MF Global sows winter of discontent for CME

CHICAGO Mon Dec 26, 2011 6:36pm GMT

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CHICAGO (Reuters) - Agricultural bankers and other players in the world's grain markets say fallout from the collapse of giant broker MF Global is changing cash grain trading and fuelling calls for alternatives and reforms.

Trading changes include more "back to back" transactions and more direct contracting by farmers to end users, eliminating middlemen like MF Global, merchandisers say.

Bankers and traders also say anger with lack of oversight by the Chicago Mercantile Exchange's clearing house regarding MF Global's supposedly secure customer accounts is rampant, spurring calls for more regulation of a traditionally close-knit, clubby and "self-regulating" industry.

Proposals have included the idea of setting up a separate "insurance fund" to hold the so-called "segregated" accounts that futures commission merchants (FCM's) now hold and account for with the exchange clearinghouse, which is supposed to "mark to market" every trade every day to assure adequate capital.

Up to $1.2 billion (767.5 million pounds) in such segregated customer funds are still missing eight weeks after MF Global collapsed into bankruptcy after a revelation it had made a $6 billion bet on European sovereign debt that went sour.

"I don't think people are satisfied with CME's response. What the banks thought was rock solid isn't as rock solid any more," said Lance Holden, senior vice president with Wells Fargo Bank, the largest private lender to agribusiness that had customers who lost funds with MF Global.

CME Group chief operating officer Bryan Durkin told a packed meeting of the National Grain and Feed Association this month, echoing earlier testimony by CME executives to Congress, that MF Global was the culprit, not CME's clearing house.

"This was the failure of a firm. A firm that broke the rules, not the failure of any clearing house. At CME, we met our obligations," Durkin told the gathering of 700 farm bankers, grain traders, brokers and farmers in Chicago.

"We believe all customers affected should have their full balances and property returned by MF Global. Until then, we will not consider the process complete," Durkin said.

CME, looking to line up with its futures-trading customers and the banks like Wells Fargo who finance them, has pledged at least $550 million to the court trustee now sorting out the MF Global mess to help make good customers who were victimized.

But CME will need to do more, grain traders said.

"We want to get the confidence back and restore confidence with the lenders too," said Diana Klemme, vice president of Grain Services Corp in Atlanta, which advises grain buyers and sellers on marketing and risk strategies.

"In the end the loss of even a dime by users of the system will have a chilling impact," said Jeff Hainline, president of Advance Trading, an Illinois brokerage with many farmer and farm cooperative clients.

VOTING WITH THEIR FEET

As the CME's regulator, the Commodity Futures Trading Commission, as well as Congress and the bankruptcy court try to sort out accountability for the missing funds, many farmers and grain traders have backed off using CME's grain futures, the world pricing and risk-management benchmark for decades.

"We are watching closely how these events play out to figure out what do we need to ask more of from a counter-party risk standpoint," said Sam Miller, senior vice president of agricultural banking at M&I Bank in Appleton, Wisconsin, who had customers who lost money with MF Global.

Miller said he's seeing more interest among bank customers to sell commodities directly to end-users but they are looking at all their choices -- over-the-counter privately negotiated deals, options markets, and back-to-back deals where purchases and sales are done simultaneously.

"We do see more contracts between a seller and somebody who is actually going to use the product," Miller said.

"There are some real concerns about figuring out just what happened and how we make sure the situation never repeats," said NGFA Treasurer and director of marketing Todd Kemp. "Of course, the number one issue among customers right now is return of supposedly segregated funds to customers."

Kemp said NGFA members, which include more than 1,000 firms who buy and sell grain, will find it hard to market grain without the CME. But confidence has been deeply shaken in the CME and the FCM's who hold customer funds, he said.

"Our task in that respect is to re-establish confidence and examine changes that might help ensure safety of customer funds in the future," he said. "Some have suggested that we might look at changes in which entity holds customer funds.

"Instead of the FCM, should the clearinghouse or exchange, or maybe some independent third party, hold the funds? Should we look at extending some form of insurance to commodity accounts?" Kemp said. "Our Risk Management Committee will begin those discussions soon."

Oversight and accountability must be addressed, he added.

"NGFA historically has not been an organization that believes in more government regulation. However, it's clear that in some way customer protections need to be improved," Kemp said.

Even bankers may seek more regulation -- of brokers.

"Futures trading is supposed to be riskless from the transaction side. If you've got outside risk, people may use different types of products," said Holden of Wells Fargo.

Grain elevators, farmers and others using futures markets to hedge price risk often borrow 90 percent or more of the value of their crops or livestock to finance futures trades.

The government-linked Farm Credit System (FCS), for example, lent some $6 billion to make sure grain elevators could make margin calls when grain prices plummeted in 2008.

So grain traders are closely watching the stance of CoBank, the Denver-based FCS bank with $62 billion in assets and one of the biggest lenders to U.S. grain elevators.

"CoBank has not changed its credit policies in light of the events at MF Global." Lori O'Flaherty, chief credit officer for CoBank, told Reuters in an interview. "But the failure of this institution highlights the need for close monitoring of counterparty risk, both by banks and their customers, during these volatile economic times."

Bankers said CME will also remain squarely in the grain industry's sights, as an institution that must re-earn trust.

"CME -- all of the exchanges have been focused on contracts, more growth, all these hedge funds, private equity funds that are getting into these markets. They are focused on that instead of their base business," Holden said. "That something like missing segregated funds could happen -- that's a big miss."

(Editing by Peter Bohan, Leslie Gevirtz)

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