* Comment period for proposed CFTC margin rule ends Friday

* Rule changes decades-old futures industry "ecosystem": broker

* Swaps users see rule as providing necessary protections

By Christine Stebbins and Ann Saphir

CHICAGO/SAN FRANCISCO, Feb 13 (Reuters) - The Commodity Futures Trading Commission is bracing this week for a barrage of criticism over a proposed rule that brokerages say could cost the industry tens of billions of dollars.

At issue is a single sentence in a lengthy rule proposal tied to the landmark Dodd-Frank financial reform law. The sentence requires futures brokers "at all times" to have funds that exceed the sum of customer deficits.

Regulators stung by massive losses of supposedly safe customer funds at failed brokerages MF Global and Peregrine Financial say the rule will help protect customer money by preventing the use of extra funds from one customer to cover temporary shortfalls of another.

William Thum, The Vanguard Group's top derivatives lawyer, said that such rules are only fair, and are already standard practice in the vast over-the-counter swaps industry. No trader, he and other investment fund managers say, should be on the hook for another trader's loss just because both happen to use the same broker.

But brokers in the quadrillion-dollar U.S. futures industry argue that current practice, which allows them to credit the excess funds of some customers against the deficits of others for short periods, reduces costs for all traders while protecting funds from improper use.

"You want customer protections. But you also want to make sure you're not obliterating a whole market sector potentially, which would be the very futures commission merchants that handle commercial hedge business," said Diana Klemme, vice president of Grain Services Corp, an advisory firm that helps many grain elevators and farmers hedge using grain futures contracts.

In the normal course of futures trading, customers put up funds, called margin, to back their positions, and are required to pony up more when their trading positions go against them. Their margin requirements drop when their positions gain in value, but customers will often leave extra funds at their brokerages as a cushion against future margin calls.

Under the new rule, brokerages would be required "at all times" to have funds on hand that exceed the sum of all customer deficits, effectively forcing them to keep much more capital than they do now. That capital, they say, will need to come from customers, raising costs.

The CFTC is also demanding futures traders meet demands for new money, so-called margin calls, in one day, not three as is the current case.

Klemme and others say the new rule would change the way the U.S. futures industry has worked most of its history, requiring customers in many cases to prepay margin requirements to ensure they have adequate funds in their accounts, brokers say.

Additionally, some traders argue that requiring customers to lodge even more money with their brokers than they do now makes the industry even more vulnerable to the loss of customer money through the kind of mishandling that took place at MF Global and Peregrine Financial.

ISDA, the main lobby group for swaps dealers, told regulators last week that the new rule could cost $200 billion to $250 billion for derivatives industry as a whole.

While big banks, hedge funds and brokers may have little problem meeting that requirement, it's an entirely different story for smaller brokerage houses with smaller customers whose pockets aren't as deep, brokers said.

Gerald Corcoran, chief executive of futures broker RJ O'Brien, told a CFTC panel last week that it would be difficult to comply with a proposed rule demanding real-time measurements of margin requirements.

"The ecosystem just can't handle it right now," Corcoran said. "You just can't get margining and settlement prices tick by tick throughout the day, especially in the less liquid markets ... We don't even know what the margins are on a real-time basis."

The firm, which is the largest independent U.S. futures brokerage, processed 50,000 paper checks from its retails clients last year, according to Corcoran. If the new rules take effect, the check-writing customers would have to double or triple their margin requirements to ensure they have adequate funds in their accounts, he said.

"This will be a very, very costly impact to farmers and ranchers to meet their daily margin requirements," Corcoran said.

So far, the CFTC has received more than 70 comments on its proposed rule change, with industry groups - including National Grain & Feed Association, the largest U.S. grain trade group, and the Futures Industry Association - planning to send additional comments by a Friday deadline.

Michael Dawley, who runs Goldman Sachs' futures business and also heads FIA, warned that the single sentence could upend the futures industry and put many brokers out of business.

"It's one of the most monumental events that I've ever seen," he told regulators last week. "If we have to go down that path, I would encourage the (CFTC) to spend a lot more time focusing on the unintended consequences. It may be the right decision long term, but don't underestimate how big of a deal it is."

Regulators remain skeptical that the costs would really be that big and say the flip side of the debate currently is the unacknowledged costs of the system tied to having diligent, well-margined customers, in effect financing those who take hours or in some cases days to meet margin calls.

While they acknowledge that the new rules would not have prevented the customer losses from the MF Global and Peregrine failures, they say the industry cannot withstand another failure, for any reason, and that the current way customer margins are handled makes the industry vulnerable.

Vanguard's Thum agreed. "We don't want our margin excess to support other customers," he said. "Our shareholders are watching this space very carefully. They do not want to see our margin used for any reason."

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