Refco ramifications: A crisis with a twist


Felix Salmon
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Latin America is no stranger to banking crises. Every so often a banking system will implode, and depositors will lose all or some of their money.

A number of Latin banks had credit lines to Refco

It has happened again.

This time, though, there’s a twist: the banks losing money weren’t taking the deposits, they were making them. Banks across the world, but especially in Venezuela and central America, had accounts at an unregulated Bermuda-based financial institution called Refco Capital Markets.

“RCM is a nightmare for a big part of the financial intermediaries tier of the Venezuelan banking system,” says a veteran Venezuelan financial industry observer. In return for loans from RCM, those Venezuelan intermediaries placed securities on deposit there; it seems now that they might not get these back. Although these were collateralized loans, often RCM would loan only up to half the value of the collateral, so the banks would still lose 50% of their money. And most of the time the banks didn’t draw down their entire credit line with RCM.


RCM was a wholly owned subsidiary of Refco, the US financial institution that went public with a $585 million IPO last year in August and collapsed two months later.

When Refco entered bankruptcy, all accounts at RCM were frozen. It soon became clear that RCM was not holding all the funds. Clients had entrusted the financial group with $3.6 billion but RCM had only $1.9 billion on deposit.

Overnight, dozens of Latin American banks discovered that they had to line up alongside thousands of other Refco creditors and litigate to get any of their money back.

Some of the sums involved are small; others make it into eight or even nine digits. According to, an official refco court filings website, the biggest is the $208.5 million owed to a Guatemalan entity called Bancafe.

In Venezuela, Banco Federal has $78.7 million on the line, while Banesco, through Panamanian sister entities, is owed $110.2 million. One of the things that most of RCM’s creditors have in common is that they are either based in or deal in emerging markets.

Emerging markets shop

To get an idea of the degree to which RCM was essentially an emerging markets shop, note that so far the most credible bid for the company comes from veteran Latin American investment banker Carlos Abadi. He is backed by emerging-market hedge fund Greylock Capital, with support from Russian hedge fund VR, and is advised by the emerging market investment bankers at Dresdner Kleinwort Wasserstein.

RCM acted as a prime brokerage: clients would give their securities – bonds, stocks, loans, anything – to RCM, and RCM in turn would lend them out in repo transactions. Meanwhile, RCM’s clients could borrow money against their own securities.

But what RCM’s Latin clients didn’t know was that Refco itself was borrowing against its clients’ securities, and using the money elsewhere in the Refco empire. If there were $4 billion of securities at RCM, Refco would borrow $2 billion against them, and send it upstream to other parts of the Refco empire. A mere $50 million would be left in RCM to cover client redemptions.

Refco didn’t own the securities held on account with it at RCM: they were liabilities, not assets. But Refco behaved very much as though they were assets, according to testimony from lawyers for RCM’s creditors at the bankruptcy trial before the Southern District Court in New York. “RCM appears to have been used as a piggybank for the rest of the Refco enterprise,” says a court filing by Abadi.

When Refco went bankrupt, various arms of the Refco empire owed RCM billions of dollars. And RCM’s clients, who thought they had securities safely on deposit at an offshore prime brokerage, discovered that they were being treated just like any other creditors of Refco.

“In a normal Chapter 11 bankruptcy, there is only one class of creditors,” says Rhett Campbell, a bankruptcy attorney at Thompson and White in Houston. “In a bankruptcy or liquidation of a stockbroker, customers have a preferred position, because the stockbroker maintains accounts on behalf of its customers. RCM was not a registered stockbroker – it was unregistered and unlicensed – but it was acting as a stockbroker.”

Chapter 7

In the latest development in the case, US bankruptcy judge Robert Drain ruled that he would treat RCM as a stockbroker and convert the proceedings to a Chapter 7 bankruptcy, unless the squabbling creditors could agree on a deal within 45 days. That’s great news for RCM’s depositors, which now seem guaranteed to get at least half of their money back. But the Abadi plan is not yet dead.

“If you convert to Chapter 7, there will be no Abadi plan,” says one of Abadi’s advisers. “But if people now are willing to consider something other than taking their property home, if they are willing to contemplate a pooling of securities, they could be in a much better position.”