In London the volume of trade in key base metals has almost halved since the collapse of MF Global, says Robin Bhar, commodities analyst at Credit Agricole CIB. “We are still waiting for the fallout to subside,” says Bhar, adding that trading has not been helped by the deepening of the eurozone debt crisis and the ongoing weakness in parts of the global economy.
In the US the worst affected markets were oil, natural gas and agricultural futures trading on the Chicago Mercantile Exchange (CME). Some people who have been hurt by the collapse are talking tough: “We are in a bankruptcy hearing and our money is being treated as if we were the company’s creditors, which we are not,” says John Mayer, board member of the Commodity Customer Coalition (CCC), a 7,000-member group of former MF Global clients which includes fund, commodity trading advisers and individual investors.
“My money has effectively been stolen and now I am told that I am free to open an account somewhere else. So that somebody else can steal my money too?” asks Mayer, adding that the resentment of commodity investors about the way they were handled in the wake of the company’s collapse has deterred a large number of them from coming back into commodities.
Andrew Lamb, chief executive of CME Clearing House in Europe, says that one of the key lessons to be learned is that clearing houses should have more legal power to transfer collateral in client accounts when an intermediary collapses and that clearing houses need to be ready for “military-style operations to marshal clients’ money.”
The first signs that there was something seriously wrong at the company emerged in the spring when US regulators noticed that the broker had removed some of the assets it had pledged as collateral on repo-to-maturity debt transactions. By August, the Financial Industry Regulatory Authority had asked the firm to boost its capital levels because of its exposure to European debt.
The situation eventually boiled over after October 25th when the company reported rising losses in the third quarter. In quick succession its shares were sold down by over 50%. Ratings agency Moody’s Investors Service cut the company’s debt ratings to a step above junk. At the same time, MF Global began talking to a potential buyer; but those talks collapsed as it became apparent that there was a shortfall of money in the company’s accounts. By October 31st the company had filed for Chapter 11 at the US bankruptcy court in New York, listing assets of $41bn and liabilities of $39.68bn. Within hours MF Global’s staff was barred from trading, including on the CME, where it carried its biggest exposure, and within days from the London Metal Exchange, the Intercontinental Exchange and a host of almost 30 other exchanges.
The worst fallout has been in the US where regulators found that there is potentially more than $1.2bn missing from segregated client accounts. In Australia, a regulatory loophole, which is now likely to be addressed by Australia’s securities regulator, allowed MF Global to effectively pool client funds for hedging purposes, something that is forbidden under the UK or US regulatory regimes. “There has been no evidence of something similar in the UK,” says Monica Fiumara, senior spokesman at KPMG, the administrator for MF Global’s European operations. Regulators are still trying to piece together how the shortfall actually came about. The Commodity Future Trade Commission’s (CFTC’s) Scott O’Malia admits that “at this time, we have not identified the cause of the segregation shortfall”.
MF Global’s situation is unique in respect of missing funds from segregated accounts. There have been bigger bankruptcies in the past, notably Lehman Brothers, or the collapse of commodities broker Refco in 2005. However, client funds in segregated accounts were always safe and were eventually returned to their holders. “We always thought that the concept of segregated accounts was sacrosanct, that money from such accounts could never disappear. There have been bankruptcies before, but ever since the Chicago Mercantile Exchange was formed in 1870 nobody has ever lost a single penny from a segregated account. That certainty is now gone,” says Mayer.
What made the situation worse for commodities investors is that all futures accounts were frozen, leaving the markets to move against locked-in traders. Then when about 10% of the accounts were moved to other futures brokers by the CME, the margin deposits with MF Global were not transferred. The exchange was in a bind, and could effectively only transfer the collateral it controlled itself.
Commodity investors have to deposit a level of margin with a broker to ensure that they are able to pay for all their future transactions. Smaller investors frequently put up almost the maximum of their finances in the account to be able to leverage their trade.
With margin deposits still in MF Global, a lot of investors had no way of raising additional cash which they needed to deposit with a new broker, and they hastily closed out their accounts. On top of that, new brokers asked for a higher margin because of the risk involved. A total of $410m has been transferred; meanwhile some 5,000 accounts were placed with ten other clearing firms that trade on the CME.
The CME thinks it has come under misplaced criticism for its handling of the fallout from the collapse. In a terse statement issued on November 17th, the CME said: “In response to inaccuracies reported yesterday, CME Group confirmed today that it followed CFTC requirements and CME rules and procedures in reviewing MF Global’s segregated funds statements and coordinating that review with the CFTC. CME was advised in the early hours of Monday, October 31st that there was an actual shortfall in the segregated funds account and was told the CFTC was advised concurrently. Shortly thereafter, CME Group discussed the shortfall in a conference call with the CFTC and other regulators. CME Group is confident that it complied with all its obligations as a designated self-regulatory organisation (DSRO) pursuant to the Commodity Exchange Act.”
The CME’s Andrew Lamb says the exchange’s hands were tied on the issue and that the decision was made by the trustee, James Giddens, who handles MF Global’s accounts. “A clearing house can only transfer with client positions the collateral that it holds. If they are held at an intermediary, like MF Global, they are not accessible by the clearing house—the only collateral that can be ported is the collateral that it has possession of,” says Lamb. However, he notes that in future clearing houses should have more legal right to protect the clients’ money.
Those MF Global’s commodity clients that had open positions retrieved between 4% and 20% of the money they had with the company, depending on how much margin they had deposited with the broker, explains CCC’s Mayer. “I only got 5% of my investment back,” adds Mayer, who is a long-time commodities investor. “You can see how I would find it galling,” he says.
Clients who had no open positions but only held a cash deposit had no access to their money for the first two weeks but then the release of $520m was negotiated that will give cash clients around 60% of their money back. What will happen with the remaining 40% remains an open question.
In Europe, where the administration of the company’s assets has fallen to KPMG to handle, none of the clients’ money has yet been returned. When KPMG took over there were approximately 1.6m open positions across 30 jurisdictions. Since then, positions on most of the big exchanges have been liquidated, as have over-the-counter (OTC) positions in metals and plastics, while other positions have been moved to other brokers.
Richard Heis, KPMG’s joint special administrator, explains that the delay in returning clients’ money stems from the sheer volume of accounting entries the administrators had to make and the fact that now that MF Global UK has been cut off from exchanges and clearing houses “a significant amount of book squaring needs to happen manually”.
The administrator has been discussing with the UK Financial Services Authority whether it would be feasible to distribute some money to clients but it has said that the final distribution won’t happen until all client risk positions have been liquidated or transferred and all claims have been validated.
However, a few companies stand to benefit from the demise of MF Global. One of them is US broker INTL FCStone, which is said to be in the process of buying MF Global’s ring dealing seat on the London Metal Exchange (LME) and taking over the company’s metals trading team. MF Global had share holdings in the LME valued at around $8.05m and now that several exchanges have expressed an interest to buy the LME, those shares could shortly become worth much more.
Another part of MF Global’s operations that is likely to attract a buyer is the company’s over-the-counter diesel and fuel business, a lucrative but less visible part of MF’s energy operations. Even so, the winners are too few compared to the sea of traders who had their fingers burnt in the process and who point to exchanges, clearing houses and regulators as the ones who should have protected them from the fallout.
The soul searching has already begun and CFTC’s O’Malia says that the situation has highlighted areas that the commission should re-examine, including “the manner in which it ensures that intermediaries are complying with segregation requirements and its role in protecting customer positions and funds in the days leading up to and following the insolvency of an intermediary”.