The mysterious disappearance of a Chicago trading giant

Puzzling losses, a closely guarded auction and possible redemption – sources unpick Ronin’s collapse

More than a month after Ronin Capital’s portfolios were seized and sold off by clearing houses, much about the affair remains unknown, including the source of the firm’s losses and the results of the auction at CME.

It’s not just observers that are in the dark. Risk.net understands Ronin’s management team is still waiting to find out what happened in the auction – information that could ultimately help determine whether the famed Chicago prop trader has some kind of future.

Five sources, including two with close links to the firm, think it could have. They argue the rates books at the heart of Ronin’s trading were hedged and healthy. “I would bet you a pint that Ronin will simply scale back,” says a well-connected hedge fund source in Chicago.

Two sources familiar to the situation tell Risk.net that Ronin’s portfolios at CME were “well within risk limits” and that the firm had met its margin requirements. “There were good portfolios associated with the firm that were auctioned off,” says a third source close to Ronin.

According to its most recent regulatory filings, rates instruments made up 84% of Ronin’s books. The firm’s losses appear to have come primarily from its far smaller equities business – although another layer of mystery is added by Ronin’s cross-holdings in Parplus Partners, a hedge fund that collapsed in March, leaving its clearer ABN Amro with losses of $200 million.

Ronin is said to have been short equity volatility when the coronavirus outbreak slammed markets in March. Those trades were cleared at the Options Clearing Corporation, with ABN Amro also acting as Ronin’s clearing broker.

The Cboe Volatility Index, or Vix, more than doubled from 39 on March 3 to 83 on March 16 before dropping back to 66 at the close on March 20. Ronin is understood to have missed at least one margin call from ABN Amro over this period.

Rather than liquidating the positions immediately, ABN is said to have allowed Ronin to trade out of them, under close supervision. Ronin remains a client of ABN, which may only see a small loss on the trades, despite taking a big hit on similar trades made by Parplus.

If there was a loss, and somehow member default contributions had been impacted, it would have been a complete disaster for CME

Head of risk at a US FCM

The losing volatility trades are said to have drained Ronin’s capital, taking it below CME’s minimum standards for non-bank clearing members. The exchange announced on March 20 that it had unloaded Ronin’s portfolios after determining the firm was “unable to meet its capital requirements going forward”.

Critics of the exchange’s handling of the matter say it was too quick to pull the plug and that the auction was poorly attended. “I don’t know why they did the auction so quickly,” says the source close to Ronin. “There were people interested in the portfolio that didn’t participate.”

Others, including several large futures commission merchants (FCMs), strongly support the CME’s response. “If you don’t meet the standards, CME reserves the right to terminate your membership. Why should they take the risk of waiting for volatility to come down when they don’t have transparency on the type of leverage Ronin was using?” asks the head of risk at one US FCM.

“You’ve got to see things from our perspective: if there was a loss, and somehow member default contributions had been impacted, it would have been a complete disaster for CME.”

Some are convinced the market has not seen the last of Ronin. The hedge fund source in Chicago claims there was “lots and lots of initial margin left over” after the auction, which could be used to restart the firm.

The head of clearing at a US bank says the fact Ronin continued to meet margin calls at CME could pave the way for a comeback. “It was more a capital threshold being breached, rather than a margin call being missed,” he says. “I don’t think you can describe it as less serious, but it does feel like a recovery from that is easier.”

Risk.net has pieced together a partial picture of the circumstances surrounding Ronin’s collapse by speaking with 15 rival proprietary trading firms, futures clearing merchants and others in the market.

CME declined to comment. Ronin did not respond to repeated requests for comment.

A Chicago story

Ronin is named after the wandering, masterless samurai of feudal Japan

Ronin is majority owned by John Stafford Jr and his son, John Stafford III. The elder Stafford started out as an options trader on the floor of the Chicago Board Options Exchange in 1975. He founded Stafford Trading, an options market-making and proprietary trading firm, in 1996. TD Securities acquired Stafford’s market-making business at the end of 2001, and the proprietary trading operation became Ronin Capital.

The Staffords turned Ronin into a force in Chicago prop trading. At one point, it had more than 200 employees and around $20 billion of assets. And while Stafford Jr’s roots were in equity options, Ronin’s rates business thrived under the leadership of Stafford III.

According to its most recent regulatory filings, Ronin held $14.6 billion of financial instruments at fair value at the end of 2018, of which $12.3 billion was government securities. Equity exposures were small in comparison – $634 million in securities and roughly $1 billion in swaps and options, along with $557 million of options on futures.

It is Ronin’s equity strategies – and its ties to a hedge fund run by one of its former traders – that appear to have been the source of its troubles.

