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Sunday, November 13, 2011

The MF Global Bankruptcy May Be As Close As Your Grain Elevator


How close are you to the bankruptcy filing of MF Global and the subsequent liquidation of its client accounts by the federal government?  Based on its popularity with elevator managers for clearing grain hedging accounts through the Chicago Mercantile Exchange (CME), many Cornbelt farmers may be closer than they think to the 7th largest bankruptcy filing in US history.  What has happened, what is happening, and what will be happening?  There are some lessons being learned that will impact the relationships involving farmers, grain elevators, and the banks that lend to both of them.

The MF Global financial failure occurred, even after the implementation of the Dodds-Franks federal legislation designed to prevent such occurrences.  Nevertheless the Wall Street investment house with subsidiaries worldwide filed for bankruptcy October 31 after attempts at selling assets of the company failed over the prior weekend.  Its investments in numerous European banks soured when European governments refused to bail out the banks.  The company was losing money and $660 million investor funds could not be immediately tracked because they were not in segregated accounts.  Those include many margin and hedging accounts belonging to clients such as farmers and elevators.

Because of the impact on grain elevators the National Grain and Feed Association conducted a webinar with members on November 10.  It was designed to provide early guidance for holders of MF Global trading accounts and suggesting potential impacts of the various legal actions that are pending.  Those actions include two bankruptcy filings by two of the three MF Global companies, and federal action against a third involving the Securities Investor Protection Act (SIPA), in which a trustee is handling the open hedging accounts.

The scope of the action most closely impacting farmers and elevators is the $660 million in undifferentiated trading accounts, which the SIPA trustee is attempting to find among the MF Global deposits in other investment houses.  That represents 11.6% of the accounts, which seems to be the amount that could be lost by investors.  However, all funds could eventually be found and returned to investor accounts.  But in the meantime, there are about 17,000 hedging accounts at the CME which have been transferred to 11 other brokerages, with only 85% of their margin intact.  According to Dale Michael, Managing Director of Credit and Risk Management of the CME, MF Global had $1.5 billion in CME accounts, and was over collateralized, or had more money standing in trading accounts than was needed.  But Michael says the CME can only do what the SIPA trustee says can be done, and part of that is to prohibit account holders from withdrawing money until all funds have been accounted for.  Bankruptcy attorney George Angelich of Arent Fox LLP, says that could take months or years.

In the meantime, the CME has posted a $300 million bond, of sorts, to convince the SIPA trustee to allow a distribution of the MF Global funds it holds to the account holders and allow full trading to resume.  The funds are not related to the $500,000 indemnification funds that the Securities Investor Protection Corporation, which administers the SIPA, and provides to investors who lose money from equities resulting from problems with investment companies.  And what is more those do not protect commodity investors.  Angelich said it would only take a small change in federal law to add “commodity” to the SIPA and indemnify farmers and elevators which may lose funds in the current situation.

Angelich says there are numerous investigations underway to determine if there were civil or criminal law violated, in addition to the SIPA trustee and the trustees in the other two bankruptcy filings on October 31.  Michaels says the CME has also looked into the solvency of the MF Global accounts, and found them being managed within the terms of the law prior to October 31, but problems developed after November 1. 

Going forward, Angelich advised elevator managers and any others holding MF Global trading accounts to consult with an attorney.  One reason is to ensure that any claim is filed properly and on a timely manner.  There is a November 15 deadline for the filing of claims in which the account may have held identifiable property, such as a warehouse receipt, Treasury bill, document of title, bill of lading or other document that can be physically returned to the owner by November 23.  A statement that shows a certain amount of cash in an account is not considered physical property and will remain under the control of the SIPA trustee, and claims may be filed later.  Also, account holders which had deposited margin money for the express purpose of taking or making physical delivery of the underlying commodity on a futures or options contract would be able to file a claim to have those funds returned, but Angelich says be prepared to answer many questions.  Angelich also said anyone who withdrew funds from MF Global accounts in the waning days before the bankruptcy filing could be the target of the trustee to return the funds.

How will agriculture feel the impact?  Everyone close to the MF Global issue has been given a stinging lesson in risk management. 
1) Congress will undoubtedly revisit the Dodds-Frank financial services legislation with unknown levels of more regulatory control being applied and subsequent pass-through of cost to the consumer, as well as determine the extent of the futures industry not using segregated accounts.
2) Bankers who loan money for hedging or margin accounts will likely ask many more questions revolving around the security of their money, should there be a recurrence of events.
3) Everyone will learn the term “counterparty risk,” which frequently was applied to the farmer by elevator managers who were concerned about non-delivery of committed grain, such as in the hedge-to-arrive difficulties of 1996. 
4) Many farmers may start asking their elevator manager where his accounts are traded, if there is risk, and how the elevator is protecting the farmer’s interest in the performance of grain sale contracts.
5) All of those issues will increase costs, and there will likely be increased costs involved in the business of selling a bushel of grain, meaning less profitability for everyone involved.  Those lost profits will be used to insure future losses do not recur.

The MF Global bankruptcy may be as close to you as your grain elevator manager.  The company held over 17,000 hedging accounts, and many elevators now have margin accounts with only 85% of required liquidity.  Federal laws, under which the $660 million shortfall is being recovered, will freeze many accounts, and particularly funds that were excess to the required margin.  Holders of accounts are urged to seek legal advice on pursing claims for return of their money, when it is recovered from unsegregated accounts.

(Disclosure: The author grew up with Jon Corzine, former CEO of MF Global, attended school and 4-H club meetings, and have been friends since two farm boys were old enough to have friends.)

Posted by Stu Ellis on 11/13 at 10:41 PM | Permalink


What about if the demise of MF Global was deliberate? Any wise man in the know would not risk money in the Eurozone this year. Did it help the Eurozone? Someone profited. Was this done so that the exposed bankers would be safer on the backs of honest Farmer? Many smaller investors? And the disruption and loss of trust? A terrorist or hacker could not have done this much damage! Fire up the Tractor Ma! It's a Convoy! Rolf: Likely there were some who profited because there are two sides of the market. Some analysts are pointing to the prior financial difficulties of MF Global, which may have lead to decisions to take riskier positions on the European debt issues, in an effort to seek higher rewards. Unfortunately, those governments did not bail out their banks as the US did in 2008. Your point about the terrorist or hacker is well taken. ~Stu

Posted by: Rolf T. Watness at November 14, 2011 8:08PM

Dear Stu: Do you suppose each seperate investor will just take it in the Can't Bust 'Ems or will Agricultural Fraternities bind together and get vocal? Also: Will the Commodities Market find other places to trust than the CME? Did MFGlobal's "bad bet" help the Eurobond crisis? Rolf: Fabulous questions for a great discussion. Anyone want to offer their thoughts? ~Stu

Posted by: Rolf T. Watness at November 15, 2011 5:05PM

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