July 2012

The fallout from Peregrine Financial Group continues as US Commodity Futures Trading Commission (CFTC) chairman Gary Gensler testifies before the US Senate Committee on Agriculture this morning, where he identified the regulator’s plan to improve the protection futures commission merchant (FCM) client funds.

According to his published statement, available on the regulator’s website, the CFTC approved a set of rules proposed by the National Futures Association (NFA) regarding improved controls for segregated and Part 30 secured accounts.

The Chairman also would like to increase transparency by letting self-regulatory organizations (SROs) and the CFTC electronically access FCM bank and custodial accounts without prior FCM permission as well as having the FCM provide clients with details on where and in what fashion their assets are held. He also suggests that the CFTC should consider enhancing the controls on how FCMs handle customer accounts and creating new rules on SRO’s requirements for conducting examinations and audits.

These suggestions might prevent future Peregrine and MF Globals from happening, but what are the chances that the regulator would be able to capitalize on these changes? Chairman Gensler points this out in his testimony.

The Commission’s limited resources have historically not allowed for direct oversight of FCMs.  There are 46 staff members, including 35 audit staff, on the CFTC’s examinations team who oversees four SROs, which in turn have responsibilities for more than 1,000 entities.  On top of the current lack of staff for examinations, our responsibilities are expanding to include reviews of many new market participants.  For instance, there are currently 115 FCMs, and staff estimates a similar number of swap dealers will ultimately register.  More frequent and in-depth examinations are necessary to assure the public that firms have adequate capital, as well as systems and procedures in place to protect customer money.  Greater coverage by regulators – like having more cops on a beat – will improve integrity and heighten the deterrent effect of the review process.

It would be nice to view Peregrine and MF Global as individual incidents, but they cannot. These are the results of years of poor regulatory oversight of the industry. Or to quote the Wizard of Omaha Warren Buffet, “It’s only when the tide goes out that we learn who has been swimming naked.”

I bet in the weeks and months ahead we will see more damp, flabby backsides flapping in the wind.

Don’t lay the blame at the feet of the CFTC as some do. The CFTC staff is among the hardest working professionals in the regulatory space. It’s weakness, along with its sibling regulator US Securities and Exchange Commission (SEC), is that it is not self-funded or partly self-funded.

Every year the US market regulators traipse up to Capitol Hill and pitch their budgetary needs and that’s when politics really where politics truly makes an unholy mess of it. As a result, the regulators tend to get just enough funding to cover some basic necessities but not near enough to keep up with the rapid evolution of the market.

By keeping the regulators on a short fiscal leash, the US Congress allows firms to continue to swim naked at the peril of the entire financial market.