MF Global battered by storms. Monday, March 17, 2008
As I suggested last week here, firms like MF Global, where I used to work, were certain to fall under suspicion that they too would be encountering difficulties in the current climate. Today, the firm lost as much as 80 per cent of its value on rumours of financial difficulties. This comes on top of the falls resulting from a loss of $141m attributable to unauthorised trading in February.
At 27 Feb 2008, the shares were trading at $29.24 and today went as low as $3.64.
One of the few large brokers not to be owned by a bank, MF Global intermediates between its' customers and the Exchanges. As a generality, the firm does not take proprietary positions, but does remain exposed to counterparty and liquidity risk in these turbulent times.
As a major player, MF Global's client base will be split between those with long open interest positions and those with short i.e. some clients will be losing money in the market, but others will be profiting. The key challenge is therefore to manage the cash flows between the various parties, as I well recall from my role as Director of Treasury for the firm.
Exchanges can demand intra-day margin calls which have to be settled immediately - failure to so do can result in the firm being suspended from further trading until their balance falls back within headroom or calls have been settled. The consequences of this are so material that an Exchange will always be the first priority in allocating cash, assuming stock collateral isn't readily available. Often stock collateral cannot be moved sufficiently quickly to meet calls or the right "type" is not on hand.
Profiting clients may demand immediate repayment of their funds, especially if they have any concerns about the Broker. Conversely clients losing money may be slower in settling losses, despite intra-day calls being made on them. It is this timing difference between inflows and outflows has to be funded either from internal cash resources or from bank borrowings e.g. MF Global issued a statement it had a committed and used credit line of $1.4bn. In addition, it also denied claims that Joe Lewis, the investor who lost $1.16bn on his stake in Bear Stearns, was a client - the implication of the rumour being his broker would face substantial losses on his account.
Sadly, any doubts about the ability of a broker or its customers to settle margin calls, will normally prompt a "run" on the firm, regardless of the facts, even from segregated customers whose funds are held separately from the bank accounts of the company [albeit segregation in practice in the market has some notable weakness in terms of timing differences i.e. you segregate cash today in respect of the balances as at last night.
MF Global was not alone in being affected. Lehman was down 34% and ICAP 16%. Unfortunately, as it was hit hardest so MF Global has captured all the financial headlines which will exacerbate worries amongst clients. Moreover the wording of company statements that it "is very well capitalised" and has "sufficient funding to conduct our business in normal course" will not allay fears - if you'd noticed, Bear Stearns was well capitalised and these are not normal markets.
Unsurprisingly, other firms are seeking to disassociate themselves from any connection with MF Global eg Penson Worldwide which only adds to the gloom and fear.
Client/counterparty reaction in the coming days will determine the fate of the firm. As is the case for almost every firm, if these groups panic and pull funds in size, then MF Global will collapse - the firm is not in the category of "too big to fail" despite its chunky portion of business on derivatives exchanges, notwithstanding that the Exchanges and regulators would certainly try to organise an orderly transfer of business.
UPDATE: And now a class action is being launched against MF Global on behalf of investors as a result of the unauthorised trading loss, according to CNN.