The U.S. futures regulator on Wednesday adopted further protections for customer collateral posted in swap trades, an area of heightened importance as the search continues for hundreds of millions of dollars in missing MF Global customer money.

The Commodity Futures Trading Commission also will vote on its draft of the Volcker rule that cracks down on banks' risky trading, a version similar to one introduced by four other regulators last October.

The measure to protect swap traders' collateral used in trades to reduce risk was approved by a 4-1 vote with CFTC Republican Jill Sommers as the lone dissenter.

The rule was called for in the Dodd-Frank financial oversight law, but efforts to boost protection and segregation of customer collateral have gained momentum following the collapse of futures brokerage MF Global last October.

Investigators have estimated there is a $600 million to $1.2 billion shortfall of customer funds. Regulators have said it appears MF Global improperly diverted customer funds for the firm's use.

Chairman Gary Gensler said the CFTC is taking a broad look at protection of customer funds. He said the agency will review proposals from market participants and consider making recommendations on further safeguarding client collateral.

The CFTC, he said, also will determine whether it would be appropriate to eventually consider segregation protections for futures that are similar to those we hope to adopt today for swaps.

Scott O'Malia, a Republican CFTC commissioner, warned the rule approved on Wednesday only addresses one of three categories of risk that an intermediary such as MF Global can pose to customers.

I believe that it is important to detail (our rule's) limitations, so that we do not offer market participants a misleading sense of comfort in light of the collapse of MF Global, Inc, said Scott O'Malia, a Republican CFTC commissioner, who supported the rule despite some concerns.

It protects against fellow-customer risk, but not two others: that an intermediary improperly segregates cleared swaps customer collateral or that an intermediary experiences losses on its investment of cleared swaps customer collateral, which it cannot cover using its capital, he said.

The rule to protect swap traders' collateral, close to what the CFTC proposed in April, allows brokers to pool customer collateral but would prevent them from comingling the funds with their own capital.

It also lays out what happens in the event of a default. If one occurs by both the clearing member and one or more of its customers, the clearinghouse can only collect collateral of the defaulting member, or its own resources.

Each individual account would be legally protected and funds from non-defaulting members could not be tapped to cover losses from another firms' default.

Bart Chilton, a Democratic commissioner, pushed for further measures to protect U.S. investors and consumers.

I believe that the lessons of MF Global teach us that we don't have the luxury of time in making additional progress to protect customers. We need to do more. And we need to do it now, said Chilton.

The CFTC has finalized nearly two dozen rules, but it is behind on completing much of a regulatory framework for the $700 trillion over-the-counter derivatives market required under the Dodd-Frank law. Many of the high-profile and controversial rules remain.

VOLCKER RULE

The CFTC also will propose its Volcker rule that is designed to prevent U.S. banks from trading with their own funds and prohibit banks from investing in or sponsoring, beyond a small amount, hedge funds or private equity funds.

It would have the most impact on large banks such as Goldman Sachs and Morgan Stanley.

The CFTC said its proposal largely mirrors an October proposal from the Federal Reserve, Securities and Exchange Commission, Federal Deposit Insurance Corp and the Office of the Comptroller of the Currency that is now open to public comment.

The CFTC's proposal, however, includes about a dozen questions asking whether certain provisions of the joint Volcker rule should not apply to banking entities regulated by the CFTC. The proposal will be open to a 60-day public comment period.

The CFTC also will vote on Wednesday to finalize at the meeting rules for registration of swap dealers and major swap participants, and business conduct standards for swap dealers and major swap participants with counterparties.

The futures regulator has tentatively scheduled a rule-making meeting for January 25 when the CFTC is expected to vote on joint rules with the Securities and Exchange Commission on defining a swap dealer and a major swap participant.

(Reporting By Christopher Doering; Editing by Bob Burgdorfer and David Gregorio)

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