RE MF GLOBAL HONG KONG LTD

HCCW356/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) PROCEEDINGS NO. 356 OF 2011

____________________

____________________

_____________________

D E C I S I O N

_____________________

1.  I have before me an application by the Joint and Several Provisional Liquidators of the Company appointed by me on 2 November 2011 and by a subsequent order made on 9 November 2011 extending that appointment.

2.  The application is made by a summons dated 13 December 2011 in which the Provisional Liquidators seek (1) the sanction of the court to make an interim distribution of an amount not exceeding HK$500 million from moneys that are held by the Company on behalf of its clients (“client money”) in its segregated bank accounts to clients that have a proprietary interest in such funds (“qualifying clients”) and (2) an order that the costs and expenses of the Provisional Liquidators in collecting in and dealing with such client money, including the cost of the application, the interim distribution and any final distribution of the client money be paid out of those assets prior to any final distribution and be borne on a pari passu basis by the qualifying clients.

3.  The Company is a licensed broker providing execution and clearing services for exchange traded futures and options, over the counter derivative products, as well as non-derivative foreign exchange products and equities in the cash market.

4.  The Company is also a trading participant of the Hong Kong Futures Exchange Limited and the Stock Exchange of Hong Kong Limited and a clearing participant of the Hong Kong Securities Clearing Company Limited, the HKFE Clearing Corporation Limited and the SEHK Options Clearing House Limited. 

5.  As a regulated entity in Hong Kong the Company is required to comply with, amongst other securities regulations, the Securities and Futures (Client Money) Rules.  Section 5 of those rules requires that client money remain in segregated accounts until their payment either to the client on whose behalf the moneys are held in accordance with written directions or standing authorities given by such client, or to meet the client’s trading and settlement obligations.  Clause 35.1.5 of the client agreements entered into between the company and its futures and options clients reflect this position.

6.  The clients’ money with which the Provisional Liquidators’ application is concerned relates to the Company’s clients that traded futures and options.  The reason why the Provisional Liquidators have made this application can be summarised as follows. 

7.  The combined pool of client money held for futures and options clients is approximately HK$1.2 billion, including money held by HKCC affiliates and overseas brokers.  This corresponds to the cash balances that ought to be held by the Company for such clients as at 28 October 2011, provided that the Company receives in full the sums payable by its overseas affiliates and overseas brokers. 

8.  The Provisional Liquidators currently have the equivalent of approximately HK$1 billion under their control in Hong Kong in respect of such client money.  Since the Company was placed into provisional liquidation there has been a freeze on any payments out, including payment of any client money.  This has had a significant adverse effect on those clients with funds comprised in the client money. 

9.  These are described in some detail by Mr Cowley in his affidavit in support of this application and many of the clients for whom this problem has significant commercial ramifications are professional clients.

10.  The trustee of the Company’s US affiliate, MF Global, Inc., has obtained court orders approving the return of approximately two-thirds or more of US segregated customer assets by value on a pro-rata basis.  The fact that such sums have been released in the US has heightened the frustration experienced by the Company’s clients in Hong Kong whose funds are held by the Company.

11.  This application has therefore been brought in the interests of relieving the severe liquidity distress caused to the affected clients.  The application is supported by the Securities and Futures Commission who have been served with the papers constituting the application and I am told have a representative in court today. 

12.  I have also been sent a fax by the Official Receiver, dated 14 December 2011.  The Official Receiver has also been served with the application.  The Official Receiver has no objection in principle to the application.

13.  The client money that is held by the Company in segregated bank accounts for its futures and options clients represents realised profits and margin of each client’s trading position.  The Company has more than 50 such segregated accounts with nine different banks.  Some of those accounts are in a single currency, others are in multiple currencies.

14.  The Provisional Liquidators have undertaken an analysis of the Company’s trading records and bank statements to determine whether a precise reconciliation or tracing of each client’s entitlement to the client money is possible. 

15.  As a consequence of how the Company conducted its futures and options business, in particular how margin requirements were managed collectively, the Provisional Liquidators believe that such a tracing exercise would be extremely difficult to undertake.  It would involve substantial work over a fairly lengthy period of time, be prohibitively expensive and there would be no guarantee that it would result in precise figures.

16.  There is one exception I am told: moneys held with JP Morgan Securities Company Limited which relate to trades effected on the Korean markets for MF Global UK where no money was held in the Company’s segregated bank accounts for this affiliate.  These can be matched and traced specifically.

17.  The practical difficulties in undertaking a tracing of each client’s precise entitlement to client money as a result of how the Company conducted its futures and options business are summarised by the Provisional Liquidators as follows.

18.  The first group of difficulties relates to the margin practice of the Company.  The margin that a client may be required to deposit with a company is calculated based on that client’s aggregate futures and options position across the different markets and exchanges traded by that client.  Margin calls were therefore made on the basis of whether there was free equity across the client’s portfolio or a client’s margin position was in deficit. 

19.  The practice also applied in respect of the omnibus accounts maintained by the Company with its overseas affiliates and overseas brokers through which futures and options transactions on the relevant overseas exchange were executed on behalf of the Company’s clients.

