons from the past and consider ongoing challenges to the system. We want to make sure the agency that is responsible for protecting these markets has the authority, staff, and modern technology it needs to do its job.”
Terrence Duffy
CME Group Executive Chairman and CEO Terrence Duffy testified against funding the CFTC through user fees and against merging the CFTC with the Securities and Exchange Commission.
Pressed repeatedly by Stabenow to state how the CFTC should get the funding to do its job, Duffy replied, “It is hard for me to make suggestions to the government,” but he eventually acknowledged that he believes the taxpayers should pay for the costs of the CFTC and that the taxpayer gets a good return from the CFTC for the money spent.
Duffy also said he would prefer a one-line reauthorization of the CFTC rather than a complicated legislative rewrite.
Dennis Kelleher, president and CEO of Better Markets, a group that promotes public interest in the capital and commodity markets, testified that critics of Dodd-Frank who talk about the costs to the industry fail to take into consideration of the full costs of the financial crisis, which he calculated at $12.8 trillion.
“Don’t relitigate Dodd-Frank,” Kelleher told the committee, adding that the CFTC needs the authority to impose user fees to fund itself.
In light of the authority over swaps that Dodd-Frank gave to the CFTC, Kelleher said, the agency should be renamed the Commodities Futures and Swaps Trading Commission or the CFSTC.
In the wake of the 2008 financial crisis and the MF Global and Peregrine Financial Group cases, the CFTC has been trying to enhance customer protection. But two provisions of a rule that the CFTC proposed last November “would dramatically increase customers’ risk,” John Heck, senior vice president of The Scoular Company in Omaha, Neb., testified at the hearing on Wednesday.
If the CFTC continues to take the position that “its hands are tied due to provisions of the Commodity Exchange Act, congressional action may be needed to clarify the matter,” Heck said, who serves as chairman of NGFA’s Finance and Administration Committee, co-chairs the association’s Customer Protection Task Force, and serves on the NGFA’s board of directors and executive committee. NGFA represents more than 1,000 companies in farm service businesses.
John Heck
One provision of the proposal would decrease the time in which customers’ margin calls must arrive to their futures commission merchant (FCM) from the current three days to just one day. If it didn’t, the FCM would have to take a capital charge for that “undermargined” amount.
The NGFA is “urging the CFTC to maintain the current three-day timeline,” Heck said. “Otherwise, we fear FCMs would require their customers to pre-margin their hedge accounts. That would result in customers being required to send more money to their FCM, potentially putting a greater amount of segregated customer funds at risk in the event of another FCM insolvency.”
The second provision of CFTC’s proposal that is objectionable to the NGFA 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,” Heck said. But the CFTC’s proposal seeks to change that consistent historical interpretation to require that every customer be fully margined on a continual, 24/7 basis, he noted.
“Contrary to the commission’s intent, this proposal actually exposes futures customers to much more risk,” said Heck, because they would have to send more money to their FCMs.
If these provisions stay in place, he said, “Some customers likely would exit futures markets in favor of lower-cost risk management alternatives. We believe this potential exodus from futures markets would be most clearly seen among agricultural producers who utilize futures for risk management purposes and among smaller grain-hedging firms.”
Heck also testified that NGFA believes the U.S. bankruptcy code “needs to be harmonized with the Commodity Exchange Act and CFTC regulations to clarify and ensure that customers come first in FCM insolvencies.”
But he also said that NGFA urges a cautious approach to specific new customer protections because the group is “very mindful that most new customer protections will come at a cost – and that, eventually, the cost most likely will be borne by the customer.”
“On the bright side,” Heck added, “since the collapse of MF Global, significant new operational safeguards that should enhance the safety of customer funds have been put in place on commodity futures accounts by exchanges and regulators. These enhancements, already in place, should help mitigate costs of insurance or other customer protection efforts.”
He said that NGFA has not taken a formal view of whether proposed insurance to protect customers should be offered by the government or the private sector.
Walter Lukken
Walter Lukken, president and CEO of the Futures Industry Association, testified that the reinterpretation of the “residual interest” application of the CEA “will result in a tremendous drain on liquidity that will make trading significantly more expensive for customers hedging their financial or commercial risks, and will adversely affect the ability of many FCMs to operate effectively.”
It would result “in customers being asked to pre-fund their margin or pay to use the capital of the FCM as an injection into the customer account,” he said.
“Assume a grain elevator places a short corn hedge at the open on Monday morning,” Lukken testified. “During Monday’s trading, adverse news drives the price of corn limit up (40 cents). Under the new interpretation, the FCM will need to require the elevator to have sufficient money in the account before placing the trade on Monday to cover initial margin as well as a daily limit move.”
“This ‘prefunding’ is a problem for the elevator because it forces the elevator to keep excess funds at the FCM at all times,” he continued. “It is also a problem for the elevator’s bank, because banks will generally not lend for margin until the position has been established and the FCM provides a confirmation of the position to the bank.”
In her opening statement, Senate Agriculture Committee Chairman Debbie Stabenow, D-Mich., noted that the 2008 near-collapse of the global financial markets had cost 8 million Americans their jobs. In what appeared to be a reaction to industry criticism of the Dodd-Frank financial services reform act, Stabenow said, “There was no question that we needed serious market reform.”
In the reauthorization, she added, “We need to examine lessons from the past and consider ongoing challenges to the system. We want to make sure the agency that is responsible for protecting these markets has the authority, staff, and modern technology it needs to do its job.”
Terrence Duffy
CME Group Executive Chairman and CEO Terrence Duffy testified against funding the CFTC through user fees and against merging the CFTC with the Securities and Exchange Commission.
Pressed repeatedly by Stabenow to state how the CFTC should get the funding to do its job, Duffy replied, “It is hard for me to make suggestions to the government,” but he eventually acknowledged that he believes the taxpayers should pay for the costs of the CFTC and that the taxpayer gets a good return from the CFTC for the money spent.
Duffy also said he would prefer a one-line reauthorization of the CFTC rather than a complicated legislative rewrite.
Dennis Kelleher, president and CEO of Better Markets, a group that promotes public interest in the capital and commodity markets, testified that critics of Dodd-Frank who talk about the costs to the industry fail to take into consideration of the full costs of the financial crisis, which he calculated at $12.8 trillion.
“Don’t relitigate Dodd-Frank,” Kelleher told the committee, adding that the CFTC needs the authority to impose user fees to fund itself.
In light of the authority over swaps that Dodd-Frank gave to the CFTC, Kelleher said, the agency should be renamed the Commodities Futures and Swaps Trading Commission or the CFSTC.
