NEW YORK/CHICAGO Call it the mother of all margin calls: Up to 50,000 former customers of bankrupt broker MF Global must find some $1 billion in additional collateral almost overnight, or be forced out of their trades.
Come Friday, with the mass transfer of commodity trading accounts from Jon Corzine's fallen firm to six of its erstwhile rivals, margin clerks will be wrapping up a reckoning of how much additional money is needed to cover millions of positions. Clients who can't quickly meet their margin will have to liquidate, making for a tumultuous day's trade.
A court order to move the trades late on Wednesday brought only marginal relief to clients who have been essentially frozen out of their funds and positions since Friday. While accounts will now be transferred more quickly, only 60 percent of the collateral will be moved to the new brokers.
That figure may yet fluctuate as brokers scramble on Thursday to work out the details, but the net result is still likely to mean that customers will be forced to post a hefty sum within a day or two. Many of MF Global's mainly small-scale clients may fail, triggering a mass liquidation of both short and long positions that may roil markets.
"I've got somewhere in the region of 8,000 positions. We can't afford to double margin those sorts of positions," said Tom Wacker, a proprietary gold futures trader in New York. "If we can't get our positions transferred they're going to be liquidated and we're going to lose a lot of money."
Eventually, in days or weeks, the remainder of the money should be returned. The $600 million that regulators say MF Global may have misappropriated from customers could remain outstanding, but that is less than a tenth of its funds.
In the meantime, however, brokers are unlikely to extend loans to new, unfamiliar customers to make up the margin gap -- and in some cases may simply refuse to take them at all.
"We are going to require full margin on our accounts," says Sean O'Connor, chief executive of INTL FCStone, the second-smallest of the six futures commission merchants (FCMs)selected to take the accounts.
FC Stone processes "hundreds" of account transfers a month, but the speed and scale of this week's activity makes it an enormous challenge, he said. Transfers only began in earnest late on Wednesday, as overworked MF Global brokers were unable to keep pace with requests earlier in the week.
"The CME has said the way they would like to handle this is the accounts are moved or they liquidate it within five days, so this will be resolved by Monday," O'Connor told Reuters.
That means crunch time on Friday as the six firms -- ABN Amro Chicago Clearing, ADM Investor Services, Dorman Trading, FCStone, R.J. O'Brien and Rosenthal Collins Group -- calculate the margin required for traders to keep their trades open.
Some traders grew increasingly frantic, fearful of being forced out of positions if a broker won't take them on.
Stephen Harbeck, president of Securities Investor Protection Corp, a group that recovers assets from failed brokerage firms, told Reuters that they were having trouble finding brokers willing to take on the accounts.
A mass liquidation in the commodity markets wouldn't have the same effect as in equities, when most of the trade would be selling. For every long futures position there's an offsetting short, and therefore just as many customers should be selling long positions as buying back short ones.
But it may make for a wild session.
"Risk managers out there are going to be as cautious as possible. Obviously with no money coming out of MF, positions are going to have to be liquidated just because there will be accounts that are carrying debit balances over," said Rob Kurzatkowski futures analyst with OptionsXpress in Chicago.
"I think we're going to see extremely volatile trading."
WHEN MARGINS CALL...
Margin works like this: an exchange requires that its members (clearing brokers like MF Global) place money on deposit when they take trades from customers. The clients post those funds to MF Global, which places them in a special segregated account that can be reviewed by the exchange.
When MF Global filed for bankruptcy on Monday, almost all that collateral was essentially frozen. Some customers were able to liquidate positions or transfer, but they were not able to get any funds out of the broker. And the remaining employees have been overwhelmed by customer demands.
"Like a lot of others, I'm depending on the media for what's going on," one MF Global broker told Reuters.
Wednesday's court proceeding would release some 60 percent of those funds and move the accounts to new brokers; with total funds are estimated at $2.5 billion, around $1 billion would remain at MF Global, according to the order. It was not clear which of the brokers would get the lion's share, although one industry source said R.J. O'Brien had led the effort, and as the largest of the bunch would likely get a large portion.
The overall amount of additional funds required isn't particularly large in the grand scale of things.
When exchanges raise minimum margins for a specific commodity, which they do routinely when prices are volatile, the market adjustment can be more significant. In September, a 21 percent hike in CME gold margins was equivalent to a call for $2 billion to top up escrow accounts to maintain all open positions, long and short.
While MF Global's funds represent only 4.3 percent of all segregated FCM accounts, the impact of the margin call could be much larger. Not only did the firm service a large share of smaller retail and day-traders who will be hard-pressed to come up with the additional capital, they also serviced some of the most active players: it was the No. 1 most active broker on the New York metals and energy markets, and No. 2 in Chicago.
The silver lining may be that commodity prices, as a whole, are broadly unchanged from where they were on Friday, when most of MF Global's positions were last fully margined. If prices had instead fallen, for instance, any clients holding long positions would have had a disproportionate need for collateral relative to short positions, fueling more selling than buying.
NOT THE FIRST TIME
The current process is similar to what occurred in 2005 to Refco, which had collapsed in a massive fraud scandal. Funds from segregated accounts were distributed out at 50 percent initially, followed quickly by two sets of 25 percent. In the end, all funds were returned to brokerage customers.
It was nearly six years ago to the day that MF Global's former parent Man Financial paid $282 million to buy most of Refco, its fallen rival. Overnight, Man grew by more than half, becoming the fourth largest in the industry.
But its growth then stalled. As of this August, MF Global held $7.3 billion in its segregated accounts -- compared to $7.2 billion in December 2005, a month after its deal, according to Commodity Futures Trading Commission data.
Even so, MF Global was nearly three times the size of the next-largest independent broker, and divvying up even a portion of those accounts could be a welcome windfall for brokers who have suffered doubly over the past decade -- first through a wrenching shift to electronic trading and now years of depleted interest income due to near-zero rates.
However, shareholders in FCStone were not impressed. Its shares rose just 1 percent, pacing the overall market.
"Remember this isn't the first time we've had a transfer of funds from a failed broker," said Dennis Gartman, a veteran trader and commentator who also serves on the board of the Kansas City Board of Trade (KCBT).
"This is the first time we've had one this massive in size, this public in nature, and this egregious in terms of the man who was behind the losses. But what will happen is that they transfer with a portion of the collateral, and the rest will follow. They want to keep some capital on hand just in case."
Gartman said the KCBT wasn't anticipating particularly volatile trading on Friday, with MF Global's short and long positions in its mainstay wheat contract roughly balanced.
(Additional reporting by Matthew Robinson, David Sheppard in New York, Mark Weinraub in Chicago; Writing by Jonathan Leff; Editing by Alden Bentley)