Jurisdiction - Australia
Australia – MF Global – Landmark Decision On Client Money Entitlements.

31 August, 2012


Legal News & Analysis – Asia Pacific – Australia – Regulatory & Compliance


In brief


  • The MF Global group collapsed in November 2011, due to significant financial difficulties faced by its US-based parent. Administrators were appointed to the Australian group entities on 1 November 2011. MF Global Australia Limited (“MFGA“) subsequently went into liquidation on 2 March 2012. MFGA was one of the largest futures brokers and providers of contracts for difference (“CFDs“) in Australia.
  • At the time of its collapse, MFGA held a substantial amount of funds in segregated client money accounts (“CMAs”), and additional funds were subsequently able to be recovered from clearing houses and counterparties with which MFGA had open positions, which were subsequently closed.
  • Client monies held in CMAs and recoveries by the Liquidators of MFGA were not sufficient to meet all claims by all clients of MFGA. The Liquidators of MFGA instituted representative proceedings with a view to obtaining court orders regarding the distribution of client monies and amounts recovered from clearing houses and counterparties. Representatives of various categories of claimants appeared in these proceedings to argue the position of their respective categories.
  • On 29 August 2012, Black J handed down his decision in these proceedings. The decision has particular significance for Australian financial services licenceholders who handle client money.




MFGA was one of the largest futures brokers and providers of contracts for difference (“CFDs“) in Australia. Due to significant financial difficulties faced by its US-based parent, administrators were appointed to MFGA on 1 November 2011. MFGA subsequently went into liquidation on 2 March 2012.


MFGA was the holder of an Australian financial services (“AFS“) licence and a participant of ASX’s futures markets. As an AFS licensee and market participant MFGA was required to keep “client money” in a CMA, separate from its own funds. Under the Corporations Act 2001 (Cth) (“Corporations Act“), monies held in a CMA are held in trust. Monies in such accounts are permitted to be used for various purposes set out in the Corporations Regulations. Monies received by MFGA from its clients were used by MFGA to, in turn, meet margin and settlement obligations to clearing houses and over-the-counter (“OTC“) derivatives counterparties (“hedge counterparties”) with whom MFGA hedged its exposure to clients.


At the time the administrators were appointed, MFGA had over 50 CMAs, many with significant balances, and in a number of different currencies. MFGA also had a large number of open positions in futures and OTC derivatives, which were subsequently closed out on or following the appointment of the administrators.


Following the appointment of the administrators, it became apparent that there was not enough money in the CMAs to pay all client claims in full (because, for example, some of the funds had been used to pay margin to futures clearing houses in respect of client positions, or to margin MFGA hedging positions with hedge counterparties). Although the Liquidators were able to recover a significant amount of money from clearing houses and hedge counterparties, there remained a shortfall in funds to meet clients’ claims.


The purpose of the court proceedings was to resolve a series of questions to enable the Liquidators to determine the entitlement of the different categories of clients and claimants to the money held in CMAs, and the monies recovered from clearing houses and counterparties.


The proceedings had the practical effect of determining which groups of clients would bear the shortfall and to what degree. Representatives of each category of affected clients, as well as of general creditors, were appointed to submit arguments in respect of the key issues. Different categories of claimants would stand to recover greater or lesser amounts, depending on the Court’s decision on various questions.


Although the Corporations Regulations provide expressly for a framework for dealing with clients’ entitlements to money in a CMA upon the appointment of an administrator, the application of these provisions was far from straightforward in the circumstances of MFGA, where there were multiple CMAs, multiple products and multiple clearing houses and hedge counterparties involved.


The decision sheds light on the interpretation of the provisions in the Corporations Act and Corporations Regulations which regulate the handling of client money and the operation of CMAs, and also on the way in which parties to OTC derivatives should regard monies they receive from counterparties.


It also paves the way for reforms in this area, the potential for which was foreshadowed in the Discussion Paper issued by Treasury in November 2011 following the collapse of MF Global entitled “Handling and use of client money in relation to over-the-counter derivatives transactions”.


The key questions


The case involved the Liquidators of MFGA seeking declarations and directions on a number of key questions. Many of the questions were highly specific to the facts of the case. In this update we focus only on the key questions which may have broader implications within the financial services industry. These included the following:  Was MFGA entitled to use monies standing to the credit of the CMAs to meet its own margin and settlement obligations to hedge counterparties? If used for that purpose, are such monies in the hands of the hedge counterparty subject to a trust in favour of the clients of MFGA?


