collateral protection for assets: current legal...
TRANSCRIPT
Presenting a live 90‐minute webinar with interactive Q&A
Collateral Protection for Collateral Protection for Financial Assets: Current Legal TrendsBest Practices for Protecting Collateral in a Post‐Lehman and MF Global World
T d ’ f l f
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
TUESDAY, DECEMBER 4, 2012
Today’s faculty features:
Craig S. Unterberg, Partner, Haynes & Boone, New York
Michele Navazio, Partner, Sidley Austin, New York
Daren R. Domina, Partner, Haynes and Boone, New YorkDaren R. Domina, Partner, Haynes and Boone, New York
The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.
Tips for Optimal Quality
S d Q litSound QualityIf you are listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection.
If the sound quality is not satisfactory and you are listening via your computer speakers, you may listen via the phone: dial 1-888-450-9970 and enter your PIN when prompted Otherwise please send us a chat or e mail when prompted. Otherwise, please send us a chat or e-mail [email protected] immediately so we can address the problem.
If you dialed in and have any difficulties during the call, press *0 for assistance.
Viewing QualityTo maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key againpress the F11 key again.
Continuing Education Credits FOR LIVE EVENT ONLY
For CLE purposes, please let us know how many people are listening at your location by completing each of the following steps:
• In the chat box, type (1) your company name and (2) the number of attendees at your locationattendees at your location
• Click the SEND button beside the box
Program Materials
If you have not printed the conference materials for this program, please complete the following steps:
• Click on the + sign next to “Conference Materials” in the middle of the left-hand column on your screen hand column on your screen.
• Click on the tab labeled “Handouts” that appears, and there you will see a PDF of the slides for today's program.
• Double click on the PDF and a separate page will open. Double click on the PDF and a separate page will open.
• Print the slides by clicking on the printer icon.
Collateral ProtectionP t L h & MF Gl b lPost-Lehman & MF Global
December 4, 2012
Craig Unterberg, Haynes and Boone, [email protected] | 212.659.4987
Miki Navazio, Sidley Austin LLPMiki Navazio, Sidley Austin [email protected] | 212.839.5310
Daren R. Domina, Haynes and Boone, LLPd d i @h b | 212 6 9 4963
5
[email protected] | 212.659.4963
OVERVIEW
1. Legal Framework of Collateral Protection2. Financial Institution Insolvency3. Applicability to Swap Dealers4. Case Studies: Lehman & MF Global5 Collateral Protection Trends5. Collateral Protection Trends6. Dodd-Frank
6
Legal Framework: Article 8
• Our focus will be on the indirect holding systemApplicable to securities intermediaries• Applicable to securities intermediaries
• A person that maintains securities accounts for others is a “securities intermediary”others is a securities intermediary
• Obligations on securities intermediaries are set forth in Article 8forth in Article 8
7
Legal Framework: Article 8
• §8-504 requires securities intermediaries to maintain a quantity of financial assets equal tomaintain a quantity of financial assets equal to all securities entitlements it has established
• Compliance with §8-504 contains exceptions toCompliance with §8 504 contains exceptions to the “perfect match” rule
• Example: a temporary shortfall due to failure toExample: a temporary shortfall due to failure to deliver by a counterparty in trade settlement
8
Legal Framework: Regulation &Legal Framework: Regulation & Oversightg
• Broker-dealers / FCMsArticle 8– Article 8
– Federal statutes– SEC and SRO oversightSEC and SRO oversight
• Banks (Custodians)– Article 8– Federal and State statutes– FDIC oversight
9
Legal Framework: Broker-Dealers
• Rule 15c3-3 limits broker-dealer’s use of customer’s securitiescustomer s securities
• Cap on a broker-dealer’s rehypothecationT f th t t• Terms of the account agreement can impact applicability of the customer
t ti lprotection rules– Rehypothecation
10
– Cross-collateralization
Legal Framework: FCMs
• FCMs must segregate customer funds pursuant to CEA § 4d(a)(2)– FCM may not grant any lien on customer collateral (other than to DCOs)
• FCMs may invest customer collateral in “permitted investments” under CFTC rule 1.25 and retain gains
– Since MF Global, CFTC has revised rule 1.25 to limit list of permitted investmentsinvestments
• LSOC (for cleared swaps)– collateral legally segregated, but commingled in one account
mitigates “fellow customer” risk– mitigates fellow customer risk• FCM not permitted to use one customer’s collateral to satisfy another
customer’s obligations or the FCMs obligations– balances benefits and costs in protecting market participants and the public
11
Legal Framework: B/D and FCM Regulatory ComplianceRegulatory Compliance
• The regulatory oversight for customer t d t ti i h dl d th hassets and protections is handled through
a combination of: – audits (internal and external);– regulatory examinations; and– reporting requirements.
