Fixing MF Global’s Mess

The official cutoff date for the MF Global bankruptcy has been set at October 31, 2011. It’s been one month since customers have had free access to all of the working capital that is supposed to be untouchably held by the exchanges. As of this writing, the best case scenario has been…..well, I guess there really hasn’t been a, “best case scenario.”


Customers who were trading through MF Global and had open trades on Oct. 31 had 60% of the maintenance margin plus their open trades transferred by the Trustee, James W Giddens to one of six qualified Futures Commission Merchants (FCM’s). The practical outcome of this was that a customer with $1 million dollars in their account and one contract of corn found themselves on margin call with a new broker chosen for them by the exchange. The customer would have to pony up another $600 to meet the margin call because they were unable to tap the $997,643 in margin reserves held in their segregated funds account with MF Global.


U.S. Bankruptcy Judge Martin Glenn approved the distribution of 60% of the assets from accounts that held only cash as of 10/31 on Thursday, the 17th of November. However, no date has been set for the distribution of these funds. Furthermore, it provides no more relief to those customers who were actively trading their accounts and needed access to the segregated funds they placed with the exchanges as good faith collateral for their trading positions. This process has left the most active traders as the least capitalized.


The exchange’s bylaws are written so that a shortfall in segregated funds on the part of one firm must be made up proportionately by the other member FCM’s. This has created a co-operative understanding among the member firms for more than 100 years. It has also led to complacency. This would never have happened had the members of the exchanges had the opportunity to audit each other in the same manner that all of the offices and individuals are audited each and every year.


Frankly, chasing down the last dime of revenue has become the joint pursuit of the exchanges and the FCM’s since 9/11.  The clearest example of this is the continuation and expansion of trading days during bank holidays.  Prior to 9/11, the exchanges and the banks had the same holiday structure. This ensured that the funds would be available in case a trader or member firm needed to add cash to meet margin calls. Post 9/11, we’ve decoupled from the banks and trade more calendar days per year than ever. This is a game of, “hot potato.” Every firm hopes it’s not their customer that needs to wire funds on a bank holiday. This has proven to be a sound strategy as the firms and the exchanges have generated many more days’ worth of revenue….so far.


There are 10 federal holidays per year. The markets lost four days of business due to the tragic events of September 11th. Using our current business calendar, we’ll regain three lost business days this year, just like last year. Here we are ten years down the line and we’ve recouped nearly 30 business days compared to the four we’ve lost. It would take a margin call seven times the revenue of one business day to undermine the success of working the bank holidays over the last ten years.


The purpose of this is to place the responsibility for making John Q. Trader whole directly on the shoulders of the FCM’s and exchanges. The idea that they can continue to look for ways to squeeze extra revenues out of a system that doesn’t place its customers first is personally revolting. There are so many simple solutions to a problem that should’ve never arisen. Excusing common sense for a second and placing the primary focus back on exchange driven profit centers we can easily implement a safety policy for the exchanges, the FCM’s and the customers.


The average three-month volume at the Chicago Mercantile Exchange through last month was 14.6 million trades per day. Exchange and clearing fees currently total around $1.20 for each buy and sell. Raising the clearing costs by a nickel per side would increase clearing costs by less than 5% and raise nearly $730,000 per business day. The current MF Global customers should be made whole, NOW. The revenue generated by this tax would offset the MF Global losses in six months. The battle lines for the lawsuits won’t even be drawn by that time.


My greatest fear in this entire situation is the audacity exhibited by exchanges and the FCM’s in becoming so big that they’ve forgotten their customer base. This business was founded on the meatpacking houses of Chicago and the grain elevators up and down the Mississippi river. It has come along way from the blackboard trading my father remembers on Franklin Street. I just hope the age of electronic clearing and corporate profits haven’t killed the goose that laid the golden egg.



