Hypothecation and Investment of Customer Funds and Securities

[EB]

Regarding the issues raised in Pascal's Comment of the Day and follow up comments, I'm opening this thread to discuss the ultimate trade: keeping our cash and securities safe in the event of another global meltdown. The ZeroHedge link is here:

http://www.zerohedge.com/news/why-uk...an-banks-jeffe

On the hypothecation issue, my understanding is it relates only to securities pledged by customers as margin, not cash. That being said, it is still legal for futures brokers (I don't know about securities brokers) to invest customer cash in any number of ways, including sovereign debt, or repo it, both internally and externally. The so-called MF Global Rule that was passed a few days ago gives firms six months to comply.

The bottom line in relation to all the articles that are being published about possible abuses of customer funds and securities is that we really don't know all the exact technical questions to ask and probably cannot rely on the statements that are being released, as they might be simply cleverly worded to mask risks.

My preferred method for broker hunting is now very simple: identify futures commission merchant (FCM) clearing firms where the owners have significant skin the game. That is, will their personal fortunes go down with the ship? These are likely to be smaller operations, but they should also be better run with more of an eye toward risk management. The importance of being a clearing firm is to reduce reliance on third parties. I suppose the flip side is you can hold your nose and go with one of the true too-big-to fail brokers.

In any case, I've written in this forum before that one of the benefits of leverage in futures is the ability to maintain low cash balances, especially with the eMinis and currencies, where it is possible to post as little as $500/contract during the day. I suspect that's the shell game all customers are trying to play now...keeping as little cash as possible in their accounts.

Also, even with insurance, such as SIPC (which does not cover futures accounts), it can be months before funds are returned. The FDIC, which insures bank accounts (currently unlimited coverage for non-interest bearing checking accounts), is quicker. In all, I would hesitate to put more than 10% of my net worth in any particular entity taking into consideration its affiliates. And, in the worst case scenario whereby we are faced with a bank holiday, it would not hurt to have a month's worth of cash on hand, as ATM withdrawals would likely be limited.