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New regulations aim to prevent clearinghouses, such as those run by Chicago's CME Group Inc., from mixing customer funds with their own.

Regulators approve Dodd-Frank investor protections in wake of MF Global

by Peter Rawlings
Jan 11, 2012

The Commodity Futures Trading Commission voted 4-1 to approve new rules designed to rein in the type of trading in derivatives by banks that helped fuel the 2008 financial crisis.

The new regulations include requirements that brokerage firms and derivative clearing organizations, such as the clearinghouse for Chicago's CME Group Inc., store customer funds in separate accounts from the institutions' own collateral.

Commissioner Bart Chilton said imposing stringent restrictions on where customer money is kept is more important than ever in the wake of MF Global Holdings Ltd.'s bankruptcy, which may have left customers short as much as $1.2 billion. The MF Global bankruptcy “is now a constant clanging bell alerting us that we have to change in order to ensure that customer funds―tax payers' money―are taken care of, first and foremost, before anything else,” Chilton said in his opening statement.

Clearing organizations, which facilitate the trading of derivatives by guaranteeing the credit of buyers and sellers, will also now be prohibited from using the funds of others clients to back such trades or to cover defaults. “For the first time, customer money must be protected individually all the way to the clearinghouse,” said CFTC Chairman Gary Gensler.

However some analysts think the new measures are mostly redundant―the government already prohibits spending customer money to pay company debts. “I'm reminded of the town with the bridge with a 50 mph speed limit, and when somebody crashed while going 100 mph they changed the speed limit to 25,” said John Cochrane, a professor of finance at the University of Chicago Booth School of Business.

The CFTC also voted to establish standards for the marketing of derivatives by swap dealers, who will have to report the value of their total outstanding swaps every day. Credit default swaps―arrangements by which one party agrees to insure another party against the default of a loan―featured prominently in the 2008 financial crisis, when so many people defaulted on their mortgages simultaneously that the insurance the swaps were supposed to provide could not be paid out.

Leading up to 2008 “many customers were not provided a full picture of the risks of various products, including specifically mortgage-backed securities,” said Commissioner Scott O'Malia. The new rules aim to remedy this by requiring a daily update by dealers of the outstanding value of their swaps.

The CFTC will also implement stricter guidelines for deals with so-called special entities, such as pension plans and endowments. In order for swap dealers to trade with these entities, the new rule will require the dealer to have a “reasonable basis” to believe the entity has a representative that meets certain standards, such as sufficient knowledge of the risks of swap transactions and independence from the swap dealer.

The sole dissenting voice in the vote on the new rules belonged to Commissioner Jill Sommers, who had concerns that the CFTC had not been able to study the regulations thoroughly. “The external business conduct rules are lengthy and extremely complex and I do not think we have taken sufficient time to fully consider all of their implications,” Sommers said.

She also objected to the commission's “piecemeal approach” to legislating, pointing out that several of the entities subject to the new regulations―such as swap dealers and major swap participants―would not be technically defined by the commission until a subsequent vote on Jan. 25.

New rules governing the registration of swap dealers with the CFTC passed unopposed.