InteractiveBrokers "hyper-hypothecates" $14.5b of Customer Funds?

[Enginer]

Jim Sinclair jsmineset.com linked this scarey Reuters article that may have been posted already..

MF Global and the great Wall St re-hypothecation scandal:

http://newsandinsight.thomsonreuter...d_the_great_Wall_St_re-hypothecation_scandal/

which is what you've been talking about.

Is there NO honesty left anywhere?

 

[braincell]

Quote from def:

Wow - pretty serious accusations here but how many of you really understand what hypothecation is? This is all about margin and stock loan. Remove the ability to hypothecate and you might as well suck out a massive amount of liquidity from the system.

First, let me get this out of the way. The accusations or assumptions that IB client money is used to fund Timber Hill are completely false. The companies are separate.

Client money is segregated. However, if you utilize margin and are long shares, IB can lend some of those shares out to others. These are not risky loans as there are limits on how much can be lent and they can be recalled at anytime and marked to market real time. Those are the rules, they are fair, not risky and add a ton of liquidity into the system.

The comments and fears presented here are a classic over-reaction to margin lending. Do not put IB or other firms on the same plate as MF. IB has a very strict policy when it comes to margin and deficits (ie. real time liquidations) and a very conservative risk management and investment policy. Many clients scream that they want more margin and that the stock loan list isn't long enough and now many of you are calling the kettle black. Before believing everything you read, do your homework and then decide if the practice is risky. Some banks are silly when it comes to greed and what they lend out. Others are not. IB has a long history of being conservative and risk adverse. Our large capital base and handling of client credit should also provide additional comfort. Many of the comments and assumptions on this thread are baseless.

Let's not over-react and create fear where their should be none - and I say this in regards to the comments on the other firms mentioned in this thread as well.

I need to put in a days work now so do not expect any replies for quite some time from me. I agree this is something that needs further clarification so you can be better educated on the subject as well as placate the unfounded fears expressed here. However, this this discussion should be for the industry and not single out IB.

So that means each time a customer closes a long, those shares are taken away from the collateral? Does that mean that the loan to IB based on hyopthecation and rehypothecation is returned immediately to the lender? Further, does this mean that if a customer closes a long position worth 100k, IB needs to return a loan 'immediately' of around 140k + 196k = 336k? How does that affect it's liquidity, and what are the risks of a liquidity dryup in case of unprecedented collateral decrease?

My second point, and this should probably be voted on the IB website, is we need complete transparency client-side as to how much of our accounts total are in securities vs commodities accounts. This should not be done behind the scenes, as then part of our risk is behind the scenes, and this is unfair. Note however that the "one account" policy of IB is a very good one, and I'd on the other hand hate to have to pay to transfer between securities vs commodities accounts like at other brokers. I'm sure an intermediate solution can be found.

 

[mikkom]

Quote from western:

Thanks for replying Def. The margin lending you described appears to be standard hypothecation, which I am totally ok with.

But it is re-hypothecation that I am concerned with. I found this definition on the web.

"Re-hypothecation occurs when banks or broker-dealers re-use the collateral posted by clients such as hedge funds to back the broker's own trades and borrowings."

Can you confirm that IB does not do this?

I would also like to hear yes/no answer to this question ASAP.

It's a kind of a red flat to me when representative says "I'm in hurry so I can't aswer any further questions now" when a very serious issue is raised by a press and then wanted to be clarified by a huge amount of their customers here

 

[Ghost of Cutten]

One major problem here is that is seems very difficult, even *after* the MF crisis, for a normal customer to be able to find a simple trading account where they know their money is not used for anything other than funding their own trading, where the assets are held in their own name, where the credit risk is essentially zero.

Yes, we know this would be more expensive. Personally my trading volume is pretty low, so I would not mind paying 10 times the commissions in order to reduce credit risk to zero. So, where is the conservative futures broker that offers this?

