The National Grain and Feed Association has submitted to Congress and the Commodity Futures Trading Commission (CFTC) additional substantive recommendations to enhance customer protections in the event of another MF Global-type liquidation of a futures commission merchant (FCM).
In a letter to members of the House and Senate Agriculture Committees, as well as the Commodity Futures Trading Commission (CFTC), the NGFA stressed that many former MF Global customers still are seeking return of 28 percent of their funds that were to have been segregated and secure. The NGFA noted that its new recommendations supplement a set of preliminary recommendations it developed and communicated to Congress and the CFTC on April 2 that would enhance reporting, transparency and accountability in an effort to prevent a recurrence of an MF Global-type bankruptcy.
The NGFA’s new recommendations focus primarily on policy changes that likely require congressional action, and are targeted at protection of customer assets in the event of an FCM bankruptcy. FCMs are those entities that solicit or accept orders for the purchase or sale of futures or options contracts subject to the rules of a commodity exchange.
The NGFA’s recommendations include the following:
Amendments to U.S. Bankruptcy Code: The NGFA proposed the following five reforms to the U.S. bankruptcy code, which it said are “critically important” to preserving customers’ rights and protecting customers’ assets in the event of future FCM insolvencies:
- The NGFA urged that CFTC bankruptcy regulations (Part 190) be incorporated into the U.S. bankruptcy code (Chapter 7, Subchapter IV) because they provide much greater and more detailed guidance for the liquidation of a commodity broker or FCM.Generally, the existing bankruptcy code provides a limited description of the liquidation processof a commodity futures broker.Amending the bankruptcy code in this manner would harmonize the statutes and avoid interpretative inconsistencies, the NGFA said.
- To strengthen commodity customer protection, the bankruptcy code should give the CFTC a specific, identifiable role in the liquidation of an FCM, including the authority to appoint its own trustee to represent exclusively the interests of commodity customers.Currently, under the Securities and Investor Protection Act (SIPA), the CFTC has a limited role.Further, the SIPA trustee is obligated to protect the interests of both securities and commodities customers.In the case of the MF Global Inc. bankruptcy, in which more than 95 percent of the assets and accounts affected were those of commodities customers, the NGFA said the CFTC should have had the power to play a much larger role.
- Clearly state that customers always are first in line for distribution of funds from assets of the bankrupt FCM -- ahead of creditors --and that all proprietary assets, including those of affiliates, be directed to customers first.Currently, an FCM is required to keep customer funds segregated from the firm’s proprietary funds, but customer property is commingled.As a result, under the current statutory scheme, all customers share pro ratain the event of a shortfall.The NGFA said such a change would provide incentives to FCMs and any controlling parent firm to implement adequate internal controls to prevent violations of the segregation rules, since they would have knowledge that their claims could be subordinated inthe event of a shortfall.Further, this reform would provide clarity to regulators and to the courts on prioritizing claims, an area in which precedent has not been established.
- Expressly authorize the establishment of customer committees to represent commodity futures customer interests during bankruptcy proceedings.During the MF Global bankruptcy, creditor committees were established under the MF GlobalHoldings Chapter 7 proceeding.But there was no statutory authority under the SIPA liquidation of the MF Global Inc. FCM to establish such customer committees.
- Any transaction involving the misappropriation of FCM customers’ property no longer should be protected under so-called “safe-harbor” provisions of the bankruptcy law, regardless of the intent underlyinga fund transfer.Under current law, powers of a trustee to recover customer funds are limited under such “safe-harbor” provisions unless actual intent to defraud customers and/or creditors can be proven.
The NGFA noted that other organizations also are working to develop specific recommendations for changes to the bankruptcy code designed to enhance customer protections, and signaled that it would “welcome the opportunity to work cooperatively with such groups to develop consensus reforms” that can be enacted more expeditiously by Congress.
Fully Segregated Customer Accounts: Establish a new type of voluntary account structure for use by FCM customers that would shield customer assets from pooled losses if an FCM bankruptcy occurs. As noted previously, the Commodity Exchange Act and U.S. bankruptcy code currently provide for pro-rata distribution of all customer property held by an insolvent FCM.In the case of MF Global, the result has been that many former customers of the firm thus far have received only 72 percent of their “supposedly safe” segregated funds through distributions from the trustee, the NGFA said, with no assurance they ever will receive all of their funds.
In establishing this new voluntary account structure, the NGFA said it will be of paramount importance that fully segregated customer funds not fall under the “customer funds” definition of the bankruptcy code, thereby exposing them to pro-rata distributions (as discussed previously in recommendations for changes to the bankruptcy code). The NGFA advocated a voluntary approach to the establishment of a fully-segregated account structure, noting that it likely will result in additional costs to be borne by customers utilizing this option.Doing so would give individual FCM customers the option to make independent decisions on whether the additional protections are commensurate with any additional costs. The NGFA said it would explore working with like-minded organizations to design a full-segregation option that responds to customer needs.
Pilot Program for Full-Segregation Option: The NGFA proposed that a pilot program be created “at the earliest possible date” involving commodity futures customers, FCMs, banks and regulators to test the mechanics and begin to judge the true costs of a “full-segregation” account structure, in which FCM customer assets would be shielded from pooled losses.The NGFA said a pilot project could facilitate the process of moving as quickly as possible toward a more generally available full-segregation option for customers. The association offered to work with its member companies, the CFTC and other stakeholders to identify potential participants for such a pilot project.
SIPC-Like Insurance for Commodity Futures Customer Accounts: Because the full-segregation option ultimately may not prove to be practical for all market participants, the NGFA recommended enactment of legislation to provide that insurance coverage to protect against FCM bankruptcies be extended to commodity futures accounts.Such insurance currently is provided to securities account customers through the Securities InvestorProtection Corporation (SIPC).
“We believe that a significant fund could be established through very modest dedicated assessments on commodity futures transactions,” the NGFA said.“Details concerning the appropriate size of such a fund and the appropriate level of assessment will need to be determined. But we believe the customer protections provided will be significant and meaningful to market participants.”
In its statement, the NGFA did not recommend whether housing a commodity futures insurance fund within the existing structure of the SIPC was advisable, or whether a new and separate SIPC-like entity should be established that is dedicated to providing insurance protection for commodity futures accounts.But the NGFA said it believed strongly that insurance protection for commodity futures accounts should be established.