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5 Steps CME Group Must Take to Avoid Long-Term Decline


Despite its $300 million pledge, customers are still frozen and violated. Recovery in a broad sense is less real today than it was three weeks ago.

It didn't have to be like this, CME.

On day one, an announcement from you guaranteeing what was supposed to be safer than bank deposits in the eyes of your sophisticated customers, their segregated accounts, could have paved the way to normalcy almost immediately. You then could have carried on searching for the money to pay yourselves back. A precedent would have been set, and you could have been that White Knight, perhaps even gaining confidence from your customers.

Instead, you played chicken, and lumped the risk on the backs of your "bread and butter." Now, that base, in MF Global's (MFGLQ.PK) case, roughly one-third of your transaction volume, sits deeply disenfranchised. Those with warehouse receipts are still unable to access their property after three weeks. With statements from the Trustee that such property could be subject to a general proration, investors will assuredly pause before allowing you to be the custodian of their goods. Yes, unfortunately, for my favorite marketplace in the world, things have broken down fast and hard. Now the solutions become harder to engineer, and must be bigger in scope. Like a mold problem, the CME Group (CME) missed its chance to clean it up in its infancy. Now the problem has taken over the entire house. With each passing day, it's going to take more and more.

On October 31, the day of the MF Global bankruptcy, I had placed six or seven calls to CME telling them quite sternly that aggressive action was necessary. They informed me they would pass my comments on and were doing all they could do. Standard answer to be sure. Well, since that didn't work, and with a growing following on the cover I've given to this ever-important issue, I will attempt again to provide you with a roadmap to rebuilding the bridge with your customers, your revenue base. Perhaps you will listen this time.

Before diagnosing any medication, one must be clear what the problem(s) is. In this case, there are many. It may be easier to list them. These are the current problems facing CME Group:

Short-Term Problems
  1. Customer accounts that were transferred are largely underfunded to trade.
  2. Thousands of customers in cash and/or property (securities/warehouse receipts/bills of lading/etc.) remain frozen.
Long-Term Problems
  1. The notion of customer-segregated funds has been blown out of the water; that great confidence shattered. This particularly affects the mindset of your biggest customers. Rightly, precedent in this case thus far should mandate you cease to advertise as such. Nonetheless, your savvy customers are now the wiser, and anyone who isn't, isn't as savvy as they think.
  2. There is no confidence in bookkeeping. If your biggest brokerage has books that CFTC regulators claim are taking days for would-be hours to dissect, what does that mean for all others? If three weeks have elapsed without being able to locate $600 million of missing funds, then Jon Corzine could write a Cliffs Notes guide on how to beat the regulators and steal from customer funds. How could an audit by the CFTC as late as the Wednesday before the bankruptcy leave so many holes to plug? Truly, this is the second scariest problem after rendering the notion of a customer-segregated account nothing more than an urban myth (and heavily advertised one!).
  3. Property rights, storage confidence, the basis of an Exchange that moves things, are fragile like the miniatures in Tennessee Williams's The Glass Menagerie.
  4. When there's smoke; there's fire! Unfortunately, CME Group's large inaction from inception has not only hurt its customer base, but also the brokerages it aims to protect. From this point forward -- and I say this with a degree of confidence that is exceedingly high -- any whiff of a bad bet, lopsided books, bad earnings, you name it from a brokerage house, will lead to a flood of transfers. Yes, before MF Global, customers stuck it out as their supposed segregated accounts were always sold to another brokerage seamlessly. Most customers stuck around for the transition because of confidence in the laws. As I stated in my opening paragraph, the obstacles now, after the fumble by the Exchange, are much harder to reverse. Even with a benign dénouement to this horror film, this aforementioned condition is likely to persist. Customers are going to be looking at every move of their prime brokerage houses, and will most certainly not be giving them any benefit of the doubt. With Trustees and lawyers, claim forms yet to be released, missing money -- who would subject themselves to this risk? I can guarantee that some brokerages fail due to such a "bank run" over the next few years that could have otherwise remained solvent and worked through their problems.
Please note CME Group, that I am not out to get you. I am surely not telling you anything you don't already know. I am simply trying to break the paralysis, and perhaps relay to you on a grand scale, that customers -- not only those from MF Global, but across brokerages -- are hurting and seething more than you know. Here's what you can do now.

