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Futures industry refortifies

In the final dog days of summer, David Adcock, like many other Midwest farmers, hurried to harvest -- or salvage -- what he could. After an inspection, he feared that weak stalks would not withstand the winds of strong seasonal storms.

“I was afraid this crop would be a lot worse than anyone ever imagined,” says the Atwood, Illinois, producer. All those stalks standing there, deceptively strong, had cobs that were empty of golden value.

That’s almost a metaphor for the two big brokerage firms that failed in the past year, testing the strength of, and confidence in, a 150-year-old trading system.

As producers finish in their fields, the futures industry is trying to find ways to fortify its system and earn back the confidence of the farmers, ranchers, and grain industry businesses for whom hedging is essential. And today, one year after the crisis of trust began with MF Global’s failure, there are signs that trust is still alive, and reforms and due diligence measures are taking root.

Unprecedented and uncharted territory are the terms industry officials used as they began the cleanup process after MF Global’s demise.

Futures trading had been rooted in the track record that, while money could be lost with poor trading decisions, it was never lost due to system failure.

“Until MF Global, no customer had ever suffered a loss due to improper handling of funds,” CME Group Executive Chairman and President Terrence Duffy told the House Committee on Agriculture in a post-MF Global hearing.

Indeed, even after the landmark failings of big firms like Refco (in 2005) and Lehman (in 2008), the regulated commodity customer accounts were transferred to new clearing firms without disruption. In the MF Global case, disruption occurred because a shortfall was discovered in the until-now-sacrosanct segregated funds.

The sanctity of segregated funds is at the heart of the industry’s trust crisis, and so it has become the focus of most of the proposed reforms.

Working with the National Futures Association (NFA), the Commodity Futures Trading Commission (CFTC), and other industry groups, the CME Group has taken “aggressive steps” to add greater transparency and verifications of segregated funds that are held on behalf of clients, according to Bryan Durkin, CME Group’s chief operating officer.

“Nothing is more important than the confidence of our customers, the confidence they have in the marketplace in general, and the markets that we offer for their risk-management needs.”

To that end, Durkin says the industry has put into place and is in the process of implementing new requirements designed to deter another firm from misusing customer funds. Reforms include:

  • Daily segregation reporting by all futures commission merchants.

  • Bimonthly reporting on investment of segregated funds.

  • Increased surprise reviews of customer segregated funds.

  • Periodic electronic confirmation of customer segregation balances from firms via an e-confirm system.

  • Proposal of the Corzine Rule, which requires CEO/CFO sign-off of customer segregated fund distributions.

Trust is a must

Other more aggressive reforms have been proposed. The National Grain and Feed Association (NGFA), whose members handle approximately 70% of all U.S. grains and oilseeds, issued two sets of recommendations. Other reforms, such as a futures industry insurance program or changes to the U.S. bankruptcy code, need much more work and feasibility testing.

“It was our fear that as we get past the immediate emotions of the MF Global situation and get into the drudgery of a long, hot summer, people would let their guard down and reforms would not continue,” says NGFA’s Todd Kemp.

Indeed, as 2012 unfolded, the Bankruptcy Trustee in the MF Global case was able to return approximately 80% of MF Global customers’ money in installments as the bankruptcy process proceeded.

Adcock, who was not too keen on trading again after his brush with MF Global, bit the bullet and bought back some contracts the first week of June on forward sales he’d made earlier in the year. His fear of drought overcame any concerns he had about using the markets as a business tool, he says.

“I had to trust someone, because I wanted my contracts back,” Adcock says. He used the same introducing broker he has always used, who is now affiliated with a new “reputable” clearing firm.

And in the middle of the long, hot summer, it happened again. Peregrine Financial Group (PFG) failed, its CEO accused of misusing customer funds. For the futures industry, it seems that necessity is the mother of retention. Despite shaken trust, the drought year has required buyers and sellers to use every possible tool to protect themselves.

“The thing is, we can’t not hedge,” says Gail Ortegren, vice president of Grains for Cooperative Producers Incorporated, Nebraska’s largest farmer-owned cooperative by storage volume. Ortegren has been in the grain elevator business for nearly 40 years and has never seen anything like the firm failures in the last year. “The most disappointing thing about it is that I always operated under the assumption that those funds were untouchable,” he says. “We all did.”

