New NFA Rules: Learning from the MF Global Bankruptcy

First up, lemme give you a brief background of the National Futures Association (NFA).

The NFA is a self-regulatory organization that oversees the futures market in the United States. Its mission is three-fold: (1) to ensure the integrity of the futures market, (2) to protect market participants, and (3) to ensure that all NFA members meet their regulatory responsibilities.

In simple English, this means that the NFA’s job is to make sure that companies who participate in the futures markets play fairly and to protect everyday market ninjas like you and I.

Last May 17, the NFA Board of Directors agreed on new proposals regarding the treatment of segregated funds run by futures commission merchants (FCMs). The new rules were submitted to the Commodities Futures Trade Commission (CFTC) and some analysts believe that it is only a matter of time until they get approved.

But what are FCMs and why is the NFA hot on their heels, you ask?

According to the NFA, an FCM is any individual or organization that:

a) Accepts orders to buy or sell futures contracts, options, or retail off-exchange forex contracts, and
b) Accepts funds from customers to support these positions.

The agency decided to be stricter with these firms primarily because in the past, some have violated certain rules pertaining to handling of their customers’ accounts. Recommendations were made earlier this year after the collapse of MF Global, which was one of the world’s largest financial derivatives brokers.

FCMs are allowed to have residual interest in excess of the amount that is needed to meet segregation requirements. These funds can be used to help fund a customer’s obligations just in case he or she doesn’t have enough cash in his account. An example of where residual interest funds may be used is when one needs to make margin requirements for holding a position.

MF Global was a dealer/FCM that held its own positions in highly leveraged sovereign debt. However, it came to a point where they needed funds to maintain those positions as the market went against them. In order to meet margin requirements, MF Global withdrew excessive amounts of residual interest from its customer segregated accounts to support its positions.

By now, we all know what happened. MF Global couldn’t fight the market and eventually went bankrupt. Not only did it go under, but it blew away all their customers’ funds and created a storm of mistrust in the global financial system.

No one wants a repeat of that financial fiasco. So now, NFA officials have taken it amongst themselves to introduce new rules under the NFA Financial Requirements Section 16.

The new proposal calls for all FCMs to have clearly written policies and procedures with regards to its residual interest in any fund. If it gets approved, firms must cite a target amount (in USD) or percentage that they intend to keep as residual interest in segregated funds.

Furthermore, no FCM will be allowed to withdraw more than 25% of its residual interest in a fund without the written permission of the FCM’s CEO or CFO.

Finally, in order to increase accountability among firms, all FCMs will also be required to submit financial and operational data to the NFA on a monthly basis. They also have to agree to have some of the data they submit to be made available to the public.

These regulations will directly affect FCMs but not really introducing brokers, which make up a chunk of the U.S. forex market. However, in my own ninja opinion, this step by the NFA is worth noting as it helps restore the confidence of the general public back in the financial markets.

Then again, that’s just me. What do you think?

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