MF Global, spun off from a hedge fund manager, has growth plans that include leveraging its status as a Treasury securities dealer.
By Ken Tarbous
January 15, 2010
MF Global aspires to be more than just a broker-dealer and clearing house. Spun off in an IPO three years ago by hedge fund manager Man Financial, the futures and options brokerage has plans to compete with Wall Street banks.
Well along in the application process to become a U.S. primary dealer, MF Global this month completed the relocation of its corporate domicile from Bermuda — a locale fraught with negative associations for many in the financial world — to Delaware. It's a move the company acknowledges was, in part, "reputational," but some market participants see an attempt to placate the Federal Reserve.
"We believe this move to Delaware will help MF in the process to become a primary dealer," Roger Freeman, an analyst at Barclays Capital, said in a report.
While foreign entities are allowed into the elite club of primary dealers that deal directly with the Fed trading in Treasury securities, Bermuda is seen as a domicile with light corporate governance and the Fed must consider its public image when it approves new primary dealers.
"The Fed is cognizant of their own reputational risk. If they allow a dealer who shouldn't become a dealer, that might have an impact on their own reputation," says a market participant involved in his bank's primary dealer operations who did not want to be named.
MF Global's quest to become a primary dealer is not a done deal, and the company declined to discuss its application.
Motivation for becoming a primary dealer goes beyond making money on Treasury transactions.
Prestige and the attendant growth in client and counterparty bases play a large role in deciding to push to become a primary dealer, and that likely has been a factor in MF Global's thinking, market participants say.
"Some institutions will only deal with primary dealers. If nothing else, they feel like the primary dealers are more scrutinized by the Fed. Whether or not that's true, it's the perception," says one market participant who declined to be named.
The New York Fed, for its part, reiterated this week that the primary-dealer designation is not an endorsement. Indeed, Lehman Brothers and Bear Stearns were primary dealers.
Meanwhile, the road to becoming a primary dealer may have gotten tougher in recent days.
The New York Fed announced this week a "more formal" set of rules and requirements for primary dealers. With these new rules primary dealer firms have to hold at least $150 million in net capital, up from $50 million.
Treasury volume is expected to be up next year as the U.S. government finances a record deficit, making the role of primary dealers all the more lucrative in that the business area can draw in new clients and help leverage relationships with existing clients, particularly in fixed income.
"When you are a primary dealer, you see some flows you wouldn't otherwise see, particularly in repos. There are certain advantages in becoming a primary dealer. That's where the moneymaking opportunity is. You can see who is buying. The flow, that's where you can take advantage of market," says a market participant who was involved in his bank's primary dealer operations and did not want to be named.
MF Global has not stood by and waited for that primary-dealer status to build up its presence in fixed income.
Since last year MF has been building its high-grade corporate and high-yield business areas as part of its expansion in the fixed income, Niamh Alexander, equity analyst Keefe, Bruyette & Woods who tracks MF Global.
Geographically, Asia remains a growth area where the brokerage has added sales and trading professionals, Alexander says. But there have been notable changes within the ranks of management and high-profile roles.
In October 2008, former Chicago Board of Trade chief executive officer Bernard Dan, who joined MF Global in June 2008 as president and North America chief operating officer, was named CEO. In April 2008, Randy MacDonald, who filled several roles at TD Ameritrade Holding from 2000-2007, joined as chief financial officer.
Robert Lyons joined in September as COO for North America after spending more than 20 years at Bear Stearns, serving as COO in the global equities division, among other roles. And in October, James O'Sullivan was hired as MF Global's chief economist, coming from a similar role at UBS.
Aside from Treasuries and corporate debt, MF Global has also stepped up its presence in the important government agency debt business.
Late last year, MF Global received accreditation as a Federal Home Loan Bank underwriter and reallowance dealer.
FHLB discount note issuance totaled nearly $1.5 trillion in 2009 and overnight issuance averaged about $23 billion per day.
Those new business relationships could be leveraged in other business areas, including what one analyst who declined to be named named says may be an expansion into investment banking at a time when the number of major Wall Street firms has been whittled down by the credit crisis.
With all the plans to grow beyond its roots, MF Global has encountered some difficulties with regulators in recent years. In December, for example, Commodity Futures Trading Commission regulators fined MF Global $10 million for risk-management practices related to a rogue futures trader's actions in 2008.
And, as is the case with any buildout on Wall Street, firms with ambitions need to spend money to attract talent. MF Global has spent more on compensation and expenses, while taking in lower revenue because of declines in futures trading volume across the industry, something that has caught the attention of rating agencies.
In November, Moody's Investor Service downgraded MF Global's outlook from stable to negative, maintaining its issuer rating at Baa2, still an investment-grade rating, according to Alexander Yavosky, vice president and senior financial institutions group analyst at Moody's.
A number of issues factor into rating agency analysts' thinking and one of them was the issue of compensation and expenses.
In addition, MF Global has a highly levered balance sheet, a way of maintaining revenue in a low interest rate environment that increases risk for creditors, Yavosky says.
MF Global is not alone in its efforts to become a primary dealer. Other firms vying for the role include Scotia Capital, Societe Generale, and TD Securities, according to market sources.
Like MF Global, these companies may be looking to use the primary dealer status as a stepping stone to becoming a full service bulge-bracket firm like Bank of America Merrill Lynch or JPMorgan Chase.
