MF Global UK Ltd, Re

This was an application for directions by the administrators of MF Global UK Limited as to the valuation basis for clients' entitlements to pooled client money following a primary pooling event. The central legal question was whether client money entitlements in respect of open positions are to be valued by reference to notional market/mark-to-market values as at the primary pooling event (PPE) in accordance with CASS 7 and Annex 1, or by reference to the actual prices at which the positions were subsequently closed out (the "liquidation value"), applying the hindsight principle used in insolvency valuations.

The court held that CASS 7 and CASS 7A, read with the definition of "client equity balance" in the FSA Handbook Glossary and Annex 1 to CASS 7, require a notional close-out valuation as at the PPE (using published closing or settlement prices or other appropriate pricing sources). The hindsight principle — valuing entitlements by reference to later actual close-out prices — does not apply to the distribution of pooled client money under CASS 7A. The decision relied on the terms and structure of CASS 7/7A, the Supreme Court majority in Lehman, the role of Annex 1 reconciliations and policy reasons of consistency, speed and the design of the client money regime.

Background and parties: MF Global UK Limited (MFG UK) entered special administration on 31 October 2011. The administrators sought directions as to how client money entitlements should be valued when a primary pooling event (PPE) occurs. Two representative respondents were joined: Attestor Value Master Fund LP (representing clients who would benefit if open positions were valued at market value as at the PPE) and Schneider Trading Associates Limited (representing clients who would benefit if entitlements were valued by reference to the subsequent actual close-out prices). The Financial Services Authority participated and supported the market-value-at-PPE position. The administrators took a neutral position.

Nature of the application / relief sought: The administrators applied for a direction whether a client's client money entitlement in respect of an open position is to be valued as at the PPE by reference to the market / mark-to-market value as at the PPE or by reference to the liquidation value (the price at which the position was actually closed out after the PPE).

Issues framed: (i) Whether the client money entitlement is to be ascertained by reference to the notional values produced by Annex 1 to CASS 7 (including the Glossary definition of "client equity balance") calculated as at the PPE, or instead by reference to the actual later close-out prices (applying the hindsight principle); (ii) whether any perceived gap in CASS 7/7A should be filled by application of the hindsight principle; (iii) whether expert evidence about pricing difficulties for illiquid or OTC instruments requires a different approach.

Reasoning and conclusions: The court started from the proposition that the client money distribution rules are a code designed to implement MiFID protections by creating a trust in favour of clients. CASS 7 and 7A and Annex 1 prescribe the manner of calculating individual client balances and client equity balances, with client equity balance expressly defined as the amount that would be payable if open positions were liquidated at closing or settlement prices published by exchanges or other appropriate pricing sources. The Supreme Court majority in Lehman was treated as authoritative that client money entitlement is to be ascertained by the calculation prescribed in Annex 1 (with mandatory set-off under CASS 7A.2.5R), not by a general resort to contractual claims or subsequent close-out results.

The court analysed the hindsight principle (its general application in insolvency to estimate contingent claims) and concluded that it applies where an estimate of a contingency is required. By contrast, CASS requires a notional valuation at a single date (the PPE). The wording, structure and purpose of CASS 7/7A (and Annex 1) show no intention to adopt hindsight for the distribution of pooled client money. The phrase "or other appropriate pricing source" in the definition of client equity balance was held to provide alternative notional pricing where exchange prices are not available, not to convert the valuation into a post-hoc reliance on actual closed-out prices. Expert evidence on difficulties of pricing certain instruments did not persuade the court that the FSA intended hindsight to apply; the chosen regime favours consistency with daily mark-to-market reconciliation and timely distribution. The court therefore concluded the hindsight principle does not apply to the calculation of client money entitlements under CASS 7A and that valuation should be by reference to the notional close-out at PPE using published or other appropriate pricing sources.

Procedural note: The judge indicated he would invite the parties to agree precise drafting of the directions consistent with his conclusions.

This was a first instance application for directions. The court directed that the client money entitlement of each client is to be calculated by reference to the individual client balance and the client equity balance as determined in accordance with Annex 1 to CASS 7 (and the Glossary definition), taken as at the primary pooling event. The court held that the hindsight principle — valuing entitlements by reference to actual subsequent close-out prices — does not apply to the distribution of pooled client money under CASS 7A. The rationale was that CASS 7/7A and Annex 1 prescribe a notional close-out valuation at the PPE for consistency with the daily reconciliation regime and the intention of the client money code, and Lehman supports the Annex 1-based calculation.