* Case shines spotlight on long-standing industry practice

  * Firms have legal leeway with 'segregated' customer funds

  * Clients demanding assurance their money is safe

  * Backlash could rock industry already under pressure

  * Investor trust in 'segregated' accounts vital to markets

  By David Henry, David Sheppard and Matthew Goldstein

  NEW YORK, Nov 11 (Reuters) - Almost two weeks after the bankruptcy of commodities firm MF Global, customers at rival firms are all asking the same question: How safe is my money?

  MF Global's collapse is confronting clients across the industry with the harsh truth that while their accounts may be termed " segregated" that does not mean they are off-limits from trouble at a commodity futures firm, much less backstopped by any government insurance fund.

  MF Global revealed to regulators during its Oct. 31 bankruptcy that it was short perhaps $600 million in customer funds - money which the firm was supposed to keep in " segregated" accounts maintained under a raft of laws and regulations.

  The concerns among investors have reached such a pitch that futures exchange operator CME Group announced late Friday that it will provide a guarantee for $300 million of the missing money in the MF Global case.

  " I've lost a good deal of money already over this. Now I'm a big boy who should have known better, with over 25 years experience in the futures industry, but what they were doing with client funds is to me outrageous," said Stuart McClellan, an independent trader from Norfolk in the United Kingdom, who previously worked for Schroders in London.

  McClellan has more than $110,000 tied up in MF Global, which he doesn't know if he will get back.

  " Using the excess collateral in clients' funds to trade is not illegal, but to my mind it's immoral. There is a huge risk," he said.

  Futures commission merchants, as brokers in the industry are known, have always been allowed, with certain restrictions, to invest customers' so-called " excess margin," or the funds in their accounts over and above the collateral required to maintain trades. The brokers then book any profits for themselves.

  Segregation simply means that customer deposits can't be mixed with the firm's own money or used to cover firm expenses. They must always be available for customers to trade with or withdraw at a moment's notice. In other words, customer segregated money isn't some big cookie jar for the firm to dip into when it is short on cash.

  " That is what is so shocking about MF Global's situation," said Michael Greenberger, a former director of the Division of Trading and Markets at the Commodity Futures Trading Commission (CFTC) and now a law professor at the University of Maryland.

  " If that stability is not present, people will not want to go into what is already a highly volatile trading environment," he said.

  Now with each passing day that missing money has not been found, there is growing concern that MF Global may have abused its legal latitude with the segregated customer accounts.

  The fear is that MF lost the segregated funds in bad trades or used them illegally to meet other obligations. By this time, traders and investigative sources say, it should have been possible to trace the money, if it still exists, in some account with another financial institution.

  Some traders who tried to withdraw funds from MF Global prior to the bankruptcy received checks that bounced.

  Commodity traders and investors are now saying they will demand their brokerage houses reveal exactly what they plan investing customer funds in.

  Don McAfee, a private investor from the San Juan Islands in Washington state, said he had been a " novice" trader of commodities who had become interested in the sector, in part because he saw less risk from the fate of individual banks and brokerages than in equities or bonds.

  " It was a way of diversifying out of just playing stocks, and I was very attracted to the fact you did not seem to have any counterparty risk," McAfee said, who has around $220,000 still frozen at MF Global.

  " In the future I am going to want an ironclad guarantee that my account is fully segregated. And if it's not I need to know that at most it's being invested in U.S. Treasuries, not commercial paper or foreign bonds."

  PRESSURE MOUNTS ON RIVALS

  Brokers at rival firms, who had perhaps hoped to benefit from the disappearance of one of their fiercest competitors, are fielding endless calls from concerned customers and fearing a run on their own accounts.

  " I'm getting calls from people, wanting to know if this could happen again, if I can give them proof that the banks I'm dealing with are okay and that their money is safe," said one broker on the floor of the Chicago Board of Trade (CBOT) on Thursday, who asked not to be identified.

  " That's never happened to me before. There's a lot of fear,' he said.

  Other traders said they were looking to spread their accounts across multiple brokers to limit their risk, after watching friends and colleagues locked out of the market over the past two weeks. Others said they were looking into insuring their funds.

  The failure to free up client funds quickly after the bankruptcy was further undermining faith in the safeguards in the commodities market, said Michael " Mack" Frankfurter, co-founder of commodity trading advisor Cervino Capital Management LLC in Beverly Hills.

  " There is unintended consequences and systemic risk evolving in this situation. It's not about what needs to be done going forward... It's about what needs to be done immediately to save the industry," he said.