20.  With certain exceptions clients were generally allowed to meet margin obligations in a currency different to that of the relevant futures and options position traded and client moneys deposited into the Company’s segregated bank accounts were treated as a single pool. However, the money so deposited would be preserved in the remitting and deposited currency and where that currency is different from that of the underlying transaction giving rise to the margin call the Company would use funds of the relevant currency from the segregated bank account to meet that obligation, even though that client may not have deposited the funds in that currency.

21.  The same process in reverse applied where a client wished to close out a position on an overseas exchange and withdraw profits and margins which had been posted in respect of that position.

22.  The second groups of difficulties relates to the reconciliation of client money.  Reconciliation of segregated bank balances, broker receivables and clients’ payable balances were performed on daily bases, including on a currency basis pursuant to which the Company would ensure the aggregate funds in its segregated bank accounts matched it clients’ payable balances collectively without specific tracing to each individual client’s position.

23.  For these reasons the money of one client in the Company’s segregated bank accounts cannot specifically be distinguished from that of another client in that account.  To trace each individual client’s interest in the client money Provisional Liquidators would have to recreate fund flows for each client, an exercise that would not only be time consuming and prohibitively expensive, but also be unlikely to yield a precise result and may not ultimately be possible based on the analysis undertaken to date by the Provisional Liquidators.

24.  The constraints and considerations in determining whether it would be pragmatic or appropriate for provisional liquidators to undertake the kind of forensic tracing exercise of each client’s entitlement to the client money has been considered, albeit in the context of securities themselves, in a number of decisions by the courts of Hong Kong, in particular Re Chark Fung Securities Company Limited (HCCW 362/1998, 13 November 2002, Kwan, J (unrep)) and Re Law Siu Kong, Christopher trading as Lawsons Securities Company (HCMP 2477/2002, 24 February 2006, Kwan, J (unrep)).

25.  Mr Melvin Sng who appeared on behalf of the Provisional Liquidators submitted that it would not be in the best interests of those clients beneficially entitled in the client money for the Provisional Liquidators to attempt a forensic tracing of their respective entitlements for three reasons. 

26.  Firstly, this would result in substantial cost and expense being incurred resulting in the depletion of assets that are otherwise payable to them.

27.  Two, the exercise would require a lengthy period of time to complete and would aggravate the financial distress already being experienced by those clients as a result of being unable to recover their moneys. 

28.  Thirdly, there is uncertainty whether such a forensic tracing exercise would be possible and/or yield a precise result.

29.  I accept that the evidence filed by Mr Cowley demonstrates that all these three points are valid.

30.  Mr Sng also submitted, relying on a number of authorities, in particular that of the Ontario Court of Appeal in Re Ontario Securities Commission [1985] DLR 30, that where practical considerations do not favour a forensic tracing of each client’s entitlement, a pari passu ex post facto approach to the distribution of trust funds is appropriate.  I accept that that is the case in the present situation. 

31.  Having considered carefully the fact that the Company does not yet have confirmation from its overseas affiliates and overseas brokers regarding the actual close out amount for the relevant client positions and the risk that the Company may not receive in full moneys payable by its overseas affiliates and brokers, the Provisional Liquidators have formed the view that it is possible and appropriate to effect an interim distribution of an amount not exceeding 500 million from the client money to clients that are entitled to it.

32.  Mr Cowley in his supporting affidavit summarises the intended approach to the proposed interim dividend as follows. Firstly, only qualifying clients with a demonstrable entitlement to client money will be entitled to receive payment.

33.  Secondly, qualifying clients must settle any amount owed to the company or any of its affiliates prior to receiving an interim distribution.

34.  Thirdly, the interim distribution will be made on a pari passu basis.

35.  Fourthly, qualifying clients will be required to sign an agreement acknowledging that the interim distribution remains subject to final adjustment, represent that the qualifying clients has no liabilities to any MF Global entity and undertake to repay on demand any amount overpaid.

36.  Finally, the distribution will take into account a qualifying client’s net position where it has multiple accounts and will be converted into Hong Kong dollars.

37.  The proposed terms of the interim distribution have been communicated to non-affiliate qualifying clients of the Company by a letter dated 2 December 2011.  The affiliate qualifying clients were also informed of the proposed interim distribution on 12 December.

38.  To date the Provisional Liquidators have received 51 responses from qualifying clients representing 99 per cent of the non-affiliate qualifying clients in terms of total free equity as at 28 October 2011, which support the proposed interim distribution.

39.  The Provisional Liquidators seek an order that their costs and expenses in administering, collecting in and dealing with the client money, including the costs of this application and the costs and expenses associated with effecting the interim distribution, be paid out of the client money prior to any final distribution and be borne on a pari passu basis by the qualifying clients.

40.  I am satisfied, having been take to the relevant authorities by Mr Sng, namely, Re Berkeley Applegate [1989] Ch 32 and C A Pacific Finance Limited (in Liquidation) (2) [1999] 2 HKC 652, that this is the appropriate approach in a case such as the present.

41.  I have therefore made an order in the terms of the summons dated 13 December 2011.