Last updated: December 9, 2011 11:06 pm

MF Global probe reveals oversight blind spots

As Jon Corzine apologised to lawmakers over the collapse of MF Global, the chief overseer of the firm’s futures broker sounded a different tone.

Terry Duffy, chairman of the CME Group, vigorously defended his industry before the House agriculture committee, saying the fact that “a firm failed to comply with applicable rules” did not mean the system used to protect customer accounts had failed.

This week’s congressional hearing on MF Global has intensified pressure on CME, the powerful Chicago futures exchange operator that has zealously guarded its role as designated self-regulatory organisation for MF Global and other US futures commission merchants (FCMs).

The unexplained disappearance of client funds from MF Global has undermined investors’ faith that no one lost money due to broker default – a fact that Mr Duffy and others in the futures industry can no longer tout.

The US Commodity Futures Trading Commission is the government regulator for US markets in futures, options on futures and now most over-the-counter derivatives.

But the CFTC delegates the job of checking futures firms to CME, the former member-owned Chicago Mercantile Exchange that listed shares in 2002.

“The self-regulatory organisations are the frontline auditors for FCMs,” Jill Sommers, the CFTC commissioner in charge of the agency’s MF Global investigation, told the committee. Ms Sommers is a former CME lobbyist.

Keeping customer cash separate from house funds is a cardinal rule of the futures market. Regulators’ failure to spot a hole of as much as $1.2bn in MF Global’s customer accounts has prompted questions about CME’s role as a self-regulator.

Scrutiny is especially strong because CME is a for-profit exchange operator whose revenues derive from trading volumes. MF Global was one of the top brokers by volume on CME’s exchanges.

The CME “want fair and efficient markets. Their next goal has got to be profit. That’s not my goal. My goal is to protect consumers,” said Bart Chilton, another member of the CFTC.

CME said: “No one has a higher interest in ensuring the integrity of the markets than CME Group.”

Securities regulators began pressing MF Global in June to raise more capital against its positions linked to sovereign debt. On September 1, MF Global disclosed that Finra required the firm to raise capital.

However, that red flag was not picked up aggressively by futures regulators. The CME did not arrive on site at MF Global until days before the bankruptcy filing on October 31.

In testimony, Mr Duffy revealed that on the Thursday before the bankruptcy filing, two CME auditors made an unannounced visit to MF Global’s office in Chicago and reviewed daily reports on customer funds through the next day.

The auditors “noted only immaterial discrepancies” in the customer funds reports that had been filed on Wednesday by the time they left on Friday, having verified 85-90 per cent of the funds with third parties.

However, CME suggests MF Global transferred funds out of customer accounts on Thursday or Friday – and only informed the CME and CFTC of those transfers on Sunday.

CME has acted fast to shore up futures markets since the MF Global collapse, offering a $550m guarantee to try to free remaining customer funds.

Yet “the damage has already been done”, says John Roe, an introducing broker at BT Trading in Chicago, a firm that had all $15m or so of its client funds at MF Global.

While legislators may examine the self-regulatory structure, it would be difficult to shift daily oversight responsibilities to the CFTC.

“The futures world operates with a self-regulatory system of oversight, because the CFTC cannot afford and doesn’t have the resources to put a watchdog into every futures commission merchant,” Collin Peterson, the ranking Democrat on the committee, said at the hearing.

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