The worldwide financial contagion spreading through subprime
markets may now be hitting the futures industry in a serious
fashion. Sentinel Management Group has frozen assets largely
composed of margin excesses belonging to futures market
participants including hedge funds, brokers and
commodity trading advisors meaning that these clients
could find themselves unable to meet margin calls.
Futures industry executives told FO Week that this
could pose a major financial shock to the futures industry,
although there have been ongoing meetings to resolve the issue
between Sentinel and the National Futures Association, the
designated self-regulatory organisation of the firm and
One senior executive of an FCM, whose firm has often done
business with Sentinel, estimates that 80% to 90% of
Sentinels assets are tied to the futures industry with
clearing FCMs, non-clearing FCMs, hedge funds and CTAs.
Sentinel, a registered FCM and cash management firm, reported
it held $1.52bn in US customer segregated funds and another
$3.8m for non-US futures customers on 30 June, according to
This is a huge deal, the executive said. If
it gets to the point where Sentinel says they cant do
anything and sells their portfolio at 50 cents on the dollar,
there are clearing firms that would no longer be able to meet
segregated fund requirements. And thats where this
becomes a big problem for the Merc. There is the potential for
this to become very ugly, but I think thats unlikely at
The Chicago money manager blamed liquidity risk in credit
markets for its fund freeze as its portfolio appears to
be mired in immobile commercial credit markets. This puts the
firm in a situation in which it is effectively stymied
the only way to allow customers access to funds is to trade
We are concerned that we cannot meet any significant
redemption requests without selling securities at deep
discounts to their fair value and therefore causing unnecessary
losses to our clients, Sentinel said in a letter to
Credit markets have experienced a liquidity crisis
in the past several weeks. Investor fear has overtaken reason
and has induced a period in which most securities have ceased
to trade. This fear, while warranted in some cases, has spilled
over into the rest of the credit market and liquidity has dried
up all over the street, the firm said.
This liquidity crisis has caused bids to disappear from
the market and makes it virtually impossible to price
securities or to trade them. High grade securities are trading
like junk bonds as panicked investors dump names like General
Electric at Tyco-like prices, it added.
This means that the company has chosen to protect customer
investment in the long term in the hope that those same
customers will not require any of their margin excess during
the normal course of trading in the short term.
Sentinel, which could not be reached for comment, raised
further confusion in the market when a letter to customers
leaked to the media stated that the firm asked the Commodity
Futures Trading Commission (CFTC) to freeze the redemptions to
customers. A CFTC spokesperson said the regulator is
aware of the situation and is monitoring it.
However, sources close to CFTC said the agency does not have
jurisdiction to intervene in what is considered a business
matter between a firm and its customers, not a market
Sentinel has since retracted the statement regarding the CFTC.
However, the firm said in its letter that it would make
redemptions to customers until it can honour them in an
We will continue to monitor the markets and we will raise
cash as opportunities present themselves. We understand that
this will obviously cause inconveniences on your part, however,
at present, we do not see an alternative, Sentinel said.
We don't believe it is in anyone's best interest if a run
on Sentinel took place and we were in a forced liquidation
CME Group released a statement saying that Sentinel had told
CFTC the firm would stop accepting redemptions. The exchange
clarified that any futures risk is not directly related to it,
in that Sentinel is not a CME Group clearing firm. It added
that all of its clearing members, some of which use Sentinel
for investment advisory and investment services,
remain in good standing with the exchange.
The Merc is recognising Sentinels funds as good
funds because they think this thing will resolve itself without
real loss to those Sentinel investors who are their clearing
members, said one executive.
That could change however if the commercial paper held by
Sentinel continues to decline in value. If so, sources said CME
Group clearing members, as well as clearing members of other
exchanges, could be asked to provide more margin to CME
And this is where it could hit the futures industry hard.
Industry sources have said for weeks that credit lines have
been shrinking or drying up for months now. Those firms would
then have to go back to customers for more margin, which then
could have a ripple affect on their firm if nervous customers
close out accounts. The situation also could be exacerbated if
other big funds and cash management firms are hit like
You have to start asking yourself, Is everyone in
this going to come out okay?
And if there are firms that wont be okay that Im
doing business with, they may owe us money, one executive
said. There could well be a domino effect.