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MF Global Bankruptcy

Written by: Kent Thiesse

Farming is a business that involves a certain amount of risk, whether it be weather risk, disease risk, financial risk, marketing risk, etc., and most farm operators have developed strategies to manage those risks. One of the strategies that is used to manage grain and livestock marketing risk is to “lock-in” a profitable price for the grain or livestock that is being produced, using forward contracts or price “hedging” positions. One risk that farmers have never worried about is that the so-called “segregated funds” that they have in a grain or livestock hedging account would somehow be at risk. This all changed on October 31, 2011, when a company called MF Global Financial filed for bankruptcy.

The grain and livestock futures transactions that are handled by commodity brokers for customers are usually processed through so-called “clearing houses”, which also manage the “margin accounts” that are required to be maintained. These “margin accounts” are placed into so-called “segregated funds”, which means there are very strict regulations on how these funds can be used by the firms that are managing them, in order to protect the integrity of the “margin accounts”. MF Global was one of the major “clearing houses” for grain and livestock futures trading until October 31, 2011, when the firm filed for Chapter 11 bankruptcy.

According to the Congressional Research Service (CRS), MF Global had about 50,000 futures customers, and about two-thirds of those customers had futures positions and “margin accounts” that were affected when the company filed for bankruptcy. It was estimated that approximately $1.2 billion of customer funds were still tied up as of mid-February, and return of those funds is still very much in limbo, pending further bankruptcy court action and fund availability. This has resulted in losses of several thousands of dollars for many producers and ag businesses, and even millions of dollars for some grain elevators and ag processors.

It is not known what laws, if any, were broken by MF Global, or what happened to all the funds that were supposedly in the “segregated accounts” for margin funds. Several Congressional hearings were held late in 2011, and there has been considerable speculation regarding potential misuse of those funds, and possible violations. The Commodity Futures Trading Commission (CFTC) oversees firms and companies that are involved in commodity futures trading. There are already many laws on the books that affect futures trading, “margin accounts”, etc., which are enforced by the CFTC. It is also not clear of how much, if any, of the remaining millions of dollars owed to farm operators and ag businesses will be repaid, or when repayment might occur.

What does the MF Global problem mean for the future ?

Some farm operators have taken the attitude that the MF Global bankruptcy and loss of funds does not affect them, since the do not “hedge” grain or livestock, and have never used the commodity futures markets. However, the MF Global situation could have long range impacts that affect every farm operator, regardless of the marketing strategies that they regularly utilize. In fact, some farm management experts have said that the end results of the MF Global situation could have more impact on the financial future of farm operations than the passage of the next Farm Bill, which is now being debated in Congress.

Obviously, the first follow-up priority will be to restore the millions of dollars that were lost by the farm operators and ag businesses due to the bankruptcy filing by MF Global in 2011. The second priority will be to review the laws and regulations governing futures trading, along with the oversight by the CFTC, to make sure that this situation does not happen again in the future. Some members of Congress, as well as some ag groups, are likely to call for very restrictive regulations on commodity futures trading and handling of funds. While some adjustments may be necessary, there can be a tendency to “over-regulate” following a situation such as the MF Global bankruptcy. Some experts have suggested that there are already adequate laws on the books to protect the integrity of futures trading and the margin account funds, but that the problem lies with enforcement of those laws.

Some have also suggested that future protection and laws should be implemented that involve more requirements for insurance to be purchased by commodity brokers and others that handle futures contracts. It is likely that the added cost of this insurance will be passed on to the customers, which are farm operators, grain elevators, and ag processors. The grain elevators and ag processors will likely recoup their costs by bidding lower prices for the grain and livestock that they buy from all farmers. If laws are passed that are too restrictive regarding futures trading, it could actually reduce the market alternatives that grain and livestock producers have available, thus impacting their overall profit potential.

Another potential outcome of the MF Global bankruptcy could be more restrictions by lending institutions with regards to loans for hedging accounts and futures trading. Most ag lenders have recognized grain and livestock hedging as a viable and relatively safe financial risk management tool for farm operators, and it likely is still a fairly safe tool to use. However, if either new laws or Federal examiners place significant additional restrictions on lending institutions with regards to loans for “margin accounts” and futures trading, it could reduce the ability of some farm operators or businesses to have adequate operating capital for grain and livestock hedge accounts, or result in higher interest rates. Again, any extra costs incurred by grain elevators or ag processors will likely be reflected in lower market prices that are offered to all farmers.

The MF Global bankruptcy situation, and follow-up actions, are far from over, and could affect farm operators for years to come. In this era of high market volatility and wide ranging profitability, farmers and agri-businesses need all the financial risk management tools available to them. Hopefully, Congress, the regulators, and the agriculture industry will find some workable solutions for the future.