- The Denials Begin: Interactive Brokers Is First To Claim It Has Not Engaged In Commingling Rehypothecation (ZeroHedge, Dec. 10, 2011):
Now that the rehypothecation bogeyman has been let loose, and the question of just how many paper (and apparently physical) assets have been double, triple, and n-counted (where n can be a number up to “infinity”) by the infinitely daisy-chained modern global financial system in which one’s liability is someone else’s asset….apparently up to infinity times, the next logical step was for the firms named in the original Reuters article (‘MF Global and the great Wall St re-hypothecation scandal’) to step up and begin denials they had anything to do with anything. Sure enough, below is the first (of many) such response, by Interactive Brokers, claiming it has been greatly misunderstood and unlike MF Global, it has done nothing wrong at all. Of note is that IB was simply one of many brokers mentioned in the Reuters piece, where we read that
“Engaging in hyper-hypothecation have been Goldman Sachs ($28.17 billion re-hypothecated in 2011), Canadian Imperial Bank of Commerce (re-pledged $72 billion in client assets), Royal Bank of Canada (re-pledged $53.8 billion of $126.7 billion available for re-pledging), Oppenheimer Holdings ($15.3 million), Credit Suisse (CHF 332 billion), Knight Capital Group ($1.17 billion),Interactive Brokers ($14.5 billion), Wells Fargo ($19.6 billion), JP Morgan($546.2 billion) and Morgan Stanley ($410 billion).“
Sure enough, we predicted a firm would have to promptly step up and “deny all charges.” To wit: “Oh Jefferies, Jefferies, Jefferies. Barely did you manage to escape the gauntlet of accusation of untenable gross (if not net) sovereign exposure, that you will soon, potentially as early as tomorrow, have to defend your zany rehypothecation practices.” As it turns out Jefferies, and all the other mentioned banks tried to avoid this festering can of worms by completely ignoring the topic… until Interactive Brokers’ response now demands that every single named bank has to do the same and come out with an outright explanation of why it has billions in hyper-hypothecation, or else not journalists and bloggers, but the market itself will suddenly start asking questions. Something tells us it will not be nearly as easy enough for the others to deny all charges… Incidentally, if this indeed becomes “the next big thing”, what the potential collapse of (re) hypothection means is that PBs will be unable to lend out shares anymore, in effect collapsing stock shorting as there is one giant short stock recall/forced buy in. Ironicaly the unwind of the biggest market fraud could result in the entire market pulling one last “Volkswagen“style hurrah, before all hell breaks loose.
From Interactive Brokers
Below the response we have put forth regarding the Thomson Reuters article:
Recently, much has been written about the safety of customer assets held by brokers and we believe that customers are justified in their concerns. And so, we are writing to help clarify your understanding of how brokers are permitted to operate and, in particular, how Interactive Brokers protects its customers assets while servicing their needs to trade on margin.
To start, and so as not to leave any confusion as to the position of IB vis-à-vis the Thomson Reuters news article, IB DOES NOT, in any way:
1. Circumvent U.S. securities or commodities rules at the expense of our customers;
2. Invest customers’ segregated funds in foreign sovereign debt or utilize in-house repurchase agreements;
3. Commingle or utilize customer segregated assets for proprietary operations;
4. Enter into agreements which are designed to take advantage of supposedly unrestricted U.K. re-hypothecatio n rules; or
5. Engage in transactions deemed as “hyper-hypo thecation”.
More specifically, regarding hypothecation and the level of such activity at IB: – The hypothecation and re-hypothecation of customer assets is a standard and essential practice, which U.S. brokers employ in the course of financing customer activity. The rights to do so are longstanding, have been explicitly provided by regulation and one should not be surprised to see boilerplate consent language in each broker’s customer agreement acknowledging this.
For example, a customer who incurs a margin debit by virtue of the fact that they have purchased securities with only partly their own money, thereby relying upon the broker to lend them the funds to pay the balance at settlement, subjects a portion (up to 140% of the amount borrowed, also referred to as the margin debit) of those securities to a lien on behalf of the broker. The lien is also known as hypothecation. The broker, in turn, may pledge or re-hypothecate the securities upon which they have a lien to replace the cash.
In the case of IB, this re-hypothecatio n typically takes place in the form of a stock loan. In simple terms, IB borrows money from a third party, using the customer’s margin stock as collateral, and it lends those funds to the customer to finance the customer’s purchase.
Similarly, a customer who carries a futures position must place a margin deposit with IB. IB may pledge the customer’s cash deposit to a futures clearing house in support of the margin required on that position.
While IB is not in a position to comment on the practices of others and whether they comply or fail to comply with these regulations, or do so in a manner which introduces unwarranted risk to the firm and its customers, we can state that we comply with all regulations and utilize investment policies that tend to be more conservative than those permitted under the regulations.
The Thomson Reuters news article alleged that IB, among other brokers, engaged in a practice that the author categorizes as “hyper-hypo thecation” (apparently a term used to describe a process in which a broker alters the risk of one financial instrument into the exposure of multiple other instruments and perhaps multiple counterparties through a daisy-chain series of pledges) at an amount of $14.5 billion.
While we are not sure of the author’s source for this number, we would refer interested parties to footnote 10 (“Collateral ”) on page 17 of our June 30, 2011 financial statement, which is posted on the IB website (http://www.interactive brokers.com/d…Unaud_Finls .pdf) and reads as follows:
“At June 30, 2011, the fair value of securities received as collateral, where the Company is permitted to sell or repledge the securities was $16,817,859,287, consisting of $13,022,386,422 from customers, $2,886,934,605 from securities purchased under agreements to resell and $908,538,260 from securities borrowed. The fair value of these securities that had been sold or repledged was $4,526,153,369, consisting of $2,583,920,633 deposited in a separate bank account for the exclusive benefit of customers in accordance with SEC Rule 15c3-3, $761,740,278 securities loaned, $877,478,486 securities borrowed that had been pledged to cover customer short sales and $303,013,972 securities that had been pledged as collateral with clearing organizations.”
A closer examination of this $16.8 billion balance reveals the following:
1.$13.0 billion represents the amount IB is authorized to pledge (largely based upon 140% of customer debit balances), of which only $0.8 billion has been repledged, largely through stock lending.
2.$2.9 billion represents the investment of customer’s cash balances in reverse repurchase agreements where the underlying collateral is U.S. treasury securities. These transactions are conducted with third parties and guaranteed through a central counterparty clearing house (FICC). $2.6 billion of this collateral, technically a repledge (i.e., part of the $4.5 billion “sold or repledged”), is not re-hypothecated and it remains in the possession of IB and held at a custody bank in a segregated Reserve Safekeeping Account for the exclusive benefit of customers. The remaining $0.3 billion represents collateral pledged to clearing organizations.
3.$0.9 billion represents short sale transactions whereby the sales proceeds have been pledged as collateral to fully secure the borrowed securities. These transactions are classified as securities sold (i.e., part of the $4.5 billion “sold or repledged”).
Based upon this information, which reflects prudently risk-managed broker financing transactions, we believe a fair-minded author would have drawn a different conclusion regarding IB and hyper-hypotheca tion given a minimum level of investigation and contact.