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MF Global Ruins the Futures Industry

The opinions expressed by columnists are their own and do not necessarily represent the views of

CME($CME) is getting some bad press from this whole MF Global fraud disaster. Reuters headline sums it up correctly, “tarnished”.

For me, it is a tremendously sad time. I was a part of a group that changed CME tremendously from 1991 to 2000. Initially, the effort began with a ban on dual trading. In financial pits, a minority of brokers were trading against the deck-in stock parlance it would be called internalizing order flow. We did a survey, and found the largest traders weren’t the largest locals(traders trading their own money) in the pit, but were order fillers! This seemed weird to the locals, since we were taking the risk and making the markets.

We gathered signatures on petitions. Many brokers wouldn’t trade with us, cutting our income. We got enough momentum that we forced an exchange membership vote. We won. Dual trading was banned. CME was the only exchange in the world that banned it. Volume didn’t suffer. It grew. Customers felt like they were getting a fairer shake.

Even pits that had volume thresholds under the dual trading ban levels had a cultural change. Instead of screwing over customers, brokers and locals made sure they were taken care of. Many a time I saw a broker fight tooth and nail for their order on a price print that got into time and sales. 99.9% of the time, the customer behind that order was faceless to the broker. But the broker put his reputation and money on the line for that customer to make it right.

I saw locals go out of their way to make sure the customer came first, losing money for themselves in the process. No doubt, the trading floor was the most competitive place on earth-but the culture at CME changed. We took care of the outside customer.

There was a huge political fight within CME in the mid-nineties. The CME board was controlled by brokers, and they weren’t spending a lot of money on computerized infrastructure. In monetary terms, a full seat at the CME traded close to a million dollars in 1994. By 1998, that same seat traded $280,000. It was an outward symptom of the political fight, and sea change that was going on in the industry both inside and outside our walls.

A group of locals and brokers had a different vision for the future of the exchange. In a series of board elections, the locals and brokers that had the different vision persuaded the membership that they were correct. Together, both warring factions came together to lead the CME down a different path than any other exchange in the world. Demutualization.

To be first, to lead, sometimes is a very arduous task. Transforming a one hundred year old member run organization to a publicly traded shareholder organization was extremely difficult. Not only did we have to think out of the box with regard to the way we ran our business, the organizational structure of the company, but we had to battle government regulators and the IRS. One example, we wanted to get a tax ruling on changing from a member run company to a corporate shareholder company. The IRS took over a year to rule on that simple topic.

In our strategic planning meetings, we talked about a lot of things. One was the way our clearinghouse operated. It was one of the true gems CME had built over the years. Unlike many other exchanges, CME owned its own clearinghouse. It was a strategic and operational difference.

MF Global has made a mockery of clearing. They have turned already cynical traders into forensic accountants. How do you know if the clearing firm you use is safe?

“I would be hedging some feeder cattle right now, but I’m not going to do it. I’m leaving them exposed to the cash market and I don’t like that,” Rietzke said.

“I have no confidence in the market, because it could happen at any other brokerage,” Rietzke told Reuters from his 8,000 acre ranch near the southwest Kansas town of Coldwater.

Not hedging increases the amount of risk a farmer or producer assumes. This drives up the price you pay at the supermarket for all goods and services. The farmer in the article isn’t the only one. I have heard many a trader say they are contemplating leaving the business. They are risking a lot of their own money to try and make money in the market. Now, they have to assume counter party risk from their clearing firm? They are frustrated by the whole affair.

A trader can put a trade on, lose a million bucks and say, “I was wrong. I was stupid.”. But to have a million bucks stolen from you because a CEO committed fraud is an entirely different feeling.

It is unfathomable to me how Jon Corzine isn’t held up as the equivalent of Bernie Madoff. Why is Gary Gensler still chairing the CFTC? More importantly, customers were made whole in the Refco disaster, the Lehman disaster, Sentinel, Griffin, and Stotler bankruptcies. They should be made whole today. How jaded have we become? I don’t care that Corzine was once a liberal Senator and Governor. If he was a conservative, I would still call for his head.

I don’t think the average person on the street understands the fiduciary breach that Corzine and MF made with the industry. It would be like your bank taking your checking account funds and using it to plug holes in the cash flow of the business. Then, declaring bankruptcy and you not being able to get any of your money-with a high probability of you losing all of it.
That’s robbery. Fraud.

If a large bank, like Bank of America for example, did that, wouldn’t you begin to question the entire banking system? The entire client/bank relationship? The federal bureaucracy that oversees banking? That’s exactly what is happening in the futures industry today.

Other exchanges have remained silent on the issue as well. CME isn’t alone. However, other exchanges are dinky compared to the size and scope of CME. CME sets the highest standard. They are the highest in valuation, and the largest in terms of money that flows through. Heck, the eurodollar contract($GE_F) does more in notional value in one day than the NYSE($NYX) does in a year.

CME is implicated because it owns the clearing house. The tarnish comes not from the fact that one firm committed large scale fraud and stole money from their clients. It comes from the CME’s slow footed and silent response. They haven’t engaged their customers and they lost credibility with them. Credibility that has been built up, brick by brick, over the last twenty years.

You don’t own your reputation. Your reputation is the gossip that is passed from one person to another. That gossip about CME used to be security, gold plated, fair, and ethical. Today, that reputation has been damaged. It can be repaired, but it’s going to take a while for the wounds to heal. If customers don’t get their money back, CME will bear the brunt of the pain, not the brokerage community. Even though CME isn’t at fault.

CME has lost its way. Stock buybacks, running roughshod over shareholders, and ignoring members and customers. Instead of being “intensely customer focused”, like they were after demutualization, they are simply playing “CYA” management. Now is not a time for CME to be meek. It’s time for CME to lead. If they don’t, confidence in the marketplace, and confidence in the exchange will be gone for a long time.

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