Patricia N. Gillman:Limitations on who may trade in the futures markets

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欢迎发表评论 2013年05月31日12:44 来源:和讯网 



US Counsel on behalf of Winton Capital Management Limited的Patricia N. Gillman
US Counsel on behalf of Winton Capital Management Limited的Patricia N. Gillman

    和讯期货消息 由上海期货交易所主办的“上海衍生品市场论坛”将于2013年5月28-29日在上海举办,本届论坛的主题是:期货市场的创新与转型。和讯期货作为独家财经网(博客,微博)络直播本次会议。US Counsel on behalf of Winton Capital Management Limited的Patricia N. Gillman做了主题演讲。


  It’s an honor to be here today. I would like to thank the Exchange for asking me to speak at this prestigious conference. It’s a particular pleasure because, for the last six months, I’ve been working with the Exchange staff on updating their rulebook. This has been a huge and exciting undertaking.

  The Exchange has asked me to speak about the Dodd-Frank Act. But they also asked another question that I’d like to answer first. That question is--are there limitations as to who may tradeon the US futures markets?

  I. Limitations on who may trade in the futures markets

  Only indirectly does the Commodity Futures Trading Commission (CFTC) limit who may trade on its markets. However, various CFTC registrants (commodity pool operators (CPOs), commodity trading advisors (CTAs) and futures commission merchants (FCMs) as well as the Securities and Exchange Commission (SEC) also impose limits. For example,The CFTC recognizes that futures trading is extremely risky and that only risk capital should be used if one is to trade in the futures markets. At the direction of the CFTC, the National Futures Association (NFA) has adopted rules and procedures requiring FCMs to use a “suitability test” to determine whether a customer should be allowed to open a futures account.

  This test does not set forth a particular amount of money that an investor should own or any other bright line test. Instead, it directs the FCM to look at all the facts and circumstances of each case: the age of the investor, his annual income, his net assets, the amount of his proposed investment as a percentage of his net assets, his debts, his experience in investing in derivatives and other, similar factors’s. In fact, many FCMs do require a minimum investment and if this minimum is too large in proportion to the proposed investor’s profile, will decline to open an account.

  Both the CFTC and the SEC have imposed financial requirements for persons who wish to invest in certain instruments. The CFTC limits swaps trading to Eligible Contract Participants (ECPs). These are mostly businesses in the financial industry and in commerce,and high net worth individuals. Retail customers (in this case, persons who are not ECPs) can only access this market if they invest in a fund that satisfies the definition of an ECP.

  Also, if a fund limits its investors to all or almost all qualified eligible persons (QEPs), it doesn’t have to comply with many of the reporting and recordkeeping requirements imposed on commodity pools. This CFTC rule provides a strong incentive for CPOs to exclude non-QEPs. An individual will satisfy the definition of a QEP if he or she has at least $2 million in securities investments or has had $200,000 in futures margin or option premiums on deposit with an FCM during the last 6 months.

  Most hedge funds require an investor to have net assets of at least $1.5 million. In this way they meet the definition of a “qualified client” in order to satisfy an SEC rule. A person who isn’t a qualified client can’t be charged a fee based on profits (we call this type of fee an incentive fee.) Today many if not most fund managers charge an incentive fee and therefore exclude persons who are not qualified clients.

  Years ago when I was an attorney at the CFTC, the markets consisted primarily of hedgers, floor traders and individuals trading their own accounts directly or with the help of their FCM. There were very few funds (that is, commodity pools) or individual managed accounts traded by commodity trading advisors.

  The composition of the markets has changed significantly over time. Today, most of the capital invested in the futures markets comes from large speculators such as hedge funds and commodity pools and individual managed accounts owned by sovereign funds, pension plans and very high net worth traders. A retail trader wanting to participate in the futures markets is most likely to invest through a hedge fund.

  Now we turn to the Dodd-Frank Wall Street Reform and Consumer Protection Act, known as Dodd-Frank. I’m going to start with a brief history of swaps up to July of 2010 when Congress passed Dodd-Frank.

