December 05, 2011

In light of the MF Global collapse, federal regulators are cracking the whip on Wall Street risk-taking. On Monday, the Commodity Futures Trading Commission approved the "MF Global rule," named after disgraced brokerage firm believed to have improperly used hundreds of millions of dollars of customer money.

The new rule will limit investment choices for customer cash in futures firms, mainly preventing firms from using client funds to buy foreign sovereign debt. It also forbids a complex transaction that allowed MF Global to basically borrow money from its own customers.

Until now, brokerage firms could invest client money in a number of securities, including sovereign debt. The list of permitted investments grew under the administration of President George W. Bush, the New York Times reports. [subscription required].

But under the new MF Global rule, if firms want to invest customer funds in foreign government bonds, they must petition the agency for a special exemption. The new rule also bans in-house repurchase agreements, or repos, in which one part of a futures firm swaps customer assets for securities such as municipal bonds or foreign-government bonds held at another part of the firm, pocketing the higher interest rates the securities yield, the Wall Street Journal notes. [subscription required].

From the Wall Street Journal:

Since such deals are done internally, they expose customers to a firms' ability to manage risk, critics of the practice say. They also leave it up to the firm to price the securities, leading to potential accounting abuses.

"I believe there is an inherent conflict of interest between parts of a firm doing these transactions," CFTC Chairman Gary Gensler said. The existing policy had been in place since 2005.

The Commodity Futures Trading Commission (CFTC), which voted unanimously to approve the rule in 2010, had originally planned to finalize it months ago -- but delayed action due to strong opposition and a powerful lobbying campaign the futures industry, largely from Jon Corzine, the former governor of New Jersey and CEO of MF Global, who resigned from the his position at the brokerage last month, amid the scandal.

At the time, Corzine said the rules were unnecessary because federal laws already prevented brokerage firms from mixing client money with company funds. The Times reports that in a letter, MF Global insisted to regulators that they were trying to "fix something that is not broken."

On Monday, the CFTC voted 5-0 for the rule.

Under the new rule, firms trading futures can still invest customer cash in securities, but they would have to do so through a third party such as a bank, in a bid to provide more transparency.

From the New York Times:

The revelation that client money was missing at MF Global has incited panic in the once-quiet futures industry. MF Global's customers, including farmers, hedge funds and other investors, are still owed millions of dollars.

Now, some customers say they are losing faith in a system that promised to protect their money. While brokerage firms can invest client money, such funds must never be comingled with company funds.

MF Global violated that principle in its final chaotic days, tapping its segregated client accounts to meet its own financial obligations, people briefed on the matter have said. About $200 million in customer money that disappeared from MF Global surfaced at one point at JPMorgan Chase in Britain, the people said.

The missing money, thought to be as much as $1.2 billion, has prompted several federal investigations in recent weeks. The futures commission is leading the hunt for the money, while the Federal Bureau of Investigation is examining potential wrongdoing.

Some regulators are also examining a flood of new rules for brokerage firms, part of an effort to prevent a repeat of the MF Global debacle.

Among these is the SEC, which is examining new regulations for accounting disclosures.

"As recent events have highlighted, the protection and preservation of customer funds is fundamental to our markets," Scott O'Malia, a Republican member of the CFTC, said in a statement. "By limiting investments of customer funds to a subset of instruments that currently have minimal risk, this final rule is a step towards enhancing customer protection."

ABOUT THE AUTHOR
Melanie Rodier has worked as a print and broadcast journalist for over 10 years, covering business and finance, general news, and film trade news. Prior to joining Wall Street & Technology in ...