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(Kitco News) - The Commodity Futures Trading Commission is proposing new rules to strengthen customer protection and is looking for a better benchmark for interest rates following a scandal where London banks were manipulating a key interest-rate benchmark.

Gary Gensler, chairman of the CFTC, said finance serves the economy and allows “the public unfettered access to markets and information, and (establishes) prices transparently and free of fraud and manipulation.”

Since the credit crisis in 2008, the agency has been working to apply new regulation to the changing world of finance, and is finalizing steps to regulate the trillion-dollar swaps industry by the end of this year.

Gensler gave comments to a futures industry conference in Chicago on Thursday via videotaped remarks. Gensler was scheduled to speak at the conference on Wednesday, but Hurricane Sandy prevented his travel.

Gensler spoke about two proposals that the CFTC is seeking public comment for: customer protection, specifically about segregating customer funds, and ensuring safe interest-rate benchmarks. He also briefed conference participants on the work done regarding swaps.

He touched on a topic that remains a very sore point in the futures industry, the bankruptcy of MF Global, which happened exactly one year ago Wednesday, and Peregrine Financial Group. In both cases, client funds were supposed to be walled-off from the firm’s own capital. Instead, monies were comingled and customers of those firms lost funds. Most have received some money back, but it’s unlikely anyone will be made whole.

There’s been a push to improve customer protection by the exchanges, firms and regulators, but damage has been done, with lower trading volume one casualty.

The CFTC, with input from the public and market participants, is proposing a rule that would strengthen the controls around customer funds at futures commission merchants. Further, the rule would set new regulations for accounting for these types of funds and would raise the minimum standards for independent public accountants who audit the futures commission merchants. Regulators would have daily direct electronic access to these firms’ bank and custodial accounts for customer funds.

Gensler also touched on the LIBOR scandal, where banks manipulated the London Interbank Offered Rate, which is an average interest rate calculated by major banks in London submitting their interest rates. The LIBOR rate is a reference rate for half of U.S. adjustable-rate mortgages.

He said there are four questions that market participants and international regulators are grappling with to make a sounder benchmark rate. One, what are the best practices to ensure a reliable benchmark? Two, how do the current survey benchmark rates measure up regarding best practices? Three, what are possible alternatives, and four, how does the industry transition to a better rate?

Gensler updated the work CFTC is doing to finalize, by the end of this year, three initiatives to standardize the trading of swaps, including the requirement that swaps be cleared, reforms to increase transparency and the cross-border application of Dodd-Frank rules.

A swap is the exchange of one security for another and has grown into a $648 trillion global market that was largely left unregulated, and problems in the market helped to set off the 2008 credit crisis. Earlier this year, the CFTC defined swap contracts to include foreign exchange swaps and forwards, foreign currency options, commodity options, cross-currency swaps and forward-rate agreements.

Futures contracts go through a clearinghouse, which takes the opposite position of every trade. Swaps are now to be cleared. “Central clearing equalizes access to the market and democratizes it by eliminating the need for market participants to individually determine counterparty credit risk,” he said.

The CFTC finalized rules earlier this year that requires swaps transactions to be processed straight through to the clearinghouse, which reduces the time between putting on the trade and the trade being accepted. This step helps to increase pre-trade transparency, Gensler said, and helps move over-the-counter swaps transactions to facilities like designated contract markets and swap execution facilities.

In July, the CFTC sought public comment on the clearing of standardized swaps, which is the last step to begin clearing the first set of swaps.

Gensler said the initial policies for clearing interest-rate and credit default swaps could be finalized as early as November. By February, swap dealers and the largest hedge funds would need to send these types of swaps for clearing, with regulations in place for other market participants by summer 2013. 

Increased transparency on interest-rate and credit default swaps is expected to kick in by 2013, when the public can see real-time reporting for these swaps and for uncleared swap transactions by swap dealers, he said. Since mid-October, swap dealers started to report cleared interest-rate and credit default swaps to swap data repositories.

“This post-trade transparency will lower costs for the rest of the economy and help financial markets better serve their function,” Gensler said.

The CFTC commissioners are now looking at recommendations regarding the final rules for swap execution facilities and minimum block sizes, he added. Gensler said the increased transparency will mean greater liquidity and better price competition for the swaps market.
The CFTC is also prepared to finalize the cross-border regulation requirements under Dodd-Frank, in consultation with the international regulatory community, he said.

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By Debbie Carlson of Kitco News dcarlson@kitco.com

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