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Opinion

Macaskill on markets: Biting off Moore than can be chewed

When Richard Moore was leaving Citigroup after two decades at the bank, in roles including global head of foreign exchange, he told colleagues he was considering a career shift to professional poker player.

Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks

Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks

He may now regret that he didn’t pursue this dream and instead allowed himself to be sucked back into banking by high stakes bond market gambler Jon Corzine.

Moore joined Corzine’s MF Global as head of Europe earlier this year, taking up his position on April Fools’ Day, which in retrospect can be seen as one of a series of warning signs about the job choice.

The biggest flashing light for Moore and other market veterans who were lured into joining Corzine – in his attempt to turn MF Global from a commodities and futures brokerage into an investment banking powerhouse – should have been the plan’s minimal chance of success without piling on risk.

Moore ran foreign exchange then European fixed income at Citi before his departure in 2008, so he should have been aware of the challenges facing any aspiring member of the investment banking oligarchy. The self-described flow monsters of banking have a virtual lock on the client volumes needed to make full service sales and trading work. Changing capital and regulatory requirements are making this business tough enough for the big firms and the prospects for new contenders have recently moved from poor to dismal.

That leaves risk-taking as the only potential avenue for success, either in the form of buying client business or making trading bets.

Corzine, the former Goldman Sachs CEO, US Senator and Governor of New Jersey, chose the most direct route for MF Global. He placed $6.3 billion of bets on bonds from some of the more exposed European sovereigns, with 51% of the exposure to Italy, followed by Spain, Portugal, Belgium and Ireland.

When Corzine justified these deals to investors on October 25, he presented them as finely calibrated trades that were virtually guaranteed to pay off by the time they matured next year.

He described the deals as fully financed and laddered, and pointed out that the Italian and Spanish exposure was partly funded by a $1.3 billion short position on France. Sadly, these trading nuances went unappreciated by MF’s derivatives counterparties and shareholders, and the firm was forced to file for bankruptcy on Hallowe’en, less than a week after Corzine’s conference call.

MF Global: A laddered portfolio

Both counterparties and investors chose to focus on the size of the trades relative to MF Global’s minimal equity and on signs of concern by regulators about capital allocation to the trades. Once counterparties started pushing for increased collateral from MF, the game was up and it faced either a forced sale or failure, in the Bear Stearns or Lehman-like fate that has become the binary option for investment banks that suffer a loss of confidence.

Moore arrived at MF Global too recently to affect Corzine’s determination to go all-in on a short-dated European government bond bet – the trades were in place – but there were other employees who investors could have expected to provide a voice of caution.

One was Michael Stockman, who was hired as chief risk officer in January. Stockman is a former CRO for the Americas at UBS, a position he held when investment banking head John Costas was running up the mortgage bets that drove an eventual loss of roughly $50 billion at the bank. Stockman later put this traumatic experience to practical use by setting up CQ Solutions, which he billed as a quantitative real-estate solutions platform. The lessons of the UBS experience seem to have been less valuable in Stockman’s role at MF Global, but he can at least turn his most recent brush with disaster to good purpose, as he lectures in a course called Financial Markets Crisis at Dartmouth College’s business school. Stockman’s students can now expect an even more acute analysis of the issues surrounding liquidity management.

Stockman reported to MF Global’s president and chief operating officer Brad Abelow, who would not be an obvious pick for a potential curb on Corzine’s enthusiasm for proprietary bond trading. Abelow has a background in banking – he was a Goldman partner responsible for operations – but he is best known as Corzine’s fixer, having served as chief of staff when Corzine was governor of New Jersey.

Munir Javeri, a former Soros hedge fund dealer who was hired as head of trading by MF Global in February, was also, in hindsight, an unlikely candidate for the role of restraining Corzine.

One lesson from the MF Global fiasco is that an attempt to break into the investment banking majors is unlikely to succeed without the assumption of risk that sensible investors should find unpalatable.

Another lesson should be that simply ticking the boxes of risk management is insufficient to ensure that an investment bank is prudently run.

MF Global made the right noises about its risk management approach. "All of our employees are risk managers," the firm said in what would turn out to be its last annual report. "Employees are expected and encouraged to escalate incidents and any matters of concern to management, and to our compliance and risk departments, to effectively manage risk."

But this approach has limitations when it is the CEO who is eagerly piling on the risk.

A third lesson is that investors and analysts should not fall for the sleights of hand that can accompany supposedly state-of-the-art risk reports. MF Global’s European bond positions came into focus in the weeks before its failure, after it emerged that regulators had pushed the firm to allocate more capital to the trades.

The actual deals were hiding in plain sight much earlier than that, though they were presented in a confusing manner. Page 77 of MF Global’s last annual report detailed the firm’s value-at-risk measures for the fiscal year ending March 31. The average VAR was $4.1 million and the total at year-end on March 31 was $2.9 million. A glance at these numbers could lead an investor to conclude that MF Global was running minimal trading risk, even though Corzine had publicly announced a drive to increase principal dealing revenues. But just below these figures came the observation that held-to-maturity and repo-to-maturity transactions were not included in the VAR calculations.

MF Global described the trades that fell into this non-VAR category as: $6.3 billion of European sovereign trades, $11.9 billion of US Treasuries and agency debt, and $1.9 billion of investment grade corporate bonds. It also provided sensitivity analysis for the impact of a 10 basis points credit spread move for the deals. That range was extremely narrow, given the trading swings of European government bonds this year, but more importantly the report did not clearly tie the deals to related repo transactions, allowing the trades to stay under the radar until regulators took action months later.

It is no surprise that so many banks trade below their book value when public disclosure can be so hard to interpret, and the sorry saga of MF Global will not speed an improvement in confidence in reporting standards.

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