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Last year when Gold shot up suddenly, something happened. FCMs which
had a concentration of clients following certain gurus, or gold bugs or
Y2K disaster scenarios suddenly realized a huge increase in customer
equity.
The owner of one large retail group at a midsize FCM I know of confided
to industry friends that the gold surge was the largest single daily
increase in equity his firm had ever had in 20+ years in the industry.
That same firm is now supposedly looking for a new clearing firm
relationship. Whether those two facts are related is not known.
What is known though, is that for a smaller privately owned FCMs, a huge
increase in customer equity from a big market move can be a cost raising
experience. If the FCM owner doesn't have the cash or securities
readily available, then they have to use lines of credit to add capital
to meet regulatory requirements. Use up the normal lines of credit
because of an exceptional move in customer equity, and capital might get
more expensive for the smaller FCM. This assumes the capital is
available. It could also mean brokerage firms reining in skilled
proprietary traders during times of good opportunity because they don't
have the capital necessary to facilitate their needs.
The other way for FCMs to get under the regulatory requirements during
times when their own equity is not enough to meet the regulations and
other capital is hard to come by or costly to acquire, is to send home
customer equity. That means the account you have sitting on the brokers
books, but have not traded recently, has a good chance of getting
temporarily jettisoned if your FCM needs to repatriate to clients the
customer's equity to meet capital requirements.
Now, I am not saying a crash is imminent, though it is a much discussed
issue these days. I am not saying that there are FCMs which are ill
prepared to meet extraordinary demands for capital, though there are
differences among FCMs worth noting. However, it is wise to be aware of
what can happen if a firm over leveraged firm is caught in a sudden need
to meet regulatory capital requirements due to client successes.
Personally, I think the concentration of index traders at some firms
could be a concern. Late last year I was hearing stories of retail
brokerages where 70% of the monthly volume for the whole firm was in the
indices. A lot of this was e-mini traders and online traders. A firm
with a customer profile like that, which was already in a highly
leveraged capital to customer equity position, could be a candidate to
have to send out equity.
Maybe getting your money out of a brokerage firm during stock market
volatility is not all bad. However, if you were expecting to be able to
actively trade, and you find you have no money in your account it would
be a problem.
Sometimes during chaotic times, brokerages find a big brother firm to
shore up their capital requirements. A FCM which uses a bank as an
exchange clearing relationship might be in a better position than an FCM
which is a stand alone FCM/Clearing member all in one, depending on
their size and if they have a corporate parent with a large
capitalization and such.
I write this not trying to scare people, but rather to raise awareness.
I write this acknowledging that I have conflicts of interest on the
subject, as my employer is a Guaranteed IB with a clearing agreement
with a large multinational futures clearing firm with a what I consider
a big balance sheet. Thus, take my words with a grain of salt.
My suggestions to traders if they were concerned with this issue would
be to look over the capital to customer funds ratio of the FCM which
holds your account. This information is available from the CFTC
website. Compare this ratio to other firms with similar customer type
profiles and see where it falls. If you have some reason to be
concerned, consider opening a second commodity account at a firm with
big balance sheet and a more balanced clientele. If your primary broker
needs to send out some funds, they can send them right to your secondary
broker and you don't miss a beat.
Regards,
John J. Lothian
Disclosure: Futures trading involves financial risk, lots of it!
Disclosure: John J. Lothian is the President of the Electronic Trading
Division of The Price Futures Group, Inc., an Introducing Broker
clearing ED&F Man International, Inc.
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