Late last year the CFTC proposed changes in the rules governing how Futures Commission Merchants (FCMs) invest client cash. Those rules — 30.7 and especially 1.25 – become infamous post MF Global. The evolution of those rules is well known. In December 2000 the CFTC allowed FCMs to invest client money is securities beyond US Govies and Munis, including “…general obligations issued by any enterprise sponsored by the United States, bank certificates of deposit, commercial paper, corporate notes, general obligations of a sovereign nation, and interests in money market mutual funds…” in the mix. In 2004 and 2005 the rules were again amended, one change allowed internal repos between the FCM and an affiliated broker/dealer. The rest is history.
So now the FCMs find themselves looking to where they can place their client cash. It is not surprising that some instruments and types of transactions are now off limits – internal repos and foreign sovereign debt. But the updated rules also imposed instrument and issuer-based concentration limits where there were none before. Munis are subject to a 10% instrument cap. GSE securities had no limit before – but are now subject to a 50% cap. CDs, CP, and corporate notes are limited to 25% of the assets in segregation. Money market funds go from no limits to a 10% instrument based cap and a 2% issuer cap (based on the family of funds). Repos are subject to a 5% counterparty concentration limit.
FCMs are now placed in the awkward position of retaining liquidity for their client funds but having to manage this using the new instrument and issuer constraints. Our Street contacts tell us the result has been FCMs reaching out to more repo counterparties. Short-term repos retain liquidity and, if there are enough broker/dealers in the mix, works for the counterparty concentration limits.
We wonder about how the rules deal with money market funds that may trade repos with the FCM’s affiliated broker/dealers? Would the rules look through to the counterparties and make those money market funds off limits? That is a very hard constraint to manage and one of those questions that no one likes to ask.