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WILL MF GLOBAL HAUNT CME IN 2012
by Elizabeth Dexheimer,
It's been four months since MF Global Holdings Ltd. filed for bankruptcy, but how long will the fallout continue to impact CME Group Inc.?
It's still too soon to tell, according to some industry experts.
CME Group, which operates the world's largest futures markets, was the primary self-regulator for MF Global Holdings Ltd. before the brokerage firm collapsed in October and was later accused of misusing customer money.
Since its fall, MF Global has cast a shadow over CME's performance.
Trading volume decreased in CME's fourth quarter and the company said it spent $30 million in expenses related to MF Global's collapse in 2011. CME reported core fourth-quarter earnings of $3.55 per share, falling short of the $3.64 a share that analysts had been expecting.
"I think, immediately after he crisis hit at the end of October, there certainly was a temporary impact on volume," CME CEO Craig Donahue said on the company's fourth-quarter earnings call. "It's very difficult to know what the lingering effect of MF Global is on volumes given all of the other kind of dynamics that are going on macro-economically and otherwise."
In February, Standard & Poor's Ratings Services lowered CME's long-term credit rating to AA- from AA, citing MF Global in its rationale.
"While we believe CME Group is making a rational business decision to support the liquidity and integrity of its market, such support raises incremental risks that were not previously factored into our ratings on the company," said Standard & Poor's.
And most recently, CME revealed in a filing with the Securities and Exchange Commission that it received subpoenas from a federal grand jury in Chicago and the Commodities Futures Trading Commission to provide information and witnesses.
The company said it could face additional litigation.
"We could incur significant legal expenses defending claims, even those without merit. In addition, an adverse resolution of any future lawsuit or claim against us could have a material adverse effect on our business and our reputation."
So far this year, CME's trading volume has gradually improved but it's not at the levels the company saw last year. In February, average daily volume was 12.8 million contracts, up 10 percent from January but down 13 percent form the year-earlier month.
But is the lag because of MF Global?
MF Global might be a part of it but there are other factors to consider as well, according to Morningstar Inc.'s Gaston Ceron.
"It's hard to tell what is keeping people back," said Ceron. "Trading is gradually improving, but it's not quite at the robust level it was."
Ceron says that it's still too early to say what kind of ultimate impact MF Global's collapse will have on CME. But he does believe there will be a regulatory impact.
"You cannot have a scandal like MF Global and not make some changes," said Ceron. "I'm sure there will be regulatory changes that come out. It's impossible not to have some oversight of some sort."
According to Christopher Allen, an analyst at Evercore Partners Inc., there is still significant political and buy side pressure on the industry overall.
"We expect to see structural changes of some sort to the FCM [Futures Commission Merchant] model and/or futures market structure as a result of MF which we suspect will be a negative drag on volumes," Allen wrote in a recent research note.
Allen also wrote that CME management "did not anticipate meaningful changes resulting from MF." Nevertheless, Evercore raised its price target for CME by 14 percent, to $285 from $250. The stock closed Thursday at $276.23.
In its recent SEC filing, CME acknowledged the possibility of further danger, that "the shortfall of customer segregated funds at MF Global may have an impact on the overall confidence in the futures markets which could have a negative impact on trading volume."
Alton Harris, a partner and chair of the Financial Services Group at law firm Ungaretti & Harris in Chicago, said that up until this point the commodity industry has had a superior reputation for safeguarding customer money.
"I don't know if you're going to be able to distinguish CME from the industry as a whole," said Harris. "I honestly think that speculation about CME's future is premature but up until this point I think it's fair to say that CME had a halo around its head…but its halo has been taken."
Mark Melin, an alternative-investing consultant and author of the book High-Performance Managed Futures, explained that CME was at the center of threats to the industry as a whole.
"This is potentially disastrous for everyone" said Melin. "The entire industry is at the brink of whether it will live or die and CME Group is going to be tied to the industry."
But Melin remains optimistic about the industry's future.
"If we win this fight, our industry kicks off to amazing heights," said Melin. "If we can come out of this and show we are protecting investors, the future of this industry can grow tremendously."
While the lasting impact of MF Global may be difficult to calculate at this point in time, CME has made an effort to reach out to the futures community in the wake of MF Global.
CME recently launched a $100 million insurance program for U.S. farmers – the Family Farmer and Rancher Protection Fund - to protect against possible brokerage insolvencies in the future.
While the effects of the fund are yet to be seen, Ceron said that he believes CME will do what it feels is necessary to restore trust in the industry moving forward.
"Trust is one of those things that is fragile but very important to the exchange," said Ceron, adding that "it might take a while, but I think CME's management team will be able to ensure that trust is there."
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