  II. Brief history of the swaps market

  Swaps trading was created in the early 1990s for banks to hedge interest rates and foreign exchange. As liquidity grew, banks started to see swap trading as another product to offer to speculators and hedgers. Throughout the decade, users of the market expanded to include hedgers other than banks, such as airlines wanting to hedge fuel costs, and hedge funds and sovereign funds looking for new, liquid investments to trade.

  The types of swaps grew from the plain vanilla (where one party wanted to exchange his fixed rate with a second party having a floating rate) to highly complex instruments that might have an embedded option. The result was an unregulated market which today amounts to a huge $633 trillion globally.

  III. The Commodity Futures Modernization Act of 2000

  In the late 1990s, the CFTC decided to examine the swaps market because of its growing size. In the futures markets, size often brings risk, as you well know. Dealers in swaps (mostly large Wall Street banks and brokerage houses) and certain industry groups like those involved with energy products lobbied Congress to prohibit the regulation of swaps and other non-futures derivatives.

  The resulting Act, The Commodity Futures Modernization Act , was a dream for those who favored deregulation. The SEC was banned entirely from regulating the swaps markets, The CFTC could continue to limit swaps markets to Eligible Contract Participants and permit swap trading on electronic markets. Otherwise it too could do little else.

  For those unfamiliar with the term ECP, here are some examples: a financial institution such as a bank, an insurance company, a mutual fund, a commodity pool with assets under management of more than $5 million, a pension plan, a broker-dealer or FCM or an individual who has amounts invested of at least $10 million.

  IV. The Events of 2007-2008

  During this period, the use of Credit Default Swaps (CDSs) as well as mortgage-backed securities almost brought down the US financial markets. A CDS acts like a form of debt-default insurance. The buyer of the CDS makes a series of payments to the seller. These payments are known as the CDS fee or spread. In exchange, the buyer will receive a payment (usually the face value of the loan) in case there is a loan default.

  At first, only persons actually hedging a loan they had made purchased CDS protection. As the market grew bigger, speculators also were drawn to the CDS market. By the end of 2007, the outstanding amount of credit default swaps was an enormous $62.2 trillion. (Source: Wikipedia)

  As the result of the market disruption in this period when mortgage backed securities went into default and CDSs were triggered, one very large investment house (Lehman Brothers) was allowed to go into bankruptcy and two well-known, old-line brokerage firms (Baer Stearns and Merrill Lynch) were forced to allow themselves to be bought by other financial companies.

  In addition, the writer of most of the CDS products, an insurance company by the name of AIG (American International Group), needed a massive infusion of capital from the US government as it had to pay out on the CDS contracts it had written to many Wall St. banks.

  V. With this history we turn to Adoption of Dodd-Frank Act

  A massive piece of legislation with 16 titles in 2300 pages of text, it was passed by Congress in the middle of 2010. Dodd-Frank was enacted to protect the economy from very large banks and other very large traders who might take the economy into a freefall if they became financially unstable.

  Also, because of the harm done by the CDS market, Congress took a long look at the enormous growth in the size of the swaps market. It decided that swaps trading also presented the opportunity for harm to the US economy because, in the US, only 5 Wall Street banks accounted for over 90% of all swaps trading.

  In the words of one commentator, the purpose of Dodd-Frank was to change swaps trading from an “opaque bilateral market to something where there is some price transparency and a more open and automated market.”

  Of the 16 Titles, we are most interested in Title VII, which directs the CFTC and SEC to impose extensive regulations on swaps trading and swaps traders. The requirements of Title VII in particular are so complex that three years after the Act’s passage, no more than 40% of the rules it requires have been adopted by the financial agencies, like the CFTC and SEC.

  We begin with a description of who is a systemically important trader under the Act.

  Dodd-Frank requires large actors in the swaps market to register and provide data to the federal government.

  The first large actor we’ll talk about is the Swap Dealer defined as a person holding itself out as a dealer in swaps; one who makes a market in swaps, or regularly enters into swaps with counterparties in the ordinary course of business for its own account.

  The CFTC has provided an exemption for Swap Dealers who engage in small amounts of swaps trading. (By small amounts they mean a person who has traded swaps with an aggregate gross notional amount of no more than $8 billion in the prior 12 months. This is the most important of the definitions. There are others we haven’t time to discuss.)

