MF Global highlights need for disclosing asset, liability and off-balance sheet exposure details

A Bloomberg article discusses the role played by the Board of Directors and complicated disclosure in MF Global's demise.

Regular readers know that market participants need financial firms to disclose on an on-going basis their current asset, liability and off-balance sheet exposures if the market participants are going to be able to assess the risk of the financial firm.

Rather than offer ultra transparency, the article describes how MF Global's disclosure failed to lift any of the opacity surrounding the trades.

MF Global’s regulatory filings don’t give dollar amounts for the gross purchases of European sovereign debt or for the hedges. Instead, the investments are shown as percentages of a bigger base of assets, leaving investors to calculate the numbers themselves. Those assets are reported on a market-value basis. 

The firm in filings and an October investor presentation disclosed the net amount at risk from its European bonds after hedges. Neither the presentation nor regulatory filings explained that the hedges matured before the bonds and thus would have to periodically be renewed....

MF Global disclosed in a May 20 filing that its net holdings among the five European countries consisted of $6.3 billion in debt at the end of March that had an average maturity of April 2012. 

The company said in the Aug. 3 filing that its European sovereign portfolio had risen to $6.4 billion of debt with an average maturity of October 2012. 

In both instances, MF Global said the figures were “net of hedging transactions the company has undertaken to mitigate issuer risk.” 

While reporting its net holdings had increased 2 percent, MF Global had expanded its bets to $11.5 billion as of June 30 from $7.64 billion as of March 31, according to data contained in the SEC filings. The firm didn’t quantify its holdings at the end of 2010. 

The firm’s hedges, known as reverse repurchase agreements, jumped to $4.93 billion at June 30 from $1.08 billion as of March 31, the data show. 

Revenue from the European sovereign trades was about $47 million during the fiscal fourth quarter ended March 31, or 16 percent of net revenue, and $38 million, or 12 percent, in the following quarter, according to an October investor presentation.

This lack of useful disclosure meant that MF Global's management was not constrained by market discipline -- market discipline would have taken the form of investors reducing their exposure to the firm and increasing the cost of funds to the firm as MF Global increased its risk.

Instead, MF Global was dependent on its Board of Directors.

Although the trades didn’t require pre-approval by the board, directors (MF) later questioned Corzine’s investment, according to a person familiar with the discussions. 

After challenging the size of the bets and the concentration on a small number of countries, the board set dollar limits on the amount of sovereign debt its chairman could buy. 

Corzine came back to the board at least once to get the ceiling raised. 

At multiple meetings, Corzine reassured directors that the trades would work out, said the person, who asked not to be identified because the discussions were private. 

Corzine said the European countries he selected wouldn’t default before the bonds matured, and that the market was mis-pricing the debt, according to the person. Underpinning Corzine’s view was the euro zone’s European Financial Stability Facility, which could backstop government short-term debt through June 30, 2013. 

Some risk managers and traders at MF Global shared the directors’ concerns, according to a former employee with knowledge of the matter. The risk-management department began asking for daily prices of credit-default swaps on sovereign debt to keep track of how the market viewed the underlying bonds, a second person said. 

The demise of MF Global, which was spun off from fund manager Man Group Plc in 2007, shows how Corzine’s stature made it hard for the board or underlings to oppose him, even as the crisis in Europe deepened. 

Directors believed that rejecting the trades would have been an affront to the veteran trader and would have been tantamount to firing him, said the person familiar with the board’s deliberations. 

The trades could have been rejected had there been market discipline.  Investors selling the stock as MF Global's risk increased would have been the equivalent of firing Corzine.

“This was a board that could not possibly have been more expert in exposure to risk, a board with at least as much, if not more, expertise than the CEO,” said Jeffrey Sonnenfeld, senior associate dean at the Yale University School of Management in New Haven, Connecticut, and founder of a nonprofit educational and research institute focused on CEO leadership and corporate governance. “This was an example of people not having the courage to stand up to the CEO.”

The failure to stand up to the CEO would not have been a problem if there had been ultra transparency as that would have permitted the market to exert market discipline on the CEO.