MF Global hit by unauthorised trader

February 29, 2008

My old firm, MF Global, is the latest to be hit by a large loss ($141m) as a result of unauthorised trading by a wheat trader in its’ Memphis office. The news caused the shares to fall by over 25%.

Apparently the trader had shorted the market and was hit when unprecedented volatility in US wheat markets, with prices falling 11 per cent but then jumping almost 20 per cent to a record $13.34½ a bushel in just three minutes. This against a backdrop of prices rising by 25% on Monday.

The CEO commented that MF Global had relaxed system trading control limits because they made trading desks less efficient when many customers were placing orders – these have now been restored.

Whilst I don’t have any insider information as yet on the specifics of how this happened, one can imagine a number of possible situations, including ones in which a trading desks feels its’ profitability is being impeded by “unreasonable” controls. For instance,

  • Limit restrictions may mean a desk can’t accept all the customer orders coming in when the flow of orders are all in a particularly direction eg all buy orders. The desk may contend it can easily lay these off but the sequencing of order means they “temporarily” breach limits.
  • In a phone broking environment, sales traders have to record orders manually. Whilst these should be immediately entered into systems during the call, sometimes when the phones are going crazy sales traders can revert to using their own paper blotters to jot down orders and resultant positions, thereby circumventing limit controls .
  • Often orders can be processed without allocating them to an account pending client allocation instructions e.g. a client has 10 accounts and hasn’t specified which account(s) to allocate the trades to. Time limits may operate on how long orders may be unallocated and likewise the number/size of unallocated orders may be limited. However, at busy times, it can be perceived as more important to get the order into the market and worry about the details later. In this situation a trader could enter orders for their own account but conceal them under the guise of unallocated client orders

This episode will be especially embarrassing to the COO of MF Global who has always been fanatical about operating rigorous internal controls, albeit tinged by commercial considerations. Whilst the fallout from this episode will not go as high as the COO, he will take this very personally.

UPDATE : MF Global shares continued to take a battering when the US market opened and at one point they were 50% lower than prior to the news at $14.22, before staging a rally. This will have financially hit many of the staff and Directors, many of whom hold shares and options, albeit many will probably see it as a buying opportunity.


Yoonew – A continuous options market on tickets

February 27, 2008

Similar to Sean Park, I’ve long maintained that the arcane ticketing industry is ripe for capital market models and techniques to be applied. The growth of online secondary markets has been spectacular and has even been embraced by traditionalists like Ticketmaster who recently acquired Getmein in the UK.

The next wave of market evolution is building, which will be very familiar to anyone in capital markets, namely an options market. Several examples now exist in the USA, with Yoonew, being one of the latest. It offers a continuous market on US sports events, most notably the Superbowl.

In Yoonew’s case the market actually culminates in physical delivery of the tickets to the event, rather than a cash payout. Hence, if you buy an option for a Superbowl ticket for a specific team then that contract will either result in you forfeiting your “single premium” if the team you select fail to reach the final or actually receiving tickets if they do. As a consequence of this structure, people selling options on teams have to be able to guarantee delivery of the event tickets by buying event tickets contracts in the Yoonew market which provide a ticket regardless of which teams reach the final.

For example, if you wanted to short Fantasy Seats for the New England Patriots in Super Bowl XLII in seating category B, you would first need to buy Super Bowl Tickets in seating category B. Purchasing tickets give you the ability to short contracts in one or both conferences. If you purchased 10 tickets, you could sell 5 contracts for every NFC team and 5 contracts for every AFC. Or you could short 10 contracts for every team in a given conference. With our Ticket Margin system you can short sell Team Fantasy Seats as long as you own enough tickets to cover the maximum number of short positions.

Operating a physical delivery constrains the number of contracts that the market can sustain – ultimately the size of the stadium is the limiter and so the market operator will set a threshold of underlying tickets it thinks it can supply to the market. This will dictate the maximum number buy orders for any given team.

There are a number of fascinating about this including

  • the ability of sports fan to buy a futures contract on a Superbowl ticket that pays out if their team reaches the final
  • the opportunity to hedge your position or arbitrage in other sports betting markets eg betfair may offer better odds of a team reaching the final
  • the reliance on the central operator to deliver on the contracts, since if it went bust or failed to get tickets the punters would have little or no recourse
  • the lack of a cash equivalent market whereby the end outcome is the price of a ticket, rather than a ticket itself

There will be many traditionalist who will contend this is scalping in disguise, but I disagree and think this represents a sensible development of the market and one that I hope that will soon be replicated in Europe. You can also see here the view of Allaboutalpha on the matter.

