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.
Mike Pink, MF Global UK Special Administrators with KMPG reported to UK customers that in addition to the ongoing legal actions against the UK estate, administrative hurdles to returning customer assets include: The details of establishing a client distribution plan, lack of filing claims forms, the still undefined costs of returning UK assets to clients and the ongoing need for continued forensic accounting.
When asked if the U.S. SIPC trustee for the brokerage unit (MFGI) shared information of the U.S. brokerage forensic account, Kent Jarrell, spokesperson for SIPC Trustee James Giddens stated, “The trustee publicly filed a report on his independent investigation into the failure of MF Global Inc. in June 2012 (updated in December), and as a public report, it was available to the Joint Special Administrators.” In a UK Customer’s meeting on Oct. 31, 2012 in London, however, Pink reported to customers that the SIPC Trustee is not sharing this information with the UK Special Administration.
On both sides of the Atlantic, the SIPC trustee and the UK Special Administrators hold funds in reserve to meet ongoing claims litigation. This, in turn prevents complete distribution to customers in the United States and the UK. These ongoing claims between the UK Special Administrators and the SIPC Trustee can be summed up in three actions: One regarding segregation of secured funds sent to London, the second regarding collateral on the return-to-maturity (RTM) repos, and the third regarding the losses incurred closing out the RTM positions.
The first and most pertinent for U.S. customers are claims on the 30.7 funds. This is property the U.S. commodity brokerage sent to the UK Brokerage in Treasury bills for security on non-domestic positions traded on, for example, the London Metal Exchange or Eurex. To date, the SIPC Trustee has distributed approximately $50 million, or approximately 5% of these funds, to U.S. customers. The UK Administrators have liquidated the T-bills and holds them in reserve in the event the SIPC Trustee is successful in this claim, which is an estimated $429 million.
In April 2013, the UK Courts will address the question if the T-Bills sent to the UK were segregated assets or not. The SIPC Trustee asserts these are segregated U.S. customer assets; whereas, MFG UK asserts they are non-segregated and were transferred to the UK with absolute title. Remember, under UK law customer funds enjoy segregation only in status of an assigned trust where title is not transferred. Further, the ability for rehypothecation of these assets may have provided an incentive to hold the T-bills in the UK. However, a recent opinion by the UK Supreme Court concerning segregation at Lehman Brothers International ruled that client funds that were not segregated can share in the distribution of client cash that was set aside in segregated accounts. While this was a victory to a degree, it is yet to be determined if it will have impact for MF Global Inc.’s U.S. customers. On this ruling, KPMG adds, “This has created uncertainty as to what money is to be treated as being part of the client money pool and, therefore, as to the value of assets that constitute the unsecured estate.”
The second claim, constituting about $600 million, is on the T-bills sent to the UK as margin collateral for the brokerage unit’s Sovereign Bond Return to Maturity (RTM) positions. The UK brokerage acted as an agent for these positions. Collateral for this trade was also sent to the UK unit and then placed with LCH.Clearnet, a UK-based clearinghouse.
This claim has taken on more complexity as Louis Freeh, Trustee for MF Global Holdings, also claims creditor status for ownership of those T-bills sent to the UK as collateral. And more recently both LCH.Clearnet Group, Ltd. and ICE Clear Europe, Ltd. also have filed suit for these same assets.
The UK Administrators outright reject the Freeh claim for MF Global Holdings as frivolous on the grounds that: the brokerage unit (MFGI) had submitted a claim against MFG UK on this, and MFG UK’s records showed that only MFGI , rather than MF Global Holdings, is the appropriate party to pursue the claim on collateral.
The third claim by Giddens against the UK estate was for losses of approximately $350 million incurred when the RTM positions were closed out. Or in other words, the difference in the value of the positions on Oct. 31, 2011, vs. when they were closed out by the Special Administrators.
This claim is noteworthy in that it is as if U.S. commodity customers filed claims for losses realized due to forced liquidation resulting from court orders in the first confusing days of the SIPC proceeding. But this is more so because it was the U.S. brokerage that went under liquidation protection of a SIPC trustee, which is “analogous to a liquidator.” And under the terms of the Global Master Repurchase Agreement (GMRP) between the U.S. brokerage (MFGI) and the UK brokerage, MFGI was therefore in default of its own agreement. UK Judge David Richards ruled that KPMG was within all rights to value the securities. Pink states that the repo dispute with Giddens was about “where that loss is borne. Our view is very clearly it’s (MFGI’s) problem.”
A ruling against MFGI on this claim was made on Nov. 1, 2012, and with the ruling MFGI was denied permission to make an appeal. Further, as the losing party, it must pay the Special Administrators’ costs (which is not unusual in Europe).
The spokesperson for the MFGI SIPC Trustee stated on Nov. 30 that Giddens is considering filing an appeal of this ruling. He added, “We are disappointed by the decision handed down. The decision, based on a technical interpretation of standard contractual terms governing repo-to-maturity trades, is likely to reduce the value of the Trustee’s claims to recover from MF Global UK various sums payable in connection with those repo-to-maturity trades. The Trustee is considering whether or not to apply to the Court of Appeal for permission to appeal the decision.”
The UK estate has not made a distribution yet based on the RTM decision and will retain reserves until outstanding claims are resolved. The U.S. brokerage claims are $147 million for the 30.7 funds plus approximately $600 million on the T-bills still held at LCH.Clearnet.
Reflecting the view of most all MF Global UK clients, Erico Matias Tavares, director of Sinclair Advisors concludes, “We entrusted a centuries old financial and regulatory system in the UK with our assets. Large broker disasters in recent years have a London connection. MFG UK is yet another case study of regulatory failings to protect client funds, the backbone of any financial system.”
Through his spokesperson, Giddens reports, “The Trustee continues to discuss a number of issues with the UK Administrators in an attempt to resolve as many matters as possible, which will help both the Trustee and the UK Administrators to maximize returns to customers and creditors.”