Todays Sydney Morning Herald
MF Global fiasco makes case for better client protection
Adele Ferguson
December 19, 2011
More than six weeks after the spectacular world-wide collapse of MF Global, the $313 million pot of Australian client money remains frozen with little hope of a full recovery, as the liquidators, lawyers and regulators try to unravel poor regulatory decisions made worse by the complex world of derivative trading, counterparty risk and the pooling of client money.
Australia's situation is in embarrassingly sharp contrast to some other countries, including Canada, which have been able to repay speedily some or all of client monies.
Part of the problem is due to shortcomings in the regulatory and legislative framework, as well as a decision to grant MF Global an exemption so it could use its British business as the market participant in Australia rather than its Australian business.
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It can be revealed this decision has left $34 million of Australian client money in limbo as a legal minefield is set to erupt. The British administrators are expected to argue the funds technically belong to MF Global UK, while the Australian administrator, Deloitte, believes they belong to Australian clients. Until the turf war is sorted out, the Australian Securities Exchange (ASX) has refused to hand over the money.
Put simply, while clients are owed $313 million, there is $232 million in the bank, leaving $81 million outstanding, which is owed by various counterparties. This includes $10 million in MF Singapore, $13 million in contracts for difference (CFDs), $5 million in margin foreign exchange and $1 million in online foreign exchange.
Given the complex situation, coupled with the exemption the Australian Securities and Investments Commission gave to MF Global in Australia, the administrator Deloitte and the law firm Blake Dawson Waldron will have to go to court next year to sort out the mess and get a ruling on how exactly to calculate and return funds.
MF Global collapsed on October 31 after it was forced to reveal it had made a $US6.3 billion bet on European sovereign debt. Some of $US1.2 billion in client money is believed to have been lent to its European affiliate to stave off insolvency. Here lies the problem. Derivatives such as CFDs - one of the key product offerings of MF Global - mostly are traded in the murky and largely unregulated over-the-counter-market, which allows organisations such as MF Global to take client money and pool it into one big account. It is a business model which results in the client becoming an unsecured creditor if the company collapses.
In some cases, these businesses use pooled client funds to meet their daily business obligations in connection with margining, guaranteeing, securing, transferring, adjusting or settling dealings in derivatives. It was this business model that was adopted by Tricom, Opes Prime, Sonray, Chartwell and many other companies in sensational collapses or near-collapses in the past few years.
According to latest Australian Financial Markets Association data, the over-the-counter market turned over $78.1 trillion in the year to June 30, compared with $$49.7 trillion for the total exchange-traded markets, which include the ASX and the Sydney Futures Exchange.
What happened at MF Global can happen again and again until regulators and the government address the issue. I have been highlighting the risks associated with the pooling of client funds since early 2008, when Tricom almost collapsed, followed by the collapse of Opes Prime. Two years later, on July 13 last year, when ASIC came out, guns blazing, with a regulatory guide relating to over-the-counter derivatives, I pointed out that, in the guide, ASIC had failed to deal with the riskiest aspect of these products: a client's money is pooled into one account, the client money can be used for purposes unrelated to that client and, if the company goes under, the client becomes an unsecured creditor.
The MF Global collapse has prompted the government to at least acknowledge the issue with the release of a consultation paper on client monies. It has set a deadline of January 27 for submissions, which covers a period when most people will be on holidays.
The risks of operating in the over-the-counter market are made worse because Australia doesn't have a compensation fund when things go bad. Canada has the Canadian Investor Protection Fund, which has come to the rescue. The futures exchange CME Group in the US has guaranteed $US550 million to the bankruptcy trustee of MF Global to increase the payout from 60 per cent to 75 per cent. In Britain, clients will be paid compensation of up to £50,000 ($77,800) per customer, and administrators have asked customers to make formal claims immediately and will make an interim payment within 14 days of approval, with the aim of completing these before March.
In Australia it is understood no client funds will be returned before April - at the earliest. Customers are yet to be given their closing balance or indication of how much is likely to be returned. Indeed, a court will have to decide this.
It is a situation becoming explosive as some clients get perilously close to collapse the longer it takes. The lawyers and administrators are doing all they can to speed the process. But the longer it takes, the more money they charge and the less clients get. Let's hope this finally gets the government off its backside to make needed changes, including the introduction of a compensation fund.
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