  The second large actor is the Major Swap Participant (MSP)

  An MSP is a person maintaining a substantial position in swaps in any major swap category. Note that hedge positions in swaps do not count when determining whether a person is an MSP. I’ll define the terms substantial position and major swap category in just a moment.

  Why regulate a Major Swap Participant? Let me offer two of several reasons:

  Its outstanding swaps create substantial counterparty exposure that could seriously and adversely impact the US banking or financial system; and

  It’s a financial entity that is highly leveraged in proportion to the amount of capital it holds and maintains a substantial position in outstanding swaps in any major swap category.

  What are the duties of Swaps Dealers and Major Swaps Participants? There are 5.

  Monitoring trading to prevent violations of speculative position limits (which we will discuss later). This includes:

  implementing an early warning system to avoid exceeding spec limits;

  testing its procedures to make sure it doesn’t exceed spec limits;

  documenting compliance with spec limits quarterly; and

  auditing procedures annually.

  Establishing risk management procedures for its daily business.

  Swap Dealers and MSPs must take into account market risk, credit risk, liquidity risk, foreign currency risk, legal risk, operation risk, settlement risk and an all-purpose category for all other relevant risks.

  Disclosing to the CFTC and other regulators general information on its trading, its practices and its financial integrity.

  Creating internal systems to obtain the information to perform all its required duties.

  Refraining from acting in an anticompetitive way or in restraint of trade

  What is a “substantial position” in the case of a Major Swap Participant?

  This is a position where the MSP has a daily average current uncollateralized exposure of at least $1 billion in each specific category, including credit swaps, equity swaps, or other commodity swaps such as a swap based on a physical commodity and the rate swap category the amount is $3 billion.

  In other words, cleared swaps are excluded from this calculation because they are collateralized.

  As you can see, the definition of MSP has been designed to catch only the largest traders.

  B. The next topic we’ll discuss is the requirement to clear standardized swaps

  First, You may be asking “What are standardized swaps?”

  These are contracts in which the terms for the specific grade and quantity of product tend to be the same. The only non-standard term is the price. These are sometimes called “Look Alike” contracts because they follow the terms of contracts traded on the futures markets.

  The Commission, with the assistance of the exchanges, is determining what contracts are standardized and must be cleared.

  What contracts don’t fall under this category?

  These are contracts with customized terms. For example, an airline may use a special kind of fuel, want a quantity that specifically matches its needs and want to liquidate the contract at a specific time. Customized contracts are generally traded by companies that are using the swap as a hedging tool.

  What are contracts “unavailable for clearing”?

  At least at this time, the CFTC is unwilling to force a Central Counterparty to clear a contract. If no CCP will clear it, then it is allowed to be executed bilaterally and certain requirements will apply as to collateral that needs to be posted between the parties.

  What are CCPs?

  These are Central Counterparties or what we in the futures industry refer to as clearinghouses. These have been created to clear standardized contracts. Unlike in the futures markets, which began with each exchange having its own clearing house, there is an expectation that swaps may be cleared on CCPs unaffiliated with the exchange on which the swap is executed.

  Swaps are deemed to be riskier than futures and therefore the margin deposited with the CCP will be higher than for futures. While futures clearing houses set futures margin based on one day’s VaR (Value at Risk), margin for swaps will be set at 5 days’ VaR, although the industry is protesting very loudly and could attempt a lawsuit to force a change in the rule. Americans are very litigious.

  C. Another requirement is that cleared contracts must be executed on an SEF (Swaps Execution Facility)

  A SEF is an electronic trading system or platform that provides an order book that shows all the bids and offers available in the market; and allows participants to enter bids and offers and execute swaps based on these bids and offers.

  This is an enormous step away from the secretive, bilateral market that has characterized swaps trading.The CFTC just passed rules regulating SEFs on May 16, 2013. The Commission has not yet announced the effective date of the SEF rules.

  One commentator (the Tabb Group) found the following benefits to requiring swaps to be executed on SEFS:

  A narrower bid/ask spread;

  A decrease in the size of commissions;

  Greater turnover velocity;

  Smaller trade position size;

  More standardized terms for swaps; and

  Greater migration to the futures markets.

