Wounds persist a year later

Nov 2, 2012

Halloween saw the oneyear anniversary of MF Global’s spectacular collapse and declaration of bankruptcy. And while the frights of that experience might be gone along with the trick-or-treaters, the injuries it caused to the agricultural industry remain in the form of shaken confidence and lost trust.

The history of futures trading traversed over a century and a half without a hitch, built as it was on the all-important rule that customer funds were sacrosanct. That worked well until the double-whammy of the collapse of MF Global, which lost customers $1.6 billion, and the similar collapse of Peregrine Financial Group, which put customers out roughly $200 million nine months later. These blows severely reduced the confidence of agricultural investors in the world of futures and securities trading.

“The general tenor is fear,” said James L. Koutoulas, speaking of general perceptions of the trading marketplace. Koutoulas is the CEO of Typhon Capital Management, a past hedge fund client of MF Global and the head of the Commodities Customer Coalition, which is a group of customers fighting for the return of the missing money.

Participation in futures trading has dropped since the events of MF Global due to this lack of confidence in the market place. According to Futures Industry Association data, overall futures and options trading participation dropped 3.3 percent by volume globally for agricultural commodities since January of 2011.

When one looks at CME Group—which includes the Chicago Mercantile Exchange, the Chicago Board of Trade, and the New York Mercantile Exchange— trading activity for futures and options since January of 2011 has gone down 8.9 percent by volume. When just looking at the Chicago Mercantile Exchange itself, the number increases to down 12.9 percent by volume and down 17.8 percent for open interest volume.

The Chicago Mercantile Exchange is one of the largest agricultural commodities clearing houses in the world. Those who were most affected by MF Global, farmers and ranchers, have not been returning to the market as they had.

Walter Lukken, president of the Futures Industry Association, said the effects of MF Global’s collapse, and Peregrine Financial Group’s to a lesser extent, destroyed trust in the system.

“Trust is lost in a moment; it takes a long time to gain it back.”

Some efforts have been undertaken to return consumer confidence in the world of futures trading.

In a letter published Oct. 30 in Futures Magazine, Terrence A. Duffy, executive chairman of the CME Group which oversaw MF Global, told investors and his peers alike:

“Our collective marketplace is too important to the fabric of the world economy to allow these issues to fester. That is why our industry took decisive action. We are demanding even more transparency and more accountability. As a result, a year later we are a better industry and our customers are safer than before.”

He outlined a number of points CME Group—in conjunction with the National Futures Association and the Commodities Futures Trading Commission—has adopted since MF Global’s and later Peregrine Financial Group’s collapse. Among these added safeguards are increased surprise inspection of trading companies’ segregated customer funds, required daily fund segregation reports, and the redundant “Corzine Rule” to hold CEOs of trading firms personally accountable for certain types of trading actions of their companies.

Duffy also discussed future changes to the commodities and futures trading industry, promising greater innovation to protect customers.

“Regulators and the industry must carefully weigh the benefits of even the most far-reaching proposals that could enhance protection for customers’ segregated funds—and we will. For in the end, that’s the most important element.”

How much these changes will mean to customer confidence has yet to be seen. Customer funds are still missing and that weighs heavily on many.

Reports vary of exactly how much of the money lost in MF Global’s collapse has been returned. Some sources say 82 percent has been returned to MF Global’s customers. Injured customers of MF Global’s UK subsidiary reportedly have seen 90 percent of their missing funds returned to them, though that is little solace to American ag producers who suffered in the downfall. Full repayment is thought to be unlikely, but more is expected to come as legal disputes over the collapse settle.

The House Financial Services’ subcommittee overseeing the congressional investigation into MF Global’s collapse announced Oct. 31 that the full investigative report will be released in the next few weeks.

“Our investigation is essentially an autopsy of how MF Global came to its ultimate demise and what policy changes need to be made to prevent similar customer losses in the future,” said Randy Neugebauer, R-TX, who chairs the House Financial Services Oversight and Investigations subcommittee.

“We must restore confidence and integrity to the futures markets and send a strong signal to customers that their accounts are safe and secure.”

The report will be taken into account in future considerations of official governmental regulations in addition to what the industry itself has put in place.

Haunting history

On Oct. 31, 2011, MF Global—at one time the largest independent futures brokerage in the world for agricultural commodities— officially declared bankruptcy. This came after what is often described as a chaotic flurry of confused action where millions were traded every day and supposedly record keeping was less than it should have been.

After sustaining significant losses after making risky bets on debt bonds from struggling European economies, MF Global was downgraded by several key rating houses. After that, it circled the drain, futilely attempting to find a buyer for the company. Potential buyers were turned off by MF Global’s deficit and the fact its books didn’t add up as they should.

The company had made a bad habit of dipping into segregated consumer accounts to help fund large trades. It would pay back the accounts by the end of the day, but towards the end, it wasn’t able to maintain that cover. Once bankruptcy was officially declared, it came to light that significant amounts of consumer money from segregated accounts—to the tune of around $1.6 billion—were simply missing.

In the months following, Jon Corzine—then-MF Global CEO, past governor of New Jersey and ex-CEO to Goldman Sachs—and other higher-ups of the company were brought before a federal investigation and questioned on the events that lead to the loss of supposedly sacred consumer funds. Corzine was famously quoted as saying he had “no idea where the money is,” and that he had no idea anything illegal was going on in his company.

In the aftermath of the collapse of MF Global, there was a flurry of action in an attempt to prevent similar occurrences in the future and to protect hedge-fund clients. CME Group, the primary clearinghouse for MF Global’s trades and overseer of the company, created a $100 million protection fund to cover customer losses in case anything similar happened in the future. There was official talk of creating more regulatory rules at the governmental level and to strip CME Group of its oversight powers due to concerns of conflict of interest.

Nothing solid came of this initial show of activity, however. No criminal charges have been brought against Corzine or any of the MF Global management and it seems unlikely that any will come in the future. The investigation has all but wrapped up. There is some possibility civil claims will be brought against Corzine, but that is unclear. Talk of added regulation from a government point of view or removing CME Group from an overseer role seems to have disappeared.

Despite his own writings mentioned earlier, Duffy told the New York Times, “We haven’t seen a dramatic change,” in reference to regulatory actions by the government. — Kerry Halladay, WLJ Editor