London Calling

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The Lehman Brothers bankruptcy could do lasting harm to London’s brokerage houses unless the United Kingdom revamps its insolvency procedures.

When Lehman filed for bankruptcy last September, scores of hedge funds that did business with the investment firm’s London-based brokerage arm were some of the biggest losers. Those hedge funds found the cash and securities they had deposited in London frozen and unreachable under UK insolvency proceedings. Even today, few if any of the hedge funds doing business in London have gotten their money unstuck. But it’s been a different story for hedge funds that had money parked with Lehman in New York—thanks largely to the actions of the Securities Investor Protection Corp. receiver.

In the UK there’s nothing comparable to the Securities Investor Protection Act of 1970, a US law that provides a measure of protection to investors during the bankruptcy of a brokerage firm. Soon after Lehman failed, a SIPC receiver was appointed and began untangling brokerage assets from Lehman’s thousands of creditors. By contrast, Lehman’s liquidators in the UK are treating the hedge funds as no different from a bond holder, a trade creditor or counterparty to a derivatives trade. That means those hedge funds’ monies will likely remain frozen until a plan for disposing of all of the investment firm’s assets in London is worked out.

Another hardship for many hedge funds trapped in London is finding out exactly where their money has gone. In the UK, there are few limits on the ability of brokers to repledge their customers’ deposits as collateral for the firm’s own financing activities. In other words, many of these deposits have been transferred into banks that Lehman’s operation in London borrowed money from. That means many of those lenders now have legal claims to the assets. A recent working paper from the International Monetary Fund found that in the aftermath of the Lehman bankruptcy, some hedge funds are moving business away from London brokerage firms to better protect their deposits.

With hedge funds reducing their borrowings and many others simply closing up shop, this may not be a pressing problem for London’s brokers right now. But when the financial crisis starts to ease, London firms may find themselves losing market share to their US rivals as hedge fund managers made wiser by the collapse of Lehman opt for a jurisdiction that provides them with more safeguards.

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