Submitted by EconomicPolicyJournal.com
It looks like Eric Holder's dogs at the Department of Justice are doing the CME Group a favor by investigating their largest derivatives swaps competitor, LCH.Clearnet, under Federal antitrust provisions. But are they also going after the large banks, and JP Morgan in particular, in roundabout fashion? And just where does the omnipresent MF global connection fit in? From Reuters today:
LCH.Clearnet, the largest clearinghouse in the $400 trillion interest rate derivatives market and also a credit derivatives clearing service, is owned by its members including banks such as JPMorgan Chase, Goldman Sachs and Deutsche Bank. A spokeswoman for the firm declined to comment.
The Justice Department is concerned that a small group of the world's largest banks can use their ownership and influence over key market infrastructure including clearinghouses, trading platforms and data services to impede competition.
Justice Department spokeswoman Alisa Finelli declined to comment on specific details of the probe, or the firms involved. But she did outline three areas the DOJ is focused on.
"The Antitrust Division is investigating the possibility of anticompetitive practices in the credit derivatives clearing, trading and information services industries," she said.
The Role of LCH.Clearnet
As followers of the MF Global saga may recall, it was LCH (among others) who delivered crushing margin calls on MF Global during its final week, $211 million of which in cash and securities was ponied up to LCH alone. However, it was the final $310 million call that sent its UK affiliate into Special Administration (similar to US bankruptcy), since it was also on the hook for collateral calls on these trades. From Trustee Giddens' June 6, 2012 report:
On many occasions, we've thrown out the fact that LCH is owned and operated by the large banks, including JP Morgan, but the DOJ investigation is one of the few media generating stories that highlights this fact. The LCH bank syndicate also participates in revenue streams from its multi-trillion dollar SwapClear platform, as we noted here. Finally, based on court transcripts, JP Morgan seems to have exerted influence over the bankruptcy structure and content of the first day motions.
Lies Before the Bankruptcy Court
As Daniel Collins writes for Futures Mag (disclosure: quoting our own work):
[T]he original sin in the MF Global debacle is how the firm was allowed to be split — the futures commission merchant/broker dealer (FCM/BD) MF Global Inc. (MFGI) into a SIPC liquidation and the parent MF Global Holdings Ltd. (MFGH) into a Chapter 11 proceeding — with a shortfall in customer segregated accounts.
It has been pointed out that this was aided by an attorney for MFGH telling a whopper to Bankruptcy Judge Martin Glenn at the initial hearing on Nov. 1. Attorney Kenneth Ziman of Skadden Arps when asked about press reports of a shortfall told the judge, “I think, to the best knowledge of management, there are no shortfalls, Your Honor. All funds are accounted for, and I’m talking about the broker-dealer. That’s to the best knowledge. All funds can be accounted for.”
No one seemed to jump in to correct the record even though attorneys for the Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) attended that hearing and Laurie Ferber, General Counsel for MF Global, acknowledged the day before that indeed there was a shortfall in customer funds.
The Judge asked about this specifically so there is a chance he may have acted differently if he was given an honest answer.
Several interested parties have stated that the appropriate action — one perhaps more likely to have occurred had the facts of the situation been clearly presented — was for a judge to place the entire entity in receivership. A receiver would have more power to pursue leads and claw back money and perhaps more importantly, a company that operated as one entity would not have been able to divorce itself from its responsibility of having to segregate customer funds and the priority of those customers’ property over general creditors would have been maintained. That is what happened in this case with MFGH and its main creditor JP Morgan attempted to jump in front of customers.
Just Who Was the Ultimate Counterparty to the Corzine Trade?
While the broker unit Trustee and prior press reports have cast LCH's role in the repo-to-maturity trades as that of simple clearing agent, a February 2012 London court filing by MF Global UK's Special Administrator, KPMG, gives a tantalizing clue that it might just have been LCH affiliates themselves who were the ultimate counterparties (thus, the trades would have been prop, not flow, as has been assumed ). From the filing:
The Repo to Maturity claim (“RTM Claim”)
81 From September 2010 onwards, the Company entered into a number of RTM transactions with MFG Inc involving European sovereign bonds. Under the RTMs, MFG Inc would repo the bonds to the Company [MF Global UK] and the Company would enter into a corresponding repo of the same bonds with a market counterparty of which the most significant were London Clearing House entities. MFG Inc has since submitted a creditor claim for $519,044,608 (£321,569,053) against the Company in connection with the RTM transactions.
It would appear that "entities" denotes affiliation because, had KPMG meant the various hedge funds and banks that conduct clearing business through LCH, it would be more appropriate to call them "members" or "customers."
Soros Profits, Customers Lose
Further, it's instructive to recall that LCH, with permission from KPMG, liquidated the $14.7 billion gross portfolio at reportedly below market prices to George Soros and others. From the Giddens' report:
After the SIPA proceeding commenced, information came to light that LCH had liquidated the positions in European sovereign debt that MFGUK maintained from MFGI. In a November 29, 2011 press release, LCH reported selling “MF Global’s fixed income positions, which had a combined nominal value of [Euro] 14.7 billion . . . with no recourse to the default fund.” According to some press reports, LCH sold the RTM positions at a discount from current market value to George Soros and others. Because these transactions took place at the LCH, the Trustee has not had full transparency into the these transactions or the amounts that might be owing to MFGI. The Trustee continues to pursue a full accounting from the MFGUK Joint Special Administrators on this and other issues.
Yet we know from KPMG reports that the margin that the US broker entity paid, and which ended up at LCH, was used to cover the loss on the firesale of the portfolio, per UK laws that are similar to US bankruptcy laws.
Now that the Department of Justice is involved, we would urge them to consider if LCH.Clearnet, acting under the sizable influence of JP Morgan, was simply a front for a scheme to defraud MF Global customers of their money in the final (and, lest we forget, "chaotic") days of the firm.
* * *
 We received a note shortly after original publication by Francine McKenna of ReTheAuditors, who said she had contacted several sources who advised that LCH.Clearnet does not engage in proprietary trading. If that is indeed the case, then KPMG flubbed the disclosure and the ultimate RTM counterparties remain at large. LCH.Clearnet did not respond to McKenna's inquiry regarding ultimate counterparties.