  WHO TO TRUST?

  MF Global's standard agreement with customers permitted the firm to " borrow, pledge, repledge, transfer, hypothecate, rehypothecate, loan or invest any of the collateral" in customer accounts. The language is typical of agreements throughout the industry, said one longtime futures trader and industry consultant who did not want to be identified because he does work for CME Group.

  The largest customers might be able to get that language tweaked in their favor a bit, perhaps with an agreement to split revenue earned on the customer deposits. But smaller investors generally have to accept the firm's plans for the use of excess cash in their accounts.

  Trading in commodities has exploded over the past ten years, increasing by more than 600 percent according to some estimates, and bringing in a new breed of 'Mom and Pop' investors hoping to protect themselves against, and benefit from, the rising costs of food and energy.

  The practice of firms using customer excess cash to make money has been a basic source of revenue for the industry for decades, if not centuries. In fact, it is revenue from those investments that has allowed the firms to cut their commission rates to attract more business.

  The practice is codified in U.S. law and regulation, which until 2000 limited use of the funds to basically U.S. Treasury and state and municipal obligations. Over the next five years, the rules were eased to permit firms to use customer money to enter into repurchase agreements and buy foreign bonds, money market funds, and assorted securities.

  PROPOSAL SHELVED

  When the financial crisis prompted second thoughts from the U.S. Commodity Futures Trading Commission, the industry fought to stop proposals to cut back on how much the firms could do with customer money.

  MF Global, which was led by ex-Goldman Sachs CEO and former New Jersey Governor Jon Corzine, teamed up with Newedge Group, a major competitor, and warned in a December 2010 letter that reducing the stream of revenue could force some futures commission merchants to shut down.

  The Futures Industry Association, an umbrella organization representing futures traders such as Goldman Sachs Group and Jefferies & Company, as well as MF Global, also pushed back against plans to stop firms investing in foreign bonds and other riskier assets with customer funds. The proposal was eventually shelved.

  The MF Global collapse prompted CFTC Chairman Gary Gensler to say Nov. 7 that he will push again to tighten the restrictions. Industry experts say that may improve the security of segregated funds, but it could also force brokers to charge higher fees.

  Meanwhile, the building outrage over the missing money is rattling industry veterans. Dennis Gartman, a board member of the Kansas City Board of Trade known for his daily market commentary, wrote Friday that if industry leaders do not act quickly to make good on the MF customer money, " the futures markets shall be under real and permanent assault."

  Todd Thielmann, a former MF Global broker on the floor of the Chicago Board of Trade, said fear was spreading fast among customers.

  " They've taken any excess money out of all firms now and they don't know who to trust."

* Palm rises 0.5 pct on strong demand, declining output

  * Palm oil records third straight week of gains

  * Dalian conference to take place over the weekend (Updates prices)

  SINGAPORE, Nov 11 (Reuters) - Malaysian palm oil futures climbed to a their highest in more than three months on Friday, buoyed by a strong demand and a surprise drawdown in stocks.

  Palm oil prices recorded a third straight week of gains on expectations of low output in the coming months as oil palm trees enter lean output phase.

  " The market is down a bit because of weaker U.S. soyoil prices overnight but it's holding on," said one Kuala Lumpur-based trader, referring to the 0.1 percent drop before the midday break. " We are entering the lean production months and demand is continuing to remain strong month after month."

  Benchmark January palm oil futures on the Bursa Malaysia Derivatives Exchange settled up 0.51 percent at 3,135 ringgit ($994.76), after climbing to as high as 3,160 ringgit, a level unseen since July 21.

  Traded volumes stood at 32,707 lots of 25 tonnes each, compared to the usual 25,000 lots as many investors were taking up positions ahead of the Dalian Commodity Exchange's China International Oils and Oilseed Conference over the weekend.

  Reuters analyst Wang Tao said Malaysian palm oil may rise more to 3,240 ringgit per tonne, and support is at 3,080 ringgit.

  U.S. soyoil futures rose half a percent on Friday after declining almost 1 percent in the previous session on a broad-based weakness in grains and oilseeds prices which stemmed from Europe's debt crisis.

  For the week, palm oil is up 4.0 percent, its third week of gains, while U.S. soyoil has lost more than 2 percent so far this week after two weeks of gains.

  Malaysia's government reported a 1.6 percent decline in stocks on the back of strong exports offsetting output, reinforcing concerns that supply will get tighter when monsoon season and La Nina rains curb harvesting in the last quarter.

