Commodity Futures Trading Commission officials weighed concerns the industry raised over changing the current residual interest deadline.
After weighing the concerns of a broad cross-section of the futures industry, staff at the Commodity Futures Trading Commission have recommended against moving the current “residual interest” deadline which requires futures commission merchants to insert their own capital into the customers’ accounts to cover any customer margin shortfalls by 6:00 p.m. Eastern time on the day of settlement.
In a report released on May 13, the CFTC stated that "staff has no basis to believe that changing the initial deadline to the time of settlement or to some other time of day would be practicable" for futures commission merchants or their customers at this time.
“This report, our recent roundtable and our earlier action to amend the residual interest rule all illustrate our commitment to protecting customer funds while at the same time not imposing undue burdens on commercial end-users.”
The report is the culmination of a lengthy policy discussion that had its genesis in 2012, when the CFTC began an effort to strengthen customer funds protections in response to the MF Global and Peregrine financial collapses. The CFTC subsequently amended its rules in a number of areas to strengthen the protections for customer funds, and those changes have now been implemented by the industry.
Amending the Rule
In October 2013 the CFTC finalized a rule that required FCMs to deposit the required amount of residual interest by 6:00 p.m. Eastern time on the day of settlement, beginning in November 2014, and called for an automatic transition to an earlier deadline by December 2018.
While there was broad industry support for the initial 6:00 p.m. deadline, commercial end-users and FCMs have warned that moving to an earlier deadline would create serious operational challenges for the industry, especially in the agricultural sector, and in effect would require some customers to pre-pay their margin requirements.
The CFTC has listened to the concerns. In March 2015 it amended the rule, removing the provision automatically phasing in an earlier deadline, and simultenously initiated a staff report to determine the feasibility of abbreviating the deadline. In March 2016, the CFTC staff hosted a roundtable to discuss the issue with industry representatives and gather input for the required staff report on the issue.
“This report, our recent roundtable and our earlier action to amend the residual interest rule all illustrate our commitment to protecting customer funds while at the same time not imposing undue burdens on commercial end-users," said CFTC Chairman Timothy Massad in a statement on release of the report. "I look forward to continuing to work with my fellow Commissioners to balance the objective of enhancing the safety of customer funds with operational concerns that are particularly important to smaller end-users.”
Industry Concerns Weighed
The CFTC report cited many of the concerns that were discussed at the March roundtable. Namely, both end-users and FCMs alike warned that an earlier deadline would introduce significant operational challenges and raise costs for end-users.
Todd Kemp, senior vice president of the National Grain and Feed Association, explained that the practical effect would be that some end-users would have to post margin with their FCM in advance of trading, and warned that pre-funding margin would be more of a risk than a protection for his members.
Todd Kemp of the National Grain and Feed Association said it would be risky and costly if end-users were forced to pre-fund their margin accounts.
"We have never believed that the threat of pre-margining adds customer protection to the system. In fact, from a customer perspective, that only increases customer risk," Kemp said at the roundtable. He added that an earlier deadline would likely result in the average grain elevator having to submit twice as much money to its FCM.
Tom Kadlec, president of ADM Investor Services, cautioned that an earlier deadline is simply not possible for customers that work with third-party banks and other institutions in other time zones. "We have 16 banks across the United States that support the agricultural community. About half are in the Central time zone and they don't start a wire process until noon, Central time. About a quarter are in the Western or Mountain time zone and they don't send wires until 2:00 p.m. That's part of the operational challenge," Kadlec said at the CFTC roundtable.
Industry representatives urged the CFTC not to look at the residual interest rule in isolation and emphasized that the customer protections now in place are working well without putting an undue burden on customers.
"We've always felt strongly that you never want to get to the point where the costs become so burdensome that you drive farmers and ranchers and some of the very small retail hedgers out," said Kemp.