FIVE years ago we decided to set up our firm’s brokerage accounts in the UK, as we believed we would be fully protected here. After all, there was no precedent of clients ever suffering any write-offs on their accounts as a result of a broker’s bankruptcy. Today we find ourselves regretting that decision.
The Lehman case is still festering in the UK courts, almost four years after the company went bust. In order to prevent this from happening again, the FSA implemented a new set of rules to streamline an insolvency process and ensure the speedy return of all client monies. But clients of MF Global UK (MFGUK) are now finding that the practical application of these rules are problematic and could generate very large write-offs – setting a very serious precedent going forward.
Despite the FSA’s best intentions, the integrity of the entire financial system in the UK is now compromised. Client funds are supposed to be sacrosanct. The good functioning of the financial markets, along with the value of all listed securities, relies on this premise. Without it nobody will feel safe in placing funds with a brokerage firm, or with any financial institution for that matter.
So how do MFGUK’s clients end up being on the hook, even if all their funds are eventually accounted for? It turns out in a multitude of ways, thanks to the new FSA rules.
Here’s an example. Suppose you were 100 per cent in cash just before MFGUK shut down. If other clients suffered losses on their positions as a result of the forced liquidations implemented by the FSA (a controversial decision, as the UK subsidiary was still liquid when the parent went under, creating all sorts of mayhem in trading positions) you will shoulder part of such losses, even if they have nothing to do with you. Does this sound right?
But there’s more. KPMG was appointed as the administrator in order to sort out the mess. But it turns out clients also pick up the tab for this. The bill so far: some $27m (£17.6m), including the fees of KPMG’s lawyers. Is it worth it? Months into the bankruptcy and clients still have no clarity on their positions and when they will get their money back. And good luck trying to get a timely and informative response out of KPMG.
And here’s the real kicker. The crucial issue is how funds held in unsegregated accounts and any shortfalls are treated. The FSA has adopted the position that clients in these circumstances should go to the back of the line, ranking as unsecured creditors. In plain English, client monies are effectively being used to pay secured creditors, even if they never lent a penny to the broker.
We would guess that most brokerage customers in the UK today believe that their funds are segregated and fully protected. After all, why would anyone willingly choose to have them treated otherwise? And yet, as many MFGUK clients recently discovered to their horror, it turns out their accounts were never segregated. Even if they were, they will still take losses.
As the process unfolds and clients slowly learn how the new rules actually work, the FSA is nowhere to be found. All queries end up being referred to KPMG, which we suspect then confers with its lawyers, who in turn may revert to the FSA given the novelty of this bankruptcy – creating more costs for clients and often leaving them no better off. The FSA did not even show up at the creditors meeting this week.
The ramifications of the MFGUK debacle should concern every UK investor. Will you continue to entrust your funds to a system that charges you all kinds of bankruptcy costs and puts you at the end of the line to claim your money back? As a benchmark, Canadian clients of MF Global already got all their money back in full.
All is not lost for UK clients and the country’s centuries-old financial system. But the FSA needs to rapidly step up and correct this situation. A good starting point is engaging at long last with MFGUK clients – we have some great ideas on how to fix this quickly and at a minimal cost to everyone involved.
Erico Matias Tavares is a director of Sinclair Advisors.