Three years after the demise of Lehman Brothers exposed problems in how brokers handle client funds, trading firms are still using lax rules to withhold cash owed to clients of failed brokerages, fuelling calls for reforms.

Clients of MF Global UK, which filed for bankruptcy after revealing it had made a $6.3 billion bet on European sovereign debt, are struggling to get their money back from accounts where their investments have been pooled.

Administrator KPMG has recovered about $1 billion of the $1.2 billion of client assets in the three months since MF Global collapsed, but the remaining $200 million of client cash is proving elusive.

The impasse is linked to legal agreements that determine whether client assets are held separately from those of other clients, in a segregated account, or mixed with other client collateral in what is known as a non-segregated account.

Brokerages like MF Global hold investments on behalf of pension funds or hedge funds. Problems arise when the broker goes bust because those assets are frozen and they are most likely invested elsewhere, which means they are sitting on someone else's books such as a bank or exchange.

KPMG has successfully reclaimed the assets and cash held by clients in segregated accounts, where there is demonstrable link between the asset and its owner.

But cash held in non-segregated accounts is proving harder to recall because the firms holding the funds are often also owed money and are wary of giving up what they have for fear they may not get what they are owed in the long run.

By their nature segregated funds are quicker and easier to collect in, KPMG said in an emailed statement.

Investment firms choose if they want their assets to be segregated or not segregated. Some opt to segregate because it is less risky, while others elect to pool assets because it is cheaper.

REGULATORY INTERVENTION

The slow progress retrieving non-segregated accounts has angered some clients who have called for tough action and a review of the rules around non-segregated accounts.

KPMG has threatened lawsuits against some firms holding MF Global client assets and the British Financial Services Authority (FSA) has stepped in to speak to these companies.

KPMG declined to comment on the possibility of rule changes but Chris Hamilton, a spokesman for the FSA, said they would be considered.

Lessons from the MF Global UK administration process will be factored into the review of the effectiveness of the HM Treasury Special Administration Regime legislation (as required in the Banking Act 2009), scheduled for early 2013, he said.

The calls came after a group of U.S. futures exchange operators led by CME Group and the IntercontinentalExchange said last week it had formed a committee to propose ways to better safeguard customer funds.

MF Global U.S. trustee James Giddens is trying to track down an estimated $1.2 billion of customer assets that have seemingly disappeared from the broker's books.

In contrast, KPMG has said it has accounted for all MF Global UK clients assets and cash, and plans to return these to their owners as soon as possible, starting in the coming weeks.

LEHMAN FALLOUT

KPMG's plan will have to take into account an imminent British Supreme Court ruling brought by British clients of Lehman Brothers, who have been arguing they had segregated accounts at the U.S. bank when it collapsed in September 2008.

The British Supreme Court is set to rule, perhaps as early as March, on the clients' claims that they had agreed with the bank before its collapse that their funds would be segregated, though the assets were later found not to have been segregated when the bank failed.

The ruling by the highest British court will have serious implications for KPMG's plan to return MF Global assets.

The ultimate classification of any entitlement to the client money pool is only likely to be determined once the Supreme Court has ruled on Lehmans, KPMG said in a statement.

MF Global filed for bankruptcy after it was forced to reveal that it had made a $6.3 billion bet on European sovereign debt, spooking investors and customers.

(Editing by Jodie Ginsberg)

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