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Opalesque Futures Intelligence

National Futures Association Board of Directors Contested Election

Friday, January 13, 2012

Deep Managed Futures Industry Issues Surface in NFA Election

With regulatory issues faced by the National Futures Association (NFA) punctuated by the MF Global saga, two well-known industry veterans are running for two separate slots on the NFA board, jointly proposing a fresh look at the managed futures regulatory structure. Ernest Jaffarian and Doug Bry are challenging two other well-known industry participants Aleks Kins and Craig Caudle.  Mr. Kins and Mr. Caudle were the only candidates recommended by the NFA nominating committee while Mr. Bry and Mr. Jaffarian successfully petitioned to be on the ballot.  Ballots are being sent out and must be returned by January 17, 2012.  For additional details, visit www.nfa.futures.org.

The election dialogue fits in perfectly with today's debate, highlighting what makes the managed futures industry so different from typical hedge fund and equity-based investment offerings. 

Jaffarian + Bry:

A Strong Call For Aggressive NFA Participation, Transparency and Even Handed Disclosure Requirements

Ernest Jaffarian operates a diversified Commodity Pool (CPO), Efficient Capital Management, where he invests in different commodity trading advisor (CTA) investments. Douglas Bry operates one such CTA, Northfield Trading.  These well known industry participants took the main industry issues in bold statements during an interview.

When asked if they are running in response to regulatory issues, Jaffarian explained, "Our industry is not in a business-as-usual environment.  The MF Global bankruptcy and the way it has been handled have compromised the integrity and sanctity of segregated funds.  In short, this is a crisis.   Many have been seriously hurt; many have risen up to work hard for change.  NFA needs to play an active and aggressive role brokering changes that will address the failings of the past without overly burdening the future."

"Our firm knows literally hundreds of CTAs, and we have seen the damage and the hurt that has come as a result of MF Global," noted Mr. Jaffarian.  "I believe it's the responsibility of all of us in the industry to restore the integrity of our investor protections, and I can't really say that without rolling up my sleeves and doing everything that's within my power to see that we make it right.  I am motivated in running for this position to make sure that the integrity of our industry is restored.  This is a critical time, and we must respond to the challenge."

"It's the responsibility of all of us in the industry to restore the integrity of our investor protections," Ernest Jaffarian, President, Efficient Capital.

"I have been a CTA for 21 years, previously served on both the NFA and MFA Boards, and have always thought that client segregated accounts were 100% safe," said Doug Bry, President of Northfield Trading LP.  "Investors need to know that their funds are secure and that the markets are fair.  We as an industry need to do everything we can to make sure that MF Global investors recover all their funds.  Our future depends on it."

Jaffarian continued, "Among the bigger issues that have existed historically, the emergence of managed futures mutual funds that are subject to the 1940's act is a positive development.  The NFA is at the nexus of regulatory harmonization between the SEC and CFTC, as well as central to the resolution of promotion and disclosure issues, and that is where we can effectively tackle these big issues.  It is experience and integrity, not popularity, that will take the day in solving these issues."

"It's very clear that the SEC and the CFTC take very different approaches toward regulation.  I want to help the regulators and investors achieve their goals.  But, what often happens with the regulators' desires to protect an investor… does not protect.  Instead, it prohibits the investor from seriously considering the investment in a proper way," Ernest Jaffarian, President, Efficient Capital.

"It's very clear that the SEC and the CFTC take very different approaches toward regulation when there are investment products that intersect both agencies such as is evident in the ‘40 Act space," observed Mr. Jaffarian.  "I want to help the regulators and investors achieve their goals.  But, what often happens with the regulators' desires to protect an investor is that the agencies seek to impose the full force of their regulations, producing a confusing environment that actually does not protect.  Instead, it prohibits the investor from seriously considering the investment in a proper way.  In summary, regulations and investors need to be fairly aligned."

When considering proper risk disclosure, Mr. Jaffarian made an interesting observation, "Yesterday while driving home from the airport, I noticed a huge casino billboard advertising, ‘We have more slots, we have more tables, we have more winners.'  How accurate is that?  Are casinos disclosing the true mathematical risk of loss in gambling?"

 "We need appropriate disclosures in managed futures that are clear and make the investments accessible without being confusing.  It's very easy for an ‘unsophisticated investor' to make a huge investment in extremely volatile stocks while being prohibited from investing in managed futures, an investment that potentially could provide mitigation to the volatility in a stock-oriented portfolio.  These things have to be looked at in clear and practical ways, and the regulatory agencies should cooperate in ways that do not overburden or overcomplicate the regulatory environment," stated Mr. Jaffarian.

Both Jaffarian and Bry favor transparency into the activities of the segregated fund accounts in the context of both the investor and regulators.  Jaffarian noted, "Transparency gives regulators the ability to respond more quickly."  There are two parts to protecting client funds, the first is restrictions on what FCMs can do with seg funds, and the second is transparency so that customers can vote with their feet if they don't feel safe.  Seg fund balances, whether held by a third party or the FCM, should be reported and checked daily.  The idea is that in addition to whatever restrictions are in place, the market will determine what is acceptable.  "How many people would have stayed at MF Global if they knew what risks were being taken with their funds," Bry concluded.

"I don't believe rethinking and redefining the regulations in providing transparency is going to require more manpower," Doug Bry, President of Northfield Trading.
In regards to additional investor protection, the duo discussed potentially utilizing an insurance fund for segregated accounts that might be organized at the exchange and FCM level.  "I don't believe rethinking and redefining the regulations in providing transparency is going to require more manpower," noted Mr. Bry.  Further Bry indicated, "Cleaning things up may actually be less of a burden in some respects.  I am not in favor of creating any additional financial burden except that which is absolutely necessary for the integrity of the industry."

