13/01/2016

Reasons why the Singapore High Court’s judgment in MF Global on the scope of the client assets/money protection regime is noteworthy Speed read MF Global Singapore Pte Ltd v Vintage Bullion DMCC [2015] SGHC 162 is important for the High Court’s statements suggesting that, as soon as monies have become due and payable to a customer on principal-to-principal trading activities and his trading ledger balance is credited with the amounts earned on his transactions, a statutory trust arises. This and other points about the client money/asset protection regime in the Commodities Trading Act and the Securities and Futures Act are discussed. The Singapore High Court held in MF Global Singapore Pte Ltd v Vintage Bullion DMCC [2015] SGHC 162 (MF Global case) that a customer’s unrealised profits, and profits earned from a closed-out contract but where the contractual right to demand payment has not yet arisen, are not subject to a statutory trust under the client money/asset protection regime in the Commodities Trading Act (CTA) and the Commodity Trading Regulations (CTR) and the Securities and Futures Act (SFA) and Securities and Futures (Licensing and Conduct of Business) Regulations (SFR). This finding may appear to be quite obvious in itself, but even if one takes that view, Judicial Commissioner Hoo Sheau Peng’s judgment in the case is notable for a number of other important observations and conclusions. This note attempts to summarise some of the main points of interest.

The case is also important for the Court’s statements suggesting that, as soon as monies have become due and payable to a customer on principal-to-principal trading activities and a customer’s trading ledger balance is credited with the amounts earned on his transactions, a statutory trust arises. While not formally decided (because the broker in this case in fact segregated all monies due to its customers arising from its principal-to-principal trading), this decision raises the issue as to whether a broker is in fact obligated to obtain the necessary funds and segregate them in order to comply with the statutory trust regime. Other noteworthy points raised by this interesting case are as follows: • The Court accepted that a person dealing in cash-settled OTC commodity derivatives transactions is a commodity broker (a view which has not always been universally accepted in the past); • A person who is exempted from licensing under the CTA, for example, under the First Schedule of the CTA, is not thereby automatically outside the business conduct regulations under the CTA and CTR, including the client money/asset protection regime; and • A person dealing with a broker as principal in respect of commodity transactions may still be a customer – and there was some useful conceptual analysis by the Court on when a person is a “customer” that may be of wider relevance beyond the specific context of the client asset/money protection regime. Introduction A broker, MF Global Singapore Pte Ltd (MF Global), was wound up by creditors and there was a dispute between the liquidators and the broker’s customers over the nature of the claims the creditors had over the monies in the broker’s segregated client money accounts. The broker had offered, among other things, leveraged foreign exchange transactions (LFX Transactions) and leveraged commodity transactions (Bullion Transactions). Vintage Bullion DMCC (Vintage) was one of its customers, and brought a claim against the liquidators of MF Global on behalf of itself and a number of MF Global’s customers. For the purposes of this case note, we will discuss the case as being brought by Vintage. As background, customers who wished to transact in LFX Transactions or Bullion Transactions would open an account and place funds with the broker by way of margin to enable them to enter into (and keep open) positions in either of the products. Such margin was deposited into customer segregated accounts, which were omnibus client accounts maintained by MF Global. The funds placed in these accounts were segregated from MF Global’s own funds. While it did not open separate accounts for each individual customer, MF Global accounted distinctly for each customer’s funds held in its customer segregated accounts.

