Thursday, December 15, 2011

Part 3: Re-Hypothecation Re: Canada

Captain Canada to the rescue?
It's clear that I must be missing something re: the implications for Canadian investors from the re-hypothecation controversy brought to the fore recently by the stunning bankruptcy of Jon Corzine's MF Global.  A recent story on Thomson Reuters asserts that "engaging in hyper-hypothecation have been Canadian Imperial Bank of Commerce (re-pledged $72 billion in client assets), Royal Bank of Canada (re-pledged $53.8 billion...)" (Christopher Elias, see Parts 1 and 2)  Now contrast that seemingly shocking statement with the following from Bruce Krasting, a highly-respected retired Wall Street veteran: "The Canadian customers of MFG got their money back within 10 days of the MFG bankruptcy. The accounts that have lost money are either USA- or UK-based. In Canada, re-hypothecation is not permitted. I got these comments from a Canadian MFG account holder: The trustee where segregated MF Global Canada customers' funds were held was RBC Dominion Securities. I don't think any of these funds ever left the trustee in Canada. Likelihood is if they left, the Canadian government would have made the parent Royal Bank of Canada eat up the losses and make full restitution."  The apparent conflict between these two statements, both from reliable sources, raises several questions.  If the latter statement is true, and re-hypothecation is not permitted, how could CIBC and RBC get away with doing it?  Or, if the former one is true, was this MFG investor just lucky that various Canadian regulatory and investment industry backstops kicked in to cover his specific loss?  (And if so, is the Canadian government potentially on the hook for billions more re-pledged by Canadian financial institutions overseas?)  Finally - and above all - can the average Canadian investor rest easy that the financial institution they invest through won't go under because of such offshore shenanigans?  There is a surprising dearth of Canadian collateral re-hypothecation information available to mere mortals such as we non-lawyers and non-accountants on the internet, a fact I can attest to after three full evenings re-searching every corner of it.  (I stopped short of the Canada Revenue Agency and several technical subscription-only sites.)  The only recurring theme I could detect out there was the opinion that if you open an account with a commodities broker or even with a stock broker on margin, you sign a document acknowledging that the company has the right to use the securities and cash in your account as collateral against the financing they get from banks to loan to you.  In other words, if you're using their money to invest in whatever you want, then they're only going to let you do so if they can use your account assets as collateral in their speculative activities - such as re-hypothecation in a foreign jurisdiction.  No margin account, no problem.  At least that's the way it looks to me.  Feel free to correct me if I'm wrong.