WITH the MF Global and Peregrine Financial scandals resulting in significant losses of customer funds due to futures commission merchant (FCM) malfeasance, the industry was reminded that customer funds in the futures market are not protected by federally mandated entities such as the Federal Deposit Insurance Corp. or Securities Investor Protection Corp. (SIPC).
Those nonprofit, member-funded corporations guarantee a certain portion of investor funds in the case of a bank or brokerage firm failure. The futures industry, to date, has no such safety net for customer-segregated funds — funds that were misused and abused in both major industry scandals last year.
Last month, CME Group, the Futures Industry Assn., the Institute for Financial Markets and the National Futures Assn. (NFA) released a study on the economic feasibility of adopting an insurance regime for the futures industry.
The study was nearly a year in the making. Commissioned by the four sponsoring groups last November, it examined four models for providing customer asset protection insurance for losses arising from the failure of a registered FCM. The study developed estimates for the costs of two potential models using customer data provided by six FCMs of various sizes and considered risk exposure data provided by CME and NFA.
Based on feedback from several insurance companies, the study focused on a proposal that would provide insurance to customers opting to participate in a captive insurance company backed by reinsurance and a second option provided to all customers under a government mandate, similar to the SIPC model.
The total cost of a voluntary program, including reinsurance and annual fees, was estimated at $18-27 million per year and was potentially too costly for FCMs and their customers.
An SIPC-like protection scheme, on the other hand, would provide up to $250,000 in coverage to all customers of U.S. FCMs to cover losses from the failure of an FCM to protect customer-segregated funds. Such a system would be funded by mandatory payments from FCMs of up to 0.5% of their annual gross revenues from futures up to a stated target funding level of $2.5 billion.
The study determined that absent any losses, the industry would reach such a funding level in roughly 55 years and assumed that a government backstop would be necessary to cover potential customer liabilities in the short run.