Chicago, Ill.—Nov. 15, 2013—CME Group, Futures Industry Association, the Institute for Financial Markets and National Futures Association today announced the release of a study on the economic feasibility of adopting an insurance regime for the U.S. futures industry.
The study was commissioned by the four sponsoring organizations in November 2012 and was conducted by Compass Lexecon, a consulting firm that specializes in the application of economics to legal, regulatory, and policy issues. Christopher L. Culp, an expert on risk management with extensive consulting experience in both insurance and derivatives, led the team that conducted the study.
“The objective of the study was to analyze and quantify the potential costs of various scenarios, including a government-mandated solution similar to what exists today in the securities industry as well as voluntary market-based solutions provided by private insurance companies,” Culp said. “The study does not provide any policy recommendations, but the hope is that it will assist policy makers by clarifying the amount of insurance coverage that could be obtained through these solutions and the potential costs for each.”
The study examined four models for providing customer asset protection insurance (CAPI) for losses arising from the failure of futures commission merchants (FCMs) and developed quantitative estimates for the potential costs of two models in particular. The analysis was based on customer account data provided by six FCMs ranging in size from large to small as well as risk exposure data provided by CME and NFA.
The four models were:
- CAPI provided to individual futures customers by primary insurance carriers;
- CAPI provided to customers of individual FCMs that purchase insurance on behalf of all of their customers;
- CAPI provided to customers of FCMs opting to participate in a captive insurance company backed partially by reinsurance; and
- CAPI provided to all customers of all FCMs under a government mandate.
To assess the potential commercial viability of the first three models, all of which would be provided by insurance or reinsurance companies on a voluntary basis, Compass Lexecon contacted a number of insurance companies to discuss the potential design and solicit realistic indications of the potential costs.
The insurance companies commented that the first two models would be too cost-intensive relative to the number of customers and assets at risk, and identified several structural impediments related to the provision of CAPI to customers or specific FCMs directly. The study therefore concentrated on developing detailed indications of the economic feasibility of the third and fourth models.
With respect to the third model, the study found that there was an interest among insurance companies in offering CAPI on a voluntary basis to U.S. futures customers. In particular, a syndicate of eight insurance companies submitted an indicative term sheet for a captive insurance company called the Futures Industry Customer Asset Protection Insurance Company (FICAP). While not a formal proposal, such a term sheet may be indicative of the potential terms that such a consortium would be interested in offering.
As proposed, FICAP would initially cover up to $300 million in claims by customers of participating FCMs. The first $50 million in losses would be covered by a first-loss deductible funded in part by the participating FCMs. The additional $250 million in coverage would be provided by the consortium of insurance companies, subject to a proposed maximum payout of $50 million per FCM. The total cost of such a program, including reinsurance and annual fees, was estimated at $18 million to $27 million per year, although the final cost would depend on actual underwriting analyses, the number of participating FCMs, and negotiations between FCMs and the insurance companies.
Based on the indicative term sheet provided by the syndicate, Compass Lexecon assessed the potential cost for FCMs that opted to participate in FICAP as well as the potential cost for their customers. The study found that the indicative terms were restrictive, but noted that negotiations on an actual deal might lead to terms more favorable to FCMs and their customers.
With respect to the fourth model, the study assessed the viability of offering the same kind of protection that is afforded to securities investors by the Securities Investor Protection Corporation. Under this model, a Futures Insurance and Customer Protection Corporation (FICPC) would provide up to $250,000 to all customers of every U.S. FCM to cover losses arising from the failure of under-segregated FCMs. FICPC would be funded by mandatory payments from FCMs of up to 0.5% of each FCM’s annual gross revenues from futures up toa stated target funding level of $2.5 billion.
The study estimated the annual funding amounts for such a program and the amount of time it would take to reach the target funding level of $2.5 billion. The study determined that it would take approximately 55 years to reach the target funding level, assuming no interim losses, and concluded that under these assumptions a government backstop would likely be necessary to close the gap between actual funds available and potential customer liabilities in order to lend credibility to the program in the short run.
The insurance study is the latest in a series of initiatives taken by the futures industry to enhance customer protections and address the concerns raised by the collapse of MF Global and Peregrine Financial Group. New rules and systems have been put in place to provide customers with more information about the status of their funds and the financial condition of their FCMs. In addition, the industry’s self-regulatory organizations have put in place systems to receive daily confirmations from all depositories holding customer segregated funds as well as new rules that will strengthen internal controls and hold senior executives accountable for authorizing the movement of customer funds and preventing any misuse.
The executive summary of the study and the full text of the study can be found on each of the sponsors’ websites.
Background on the consulting firm:
Founded in 1977, Compass Lexecon’s Chicago office pioneered the application of economics to legal and regulatory matters. As one of the world’s leading economic consulting firms, Compass Lexecon provides law firms, corporations, trade associations, and government clients with clear analyses of complex issues. Compass Lexecon has been involved in a broad spectrum of matters related to economics and finance, providing critical insight in legal and regulatory proceedings, strategic decisions, and public policy debates. The firm’s experience and expertise apply to virtually any question of economics, in virtually any context of the law, regulation, or business.
Christopher L. Culp is a Senior Advisor with Compass Lexecon, Adjunct Professor of Finance at The University of Chicago’s Booth School of Business, and Professor of Insurance at Universität Bern (Switzerland) in the Institut für Finanzmanagement. He has written four books and co-edited two books about derivatives, risk management, insurance, and/or structured finance. Dr. Culp has extensive practical consulting experience in derivatives, risk management, insurance and reinsurance, and clearing and settlement.
Background on the four sponsoring organizations:
About CME Group:
As the world's leading and most diverse derivatives marketplace, CME Group (www.cmegroup.com) is where the world comes to manage risk. CME Group exchanges offer the widest range of global benchmark products across all major asset classes, including futures and options based on interest rates, equity indexes, foreign exchange, energy, agricultural commodities, metals, weather and real estate. CME Group brings buyers and sellers together through its CME Globex® electronic trading platform and its trading facilities in New York and Chicago. CME Group also operates CME Clearing, one of the world’s leading central counterparty clearing providers, which offers clearing and settlement services across asset classes for exchange-traded contracts and over-the counter derivatives transactions. These products and services ensure that businesses everywhere can substantially mitigate counterparty credit risk.
About FIA:
Futures Industry Association (www.fia.org ) is the leading trade organization for the futures, options and OTC cleared derivatives markets. It is the only association representative of all organizations that have an interest in the listed derivatives markets. Its membership includes the world’s largest derivatives clearing firms as well as leading derivatives exchanges from more than 20 countries.
About IFM:
The Institute for Financial Markets (www.theIFM.org) is a 501(c)(3) nonprofit educational foundation and independent, non-partisan source for information and education regarding financial markets. In addition, the IFM supports and publishes peer-reviewed studies in the Review of Futures Markets, a financial journal. The IFM gratefully acknowledges the support of the Clearing Corporation Charitable Endowment, which allows the IFM to fund independent research studies.
About NFA:
National Futures Association (www.nfa.futures.org) is the self-regulatory organization for the U.S. derivatives industry, including on-exchange traded futures, retail off-exchange foreign currency (forex) and OTC derivatives (swaps). Membership is mandatory, assuring that everyone conducting business with the public on the US. futures exchanges and in the retail forex marketplace must adhere to the same high standards of professional conduct. NFA membership also is mandatory for swap dealers and major swap participants. NFA develops and enforces rules, provides programs and offers services that safeguard market integrity and protect customers.
For further information, please contact Karen Wuertz at NFA at +1 312.781.1335 or kwuertz@nfa.futures.org.
