Commodity trading advisors (CTAs) execute trades for their customers. Their customers have arrangements with introducing brokers (IBs) and/or a futures commission merchant (FCM). The CTA also has relationships with executing brokers who must maintain relationships with the various FCMs of all those customers.
The MF Global debacle created unique problems for CTAs. Their customers who cleared though MF Global had their accounts frozen on and off in the days following the bankruptcy filing. If they executed through MF Global that was another problem. And with MF Global customers on liquidation-only, other brokers were apprehensive and technically restricted from taking MF Global business. An executing broker giving up MF Global really has no way of knowing if a trade is a liquidation.
Adding to the mess is the fact that CTAs are not the customer and were not in the information loop — such as its was, which wasn’t good — in the days following the bankruptcy. This was particularly dangerous as the Securities Investor Protection Corporation (SIPC) liquidating trustee and exchanges moved accounts to new FCMs.
Marc Levitt, principal of Silicon Valley Quantitative Trading, wrote the following note to his customers on Nov. 4: "What I will need to know from you is if you will be posting more margin to your account if called on by the new FCM or will be liquidating the currently open positions."
The positions were profitable but Levitt did not know how much margin would be transferred or whether they would be able to retain their open trade equity. They weren’t.
Complicating the matter was lack of communication. The letter goes on: "What is important is that in the next 24-48 hours or so you will likely be informed of your account transferring to a broker. Please let me know ASAP when this occurs, to whom, and any contact information you may receive."
Scot Billington, principal of CTA Covenant Capital, called the situation a "pain in the ass" but added it could have been worse. Billington operates a long-term trend following program and didn’t have any orders to execute, which was a good thing because his executing brokers could not accept MF Global give-ups.
He did receive notice from JP Morgan that they were not accepting any give-ups. This was a problem as one of his customers cleared JP Morgan but he had no relationship with its order desk.
"As a CTA you constantly take risks and try to manage those risks," says Robb Ross, principal of CTA White Indian Trading. "One thing that you don’t want to deal with and you don’t want to manage is the risk of your FCM failing."
But dozens of CTAs had to deal with the MF Global situation and likely will be dealing with it for months to come.
Ross, who executed some business with and had customers clearing through MF Global, was solicited by a competing FCM on Wednesday, Oct. 26, which stated, "Hi Robb, I know you have some business over [at] MF Global. You may have heard that they have been having some problems. We’d certainly like your business."
It was not an unusual call as clearing and execution is a very competitive business. Ross, however, was very happy with MF Global and, after all, his customers’ money was safe, even if the worst happened and MF Global failed. In a refrain unfortunately repeated across the industry, Ross notes, "All the client funds are segregated, meaning that the firm could lose every dime, but those client funds are in separate accounts and not used for FCM business operations."
The first hurdle was getting customers flat, either for safety or part of normal operations. Levitt had a lumber roll to execute but could only liquidate one leg at MF Global and would have to put on the new position at a separate broker with new margin. He also had a yen position to liquidate, which was critical as the Bank of Japan had just intervened in the market that day.
Spreads added complications but options were worse. Ross was informed from his MF Global broker early Monday, Oct. 31, that all his stops were cancelled. "I had dozens of option straddles on with stops in the underlying futures markets. Now I had no stops, total exposure," Ross says. "Then the broker informed me that he had no ability to place any orders."
Ross decided to wire transfer as much capital as possible out of MF Global but it was too late. His MF Global broker told him around 9:00 that morning that another firm would liquidate his position as a give-up. This would be a trick as he didn’t have margin with them and no way to transfer funds from MF Global. Luckily his broker called back and said, "Robb, they’ve let us back in the system. I can execute trades right at this moment."
Ross was able to get flat and notes that the window of opportunity closed one hour later. "MFG brokers could no longer make trades. I had jumped through the window at the right time."
This highlights another problem. At various point in the days immediately following the bankruptcy filing, MF Global brokers had on-again/off-again access to markets. While customers were supposed to be able to liquidate orders, it was a crap shoot.
CTA and investor Andrew Abraham had 11 accounts with MF Global to transfer in the week leading up to the Oct. 31 bankruptcy. Two of them were transferred with both positions and capital; seven had the positions moved without capital; in two cases only some postions were moved and none of the capital. "It was an absolute mess," Abraham says.
"In the first 48 hours or so we tried to get out of these positions and nobody would take the give-ups," says Stanley Haar of Haar Capital Management. "In some cases they wouldn’t pick up the phone. The Kansas City Board of Trade wouldn’t pick up the phone from the MF Global desk starting on Monday, which I don’t blame them for."
Those accounts that were liquidated after the bankruptcy had a problem as the trustee refused to transfer cash positions of customers who liquidated after Oct. 31. Those customers did not receive the 60% in the second "cash only" bulk transfer but should be part of the third bulk transfer approved on Dec. 9.
Haar is very critical of the way the liquidation process transpired. "They left us with zero percent of the equity and 100% of the risk for a full week, which is beyond absurd, it is almost criminal."
These various glitches are perhaps why it was a CTA who launched the Commodity Customer Coalition (CCC).
Haar had about 10% of his business frozen as well as one of his personal trading accounts. "Obviously it is lost revenues, lost trading opportunities and a nightmare having to spend so much time battling to get money back for our clients, which is obviously subtracted from [the] time we dedicate to manage trading," Haar says.
Haar, along with many CTAs, took an active role with the CCC. "One of the more gratifying things in this whole episode was seeing how people who didn’t know each other before and to a certain degree were competitors, all came together because we recognized after the first week went by and there was almost total silence from everyone who should have been playing an active role, that we were on our own and there was no one representing our interests."
Haar says it took the CME a week to respond and is still waiting on the CFTC. "The CFTC has been brain dead basically all through this process," he says.
And it is a process because CTAs are dealing with new brokers and how they should treat positions and performance. Like the initial reaction to the bankruptcy, they have not been given much help.
"The (National Futures Association) has said nothing. They [advised commodity pools] on what to tell clients but not in terms of performance," Levitt says. "I am treating November as if all accounts were traded, though for three weeks there was no activity. My performance was up just short of 1% calculating my NAV that way. If you actually took out the accounts that were frozen, I was actually up 2.5% for the month on an unencumbered account."
Others are reporting the same and it is easy to see an accounting nightmare when things get back to normal. But the first problem will be holding onto customers. In the early days following the filing many CTAs reported that customers exclaimed they were leaving.
"It screwed me up," says Abraham. "People who were going to give me an allocation backed off because they lost confidence in the market."
Abraham’s CTA became registered this summer. Courting high-net-worth customers is often a several month process and his work was destroyed in a matter of days.
Jason Skole was particularly upset because he has nearly $200,000 frozen and has only received about 4%. With such a large amount frozen, he did not remargin his account once it was transferred. "I didn’t put any more money in, which is a pity because [my CTA] is up 15% since then. I really didn’t want to commit anything else."
Skole is unsure whether or not he will continue with his managed futures investment after this is all over. "When this occurred I said I would pull everything out once it all gets settled, but I am not sure."
While there is still hope people will be made whole, Skole certainly won’t get those returns he should have earned, his broker won’t get the commissions on those trades his CTA would have made and the CTA will not get the incentive on those profits he would have earned.
Levitt says the situation highlights the need for CTAs to have an advocate. "I do think CTAs, especially ‘small CTAs,’ could use their own voice within the industry. As we discussed, the NFA has been silent (Managed Funds Association too) in general and no one is really advocating for CTAs. The CCC is very aligned with this cause and perhaps it will splinter off into something after MF Global has settled down."