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The financial services "melt down" has raised a number of interesting questions on certain stakeholders and their entitlement to certain assets. The complexity deepens when you have Financial Services "law", such as Chapters 7 and 7A (CASS 7 and 7A) of the Client Assets Sourcebook section of the Financial Services Authority and its interaction with insolvency law and the "waterfall" of payments.
The MF Global case (under administration) raised significant questions regarding an individual’s client money entitlement.
We spoke to Felicity Toube QC at South Square Chambers to explore the issues and look at the ‘hindsight principle’.
The main issue arising in the context of the collapse of MF Global was whether an individual’s client money entitlement should be valued as at the date of the primary pooling event (PPE) (in this case administration) by reference to the market value or any mark-to-market valuation on that date, or whether it should be valued at the sum for which it was in fact liquidated. Often (but not always) contingent claims in liquidation are valued by using the value which eventuates. This is referred to as the ‘hindsight principle’. This issue will arise in the context of every collapsed firm, as it will always be necessary to value an individual’s client money entitlement.
David Richards J decided (following In re Global Trader Europe Ltd (in liq) (No 2); Milner v Crawford-Brunt  EWHC 699 (Ch) and the first instance decision In the Matter of Lehman Brothers International  EWHC 47) that the hindsight principle was not applicable to the valuation of the individual’s client money entitlement under CASS 7 and 7A. As a result, the valuation is that of the market value or mark-to-market valuation as at the date of the PPE.
Of course it was important to have certainty on the valuation question, and therefore the giving of any answer is to be welcomed. The case provides a relatively swift answer to both clients and office holders, and provides certainty.
However, ignoring hindsight means an individual client may be out of pocket, particularly in a falling market. On the other hand, where the market rises, an individual will get a windfall. Ignoring hindsight leaves an individual open to market fluctuations and ignores the reality of the situation.
Further questions arise from the fact that CASS 7A.2.5R allows a set-off between what is due to the client and what is due from the client. If set-off is permitted of a lower sum than the eventual close out figure, the windfall to a client will in reality be of an even greater sum if the client is allowed both to set-off the lower sum and to keep the ‘windfall’ extra. Questions arise as to what the court would do in relation to the ‘extra’ balance, and in particular whether recoupment would be permitted.
The decision may also cause problems if it requires an individual valuation in circumstances where it is difficult to find such a valuation. In the case of many financial collapses, companies move their positions on a portfolio basis, rather than moving individual positions. In those cases, it may prove difficult to value the individual position. However, valuation of open positions is something firms do on a continued basis while trading, in order to report to the FSA. As a result, this problem may be capable of resolution.
The hindsight principle survives intact—just not in the context of the determination of the calculation of the individual client money balance CASS Rules. The judge decided there were no contractual entitlements in question, and therefore no room for valuation of a contingency through the normal route of using hindsight.
There has been a lot of comment in the market already about whether the case was correctly decided—it could readily be argued the hindsight principle should be applied. The question of whether there will be an appeal, however, will depend upon the commercial judgment of the parties involved. At present an appeal seems unlikely, but it may well be challenged in future cases.
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