CME Group filed proposed rule changes with the Commodity Futures Trading Commission that would create a new category of clearing membership, termed a “Direct Funding Participant.” Under CME Group’s proposal, a DFP could clear all of its eligible proprietary CME Group trades directly with the CME clearinghouse but would not be obligated to contribute to CME Group’s guaranty fund or otherwise be responsible in case of a default by another clearing member. Instead, all of a DFP’s obligations (except for obligations arising from disciplinary actions against a DFP) to CME Group would be guaranteed by at least one other clearing member – termed a “DFP Guarantor” – that must also be a CME Group clearing member and be registered with the CFTC as a futures commission merchant. A DFP Guarantor’s guarantee fund deposit would be adjusted to account for the activity of the DFP it guarantees. DFPs would settle their margin requirements directly with the clearinghouse; however, if they did not, their financial obligations would have to be met by their DFP Guarantor. DFP margin requirements would be 104 percent of ordinary margin requirements, and DFP guarantors would have additional regulatory capital requirements equal to 4 percent of a DFP’s margin requirement. A DFP Guarantor would be authorized to prescribe risk controls for its DFP at CME Group exchanges, including credit controls, increased margin levels and concentration limits, among others. A DFP Guarantor could perform back-office functions for its DFP. According to CME Group in its submission to the CFTC, the purpose of its proposed initiative is, among other things, to eliminate the possibility of a customer receiving a pro rata loss allocation in the case of an FCM bankruptcy where the FCM was left with insufficient resources to satisfy its obligations to all its customers in full. In addition, CME Group claimed that its proposal could help an FCM by eliminating the posting of cash by a DFP on the FCM's balance sheet and thus the possibility of a potential increase to the FCM’s regulatory leverage capital ratio. CME Group’s DFP proposal is scheduled to take effect on the earlier of September 23, 2016, or upon CFTC approval.
My View: In its rule proposal submission to the CFTC, CME Group acknowledged that some clearing members object that FCMs may potentially incur increased regulatory capital charges to serve as a DFP Guarantor. They argued that DFPs themselves should pay a minimum margin of 108 percent of requirements, as opposed to 104 percent, and there should be no additional capital requirements for a DFP Guarantor. CME Group rejected this argument, claiming that its proposal was more equitable and questioned “whether the DFP program does in fact create heightened capital requirements on the DFP Guarantor as compared to the capital requirements set out for FCM clearing members with respect to customers under Commission regulations.” (This is because under CFTC capital rules, FCMs potentially must set aside 8 percent of a customer’s margin requirements for positions carried with it. As a DFP Guarantor, an FCM would only potentially be required to set aside 4 percent of a DFP’s margin requirements.) This latter argument by CME Group clearly has merit. However, CME Group’s initiative is certainly more advantageous to FCMs with significant excess regulatory capital as opposed to FCMs will less excess regulatory capital. It also is not clear to me from my initial review of the proposed new rules what is the obligation of a DFP Guarantor because of its guarantee of a DFP in a situation where the clearinghouse levies an assessment on all clearing members because of the large default of another clearing member. That being said, even if there is some fine tuning before these proposed rules are finalized, CME Group’s proposal would help customers that want to minimize their FCM risk and should be approved by the CFTC.