Hurricane Refco hit the futures markets two weeks ago, but none of the world’s regulated contracts or exchanges appears to have suffered real damage.
That shows the regulated futures marketplace was prepared to handle a sudden crisis like the collapse of futures and financial market brokerage firm Refco Inc. and protect people, including farmers, who use exchanges to hedge.
“The safeguards we have are acceptable,” said University of Manitoba economist and derivatives market expert Milton Boyd.
“The farmer may wonder ‘is my money safe?’ … I would say yes.”
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The North American futures trading industry contains numerous mechanisms to protect clients’ money and positions and there has never been a futures contract default. The shock absorbers the industry uses have prevented any company’s problems from becoming a major issue for hedgers.
Boyd said farmers may not realize it, but a regulated futures position has more safeguards and guarantees than a forward contract with a grain buyer.
Boyd noted that the buyer and seller involved in a futures contract must deposit margins to ensure performance of the contract. In forward contracts, there is no regulation requiring posted margins.
“If I’m a farmer and I make a (forward) contract to sell my peas or something, there’s no margin there, so hopefully the firm on the other side won’t go bankrupt and hopefully they’ll pay me for my peas.”
Contract disputes are not uncommon between farmers and buyers. In 1998, many prairie hog producers were hurt when Midwest U.S. buyers simply ignored forward contracts. That has never happened with a futures contract.
Big market player
Refco is a major derivatives market player with hundreds of thousands of clients that use it for publicly regulated futures and options trading on exchanges such as the Chicago Board of Trade and Winnipeg Commodity Exchange, and for non-public over-the-counter customs derivatives trading.
The company went into a death spiral on Oct. 10 when it revealed that it had suspended its chief executive officer for hiding a half-billion dollar debt from the company’s books. He now faces securities fraud charges.
Refco has applied for bankruptcy protection and has sold its regulated futures business.
According to many reports, Refco’s regulated futures clients have not had undue problems using their accounts, unwinding positions or withdrawing money.
Most experts consider those accounts safe because of the futures market’s multiple safeguards.
Every company that wants to act as a brokerage on a regulated exchange such as Winnipeg or Chicago must be a member of a self-regulatory organization such as the Investment Dealers Association, which imposes strict conditions on its members. This minimizes the number of companies that end up in financial trouble.
Brokerage companies have to follow strict solvency rules to operate, ensuring they will not suddenly collapse, leaving clients’ accounts in limbo.
Clients’ money administered by brokerage companies like Refco is held separate from the company’s money and kept with third-party financial institutions, such as banks.
Futures accounts are kept current by the constant adjusting of margin accounts between winning and losing positions, ensuring that no imbalances occur that could destabilize the system.
Also, exchange clearinghouses guarantee every position of every user in their system, ensuring that problems with one party to a contract position don’t affect the other side.
Overall, the system is designed to keep company problems within the company and to prevent them from leaking into the greater marketplace.
That appears to have happened.
University of Missouri hog market analyst Ron Plain said that Refco’s implosion appears to have created no ripples in Chicago pork markets.
“It looks that way to me. It looks like the system is working. It seems not to have had a dramatic impact on the market, as far as I can see,” said Plain.
Boyd said commodity exchanges everywhere take their safeguards seriously, because they can’t afford to lose public confidence.
“The whole idea of exchanges is built on trust,” said Boyd.
“If there was ever a default, it would endanger the franchise of exchanges and the futures industry. They’re very careful to make sure that a default never happens.”
