When your FCM melts down: A CTA’s perspective
As a commodity trading advisor (CTA) you constantly take risks and try to manage those risks. One thing that you don't want to manage is the risk of your client’s futures commission merchant (FCM) failing. This is what happened on Oct. 31, 2011 when MF Global melted down. Here is what it's like to be a CTA when you're FCM melts down.
On Wednesday, Oct. 26, I got a call from a competing FCM; “Hi Robb, I know you have some business over at MF global. You may have heard that they have been having some problems. We’d certainly like your business. You might want to consider what is happening over there and we’d be happy to help.”
I hadn't really thought that much about MF Global’s credit rating being downgraded that week because that shouldn’t affect the futures division; all customer accounts are segregated. I didn't think much of the call because as a CTA I constantly have brokers and FCM's that want me to just move all my business over to their company with all kinds the promises of glory and how much money they can raise for me or how much better or cheaper they’ll do executions.
People in the industry get confused with the difference between a commodity pool operator (CPO) and CTA. With a CPO, all the money is pooled together into one or more accounts. This gives the CPO a lot of authority and power as to where it places the funds.
In the past, one of the dangers of having money pooled together was a Bernie Madoff type scandal. I remember decades ago a CPO manager telling me that he had so much control over the “account” that he could write a check and leave the country; that it would be a while before anybody knew what happened. The industry has learned from these mistakes and now implement many more safe guards, such as the use of an administrator and outside accounting firms.
To move accounts, the CPO can sign one set of paperwork and then inform the investors of the change in a timely manner.
A CTA doesn’t get to pool money, they manage each account individually. Each client would have to make this decision and then re-paper the account at the new FCM if the client decided to move their money there. This can create fear, uncertainty and doubt. Clients will wonder what the problem is. It’s just not worth it.
So when I got the call from the competing FCM, I didn’t think of it beyond just another competitor wanting my clients’ business. There was no reason, based upon rumor and innuendo, to cease my five-year relationship with MF Global, liquidate all positions, and have my clients re-paper their accounts. This also would delay any trading and create opportunity costs.
There was nothing to worry about. All the client funds are “segregated,” meaning that the firm could lose every dime, but those client funds are in separate accounts and not used for the FCM’s business operations. These segregated funds are sacrosanct to the industry. They provide a level of protection for all clients.
The futures industry is a relatively small industry. Especially because the Mecca is Chicago and many industry people have been in the business two to four decades. Reputation permeates the business. If somebody does something wrong, it will follow them.
I had a very good brokerage group at MF Global; I had no reason to change ships. Plus, many other CTA and CPO operations had long-standing business with them. The group I dealt with handled 24-hour trades through their Chicago and London desks. Sometimes I would put option trades on overnight. They handled them with total professionalism. When they made a mistake, which was rare, they paid for it without argument. I had a very good situation at MF Global.