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Treasury releases discussion paper on handling and use of client money in relation to OTC derivatives

​The collapse of MF Global has underscored the need to investigate options for strengthening client money protections for OTC derivative transactions with retail clients.

The Australian Federal Treasury released a discussion paper in November on the handling and use of client money in relation to over-the-counter derivatives transactions.  In launching the paper, Assistant Treasurer and Minister for Financial Services and Superannuation Bill Shorten said that the collapse of MF Global has underscored the need to investigate options for strengthening client money protections for OTC derivative transactions.

Whilst the discussion paper focuses on the holding of client money in connection with OTC derivatives transactions with retail clients, it also seeks comment on whether exchange traded derivatives should be subject to any changes to client money rules for retail clients (as opposed to, for example, wholesale clients). 

The paper notes that the current client money rules permit the pooling of client money in a segregated account and that once there the client money is at risk as it may be:

  • used by the licensee to margin, guarantee, secure, transfer, adjust or settle derivative transactions of other clients; or
  • paid out of the account in accordance with a standing direction in the client agreement.  

A client is then exposed to:

  • any deficiency in the client money account on the insolvency of the licensee and the ranking of the client as an unsecured creditor of the licensee in respect of any such deficiency; and
  • compensation arrangements under Divisions 3 or 4 of Part 7.5 of the Corporations Act possibly not responding in relation to all or any of that deficiency.

Four indicative reform options are canvassed in the paper:

  • restricting the use of client money for margining of hedging transactions by licensees and/or limiting the client money provisions to money provided for initial margin;
  • requiring licensees to hold client money on trust for clients and separately from their own funds (reflecting the approach in the United Kingdom);
  • imposing a statutory trust on client money that prevents licensees from using client money to hedge their own derivatives position; and/or
  • requiring that licensees maintain separate segregated accounts for the client money of each client.

In addition, a number of alternative options are identified that could be put in place if licensees are permitted to continue pooling of client money and applying that money to meet obligations incurred by the licensee in dealing in derivatives, including:

  • requiring a licensee that uses one client’s money for the purpose of paying margin in respect of another client’s positions to promptly top up the first client’s account; and
  • requiring licensees to reconcile accounts to the individual client level rather than the pooled level.

Any reforms ultimately made could potentially be one or a mix of these options.

The discussion paper also considers the adequacy of reporting arrangements between licensees and clients with respect to holdings of client money and whether or not more comprehensive monthly reporting would facilitate clients making informed decisions.

Whilst the discussion paper notes that the Government has not yet made any decisions on the issues raised in it, Minister Shorten stated that the Government is moving more quickly to consider the handing and use of client money in relation to OTC derivatives in light of the recent collapse of MF Global. 

The Treasury has invited retail investors, brokers and other stakeholders to participate in the consultation process and notes that feedback from stakeholders will be taken into account in the Government’s consideration of the issues. 

If market participants have views on or concerns with the proposals and reform options canvassed in it (including the extent to which they may apply to derivatives with wholesale clients), they should raise these with the Treasury.  Written submissions on the paper are due by 27 January 2012.

 

 

 

Author(s)

  • Heidi Machin
    Senior Associate | Sydney
    T: +61 2 9296 2576
    M: +61 400 413 583
    Email
 

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