  • Are amounts recovered from MFGA’s hedge counterparties “client money” such that they should be deposited in a CMA, or MFGA’s own money, such that, in practice, this money would be available for all creditors rather than held on trust for relevant clients? Similarly, are amounts recovered from clearing houses, executing brokers or clearing brokers in respect of client positions executed through MFGA “client money”?
  • Should the balances of the many CMAs be “pooled” in some way for the purposes of determining client entitlements. If so, should there be one pool, or different pools representing, for example, the different product lines of MFGA?
  • How should each client’s “entitlement” to money in the CMAs be calculated, and on what date?
  • Should clients who had a “cash only” position at the time of appointment of administrators (ie had no open positions at that time) be preferred to clients who had open positions?
  • Can MFGA retain the interest earned on CMAs post-insolvency (such that, in practice, this money will be available for all creditors rather than just for clients)?


We discuss briefly the findings of Black J in respect of each of the key questions below.


Use of client monies for hedging


MFGA used money in the CMAs to fund and meet margin obligations in respect of derivatives which it entered into with hedge counterparties. In doing so, MFGA relied on the terms of its client agreements, and section 981D of the Corporations Act.


Black J confirmed that the use of client monies by MFGA for hedging purposes was permitted under section 981D of the Corporations Act and Corporations Regulation 7.8.02. Black J also noted that the use of client monies for this purpose was expressly provided for in the relevant client agreements and disclosed in the product disclosure statements for the relevant products.


A related question for the Court was whether client monies paid by MFGA to hedge counterparties were held by those counterparties subject to a trust in favour of MFGA’s clients. Black J rejected these arguments.


OTC recoveries and futures recoveries


A question also arose as to whether monies subsequently recovered by the Liquidators from the hedge counterparties following the appointment of the administrators were monies received for the benefit of the company (ie MFGA) and therefore available for unsecured creditors, or whether such monies were received on behalf of MFGA’s clients and therefore to be treated as trust monies under the client money regime in Chapter 7.8 of the Corporations Act.


Similarly, the question arose as to whether amounts recovered from clearing houses, executing brokers or clearing brokers in respect of client positions executed through MFGA constituted “client money”. For example, MFGA executed client orders on many exchanges around the world through executing brokers (commonly MF Global group affiliates) on the relevant exchanges. If monies were subsequently received from those executing brokers, clearing brokers or clearing houses, would they need to be treated as client money and be paid into a CMA?


Black J found that recoveries from hedge counterparties and from clearing houses, executing brokers and clearing brokers were, on receipt by MFGA, to be held on trust under Chapter 7.8.




As noted above, MFGA had over 50 CMAs in a number of different currencies. A number of the CMAs had extremely low balances, and some had extremely high balances. There was evidence that MFGA did not manage CMAs on an account by account basis, but rather within four broad product lines: futures, CFDs, margin FX and online FX.


Black J held that, although “the reference to ‘pooling’ in this context may not be entirely apt”, MFGA’s various CMAs should in effect be pooled into four “pools”, one for each of the product lines mentioned above. This was a decision based on the facts of the case, as Black J found that there was no reason to pool CMAs in circumstances where more than one CMA was maintained “but those accounts had in fact been maintained separately so that there was no mixing of funds between them”. In the present circumstances, Black J found that the lack of records of individual client deposits into and withdrawals from CMAs, and the various transfers of funds between CMAs within a particular product line, amongst other factual circumstances, meant that pooling along the four product lines was an appropriate outcome.


The decision to “pool” the CMAs was accompanied by a finding, for similar reasons, that the funds in CMAs denominated in foreign currencies should be converted into Australian dollars.


Valuing clients’ “entitlements”


Corporations Regulation 7.8.03 set out a statutory mechanism for dealing with client monies on the appointment of an administrator to an AFS licensee. The application of this regime requires a determination of each client’s “entitlement”. Further, in the event of there being a shortfall, payment to each client is to be made in proportion to each client’s entitlement. In this case it was apparent that there would be a shortfall in one or more of the client money “pools”.


There were various submissions as to the way in which a client’s “entitlement” to money in the CMAs should be calculated. For example, was a client’s entitlement to money in the CMAs the same as their contractual claim against MFGA (ie the net amount showing in their client statements)? Also, on what date should this be calculated, and could the calculation take into account events following the appointment of administrators (such as a decline in the value of a client’s open positions between the time of appointment of the administrators and the time they were ultimately closed out)?


In terms of the method of calculating a client’s entitlement, Black J ultimately held that “It appears that the only practical method of determining the clients’ entitlement in the circumstances of this case is contract-based”. The relevant contractual measure would be the gross liquidation value (“GLV”) for each client, being the amount determined in accordance with the relevant client agreements at a particular time as the amount which MFGA would owe to the client in the event all its positions were closed out at that time.


