Summary
MF Global is one of the key players in the global exchange traded derivatives (ETD) brokerage industry with the power to make and potentially, to break, markets, leading to some fascinating -and very significant- political dynamics within the industry. MF Global has been stung by recent activity on the rumour mill as well as its own frank admission of a risk system failure that cost it dearly. MF Global has a massive opportunity but knows it must work hard to ensure its reputation is whiter than white – particularly as some of its acquisitions have included key elements of the tarnished Refco name etc.
Analysis
It may be an uncomfortable fact to swallow but in the wider world, the futures and options business and indeed all derivatives generally retain something of an image problem.
Perhaps the cowboy image has gradually gone but alas, a certain “redneck” feel seems to remain – at least partially driven by a media that has predominantly tended to place derivatives trading in the “too hard” (and threfore to be avoided) box.
This is not helped by the fact that highly leveraged entities who come unstuck tend to blame the derivatives for their problems rather than the leverage instead. The CDS debacle has (putting it mildly) not been helpful either.
Ultimately the arguments for and against sound a bit like the risk to citizens from gun control or deregulated speed limits and fall outside the scope of this analysis.
Nevertheless, this is, as I never tire of saying, “a derivatives world.” The simple fact is that the growth in financial product is heavily skewed in favour of these off balance sheet products and the actual growth numbers are simply astounding year on year compared to cash products.
MF Global in fact has more customer accounts in ETD than were believed to exist according to informed industry estimates only a decade ago! MF Global is a 500 lb gorilla but it is a long way from being dominant in the sector – thanks to continuing ease of access for reasonably capitalized players to the marketplace.
However, when it comes to capital here is the rub. Traditionally most large bank groups have eventually run into difficulties producing the required return on capital in the futures/options broking business and it has been independents who have tended to succeed.
A handful of major bank brokerages survive but often they cannibalize their ETD revenue as a loss leader for more sophisticated (and much more lucrative) OTC products.
Powered by the Man hedge fund business (well to be specific the former AHL managed fund business in many respects), MF Global is a synthesis of assets from Man itself and also a series of acquisitions e.g. the Tullett & Tokyo ETD business, as well as critical components of Refco when it imploded (not long after the Cargill Investor Services acquisition).
However, owning something that used to be “Refco” has its problems as the futures/options business anyway is seen (most unfairly) in many quarters as a less reputable business than the securities markets.
In this respect, a key issue for the likes of MF Global or Interactive Brokers is to manage to broker a suite of products (increasingly cash markets as well as niche OTC such as CFDs and margned forex too) while maintaining customer confidence to clear through them.
MF Global is a well capitalized and secure brokerage. The dynamics of clearing mean it is rather difficult to lose a lot of money – sufficient to endanger the company, say, in a world of almost consistent continuous trading.
However, confidence n this marketplace is everything and if a name with a huge reputation for probity and safety such as UBS can find their image tarnished then it is difficult for MF Global simply because they are a relatively unknown name to the public in a business they do not or do not want to understand. After all, this is a company whose parent organisation still found itself being benchmarked against a chart of the German MAN truck manufacturer on CNBC until relatively recently. The public likes its finance from big trustworthy institutions and – for better or worse, richer or poorer, the general populus equate financial probity with big name, heavily branded, banks.
True, UBS has lost money as a result admittedly of proprietary trading which MF Global eschews…but in a panic, does such ahem, “minutiae” really matter to the terrified investor? Equally, do investors really make a big differentiation between what are basically relatively low risk data processing combines like MF Global and the banking leviathans who broke/trade/structure and just try to have their fingers in any pie they can find?
My general impression is a resounding no!).
So, MF Global could benefit from some more capital even if only to shore up confidence. Moreover, MF Global can doubtless find some vehicles to acquire or areas to develop further if it has a surfeit thereof. So MF Global is considering raising some capital just to make absolutely 100% sure that the marketplace understands that it is a profoundly solvent and remarkably safe pair of hands to entrust your clearing account to. In fact it is a good way to create encouraging media stories so as to try to propagate greater understanding of the company and its business model. This is vital in a world where say those cash equities brokers who are dependent on IPO and listing revenue are likely to soon report some quite traumatic results unless there is a sudden explosion of (partcularly more modest) issuances e.g. on LSE AIM etc).
That said, we know ICAP is exploring an exchange business and indeed MF Global alrady have their significant interest in the USFE…
MF Global is a leading if not number one player on virtually every market they access. Perhaps the capital may not be just to enhance their balance sheet beyond any question. Additionally, more funding could help MF Global disintermediate the major exchanges and clearing houses with whom there is considerable friction over fees.
