Unlike the later PFGBest episode, MF Global's loss of an estimated $1.6 billion in "segregated" customer funds may turn out to be an internal management goof. But that is hardly consoling, because we fragile human beings are more likely to make mistakes than to deliberately raid other peoples’ money. If a mature futures commission merchant (FCM) like MF Global can mess up under stress, it could happen at any broker regardless of past successes. This is the message that futures customers have received and that the industry must somehow address.
We do not have the luxury of knowing that large futures customers like hedgers on the Fortune 500 list have nowhere else to go. Even under the Dodd-Frank Act, they are free to hedge using private swap agreements instead of exchange-traded and cleared futures contracts.
Will they do so?
On these pages within a few days after the MF Global revelation, I suggested a structural "fix" that would place all customer funds with a separate, Commodity Futures Trading Commission (CFTC)-regulated central repository that conducts no other lines of business. Understandably, the industry looked for less dramatic changes such as heightened surveillance and enhanced auditing. The question is whether such measures — that leave customer funds at risk of future losses because of broker error (remember, MF Global collapsed over a long weekend and shortly after an audit by the CME Group) — will restore customer confidence and avoid a flight to other venues.
An insurance overlay similar to those of the Federal Deposit Insurance Corporation (FDIC) and the Securities Investor Protection Corporation (SIPC) has been suggested. This holds promise but, like FDIC and SIPC, the program would need coverage limits that may prove inadequate for larger customers. And, like enhanced oversight, it does little to reduce the risk of customer funds “going missing.”
The ultimate fall-out from MF Global is yet to be seen. Maybe it will fade into a distant memory, an aberration that rarely occurs. Or, it could loom large, especially with corporations and pension funds where “fiduciary duty” will not allow the danger to be ignored. Absent a change in the custodianship of customer funds, we can only wait and worry.