Comment Text:
SUMMARY……………………………………………………………………………………………………………………………………………
The segregation statement of funds required, funds provided and excess as required for various filings needs to be simplified. The funds required (liability) section consists of nine lines showing how the amount required to be segregated, secured or sequestered is arrived at – the tenth line is amount required. My recommendation is that the method and formula be eliminated and replaced with a single line for the amount required (the total of liquidating values for all customers’ accounts). Optionally an additional line could be included for liquidating values (deficits). The CFTC needs to play a leading role to accomplish this goal.
DETAIL…………………………………………………………………………………………………………………………………………………..
The Commodity Exchange Act (“CEAct”) and the regulations thereunder provide for the protection of customers funds on deposit with futures commission merchants (“FCM”). Specifically the funds must be separately accounted for and segregated. This requirement applies to: (1) funds of customers trading on US contract markets [“segregated”] introduced in 1936; (2) funds of customers trading on foreign markets [“secured”] introduced in 1988 ; and, (3) funds of customers dealing cleared swaps [“sequestered”] introduced in 2011.
Regulations were promulgated under these laws including one for the daily preparation of a segregation statement by FCMs:
Segregated – section 1.32 or its equivalent in 1936
Secured – section 30.7(f)
Sequestered – section 22.2(g)
The statement consists of three sections: funds required, funds provided, and excess funds in segregation. The focus here is on the funds required, or the liability section of the statement.
Section 1.32 has lacked any specificity as to content. It merely asked for the computation of funds required (liability) and provided (assets). So in 1936 it was up to the private sector to devise a method for the computation. For the asset side a list of eligible accounts was sufficient; for the liability side a list of components and a formula was necessary. A method and formula was devised for the liability section. To this day it has continued to be used in all filings for segregated, secured and sequestered. [Credit for creating formula and method goes to Albert Christian, a person associated in 1936 with the Chicago Board of Trade Clearing Corp.]
In 1936 information technology was non-existent. Daily valuations of open position for all the accounts was not feasible. The alternative was to rely on certain control accounts in the general ledger system and a valuation of only a few accounts to determine deficits. This is what the liability section of the segregation statement looked like in 1936.
(1) Customer account balances (debit or credit)
(2) Contract difference account (debit or credit)
(3) Net equity: line (1) plus line (2)- (debit or credit)
(4) Value of accounts in deficit (debit) enter as positive
(5) Funds required to be segregated line (3) plus line (4)
Note that this section does not contain a line for open trade equity. In lieu of that the balance in the contract difference account (line 2) was used. This account is equivalent to the net open gain-loss in customer and carrying broker accounts. Present day practice is to show customers’ open gain-loss for line (2).
Since line (3) consisted of all accounts including deficit accounts (debits) it was necessary to add back deficits to arrive at line (5), the sum of liquidating values (credits) for all accounts. This method and formula has been expanded to include long option value, short option value, securities owned. Essentially, however, the method and formula has remained unchanged since 1936.
The liability section can and should be simplified and that is the recommendation I am making in this submission. The number of lines used could be reduced from ten to one. That single line is the sum of the liquidating values (credits) for all customer accounts. It represents the amount required to be segregated, secured, or sequestered. Most computer software in use already produce this number, or if not, could easily be enhanced to do so.
The key and most informative number is the amount required to be segregated. How that number is arrived at is of little or no importance. A value for the total for accounts in deficit (unsecured) could be included as an additional line. Monitoring total deficits is important.
Further recommendations for this submission are:
(1) Propose by regulation a report listing the financial components of customer accounts: account name, account number, ledger balance, open trade equity, long option value, short option value, value of securities owned, and liquidating value. Report to provide three summary totals for each components: (1) total debits; (2) total credits; and (3) net debit(credit). There would be three reports, one for segregated, another for secured, and another sequestered. The total of liquidating values debit (line 1) is for accounts in deficit; the total of liquidating value credit (line 2) is for funds required.
(2) Propose by regulation a report containing an analysis of excess funds – difference between liability and assets. Main function of this report is to account for the daily change in excess.
Both reports are likely in production at most FCMs.
The language which requires the daily preparation of segregation statements lack specificity as to content. Futures commission merchant could have simply reported the liability section with one line without a challenge from the CFTC. They have not done so because in general they believe all the lines are required. This practice has recently been reinforced when the exchanges mandated daily filing via the Windjammer system.
The position of the CFTC may be that no change in regulations is necessary and that the private sector simplify the liability section on their own. That will not happen! The CFTC must play a leading role in this area. Further there are CFTC forms and schedules calling for multiple lines.
