MF Global, 2011

A broker’s bet on euro bonds, and its clients’ missing money

MF Global was a large futures broker that, in its last year, became a proprietary trader too. It bought about $6.3bn of short-dated euro-area sovereign bonds and financed them with repo-to-maturity, which the accounting rules then treated as a sale: bonds and borrowing left the balance sheet, and the expected carry was booked up front. As the euro crisis deepened, margin and capital demands grew, rating agencies downgraded the firm, and it filed for bankruptcy on 31 October 2011. About $1.6bn was missing from accounts that should have held customers’ money separately.

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What the lesson covers

1. What happened
2. The position
3. Why it broke
4. What it cost
5. What it teaches

Key terms

• Repo-to-maturity — A repurchase agreement that runs until the underlying bond matures, so the financing never needs rolling.
• Segregation — Keeping customer money and assets apart from the broker’s own, so they are not available to its creditors.
• Haircut — The discount applied to a security’s value when it is used as collateral for borrowing.
• Derecognition — Removing an asset from the balance sheet because accounting rules treat it as sold.
• Futures commission merchant — A US broker that holds customer money for futures trading and must keep it segregated.
• Principal risk — Risk a firm takes with its own capital, as opposed to acting as agent for its clients.

Every key term, A to Z

In practice

Brokers now reconcile segregated customer funds daily and report them to regulators, need senior sign-off before withdrawing their own excess from segregated accounts, and treat repo-to-maturity as secured borrowing — so a trade financed that way shows up on the balance sheet, and in the capital charge, at its full size.

Read next

• Collateral and the CSA — The cash and bonds that back an OTC exposure
• Central Clearing — A central counterparty steps into every trade
• Lehman Brothers, 2008 — Nine hundred thousand trades, closed out at once

In the app, MF Global, 2011 carries a five-step lesson, a worked example and a bank of twelve questions drawn differently every sitting.

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