  This last benefit has a new name. It’s called futurization. Of course, not everyone is happy with it, especially the Wall St. banks.

  There are many groups talking about registering as SEFs, including existing exchanges.

  D. Dodd-Frank also requires that all contracts whether cleared or not be reported to a Swap Data Repository (initials: SDR)

  Futures exchanges are required to report to the public throughout the trading day and at the close, all the following information taking place on their exchange: bids and offers, execution prices and volume, to name a few. SEFs will have similar responsibilities.

  But not all swaps will take place on an exchange or SEF. To make sure that regulators and self-regulatory organizations like the exchanges and the National Futures Association get all information on all swap executions whether on an exchange or transacted bilaterally, Dodd-Frank created the SDR.

  An exchange may register to be an SDR or the SDR may be a stand-alone entity. All SEFs must report transactions executed on their facility to an SDR. For an Over-The-Counter (or OTC) swap, most will involve at least one counterparty that is a Swap Dealer or a Major Swap Participant. The Swap Dealer or MSP then is obligated to report the transaction to the Swap Data Repository. There are also rules that apply where neither counterparty is a Swaps Dealer or Major Swap Participant.

  Suddenly there will be light where there was darkness. The SDRs, as a group, will give the regulator a picture of who is trading in the different swaps markets, the size of their positions and any unusual activity that might suggest a risk to the US financial system.

  There is an expectation that several companies will offer SDR services.Thus far we’ve talked about new registrants and new executing, clearing and reporting facilities. We now look at some risk management tools addressed by Dodd-Frank.

  E. Other risk management tools

  i. Speculative position limits, a term I mentioned earlier

  Currently, the CFTC sets spec limits for most of the ag contracts and the exchanges set position limits and position accountability limits (which are more flexible limits) for all other contracts. Dodd-Frank removed this responsibility from the exchanges and gave it to the CFTC for all but the financial futures markets. Financial futures do not have spec limits. Congress also directed the Commission to impose spec limits on certain swaps.

  What is a spec limit? It is the maximum net position in a futures or swap contract that may be held or controlled by a trader during the trading day or overnight.

  Three types of spec limits are set for each contract:

  a limit on what can be held in the spot month,

  a limit on what can be held in a non-spot month and

  a limit for all months combined.

  Usually the individual non-spot month and “the all months combined” limits are the same and the spot month limit is lower.

  Why are they used? Spec limits have been used since early in the 20th century, based on a theory that a trader may be able to corner or squeeze a market (in other words, manipulate a market) if it has a large enough position. Many academic and other research papers have failed to find that spec limits dampen volatility or prevent manipulation, even in the spot month, but Congress appears to want the CFTC to impose them.

  Spec limits do not apply to hedgers.

  The obvious reason is that the futures markets developed exclusively to give hedgers a mechanism to transfer risk. The regulators want to encourage hedgers to use the futures markets. The best way to do this is to promote an orderly market and this is what spec limits are supposed to do.

  For a hedge to be exempt from spec limits, the hedge must obtain a hedge exemption from the Commission or an exchange.

  In some cases this exemption gives the hedger a specific number of contracts they may hold. In other words, they are bound by a position limit related to their need for a set number of contracts equal to the product they are hedging. In other situations, they receive a blanket exemption which, reportedly, some hedgers have used to take large spec positions.

  The spec limit rule adopted by the CFTC, pursuant to the language in the Dodd-Frank Act, did not withstand a court challenge.

  In April the Commission appealed the court’s decision and, according to one Commissioner, will offer a new set of rules for Commission consideration perhaps as early as next month. No information is currently available on how these rules might differ from the last set.

  ii. Another example of a risk tool addressed by Dodd-Frank is Large Trader Reporting

  These are in place for physical commodity swaps and, of course, for futures. Large Trader Reports help the Commission monitor compliance with spec limits, assess the market power of individual traders and assess risk in various futures and swap markets.

  Reporting is the responsibility of the clearing FCM not the trader. In other words, an independent third party submits the data.

  Each contract has a reportable limit, even if it doesn’t have a spec limit. If the trader has a net position that exceeds that limit, a report must be made to the CFTC before the opening of the market on the following trading day.

  Reportable limits are substantially lower than spec limits.

