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.

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