MF Global: a case study of liquidity risks

Richard Heckinger

Abstract

ABSTRACT

Dealers in financial contracts need to fund the investments they take on their books; therefore, they need to have sufficient liquidity to pay for purchases and maintain their positions at current values. The broker-dealer MF Global (MFG) entered into trading strategies that, while locking in profits, still required funding and therefore sufficient liquidity to implement. In October 2011, MFG defaulted to its counterparties and customers due to its failure to maintain sufficient liquidity in order to sustain its investment strategies and agency businesses. MFG sought liquidity from a variety of sources, including, it is alleged, customer funds that were legally required to be segregated from the firm's proprietary positions and liquidity needs. This paper examines the liquidity demands on MFG and the diminished sources of liquidity supply as MFG itself and the assets underlying its investments suffered credit downgrades. Further, this paper examines the behavior of MFG and its counterparties, as well as the lessons learned with reference to the "principles for financial market infrastructures", which were published in April 2012: in particular, the lesson that customers' monies and positions should be segregated from those of the intermediary, and that sufficient financial resources(margin and liquidity) should be secured by central counterparties (CCPs) to guarantee the positions held at the CCP to all its participants.