The Solutions
  1. Pledge to cover whatever shortfall still exists in customer accounts. This will enable the Trustee to truly get folks back up and running again in the shortest time frame possible. I understand you are concerned about what you deemed the "moral hazard" of pledging money, but this theft occurred on your systems and your watch. You need to step up.
  1. Pledge in absolute terms the intention of returning all property held by Comex back to customers in their original form. This is just essential and needs no further commentary. I couldn't even imagine the lawsuits by those who paid to store assets with you, with receipts/bills, not returned. Trust me, you DO NOT want this problem.
  1. Announce a complete overhaul of software systems designed with the one intention of putting far greater controls on customer segregated funds. Again, this is common sense at this point and will serve to restore a sense that real money can be deposited with your brokerages.
  1. Bookkeeping/auditing must be greatly improved. New standards must be implemented. This fix must be woven symbiotically with greater controls of customer funds. Proving this overhaul has been properly instituted will take time, but you can win this war. With enough transparency, you may be able to convince customers that proper safeguards exist, but you must be aggressive here.
  1. New Regulations in conjunction with the CFTC. Precedent must be set that customer segregated accounts will be honored in a breakdown. With limited confidence in Regulators abilities at both the Exchange and Commission level, there must now be some Federal protection against theft ahead of a bankruptcy. All eyes are on how this saga plays out. Unfortunately, the bad executions, opportunity cost, and general anxiety that customers have faced will be hard to quantify. Any Federal protection (obviously not entirely in control of the CME Group) must establish a speedier transition of insured customer accounts.

This is now the third tough week in a row for MF Global customers. CME Group has routinely stated in our phone conversations that "It''s all in the Trustees' hands." Nonsense! Your $300 million pledge did not get you halfway there to a solution (in fact, only $50 million is an actual guarantee against losses. As I have outlined, the collateral damage in this case is great. It has become a complete mess. Lawyers are lining up all over the place. The 1066 brokers have filed suit against MF Global for their firing, JPMorgan (JPM) seeks to jump the line against customers. Our Democratic president hasn't uttered a word. Congress is late to the punch, but will likely rally. European customers vow they will never do business in the United States again. It has become utter madness, and it's global. Make good on these solutions, beginning with a pledge to back customer money and property (Steps 1-2), and you just might be at the midpoint.

But it's going to take more than that at this point. Step 3-5 have a real chance of restoring your customer base in full over time. I certainly would take another shot. Your customers want to be confident -- they are a loyal bunch, fully embracing the access to commodity trading provided by the Comex. With a 10% success rate, your existing customers are largely tough, sharp souls that have defied the odds. The risk in everyday futures trading is extreme. Coupled with an "Is My Money Safe?" gnawing, the risks may now supersede the rewards. This notion typifies what I have been hearing among most in my extensive family of commodity traders -- very dangerous ground for the Comex. Virtually everyone is attempting to pare back some. Certainly the Comex, by way of default, will have their share of business despite this scandal. But it will change, no doubt.

CME Group is a $257.51 stock with a market cap of $17.50 billion. At 55 bucks, your customers are whole. Inaction will likely see this stock fall lower than that. Transactions are down 15-20% across affected commodities, and worry extends farther than that. One would think shareholder obligations (as CME is now public) stymied the appropriate response almost three weeks ago. Now, a failure to act decisively will bring shareholder wrath.

CME Group: You can do this! You just need to wisen up. If not, perhaps I'll start up a rival Exchange someday. The opportunity will surely be there, though I'd rather leave it up to an apologetic, reformed CME Group.

(For related content, see MF Global Scandal: Is CME's Financial Guarantee Just a PR Gimmick?)

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