As regulators, exchanges and firms comb through the mess that is MF Global, its painfully clear that this industry needs some self-examination.
One of the life bloods of the futures business has come from retail and individual traders who help pump in liquidity. One may argue that some, even much of that needed speculative liquidity is now being supplanted by the proprietary trading shops and other institutional players in this space. Nonetheless, MF Global’s spectacular fall has harmed the reputation of the futures industry and produced what every good broker tries to avoid – lousy and in some cases disastrous customer experiences. For any customers who watched their trading screens get shut off, accounts frozen, positions held in limbo and then their accounts shifted off to another broker, it has been about as bad a customer experience as one can deliver. It’s akin to getting on an airplane and sitting on the runway for three days, before getting switched to another flight and flown to a different destination with another airline.
The question then for the futures industry is, what to do about it? Sure, we’ll see plenty of regulatory fixes so something like this never happens again… until it happens again. Everyone in the business knows that firms fail; just look at Sentinel, Griffin, and on and on. Firms fail and customers end up in bad situations.
What is at stake here is not just losing the trust of your customer. That’s bad enough; but how about also losing the interest and trust of any potential customer?
There are plenty of professionals in this space who believe that the futures markets aren’t for retail traders, anyhow. Most customers lose money both because they don’t take the time to learn the markets and how best to trade them; and because it’s really hard for even the best traders to make money in this sector. So why bother?
Having said all of that, the retail business is vitally important to the future of the futures industry. One can argue that if it weren’t for the retail traders, we wouldn’t have seen the likes of the e-mini S&P futures contract, which led to a host of mini-contracts used by everyone in the markets and worked hand in hand with the technology and volume renaissance we’ve seen in the industry.
So what is the industry to do? Ultimately, the industry faces two critical issues: a rebuilding of trust; and a re-engineering of the business model. Rebuilding trust can take any number of paths. Given the regulatory climate today, industry leaders are faced with a difficult and confounding challenge. After all, its the Genslers and Chiltons of the world who will likely stand in front of the cameras and Congress and say, “Here’s what we’re going to do.”
But perhaps a better suggestion would be something not so new in the history of solutions to problems: a Blue Ribbon Panel, led by industry participants, accountants, technology providers and regulators, who together can come up with solutions that will be enacted. The collective groan about another (expletive) panel is well-taken. The Financial Crisis Inquiry Commission isn’t the blueprint we’re looking for, where the legislative and rule changes come out before the report is completed. That panel also was stricken by partisan splits.
In this case, the panel should adopt the style of the one that followed the 1989 FBI sting, which rounded up 47 Chicago traders with guilty pleas from 36 of them, and a handful of acquittals. The reputational damage to the industry at the time was devastating. The Chicago Mercantile Exchange’s Leo Melamed organized a blue ribbon committee led by former Merc chairman John Gelderman, who died in 2006. Melamed mentions it in his book “For Crying Out Loud”, stating that the panel “made some recommendations, which were ultimately adopted by the board.” CME increased its surveillance and compliance resources while the Chicago Board of Trade followed suit and upgraded its computer system.
At the time, then-CME president Bill Brodsky told Futures Magazine’s Ginger Szala, “In an institution that does 100,000 trades a day and has 3,000 members, there are going to be times when people break rules,” he says. “But we have a lot of information available to us, and we’re going to be able to identify wrongdoing.”
And then Brodsky added this: “As far as I’m concerned, we’ve acted responsibly. We’re doing things that will get the message out loud and clear that this is a serious place to do business, and, if you want to do business here, you have to obey the rules.”
Of course the futures markets did recover. CME Group reported that its average daily volume in October was 12.4 million contracts.
There would be debate, no doubt, about the value of such a committee today. By November 4th, the missing shortfall of customer funds was thought to have been found Friday found in an account over at JP Morgan, and the crisis seemed to have abated. But the funds are reportedly still missing.
But this is only the start of the recovery process. This marks the second industry-rocking accounting scandal in the past five years. Dealing with the the core issues that get touted at every industry conference – transparency, liquidity, efficiency – led by the next John Gelderman, would be a start to regaining the trust of a critical part of this market.
The question is, can the industry come up with solutions that tell retail traders, “This is a serious place to do business?”
John Lothian: “I endorse Jim’s call for an industry created Blue Ribbon Panel.”