Gtalk gets meebo like chat widget

February 26, 2008

Google have released a Gtalk chat widget that you can post onto any web page, which allows visitors to chat with you whenever you are logged into your gmail account. I’ve embedded it onto this blog on the left above the meebo widget.

Whilst it’s not as slick as Meebo’s widget [little customisation available and the visitor chats in a pop-up window, assuming they allow pop-ups in their browser], it works fine. Perhaps this is the start of Google edging into Meebo’s space.

I also realised that the Gtalk widget doesn’t provide a presence indicator unlike Meebome ie. meebome tells me if there are visitors on the page in real-time and provides me with the chance to initiate a chat, whereas the Gtalk widget only lets me respond to visitors if they start the chat.

When getting answers isn’t the end of the matter, only the beginning

February 26, 2008

Below is an extract from the SocGen Internal Interim Report into Kerviel’s activities

Intermediary conclusions of the internal audit mission

The conclusions of the internal audit mission confirm the main characteristics of the fraud, as explained on January 24th 2008 by Société Générale’s management.

The author of the fraud departed from his normal arbitrage activities and established genuine “directional” positions in regulated markets, concealing them through fictitious transactions in the opposite direction. The various techniques used consisted primarily of:

• purchases or sales of securities or warrants with a deferred start date;
• futures transactions with a pending counterparty;
• forwards with an internal Group counterparty.

The author of the fraud began taking these unauthorised directional positions, in 2005 and 2006 for small amounts, and from March 2007 for large amounts. These positions were uncovered between January 18th and 20th 2008. The total loss resulting from these fraudulent positions has been identified and amounts to 4.9 billion euros, after their unwinding between January 21st and 23rd 2008.

The General Inspection department believes that, on the whole, the controls provided by the support and control functions were carried out in accordance with the procedures, but did not make it possible to identify the fraud before January 18th 2008. The failure to identify the fraud until that date can be attributed firstly to the efficiency and variety of the concealment techniques employed by the fraudster, secondly to the fact that operating staff did not systematically carry out more detailed checks, and finally to the absence of certain controls that were not provided for and which might have identified the fraud.

The Inspection General department has refrained from drawing any conclusions at this stage regarding the responsibility of the front office managers supervising the fraud’s author, given the ongoing legal investigation which has not enabled it to interview all those concerned. At this stage of the investigations, there is no evidence of embezzlement or internal or external complicity (i.e. the existence of a third party who knowingly assisted the fraudster to conceal his positions).The investigations are continuing, in particular, to cover a wider area than the activities of the author of the fraud.

Separately FT Alphaville reports that the 75 alerts raised over the trading activities of Jérôme Kerviel at Société Générale were not unusual according to Daniel Bouton, chairman and CEO of SocGen. Hmmm, perhaps they weren’t at SocGen and that was the problem!

He went onto say that “The role of the middle office is to ask questions, so it’s not surprising he [Kerviel] was asked a lot of questions.” Shame they didn’t understand the answers since, according to the report, control procedures had been respected in many cases but “no initiative was taken to verify Mr Kerviel’s assertions or to communicate the information to his superiors,” even when his assertions lacked plausibility.

Hmmm. Perhaps the internal control manual failed to explicitly point out that having investigated and received answers to questions, you were supposed to apply a sense and reasonableness test to them.

Some days you win, some you lose

February 26, 2008

Wall Street Journal is reporting that on 15 separate days last year, Citibank saw it traders lose over $100m but they also had gains of over $100m on 55 days.

In the context of Citibank profits, these days aren’t individually catastrophic [Q107 – net income from Citibank capital markets was $2.62bn], but you can bet some traders experienced a few sweats.

Contrast that with Goldman Sachs, which according to the Alea blog

During the year ended in november 2007, Goldman Sachs Daily Trading Net Revenues were positive [ winner!], 212 days out of 264 or about 80% of the time.