12
Legal Framework: BankLegal Framework: Bank Regulatory Complianceg y p
• Periodic FDIC regulatory examinations of trust departmentstrust departments
• Examine policies and account administration to prevent liabilities or loss to the bank’s capital
13
Insolvency of FinancialInsolvency of Financial Institutions
• Broker-DealersC t P t ti R l– Customer Protection Rule
– SIPC and SIPA• Custodians/Banks
– FDIC– Trust/fiduciary accounts– Assets inside/outside the estate
14
Insolvency: Broker Dealers &Insolvency: Broker-Dealers & SIPA
• Federal court appoints a SIPA trustee• Trustee tasked to return customer assets
(in whole or pro rata based on net equity)• Net equity fixed as of SIPC filing date• SIPC ProtectionsS C otect o s
– $500,000 insurance cap– $250 000 insurance cap on cash (inclusive)
15
$250,000 insurance cap on cash (inclusive)
Insolvency Risks: Broker-Dealer
• Net equity claim in excess of pro rata share of customer assets and SIPAshare of customer assets and SIPA insured amounts
ff ff• Assets moved to offshore affiliates• Failure of broker-dealer to abide by
customer protection rule
16
Insolvency: Bank/Custodian andInsolvency: Bank/Custodian and FDIC
• Assets held in trust, fiduciary or custodial accounts should not be assets of the bankaccounts should not be assets of the bank
• FDIC will attempt to transfer accounts to a successor institution
• Cash is typically held in deposit accounts subject to certain levels of FDIC insurance
17
Insolvency Risks:Insolvency Risks: Bank/Custodian and FDIC
• Assets intended to be held in trust, fiduciary or custodial accounts are open to certain riskscustodial accounts are open to certain risks– Determination that assets are not held in appropriate
account– Inability to trace the assets
• If assets are not held in appropriate account or non-traceable, then upon failure the customer is subject to FDIC receivership / conservatorship
18
Applicability to Swap Dealers
• Swap collateral is posted under the CSA• Need to determine applicability of laws to
swap dealer• Self-help remedies may be limited• Collateral subject to regulatory/bankruptcy Co ate a subject to egu ato y/ba uptcy
regime that overlays the counterparty
19
Case Study: Lehman Brothers
• In the insolvency of Lehman Brothers Inc. (“LBI”), SIPA and the SEC moved customer ( )assets out of the failed brokerage
• Pre-insolvency, LBI followed the segregation and reserve requirements
• Customers were made whole and no advances from the SIPC Fund have been made
20
from the SIPC Fund have been made
C St d L h B thCase Study: Lehman Brothers (UK)(U )
• Results for clients of Lehman Brothers International (Europe) (“LBIE”) were vastlyInternational (Europe) ( LBIE ) were vastly different
• Customers of LBIE became general unsecured creditors and their assets were frozen in the insolvency proceeding.insolvency proceeding.
• Untangling customers’ assets from those of LBIE
21
LBIE
C St d L h B thCase Study: Lehman Brothers (swap affiliates)(s ap a a es)
• Counterparties of LBSF and similar US affiliatesgeneral unsecured creditors– general unsecured creditors
– assets subject to insolvency proceeding (albeit under US bankruptcy law).
• Competing claims over customer assets had to be resolved (LBIE and other Lehman affiliates,be resolved (LBIE and other Lehman affiliates, bondholder claims, etc.)
V l ti di t
22
• Valuation disputes
Case Study: MF Global
• MF Global Inc. had a deficiency in its segregated accounts for certain customerssegregated accounts for certain customers
• As stated in a February release by SIPCAs stated in a February release by SIPC,
“Nearly all securities customers have received 60% or more of th i t l d l d 194 f f MF Gl b l Itheir account value and already 194 of former MF Global Inc. securities customers have received the entirety of their account balances because of a Securities Investor Protection Corporation guarantee.”
23
Collateral Protection Trends
• Segregate IA collateral in connection with swap transactions
Assets held by custodians subject to tri party– Assets held by custodians subject to tri-party arrangements
• Utilize cash sweeps to limit cash deposits
Move excess collateral to third party accounts in• Move excess collateral to third party accounts in non-swap transactions
24
Collateral Protection TrendsCollateral Protection Trends (cont’d)( )
• Diversify relationships with financial institutionsinstitutions
• Concentration limitsConcentration limits
• Limit offshore transactions to avoid t o s o e t a sact o s to a o dunfamiliar bankruptcy law
25
Collateral Protection Trends: Segregation
• Segregation issues for financial institutionP f ti d A ti l 9– Perfection under Article 9
– Customer access to collateral – withdrawals d b tit tiand substitutions
– Competing liens, including custodian’s claimsC fli ti i t ti– Conflicting instructions
– Fraudulent acts by customer
26
– Reporting on account collateral
Collateral Protection Trends: Segregation
• Segregation issues for customersTi d f– Time and expense of process
– Credit risk of the custodian– Ability to make withdrawals/substitutions– Ability to access collateral post-default– Release of excess collateral
27
Collateral Protection Trends:Collateral Protection Trends: Rehypothecationyp
• §8-504 prohibits rehypothecation without authorization and Rule 15c3 3 limitsauthorization and Rule 15c3-3 limits rehypo by broker dealers
f• Authorization is typically found in the customer agreement
• Limiting rehypo increases borrowing costs• Is the risk worth the cost?
28
Collateral Protection Trends:Collateral Protection Trends: Rehypothecation with B/Dyp
• A customer’s net equity claim is equal to the value of its long positions (including cash) minusvalue of its long positions (including cash) minus the value of its obligations
• Applies whether or not the customer’s assetsApplies whether or not the customer s assets have been rehypothecated.
• A customer whose assets have beenA customer whose assets have been rehypothecated stands in the same position/priority as a person whose assets have
29
not been.
Collateral Protection Trends: DoddCollateral Protection Trends: Dodd-Frank
• Mandate to offer IM for uncleared swaps segregated with custodiancustodian
• Limits on type of permitted collateral– CFTC prosed rule makes type of collateral dependent upon type of
t tcounterparty– Prudential regulators proposed rule contains fewer types, but not
dependent on counterparty
Fi l l t b bli h d b CFTC d d ti l l t• Final rule to be published by CFTC and prudential regulators• ISDA working group – dealers & buy-side – to address CSA
and tri-party agreement with adjustments following publication
30
of final rule.