  Here are some examples taken from the futures markets:

  The Spec Limit for soybeans in a single non-spot month is a net 15,000 contracts. The reportable limit is a net 150 contracts.

  The spec limit for corn in a single non-spot month is a net 33,000 contracts. The reportable limit is 250 contracts.

  One of the largest contracts traded on the Exchange, the Eurodollar contract has a Reportable Limit of net 3,000 although it does not have a spec limit.

  iii. Now we turn to another risk management tool. As a result of Dodd-Frank, CPOs, CTAs and hedge fund managers are required to file reports relating to systemic risk.

  The Dodd-Frank Act created the Financial Stability Oversight Council (FSOC), headed by the Secretary of the Treasury. All major financial agencies are members.

  The purpose of FSOC is to monitor the economy for systemic risk caused by the failure of large bank holding companies or large non-bank financial companies. Hedge funds are one example. To fall within their oversight, that is, to be systemically significant, a non-bank financial company has to have assets of at least $50 billion, eliminating almost all hedge funds.

  To assist FSOC in monitoring large traders, the CFTC has developed two forms, one for CPOs and a second for CTAs, and the SEC has developed Form PF for managers of private hedge funds.

  These forms request voluminous detail, especially from the largest registrants as to their structure and holdings.

  The SEC and CFTC forms are similar in the data they request. Large registrants of both the CFTC and SEC generally fill out the SEC’s Form PF. That is where I’ve drawn my examples:

  Just to give you an idea of the depth of information the SEC is requesting: the Form is 42 pages long!

  Reporting is based on regulatory assets under management by the advisor (gross assets without subtracting any borrowings).

  Directions are still incomplete, therefore assumptions may be used if explained by the person filling out the Form.

  We turn to some examples. They request:

  A breakdown of assets under management;

  A description of, including the size of, derivatives held by the filer;

  Details on which investor groups own interests in the fund;

  The fund’s monthly performance reported on both a gross and net basis and based on how it is reported to investors. (Note that the CFTC requires the use of a prescribed formula for calculating performance while the SEC does not.)

  The percentage of assets used in high frequency trading;

  Information on the fund’s liquidity;

  Results from VaR and other stress testing.

  The first sets of Forms have been filed by the various registrants. Persons completing these Forms still have many questions that the two agencies are answering very slowly.

  The biggest question is--what do the agencies plan to do with this information? Do they have the staff to review the Forms and does this staff understand the managed funds industry well enough to draw the proper conclusions from all this data? The answer is: we will see.

  VI. Another important rule. While not required by Dodd-Frank, relates to customer protection.

  The CFTC requires that FCMs segregate customer margin from the FCM’s proprietary funds. We refer to these as seg funds. Maintaining customer funds in a separate account at a bank is supposed to protect these funds in case the FCM becomes insolvent.

  In the past two years, two FCMs have become insolvent and assets belonging to customers have been returned slowly or not at all.

  Peregrine is the easier of the two to describe. The owner of the FCM engaged in fraud, made up numbers to make it seem like his company was growing and successful. NFA uncovered the fraud and the FCM went into bankruptcy.

  With MF Global, the company borrowed seg funds to meet its own margin calls on investments made for its own account. As questions arose about the stability of its investments, the margin calls from the firm’s lenders got larger. In very simple terms, it couldn’t meet these margin calls quickly enough, borrowed a significant amount from its customer seg funds and was discovered by the CFTC and NFA. Its downfall came about in just a few days.

  In each case, the rules respecting segregation did not protect the customer as they should have.

  Under its new customer protection rules, the CFTC along with NFA has proposed and in some cases has already implemented a number of methods to protect seg funds. In the interest of time, I’ll give only one:

  The National Futures Association requires all FCMs to send to NFA electronically, at the same time each day, the amount of seg funds held by the FCMs. In addition, NFA requires all FCMs to direct their banks to send to NFA electronically the amount of seg funds they hold for the FCM. NFA compares the two numbers to ensure that all seg funds are properly accounted for.

  Twice each month, NFA puts on its website the amount of seg funds held by each FCM. In this way, the public has access to these figures and can decide for itself whether it wants to use a particular FCM or transfer its money to another.









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