Worried about Your Accounts Falling Prey to an MF-Global-Type Scenario?
Some wise money placement tips
As the MF Global situation plays out, I continue to get questions from clients and potential clients about the safety of the markets, assets in the markets, brokerage accounts, various banks, etc. While I addressed certain larger issues in my recent piece, "The Logic and Logistics of Market Flight and Repatriation: Taking assets out of the market and putting them back in", I'd like to tackle two of the specific questions I regularly field about the safety of assets in the financial system.
Can My Financial Institution "Borrow" My Assets Like MF Global Did with Their Customers?
Whether or not your financial institution has the ability to use your assets as collateral depends on the type of account you've opened with them, and the agreements you've signed.
Have a Margin Account? Almost Definitely
Keep in mind that a margin account is essentially an account in which you "borrow" from your financial institution, and in which the assets in the account act as the collateral against your borrowing. Generally, margin agreements include a "hypothecation" clause that permits the financial institution to sell assets in the account if the account owner fails to meet credit payments, or if they fail to meet a margin call. (Hypothecate comes from a root word meaning pledge or deposit.) Often, this can mean that the financial institution can then re-hypothecate (pledge again) the client's assets as collateral for its own borrowing. The US has pretty strict re-hypothecation limits; however, the UK, which is a sizable player in the financial markets, does not, which contributed to the MF Global problem. You may want to verify which legal jurisdiction (US, UK, or other) applies to your accounts by calling or writing to your financial institution. (Keep in mind that many financial entities have overseas parent companies that may or may not be authorized to borrow against their out-of-country counterparts, so you may want to request clarification on this as well.)
Do I Have Margin on My Account? Better Check
Many broker/dealers or other institutions automatically open new accounts as margin accounts, so it may not be obvious to you that your account is on margin. Either contact your financial institution to inquire whether your account is a margin account, or review the agreements you signed at the time of account opening to determine if margin or hypothecation clauses are included. Generally, a letter of instruction to your financial institution should be sufficient to remove margin from your account.
(At PFS Group, we discourage the use of margin, so our clients have to proactively request and sign documentation for margin features on their accounts.)
Have a Checkwriting Account? Possibly
Similarly, checkwriting agreements on brokerage-type accounts often include margin clauses. Either contact your financial institution to inquire whether your brokerage account with checking features is a margin account, or review the agreements you signed at the time of initiating the checkwriting services to determine if margin or hypothecation clauses are included. Generally, a letter of instruction to your financial institution should be sufficient to remove margin from your account.
Should I Put My Money in a Smaller Bank or a Credit Union, or with a Smaller Brokerage Firm?
While it's no secret that many of the US's largest financial institutions are woefully over-exposed to credit derivatives (don't take my word for it; visit the Office of the Comptroller of Currency's website, and review their "Quarterly Derivative Fact Sheet" for the derivative exposure of 25 of the US's largest banks), and some are in shaky financial shape, don't make the mistake of assuming that "smaller" or "local" means "safer."
While smaller banks, credit unions, brokerage firms, etc, lack the "clout" of larger banks and other financial institutions, and often are not nearly as entangled in complicated credit derivative arrangements, that does not mean that they are necessarily any safer or healthier financially than their behemoth counterparts. During the days of easy credit, many smaller institutions got just as wrapped up in bad financial arrangements as their bigger brothers and sisters. You simply must do your homework, both on the institutions with which you do business, and with their significant counterparties (such as clearing firms in the case of some broker/dealers, or counterparties to reverse repurchase agreements held by your institution).
By the same token, don't assume that "bigger" means "unsafe" or "unhealthy." There are some very fine larger institutions out there with solid business practices and sound balance sheets.
Once again, here's a list of resources to help you with your research:
- Check your financial institution's ratings with a ratings agency or service, such as Bankrate.com's Safe & Sound® ratings, Bauer Financial's Star Ratings, TheStreet.com's Ratings Screener (or visit TheStreet.com's Weiss Safety Ratings), or Veribanc® Inc. AM Best, Moody's Investors Service, Fitch Ratings, and Standard & Poor's also rate the safety of financial institutions and some companies (and their debt issuance). (Note: PFSGroup has not performed any due diligence or quality review of these dealers/companies/agencies, and assumes no liability for providing this information to you. We recommend you perform your own due diligence on these firms before doing business with them.)
- Registered broker/dealers are required to file annual audited financial reports with the Financial Industry Regulatory Authority (FINRA; search for your broker/dealer's reports). The "Annual Audited Report" (Form X-17 A-5 Part III) gives information on the firm's financial condition.
- Publicly traded companies are required to disclose their financial data (usually easily located on the "Investor Information" area of their corporate websites).
- For futures contract participants, futures commission merchants (FCMs) and retail foreign exchange dealers (RFEDs) must file monthly financial reports with the Commodity Futures Trading Commission (CFTC; see Financial Data for FCMs on the CFTC's website).
- For Federal Deposit Insurance Corporation-insured (FDIC) institutions, visit the "Analysts" page and research your depository institution. The "Statistics on Depository Institutions" tool is very useful.
- For National Credit Union Administration-insured (NCUA) institutions, visit the "Credit Union Data" page and research your credit union. The "Find a Credit Union" link will help you to locate your credit union and easily view its Financial Performance Report and 5300 report.
(At PFS Group, we use National Financial Services LLC, a Fidelity Investments Company, as our clearing firm, and continue to be comfortable with their business practices and financial health.)
At the risk of repeating myself, now is no time to be lazy. It is also no time to panic. Do your research, and take the appropriate steps to remove your assets from situations you're not comfortable with. Prudent preparation = peace of mind.
About Cathlyn Harris
Cathlyn Harris Archive
|06/21/2012||Budgets & Balance Sheets||story|
|02/27/2012||Who Gets It When You're Gone||story|
|12/08/2011||The Logic and Logistics of Market Flight and Repatriation||story|
|08/26/2011||What Does “Investing Internationally” Really Mean?||story|
|12/30/2010||Eat the Frog First||story|