UPDATE 1-Insurance against failed futures brokers would be costly -study

Fri Nov 15, 2013 5:28pm EST

By Tom Polansek

CHICAGO Nov 15 (Reuters) - An insurance program to protect U.S. futures traders from financial losses when a brokerage collapses would come at a high cost, according to a study released on Friday, which was quickly criticized by a top U.S. regulator.

Bart Chilton, a member of the U.S. Commodity Futures Trading Commission, cast doubt on the findings because the study was funded by futures-industry groups supported by firms that have opposed insurance programs.

The National Futures Association (NFA), Futures Industry Association, exchange-operator CME Group Inc and the Institute for Financial Markets commissioned the study last year. It analyzed the potential costs and benefits of four insurance models, but did not make a recommendation on whether any option should be pursued.

The most feasible privately run option studied seemed to be a proposal from eight insurance companies to create a captive insurance company that would offer coverage to futures customers on a voluntary basis, said Christopher Culp, who led the study for the consulting firm Compass Lexecon.

That proposal would initially cover up to $300 million in claims by customers of participating brokers. The total cost of the program was estimated at $18 million to $27 million a year.

"The proposal is a bit restrictive and costly," Culp told reporters on a conference call.

The NFA said the study reported objective data.

"I'm like Deep Throat on this insurance study - follow the money," Chilton said. "Look, firms don't want to pay for an insurance pool to protect customers. Now we have a study funded by those guys that gives reasons why it's a bad idea. I'm certainly not shocked."

The industry began considering insurance after the high-profile failures of brokerages MF Global in 2011 and Peregrine Financial Group in 2012 resulted in the loss of hundreds of millions of dollars in customer money. MF Global's commodity customers have since been paid back.

After Peregrine's demise, Chilton proposed a futures industry version of the Securities Investor Protection Corp (SIPC), which covers up to $500,000 in losses to customers of bankrupt stock brokerages. Chilton has said he will leave the CFTC soon.

A government-mandated program similar to SIPC "would be significantly under-funded to meet its initial target funding level," according to the study.

The study analyzed a program that could provide up to $250,000 to all customers of U.S. futures brokers, known as futures commission merchants (FCMs), to cover losses arising from the failure of firms that are short on client funds. It would be funded by mandatory payments from FCMs, up to a stated target funding level of $2.5 billion.

However, it could take 55 years to reach the target funding level, and a "government backstop" likely would be needed to close the gap between actual funds available and potential customer liabilities, according to the study.

CME Group, the world's largest futures exchange operator, has previously said a public insurance fund would be too expensive and unfair to the biggest brokers.

The study found it would be "too cost-intensive" for primary insurance carriers to insure individual futures customers and for brokers, known as futures commission merchants (FCMs), to purchase insurance on behalf of all their clients.

Earlier this year, a survey of more than 500 futures traders and firms from Feb. 28 to April 15 by the grass-roots advocacy Commodity Customer Coalition found that 91.5 percent of respondents supported the creation of a customer-protection fund. The coalition helped futures customers get their money back after MF Global and Peregrine failed.