Ronin is named after the wandering, masterless samurai of feudal Japan – apt for a firm that staked independent traders to run what were effectively ring-fenced accounts.

One of those traders was James Carney, a former equity options market maker at the Cboe. He traded index volatility at Royal Bank of Canada before starting his own trading outfit – called Wolo Group – in partnership with Ronin in 2009.

Ronin fell below minimum capital requirements. They continued to make settlement, but they failed to meet the financial requirements of continuing to be a clearing member at CME

Hedge fund source in Chicago

While trading on Ronin’s proprietary account, he developed a strategy that involved trading the S&P 500 index with an overlay of Vix options and Vix ETFs. In 2017, Carney launched Parplus Partners with investment from Ronin.

The arrangements were byzantine. Ronin’s principals had a minority interest in Parplus and its related entities. The Wolo Group was an equity member of Ronin and had traded in Ronin’s proprietary account since June 2010. Ronin and one of its affiliates provided execution, technology and back-office services to Parplus.

According to Parplus’s regulatory filings, investors related to Ronin had the option to require Parplus to purchase their equity interests in the hedge fund “upon the occurrence of certain agreed-upon events”.

“The exercise of such rights could have a material adverse effect on Parplus,” the firm disclosed in its regulatory filings, and would “be expected to significantly reduce the resources available to Parplus Management and Parplus Partners with which to manage client assets”.

Parplus did not return multiple calls seeking comment.

Going, gone

The exact nature of the trades that got Ronin and Parplus into trouble – and how their relationship affected the outcome – is unclear.

Two sources with knowledge of Ronin’s volatility strategy describe it as “vanilla”. That does not mean it was without risk.

“I’ve seen this strategy before,” says the head of risk at the US FCM. “With all these strategies, what happens is, unless you have very deep pockets and can withstand volatility, you can collect for years and then some event hits, and if volatility persists for a certain period of time, you’re done.”

Parplus had relatively deep pockets. According to regulatory filings, it managed $427 million in client assets at the end of 2019. The firm reported regulatory assets under management – including shorts and financing – of nearly $1.5 billion, suggesting it was roughly 3.5 times levered.

Several sources also described Ronin as “well capitalised”. This seems to have been the case, at least a few years ago. According to its most recent regulatory filing, the firm had $138 million of net capital at the end of 2018, far above its minimum requirements.

CME

CME’s rules dictate that non-bank clearing members must maintain adjusted net capital of $5 million or the minimum amount required under Commodity Futures Trading Commission or Securities and Exchange Commission regulations, whichever is greater. As a registered broker-dealer, Ronin had to comply with SEC rule 15c3-1. According to the regulatory filing, its capital requirement under the SEC rule was just $250,000 in 2018.

Three sources familiar with the matter say Ronin was in breach of SEC rule 15c3-1 when CME determined it could no longer meet its minimum capital requirements, suggesting the losing volatility bets had wiped away practically all of its excess capital.

“Ronin fell below minimum capital requirements,” says the hedge fund source in Chicago. “Ronin continued to make settlement, but they failed to meet the financial requirements of continuing to be a clearing member at CME.”

After determining that Ronin could no longer meet its capital requirements, CME triggered a default auction. These are conducted differently at each clearing house, but generally see members and select FCM clients invited to bid on the defaulted portfolio.

Typically, these portfolios are loss-making and will elicit negative bids, forcing the CCP to dip into the defaulter’s margin and default fund contribution – and, ultimately, the contributions of other members – to compensate the winning firm.

CME moved quickly. The auction was opened an hour after CME decided to terminate Ronin’s membership, but was then extended by 30 minutes at the request of a firm that wanted to participate, according to the head of clearing at a US bank.

The winning bidder – or bidders – is unknown. Sources suggested a number of names, but Risk.net was unable to confirm them. In an email sent to staff on March 25, Ronin said it was still waiting for CME to disclose the results of the auction.

“We share the frustration many of you must feel with the lack of information, but rest assured, when we have information to share, we will let you know,” reads the email.

Risk.net understands that, as of this week, the firm is still awaiting the auction results and repayment of excess margin.

Ronin’s employees have been left in limbo, and some are said to be preparing to leave the firm. But five sources, including two close to the firm, say they would not rule out the possibility of a reboot if the margin posted to CME can be recouped. The final decision rests with Ronin’s owners.

Others in the market say CME should be more transparent about its actions and the auction results.

“I would advise CME to be open about the whole affair because there is a lot of gossip and wild stories going about, suggesting that that they jumped the gun,” says a risk manager at a third FCM. “I think it would help CME to come clean on what actually happened.”

Additional reporting by Robert Mackenzie Smith and Tom Osborn