Furthermore, at the moment we have no clue what the credit risk is at ANY firm on the street. Segregated accounts aren't segregated (and are co-mingled with other traders funds anyway), client funds are legally lent out with huge leverage to sovereigns on the brink of default, then we have this muddy issue of re-hypothecation. The fact is that 99.9% of customers have no clue what the credit risk is, what the legal rights and obligations are in the event of a broker failure, or where there money goes. NONE of the brokerage firms, regulators, or account documents make this at all clear.

So, as you are seeing here on this thread, and others, and all over the net, customers are reacting rationally by withdrawing money and scaling down risk while this lack of clarity persists. Brokers should not kick and scream when their profits get decimated by customer withdrawals.

The clear need here is for transparent credit risk and legal liability/obligation. Clients need to know the following:

i) what credit risks are they taking
ii) how does a conservative customer minimise the credit risk?
iii) if the broker goes bust in a worst case (i.e. a Nick Leeson-type blows up the company), what happens to their capital?

Brokers will now need to provide super-conservative account options e.g. stock held in customer, not street name; genuinely segregated accounts held outside the broker's reach; auto-sweeping from futures to stock accounts of all capital not needed for margin; put client capital into low-risk t-bills, not commercial paper, or Greek garbage yielding >10%.

The first brokerage firm to credibly and competently do this should see an enormous influx of client funds. The costs will be higher but I bet most customers would prefer to pay a fair cost per RT in exchange for having security of funds. No one wants to risk 100% loss of life savings to save $1 per round trip.

 

[sprstpd]

Quote from mikkom:

I would also like to hear yes/no answer to this question ASAP.

It's a kind of a red flat to me when representative says "I'm in hurry so I can't aswer any further questions now" when a *very* serious issue is raised by a press and then wanted to be clarified by a huge amount of their customers here

Oh yes! I totally agree because def's sole purpose and only job is to post responses on ET! The fact that he is shirking his duties means that I must pull out all my money before IB goes under! He's hiding something!

 

[trading spaces]

Quote from Ghost of Cutten:

One major problem here is that is seems very difficult, even *after* the MF crisis, for a normal customer to be able to find a simple trading account where they know their money is not used for anything other than funding their own trading, where the assets are held in their own name, where the credit risk is essentially zero.

Yes, we know this would be more expensive. Personally my trading volume is pretty low, so I would not mind paying 10 times the commissions in order to reduce credit risk to zero. So, where is the conservative futures broker that offers this?

Furthermore, at the moment we have no clue what the credit risk is at ANY firm on the street. Segregated accounts aren't segregated (and are co-mingled with other traders funds anyway), client funds are legally lent out with huge leverage to sovereigns on the brink of default, then we have this muddy issue of re-hypothecation. The fact is that 99.9% of customers have no clue what the credit risk is, what the legal rights and obligations are in the event of a broker failure, or where there money goes. NONE of the brokerage firms, regulators, or account documents make this at all clear.

So, as you are seeing here on this thread, and others, and all over the net, customers are reacting rationally by withdrawing money and scaling down risk while this lack of clarity persists. Brokers should not kick and scream when their profits get decimated by customer withdrawals.

The clear need here is for transparent credit risk and legal liability/obligation. Clients need to know the following:

i) what credit risks are they taking
ii) how does a conservative customer minimise the credit risk?
iii) if the broker goes bust in a worst case (i.e. a Nick Leeson-type blows up the company), what happens to their capital?

Brokers will now need to provide super-conservative account options e.g. stock held in customer, not street name; genuinely segregated accounts held outside the broker's reach; auto-sweeping from futures to stock accounts of all capital not needed for margin; put client capital into low-risk t-bills, not commercial paper, or Greek garbage yielding >10%.

The first brokerage firm to credibly and competently do this should see an enormous influx of client funds. The costs will be higher but I bet most customers would prefer to pay a fair cost per RT in exchange for having security of funds. No one wants to risk 100% loss of life savings to save $1 per round trip.