This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Mechanical Trading System Durability

Futures Truth magazine is the de facto industry standard for the mechanical trading system vetting process. They’ve been publishing and independently testing trading systems since 1985 and currently track and publish the results of more than 700 trading systems. Their magazine is not one that I subscribe to however, as a former contributor as both an author and mechanical trading system developer; I still receive the random copy from time to time.

Obviously, the reception of their most recent issue fueled a round of intellectual inquiry into the age-old question, “Will a properly designed and tested mechanical trading system withstand the test of time and the evolution of the markets it trades?” I believe the answer is an unequivocal, “sort of.” The answer really has two parts. All things being equal, a properly designed system will continue to perform in a statistically characteristic manner in the future just as it has in the past. Unfortunately, when it comes to market evolution, all things are rarely equal.

My first published trading system was called, “DCB-Bond.” It debuted in January of 2000 and has been in and out of the Futures Truth Bond Market Top 10 since release. The system was ranked 16th in the most current issue and has averaged more than $3,000 per contract in annual profits for the last five years. This trading program was designed to capture medium term trends and trades about once a month.

All things being equal, searching for medium term trends in the bond market is still an exploitable niche. The evolution of electronic trading along with the corresponding shift in trading from the pits of Chicago to the computer screens hasn’t affected the basic strategy the system uses. While the dynamic nature of the mathematical equations it uses as triggers allow it to adapt to the ever-changing nature of the market’s volatility.

Unfortunately, the evolution of electronic trading has dramatically affected the performance of a suite of short term trading systems I developed that was published in December of 2005. Historically, markets only traded during their open outcry market sessions. For example, the grain markets only traded from 10:30a.m. through 2:15p.m., Monday through Friday. Therefore, overnight market developments or weekend surprises would build up pressure that couldn’t be released until the market actually opened for the next trading session.

The build up of pressure frequently caused the markets to open at a price significantly different from the previous day’s closing price. The suite of systems that I had developed was designed to capitalize on this market behavior. The program was able to predict with a high degree of accuracy when a market would generate a build up of pressure and open in a predicted direction at a significantly different price than the previous day’s close. The advent of 24 hour access to the markets has eliminated this build up of pressure and undermined the effectiveness of my, “first profitable open” exit technique.

Mechanical trading programs offer many advantages such as the ability to quantify risk, diversify a portfolio and provide access to markets one might not normally trade. The downfalls of mechanical systems are faith in the system, discipline and how to determine whether a system is still viable or has, “blown up.” The key to the successful utilization of any trading system is understanding how and why it works. Therefore, when the fundamental premise of the system is no longer valid and all things are no longer equal it can be taken offline prior to an inevitable drawdown.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Crude Oil is Running Out of Steam

Many of you may have noticed that gasoline prices have moderated since the Labor Day Holiday rally. This is typical seasonal behavior, however I think there may be more room to the downside rather than a rush back to the highs in time for Christmas travel. One thing is for certain; commercial traders’ actions clearly reflect their negative bias in the crude oil market.

Commercial traders sold nearly 22% of the positions they picked up on the market’s decline to $75 per barrel in early October. This type of selling extends beyond simple profit taking. They are clearly placing bets that resistance around $100 per barrel will hold. This is the exact opposite view that commodity fund managers and the retail money they allocate have of the crude oil market.

Steve Briese has devoted 20 plus years to tracking the Commitment of Traders Reports and he noticed an anomaly in this week’s reporting. His analysis was based on adding in the long only positions of Commodity Index Traders. These are the fund managers who maintain the balance of positions for commodity based exchange traded funds as well as the Jim Rogers type funds, which invest directly in the futures markets. Adding their long only positions to the crude oil market shows that commercial traders have actually set a new net short record position. Commercial traders have sold more forward production at these prices than ever.

Clearly we have come to a tipping point. Retail investors through their purchases of commodity fund shares have swallowed up the 47,000 contracts that commercial traders have sold. In spite of the size of these positions changing hands, we’ve seen the total number of outstanding contracts decline by nearly 20% since the peak in May. This decline in open interest while the market is climbing is strongly viewed as a technically weak move.

