New Rules on Swaps Will Protect Big Traders
Wall Street investors will receive significant new protections under a plan adopted by federal regulators on Wednesday, an overhaul that comes in the wake of the collapse of MF Global.
When MF Global filed for bankruptcy last year, some $1.2 billion in customer money vanished from the brokerage firm. The firm’s futures customers, farmers and hedge funds alike, are still without nearly a third of their money.
But the new rules would not prevent a brokerage firm from repeating MF Global’s mistake of misusing customer money, nor would they apply to any futures industry clients like those of MF Global.
Instead, the changes affect only customers who trade swaps, complex derivative contracts that allow companies to hedge exposure to interest rates and other financial products. These investors are usually Wall Street banks, hedge funds and large companies.
The Commodity Futures Trading Commission voted 4 to 1 on Wednesday to adopt the overhaul.
The rules seek to protect swaps customer accounts by segregating them from a brokerage firm’s money. And when a swaps customer defaults at a bankrupt brokerage firm, the new rule will keep other customers’ cash off limits.
“Today’s segregation rule is an important step forward in protecting customers and reducing the risk of swaps trading,” Gary Gensler, the agency’s chairman, said at a meeting in Washington on Wednesday.
“Segregation of customer funds is the core foundation of customer protection in the commodity futures and swaps markets.”
The commission has spent more than a year writing some 50 rules under the Dodd-Frank Act, the regulatory crackdown passed in response to the financial crisis.
On Wednesday, the agency also took up final rules that detailed standards for swaps traders and outlined how such firms should register with regulators. Commissioners voted 4 to 1 to adopt those rules.
Separately, the agency voted on an initial plan known as the Volcker Rule to bar banks from using their own money to place trades. Named for Paul Volcker, the former chairman of the Federal Reserve, the agency’s proposal comes three months after several other regulators first voted on the rule.
The C.F.T.C. approved the plan on a vote of 3 to 2.
Even amid this wave of arcane rules, the agency’s new customer segregation policy stands out as one of its most complex.
Though the rule requires brokerage firms to keep their house accounts separate from customer cash, customer money can be pooled together as long as the firm is not in bankruptcy. Under the rule, brokerage firms must turn over, at least once a day, data indicating that their customer accounts are safe.
Such protections mirror longtime rules for the futures industry; the swaps industry had been largely unregulated for decades. Unlike in the futures industry, however, when a brokerage firm fails in the swaps industry because one of its customers defaults, cash from customers in good standing cannot be raided.
Jill Sommers, a Republican commissioner who voted against the rule, said she was wary of affording special treatment to swaps customers.
“I’m very concerned,” she said, of adopting “protections that do not apply” to futures customers. “I do not accept this piecemeal approach to customer protection as a step in the right direction.”
Alluding to the MF Global debacle, Ms. Sommers added that “due to the recent events we need to rethink this approach so we can provide adequate protections in a comprehensive and coherent way.”
Mr. Gensler indicated he was open to extending the rules to the futures industry. But first, he said, his staff must analyze such changes and hold public meetings to ponder the overhaul.
And the changes, some commissioners said, are not a cure-all even for swaps.
Some giant money managers like Fidelity Investments have pushed the agency to go even further to protect swaps customers, saying customer money should not be pooled at all. The MF Global case has highlighted that unless each customer account is held separately, it is difficult to detect a misuse of client cash.
Scott O’Malia, a Republican commissioner who said he reluctantly supported the rule, said that it would not prevent a repeat of MF Global.
“This rule-making does not address MF Global,” he said. “By its own admission, this rule making only protects against fellow-customer risk.”
But the agency’s Democratic commissioners defended the rule as an initial step toward safer customers and better markets.
“We shouldn’t let the perfect be the enemy of the good,” said Bart Chilton, a Democratic commissioner.