Various types of sums held in customer segregated accounts MF Global generated daily statements for customers, which would reflect the customers’ daily trade activity in LFX Transactions and Bullion Transactions. In this regard, such statements would include information on: • Unrealised Profits: the paper value of the open position determined with reference to the market price of either the underlying currency or reference bullion. The Court characterised the Unrealised Profits as contingent debt obligations. • Forward Value: the profit earned from a position when it was closed. Contractually, MF Global had no obligation to pay this amount to the customer until a later date, as specified in the terms of the customers’ agreement as “the date on which the respective obligations of the parties to a foreign exchange or over-the-counter transaction are to be performed” (Value Date). The Value Date would usually be two days after the close-out date but was sometimes later. The Court characterised the Forward Value as a prospective liability. • Ledger Balance C/F: On the Value Date, the sum reflected under the Forward Value would be credited to the customer’s running account with MF Global as “liquidation profit”. This amount would be added to the sum reflected under “Ledger Balance C/F”. The Court characterised the amounts in the Ledger Balance C/F as a certain present debt: they were available to the customer for withdrawal and the customer could require MF Global to effect immediate payment of that sum. When MF Global went into a voluntary creditors’ liquidation, Vintage sought to claim all of the sums held in the customer segregated accounts in respect of Unrealised Profits, Forward Value and Ledger Balance C/F as its own. It asserted (amongst other things) that all the money was subject to a statutory trust. Court rules that no statutory trust arose over unrealised profits and forward value sums The Court concluded that while the relevant regulations did impose a statutory trust over customers’ funds, only the amounts accounted for as Ledger Balance C/F were subject to the trust. The rationale of the Court was as follows: • The Bullion Transactions were governed by the CTA and the CTR. Regulation 21 of the CTR required a commodity broker to treat, among other things, all money “accruing to” a customer as a result of margined commodity trading as belonging to the customer. • The LFX Transactions were governed by the SFA and the SFR. Regulation 16 of the SFR provided that money received “on account of” a customer must be deposited in a trust account and, in the view of the Court, imposed a statutory trust over such money. • With respect to the Bullion Transactions, the Unrealised Profits from the Bullion Transactions could not be money that had accrued and therefore subject to the statutory trust under the CTA, as these represented only contingent debts. The Forward Value was an accrued debt but did not amount to money that had accrued as MF Global was not

obliged to pay the customer until the Value Date. Only the Ledger Balance C/F amounted to moneys that had accrued and were due and payable to a customer as these were sums to which the customer had a right to demand immediate payment. For similar reasons, the Unrealised Profits and Forward Value from the LFX Transactions did not amount to “money received on account of a customer”, while the Ledger Balance C/F from the LFX Transactions did. Other issues The case is also useful for its confirmation that the mere segregation of funds into a client omnibus account alone does not create an express trust. Further, in the view of the Court, the mere fact that MF Global had set up customer segregated accounts to comply with its obligations under the CTR and the SFR did not evince an intention in fact to be an express trustee of the money held in those accounts. The case also raises a number of other interesting issues which we discuss further below. A person dealing in cash settled OTC commodity derivatives transactions is a commodity broker MF Global’s Bullion Transactions were all cash settled transactions. Under the CTA, a commodity broker is defined as a person who, among other things, carries on the business of soliciting, or accepting orders, for the “purchase or sale” of any commodity by way of or relating to any commodity contract. Under the CTA, “commodities” generally refers only to tangible commodities. Some participants in Singapore have taken the view that cash settled commodity contracts would not fall under this rubric as there is no “purchase or sale”. Interestingly, the point was not taken by the liquidators in this case, and the Court also found no impediment to concluding that the CTA and its regulations applied to MF Global as a commodity broker notwithstanding that all its Bullion Transactions were cash settled. In our view, this conclusion must be correct as the contrary view would leave a substantial lacuna in the CTA. Being exempt from a licence under the CTA does not automatically confer exemption from business conduct requirements, including the client asset/money protection regime. For reasons that were not canvassed in the judgment, and rightly or wrongly, MF Global took the view that it was exempt from holding a commodity broker’s licence. Nonetheless, the Court held that this did not exempt it from the client asset/money protection regime as that applied to all commodity brokers and not only licensed persons. The case is therefore a useful caution that an exempt person under the CTA would still be subject to its business conduct provisions unless a specific exemption has been obtained from IE Singapore. When is a person dealing with a broker as principal a customer of the broker? MF Global transacted with Vintage as principal in respect of the LFX and Bullion Transactions,

