Don't taint us with the MF Global brush, rivals say

By Jeanine Prezioso

NEW YORK (Reuters) - MF Global's attempts to juice returns with leveraged bets on European debt were an understandable response to years of profit-sapping ultra-low interest rates, rival brokers say.

But they said that much less risky business has helped revive the fortunes of the independent futures commission merchants that are vital cogs in global markets.

FCMs weathered a dramatic shift to electronic trading on many of the world's exchanges. Then, they had to remake their business to contend with the ultra-low U.S. interest rate policy that the Federal Reserve adopted to boost the economy since the 2008 financial crisis has deprived them of interest income from collateral that they had grown accustomed to.

Corzine's solution was to remake MF Global as a full-scale investment bank with risky trading on its own books, replete with a $6 billion bet on euro zone debt. Others say they are thriving by delving deeper into niche markets, offering broader services and even raising fees.

"What happened since 2008, with interest rates at zero, is that (the old) business approach doesn't work anymore," says Sean O'Connor, chief executive with INTL FCStone LLC (NasdaqGS: INTL ), one of the leading independent brokers who has expanded into new markets through acquisitions and advisory services.

"Generally the industry has been unprofitable for two to three years now and that pressures FCMs (futures commission merchants) to make up the difference," O'Connor told Reuters. "I imagine that's what MF Global was trying to do. They were trying to change it so they could run a profitable business."

The revelation on Tuesday that MF Global -- which has filed for bankruptcy in the most jarring financial collapse since Lehman Brothers -- had failed to protect all of its segregated customers accounts has had a further chilling effect on the financial industry, making it more critical than ever to draw a sharp distinction between MF Global and the business model.

If indications of a misappropriation of funds by MF Global are proven, customers may begin to question the benefit of sticking with a smaller, independent broker. Memories of Refco, which collapsed in 2005 after revelations of fraud, are still fresh enough for many traders.

"If they do ultimately pierce the segregated account structure or concept, your money's not safe anywhere," said one veteran fund manager who had removed his funds from MF Global accounts last week.

NO RATE

The business of futures broking has been through a tough ten years. First came the rise of the electronic platform that cut the need for a middle man, reduced commissions to spare pocket change and rendered many floor brokers obsolete.

Then came the financial crisis in 2008, which reduced U.S. interest rates to near zero, sapping the steady stream of revenue that brokers had extracted from managing billions of dollars in customer accounts and collateral.

This isn't a big issue for the biggest brokers, which are uniformly investment banks like Goldman Sachs (NYSE: GS ) and JP Morgan (NYSE: JPM ), which can use broking to complement other services. MF Global was the only non-bank among the 10 biggest FCMs, which as a whole control over 80 percent of funds.

Smaller brokers have been forced to try everything, within their limits, to squeeze yield out of client's money to generate profits. Corzine, however, went to an extreme by taking a $6 billion punt on euro zone debt that ultimately brought down the 230-year old firm, they say.

"This was patent stupidity on the part of (MF) management and nothing more," Dennis Gartman, a former floor trader who publishes a commodities industry newsletter, told Reuters.

While MF Global was by far the largest independent broker at three times the size of the nearest peer, it had suffered a slow exodus of its customer business over the past year. Money in segregated accounts fell by more than $1 billion or nearly 14 percent from a year ago, according to regulatory data.

Others have taken a different route.

Interactive Brokers LLC, the all-electronic firm that had been in talks last weekend to buy part of MF Global, has prospered by driving higher volume. They opened new offices in Tokyo and Mumbai last year.

"We've always made money off of commissions and have not had to rely on interest rates," says Steve Sanders, senior vice president of marketing at the privately held firm.

Meanwhile, FCStone has selectively picked up assets to fortify its business, such as the purchase earlier this year of Hencorp Becstone Futures L.C., a mid-size broker that gave the firm a foothold in the coffee market.

It remains small, having maintained an FCM market share of just under 1 percent for most of this year, but income rose 55 percent in the second quarter. Shareholders have lauded it even as MF Global fails: Since the beginning of 2009, its shares are up nearly 70 percent; since the start of October, as MF Global's spiral deepened, FCStone is up 18 percent.

"FCMs have to re-price their services or interest rates have to go up. FCMs do a lot for their customers -- they provide capital, take risk and provide clearing operational services as well as all the systems that entails and that needs to be priced accordingly," says O'Connor.

(Reporting by Jeanine Prezioso; Editing by David Gregorio)