MF Global’s fall puts spotlight on CME Group

The case of the missing customer funds at MF Global is putting a spotlight on the failed broker’s de facto supervisor, CME Group.

CME, the largest US futures exchange operator, is also the designated self-regulatory organisation for more than 50 futures brokers, including MF Global. As such, CME had direct responsibility for making sure MF Global’s books were square.

MF Global filed for bankruptcy protection on Monday, sending its customers scrambling to extract cash from accounts and move positions to other brokers.

Craig Donohue, CME chief executive, said this week that MF Global was “not in compliance with CFTC and CME customer segregation requirement”, suggesting the company may have failed to follow a key commandment of futures broking: to segregate customer accounts from house accounts.

Federal authorities, including the Commodity Futures Trading Commission, are investigating.

On Wednesday, CME clarified that it had audited MF Global’s segregated customer funds last week and found them in compliance. However, it added: “It now appears that the firm made subsequent transfers of customer segregated funds in a manner that may have been designed to avoid detection insofar as MF Global did not disclose or report such transfers to the CFTC or CME until early morning on Monday October 31 2011.”

MF Global refused to comment on CME’s statement.

CME’s dual role puts it in a delicate position. MF Global, according to its website, was the top broker by volume at CME’s metals and energy exchanges in New York and in the top three at its Chicago exchanges. CME’s main source of revenue is clearing and transaction fees.

Brokers themselves have questioned letting exchan-ges be overseers. “Given their strong market knowledge and proximity to the trading markets, they provide the best forum for addressing many of the futures markets’ oversight functions,” the Futures Industry Association said in a 2004 letter to the CFTC. “However . . . we are concerned about potential conflicts of interest.”

The hole in MF’s accounts was discovered as regulators and abortive buyer Interactive Brokers scoured its books over the past week. Since at least last Thursday, MF Global told regulators that all the money was accounted for.

It was only after the bankruptcy filing that MF Global’s general counsel communicated in writing to the regulators that there were insufficient funds in the segregated accounts, according to people familiar with the matter.

The MF Global case raises the question of whether CME was vigilant enough in warning that the broker-dealer might collapse. As is normal practice, when MF’s customer segregated funds at CME fell below acceptable levels, the company was given time to top up those accounts.

“This certainly suggests there’s some kind of deficiency in their oversight,” says the head of a Chicago proprietary trading firm.

Experts say the sudden nature of MF Global’s demise meant a quickly shifting financial picture for regulators.

“My guess is this happened so fast, they lost track of it,” says Michael Greenberger, a former senior CFTC official and law professor at the University of Maryland.

The segregation of customer funds has been enshrined in federal law since the 1930s. Designated self-regulatory organisations such as CME must enforce minimum financial and reporting requirements for members such as MF Global. Futures brokers are required to calculate by noon each day that they are in compliance with customer funds custody requirements.

Still, “no outside regulator looks at seg funds on a day-to-day basis”, says a senior executive at another US futures brokerage.

MF’s collapse also highlights weaknesses at the CFTC, which regulates CME. Collin Peterson, who helps oversee the CFTC as the top Democrat on the House agriculture committee, says he will call for a probe into how the agency supervised the broker. rule that would mandate segregated accounts for swaps customers.

Additional reporting by Shahien Nasiripour and Kara Scannell in New York