Keeping all the clients of a failed futures commission merchant connected to the derivatives market in a stressed environment will be a tall order and not everyone will wind up happy, according to members of the CFTC’s Market Risk Advisory Committee.
Committee members suggested three possible way that clients could remain connected to the market rather than having a central counterparty liquidate clients’ positions, during the committee’s third meeting with the CFTC.
One of the simplest methods to maintain a market connection would be for FCM clients to designate a backup FCM when establishing a relationship with their primary FCM, according to Kevin McClear, general counsel at ICE Clear Credit. “They should be ready to port their accounts in the unfortunate circumstance that their primary FCM becomes insolvent.”
However, Luke Zubrod, director of risk and regulatory advisory services at Chatham Financial, sees the minimum fees charged by FCMs could lead smaller financial entities to forego establishing a backup FCM.
“These fees generally range from about $60,000/year minimum to about $120,000/year or more depending on circumstances and the FCM,” he explained. “This could prove prohibitive for someone who is going a single hedge over a five-year period. They would have to agree to $300,000 to $600,000 just for the benefit of clearing that one interest rate swap.”
Instead of relying on FCMs’ clearing services, clients theoretically could self-clear their own accounts, suggested Sunil Cutinho, president of CME Clearing before he knocked down his own suggestion.
“Self-clearing is beyond the reach for a vast number of client because of their charters,” he said. “They cannot participate in mutualization nor can they become clearing members in some cases.”
The most likely scenario likely would consist of a CCP porting a portion, or all, of a failed FCM’s portfolio of client accounts to other FCMs, which would require the use of gross margining according to Cutinho.
“Porting has been successful in the United States through several circumstances,” he added. “We’ve done this during the financial crisis, before the financial crisis, and post-financial crisis.”
Since porting would need to be done as quickly as possible, CCPs cannot let the receiving FCMs cherry-pick from the failed FCM’s portfolio of clients, Cutinho advised. “An FCM would take the entire client portfolio or subsegments of it.”
To facilitate account porting, CME Clearing proposed a new rule ,in which CCP members would share end-client information with their CCP so that the CCP may maintain contact with end users during a port.
The rule is still in play, acknowledged Cutinho. “We have given our firms a timeline to comply with it,” he added.
Featured image via CFTC