  Investors are watching weather conditions in Southeast Asia on concerns La Nina rains may further disrupt oil palm harvesting during the year-end monsoon season -- a scenario that could reverse a near 20 percent decline in prices this year.

  In other related markets, Brent crude rose above $114 a barrel, on hopes that developments in Italy and Greece were part of a move that will help avert a wider crisis in the region.

  China's most active May 2012 soybean oil contract < 0#DBY:> ended up 0.98 percent, but an analyst said uncertainty surrounding the euro zone crisis may weigh on prices.

  " Gains will be capped in the short term unless there is positive news from Europe to boost investors' confidence," said Huang Zhi Qiang at Guotai & Junan Futures.

  Palm, soy and crude oil prices at 1012 GMT

By David Brunnstrom

  BRUSSELS (Reuters) - The head of NATO says he remains optimistic about U.S.-European defence cooperation, particularly in missile defence, in spite of the risk of massive new U.S. budget cuts and fears of recession in Europe next year.

  In an interview with Reuters, Anders Fogh Rasmussen, who often describes himself as a natural optimist, also brushed aside any concern over what impact a possible unravelling of the euro zone currency union could have on cohesion of the NATO alliance of 28 nations -- 26 of which are European.

  " That's a very hypothetical question," the former Danish prime minister said. " I don't think it will unravel on the contrary, I do believe European countries will find solutions to the problems in a very determined manner."

  Speaking on his way back from a visit to Georgia on Thursday, Rasmussen said the economic crisis should boost his " smart defence" initiative to encourage greater cooperation in defence projects.

  " Actually, it's an old truth and very often repeated that in every crisis there is also an opportunity and I think that's what we are seeing right now," he said.

  " Of course, defence ministers are faced with huge challenges because of declining budgets and it's obviously a matter of concern, but it's also an opportunity to do business in new ways and in particular an opportunity to make more efficient use of scarce resources."

  Rasmussen said he was confident after meeting U.S. President Barack Obama and Congressional leaders in Washington this week that NATO's flagship cooperation project -- missile defence -- would survive even if Washington were to make radically higher defence cuts on top of $450 billion (281 billion pounds) faced over the next decade.

  " I am sure it is ring-fenced and protected against cuts," he said. " I got the impression... that there is bipartisan support for continuing that project."

  He said he was also " sure the Americans are aware" of the importance of the U.S. military presence in Europe when it came to improving the ability of allied forces to operate together.

  FEARS OF MASSIVE U.S. CUTS

  The failure so far by a U.S. Congressional " super committee" to produce a deficit-cutting plan has raised fears of sweeping cuts in U.S. defence spending that could involve further scaling back of the U.S. military commitment to Europe.

  The legislation that created the panel gave it until November 23 to come up with a plan to cut deficits by at least $1.2 trillion over the next 10 years. It will trigger automatic cuts estimated at $54.7 billion annually in both defence and non-defence spending if the committee fails to reach agreement.

  Rasmussen declined to speculate on how further U.S. cuts could affect the U.S. military presence in Europe, which he called " an essential element" of the trans-atlantic relationship.

  " But obviously that military presence can adapt over time, taking into account the development in the overall security environment," he said. " So we may very well see such adaptations in the wake of budget cuts, but ... at the end of the day it is a national and in this case a national American decision."

  Rasmussen said he had been encouraged by recent U.S. decisions showing " a strong commitment to collective defence and also an American presence in Europe."

  " The fact that the United States will provide an input to the NATO missile defence system demonstrates a continued American commitment to Euro-Atlantic security and the continued presence in Europe," he said.

  " Recently you have seen announcements that NATO allies will host such missile defence facilities. Turkey, Romania, Poland recently also Spain. So actually you see that American presence in Europe now adapted to new security challenges and I find that quite encouraging."

  The importance of the missile defence system was underlined on Tuesday when the International Atomic Energy Agency reported that Tehran appeared to have worked on designing an atomic bomb and may still be conducting secret research to that end.

  Iran denies seeking a nuclear bomb and says its nuclear programme is for civilian purposes.

  Rasmussen reiterated that NATO had " no intention whatsoever" to intervene in Iran and believed a solution should be found via political and diplomatic pressure on Tehran.

  He said the missile defence programme, which U.S. officials say is to protect against attack from states like Iran, would " proceed irrespective of what is going on in Iran."

  " The fact is that more than 30 countries in the world have missile technologies or are aspiring to get missile technologies, some of them with a range that they can hit NATO territory already."

  (Reporting by David Brunnstrom Editing by Rex Merrifield and Myra MacDonald)