and not as agent. Nevertheless, the Court found that Vintage was its customer. Under section 30(6) of the CTA, a customer is defined as “a person on whose account a commodity broker carries on trading in any commodity contract”. MF Global argued that the phrase “on whose account” should be construed to mean “on behalf of” and accordingly a person was a customer of MF Global only if MF Global was its agent. This argument was rejected by the Court which held that a customer under the CTA and CTR is one who possesses a brokerage account with a commodity broker under which trades in commodity contracts are entered into and charged to his or her expense. The Court also took into account that a person who possessed an account with MF Global was conventionally referred to as a “customer” and was referred to as such in MF Global’s master trading agreement with him. The Court, however, appeared to implicitly accept that, where the term “on behalf of” is used and an express distinction is drawn between a financial institution acting “on behalf of” a customer and a financial institution dealing as principal, the former expression is apt to refer to the financial institution acting as an agent. This is significant as section 2 of the SFA defines a customer as both including (a) a person on whose behalf a licensee under the SFA carries on any regulated activity and (b) a person with whom the licensee enters or will enter into transactions as principal in connection with certain enumerated matters only that do not cover the full universe of transactions which a securities broker may undertake (i.e., the sale or purchase of securities or futures contracts or in connection with leverage foreign exchange trading). The legislative wording would tend, in the author’s view, to suggest that limb (a) of the definition in the SFA only applies to an agency situation. However, based on the author’s experience, it would appear that the Monetary Authority of Singapore adopts a wider view, although whether this is correct or not remains open. It would be fair to suggest, however, that a Singapore court may not necessarily be persuaded by fine technical arguments but will likely take into account the commercial realities of the situation. Indeed, the Court’s approach in the MF Global case represents a “realist” approach to the interpretation of the client asset/money protection regime. Are financial institutions obliged to obtain the necessary funds to segregate in respect of amounts due and payable to a customer and credited to a ledger account in the customer’s favour, when engaged in principal-to-principal trading? The Court made clear that once MF Global credited a customer’s Ledger Balance C/F with the amounts earned on a transaction the customer would have a right to receive money immediately from MF Global. Accordingly, if this was a commodity trading transaction, this would be money accruing to the customer within the meaning of regulation 21(1)(a) of the CTR and the statutory trust obligation would arise. Similarly, if this was a securities trading transaction, this would be

money received on account of the customer within the meaning of regulation 16(1)(a) of the SFR and the segregation obligation would seemingly arise. See for example paragraph 129 of the judgment, where the learned JC noted that: “... In my provisional view, as the statutory trust arises on receipt or accrual of the money, securities or property, a customer may assert proprietary rights if the money, securities or property are identifiable.” This appears to draw a distinction between the point where the statutory trust regime arises (i.e. at the point of “accrual”) and when the customer may assert proprietary rights (i.e. when money is “identifiable”). The Court also emphasised that there was: “... no basis for the Liquidators ... to argue that the provisions in the SFA and SFR only apply to “money or other assets” which belong beneficially to the customer. Moreover, to my mind, this would run counter to the legislative purpose behind these provisions, which is to confer protection on investors and consumers .. Little purpose would be served if Div 2 of Pt V is confined to trust property already protected by equity.” Or, in other words, the Court’s view was that the client asset/money protection regime was not confined to money already beneficially owned by the customer – although this notion may have to bend to the words of the relevant provision in certain specific situations (see, for example, regulation 15(3) of the SFR which defines “customer assets” as securities and assets that are “beneficially owned” by a customer of the holder. In the MF Global case, MF Global had in fact placed the requisite funds in the relevant omnibus client accounts. The Court therefore did not have to directly determine the question as to whether the client asset/money protection regime imposed a positive obligation to, if necessary, obtain the requisite funds to credit into the relevant client accounts whenever monies had become due and payable to a customer under a principal-to-principal trade, and what consequences would follow if the financial institution failed to do so. However, the MF Global case at least opens the possibility that a financial institution engaged in principal-toprincipal trading would be bound to segregate monies which had become due and payable to customers and have been notionally credited to a ledger account in the customer’s favour. In the case of a bank, however, a further argument could be made, namely that the monies could be argued to have been “paid” to the customer by deposit into the customer’s bank account. But that is a different subject for another day.

Contact information Yin Mei Lock

+65 6671 6188

Partner, Singapore

[email protected]

Kenny Kwan

+65 6671 6088

Partner, Singapore

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Lian Chuan Yeoh

+65 6671 6075

Counsel, Singapore

[email protected]

Wee Teck Lim

+65 6671 6142

Professional Support Lawyer, Singapore

[email protected]

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