Finally, I’ll throw in a wild card; declining retail interest in the futures markets. Every market has a directional wild card bias. The crude oil market has a built in fear bias to the upside based on potential supply disruptions. This may be the first time I’ve really considered a negative bias in public sentiment in this market. This is based solely on the MF Global implosion and the heinous nature of their commingling of segregated funds.

MF Global customers’ trading account cash was supposed to be 100% separate from MF Global’s operating cash. That is the purpose of segregated funds. Customer funds are always protected regardless of the brokerage firm they clear through. John Corzine, who once held the trust of the entire state of New Jersey, has broken the trust in this principal and possibly, the retail investors’ faith in the futures markets. The withdrawal of retail market participants in the futures markets will force the long only Commodity Index Funds to liquidate positions to maintain the proper portfolio allocations as retail customers make redemption requests. Given the record speculative long interest, we could see a sell off in the crude oil market similar to the 2008 correction of more than 50% or, at least a re-test of the $75 October lows.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Customer Safety Comes First

Barry Lind and my father, Jack Waldock founded Lind-Waldock in 1965. One of the primary compliance categories in opening a new futures account is, “know your customer.” For 35 years the business was based on genuinely, “knowing their customers.” Their belief in doing business the old school way allowed them to provide superior order execution on behalf of individual traders as well as providing them with top-level research. This process helped them to break down the barrier of institutional preferential treatment.

Refco bought Lind-Waldock in 2000 primarily for Lind-Waldock’s clean compliance record and presence in the retail market. Refco went public in 2005 and also went bankrupt in 2005 due to the accounting improprieties of Phil Bennett, their CEO. Man Financial bought the Lind-Waldock portion of Refco’s operations in the ensuing bankruptcy. Man financial went public in 2007. They retired the Lind-Waldock name in August of this year and operated under the MF Global name and have now gone bankrupt as well.

Now that the history lesson is over, lets talk about the recent developments. The primary issue at hand hinges on the sanctity of the term, “segregated funds.” Cash in a customer’s futures trading account is held in segregated funds. This money is completely separate from the clearing firm’s operating cash and is not to be mixed in with the clearing firm’s assets in any way shape or form. This is guaranteed by the various exchanges as margin collateral and is a collective covenant of all Futures Commission Merchants (FCM’s) that are members of a given exchange.

MF Global and their CEO, former New Jersey Governor John Corzine are accused of using customers’ segregated funds equity to guarantee bets he made on European sovereign debt as he attempted to transition from the historical business of providing trade execution services and retail customer trade assistance to investment banking, proprietary trading and the greedy pursuit of becoming the next Goldman Sachs, his former firm. These actions are in violation of all of our governing bodies – NFA, CFTC, FINRA, etc.

The losses incurred as a result of his pursuit to be a big shot has left a $700 million dollar shortfall in MF Global’s books. Dipping into segregated funds has created an accounting nightmare as customers close their accounts and transfer to solvent brokers. The segregated funds covenant of the FCM’s with the exchanges is to guarantee the customers’ equity. This is the peace of mind that trading on an exchange versus cash markets is supposed to bring.

The $700 million dollar shortfall should be covered, whether through the joint efforts of the FCM members of the exchanges or, the exchanges themselves. To put this in perspective, the top 10 FCM’s have a combined equity of more than $1 trillion dollars and the Chicago Mercantile Exchange is valued at more than $17 billion. Therefore the $700 million is a manageable number as a portion of this capital pool.

 Customers must be made whole in order to maintain the integrity of the exchanges and instill the confidence in the investing public. The longer this thing is drawn out, the more likely this erosion of confidence in the governing bodies will devolve into retail investor panic. The remaining FCM’s as well as the exchanges must do everything in their power to prevent an easily covered black eye of a monetary issue from becoming a public perception issue more akin to a terminal disease.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.