Wall Street Crackdown Triggered by MF Global May Get Dialed Back

(Bloomberg) -- After MF Global Holdings Ltd. imploded and more than $1 billion of client money went missing in 2011, Washington ratcheted up restrictions on what futures brokers could do with customer funds. Now, regulators in the Trump era are examining whether the shackles should be loosened.

The rules in question stiffened limits on brokers’ ability to invest collateral that clients post for trades. The Commodity Futures Trading Commission approved the overhaul after former MF Global Chief Executive Officer Jon S. Corzine made wrong-way bets on European sovereign debt that helped trigger the firm’s collapse and set off a political firestorm.

But Wall Street has long complained that the regulations were an excessive overreaction that wouldn’t have even prevented MF Global’s failure. Worse, the industry says the restrictions are unnecessarily eating away at its profit margins, fueling a decline in the number of futures brokers. One worry: a smaller pool of brokers concentrates risk, potentially exacerbating the harm to the financial system if a firm failed.

Those arguments are resonating at the CFTC under Chairman Heath Tarbert, who took over in July as President Donald Trump’s second head of the derivatives regulator. One of Tarbert’s top deputies, Joshua Sterling, said in a speech last month that the agency was evaluating an industry request to ease the requirements, adding that softening them “makes great sense.” The changes Sterling referenced were limited in scope, according to a CFTC spokeswoman.

Leash Loosened

Any potential move would be the latest example of Trump-appointed regulators slackening the tight leash that was put on Wall Street in the years after the 2008 financial crisis. It would also represent a significant de-regulatory step by Tarbert, who directs the agency’s agenda. The former law partner and Treasury Department official has made a point of emphasizing the regulator’s role in promoting economic growth.

“We are focused on getting each issue we face right, not on serving the interests of any particular person or group,” Sterling, who heads the CFTC’s division of swap dealer and intermediary oversight, said in a statement. “As always, any staff recommendation for commission action would be based entirely on sound legal judgment that has a strong basis in fact.”

Changing the regulation would require a lengthy process that involves seeking public comment and multiple votes by the CFTC’s politically-appointed commissioners. Plus, federal agencies rarely grant everything that industry asks for in rule-making requests.

‘People Forget’

Some traders say backpedaling would be a mistake.

James Koutoulas, CEO of hedge fund Typhon Capital Management, said the CFTC’s willingness to re-examine broker rules demonstrates the lobbying prowess of banks. He added that customer funds shouldn’t be used for “unknown and uncompensated” risks.

“It’s beyond the pale,” said Koutoulas, who co-founded the Commodity Customer Coalition in response to MF Global’s bankruptcy. “A crisis happens and then everything tightens up, but then people forget.”

MF Global’s October 2011 collapse badly damaged Corzine’s reputation and embarrassed the CFTC, which faced a barrage of criticism from futures traders for failing to safeguard their funds at a firm it regulated.

‘MF Rule’

Corzine, a former co-CEO of Goldman Sachs Group Inc. and an ex-Democratic governor of New Jersey, had orchestrated about $6.3 billion of bets on some of Europe’s most indebted nations at the height of the region’s sovereign debt crisis. The CFTC alleged that MF Global used customer funds to support its operations as the firm spiraled toward a meltdown. It took years for clients to recoup their money.

The debacle prompted the CFTC to approve what’s known as the “MF Rule” in December 2011. The regulation tightened limits on how brokers can invest margin posted by clients. The CFTC also banned brokers from using customer funds to purchase foreign sovereign debt. In addition, the agency prohibited brokers from using client collateral to lend money to affiliates through short-term repurchase agreements.

The Futures Industry Association urged the CFTC in a letter last month to allow firms to invest in sovereign debt from Canada, France, Japan and Germany and the U.K. The trade group, whose members include Goldman Sachs and JPMorgan Chase & Co., argued that these bonds have “low risk of default” and brokerages should be able to buy and sell them through resale and repurchase agreements.

The FIA also called on the regulator to ease a prohibition on using assets held in customers’ segregated accounts for repo transactions with affiliates. The group said that a number of other restrictions for handling client money should remain in place and the FIA letter didn’t seek a rollback of rules that require brokers to keep clients’ collateral separate from other funds.

Protecting Customers

“FIA has asked the CFTC to review and update its list of permissible liquid investments for customer funds to reflect the regulatory and market developments without change to these important customer safeguards,” Steve Adamske, a spokesman for the group, said in a statement. “This review will help these markets remain vibrant without compromising important customer protections.”

Sterling, the CFTC official, didn’t say in his Sept. 26 speech before a banking industry association which changes sought by the FIA are under consideration by the regulator. Sterling said softening the rules may be a good idea because it would align regulations for futures brokers with those of clearinghouses, which had their restrictions loosened last year.

--With assistance from Robert Schmidt.

To contact the reporters on this story: Ben Bain in Washington at bbain2@bloomberg.net;Silla Brush in London at sbrush@bloomberg.net

To contact the editors responsible for this story: Jesse Westbrook at jwestbrook1@bloomberg.net, Gregory Mott

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