"When we talk about a protective insurance fund, that will require some financing and broad industry participation.  But, there are ways to accomplish this that need to be explored," Bry and Jaffarian said.  "There is already a fund set up at all of the exchanges that guarantees the integrity of the transactions, but not to protect segregated funds on the FCM level,"

Kins and Caudle:

Bold Views on MF Global, The State of Managed Futures Political Representation, Investor Protections, Transparency and Restoring Investor Confidence

Opposing Mr. Bry and Mr. Jaffarian are NFA nominating committee endorsed candidates CEO Craig Caudle, president of diversified commodity pool operator Liberty Funds, and CEO Alex Kins, founder of transparent CTA investment platform AlphaMetrix, both of whom expressed equally strong and frank views regarding current issues facing the managed futures industry, which were outlined in statements sent to NFA members.

Regarding the MF Global situation, "The inability to manage risk associated with the account for a period of time and the lack of information from all parties involved was something I have not based in my 20 years in the business," Mr. Caudle noted.  There is plenty of blame, fault, and misinformation still being spread around from the situation. The idea that NFA (National Futures Association) was not fully engaged in the MF situation from the outset and that the NFA should have been more proactive is a bit misguided."

Noting an important regulatory line in the sand, Mr. Caudle continued: "The NFA does not have direct oversight of FCM's who are also a members of the exchange.  MF Global was a clearing member of many exchanges. The exchange therefore acted as Designated Self Regulatory Organization (DRSO). MF Global's registration as a Broker-Dealer complicated matters.  The SEC, FINRA and SIPC took the lead on the situation which put the CFTC in a subordinate position.  The NFA had people on the spot to assist and advise the CFTC at every opportunity. Protecting the customer's assets and the interest of our industry has been paramount," he said, noting he expected some rule changes to occur as a result of the MF Global scandal.

"With all of the money the Managed Funds Association spent on lobbying and time spent educating government officials, one would think they might have been able to act quickly to impact the situation positively."  Craig Caudle, CEO, Liberty Funds

Hitting on a topic typically discussed in hushed tones around LaSalle Street, Mr. Caudle didn't back down from speaking candidly about the subversion of industry lobbying groups by Wall Street financial lobby interests.  "The Managed Funds Association (MFA), founded years ago by the CTA/CPO community, has become a large Washington D.C. presence with many politically active employees. Although the MFA is now dominated by hedge funds, this organization is still supposed to represent the managed futures industry's interests in Washington.  With all of the money MFA spent on lobbying and time spent educating government officials, one would think they might have been able to act quickly to impact the situation positively."

Mr. Caudle's tough talk didn't just address the defacto lack of a strong voice for the managed futures industry, he also picked up on a theme discussed by many who remember the days when exchanges were membership only entities.  "The exchanges would also seem to be any place to direct more criticism and concern. Previous FCM bankruptcies were handled immediately by the exchanges and the clearinghouse. Now that exchanges are public corporations has their role in the industry and responsibility to customers changed?"
Fellow candidate Aleks Kins made equally strong statements, but started by addressing a larger issue.

"There is one issue that is currently more omnipresent than MF Global," Mr. Kins noted, touching on the misperception that often comes from painting Wall Street investment banks with the same brush as managed futures. "It deeply saddens me to see that the financial industry in general has been vilified in the court of public opinion in the last few years.  It further saddens me that with the recent developments at MF global the crisis of confidence has hit home in the futures industry."

Highlighting what makes managed futures different from a typical hedge fund investment, Mr. Kins noted the importance of investor protections.  "I feel that transparency and systemic integrity is the only way to build confidence in the industry. Solutions must be developed by regulators so that increased reporting requirements, such as Dodd Frank, do not create increased burden and expense for industry participants.  In short is my opinion that rule 1.25 which allows FCM's to invest client capital in a wide array of instruments including but not limited to mortgage-backed securities agencies and sovereign debt is far too liberal and acted as a catalyst in the downfall of MF global."

"FCM's should be required to develop automated daily reports that divulge their segregated customer account balances and holdings to exchanges.  Appropriate information such as compliance to guidelines need to be made public," Alex Kins, CEO, AlphaMetrix

Outlining what he plans on accomplishing, Mr. Kins finished, outlining rather important points.  "If reelected I would advocate three very important and necessary reforms that would a greatly mitigate the risk of the collapse of any FCM in the future and be creating mechanism to make clients of FCM's whole if the FCM collapses the three concepts are:
A New World: In our post-2008 world the scope of instruments allowed under CFTC rule 1.25 must greatly narrow what once was considered low risk such as G 10 sovereign debt is now high risk and regulations must change to adapt

Increased Transparency: FCM's should be required to develop automated daily reports that divulge their segregated customer account balances and holdings to exchanges.  Appropriate information such as compliance to guidelines need to be made public.

Recovery Mechanism: A new mechanism such as FDIC for bank depositors needs be developed to protect the clients of FCM's in case the completely unforeseen happens in the future.  The CME has a record of no default at the exchange for 150 years.  Many industry participants do not realize is that the clearing facility protects a default from one member to another member but does not contemplate the clients of FCM's. As such, the 150 year record of the CME remains intact even after MF global.  A committee should be formed that is comprised of exchange members and CFTC members to develop a recovery mechanism. A viability study should be prepared which contemplates government and free market solutions such as pools or bonds."

For additional information visit:
www.NFA.Futures.org
www.EfficientCapital.com
www.NTLP.com
www.AlphaMetrix.com
http://www.LibFunGrp.com



 
This article was published in Opalesque Futures Intelligence.
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