How MF Global Lobbied the CFTC to Delay Implementation of Rules Prohibiting Leveraged Sovereign Debt Exposure
The Very Reasons For Their Downfall Were at the Center of Lobbying Efforts Close to One Year Ago
Close to a year before the firm imploded under the weight of toxic sovereign debt, MF Global appears as to have successfully lobbied the Commodities Futures Trading Commission (CFTC) to delay implementation of rules designed to eliminate the very investments that became their crippling liabilities. While the CFTC is now apparently lobbying in favor of what is known as Rule 1.25, the agency apparently initially relented to the requests from Jon Corzine and his political pressure. The rest is history, with the once proud MF Global now a memory and regulators scrambling to piece together the mystery of $1.2 billion in "missing" assets.
In a letter obtained by Opalesque Futures Intelligence, MF Global Executive Vice President and General Council Laurie R. Ferber co-wrote a letter with another FCM asking the CFTC not to "fix something that isn't broken," referring in part to rules that would have severely limited MF Global's exposure to sovereign debt. In addition to encouraging hands off approach to sovereign debt, the letter written to CFTC Secretary David Stawick on December 10, 2010 seeks to keep prying CFTC restrictions off investments in items such as securities from Government Sponsored Entities (GSEs), such as bonds from Fannie Mae and Freddie Mac, to reverse repurchase transactions, commercial paper and notes. In other words, the issues at the center of MF Global's problems are what the firm lobbied against a year before their downfall.
The letter indicates that MF Global not only opposed the rules limiting investments in sovereign debt, but ironically argued rules limiting such investments would be the cause of systematic risk. "The commission has proposed changes so sweeping that they may in fact increase systematic risk by imposing new burdens on otherwise effective, efficient and liquid settlement processes," the letter reads.
The letter cites an internal CFTC study that "revealed negligible investment [by FCMs] in foreign sovereign debt," highlighting the generally assumed management principal of FCM's primarily investing in U.S. debt instruments. Foreshadowing the coming MF Global crisis, the letter notes internal CFTC document concluded "recent events undermining confidence in the solvency of a number of foreign countries." In other words, close to one year ago the CFTC had given MF Global a warning about foreign sovereign debt that was essentially ignored by Mr. Corzine & Company.
"In our view, the CFTC's proposal is unnecessary and will eliminate a liquid, secure, profitable and necessary category of investment for FCMs," the document claimed, highlighting the difficult corner to which Mr. Corzine had painted himself with MF Global. Most FCMs significantly rely on interest income from their client segregated funds to support business operations, typically accounting for approximately 30% of budgeted revenue in a given year. With U.S. interest rates at historic low levels, this put a crimp in the cash flow of many FCMs, a shortfall Mr. Corzine & Company decided to make up with highly leveraged sovereign debt exposure.
In a statement that hints at the MF Global's precarious position, the letter concludes: "If FCMs apply prudent standards through the application of sound risk policies and have sufficient capital to cover any losses in customer funds because of their investments, they should be permitted to take reasonable and limited risks in the investment of customer funds - as they do now, under a CFTC regime that has functioned successfully for many years," an apparent nod to the reign of CFTC chairman and former Goldman Sachs alumni Gary Gensler.
With perhaps Mr. Corzine's forceful Wall Street lobbying efforts put on hold, shall we say, the CFTC now might be free to institute regulations that many on LaSalle Street have always favored. Speaking with Bloomberg's Stephanie Ruhle on November 25, CFTC Commissioner Bart Chilton, was pushing for passage of what is known as rule 1.25, of which Corzine had heavily lobbied against. The issue could be decided in hearings as quickly as December 5.
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