In November 1986, shaken by traders' losses after a brokerage went bust, the U.S. futures industry considered, and then rejected, the notion of insuring customer funds in a broker default.
The collapse last month of MF Global Holdings Inc, and hundreds of millions of dollars of still-missing customer money, is forcing a rethink of that 25-year-old decision.
Executives at the National Futures Association have been talking with senior management at CME Group Inc and other market participants about how best to safeguard customer funds in future broker bankruptcies, Dan Driscoll, NFA's chief operating officer, told Reuters in an interview.
Under discussion is the feasibility of a government-sponsored insurance fund modeled after the Securities Investors Protection Corporation (SIPC). Another option is an industry-sponsored bailout fund, Driscoll said.
Neither response would prevent a broker's misuse of customer funds, as CME has said happened with MF Global, but some type of insurance could help restore shattered faith in the industry, helping allay growing fears that money parked at futures brokerages simply is not safe.
In the past, one reason there hasn't been a SIPC is there hasn't been a clearing firm that went bankrupt and lost customer funds, Driscoll said. Now there is. It's a big amount of money, and it really has an impact on customer confidence.
But questions about how to pay for such insurance hang over the debate. Both schemes could make trading more expensive, forcing brokers -- many of whom have seen profit margins shrivel -- to push more costs down to customers.
MF Global was one of the biggest U.S. futures brokerages until it filed for bankruptcy protection on Oct 31, after revelations it had made a bad $6.3 billion bet on European sovereign debt, sparked a liquidity crunch.
Customers are still struggling to get their frozen funds back, and the bankruptcy trustee estimates that as much as $1.2 billion in customer funds has simply disappeared.
CME, which puts the estimate of lost money significantly lower, has offered $50 million to repay customers stuck with losses after the final accounting.
A CME spokeswoman declined to comment on whether CME would support an industry-wide bailout fund for customers.
Could there be a SIPC-type approach for futures? Yes, said Don Horwitz, of Oyster Consulting in Chicago. It's not as if they could just overlay it, there are some costs, but this will be one of the things I'd think would be considered.
After the collapse of the Bernie Madoff ponzi scheme in late 2008, SIPC raised its broker assessments from a flat $150 per firm per year to a quarter of a percent of yearly operating revenues, costing bigger firms hundreds of thousands of dollars, Horwitz said. All told SIPC collected $410 million last year.
Talks among industry leaders so far have been one-on-one, Driscoll said, but in coming days there would be an effort to bring participants around a table to hash out a formal set of proposals.
Adopting an insurance scheme, particularly one modeled after that used to backstop securities markets, would be an about face for the futures industry, which has long said its customer funds are safer and its markets more reliable and transparent than the highly regulated world of stock trading.
Created in 1970 to help restore confidence to the securities markets, SIPC has authority to use its funds to pay back securities customers up to $500,000 per account when brokerages fail. The insurance, which is funded by member brokers, does not cover futures accounts.
The futures industry seeks to protect customers by requiring brokers to wall off customer accounts from their own funds.
The system is an important selling point for CME, which touts the stringency of fund segregation in materials aimed at winning business from fund managers.
The safety of customer fund segregation was also among the reasons that NFA cited when it recommended against adopting a bailout fund 25 years ago, in the wake of the collapse of Volume Investors, a brokerage on New York's Commodity Exchange. With $13.7 million in customer funds, it was one of the largest futures brokerage failures of its time.
By contrast, MF Global had about $5.5 billion in funds when it went under.
COMEX -- which is now owned by CME -- in the end spent $3.6 million repaying traders who lost money in the bankruptcy. The payout equaled about 12 percent of the average customer funds held by a futures broker at the time.
Futures trading has skyrocketed since then; an equivalent payout today would come to $170 million, based on the latest figures on futures customer funds published by the Commodity Futures Trading Commission.
In a 122-page report entitled Customer Account Protection Study, dated November 20, 1986, the NFA concluded that insolvencies were so rare and fund segregation and other protections so strong that it does not appear that even retail customers would require a public commitment to account insurance to maintain participation in the futures industry.
Post MF Global, that argument no longer passes muster. Trader anger at the brokerage and its regulators is mounting, and many smaller market participants are pulling or threatening to pull their money from futures markets.
Volume Investors' 1985 failure affected fewer than 100 traders. MF Global had tens of thousands. Industry executives say that if industry does not come up with its own solutions, change will be foisted on it.
I don't think they'll get off without a fix, Horwitz said.
Not all market participants support the idea.
John Roe, a Chicago broker and former MF Global customer, said he fears an insurance scheme would only encourage risk taking by assuring traders there will always be a savior ready to pick up the pieces should something go wrong.
When there's a car wreck, do you look for a better tow truck? Roe asked. Let's build a better car.
(Reporting by Ann Saphir; Editing by Alden Bentley)