Thursday, December 8, 2011

Canadian Banks Heavily Involved in Re-Hypothecation

Re-hypothecation (where client collateral is used again to obtain funds for a financial firms own trades) and churn (where the counterparty RE-uses the collateral to obtain more funding, and so on) is the West's least known shadow banking system. The unlimited re-hypothecation of funds mostly through the UK (which has no limits) and a bit through the US (which has relaxed their limits since the late nineties and into the 2000s (funny, just the same time they were relaxing every other limit on shady financial activity)) results in a money multiplier effect backed by, on average, 25% capital.

Canadian banks appear to be deeply involved in dipping into their client's assets to obtain funding for themselves, a la MF Global. Note, once your bank or brokerage has sent your assets to the UK and a firm there has then re-hypothecized them, you will not see them again if your financial firm's bets go bad. The regulation is so poor it is up to the individual investor to arrange limits on their financial firm's actions regarding their own assets.

MF Global and the great Wall St re-hypothecation scandal
firms have been piling into re-hypothecation activity with startling abandon. A review of filings reveals a staggering level of activity in what may be the world’s largest ever credit bubble.

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).


knowledge is power said...

I have been trying to understand the "MF Global effect" and i realize that has called a lack of confidence within the financial (futures) markets, because they were able to freeze customer accounts that were still locked into trades and they were unable to sell. Basically can you explain how hypothecation and churning effects traders,especially with regular trading ( like with a discount broker). I know that if they fail i may get screwed but i want to know excatly what htey are doing within my money and how to avoid it. Thanks

GG said...

This isn't the area I usually cover, I'm generally observe things at the level of systemic risk to the banking system and rehypothecation and churn create an undercapitalized shadow banking system introduce its own risk to the system.

Until there is a test case, no one knows how much protection the average brokerage customer has. That's my take. I keep my money spread around at a lot of places to mitigate, but that just let's me sleep better.

If you click through to the linked article there is the relevant section from the client agreement from MF Global. So, definitely pull your agreements and look for a similar provision. If so, contact your broker and see if you can get it amended.