Do pass on your suggestions to ibmgmt @ interactivebrokers.com

 

[ammo]

Quote from braincell:

So that means each time a customer closes a long, those shares are taken away from the collateral? Does that mean that the loan to IB based on hyopthecation and rehypothecation is returned immediately to the lender? Further, does this mean that if a customer closes a long position worth 100k, IB needs to return a loan 'immediately' of around 140k + 196k = 336k? How does that affect it's liquidity, and what are the risks of a liquidity dryup in case of unprecedented collateral decrease?

My second point, and this should probably be voted on the IB website, is we need complete transparency client-side as to how much of our accounts total are in securities vs commodities accounts. This should not be done behind the scenes, as then part of our risk is behind the scenes, and this is unfair. Note however that the "one account" policy of IB is a very good one, and I'd on the other hand hate to have to pay to transfer between securities vs commodities accounts like at other brokers. I'm sure an intermediate solution can be found.

Those funds are electronically transferred from their broker to your broker daily.If you have to fight to find out the truth now, how will it be later when or 'if they are in mf global's position,another thing,most firms clear thru or bank thru one of the larger banks ,what bank is IB using and even if solvent,is their bank? These facts should all be out in the open,it's not as if you are applying for a loan, they are applying for your business. When wiring funds,it used to be harris bank which is now part of bank of montreal,one of the top 20,i doubt no matter how secure your clearing house is,the bigger worry would be where they hold their money top 20 http://www.onlinebankingreport.com/resources/100.html

 

[Ghost of Cutten]

A second issue is the regulatory arbitrage problem. As an example, i currently use IB for most of my futures and options trading. Indeed, until a week or two ago, I used it for my stock trading as well - no more, after the MF blowup.

Now, when I went to open my account, IB refused to let me open an account with their US branch, because I was resident in Europe. Instead they only offered an account at IB UK. At the time I knew the US had better protections, but I didn't think it was that much of an issue, so I didn't bother going through the expense and red tape of forming a Delaware corporation to get US regulatory protection.

Now, it has become obvious that the risk with a UK-based IB account (the one that handles ALL EU business) is significantly higher than IB USA. So, the only logical option is to form a US company, just so that I can use the branch of IB that doesn't take lunatic risks with client capital by exposing us to legal and regulatory bullshit. It's not like customers of IB UK are in any way compensated for the inferior regulatory protections they have. They are simply given the shaft.

Why does IB screw its non-US customers in this fashion? I have opened accounts with other US futures brokers who didn't even have a foreign presence or division at all, and I could open an account at their US/home branch with no problems. I am covered by the US regulatory protection, pay the US regulatory fees and so on. IB is rooking its customers by forcing them to use the inferior and risky UK regulatory system - it's pretty obvious this is so that IB can increase profit by being less regulated on those client funds. This is shady as hell and a shabby way to treat customers.

 

[Ghost of Cutten]

Quote from ammo:

Those funds are electronically transferred from their broker to your broker daily.If you have to fight to find out the truth now, how will it be later when or 'if they are in mf global's position,another thing,most firms clear thru or bank thru one of the larger banks ,what bank is IB using and even if solvent,is their bank? These facts should all be out in the open,it's not as if you are applying for a loan, they are applying for your business. [/url]

This is an excellent point. The lack of transparency really is shocking, and a sign of contempt for the customer. Even now, WEEKS after one of the largest independent brokers went belly up and wiped out over $1 billion of allegedly safeguarded customer funds, NO broker is saying what happens to customer funds if they blow up too. All we hear is the sound of silence! The entire futures brokerage industry is one big joke at the moment.

 

[braincell]

I can imagine Peterffy reading any of this and thinking "but everyone does it!". As risk averse as IB may be, the "everyone does it" clause puts them in a position where they must do or die - at least I see that as highly likely. Creation of a broker where credit risk would be close to zero with high commissions is a nice thought, but I believe there aren't enough customers right now that even understand the risks, so the demand for such a broker might still be small. The whole MF Global business might change that to some degree, but I doubt it will change it enough.

It would be nice if def posted some more info or at the very least assured us that IB management has heard our concerns. These concerns aren't going to go away, they will slowly start spreading to more and more customers.