The CME Group is getting bashed in the hallways, elevators and reportedly on the trading floors of the exchange over the way the MF Global bankruptcy played out. While some of this sometimes caustic criticism is justified, much of it is not.
Yesterday the CME put out a customer letter to bring those impacted by the bankruptcy up to date. It is also aimed to explain how the system works and that the guarantee fund is meant to protect the integrity of the clearinghouse. The CME points out that on “October 31, when the trustee was appointed, MF Global was over-collateralized at CME Clearing.”
“All MF Global obligations to the clearing house were satisfied and its house positions were liquidated the following day. The guarantee fund, which is designed to ensure the clearing house’s obligations to perform as a counterparty, was not subject to any loss.”
There is an old saying that generals always fight the last war and this may have been the case with the CME and MF Global. The CME was expecting MF Global’s customer business to be seamlessly sold to a new firm, much like when Man Financial took on the customer assets of Refco when that firm declared bankruptcy.
“Until early Monday morning, October 31, it had been expected that MF Global would be sold and all customers would be fully protected, as a purchaser would take over positions, customer property and operations.”
Of course, this didn’t materialize. Instead of playing out like the Sentinel case, where the CFTC and SEC both showed up in court at the same time to argue for releasing or freezing of the customer funds, this time it was the Securities Investor Protection Corporation (SIPC) that showed up in court and had a trustee appointed.
And then everything changed.
“The U.S. Bankruptcy code and CFTC bankruptcy regulations require that free credit balances be frozen at least on an interim basis, and that fully-paid securities and warehouse receipts may not be made immediately available.”
So instead of the expectation that MF Global’s customer positions and equities would move to an acquiring firm, the U.S. Bankruptcy code took over.
The CME is not the only clearinghouse MF Global was involved with.
“MF Global and its affiliates were members of many clearing houses and its customers’ funds supported trading in many jurisdictions, under various regulatory regimes.”
While we will never have regulatory harmonization, the various regulatory regimes applied to the MF Global bankruptcy made it particularly complex. KPMG, for example, is handling open positions associated with MF Global in the UK as well as liquidations of assets in Asia.
Should Have, Could Have
Customer funds are supposed to be held in segregated accounts. According to the CME, the shortfall in customer funds occurred shortly before the trustee took over on Monday.
“All U.S. customer funds should have been held in segregation and should have been available to support a full transfer of positions and assets. Instead, it appears that there was a significant shortfall in the U.S. segregated accounts at MF Global beginning shortly before the trustee took over.”
We Are Not In Control
One thing that has been clear from the beginning is that this experience is different from others. Customer accounts were not moved quickly to new firms on the Monday of the bankruptcy, but once the trustee allowed the CME to move positions and minimum margins moved en mass in two days.
“The SIPC trustee has complete control over customer funds at CME Clearing, at other U.S. clearing houses and the funds at MF Global.”
There are lessons to be learned from this disaster. In Monday’s JLN, Jim Kharouf called for the appointment of a blue ribbon panel to discuss the issues arising out of the MF Global bankruptcy and that should happen. A CME board member appeared in our offices today to collect input. Clearly extraordinary times call for extraordinary measures. The CME appears to get it. And judging from their letter, they also understand the importance of communication.