The socialisation of client money August 3, 2010 at 4:40 pm

Suppose you find yourself in a situation where you have to leave money with a financial institution. If it isn’t a deposit, then it won’t be covered by any deposit protection scheme. How can you protect yourself against the institution failing? The answer always used to be, make sure that the money is classified as client money and fully segregated. That is, the firm has to keep it somewhere apart from its own money, and you can identify and reclaim it in the event of default. How that works is horribly complex, as are the regulations for client money, but the idea is simple enough.

Now, in CRC Credit Fund Ltd and others vs. the Administrators of Lehman Brothers International, the Court of Appeal has thrown a spanner in the works. They have ruled that what counts as client money is not the money that has been properly segregated, but rather that it also includes funds that should have been but weren’t. [The usual ‘I am not a lawyer, this is not advice’ caveats apply here and throughout.] That’s hideous. It means that there is no point in checking that your funds have been properly segregated. Client money does not form multiple segregated accounts, one per client, you see: it is one big lump, a totality of client money against all client claims. That means that if anyone has not had their funds seg’d (you knew it was only a matter of time before the jargon hit), then everyone’s properly seg’d funds can be used to pay them in the event of the insolvency of the firm. I would have thought that that blows rather a large hole in the UK’s client money regime. Certainly if the judges were trying to make the UK regime safer, it is not clear that they succeeded: arguably, they have made it rather less safe.

3 Responses to “The socialisation of client money”

  1. […] This post was mentioned on Twitter by Izabella Kaminska, Siram. Siram said: Chapter 94162 of the Lehman's London office bankruptcy. http://bit.ly/aIg3eD or why segregation of client money should've been regulated. […]

  2. Thank you for this, I didn’t know this. I knew that segregation isn’t regulated in the UK like it is in the US. Shouldn’t this be regulated like it is in US? That would make it a bit easier to unwind a BD without causing the added disruptions Lehman’s UK office caused.

  3. Siram – It depends what you mean. It is regulated, but there is not one required seg model. Rather firms have to disclose what options are available and their costs, and clients pick a model. The problem with Lehman here was that most people did not pick seg’d funds: basically they saved a bit of money but took a lot more risk. Note too that in the US model there is some risk – in an FCM bankruptcy, for instance, clients can lose money.

    I do agree with you about unwinding however. This judgment will complicate the bankruptcy of LBI hugely. It isn’t just banks that need living wills, it is broker/dealers and related entities (including FCMs) too.