Hedge Funds asked to play the role of “fish in a barrel”

February 26, 2008

In a report this week, the US Government Accountability Office has concluded that the use of multiple prime brokers by a hedge fund could pose risks to the economy since no single broker had a complete view of a fund and its’ leverage. According to the report, hedge funds “often declined to share information about specific positions” with brokers.


I can certainly understand why the regulators might prefer the simplicity of hedge funds using a single broker. It would indeed allow a broker to better understand what the fund was up to and give the regulator a single broker to blame if things went awry. However, there are many reasons why a hedge fund chooses to use several brokers including

  • to encourage competitive pricing between brokers and allow comparisons on service and price to be made
  • to benefit from specialisms individual brokers can offer in particular products or stocks
  • to avoid a broker being able to “take advantage” of knowing the positions and strategies of a fund via the prices quoted for assets and stock lending. Regardless of what “chinese walls” brokers claim to operate, all hedge funds are concerns about chinks in such walls
  • concerns by a hedge fund about their counterparty exposure and concentration risk in using a single firm. For instance, when Refco went bust, a number of its clients found themselves unable to trade elsewhere for a short time until positions were released by the liquidators.

Spreading business between firms is usually more costly to a hedge fund in terms of reduced collateral netting opportunities and higher commission rates, but the merits are evidently considered to outweigh the demerits. Moreover, I can think of few, if any, firms who can claim to have a complete view of their counterparties especially brokers that trade with each other.

To advocate the funds should relinquish these benefits smacks of unfairly favouring one constituency over another to make a regulators life easier.

Food for thought – subsidies that encourage starvation

February 26, 2008

I’ve never been involved in the agricultural futures markets but it’s hard to ignore the staggering rise in the prices of wholesale prices for foodstuffs some of which have more than doubled in a year. These increases have been exacerbated by rises in oil prices and freight costs, with the result that basic foodstuffs are becoming more costly.

Demand forces can can be identified in some cases eg Higher import demand by China and India have driven up the price of powdered milk, which in turn has driven up the price of fresh milk. However, the price of foodstuffs such as maize have been directly hit by the introduction of US Government subsidies aimed to encourage the production of bio-fuels using these commodities.

The subsidies were intended to stimulate a switch to bio-fuels, the hope being that this would provide triple benefits:
– answering environmental critics by lessening the use of oil
– boosting investment in bio-fuel technologies spurred by the growth in demand
– encouraging less dependence on oil

The size of subsidies have resulted in 4% of global maize production being re-directed to bio-fuels and away from foodstuffs. This has distorted the market and pushed up prices. Whilst Government intervention is not unprecedented in order to social and environmental objectives, aside from retail consumers, this action has directly hit food aid programmes. Faced with higher basic foodstuff prices, they face the choice of asking donors for more money to maintain capacity or reducing either the volume of food distributed or number of people fed.

One man’s subsidy is another man’s empty bowl.

Commodities Last Price/
Today’s Change Year Change
Corn: CBOTAs of Feb 25 2008 20:51 GMT. 533.25

Mar 08
+11.00 +2.11% +25.40%
Wheat: CBOTAs of Feb 25 2008 20:51 GMT. 1,124.50

May 08
+60.00 +5.64% +133.06%
Soybeans: CBOTAs of Feb 25 2008 20:51 GMT. 1,469.25

May 08
+31.00 +2.16% +88.49%
Soybean Meal: CBOTAs of Feb 26 2008 09:12 GMT. 372.9

May 08
-1.60 -0.43% +63.84%
Cocoa: LIFFEAs of Feb 25 2008. 1,354

Jul 08
+8.00 +0.59% +42.83%
Coffee (Robusta): LIFFEAs of Feb 26 2008 09:07 GMT. 2,572

May 08
+80.00 +3.10% +65.83%
Coffee (Arabica): NYBOTAs of Feb 26 2008 08:50 GMT. 163.10

May 08
-0.90 -0.55% +38.46%
White Sugar: LIFFEAs of Feb 25 2008. 376.00

May 08
0.00 0.00% +12.57%
Cotton: NYBOTAs of Feb 26 2008 08:52 GMT. 79.25

May 08
+0.44 +0.56% +43.13%
Orange Juice: NYBOTAs of Feb 25 2008. 126.00

May 08
0.00 0.00% -38.86%
Cattle: CMEAs of Feb 25 2008 22:44 GMT. 94.83

Apr 08
+0.85 +0.90% -0.13%