Brokers warn of dangers from wider equities protection

STOCKBROKERS have firmly opposed opening up a $100 million equities protection scheme to cover investor losses from any future collapse of brokers such as MF Global that specialise in derivatives.

By InvestSMART · 21 Dec 2011

By InvestSMART ·
21 Dec 2011

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STOCKBROKERS have firmly opposed opening up a $100 million equities protection scheme to cover investor losses from any future collapse of brokers such as MF Global that specialise in derivatives.

The worldwide failure of MF Global has highlighted gaps in investor protection schemes with doubts remaining over the ability of the firm's Australian clients to recover a shortfall of about $80 million in its funds.

The $100 million National Guarantee Fund only protects clients of stockbrokers that are participants of the Australian Securities Exchange. This leaves investors that trade with brokers that trade contracts for difference and other stock lending firms without a safety net.

Australia has experienced rapid growth in over-the-counter derivatives trading in recent years and other less regulated forms of equities trading, but several collapses, including Opes Prime, have resulted in hundreds of millions of dollars in investor losses.

"We would oppose any move to extend its [National Guarantee Fund] application more broadly, or permit its funds to be used for purposes other than it was originally specified," said David Horsfield, the managing director of the Stockbrokers Association of Australia. "The amount of the balance sitting in the National Guarantee Fund is not unlimited and could be tested if there were a default on a not-exceptional scale."

Mr Horsfield's comments were contained in the associations submission to the federal government's review of rules surrounding financial market infrastructure.

The association's main concern is the relatively small size of the fund compared to the $4 billion daily turnover of equities across Australia's two main stock exchanges.

"The [National Guarantee Fund] must not be available as the default fund," Mr Horsfield said.

In contrast, the Canadian Investor Protection Fund covers all investment accounts operated by brokers, regardless of whether they hold stocks, bonds, futures or currencies. In the event of a broker going insolvent, the Canadian system reimburses each investor account for losses up to the equivalent of $US1 million.

The US also has an investor protection scheme, although coverage is not as generous, with each trading account protected for losses of up to $US500,000.

Australia's National Guarantee Fund was originally paid for from interest from stockbrokers' trust accounts, but since 2004 it has been self-funding.

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Frequently Asked Questions about this Article…

What is the National Guarantee Fund and who does the $100 million equities protection cover?

The National Guarantee Fund is a $100 million investor protection fund that only covers clients of stockbrokers who are participants of the Australian Securities Exchange (ASX). It was set up to protect certain stockbroking clients, not all types of trading accounts.

Does the National Guarantee Fund protect investors who trade contracts for difference (CFDs) or use derivatives brokers?

No. The fund does not cover investors who trade with brokers that specialise in CFDs, over-the-counter derivatives or other stock-lending arrangements unless those brokers are ASX participant stockbrokers. That leaves some derivatives and CFD clients without this safety net.

How did the MF Global collapse highlight gaps in Australia's investor protection schemes?

The worldwide failure of MF Global exposed weaknesses in coverage: the article notes doubts over whether Australian clients can recover about $80 million that was short in its funds. The case showed that not all broker models are covered by the National Guarantee Fund.

Why do stockbrokers oppose widening the equities protection scheme to cover more firms?

Stockbrokers, represented by the Stockbrokers Association of Australia and its managing director David Horsfield, argue the fund is relatively small compared with market activity and could be strained by larger defaults. They oppose extending the fund's application or using it for purposes beyond its original design.

How does Australia’s investor protection compare with schemes in Canada and the US?

Canada’s Investor Protection Fund provides broader coverage — reimbursing investor accounts across instruments (stocks, bonds, futures, currencies) up to the equivalent of US$1 million per account. The US system also offers protection but is less generous, covering up to US$500,000 per trading account. Australia’s National Guarantee Fund is narrower in scope.

Has the growth in over-the-counter derivatives trading in Australia affected investor risk?

Yes. The article says Australia has seen rapid growth in OTC derivatives and less-regulated forms of equities trading. Past broker collapses such as Opes Prime have led to hundreds of millions of dollars in investor losses, raising concern about protection gaps.

How is the National Guarantee Fund funded, and is it large enough for market risks?

The fund was originally paid for from interest on stockbrokers' trust accounts and has been self-funding since 2004. Critics point out the $100 million balance is limited compared with about $4 billion in daily equities turnover across Australia's two main exchanges, so it may not be large enough to cover major defaults.

Should the National Guarantee Fund be used as the default protection for broker failures?

According to the Stockbrokers Association of Australia, the National Guarantee Fund must not be treated as a default fund. The association argues its limited size and original purpose mean it shouldn't automatically be called upon to cover failures beyond its intended scope.