That left open the question as to the time at which GLV would be calculated for the purposes of determining a client’s entitlement. Black J held that a client’s entitlement should be calculated based on the GLV of the client’s accounts using mark-to-market prices as at 31 October 2011 (being the last trading day before the appointment of administrators early on 1 November 2011). The Liquidators had in communications with clients used this date, but adjusted the GLV as at 31 October 2011 to take into account the actual close-out prices of positions which were open as at 31 October 2011 but which were subsequently closed out. The Liquidators explained to the Court their reasons for adopting this approach. Certain classes of clients put forward arguments to the effect that a client’s GLV as at 31 October 2011 should not be adjusted for subsequent events, such as close outs.


Black J noted that “The question is not a simple one since there are factors supporting each of the two possible approaches.” Ultimately, Black J held that there was consistency in pooling CMAs and adopting a contractual basis for entitlements as at the date of appointment of administrators on the one hand, and on the other hand treating the clients in the relevant pools as sharing proportionately in the performance of the pools (including of open positions relating to those pools) from that date.


“Cash only” clients


The representative of the “cash only” clients (ie clients with no open positions as at the time of appointment of administrators to MFGA) put forward various arguments to support a finding that such clients should be preferred over clients with open positions at the time of appointment of administrators.


Black J did not accept these submissions.




MFGA’s client agreements and disclosure documents contained various statements to the effect that MFGA was entitled to retain interest on CMAs, although different wording was used in respect of different product lines.


Black J held that statements in disclosure documents to the effect that MFGA was “entitled” to retain interest on CMAs were sufficient to assert both a right to retain interest and an intention to do so. There were some statements in the CFD and Margin FX documentation that interest on CFD and Margin FX CMAs would be paid at an agreed rate, which Black J found should be effective. However, Black J also held that any claim of MFGA to interest on CMAs would be subject to the order of payment out of the CMAs set out in reg 7.8.03(6) of the Corporations Regulations and would only be paid to MFGA if all higher-ranking claims (ie client claims) were satisfied in full. The practical effect of this is likely to be that interest on CMAs, at least in respect of some of the “pools”, will generally be available for clients in any event.


Implications for other AFS licensees


Some of the key implications of the above findings are as follows:

  • The decision confirms that section 981D of the Corporations Act allows an AFS licensee which receives client money in connection with services related to derivatives to use that client money to meet obligations which the AFS licensee incurs under derivatives it enters into to hedge the AFS licensee against its potential exposure to clients under OTC derivatives entered into with clients. Recent statements by ASIC and Treasury had raised a question mark in respect of the scope of section 981D. Nevertheless, OTC product providers who wish to use client monies for hedging purposes should review their client agreements and disclosure documents to ensure the use of client monies for this purpose is clearly provided for, and to ensure compliance with other financial services laws and licence conditions.
  • The decision confirms that hedge counterparties which deal with retail OTC derivative product providers can continue to deal with those providers on a principal to principal basis, with confidence that monies the hedge counterparty receives are not subject to a trust in favour of the provider’s clients. Had the decision on that question gone the other way, there would have been significant implications for OTC derivatives markets, including issues concerning netting.  Although Black J ultimately found that statements in disclosure documents to the effect that MFGA was “entitled” to retain interest on CMAs were sufficient, AFS licensees may wish to consider reviewing their disclosures in respect of interest on CMAs to ensure that the AFS licensee has clearly indicated that it will be retaining interest on CMAs (if that is the intention).
  • Black J found that section 981H means that “client money” is subject to a trust on its receipt by the relevant AFS licensee. Given that section 981B only provides that client money must be paid into a CMA on the day it is received or the next business day, OTC derivative product providers will need to consider their processes and procedures to ensure monies are deposited into a CMA, consistent with that requirement.
  • It is likely that the decision will lead to OTC derivative product providers and clients alike looking closely at the way in which monies received by OTC derivative product providers are held and used. For example, consideration is likely to be given to the use of multiple CMAs and foreign currency CMAs, hedging activities, transfers between CMAs and client disclosures.


Next steps


Black J relisted the matter for further directions on 12 September 2012 to afford the parties the opportunity to make submissions on the form of orders and the issues reserved for further submissions, including the Liquidators’ remuneration, expenses and costs.


The orders to be sought by the Liquidators on 12 September 2012 will include orders setting out the process for the orderly distribution of the client money in accordance with the judgment.



For further information, please contact:

Jonathan Gordon, Partner, Ashurst
Tony Ryan, Partner, Ashurst
Corey McHattan, Ashurst
Emanuel Poulosr, Ashurst


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