MF Global situation should end the float

December 4, 2011 06:01 PM

A frustrating aspect of the MF Global debacle is that as we get further away from the bankruptcy, the situation appears to be becoming less clear.

From our perspective and the perspective of our readers, the machinations of MF Global and its discredited leader Jon Corzine are less important than the ongoing effort to return customer money and addressing the structural breakdown in Futures regulation as it pertains to segregated funds.

But now we are hearing talk that certain off balance sheet account maneuvers may be the cause of the MF Global’s trouble — related to the firms over-leveraged bets not the seg fund shortfall that is the result of: a) illegally comingling customer funds, b) extremely poor accounting/record keeping processes or c) what is behind curtain number three.

Reuters reported Friday that the firm needed to be creative because other sources of income such as the float have dwindled. “MF Global earned $286.8 million in its last full fiscal year from interest income after expenses. Three years earlier, that figure was $502.1 million,” noted a Reuters story.

Maybe it would be a good time to tighten the rules on ways futures commission merchants (FCMs) can invest segregated customer funds to earn interest. These rule 1.25 investments may be involved in the so called customer shortfall.

At Futures we have been reporting for several years on the frustration the current low interest rate environment has been causing FCMs. Historically FCMs earned a large portion of their profits through interest income i.e. the float. That is hard to do in a zero interest rate environment. Perhaps MF Global was getting overly creative with these investments as well.

Most heads of FCMs we spoke to over the last few years have concluded that they no longer can count on the float as a revenue stream. That may be a good thing. It was always a little strange that a broker can make money on your money, backing your trades that they already earn a commission on. Some FCMs return interest income to its customers. And large institutional customers sweep their accounts daily moving excess margin capital into a third party cash manager to earn a few basis point above the risk free rate.

Seeing that the current environment does no leave room for brokers to earn interest on the customer funds it holds, now might be the ideal time to end the practice.

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About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.