Trustees bicker as MF Global customers wait

As disastrous as the MF Global debacle has been to its customers, who still have not been made whole more than a year after the firm went under, those customers with funds held overseas in secured accounts have seen the worst of the MF Global mess. While customers trading exclusively in the United States received or were assured more than half of their money by Christmas 2011, only 5% of the money held in secured accounts has been returned one year later.

MF Global UK Limited (MFG UK) is a UK division of MF Global Holdings, Ltd. It was a broker dealer regulated by the Financial Services Authority (FSA) and as described by MF Global UK, it “delivers trading and hedging solutions across all major markets for futures and options, commodities, fixed income, equities and foreign exchange.”

The firm also provided client financing and securities lending. MFG UK had approximately 700 clients with more than 1,300 claims on retail, foundations, family offices and institutional accounts. Assets held by UK, both customers and creditors, as reported by KPMG exceeded $3 billion.

As MF Global Holdings entered Chapter 11 bankruptcy and MF Global Inc. (MFGI) entered its Securities Investor Protection Corp. (SIPC) liquidation, MFG UK filed on the same day for Special Administration in the UK, which is a similar bankruptcy procedure to the U.S. Chapter 11 proceedings that allows a company to continue to operate as it reorganizes. Such proceedings are in contrast to a U.S. proceeding under the Securities Investor Protection Act (SIPA) where a firm is wound down, customer assets recovered and the firm liquidated.

As the UK brokerage entered Special Administration (under KPMG) on Oct. 31, 2011, UK Client assets were frozen. The most recent update from KPMG states that $2.3 billion of UK client and creditor assets have been recovered since and are under the control of the Special Administrators.

This is the very first special administration under new UK “Special Administration Regime” (SRA) rules designed to allow failed investment banks and brokerages to expeditiously recover and return creditor funds. The SRA rules were drafted in response to the Lehman Brothers bankruptcy.

Segregation and Rehypothecation in the UK

Under UK rules, firms are required to keep client money in segregated accounts only if an account holds status as a legal trust. This means that when a client opens an account and sends funds to a UK financial institution, the property is held by the institution and is generally not titled in the customer’s name, unless special arrangements are made to secure that the client holds title to his funds. So in most cases, clients are therefore deemed general creditors if the institution fails. Oftentimes it still is not even clear if an account should be segregated or not. This is one of the questions the UK Special Administrators is to determine with each account under the new laws. And that also is why, for example, between 2002 and 2009 JPMorgan found itself in a grey area of UK regulation, and failing to segregate an estimated $23 billion of client funds following the merger of JPMorgan and Chase in its futures and options business. This error went undetected for almost seven years, and the FSA ultimately fined JPMorgan £33.32 million ($53.45 million) for its failure to segregate.

Under UK law, customer funds and securities may be rehypothecated, lent out to third parties, who may in turn also lend out the securities and funds. In some countries, such as Canada, this practice is banned altogether. In the United States it is limited. This ability to lend out customer assets without limitations is an incentive for global institutions to place customer assets in the UK.

As an aside and as the Lehman Brother’s debacle reveals, if client assets have been rehypothecated in accordance with brokerage agreements, “these assets will not be available for return to you.” As PWC advises Lehman Brothers clients.

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