He adds, “We are a little more cautious going forward, but we have to hedge in a volatile environment.” CME agricultural sector volumes were up 11% for the second quarter over the same period last year, confirming that hedgers, no matter how shaken, are still using the tools. Those at particular risk now are dairy and livestock operations trying to protect delicate margins in the wake of high feed prices.


Stolen monies

Mike Casey balances risk every day at Alliance Dairies. They market milk from 18,000 dairy cows on five dairies in Florida and Georgia, and produce the majority of their own feed. They buy, sell, and manage the value of their feed inventory through their Suwannee Valley Feeds division. “Do I trust the system? The price discovery part, yes,” Casey says. “We need a way to discover a fair price. It’s essential to business. We need to protect what we’ve worked a lifetime to build.”

Casey remembers the tense days when MF Global went down. “That was a testy weekend, when we had to remargin all of that money. Our trades went through, but our margin money didn’t. If the market moved against you, you’d be taken out.”

Casey hates to see MF Global cause farmers to shy away from risk management. “It is not risk management that is the problem here. It is that someone stole money. Someone is sitting in Ireland drinking a Guinness on us.”

Alliance Dairies and Suwannee Valley Feeds are about 80% whole at this time and are expecting to be 100% eventually. Casey continues to have faith in his introducing broker, Chicago-based Commodity Ingredient Hedging, and has also diversified by opening another account with a second clearing firm. That’s a step many in the industry are recommending for hedgers with large accounts; it’s an extra safeguard against further firm failures.

“We learned so much through the process,” Casey says. “We reinterviewed our brokerage and clearing firms to be sure that we wanted to continue moving forward with our risk-management program. Along the way, we discovered that there are some great minds in this industry -- good people we never would have met if this hadn’t happened. Complacency would have set in.”

Do the due diligence

It was one of the systematic changes implemented after the MF Global failure that led to the PFG investigation and its subsequent failure, according to CME Group Chairman Duffy’s July 25 testimony to the House Agriculture Committee. The new electronic account confirmation was the undoing of Russ Wasendorf Sr. That’s how his misreporting and forgery of the firm’s financial statements were uncovered.

As the tightened regulations go into effect, the industry’s focus is widening to encourage and support due diligence. Basic information is readily available, including disciplinary history of any firm or individual who conducts business on the U.S. futures exchanges, through a database at NFA’s website ( Customers should drill deeper. “We ask a lot more questions,” Ortegren says.

“We stay a little more informed about the companies you are doing business with. We try to be as diligent as we possibly can and trust the system.”

Transparency should be the new standard, according to Tom Kadlec, president of ADM Investor Services in Chicago.

“Know the people you are doing business with,” Kadlec says. “A strong balance sheet, communication, personal touch, and values -- these are the qualities of a stable firm,” he says.

Bryan Doherty, a long-time Stewart-Peterson Group broker who clears trades through ADMIS, believes that all these experiences will make the industry stronger. “When there is people’s money involved, it is always very emotional and trying at the time. Over time, I think we’ll look back on this and find that increased scrutiny and awareness will make farmers more secure and the industry stronger.”

Nevertheless, the greatest frustration stems from reports that, as of this writing, no criminal charges may be filed as a result of the MF Global losses. An August 15 New York Times article says those close to the case believe the investigation is in its final stages, and investigators are concluding that “chaos and porous risk controls at the firm, rather than fraud, allowed the money to disappear.”

That aggravates Casey. “We need to enforce the regulations we have. When people take money, they need to be brought to justice. They literally put others out of business as they were being chauffeured away in their Mercedes.”

That argument needs to be taken up with the CFTC and the U.S. Department of Justice, says CME’s Bryan Durkin.

“It’s important to note that this was a failure of a firm that broke the rules,” Durkin says.

“I certainly hope that farmers take a very good look at the very responsive action that the CME Group and the industry at large have taken to further enhance a very strongly operating system,” he says. “These were unprecedented events, and we certainly appreciate very deeply how this had a negative impact on the industry. We’re taking the steps to ensure we don’t ever have a repeat.”

Editor's Note: Angie Molkentin, a freelance writer for Successful Farming, contributed this article. Look for this story and more in the special mid-November Marketing Issue of Successful Farming magazine due out soon!

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